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The SEC has proposed the full adoption of IFRS by U.S. filers by 2014, with larger firms adopting the international standards as early as 2010.  One important change to U.S. accounting standards that would accompany a move to IFRS is the elimination of the Last-in First-out (LIFO) accounting method for inventory.  Moreover, because of the LIFO conformity rule, a move away from LIFO for financial reporting purposes also means that the advantages of LIFO for tax purposes could be lost to these firms.

The purpose of this study is to examine the income, balance sheet, cash flow and tax effects of a required move to FIFO from LIFO.  Presently, approximately 36% of U.S. companies use LIFO for at least a portion of their inventories.  We examine a sample of 30 such companies with the greatest LIFO exposure.  We find that on average, had FIFO been used by these firms in 2007, pre-tax income and net income would be higher by 11.97% and 7.42%, respectively, the current ratio would be higher by 26.2% and shareholders’ equity would be higher by 34.2%.  Of particular note is the significant amount of income taxes that these firms would owe, ranging up to the hundreds of millions if not billions of dollars, if they were required to adopt FIFO accounting.  Accordingly, investors, lenders and other users of financial statements will want to watch developments on this front carefully.


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The FASB recently issued Proposed Statement of Financial Accounting Standards, Accounting for Hedging Activities:  An Amendment of FASB Statement No. 133.  The proposed standard simplifies the accounting for hedging activities and generally increases the appeal of hedge accounting.  In this report we survey firms’ reporting practices and examine hedges and hedge accounting generally and seek to determine why firms may decide not to designate derivativesas hedges for accounting purposes. In reviewing the reports of a large sample of firms, we find the following four explicit reasons why companies may decide not to designate derivatives as accounting hedges:  (1) the substantial cost of documentation and ongoing monitoring of designated hedges; (2) the availability of natural hedges that can be highly effective; (3) a new accounting standard that broadens the applicability of natural or economic hedges; and (4) qualifying hedges are not available or are too costly or documentation is untimely, inadequate, or unavailable.  In addition, a fifth reason, not offered as such by the surveyed firms, is the increased risk of restatement that accompanies hedge accounting.  The proposed standard combined with the recently-released SFAS 159, The Fair Value Option for Financial Assets and Liabilities, offer companies a welcome relief to the onerous accounting and reporting requirements of SFAS 133.


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In Preliminary Views: Financial Instruments with Characteristics of Equity, the FASB expresses a preference for a basic ownership approach for distinguishing between liabilities and equity. Under this approach, preferred stock, long considered a component of shareholders’ equity, would be reported as a liability. If this change takes place, the impact on the balance sheet and income statement, including measures of leverage and interest coverage will be great, especially for companies that have relied heavily on preferred stock for financing.

In this study, consistent with the proposal, we revise balance sheet and income statement measures of leverage, interest coverage and pretax income and seek to identify sectors and some companies where the effects will be greatest. Debt covenants for companies that use significant amounts of preferred stock may need to be revised. There may also be pressure to refinance outstanding preferred stock with debt or common equity. Overall, we find that the median firm with outstanding preferred stock would see its liabilities to equity ratio increase by 4.17%. The median company would see a decline of 5.99% in times interest earned and a 6.37% decline in pretax income.


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The newly-revised SFAS No. 141 (R), Business Combinations, offers some important changes in accounting for in-process research and development (IPR&D). Long expensed at the time of acquisition, IPR&D will henceforth be capitalized and subsequently amortized, though abandoned projects will be written off. The expectation is that earnings in years following an acquisition will be lower, though the impact is entirely dependent on whether new acquisitions result in additional amounts of capitalized IPR&D and the amortization period for previously-capitalized amounts. In this study we look at the significance of IPR&D over the period 1998 through 2006 relative to selected measures, including net sales and total assets, for a large cross-section of firms and within five technology industries. We then recast pretax income in 2006 for our sample and for fifteen firms from the five industries assuming IPR&D incurred over the 2003 – 2005 time period had been capitalized and subsequently amortized.

Across our sample period we find that the median firm that incurs IPR&D spends about 1.47% of sales and .91% of assets on those acquired projects. The effects, however, in certain industries and at selected companies were much greater. We also find that pretax income in 2006 is reduced by approximately 1.12% if IPR&D were capitalized and amortized over afive-year period. What is unclear is the extent to which companies may need to take charges for IPR&D projects abandoned in the future. Analysts and investors will want to be prepared for all of these changes as they begin to review financial statements for technology firms in 2009 and beyond.


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The recently enacted FASB Statements 160 and 141(R) bring changes to accounting for noncontrolling interests (formerly known as minority interests) for companies with fiscal years beginning after December 15, 2008. In particular, SFAS No. 160 will change the presentation of minority interests on the financial statements. The minority interests in shareholders' equity will be required to be reported as a component of total shareholders' equity. In addition, consolidated net income as presented on the income statement will include minority interests in income. For clarity, companies are instructed in both cases to break out the portions of equity or income attributed to the minority interest, but the "bottom line number" will change with the enactment of these statements.

This report examines the consequences of these changes for companies reporting minority interests. In particular, we find that (1) shareholders’ equity will increase by 2%, though 10% of the companies will see increases of over 25%; (2) income from continuing operations will increase by 3%, though 12% of the companies will see increases of over 25%; (3) liabilities to shareholders’ equity will decline by 2%, though 10% of the companies will see declines of over 20%; and (4) times interest earned will increase by 1%, though 9% of the companies will see increases of over 10%. Investors, analysts and other users of financial statements will want to be prepared to take these upcoming accounting changes into account.


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A slowing U.S. economy is impacting retail sales and hurting the retailers. The purpose of this study is to examine the extent to which problems seen at the macro level are hurting the retailers as a group and within four industry sub-groups, department stores (fashion), department stores (variety), warehouse stores and dollar stores. We look at the performance of 22 retailers using the Operating Growth Profile™ and Free Cash Growth Profile™, two metrics that are very useful in evaluating a firm's ability to generate cash flow as it grows.

While the Profile for the retail industry did improve each year between 2002 and 2006, a decline is noted in the twelve months ended with the third quarter of 2007. However, not all industries are declining. We noted modest improvements for the warehouse stores and dollar stores.


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SFAS No. 158, released in September 2006, eliminates delayed recognition of pension plan and other post employment benefits (OPEB) components. For most companies, the changes caused by the adoption of SFAS No. 158 resulted in a reduction in assets, an increase in liabilities and a decline in shareholders equity. In the first part of this research report, we examine changes to the balance sheet and its effects on measures of leverage and profitability for the 30 companies in the Dow Jones Industrial Average caused by the initial adoption of SFAS No. 158.

In the second part of the report, we concentrate on likely other future pension accounting changes that could impact financial statements even further. In particular, we examine the possible effects on pension expense and income from continuing operations if full pension costs were recognized in income, instead of flowing through other comprehensive income. Using the past five years as a guide, we see a decided increase in earnings volatility that would result from such an accounting change.


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