Contrarians or soothsayers?

By Wanda A. Wallace

In Brief

FASB Dissenting Votes Tell a Tale

An extremely informative section of each Statement of Financial Accounting Standards records the dissents registered by FASB members. They often highlight an essential point of debate upon which compromise was unachievable. We all understand the idea that majority opinions may be wrong—most once believed that the world was flat. Have the expressed dissents of past standards emerged later on as majority perspectives? Are there identifiable themes across past dissents that continue to be debated? Can an analysis of past dissents provide insights for standards setters and practitioners applying the standards? The author analyzes dissents to past FASB opinions to determine whether dissenters are soothsayers of future concerns or simply contrarians.

Statements of Financial Accounting Standards (SFAS) are often hotly debated in comment letters and public forums before they are finalized. Even upon its approval, a minority of the seven FASB members can voice dissent: The majority of SFASs have included dissents and over a third have attracted two or more dissenters from the seven-member board. Exhibit 1 depicts the proportion of dissents to the first 137 SFASs: 44% received unanimous approval, 20% received a single dissent, 22% received two dissents, and 14% received three dissents.

Exhibit 2 breaks down by member the 145 dissenting opinions expressed over the past 28 years. Because the length of term and number of standards passed during that term have varied for board members, the opportunity to register dissent has varied. Nonetheless, Kirk, Sprouse, and Walters were responsible for the largest proportions of dissents, followed by March, Morgan, Mosso, and Lauver. No other board member accounts for more than five percent of the 145 dissents.

Recurring Themes

Exhibit 3 identifies a set of 23 mutually exclusive themes and their associated SFASs. Most of the SFASs fall into three themes: 1) specialized practices or industry guidance, 2) debt and securitizations, and 3) pensions and other compensation. Leases, changing prices, and deferrals are the next most common themes.

In identifying the themes, it was necessary to select a single classification for each SFAS. For example, although a statement that defers or rescinds a previously issued statement relates to the initial theme, for the purposes of analysis, such statements were tracked as a deferral and elimination. Similarly, SFASs that addressed both changing prices and foreign currency were classified according to the primary thrust of the statement.

The average dissents per SFAS within each theme vary from zero to 2.75 (see Exhibit 4). The most dissented-upon theme was the capitalization of interest, followed by cash flow, impairment of long-lived assets, and changing prices. Such comparisons are descriptive rather than statistical in nature because the number of SFASs within each theme ranges so broadly.

Inconsistencies Among Standards

Dissents frequently point to inconsistencies among the standards. The standards are cited as inconsistent with statements of financial accounting concept or the conceptual frameworks in seven different pronouncements. The dissents contain eleven references to APBs and ARBs (three to APB 20 and two to APB 11) and eleven references to SFASs (three to SFAS 2 and two to SFAS 5). An AICPA issues paper (March 1980) is also cited.

Reversed Dissents: The Foreign Currency Example

In his dissent to SFAS 8, Mays argues that the conceptual superiority of the temporal method was flawed, because it pretended that historical cost accounting was the equivalent of an acquisition in foreign dollars. He also notes that the unrealized status of translation gains and losses is important to consider. Mays expresses concern both for investors’ misinterpretation and for the companies’ inducement to protect against accounting exchange exposure because the pronouncement departed from economic results.

SFAS 52 had three dissents from Block, Kirk, and Morgan that reflect the majority position in SFAS 8. Specifically, the dissenters state that the SFAS 8 method of a single dollar focus for consolidated entities without direct entries to equity, which recognizes all gains and losses in net income (transaction and translation), is preferable because the summation of foreign operations in functional currencies does not translate into consolidated results in dollars. They criticize SFAS 52’s focus on net investment rather than individual assets and liabilities, in contrast with the dissenteing view in SFAS 8 that the focus on individual assets was misplaced. While Mays was no longer on the board when SFAS 52 was issued, the majority in the later pronouncement embraced his minority viewpoint on SFAS 8.

The Portfolio and Individual Asset Quagmire

The issue of whether to account for individual assets or for a portfolio of assets has permeated a number of dissents. The SFAS 19 dissent by Litke, Mays, and Walters points out that an area-of-interest capitalization up to a ceiling of the discounted cash flows would have been acceptable. Their notion was to measure the success or failure of a portfolio of oil wells, determined temporally or geographically, rather than to adopt the full cost approach. Litke cited the absence of conceptual support for successful-efforts accounting and called for area-of-interest accounting with supplemental disclosures. Mays said that either a collective success or an individual basis should be used, but not a blend.

Similarly, in dissents to SFAS 41, Mosso, Sprouse, and Walters observe that the relevant analogy for real estate investment properties is a portfolio of investments rather than individual property, plant, and equipment. They contend that an estimated fair value is sufficiently reliable to be included in financial statements as supplementary information.

In their dissent to SFAS 62, Morgan and Walters explain that borrowings and assets are intertwined during the capitalization period, but the borrowings are subsequently treated as part of fungible funds available for interest capitalization on other assets. They think that one or the other must be applied, but not both.

Common Stock Equivalents

In his dissent to SFAS 55, Walters says that the pronouncement perpetuates a fundamentally defective notion of common stock equivalency. He explains that financial statements need factual data to help the user estimate the probability, timing, and amount of potential dilution. Primary earnings per share (EPS) possesses neither relevance nor reliability because it does not predict dilution, while implying imminent or predictable dilution. He contends that APB 15 should eliminate the notion of common stock equivalency. In a March 1985 dissent to SFAS 85, Block calls for the amendment of APB 15 to eliminate common stock equivalence, the retention of fully diluted EPS as a useful warning signal, and the computation of primary EPS based on average common shares actually outstanding. While this position had been previously expressed in February 1982, it was not until February 1997 that SFAS 128 separated primary EPS from the common stock equivalency notion.

The Interrelationship of Costs and Revenues

Several dissenters address the fallacy of determining the revenue of a period based on its expenses. In their dissent to SFAS 17, Gellein and Kirk were the first to point out that expedience is the only reason to use this method. Litke, Mays, and Walters, who contend that no necessary correlation exists between costs and the values of the reserves and that the fair value method should be adopted, reprise this theme in their dissent to SFAS 19.

March, Morgan, and Sprouse dissent to SFAS 69 because they found no relation between costs, revenues, and cash flow and the measure of interest for gas reserves. They call for supplementary information by significant geographic area on proven reserve quantities, capitalized and incurred costs, and the results of production. An outsourcing consideration appears in Wyatt’s dissent to SFAS 91. SFAS 91 specifies activities intended to limit deferral on loan origination activities to direct costs only but does not limit such deferral if an independent third party receives payment. Wyatt contends that the nature of the parties to whom the payments are made should not form the basis of the accounting. Instead, this intended link of costs to revenue should be accounted for similarly when similar activities are involved.

In arguing that the same principles should apply to rate-regulated and unregulated enterprises, Block observes in his dissent to SFAS 71 that regulators cannot assure realization of future revenues because they cannot guarantee the following: an exclusive franchise; a price-insensitive demand without competition from alternative goods or services; a stable regulatory environment; or an assurance that customers will exist, goods and services will be delivered, and rates will be paid. Kirk similarly observes that no income should be recognized until the rates that cover the costs are actually charged to customers.

Lauver raises similar points in his dissent to SFAS 92. He observes that phase-in periods are adopted because rates are otherwise unacceptable and he challenges the presumption that they will prove acceptable in the future. Lauver also observes that the relationship of present costs to future revenue is too tenuous to warrant the accounting treatment of SFAS 92. He disavows the granting of amnesty to inappropriate accounting under SFAS 71 and 92 and prefers eliminating from the balance sheet amounts capitalized as an allowance for earnings on shareholders’ investments.

Changing Prices

Dissenters to SFAS 33 hold differing views. Mosso urges adoption of a single current cost measure because it will be most useful to investors. Walters believes that the current cost method needs voluntary experimentation before promulgation. Both oppose the dual approach and each believes that the subject matter is critically important. Mosso dissents to SFAS 89 for the same reasons: inflation is a critical factor that had been dealt with inconclusively in SFAS 33 and should not be written off as a lost cause. Lauver observes that SFAS 33 was a monumental change and that five years is too short a period to expect widespread use of disclosures. Lauver and Swieringa emphasize the inability of due process to quickly react to crises, and they call for continuing efforts to ensure data continuity, system development, and accessibility to information when inflation again climbs domestically. Swieringa points out that lower inflation and limited use of the SFAS 33 disclosures are not independent.

Other dissents to SFASs that deal with changing prices contain similar concerns. March and Mosso dissent to SFAS 40 because FASB had yet to develop techniques to measure inflation’s erosive effects on business capital. Mosso, Sprouse, and Walters dissent to SFAS 41, calling for estimated fair value of income-producing real estate as supplementary information. SFAS 41 permits constant dollar accounting and the current cost method for real estate investment properties even though testimony overwhelmingly indicates that neither was useful for tracking specific price changes. Furthermore, the dissenters challenge current cost depreciation for real estate investments that maintain value or appreciate, and they call for fair value information relevant to value change and cash flow.

Interest Expense

Block, Kirk, and Morgan dissent to SFAS 34’s requirement to capitalize interest during construction, noting that treating interest expense as a period cost results in a more comparable return on capital assessments. Linking interest costs to noncash reserves is not only arbitrary, but such interest capitalization also leads to subsequent misstatements of return on total capital because financing costs are mixed with asset values.

The dissenters also address an undefined test of materiality imbedded in SFAS 34, which they believe would lead to arguments between preparers and auditors and to difficulties in explaining to users why interest was not capitalized. SFAS 34 is a classic example of soothsaying, because FASB later found it necessary to issue SFAS 42 in order to establish that SFAS 34 was not intended to set a new standard for determining the materiality threshold for capitalization of interest cost.

In Block’s dissent to SFAS 62, he objects to blending the dissimilar business activities of borrowing, temporarily investing funds, and acquiring capital assets into a single asset. Amortizing a net amount of interest expense or income over the life of fixed assets as depreciation rather than currently recognizing it as interest expense or income distorts the return on capital from interest expense and depreciation and distorts the return on financial assets from interest income. In rebutting the argument for extending the capitalization period beyond the time when acquisitions were under way, Block rejects management consideration of financing issues as a sufficient justification. Accounting should reflect the nature and circumstances of the transactions rather than the motivations and expectations that led to them.

Compensation Issues

In SFAS 35, March, Morgan, and Walters contend that actuarial statements do not belong within financial statements. They argue that SFAS 35 invites comparison of items that do not possess enough common properties to be directly comparable, leading to an unjustified aura of reliability for estimates. Because the ability to pay benefits when due depends upon the continuing support and financial health of the plan’s sponsor, the prescribed comparison of the present value of benefits and the market value of assets at points in time possesses little informational value.

Brown argues similarly in his dissent to SFAS 87, observing that detailed methods are arbitrary and produce a complex accounting standard in pursuit of a level of precision and exactness that is unattainable. The implementation details should consider the circumstances of each plan situation; disclosures of plan asset and pension obligations would carry more information than numbers in the financial statements. (Contrast this point of view with the dissents to SFAS 123 that call for financial statement expense reporting rather than pro forma note disclosure for stock-based compensation.)

Sprouse emphasizes that actuarial methods are not appropriate for financial accounting and that the creation of an intangible asset or its elimination is unreconcilable to the conceptual framework, is not understandable by users, and will decrease credibility. He points out that contingent future events cannot have present obligations, posing the question: Why reflect future promotions and inflation in SFAS 87 when this is not also done for salaries? Wyatt likewise observes that actuarial asset value has no basis as an accounting concept and that using market values of assets to delay gains and losses compromises the rationale for fair market value. None of the dissenters believe that comparability results from the SFAS 87 guidance.

The problems with estimates’ reliability also permeate oil and gas reserve issues; current cost applications; the capitalization of costs imputed for equity funds used during construction and for intercompany profits in regulated industries; and foreign currency implications. The costs to audit actuarial numbers are real but have questionable benefits.

Expense recognition issues have also caused dissents. For example, Kirk and Sprouse explain that SFAS 43 would result in identical situations being accounted for differently because nonvesting sick pay may be recorded as a liability, although this is not required. Moreover, such costs are contingent because future absences do not arise unless illness occurs. Liability ought to be the result of employees rendering past service. If the costs are both unvested and contingent, no accrual should be permitted. In his dissent to SFAS 87, Sprouse similarly emphasizes that future inflation and promotions are contingent future events and ought not to be reported in present obligations.

Interestingly, March dissents to SFAS 34 because its requirement that an employee accept an offer of termination benefits before a liability is recognized elevates the legal obligation when the liability is reasonably estimable and reliably measurable prior to the acceptance.

Detailed Standards

Walters’ dissent to SFAS 66 complains that detailed and arbitrary guidelines should not be dignified as accounting standards; to do so debases accounting standards and inevitably will diminish their stature and the effectiveness of the accounting profession. The strength and purpose of the accounting profession arise from applying broad accounting and reporting objectives and standards to specific circumstances with professional judgment and objectivity. In a dissent to SFAS 66, Morgan observes that it would be more prudent to complete broader, more general projects, a point he reiterates in his dissent to SFAS 67, in which he considers the 1982 Financial Accounting Foundation structure report that called for FASB to focus on broad accounting standards and to develop alternatives for addressing implementation questions and emerging issues.

In somewhat similar vein, March, Morgan, and Sprouse oppose requiring the disclosure of the computations and analysis leading to standardized measures of discounted future net cash flows of proven oil and gas reserves. The cost of mingling management production forecasts, current costs, and prices at a prescribed 10% discount rate would exceed any limited benefit of measuring something that does not exist. Such a measure would be unreliable, overly subjective, and have no representational faithfulness. Users might erroneously assume that the measure represents fair value, whereas it actually results from management forecasts of future production quantities based upon subjective assumptions. They contend that the measure would have no meaningful benchmark outside the management group that created it.

Mosso’s dissent to SFAS 96 points out that the scheduling of reversals and the application of tax strategies in a formulized manner do not predict future cash flows as well as the simpler tests for probable occurrence and realizability. The indefinite reversal exceptions that arose from the application of SFAS 23 were caused by a failure to discount, which impaired comparability. North- rop’s dissent explains that SFAS 96 does not achieve comprehensive tax allocation and creates significant implementation complexities that distort the effective tax rate. He observes that SFAS 96 requires the design of hypothetical tax strategies—which are not intended to be implemented but developed for accounting purposes only—that result in more complex implementation than the tax law. The result is less relevant financial statements and increased costs.

Existing Guidance

Litke dissents to SFAS 19 because the accounting literature’s definition of asset includes oil and gas reserves-in-place. March and Morgan express a preference for the existing application of contingencies and allocation principles instead of SFAS 38. Of interest is the observation in SFAS 39 by Sprouse and Walters that SEC requirements do not relieve FASB of its responsibility to identify and require the presentation and disclosure of sufficient and necessary information. March and Mosso contend that SFAS 34 wisely introduced flexibility and that SFAS 42 was not needed. In describing their reason for dissenting to SFAS 43, Kirk and Sprouse apply SFAS 5 and recognition principles to address the appropriate handling of accruals. The dissenters to SFAS 44 point out that operating rights are already subject to current accounting standards on intangibles, requiring a change in amortization when their value drops. March and Walters perceive no need for SFAS 44. In similar manner, Morgan dissents to SFAS 47, saying that SFAS 5 already covers the issue. Morgan dissents to SFASs 35, 66, and 67, citing “no urgent need.”

Restatement Objectives

In dissenting to SFAS 52, Mr. Morgan explains that restatement fosters the incorrect conclusion that the financial statements provide results as if SFAS 52 had been in effect for earlier periods, which cannot be the case since hedging is a function of accounting. Moreover, voluntary restatement decreases the comparability of financial reporting because it is not universal. He calls for a prohibition of restatement as a method of transition, preferring instead to use an adjustment from the SFAS 8 basis to the SFAS 52 basis as the opening translation adjustment in equity for the first year in which the latter would be effective.

Kirk and Sprouse similarly criticize SFAS 9 for creating an accounting illusion. The “as if” approach pretends that income tax provisions for deferred taxes had been made before1975. They support retroactive restatement.

In the SFAS 11 dissent, Litke calls for requiring all companies to restate under SFAS 5 rather than permitting those using the cumulative effect methods to change to the SFAS 11 method. SFASs should eliminate rather than create unjustifiable accounting differences.

In dissenting to SFAS 87, Sprouse first avers the impropriety of actuarial methods in financial accounting but then concludes that he would support their continued application if other issues were adequately addressed such that the change would not be disruptive. In contrast, Foster’s dissent to SFAS 125 criticizes the position that securitizations should not be accounted for at fair value because of the substantial impact on the reported financial position of certain entities and on their markets. Such concerns should have little weight in determining appropriate accounting. In his dissent to SFAS 91, Mr. Wyatt says that the comparability of financial presentation achieved by applying standards on a retroactive basis for all years presented is an objective that FASB should strive to achieve unless it is impractical. This leads him to oppose the implication in SFAS 91 that prospective application is preferable.

Apparent Lessons

The dissenters have acted as soothsayers of future positions on foreign currency, earnings per share, and fair market value. The ideas expressed in dissents are also likely to emerge later on in debates over new standards. Important recurring debates revolve around the portfolio vs. individual asset accounting approach, the level of desirable detail within the standards themselves, and the preferred transition between accounting approaches and new standards. Internal consistency within a standard, its reflection of actual economic results, and the achievement of similar accounting for similar circumstances are the criteria most likely to result in dissent if a standard does not meet them.

FASB members disagree about whether volatility and divergence from past practices should be a consideration when setting standards. The general attitude has accepted a decreasing diversity of practice, with a concomitant concern that context matters and that judgment should be permitted or certain transactions exempted. Tension is reflected in standards that fluctuate between evenhandedness and asymmetric treatment. Dissenters claimed that regulated industries were allowed premature revenue or asset recognition and contingent unvested compensation was allowed premature liability recognition. There is a schism between those that prefer note disclosure over financial statement presentation, and another between those that want to reflect management intent and those that prefer more objectivity.

The most striking story in the history of dissents to FASB standards occurs in the area of accounting for changing prices. Nine different pronouncements, all with significant dissents, started at dual presentations, moved to differential application, and eventually ended at rescission. The fact that 15 standards have involved exclusion of certain groups, deferrals, and rescission or elimination of previously issued guidance raises the question of whether future standards could concurrently address the issues of exclusion and the timetable with sufficient detail to avoid future deferrals and rescissions with their associated costs.