Board Meeting Handout Consolidation: Principal versus Agent Analysis January 29, 2014

Transcription

1 Board Meeting Handout Consolidation: Principal versus Agent Analysis January 29, 2014 PURPOSE OF THIS MEETING 1. At the January 29, 2014, Board meeting, the staff will ask the Board how to further integrate rights held by other parties, one of the principal versus agent factors included in the proposed FASB Accounting Standards Update, Consolidation (Topic 810): Principal versus Agent Analysis, within the existing guidance in Topic 810, Consolidation, for voting interest entities (VIE) and variable interest entities (VOE). Background 2. The guidance in the proposed Update includes the following three factors to evaluate whether a decision maker is using its authority as a principal or an agent: a. Rights held by other parties b. Fees paid to a decision maker c. Exposure to variability of returns from other interests. 3. At the December 11, 2013, Board meeting, the Board agreed that the principal versus agent factors should be further integrated within the existing guidance in Topic 810 rather than included as a separate principal versus agent analysis. 4. The staff believes that rights held by other parties should be the first principal versus agent factor that is considered by the Board for integration as a part of redeliberations because the VOE model provides the greatest weighting or emphasis to voting rights when determining if shareholders have a controlling financial interest in a legal entity. 5. For purposes of this analysis, rights held by other parties pertain to voting rights that include any of the following: a. Kick-out (removal) rights over the decision maker b. Liquidation rights over the legal entity The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

2 c. Participating rights over the activities that most significantly impact the entity s economic performance. All of the above items are exercisable without cause and without barriers (collectively referred to herein as substantive voting rights ). Substantive voting rights provide the ability to direct the activities that most significantly impact the economic performance of a legal entity. 6. The staff identified two areas of Topic 810 that are significantly impacted by the evaluation of substantive voting rights: a. Paragraph , which the staff has referred to herein as the VIE/VOE scope determination. b. Paragraph A, which the staff has referred to herein as the primary beneficiary (PB) determination. 7. At the January 8, 2014 Board meeting, the staff discussed how substantive voting rights impact those two areas within Topic 810. At this meeting, the Board directed the staff to perform additional analysis related to the alternatives considering substantive voting rights when evaluating the VIE/VOE scope determination. 8. Therefore, at the January 29, 2014, Board meeting, the staff will present the following questions to the Board: a. Question 1 How should substantive voting rights be evaluated in the VIE/VOE scope determination? b. Question 2 How should substantive voting rights be evaluated for the PB determination? 2

3 Alternatives for Board Consideration and Staff Recommendations Question 1 How Should Voting Rights Be Evaluated in the VIE/VOE Scope Determination? 9. Alternative A Substantive voting rights exercisable by non-decision-maker equity holders with equity at risk would be required to meet the power characteristic 1 in the VIE/VOE scope determination. The decision-maker equity holder, if one exists, would be allowed to participate in the substantive voting rights. Nonvoting share classes or whollyowned voting equity, when divisible, would not preclude a legal entity from meeting the power characteristic in the VIE/VOE scope determination. 10. Separately, as it relates to limited partnerships and similar entities only, an amendment to the power characteristic would be provided, which would retain concepts currently in Subtopic , Consolidation Control of Partnerships and Similar Entities (that is, the guidance originally issued as EITF Issue No. 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights ). Limited partnerships and similar legal entities would require (a) a single limited partner or (b) a vote of a simple majority of partners (or a lower threshold) to be able to exercise substantive voting rights. However, such rights would not determine a consolidation conclusion (as is the case in Subtopic ) but would determine VIE/VOE classification. In addition, a general partner may participate in the substantive voting right (if allowed in the legal entity), which is not currently permitted in Subtopic This specific amendment would accommodate the superseding of applicable guidance in Subtopic This specific amendment for limited partnerships and similar entities would be provided in all alternatives and is the only amendment recommended in Alternative C. 11. Alternative B The same as Alternative A, however, substantive voting rights would be evaluated on the basis of the effectiveness of those rights within the equity group at risk. 1 Paragraph (b)(1) includes a criterion that states that an entity would be considered a variable interest entity if the equity holders of a legal entity as a group lack the power through voting rights or similar rights to direct the activities of the entity that most significantly impact the entity s economic performance (referred to herein as the power characteristic ). 3

4 12. Alternative C Only amend the power characteristic for limited partnerships and similar entities to address the elimination of the guidance originally included in EITF Issue 04-5 by the proposed Update. 13. An amendment that would be provided to the power characteristic retains concepts originally included in EITF Issue Specifically, limited partnerships and similar legal entities would require (a) a single limited partner or (b) a vote of a simple majority of partners (or a lower threshold) to be able to exercise substantive voting rights. However, such rights would not determine a consolidation conclusion (as in Subtopic ), but would determine VIE/VOE classification. In addition, a general partner may participate in the substantive voting right (if allowed in the legal entity), which is not permitted currently in Subtopic This amendment would accommodate the superseding of applicable guidance originally included in EITF Issue 04-5 by the proposed Update. This amendment for limited partnerships and similar entities would be provided in all alternatives. 14. Alternative D The same as Alternative C, however, provide an additional condition to address disproportionality between substantive voting rights and economics (the disproportionality condition ) that would be the inverse of the current guidance in paragraph (c). The disproportionality condition would create a floor for determining the substance of an equity group at risk when substantive voting rights are disproportionate (while the guidance in paragraph (c) creates a ceiling ). 15. The staff recommends Alternative C. Question 1 for the Board Which alternative would the Board like to pursue when considering how to evaluate substantive voting rights within the VOE/VIE scope determination? Question 2 How Should Substantive Voting Rights Be Evaluated for the PB Determination? 16. Alternative A Substantive voting rights exercisable on a simple majority basis by the specified variable interest holder group, excluding the decision maker and the decision 4

5 maker s related parties, should be a determinative factor in the power criterion 2 that a decision maker in a VIE is not the PB. In addition, a unilateral right held by a variable interest holder also would be determinative. 17. Alternative B Consistent with the guidance in the proposed Update, the effectiveness of substantive voting rights would need to be evaluated. Unilateral substantive voting rights held by a single variable interest holder would be determinative that the decision maker in a VIE would not be the PB. However, substantive voting rights held by a broader variable interest group, excluding the decision maker and its related parties, would need to be evaluated on the basis of the facts and circumstances for its effectiveness. 18. Alternative C The threshold for evaluating substantive voting rights to overcome the power criterion in the PB determination should only be on a unilateral basis. 19. The staff is split in its recommendations; some staff members support Alternative A and some staff members support Alternative C. Question 2 for the Board Which alternative would the Board like to pursue when considering substantive voting rights within the PB determination? 2 The staff has referred to the guidance in paragraph A(a) as the power criterion herein. 5

6 Board Meeting Handout Accounting for Financial Instruments: Classification and Measurement January 29, 2014 Background 1. At its December 18, 2013 meeting, the Board tentatively decided no longer to pursue the solely payments of principal and interest model to assess the contractual cash flow characteristics of financial assets. Additionally, the Board decided to retain the embedded derivative bifurcation requirements for hybrid financial assets in current U.S. generally accepted accounting principles (GAAP). 2. In light of the tentative decision reached by the Board about the contractual cash flow characteristics assessment, the staff believes that it is appropriate for the Board to consider whether it would like to continue developing the business model assessment in the FASB s proposed Accounting Standards Update, Financial Instruments Overall (Subtopic ): Recognition and Measurement of Financial Assets and Financial Liabilities, as clarified by the Board at the joint FASB and IASB meeting on November 20, 2013, or whether it would like to pursue another alternative. Alternatives to assess the business model of financial assets 3. Following are four alternatives that the staff has developed for the Board s consideration: (a) Alternative A: Evaluate the business model of financial assets on the basis of the business activities that an entity employs in acquiring and managing those financial assets.

7 (b) (c) (d) Alternative B: Continue pursuing the business model assessment in the proposed Update, as clarified by the Boards at the November 20, 2013 joint Board meeting. This business model has a cash flow (value) realization focus. Alternative C: Develop a model similar to the current model for securities in Topic 320, Investments Debt and Equity Securities, that would apply to both loans (including trade receivables) and securities. Alternative D: Retain existing U.S. GAAP. Under this alternative, the staff would identify targeted improvements that can be made to the tainting guidance in Topic 320.

8 Summary of the Alternatives Classification Categories Alternative A Alternative B Alternative C 1 Alternative D Debt Instruments 2 Debt Instruments Debt Instruments Debt Securities 1) Amortized Cost 1) Amortized Cost 1) Held to Maturity (AC) 1) Held to Maturity (AC) 2) FV-OCI 2) FV-OCI 2) Available for Sale (FV-OCI) 2) Available for Sale (FV-OCI) 3) FV-NI. 3) FV-NI. 3) Trading (FV-NI). 3) Trading (FV-NI). Loans 1) Held for Investment (AC) 2) Held for Sale (LOCOM) Objective of AC/HTM Objective of FV- OCI/AFS Equity Investments 1) FV-NI. Originating or acquiring debt instruments through financing activities. Acquiring debt instruments to invest to earn investment income, to manage the interest rate risk, to match duration of debt instruments to that of the liabilities they are funding by regularly rebalancing the portfolio, or to manage liquidity needs. Equity Investments 1) FV-NI. Holding the debt instruments for collection of contractual cash flows. Holding the debt instruments for both collection of contractual cash flows and selling financial assets to realize changes in their fair value. Equity Investments 1) Trading (FV-NI). Positive intent and ability to hold the debt instruments for the foreseeable future or until maturity or payoff. Debt instruments not classified as either HTM or trading (residual category). Equity Securities 1) Trading (FV-NI). Debt Securities Positive intent and ability to hold the debt securities to maturity. Loans Intent and ability to hold the loan for the foreseeable future or until maturity or payoff. Debt Securities Debt securities not classified as either HTM or trading (residual category). Loans Not Applicable. Category not available to loans. 1 The definitions of the three categories in this alternative are preliminary. If the Board tentatively decides to pursue this model, the staff will perform further analysis and outreach to define the categories. In addition, some of the other issues in this alternative that the staff may bring back include consideration of sales out of each of the three categories and reclassifications. 2 For the purposes of this table, debt instruments include both loans and securities.

9 Objective of FV- NI/Trading Includes debt instruments that are held for trading purposes (also the residual category). Includes debt instruments that are held for trading purposes (also the residual category). Debt instruments that are acquired or originated for the purpose of selling them in the foreseeable future. Debt Securities Debt securities that are acquired or originated for the purpose of selling them in the near term. Tainting No tainting. No tainting of current portfolio. However, sales should be considered for future business model assessment. Reclassification No reclassification allowed. If instruments are subsequently identified for sale from the amortized cost category, they will be measured at amortized cost less impairment, where impairment is an amount equal to the entire difference between the asset s amortized cost basis and its fair value. Reclassification allowed upon change in business model, which will only occur when an entity has either stopped or started doing something on a level that is significant to its operations (generally upon acquisition or disposition of a business line). No tainting of current portfolio. However, sales should be considered for future classification assessment. No reclassification allowed. If instruments are subsequently identified for sale from the amortized cost category, they be will be measured at the lower of cost or fair value until they are sold. Loans (measured at the lower of cost or fair value) Does not have intent and ability to hold the loan for the foreseeable future or until payoff. The staff would look to make targeted improvements to the current tainting guidance. Retain current reclassification guidance that states reclassifications are expected to be rare. Question for the Board Which of the four alternatives does the Board prefer for assessing the business model of financial assets?

10 Board Meeting Handout FASB Agenda Prioritization January 29, 2014 PURPOSE OF THIS MEETING 1. The purpose of this meeting is to discuss the FASB s agenda prioritization, which may include a discussion about research on certain projects and the Board may vote to add or remove certain projects from the Board s or the EITF s agenda. 2. The organization of this memorandum, which is consistent with how the staff recommends organizing the Board meeting, is: a. Projects for the Board to vote whether to remove from the Board s or EITF s technical agenda b. Projects for the Chairman, in consultation with the other Board members, to consider adding to the research agenda c. Projects for the Board to vote whether to add to the Board s or EITF s technical agenda and scope considerations. Projects for the Board to vote whether to remove from the Board s or EITF s technical agenda 3. The table below is a summary of projects the staff recommends removing from the Board s or the EITF s agenda: Project Board s agenda Emissions Trading Earnings per Share Income Taxes (short-term convergence project; not The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

11 PIR findings) Project EITF s agenda Not-for-Profit Financial Reporting: Other Financial Communications Investment Property Entities and Investment Companies: Real Estate Property Investments Application of the AICPA Audit and Accounting Guide, Investment Companies, by Real Estate Investment Companies (EITF 09-D) Commodity Inventories of Brokers and Dealers (EITF 06-12) Interpretation of Constraining Conditions of a Transferee in a CBO Structure (EITF 03-15) Multiple Foreign Exchange Rates (EITF 10-B) Potential EITF Issue on Application of EITF When a Special-Purpose Entity Holds Equity Securities (EITF) Question 1 for the Board Does the Board agree with the staff recommendation to remove the projects in the list above from the Board s or EITF s technical agenda? Projects for the Chairman, in consultation with the other Board members, to consider adding to the research agenda 4. Under the FASB s Rules of Procedure, the Chairman has the authority to direct the staff to perform research on specific issues that are on the technical agenda or that may be added to the FASB s technical agenda. 5. The Chairman recently instructed the staff to summarize potential research projects and the staff s recommendation for each project. The Chairman would like input Page 2 of 5

12 from the other Board members on those projects at the public board meeting on January 29, Some of the items included below are on the Board s technical agenda, but are inactive. In those cases, the objective of the research is to identify potential options for moving forward. At the conclusion of the research for each project, the Board would be asked to vote on the next step (e.g., activate project potentially with a modified objective, remove project from technical agenda). 7. The Chairman is seeking feedback from the other Board members about whether or not to perform research on the following projects: Project Accounting for Employee Benefit Plans AFI Hedging AFI Liquidity and Interest Rate Disclosures Conceptual Framework Definition of a Nonpublic Entity Phase Two Financial Statement Presentation Liabilities & Equity: Short-term Improvements Simplifications Initiative Question 2 for the Board Do the Board members have any feedback for the Chairman about adding (or not adding) the projects listed above to the research agenda? Projects for the Board to vote whether to add to the Board s or EITF s technical agenda and scope considerations 8. The staff recently completed research on each of the projects included in the table below. The staff plans to ask the Board to vote whether or not to add each project to Page 3 of 5

13 the Board s or EITF s technical agenda. In addition, the staff plans to ask the Board to vote on the scope of each project added to the Board s or EITF s agenda. Project Accounting for Government Assistance Operating Segments Pensions and Other Postretirement Benefit Plans Troubled Debt Restructurings (TDRs) Questions 3 and 4 for the Board Would the Board like to add Accounting for Government Assistance to the Board s or the EITF s technical agenda? If yes, what is the scope of the project? Questions 5 and 6 for the Board Would the Board like to add Operating Segments to the Board s or the EITF s technical agenda? If yes, what is the scope of the project? Questions 7 and 8 for the Board Would the Board like to add Pensions and Other Postretirement Benefit Plans to the Board s or the EITF s technical agenda? If yes, what is the scope of the project? Page 4 of 5

14 Questions 9 and 10 for the Board Would the Board like to add Troubled Debt Restructurings (TDRs) to the Board s or the EITF s technical agenda? If yes, what is the scope of the project? Page 5 of 5