FASB Update Christine DiFabio Director, Technical Activities Financial Executives International
Future of FASB and Financial Reporting • FEI is supportive of an independent standard-setting process for establishing accounting principles • Necessary to allow for the process of due process • Importance of the relationship of FASB and the IASB
TIMING of SIGNIFICANT FASB PROJECTS • FASB undertaking several large projects with significant impacts • FASB must allow adequate time for due process: preliminary views, extended comment periods, field testing, etc. • When issuing standards in Q4, FASB must take into account timing of standard (relative to year-end) and effective date and allow for adequate and necessary time for planning of implementation. • Significant issues during the implementation of FIN 46 based on timing of issuance vs. effective date. • Potential for similar issue with share-based payments: Final standard expected in Q4 with implementation beginning in January 2005
FASAC 2004 Survey – Priorities of the FASB • Revenue Recognition • Reporting Financial Performance • Fair Value Measurement • Simplification and Codification • International Short-Term Convergence • Employee Benefits/ Pension Accounting Business Combinations • Business Combinations: Purchase Method Procedures • Conceptual Framework • Equity-Based Compensation • Leases
Revenue Recognition Project • Recently delayed project timeline • Preliminary views document to be issued in 2Q ’05 • Joint project with the IASB • Major change in current accounting • Basic model still based on FV of performance obligations • Exploring cases where FV is not observable • Proposed model asset-liability focused, with residuals falling out to income statement accounts
Reporting Financial Performance • Joint project with the IASB • Currently in the process of finalizing joint task force (includes at least 2 FEI/CCR Members) • Preliminary views document due some time in 2005 • Develop single statement of comprehensive income • Focus on presentation and not accounting
Fair Value Measurements • FASB currently deliberating comments on ED • FASB has noted that many of the 85 comments indicated concern on “what was to come” – looked at ED as first step to Fair Value; FASB “this is not the case” • Comments – Address conceptual framework and “relevance and reliability” first • Final standard expected in Q4
Fair Value Measurements EDProposed Requirements • Establish a framework for measuring fair value to apply broadly to both financial and nonfinancial assets and liabilities • Defines FV: The price at which an asset or liability could be exchanged in a current transaction between knowledgeable, unrelated willing parties (market place participants) • Expanded disclosure requirements • ED states that the framework proposed would improve consistency, reliability and comparability of financial reporting • Interestingly, relevance was left out • Arguably, use of fair value is not as “reliable” or as “comparable” or “consistent” as historical cost or other more easily verifiable measurements • Effective for fiscal years beginning after 6/15/05
Fair Value Measurements:Hierarchy • Groups into 3 broad categories (levels) the inputs that should be used for FV • Level 1 estimates – Unadjusted quoted market prices • Level 2 estimates – Quoted market prices adjusted for appropriate differences. Price effect of the differences must be objectively determinable. • Level 3 estimate – Requires judgment in the selection and application of valuation techniques and relevant inputs. Relevance and reliability of the inputs should be considered. Emphasis is on market inputs
Codification and Retrieval ProjectRecent FASB Survey • Over 1,400 participants • 95% agree that the FASB should pursue a codification • 80% believe the structure of U.S. GAAP is confusing • 85% believe that it takes an excessive amount of time to gain comfort with research results • 87% believe that the codification would make GAAP more understandable • 96% believe that the codification would simplify retrieval when performing research Slides on Codification and Retrieval Project can be found directly on FASB website.
Codification and Retrieval ProjectThe Vision • All relevant U.S. accounting and financial reporting literature contained in • a single, authoritative, timely, comprehensive, integrated codification • a single, fully-functional, online, real-time database designed for the codification • Goal • Give constituents the information that they need in one spot Slides on Codification and Retrieval Project can be found directly on FASB website.
Codification and Retrieval ProjectThe Vision • Authoritative Codification • Integration and synthesis of all existing U.S. GAAP into a topically-organized integrated codification • The sole source of authoritative GAAP • Eliminates need to access multiple sources • Assumes AICPA guidance is fully integrated with FASB guidance within each topical section • Assumes SEC guidance is included within each topical section – but segregated • Consistent structure within topical sections • Standards process will change to immediately update codification upon completion of new standards, issues, Q&As, etc. • Positive impact on other simplification matters (e.g., principles-based standards, all-inclusive reviews, IAS convergence, conceptual framework) Slides on Codification and Retrieval Project can be found directly on FASB website.
Codification and Retrieval ProjectThe Vision • Retrieval • Single, fully-functional, online, real-time database • Content and processes designed for • Maximizing the codification structure • Electronic use – structure, navigation, links, etc. • End-user access and large-user licensing • Database and processes designed for immediate updates • Designated as authoritative electronic reference source for tagged financial statements Slides on Codification and Retrieval Project can be found directly on FASB website.
Short-Term ConvergenceEfforts • Goal • Review of current differences in FAS and IAS • Prioritize differences from easily remedied to more difficult • Goal is to reach agreement on most appropriate treatment • Significant differences to be addressed in individual future projects • Currently deliberating responses to 4 ED’s: • Accounting Changes & Corrections (Q1 ’05 Standard/ Change in effective date) • Inventory Costs (Q4 Standard) • EPS (most likely Q1 ’05 Standard) • Nonmonetary Asset Exchanges (Q4 Standard)
Short-Term ConvergenceExposure Drafts • Accounting Changes and Error Corrections • Voluntary changes in accounting to be applied by retrospective application rather than by cumulative effect adjustments • Earnings per Share • Amend computational guidance of FAS No. 128 • Inventory Costs • Exclusion of unusual amounts of idle capacity and spoilage cost from the cost of inventory • Exchanges of Productive Assets • Accounted for based on fair values of assets
Short-Term Convergence:Income Taxes • Intent: To significantly reduce the # of differences between 109 and IAS 12 without replacing or reconsidering the fundamental principles of either standard • Current scope includes eliminating Statement 109 exception to recognize deferred taxes on investments in foreign subsidiaries (unremitted foreign earnings) • To be considered at joint FASB-IASB Board Meeting in October • Significant concern from CCR members regarding complexity of reporting that would result from removal of exception
Business CombinationsPurchase Methods Procedures • Tentative Decisions currently out for review • Exposure Draft expected later this quarter in conjunction with IASB • Expected roundtables in Q1 with a final standard in second half of 2005 • Field Testing in progress • Proposed effective for business combinations occurring in fiscal years beginning after 12/15/05
Business CombinationsKey Proposed Changes • Expensing transaction and acquisition-related restructuring costs • Recognizing contingent consideration and contingent assets and liabilities at FV at the acquisition date, with adjustments to fair value recorded through earnings each reporting period thereafter • Recognizing full FV of assets acquired, liabilities assumed, and minority interests in partial business combinations • Reflecting minority interests in equity • Capitalizing acquired IPR&D costs
Business CombinationsSignificant Impacts • Significant income statement charges in connection with acquisition • Increase income statement volatility in subsequent periods • Heavy reliance on valuation models for initial and ongoing accounting for contingent assets and liabilities and contingent consideration
Business Combinations • Basic consolidation model changes to economic entity approach – minority interests are recognized as a component of equity • Resulting potential financial reporting changes: • Potential recoding of “holding” gains and losses in step acquisitions and partial dispositions • Treatment of changes in ownership interest in a subsidiary as capital transactions when there is no change in control • Balance sheet impact that may affect financial ratios (i.e. return on equity) • Income Statement impact on gross margin and net income
Business Combinations • Based on principle that a business combination is an exchange of FV consideration between independent parties • Differs from the traditional cost-based foundation • Minority interest represents a component of equity; minority shareholders own a residual interest in the consolidated entity • Differs from traditional parent company approach which results in classifying minority interest as a “mezzanine” item between liabilities and equity
Conceptual Framework • Plan to issue “invitation to comment” • Joint revised conceptual framework with the IASB • Will include definition of a liability and relevance/reliability of FV as a measurement attribute • Timeline/plan to be discussed at Joint FASB/IASB Board Meeting in October
Conceptual Framework • FEI opinion that this is integral to FASB future and should take priority before any new standards are issued. • Framework has over the years been updated in piecework resulting in inconsistent application and implementation in accounting practice. • Emphasize the important of relevance and reliability in financial reporting.
FASB Stock Option Redeliberations: Recent Decisions • Represent a cost to be recognized as an expense • Cost measured based on a grant-date fair value • Valuation Model – no preference will be noted. Choice based on list of measurement objectives and related principles (Change from ED) • Cost should be recognized over requisite service period • Graded vesting and tax accounting – revert to current requirements of FAS 123 (Change from ED) • Transition – Allow for modified prospective and retrospective methods (Change from ED) • Effective date - TBD
Valuation of Employee Stock Options and Other Equity-Based InstrumentsFERF Research Publication • Provides an overview of Employee Stock Options (ESOs) and the different valuation models. • Summarizes the 2004 FASB Exposure Draft • Outlines the binomial valuation model in detail. • Discusses the potential impact that the new guidelines may have on the design of equity-based compensation instruments.
Other FASB Areas for Discussion • Update on FAS 150 for Private Companies • FIN 46 Effective for Private Companies • Proposed Interpretation to FAS 109 for Uncertain Tax Positions • Recent EITF Discussions • EITF 03-1 • EITF 04-8
FAS 150 Update • Classification, measurement and disclosure requirements of 150 were delayed for mandatorily redeemable instruments of non-SEC registrants • Issue will be addressed through Liabilities and Equity Project • At 10/6 Board Meeting, Board directed staff to move forward on Base Approach to distinguish liabilities from equity for single component instruments • This approach would categorize mandatorily redeemable shares (non-public co) as equity, unlike unintended consequence of FAS 150 • Wouldn’t expect a final standard until the earliest 2006
Base Approach • Instrument is a liability if it requires/may require issuer to settle in assets, shares, or other instruments and does not establish a direct or indirect ownership relationship • Direct ownership: Most subordinated interests in the entity share prorata in earnings and losses of an entity (reference instrument) • Considered equity regardless of any settlement obligation • Indirect ownership: Instrument indexed to and in the same direction as the reference instrument • Considered liability if its ultimate settlement, if any, would not result in establishing a direct ownership relationship
FIN 46 (R)Consolidation of Variable Interest EntitiesFor Non-Public Companies • Any entity (i.e., SPE or non-SPE) created before December 31, 2003 • FIN 46R must be adopted no later than the beginning of the first annual reporting period beginning after December 15, 2004. FIN 46 is not required to be adopted. • Any entity (i.e., SPE or non-SPE) created after December 31, 2003 • Apply FIN 46R from the first date the enterprise becomes involved in the potential variable interest entity.
FIN 46 (R) • Based on concept that companies that control another entity through interests other than voting interests should consolidate the controlled entity • Defining controlling financial interest = company’s exposure (variable interests) to economic risks and potential rewards from VIEs assets and activities • Requires extensive judgments and estimates with few examples
Accounting for Tax Uncertainties • Proposed Interpretation to FAS 109 • ED expected in Q4 ’04, effective for periods ending after March 15, 2005 (i.e. Q1 for calendar year companies) • Report adoption as a cumulative effect of accounting change • Address accounting for tax uncertainties that arise when a position that an entity takes on its tax return may be different from the position that the taxing authority may take
Accounting for Tax UncertaintiesTentative Decisions • In order to record a benefit for a tax uncertainty, the related interpretation of any tax law, regulation, rule, or ruling must be PROBABLE of being upheld on audit by the taxing authority • Tax benefit recognized for a tax uncertainty should be derecognized if it later becomes less than probable of being upheld • If benefit not recognized (not probable), a liability must be established for underpayment of current taxes – classified as CURRENT TAX PAYABLE (not deferred tax liability) • Clarify that unrecognized benefits of tax uncertainties are subject to disclosure requirements of FAS 5 for gain contingencies • Effect of changes in liability for tax uncertainties during interim periods should be reported as discrete events, not as components of estimated annual effective tax rate
EITF Issue 03-1, “The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments • Final FSP EITF 03-1-1: Delayed effective date of paragraphs 10-20 of 03-1 • Para 10-20 give guidance on how to evaluate and recognize an impairment loss that is other than temporary • Delay effectives until decisions reached regarding FSP 03-1-a • Deferral does not include disclosure requirements
Proposed FSP EITF 03-1-aImplementation Guidance for Application of Paragraph 16 of EITF 03-1 • Comments due October 29th • Relates to evaluating whether an impairment is other-than-temporary for debt securities that cannot be contractually prepaid or otherwise settled in such a way that the investor would not recover substantially all of its cost • Directly applies to debt securities that are impaired solely because of interest rate and/or sector-spread increases and that are analyzed for impairment under paragraph 16 • “Tainting Concerns”
EITF Issue 04-8 CoCo’s • EITF reconsidered on September 30th – Final pending ratification by FASB • Include contingently convertible debt securities, along with mandatorily redeemable contingently convertible preferred stock, and Instrument C (as described in EITF Issue 90-19). (All with market price conditions) in diluted EPS computations regardless of whether market price trigger has been met • Effective for periods ending after 12/15/04 • Restate all periods during which instrument is outstanding • Consensus need not be applied to instruments that were repaid in cash prior to the end of the period of adoption. • Determination of the dilutive effect upon adoption is based on the form of the instrument as it exists at the end of the quarter of adoption.
Focus on Small Business • AICPA Task Force • IASB Paper on SME (responded to by CPC): Would not agree to different accounting for SME – different disclosure only • Differential Accounting Standards: Generally, not appropriate. The characteristics of relevance and reliability are equally important to all entities. • Approach does not seem consistent with objective of “principles based” standards. • The needs of users (small vs. large) should be considered from a disclosure not accounting perspective. • Letter echoes sentiment at recent FASAC meeting • FASB Small Business Advisory Committee • SEC request to COSO to develop an internal control framework designed specifically to address small business needs
Emerging Issues for Financial Executives Christine DiFabio Director of Technical Activities Financial Executives International