It’s All About the Accounting

December 5, 2007

Neal J. HannonDirector, Financial Reporting Technologies

Financial Accounting Foundation

It’s All About the Accounting

Predicting the future is easy. Just note what is possible today then anticipate how people will use it when simplified.

DisclaimerThe views expressed in this presentation are my own and do not represent positions of the FAF or FASB. Positions of the FAF /FASB are arrived at only after extensive due process and deliberations.

Outline

It’s All About the Accounting

Sub-theme: If the accounting’s not right, the XBRL is not right

Evolution and Structure of AccountingNature of US GAAP XBRL and the US GAAPThe triad of accounting embedded in XBRLTagging the accountingYour role in the review of the US GAAP taxonomy

Evolution of Accounting Structure and nature of accounting Translating accounting into software Digesting and assimilating hundreds of

accounting packages into a standardized way of representing business data to a computer

The Franciscan Roots of Modern Accounting

 First surviving accounting textbook:       “The Summa” written by Fra. Luca Pacioli in 1494       (included illustrations by L. Da Vinci)

A best seller in its dayPublicized the Method of VeniceHelped to spread literacy in the middle class

  

Luca Pacioli—the “Father of Accounting”

A mathematician and merchantBecame a Franciscan friarFranciscans came out of, and ministered to, merchant classDid not invent double-entry accounting but spread the knowledge

The Method of Venice(Double-entry Accounting) A binary (0,1) method for recording economic eventsInvention of the “Debit” and “Credit” concepts from the Italian terminologyAllowed for much easier addition and subtraction before calculators were invented 

DebitComes from the Italian “debito”which comes from the Latin “debita” and “debeo”which means:       OWED TO the proprietor       or an asset of the proprietor  CreditComes from the Italian “credito”which comes from the Latin “credo”which means:

Trust or belief (in the proprietor)    or OWED BY the proprietor  

From the 13th century to the present:Double-entry accounting spread throughout the worldAccountants in each country adapted accounting practices to

suit their:CulturesLaws & regulationsCapital market structuresEnvironments

National differences in accounting rules and practices render financial statements of companies based in different countries UNCOMPARABLE

Securities Act of 1933

Often referred to as the "truth in securities" law, the Securities Act of 1933 has two basic objectives: ◦ require that investors receive financial and other

significant information concerning securities being offered for public sale; and

◦ prohibit deceit, misrepresentations, and other fraud in the sale of securities.

Securities Exchange Act of 1934

With this Act, Congress created the Securities and Exchange Commission. The Act empowers the SEC with broad authority over all aspects of the securities industry. This includes the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies as well as the nation's securities self regulatory organizations (SROs).

Sarbanes-Oxley Act of 2002

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, which he characterized as "the most far reaching reforms of American business practices since the time of Franklin Delano Roosevelt." (the 1930’S)

The Act mandated a number of reforms to enhance corporate responsibility, enhance financial disclosures, combat corporate and accounting fraud

Created the "Public Company Accounting Oversight Board," also known as the PCAOB, to oversee the activities of the auditing profession.

The SEC has a unique position in the financial reporting process. The Commission not only has authority under the securities laws of the United States to set accounting standards to be followed by public companies but also the power to enforce those standards.

Practically since its inception, the Commission has looked to the private sector for leadership in establishing and improving the accounting methods used to prepare financial statements.2 The body currently performing that function is the Financial Accounting Standards Board, or the FASB. As a result, the FASB has the power to set, but not enforce, accounting standards to be used by public companies.

Robert K. HerdmanFormer Chief Accountant, U.S. Securities & Exchange Commission

FAF Overview Non-stock, Delaware corporation Incorporated in 1972 IRC Section 501(c)(3) Status Operating exclusively for educational

purposes Located in Norwalk, CT

FAF Purposes Establish and improve financial accounting

and reporting standards Educate constituents as to standards Responsible for oversight, administration,

and finances of Standards Boards (FASB and GASB) and Advisory Councils

Protect independence and integrity of standard-setting process

Generally Accepted Accounting Principles (GAAP) is the standard framework of guidelines for financial accounting, mainly used in the U.S.A.. It includes the standards, conventions, and rules accountants follow in recording and summarizingtransactions, and in the preparation of financial statements.

Evolving US GAAP and XBRL

New and unique situations arise continuously

During “pre-clearing” process, SEC often consults FASB for guidance but remains the final arbitrator of accounting

Will/should future guidance from the SEC include how to properly tag a transaction?

Principles

GAAP accommodates variation in applied accounting methods as long as the methods generally adhere to GAAP’s set of principles…..

This drives computers crazy!

Do You Remember Vinyl Records?

Had to Play from start to finish

Record could be damaged if you attemptedto play a specific track.

Similarly , Notes and Disclosures todayare made to be read and understood in one way, the whole Note from start to finish.

Vinyl Records And Disclosures

The technology dramatically changed how we relate to musicand gave us more power to select individual cuts suited tomusical tastes and preferences

Then Came Digital•Individual Tracks Separated•Choose Your Own Order for Play•Start and Stop

George Martin and the Beatles The task

◦ Collect, identify, classify the entire set of music created by the Beatles

◦ Using master tapes, break out the riffs◦ Re-configure music into digital sound bytes

The results◦ New Music.. The Beatles Love Album

Chairman Cox and Interactive Data The task

◦ Collect, identify, classify the entire set of GAAP created by US Authoritative Sources of GAAP

◦ Using financial statement hierarchy, break out the elements into an XBRL taxonomy

◦ Re-configure accounting into digital bytes The results

◦ New Filings.. The SEC Interactive Data initiative in XBRL

The XBRL “Principles” Problem How do you tag a principle? Computers need consistency

◦ Like transactions reported the same way

What About the US GAAP Taxonomy?

How was it constructed?

US GAAP TaxonomyDevelopment Effort

XBRL US

GAAP,SEC Regulations

Codification projectAudit check lists

SEC

Internal and PublicTesting

XBRLprotocols

TaxonomyRelease

CFOInvestor Relations

AnalystsInvestors

Currentreporting

XBRL Accounting Triad Labels Definitions References

Label – may or may not be close to a company’s financial statement presentation. The common language label could also bedifferent from the XBRL label

Definition – Definitions for US GAAP requireddisclosures will most likely contain languagedirectly from authoritative literature.

References – References point to authoritative literature with disclosure requirements or to directional references

The XBRL Accounting Triad

Getting the accounting right means the XBRL must create an alignment of the company’s reporting intent with the accounting treatment suggested by the combination of the label, the definition and the authoritative references. In XBRL, meta data counts.

Tagging a Note -IBM

Revenue Recognition: Hardware  Revenue from hardware sales or sales-type leases is recognized when the product is shipped to the client and when there are no unfulfilled company obligations that affect the client’s final acceptance of the arrangement. Any cost of these obligations is accrued when the corresponding revenue is recognized. Revenue from rentals and operating leases is recognized on a straight-line basis over the term of the rental or lease.

Tagging a Note -IBM

Revenue Recognition: Hardware Revenue from hardware sales or sales-type leases is

recognized when the product is shipped to the client and when there are no unfulfilled company obligations that affect the client’s final acceptance of the arrangement.

Any cost of these obligations is accrued when the corresponding revenue is recognized.

Revenue from rentals and operating leases is recognized on a straight-line basis over the term of the rental or lease.

From SpiderMonkey, an XBRL taxonomy development tool used to prepare the US GAAP taxonomy

Tagging a Note -IBMRevenue Recognition: Hardware Revenue from hardware sales or sales-type leases is

recognized when the product is shipped to the client and when there are no unfulfilled company obligations that affect the client’s final acceptance of the arrangement.

Description of accounting policies associated with the recognition of gross revenues and gross revenue adjustments, which are components of net revenues in the statement of operations for the period.

From thetaxonomy

Description of accounting policies associated with the recognition of gross revenues and gross revenue adjustments, which are components of net revenues in the statement of operations for the period.

Standard label in English:Revenue Recognition Accounting Policy, Gross and Net Revenue Disclosure

Standard label in XBRL:RevenueRecognitionAccountingPolicyGrossNetRevenueDisclosure

Accounting Principles Board Opinions (APB)Number 22, Paragraph 8

Label

Definition

Authoritative Reference

Will the Meta Data Count? XML is a wonderful language for describing objects

in computer readable formats. XML depends on meta data to describe the contents of its digital message.

XBRL must contain several attributes in order to transform numbers into meaningful business reporting interactive data.

When we move from a paper based reporting world to an interactive data world, the data contained in a finding will not be complete or understandable without accurate meta data accompanying the element reported.

Will the Meta Data Count? So.. If a filing contains a label that is further described by a

definition and a reference, the computer referencing the item will have all three pieces of information as discoverable meta data

Label Definition Reference

If the definition is off or the reference is wrong, is the tagged data also wrong? What if an investor, reading the XBRL meta data, relies on the XBRL definition or reference? Shouldn’t the entire financial information supply chain care about the triad of accounting?

Key Considerations Taxonomies must be well developed

◦ Complete and accurate tagging system is key to achieving benefits

◦ Be considerate of whether tags faithfully represent financial reporting under GAAP

◦ FASB’s Codification project will change taxonomies◦ IFRS- US GAAP Convergence – tags will converge as

standards do

Future standard-setting and XBRL◦ More accommodative to global comparability issues? ◦ Should Taxonomy guidance issued with new

standards?

For Example

Let’s look at how a company might want to use the US GAAP taxonomy for reporting

“Franchise Fee Revenue”

Step One: Review Accounting Literature

Step Two: Find Franchise Fee Revenue in Taxonomy

Franchise Revenue; not Franchise fee revenue

Note: the 12-05-07 taxonomy has anElement named “InitialFranchiseFees”

Step 3:

Examine the Definition for fitness for use. Does this match your internal definition of the accounting concept?

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Step 4

Check the References

In this case, the taxonomy contains to reference guidance.

However, we did find some guidance in FAS 45. The accountant should review FAS 45 and determine if the definition, label combination will provide the accounting treatment desired.

This is an example of what a practitioner could report to XBRL US during the public review of the taxonomy.

What Can Go Wrong? A company begins the process of producing financial

statements Complies with Sarbanes-Oxley Obtains auditor signoff for the accounting. Process yields an amount for an account called deferred

revenue. The US GAAP taxonomy has a label called “deferred

revenue”. In fact, it has several.

So...What’s an Accountant to do?

All three accounting points of reference need to be assessed:◦ English label

and its associated XBRL label

◦ Definition◦ Reference

What if the taxonomydoesn’t quite cut it?

Follow the preparers guide for creating entity specific extensions

Guidelines should be published soon Make comments to XBRL US for areas your

entity needs additional elements

Public Taxonomy Review Starts December 5th

Feedback on the accounting critical to the success of the SEC’s initiative.

Anyone in the world can comment on the taxonomy.

The unique part of this taxonomy is in the notes and required disclosures

Reviewing the Accounting for Notes and Disclosures If you are an SEC filer, examine your current

SEC filings and dissect each piece of information contained in the disclosure.

After the specific data contained in the note is parsed, compare to the elements available in the US GAAP taxonomy.

Match your reported information to the elements available in the note taxonomy and determine the fit.

Reviewing the Accounting for Notes and Disclosures

If you determine that something is missing or incorrectly stated, file a note with the XBRL US public test website.

Tagging software should be able to assist you in this process soon.

FASB Codification Major multi-year project Purpose is to develop a comprehensive

codification of all existing accounting literature

Easily retrievable database will be maintained

Codification will be immediately updated upon issuance of new standards

The Accounting Impact of Codification The codification project, which will classify all

authoritative GAAP in one place, will alter the way accounting in the US is accessed and used.

The 20 or so sources of current GAAP will become one, rendering all references in the present US GAAP taxonomy to be incorrect.

In 2008, as the authoritative literature is re-organized, so will the references in the taxonomy.

When the codification becomes GAAP, the XBRL taxonomy will be ready.

Conversion or IFRS? The leaders of the IASB, SEC and FASB have

consistently stated that the goal is to create one set of world class accounting standards.

FASB and IASB have been working on improvements to standards since 2002.

The SEC is now accepting IFRS accounting statements from foreign filers.

The SEC has also indicated a willingness to consider allowing US companies to file in IFRS

It’s not a matter of if

But When

And some think IFRS will be the World’s standard within the next 5 years

The Wonderful New World of Accounting All US GAAP accessible in an

understandable format US GAAP modeled in a comprehensive and

robust interactive data format, complete with references and definitions

Complexity in accounting under siege◦ SEC committee◦ FASB conceptual framework and financial

statement presentation projects

The Wonderful New World of Accounting Sarbanes/Oxley PCAOB Emergence of IFRS in the global economy European Union influence XBRL world wide

Accounting Action Points Know your taxonomy

◦ Get familiar with the major components that will effect your reporting entity

Participate in the public testing period◦ Visit XBRL US’s website and take a good look◦ Propose changes and improvements

Create instance documents ◦ test the veracity of the taxonomy

Thank you

Neal J. Hannon

Director, Financial Reporting TechnologiesFinancial Accounting FoundationFASB/GASBnjhannon@f-a-f. org203-956-5219