Liabilities & Equity Targeted Improvements

Transcription

1 Liabilities & Equity Targeted Improvements July 19, 2016 Private Company Council (PCC) 1

2 EITF 07-5 Requires liability classification for instruments with down round features (strike price adjusts down based on the pricing of future equity offerings) For instruments in the scope of Subtopic , GAAP requires an evaluation of whether an instrument is indexed to and settled in own stock. A down-round feature precludes an instrument (or embedded feature) from being indexed to an entity s own stock. The instrument (or embedded feature) requires mark-tomarket accounting under Topic 815. Sources of Complexity Fair value measurement (initially and at each subsequent reporting period) Accounting may not reflect economics (for example, P&L impacts are recorded as stock price increases, even if down round is to protect investor from declines in price) Example 1: Convertible Instruments with a Down- Round in an Embedded Conversion Option* Debt recorded at fair value on Day 1 and accreted up to par value Conversion option marked-to-market with changes in value recorded in net income Example 2: Warrant with a Down-Round Instrument marked-to-market with changes in value recorded in net income * Assume embedded conversion option meets the definition of a derivative 2

3 Tentative Board Decision: Down Rounds Current Accounting Proposed Accounting Classification Liability Down round* does not impact classification; May be equity or liability based on instrument and other features Initial Measurement Subsequent Measurement Overall instrument Fair value Overall instrument Remeasured at fair value each reporting period; P&L Impact *A standard anti-dilution provision is not considered a down round feature. Recorded at proceeds and no accounting for the down round feature on Day 1 accounting for instrument depends on if its equity or liability classified Ongoing accounting depends on whether instrument is liability or equity classified only account for the down round feature when triggered: If equity classified, then dividend If liability classified, then P&L impact Key Simplification Certain instruments with down round features would no longer be classified as liabilities and measured at fair value under EITF For example: - Freestanding warrants with down round features - Preferred shares with down round features Board directed staff to ballot Exposure Draft 3

4 Project Timeline September 2015 Board Meeting: Directed staff to begin drafting Exposure Draft (ED) January 2016 Issued staff draft of ED, for review by Board members March-April 2016 Issued External Review draft of ED, reviewed 137 External Review comments TBD (late July 2016) Board to issue Invitation to Comment on Future Agenda October- December 2015 Research on scope interaction with existing GAAP and valuation issues (including outreach) February 2016 Board added broader project on distinguishing liabilities from equity to its research agenda July 2016 PCC Meeting TBD Issue Liabilities and Equity: Targeted Improvements ED 4

5 Complexity: Valuation of the Effect of the Down Round Feature Fair Value Measurement: Determine the fair value of the down round feature under Topic 820, Fair Value Measurement, using a with-and-without approach: - Comparing a similar instrument without the down round feature and an adjustment of terms to reflect the absence of the down round feature to the fair value of the instrument with the down round feature after the strike price has been reduced - Concerns: Possibly too complex and costly for private companies to apply Different interpretations of mechanics to meet the objective Alternative measurement method: Allows an entity to value the effect of the down round feature as the difference between the following amounts determined immediately after the down round feature is triggered: - The fair value of the financial instrument (without the down round feature) with a strike price corresponding to the initial strike price of the instrument issued - The fair value of the financial instrument (without the down round feature) with a strike price corresponding to the reduced strike price upon the down round feature being triggered. 5

6 Complexity: Interaction with Existing GAAP for Separation of Certain Convertible Instruments Some instruments would be scoped out of Topic 815 derivative accounting and, therefore, would no longer be separated under that guidance. - Convertible instruments that are subject to an existing separation model in GAAP would not be subject to the new down rounds model Consistent with Board s approach when developing the cash conversion model. Thus, more instruments would be in the scope of the convertible instruments models (i.e., cash conversion, beneficial conversion feature) and have incremental accounting requirements. For example, convertibles with down round features that would not otherwise be captured by Topic 815: o Convertible preferred stock with an embedded conversion option containing down round feature o Convertible debt with an embedded conversion option containing down round feature 6

7 Complexity: Interaction with Existing GAAP for Separation of Certain Convertible Instruments Beneficial conversion feature (BCF) model would override proposed down rounds model to avoid creating non-intuitive outcomes - For example, if a convertible debt instrument has two contingent BCFs that coexist (one that is a down round as defined in this project and one that is a down round that does not meet the definition in this project), if different models were applied: There would be inconsistent accounting for very similar features because of different measurement models: o BCF model intrinsic value o Down rounds model fair value or alternative measurement method Accounting for down round feature in scope of DR model would depend on which feature gets triggered first Risk of incorrect navigation through models 7

8 High-Level GAAP Navigation for Convertible Instruments, Incorporating the Proposed Model for Down Round Features Instruments with down rounds captured here under current GAAP Is the embedded conversion option required to be bifurcated & MTM under Topic 815? N Y Bifurcate & MTM embedded derivative Down round feature will no longer cause an instrument to fail the derivatives scope exception. Ignoring down rounds here pushes the analysis down the chain to the BCF model. Does the convertible debt* contain a cash conversion feature? Y Separate (using the liability first method) N Does the convertible debt or convertible preferred contain a BCF or contingent BCF (that is, is the conversion feature in the money at the commitment date)? N Y Separate BCF (at intrinsic value) into liability & equity components or 2 equity components If no cash conversion feature exists this will likely capture most of all down rounds because they are economically similar to BCFs. Is the convertible debt issued at a substantial premium? Y Premium represents paid-incapital ( ) N Down rounds captured here under proposal Does the convertible debt or convertible preferred have a down round feature? N Y Apply proposed down rounds model **Also applies to convertible preferred stock classified as a liability. Account for single liability or equity instrument 8

9 Complexity: Valuation of the Effect of the Down Round Feature and Interaction with Existing GAAP Feedback received: - Potential partial double counting of the fair value of the down round feature because the down round feature is initially captured as part of the recorded basis of the financial instrument if it is likely at initial recognition that it will be triggered. - Does it make sense to have two different measurement attributes for economically similar features (down rounds captured by BCF model versus those captured by new down rounds model)? 9

10 Complexity: Impact of Trigger Only account for the down round feature when triggered: - If equity classified dividend: Recognize the value of the effect of the down round feature, when triggered, as a reduction of retained earnings and an offset to additional paid in capital. - If liability classified P&L impact: Recognize the value of the effect of the down round feature as a reduction of earnings and an adjustment of the carrying amount of the liability-classified instrument that includes the feature. Basis adjustment subsequently amortized through earnings using the interest method or recognized as part of extinguishment gain/loss Feedback received: - Subsequent amortization of the basis adjustment effectively reverses the initial charge to expense - Non-intuitive outcome for liability-classified instruments that are in-form equity would result in an income recognition pattern that is generally applicable to debt instruments - For equity-classified instruments, upon a down round being triggered, a charge to retained earnings and an offsetting entry to equity (APIC) will have an immediate net nil impact on equity, while for liability classified instruments the impact is reversed over time 10

11 Complexity: Impact of Trigger Instrument Board Decision Alternative Suggestions Equity-Classified Instruments Warrants Convertible preferred shares (if any) Preferred shares Liability-Classified Instruments Convertible debt (if any) Liability-classified equitylinked instruments (e.g., warrants) DR Retained Earnings CR APIC DR Expense CR Basis of Liability-Classified Instrument DR Retained Earnings CR Basis of Equity-Classified Instrument *(i) DR Expense CR APIC or *(ii) DR Liability (discount) CR APIC *Some would require (i) for liability-classified instruments in equity form and (ii) for debt instruments 11

12 Discussion Questions Do PCC members have any concerns about the proposed approach to accounting for the down round feature at trigger and subsequent measurement of the down round feature versus alternatives suggested (slide 11)? Would PCC members support the current approach or support one of the alternatives? Do PCC members have any concerns about the potential for errors in applying this area of GAAP, specifically due to the changes in navigation? For example, is there a risk that a private company may incorrectly apply the down rounds model to a convertible instrument rather than the BCF model, as would be required under the new navigation (see flowchart on slide 8)? Do PCC members have any concerns about complexity, given that the broader liabilities and equity research project has been added to the FASB s agenda? What are PCC members thoughts on the interaction of this project with the broader liabilities and equity research project? 12

13 Project Overview: Simplifying the Balance Sheet Classification of Debt (Current vs. Noncurrent) July 19, 2016

14 Simplification Initiative Objective Reduce cost and complexity while maintaining or improving the usefulness of the information Projects include narrow-scope items that the FASB can complete in the short term Simplification is not always simple Project added to Board s agenda in August

15 Simplifying the Balance Sheet Classification of Debt (Current vs. Noncurrent on a Classified Balance Sheet) Current Guidance Proposed Change What? Narrow scope rules on specific types of debt arrangements Overriding principle for the classification of debt that can apply to all arrangements* How? Mix of guidance using contractual maturity and management judgments Increase focus on contractual maturity and borrower s rights less focus on judgment or intent When? Some circumstances considered as of the financial statement issuance date, while others use the reporting date Criteria considered as of the reporting date * Includes convertible debt and liability classified mandatorily redeemable instruments Working group of PCC members participated in outreach with financial statement users 3

16 Tentative Board Decision Classification principle Debt would be classified as a noncurrent liability if either of the following criteria are met as of the balance sheet date: - Liability is contractually due to be settled more than one year (or operating cycle, if longer) after balance sheet date - Entity has contractual right to defer settlement of liability for at least one year (or operating cycle, if longer) after balance sheet date Proposed Update to be Issued in 3Q 16 4

17 PCC Feedback Waivers of Debt Covenant Violations (when waiver is received after the balance sheet date but prior to financial statement issuance) Initial Board Decision Classification principle would result in current classification because borrower is in default as of year end (change from existing GAAP, which requires noncurrent classification) Board Decision in Proposed Update Exception to the principle: The waiver should be considered when determining the balance sheet classification, unless the waiver results in extinguishment or troubled debt restructuring (additional disclosure requirements) PCC members unanimously supported this proposal 5

18 PCC Feedback Short-term debt at the balance sheet date that is subsequently refinanced (after the balance sheet date but prior to financial statement issuance) Board Decision Classification principle would result in current classification because debt is due within one year as of the balance sheet date (change from existing GAAP, which requires noncurrent classification) PCC Feedback PCC members views differed on whether to support current classification of these obligations Differing views on the economics and whether the refinance is an event that provides additional evidence about conditions that: b) Did not exist at the balance sheet date but a) Existed at the balance sheet date (that is, arose subsequent to that date (that is, recognized subsequent event) nonrecognized subsequent event) 6

19 Refinancing Considerations Some PCC members suggested that the refinance only impact classification when it is with the same lender; FASB considered this and decided not to make that change: - May be confusing for financial statement users if the classification is impacted solely based upon who the lender is - Complexity in determining if it is the same lender when the lender is a consolidated group of lenders (additional implementation guidance may be needed) Inconsistencies with subsequent events guidance - Could cause the Board to reconsider prepayments or debt covenant failures that occur after the balance sheet date but before the financial statements are issued Project Rationalization Objective of project is simplification, but if more exceptions are added, the new guidance becomes more complex Question on Refinances included in Proposed Update 7

20 Project Timeline August 2014 Added to Technical Agenda January 2015 Board Meeting: Start of Initial Deliberations May 2015 PCC Update July 2016 PCC Update September 2014 PCC Update February 2015 PCC Update July 2015 Board Meeting: Completion of initial deliberations; Permission to ballot an ED 3Q 16 Target to Issue ED 8

21 Government Assistance Disclosures 1

22 Scope A legally enforceable agreement in which a company receives value from the government Excluded Transactions - The government is legally required to provide a nondiscretionary level of assistance because the company met eligibility requirements without specific agreement between the government and the entity. - In which the government is solely a customer Copyright 2016 by Financial Accounting Foundation, Norwalk, CT. For non-commercial, educational /academic purposes only. 2

23 Proposed Amendments Current GAAP No explicit guidance No guidance on accounting for or the disclosure of government assistance received by business entities. Proposed Update (November 2015) Required annual disclosures for certain transactions Nature of assistance, related accounting policy and effect on financial statement amounts. Significant terms and conditions of the agreement which might include: Duration of agreement Tax or interest rate Commitments and contingencies Provisions for recapturing government assistance Copyright 2016 by Financial Accounting Foundation, Norwalk, CT. For non-commercial, educational /academic purposes only. 3

24 Feedback on Proposed Update Comment period ended February10, comment letters received Positive comments on the proposal include - Stakeholders are supportive of increasing transparency and reducing diversity in practice in accounting for government assistance. - Agreed with the notion of legally enforceable agreement provided that certain terms are further clarified (i.e. value, discretionary, and impracticable). Copyright 2016 by Financial Accounting Foundation, Norwalk, CT. For non-commercial, educational /academic purposes only. 4

25 Feedback on Proposed Update Issues raised - Scope is too broad and should exclude specific agreements with Topic 740 Income Taxes or that part of the scope of this project is already captured under Topic 275 Risks and Uncertainties. - Majority of stakeholders disagreed with disclosing quantitative amounts of assistance received but not recognized due to cost and reliability concerns. - Practitioners stated that they may not have access to verify information for arrangements with foreign governments. - Concerns of breaching confidentiality clauses, concerns that governments would be less likely to enter into agreements, and concerns that disclosure would result in a competitive disadvantage were also raised. Copyright 2016 by Financial Accounting Foundation, Norwalk, CT. For non-commercial, educational /academic purposes only. 5

26 Redeliberations On June 8, 2016, the Board redeliberated prevalent issues and made the following decisions: - Government assistance that is provided to an entity in the form of benefits that are available in determining taxable income or that are determined or limited on the basis of income tax liability, in accordance with Topic 740, Income Taxes, will not be included in the scope of this update. - Entities will not be required to disclose the amount of government assistance received but not recognized directly in the financial statements. - An entity which omits required information because the information is legally prohibited from being disclosed will disclose a description of the general nature of the information omitted and the specific source of the legal prohibition. - Employee benefit plans will not be within the scope of this update. The Board will continue redeliberations in Q3, 2016 Copyright 2016 by Financial Accounting Foundation, Norwalk, CT. For non-commercial, educational /academic purposes only. 6

27 Financial Performance Reporting Research Project Private Company Council Meeting July

28 Research Project on Performance Reporting FASB directed staff to perform research on a financial statement presentation project in January 2014 Re-scoped from the previous financial statement presentation project, which went inactive in 2011 Objective of research is to identify & evaluate alternatives for improving financial performance reporting Invitation to Comment to be issued this summer 2

29 Reasons for Undertaking This Project Ranked as top priority across stakeholders in 2015 FASAC agenda survey Stakeholders continue to raise concern McKinsey 3

30 Scope of the Research Project Primary objective The primary objective is to evaluate ways the FASB might improve the relevance of information presented in the performance statement. Two focus areas for the performance statement: (1) categorize the income statement into operating and nonoperating activities (2) distinguishing between recurring & nonrecurring or infrequently occurring items 4

31 Scope of the Research Project (Cont d) Improvement areas Performance reporting Areas where related improvements may also be considered Transparency of remeasurements Additional disaggregation in the performance statement Related changes to segment reporting Linkages across the primary statements 5

32 Previous Performance Reporting Projects FASB (1979) FASB (1981) AICPA (1994) FASB and G4+1 (1998) UK ASB (2000) FASB and IASB (2008) FASB and IASB (2010) Reporting Earnings Task Force Discussion Memorandum Analysis of Issues Related to Reporting Earnings Conceptual Framework Exposure Draft Reporting income, Cash Flows and Financial Position Jenkins Committee Report Special Committee on Financial Reporting G4+1 Special Report Reporting Financial Performance Exposure Draft Reporting Financial Performance Joint Project Discussion Paper Preliminary Views on Financial Statement Presentation Joint Project Staff Draft of an Exposure Draft Financial Statement Presentation 6

33 Categorizing the Income Statement Structure of the income statement Operating and Nonoperating activities Approaches identified Establishing an operating activity category: (1) Definition of operating activities - Direct definition of operating activities - Residual definition (such as the cash flow statement definition) - Broad industry lines (2) Describe the meaning of operating activities - Board description, standardize certain aspects for comparability - Board description, accounting policy choice for all other aspects (3) Self-defined category of operating activities (4) Build upon a voluntary categorization; (pensions, restructuring expenses) (5) Define EBIT or EBITDA, if presented 7

34 Board Feedback Operating Activities Challenges to establishing an operating activities category: - Conceptual challenges to define operating activities for all types of entities - Previous standard-setting attempts have not been successful - Divergent views on what are the operations of an entity Establishing a structure for the income statement could be an incremental step to tackling the most controversial issues in financial reporting, such as distinguishing liabilities from equity Unclear demand for standardizing accounting guidance: - Practice has developed such that voluntary reporting of operating income is commonplace. Potential to add significant complexity. 8

35 Disaggregating Performance Information Content and display of the income statement Staff has been considering how to combine or separate performance information into discrete lines. Approaches identified Three alternatives so far: (1) Redefining infrequently occurring items in Subtopic (2) Defining and distinguishing remeasurements (3) Disaggregating functional lines into natural components Other areas for research: - Minimum lines, if any, for presentation - Principles for aggregation, distinguishing lines, and display of lines 9

36 Board Feedback Content and Display Challenges with disaggregation alternatives: - Limited concepts in which to base any standards-level improvements - Previous standard-setting attempts have not been successful Some of the approaches are potentially more operable than others: - Disaggregating functional lines into natural components - Redefining infrequently occurring items Current Conceptual Framework project on presentation: - Factors for aggregating performance information into reasonably homogeneous groups 10

37 Invitation to Comment (ITC) 11

38 2015 FASAC Survey PCC Results Surveys FASAC & members of other FASB advisory groups (EITF, PCC, IAC, NFP Advisory Committee, SBAC) Asked: What are the most needed financial reporting improvements and why? What is the problem and what are feasible alternatives? When is the solution needed, and for whom? Results discussed with each FASB advisory group 12

39 FASAC Survey Feedback by Stakeholder Group Topics EITF FASAC IAC NAC PCC SBAC Financial Performance Reporting Improving Cash Flow Classification Pensions and OPEB Liabilities vs Equity Intangible Assets Other Comprehensive Income Consolidations Segment Reporting X X X X X X X X X X X X X X X X X X X X X X X X X X X Inventory and Cost of Sales Collaborative Arrangements Equity Method X X Income Taxes X 13

40 FASAC Survey Feedback by Stakeholder Type Topics Preparer User Practitioner Other Financial Performance Reporting X X X X Improving Cash Flow Classification X X X X Pensions and OPEB X X X X Liabilities vs Equity X X Intangible Assets X X Other Comprehensive Income X Consolidations X Segment Reporting X Inventory and Cost of Sales X 14

41 FASB Future Agenda Public Consultation ITC to be issued July/August Four chapters: 1) Intangible Assets (including Research and Development) 2) Pensions and Other Postretirement Benefit Plans 3) Distinguishing Liabilities from Equity 4) Reporting Performance and Cash Flows 15

42 Chapter 4 Reporting Performance and Cash Flows ITC discusses performance reporting and presentation for: (a) Income Statement (b) Segment Reporting (c) Other Comprehensive Income (d) Statement of Cash Flows Feedback to the ITC provides an opportunity to reconsider the scope of the performance reporting research project, potentially establish additional projects and the phasing of when those projects are undertaken. 16

43 Questions for Discussion Q1: On what basis did PCC members decide to rank performance reporting in the Top 5 priorities? Q2: What aspects of performance reporting do PCC members believe are most in need of improvement? Q3: Do you think the FASB should structure the income statement with an operating and nonoperating activities category? If so, how would you approach this? Q4: Do you think the FASB should focus on the disaggregation of performance information within the income statement? If so, on what basis would you disaggregate information? Q5: Are there other areas of improvement that the staff should consider? 17