Emerging Issues Task Force Agenda Report October 6, 2010 Agenda Decisions

Transcription

1 1110REPORT Emerging Issues Task Force Agenda Report October 6, 2010 Agenda Decisions Decisions on Proposed Issues 1. Cash Flow Statement Presentation of Derivative Instruments with an Other-Than-Insignificant Financing Element Pages 1-5 Other Matters o Proposed Agenda for the 6 o Status of Open Issues and Agenda Committee Items 7-10 EITF Agenda Report Fourth Quarter 2010

2 1110REPORT Emerging Issues Task Force Agenda Committee Description of Potential New Issue Discussion Date: October 6, Cash Flow Statement Presentation of Derivative Instruments with an Other-Than- Insignificant Financing Element Background Topic 815, Derivatives and Hedging, states that an instrument accounted for as a derivative that at its inception includes off-market terms or requires an up-front cash payment or both, often contains a financing element (paragraph ). If an other-than-insignificant financing element is present at inception, then "the borrower shall report all cash inflows and outflows associated with that derivative instrument in a manner consistent with financing activities as described in [Topic 230, Statement of Cash Flows]" (paragraph ). Paragraphs through (formerly FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, paragraph 45A), state the following: An instrument accounted for as a derivative under this Subtopic that, at its inception, includes off-market terms, or requires an up-front cash payment, or both often contains a financing element. Identifying a financing element within a derivative instrument is a matter of judgment that depends on facts and circumstances If an other-than-insignificant financing element is present at inception other than a financing element inherently included in an at-the-market derivative instrument with no prepayments (that is, the forward points in an atthe-money forward contract) then the borrower shall report all cash inflows and outflows associated with that derivative instrument in a manner consistent with financing activities as described in paragraphs through Additionally, the Basis for Conclusions of FASB Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, paragraph A39 (which amended Statement 133 and added paragraph 45A), stated the following: A39. Two characteristics often are associated with a derivative that contains a financing element upfront cash payments and off-market terms (for example, terms, rates, or EITF Agenda Report (Decisions on Potential New Issues) Fourth Quarter 2010, p. 1

3 prices that are not consistent with the current market for that type of contract). The Board agreed that those characteristics indicate that the derivative contains a financing element at inception. However, the Board chose not to establish a specific criterion for when a derivative does or does not contain a financing element because of the unlimited ways to structure those arrangements. Rather, identification of a financing element should be based on the specific facts and circumstances. The Board decided that the presence of only an insignificant financing element at inception does not warrant modifying the entity's cash flow reporting. However, when an other-than-insignificant financing element is present at inception, the borrower in the arrangement should report all of the derivative's cash inflows and outflows as a financing activity in the statement of cash flows. The Board noted that while it may be conceptually preferable to report only those cash flows associated with the financing element as a financing activity in the statement of cash flows, identifying those cash flows would be difficult. Therefore, because of cost-benefit concerns, the Board decided to require in those circumstances that all cash inflows and outflows associated with derivatives that contain an other-than-insignificant financing element at inception be reported as cash flows from financing activities. As a result, the Board also amended FASB Statement No. 95, Statement of Cash Flows. The Board considered whether it should require entities to revise their statements of cash flows retroactively for this change in reporting but decided that retroactive application would be overly burdensome and would not be cost beneficial. [Emphasis added.] Following are two examples of how a derivative could be structured to include off-market terms and/or require up-front cash payments that represent a financing element. The 2 examples are based on market conditions in which a 2-year interest rate swap that has a 0 fair value, includes the following terms: a $10 million notional amount, quarterly net settlements based on a receivefixed leg that is based on an annual 6.65 percent rate, and a pay-variable leg that is based on 3- month US$ LIBOR. Altering the rate for one of the legs. The derivative could be structured to increase or decrease the rate applicable to one of the legs, such as by reducing the rate for the receive-fixed leg to 1.65 percent, thereby changing the fair value of the swap and requiring the receive-fixed, pay-variable party to receive an up-front payment for that fair value. (That party is the borrower of the "financing element" under this structure.) Having different rates apply to different periodic payments (unrelated to the forward interest rate curve). The derivative could be structured to decrease the rate applicable to the receive-fixed leg for the first 4 quarterly payments (such as from 6.65 EITF Agenda Report (Decisions on Potential New Issues) Fourth Quarter 2010, p. 2

4 percent to 2.65 percent) and then increase the rate applicable to the receive-fixed leg for the final 4 quarterly payments (such as from 6.65 percent to 10.7 percent). The terms would be adjusted to keep the initial fair value of the interest rate swap at zero; thus, there would be no up-front payment. (In this structure, the receive-fixed, pay-variable party would be receiving deliberately large payments in the first year and would be making large payments in the final year; thus, that party is the borrower of the "financing element" under this structure.) Under current guidance, all cash flows associated with these derivative transactions are reported as financing activities within the statement of cash flows. That is, the upfront cash payment received by the receive-fixed, pay-variable party (in the first example above) and the deliberately greater payments received during the first year by that party (in the second example above) should be reported as financing activities within the statement of cash flows. Additionally, commodities contracts present similar fact patterns, for example, an oil producer/manufacturer could receive an upfront payment from an entity in connection with a long-term contract for oil. If the contract is a derivative instrument, then all cash flows under this arrangement would also be classified as financing activities. Scope This issue applies to all entities that have entered into derivative instruments within the scope of Topic 815 that at inception include an other-than-insignificant financing element (specifically, if at inception there are off-market terms or a requirement for an up-front cash payment or both). Accounting Issue and Alternatives Whether all cash inflows and outflows in a derivative instrument that contains an otherthan-insignificant financing element should be reported as financing activities in the statement of cash flows or whether certain cash flows representing operating activities should be bifurcated and presented within operating activities if such amounts can be measured reliably. EITF Agenda Report (Decisions on Potential New Issues) Fourth Quarter 2010, p. 3

5 View A: The presentation requirements are appropriate and should be retained; no bifurcation should be allowed. All cash inflows and outflows that are related to a derivative instrument that contains an other-than-insignificant financing element should be presented as financing activities. Paragraph states explicitly that an other-than-insignificant financing element at inception (other than a financing element inherently included in an at-the-money (ATM) derivative with no prepayments) would require the borrower to report all cash flows associated with that derivative as financing cash flows. That guidance does not contemplate bifurcation of the cash flows under any circumstances and does not provide an exception for derivatives even if those derivatives clearly constitute part of a reporting entity's ongoing core operations. Supporters of this view express concern about the potential implications of allowing bifurcation in the presentation of the cash flow. If bifurcation is allowed in cash flow presentation, questions may arise regarding the presentation of the derivative instrument in the statement of comprehensive income and the statement of financial position (that is, bifurcating the presentation of the derivative on those statements). Supporters of View A cite a December 2003 SEC speech in which Gregory Faucette, SEC staff, indicated that it would be inappropriate to present gains and losses on a non-hedging derivative under multiple captions in the income statement. For example, it would be inappropriate for an entity to classify separately the unrealized gains and losses on an economic derivative in the caption "risk management activities," while classifying realized gains and losses on the same derivative (for example, periodic or final cash settlements) in a separate revenue or expense line item that may be associated with the underlying in the economic hedge. Mr. Faucette's discussion echoed prior SEC staff comments made at the September 2003 AICPA SEC Regulations Committee. View B: The presentation requirements should be amended to allow bifurcation of the derivative instrument. If an entity can measure reliably the cash flows associated with the financing activities apart from the cash flows from operating activities, then the cash flows should be allowed to be bifurcated and presented as financing/operating as appropriate. EITF Agenda Report (Decisions on Potential New Issues) Fourth Quarter 2010, p. 4

6 The requirements in Topic 815 should be amended to acknowledge significant improvements in the measurement and valuation of complex derivative instruments. Supporters of this view recognize the statements made by the Board in paragraph A39 of the Basis for Conclusions of Statement 149 (presented above), that the conceptually preferable approach would be to present only those cash flows associated with the financing element as a financing activity in the statement of cash flows. However, at that time the Board acknowledged that the identification of such cash flows may be difficult and because of cost-benefit concerns decided to require presentation as financing cash flows for all cash flows. Additionally, proponents of View B note that the option to bifurcate was never exposed for comment to determine the feasibility of the bifurcation approach. Proponents of View B believe that while paragraph does not provide an exception for certain types of derivative instruments, the substance of the transaction should weigh heavily on the cash flow presentation. In the extreme, a company's entire cost of sales could wind up in financing activities if a substance consideration is not available in those scenarios. Proponents of View B also believe that paragraph is, in part, premised on the fact that the financing element is not reliably distinguishable from the operating or investing element and the requirement for the borrower to reflect all cash flows as financing reflects an anti-abuse objective. View B supporters believe (a) that the financing element is reliably distinguishable in that the isolation of that element involves measurement inputs and techniques used for other measurements and disclosures in the financial statements and (b) that the anti-abuse objective results in misleading financial reporting because payments that are clearly related to operations are classified in financing. Finally, while acknowledging the SEC staff speech noted above, supporters of View B state that the SEC staff remarks were specific to the income statement and should not be indicative of the SEC staff's views on presentation in the statement of cash flows. Agenda Decision: This issue was not added to the EITF agenda at this time. EITF Agenda Report (Decisions on Potential New Issues) Fourth Quarter 2010, p. 5

7 FASB EMERGING ISSUES TASK FORCE Proposed 2010 Agenda Issue Proposed Staff Number Issue Time Assigned Administrative Matters 8:30-8:45 Brower 10-D Fees Paid to the Federal Government by Pharmaceutical Manufacturers 8:45-9:30 Worshek/ Bauer 09-H Health Care Entities: Revenue Recognition 9:30-10:15 Hildebrand/ Cadambi * * * BREAK * * * 10:15-10:30 10-G Disclosure of Supplementary Pro Forma Information for Business Combinations 10:30-11:15 Breen/ Catalano 10-A How the Carrying Amount of a Reporting Unit Should Be Calculated When Performing Step 1 of the Goodwill Impairment Test 11:15-12:00 Worshek/ Couch * * * LUNCH * * * 12:00-1:00 10-E Accounting for Deconsolidation of a Subsidiary That Is In-Substance Real Estate 1:00-2:00 Cadambi/ Farber 10-F Accounting for Legal Costs Associated with Medical Malpractice and Similar Claims 2:00-3:00 Hildebrand/ Gonzales Proposed Agenda p. 6

8 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 2010 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 EITF Liaison FASB Staff Immediate Plans Due Date - Deliverable 09-H Health Care Entities: Revenue Recognition 10-A How the Carrying Amount of a Reporting Unit Should Be Calculated When Performing Step 1 of the Goodwill Impairment Test 10-D Fees Paid to the Federal Government by Pharmaceutical Manufacturers 10/09 3/10, 7/10, 9/10 11/10 Hanson Hildebrand/ Cadambi 2/10 7/10, 9/10 11/10 Hauser Worshek/ Couch 6/10 7/10 11/10 Bielstein Worshek/ Bauer Supplement following exposure of a proposed Update Supplement following exposure of a proposed Update Supplement following exposure of a proposed Update Proposed Update comment deadline November 5, 2010; Proposed Update comment deadline November 5, 2010; Proposed Update comment deadline October 8, 2010; Status of Open Issues and Agenda Committee Items p. 7

9 Issue No. Description Date Added Date(s) Discussed EITF Liaison FASB Staff Immediate Plans Due Date - Deliverable 10-E Accounting for Deconsolidation of a Subsidiary That Is In- Substance Real Estate 6/10 9/10 11/10 Hauser Cadambi/ Farber Supplement 10-F Accounting for Legal Costs Associated with Medical Malpractice and Similar Claims 10-G Disclosure of Supplementary Pro Forma Information for Business Combinations 7/10 7/10 11/10 Hanson Hildebrand/ Gonzales 8/10 9/10 11/10 H. Schroeder Breen/ Catalano Supplement following exposure of a proposed Update Supplement following exposure of a proposed Update Proposed Update comment deadline October 8, 2010; Proposed Update comment deadline November 5, 2010; Status of Open Issues and Agenda Committee Items p. 8

10 Issue No. Description Other EITF Issues including Inactive Issues Pending Developments in Board Projects Date Added Date(s) Discussed FASB Staff Immediate Plans Due Date - Deliverable Interpretation of Constraining Conditions of a Transferee in a Collateralized Bond Obligation Structure 11/02 N/A Not scheduled TBD 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 to determine whether to begin discussions on this Issue or to request that the Issue be removed from the agenda. Future Agenda Committee or EITF 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 TBD Pending the outcome of the Board's project to amend ARB No. 43, Restatement and Revision of Accounting Research Bulletins. Future EITF 09-D Application of the AICPA Audit and Accounting Guide, Investment Companies, by Real Estate Investment Companies 2/09 N/A N/A Yang/ TBD Pending the outcome of the Board's projects on consolidation and investment properties. Future EITF 10-B Accounting for Multiple Foreign Exchange Rates 3/10 7/10, 9/10 N/A Farber/ Brower No immediate plans to address this Issue. N/A Status of Open Issues and Agenda Committee Items p. 9

11 Issue No. Description Issues Pending Furthe Consideration by the Agenda Committee Date Added Date(s) Discussed FASB Staff Immediate Plans Due Date - Deliverable N/A 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 9/00 N/A Not scheduled TBD Statement 155 did not address this Issue. Therefore, the FASB staff will bring this Issue to the Agenda Committee at a future to determine whether to begin discussions on this Issue. Future Agenda Committee Status of Open Issues and Agenda Committee Items p. 10