The top ten financial reporting challenges companies face in 2005 were identified by Financial Executives International (FEI), a professional association of CFOs, treasurers, and controllers based in Florham Park, New Jersey. Commenting on the survey findings, FEI CEO and President Coleen Cunningham said, “The continuing and collective effort to improve the clarity, consistency, and transparency of financial reporting as well as the continuing effort towards convergence with international standards promises to keep the CFO’s job interesting and
challenging in 2005.”

The challenges will have an impact on the way companies manage their businesses, report financial results, and compensate employees. For CPA firms, these challenges offer opportunities to assist company decision makers in meeting them.

The challenges include:

1. Stock option expensing. The Financial Accounting Standards Board (FASB) has mandated that all stock compensation be expensed beginning June 30, 2005, for most public companies. Smaller public companies and private firms have until the first annual reporting period after December 15, 2005.
2. Complying with Sarbanes-Oxley Section 404. The requirement for reporting on internal controls is already in place for accelerated Securities and Exchange Commission (SEC) filers with years ending after November 15, 2004. During 2005, however, all companies must comply. Increasingly, lenders and state regulators are asking private companies about the status of their internal controls environment. Private companies may also see audit procedures used by their external auditor become more “integrated” with internal controls as the audit firms change their procedures.
3. Revenue recognition. The FASB is deliberating over a new approach that would recognize revenue in terms of changes in assets and liabilities, rather than an earnings process. Although effecting such a major change may take years to accomplish, it is vital that stakeholders join the debate now in response to the FASB’s Preliminary Views being developed for issue in the fourth quarter of 2005.
4. Assessing sustainability of tax benefits. The FASB seeks to clarify that the tax benefits recorded in an entity’s tax returns must be “probable of being sustained” before they are recorded in financial statements. A final statement is expected in the third quarter of 2005 following an exposure draft to be issued in the first quarter of 2005.
5. Recording taxes on repatriated earnings. According to the American Jobs Creation Act, companies can repatriate earnings from foreign subsidiaries into the United States at an 85% reduction through the end of 2005. Companies who elect this option may need assistance in calculating their tax liability.
6. Accounting for business combinations. The FASB and the International Accounting Standards Board (IASB) are expected to require major changes to Business Combination accounting, moving towards a “fair value” model. Among other changes, contingent assets and liabilities associated with an acquisition would have to be recognized at fair value at the date of the acquisition with any changes reflected in earnings, and all acquisition-related costs paid to third parties would have to be expensed as incurred. An exposure draft is expected to be issued during the first half of 2005, with a final statement scheduled for the fourth quarter.
7. Expensing inventory costs. FASB Statement of Accounting Standards No. 151, Inventory Costs, an amendment of ARB No. 43, Chapter 4, issued in November 2004, is effective for fiscal years ending after June 15, 2005. It defines the term so abnormal in reference to amounts of idle freight, handling costs, and spoilage that is required to be expensed currently. The clarification makes FASB’s language more consistent with the IASB’s inventory standards.
8. Disclosing off-balance-sheet items. CFOs will need to comply with the SEC’s suggestion in a report to be issued in early 2005. It is expected to address such items as pensions and leases among others.
9. Translating reports to XBRL. The SEC asked companies to voluntarily use eXtensible Business Reporting Language (XBRL), a new code designed to increase efficiency and reduce error in the electronic communication of business and financial data. More companies are expected to follow this trend in 2005.
10. MD&A guidance. The SEC periodically provides filing companies with guidance on making their Management Discussion and Analysis (MD&A) as informative and transparent as possible. This year’s SEC reviews also indicated the commission’s belief that the Critical Accounting Policy notes need further clarification. Companies will need to ensure that their disclosure of Critical Accounting Policies clearly and adequately explain the business model.