The Big Three Convergence Projects

Transcription

1 The Big Three Convergence Projects - Revenue Recognition - Leases - Financial Instruments Jimmy Barge Susan Cosper Paul Beswick Jan Hauser Mark LaMonte 1

2 Revenue Recognition FASB and IASB issued their second exposure drafts on how to recognize revenue Eventually, this project will replace all those FASB s, AICPA SOP s, and EITF s on revenue recognition in the Codification (as well as the SEC s SAB 104) The new model s goals : Remove inconsistencies, more robust, comparability, more useful, and simplify! If adopted, there would be convergence! Is the 2nd proposal better? 2

3 Revenue Recognition the new model Core Principle: Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled for those goods or services Note nothing about completing the earnings process! Seems Easy? Just follow five steps! 3

4 The Five Steps 1. Identify the contract (creates enforceable rights) 2. Identify separate performance obligations (note- these are liabilities not deferred revenue!) 3. Determine the transaction price 4. Allocate price to the separate performance obligations 5. Recognize revenue when (or as) entity satisfies a performance obligation. Seems Easy? 4

5 2. Identify performance obligations If there is more than one good or service, account for each separately if distinct If not distinct, combine with other goods or services until you have a bundle that is distinct Example: Install a burglar system and monitor it for five years one or two distinct obligations? Is each sold separately? Can customer benefit from each on its own? Is bundle highly integrated? 5

6 3. Determine the price How much the entity expects to be entitled to. -Variable consideration (e.g., royalties) estimate the probability weighted expected amount (hmm?) or the most likely amount. Constraint can t cumulatively record more than the reasonable assured amount that entity is entitled to. Can royalties meet this test? -Adjust for time value of money if significant -Credit risk display adjacent to revenue 6

7 4. Allocate the transaction price Amount expected for each separate performance obligation Based on relative stand-alone selling price and, if not observable, estimate it (somehow) Ex Install (upfront) and monitor (over 5 years) burglar alarm system $5,000 total how much to allocate to each performance obligation? 7

8 5. Recognize revenue when (or as) performance obligations are satisfied Overall: Entity transfers the promised goods or service to the customer (dr. Performance obligation / cr. Revenue) When? Customer obtains control either (i) over time or (ii) a point in time (such as when customer has unconditional obligation to pay, legal title, physical possession, and risks and rewards) Over time - 1) the entity s performance creates or enhances an asset that the customer controls as the asset is created or enhanced OR 2) if it does not, at least one of the following: 1.The customer receives a benefit as the entity performs each task 2. Another entity would not need to re-perform work performed 3. The entity has a right to payment for performance to date DOES THIS MAKE SENSE? IS % OF COMPLETION OK? 8

9 Other Issues Onerous test to record losses (contracts over one year) recognize loss if costs of settling performance obligation exceed the transaction price allocated to that performance obligation (dr. loss, cr. liability) Warranties, sales returns, contract costs Disclosures to understand the nature, amount, timing, and uncertainty of revenue and cash flows - Reconciliations, significant judgments, and much, much more plus interims too is it too much? Do nonpublic companies get a break? 9

10 Timing and Transition Proposal adopt on a retrospective basis. Would this be practical for preparers? Too costly? Is this what users want? When would a new standard be effective? No earlier than 2015! But, 2013, 2014 and 2015 if retro! Will many companies/industries have major changes? What are the comment letters saying? Support? Preparers, Auditors, Users, Regulators? Our audience? 10

11 Leases - are they going on the balance sheet? Yes/Maybe? Lease accounting model under FAS 13/Cod. 840 (and its many, many amendments and interpretations) is considered broken and unfixable the issue is that for lessees almost are leases are not reported on the balance sheet! The FASB (& IASB) proposed a new model (8/10) Lessee: Asset - Right to use an asset during the lease term Liability - Obligation to pay rentals (present value) Lessor: Asset- Right to receive rent a receivable (present value) Liability- Performance obligation or derecognition approach Reaction 1000 letters many said its overly complex and costly 11

12 So What Happened? FASB/IASB listened to the concerns and in July 2011 decided to reexpose Various decisions have been reached but significant issues have not been resolved and the ability to achieve convergence and the timing of reexposure is uncertain! (Achieving convergence is difficult!) 12

13 What do the Boards agree on? Lessees should put noncancellable leases on the balance sheet the primary objective of the whole project! Many of the details have been agreed to thus improving the original proposal For example: - Lease term include renewal options only when there is a significant economic incentive to renew -Use operating lease accounting for leases of 12 months or less (including renewal options ) So what is the problem? 13

14 Amortizing the right to use asset? The problem - using the S/L method to amortise the asset and the effective interest method on the liability results in higher up front expense than operating lease accounting Isn t the concern off-balance sheet financing rather than the income statement? Two different methods for fixing the problem are being considered but FASB & IASB disagree on which one is acceptable (almost unanimously) 14

15 Choices for amortization (to avoid front loading) Method A Interest based approach - Asset and liability are inextricably linked 1 lease - Use the present value of remaining economic benefits under lease to determine amortization Method B Underlying asset approach - Use lessor s leasing pricing considerations - Consider underlying asset consumed by lessee and lessor s return on investment in lease and residual to determine amortization FASB likes A but IASB likes B??? 15

16 What will happen now? Can the FASB and IASB get together? What is the current status and possible timetable? Is there any hope for convergence? Is fixing amortization problem crucial? Will users be better off if most leases have to go on the balance sheet? Views of the audience? 16

17 Financial Instruments too complex! 17 FASB is focusing on 3 distinct aspects for these FASB/IASB projects: How to classify and measure financial instruments (more fair value?) Derivatives and hedging how can FAS 133 be fixed! Impairment we need a new model! But the end is nowhere in sight!

18 Measurement ED on classification and measurement issued 5/10 to catch up with IFRS 9 Financial instruments classification geared towards a new business activity model Still would use historical cost or fair value thru income or OCI but it would be different than we do today Nothing much has been happening? Status? Convergence possibilities?

19 Derivatives and hedging Everyone agrees its too complex 5/10 FASB issued proposal to fix FAS 133 2/11 FASB asked for comments on the IASB s proposed fix The two approaches are different but again nothing much has been happening Status? Chance for convergence?

20 How to Recognize Impairment Problem for loans and securities too little, too late The new idea (from both FASB & IASB) three buckets to reflect pattern of deterioration The goal would be to recognize Expected Losses - The current higher threshold of probable would be gone! 20

21 The Three Buckets a taste! #1 Originated and non-impaired acquired loans record only losses expected to occur in next year. If credit quality deteriorates by more than an insignificant amount and it s reasonably possible all or some of cash flows won t be collected, move down to #2 or #3. For #2 or #3, now record losses expected over the entire life (e.g., 20 years) of the loan not just one year. #2 - Group loans on a portfolio level #3 - Determine expected loss at loan level Is this operational? Status? Convergence? 21

22 Summary Views Are we heading in the right direction on these three convergence projects? Is there hope? When might these changes be adopted (if ever)? What does our audience think? 22 Q & A s