Quarterly Accounting Update: On the Horizon

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1 Quarterly Accounting Update: On the Horizon The following selected FASB exposure drafts and projects are outstanding as of June 30, FASB Simplification Initiative The FASB s Simplification Initiative is a tightly-focused initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. The projects included in the initiative are intended to improve or maintain the usefulness of the information reported to investors while reducing cost and complexity in financial reporting. In addition to the Simplification Initiative, the FASB recently completed several projects, and currently is working on several projects, that are intended to reduce cost and complexity in financial reporting. The FASB launched the initiative earlier this year to reduce the cost and complexity of financial reporting by making targeted changes to U.S. GAAP while maintaining or improving the usefulness of information for investors. Simplifying the Measurement of Inventory The proposed ASU would require inventory to be measured at the lower of cost and net realizable value. As such, it would eliminate existing requirements to consider the replacement cost of inventory and the net realizable value of inventory less an approximately normal profit margin. However, the proposal does include a scope exception for inventories measured using the last-in, first-out (LIFO) method and the retail inventory method (RIM). Entities that use the LIFO method and RIM would continue to apply their current impairment models. Accounting for Income Taxes The FASB issued two proposed ASUs, which are expected to simplify accounting for income taxes by: Eliminating the requirement for organizations that present a classified statement of financial position to classify deferred tax assets and liabilities as current and noncurrent, and instead require that they classify all deferred tax assets and liabilities as noncurrent. Eliminating the prohibition on the recognition of income taxes for transfers of assets from one jurisdiction to another. Employee Share-Based Payments The proposed ASU would allow an employer to repurchase more of an employee s shares than it can today for tax withholding purposes without triggering liability accounting and would require that any cash paid for these repurchases be classified as a financing activity on the statement of cash flows. The proposal also would provide a policy election to account for forfeitures as they occur. Further, it would require all income tax effects when awards vest or are settled to be recognized in income rather than through additional paid-in capital (APIC) in certain cases. That is, APIC pools would be eliminated. In addition, it would require awards with put features that are contingent on an event within an

2 employee s control to be classified as equity until it is probable that the event will occur. It also would give private companies the option to use two practical expedients for estimating an award s expected term and measuring liability classified awards. Equity Method Accounting The proposed ASU would simplify the equity method of accounting by eliminating the requirement that an investor identify, account for and make disclosures about the difference between the cost basis of an investment and its proportional interest in the equity of the investee (i.e., a basis difference). As a result, investors would no longer have to estimate the fair value of an investee s assets and liabilities to allocate basis differences and track adjustments related to basis differences. The FASB also proposed eliminating the requirement to account for an equity method investment retrospectively when an investor increases its ownership interest in a non-consolidated subsidiary to a level that qualifies for the equity method. Financial Instruments The FASB continues to work on its financial instruments project. This project took on heightened significance in the wake of the 2008 financial crisis and once was considered an essential international accounting convergence project. Negotiations with the IASB to write global accounting guidelines have since fallen apart, and the amendments the FASB plans to publish in 2015 are expected to change U.S. GAAP and not match the IASB s revisions to its standards. The project has three primary areas that are being individually addressed, (1) classification and measurement, (2), impairment and (3) hedging. Classification and Measurement The FASB tentatively decided to retain the separate models in current U.S. GAAP for classifying and measuring loans and debt securities rather than overhaul its guidance in this area, as it had proposed in In a change from today s accounting, however, equity securities would be measured at fair value with changes in fair value recognized in net income. Impairment The new guidance is expected to (1) eliminate the concept of time until recovery in today s otherthan-temporary impairment (OTTI) model for available-for-sale (AFS) debt securities, (3) require an impairment allowance for AFS debt securities instead of direct write-downs and (4) change how credit losses are estimated for all loans and receivables, including trade receivables. The FASB also recently revisited an earlier credit impairment decision by tentatively deciding to broaden the definition of a purchased credit-impaired (PCI) financial asset. This could result in more financial assets being accounted for as PCI than under both the FASB s original proposal and current US GAAP. The FASB now plans to define a PCI asset as one that has experienced more than insignificant deterioration since origination, rather than one that has experienced significant deterioration since origination. Entities that purchase debt securities they classify as AFS or held to maturity would have to consider whether

3 these securities are credit impaired and if so, follow the PCI accounting model. The FASB expects to issue final guidance in the fourth quarter of Separately, the FASB decided that the FASB staff will perform research on the hedging phase of the project. The objective of this project is to make targeted improvements to the hedge accounting model based on feedback received from preparers, auditors, users, and other stakeholders. The FASB will consider opportunities to align with IFRS 9, Financial Instruments, which was issued in Leases In May 2013, the FASB issued a proposed ASU, Leases, which was a revision of the 2010 proposed ASU. The core principle of the proposed requirements is that an entity should recognize assets and liabilities arising from a lease. In accordance with that principle, a lessee would recognize assets and liabilities for leases with a maximum possible term of more than 12 months. A lessee would recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the leased asset (the underlying asset) for the lease term. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee would depend on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset. For practical purposes, this assessment would often depend on whether the underlying asset is property or assets other than property. In their 2014 meetings, the FASB and the IASB began to back away from the lessee accounting model they proposed in May In redeliberations, the IASB supported a single on-balance sheet model, while the FASB supported a dual on-balance sheet model that would use the International Accounting Standard (IAS) 17, Leases, classification principles. These principles are similar to current U.S. GAAP but without bright lines. The Boards also indicated that they do not intend to significantly change lessor accounting. Instead, they supported retaining a dual classification model. The Boards also reached certain tentative decisions on lease term, a short-term lease exception and other ways to simplify their 2013 proposal. In December 2014, the Boards moved closer to finishing the controversial lease accounting standards by settling a central part of the project: the definition of a lease. The Boards have decided to define a lease as a contract that conveys the right to use an asset for a period of time in exchange for consideration. A business determines if it has a lease, in part, by figuring out whether it has control over the use of the rented item, such as the freedom to drive a leased delivery truck on any route. The redeliberations will continue on a joint basis, with the intention of minimizing any differences between U.S. GAAP and IFRS. The Boards plan to issue a final standard in the fourth quarter of 2015.

4 Disclosure Framework The objective and primary focus of this project is to improve the effectiveness of disclosures in notes to financial statements by clearly communicating the information that is most important to users of each entity s financial statements. Although reducing the volume of the notes to financial statements is not the primary focus, the FASB hopes that a sharper focus on important information will result in reduced volume in most cases. On March 4, 2014, the FASB issued an Exposure Draft, Conceptual Framework for Financial Reporting: Chapter 8 Notes to Financial Statements, intended to improve its process for evaluating existing and future disclosure requirements in notes to financial statements. Specifically, it addresses the FASB s process for identifying relevant information and the limits on information that should be included in notes to financial statements. If approved, it would become part of the FASB s Conceptual Framework, which provides the foundation for making standard-setting decisions. A final Concepts Statement is expected to be issued by the end of Financial Statements of Not-for-Profit Entities On April 22, 2015, the FASB issued a proposal that would significantly change the financial statements of not-for-profit (NFP) entities, including business-oriented health care entities. The proposal would require NFPs to present two rather than three net asset classes and standardized measures of operating performance. It also would change how NFPs report cash flows, classify expenses and provide information about liquidity. Business-oriented health care NFPs would no longer be allowed to present a performance indicator as a U.S. GAAP measure. The FASB has said that, before finalizing the guidance for NFPs, it will consider its decisions on related projects such as its research on financial performance reporting and improving classification guidance for the statement of cash flows. Prepaid Stored Value Cards On April 30, 2015, the FASB issued a proposal that would require entities (typically banks or other financial institutions) that issue certain prepaid stored-value cards that are redeemable only from thirdparty merchants for goods or services, cash or a combination of the two to recognize breakage, which is the value that is not redeemed by cardholders. Under that proposal, an issuer s liability for the cards would be considered a financial liability. Clarifying the Definition of a Business This project is intended to clarify the definition of a business with the objective of addressing whether transactions involving in-substance nonfinancial assets (held directly or in a subsidiary) should be accounted for as acquisitions (or disposals) of nonfinancial assets or as acquisitions (or disposals) of businesses. The project will include clarifying the guidance for partial sales or transfers and the corresponding acquisition of partial interests in a nonfinancial asset or assets.

5 Clarifying Certain Existing Principles on Statement of Cash Flows In November 1987, the FASB issued FASB Statement No. 95, Statement of Cash Flows. Statement 95 was later codified in Accounting Standards Codification (ASC) 230, Statement of Cash Flows. Recently, FASB staff research indicated that there was diversity in practice with respect to the classification of certain cash receipts and payments. The FASB staff s research also indicated that the primary reasons for the diversity in classification is the result of lack of specific accounting guidance and inconsistent application of the existing principles within ASC 230. This project will include clarifying existing principles in ASC 230 on how to classify cash receipts and cash payments. As part of the project, the FASB staff will research potential additional disclosures that could result in increased relevance for users. EITF Agenda Items At its June 2015 meeting, the FASB's Emerging Issues Task Force (EITF) reached final consensuses on two issues. The final consensuses must be ratified by the FASB before becoming final ASUs: Issue No. 15-A, Application of the Normal Purchases and Normal Sales Scope Exception to Certain Electricity Contracts within Nodal Energy Markets The Task Force reached a final consensus that a forward contract for the physical delivery of electricity through an electricity grid operated by an Independent System Operator meets the physical delivery criterion under the normal purchases and normal sales scope exception to derivative accounting. Accordingly, an entity can elect not to apply derivative accounting for such contracts provided that the other criteria are also met. Issue No. 15-C, Accounting Issues in Employee Benefit Plan Financial Statements The Task Force reached final consensuses to (1) eliminate the fair value disclosure for Fully Benefit- Responsive Investment Contracts (FBRICs) that are measured at contract value, (2) simplify the presentation and disclosure requirements for an employee benefit plan s investments, and (3) provide a measurement date practical expedient for the measurement of plan assets. The EITF also discussed and reached consensuses-for-exposure on two other issues: Issue 15-D, Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships addresses the effect of derivative contract novations on existing hedge accounting relationships. Issue 15-E, Contingent Put and Call Options in Debt Instruments addresses whether a contingent put or call option embedded in a debt instrument should be considered clearly and closely related to the debt instrument when the contingent event is indexed to an extraneous event or factor that is other than interest rates or credit risk. The EITF also began to discuss the first six of nine issues related to classifying certain cash receipts and payments in the statement of cash flows (Issue 15-F, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments).

6 PCC Activities At its May, 2015 meeting, the Private Company Council (PCC) discussed the following projects: Effective Date of PCC Alternatives: The PCC directed the FASB staff to conduct further research and develop recommendations for private companies to have an unconditional option to make an initial election of a PCC alternative. This would remove the requirement for private companies to assess preferability if they initially elect PCC accounting alternatives after the effective date. Share-Based Payments: The FASB staff presented research and discussed stakeholder input on possible private company alternatives for the accounting for share-based compensation. The PCC will continue its discussion in a future meeting, and will take into consideration feedback received in connection with the FASB s exposure draft on employee-based payment accounting improvements. The PCC also discussed the FASB s projects on Disclosures by Business Entities about Government Assistance and Disclosure Framework and continued to express concerns about the FASB s project on Simplifying the Balance Sheet Classification of Debt. The PCC also asked the FASB staff to consider conducting research on clarifying the application of certain aspects of variable interest entity guidance (that are not already addressed by ASU , Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements) to private companies under common control.