EITF ABSTRACTS. Title: Recognition by a Seller of Losses on Firmly Committed Executory Contracts 1

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1 EITF ABSTRACTS Issue No Title: Recognition by a Seller of Losses on Firmly Committed Executory Contracts 1 Date Discussed: January 17 18, 2001 References: ISSUE FASB Statement No. 5, Accounting for Contingencies FASB Statement No. 13, Accounting for Leases FASB Statement No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets FASB Technical Bulletin No , Accounting for Loss on a Sublease Not Involving the Disposal of a Segment FASB Concepts Statement No. 6, Elements of Financial Statements FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements AICPA Accounting Research Bulletin No. 43, Chapter 4, Inventory Pricing AICPA Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts AICPA Statement of Position 97-2, Software Revenue Recognition AICPA Audit and Accounting Guide, Health Care Organizations 1. At the inception of a firmly committed executory contract, the seller of goods and services typically expects that the consideration to be received from the counterparty over the term of the contract will equal or exceed the costs to be incurred to deliver the specified goods or services over the term of the contract. During the term of the contract it is possible that the costs to be incurred by the seller to deliver the required goods or 1 The EITF Agenda Committee recommended that the seller s accounting for firmly committed executory contracts be addressed as a separate EITF Issue. Accordingly, Issue has been added to the agenda and Issue No , Recognition by a Purchaser of Losses on Firmly Committed Executory Contracts (formerly Recognition of Impairment Losses on Firmly Committed Executory Contracts ), has been renamed so that the respective scopes of the two Issues are identified more clearly. Page 1

2 services increase and, eventually, may exceed the amount of consideration under the contract that will be received for those goods or services. Alternatively, the seller s costs may remain relatively unchanged; however, current market conditions indicate that if the seller entered into the contract currently, consideration to the seller for the undelivered goods or services would be greater than the price specified in the existing arrangement. 2. Currently, other than certain industry- and transaction-specific guidance, no authoritative accounting pronouncements address when an impairment loss should be recognized and how that loss should be measured for a seller s contractual performance obligations that do not meet the definition of a derivative under Statement This Issue addresses the accounting recognition and measurement related to loss contracts in which future performance (delivery of either services or goods) is required. This Issue does not address the accounting recognition and measurement of impairment losses related to a purchaser s contractual rights under a firmly committed contract. This Issue only addresses impairment accounting by a seller under a firmly committed executory contract that will be executed by the seller and not otherwise terminated before full performance occurs and that was initially entered into at fair value. The accounting for losses on contract terminations is addressed generally in Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), and in other interpretive literature. 4. The issues are: Issue 1 When a seller, or service provider, under a firmly committed executory contract that requires the seller to deliver goods or services to the counterparty in the future for specified consideration should recognize a loss under the contract Page 2

3 Issue 2 If a loss should be recorded, how the loss should be measured. EITF DISCUSSION 5. At the January 17 18, 2001 meeting, the Task Force discussed this Issue and observed that existing authoritative guidance on the Issue covers only a portion of the types of firmly committed contracts entered into by sellers. The Task Force expressed support for developing criteria under which a seller should recognize a loss under a firmly committed executory contract that will be executed by the seller and not otherwise terminated before full performance occurs and that was initially entered into at fair value ( loss contracts ). However, certain Task Force members suggested that any methodology developed under this Issue should limit a loss contract liability to the amount that would be paid to terminate, transfer, or otherwise liquidate the contract. The Task Force recognized that due to the broad scope of this Issue, any model developed could be inconsistent with other authoritative guidance for specific transactions or industries and asked the FASB staff to identify potential conflicts. [Note: See STATUS section.] Certain Task Force members observed that any model developed for this Issue should include a mechanism that ensures that a loss is not recognized twice (that is, through recognition of a loss contract liability and an impairment of assets [Note: See STATUS section.] or leases used to provide the goods or services under the contract). Other Task Force members suggested that any proposed methodology should address when, and how, individual contracts should be combined, as well as provide indicators of when a contract should be reviewed for possible loss recognition. STATUS 6. Statement 144 was issued in August Statement 144 establishes financial accounting and reporting standards for the impairment of long-lived assets to be held and Page 3

4 used and supersedes Statement 121. However, Statement 144 applies only to recognized long-lived assets and, therefore, retains the scope exclusion in Statement 121 for unrecognized long-lived assets to be held and used, including contractual assets. 7. At the November 21, 2002 meeting, the Task Force agreed to discontinue further discussion of this Issue. The Task Force observed that the accounting for executory contracts is an extremely broad topic with significant and pervasive implications on financial reporting. However, due to the lack of authoritative guidance on this subject, the Task Force requested the FASB staff to explore with the Board the possibility of a Board project to address executory contract accounting. 8. No further EITF discussion is planned. Page 4

5 Suggested Index Entries for Issue No , Recognition by a Seller of Losses on Firmly Committed Executory Contracts CONTINGENCIES Recognition of Losses on Firmly Committed Executory Contracts IMPAIRMENT Recognition of Losses on Firmly Committed Executory Contracts Page 5