No. 29-Accounting for Nonmonetary Transactions-Issued May 1973 No. 30 -Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions-Issued June 1973 No. 31 -Disclosure of Lease Commitments by Lessees-Issued June 1973 Statements No. 1 No. 2 -Statement by the Accounting Principles Board-Issued April 1962. Disclosure of Supplemental Financial Information by Diversified Companies-Issued September 1967 No. 3 - Financial Statements Restated for General Price-Level Changes-Issued June 1969 No. 4 Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises-Issued October 1970 EXHIBIT E THE STUDY'S OUTDATED ANALYSIS OF ALTERNATIVE ACCOUNTING PRINCIPLES The Study supports its criticism of accounting alternatives by reproducing a table attributed to Professor Abraham Briloff which shows a variety of alternative accounting methods available to account for the same business transactions. The Study's reliance on that table is misplaced, for the data presented are based on a 1965 research study which was not updated in the Study to reflect 12 years of progress by the FASB and its predecessor, the Accounting Principles Board. The Study also makes no effort to distinguish among those alternatives necessary to reflect clearly different circumstances or wholly different transactions, even though the 1965 research study took care to do so when originally published. This Exhibit E, prepared by the FASB's technical staff, discusses in detail the Study's outdated tabulation and the Staff's assertions. Set forth at the conclusion of this Exhibit is a table which restates the information shown in the Study on the basis of accounting principles in effect in 1977. Of the 42 "alternatives" listed in the Study's table, 30 are not alternatives or are of such minor import as to be immaterial in their effect on financial statements, as the following tabulation and the reconciliation on page E-8, updating and correcting the Study's table, show: 14 apply to circumstances which clearly differ and for which there are have been eliminated. is now the sole practice. relate to items having no material effect on financial statements. 1 1 is not an accounting method. 10 2 10 42 are rare and disappearing. are practices which may be alternatives. = Of the 10 practices which may be alternatives, 2 are currently under study by the FASB in its Extractive Industries project. The basis for the Study's chart is a tabulation from Accounting Research Study No. 7, "Inventory of Generally Accepted Accounting Principles," prepared for the AICPA by Paul Grady in 1965. As mentioned, no attempt was made in the Study to update Mr. Grady's research to account for developments in the twelve years since its publication. Further, in borrowing from Grady's inventory, the Study distorts its significance and ignores the distinctions Grady highlighted between true alternatives and variant practices required by differing circumstances or transactions. In this regard, Mr. Grady was careful to preface his "inventory" with the following statement: "The following list of alternative methods does not purport to be The following summary of the accounting methods tabulated by the Study shows that rather than constituting interchangeable alternatives-certain of the methods are essential to meet differing circumstances or wholly different transactions, others have been or are being addressed in official pronouncements aimed at narrowing areas of difference and inconsistencies in practice, and with respect to others, the method chosen has little effect on financial statements generally used by investors and creditors. 1. When revenue generally recognized Grady stated in 1965 that revenue is recognized in the sale of products or services on three bases: 1. At the time of sale 2. At the time of collection of sales price 3. At the time of completion of the product. Notwithstanding the existence of separate approaches to revenue recognition, accounting standards provide criteria for the application of the appropriate method, depending upon the circumstances. Generally, revenue recognition is based upon the principle of realization. Thus, under ARB No. 43, Chapter 1A and APB Opinion No. 10, where the collection of receivables can be estimated with reasonable accuracy, revenue is realized at the time of sale and it is recognized for financial accounting purposes at that time. When the collectibility of a receivable is subject to a significant degree of uncertainty, proper recognition of revenue must await collection following sale. As Grady explains and as existing accounting literature confirms, it is only in the exceptional case that revenue may be properly recognized upon completion of the product and prior to its sale. As stated in ARB No. 43, Chapter 4, Statement 9, such method of recognition is appropriate only in highly specialized circumstances where, by the nature of the product, an assured market and price exist, as, for example, in the case of certain agricultural products and precious metals. Clearly, each of the three "alternatives" cited by the Study addresses a specific set of circumstances, and no one uniform method of revenue recognition would be appropriate for all. 2. When revenue recognized for long-term contractors Grady's inventory noted in 1965 that revenue is recognized in the context of long-term contracting operations on two alternative bases: either proportionately over the period of performance ("percentage-of-completion method") or at the time the contract is completed ("completed contract method"). Percentage-of-completion accounting was developed in response to the unique character of long-term construction contracts that often require years to complete. When reliable estimates are available, the percentage-of-completion method permits the financial statements of construction contractors to reflect periodic progress over a period of years. In the same circumstances, the completed-contract method might produce wide swings of losses and profits because all accumulated progress would be reported in the year the contract is completed. APB Statement No. 4 states that the appropriateness of the recognition of revenue as construction progresses is based on the consensus that a better measure of periodic income results. ARB No. 45 expressly notes that, when estimates of costs to complete and the extent of progress toward completion are reasonably dependable, the percentage-of-completion method is preferable. Where the lack of dependable estimates or inherent hazards cause estimates to be doubtful, however, ARB No. 45 states that recognition upon completion of the contract is preferable. Here again, the existence of alternative modes of revenue recognition provides improved financial reporting where circumstances differ. 3. Accounting for unfunded pension cost The Study lists the two methods of accounting for pension payments to employees that were cited by Mr. Grady in 1965. It overlooks, however, that in 1966 APB Opinion No. 8 prohibited one of the two methods and affirmed the appropriateness of the other for accounting for such payments. The first method, commonly referred to as "pay-as-you-go", was, at the time of Grady's research, a vestige of earlier pensions "voluntarily" granted by corporations. With the surge of formal pension plans in the late 1940's and 1950's, however, advance funding of pensions developed as a general practice. In 1956, ARB No. 47 prohibited “pay-as-yougo" accounting for vested pension benefits and required that those benefits be accounted for on the accrual basis. In 1966, APB Opinion No. 8 responded to the surviving diversity in accounting practice by prohibiting pay-as-you-go accounting for the cost of pension plans and by requiring that unfunded pension costs be accounted for on the accrual basis (the second of the prior two methods) independent of the method of funding. Thus, "pay-as-you-go" is no longer an acceptable method of accounting for unfunded pension costs. Also, as a result of the Employee Retirement Income Security Act of 1974 (ERISA), the subject of accounting for pension costs is on the FASB's technical agenda as noted below. 4. Accounting for funded pension cost Grady stated in 1965 that pension payments made indirectly to retired employees through the medium of a fund are charged to expense on three different bases: "1. When payments are made to the fund 2. Normal or current costs on an accrual basis over the period of service of the employees ... 3. So-called past service credits at time of adoption of plan (a) Not provided for, except as to interest (b) Accrued over period permitted in Income Tax Code, over remaining service life of employees or over longer period such as total average service life of employees...” In borrowing from Mr. Grady's 1965 tabulation, the Study overlooks the fact that in 1966 APB Opinion No. 8 prohibited the first of Grady's three "alternatives". Items 2 and 3 are not, in fact, alternatives but are different subjects: normal costs and past service costs (i.e., costs related to service prior to adoption of the pension plan or amendment of it). Actuarial methods determine the annual pension costs to be accrued for normal costs and past service costs. APB Opinion No. 8 requires that pension costs be accrued annually on a consistent basis and sets limits within which the annual accrual must fall. In view of the recent ERISA legislation, the FASB has the subject of accounting for pension costs on its technical agenda. With regard to pension funding methods, it is interesting to note that, in enacting ERISA, Congress allowed alternative practices in a number of important areas in recognition of the variety of conditions existing among employers and their pension plans. 5. Charging of real and personal property taxes to income Grady cited in 1965 eight different methods of charging real and personal property taxes against income. Grady's list quoted verbatim from ARB No. 43 (1953), which, in turn, summarized ARB No. 10 (1941). ARB No. 10 and ARB No. 43, though observing that the eight methods listed were methods that had been followed, recommended the monthly accrual of such taxes during the fiscal period of the taxing authority as the most acceptable basis. The differences in methods stem basically from the question of when these taxes should be accrued and recognize legal technicalities that may vary significantly among taxing jurisdictions. The subject of accounting for real and personal property taxes has not appeared in subsequent pronouncements of accounting standards because of the relative insignificance of these taxes in almost all financial statements. Moreover, any of the eight methods, followed consistently, produces virtually the same result year after year as any other, with any differences caused by changes in assessed valuations or tax rates from year to year. For the above reasons, these items are poor examples for any of the Study's assertions on alternatives. It is nevertheless interesting that the methods cited by the Study for this relatively unimportant item account for almost 20% of its outdated listing of accounting alternatives. 6. Treatment of tax versus financial accounting divergencies Grady stated in 1965 that "when items affecting taxable income are reported in financial statements and income tax returns in different periods: 1. The tax effect is allocated between periods in the financial statements 2. The tax effect is not allocated between periods 3. The tax effect is allocated for some items but not for others." |