MINUTES OF THE JULY 19, 2016 PRIVATE COMPANY COUNCIL MEETING

Transcription

1 MINUTES OF THE JULY 19, 2016 PRIVATE COMPANY COUNCIL MEETING Location: FASB Offices 401 Merritt 7 Norwalk, Connecticut Tuesday, July 19, 2016 Starting Time: Concluding Time: 8:30 a.m. 12:30 p.m. PCC Members Present: Candace Wright, Chair George Beckwith Steve Brown Jeffery Bryan Timothy Curt Thomas Groskopf David Lomax Harold Monk Carleton Olmanson Larry Weinstock FASB Board Members Present: Russ Golden (Chairman) Christine Botosan Daryl Buck Jim Kroeker Hal Schroeder Marc Siegel Larry Smith FASB Board Members Absent: None FASB Staff Present: Susan Cosper *Rosemarie Sangiuolo *Halie Creps Jeffrey Mechanick *Maria Khrakovsky *Nick Cappiello Michael Cheng *Melissa Rutzen *Peter Proestakes Benjamin Dart *Lauren Mottley *Ryan Egan Brian McKeown *Dianora DeMarco *Alicia Posta *Mary Mazzella *Liz Gagnon *Matthew Esposito *For certain issues only. FAF Trustees Present (in the audience): Diane Rubin, Terry Warfield, Charles Noski, Daniel Ebersole, John Dugan, Eugene Flood, and Nancy Kopp July 19, 2016 PCC Meeting Minutes, p. 1

2 INTRODUCTORY REMARKS Private Company Council (PCC) Chair, Candy Wright, opened the meeting referencing the PCC s discussion of Disclosure Framework Inventory, which took place at the PCC s closed meeting the previous afternoon, and noted that the topic will be discussed further at a future meeting. The Chair also welcomed the FAF Trustees in attendance, and thanked them for coming. The Chair discussed the Town Hall Meeting at Baruch College, which was held in June, stating that although it provided a good discussion, the PCC is still looking for more feedback regarding emerging issues, which they hope to get from the next Town Hall Meeting to be held July 22 nd at the AICPA s National Advanced Accounting and Auditing Technical Symposium (NAAATS) in Salt Lake City. The Chair solicited feedback from other PCC and Board members about how they viewed the town hall meetings and commented that the town halls are an important way to ensure that the PCC is made aware of any emerging issues. Daryl Buck, FASB Board member, agreed with Ms. Wright and added that town halls provide an opportunity for the Board and PCC members to share how their thought process helps them make decisions. Daryl also stated that one explanation could be that there aren t many pressing problems. LIABILITIES AND EQUITY The staff discussed the status of this FASB project. The staff provided the PCC with an overview of the tentative decisions reached in accounting for financial instruments with down round features (strike price adjusts down based on the pricing of future equity offerings). The staff highlighted that a down round feature would not affect the classification of the related instrument as a liability or equity and that the effect of the down round feature would be recognized only when the feature is triggered. The staff briefed the PCC on areas of complexity related to that potential accounting model that were identified by external reviewers of the Proposed FASB Accounting Standards Update. Three areas of complexity, which relate to (1) the measurement of the effect of the down round feature upon that feature being triggered, (2) the interaction of the potential model for financial instruments with down round features with existing separation models for convertible instruments, and (3) the approach for classification and recognition of the effect of the down round feature once triggered, and the related consequences of each were explained. On the third area of complexity, the staff explained that under the Board s tentative decisions, an expense would be recognized for a liability-classified financial instrument with a down round feature, and an offset recorded to the basis of the related liability-classified financial instrument, with that basis adjustment amortized over time. One PCC member asked about the Board s basis for the reversal over time of the basis adjustment. The staff replied that the accounting for registration payment arrangements was considered and analogized to while developing this model. In accounting for registration payment arrangements, the issuer of the instrument with the related registration payment arrangement would recognize an obligation (if required) under the FAS 5 model regardless of whether the penalty would be paid in cash or shares. The scenarios in the current project can be looked at similarly because there is an additional obligation that could be resolved with shares. Therefore, any time that a liability has a basis adjustment, that basis adjustment would be amortized over time. The staff also explained that while not the approach used in this model, it is a long-standing practice to recognize a transfer of value to investors July 19, 2016 PCC Meeting Minutes, p. 2

3 related to convertible instruments as a credit to APIC, similar to the substance of writing a call option on the shares that will be physically settled. Several Board members clarified that because consideration has been given, the tendency is to conclude that it should go to expense; however, a credit to the liability will eventually result in an unwinding of an expense. It was noted that this is not an equity component so a credit to APIC does not seem intuitive either. The staff further clarified that if a potential benefit is given to a shareholder, then it is an expense, but if the down round feature is not triggered, then it becomes a benefit for the company over time. Therefore, the issuer would amortize that initial expense over time through earnings. One PCC member asked the staff to explain the calculation of the effect of the down round feature being triggered. The staff gave an example to clarify that if you were to create two hypothetical instruments with strike prices corresponding to the time before and the time after the down round feature is triggered, that this could be used as a proxy for the fair value of the down round feature itself. A Board member clarified that the example is hypothetical because it does not have a down round feature while the actual instrument does. This scenario is like a fair value of a stock option repricing in which you calculate a before and after value, so there is precedent for using a proxy, but it is hypothetical because the actual instrument has the down round feature while the proxy instruments do not. This is supposed to be an easy way to figure out what the benefit is to the holder of the down round feature. One PCC member asked if the alternative measurement is used, where it would be included in the fair value hierarchy. The Board members said that they would need to consider that and answer the question in the standard. The staff asked the PCC members if they had any thoughts or concerns on the proposed amendments. One PCC member commented that in their personal experience, the current accounting for down rounds is not intuitive because the down round feature must be initially measured at fair value and then reversed over time in many cases if the warrant expires, which confuses users. Such accounting for a down round feature is not intuitive especially since, in all likelihood, it will never be triggered. Another PCC member expressed disappointment with the end result of the project, because he thought the goal of the project was to end up with accounting that is simpler than current GAAP. The PCC member acknowledged that down round features are more common in a private company setting and that as it pertains to equity-classified instruments, neither current GAAP nor the Board s proposal results in intuitive accounting. The PCC member commented on the navigation of the guidance and the changes to the navigation when introducing the new model for down rounds. Private company accounting is supposed to be simpler, but going through all of the accounting models (for example, derivatives, beneficial conversion features, and so forth) just to see whether the proposed simplification is going to provide a benefit does not seem worth July 19, 2016 PCC Meeting Minutes, p. 3

4 the effort. If this is the best answer, then perhaps this question should be deferred and addressed as part of a broader project. The intuitive answer is that if the instrument that is issued is only settled in the company s equity and the only real effect is dilution, then instead of doing a recognition and measurement project, the issuer should just disclose the existence and terms of the down round feature and when it has been triggered. A Board member acknowledged the difficulty in deciding whether they should do a narrow fix or wait for a broad reconsideration of the guidance to address the problems as part of a larger liabilities and equity research project (to be including in the Board s forthcoming Invitation to Comment) that could take much longer. A PCC member responded that because of the difficulties in current practice and knowing that a broader project could take much longer, a narrow-scoped project makes sense. A Board member agreed that the guidance is difficult to understand and should be addressed; however, he also said that there are two different approaches to distinguishing liabilities from equity that need to be considered. One approach would stipulate that the form of settlement is the most important issue, while another approach would stipulate that unless it is pure equity, it needs to be classified as a liability and so the debate is only about measurement. The accounting for down rounds needs to be simplified while also including a way to capture that one class of shareholders receives a benefit (through the down round feature) that other shareholders may not be getting. If you exercise that benefit, how would other shareholders know that they have been diluted when a private company does not compute EPS? A PCC member remarked that the flowchart would be helpful in navigating the guidance and would be beneficial for practitioners. Another PCC member commented that adding the flowchart is better than waiting three to four years for a broader project but believes that there still could be a private company alternative that would override existing guidance. A Board member asked the PCC member to clarify what the potential alternative would be. The PCC member responded that for equity instruments that are settled in shares, there would be no recognition and measurement for the down round feature, only disclosure of the feature and the triggering event. A Board member asked the PCC member to clarify that if the instrument is in the money at inception, whether there should be recognition of that value instead of just disclosing it. The Board member wanted to clarify whether there should be a difference in accounting between items that are in or out of the money at inception. The PCC member responded that you should follow current accounting for those items that are in the money at inception. A Board member asked why there should be a difference between the accounting for items that are in the money and for those that are out of the money if all the PCC member wants is simplification of the accounting and adequate disclosure around the transaction. The PCC member responded that accounting for down round features does not result in a meaningful number on the financial statements, and the true meaningful number is how much of the company a shareholder would own after the dilution. Therefore, going through complicated models to get to a meaningless number is not worth the effort. The Board member countered saying that some users have said that any time there is a distribution, regardless of the form of settlement, that is disproportionate to the equity holders, it should flow through the income statement. July 19, 2016 PCC Meeting Minutes, p. 4

5 A PCC member responded that not only do few private company stakeholders agree with that view, the Private Company Decision Making Framework would say that items that relate to cash when settled tend to be more relevant from a private company perspective. Intrinsic value or fair value is less relevant for private companies, which is one of the differentiating factors used to decide when a private company should get an alternative. The staff pointed out that the situation can still exist for smaller public companies, so if the FASB addresses down rounds for only private companies, then the next question will likely be from public companies asking why the alternative does not apply to them. A Board member stated that if most down round features are never triggered, then it could be beneficial to have no accounting until the trigger occurs. The Board member asked whether any consideration had ever been given to simply amending the guidance to say that there would be no accounting until the time when the feature is triggered and from that point to keeping the current accounting. A staff member commented that if that route was taken, the only true difference would be for warrants because the Beneficial Conversion Feature model would still be retained for convertible instruments. The Board member commented that no new complexity should be added; amendments only should be made that try to simplify, if possible. Another Board member commented that an issue with that approach is that if you had, for example, an instrument that is not a convertible instrument and is just a forward option with a down round, and if you ignore the down round feature entirely at inception, then applying today s accounting subsequent to the feature being triggered would result in it moving from equity to a liability that has to be marked to market thereafter even though it is no more likely to be triggered again than it was the first time. A Board member asked if you had a down round that was settled in cash, which would make it a liability, would you follow current GAAP or find another alternative? A PCC member responded that if you are trying to do a narrow simplification and not revisit the entire area of guidance, then you should leave current GAAP in place for instruments classified as liabilities with a down round feature. A PCC member asked whether an analysis was done to consider the increased complexity that would be created by having more convertible instruments within the scope of the new model. The staff responded by saying that the FASB included that question as part of the outreach process, but stakeholders indicated that there was no way to quantify the volume of instruments that would be captured under this model. A PCC member asked if the basis for conclusions, which states that warrants with down round features are rare, had been reconsidered based on the outreach performed. The staff responded that the outreach focused on public companies, and the stakeholders in that space indicated that these types of instruments are rare. The more common instrument is convertible debt with a cash conversion feature that is specifically structured to not trigger down round accounting. Staff also commented that the goal of the project is to build a model that can adapt and contemplate future changes to existing instruments. July 19, 2016 PCC Meeting Minutes, p. 5

6 A Board member further clarified that it is much easier to get information on how many of these features are being used for public companies as opposed to private companies. The Board member also stated that instruments are often negotiated and structured in such a way that it is difficult to determine what is prevalent in the market today. The Board member also stated that liabilities and equity will be discussed in the Invitation to Comment and posed the question of whether the Board should deal with this holistically or on a piecemeal basis. The Board member agreed that the guidance is too complex and needs to be reexamined. A PCC member asked, if the alternative that the PCC is proposing makes sense for public and private companies, then why not make it available to both public and private companies since improving GAAP is the end goal of the Simplification Initiative. A staff member said that understanding user relevance from a recognition perspective, as well as whether any alternative would fit into the PCDMF, would be critical to that thought process. Another staff member asked why an exception would be created only for equity instruments with a down round feature and not for other instruments with contingent BCF features. PCC members stated that they were not sure, but that from a private company perspective, disclosure would be more relevant to users. A Board member confirmed that he would also struggle to provide a basis for improving this for one type of instrument or feature and not for another. The PCC member responded that a private company alternative would make sense as a narrow improvements for private companies with the broader concerns being addressed in a larger liabilities and equity project. A Board member clarified that the PCC s suggested alternative for equity instruments with down round features would be disclosure for instruments issued at the money and out of the money, whereas in the money instruments would require accounting and disclosure. The Board member stated that this approach would simplify the accounting for private companies, which would be the basis for the change, but suggested that this alternative would require more research first. However, the Board member and a PCC member raised concerns about the interaction between the alternative and employee stock based compensation accounting. The PCC discussed the alternative and made the subsequent recommendation: PCC members voted 7-3 in favor of recommending that the FASB consider a disclosure-only private company alternative for equity form instruments with down round features. BALANCE SHEET CLASSIFICATION OF DEBT The staff presented a summary of tentative Board decisions and prior PCC feedback on the FASB s simplification project. The staff noted that the Board had completed its initial deliberations and that there have been no changes to the project since the staff s last discussion with the PCC in September As such, the staff indicated that the primary purpose of the discussion was to provide new PCC members with an overview of the project. One PCC member expressed concern with the probability assessment required under current GAAP as it relates to the classification of debt with a waiver of a covenant violation. The PCC member explained that current GAAP includes an example that illustrates current classification of debt because of a probability assessment, even though a waiver was granted for a period greater than 12 months. In this case, the PCC member thought the legal term of the waiver July 19, 2016 PCC Meeting Minutes, p. 6

7 should prevail over the probability assessment for that specific violation, but not for future violations or violations of other covenants, which then should result in noncurrent classification of the debt. The PCC member believes that in this scenario, it should not be necessary to perform the probability assessment for that specific non-compliance. The PCC member stated that presenting the debt as current would be misleading to other lenders who are not privy to that arrangement and seems to be contrary to the borrower s contractual right. The staff noted that this aspect of the Board s tentative decisions in the current debt classification project is the retention of current GAAP and that the PCC member s concern had not been raised by other stakeholders during initial deliberations. Other PCC and Board members questioned whether the probability assessment was being required because the waiver does not cover other future covenant violations, which are separate from the covenant that was violated. A Board member clarified that the waiver is only against the lender calling the debt in the next 12 months over that specific violation. If the lender has the ability to call the debt due to a future violation, then the probability assessment needs to be performed to assess the likelihood of other future violations. Another Board member said that it makes sense to classify the debt as noncurrent if the lender waived their right to call the debt, regardless of other violations committed in the next 12 months; however, if the lender only waived their right to call the debt with respect to only one covenant and not future covenants, then the probability assessment must still be performed. One PCC member asked how common waivers for a period of 12 months (or greater) are in practice, and another PCC member, who is a lender, remarked that they are uncommon based on his experience. A PCC member asked the Board members to examine how the IASB has addressed refinancing arrangements and the borrower s contractual right, to see if convergence makes sense. He also asked if the term debt waiver was going to be defined and if guidance would be provided for the 10% test. The staff clarified that debt waiver would not be defined and that the only reference to the 10% test is back to existing GAAP on debt modifications. On convergence with the IASB, the staff explained that the IASB project will not be redeliberated by the IASB until after the completion of its conceptual framework project. A Board member commented that if there is an inconsistency between the accounting standard and an example, then that should be rectified. He also commented that regarding debt waivers, the Board already provided an exception that is not consistent with aspects of subsequent events guidance, and therefore not in compliance with the principle that the FASB is trying to put in place. The Board member commented that this point is an exception to the principle, and can be modified to whatever the Board decides, so the Board could extend the notion of contractual rights beyond the measurement date; however, an acknowledgment must be made that it is not within the principle the Board is trying to establish. One PCC member asked whether showing the debt as noncurrent was relevant for users when considering the refinance. Another PCC member responded that if users are working closely with the company and view it as noncurrent, then that classification would be relevant for them, and July 19, 2016 PCC Meeting Minutes, p. 7

8 they want to communicate to other financial statement users that they view that loan as noncurrent. A Board member clarified that if the FASB explores the option of keeping current GAAP the same for refinances, then there doesn t need to be a project at all because it is not a big enough change to GAAP to warrant a project. In response to some PCC members suggestion for creating a private company alternative for refinances, the staff commented that in the context of the PCDMF, it is rare that there should ever be a presentation difference between public and private companies. A PCC member said that he believes that current GAAP for refinances between the balance sheet date and the issuance date of the financial statements should be kept, but if the Board chooses to change current GAAP, then he does not want a private company alternative. Board members also clarified that if a reconsideration of refinancing arrangements was going to be made, then subsequent events guidance needs to be revisited as a whole (for example, to consider the impact of prepayments of debt after the balance sheet date but prior to financial statement issuance). The PCC discussed the project and made the following recommendation: PCC members voted 9-1 in favor of recommending that the FASB retain the current accounting on how refinances affect debt classification. DISCLOSURES BY BUSINESS ENTITIES ABOUT GOVERNMENT ASSISTANCE The staff provided background on the project and tentative decisions reached by the Board since the April 2016 PCC meeting. PCC members expressed support for the decisions made at the June 8, 2016 Board meeting. A PCC member asked whether the Board thought that more issues regarding the scope of Topic 740 would arise as a result of this proposed Update because income tax is not explicitly defined in current guidance. A Board member responded that preparers have to make a determination about what is included within the scope of Topic 740 today, and would continue to do so in the same manner if this proposed update were to go final. The Board member acknowledged that while this project may put more pressure on what is defined as an income tax, this project does not change anything about what is included within the scope of Topic 740. The PCC Chair said that she appreciated that the Board and staff incorporated PCC feedback; specifically, no longer requiring entities to disclose government assistance received but not directly recognized in the financial statements. FINANCIAL PERFORMANCE REPORTING The staff provided general background information on the project, including why the project was added to the agenda, the reasoning behind the scope of the project, and the information to be included in the upcoming Invitation to Comment. July 19, 2016 PCC Meeting Minutes, p. 8

9 A PCC member said that focusing on defining operating, nonoperating, and infrequently/frequently occurring may not achieve the objective of the project. Past attempts were unsuccessful at trying to describe or define those terms. Instead of disaggregating accounts, since companies are run by departments, disaggregation by department would be more useful. To increase comparability between the financial statements, the income statement should be categorized into three distinct categories. The first category would be current earnings, which is similar to how companies often create the non-gaap metric EBITDA, the second category would represent long-term earnings related more to capital-type expenses such as depreciation, amortization, and interest, and the third category would include earnings due to external factors such as changes in fair value. However, fair value gains and losses would be reclassified into the first or second category when the asset or liability is realized or settled. A Board member asked whether the PCC member was describing departments as a proxy for segments. The PCC member responded that he did not mean segments, and that knowing how money is spent across departments is more relevant for seeing how a business is managed. Another Board member asked the PCC whether performance reporting is a top priority for private companies. One PCC member stated that performance reporting is not a priority because users of private company financial statements have greater access to company management. Conversely, a different PCC member commented that the discourse about the usefulness of financial statements and accounting information indicates that improvements should be made to performance reporting, so it is a higher priority in his view. A PCC member asked whether the staff thought about providing a best practices guide based on industries that could show what good presentation and disclosure is supposed to look like. A Board member responded that the role of the FASB is to set standards. It is not the role of the FASB to issue best practice guides. There are other organizations that already do that. A Board member asked how the three-category approach proposed by a PCC member would apply to a financial institution. The PCC member replied that the approach would work if the categories were based on principles and did not specifically define what went into each category. However, the PCC member agreed that financial institutions were different from other companies and that his approach would need to be flexible to apply to general purpose financial statements. A Board member commented that there may be an economic basis for the approach proposed by the PCC member. The current earnings category as proposed by the PCC member could be likened to the economic concept of earnings derived from in-use assets, whereas the earnings from the external factors category could be likened to gains and losses from in-exchange assets. The second category, the one that included interest and depreciation, could be likened to the performance category related to the capital structure. The economic basis for such an approach is not exact, but is fairly similar. Another Board member asked whether, under the three-category approach, depreciation could be capitalized or allocated to cost of goods sold or whether it would always be separated into the second category. The PCC member said that depreciation would be separated. Another PCC July 19, 2016 PCC Meeting Minutes, p. 9

10 member said that if this approach was truly principles-based, then a reporting entity could structure manufacturing depreciation into current earnings and non-manufacturing depreciation into long term earnings. A PCC member advised the Board to be careful about creating a single set of requirements for the income statement because on an industry-by-industry basis, what is important for one industry may not be important for another industry. The staff responded that categorizing the income statement is problematic for that reason. However, if the Board were to focus on disaggregation, then that may be less problematic. A Board member confirmed that disaggregation could result in more useful information, because additional performance information is often needed in cases in which users do not have the same level of access to management that private company users may have. A PCC member said that some alternative GAAP measures are being widely used and some users find those measures to be relevant. While not all companies want to present non-gaap measures, the Board could consider incorporating those measures into GAAP. A Board member responded that it would be difficult for the Board to develop non-standardized entity-specific metrics and make them standardized. A PCC member said that EBITDA is widely used and would be easy to define. Conversely, another PCC member responded that EBITDA would be difficult to define because companies are already defining it in different ways and commonly report adjusted-ebitda metrics. A Board member responded that even if the FASB standardizes a metric, companies will create new non-gaap performance metrics. Another Board member added that non-gaap metrics are popular because there are audited GAAP statements behind the numbers. Said differently, audited financial statements are the foundation from which entities report their adjusted performance measures. However, this does not mean that the FASB should seek to standardize those metrics. OPEN PCC DISCUSSION A PCC member said the technical amendments in ASU No : Technical Corrections and Improvements, altered the definition of readily determinable fair value to include other types of entities beyond mutual funds. This has created inconsistencies between the stable value fund example in ASU No : Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), Health and Welfare Benefit Plans (Topic 965): (Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, (Part III) Measurement Date Practical Expedient, and the definition in Update While it is only disclosure, there are troubles in practice about what qualifies for the practical expedient and what to do if the item in question does not qualify for the expedient. Another PCC member discussed the need to eliminate (for private companies) the fair value disclosures for held-to-maturity debt securities (originally in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities), similar to the elimination of that requirement for other financial instruments (originally in FASB Statement No Disclosures about Fair Value of Financial Instruments) in ASU No : Financial July 19, 2016 PCC Meeting Minutes, p. 10

11 Instruments Overall (Subtopic ), Recognition and Measurement of Financial Assets and Financial Liabilities. CLOSING REMARKS The PCC Chair thanked everyone for their attentive participation and mentioned that the next meeting would be in September, with discussions regarding the PCC s technical agenda happening before then. The PCC Chair indicated that there were no further topics on the formal agenda for the meeting and adjourned the meeting. July 19, 2016 PCC Meeting Minutes, p. 11