Quarterly Accounting Roundup: An Update of Important Developments

Transcription

1 Financial Reporting Presents: Quarterly Accounting Roundup: An Update of Important Developments Jim Johnson Georganne Gage Walters Randall Sogoloff Vince Smith April 12, 2006

2 Agenda Accounting for Certain Hybrid Financial Instruments Accounting for Servicing of Financial Assets Georganne Gage Walters Variability to Be Considered in Applying FIN 46(R) Classification of Options and Similar Instruments Accounting for Life Settlement Contracts Randall Sogoloff The Fair Value Option Accounting for Pension and Other Postretirement Plans Renewable Intangible Assets Vince Smith Other Topics Discussed by the FASB Questions and Answers

3 Keep in Mind: This webcast does not provide official Deloitte & Touche interpretive accounting guidance. Check with a qualified advisor before taking any action. See later slides for information on obtaining written summaries of issues discussed today.

4 Learning Objective To enhance participants understanding of important accounting issues and developments pertaining to: FASB Statements and FASB staff positions finalized and proposed during the first quarter of 2006 Other current projects discussed by the FASB during the first quarter of 2006

5 FASB Statement No. 155, Accounting for Certain Hybrid Financial Instruments 1.1

6 Hybrid Financial Instruments FASB Statement 155 issued in February Amends FASB 133 and 140 What s a hybrid instrument? A financial instrument with an embedded derivative Why this project? Simplify accounting for hybrids by allowing fair value election for the entire instrument Eliminate temporary exemption for beneficial interests in securitized financial assets from the bifurcation requirements of FASB 133 (prospectively) 1.2

7 Hybrid Financial Instruments Elimination of temporary exemption in DIG Issue D1 Interests in securitized financial assets must now be evaluated for derivatives IO and PO strip exemption refined No modifications to the strips (incremental servicing fees, guarantee fees, other changes in terms) Credit risk and concentration of credit risk in securitized financial assets are not considered embedded derivatives under FASB 155 Many, many securitizations have redistributed credit risk 1.3

8 Hybrid Financial Instruments Example Securitization vehicle Holds fixed-rate bonds Prior to 155, no requirement to evaluate for derivatives Senior fixed rate interest Subordinate fixed-rate interest No embedded derivative exists Credit losses on bonds allocated to subordinate interest 1.4

9 Hybrid Financial Instruments Fair value measurement election Scope Recognized hybrid financial instruments with embedded derivatives that would otherwise require bifurcation Must fully evaluate to determine whether an embedded exists When can the election be made? On adoption of FASB 155 for existing hybrids Initial recognition of a hybrid financial instrument Remeasurement (new basis) event Examples include a business combination, significant modification of debt Not other-thantemporary impairments! 1.5

10 Hybrid Financial Instruments Fair value measurement election (cont d.) Documentation Concurrent or preexisting policy for automatic election Instrument-by-instrument Hybrids measured at fair value may not be designated as a hedging instrument Disclosure requirements Balance sheet presentation Income statement disclosures Fair value election is irrevocable! 1.6

11 Balance Sheet Presentation Separate line item: Borrowings, at fair value Borrowings, at amortized cost $ X,XXX X,XXX OR Disclosed parenthetically: Borrowings (including $X,XXX measured at fair value) $ X,XXX 1.7

12 Hybrid Financial Instruments Other highlights of FASB 155 Amendment to FASB 140 Eliminate restriction on passive derivative instruments that may be held by a QSPE Transition Difference between total carrying amount of bifurcated financial instrument and fair value of combined recognized as cumulative-effect Effective date Provided no interim financial statements have been issued Beginning of fiscal year after September 15, 2006 Early adoption permitted as of beginning of fiscal year (e.g., January 1, 2006 for calendar year-end entities) 1.8

13 Polling Question Does your organization invest in securitized financial assets? Yes No Don t know / Not applicable

14 FASB Statement No. 156, Accounting for Servicing of Financial Assets 2.1

15 Servicing of Financial Assets FASB Statement 156 issued in March Why this project? Servicing rights currently measured at LOCOM Economic hedges measured at fair value Hedge accounting requirements difficult to meet Results in income statement volatility Initial measurement at fair value Provides a choice of subsequent measurement methods Amortization method (exists currently in FASB 140) Fair value method 2.2

16 Servicing of Financial Assets Initial recognition in a transfer Prior accounting resulted in different measurement for servicing rights Purchased or assumed Initially measured at fair value Retained in securitization Initially measured based on allocation of previous carrying amount Separately recognized servicing rights must be initially recognized at fair value Servicing rights treated as part of proceeds Impact on gain/loss calculations Regardless of subsequent measurement election 2.3

17 Servicing of Financial Assets Fair value election basics Make election separately for each class of servicing rights What s a class and how are they identified? Are classes different than strata? Additional required disclosures by class Election is irrevocable Transfers of servicing rights from class measured at fair value to class measured under amortization method is prohibited Must be made as of the beginning of fiscal year Provided no interim financial statements have been issued 2.4

18 Servicing of Financial Assets Before Statement 156 After Statement 156 Strata 1 Strata 2 Strata 3 Class 1 Strata 1 Strata 2 Strata 3 Class 2 Measured under amortization method Measured under fair value method 2.5

19 Servicing of Financial Assets Fair value election basics (cont d) Election can be made for existing servicing rights Reduce carrying amount by any related valuation allowance Difference between fair value and carrying amount is cumulative-effect adjustment to beginning of period retained earnings No additional fair value measurement guidance provided FASB 140 presumably price paid or received if purchased or assumed If fair value cannot be reasonably estimated, servicing rights must be included in a class measured under the amortization method 2.6

20 Servicing of Financial Assets Other highlights of FASB 156 One-time reclassification of available-for-sale securities to trading Only available on adoption of FASB 156 Limited to those securities held to offset income statement effect of changes in fair value of servicing rights Presentation and disclosure Separate balance sheet disclosure for servicing rights measured at fair value Parenthetical or separate line item Additional footnote disclosures for all servicing rights 2.7

21 Balance Sheet Presentation Separate line item: Mortgage servicing rights, measured under fair value method Mortgage servicing rights, measured under amortization method $ X,XXX X,XXX Disclosed parenthetically: OR Mortgage servicing rights (including $X,XXX measured under fair value method) $ X,XXX 2.8

22 Servicing of Financial Assets Other highlights of FASB 156 (cont d) Effective date Beginning of fiscal year after September 15, 2006 Early adoption permitted as of beginning of fiscal year (e.g., January 1, 2006 for calendar year-end entities) No financial statements (including interim periods) have been issued 2.9

23 Polling Question How does your company plan to deal with the fair value election available in FASB 156? We plan on measuring all servicing rights at fair value We plan on measuring some servicing rights at fair value We will continue using the amortization method for all servicing rights Don t know / Not applicable

24 FSP FIN 46(R)-6, Determining the Variability to Be Considered in Applying FASB Interpretation No. 46(R) 3.1

25 Determining Variability to Consider Why this issue? Diversity exists in how to determine variability. Cash flow versus fair value methods Understanding an entity s variability is the key to applying Interpretation 46(R). It impacts: whether an entity is, or is not, a variable interest entity (VIE) which interests are variable interests in the entity how expected losses and residual returns of the entity are calculated which party is the primary beneficiary of the VIE. FASB Decided on the By Design Approach 3.2

26 Determining Variability to Consider Determining a variable interest is a question of: Which assets, liabilities, or contracts create the entity s variability and which assets, liabilities, equity, and other contracts absorb or receive that variability. The latter are the entity s variable interests. 3.3

27 Determining Variability to Consider Steps in Applying the By Design Approach Step 1: Analyze the nature of the risks in the entity. Step 2: Determine the purpose for which the entity was created and determine the variability that the entity is designed to create and pass along to its interest holders. The activities of the entity The terms of the contracts the entity has entered into The nature of the entity s interests issued How the entity s interests were negotiated with or marketed to potential investors Which parties participated significantly in the design or redesign of the entity 3.4

28 Determining Variability to Consider Indicators in Applying Step 2 Risk Transfer: For an instrument that transfers all or a portion of the risk or return (or both) of certain assets or operations of an entity to holders of that interest, the variability that is transferred strongly indicates a variability that the entity is designed to create and pass along. 3.5

29 Determining Variability to Consider Indicators in Applying Step 2 (continued) Certain derivative instruments: Their status as being a creator of variability is strongly indicated if (a) its underlying is an observable market rate, price, index of prices or rates, or other market observable variable (including the occurrence or nonoccurrence of a specified market observable event) and (b) the derivative counterparty is senior in priority relative to other interest holders in the 3.6 entity.

30 Determining Variability to Consider Indicators in Applying Step 2 (continued) Exception: If changes the fair Certain derivative value or instruments: cash flows of the Their derivative instrument are status as being a creator of variability is expected to offset all, or strongly indicated essentially if (a) all, of its the underlying risk or return is an (or both) related to a majority of observable market the assets rate, or operations price, index of the of prices entity, a further analysis of the or rates, or other design market of the entity observable will be variable necessary. (including the occurrence or nonoccurrence of a specified market observable event) and (b) the derivative counterparty is senior in priority relative to other interest holders in the entity. 3.7

31 Determining Variability to Consider Indicators in Applying Step 2 (continued) Subordination: For entities that issue both senior interests and subordinated interests, the variability that is absorbed by an interest that is substantively subordinate strongly indicates a particular variability that the entity was designed to create and pass along to its interest holders. 3.8

32 Determining Variability to Consider Interest Rate Risk (periodic interest receipts/payments) Excluded from the variability to consider if the entity is not designed to create and pass along that interest rate risk to interest holders. An entity is likely designed to create and pass along interest rate risk when: an interest rate mismatch exists between assets and liabilities of the entity or fixed-rate investments are held by the entity, that by design, will be required to be sold prior to maturity to satisfy obligations of the entity. Refer to FASB examples in Appendix A 3.9

33 Determining Variability to Consider Effective Date Beginning the first day of the first reporting period beginning after June 15, Early application will be permitted if financial statements have not yet been issued. Transition Prospective application to entities with which the enterprise becomes involved. Applies to existing entities if a reconsideration event occurs under paragraph 7 of FIN 46(R). Retrospective application is permitted, but not required (would have to be completed no later than the first interim or annual reporting period ending after July 15, 2006). 3.10

34 Polling Question How much of an effect do you believe the guidance in the FSP will have on your FIN 46(R) analyses? Significant effect Some effect No effect at all Too early to tell Not applicable

35 FSP FAS 123(R)-4, Classification of Options and Similar Instruments Issued as Employee Compensation That Allow for Cash Settlement upon the Occurrence of a Contingent Event 4.1

36 Liability Awards FSP 123(R)-4: If public, don t forget ASR 268 and EITF Topic D-98. FSP 123(R)-4 allows for probability assessment of contingent events that are outside the employee s control. Example - option will be cash settled upon a change of control. If the contingent event (change of control) is not considered probable of occurrence and outside the employee s control then liability classification is not required. For public companies applying FAS 123(R), liabilities must be marked to market. For non-public companies, a policy choice is made between marking to market and marking to intrinsic value. If the contingent event is within employee s control classify the option as a liability regardless of probability. If contingent event becomes probable follow modification accounting and reclassify to liability (See FSP par 6). 4.2

37 Liability Awards FSP 123(R)-4: Effective upon initial adoption of FAS 123(R) If already adopted apply to the first reporting period beginning after February 3, 2006 Retrospective adoption required Early adoption permitted Only applicable to employee options 4.3

38 FSP FTB , Accounting for Life Settlement Contracts by Third Party Investors 5.1

39 Life Settlement Contracts Life Settlement Contract A contract between the owner of a life insurance policy and a third-party investor and has the following characteristics: The investor does not have an insurable interest, The investor provides consideration to the policy owner of an amount in excess of the current cash surrender value of the policy, and The contract pays the face value of the life insurance policy to an investor when the insured dies. FSP provides two methods: Investment method Fair value method 5.2

40 Life Settlement Contracts Effective date FSP shall be applied to fiscal years beginning after June 15, Earlier applications is permitted. Transition An investor shall apply the FSP prospectively. At the date of adoption, an investor shall make a one-time irrevocable election to account for its currently held life settlement contracts on an instrument-by-instrument basis using either method and recognize a cumulative effect adjustment to beginning retained earnings. Disclosure requirements applied as of the most recent statement of financial position or income statement presented. 5.3

41 Proposed Statement of Financial Accounting Standards, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No

42 Fair Value Option Current GAAP uses different measurement attributes for different assets and liabilities Leads to earnings volatility (mismatches) Under the exposure draft, a company may irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and liabilities on a contract by contract basis. Mitigates volatility without complex hedge accounting Achieves convergence with International standards Expands the use of fair value measurement 6.2

43 Fair Value Option Examples of instruments within the scope of the proposed Statement: Equity method investments; Equity securities that do not have readily determinable fair values; Insurance and reinsurance contracts that are financial instruments; Warranty obligations that are financial liabilities and warranty rights that are financial assets; and Unconditional purchase obligations recorded as financial liabilities. The fair value option may not be elected for any of the following: An investment that would otherwise be consolidated; Employers and plans financial obligations for pension benefits, other postretirement benefits, post-employment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements; Financial liabilities recognized under lease contracts (however, this exclusion does not include a contingent obligation arising out of a cancelled lease or a guarantee of a third-party lease obligation); Written loan commitments that are not accounted for as derivative instruments; and Financial liabilities for demand deposit accounts. 6.3

44 Fair Value Option Balance Sheet Presentation Requires separate display on the face of the balance sheet of those items valued at fair value from those measured under different attributes. Display separate line items for the fair value and non-fair-value carrying amounts, or Present the aggregate of those fair value on non-fair-value amounts and parenthetically disclose the amount of fair value included in the aggregate amount. Amends FAS 115 to require securities reported at fair value to follow these presentation requirements. Requires additional disclosure for significant changes in fair value. 6.4

45 Fair Value Option Effective as of the beginning of each reporting entity s first fiscal year that begins after December 15, The adjustment would be accounted for as a cumulative-effect adjustment. Comment period ended on April 10,

46 Polling Question If a final statement is issued, do you intend to take advantage of the fair value option? Yes No Too early to tell Not applicable

47 Proposed FASB Statement, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans 7.1

48 Recognition of the Funded Status Requires recognition of a plan s over-funded or underfunded status as an asset or liability in the statement of financial position Measured as the difference between the fair value of a plan s assets and the benefit obligation Unrecognized prior service costs and credits and unrecognized net actuarial gains and losses are recognized as a component of other comprehensive income No change in how amounts are recognized in the income statement Unrecognized net transition assets and obligations are recognized as an adjustment to beginning retained earnings Amounts are no longer included as a component of net periodic benefit cost 7.2

49 Recognition of the Funded Status Presentation and Classification on the Financial Statements Aggregate the assets derived from all over-funded plans and record as an asset on the statement of financial position. Aggregate the liabilities derived from all under-funded plans and record as a liability on the statement of financial position. Current and non-current portions of the assets and liabilities recognized are to be reported separately on the face of the statement of financial position. 7.3

50 Recognition of the Funded Status Effective Date and Transition Effective for all entities for fiscal years ending after December 15, 2006 and should be applied retrospectively Unrecognized prior service costs and credits and unrecognized actuarial gains and losses Unrecognized transition asset or transition obligation Recognize as a component of OCI, net of tax, amounts that were not included in net periodic benefit cost for each period presented Recognize as an adjustment to the opening balance of accumulated. OCI, net of tax, amounts not yet included in net periodic benefit cost as of the beginning of the period initially applied. Recognize as an adjustment to the opening balance of retained earnings, net of tax, amounts not yet included in net periodic benefit cost as of the beginning of the period initially applied. Any previous amortization of transition asset or obligation is removed from net periodic benefit cost for all periods presented. 7.4

51 Measurement Date Requires plan assets and benefit obligations be measured as of the date of the fiscal year-end statement of financial position Effective Date For public companies the requirement shall be applied for fiscal years beginning after December 15, 2006 For non-public companies and not-for-profit organizations the requirement shall be applied for fiscal years beginning after December 15, 2007 Net periodic benefit cost shall be measured for the upcoming fiscal year as of the beginning of the fiscal year the requirement is applied 7.5

52 Measurement Date Transition For transactions or changes that occur in the period between the beginning of the measurement date that would have been used for the upcoming fiscal year and the beginning of the upcoming fiscal year: Net periodic benefit cost Effects of curtailments and settlements Changes in prior service costs and credits and actuarial gains and losses Recognized as an adjustment to the opening balance of retained earnings as of the beginning of the fiscal year the requirement is applied, net of income taxes Recognized in earnings of the period incurred and not as adjustment to retained earnings Recognized as an adjustment to the opening balance of accumulated OCI as of the beginning of the fiscal year the requirement is applied, net of income taxes 7.6

53 Polling Question Does your company utilize a measurement date that is different than its fiscal year end date? Yes No Don t know Not applicable

54 Disclosures and Next Steps Disclose separately The amount of prior service cost and credit and net actuarial gain and loss recognized in OCI, and cumulatively in accumulated OCI Amounts subsequently reclassified into earnings The portion of prior service cost and credit and net actuarial gain and loss that will be reclassified into earnings in the upcoming fiscal year Disclosures Eliminated Reconciliation of the over-funded or under-funded status to amounts recognized in the financial statements Information regarding the additional minimum liability The measurement date used (if other than reporting date) Next Steps Comment period ends May 31, 2006 Public roundtable meeting on June 27,

55 Proposed FASB Staff Position No. FAS 142-d, Amortization and Impairment of Acquired Renewable Intangible Assets 8.1

56 Proposed FSP FAS 142-d Amends paragraphs 11(d) of FAS 142, Goodwill and Other Intangible Assets Renewals should be considered to the extent that they are reasonably assured Requires the fair value of a renewable intangible asset at acquisition to be attributed to: The initial contractual period of use Each future renewal period Amounts attributed to the above should be amortized over each respective period 8.2

57 Proposed FSP FAS 142-d Facts Intangible asset related to a 1 year contract with a 1 year renewal period that will require material modifications to its existing terms, but is reasonably assured Total fair value is based on the cash flows generated from both the original contractual period and the renewal period = $190 Discounted cash flows of initial contractual period = $100 Discounted cash flows of renewal period = $90 Before FSP FAS 142-d FV is based on cash flows of 2 years Intangible asset amortized over 1 year After FSP 142-d FV is based on cash flows of 2 years Intangible asset amortized over 2 years Year 1 amortization = $190 Year 2 amortization = $0 Year 1 amortization = $100 Year 2 amortization = $90 8.3

58 Proposed FSP FAS 142-d Renewable intangible assets will be tested for impairment using the methodology used to test indefinite-lived intangible assets Applied prospectively to newly acquired renewable intangible assets and preexisting renewable intangible assets that are renewed after June 15, 2006 Amendment to paragraph 11(d) of Statement 142 shall be applied to interim and annual periods beginning after June 15,

59 Other Topics Discussed by the FASB 9.1

60 Proposed FSP FAS 13-a Overview Requires that the expected timing of cash flows relating to income taxes generated by a leveraged lease should be reviewed annually or more frequently when circumstances indicate that a change in timing is probable of occurring. Recalculate leveraged lease rate of return and allocation of income to positive tax years Gains/losses are recognized in the period which the assumption changes 9.2

61 Proposed FSP FAS 13-a Recent Decisions Eliminated the requirement to reclassify the leveraged lease if the lease no longer qualifies as a result of the most recent recalculation Eliminated the requirement to include interest and penalties in the recalculation of a leveraged lease transaction Advance payments and deposits made to IRS should not be considered in the recalculation of a leveraged lease Effective date and transition modified to be consistent with final interpretation on uncertain tax positions 9.3

62 Fair Value Measurements Moved to a three-level hierarchy Level in the hierarchy is based on the lowest level input Added emphasis that a FV estimate must include all assumptions and only assumptions that a market participant would use to measure FV Reaffirmed that cost and/or effort of obtaining or deriving market inputs is not a sufficient basis for excluding or not obtaining such inputs 9.4

63 Fair Value Measurements Decision to remove the transaction price presumption Continuing analysis around appropriate disclosures Standard will not be re-exposed - final Statement expected by June 30, 2006 Effective date for fiscal years beginning after November 15,

64 Uncertain Tax Positions More-likely-than-not of being sustained under audit recognition threshold Measurement attribute for the amount of recognized tax benefit is the best estimate of the maximum amount that is more-likely-than-not to be realized 9.6

65 Uncertain Tax Positions Facts Tax position to reduce income taxes by $100 30% chance of realizing $100 benefit 51% chance of realizing at lease $90 benefit 75% chance of realizing at least $80 benefit Greatest amount that is at least more-likelythan not realizable 9.7

66 Uncertain Tax Positions Interest and Penalties Presentation of interest and penalties is an accounting policy choice Transition and Effective Date A change in net assets is considered a change in accounting principle and a cumulative effect adjustment to the opening balance of retained earnings Effective as of the beginning of the first annual period beginning after December 15,

67 Polling Question How many times did you hear the term fair value option during this webcast? 10 or less More than 20

68 Other Resources Jim Johnson Randall Sogoloff Contact Information Georganne Gage Walters Vince Smith

69 Other Resources Accounting Roundup Heads Up Subscription to DART Publications ntingroundup up Subscriptions to Deloitte Publications iptions

70 Questions