The Public Company Accounting Oversight Board is getting a little more direct about where it is being denied the access necessary to complete international inspections—and resistance seems most pronounced in the European Union and China.

In an effort to be upfront about how far behind the international inspections are falling, the PCAOB said it conducted inspections in only 15 of the 27 countries where it planned to perform overseas inspections in 2009. “Access to information necessary to conduct inspections was, and continues to be, denied in China, Finland, France, Germany, Greece, Ireland, the Netherlands, Norway, Portugal, Sweden, Switzerland, and the United Kingdom,” the PCAOB said in a statement.

So in lieu of publishing inspection reports, the board published a list of 52 firms that are auditing financial statements issued in U.S. capital markets but have not been inspected in at least four years. The board’s rules require that all audit firms performing fewer than 100 audits annually must be inspected at least every three years.

Most of the 52 firms that have not been inspected are affiliates of Big 4 firms Ernst & Young, Deloitte & Touche, KPMG, and PricewaterhouseCoopers. A few are affiliates of second-tier firms Grant Thornton and BDO Seidman. All 52 firms are located in countries of the European Union, China, or Hong Kong.

The PCAOB first indicated it was having trouble getting international inspections completed when it sought an adjustment in the rules regarding when firms were due to be inspected. The board promised it would prioritize its inspection schedule to target firms that audited the greatest amount of market capitalization, but it was unable to reach at least two of the highest priority firms under that criteria in 2009.

The board identified 33 countries where inspections have taken place through 2009 and 28 countries where it wants to perform inspections in 2010. The dozen countries that the PCAOB identified as having restricted access so far are all on the 2010 wish list. Greece and Ireland are the only European Union countries where the PCAOB has completed inspections.

The Financial Accounting Standards Board and the International Accounting Standards Board reached some key agreements this week to finalize a proposed new approach for explaining income information to investors.

The two boards reached some verbal agreements in their joint project on how companies would be required—or in some cases allowed—to present information in a “statement of comprehensive income,” a new financial statement that would replace the existing income statement.

The idea is to provide a more comprehensive view of an entity’s income, in part to scuttle the almighty reliance currently placed on the “net income” figure that becomes the bottom line on existing income statements. The new statement is aimed at giving a more balanced view of not only profit-and-loss figures but also other comprehensive income, which reflects gains and losses that have not yet been realized. That often includes things like gains or losses on securities or derivatives, pension costs, or foreign investments and currency hedges.

At a joint meeting, the two boards agreed that an entity would be required to display total comprehensive income and its components in the new statement of comprehensive income, but it will have some flexibility to name the two key sections. One section has to display profit-or-loss figures, and the other has to display other comprehensive income as it is defined in current accounting standards.

The boards agreed they’ll retain existing requirements that give entities an option to display components of other comprehensive income before or after related income tax expense has been factored in, but they have to provide one amount for the aggregate income tax effects on the face of the statement. Entities can decide if they will link income tax effects related to each component of other comprehensive income on the face of the statement or in the footnotes.

The new standard will not redefine what goes into other comprehensive income or what goes into each of its components, the boards determined. Staff at FASB and IASB are preparing the draft standard that will be voted on by both boards. The boards are projecting an exposure draft to be published at the end of the first quarter.

Restatements and material weaknesses took a sharp dive in 2009, but it’s not entirely clear whether that means companies are making fewer mistakes or just catching and reporting fewer mistakes.

In 2009, only 75 companies with markets capitalizations of at least $250 million restated their financial statements, according to data from Glass Lewis & Co. That’s fewer than half the 172 companies that restated in 2008—and even that was a steep drop from the 334 that restated in 2007. Glass Lewis said the 2009 figure represents the lowest restatement rate since 2001, when massive corporate frauds at Enron, WorldCom and others began a whirlwind of accounting clampdown and restatements.

The number of companies reporting material weaknesses also dropped considerably to 69 in 2009 from 193 in 2008 and 325 in 2007. Only 87 companies in 2009 received adverse opinions on internal controls from their external auditors, down from 202 in 2008 and 263 in 2007.

Lower numbers in restatements and material weaknesses could indicate companies are producer cleaner financial statements, but it could also mean they’re just not finding or reporting mistakes, Glass Lewis said. “Unfortunately, I don’t think there’s a definitive way to tell ahead of time whether companies and auditors are missing anything,” said Research Analyst Mark Grothe. “You have to wait and see if they discover and report any errors in the future that they should’ve known about today.”

Corporations and their auditors are operating under relaxed standards for assessing and auditing internal controls over financial reporting, with the earlier, more rigid Auditing Standard No. 2 replaced by guidance for management from the Securities and Exchange Commission and a more risk-based Auditing Standard No. 5.

“Obviously if the standards were still the same for internal-control audits, materiality thresholds and correcting errors, it would be easier to attribute the declines to better financial reporting,” said Grothe. “But the fact that all of these have been relaxed gives credibility to the argument that executives and auditors are just missing things.”

The Securities and Exchange Commission has pondered the meaning behind lower numbers of restatements and material weaknesses. “Observations from annual reviews of registrants’ disclosures of material weaknesses make me wonder whether registrants and auditors are identifying and reporting all material weaknesses,” said Doug Besch, SEC professional accounting fellow, in a speech to the American Institute of Certified Public Accountants in December.

Glass Lewis also examined the rate of auditor turnover, which often is associated with accounting disputes that lead to restatements and material weakness disclosures in later periods. The firm said 62 companies changed auditors in 2009, down 33 percent from 2008. Big Four firms picked up a net of 16 new audit engagements, likely because the firms have more “bandwidth” to take in more work now that internal control audit work is maturing.

More key findings from the firm’s research:
• Expense recognition, mis-classifications, and taxes remained the most common error type.
• Last year, companies delayed 115 financial reports, down 58 percent from 2008.
• In the fifth year of Sarbanes-Oxley Section 404(b) audits, the 87 adverse opinions given by auditors represents a 78 percent decline from the first year.
• The percentage of companies with ineffective controls fell to 2 percent in 2009 from 6 percent in 2008.

The Financial Accounting Standards Board has decided to go ahead with a proposed deferral for certain elements of its new consolidation requirements. The final Accounting Standards Update is being drafted by FASB staff and is expected to be published in mid-February.

At a regular weekly meeting, the Board reviewed comments to its proposed update, Consolidation (Topic 810): Amendments to Statement 167 for Certain Investment Fund, which would defer the effective date of FAS 167. That’s the accounting standard FASB adopted along with FAS 166: Accounting for Transfers of Financial Assets in the wake of financial crisis to bring more off-balance-sheet activity on to corporate balance sheets. (Both are now found in the Accounting Standards Codification under Topic 860 Transfers and Servicing and Topic 810 Consolidation.)

The one-year deferral is being granted for interests in entities that have all the attributes of an investment company as specified under existing guidance under Topic 946 in the Codification and where it is industry practice to apply the financial reporting measurement principles found in the same guidance.

FASB expects the deferral to apply most significantly to those in the investment management industry, but it is not intended to apply for interests in securitization entities, asset-backed financing entities, or entities that formerly considered “qualifying” special purpose entities. The Board plans to provide details in the final Update on what qualifies for the deferral and what does not.

FASB agreed to consider the deferral in the interest of convergence with international accounting rules. The International Accounting Standards Board is working on a similar project to bring more off-balance-sheet instruments on to corporate balance sheets, but it was reaching some different conclusions about how to address funds directed by investment managers. FASB agreed to set the requirements aside for now for those funds while the two boards work on a more comprehensive solution for both U.S. and international rules.

The Internal Revenue Service is planning to require corporate taxpayers to provide brief descriptions of their uncertain tax positions along with the maximum amount of tax exposure if those positions are not sustained.

IRS Commissioner Doug Shulman, in a speech to the New York State Bar Association, said the IRS is looking for ways to make its audit and examination processes more efficient. “It would add efficiency to the process if we had access to more complete information earlier in the process regarding the nature and materiality of a taxpayer’s uncertain tax positions,” he said, according to his prepared remarks.

The new disclosure requirement would cut to the chase, he said, helping the IRS “prioritize selection of issues and taxpayers for examination.” The IRS published the eight-page proposed disclosure requirement and is seeking taxpayer comment on it through March 29.

Shulman said it would apply to corporate taxpayers with assets of at least $10 million who prepare financial statements that are subject to Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes, now found in the Accounting Standards Codification under sub-topic 740-10 on Income Taxes.

FIN 48 took effect in 2007 requiring companies to disclose in their financial statements where they may have some uncertainty about positions they’ve taken on their corporate tax returns. Corporate taxpayers challenged FIN 48 vigorously, claiming it provided the IRS with a roadmap to perform the tax audit.

The IRS disclosure requirement would compel companies to provide with their tax returns a “concise description” of those positions, along with the maximum amount of U.S. income tax exposure if those positions are not sustained under a legal challenge. “By concise, we mean a few sentences that inform us of the nature of the issue, and not pages of factual description or legal analysis,” Shulman said.

The IRS announcement points out that case law has given the IRS the right to ask for more detailed information about the analysis that goes into corporate tax returns and uncertain tax positions, especially by asking for the tax accrual work papers that form the basis for establishing corporate tax positions.

“We could have asked for more—a lot more—but chose not to,” Shulman said. “We believe we have crafted a proposal that gives us the information we need to do our job without trying to get in the heads of taxpayers as to the strengths and weaknesses of their positions.”

The proposal does not require companies to disclose their risk assessment or the amounts they’ve reserved to pay taxes in case they might lose a particular tax argument, Shulman said. It also does not change the IRS “policy of restraint” with respect to asking for the work papers, he said. Instead, the disclosure requirement focuses on maximum exposures “so we can allocate our exam resources appropriately,” he said.

“We do not believe we will be adding substantial new work or burden on taxpayers,” he said. “These taxpayers are already required to establish tax reserves for uncertain positions in determining their financial statement income under U.S. or foreign accounting standards, such as FIN 48. So the work is already being done. We are asking for more transparency.”

Where companies are required to measure assets and liabilities at fair value, they’ll have some new disclosures to provide regarding changes in how they measure those values.

The Financial Accounting Standards Board has finalized Accounting Standards Update No. 2010-06 to amend Accounting Standards Codification Topic 820 in a way that elicits new disclosures about how fair value is measured and synchronizes the disclosure requirements with international rules. It takes effect for the 2010 reporting year for calendar-year companies.

The new rule requires companies to disclose where they transfer items in and out of “Level 1” and “Level 2” measurement methods under the three-level hierarchy for measuring fair value. Level 1 measurements rely solely on objective market evidence of fair value, while Level 2 measurements are based on a mixture of market evidence and internally development assumptions or estimates.

The new rules also require companies to describe activity that takes place in Level 3 measurements, where fair values are established based solely on models and other internal estimates and assumptions. For instruments measured at Level 3, companies will be required to present separate information, not final net numbers, on purchases, sales, issuances, and settlements.

David Larsen, managing director for Duff & Phelps, said the update clarifies that fair-value measurements for major classes of assets and liabilities should be disclosed separately. It also clarifies the required disclosure of the techniques and inputs companies use to estimate fair value, he said.

“The update will require some additional effort by companies to prepare,” said Larsen. “However, all required data should be readily available.”

The final rule does not include any new requirements for a “sensitivity analysis,” said Larsen, or disclosure of the impacts if the company were to use other possible alternative inputs. FASB proposed some requirements around sensitivity analysis but dropped the requirement from the final guidance.

Larsen said FASB and the International Accounting Standards Board are working jointly on how to harmonize fair-value requirements, including whether and how to require some kind of sensitivity analysis.

As they promised, accounting standard setters are stepping up the pace and length of dialogue on some of the most vexing accounting issues in hope of achieving common approaches to U.S. and international rules sooner rather than later.

The Financial Accounting Standards Board and the International Accounting Standards Board met in London for an all-day and two half-day sessions this week to wade deeper into how to get converged standards on fair value measurement, leasing, revenue recognition, financial instruments, consolidation, derecognition, and financial statement presentation. They also worked through issues related to hedge accounting, discontinued operations, insurance contracts and post-employment benefits.

The two boards promised the Group of Twenty leaders they will pick up the pace of standard setting to narrow the differences between International Financial Reporting Standards and U.S. Generally Accepted Accounting Principles. The Financial Crisis Advisory Group reported to the G20 that weaknesses and differences in accounting standards were at least a contributing factor to the financial crisis that brought chaos to the global economy.

With respect to fair value, the boards decided to retain a notion that fair value is the same as an exit price in a hypothetical transaction, but they didn’t discuss or decide how to address gains or losses that might arise when a live transaction is different from the fair value of the transaction. They agreed that the fair value of a liability includes the effect of nonperformance risk, and that they will provide clarification on what that might include besides just credit risk.

As for revenue recognition, the boards tentatively decided they will require entities to disclose the nature of contracts and related accounting policies, the principal judgments involved, a reconciliation of beginning and ending net contract positions, a total amount of outstanding performance obligations as well as the expected timing for their resolution, and information about onerous contracts.

The two boards will meet jointly again five times in February via videoconfernce.

The Securities and Exchange Commission has approved a new auditing standard on engagement quality reviews, clearing the way for the standard to take effect for audits of 2010 financial statements.

Auditing Standard No. 7, Engagement Quality Review, establishes a new, more rigorous approach for audit firms to follow in reviewing their own audit work internally before issuing audit reports. It was developed and adopted by the Public Company Accounting Oversight Board to beef up the traditional “concurring partner” review, which audit firms have long performed internally as a professional practice.

AS 7 will take effect for audits on interim periods and fiscal years beginning on or after Dec. 15, 2009. In approving the new standard, the SEC suggested the PCAOB consider offering some implementation guidance, especially regarding new documentation requirements. The PCAOB said such guidance will be published “in the near future.”

The SEC received only nine comments on the proposed standard, most generally supportive, but a few raising questions about documentation requirements and other details. The SEC said it didn’t find anything inconsistent between the new standard and existing requirements. “However, since several comments were related to this point, we encourage the PCAOB to provide further implementation guidance on the documentation requirement,” the SEC wrote in its adopting release.

The PCAOB’s acting chairman, Daniel Goelzer, said the standard represents an important milestone in the PCAOB’s mandate to improve auditing under Sarbanes-Oxley. “This standard should improve the reliability of audited financial statements by increasing the likelihood that reviewers will identify significant engagement deficiencies before audit reports are issued to the investing public,” he said in a statement.

Martin Baumann, chief auditor for the PCAOB, said a well-performed engagement quality review “can serve as an important safeguard against erroneous or insufficiently supported audit opinions.”

The PCAOB developed the standard because it found in audit firm inspections that firms generally were not performing adequate internal reviews on audit engagements before issuing their audit reports. Reaction to the initial proposal raised concern that prescriptive language would compel audit firms to regard the review process as, in essence, a second audit. The PCAOB revised language through the comment and deliberation process to guard against such a result.

The Emerging Issues Task Force of the Financial Accounting Standards Board is looking at some accounting changes that will have potentially dramatic consequences for insurance companies’ earnings, credit ratings, and financial leverage.

The Georgia Tech Financial Analysis Lab wanted to foretell the possible impact of the EITF’s plan to recommend that insurance companies should expense rather than capitalize certain costs associated with getting new insurance business. The EITF is looking at recommending new guidance in Issue No. 09-G, “Accounting for Costs Associated with Acquiring or Renewing Insurance.”

To ascertain the possible impact, the Georgia Tech lab studied 2007 and 2008 financial statements for 28 entities that would be affected and determined the rules would boost their average ratio of liabilities to equity, a key metric of financial leverage, from 9.88 to 63.91. That would be enough to damage credit ratings and require infusions of new equity, the study determined.

While leverage generally would increase under the proposed new approach, the result for pre-tax earnings is not as consistent. The proposed rules generally would require companies to expense rather than amortize certain acquisition costs, which intuitively suggests a reduction in earnings, says Charles Mulford, director of the Georgia Tech research operation and author of the study.

Some entities in fact would see declines in pretax income of 20 percent or more, but some would see similar increases in pretax income, he says. “We found plenty that would report lower earnings, but some would report higher earnings,” he adds.

Mulford says the primary objective of the research was to ascertain whether a change in accounting rules would have a material impact for affected companies. “When it comes to the balance sheet, we find significant reduction in assets and shareholder equity pretty much across the board,” he says. “The impact on financial leverage is quite dramatic.”

If FASB is looking for other instances where acquisition costs are capitalized, it might also take interest in the retail practice of capitalizing certain marketing costs related to direct response advertising. Currently, retailers who mail coupons and catalogs, for example, are allowed to capitalize those costs if they have historical evidence that they lead to revenue, says Mulford.

Some companies are still struggling with new requirements for pension plan disclosures, prompting PricewaterhouseCoopers to publish some guidance of its own to help clarify things.

The Financial Accounting Standards Board adopted a staff position in late 2008 now found in the Accounting Standards Codification at ASC 715-20-50 describing expanded new disclosure requirements about investments and other assets that are funding pension and other post-employment benefit obligations. The new disclosure requirements took effect Dec. 31 for calendar year-end companies.

PwC says the economic environment has caused a number of employers to take actions such as freezing plans that trigger requirements to remeasure plan obligations and plan assets—and the timing of those requirements can vary depending on the specific circumstances at play. That has led to a lot of questions, says PwC Partner Murray Akresh. “Getting the accounting right for the plan freeze is sometimes complicated,” he said.

Companies also are finding a lot of complexity around how to make proper disclosure for plans that are offered and administered in various different countries. “They have to get this new information not only for their U.S. plans, but also their foreign plans, summarize it, and draft up the new disclosure requirements,” he said. “It’s a pretty quick timetable for companies. There are a lot of things to do in a short period of time. It’s a lot of new information.”

Akresh said companies are encountering problems not only in gathering the data they need to prepare the new disclosures, but also questions about how to present it. Companies have some latitude to use their own judgment, he said, “so it take some thought by companies about how to use that judgment.”

The 15-page PwC guidance covers plan disclosure requirements, interim re-measurements, assumptions, accounting changes, valuation of plan assets, and changes brought about with the Pension Protection Act.