Emerging Issues Task Force Agenda Committee Report January 29, 2007

Transcription

1 0307REPORT Emerging Issues Task Force Agenda Committee Report January 29, 2007 Decisions on Proposed Issues Pages 1. Accounting for Ticket-Change Fees in the Airline Industry Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development Activities Accounting for Convertible Instruments That Require or Permit Partial Cash Settlement upon Conversion Other Matters o Agenda for the March 15, 2007 EITF Meeting 17 o Status of Open Issues and Agenda Committee Items EITF Agenda Committee Report January 29, 2007

2 0307REPORT Emerging Issues Task Force Agenda Committee Decisions on Proposed Issues 1. Accounting for Ticket-Change Fees in the Airline Industry Background Passengers who make changes to their non-refundable airline tickets are charged a ticket-change fee by the airlines. Ticket-change fees are intended to compensate the airline for the cost of processing a ticket change (or exchange), and to give the passenger the right to apply the fees paid for the original ticket towards the purchase of a new ticket. Ticket-change fees are nonrefundable, have no separate value to the passenger once paid, and do not attach to the ticket (that is, if the ticket is exchanged again, only the amount paid for the ticket can be applied by the passenger towards future travel (which excludes the amount paid for the ticket-change fee)). Fare policies of most airlines require passengers with non-refundable tickets who wish to cancel their existing tickets to do so prior to the related scheduled departure date to be eligible for the right to exchange that cancelled ticket for a new ticket on another flight with that airline. Under most airline policies, passengers then have the ability to exchange their cancelled tickets before or after their original flight departure dates. Most airlines recognize ticket change fees as revenue in advance of the passenger's scheduled flight; some when the ticket is exchanged for a new ticket, others when the passenger cancels the flight reservation (that is, the ticket). However, the timing and methodology of charging ticketchange fees vary among airlines. Some airlines assess the ticket-change fee to their passengers by reducing the value (that is, the original ticket purchase price) of the cancelled ticket by the amount of the ticket-change fee at the time the passenger notifies the airline that the original ticket is being cancelled. Other airlines assess ticket-change fees when the new ticket is issued in exchange for the cancelled ticket, which may occur before or after the original flight departure date. In addition to ticket-change fees, the airlines may also charge passengers the incremental difference between the fares of the cancelled ticket and the new ticket. Those incremental charges to the ticket price, exclusive of ticket-change fees, are not addressed in this issue. EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 1

3 The issue is whether ticket-change fees should be evaluated and accounted for as part of a multiple-deliverable arrangement pursuant to EITF Issue No , "Revenue Arrangements with Multiple Deliverables," or whether the presumption in paragraph 2 of Issue can be overcome such that ticket-change fees should not be evaluated in combination with the passenger's purchase of the airline ticket. Paragraph 2 of Issue states, in part: In applying this Issue, separate contracts with the same entity or related parties that are entered into at or near the same time are presumed to have been negotiated as a package and should, therefore, be evaluated as a single arrangement in considering whether there are one or more units of accounting. That presumption may be overcome if there is sufficient evidence to the contrary. Questions have also arisen on the timing of revenue recognition if the presumption in paragraph 2 of Issue can be overcome. Accounting Issue and Alternatives Issue 1: Whether an airline should account for a ticket-change fee in combination with the passenger's purchase of an airline ticket as a part of a multiple-deliverable arrangement pursuant to the scope of Issue View A: Airlines should not account for ticket-change fees pursuant to Issue since ticketchange fees represent a transaction that is separate from the original purchase of the ticket. Proponents of View A believe that there is a reasonable basis on which to argue that the ticketchange fee transaction can overcome the presumption in paragraph 2 of Issue and therefore represents a transaction between the airline and its passenger that is separate and independent from the transaction for the airline ticket sale. Proponents of View A point out that ticket-change fees are charged by the airline subsequent to the initial sales transaction and are not "negotiated" at the time of the sale of the original ticket since there is no requirement for the passenger to pay them at the time of the original ticket sale. Ticket exchanges are performed at the request of the passenger for passenger convenience reasons. The ticket-change fee is a voluntary charge borne by the passenger because of an event that was not contemplated at the EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 2

4 time of the original ticket sale. Proponents of View A therefore believe that the initial ticket sale and the subsequent ticket-change fee should not be presumed to be a part of a single arrangement as contemplated under paragraph 2 of Issue and, accordingly, each individual transaction should be evaluated separately for purposes of determining the appropriate revenue recognition. In determining whether the ticket-change fee should be evaluated in combination with the ticket purchase, proponents of View A analogize to AICPA Technical Practice Aid No , Software Revenue Recognition for Multiple-Element Arrangements, which provides guidance for when separate arrangements should be evaluated as one arrangement for purposes of determining revenue recognition. TPA states, in part: A group of contracts or agreements may be so closely related that they are, in effect, part of a single arrangement. The form of an arrangement is not necessarily the only indicator of the substance of an arrangement. The existence of any of the following factors (which are not all-inclusive) may indicate that a group of contracts should be accounted for as a single arrangement: The contracts or agreements are negotiated or executed within a short time frame of each other. The different elements are closely interrelated or interdependent in terms of design, technology, or function. The fee for one or more contracts or agreements is subject to refund or forfeiture or other concession if another contract is not completed satisfactorily. One or more elements in one contract or agreement are essential to the functionality of an element in another contract. Payment terms under one contract or agreement coincide with performance criteria of another contract or agreement. The negotiations are conducted jointly with two or more parties (for example, from different divisions of the same company) to do what in essence is a single project. In evaluating the above factors, proponents of View A believe that there is a reasonable basis on which to overcome the presumption that the original sale and the ticket-change fee should be considered one arrangement subject to the guidance in Issue since the ticket-change fee is not (a) negotiated as part of the initial arrangement, (b) essential to the functionality of the airline providing passenger transportation, and (c) refundable if the flight is cancelled. Proponents of EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 3

5 View A acknowledge that the timing of the cancellation of the original ticket and assessment of the ticket-change fee could occur near the time of the original sale of the ticket, but do not believe that this factor alone indicates that the original ticket purchase and the ticket-change fee should be considered as a part of one arrangement to be evaluated under Issue Proponents of View A also point out that the airlines have provided separate value to the passenger because the ticket change (that the passenger was not otherwise entitled to) provides utility to the passenger on a standalone basis. The passenger makes a voluntary decision to pay the change fee to preserve the value of the original ticket (because the passenger believes that the value received is equal to or greater than the fee charged). In addition, proponents of View A also point out that if the airline incurs incremental costs to provide the change (which the airline was not obligated to incur at the time of the original transaction with the passenger) and charges an additional fee to recover those costs, there would be no need to link the ticket-change fee to the transportation fee, which is already priced at fair value. View B: Airlines should account for ticket-change fees pursuant to Issue since an airline cannot reasonably overcome the presumption in paragraph 2 of Issue Proponents of View B believe that in evaluating ticket-change fees, an airline cannot overcome the presumption in paragraph 2 of Issue that the two transactions should be evaluated as one arrangement since the two transactions are interrelated (that is, the passenger ticket cannot be used if the ticket change fee is not assessed). Proponents of View B believe that the airline should be required to evaluate the potential for multiple deliverables with separate units of accounting pursuant to paragraphs 8 and 9 of Issue Proponents of View B are not of the view, however, that the ticket-change fee would satisfy the separation criteria set out in paragraph 9 of Issue Proponents of View B acknowledge that the airline performs many other services for its passengers including accepting flight reservations, providing customer service, and other activities, but that the actual transportation is the most significant aspect of the overall arrangement. Proponents of View B believe that when evaluated, the combination of services is likely to qualify as a single unit of accounting and performance would not be deemed EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 4

6 to have taken place until the airline provides transportation to the passenger (for the changed reservation). Likewise, the ticket-change fee would not provide value to the customer on a standalone basis since the customer could not likely resell the delivered item. Therefore, the ticket-change fee would not qualify as a separate unit of accounting and would therefore be subject to the provisions of paragraph 10 of Issue 00-21, which states, in part: The arrangement consideration allocable to a delivered item(s) that does not qualify as a separate unit of accounting within the arrangement should be combined with the amount allocable to the other applicable undelivered item(s) within the arrangement. The appropriate recognition of revenue should then be determined for those combined deliverables as a single unit of accounting. Other proponents of View B believe that a ticket-change fee represents a modification to the terms of the original arrangement, including the transaction price and timing of the services. The ticket exchange and related ticket-change fee does not represent a separate deliverable. Still others believe that the accounting for ticket-change fees should be analogized to the accounting for certain activation fees, which are typically nonrefundable, up-front fees charged to customers at the initiation of an arrangement containing ongoing services. SEC Staff Accounting Bulletin No. 104, Revenue Recognition, requires the deferral of revenue unless the fees represent the consummation of a separate earnings process. Proponents of View B believe that the earnings process has not been completed until the transportation is provided to the customer. Potential Sub-Issue: If the Task Force concludes on Issue 1 that the airline ticket-change fee is outside of the scope of Issue 00-21, the timing of when an airline should recognize revenue on the transaction. Agenda Committee Decisions: The Agenda Committee decided not to add this issue to the EITF agenda. EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 5

7 2. Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development Activities Background Companies involved in research and development activities (R&D entities) may make prepayments for goods or services that will be used in future research and development activities. For example, contract research organizations (CROs) commonly require payments in advance of performing clinical-trial management services. These fees generally relate to a variety of activities, such as per-patient clinical-trial treatment costs and travel costs for CRO personnel. An R&D entity may also contract with a third-party to manufacture products or active ingredients that will be used in clinical trials. In such cases, the R&D entity is often required to make a prepayment to "secure" manufacturing capacity at the contracted facility or to cover the contract manufacturer's start-up costs. The business purpose of these payments varies. CROs and/or others contracting with R&D entities may require advance payments because they will enter into "take or pay" arrangements with other parties to complete the agreed upon services or deliver the contracted goods and would be required to compensate those counterparties even if the R&D entity's research and development activities are terminated. In addition, advance payments are generally made to CROs and manufacturers to secure capacity due to limited technical resources and manufacturing space, respectively. These arrangements generally involve one specific research and development project (for example, the development of a drug compound), and the activities to be performed under these arrangements do not have an alternative future use at the time the arrangements are executed. In these types of arrangements, a portion of the advanced payment may be refundable; however, it is common for at least a portion of the fees to be non-refundable. Diversity exists with respect to the accounting for the non-refundable portion of a payment made by an R&D entity for future research and development activities. The accounting issue below focuses on non-refundable advance payments, since refundable payments generally represent deposits or pre-payments that are capitalized until goods or services are received or the amounts are no longer refundable. EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 6

8 Accounting Issue and Alternatives: Issue: Whether non-refundable advance payments for goods that will be used or for services that will be performed in future research and development activities should be accounted for pursuant to FASB Statement No. 2, Accounting for Research and Development Costs. View A: Payments should be expensed as incurred (when paid) in accordance with paragraphs 11 and 12 of Statement 2. Proponents of View A believe that payments under these types of arrangements should be expensed as incurred pursuant to Statement 2. Paragraph 12 of Statement 2 indicates that "all research and development costs encompassed by this Statement shall be charged to expense when incurred." Supporters of this view believe that costs are "incurred" when the rights under an arrangement are exchanged for a payment or an obligation to pay. Proponents of View A believe that the substance of the transaction involves the R&D entity obtaining a right to future goods or services (that is, an intangible asset) in exchange for the advanced payment. Paragraph 11(c) of Statement 2 states, in part:...the costs of intangibles that are purchased from others for a particular research and development project and that have no alternative future uses (in other research and development projects or otherwise) and therefore no separate economic values are research and development costs at the time the costs are incurred. Proponents of View A believe that the business purpose for these advanced payments (particularly the non-refundable nature of the payments) is generally instructive as to the appropriate accounting. The basis for conclusion in Statement 2 supports the requirement to expense all research and development costs based primarily on the high degree of uncertainty about the future benefits of individual research and development projects. By requiring these advanced non-refundable payments, the counterparties to these arrangements (CROs and manufacturers) effectively eliminate financial risk caused by uncertainties inherent in R&D activities. The financial risk of these uncertainties has been retained by the R&D entity. EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 7

9 To the extent prepayments relate to services to be performed, proponents of this view also point to the guidance in Statement 2 regarding fixed assets, highlighting that Statement 2 does not allow a fixed asset acquired for a specific project to be capitalized and amortized over the period of time the asset will be used (even though the asset is expected to benefit future periods through its use in the R&D project). Proponents of View A also reference the guidance in paragraph 18 of AICPA Statement of Position No. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, which highlights that certain costs that may have been eligible for capitalization should be expensed to the extent they relate to research and development activities. Paragraph 18 of SOP 98-1 states: The following costs of internal-use computer software are included in research and development and should be accounted for in accordance with the provisions of FASB Statement No. 2: a. Purchased or leased computer software used in research and development activities where the software does not have alternative future uses. b. All internally developed internal-use computer software (including software developed by third parties, for example, programmer consultants) if (1) the software is a pilot project (that is, software of a nature similar to a pilot plant as noted in paragraph 9(h) of FASB Statement No. 2) or (2) the software is used in a particular research and development project, regardless of whether the software has alternative future uses. [Footnote reference deleted.] View B: Payments should be recorded as an asset until the goods have been delivered or the related services have been performed. Proponents of View B believe that the costs associated with this type of arrangement are not "incurred" until the products have been delivered or the related services have been performed. Proponents of View B believe that rights to the undelivered goods or unperformed services are a future economic benefit to a company making such payments. They believe payments made under these types of arrangements should be capitalized as a prepaid asset until the counterparty EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 8

10 has performed under the contract. Supporters of this view point out that although these payments are contractually "non-refundable," companies generally have legal recourse against a third party service provider for nonperformance under such a contract, so payments should not be expensed until the products have been delivered or the related services have been performed. Proponents believe that paragraph 249 of FASB Concepts Statement No. 6, Elements of Financial Statements, provides further support for this view and states, in part: Costs incurred for services such as research and development, relocation, repair, training, or advertising relate to future economic benefits in one of two ways. First, costs may represent rights to unperformed services yet to be received from other entities. Those kinds of costs incurred are similar to prepaid insurance or prepaid rent. They are payments in advance for services to be rendered to the entity by other entities in the future. Second, they may represent future economic benefit that is expected to be obtained within the entity by using assets or in future exchange transactions with other entities. Proponents of View B believe that the guidance contained in paragraph 11(c) of Statement 2 relating to intangible assets was meant to apply to intangibles that are acquired for immediate use in research and development activities (for example, a license to an unproven drug compound, a patent, and so forth) and was not intended to address payments for goods or services to be received in the future. Proponents of View B also believe that requiring immediate expensing of prepayments for future goods or services may allow companies to artificially "time" the recognition of research and development expense. Agenda Committee Decisions: The Agenda Committee agreed to add this issue to the EITF agenda. EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 9

11 3. Accounting for Convertible Instruments That Require or Permit Partial Cash Settlement upon Conversion Background At the September 7, 2006 EITF meeting, the Task Force recommended that the Board consider a short-term project to address the accounting for convertible debt instruments separately from its liabilities and equity project. At its January 3, 2007 meeting, the Board decided not to undertake a short-term project to amend the guidance in APB Opinion No. 14, Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants, on the accounting for convertible debt instruments, but to commit both the FASB and the IASB to a more aggressive timeline for the modified joint liabilities and equity project. The applicability of the existing guidance in Opinion 14 to convertible instruments that require or permit partial cash settlement upon conversion was not addressed in connection with those deliberations. EITF Issue No , "Convertible Bonds with Issuer Option to Settle for Cash upon Conversion," provides accounting and earnings-per-share guidance for three types of structured convertible debt instruments. One of the instruments within the scope of that Issue, referred to as "Instrument C," is described as follows: Instrument C: Upon conversion, the issuer must satisfy the accreted value of the obligation (the amount accrued to the benefit of the holder exclusive of the conversion spread) in cash and may satisfy the conversion spread (the excess conversion value over the accreted value) in either cash or stock. At the May 9, 1991 EITF meeting, the Task Force reached a consensus that Instrument C should be accounted for as indexed debt, rather than convertible debt. Under that original consensus, an issuer was required to adjust the carrying amount of the instrument in each reporting period to reflect the current stock price, but not below the accreted value of the instrument, with those changes in the carrying amount recognized in earnings. At the January 23-24, 2002 EITF meeting, the Task Force modified that consensus to specify that Instrument C should be accounted for like convertible debt (that is, as a combined instrument) if the conversion spread EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 10

12 meets the requirements of EITF Issue No , "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock." The Task Force also reached a consensus that the diluted earnings-per-share guidance in Issue should be amended to specify that the if-converted method should not be used to determine the earnings-per-share implications of Instrument C. Instead, there would be no adjustment to the numerator in the earnings-per-share computation for the cash-settled portion of Instrument C because that portion of the instrument will always be settled in cash. The conversion spread should be included in diluted earnings-per-share based on the provisions of paragraph 29 of FASB Statement No. 128, Earnings per Share, and EITF Abstracts, Topic No. D-72, "Effect of Contracts That May Be Settled in Stock or Cash on the Computation of Diluted Earnings per Share." At the July 31, 2003 EITF meeting, the Task Force discussed EITF Issue No. 03-7, "Accounting for the Settlement of the Equity-Settled Portion of a Convertible Debt Instrument That Permits or Requires the Conversion Spread to Be Settled in Stock (Instrument C of Issue No )." At that meeting, the Task Force reached a consensus that upon settlement of a security with the characteristics of Instrument C in Issue by payment of the accreted value of the obligation (recognized liability) in cash and settlement of the conversion spread (unrecognized equity instrument) with stock, only the cash payment should be considered in the computation of gain or loss on extinguishment of the recognized liability. That is, any shares transferred to settle the embedded equity instrument (referred to as the excess conversion spread in Issue 90-19) would not be considered in the settlement of the debt component. Issuances of convertible instruments with the characteristics of Instrument C have proliferated in periods subsequent to the modification of Issue and the consensus in Issue Additionally, the issuance of convertible instruments with the characteristics of Instrument C became even more prevalent after EITF Issue No. 04-8, "The Effect of Contingently Convertible Instruments on Diluted Earnings per Share," eliminated the diluted earnings-per-share benefits associated with contingently convertible instruments ("Co-Cos") that contain a market price EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 11

13 trigger. A number of issuers amended the terms of Co-Cos that were outstanding prior to the consensus in Issue 04-8 to incorporate the characteristics of Instrument C. Such amendments enabled those issuers to continue to avail themselves of favorable diluted earnings-per-share treatment after adoption of Issue Some entities have issued instruments with characteristics similar to Instrument C and have analogized to the guidance in Issue 90-19, as modified, to determine the appropriate accounting and earnings-per-share guidance. 2 After observing the activities in the marketplace that have occurred since the consensus in Issue was modified to provide more favorable accounting and earnings-per-share treatment for convertible instruments structured as Instrument C, questions have been raised as to whether the accounting guidance in Issue 90-19, as modified, appropriately reflects the economics of those instruments. Accounting Issue and Alternatives Issue: How a company should account for a convertible instrument that requires or permits partial cash settlement upon conversion if the embedded conversion option is not required to be separately accounted for as a derivative under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. View A: A company should account for convertible instruments that require or permit partial cash settlement upon conversion in the same manner as other convertible instruments pursuant to the guidance in Opinion 14 and its related interpretations. This view is consistent with the existing consensus in Issue 90-19, as amended, on the accounting for Instrument C. Proponents of View A observe that the monetary value received by the holder upon conversion is the same regardless of whether (a) a convertible instrument is physically settled in shares or (b) the principal amount of a convertible instrument is paid in cash and the embedded conversion option is net-share settled. Accordingly, they believe that a convertible instrument with the characteristics of Instrument C should be accounted for in the same manner as other convertible 1 Paragraph 9 of Issue 04-8 permitted entities that modified Co-Cos prior to the effective date of that consensus to retrospectively apply that consensus as if the modified terms had been in effect in prior periods. 2 One such variation was described as "Instrument X" in a speech by an SEC staff member at the AICPA Conference on Current SEC Developments in December EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 12

14 debt instruments. Paragraph 3 of Opinion 14 describes the convertible debt instruments subject to that Opinion as follows: Convertible debt securities discussed herein are those debt securities which are convertible into common stock of the issuer or an affiliated company at a specified price at the option of the holder and which are sold at a price or have a value at issuance not significantly in excess of the face amount. The terms of such securities generally include (1) an interest rate which is lower than the issuer could establish for nonconvertible debt, (2) an initial conversion price which is greater than the market value of the common stock at the time of issuance, and (3) a conversion price which does not decrease except pursuant to antidilution provisions. In most cases such securities also are callable at the option of the issuer and are subordinated to nonconvertible debt. View A proponents observe that convertible instruments with the characteristics of Instrument C typically have the characteristics of convertible debt as described in paragraph 3 of Opinion 14. Accordingly, those proponents believe that Opinion 14 and its related interpretations (including EITF Issue Nos. 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios," and 00-27, "Application of Issue 98-5 to Certain Convertible Instruments") provide the relevant guidance on accounting for convertible instruments with the characteristics of Instrument C when the embedded conversion option is not separately accounted for as a derivative instrument under Statement 133. As such, View A proponents believe the existing guidance on the accounting for Instrument C in Issue 90-19, as amended, should be retained. Some View A proponents also observe that there are practical difficulties associated with separating convertible instruments into liability and equity components. Those proponents believe a requirement to separate convertible instruments with the characteristics of Instrument C into their liability and equity components would add complexity to U.S. GAAP. View B: Opinion 14 does not provide guidance on accounting for convertible instruments that require or permit partial cash settlement upon conversion; therefore, a company should separately account for the liability and equity components of such instruments in a manner that reflects the company's economic interest cost. EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 13

15 Under View B, the issuer of a convertible instrument with the characteristics of Instrument C would first determine the carrying amount of the liability component by measuring the fair value of a similar liability (including any embedded derivative features other than the conversion option) that does not have an associated equity component. The carrying amount of the equity instrument represented by the embedded conversion option is then determined by deducting the fair value of the liability component from the initial proceeds ascribed to the convertible instrument as a whole. Proponents of View B refer to the following discussion in Opinion 14: 7. The most important reason given for accounting for convertible debt solely as debt is the inseparability of the debt and the conversion option. A convertible debt security is a complex hybrid instrument bearing an option, the alternative choices of which cannot exist independently of one another. The holder ordinarily does not sell one right and retain the other. Furthermore the two choices are mutually exclusive; they cannot both be consummated. Thus, the security will either be converted into common stock or be redeemed for cash. The holder cannot exercise the option to convert unless he forgoes the right to redemption, and vice versa. [Emphasis added.] 12. The Board is of the opinion that no portion of the proceeds from the issuance of the types of convertible debt securities described in paragraph 3 should be accounted for as attributable to the conversion feature. In reaching this conclusion, the Board places greater weight on the inseparability of the debt and the conversion option (as described in paragraph 7) and less weight on the practical difficulties. [Emphasis added.] 18. The Board recognizes that it is not practicable in this Opinion to discuss all possible types of debt with conversion features, debt issued with stock purchase warrants, or debt securities with a combination of such features. Securities not explicitly discussed in this Opinion should be dealt with in accordance with the substance of the transaction. For example, when convertible debt is issued at a substantial premium, there is a presumption that such premium represents paid-in capital. [Emphasis added.] View B proponents observe that the APB's conclusion on the accounting for convertible debt was based on the inseparability of the debt and the conversion option such that the holder cannot EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 14

16 exercise the option to convert into equity shares unless the holder forgoes the right to repayment of the debt component. They further observe that that rationale is not applicable to convertible instruments with the characteristics of Instrument C because the holder is entitled to both repayment of the debt instrument and net-share settlement of the conversion option. Additionally, proponents of View B observe that the diluted earnings-per-share treatment specified in Issue for Instrument C is a treasury-stock-type method that is consistent with the diluted earnings-per-share treatment of debt issued with detachable warrants. Consequently, the consensus in Issue requires that Instrument C be treated as convertible debt for accounting purposes but prescribes a diluted-earnings-per-share methodology that is consistent with debt issued with detachable warrants. Proponents of View B believe that under this view, the interest yield on the convertible instrument provides the best representation of the issuer's economic borrowing costs by giving accounting recognition to the portion of those borrowing costs that were "paid" to the investors through the equity component. Additionally, proponents of View B refer to the discussion in the basis for conclusions in FASB Statement No. 123 (revised 2004), Share-Based Payment, for a discussion of the Board's conclusion that compensation cost should be recognized for employee services rendered in exchange for valuable financial instruments, including equity share options. For the same reasons, View B proponents believe that interest cost should be recognized for the portion of an entity's borrowing cost that is "paid" through the issuance of an embedded conversion option that is net-share settled when the debt instrument is repaid. View B proponents believe the benefits of separately accounting for the liability and equity components of a convertible instrument that requires or permits partial cash settlement upon conversion outweigh the costs or practical difficulties associated with that treatment. Those proponents observe that such treatment is broadly required for convertible debt instruments under IFRS. 3 View B proponents also observe that convertible instruments issued in the United States typically contain contingent interest provisions that entitle the issuer to receive a tax 3 Refer to International Accounting Standard 32, Financial Instruments: Presentation. EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 15

17 deduction based on the nonconvertible debt rate. 4 In other words, issuers of convertible debt instruments, including convertible instruments with the characteristics of Instrument C, are already performing the computations that would be required under View B in connection with the preparation of their U.S. federal income tax returns. Additionally, a View B consensus would eliminate the need to evaluate whether a convertible instrument with the characteristics of Instrument C contains a beneficial conversion feature. Based on those factors, View B proponents believe that such a consensus would reduce complexity by better reflecting the economics of such instruments, by improving comparability between U.S. GAAP and IFRS for a subset of convertible instruments, and by eliminating a difference between an entity's financial statements and its federal income tax returns. Agenda Committee Decisions: The Agenda Committee agreed to add this issue to the EITF agenda. 4 Refer to IRS Revenue Ruling EITF Agenda Committee Report (Decisions on Potential New Issues) January 29, 2007, p. 16

18 FASB EMERGING ISSUES TASK FORCE Proposed March 15, 2007 Meeting Agenda Issue Proposed Staff Number Issue Time Assigned Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards 8:30 9:15 Trench/ Cosper 9:15 9:45 Stevens/ Paul Administrative Matters - New Issues - Other Matters 9:45 10:15 Cosper * * * BREAK * * * 10:15 10:30 06-I Accounting for Joint Development, Manufacturing, and Marketing Arrangements in the Biotechnology and Pharmaceutical Industries 10:30 12:00 Bolash/ Beswick * * * LUNCH * * * 12:00 1:00 07-A Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development Activities 1:00 2:00 Cosper/ Bolash * * * BREAK * * * 2:00 2:15 07-B Accounting for Convertible Instruments That Require or Permit Partial Cash Settlement upon Conversion 2:15 3:15 Stevens/ Sarno EITF Agenda Committee Report (Proposed Agenda) January 29, 2007, p. 17

19 Status of Open Issues and Agenda Committee Items The following represents the FASB staff's assessment of the status and immediate plans with respect to the open Issues on the Task Force's agenda. The Issues on the proposed agenda for the March 15, 2007 meeting are considered either high priority issues or issues on which meaningful progress can be made within the staff's given complement of resources. The staff's prioritization of issues is based primarily on the FASB staff's understanding of the level of diversity in practice created by each respective Issue, the financial reporting implications of that diversity, the current interaction, if any, of the Issues with active Board projects, and current resource availability among the staff (with respect to both time and relevant technical expertise). Issue No. Description Date Added Date(s) Discussed Meeting EITF Liaison FASB Staff Immediate Plans Due Date - Deliverable Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment Split- Dollar Life Insurance Arrangements 10/06 11/06 3/07 Holman Trench/ Cosper The FASB staff will prepare an Issue Summary Supplement for a future meeting. March 2007 EITF meeting Accounting for Tax Benefits of Dividends on Share-Based Payment Awards 10/06 11/06 3/07 Hauser Stevens/ Paul The FASB staff will prepare an Issue Summary Supplement for a future meeting. March 2007 EITF meeting EITF Agenda Committee Report (Status of Open Issues and Agenda Committee Items) January 29, 2007, p. 18

20 Issue No. Description Date Added Date(s) Discussed Meeting EITF Liaison FASB Staff Immediate Plans Due Date - Deliverable Accounting for Physical Commodity Inventories for Entities within the Scope of the AICPA Audit and Accounting Guide, Brokers and Dealers in Securities 8/06 11/06 Not scheduled Johnson Fanzini/ Jacobs The FASB staff will prepare an Issue Summary Supplement for a future meeting. N/A 06-I Accounting for Joint Development, Manufacturing, and Marketing Arrangements in the Biotechnology and Pharmaceutical Industries 8/06 N/A 3/07 Schroeder Bolash/ Beswick The FASB staff will prepare an Issue Summary for a future meeting. March 2007 EITF meeting 07-A Accounting for Advance Payments for Goods or Services to Be Used in Future Research and Development Activities 1/07 N/A 3/07 TBD Cosper/ Bolash The FASB staff will prepare an Issue Summary for a future meeting. March 2007 EITF meeting 07-B Accounting for Convertible Instruments That Require or Permit Partial Cash Settlement upon Conversion 1/07 N/A 3/07 TBD Stevens/ Sarno The FASB staff will prepare an Issue Summary for a future meeting. March 2007 EITF meeting EITF Agenda Committee Report (Status of Open Issues and Agenda Committee Items) January 29, 2007, p. 19

21 Issue No Other EITF Issues including Inactive Issues Pending Developments in Board Projects Description Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees Date Added Date(s) Discussed 5/00 7/00, 7/01, 11/01, 1/02, 3/02 Meeting FASB Staff Immediate Plans 3/07 Sarno The FASB staff will bring this issue to the Task Force at a future meeting to request that the Task Force remove this Issue from the agenda. Due Date - Deliverable March 2007 EITF Meeting Admin. Session The remaining issue in Issue is Issue 3: For transactions that include a grantee performance commitment, how the grantee should account for the contingent right to receive, upon performing as specified in the arrangement, grantor equity instruments that are the consideration for the grantee's future performance. The Task Force asked the FASB staff to focus on improving the guidance (originally from Issue 96-18) used to determine the date at which a commitment for counterparty performance to earn the equity instruments is reached Application of EITF Issue No. 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios," to Certain Convertible Instruments 5/00 11/00, 1/01 Not scheduled TBD Pending further progress on Phase II of the Board's liabilities and equity project. N/A EITF Agenda Committee Report (Status of Open Issues and Agenda Committee Items) January 29, 2007, p. 20

22 Issue No. Other EITF Issues including Inactive Issues Pending Developments in Board Projects Description 02-D The Effect of Dual-Indexation both to a Company's Own Stock and to Interest Rates and the Company's Credit Risk in Evaluating the Exception under Paragraph 11(a)(1) of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities Date Added 3/02 Date(s) Discussed N/A Meeting Not scheduled FASB Staff Jacobs Immediate Plans Pending further progress on Phase II of the Board's liabilities and equity project. Due Date - Deliverable N/A Interpretation of Constraining Conditions of a Transferee in a Collateralized Bond Obligation Structure 11/02 N/A Not scheduled Lusniak The Board's project on QSPE's is not expected to address this Issue and, therefore, the FASB staff will bring this Issue to the Agenda Committee at a future meeting to determine whether to begin discussions on this Issue or to request that the Task Force remove this Issue from the agenda. Future Agenda Committee or EITF Meeting EITF Agenda Committee Report (Status of Open Issues and Agenda Committee Items) January 29, 2007, p. 21

23 Issue No. Other EITF Issues including Inactive Issues Pending Developments in Board Projects Description 05-4 The Effect of a Liquidated Damages Clause on a Financial Instrument Subject to EITF Issue No , "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock" Date Added Date(s) Discussed Meeting FASB Staff Immediate Plans 2/05 6/05, 9/05 03/07 Stevens The FASB staff will bring this Issue to a future EITF Meeting to request that the Task Force remove this issue from the agenda following the issuance of FSP EITF , "Accounting for Registration Payment Arrangements," on December 21, Due Date - Deliverable March 2007 EITF Meeting Admin. Session Issue No. N/A Description Application of EITF Issue No , "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets," When a Special-Purpose Entity Holds Equity Securities and Whether an Investment That Is Redeemable at the Option of the Investor Should Be Considered an Equity Security or Debt Security Issues Pending Further Consideration by the Agenda Committee Date Added 9/00 Date(s) Discussed N/A Meeting Not scheduled FASB Staff Jacobs Immediate Plans Statement 155 did not address this Issue. Therefore, the FASB staff will bring this Issue either to the Agenda Committee at a future meeting to determine whether to begin discussions on this Issue or to a future EITF meeting to request that the Task Force remove this Issue from the agenda. Due Date - Deliverable Future Agenda Committee or EITF Meeting EITF Agenda Committee Report (Status of Open Issues and Agenda Committee Items) January 29, 2007, p. 22