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Change Agent

Robert Herz discusses FASB's priorities, the road to convergence and changes ahead for CPAs.

Journal of Accountancy | February 2008

Robert Herz has led FASB through a period of tremendous change in the accounting profession. The former PricewaterhouseCoopers chief technical partner took the helm at FASB on July 1, 2002, just weeks before the Sarbanes-Oxley Act was signed into law. Within four months of his arrival, FASB and the International Accounting Standards Board (IASB) would ink the Norwalk Agreement, committing to develop a single set of accounting standards that could be used internationally for domestic and cross-border financial reporting. Early in his tenure, Herz also set a goal of simplifying and improving U.S. GAAP.

In July 2007, Herz was reappointed to a second five-year term as FASB’s chairman. He spoke recently with the JofA about simplifying accounting standards, the need for a national blueprint for convergence and the future of FASB. What follows are excerpts from that conversation.

JofA: You testified before Congress in October about the need to have a national blueprint for convergence. Tell us about your vision for that blueprint.

Herz: What I said on Capitol Hill is what’s reflected in the joint comment letter from FASB and our FAF trustees. It stems from the belief that we should get to the ultimate goal, at least for public companies, of common, high-quality financial reporting across the global capital markets. We’re driven by that end goal for public companies and maybe for certain other publicly accountable entities—banks, insurance companies and other similar entities.

And in thinking about that issue, the SEC asked an open-ended question about how, once they drop the requirement for foreign issuers to reconcile to U.S. GAAP, which they have now done, should IFRS also be permitted for U.S. registrants?

Our answer was well, that may be one question, but it is not the entire question. To us, the right question is, “How do we get to the goal of the single set of high-quality international standards that we and the IASB have been working toward?” In that regard, we think that a “Pax Americana” in financial reporting where everybody around the world does U.S. GAAP is not on the table. Ten years ago, people talked about that. But the world’s moved on.

So it’s likely to be IFRS. But, in our view, it needs to be what we call “improved IFRS” because there are some very critical issues relating to the IASB and IFRS that we feel need to be addressed. If we’re going to ride the IASB and the IFRS horse, we want to make sure that it’s as good as it can be. We want to make sure that the IASB is strong, is independent, is well resourced, and is properly funded in a broad-based and secure way.

There are currently gaps in IFRS in certain areas. And just like U.S. GAAP, IFRS needs improvement in a number of major areas, which are the subject of our joint projects with the IASB. And there are issues relating to the emergence of national variants and “as adopted” versions of IFRS.

Assuming that those important international issues can be satisfactorily resolved, we say in the U.S., rather than just giving public companies an open-ended choice between U.S. GAAP and IFRS, we need to have an end game in mind. To get to that end game, we need to have what we call a blueprint, or a national plan.

We need to get the right parties together and create this blueprint on how to get it done in this country. Once you understand all the issues and steps, you can then set target dates for transitioning our reporting system. It might be all in one wave, it might be more than one wave—staggered to allow for learning and to deal with system capacity issues. It might allow for some early adoption in certain circumstances.

Another important part of the blueprint is what do we do about private companies and not-for-profits, because right now under U.S. GAAP, we have a vertically integrated system. I think people agree with that. If U.S. public companies were to go to IFRS, what would we do about the private companies and not-for-profits?

JofA: What do you think we should do about private companies?

Herz: Well, a couple things. One is that part of the blueprint ought to be the IASB and FASB completing most, if not all, of our joint projects in major areas. If we do that, U.S. GAAP and IFRS will be much closer, so there would be fewer differences and the transition would be less costly and complex. But to the extent that there are remaining differences, we are going to have to deal with that and whether private companies would also go to IFRS.

IASB is in the process of developing a small- and medium-enterprises set of standards. And we’ve asked the Private Company Financial Reporting Committee to monitor that and provide input into that.

I don’t know the exact answer. What I know is that in order to make an effective and orderly transition, there needs to be a process.

JofA: What do you think is a realistic time frame for convergence if we’re looking at an improve-and-adopt plan based on IFRS?

Herz: I’d say, if everything went absolutely right, it’s a minimum of five years. But things never go absolutely right. Most countries have allowed for four or five years. And in the U.S., we have probably more issues and more complicated issues than almost anybody else.

JofA: Has the board discussed what FASB’s role and mission would be in a converged world?

Herz: We’ve discussed possibilities, but that will have to be for further discussion, not just by us. Clearly the SEC would have to be a key party. We think that U.S. constituents would have to be very much engaged in that. But there are different possibilities.

One possibility is we do like the Accounting Standards Board in the U.K. and certain other national standard-setters—they are still there even though their countries have adopted, for public companies, IFRS.

They are still there because while some countries have adopted IFRS for public companies, they still have a local GAAP for private companies, not-for-profits, and in some cases, governmental entities. They are also still there because they provide national input and resources to the global process and help with the implementation of the global process in their country. So that’s one possibility.

Another possibility—and this is just something that seems to me would be a natural concomitant of the IASB being the recognized global standards-setter—is they are going to need a presence and resources on the ground in the major capital markets around the world.

One of the things I think people like and respect about us is they’re able to readily engage us. So there may be a concern that with the IASB being in London, if they’re only in London and have no people locally, that it’s harder to do that. And so you can envisage the IASB of the future having a branch here with staff and some board members who reside here, maybe one in Japan, maybe one in China. So that’s another possibility, both are possibilities.

JofA: Which path do you favor?

Herz: I think first we need to decide where this country’s going in that whole regard. The SEC could say, “We think broad choice is just fine. No end game. Just let the market decide between GAAP and IFRS.”

I’m not in favor of that personally. I think a two-GAAP system for U.S. public companies would just add immense cost and complexity to our already-complicated system, but the SEC could say that. In which case, our agenda, what we do, how long we’re around in our current form, could be many years.

JofA: Convergence brings to the forefront concerns about the cost of reworking tax accounting systems and the consequences for the U.S. tax code. The AICPA has taken the position that LIFO should continue to be an option for tax purposes even if U.S.-based companies issue their primary financial statements in IFRS, which does not allow LIFO. What are your thoughts?

Herz: That is one issue among many issues in moving to IFRS—that we have the tax conformity requirement—and that would need to be dealt with because there are a number of major U.S. companies that are on LIFO and the consequences of coming off LIFO, depending on how it was done, could cost them hundreds of millions or billions of dollars. So that’s an issue that would have to be addressed.

I’m not enough of a tax expert to say whether the LIFO method of accounting for taxes is a good way of adjusting for inflation. Other countries have other tax methods of providing some relief from inflation.

JofA: What results do you hope to see from the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR) led by Robert Pozen?

Herz: The overall objectives are to come up with some workable recommendations that are practical to implement and that could have a real impact on improving our reporting system and making it less complex. This is a very important effort.

I also think they need to weigh in on convergence. I think it’s almost impossible to think about what to do with the U.S. reporting system and divorce it from all that’s going on in convergence and the potential use in this country of IFRS. I believe they will be thinking about that soon.

JofA: One recommendation that has come out of the SEC advisory committee in the early stages is discussion of a decrease in the use of industry-specific guidance. What do you think of that strategy?

Herz: That, I think in part, came out of speeches I made last spring. I believe that we have too much industry-specific guidance in the U.S. Some of it’s outdated, and some of it’s fitted to industries that have begun to converge. I agree with their preliminary view that accounting ought to be more around activities, not industries.

You can have the same activity done by an insurance company, a bank, an investment company, a securities broker/dealer and you may have four different methods of accounting. And that’s got to add to complexity. A lot of it emanated from different revenue recognition methods for specific industries. And that’s why our revenue recognition project with the IASB is very important. It could help a great deal.

JofA: What role does the Private Company Financial Reporting Committee play in the standard-setting process?

Herz: The committee was created to see whether or not, based upon either clear cost/benefit considerations or clear differences in the user preferences in that market, there ought to be some differences in standards for public and private companies.

We’re looking for them to have good discussions, a robust process. Providing they do that, it’s our responsibility and commitment to take their recommendations seriously.

JofA: Do you believe there’s a need for an industry-specific framework, such as the one being developed by the Enhanced Business Reporting Consortium, to serve as the basis for taxonomy development for information not captured in the primary financial statements and notes?

Herz: Well, go back to my former incarnation. Seven or eight years ago, while at PricewaterhouseCoopers, I wrote with three other people “The Value Reporting Revolution.” It’s all about EBR and reporting of key nonfinancial information. EBR took the value reporting work that had been done by PwC and further developed it.

I strongly believe that financial reporting is very important because it is the end result of your performance, but to understand a company’s performance and also understand where the company is going you need more than financial reporting. You need EBR. You need the key nonfinancial performance indicators. You need to put those in the context of the company’s strategy. Those will give you a much richer idea of what’s going on in the company and also those are often leading indicators to its future financial performance.

JofA: What changes are coming with regard to employers’ accounting for the effects of defined-benefit pension plans?

Herz: Well, we did phase one where we, in our terms, fixed the balance sheet. The big question is where to go now. The IASB is also working on that and they’re going to come out with a discussion document next year with some of their thoughts on the next steps, and we’re following that.

But the big issues are what to do in the income statement. Statement no. 158 left the whole recycling, the whole Rube Goldberg model in place for the income statement. Do we get rid of it completely? Do we change it so it’s less Rube Goldberg, so that it’s simpler?

A lot of that is interwoven with our project on financial statement presentation, where we’re proposing dividing the financial statements between business, investing and financing activities.

So you could, for example, contemplate an income statement in the future that has the annual service cost in the business or operating section, the interest cost on the accretion of the pension obligation in the financing section, and the movement in the value of the plan assets in investing activities.

There are also issues around cash-balance plans, which increasingly are becoming the predominant form of defined-benefit plan. Some people believe there are some real issues there with how the accounting is done currently. There are also issues around multi-employer plans. Some believe participating sponsor companies are in for dramatically increasing costs that are not currently transparent to investors.

JofA: Talk about changes you see coming with regard to accounting for leases.

Herz: Well, we have a major joint project with the IASB on that. The approach we’re looking at is what’s called a rights-and-obligations approach. It is a different way of thinking, saying that instead of trying to get either/or type classifications, all-or-nothing type accounting around bright lines in order to determine who is the substantive owner of the equipment—the lessor or the lessee—let’s just account for the actual rights and obligations created by the leasing arrangement.

Suppose you had leased a large piece of equipment and the lease says you will lease the equipment for 10 years, and you’ll make 120 monthly payments to use the equipment for the 10 years.

Under this approach what you have is an asset, that is, a right to use the equipment for 10 years, and you have an obligation to make 120 payments, and let’s put those both on the balance sheet rather than trying to make an all-or-nothing determination as to who substantively owns the underlying equipment.

Now the devil’s going to be in the details because my example of that lease is a highly simplified one. It has no renewal options, no contingent rents, no other fancy bells and whistles that are often in leasing arrangements, so we’re going through those as well to understand how those might affect the model.

Our plan is to expose a first-stage document, we and the IASB, outlining this approach and how it would work. We’ll also probably hold roundtables, and then, based on the input, we’ll work together toward an exposure draft.

JofA: In closing, is there anything else you’d like to highlight for our readers?

Herz: We try hard to balance the pace of change with maintaining an open, thorough and deliberate process in order to engage all points of view. We reach out to many different groups for viewpoints, hosting roundtables and visiting companies and constituents. When we give people the chance to comment, we learn, and we deliberate using that input. While it’s a very involved process, and can be frustrating at times, it’s also very rich.

We’ve also made significant efforts to simplify U.S. GAAP by rationalizing the accounting standard-setting structure, by codifying the literature in an integrated and more useable form, and by trying to make our documents more understandable.

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