The CPA Journal: Will there be any long-lasting adverse consequences to the Board for having changed its position on the stock compensation project?

Dennis Beresford: What we have to see over time is whether we will be commended for having listened carefully as part of the due process of an open standard-setting system or will we be condemned for having bowed to pressure. Patricia McConnell, a managing director of Bear Stearns and sometimes spokesperson for the Association for Investment Management and Research, was highly critical of our actions. On the other hand, we mostly have had a very favorable reaction. Those that will have to apply the standard seem willing to provide information in a footnote but, because of concerns about valuation methods, are not quite ready to accept the accounting we initially proposed. We were convinced that either the SEC or Congress would overrule us on the issue. The latest proposed legislative answer would have had the SEC explicitly vote on every pronouncement we issued, as well as those of the AICPA and the EITF. Such a result, in our opinion, would have been the beginning of the end of private-sector standard setting. We concluded it was in the best interests of all our constituencies that that not happen.

CPAJ: It was reported that at a meeting of the Financial Accounting Standards Advisory Council your oversight organization, you expressed disappointment that you had not received the backing of the body in holding your position and some members of FASAC expressed disappointment on the part of the Board for not holding its ground.

Beresford: There are a number of members of FASAC who were strongly supportive of our proposal. They individually expressed their disappointment. There were, however, many Council members who felt we did the right thing. My expression of disappointment was not specifically directed at FASAC. I was disappointed in the level of support generally - from the large accounting firms and many of the big corporations. It seemed too much of the opposition was for the wrong reasons. We understood the difficulties many were having with the measurement of value issues, but many of the nonsupporters objected purely on political grounds, or they were just opposed to having to record more expense.

CPAJ: I think there was a fair amount of grass-roots support for the Board by the rank and file in the accounting profession. There did not seem to be any real convincing argument not to recognize some form of expense. And when you think about some of the other tough issues you have dealt with - postemployment benefits for example - isn't this small potatoes?

Beresford: If there was some way to measure what the total impact of our proposal would have been on all companies, I'm sure it would not be nearly as big an issue as, let's say, retiree health-care costs. But it is very material to some companies, especially some of the high-tech, start-up companies. However, it also would have had a large impact on companies such as Microsoft, PepsiCo, or Toys 'R' Us. Some of these companies have very broad-based plans and give options to a large percentage of their employees.

CPAJ: Some of those that tried to influence the outcome did so on the basis that it was not a big issue, not worth the time and effort it was taking. Then why all the fuss?

Beresford: It was a unique issue. It energized the CEO types more than I've ever seen. On most issues, companies are very concerned with the impact on earnings per share. Here some were more interested about how it would affect the number of options they would be granting in the future.

CPAJ: Wouldn't the marketplace adjust to the effects of any new standard you establish?

Beresford: I think so. It was a classic case of the sky is falling. And no matter how many examples we gave to demonstrate that accounting principles do not lead to falling skies - SFAS No. 115 on marketable securities or SFAS No. 106 on retiree health care - many people argued this issue was different.

CPAJ: What about the future effectiveness of the Board?

Beresford: I think it's a net positive for us. SEC Chairman Arthur Levitt was very complimentary when it was all over, saying the experience showed how well the private-sector process works. We operate in the real world - a world in which people can go to their members of Congress and seek legislative relief from things they don't like or to which they object. Our hope is that in the future we will get the support of the accounting firms, preparers and users of financial statements, and even Congress for what we are doing. I'd like to think this was an aberration. And, by the way, the information we will require will be exactly the same that would have been required under an expensing scheme. Informed users will have the information.

This experience is not dissimilar to what happened with the Board's proposals on oil and gas accounting in the mid-1970s or the investment tax credit the APB had to deal with. If enough people don't support what we do, our foundations can prove to be very fragile. But I think our success over the last 20 years demonstrates the basic process works. We are not exactly clear on the lessons to be learned from this particular issue, but we will do our best to build on the experience.

CPAJ: In looking over your agenda for the next year or so, do you see any issues that will attract as much attention or cause another challenge to your authority?

Beresford: I think accounting for derivatives and hedging is the most sensitive project we are working on now. It has the potential for controversy. We are still not there as far as a final solution is concerned. At the moment, our thinking is that all freestanding derivative instruments should be recorded on the balance sheet as assets and liabilities at fair or market value, with some deferral of gains and losses under certain conditions. It will give derivatives much more visibility. Generally our corporate constituents do not like market value accounting - they love historical cost. But the historical cost of a derivative is zero for the most part. The rules on derivatives and hedging have just not kept pace with the sophisticated kinds of instruments now being issued and traded. Although there may be controversy over some of the approaches we are discussing, most involved with derivatives would agree something needs to be done. But I think there will be people on both sides of the issue, with the debate focusing on the technical considerations - a more normal situation.

CPAJ: What kind of issuer of financial statements will be most affected by the new derivatives accounting?

Beresford: Those affected will be widespread. Almost all companies of any size use derivatives to hedge against some risk. It could be an agricultural producer, anyone involved in foreign currency transactions, and anyone involved in interest sensitive instruments - banks, insurance companies, savings and loans, institutions like that.

CPAJ: Could you give us a simple example and how it might change under the new accounting?

Beresford: An example might be a manufacturer that uses silver in the fabricating process, but whose selling price is relatively fixed by market conditions. It would be natural for the company to want to lock- in the price of silver. There are many ways to do that. They could enter in forward contracts to buy the silver at fixed prices. Or they could plan to buy silver at the market, but enter into certain derivative transactions for instruments that would move conversely to the silver market. Right now neither of those two approaches would lead to accounting entries as the prices change. Our tentative conclusions would have the derivative instruments accounted for in the balance sheet, with the gains and losses deferred as an element of stockholders' equity until the silver was purchased and the derivative realized. But keep in mind this is a simple example. Some companies hedge their risks on a global or enterprise level basis, with no direct connection to particular individual assets or liabilities.

CPAJ: What about the consolidation project? Is that likely to lead to some consternation?

Beresford: We are not far enough along to know. We issued a preliminary views document on that for which we have received about 90 comment letters. That is not at a level that indicates any great controversy brewing. But that document was at the policy level. Still to be dealt with are the procedural issues of consolidation - intercompany items, minority interests, and the like. We hope to package the policy and procedural issues together into an exposure draft for the fall of 1995.

Disaggregated disclosures is an issue related to consolidations. Having decided who and what makes up the consolidated entity, you must then deal with the disclosure of information about the components in the consolidation. It's a reconsideration of segment reporting, something users are very interested in. We are working with the Canadian standard setters on this one. I also believe you plan to publish an article by Paul Pacter and Patricia McConnell that points out where the international Accounting Standards Committee is headed on this subject, which position contrasts with ours and that of our Canadian colleagues.

CPAJ: The AICPA Accounting Standards Executive Committee (AcSEC) just issued an SOP on disclosure of certain significant risks and uncertainties. Many observers feel the issues covered by this SOP are too broad and far-reaching to have been dealt with by AcSEC The right party was FASB. Some also feel that body was pressured into issuing something.

Beresford: My personal view, not shared by others on the Board, is that I agree with the observers. There is a role for ACSEC in setting accounting standards but it needs to be carefully determined. That body can best serve the process by dealing with specialized industry situations and more narrow issues. It would be difficult and costly for us to attain the knowledge needed to establish standards in certain highly specialized industries such as insurance or health care. So SOPs and audit guides can best come from ACSEC and the AICPA. But this issue was too broad. We may have somewhat of a similar issue. We just gave our blessing to a project of ACSEC on environmental liabilities. The project seeks to give guidance on how to deal with environmental liabilities using existing accounting rules. But environmental liabilities are a broad issue, and should we have allowed ACSEC to proceed? In this case I think it's OK. But we will be very careful in the future as we look at future ACSEC projects.

CPAJ: When I think of the new SOP, I can't help but think how it might have been applied by Intel prior to its problems with its Pentium chip. Should its management have disclosed that the estimate of product warranty costs was subject to change in a material amount if its new chip contained a mathematical flaw?

Beresford: It will be a difficult document to apply - we will have to see how it shakes out over time. I think the project was initiated, at least in part, over the concern of some about litigation. It was felt that if the risks of a company were better explored and disclosed, lawsuits would less likely be successful. But after the project was finished, I think there were serious differences of opinion about whether it will serve to decrease or increase liability risk.

CPAJ: FASB seems much more involved in the international standard- setting scene than it was perhaps two or three years ago. An example is the disaggregation project with Canada that you spoke of earlier. But we hear the joint-earnings-per-share project may not be going as well.

Beresford: We have a project we are working on as does the IASC on earnings per share. The IASC is a little more difficult to work with than the Canadian board. They don't meet as frequently. We have reached agreement with the IASC steering committee on most of the issues. But there are areas where we have significant differences of opinion, principally diluted EPS. More specifically the issue is whether to use average-during-the-year or year-end amounts in computing diluted earnings per share. Is the answer supposed to tell the reader what it would have been or what it is likely to be if certain events had taken place? The steering committee recently met with the full IASC. We hope they see things our way, but we will keep an open mind as well.

CPAJ: Are you at an impasse?

Beresford: I don't think so at all. I personally think we are close enough to go ahead. At the extreme you might have additional information for U.S. GAAP preparers who want to comply with international standard as well. We still hope we can reach agreement on all counts. The two projects are test cases for us in some way. Both disaggregated disclosure and earnings per share are nonconceptual matters. They are more analysis-type projects. They do not involve whether net income should be higher or lower, or whether an item belongs on the balance sheet or not. Those types of issues are a lot more controversial, and we will have a harder time harmonizing them. We feel our current projects, while important, are perhaps the baby steps toward harmonization.

CPAJ: I attended a conference on accounting in the three NAFTA countries. A project was described involving the three accounting standard setters that identified the differences among the three countries. A report of that project gives the impression harmonization among the three will not be easy.

Beresford: The Canadians and we are not that far apart. In some respect it depends on the individual company and the type of business it is in. Mexicans are further apart from us, principally because of what has been an inflationary Mexican economy. Our hope is that by identifying the differences we can better set our priorities when deciding which issues to look at, keeping in mind the benefits harmonization can bring.

CPAJ: Based on the Jenkins Committee report that says users are not asking for elimination of all alternatives, just the necessary information to deal with them, might it be that all that is needed are the reconciliations of one GAAP to the other so users can make their own judgments?

Beresford: Users seem to feel reconciliations are important.

CPAJ: Speaking of the Jenkins Committee report on improving business reporting, having had time to digest its recommendations, what is FASB doing in response to it?

Beresford: We have not begun to work on any of its recommendations. We are still analyzing its contents. It is somewhat controversial. We talked to FASAC about it at our last two meetings. The advice we seem to be getting is that we need to get more people involved in the process before we begin to act. We will probably issue an invitation to comment or some sort of document to call attention to the issues and ask for comment and advice on how to prioritize. A major question is whether we should work on some of the nonfinancial aspects or should some other body. Joe Anania of our Board will work with the Jenkins follow-up coordinating committee under the leadership of Jerry Weygandt of the University of Wisconsin. That group is analyzing the recommendations to see who is the likely group to do what.

CPAJ: In reading the long-form Jenkins report, it appears to suggest that some group establish standards for nonfinancial information - for example, a standard for presentation of sales per employee. You are groping with whether FASB should deal with that And the possibilities for nonfinancial information are so vast, who could possibly establish standards for all of it?

Beresford: Many in the business community are fearful this will produce information overload. We have no feeling of turf protection but do feel our charter is broader than just financial statements. But we are not rushing to grab hold of everything in the report. The coordinating committee's ideas will be important input to us.

CPAJ: What is your overall reaction to the report, now that it has been out therefor a while?

Beresford: I've participated in a number of programs at which its recommendations have been discussed. There was, of course, The CPA Journal symposium, and I participated in an all day program at the University of Southern California, and two or three other panels. Every time it's discussed, it takes on a more complicated look. It becomes harder and harder to get my mind around it.

CPAJ: Many of our readers from small practices seem perplexed on how the recommendations will impact them and their clients. The notion of flexible reporting has not been well explained.

Beresford: It seems to be controversial at many different levels. Small companies and their advisors claim it will increase standards overload and increase costs; large companies say they are already providing the information and it's just designed to increase audit fees. Some of the large accounting firms have found fault with certain aspects. It's the natural result of a document seeking change. The outstanding contribution is, of course, the involvement of users in the project. Jenkins was able to get more users involved than we have been able to do. But it has been abundantly clear there is no one view shared by all users.

We will be better able to evaluate its contribution five or 10 years from now, when we can look back and see the impact it has made. I think it will be sizable.

CPAJ: Bob Israeloff, chair of the AICPA, is very concerned about standards overload on the local practitioner and the closely held business. How do you view this issue and your responsibility to perhaps deal with it?

Beresford: I met with Bob just recently to discuss his concerns. We are looking at disclosure overload not just for the small or local practitioner. It affects all preparers and auditors. Some of Bob's concerns relate more to how the practitioner can produce statements for management that perhaps short-cut some principles and disclosures. We question whether two different forms of GAAP are workable.

CPAJ: Ray Groves, immediate past chairman of Ernst & Young and your former boss, in a piece in the Wall Street Journal, spoke of standards overload and made suggestions for ameliorating the situation.

Beresford: We have been concerned well before Ray's piece in the Journal We have asked the FEI and IMA if they were interested in doing some research in this area. Jim Leisenring and I have spoken on the issue. I'll have to admit, however, that we have not done that much about it, except to challenge ourselves as we set new standards. We are considering a symposium in perhaps October of this year. We will ask people to prepare papers for discussion at the symposium on what is perceived to be the problem and some potential solutions.

Some behind-the-scenes work has shown we are told conflicting things. At the same time Ray Groves was speaking about overload, his firm was suggesting we solve the stock compensation issue with more disclosures in excruciating detail. We hear that quite often. Another example is pension accounting. People didn't like some of the accounting possibilities, like marking securities in pension funds to market. The resulting compromise introduced the idea of corridors and other smoothing techniques. But that necessitated a whole range of disclosures so analysts and others would understand what was going on. So my point is that the proliferation of disclosures has, in some measure, been the result of helping the medicine go down. But having said that, I would agree that there is a need to take a careful look at disclosures and how they can be reduced. We know some disclosures have been improperly used to obfuscate matters rather than reveal them. We haven't found obvious solutions yet, but we are on the case.

CPAJ: Maybe the task of looking at the disclosure issue needs to he done by someone other than a standard setter.

Beresford: We need to look at it also. If the cost of a disclosure is 10 and the benefit is only one, there should be some way of eliminating it or finding an appropriate alternative that doesn't cost 10. Unfortunately, most real-life situations aren't this clear.

CPAJ: The workings of your Emerging Issues Task Force (EITF) are under a 10-year review. Is there anything to report at this time? In soliciting comments, the impression was given that the SEC was misusing the EITF forum to promulgate its own point of view.

Beresford: That study is going well. It's being done privately. Mike Sutton of Deloitte & Touche, who was recently named the new chief accountant of the SEC, led the review. A report is expected in May. As far as misuse of the forum, I think that was just an issue the study group raised for others to comment upon. I think most observers feel the EITF is doing a good job.

CPAJ: Thank you for presenting your views and comments to us. We look forward to meeting with you from time to time to learn of the important issues confronting the FASB.

RELATED ARTICLE: DENNIS R. BERESFORD, CPA

Dennis R. Beresford, CPA, has served as chairman of the Financial Accounting Standards Board since January 1, 1987, after a productive career with Ernst & Young. He is a former chair of the AICPA's Accounting Standards Executive Committee and a former member of both the International Accounting Standards Committee and the Financial Accounting Standards Advisory Council. He was active in the Institute of Management Accountants and one of the first individuals to earn the Certificate in Management Accounting He is a member of the American Accounting Association and Financial Executives Institute.