The Lehman Brothers autopsy is unfolding in full spectacle fashion as Wall Street pores over the sordid details of bad mortgage holdings and some aggressive off-balance-sheet maneuvers—all described in a 2,200-page bankruptcy examiner’s report released late yesterday.

Examiner Anton Valukus, chairman of Jenner & Block, published nine volumes alleging Lehman management played a shell game with the blessing of its audit firm, Ernst & Young, to shuffle $50 billion in troubled assets on and off the books under the noses of investors, regulators, and even the firm’s board of directors.

Valukus concluded the business decisions that led Lehman to crisis may have represented permissible business judgments. “But the decision not to disclose the effects of those judgments does give rise to colorable claims against the senior officers who oversaw and certified misleading financial statements—Lehman’s CEO Richard S. Fuld, Jr., and its CFOs Christopher O’Meara, Erin M. Callan, and Ian T. Lowitt,” the examiner wrote. “There are colorable claims against Lehman’s external auditor Ernst & Young for, among other things, its failure to question and challenge improper or inadequate disclosures in those financial statements.”

The report describes accounting maneuvers dubbed inside Lehman as “Repo 105” and “Repo 108” transactions to move securities off the balance sheet for seven to 10 days at a time. The transactions were meant to look like standard repurchase and resale transactions that are common in investment banking to secure short-term financing, except Lehman accounted for them as “sales” to get the transactions off the balance sheet, the report says.

Through spokesman Charlie Perkins, Ernst & Young said in a statement that Lehman’s September 2008 bankruptcy resulted from “a series of unprecedented adverse events in the financial markets.” The firm notes its last Lehman audit was for the fiscal year ending Nov. 30, 2007.

“Our opinion indicated that Lehman’s financial statements for that year were fairly presented in accordance with Generally Accepted Accounting Principles (GAAP), and we remain of that view,” E&Y said. “After an exhaustive investigation the Examiner made no findings in his report that Lehman’s assets or liabilities were improperly valued or accounted for incorrectly in Lehman’s November 30, 2007 financial statements.”

Compliance Week will provide full coverage of the allegations of misleading accounting in a future edition.

If you were confused over the complexity of derivative and hedging rules as it relates to recent chaos in credit markets, perhaps the latest clarification from the Financial Accounting Standards Board will help clear things up.

FASB published Accounting Standards Update No. 20101-11 – Derivatives and Hedging (Topic 815): Scope Exception Related to Embedded Credit Derivatives to try to clarify how embedded credit derivative features should be treated in such exotic financial instruments as collateralized debt obligations and synthetic CDOs. FASB heard a flurry of questions and confusion over how to treat certain embedded credit derivatives as credit markets tanked and companies struggled with how to value toxic, debt-based instruments such as CDOs and others.

The guidance is intended to address uncertainty over a scope exception that is already provided for embedded credit derivatives in existing hedge accounting rules (specifically, paragraphs 815-15-15-8 through 15-9 of the Accounting Standards Codification). The guidance tries to explain in what kind of contracts the embedded credit derivative scope exception applies and in what kind of contracts it does not apply. The difference is important because in some cases the embedded credit derivative is subject to bifurcation, or extraction from the host contract, so that it gets separate accounting treatment.

The new rule calls out three specific instances where the embedded credit derivative likely still requires separate accounting, despite any apparent exceptions that are provided in Generally Accepted Accounting Principles. The three instances focus attention on establishing where there may be risk and who may be exposed to it.

FASB said it is providing the clarifications and related additional examples to help resolve potential ambiguity about the breadth of the embedded credit derivative scope exception provided elsewhere in GAAP. The guidance is effective for the first quarter beginning after June 15, 2010, with early adoption permitted.

The Internal Revenue Service is launching a comprehensive study built around an exhaustive audit program to determine how fully—or not—companies are complying with employment tax reporting and payment obligations, most notably payroll taxes, fringe benefits, independent contractors, expense reimbursements, and other related payroll issues.

It’s the first such undertaking in 25 years, according to the IRS, prompted by the significant changes that have taken place in business practices with respect to employment tax issues. The Employment Tax National Research Program will begin with 2,000 random audits of taxpayers over each of the next three years for a total of 6,000 examinations.

The IRS said it is doing the study to get a better grip on the compliance characteristics of employment tax filers. The results will be used to gauge the extent to which businesses generally comply with employment tax law and the related reporting requirements. It also will help the IRS identify tax returns with the greatest risk for non-compliance.

The IRS stated two main goals for the study: to compile “statistically valid information” for determining the employment tax gap, or the amount by which employment taxes are underpaid, and to determine what areas of employment tax lead to the most compliance problems.

David Fuller and Jerry Holmes, attorneys at the law firm of Morgan Lewis & Bockius and former IRS managers, said companies selected for the audit can expect it to be painful. According to their description of the audits in a Thompson bulletin, they’re not surprised by the issues the IRS is targeting, but they’re taken aback by the planned scope.

“Even the most conservative taxpayers and those most closely in compliance will not be spared the expense of defending themselves in one of these ‘comprehensive’ audits, since the IRS is trying to collect detailed audit data even from conservative taxpayers,” the pair wrote.

Their inside sources at the IRS said the audits will be “excruciating” and somewhat like seeing a proctologist, Fuller and Holmes said. “While perhaps overly graphic and crude, these descriptions of pain and foreboding lead us to conclude the National Research Project is a tsunami, not a ripple on the sea,” they wrote.

In its alert to employers the IRS advises companies to plan their response carefully should they receive a letter initiating an audit under the research program. The IRS says companies should form an internal team consisting of representatives from payroll, accounts payable, accounting, human resources, internal auditing, general counsel, and outside tax professionals.

As audit regulators review comments on their reworked proposal for seven new risk assessment standards, they’re also getting some pretty forthright advice on how to write audit rules.

Even the U.S. Government Accountability Office has weighed in on where the Public Company Accounting Oversight Board may be inviting trouble with its latest attempt. The PCAOB’s approach “will increase the likelihood of misinterpretations, inconsistent application of the standards, and higher costs for all users with a disproportionate burden on smaller and mid-sized firms,” wrote Jeanette Franzel, managing director in financial management and assurance for the GAO.

The comment period ended earlier this week for the PCAOB’s round-two proposal of seven standards that are intended to steer auditors in a new direction when it comes to assessing and responding to risk of misstatement in an audit of public company financial statements. The concepts behind each of the seven standards focus on audit risk, audit planning and supervision, consideration of materiality in planning and performing an audit, identifying and assessing risks of material misstatement, the auditor’s responses to the risks of material misstatement, evaluating audit results, and audit evidence.

The major audit firms and the Center for Audit Quality commented not only on the proposals, but also on PCAOB’s method for developing the standards. They’re concerned that the PCAOB’s rationale and approach in many ways is simply unclear.

The CAQ, for example, along with most of the major firms, told the PCAOB it needs to provide a better description of how it expects auditor performance to change under the new rules. They’re looking for more detailed comparisons of proposed standards with existing standards, not only of the PCAOB itself but also the International Auditing and Assurance Standards Board and the Auditing Standards Board of the American Institute of Certified Public Accountants. They’re looking for more collaboration and convergence, so auditors can work from a more cohesive set of requirements.

“We request the board consider further enhancements to its standards-setting process that would provide additional visibility to the board’s rationale and expectations for changes to practice,” wrote Cindy Fornelli, executive director of the CAQ.

The PCAOB has not set a timeline for when it will act on the comments to move toward finalizing the new standards. The board issued its first proposal in October 2008 and its second proposal in December 2009.

The Financial Accounting Standards Board has finalized a deferred effective date for investment companies in complying with new consolidation rules intended to bring more assets on to corporate balance sheets.

FASB recently added Accounting Standards Updated No. 2010-10 to its Accounting Standards Codification to defer the effective date of the consolidation requirements of Financial Accounting Statement No. 167, which have been folded into the Codification under Topic 810 Consolidation. The deferral applies only to companies that meet the criteria of an investment company, however, meaning it does not apply to a reporting unit that has either a direct or in indirect obligation to fund any losses that could potentially be significant to the entity.

FASB said the deferral does not apply to interests in securitization entities, asset-backed financing entities, or entities that once held the designation of qualifying special-purpose entities. Those, in fact, are precisely the vehicles FASB had in mind for bringing on the balance sheet when it wrote FAS 167 to curb off-balance-sheet abuses.

After FASB approved the original standard, it started hearing concerns that it produced a different outcome for investment companies than the International Accounting Standards Board likely would pursue for international rules. In addition, and perhaps even more importantly, the new rule also produced some unintended consequences for investment companies, whose investment managers would be required under the new rule to consolidate onto their corporate balance sheets investment funds that they manage.

That’s because the new standard requires consolidation based on a control concept, said Jay Hanson, national director of accounting for McGladrey & Pullen. “That just didn’t make any sense,” he said, so the board agreed to carve investment companies out of the requirement for at least a year while it re-examines how to address the concern.

“The deferral is quite limited,” Hanson said, applying only to entities that have all the attributes of investment companies. Every other entity – where the standard was aimed in the first place – is required to comply with the original effective date, which is for all interim and annual periods beginning after Nov. 15, 2009.

After consulting with staff at the Securities and Exchange Commission, a Center for Audit Quality task force says companies with operations in Venezuela should consider new accounting for those operations because the economy there is considered inflationary.

The Center for Audit Quality issued an alert advising companies with operations in Venezuela they should take a close look at the Venezuelan economy in light of Accounting Standards Codification Topic 830 Foreign Currency Matters. The International Practices Task Force, a sub-committee of the CAQ SEC Regulations Committee, says its analysis of the criteria suggests Venezuela should be considered inflationary for accounting purposes.

That triggers some changes in accounting and financial reporting for companies that have operations in Venezuela, says Carol Banford, managing partner for Grant Thornton. “It’s important because in countries where you have high inflation, the financial statements actually have less and less meaning each year as the inflation increases,” she says.

To keep financial statements relevant, companies with subsidiaries in inflationary economies are required to convert the subsidiary’s results of operations from the local currency to the parent company’s currency to report from a more stable platform, she says. “You use the parent company’s currency to translate the subsidiary’s financial information, so the financial information coming forward for the subsidiary is meaningful and stable,” she said. “You tend to get more realistic information that way.”

With SEC staff’s guidance, the Task Force determined Venezuela should be considered inflationary for financial reporting periods beginning Dec. 1, 2009. Other countries also considered inflationary as of late September include Myanmar and Zimbabwe, while countries on the watch list include the Democratic Republic of Congo, Ethiopia, Guinea, Iran, Iraq, and the tiny island nations of Seychelles and São Tomé and Príncipe.

Banford says the determination likely affects a limited number of companies now, but it does put companies on alert to pay attention to national economies where they operate as countries begin to emerge from recession and economic crisis.

Accounting rulemakers are putting the finishing touches on a report that will update capital markets on their efforts to converge U.S. and international accounting standards.

The Financial Accounting Standards Board and the International Accounting Standards Board are expected to publish the first of what will become a series of quarterly reports to document their progress in making U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards more consistent with one another. The two boards announced in November they would provide quarterly updates on their convergence progress given the implications on some important policy fronts.

For one, the Securities and Exchange Commission has hinged its plan for moving U.S. capital markets to IFRS on the ability of the two boards to eliminate substantial differences between GAAP and IFRS. The SEC published a work plan this week updating where it stands on adopting IFRS in the United States, and the plan focuses on the convergence movement as a key criteria for when and how the Commission ultimately will transition U.S. registrants over to IFRS.

Even further, the Group of Twenty nations are watching the convergence effort, hoping it will eliminate differences in accounting standards that it believes may have played a role in the economic crisis.

A spokesman for IASB said the two boards are expected to issue their first joint quarterly progress report very soon. A spokesman for FASB said the various project updates posted by the two boards demonstrates “quite a bit of progress” in recent months.

“We remain committed to working with IASB,” said spokesman Chris Klimek. “(We) appreciate the SEC’s leadership and additional guidance on this important matter, and like everyone, we will be studying the work plan carefully in the days ahead and discussing what it means for us.”

Public companies now have a new requirement to follow in accounting for events that take place after a financial statement period ends but before the statements are issued.

The Financial Accounting Standards Board published Accounting Standards Update No. 2010-09 to amend Accounting Standards Codification Topic 855, Subsequent Events, which describes how entities should treat “subsequent events.” That refers to significant events that might be of interest to investors taking place after a financial statement period closes but before results of the period are disclosed to investors and regulators.

The new guidance clarifies which entities are required to evaluate subsequent events through the issuance of financial statements and the scope of the disclosure requirements related to subsequent events. FASB adopted the original standard as Financial Accounting Standard No. 165: Subsequent Events before it was folded into the Codification under Topic 855.

FASB developed the standard on subsequent events along with a proposed new standard on going concerns, to update and clarify accounting requirements that have long been observed under auditing standards. While the subsequent event standard was finalized in May 2009, FASB is still deliberating comments and making changes to the going concern proposal, hoping to provide a revised exposure draft before the end of the first quarter.

In an alert to its clients, PricewaterhouseCoopers said FASB amended the guidance to remove the requirement for filers subject to regulation under the Securities and Exchange Commission to disclose the date through which an entity has evaluated subsequent events. That change is intended to assure FASB’s requirement is consistent with current SEC guidance, PwC said.

The board says the new guidance on subsequent events has the potential to change reporting for both public and private companies, but the nature of any reporting changes will depend on how companies have treated subsequent events under old literature.

The guidance is effective immediately for any entity subject to the requirements of U.S. Generally Accepted Accounting Standards, except conduit bond obligors, who will be required to apply the guidance for fiscal years ending after June 15, 2010.

Audit regulators are putting down early notions that a new rule on internal reviews requires copious documentation.

The Public Company Accounting Oversight published a single question and answer addressing implementation of Auditing Standard No. 7: Engagement Quality Review addressing the new standard’s documentation requirements. The Securities and Exchange Commission called for the guidance when it approved the new standard in early January.

AS7 replaces earlier professional standards established by the American Institute of Certified Public Accountants for how audit firms should review their audit work internally before publishing their audit reports. The standard provides more rigorous requirements for all accounting firms auditing public company financial statements to review engagements internally in the hope that it will reduce audit deficiencies before reports are issued.

The PCAOB developed the standard in response to observations by inspectors that audit firms weren’t putting enough elbow grease into the internal review process, causing audit reports to be issued that should have been cleaned up internally before they were issued. Critics of the new standard worried the new requirements would lead to redundant audit work, driving unnecessary audit costs for public companies.

The standard is in effect for audits of interim and annual periods beginning after Dec. 15, 2009. When the SEC issued its order approving the new standard, it instructed the PCAOB to provide implementation guidance to address questions about how much documentation should be provided to comply with the review standard.

The resulting guidance addresses a single question in less than three pages. It says audit firms should not read language in the release adopting the standard to mean that they are required to provide documentation of all the interactions between the engagement quality reviewer and the engagement team, including those that take place before an audit deficiency is identified.

Instead, the PCAOB says, the new standard focuses on how to document interactions once a significant engagement deficiency is identified. The documentation should contain enough information “to enable an experienced auditor, having no previous connection with the engagement, to understand the procedures performed by the engagement quality reviewer, and others who assisted the reviewer, to comply with the provisions of this standard,” the PCAOB wrote.

Facing a tidal wave of new accounting requirements that are coming on board, a committee of Financial Executives International is appealing to rulemakers to think carefully about when and how a host of new standards will take effect.

Arnold Hanish, chairman of FEI’s Committee on Corporate Reporting and chief accounting officer at Eli Lilly, wrote to the chairmen of the Financial Accounting Standards Board and the International Accounting Standards Board to ask them to consider the big picture as they set effective dates for some substantial new accounting requirements.

Hanish was referring specifically to FASB’s and IASB’s projects on financial statement presentation, leases, pensions, revenue recognition, financial instruments, and liability and equity, all of which are key to the two boards’ efforts to converge U.S. Generally Accepted Accounting Standards with International Financial Reporting Standards.

The boards are acting under a tight timeline to seek convergence on some key areas in the two accounting rulebooks by mid-2011, in part to satisfy the Group of Twenty nations that identified differences in accounting standards as at least a contributing factor to the economic crisis.

Hanish called on FASB and IASB to “deliberate the effective dates and transition of the major convergence standards holistically, rather than on a standard-by-standard basis,” he wrote, to reflect how significant the transition will be for companies adopting the new standards and how interrelated some of the new requirements will be.

In his letter, Hanish described some of the interdependencies among the new requirements that will impact how companies will implement them. New requirements for financial statement presentation, for example, will impact what information must be gathered, which will have an impact on other convergence standards. Likewise, a new definition for a liability will impact what types of assets and liabilities would be accounted for under a new standard for financial instruments, he wrote.

As such, Hanish called on the boards to consider an aggregated effective date for the final converged standards with a three-year implementation period, giving companies the option to adopt early if they’re prepared to do so. “Providing adequate time for the body of converged standards will allow companies to thoughtfully identify the impacts, develop approaches that respond to the change, implement and test solutions, and conduct the necessary training to impacted internal and external individuals specific to their company and industry needs,” he wrote.

FASB and IASB continue to make substantial progress on the core convergence standards, meeting monthly in extensive sessions to reach dozens of preliminary decisions. The boards expect to issue an exposure draft on a new method of financial statement presentation in April 2010.

They’re also identifying areas, however, where they can’t agree and will issue standards that differ. In the financial statement presentation project, for example, FASB plans to require entities to disclose operating assets, liabilities, and cash flows by reportable segment while IASB will not require such a breakdown. IASB meanwhile plans to require the presentation of net debt information as part of the analysis of change and will include minimum line item requirements for the statement of financial position while FASB will not.