III-1. FASB/IASB DEVELOPMENTS Presenters: Muneera S. Carr, Comerica Bank Joseph DiLeo, Deloitte & Touche Reto Micheluzzi, PricewaterhouseCoopers SEC Hot Topics Institute Dallas, TX September 8, 2016
FASB Update Muneera Carr, Comerica Bank Executive Vice President and Chief Accounting Officer Joseph DiLeo, Deloitte Managing Director, National Office Accounting Services Reto Micheluzzi, PricewaterhouseCoopers Accounting Advisory Partner
Agenda New stock compensation guidance Highlights of new revenue recognition model and implementation challenges Overview of new leasing guidance What s changing under the new impairment model (CECL) 3
Stock Compensation
Stock compensation guidance updated Component Income Taxes Tax Withholding Updates to Guidance Eliminates windfall pool concept Excess tax deficiency / benefit recognized through income statement as opposed to equity Removes tax component in EPS Threshold has been increased to the maximum marginal rate Forfeitures Cash Flow Option to recognize forfeitures as they occur as opposed to accruing Windfalls are operating outflow Cash paid for tax on net settlement is financing outflow Standard is effective first quarter 2017 Transition method in this update vary with each amendment 5
New standard changes the treatment of excess tax benefit/deficiency Different measurements of compensation expense between financial accounting and tax accounting create an excess tax deficiency/benefit Financial accounting: compensation expense based on grant date fair value Tax accounting: compensation expense based on value at vesting date (for restricted shares and restricted stock units) or exercised/expiration date (for options) Example 1: Company X issued 100 shares of restricted stock with fair value of $30 Over the Vesting Period: Compensation expense = $3,000 Tax benefit = $1,050 At vesting (Stock @ $35): Tax compensation expense = $3,500 Tax benefit = $1,225 Example 2: Company X issued 100 stock options with fair value of $10 (Stock @ $30) Excess tax benefit $175 Impact of new rules: Previously recorded as adjustment to equity (paid in capital) Now will recognize in tax line of income statement Over the Vesting Period: Compensation expense = $1,000 Tax benefit = $350 At expiration (Stock @ $25): Tax compensation expense = $0 Tax benefit = $0 Excess tax deficiency $350 NOTE: Assumes a 35% tax rate 6
Revenue Recognition
Effective date and transition Effective date Public business entities: Periods beginning on 1/1/2018 and interim periods therein All other entities: Periods beginning on 1/1/2019 and interim periods beginning after 1/1/2020 Early adoption will be permitted Transition Entities can apply the amendments using either of the following transition methods: Retrospective to each period presented in the financial statements Retrospective with a cumulative effect adjustment of adopting the new standard and certain additional disclosures Transition Relief Package: Entities adopting retrospective to each period presented are not required to: - Reassess completed contracts that begin and end within the same reporting period - Reassess transaction price of completed contracts with variable consideration - Disclose remaining performance obligations for periods before the date of initial adoption and when it expects to recognize that amount as revenue 8
Narrow-scope improvements & practical expedients Collectability The objective of the collectibility criterion in paragraph 606-10-25-1 To determine if there is a substantive transaction between the entity and the customer (i.e., a contract exists) Collectibility can be evaluated on a subset of the contract amount: - Entity can mitigate credit risk to the amount of goods or services that entity expects will transfer to customer (e.g., because entity can stop transferring goods or services to customer) - Significant judgment based on entity s customary business practices and knowledge of the customer The accounting for when an arrangement is not deemed a contract under the revenue standard (does not meet the criteria in paragraph 606-10-25-1) Revenue can be recognized in the amount of consideration received when consideration is nonrefundable and: - The control of the goods or services has been transferred - The entity has stopped transferring goods or services and has no obligation to transfer additional goods or services Changes do not equate to the cash basis of accounting 9
Narrow-scope improvements & practical expedients Sales taxes and noncash transactions Presentation of Sales Taxes and Other Similar Taxes The ASU provides entities with an policy election to exclude amounts collected from customers for sales taxes from the transaction price (i.e. report sales tax on a net basis) without apply the principal/agent guidance. Gross reporting of sales taxes or other similar taxes would only be appropriate if an entity is the principle for such taxes under the principal/agent guidance. Noncash transactions ASC 606 currently states that noncash consideration should be measured at fair value but does not provide clear guidance on when to measure consideration. The ASU amends ASC 606 to clarify that - Noncash consideration should be measured at contract inception - Variable consideration guidance only applies to variability resulting from reasons other than the form of the consideration (i.e., the constraint would not apply to variability due to the form of the consideration) 10
Identifying performance obligations Clarification on other implementation topics Distinct goods or services Immaterial promises Shipping and handling Determine the nature of the promise to transfer good or services multiple or combined performance obligations? Indicators of not separately identifiable promises include, but not limited to: a. Performing a significant service of integrating b. Significant modification or customization c. The goods or services are highly interdependent or highly interrelated What about immaterial promises to transfer goods and services? Can evaluate the materiality of promises at the contract level If the promises are immaterial, the entity would not need to evaluate such promises further Does not apply to customer options that that provide the customer with a material right (e.g., accumulating loyalty point programs) How should shipping and handling services be treated? If performed before control transfers to the customer, they are fulfillment costs If performed after control transfers, entities are allowed to elect a policy to treat shipping and handling activities as fulfillment costs 11
Licensing Nature of the License to Intellectual Property ( IP ) Must determine the nature of the license right to access or right to use Functional (right to use, typically) Significant standalone functionality Software, biological compounds or drug formulas, completed media content Recognized at a point in time Symbolic (right to access) Does not have standalone functionality Entity provides both a right to IP AND support and maintenance for the IP Examples include brands, trade names, logos, franchise rights Revenue is recognized over time. 12
Principal versus agent considerations Unit of account is specified good or service Entities will need to assess whether they control each specified good/service before it is transferred to the customer Because the unit of account is the specified good or service, an entity may be both a principal and agent in the same contract with a customer Indicators of Control: Inventory Risk Responsibility for providing the good or service Control Latitude in establishing price ASU removes two indicators: - Exposure to credit risk - Form of consideration (e.g., commission) No single indicator is considered determinative of control. 13
Other Revenue-related Activities Other Transition Considerations for SEC registrants Recent comments from staff in the SEC s Office of the Chief Accountant SAB Topic 11.M (SAB 74) Disclosures - Importance to investors timely education and engagement - Expectations that impacts specific to the registrant will be more precise as effective date of the new revenue standard approaches - Examples of adoption of other new standards in which transparent disclosures prevented adverse market reactions Revised financial statements in registration statements - Fourth year and impracticability Office of the Chief Accountant has conducted consultations on matters related to the new revenue standard and encourages registrants to consult with OCA - For example, regarding complex, innovative transactions without clear guidance Topic 11 recently added to Division of Corporation Finance s, Financial Reporting Manual Selected financial data, quarterly financial data, ratio of earnings to fixed charges Significance tests related to provision of other entities financial statements 14
Implementation challenges Project management Internal dynamics Centralized or Dispersed Resources and bandwidth Multi-disciplinary approach Communication and education Clear Responsibility Competing goals: business leaders, reporting leaders and reporting preparers and systems controls Conflict resolution and steering committees Questions Diversity of Terms & Conditions Sampling Risk Diversity vs. Solution Issue analysis Industry and expert perspective Auditor involvement Holistic versus single feature Technical interpretations and conclusions 15
Implementation challenges continued Completeness Contract Terms Sampling Risk Information Sources Tax implications Transactions & deals Parallel Guidance Acquisitions and Divestitures Technology & systems Gather and confirm Current data deficiencies Changing conclusions Competing Agendas Implementation of new systems Communication Involvement at executive management level 16
Leases
The Big Picture Key takeaways from this presentation Most leases on balance sheet for lessees Classification will drive expense profile Lessor model largely unchanged Most changes result from alignment with ASC 606 FASB tried to make things easy Classification, reassessment, transition Effective 2019 but don t wait to assess impact Process and systems changes may be required Potential impact on debt covenants 18
Effective date and transition Effective date Public business entities: Periods beginning on 1/1/2019 and interim periods therein All other entities: Periods beginning on 1/1/2020 and interim periods thereafter Early adoption will be permitted Transition Lessees and lessors are required to use a modified retrospective transition Would apply the new model for the earliest year presented in the financial statements Application of approach linked to current lease classification and new lease classification An entity can use hindsight when evaluating lease term Transition Relief Package: Lessees/lessors not required to reassess the following upon transition: - Whether any expired or existing contracts are leases or contain leases - The lease classification for any expired or existing leases - Initial direct costs for any existing leases 19
Introducing the new standard Scope: What s in and what s out? Applies to leases of property, plant, or equipment Does not apply to: - Leases of intangible assets - Leases to explore for or use nonregenerative resources - Leases of biological assets - Leases of inventory - Leases of assets under construction Basic Definition: What does the new definition look like? A lease is a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment for a period of time in exchange for consideration Lessor Control the use of an identified asset Consideration Lessee 20
Definition of a lease For a contract to be, or contain a lease it must: Depend on the use of an identified asset Consider: Whether asset explicitly or implicitly identified Whether asset is a physically distinct portion of a larger asset rather than a capacity portion Lessor substitution rights (i.e., whether substantive) Warranty or upgrade provisions Convey the right to use the asset Right to obtain substantially all of the economic benefits from asset use Directly/indirectly in many ways Includes primary output and by-products Do not consider benefits related to ownership of asset AND Right to direct the use of the asset over lease term How and for what purpose Additional considerations when relevant decisions about how and for what purpose are pre-determined before period of use Judgment needed to assess whether limits on use of an identified asset constitute protective rights 21
Right to Control the Use of the Asset Decision tree of right to control the use Customer Yes Does the customer have the right to obtain substantially all of the economic benefits from use? Yes Who has the right to direct how and for what purpose the asset is used? Neither Does the customer have the right to operate the asset? No Did the customer design the asset? Yes No Supplier No Contract contains a lease Contract does not contain a lease 22
Contracts that contain multiple components Separating lease and nonlease components Contracts with multiple lease components for different underlying assets An asset will be considered a separate lease component if: Lessee can benefit from the use of the underlying asset either on its own or using other resources that are readily available The underlying asset is not highly dependent on or highly interrelated with other assets in the arrangement NOTE: Land and other elements evaluated separately unless the accounting for the land element would not be significantly different Contracts with lease and nonlease components (i.e., separate services) An activity is a nonlease component if it transfers a good or service to the lessee CAM and utilities would likely be nonlease components Property taxes and insurance would likely be combined with the lease component(s) Standard provides specific lessee and lessor guidance on how consideration should be allocated to each contract component 23
Lease classification Overview of the criteria Lease would be classified as a finance lease (lessee) or a sales-type lease (lessor) when... Lease transfers ownership of the underlying asset to lessee by the end of the lease term Lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise Lease term is for a major part of the remaining economic life of the underlying asset Present value of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset NEW criterion Leased asset is so specialized in nature that it is expected to have no alternative use to the lessor at the end of the lease term The standard states that the use of the thresholds under ASC 840 may be a reasonable approach to evaluate major part and substantially all 24
Lease term Initial determination and reassessment Lease term: Noncancelable period, plus Renewal options that are reasonably certain to be exercised by a lessee Termination options that are reasonably certain not to be exercised by a lessee Options to extend (or not to terminate) that are controlled by the lessor Reassessment requirements: Lessees are required to reassess lease term when: A significant event or change in circumstances occurs that is in the control of the lessee A contract term obliges the lessee to exercise (or not exercise) a renewal or termination option Lessee elects to exercise or not exercise a renewal or termination option that was not previously deemed reasonably certain of being or not being exercised Would reassess when there is a modification that does not result in a separate contract Lessors would not be required to reassess lease term, unless there is a modification that does not result in a separate contract 25
Lease payments What amounts are included in lease payments? Fixed lease payments Variable payments Residual value guarantees Purchase and termination options Discount rate Payments specified in the lease agreement In-substance fixed payments Payments that depend on an index or a rate Excludes payments based on usage or performance Reassessment required under certain circumstances Lessees Amount that it is probable will be owed under the RVG at the end of the lease term Lessors The full amount at which the residual asset is guaranteed by the lessee or third party Treated in a manner consistent with the accounting for renewal options Include options that a lessee is reasonably certain to exercise Lessor Rate it charges the lessee (i.e., rate implicit in the lease) Lessee Rate implicit in the lease if readily determinable; otherwise the lessee s incremental borrow rate Non-public business entity lessees Accounting policy election to use riskfree rate is permitted 26
Lessee accounting model What does the lessee model look like? Most 1 leases recorded on balance sheet using a right-of-use asset approach: Initial Measurement Subsequent Measurement Lease obligation: PV of lease payments not yet paid ROU asset: lease obligation + initial direct costs lease incentives + prepaid lease payments Lease obligation: amortized using the effective interest method ROU asset: depends upon lease classification Expense recognition pattern: Finance lease: front-loaded Operating lease: generally straight-line 1 Short-term leases: A lessee can elect, by asset class, not to record on its balance sheet a lease with a lease term of 12 months or less and which does not include a purchase option that the lessee is reasonably certain to exercise 27
Current Expected Credit Loss Model
Summary of changes under CECL Allowance for loan losses US GAAP Incurred losses in the loan portfolio (collectively evaluated for impairment) Specific valuation allowances Summary of proposed changes Replace incurred loss (loss emergence period) with full lifetime of the loan Reflects contractual life less prepayments, but without consideration of renewals, extensions or modifications Except when expected in conjunction with a TDR Inclusion of forward looking information (e.g., macroeconomic factors) either through a model or through a qualitative framework Revert to historical information beyond the period you can reasonably forecast Off balance sheet considers the period over which the commitment is legally binding, unless unconditionally cancellable No threshold for identification of individually impaired loans Maintains practical expedient for collateral dependent loans Measurement approach is similar to today when using discounted cash flow modelling approach 29
Summary of changes under CECL Trouble Debt Restructurings and Purchase Credit Impaired US GAAP Trouble Debt Restructurings Purchase Credit Impaired Summary of proposed changes Impairment measured using the CECL model -- DCF no longer required although impact of concession must be recognized No change to criteria for identifying a TDR More than insignificant credit deterioration (PCD) Basis grossed up to reflect expected loss estimate Initial credit loss will not be recognized in income (since FV day 1) Changes (+ / -) going forward recognized immediately in income Follow an accrete to contractual interest model 30
CECL Impairment Model Change Summary Securities Summary of proposed changes AFS HTM PCD 1 Do not consider certain qualitative factors such as duration of unrealized loss to determine credit loss Record write-down through an allowance if credit loss is recognized Credit loss measured can exceed total unrealized loss as the difference between the amortized cost basis and PV of ECFs Capped at total unrealized loss Record and measure expected credit losses at acquisition through P&L Recognize ECLs in an allowance on the acquisition date Credit loss measured using reasonable and supportable method for determining ECLs DCF is not required Gross up balance sheet for credit loss reserve at acquisition Recognize ECLs in an allowance on the acquisition date Credit loss measurement changes same as for AFS and HTM securities 1 PCD Model could apply to either AFS or HTM securities 31
Appendix - Revenue
Licensing Other provisions of the ASU Royalties Should not split a royalty into a portion subject to the salesand usage-based royalty guidance and a portion that is not If guidance does not apply, should be accounted for as variable consideration Guidance applies when a license is the predominant item Restrictions Restrictions of time, geography, or use affect the scope of the license (i.e., they are attributes), but do not define it s nature when evaluating whether its functional or symbolic. Restrictions should be distinguished from provisions that require the entity to transfer additional licenses to the customer Renewals If a license that provides a right to use an entity s IP is renewed or extended, revenue should not be recognized until the beginning of the renewal period (rather than upon the time the renewal agreement is reached). For sales- or usage-based royalties exception, recognize revenue when subsequent sales or usage occurs. 33
New revenue guidance Deloitte resources Heads Up Newsletters - FASB Makes Narrow Scope Amendments to New Revenue Standard - FASB Clarifies Guidance on Licensing and Identifying Performance Obligations - FASB Clarifies the New Revenue Standard s Principal- Versus-Agent Guidance - FASB Confirms Decision to Defer Effective Date of New Revenue Standard by One Year - Boards Issue Guidance on Revenue From Contracts With Customers TRG Snapshot Series Industry Spotlight Series Revenue From Contracts With Customers: A Roadmap to Applying the Guidance in ASU 2014-09 and more available at US GAAP Plus.com (http://www.iasplus.com/en-us) 34
Appendix - Leases
Disclosure requirements Disclosure Objective: Enable financial statement users to assess the amount, timing, and uncertainty of cash flows arising from leases Lessee disclosures - Nature of its leases - Information about leases that have not yet commenced - Related-party lease transactions - Accounting policy election regarding shortterm leases - Finance and operating lease costs - Short-term and variable lease costs - Sublease income - Gain or loss from sale-and-leaseback - Maturity analysis for lease obligations - Weighted-average remaining lease term - Weighted-average discount rate Lessor disclosures - Nature of its leases - Significant assumptions and judgments used - Related-party leases transactions - Tabular disclosure of lease-related income - Components of the net investment in a lease - Information on the management of risk associated with residual asset - Maturity analysis of operating lease payments and lease receivable - Information required by ASC 360 36
Lessee involvement in asset construction Current build-to-suit guidance is not carried forward in new standard New accounting depends on whether the lessee controls the underlying asset during the construction period: Lessee controls asset during construction - Asset is effectively owned by the lessee during the construction period - Arrangement would be subject to sale-and-leaseback accounting upon completion of construction Lessee does not control asset during construction - Costs related to the construction or design of the underlying asset would be accounted for under other U.S. GAAP topics Standard provides indicators a lessee should consider when evaluating whether it controls the asset being constructed 37
Other key provisions Modifications Subleases Sale-leaseback Leasehold improvements Specific guidance in new standard Accounting depends on whether a modification results in a new contract Head lease and sublease accounted for as two separate leases Sublease classification based on underlying asset Offsetting generally prohibited Use ASC 606 to evaluate whether sale occurs (i.e., control transfers) Existence of substantive repurchase options would not result in sale If sale-leaseback, account for sale and leaseback as two transactions recognize full profit (only if leaseback is operating) and account for lease. Lessor and lessee both account for a failed sale-leaseback as a financing transaction. Generally capitalized and amortized over the shorter of their useful life or remaining lease term unless: - Lease transfers ownership at the end of lease term, or - It is reasonably certain that lessee will exercise purchase option 38
Other key provisions and resources But wait, there s more Contract combinations Leveraged lease accounting Accounting for leases at a portfolio level Leases in a business combination Impairment considerations U.S. GAAP to IFRS comparison and more available at US GAAP Plus.com (http://www.iasplus.com/enus) 39