Board Meeting Handout Agenda Prioritization Board Meeting August 19, 2015

Transcription

1 Board Meeting Handout Agenda Prioritization Board Meeting August 19, 2015 PURPOSE OF THIS MEETING 1. The purpose of this decision-making Board meeting is for the Board to consider five potential new projects and whether each project should be added to the Board s or the EITF s technical agenda. BACKGROUND INFORMATION 2. The following table is a summary of the potential new projects that the Board is planning to discuss and vote whether to add to the agenda: Project Simplifying the Measurement of Asset Retirement Obligations Accounting for Contract Adjustments between Healthcare Providers and Insurance Companies Accounting for Cumulative Preferred Stock Accrued Dividends Accounting for Notional Pooling Arrangements in Consolidated Financial Statements Clarification of the Regular Way Security Scope Exception in Topic 815 The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 20

2 SIMPLIFYING THE MEASUREMENT OF ASSET RETIREMENT OBLIGATIONS PURPOSE OF THIS MEETING 3. The Board will decide whether to add a project to its agenda to simplify the initial and subsequent measurement of an asset retirement obligation (ARO), and, if so, whether it should be a Board or an EITF project. BACKGROUND INFORMATION 4. This potential new project was identified through the Board s Simplification Initiative. The Board previously committed to an initiative to identify, evaluate, and improve areas of generally accepted accounting principles (GAAP) for which cost and complexity can be reduced while maintaining or improving the usefulness of the information. 5. The staff previously presented this potential project to the Board at the March 2015 agenda prioritization meeting. At that meeting, the Board considered staff research about alternative ways the Board might simplify the measurement of AROs. Specifically, the Board discussed a potential cost accrual approach and an approach that would require an entity to measure the fair value of the entire ARO on a recurring basis. However, the Board did not make any decisions. Rather, the Board directed the staff to perform additional research to evaluate the various measurement alternatives identified by the staff. 6. Subtopic , Asset Retirement and Environmental Obligations Asset Retirement Obligations, requires an entity to recognize a liability for an ARO at the time the obligation is incurred. An entity also capitalizes an asset retirement cost by increasing the carrying amount of the related long-lived asset by the same amount as the liability. 7. The measurement objective for the initial measurement of an ARO liability is fair value. That is, an entity is required to estimate the price that would be received to sell Page 2 of 20

3 an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 8. To the extent there are revisions to the timing or the amount of the original estimate of undiscounted cash flows, paragraph requires an entity to adjust the carrying amount of the ARO liability and the related long-lived asset. 9. Upward revisions to the initial estimated cash flows are accounted for as new AROs. The incremental cash flows are often referred to as ARO layers and are measured at fair value in accordance with Topic 820. The new layer is discounted using the creditadjusted risk-free rate at the time the revision is made, but the initial estimated cash flows (and any layers added subsequent to the initial layer) are not remeasured. 10. Downward revisions to the initial estimated cash flows are discounted using the credit-adjusted risk-free rate that existed when the original liability (that is, the layer to which the estimated cash flows relate) was recognized. Because the downward revision does not take into account current interest rates, it is not considered a fair value measurement. If an entity cannot identify the layer to which the downward revision relates, it may use a weighted-average credit-adjusted risk-free rate to discount the downward revision to estimated future cash flows. ISSUE 1: AGENDA DECISION 11. Some stakeholders have raised concerns about the measurement of AROs. Specifically, some stakeholders stated that the measurement of changes resulting from revisions to cash flow estimates is overly complex and provides information that is not useful. 12. The staff has identified two potential alternatives. Alternative 1: Measure an ARO Liability at Fair Value on a Recurring Basis 13. A fair value approach would measure an ARO liability at an amount that an entity would be required to pay in an active market to settle the obligation in a current transaction in circumstances other than a forced settlement. A fair value measurement Page 3 of 20

4 would be representative of the amount that a willing third party of comparable credit standing would demand and could expect to receive to assume all of the duties, uncertainties, and risks inherent in the entity s obligation. This approach is similar to what is required by current GAAP; however, under this approach, the entire ARO would be remeasured at fair value on a recurring basis. Therefore, the ARO layers about which stakeholders have raised concerns would be eliminated. However, subsequent changes in the estimated ARO would be recognized in earnings. Alternative 2: Measure an ARO Liability Using a Cost-Accumulation Approach 14. A cost-accumulation approach would require an entity to measure an ARO liability using the incremental costs that it anticipates it would incur to settle the liability. A cost-accumulation approach ignores cash flows related to items such as allocated overhead, profit margin, and assumptions market participants would make about estimated cash flows. The cost-accumulation approach would apply to both the initial and subsequent measurement of an ARO. To the extent there are changes in estimated costs, the entire ARO would be remeasured using assumptions as of the remeasurement date. Subsequent changes in the estimated ARO would be made by increasing or decreasing the carrying amount of the related long-lived asset by the same amount as the liability. Questions for the Board 1. Does the Board want to add a project to the FASB s agenda about the initial and subsequent measurement of ARO liabilities? 2. If so, should it be a Board project or an EITF project? 3. Is there further research that the Board would like the staff to perform? Page 4 of 20

5 ACCOUNTING FOR CONTRACT ADJUSTMENTS BETWEEN HEATHCARE PROVIDERS AND INSURANCE COMPANIES PURPOSE OF THIS MEETING 15. The Board will decide whether to add a project to its agenda related to the disclosure of contractual adjustments and discounts by certain entities, and, if so, whether it should be a Board or an EITF project. 16. The FASB received a written agenda request from a stakeholder about disclosure of the difference between (i) a hospital s rack rate (also referred to as the established rate) and (ii) the negotiated rate paid by a non-government third-party payor (insurance entity s payments on behalf of insured patients). This difference is commonly referred to as a contractual adjustment. RELEVANT GAAP 17. Paragraph provides the following relevant guidance for revenue recognition for health care entities: The provision for contractual adjustments (that is, the difference between established rates and expected third-party payor payments) and discounts (that is, the difference between established rates and the amount billable) are recognized on an accrual basis. These amounts are deducted from gross service revenue to determine net service revenue. 18. GAAP did not develop the term contractual adjustments. The term is commonly used with the same meaning as stated in the Codification paragraph referenced above. GAAP does not require an entity to disclose the amount of contractual adjustments. However, GAAP does require an entity to disclose the difference between original estimates of contractual adjustments and discounts and subsequent revisions to that estimate. [Paragraph ] 19. The aforementioned industry specific guidance will be superseded upon the effective date of Accounting Standards Update No , Revenue from Contracts with Customers (the new revenue standard). In Step 3 (determine the transaction price) of Page 5 of 20

6 the new revenue standard, an entity must consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. In determining the transaction price, an entity is required to consider variable consideration and constraints on estimates of variable consideration. The new revenue standard includes disclosure requirements about significant estimates. 20. The Board recently completed standard setting action that impacts both health insurance companies (Accounting Standards Update No , Disclosures about Short-Duration Contracts) and healthcare providers (Accounting Standards Update No , Revenue from Contracts with Customers). Improvement of disclosures were a key element of both of those projects and disclosure was the subject of significant outreach, including with investors. ISSUE 1: AGENDA DECISION 21. The overall objective of financial reporting as stated in FASB Concepts Statement No. 8, Conceptual Framework for Financial Reporting - Chapter 1, The Objective of General Purpose Financial Reporting, and Chapter 3, Qualitative Characteristics of Useful Financial Information, is as follows: OB2. The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling, or holding equity and debt instruments and providing or settling loans and other forms of credit. 22. The proposed FASB Concepts Statement, Conceptual Framework for Financial Reporting Chapter 8: Notes to Financial Statements included a discussion about how the objective of financial reporting is met in the context of the notes by providing information that assists a user s assessment of prospects for net cash inflows to the reporting entity. [Paragraph D6] Page 6 of 20

7 23. Contractual adjustments do not result in a cash flow to either the healthcare entity or the insurance entity. The amount of cash the entity expects to receive, and ultimately receives, does provide decision useful information and that amount is the basis for the amount of revenue that an entity should present on its statement of operation under both existing GAAP and the new revenue standard. 24. While disclosure of the contractual adjustments might provide information that is useful to some investors, Chapter 1 within Concept Statement 8 states that generalpurpose financial reports do not and cannot provide all of the information that existing and potential investors, lenders, and other creditors need. Those users need to consider pertinent information from other sources, for example, general economic conditions and expectations, political events and political climate, and industry and company outlooks. Although an individual user might find the information useful, the Board, in developing financial reporting standards, seeks to provide the information that will meet the needs of the maximum number of primary users. Question for the Board 1. Does the Board want to add a project to the Board s or the EITF s agenda related to the disclosure of the amount of contract adjustments? Page 7 of 20

8 ACCOUNTING FOR CUMULATIVE PREFERRED STOCK ACCRUED DIVIDENDS PURPOSE OF THIS MEETING 25. The Board will decide whether to add a project to its agenda related to the timing of recognition of undeclared cumulative preferred stock dividends, and, if so, whether it should be a Board or an EITF project. BACKGROUND INFORMATION 26. Preferred stock is a security that has preferential rights compared to common stock. For example, preferred stockholders generally have priority over common stockholders when receiving dividends. Preferred stock often includes a stated dividend rate. The rights and preferences applicable to the preferred stock are typically described in agreements between the entity and its preferred stockholders. 27. For various reasons, a company might not declare dividends (for example, if it is experiencing operating losses or has little cash available). Dividends on preferred stock may be cumulative, whereby dividends omitted (that is, undeclared) in a previous period must be paid before the payment of dividends on other lower priority classes of stock. If a corporation omits a dividend on its cumulative preferred stock, such omitted dividends are in arrears. 28. AICPA Technical Practice Aid , Accrual of Preferred Dividends (AICPA TPA ), includes guidance that indicates that recording a liability for cumulative preferred stock dividends should be recognized when the dividends are declared. In addition, paragraph (b) requires disclosure of the aggregate and per-share amounts of arrearages in cumulative preferred dividends. ISSUE 1: AGENDA DECISION 29. The FASB received a request to add a project to the agenda that would address whether issuers of cumulative preferred stock should record a liability as dividends accumulate (that is, prior to declaration). This issue applies to all reporting entities Page 8 of 20

9 that issue nonredeemable cumulative preferred stock dividends. However, the staff has determined that this issue may require reconsideration of other areas of GAAP related to the accounting for preferred stock and, potentially, common stock. 30. If this project is added to the agenda, the FASB staff has identified three alternatives to address this issue. (a) Alternative A: Clarify the existing accounting guidance by codifying certain concepts found in AICPA TPA , within the FASB authoritative literature. (b) Alternative B: Require an entity to accrue a dividend liability as dividends accumulate on nonredeemable preferred stock, prior to declaration, if certain circumstances are met. (c) Alternative C: Require an entity to accrue a dividend liability as dividends accumulate on nonredeemable preferred stock, prior to declaration, in all circumstances. Questions for the Board 1. Does the Board want to add a project to its agenda about the timing of recognition of undeclared cumulative preferred stock dividends? 2. If yes, should it be addressed by the Board or the EITF? 3. If yes, does the Board prefer Alternative A, B, or C? Page 9 of 20

10 ACCOUNTING FOR NOTIONAL POOLING ARRANGEMENTS IN CONSOLIDATED FINANCIAL STATEMENTS PURPOSE OF THIS MEETING 31. The Board will decide whether to add a project to its agenda about the presentation of notional pooling arrangements in consolidated financial statements and, if so, whether it should be addressed directly by the FASB or added to the agenda of the EITF. BACKGROUND INFORMATION 32. Cash pooling arrangements are used by some entities to manage their liquidity on a more centralized basis. In a cash pooling arrangement, a parent and each of its subsidiaries participating in the arrangement maintain separate bank accounts with the same bank. The individual bank accounts may be in a cash-positive (deposit) position or a cash-negative (overdraft) position and are combined for purposes of determining the net cash position used for investment or liquidity needs. 33. Generally, there are two types of cash pooling arrangements physical and notional. In a physical pooling arrangement, also referred to as zero balancing, each subsidiary maintains its own account, which is normally a sub-account linked to a main account. At the close of business each day, all positive cash balances in the sub-accounts are physically transferred to the main account and any deficit balances in the subaccounts are covered by borrowings from the main account. 34. Physical pooling can be done across multiple legal entities located in the same or different countries but must be done in the same currency. As a result, physical pooling arrangements may involve foreign currency exchange considerations. Physical pooling arrangements also may involve withholding tax considerations on intercompany loans, depending on tax or regulatory environments. Page 10 of 20

11 35. A notional pooling arrangement is similar to a physical pooling arrangement in that each subsidiary maintains its own account with the same bank. However, unlike a physical pooling arrangement, cash is not physically transferred in a notional pooling arrangement. Instead, the bank calculates a net notional position in a single currency from all of the accounts that participate in the arrangement. The net notional position represents a combined net cash position that is available for any of the participating accounts. Because there is no physical movement of funds, there typically is no intercompany loan accounting. When notional pooling involves bank accounts denominated in multiple currencies, the currencies are virtually converted to a common base currency as part of the pooling process. 36. In a typical notional pooling arrangement, each entity participating in the arrangement enters into a written agreement with the same bank. The agreement specifies that the entity and each of the participants have the option to ask the bank to transfer funds from any cash-positive accounts to any overdraft accounts. In addition, the agreement specifies that the bank has the ability to offset any overdraft account with the cash-positive accounts of the other participating entities. However, absent a bankruptcy or other unusual event, the entity and the bank do not expect to physically move cash from any individual cash-positive account to any individual overdraft account. 37. A disadvantage to notional pooling is that it is not permitted in all countries, including the United States (U.S.) and Germany, where tax authorities consider it to be a comingling of funds. However, a U.S. company could have foreign subsidiaries that participate in notional pooling arrangements. Notional pooling is most common in countries that have minimal or no withholding tax on interest earned in a pooling arrangement, such as the United Kingdom, the Netherlands, and Belgium, and arrangements will vary depending on local laws and regulations. ISSUE 1: AGENDA DECISION Page 11 of 20

12 38. Currently, there is diversity in practice in the presentation of notional pooling arrangements in a reporting entity s consolidated financial statements. Some reporting entities present the cash deposit and overdraft balances gross on the balance sheet, while other reporting entities present those amounts net. 39. The Codification does not specifically address notional pooling arrangements. Cash on deposit at a financial institution is outside the scope of Subtopic , Balance Sheet Offsetting, based on the guidance in paragraph A. That paragraph states that cash on deposit at a financial institution is considered cash rather than an amount owed to the depositor and, therefore, does not satisfy the conditions for a right of setoff to exist. Notwithstanding this guidance, some believe that offsetting cash deposit and liability accounts under a notional pooling arrangement more faithfully presents the cash position of a parent in its consolidated financial statements and that these arrangements are similar to master netting arrangements for derivatives. 40. Others believe that the issue is not whether cash deposit and liability accounts can be set off but whether the accounts that participate in a notional pooling arrangement represent a single unit or multiple units of account. 41. If this project is added to the agenda, the FASB staff has identified four alternatives to address this issue. (a) Alternative A: A notional pooling arrangement should be presented on a gross basis in a reporting entity s consolidated financial statements. (b) Alternative A' A notional pooling arrangement should be presented on a gross basis in a reporting entity s consolidated financial statements with positive cash balances that offset overdraft positions presented as restricted cash. (c) Alternative B: A notional pooling arrangement should be presented on a net basis in a reporting entity s consolidated financial statements. Page 12 of 20

13 (d) Alternative C: The presentation of a notional pooling arrangement should be a policy choice that is applied consistently and disclosed in the financial statements. Questions for the Board 1. Does the Board believe that a project to address the presentation of notional pooling arrangements should be added to the FASB s agenda? 2. If yes, should it be addressed directly by the FASB or added to the agenda of the EITF? 3. If yes, what further research should the FASB staff perform? Page 13 of 20

14 CLARIFICATION OF THE REGULAR WAY SECURITY SCOPE EXCEPTION IN TOPIC 815 PURPOSE OF THIS MEETING 42. The Board will decide whether to add a project to its agenda to clarify the guidance related to the regular-way securities scope exception to derivative accounting in Topic 815, Derivatives and Hedging. If the Board decides to add the project to its agenda, the Board will then be asked to make technical decisions about the issues raised in the agenda request and whether it wants to proceed to issuing an Exposure Draft of a proposed Accounting Standards Update. BACKGROUND INFORMATION 43. When FASB Statement No. 133, Derivatives and Hedging, was originally issued in June 1998, the Board noted (in the basis for conclusions) that accounting practice was inconsistent with respect to the timing of recognition of transfers of various financial instruments. Some transfers of securities were recognized as of the date of trade (often referred to as trade-date accounting). Other transfers were recognized as of the date the financial instrument was actually transferred and the transaction was settled (often referred to as settlement-date accounting). During the period between trade and settlement dates, the parties essentially have entered into a forward contract that might meet the definition of a derivative if the financial instrument is readily convertible to cash. Requiring that all forward contracts for purchases and sales of financial instruments that are readily convertible to cash be accounted for as derivatives effectively would require settlement-date accounting for all of those transactions. Additionally, the Board noted that resolving the issue of trade-date versus settlement-date accounting was not an objective of the project that led to Statement 133. Therefore, the Board decided to explicitly exclude forward contracts for regular-way security trades from the scope of Statement Specifically, paragraph 10(a) of Statement 133 stated the following: Page 14 of 20

15 Notwithstanding the conditions in paragraphs 6 9, the following contracts are not subject to the requirements of this Statement: (a) Regular-way security trades. Regular-way security trades are contracts with no net settlement provision and no market mechanism to facilitate net settlement (as described in paragraphs 9(a) and 9(b)). They provide for delivery of a security within the time generally established by regulations or conventions in the marketplace or exchange in which the transaction is being executed. 45. Paragraph 59(a) of Statement 133 also clarified that some so-called to-beannounced (TBA) contracts also may qualify for the regular-way scope exception: Forward purchases or sales of to-be-announced securities or securities when-issued, as-issued, or if-issued. A contract for the purchase and sale of a security when, as, or if issued or to be announced is excluded from the requirements of this Statement as a regular-way security trade if (1) there is no other way to purchase or sell that security and (2) settlement will occur within the shortest period possible for that security. 46. In April 2003, FASB Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, amended those scope exceptions in two ways. For forward purchases or sales of TBA securities or securities when-issued, as-issued, or if-issued, the Board added a third requirement to qualify for the exception in paragraph 59(a) above, indicating: and (3) it is probable at inception and throughout the term of the individual contract that the contract will not settle net and will result in physical delivery of a security when it is issued. [Paragraph 23] 47. The basis for conclusions explained this amendment as follows: Paragraph 10(a) indicates that contracts are eligible for that exception only if they have no net settlement provision and there is no market mechanism to facilitate net settlement. Paragraph 59(a) of Statement 133 discusses the application of that scope exception to when-issued securities or other securities that do not yet exist. Constituents questioned whether that exception was applicable to when-issued securities or other securities that do not yet exist if a market mechanism exists, which is the case for GNMA to-be-announced forward contracts. [Paragraph A14] The Board considered constituents comments and decided that the regular-way security trades exception in paragraph 10(a) should apply to certain securities referred to as when-issued securities or other Page 15 of 20

16 securities that do not yet exist, even if they have net settlement provisions or a market mechanism exists if it is probable at inception and throughout the term that the contract will not settle net and will result in physical delivery. The Board reasoned that requiring whenissued securities or other securities that do not yet exist to be accounted for as derivatives if there is no intention to net settle the contract would not be cost beneficial. [Paragraph A15] 48. Furthermore, as it pertains specifically to the issue in this potential agenda topic, Statement 149 amended both the baseline regular-way securities trade exception language in paragraph 10(a) and the TBA contract language in paragraph 59(a) by indicating the following: If an entity is required to account for a contract to purchase or sell an existing security on a trade-date basis, rather than a settlement-date basis, and thus recognizes the acquisition (or disposition) of the security at the inception of the contract, then the entity shall apply the regularway security trades exception to that contract. [Paragraph 7; emphasis added.] In addition, if an entity is required to account for a contract for the purchase or sale of when-issued securities or other securities that do not yet exist on a trade-date basis, rather than a settlement-date basis, and thus recognizes the acquisition or disposition of the securities at the inception of the contract, that entity shall apply the regular-way security trades exception to those contracts. [Paragraph 23; emphasis added.] 49. The basis for conclusions explained this amendment as follows: [The amendments] remove from the scope of [Statement 133] contracts for the purchase or sale of when-issued securities or other securities that do not yet exist for which the acquisition or disposition of securities is required by the entity to be accounted for on a trade-date basis. Language relating to trade-date accounting was added to clarify that if an entity is required to account for a contract under trade-date accounting and thus already recognizes the acquisition or disposition of the securities at inception of the contract, that contract is not included within the scope of Statement 133. [Paragraph A10] 50. In October 2012, the Board issued Accounting Standards Update No , Technical Corrections and Improvements. The technical corrections in that document amended the regular-way securities scope exception as follows: The scope exception for regular-way security trades applies only to a contract that requires delivery of securities that are readily convertible to cash except that the scope exception also shall or may apply in any of the following circumstances: Page 16 of 20

17 a. If an entity is required, or has a continuing policy, to account for a contract to purchase or sell an existing security on a tradedate basis, rather than a settlement-date basis, and thus recognizes the acquisition (or disposition) of the security at the inception of the contract, then the entity shall apply the regularway security trades scope exception to that contract. b. If an entity is required, or has a continuing policy, to account for a contract for the purchase or sale of when-issued securities or other securities that do not yet exist on a trade-date basis, rather than a settlement-date basis, and thus recognizes the acquisition or disposition of the securities at the inception of the contract, that entity shall apply the regular-way security trades scope exception to those contracts. c. Contracts for the purchase or sale of when-issued securities or other securities that do not yet exist, except for those contracts accounted for on a trade-date basis, are excluded from the requirements of this Subtopic as a regular-way security trade only if all of the following are true: 1. There is no other way to purchase or sell that security. 2. Delivery of that security and settlement will occur within the shortest period possible for that type of security. 3. It is probable at inception and throughout the term of the individual contract that the contract will not settle net and will result in physical delivery of a security when it is issued. (The entity shall document the basis for concluding that it is probable that the contract will not settle net and will result in physical delivery.) Example 9 (see paragraph ) illustrates the application of item (c) in this paragraph. ISSUE 1: AGENDA DECISION 51. The staff will discuss the following proposed language with the Board related to clarifying the regular-way securities scope exception and addressing potential unintended consequences from the amendments made in Update : > > > Regular-Way Security Trades Regular-way security trades are defined as contracts that provide for delivery of a security within the period of time (after the trade date) generally established by regulations or conventions in Page 17 of 20

18 the marketplace or exchange in which the transaction is being executed. For example, a contract to purchase or sell a publicly traded equity security in the United States customarily requires settlement within three business days. If a contract for purchase of that type of security requires settlement in three business days, the regular-way security trades scope exception applies, but if the contract requires settlement in five days, the regular-way security trades scope exception does not apply unless the reporting entity is required to account for the contract on a trade-date basis the conditions in paragraph A are met Except as provided in paragraph A, a contract to purchase or sell an existing security only qualifies for the regular-way security trades scope exception if all of the following conditions are met at the inception of the contract: a. The contract requires delivery of securities that are readily convertible to cash. b. The contract provides for delivery of a security within the period of time after the trade date generally established by regulations or conventions in the marketplace or exchange in which the transaction is being executed. c. The contract does not require or permit net settlement (as discussed in paragraphs through ). d. No market mechanism exists to facilitate net settlement of that contract (as discussed in paragraphs through ) A Regardless of whether the conditions in paragraph are met, an entity shall apply the regular-way security trades scope exception to a contract to purchase or sell an existing security if both of the following conditions are met at the inception of the contract: (1) The entity accounts for the contract to purchase or sell the security on a trade-date basis, rather than a settlement-date basis (and, thus, recognizes the acquisition or disposition of the security at the inception of the contract). (2) For the entity purchasing the security, the security is measured at fair value on the balance sheet on an ongoing basis Except as provided in paragraph A, a contract for the purchase or sale of when-issued securities or other securities that do not yet exist only qualifies for the regular-way security trades scope exception if all of the following conditions are met at the inception of the contract: a. There is no other way to purchase or sell that security. b. Delivery of that security and settlement will occur within the shortest period possible for that type of security. Example 9 (see Page 18 of 20

19 paragraph ) illustrates the application of this criterion. c. It is probable at inception and throughout the term of the individual contract that the contract will not settle net and will result in physical delivery of a security when it is issued. (The entity shall document the basis for concluding that it is probable that the contract will not settle net and will result in physical delivery.) A Regardless of whether the conditions in paragraph are met, an entity shall apply the regular-way security trades scope exception to a contract for the purchase or sale of when-issued securities or other securities that do not yet exist if both of the following conditions are met at the inception of the contract: a. The entity accounts for the contract to purchase or sell the security on a trade-date basis, rather than a settlement-date basis (and, thus, recognizes the acquisition or disposition of the security at the inception of the contract). b. For the entity purchasing the security, the security is measured at fair value on the balance sheet on an ongoing basis Note that contracts that require delivery of securities that are not readily convertible to cash (and thus do not permit net settlement) are not subject to the requirements of this Subtopic unless there is a market mechanism outside the contract to facilitate net settlement (as described in paragraph ) A contract for the purchase or sale of when-issued securities or other securities that do not yet exist is eligible to qualify for the regular-way security trades scope exception (as discussed in paragraph paragraphs through 15-17A) even though either of the following is true: a. That contract permits net settlement (as discussed in paragraphs through ). b. A market mechanism exists to facilitate net settlement of that contract (as discussed in paragraphs through ). See Example 9 (paragraph ) Net settlement (as described in paragraphs and ) of contracts in a group of contracts similarly designated as regular-way security trades would call into question the continued application of the scope exception to such contracts This Subtopic does not change whether an entity recognizes regular-way security trades on the trade date or the settlement date. Page 19 of 20

20 Questions for the Board 1. Does the Board want to add a project to its agenda that would clarify the regular-way securities scope exception to derivative accounting in Topic 815? 2. If so, does the Board believe that the language in the regular-way securities scope exception should be amended as articulated in paragraph 10 above? ISSUE 2: TRANSITION, TRANSITION DISCLOSURES, EFFECTIVE DATE, AND EXPOSURE PERIOD 52. To the extent that the proposed guidance results in changes to practice, the potential outcomes are as follows: (a) An entity that had been accounting for a contract as a derivative would no longer be required to do so. (b) An entity that had not been accounting for a contract as a derivative would be required to do so. 53. The amended guidance could be applied on a retrospective basis, modified retrospective basis, or on a prospective basis. Questions for the Board 3. What transition approach does the Board want to require? 4. What transition disclosures does the Board want to require? 5. Does the Board believe that the benefits of amending the regular way securities scope exception justify the costs? 6. Does the Board grant the staff permission to draft an Exposure Draft of a proposed Accounting Standards Update for vote by written ballot? 7. If yes, what comment period does the Board select for this proposed Update? Page 20 of 20