Video"This came totally out of the blue for us," is how John Devine, CFO of General Motors Corp., speaking during the company's second-quarter earnings call, summed up what many CFOs must be thinking about a recent rule change proposed by the Financial Accounting Standards Board.
The rule concerns contingent convertible bonds ("Co-Cos," for short). They work like regular convertible bonds, with a small — but crucial — difference. Unlike a standard convertible, which an investor can trade in for stock at a fixed price whenever it makes sense, Co-Cos can be converted only when the share price reaches a certain target. This distinction allows the bonds to slip through an accounting loophole: the securities don't get factored in diluted earnings per share until the stock price hits the target. "These are used purely to avoid upfront EPS dilution," says Chris Senyek, an accounting analyst with Bear Stearns. "There's no other economic significance to the contingent feature."
Now FASB intends to shut the loophole. If the proposed rule goes into effect, companies will have to record an increase in shares outstanding on the day they issue a Co-Co, thus reducing EPS. And the change would be retroactive, a step the board generally reserves for particularly egregious accounting practices, says Dennis Beresford, professor of accounting at the University of Georgia and FASB's former chief.
This last point explains Devine's consternation — GM predicts that because of already issued Co-Cos, its EPS will drop by $1, down 14 percent from its 2004 target of $7 per share.
GM isn't alone. Delighted by the prospect of cheap financing and delayed EPS dilution, companies now issue more Co-Cos than regular convertible bonds. According to Bear Stearns, in fact, 84 percent of convertible bonds issued this year contained a Co-Co provision, up from 65 percent last year.
As FASB mulls its final decision, companies are looking for ways to avoid the hit. One alternative, which GM plans to pursue, is to settle its Co-Cos using cash rather than shares (possible only when the bond includes such a provision). As for Co-Cos themselves, this looks like their end, says Senyek: "I expect the use of the contingent feature to drop off almost completely." —Don Durfee
One Size Fits All?
Should there be a "little GAAP"?
That's a question the American Institute of Certified Public Accountants is currently tackling. Last winter, the New York-based professional organization formed a Private Company Financial Accounting Task Force to determine just how well generally accepted accounting principles are working for different stakeholders.
"The debate [over little GAAP] has been around for 30 years," says Daniel Noll, the AICPA's director of accounting standards. What's made it more pressing now, he explains, is that since Sarbanes-Oxley, some smaller firms believe that "GAAP focuses more on public companies." Moreover, it is not clear that lenders and investors actually find GAAP reporting at private companies relevant to their decision-making process.
The task force is surveying numerous constituents — including CFOs — on their views. "If it turns out GAAP is working properly, our work is done," says Noll. But if it's not, the task force will draw up recommendations on how to refine GAAP to present to FASB and others. —Lori Calabro
Spurning the CFO Act
Some think it was just an oversight that the Department of Homeland Security, created two years ago, became the only cabinet-level agency not subject to the CFO Act of 1990. Indeed, bills in both houses of Congress now seek to apply the act to the DHS — which would require Senate approval for its CFO and setting standards for departmental audits. And the Government Accountability Office (GAO) calls passage of the bills "of critical importance."
One adamant opponent of applying the act at the DHS, though, is Andrew Maner, the agency's CFO. "Everyone is quick to make us like the other departments," he says, but they "ought to give [us] a chance to do things our way." The DHS "way" has involved voluntarily launching an audit, though one lacking the complete internal-controls reviews the CFO Act mandates. And, of course, Maner's appointment by President Bush didn't require Senate approval.
Maner — former chief of staff to the U.S. Customs and Border Protection commissioner, and before that a press officer for President George H.W. Bush — calls Senate confirmation "unnecessary" and potentially obstructive. The Defense Department, he notes, recently suffered through not having a controller because confirmation was held up. Besides, he asks, "What better way is there to do the job than to just get a CFO in and get things working?"
No one doubts that finance has worked hard to combine 22 agencies into one $40 billion department. "There's no handbook that exists that tells you how to do this. We're trying to integrate and get on one system," says Maner. The voluntary audit, he adds, was a major achievement and identified material weaknesses now targeted for repair.
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