Current Developments FASB, AICPA and SEC Jim Brendel, CPA, CFE March 1, 2013
Agenda FASB Developments Selected Projects and Initiatives Revenue Recognition Leases Impairment of Intangible Assets Other than Goodwill Other Proposed Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SME s) Common SEC Review Comments AICPA Clarified and Converged Standards for Auditing and Quality Control
Revenue Recognition
Revenue Recognition Joint project between FASB and IASB Objective: To develop a single, principle-based revenue standard for US GAAP & IFRS Revenue standard aims to improve accounting for contracts with customers by: Providing a more robust framework for addressing revenue issues as they arise Increasing comparability across industries & capital markets Requiring better disclosure
Revenue Recognition cont d US GAAP Many standards (over 100) Significant industry specific guidance IFRS Two key standards: IAS 18, Revenue, and IAS 11, Construction Contracts Little industry guidance
Revenue Recognition cont d Applies to: Contracts with customers Gain/loss recognition on sale of some nonfinancial assets (intangibles and PP&E) Certain nonmonetary exchanges Many industry-specific transactions such as real estate sales
Revenue Recognition cont d Core principle of revised proposals: Recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Identify contract(s) with the customer Identify separate performance obligations Determine transaction price Allocate transaction price Recognize revenue when performance obligation is satisfied
Revenue Recognition Differences from Existing Standards Collectibility: Revenue is still recognized gross but probability of collection is no longer a revenue recognition criterion Entity should present any initial and subsequent impairment of customer receivables, to the extent material, as an operating expense Originally required to be netted against revenues
Revenue Recognition Differences from Existing Standards cont d Allocation of transaction price: If stand-alone selling price not available, an estimate may be made New guidance is less restrictive than current guidance applicable to software revenue recognition (VSOE considerations), and may result in earlier recognition of revenue in some cases Time value of money should be incorporated into amount of consideration, if it is significant and exceeds one year
Revenue Recognition Differences from Existing Standards cont d Constraint on recognizing revenue on variable consideration (fixed and determinable N/A): An entity should recognize revenue as performance obligations are satisfied only up to the amount that the entity is confident will not be subject to significant reversal in the future Adjusted in transaction price
Revenue Recognition Differences from Existing Standards cont d Bill and Hold Transactions: Not previously discussed in GAAP, but part of SEC guidance New guidance is very similar to SEC guidance May impact private companies that were aggressive in recording certain bill and hold transactions as revenue
Implications of Revenue Changes Any contract tied to GAAP revenue will be impacted Earn-outs on purchase agreements Compensation agreements Buy/sell arrangements, etc. Debt covenants may be impacted Some debt agreements are being drafted currently to require good faith renegotiation of covenants based on any new accounting pronouncements
Revenue Recognition Redeliberations & Next Steps Transition Full retrospective adoption Simplified transition Apply new standard to all existing contracts at effective date (and all subsequent contracts) Recognize cumulative effect in opening balance of retained earnings at effective date Disclose impact of adopting new standard for existing and new contracts in the period adopted.
Revenue Recognition Redeliberations & Next Steps Effective date (tentative decision) Annual reporting periods beginning on or after January 1, 2017 Final standard expected to be issued during Q2 2013
Leases
Lease Exposure Draft Why a Leases Project? Existing lease accounting does not meet users needs Accounting depends upon classification Contractual rights and obligations (assets and liabilities) are offbalance sheet Many users adjust financial statements Structuring opportunities Current lease classification often based on bright lines Significant difference in accounting on either side of operating/finance lease line
Lease Exposure Draft cont d Who does this apply to? All leases (with limited exceptions of leases of intangibles) Includes capital and operating leases
Lease Exposure Draft cont d What are the major provisions? Proposed Right-of-Use Model: A lease contract is one in which the right to control the use of an asset (for a period of time) is transferred to the lessee All leases (except certain short-term leases) would be presented on the balance sheet Dr. Right of Use Asset Cr. Liability Short-term leases would be defined as a lease with a potential maximum period of 12 months or less
Lease Exposure Draft cont d Two Types of Leases: Accelerated Leases Lessee consumes more than insignificant portion of leased asset Lease term is major part of economic life of asset PV of lease payments is substantially all of FV of asset Examples: Airplane with a 10-year lease; vehicle lease, equipment, etc. Straight-Line Leases Lessee does not consume more than insignificant portion of leased asset Lease term is insignificant relative to economic life of asset PV of lease payments is insignificant relative to FV of asset Examples: Land or building
Lease Exposure Draft Lessee Model Balance Sheet Income Statement Dr. ROU asset 2 Cr. Lease liability 1 Lessee consumes more than insignificant portion of leased asset Lessee does not consume more than insignificant portion of leased asset Amortization expense Interest expense Lease expense 1 Measured at present value of lease payments 2 Initially measured at same amount as liability, plus prepayments and initial direct costs
Lease Exposure Draft Lessor Model Asset Subject to Lease Lessee acquires more than insignificant portion of leased asset Lessee does not acquire more than insignificant portion of leased asset Receivable & Residual Approach Approach similar to operating lease accounting
Lease Exposure Draft Initial Exposure Draft Expense Recognition is Front Loaded 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 Original ED Front- Loads Expense Recognition Existing GAAP Expense Recognition is SL Actual Cash Rent Payments 1.00-1 2 3 4 5 6 7 8 9 10
Lease Exposure Draft Initial Exposure Draft Expense Recognition is Front Loaded cont d The boards discussed various ways to resolve the expense recognition issue FASB and IASB had divergent preferences for how to resolve Compromise was reached on recognition pattern Dual model approach A pragmatic solution a compromise between conceptual purity and practical application Preserves the primary objective of requiring lessees to recognize lease assets and liabilities on balance sheet Allows for a distinction in expense recognition pattern Straight-line for certain leases Front-loaded pattern for other leases
Lease Exposure Draft Disclosures Additional quantitative and qualitative disclosures will be required to understand the timing and amount of cash flows on leases Maturity schedule of all lease payments Disclose a maturity analysis of future contractual commitments associated with services and other nonlease components that are separated from a lease contract
Lease Exposure Draft Potential Impacts Balance sheet will be grossed up with ROU assets and liabilities Operating leases will either be charged to amortization expense or lease expense EBITDA and other financial statement ratios could be impacted
Lease Exposure Draft Where Are We Now 2010 2013 2013 TBD August 2010 Exposure Draft Leases Comment period: 4 months 786 comment letters received Contained proposals for both lessees and lessors Q2 2013 2 nd Exposure Draft Leases Consultation TBD Final Standard Leases Re-expose proposals Outreach Effective date: TBD (likely 2015 or 2016 at earliest) Comment period: 120 days Focus on revisions to 2010 proposals Will contain proposals for both lessees & lessors Working group meetings Redeliberations Will contain guidance for both lessees and lessors
Impairment of Intangible Assets Other Than Goodwill
Impairment of Intangible Assets Other Than Goodwill Impairment of indefinite-lived assets other than goodwill Simplifies the impairment testing for indefinite-lived intangible assets other than goodwill Applies to indefinite-lived assets such as: Customer lists, trademarks, licenses, distribution agreements, etc.
Impairment of Intangible Assets Other Than Goodwill cont d Previous Guidance Required intangible assets to be tested for impairment at least annually Compare the book value or carrying value to the fair value Impairment = loss in realizable value Preparer feedback was to allow for a qualitative approach for testing impairment Reduce testing costs New Guidance Allows for a qualitative evaluation of the likelihood of impairment
Impairment of Intangible Assets Other Than Goodwill cont d STEP 1 Assess qualitative factors (e.g., industry trends, revenues, cash flows, etc.) STEP 2 Not more likely there is an impairment STOP Is more likely there is an impairment Calculate the fair value of the asset and compare to book value New guidance does not change how an impairment loss is recognized
Impairment of Intangible Assets Other Than Goodwill cont d When is this guidance effective? Fiscal years beginning on or after September 15, 2012. Early adoption is permitted.
Other FASB Developments
Other Selected FASB Projects Investment Companies Consolidation Liquidation Basis of Accounting Balance Sheet Offsetting Comprehensive Income - Reclassifications Going Concern Disclosure Framework
Other FASB Initiatives Private Company Council Private Company Decision Making Framework Implementation Initiatives Pre-agenda Research Complexity Initiatives
Proposed Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SME s)
Proposed Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SME s) Major Problems With Big GAAP: Maintaining two sets of books GAAP & Tax Costly appraisals to mark assets to market Self-reporting of tax uncertainties Consolidations (VIE s, etc.)
Proposed FRF for SME s cont d What is FRF for SME s? Reporting system developed by the AICPA Expected to be released in mid-2013 Available for use in every industry Available to incorporated and unincorporated entities Not a required framework Blends traditional accounting method with tax methods
Proposed FRF for SME s cont d Key Features of New Framework: Use taxes payable method for income tax reporting no deferred taxes Use historical costs, as opposed to FMV, for valuing assets No mark-to-market for derivatives No comprehensive income All leases treated as operating leases No VIEs Departure from GAAP on Goodwill and Intangibles Goodwill Follow tax amortization of 10 years Intangibles Best estimate of amortization period or 10 years
Proposed FRF for SME s cont d FASB is working on its own framework NASBA AICPA should table or withdraw its proposal and let the Private Company Council do its work (standing comes under the 10 th Amendment and Sarbanes Oxley).
Common SEC Review Comments
Common SEC Review Comments Management s Discussion and Analysis (MD&A) Results of operations Deficiencies: Boiler plate language Over simplifications Causes and effects omitted Performance metrics omitted (e.g., same store sales) Offsetting changes not disclosed Liquidity Deficiencies: Inaccurate or incomplete descriptions Contractual obligations table is incomplete Obligations subject to uncertainty not included or disclosure is incomplete (e.g., uncertain tax positions, variable interest payments, OPEB plans)
Common SEC Review Comments cont d Segment Information Deficiencies: Segment information inappropriately aggregated Lack of on-going analysis Suggestions from staff: Registrants should provide a comprehensive response to staff s comments, including how CODM makes resource allocations and assesses performance, in aberrations Continually monitor facts and circumstances
Common SEC Review Comments cont d Income Taxes Deficiencies: Reversals of valuation allowances: Consider all evidence, both positive and negative Degree to which positive evidence is verifiable Current state of economy Consistency of assumptions (e.g., DTA reversal with a goodwill impairment) Deferred tax assets in loss years: Economic slowdown is not an aberration Magnitude and duration of losses Drivers of losses Registrant s ability to make accurate forecasts Consistency of assumptions
Common SEC Review Comments cont d Goodwill Impairment Deficiencies: Reporting units at risk of failing Step 1: Staff recommends disclosure Disclosure should include changes in circumstances and assumptions that could affect potential impairment Interim impairment tests should be disclosed Goodwill Impairment Charges: Disclose changes in circumstances that led to change Why now?
Common SEC Review Comments cont d Revenue Recognition Deficiencies: Collectibility reasonably assured Customer s credit worthiness Payment terms Collection practices, including history of modifying terms, or making other concessions Write-off history Non-GAAP Disclosures: Do not present a full non-gaap income statement for purposes of reconciling non-gaap financial measures to U.S. GAAP measures
AICPA Clarified and Converged Standards for Auditing and Quality Control
Key Changes Impacting Audits Explicitly requires determination whether applicable reporting framework is acceptable Explicitly requires management acknowledgement of their responsibilities at onset of audit engagement Changes to wording of the auditor s report, including the use of paragraph headings and expansion of the description of management s responsibilities Requires more specific procedures to detect illegal acts Additional requirements related to opening balances in initial audits
Key Changes Impacting Audits cont d SASs that are most substantially revised from the standards they supersede: Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Generally Accepted Auditing Standards (supersedes the 10 standards and all the general standards) Terms of Engagement (clarifies procedures for engagement acceptance and results in revision to engagement letter language) The suite of SASs that address special purpose financial statements
Key Changes Impacting Audits cont d SASs that are most substantially revised from the standards they supersede: cont d Group Audits (Including the Work of Component Auditors) (changes focus in audits that involve the work of another auditor from the coverage by each auditor to the extent of the involvement of the group engagement partner, formerly referred to as the principal auditor )
Questions
Thank you Jim Brendel, CPA, CFE Partner In-Charge, Denver 303-298-9600 jbrendel@heincpa.com www.heincpa.com