CFA Institute would tighten financial-reporting standards

Oct 31, 2005 @ 12:01 am

By Sara Hansard

WASHINGTON - The organization that set the gold standard for how mutual fund companies report fund performance wants rulemakers to require public companies to put more of their financial obligations on their books, including pension debt.

On Oct. 24, the New York-based CFA Centre for Financial Market Integrity presented model financial-reporting standards to a joint meeting of the Financial Accounting Standards Board and the London-based International Accounting Standards Board. The meeting took place at the FASB's headquarters in Norwalk, Conn.

The two standards boards are working together to update accounting rules and make U.S. and international accounting standards more compatible. Many of the ideas endorsed by the CFA Centre, which is the policy and advocacy arm of the Charlottesville, Va.-based CFA Institute, are being considered by the two accounting-standard-setting organizations.

The CFA Institute, formerly the Association for Investment Management and Research, administers the chartered financial analyst designation. Although it has no legal authority, the group was instrumental in changing performance reporting for mutual fund and investment advisory companies in the 1990s by creating a series of best practices that were widely adopted by institutional investors, and later by the industry.

Not asking much

Some of the CFA Centre's objectives go beyond what the standards boards are considering.

However, "We're not asking for things that companies can't do right now," said Rebecca McEnally, project director of the Comprehensive Business Reporting Model and director of the CFA Centre's capital markets policy group. "We're asking for practical changes that companies can actually implement, should they choose to do so."

The goal of the new standards is to be more useful to investors, said Ms. McEnally, who works in Charlottesville. The standards in effect at about 15,000 U.S. public companies leave out much information that would be relevant to investors, she added.

"If I own common shares in a major U.S. company, I'm not entitled to a dividend until every creditor, preferred shareholder [and] debt holder is taken care of," Ms. McEnally said.

"If you think about me when you're preparing financial statements, you need to recognize all of those prior claims in the financial statements. They currently do not do that."

One of the most important examples of that, she said, is the fact that pension obligations aren't included on company balance sheets. "Pensions are frequently, for companies, the biggest obligation or debt," Ms. McEnally said.

But lobbyists for companies that offer defined benefit pension plans warned that when Great Britain adopted such a pension system, it contributed to a decline in defined benefit plans.

The issue is: "If you change the accounting treatment, do you undermine the policy incentives for plan sponsors to stay in the system," said Lynn Dudley, vice president of retirement policy for the American Benefits Council in Washington.

Other examples of items that the CFA Centre wants included on the balance sheet are financial obligations for operating leases, securitized assets and receivables.

Companies frequently issue debt based on securitized assets and receivables, but that debt isn't on the balance sheet, Ms. McEnally said.

In addition to adding such big-ticket items to company balance sheet reports, the CFA Centre also wants all balance sheet items to be measured at fair value. The FASB has implemented a controversial rule that requires companies to value stock options at fair-market value, but fair-value standards haven't been set as a principle for all balance sheet items.

The standards board is expected to issue a fair-value principle later this fall.

"If you go to buy a car, you don't care what it cost five or two years ago," Ms. McEnally said.

Debt bonds issued by companies are among the largest items that aren't required to be valued at current market worth.

In addition, the CFA Centre is calling for a direct-method cash flow statement that would give more detail about operating inflows and outflows. That would include what was paid for investments; whether investments are in marketable securities or property, plant and equipment; whether stock has been sold for cash; whether new debt has been issued for cash; or whether debt has been paid off.

Currently, operating cash flows reported by companies don't include those details, nor do they show what companies pay in expenses for things such as

employee salaries, how much is collected for selling goods and services, or management's estimates about how much will be

collected from credit sales. Operating cash flows show only net changes at the end of a year.

"Kudos for CFA to speak up and share their views on what they believe is needed on financial reporting," said Dan Noll, director of accounting standards for the American Institute of Certified Public Accountants in New York.

"I dare say we'd also like to hear from other investor users of company reporting, as well as lenders," he said.

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