FASB/IASB Joint Projects - presented by McGladrey at 2011 NYSSCPA Private Company Accounting & Auditing Conference

FASB/IASB Joint Projects
Brian H. Marshall, Partner, McGladrey & Pullen, LLP
Richard K. Stuart, Partner, McGladrey & Pullen, LLP
June 16, 2011

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©2011 McGladrey & Pullen, LLP. All Rights Reserved.

Agenda

 FASB/IASB Progress Report – April ‘11
 Joint Revenue Recognition Project
 Joint Financial Instruments Project
 Joint Leases Project
 Status of Other Joint Projects

1 ©2011 McGladrey & Pullen, LLP. All Rights Reserved.

FASB/IASB Progress Report – April ‘11



 Joint standards on Statement of Comprehensive
Income & Fair Value Measurement expected (&
subsequently issued) in Q2
 Priority projects
- Revenue Recognition
- Leases
- Financial Instruments
 Timetable extended for priority projects from 2Q to
2H 2011
 Effective dates will allow sufficient time for changes



 Revenue Recognition and Leases Projects
- Boards’ timetables are in sync for both projects
- Final redeliberations are in progress
- Consider whether re-exposure is necessary
- Even without re-exposure, draft standards will be
made available for review
- Boards will then determine whether to proceed to
finalize the standards



 Financial Instruments Project
- Various Board sub-projects
1. Balance Sheet – Offsetting
 Boards’ timetables are in sync
2. Classification and Measurement
 FASB expects to complete in 2H 2011 and
consider whether re-exposure is necessary
 IASB completed in 2010



 Financial Instruments Project
- Various Board sub-projects
3. Impairment
 Boards’ timetables are in sync
 Basic impairment approach to be determined
by end of 2H 2011
 Consider whether re-exposure is necessary
4. Hedge Accounting
 IASB plans to finalize in 2H 2011
 FASB timing unclear



 Insurance Project
- Different Board timetables:
• IASB expects to issue final document by end of
2011
• FASB expects to issue an ED in 2H 2011 and
final standard in 2012


Timetable for Selected Joint Projects

Joint Project 2Q 2011 2H 2011 2012 & Beyond
Revenue Recognition F
Leases F
Financial Instruments F
Insurance ED F
Fair Value Measurements Issued
Statement of Comprehensive Income F
Consolidation ED F
Reporting Discontinued Operations ED F
Emissions Trading Schemes ED, F
Financial Instruments with ED, F
Characteristics of Equity
Financial Statement Presentation ED, F


Joint Revenue Recognition Project



 Exposure Draft issued in June 2010
 Redeliberations began in January 2011



 Scope
 Steps in applying the model
1. Identify the contract with a customer
2. Identify the separate performance obligations in the
contract
3. Determine the transaction price
4. Allocate the transaction price to the separate
performance obligations
5. Recognize revenue when each separate
performance obligation is satisfied


1. Identify the Contract with a Customer

 Contract is an enforceable agreement between
parties
 Can be written, verbal or implied
 Contract combination
- Required for contracts entered into at or near the
same time if certain other criteria are met


2. Identify the Performance Obligations

 Promise in a contract with a customer to transfer a
good or service to that customer
 Account for performance obligations separately if both
of the following criteria are met
- The good or service has a distinct function
- The good or service is transferred at a different time from
other promised goods or services in the contract
 However, a bundle of promised goods or services is
accounted for as one performance obligation if the
entity provides a service of integrating those goods or
services into a single item


3. Determine the Transaction Price

 Estimated amount of consideration to which the
entity will be entitled
- If price is variable (e.g.; contingencies, rebates,
royalties), estimate based on probability-weighted or
most-likely amount
- Time value of money
- Fair value of noncash consideration
 Collectibility is not considered


4. Allocate the Transaction Price

 Based on relative standalone selling price of
goods or services
 Standalone selling price:
- Observable price when sold separately (best)
- Cost plus margin
- Adjusted market assessment
- Residual technique allowed if highly variable
 Subsequent changes to transaction price
generally allocated to all performance
obligations unless certain criteria are met


5. Recognize Revenue

 Recognition limited to cumulative revenue the entity is
reasonably assured of being entitled to receive
 Recognize revenue as goods or services are transferred
 Determine whether separate performance obligations
are goods or services
 Goods – recognize revenue when customer obtains
control based on following indicators:
- Customer has an unconditional obligation to pay
- Customer has physical possession
- Customer has risks and rewards of ownership
- Customer has legal title


5. Recognize Revenue

 Services – recognize revenue as the entity provides
service if performance obligation is satisfied
continuously based on either of following criteria:
- Entity’s performance creates or enhances an asset the
customer controls as it is created or enhanced, or
- Entity’s performance does not create an asset with an
alternative use and one of several other criteria are met
 Select a method for service revenue recognition
that faithfully depicts the entity’s performance
- Input methods
- Output methods


Other Issues

 Return rights
 Product warranties
 Licensing
 Onerous contracts
 Costs of obtaining and fulfilling a contract


Joint Financial Instruments Project


Balance Sheet Offsetting

 Exposure Draft issued in January 2011
 An entity would be required to offset an eligible asset
and an eligible liability when both of the following exist:
- It has an unconditional and legally enforceable right of setoff
- It intends either to settle the asset and liability on a net basis or
to realize the asset and settle the liability simultaneously
 Would apply whether the right of setoff arises from a
bilateral or multilateral arrangement
 Would eliminate the current exception that permits net
presentation of derivatives when the right of setoff or
intention of setoff is conditional


Classification and Measurement

 Exposure Draft issued in May 2010 (on impairment
and hedging as well)
 Equity securities other than equity method
investments – measure at fair value through net
income
- Practicability exception for nonpublic entities for
nonmarketable equity securities
• Measure at amortized cost less OTTI
• Recognize upward adjustments to fair value when change in
price is observable



 Debt securities
- Measure at fair value through net income if held for
sale/transfer and/or doesn’t meet other criteria
- Measure at fair value through OCI if business
strategy is to invest cash to either maximize total
return or manage interest rate/liquidity risk by
collecting contractual cash flows or selling the
instrument



 Debt securities
- Measure at amortized cost if following criteria are
met
• Business strategy is to manage through customer financing
activities (lending or borrowing)
• Holder can manage credit risk by negotiating potential
adjustments with counterparty in the event of potential
credit loss
 Sales/settlements would be limited to circumstances to
minimize losses due to deteriorating credit
• Instrument is not held for sale/transfer at
acquisition/issuance



 Derivatives measured at fair value through net
income unless designated as certain type of
hedging instrument
 Hybrid financial instruments
- Retain requirements for bifurcation/fair value
recognition for embedded derivatives
- Apply classification/measurement model separately
to host contract


Impairment

 Impairment model for financial assets not
carried at fair value through net income:
- Separate models originally proposed by FASB and
IASB
- Published supplementary document on proposed
common solution/model for open loan pools in
January with comments due in April
- Based on feedback on supplementary document,
plan to develop a new model


Impairment

 Expected losses should be estimated with objective
of expected value
- Identify possible outcomes, estimate likelihood of each
and calculate probability-weighted average
 Expected losses measured as all shortfalls in cash
flows on a discounted basis
- Unwinding of discount should be reflected in credit losses
 Recognize interest income based on effective rate
applied to amortized cost balance that is not
reduced for impairment


Next Steps

 Develop updated model / objectives on
impairment
 Redeliberate balance sheet offsetting and
hedge accounting
 Develop risk disclosures over involvement in
financial instruments
 Disseminate additional exposure drafts as
considered necessary
 Determine effective dates/transition


Joint Leases Project


Joint Leases Project

 Exposure Draft issued in August 2010
 Redeliberations began in February 2011
 Objective of the project is to propose a new
approach to lease accounting to address
perceived shortcomings of current model
 Would apply to all leases with certain limited
exceptions


Perceived Problems with Current Model

 Current model is “broken”
- Similar transactions can have different accounting
- Structuring opportunities
- Complex, rules-based
- Assets and liabilities not recognized on balance
sheets


Proposed Model: Scope

 Would not mention in substance
purchases/sales
 Intangibles not required to be accounted for
under this standard


Lease Definition

 Right to use a specified asset for a period of
time in exchange for consideration
- Fulfillment of contract depends on use of specified
asset(s)
- Contract conveys right to control use for a period of
time
- Would not include right to use incidental assets


General

 Short-term leases
- Elect (by class of asset) not to apply right-of-use
model
- Subject to reconsideration based on May meeting
 All initial measurements based on information at
lease commencement


Lease Term

 Noncancelable period plus optional periods with
“significant economic incentive”
 Consider only economic factors
 Reassess if economic factors impacting option
exercise change significantly


Arrangements with Lease and Non-Lease
Components
 Lessees: separate unless there are no
observable prices
- Allocate based on relative stand-alone purchase
price (if observable);
- Otherwise, residual method
 Lessors: always separate
 Open issue: should private company lessees be
given an option not to separate?


Lease Payments

 Variable Lease Payments
- Based on index or rate—include using prevailing
rates/indices at commencement
- If payments represent in substance minimum lease
payments, include in measurements
 Other Lease Payments
- RVG: difference between expected RV and
guaranteed RV
- Term penalty: consistent with lease term
- Exercise of purchase options: included in
measurement if there is a significant economic
incentive to exercise


Classification

 Finance or other-than-finance
- Decision reversed at May meeting
- Conclusion: all leases have a financing element
 Reversal means leases will be accounted for in
manner in ED
- Expense will be front loaded


Proposed Lessee Model

 Discount Rate
- Rate charged by lessor (if a finance lease and the
rate is readily determinable
- Otherwise, incremental borrowing rate
 Sale-Leaseback
- Are requirements for sale recognition met?
• Yes: sale-leaseback accounting applies
• No: financing transaction


Status of Other Joint Projects


Fair Value Measurements – ASU 2011-04

 Converged guidance issued in May 2011
 Blockage discounts prohibited for all fair value
measurements
 Other discounts or premiums (for non-Level 1
measurements) may be applied if consistent with
unit of account and would be considered by a
market participant
 Concepts of “highest and best use” and
“valuation premise” apply only to nonfinancial
assets
 Exception to fair value requirements provided for
financial instruments managed in a portfolio


Fair Value Measurements – ASU 2011-04

 Principal market – determined based on
market with greatest volume and level of
activity the Company can access
 Fair value of instrument classified in equity
measured from perspective of market
participant that holds instrument as an asset
 Additional disclosures required
 Effective for nonpublic entities for annual
periods beginning after December 15, 2011,
with early application permitted


Other Joint Projects

 Statement of Comprehensive Income
 Consolidation
 Reporting Discontinued Operations
 Insurance
 Following projects are lower priority with no
further discussion expected until 2012
- Emissions Trading Schemes
- Financial Instruments with Characteristics of Equity
- Financial Statement Presentation


McGladrey Thought Leadership

 More Accounting Changes Coming
 FASB Tentatively Decides to Significantly
Revise Proposed Revenue Recognition
Standard
 http://mcgladrey.com/Assurance/Accounting-
Resources
 http://mcgladrey.com/Publications/Publication-
Subscription


QUESTIONS?


FASB/IASB Joint Projects - presented by McGladrey at 2011 NYSSCPA Private Company Accounting & Auditing Conference

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