LAW AND ACCOUNTING COMMITTEE SUMMARY OF CURRENT FASB DEVELOPMENTS 2014 Spring Meeting Los Angeles, CA

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1 LAW AND ACCOUNTING COMMITTEE SUMMARY OF CURRENT FASB DEVELOPMENTS 2014 Spring Meeting Los Angeles, CA Randall D. McClanahan Butler Snow LLP GOING CONCERN In July 2013, FASB issued a Proposed Accounting Standards Update No , Presentation of Financial Statements (Topic 205): Disclosures of Uncertainties about an Entity s Going Concern Presumption. This proposed update states that management would assess an entity s potential inability to continue as a going concern at each reporting period. Management would consider the likelihood of an entity s inability to meet its obligations as they became due for a reasonable period of time. Disclosures would begin when (i) management believed it was more likely than not that the entity would not be able to meet its obligations within the next 12 months as it became due; or (ii) it is known or probable that an entity will not be able to meet its obligations within 24 months. When the likelihood of such event became probable, management of public entities would assert in the financial statements that there was substantial doubt about an entity s ability to continue as a going concern. Management may not consider any mitigating effect of plans that are outside the ordinary course of business. Disclosures must be sufficient to enable users to understand the events giving rise to the entities potential inability to meet its obligation. Disclosures would include: Condition and events giving rise to this uncertainty. Possible effect of such conditions or events on the entity. Management s analysis of the significance of these conditions. Mitigating conditions and events. Management s plans to address the situation. The comment period ended on September 24, On November 6, 2013, the Board met and decided to address the following during rediliberations: 1

2 Initial disclosure threshold. Consideration of management s plans outside the ordinary cause of business. Content of disclosures. 24-month assessment period. Substantial doubt threshold. Application of the substantial doubt threshold to non-sec filers. The required disclosures in the original proposed update were met with significant criticism and viewed as requiring excessive forward-looking information. On March 26, 2014, the FASB tentatively decided to remove the first-level of required disclosures (i.e., that it was more likely than not an entity would be able to meet its obligations within the next 12 months when they become due). Instead, disclosures would begin when there was substantial doubt about the entity s ability to continue as a going concern. Substantial doubt would be defined using the term probable, as defined in Topic 450 for loss contingencies. The Board also decided to revise the second disclosure trigger to a 12-month, as opposed to a 24-month, period. Additional outreach is continuing on the proposed decision to reduce the assessment period to one year, and deliberations are expected to continue in May. Discussions will also take place with the private company council. REVENUE RECOGNITION On November 14, 2011, the FASB issued a revised Proposed Accounting Standards Update, Revenue Recognition (Topic 605), Revenue from Contracts with Customers, Revision of Exposure Draft Issued June 24, The core principle of this proposed update was that an entity should recognize revenue in connection with the transfer of goods or services in an amount that reflects the consideration to which the entity expects to be entitled. There were no scope exceptions for particular industries, but certain activities were not included, such as contracts relating to financial instruments, insurance, leases, and guarantees other than product warranties. As a result, industries that currently have their own revenue recognition standard, such as software, real estate, and construction, would apply this standard. Per the Exposure Draft and also after subsequent redilberations, the following five steps would be applied in analyzing revenue recognition: Step 1 - Identify the contract with a customer. 2

3 Contracts would generally be considered on an individual basis but would be combined if (i) they were negotiated as a package, (ii) the amount of consideration depends on the price or performance of the other, or (iii) all goods and services are considered part of a single obligation. In the rediliberations, the Boards determined that a contract modification would be approved when it created enforceable rights and obligations. For example, before a change order would affect revenue recognition, the change order must create an enforceable right. Step 2 - Identify the separate performance obligations in the contract. Each promised good or service is accounted for separately if it is distinct. A good or service is distinct if the entity regularly sells it separately, or the customer can benefit from the good or service on its own or with other resources available. If the good or service is not distinct, an entity would combine the good or service until the bundle of goods or services is distinct (obviously, this may mean that all contracted goods and services for a particular contract are treated as a single performance obligation). In the rediliberations, the Board decided that a good or service should be accounted for as a distinct good or service if the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer. Factors in determining whether a good or service is distinct include: Whether the entity provides a significant service of integrating the good or service into the bundle of goods or services that the customer has contracted. Whether the customer is able to purchase the good or service without affecting the other goods or services in the contract. Whether the good or service significantly modifies or customizes another good or service in the contract. Whether the good or service is part of a series of consecutively delivered goods or services promised in the contract, the performance obligations are satisfied over time and the entity uses the same method for measuring progress of the transfer of the goods or services. Step 3 - Determine the transaction price (the amount to which an entity expects to be entitled). 3

4 The transaction price (and correspondingly, revenue) is not adjusted for customer credit risk. Impairment losses would be presented adjacent to revenue in the income statement and as an expense. The transaction price would be reassessed at each reporting date. Additional guidance will be given to distinguish between doubts about collectibly from customer credit risk that would be accounted for either as variable consideration (such as a price concession) or an impairment loss. If the contract has a financing component, then the consideration should be adjusted to reflect the time value of money. Non-cash consideration should be measured at fair value. If an entity expects to pay consideration to a customer, the entity would account for the consideration as a reduction of the transaction price (unless payment is in exchange for a distinct good or service). The transaction price should include the minimum amount of variable consideration that is expected to be received and that would not result in a subsequent revenue reversal. If a sale involves a loan, the entity would consider a customer s credit risk. Step 4 - Allocate the transaction price to separate performance obligations in the contract. If there are multiple performance obligations, allocate the transaction price to each separate performance obligation based on relative standalone selling prices. If there are no separate observable selling prices, the entity should estimate them. If an entity gives discounts to a customer, and selling prices indicate evidence of a separate performance obligation to which discounts should be allocated, then the discount should be allocated to these performance obligations, as opposed to all performance obligations. In the rediliberations, the Boards decided that an individual entity may use a portfolio technique to allocate the transaction price, if the method yields results similar to those if the entity applied the guidance to each individual contract. 4

5 In the rediliberations, the Board also decided to retain the residual approach for allocating price of a good or service if the stand-alone price is variable or uncertain and also for contracts when there are two or more goods or services that have highly variable prices, but at least one of the other goods or services has a stand-alone price that is not highly variable. Step 5 - Recognize revenue when (or as) the entity satisfies a performance obligation. Defined by when the customer obtains control of that good or service. Indications of transfer of control include the following: (i) the entity has the present right to payment for the asset; (ii) the customer has legal title to the asset; (iii) the entity has transferred physical possession of the asset; (iv) the customer has significant risks and rewards of ownership of the asset; (v) the customer has accepted the asset. If a performance obligation is satisfied over time, then a method of measuring progress, such as outputs or inputs, would be determined. For variable consideration, recognize revenue when the entity is reasonably assured of being entitled to the consideration in exchange for a performance obligation. Both of these criteria must be met for an entity to be reasonably assured of variable consideration: (i) the entity has experience with similar types of performance obligations and (ii) the entity s experience is predictive of the amount of consideration to which the entity is entitled. A performance obligation will be deemed satisfied over time (in such case, control is transferred over time) if at least one of the following tests is met. The asset created does not have an alternative use and the entity has a contractual right to payment for performance to date. The assessment of alternative use will be made at the inception of the contract. The customer consumes benefits of performance as throughout the process, and another entity would not have to substantially re-perform such work. The customer controls the asset as it is being produced or enhanced. If performance obligation is satisfied over time, the entity would be required to recognize revenue over time. This could result in an entity recognizing revenue before the product is delivered. 5

6 The FASB has reaffirmed its earlier decision to prohibit early application, and the standard would be applied retrospectively. The standard would apply to public entities for annual reporting periods beginning after December 15, 2016, including interim reporting periods therein. The effective date would be a year later for nonpublic entities. The process has reached its final stages, and the standard will probably be released in the very near future. LEASES The FASB and the IASB issued a Discussion Paper/Preliminary Views document on March 19, 2009, to examine and reconsider FAS 13, Accounting for Leases, and IAS 17, Leases. On August 17, 2010, the FASB issued an Exposure Draft, Leases (Topic 840). This document was deliberated over a period of years. On May 16, 2013, the FASB and IASB issued a revised Exposure Draft, Leases (Topic 840). Certain key provisions of the Exposure Draft include the following: Definition of a Lease Scope Leased asset must be specifically identifiable. A contract does not contain a lease if an asset is incidental to the delivery of specified services. A lease conveys the right to use the asset. The Exposure Draft does not provide guidance in distinguishing between a lease and a sale of an underlying asset. If the structure of the transaction does not constitute a lease, then its proper accounting is governed by another standard. An entity will determine whether a contract is a lease based on the substance of the contract, such as whether the fulfillment of the contract depends on the use of an asset and conveys the right to control the use of the asset. The following are within the scope of the standard: Right of use assets in a sublease Leases of noncore assets Long-term leases of land 6

7 The following are not within the scope of the standard: Lessee Accounting Leases for the right to explore for minerals, oil and gas, etc. Leases of biological assets Short-term leases Lessee will recognize a right of use asset for all leases except short-term leases. Lessees would apply one or two accounting approaches: (i) a financing approach or (ii) a straight-line approach. For leases of property; the straight-line approach should be used unless: The lease term is for the majority of the economic life of the underlying asset; or The present value of the fixed lease payments represents substantially all of the fair value of the underlying asset. For leases of assets other than property, the lease should be accounted for on a financing approach (i.e., interest and amortization) unless: The lease term represents an insignificant portion of the economic life of the underlying asset. The present value of the fixed lease payments is insignificant relative to the fair value of underlying asset. The lessee s general rule for assets other than property: Initially recognize a liability to make lease payments and a right of use asset. The liability will be subsequently measured using the effective interest method. Right of use asset will be amortized on a systematic basis that reflects the pattern of consumption, resulting in greater total expense in earlier years. 7

8 Recognize interest expense and amortization expense separately in the income statement. The lessee s general rule for leases of property: Lessor Accounting Initially recognize a liability to make lease payments and a right of use asset, both measured at present value of the lease payments. Measure the liability to make lease payments using the effective interest method. Measure the right of use asset as a balancing figure such that the total lease expense is recognized on a straight-line basis (i.e., effectively meaning that amortization is a plug figure ). Recognize lease expense as one amount in the income statement. Lessor will account for lease under one of two approaches: (i) receivable and residual; or (ii) operating lease. If the lessee acquires and consumes more than an insignificant portion of the leased asset, or the present value of lease payments accounts for substantially all of the value of the asset, a lessor would recognize a right to receive lease payments and a residual asset at the commencement of the lease. The right to receive lease payments would initially be measured as the sum of the present value of the lease payments, and subsequently measured at amortized cost. A residual asset would be measured as a combination of (i) the gross residual asset and (ii) the deferred profit. If the lessee acquires less than an insignificant portion of the leased asset, then the lessor should account for the underlying asset and recognize lease income over the lease term (i.e., similar to current operating lease format). Deferred profit is not recognized until the residual asset is sold or released to another lessee. A lessor s lease of investment property would not be treated under the receivable and residual approach. In such cases, the lessor should 8

9 Subleases Lease Term continue to recognize the underlying asset and recognize lease income over the lease term. The head lease and the sublease should be accounted for as separate transactions. Sublessors utilize lease accounting on the head lease and lessor accounting on sublease. The lease term will be the non-cancellable base period plus any periods for which there is a significant incentive to extend the lease term. Contract, asset, market and entity specific factors would be considered in determining the economic incentive for renewal. The lessor and lessee will only reassess the lease term when there is a significant change in relevant factors that would affect the lessee s decision to exercise or eliminate an option to extend the lease period. Accounting for Purchase Options The exercise of a purchase option should be included in the computation of a lessee s liability for lease payments if the lessee has a significant economic incentive to exercise the purchase option. If the lessee does have a significant economic incentive to exercise the purchase option, then the right of use asset should be amortized over the economic life of the asset, rather than the lease term. Short-Term Leases A short-term lease will be a lease with a maximum possible term of 12 months or less. The lessees and lessors will have the option to elect to account for all short-term leases of a portfolio asset class by recognizing lease payments in profit or loss on a straight line basis, rather than by recognizing a lease asset or liability, unless another rational basis is more representative. Residual Guarantees 9

10 Lease payments should include the amount expected to be payable under residual value guarantees, except if provided by an unrelated third party. The lessor should not recognize amounts to be received under a residual value guarantee until the end of the lease. Discount Rate The lessor uses the rate it charges the lessee. The lessee should use the rate the lessor charges the lessee, unless that rate is not available. In that case, the lessee should use its incremental borrowing rate. Nonpublic entities will have the election of using a risk-free discount rate for all leases. Contract Modifications If there is a substantive change to the existing contract, the modified contract should be accounted for as a new contract. A substantive change is a change in contractual terms that results in a different determination of whether the contract is or contains a lease. If there are changes other than to the contractual terms that affect the assessment of whether the contract is a lease, then the contract should be reassessed to determine whether it is a lease. Separating Lease and Non-Lease Components The lessor and lessee have to identify and separately account for the lease and non-lease components of a contract. Payments should be allocated in accordance with the guidance on revenue recognition. Each separate lease component should be accounted for as a separate lease. Sale and Leaseback If a sale has occurred, the transaction should be accounted for as a sale and then a separate leaseback. The revenue recognition guidance will be applied to determine whether a sale has occurred. If sale has not occurred, then the contract should be accounted for as a financing. 10

11 If the seller/lessee has the ability to direct the use of, and obtain substantially all of the remaining benefits from the asset, a sale has not occurred. Cancellable Leases If a lease is cancellable by both the lessor and lessee with minimum termination payments, then such lease meets the definition of a shortterm lease if the initial noncancellable period is less than one year. This analysis does not change the definition of short-term lease and lease term. Transition Guidance Lessees For capital leases, a lessee is not required to make any adjustments to the carrying amount of the lease assets and lease liability, and can reclassify such assets and liabilities as right-of-use assets and liabilities. Otherwise, the lessee may apply a full retrospective application. For operating leases subject to the interest and amortization method: (i) recognize liabilities for lease payments at the present value of remaining lease payments, discounted using the lessee s incremental borrowing rate; (ii) recognize right-of-use assets at an amount equal to the proportion of the liability to make lease payments calculated on the basis of the remaining lease payments; and (iii) record any difference to retained earnings. Otherwise, the lessee may apply a full retrospective application. For operating leases subject to straight line approach: (i) recognize a liability to make lease payments measured as present value of remaining lease payments, discounted by lessee s incremental borrowing rate; and (ii) recognize a right of use asset equal to the related liability to make lease payments. Transition Guidance Lessors Lessors may apply a full retrospective approach. For finance/sales and direct finance leases, a lessor can reclassify the carrying amount as a lease receivable. For operating leases: Recognize a right to receive lease payments equal to present value of the remaining lease payments. 11

12 Recognize a residual asset consistent with the measurement of the residual asset. De-recognize the underlying leased asset. Disclosures Nonpublic entities will be exempt from the requirement to provide a reconciliation of the opening and closing balance of the lease liability. Potential Effects of these Proposals: The lessee s balance sheet would grow due to the recognition of an asset and liability for all previously accounted for operating leases. Lessee s leverage ratios would decrease. Lessee s interest coverage ratios computed on an earnings basis would decrease. Any lessee measures involving EBIT or EBITDA would improve since portions of the lease payments would now be characterized as interest expense and depreciation expense. Operating cash flow for a lessee would improve since payments for leased assets would be classified as financing activities rather than operating activities. For leases previously accounted for as operating leases, the lessor s balance sheet would grow under the proposals. Consequently, the lessor s ratios would also be affected. For leases accounted for as finance leases, the effect on lessors would depend on the specific characteristics of the lease. Loan covenants, financing agreements, and regulatory requirements could be affected. The Boards have been rediliberating the Exposure Draft. As of their meetings on March 18-19, 2014, the FASB has decided as follows: A dual approach will be used for lease accounting, with existing capital/finance leases accounted for as Type A leases (i.e., interest and amortization) and most existing operating leases as Type B leases. Type A leases would recognize the amortization of a right of use asset, and Type B leases would recognize a single total lease expense. 12

13 The receivable and residual approach will be eliminated for lessors, and lessors will probably use an approach equivalent to sales/direct financing leases. Lease guidance may be applied at a portfolio level by both lessees and lessors. Lease options will only be considered in lease term if it is reasonably certain that the lessee will exercise the lease. The term reasonably certain is basically the same threshold as reasonably assured in existing GAAP. The short-term lease period will remain at 12 months. Joint deliberations are continuing. The effective date is not expected to be before at least January 1, INSURANCE CONTRACTS In July 2013, the FASB issued a Proposed Accounting Standards Update No , Insurance Contracts (Topic 834). This update represents a significant overhaul to the manner of accounting for insurance contracts. Insurance contracts would be measured by either (i) the building block approach or (ii) the premium allocation approach. The building block approach would typically apply to life annuity and long-term health contracts. The premium allocation approach would generally apply to property, liability and short-term health contracts. Modifications from current GAAP would include the following: Current insurance accounting applies only to insurance entities, whereas the proposed guidance would apply to any entity issuing an insurance contract. Assumptions concerning the contract are usually fixed at inception under current GAAP, whereas the update would require expected cash flows to be measured each reporting period. Liability under the premium allocation approach would be based on probability weighted expected cash outflows, as opposed to best estimate of expected cash outflows under current GAAP. The margin for contracts accounted for in the building block approach would generally be presented in financial statements, as opposed to include as a part of the insurance contract liabilities under the current long duration model. 13

14 Comments were due on October 25, The FASB held a series of public round tables in late At its February 19, 2014 meeting, the FASB began redeliberations and decided that the project s emphasis should be on targeted improvements to existing GAAP. ACCOUNTING STANDARDS UPDATE NO VARIABLE INTEREST ENTITIES PRIVATE COMPANIES In March 2014, the FASB issued Accounting Standards Update , Consolidation (Topic 810) Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements, a consensus of the Private Company Counsel. Update allows a private company to choose not to apply the variable interest entity guidance in considering whether to consolidate a lessor entity provided that (i) such entity is under common control of the lessee; (ii) the lessee is in a leasing relationship with the lessor; (iii) substantially all activities between the two parties are related to the leasing activities; and (iv) if the lessee guarantees or provides collateral for the obligation of the lessor related to the leased asset, the principal amount of the guarantee or collateral may not exceed the amount of the leased asset. The trade-off would be that the private company would have enhanced disclosures. Update No will be applied retrospectively and is effective for annual periods beginning after December 15, 2014 and interim periods within annual periods beginning after December 15, Early application is permitted. ACCOUNTING STANDARDS UPDATE NO TECHNICAL CORRECTIONS In March 2014, the FASB issued Accounting Standards Update No , Technical Corrections and Improvements Referred to Glossary Terms. Update No modifies the Codification for certain master glossary terms. It is effective immediately for both public and non-public entities. ACCOUNTING STANDARDS UPDATE NO SERVICE CONCESSION ARRANGEMENTS In January 2014, the FASB issued Accounting Standards Update No , Service Concession Arrangements (Topic 853), a consensus of the FASB Emerging Issues Task Force. Update provides that service concession arrangements shall not be accounted for as a lease, but instead should be accounted for under other applicable topics of the codification. Until this pronouncement, GAAP did not directly address service concession arrangements. Additionally, the infrastructure should not be accounted for as property, plant and equipment of the operating entity. The amendments will be effective for public entities for annual periods and interim periods within such periods, beginning after December 15, The effective date for nonpublic entities will be a year later. Early adoption is permitted. 14

15 ACCOUNTING STANDARDS UPDATE NO RECEIVABLES TROUBLED DEBT RESTRUCTURINGS BY CREDITORS In January 2014, the FASB issues Accounting Standards Update No , Receivables Troubled Debt Restructurings by Creditors (Sub-Topic ), Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure, a consensus of the FASB Emerging Issues Task Force. Update provides that a repossession or foreclosure occurs upon one of the following: The creditor obtains legal title to the residential real estate following the foreclosure; or The debtor conveys all interest in the residential real estate to the creditor to satisfy the loan via a deed in lieu of foreclosure or a similar legal agreement. The effective date for public and private entities will be for annual periods beginning after, and interim periods within, December 15, 2014 and December 15, 2015, respectively. An entity can use either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. ACCOUNTING STANDARDS UPDATE NO DERIVATIVES IN HEDGING PRIVATE COMPANIES In January 2014, the FASB issued an Accounting Standards Update, Derivatives in Hedging (Topic 815), Accounting for Certain Receive - Variable, Pay - Fixed Interest Rate Swaps Simplified Hedge Accounting Approach, a consensus of the Private Company Council. This update proposes to provide a simplified method for accounting for swaps entered into for the primary purpose of hedging the interest rate on loans. The effective date is for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, Both a modified retrospective approach and a full retrospective approach are permitted. ACCOUNTING STANDARDS UPDATE NO GOODWILL AND OTHER PRIVATE COMPANIES In January 2014, the FASB issued an Accounting Standards Update, Intangibles Goodwill and Other (Topic 350), a consensus of the Private Company Council. Update provides for an alternative goodwill accounting method for private companies. A private entity that elects the accounting alternatives proposed by the update would amortize goodwill on straight-line basis over the useful life of the primary asset, not to exceed ten years. Goodwill would be tested for impairment at either an entity-wide level or reporting unit level only when (i) a triggering event (an event that indicates goodwill may be below its carrying amount) occurs and (ii) indications are that goodwill is impaired. If a triggering 15

16 event occurs, an entity may assess qualitative factors to determine whether the fair value of the entity or reporting unit is less than its carrying amount (a more likely than not evaluation). Alternatively, the entity may bypass the qualitative test and go straight to performing a quantitative assessment. Update No is effective for new goodwill recognized in annual periods after December 15, 2014 and interim periods within annual periods beginning after December 15, 2015, but early adoption is permitted. The guidance is to be applied prospectively to goodwill existing at time of adoption. ACCOUNTING STANDARDS UPDATE NO INVESTMENTS In January 2014, the FASB issued Accounting Standards Update No , Investments - Equity Method and Joint Venture (Topic 323), Accounting for Investments in Qualified Affordable Housing Projects, a consensus of the FASB Emerging Issues Task Force. This update addresses accounting for investments in flow through limited liability entities that manage or invest in low income housing tax credit affordable housing projects. Update provides that such entities may account for investments in qualified affordable housing projects under the amortization method if certain conditions are met. Under prior GAAP, such entities would account for these investments under the effective yield method if certain conditions were met; otherwise, the equity or cost method would be used. The effective date for public entities and private entities would be for annual periods and interim periods within such periods beginning after December 15, 2014 and December 15, 2015, respectively. The guidance is to be applied retrospectively. ACCOUNTING STANDARDS UPDATE NO PUBLIC BUSINESS ENTITY In December 2013, the FASB issued Accounting Standards Update No , Definition of a Public Business Entity An Amendment to the Master Glossary. The purposes of Update No are to (i) amend the Master Glossary of the Codification to include one definition of a public business entity that will be used in the future for GAAP purposes, and (ii) identify business entities that are excluded. The update provides that the following will not be included in the definition of a private company: Entities required to file or furnish financial statements with the SEC, or that file or furnish financial statements within the SEC. Entities required by the 1934 Act to file or furnish statements with a regulatory agency other than the SEC. Entities required to file or furnish statements with a domestic or foreign regulatory agency in preparation for the sale of securities that are not subject to contractual transfer restrictions. 16

17 For-profit entities that are conduit bond obligations for conduit debt securities traded in a public market. Entities whose securities are unrestricted and that are required to provide U.S. GAAP financial statements on a publically available basis pursuant to a legal or regulatory event. All not-for-profit entities and employee benefit plans are exempt from the definition of a public business entity. Stand-alone statements of a consolidated subsidiary of a public company are also exempt, except for their statements that are included in an SEC filing by their parent. The update does not have a particular effective date, but the definition of a public business entity will be used in other future updates. This update does not affect existing GAAP. ACCOUNTING STANDARDS UPDATE NO INCOME TAXES In July 2013, the FASB issued Accounting Standards Update No , Income Taxes (Topic 740), Presentation of an Unrecognized Tax Benefit when a Net Operating Loss Carryforward or Tax Credit Carryforward Exists, a consensus of the FASB Emerging Issues Task Force. This Update provides that an unrecognized tax benefit would generally be presented as a reduction to a deferred tax asset for a net operating loss or tax credit carryforward. If, however, the carryforward is not available under the tax law of the applicable jurisdiction to offset any additional taxes resulting from a disclosure of a tax position, or the entity does not intend to use the deferred tax asset for that purpose, the unrecognized tax benefit would be a liability. The proposed update would be applied retrospectively. ACCOUNTING STANDARDS UPDATE NO DERIVATIVES IN HEDGING In July 2013, the FASB issued Accounting Standards Update No , Derivatives In Hedging (Topic 815), Inclusive of the Fed Funds Effective Swap Overnight Index Swap Rate as a Benchmark Interest Rate for Hedge Accounting Purposes, a consensus of the FASB Emerging Issues Task Force. Update No permits the Fed Funds Effective Swap Rate to be used as a U.S. benchmark interest rate for hedge accounting purposes. The amendments apply to new or redesignated hedging relationships entered into on or after July 17, ACCOUNTING STANDARDS UPDATE NO FAIR VALUE MEASUREMENT In July 2013, the FASB issued Accounting Standards Update No , Fair Value Measurement (Topic 820), Deferral of the Effective Date of Certain Disclosures for Non-public Employee Benefit Plans in Update No This update defers indefinitely the required disclosures in Update regarding quantitative of information about significant unobservable inputs used in level 3 fair value measurements. The deferral only applies to disclosures by non-public employee benefit plans about investments in the plan sponsors 17

18 own securities. This update is effective immediately for entities that have not issued final statements. ACCOUNTING STANDARDS UPDATE NO INVESTMENT COMPANIES In June 2013, the FASB issued Accounting Standards Update No , Financial Services Investment Companies (Topic 946), Amendments to the Scope, Measurement and Disclosure Requirements. These amendments affect the scope, measurement, presentation, and disclosure requirements for investment companies in GAAP. These amendments: Amend the investment company definition. An investment company is an entity that: Obtains funds from one or more investors and provides investment management services. Whose business purpose is investing funds of others solely for investment income and capital appreciation. Require an investment company to use fair value measurements for noncontrolling ownership interests in entities other than investment companies. Prohibit an investment company with a non-controlling interest over another investment company from using the equity method of accounting. Require additional disclosures. An investment company usually possesses the following characteristics, but the absence of one is not in and of itself determinative as to investment company status. Multiple investments. Multiple investors. Investors that are not related to the parent entity or the investment manager. Ownership interests in the form of equity or partnership interests. The Board has decided that an investment company should measure all controlling financial interests in another investment company at fair value, rather than consolidating both subsidiaries. This update is effective for fiscal years beginning December 15, 2013, with earlier application not permitted. 18

19 ACCOUNTING STANDARDS UPDATE NO PRESENTATION OF FINANCIAL STATEMENTS LIQUIDATION BASIS In April, 2013, the FASB issued Accounting Standards Update No , Presentation of Financial Statements (Topic 325), the Liquidation Basis of Accounting. This update provides that financial statements should be prepared on a going concern basis unless liquidation is imminent. Liquidation basis financial statements would reflect information about an entity s resources and obligations in liquidation. Liquidation is imminent if: (i) a plan of liquidation has been approved by the person or persons within the organization with the authority to make the plan effective and the likelihood is remote that the plan will be blocked by other parties or (ii) a plan to liquidate is being imposed by outside forces and it is unlikely the entity will return from liquidation. Liquidation basis financial statements should provide relevant information about the liquidation resources and obligations of an entity. These financial statements would be: (i) a Statement of Net Assets in Liquidation and (ii) a Statement of Changes in Net Assets in Liquidation. Management must update its assessment of an entity s ability to meet its obligations as they become due if a subsequent event that significantly affects management s assessment occurs before the financial statements are issued. The Board has tentatively clarified the measurement approach as (i) measure assets at the estimated amount it costs to collect (typically fair value); (ii) measure contractual liabilities at contractual amounts and (iii) accrue all expected costs and income if the entity can reasonably estimate those amounts. Additionally, the first statement of changes in net assets would present only changes in net assets in the period since liquidation. The Board has affirmed its prior decision that there would be no need to differentiate for non-public entities. These amendments are effective for annual reporting periods beginning after December 15, 2013 and interim periods therein. ACCOUNTING STANDARDS UPDATE NO NOT FOR PROFIT ENTITIES In April 2013, the FASB issued Accounting Standards Update No , Not For Profit Entities (Topic 958), Services Received from an Affiliate, A Consensus of the FASB Emerging Issues Task Force. Update No requires a not-for-profit entity to recognize all services received by an affiliate if they directly benefit the not-for-profit entity. The general rule is that the services are recognized at the cost recognized by the affiliate. If this accounting would result in significant understatement or overstatement, the recipient entity may elect to recognize the services received for fair value. The amendments are effective for fiscal years beginning after June 15, FINANCIAL INSTRUMENTS CLASSIFICATION AND MEASUREMENT 19

20 On February 14, 2013, the FASB issued a Proposed Accounting Standards Update, Financial Instruments Overall (Subtopic ), Recognition and Measurement of Financial Assets and Liabilities. This update proposes to classify and measure most financial instruments depending on (i) the business model in which they are managed and (ii) their contractual cash flow characteristics. For financial assets with contractual cash flows solely based on payments of principal and interest, the classification and measurement categories are as follows: Fair value with changes in fair value recognized in other comprehensive income ( FV-OCI ), if the objective is to (i) hold assets to collect contractual cash flows and (ii) sell assets. Amortized cost, if the asset is held within a business model whose objective it is to hold assets for purpose of collecting contractual cash flows. Fair value for which all changes in fair value are recognized in net income ( FV- NI ), if assets are not held and managed under either of the other two business models. Financial liabilities would generally be measured at amortized cost, unless (i) the business strategy at the incurrence of the liability is to transfer the obligation to a third party and (ii) the financial liability results from a short sale. Nonrecourse financial liabilities requiring settlement with cash flows from the related financial asset would be measured on same basis as the related financial assets. For financial assets and liabilities measured at FV-OCI, the following changes in fair value would be recognized in net income: Current period interest or expense Current period credit losses on financial losses Charges in fair value attributed to the hedged risk Realized gains and losses on sale Foreign currency gains and losses Equity investments would be measured at FV-NI, unless they qualify for equity method accounting or consolidation. The initial measurement of financial assets and liabilities would be as follows: If measured at amortized cost or FV-OCI, transaction price. 20

21 If measured at FV-NI, measured at fair value. If the business model changes, then the financial assets would be prospectively reclassified as of the last day of the reporting period in which the change occurs. Comments were due May 15, The FASB is continuing rediliberations. On March 12, 2014, the Board voted to retain the existing models in US GAAP for determining classification of loans and securities. GOODWILL FOR PUBLIC ENTITIES AND NOT-FOR-PROFITS The FASB added this project to its agenda on November 25, This topic was addressed at Board meetings on February 12, 2014 and March 26, At its March 26 th meeting, the Board decided to consider the following four alternatives to account for goodwill after a business combination: Amortize goodwill over ten years, or less than 10 years if another useful life is more appropriate. Goodwill would be tested only when a triggering event occurs, and the test would be either at the entity level or reporting unit level. Amortize goodwill over its useful life not to exceed a maximum number of years. Write off goodwill at the acquisition date. Account for goodwill under a nonamortization approach that uses a simplified impairment test. Further discussions have been deferred until after the IASB has issued findings on the implementation of IFRS 3. RECEIVABLES TROUBLE DEBT RESTRUCTURING BY CREDITORS On January 17, 2014, the FASB issued a Proposed Accounting Standards Update, Receivables Trouble Debt Restructuring by Creditors (Sub-Topic ), Classification of Certain Government Guaranteed Residential Mortgage Loans upon Foreclosure, a consensus of the FASB Emerging Issues Task Force. This exposure draft provides that a residential mortgage loan must be derecognized and a separate receivable recognized, following foreclosure, if both of the following characteristics are present: A loan has a government guarantee that is not separable from the loan before foreclosure entitling the creditor to payment in full of the unpaid balance of the loan. 21

22 At the time of foreclosure, the creditor has the intent to make a claim upon the guarantee and the ability to recover the full payment of the loan through the guarantee. The comment period ends April 30, CONSOLIDATION COLLATERALIZED FINANCING ENTITY FAIR VALUE ACCOUNTING In October 2012, the FASB issued an Exposure Draft Proposed Accounting Standards Update Consolidation (Topic 810), Accounting for the Difference between the Fair Value of the Assets and the Fair Value of the Liabilities of a Consolidated Collateralized Financing Entity, a consensus of the FASB Emerging Issues Task Force. This update defines a collateralized financing entity as an entity that holds debt instruments and issues beneficial interests in those financial assets, yet has no equity. If such entity measures its assets and liabilities at fair value, then the entity must determine the fair value of the assets and liabilities consistent with how market participants would price the entity s net risk exposure at the measurement date. These amendments would be applied using a modified retrospective approach to consolidated collateralized financing entities that existed as of the date of the adoption. Early adoption would be permitted. The effective date will be determined after feedback is considered. TRANSFERS AND SERVICING On January 15, 2013, the FASB issued a Proposed Accounting Standards Update, Transfers and Servicing (Topic 860), Effective Control for Transfers with Forward Agreements to Repurchase Assets and Accounting for Repurchase Financings. The Exposure Draft provides that repurchase agreements and similar transactions would be accounted for as a secured borrowing if the following conditions were met: (i) the agreement involves a transfer of existing financial assets; (ii) the agreement involves a right and obligation to repurchase the financial assets; (iii) the same counterparty is involved; (iv) the repurchase agreement is entered into contemporaneously with, or in contemplation of, the initial transfer; (v) the repurchase obligation is fixed or readily determinable; and (vi) the specified financial assets are identical or substantially the same, or if the settlement of the forward contract to repurchase or redeem the transferred assets is at the maturity of the transferred assets, the settlement is in cash. For transition accounting, a cumulative effect approach would be appropriate for repo-to-maturity transactions and repurchase financings involving a repo-to-maturity. For all other repurchase agreements, the revised guidance would be applied prospectively. Comments were due on March 29, In the rediliberations, the FASB has decided: To require repurchase to maturity transactions to be accounted for as secured borrowings. 22

23 To affirm the decision in the Exposure Draft to eliminate current accounting requirements for limited repurchase financings. To modify disclosures for repurchase agreements, securities lending transactions and repurchase-to-maturity transactions accounted for as secured borrowings. To implement a cumulative-effect approach for all changes in accounting. The Board has directed the staff to draft a final update. BUSINESS COMBINATIONS PRIVATE COMPANIES On July 1, 2013, the FASB issued a Proposed Accounting Standards Update, Business Combination (Topic 805), Accounting for Indefinite Intangible Assets in a Business Combination, a Proposal of the Private Company Council. The proposed update provides that the private entities can elect to recognize accounting for goodwill only those identifiable intangible assets that arise for contractual rights with noncancellable lease terms or that arise from other legal rights. This amendment would be applied prospectively. The FASB addressed this agenda item at its March 26, 2014 meeting and deferred further discussion until April 29, Comments were due on October 14, CLARIFYING THE DEFINITION OF A BUSINESS On May 29, 2013, the FASB decided to add a project to clarify the definition of a business. This project will clarify guidelines regarding whether acquired nonfinancial assets should be accounted for as acquisitions of nonfinancial assets or of businesses. The Board has not begun deliberations. FINANCIAL INSTRUMENTS CREDIT LOSSES On December 20, 2012, the FASB issued an Exposure Draft, Proposed Accounting Standards Update, Financial Instruments Credit Losses (Subtopic ), Under current GAAP, credit losses are recognized when probable. This Exposure Draft proposes to require an entity to determine impairment by estimating the amount of contractual cash flows not expected to be collected on financial assets held at the reporting date. Entities would be prohibited from estimating expected credit losses solely on the basis of the most likely outcome. Instead, entities would consider historical loss experiences with similar assets, reasonable forecasts, and current conditions. The Board will determine an effective date when the proposals are finalized. Comments were due on April 30, 2013, but the FASB extended the comment period to May 31,

24 During the rediliberations, the FASB determined that for financial assets measured at FV-OCI, expected credit losses should not be recognized if the fair value exceeds its amortized cost basis. Otherwise, credit losses are recognized but limited to the difference between fair value and amortized cost basis. In estimating a credit loss, all contractual cash flows should be considered, and the risk of loss should be considered, even if remote. A discounted cash flow method and other loss-rate methods may be used. The FASB has decided: An entity should consider historical average loss experience forecasts for future periods beyond that which entity is able to make reasonable forecasts. An entity should consider all contractual cash flows over the life of the asset. Estimates of expected credit losses should reflect the risk of loss. An entity may develop an estimate of credit losses using a discounted cash flow method or other methods it develops. Rediliberations are continuing. CONSOLIDATIONS PRINCIPAL VERSUS AGENT ANALYSIS FOR VARIABLE INTEREST ENTITIES On November 3, 2011, the FASB issued an Exposure Draft, Proposed Accounting Standards Update, Consolidations (Topic 972), Principal Versus Agent Analysis. Previously, Accounting Standards Update deferred indefinitely the guidance to evaluate all variable interest entities as prescribed in FAS 167. This proposed update would rescind the indefinite deferral of Update This Exposure Draft continues to require an evaluation to determine whether a decision maker has a variable interest in an entity. It also introduces a separate qualitative analysis to determine whether the decision maker is using its power in a principal or agent capacity. If a decision maker is using its power as an agent, it is not required to consolidate the entity. If a decision maker is using its power as a principal, then it is required to consolidate the entity. In determining whether a decision maker is a principal or agent, the following factors should be analyzed: The rights held by other parties. If a single unrelated third party holds unilateral kick-out or participating rights, the decision maker is an agent. If multiple parties hold kick-out or participating rights, the decision maker must analyze the number of unrelated parties needed 24