Financial Reporting Best Practices Paper

Transcription

1 NOTE: Additional papers with specific examples on the presentation of financial statement disclosures are available on the Strength Matters website. Analysis/Input GAAP Commitments In the normal course of business, an organization may have a number of unfulfilled commitments. Generally, ordinary unfulfilled commitments are not required to be disclosed, but certain other types of commitments do require disclosure because they are large or outside the normal course of operations. Disclosure is required for a commitment to: purchase large amounts of property, plant and equipment; maintain a certain level of working capital; reduce debt by a specific amount; limit additional debt; not merge with, or acquire, another company; enter into long-term leases; enter into employment contracts; and restrict dividends. (Note: The above listing is not all-inclusive.) Loss Contingencies A contingency is a condition, situation or set of circumstances involving uncertainty that, when resolved, may result in a gain or loss. Since a loss contingency will not develop into an actual loss until certain future events occur (or fail to occur), the accounting for such a contingency depends on whether the likelihood of the future events occurring or failing to occur is probable (likely), reasonably possible (more than slightly possible but less than likely), or remote (slight). An estimated loss from a loss contingency should be recorded by a charge to operations if information available prior to issuance of the financial statements indicates that it is probable that an asset has been impaired or a liability incurred as of the date of the financial statements and the amount of the loss can be reasonably estimated. A loss contingency should be disclosed but not accrued if it is probable that a loss has occurred but the amount of the loss cannot be reasonably estimated or it is reasonably possible (but not probable) that a loss has occurred. Additionally, guarantees should be disclosed regardless of whether the likelihood of loss is remote. (Exhibit A summarizes the accounting requirements for loss contingencies.) Disclosure is also necessary if information about a loss contingency occurring prior to the financial statement date becomes available after the financial statement date but before the date of issuance. If, in this same time period, information on contingencies that occurred after the financial statement date becomes available, disclosure may still be required to prevent the financial statements from being misleading. 1

2 The following is a list of loss contingency examples: Pending or threatened litigation Actual or possible claims and assessments Risk of loss from catastrophes assumed by property and casualty insurance enterprises including reinsurance enterprises Guarantees of indebtedness of others (See further discussion below.) Obligations of commercial banks under standby letters of credit Collectability of receivables Threat of expropriation of assets Obligations related to product warranties and product defects Risk of loss or damage of an enterprise s property by fire, explosion or other hazards Agreements to repurchase receivables (or to purchase the related property) that have been sold Tax credit compliance and tax credit adjusters An organization will need to consider all the facts and circumstances of each situation when determining whether to accrue and/or disclose a loss contingency. For example, in the case of pending or threatened litigation, the organization should consult its lawyers to determine the likelihood of loss. A loss due to pending or threatened litigation or actual or possible claims or assessments should be accrued if all of the following conditions are met: the underlying cause of the litigation, claim or assessment occurred on or before the financial statement date; the likelihood of an unfavorable outcome is probable (based on the opinions of legal counsel, the progress of the case, similar experiences, etc.); and the amount of the loss can be reasonably estimated. As another example, the conditions under which receivables exist usually involve some degree of uncertainty about their collectability, resulting in a contingency. If the organization determines that the likelihood of being unable to collect all amounts due according to contractual terms of the receivable is probable and the amount of loss can be reasonably estimated, the organization should accrue the loss and disclose the contingency. Whether the loss can be reasonably estimated will normally depend on the experience of the organization, information about the ability of individual debtors to pay, and appraisal of the receivables in light of the current economic environment. Guarantees The following information is required to be disclosed for each guarantee (or for each group of similar guarantees), even if the likelihood of having to make payments under the guarantee is remote: The nature of the guarantee, the circumstances under which it arose, and the events or conditions requiring performance; The maximum potential amount of (undiscounted) future payments (not reduced by potential recoveries under recourse or collateral provisions); The carrying amount of the liability whether the guarantee is freestanding or is embedded in another contract; The nature of (1) recourse provisions enabling potential recovery from third parties of amounts paid and (2) assets held as collateral that could be liquidated for recovery purposes (along with an approximation of the amount expected to be recovered, if 2

3 estimable); For product warranties (and for other contracts excluded from the initial recognition and measurement provisions): The accounting policy and methodology used to determine the amount of the liability; The amount of any liability (e.g., deferred revenue) associated with extended warranties; and A tabular reconciliation of the beginning and ending balances of the aggregate liability, separately identifying (1) reductions for payments made, (2) changes in accruals related to warranties issued in the current period, and (3) changes in accruals related to preexisting warranties. The fair value of outstanding financial guarantees; and If the guarantee is provided by a related party, the nature of the related party relationship, a description of the transaction, the dollar amount of the transaction, and amounts due to the related party including the terms and manner of settlement. Some examples of guarantees disclosed by the CFO Group include commitments to fund future operating deficits of partnerships, construction loan repayment guarantees and guarantees to investors as to the tax credits and other benefits to be derived from properties. Operating deficit guarantees are usually required during property lease-up and stabilization and are often limited as to the duration of the guarantee and the amount required to be funded. Construction loan repayment guarantees provide for the repayment of the construction loan in the event the property is unable to achieve the benchmarks necessary for conversion to permanent financing. Tax credit guarantees are required by investors to maintain targeted yields on tax credit investments. Under these guarantees, organizations may provide additional capital or loans to fund tax credit adjusters resulting from a shortfall in tax credit delivery or tax credit recapture. CFO Group Input/Conclusion An estimated loss from a loss contingency should be accrued through a charge to operations and disclosed if it is probable that a loss has been incurred at the financial statement date and the amount of the loss can be reasonably estimated. Loss contingencies that do not meet those conditions should be disclosed if there is a reasonable possibility that a loss may have been incurred. Guarantees must also be disclosed, even if the likelihood of loss is remote. Exhibit B provides a note disclosure checklist relating to contingencies, risks and uncertainties as well as obligations under guarantee and other commitments. Exhibit C provides an example of certain representations that management may be required to make to its auditors. Further recommendations from the CFO Group with specific examples for the presentation of commitment, contingencies and guarantees in the financial statement disclosures are available on the Strength Matters website. Applicable Authoritative Pronouncements FASB ASC 450 Contingencies FASB ASC 850 Related Party Disclosures 3

4 Acknowledgements STRENGTH MATTERS gratefully acknowledges the work of staff from Novogradac and Company LLP, CohnReznick LLP, and Lindquist, von Husen & Joyce LLP and the following individuals that contributed to this paper: Chris Cherry, Homes for America, Annapolis, MD Ann Clift, Foundation Communities, Austin, TX Art Fatum, MidPen Housing Corporation, Foster City, CA Gayle Harrold, Madison Park Development Corporation, Roxbury, MA Kent Hawkins, NeighborWorks America, Kansas City, MO Caroline Horton, Aeon, Minneapolis, MN Joe Kasberg, National Church Residences, Columbus, OH David Keene, The Neighborhood Developers, Chelsea, MA Jeff Reed, Community Housing Partners Corp., Christiansburg, VA Tom Seel, FAHE, Berea, KY L. Steven Spears, Mercy Housing, Inc., Denver, CO Paul Sussman, Tenderloin Neighborhood Development Corp. Harry Thompson, Community Preservation & Development Corp., Washington, DC D. Valentine, BRIDGE Housing, San Francisco, CA Mary Vasys, Vasys Consulting Ltd, Chicago, IL Laura Vennard, Preservation of Affordable Housing, Inc., Boston, MA Last Updated December 18, 2013 DISCLAIMER This paper contains certain recommended financial reporting best practices for nonprofit affordable housing organizations that develop and own affordable housing in the United States. This paper was developed by a working group comprised of chief financial officers from certain leading nonprofit affordable housing organizations active in the networks of NeighborWorks America, Housing Partnership Network and Stewards of Affordable Housing for the Future, as well as representatives of socially responsible lenders, working in conjunction with representatives from Novogradac and Company LLP, CohnReznick LLP, and Lindquist, von Husen & Joyce LLP, three independent public accounting firms. This publication should not be construed as accounting or other advice on any specific facts or circumstances. The contents of this paper are intended for general informational purposes only, and you are urged to consult your accountants and other professional advisors concerning your specific situation and any financial reporting or accounting questions you may have. For further information, contact info@strengthmatters.net. 4

5 Exhibit A Accounting Requirements for Loss Contingencies Likelihood of Loss Probable Reasonably possible Remote Loss Can Be Reasonably Estimated Accrue the loss and disclose the contingency. Do not accrue the loss, but disclose the contingency. Do not accrue the loss. Disclose the contingency if it involves a guarantee. Otherwise, disclosure is permitted, but not required. Loss Cannot Be Reasonably Estimated Do not accrue the loss, but disclose the contingency. Do not accrue the loss, but disclose the contingency. Do not accrue the loss. Disclose the contingency if it involves a guarantee. Otherwise, disclosure is permitted, but not required. 5

6 Exhibit B Footnote Disclosure Checklist Contingencies, Risks and Uncertainties 1. Are the nature and amount of an accrued loss contingency disclosed in the financial statements if exposure to loss in excess of the amount accrued exists or disclosure is necessary to keep the financial statements from being misleading? 2. For loss contingencies not accrued, but when there is at least a reasonable possibility that a loss (or additional loss in excess of amounts accrued) may have occurred, do disclosures indicate the following? a. Nature of contingency b. Estimate of possible loss or range of loss, or a statement that such estimate cannot be made 3. Have contingencies that might result in gains been adequately disclosed but not reflected in the accounts so as not to recognize revenue prior to its realization? 4. If it is at least reasonably possible that the effect on the financial statements of significant estimates involving contingencies (as referred to in Questions Nos. 1 3) will change within one year of the date of the financial statements due to one or more future confirming events and the effect of that change would be material to the financial statements, do the disclosures include an indication that it is at least reasonably possible that a change in estimate will occur in the near term? (Note: If the entity uses risk reduction techniques to mitigate losses or the uncertainty that may result from future events and, as a result, the preceding criteria are not met, the disclosures are encouraged but not required.) 5. Have contingencies related to noncompliance with donor restrictions been disclosed, including the amounts and circumstances if the noncompliance is the result of the organization s failure to maintain adequate funds to comply with donor restrictions? Obligations Under Guarantees 1. Has the following been disclosed about each guarantee or group of similar guarantees, even if the likelihood of having to make payments under the guarantee is remote: a. Nature of the guarantee, including the guarantee s approximate term, how it arose, and the events or circumstances that would require the organization to perform under the guarantee? b. Maximum potential amount of future payments the organization could be required to make (undiscounted and not reduced by possible recoveries under recourse or collateralization provisions) or the reasons why an estimate of that amount cannot be made? (This disclosure is not applicable to product warranties or other guarantees related to the functionality of nonfinancial assets owned by the guaranteed party.) c. Carrying amount of the liability, if any, for the organization s obligations under the guarantee? d. Recourse provisions that would enable the organization to recover amounts paid under the guarantee or collateral that could be sold? (If estimable, the extent to which proceeds from the sale of collateral would be expected to cover the maximum potential amount of future payments under the guarantee should be disclosed.) 6

7 Exhibit B Footnote Disclosure Checklist CONTINUED 2. Has the following been disclosed about product warranties or other guarantees related to the functionality of nonfinancial assets owned by the guaranteed party? a. Accounting policy and methodology used to determine the organization s liability for such guarantees, including any associated liability such as deferred revenue b. Tabular reconciliation of the changes in the organization s aggregate liability for such guarantees, including the beginning liability balance, aggregate reductions for payments made, aggregate changes for accruals related to guarantees issued during the period, aggregate changes to preexisting accruals (for example, related to changes in estimates) and the ending liability balance Other Commitments 1. Are the following types of commitments disclosed? a. Obligations to reduce debt or maintain working capital b. Unused letters of credits c. Net losses on inventory purchase commitments 7

8 Exhibit C Management Representations Example 1. The following, if any, have been properly recorded or disclosed in the financial statements: a. Guarantees, whether written or oral, under which the organization is contingently liable. 2. There are none of the following: a. Violations or possible violations of laws or regulations whose effect should be considered for disclosure in the financial statements or as a basis for recording a loss contingency. b. Unasserted claims or assessments that our lawyer has advised us are probable of assertion and must be disclosed in accordance with FASB ASC 450 (if a lawyer has been consulted) or unasserted claims or assessments that are required to be accrued or disclosed in the financial statements in accordance with FASB ASC 450, and we have not consulted a lawyer concerning litigation, claims, or assessments (if a lawyer has not been consulted). c. Other liabilities or gain or loss contingencies that are required to be accrued or disclosed by FASB ASC