Bramwell’s Lunch Beat: FASB Puts Onus on Management for Going Concern Disclosures

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PwC must face $1 billion lawsuit over MF Global advice
A federal judge on Wednesday ordered PricewaterhouseCoopers (PwC) to face a $1 billion lawsuit claiming that its bad accounting advice was a substantial cause of the October 2011 bankruptcy of MF Global Holdings Ltd., a brokerage run by former New Jersey Governor Jon Corzine, Jonathan Stempel of Reuters reported.

US District Judge Victor Marrero in Manhattan said PwC's advice on “repurchase-to-maturity” transactions through which Corzine bought $6.3 billion of European sovereign debt affected how MF Global implemented its strategy and in turn contributed to its alleged losses. “This line of causation gives rise to a plausible claim that PwC proximately caused harm to MF Global,” Marrero said, according to the article.

Marrero on Wednesday noted that such factors as how MF Global employees implemented Corzine’s strategy might also have been major causes of the New York-based company’s losses, Stempel wrote. But he said a jury, not a judge, should sort out who was liable. The judge did dismiss breach of contract and unjust enrichment claims against PwC.

PwC spokeswoman Caroline Nolan said, “We respectfully disagree” with the decision to let the case go forward, according to the article. She also said PwC’s audit of MF Global complied with professional standards, and that MF Global’s treatment of the repurchase-to-maturity transactions was consistent with US Generally Accepted Accounting Principles (GAAP).

Daniel Fetterman, a partner at Kasowitz, Benson, Torres & Friedman representing the plan administrator, said: “We are pleased with Judge Marrero's well-reasoned decision, and look forward to presenting our case to a jury,” according to the article.

FASB issues guidance to improve financial reporting of going concern uncertainties
The Financial Accounting Standards Board (FASB) on Wednesday issued Accounting Standards Update No. 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern.

The update is intended to define management’s responsibility to evaluate whether there is a substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures.

Under US GAAP, financial statements are prepared under the presumption that the reporting organization will continue to operate as a going concern, except in limited circumstances. Financial reporting under this presumption is commonly referred to as the going concern basis of accounting.

US GAAP currently lacks guidance about management’s responsibility to evaluate whether there is substantial doubt about the organization’s ability to continue as a going concern or to provide related footnote disclosures.

The update provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations today in the financial statement footnotes.

“This update responds to stakeholder concerns about the diversity that currently exists in footnote disclosures because of the lack of guidance in GAAP and the differing views in practice about when substantial doubt exists,” FASB Technical Director Susan Cosper said in a written statement. “It improves the comparability of these disclosures by providing guidance on when there is substantial doubt and how the underlying conditions and events should be disclosed in the footnotes.”

The amendments in this update apply to all companies and not-for-profit organizations, according to the FASB. They become effective in the annual period ending after December 15, 2016, with early application permitted.

The update and a FASB In Focus document are available on the FASB website.

CAQ commends FASB’s issuance of guidance to improve financial reporting of going concern entities
Center for Audit Quality (CAQ) Executive Director Cindy Fornelli had this to say on Wednesday about the FASB’s new going concern guidance: “The CAQ commends FASB for its efforts in developing a standard that provides guidance regarding a preparer’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern, and, where required, to provide footnote disclosures about going concern uncertainties each reporting period.

“We believe the adopted ASU represents an improvement over the current going concern model and will provide users of financial statements with more clarity on the nature of conditions or events that may raise substantial doubt about the entity’s ability to continue as a going concern.

“The CAQ encourages accounting and auditing standard-setters to continue to work together to develop complementary standards which would further benefit financial statement users.”

CAQ provides new tool to help auditors avoid judgment tendencies, traps, and biases
Speaking of the CAQ, the public policy organization on Wednesday issued the Professional Judgment Resource, designed to provide auditors with an example of a decision-making process to facilitate important auditing and accounting judgments in a professionally skeptical manner.

It is aimed at assisting auditors who are responding to judgment challenges arising from the increasing complexity of business transactions, the development of principles-based (or objectives-based) auditing and accounting standards, the increasing focus on estimates, and other highly subjective elements.

The tool outlines an example of a decision-making process grounded in five essential actions. They are:

  1. Identify and define the issue.
  2. Gather the facts and information and identify the relevant literature.
  3. Perform the analysis and identify alternatives.
  4. Make the decision.
  5. Review and complete the documentation and rationale for the conclusion.

Additionally, it identifies several of the more common judgment tendencies and traps that can potentially lead to bias and weaken professional skepticism, and includes illustrative examples of these tendencies, as well as strategies to avoid them.

“It is critical for the public and capital markets to have trust and confidence in the reasonableness of judgments made by public company auditors,” Fornelli said in a written statement. “While there is no ‘silver bullet’ that will eliminate all psychological traps, increased awareness of them can improve an auditor’s decision-making process.”

While the Professional Judgment Resource was developed with auditors in mind, it can be a useful tool for all participants in the capital markets.

KPMG faces criticism for Espírito Santo audit work
In KPMG LLP’s office in Lisbon, Portugal, few clients provided as much audit work as the Espirito Santo Group, whose business interests ranged from banking to mining. Now the collapse of the family-owned empire is raising questions about whether KPMG should have detected problems earlier, Patricia Kowsmann, David Enrich, and Margot Patrick of the Wall Street Journal wrote on Thursday.

KPMG was the auditor of Espirito Santo Financial Group SA, a publicly traded Luxembourg finance company that filed for creditor protection in July. In Lisbon, it was the auditor of Banco Espírito Santo SA, which was bailed out in August, and of dozens of related companies. And KPMG was the auditor of three offshore investment vehicles that trafficked in Espirito Santo debt and played a part in what the Portuguese central bank describes as a fraudulent scheme.

Critics say the scope of KPMG’s audit work could have put the firm in a position to identify the billions of euros that were secretly flowing among group companies before Espirito Santo's unraveling sent shock waves across European markets this summer, Kowsmann, Enrich, and Patrick wrote.

“With the auditor playing so many roles, the question seems to be: Were they just too spread out to see the big picture, or in the worst case were they too focused on getting audit mandates to act on the big picture?” said Peter Hahn, a finance professor at London's Cass Business School, according to the article.

KPMG spokesman Brian Bannister told the Wall Street Journal that the firm “stands by the quality of the audit work” it conducted for the offshore vehicles and Espirito Santo, noting that it was performed “in accordance with all applicable professional and ethical standards.” He said KPMG doesn't believe there was any conflict of interest and that the offshore vehicles were legally separate from Banco Espírito Santo.

Insurers pay more tax on executive compensation under Obamacare: study
When Washington eliminated corporate tax deductions on health insurance executive compensation above $500,000 under President Obama’s healthcare reform law in 2013, it generated more than $72 million in additional tax revenue for the US government, a left-leaning think tank said on Wednesday, according to an article by Caroline Humer of Reuters.

The report from the Institute for Policy Studies examined executive compensation in the 2013 proxy filings from WellPoint Inc. and UnitedHealth Group Inc., among others, and found that those companies paid more taxes than they would have if the law had not been passed.

After examining the 10 largest publicly traded health insurers, it found that corporate taxes on their pay would likely increase in coming years because some 2013 compensation included stock options that predated the law, Humer wrote.

Based on those disclosures, it calculated the corporate tax each company paid on the compensation of the top five executives versus what the companies would have paid based on the US tax code that applied to insurers prior to 2013 and that continues to be used by most other US corporations outside of the health insurance industry.

The report said that if all corporations were to be taxed this way, it would raise $50 billion more in revenue for the US government, according to the article.

SEC adopts new rules on asset-backed securities and credit ratings
William Alden of New York Times DealBook reported that the US Securities and Exchange Commission (SEC) unanimously approved rules on Wednesday that would require issuers of asset-backed securities – complex investments based on mortgages, auto loans, or other types of debt – to disclose more information about the underlying loans.

The rules are meant to help investors better judge the quality of such securities.

At the same time, the SEC tightened controls on credit rating agencies, whose overly optimistic ratings helped inflate the housing bubble in the years before the financial crisis. With two of the five commissioners casting dissenting votes, the agency adopted rules to help guard against conflicts of interest in the ratings business, as well as to increase disclosure of the rating process.

“The reforms before us today will add critical protections for investors and strengthen our securities markets by targeting products, activities, and practices that were at the center of the financial crisis,” SEC Chair Mary Jo White said, according to the article. “With these measures, investors will have powerful new tools for independently evaluating the quality of asset-backed securities and credit ratings.”

The rules on rating agencies drew forceful criticism from two of the commissioners. Among other issues, those rules aim to address a potential conflict inherent in the business model of rating agencies, which are paid by the issuers of the securities they rate, by prohibiting sales considerations from influencing them, Alden wrote. The rules also require the firms like Moody’s Investors Service and Standard & Poor’s to have internal procedures for setting and revising their ratings. They will also have to increase disclosure of their accuracy.

Quick Links:

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