2016 ANNUAL ACCOUNTING & AUDITING UPDATE. A Conference Presentation of RealisticApproach Seminars, Inc.

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1 2016 ANNUAL ACCOUNTING & AUDITING UPDATE A Conference Presentation of RealisticApproach Seminars, Inc.

2 Accounting Update Matters ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

3 Accounting Standards Update Income Statement Extraordinary and Unusual Items (Subtopic ) Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items 1. The FASB determined, as part of it s simplification project, that the concept of extraordinary item did not pass the practicability test, and has eliminated this from Generally Accepted Accounting Principles. 2. This ASU replaces extraordinary with the components that used to be the determinants of whether a transaction received such designation. A. Unusual in Nature Now defined as being an event or transaction 1) With a high degree of abnormality 2) Either unrelated or tangentially related to 3) Ordinary and/or typical activities of the reporting entity. B. Infrequency of Occurrence Now defined as being an event or transaction 1) Not reasonable expected to recur (from the perspective of the reporting entity) 2) In the foreseeable future. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

4 Accounting Standards Update Income Statement Extraordinary and Unusual Items (Subtopic ) Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items 3. Transactions that meet either, or both, of the unusual or infrequency criteria (subject to materiality considerations) should be presented in financial statements as a A. Separate line item, in the computation of net income, and/or B. Footnote disclosure 4. Effective date provisions applies to both Public Business Entities and Non PBEs A. Annual periods beginning after 12/15/2015 B. Generally expected to be applied prospectively, but C. Retrospective application is allowed provided the provisions of this ASU are applied from the beginning of the (earliest) year of adoption ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

5 Accounting Standards Update Consolidation (Topic 810) -- Amendments to the Consolidation Analysis 1. The consolidation effort, in the United States, seems to be moving toward two reference points for consolidation: an entity would consolidate when it has A. A majority ownership interest now called a Voting Interest Entity (VoIE), and/or B. The principal responsibility/right related to entity variable interests now called a Variable Interest Entity (VIE). 2. This appears to be a do able compromise between the US legal control perception of consolidation requirements, and the international concept of effective control. 3. Characteristics of an entity subject to consolidation; A. Legal Entity, B. Not specifically exempted from being subject to consolidation C. A Variable interest exists. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

6 Accounting Standards Update Consolidation (Topic 810) -- Amendments to the Consolidation Analysis 4. Protocol for evaluating the significance of a variable interest (Potential VIE) A. Does the reporting entity have the power and/or obligation to absorb loss or benefits that are significant to the potential VIE (Direct Basis)? B. Is there a single entity or definable group that meets the criteria described in A, above? C. Are substantially all of the activities conducted on behalf of a single variable interest holder (could be a member of a group) 5. Protocol for evaluating the significance of a voting interest (Potential VoIE) A. Does the reporting entity either 1) Own a majority voting interest, or 2) If the reporting entity is part of a limited partnership, does the reporting entity own a majority of the limited partnership s kick out rights B. There are no non controlling shareholders or partners that hold substantive participating rights and C. There are no other conditions that indicate that control does not exist with a reporting entity, meeting the qualifications of A, above. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

7 Accounting Standards Update Consolidation (Topic 810) -- Amendments to the Consolidation Analysis 6. Other matters addressed in this ASU include A. Fees paid to a decision maker or a service provider in the form of a variable interest. B. Effect of fee arrangements on identification of the primary beneficiary in a VIE relationship. C. Related parties in primary beneficiary determination, and D. Certain investment funds. 7. Effective date provisions A. For Public Business Entities Fiscal years beginning after 12/15/2015, B. For Non PBEs 1) Fiscal years beginning after 12/15/16, 2) Interim periods within fiscal years beginning after 12/15/2017 C. Application may be done retrospectively. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

8 Accounting Standards Update Interest Imputation of Interest (Subtopic ) Simplifying the Presentation of Debt Issuance Costs 1. Issued as part of the Simplification Initiative. 2. Rather than require the use of different interest rates for measurement and recognition of debt issuance costs and discounts and/or premiums related to debt, this ASU requires that debt issuance costs be accounted for A. In the same manner as debt discounts and/or premiums as B. A direct reduction in the carrying amount of the debt instrument. 3. The approach to amortizing the debt issuance costs remains unchanged. 4. Transition and effective date: Fiscal years beginning after December 15, A. PBEs 2015, and B. Non PBEs 2015 (for annual presentations), and 2016 for interim presentations Early Application is permitted for financial statements not previously issued, and This ASU is to be applied retrospective basis. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

9 Accounting Standards Update Compensation Retirement Benefits (Topic 715) Practical Expedient for the Measurement Date of an Employer s Defined Benefit Obligation and Plan Assets 1. Issued as part of the Simplification Initiative. Introduces a new term practical expedient. 2. Addresses reporting entities with a 52/52 week year end (as opposed to a month end yearend). 3. Allows entities with defined benefit pension plans to report A. Fair value information as of the nearest month end to the fiscal year end date. B. Transactions, such as employer contributions, occurring during the spread as occurring as of the fiscal year end. (This does not include matters that are not caused by the reporting entity, such as changes in market values) 4. Narrow scope ASU, in that, other types of employee benefit plans do not qualify for the practical expedient approach. 5. Transition and effective date: Fiscal years beginning after December 15, A. PBEs 2016, and B. Non PBEs 2017 Early Application is permitted, and This ASU is to be applied prospectively. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

10 Accounting Standards Update Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (a consensus of the Emerging Issues Task Force) 1. What is the objective of the ASU? Clarification of categorization of investments measured at net asset value per share. 2. Reason for the ASU Establish an approach to disclosing measurement of certain investments in light of current fair value hierarchy A. Current approach 1) If investment can be redeemed at net asset value Level 2 in hierarchy, and 2) If investment cannot be redeemed at net asset value Level 3 in hierarchy B. Approach set forth in this ASU 1) Requirement to classify within the (FAS 115) hierarchy removed, and 2) Disclosures related to investments subject to practical expedient limited to only those for which practical expedient was used for measurement purposes 3. Effective date Years Beginning After A. PBE 12/15/2015, and B. Non PBE 12/15/2016 Retrospective presentation required for all periods presented for comparative presentations. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

11 Accounting Standards Update Business Combinations (Topic 805): Pushdown Accounting Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No. 115 (SEC Update) 1. This ASU provides amendments to SEC guidance on pushdown accounting A. SEC does not establish accounting standards promulgates rules and regulations for registrants that is B. Only binding on an SEC registrant. 2. See ASU for GAAP guidance on push down accounting. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

12 Accounting Standards Update Inventory (Topic 330): Simplifying the Measurement of Inventory 1. What is the objective of the ASU? Simplification, based on practicability, of accounting for FIFO and Average Cost inventory 2. Provisions of this ASU A. Does not apply to inventory accounted for using 1) LIFO, or 2) Retail inventory method B. Eligible inventory is accounted for at lower of cost or net realizable value. C. Net realizable value is 1) Estimated selling price (in the normal course of business), reduced for 2) Reasonably predictable cost of completion, and 3) Disposal, and 4) Transport 3. Effective for years beginning after A. PBEs 12/15/2016, and B. Non PBEs 12/15/2017 C. Early application is restrictive. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

13 Accounting Standards Update Derivatives and Hedging (Topic 815): Application of the Normal Purchases and Normal Sales Scope Exception to Certain Electricity Contracts within Nodal Energy Markets (a consensus of the FASB Emerging Issues Task Force) 1. Objective of this ASU Clarification of exception to the fair value measurement requirement for derivative financial instruments. 2. Background Information A. Derivative financial instruments are, generally, required to be measured at fair value, for financial reporting purposes unless B. The derivative qualifies for a particular scope exception ( ) 1) There are 14 types of derivative instruments that qualify for the exception ( ) 2) The exception that is addressed in this ASU has to do with Normal Purchases and Sales ( (22 51) a. The instrument is Not purchased/sold with an investment objective, and b. (Highly) probable that delivery/provision of the subject matter of the instrument will take place 3. Findings of this ASU A contract for the purchase (and delivery) of electricity to an independent system operator has the possibility of net settlement and does qualify for the normal purchase/sale scope exception 4. Effective upon issuance of the ASU, and is to be applied prospectively ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

14 Accounting Standards Update Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date 1. An example of user feedback in the standard setting process. 2. A one year extension of the effective date as it relates to ASU No , Revenue from Contracts with Customers. 3. Defers effective date for A. PBEs From years beginning after 12/15/2016 to years beginning after 12/15/2017, and B. Non PBEs From years beginning after 12/15/2017 to years beginning after 12/15/2018 C. Early application is allowed for annual reporting periods beginning after 12/15/2016 ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

15 Accounting Standards Update Financial Instruments Overall (Subtopic ) Recognition and Measurement of Financial Assets and Financial Liabilities January 2016

16 General Provisions of ASU Require that equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) A. Be measured at fair value B. With changes in fair value recognized in net income 2. Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment 3. Eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

17 General Provisions of ASU Eliminate the requirement for PBEs to disclose methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet. 5. Require PBEs to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 6. Require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. 7. Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements 8. Clarifies that a reporting entity should evaluate the need for a valuation allowance on a deferred tax asset related to available for sale securities in combination with the entity s other deferred tax assets. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

18 Accounting Standards Update Leases (Topic 842) Issued February 2016

19 What is a Lease Under ASU ? A contract is (or contains) a lease if that contract conveys 1. The right to control the use of identified property, plant, or equipment (an identified tangible asset) 2. For a period of time, in exchange for consideration. A period of time may be described A. in terms of the amount of use of an identified asset B. For example, the number of production units that an item of equipment will produce 3. To determine whether a contract conveys the right to control the use of an identified asset for a period of time, the entity assesses whether, throughout the lease period, the customer has both of the following: The right to A. Obtain substantially all of the economic benefits from use of the identified asset, and B. Direct the use of the identified asset ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

20 ASU Applicability Applies to leases of property, plant, or equipment Does not apply to: Leases of 1. Intangible assets 2. Right(s) to explore for or use non regenerative resources 3. Biological assets 4. Inventory 5. Assets under construction ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

21 What Constitutes a Finance/Sales Type Lease Lessee classifies a lease as a finance lease and lessor classifies a lease as a salestype lease when the lease meets any one of the following criteria at lease commencement: The 1. Lease transfers ownership of the underlying asset to the lessee by the end of the lease term. 2. Lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise. 3. Lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purposes of classifying the lease. 4. Present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all of the fair value of the underlying asset. 5. Underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

22 Operating And/Or Direct Financing Leases When none of the criteria enumerated, above, are met: 1. A lessee shall classify the lease as an operating lease. 2. A lessor shall classify the lease as either a direct financing lease or an operating lease. A. A lessor shall classify the lease as an operating lease unless both of the following criteria are met, 1) The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments and/or any other third party unrelated to the lessor equals or exceeds substantially all of the fair value of the underlying asset. And 2) It is probable that the lessor will collect the lease payments plus any amount necessary to satisfy a residual value guarantee. Otherwise B. The lessor shall classify the lease as a direct financing lease. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

23 Lessee Accounting Macro Approach 1. At the commencement date, a lessee shall recognize a right of use asset and a lease liability. (Same for Finance and Operating Leases) 2. Finance Leases A lessee shall recognize in profit or loss : A. Amortization (expense) of the right of use asset and B. Interest (expense) on the lease liability and C. Variable lease payments, and D. Any impairment of the right of use asset 3. Operating Leases A lessee shall recognize in profit or loss : A. A single lease cost, calculated so that the remaining cost of the lease is allocated over the remaining lease term on a straight line basis unless another systematic and rational basis is more representative of the pattern in which benefit is expected to be derived from the right to use the underlying asset B. Variable lease payments, and C. Any impairment of the right of use asset ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

24 Lessee Accounting Macro Approach 4. As an accounting policy, a lessee may elect to not apply the recognition requirements to short term leases. Instead, A. Thelesseemayrecognizetheleasepaymentsinprofitorlossonastraightline basis over the lease term and B. Variable lease payments in the period in which the obligation for those payments is incurred C. This accounting policy election for short term leases is to be made by class of underlying asset to which the right of use relates. 5. A short term lease is a lease that, at the commencement date, A. Has a lease term of 12 months or less, and B. Does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

25 Lessee Accounting For A Lease Lessee Fair Value 2 Payments $2,700, and Guarantee $1,500 Discount Rate = 54.5% January Yr 1 5, , January Yr 2 2, , , December Yr , ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

26 Lessee Accounting For A Lease Lease As A Financing Lease 1/1/Yr 1 Year 1 12/31/Yr1 Year 2 12/31/Yr2 Right Of Use Asset 5, , , Accumulated Amortization (2,538.00) (2,538.00) (2,537.00) (5,075.00) Lease Liability (5,075.00) 1, (3,669.00) 3, Lease Expense Amortization Expense 2, , , , Interest Expense 1, , Cash (2,700.00) (2,700.00) (4,200.00) (6,900.00) Total Expense Recognized 3, , , Lease As An Operating Lease 1/1/Yr 1 Year 1 12/31/Yr1 Year 2 12/31/Yr2 Right Of Use Asset 5, , , , Accumulated Amortization (3,450.00) (3,450.00) (3,450.00) (6,900.00) Lease Liability (5,075.00) 1, (3,669.00) 3, Lease Expense 3, , , , Amortization Expense Interest Expense Cash (2,700.00) (2,700.00) (4,200.00) (6,900.00) Total Expense Recognized ANNUAL ACCOUNTING & AUDITING UPDATE A 3, , , RealisticApproach Conference Presentation

27 Lessee Disclosure Requirements 1. Information regarding the nature of leasing arrangements, 2. Information about leases that have not yet commenced but that create significant rights and obligations, 3. Amounts relating to a lessee s total lease cost, which includes A. Amounts recognized in profit or loss during the period and B. Any amounts capitalized as part of the cost of another asset 4. A maturity analysis of its finance lease liabilities and its operating lease liabilities separately, showing the A. Undiscounted cash flows, on an annual basis, for a minimum of each of the first five years and B. A total of the amounts for the remaining years 5. Lease transactions between related parties 6. As applicable A. Election for accounting for short term leases, and/or B. Use of the practical expedient of not separating lease and non lease components ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

28 Lessor Accounting Macro Approach Sales Type Lease Lessor shall 1. Recognize each of the following, and 1. A net investment in the lease, 2. Selling profit or selling loss arising from the lease 3. Initial direct costs as an expense if, at the commencement date, the fair value of the underlying asset is different from its carrying amount. 4. If the fair value of the underlying asset equals its carrying amount, the initial direct costs 1. Are deferred at the commencement date and included in the measurement of the net investment in the lease. 2. The rate implicit in the lease should be defined in such a way that those initial direct costs eligible for deferral are included automatically in the net investment in the lease; there is no need to add them separately. 2. Derecognize the underlying asset ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

29 Net Investment in the Lease 1. For a sales type lease, the sum of the A. Lease receivable and B. The unguaranteed residual asset. 2. For a direct financing lease, the sum of the A. Lease receivable and B. The unguaranteed residual asset, C. Net of any deferred selling profit. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

30 Lease Receivable A lessor s right to receive lease payments arising 1. From a sales type lease or a direct financing lease 2. Plus any amount that a lessor expects to derive from the underlying asset following the end of the lease term to the extent that it is A. Guaranteed by the lessee or B. Any other third party unrelated to the lessor, measured on a discounted basis. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

31 Lessor Accounting For Sales Type Lease Discount 74% Rent Annuity $ 4,252 $ $ (2,700) $ 1,552 $ 1,148 $ (2,700) $ Guaranteed Residual ,500 4,746 2,046 1, ,500 UnGuaranteed Residual ,000 Asset Fair Value $ 5,075 $ $ (2,700) $ 2,375 $ 1,757 $ (2,700) $ 1,432 $ 1,068 $ 2,500 Sales Profit ("Proceeds" $5,075 Less "Basis" $4,000) In Current Income $ 1,075 ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

32 Lessor Accounting Macro Approach Direct Financing Type Lease 1. Lessor recognizes both of the following A. A net investment in the lease, and, when applicable B. Selling loss arising from the lease 2. Any selling profit is deferred at the commencement date of the lease, and 3. Initial direct costs are deferred at the commencement date and included in the measurement of the net investment in the lease. A. The rate implicit in the lease is defined in such a way that initial direct costs deferred B. Are included automatically in the net investment in the lease; there is no need to add them separately. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

33 Lessor Accounting For Direct Financing Lease Net Investment Interest Earned Payment Net Investment Interest Earned Payment Net Investment Interest Earned Net Investment Discount 176% Rent Annuity $ 3,670 $ $ (2,700) $ 970 $ 1,730 $ (2,700) $ $ $ Guaranteed Residual ,500 3,868 1, UnGuaranteed Residual ,000 Net Investment in Lease $ 4,000 $ $ (2,700) $ 1,300 $ 2,310 $ (2,700) $ 910 $ 1,590 $ 2,500 Discount 74% Rent Annuity $ 4,252 $ $ (2,700) $ 1,552 $ 1,148 $ (2,700) $ Guaranteed Residual ,500 4,746 2,046 1, ,500 UnGuaranteed Residual ,000 Asset Fair Value 5,075 $ $ (2,700) $ 2,375 $ 1,757 $ (2,700) $ 1,432 $ 1,068 $ 2,500 Deferred Sales Profit (1,075) (1,075) 553 (522) 522 $ Net Investment in Lease $ 4,000 $ $ (2,700) $ 1,300 $ 2,310 $ (2,700) $ 910 $ 1,590 $ 2,500 ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

34 Lessor Disclosure Requirements 1. Information regarding the nature of leasing arrangements, 2. Information about significant assumptions and judgments made in applying the requirements of the standard 3. Leasing transactions with related parties 4. Information regarding recognition of A. Profit/loss B. Interest income, and C. Lease income related to 1) Lease payments, and 2) Variable lease payments 5. Disaggregation of elements comprising net investment in leases (by type) 6. Risk management policies 7. For sales and direct financing leases changes in unguaranteed residuals 8. Maturity analysis of lease receivables (5 year schedule) 9. Maturity analysis of lease payments (operating leases) (5 year schedule) ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

35 When will this ASU be Effective? The amendments in this ASU are effective for fiscal years beginning after December 15, , For a public business entity (and certain, select, non PBEs), and , for non PBEs 3. Early application of the amendments in this Update is permitted for all entities. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

36 ASU Intangibles Goodwill and Other (Topic 350), Business Combinations (Topic 805), Consolidation (Topic 810), Derivatives and Hedging (Topic 815): Effective Date and Transition Guidance (a consensus of the Private Company Council) Added to address concerns raised by private company users about transition guidance in Accounting Standards Updates No , Intangibles Goodwill and Other (Topic 350): Accounting for Goodwill, , Derivatives and Hedging (Topic 815): Accounting for Certain Receive Variable, Pay Fixed Interest Rate Swaps Simplified Hedge Accounting Approach, , Consolidation (Topic 810): Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements; and , Business Combinations (Topic 805): Accounting for Identifiable Intangible Assets in a Business Combination. This ASU includes transition provisions that provide that private companies are able to forgo a preferability assessment the first time they elect the accounting alternatives within the scope of the aforementioned ASUs. The amendments in this Update are effective immediately. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

37 Update Liabilities Extinguishments of Liabilities (Subtopic ): Recognition of Breakage for Certain Prepaid Stored Value Products (a consensus of the Emerging Issues Task Force) 1. Liabilities related to the sale of prepaid stored value products (for example gift cards) within the scope of this Update are financial liabilities. 2. The amendments in the ASU provide a narrow scope exception to the guidance in Subtopic to require that breakage (amount of the card value that will not be redeemed) for those liabilities be accounted for consistent with the breakage guidance in Topic 606. When the A. Breakage must be deposited with the state (for example, unclaimed property), and B. Prepaid stored value product is attached to a specific bank account. This ASU is effective for Non PBEs for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, Earlier application is permitted ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

38 Update Investments Equity Method and Joint Ventures (Topic 323): Simplifying the Transition to the Equity Method of Accounting This ASU eliminates the requirement that 1. When an investment qualifies for use of the equity method 2. As a result of an increase in the level of ownership interest or degree of influence, 3. An investor must adjust the investment, results of operations, and retained earnings 4. Retroactively on a step by step basis as if the equity method had been in effect during all previous periods that the investment had been held. The amendments require that the equity method investor 1. Add the cost of acquiring the additional interest in the investee to the current basis of the investor s previously held interest and 2. Adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Now, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The ASU requires that a reporting entity that has an available for sale equity security that becomes qualified for the equity method of accounting recognize, through earnings, the unrealized holding gain or loss in accumulated other comprehensive income at the date the investment becomes qualified for use of the equity method. The amendments in this Update are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

39 Update Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) This ASU provides implementation guidance on principal versus agent considerations. 1. When another party is involved in providing goods or services to a customer, an entity is required to determine A. whether the nature of its promise is to provide the specified good or service itself (that is, the entity is a principal) or B. to arrange for that good or service to be provided by the other party (that is, the entity is an agent). 2. When an entity that is A. A principal satisfies a performance obligation, the entity recognizes revenue in the gross amount of consideration to which it expects to be entitled in exchange for the specified good or service transferred to the customer. B. An agent satisfies a performance obligation, the entity recognizes revenue in the amount of any fee or commission to which it expects to be entitled in exchange for arranging for the specified good or service to be provided by the other party. 3. An entity is a principal if it controls the specified good or service before that good or service is transferred to a customer. A. The guidance in the ASU includes indicators to assist an entity in determining whether it controls a specified good or servicebeforeitistransferredtothecustomer. B. The indicators do not override the assessment of additional evaluation, and should not be considered a checklist of criteria to be met in all scenarios. C. Considering one or more indicators often is helpful in determining whether an entity controls a specified good or service before it is transferred to the customer. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

40 Update Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net) This ASU is intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations by clarifying the following: 1. An entity determines whether it is a principal or an agent for each specified good or service promised to the customer. A. A specified good or service is a distinct good or service (or a distinct bundle of goods or services) to be provided to the customer. B. If a contract with a customer includes more than one specified good or service, an entity could be a principal for some specified goods or services and an agent for others. 2. An entity determines the nature of each specified good or service (for example, whether it is a good, a service, or a right to a good or service). 3. When another party is involved in providing goods or services to a customer, an entity that is a principal obtains control of a A. Good or another asset from the other party that it then transfers to the customer, B. Right to a service that will be performed by another party, which gives the entity the ability to direct that party to provide the service to the customer on the entity s behalf, or C. Good or service from the other party that it combines with other goods or services to provide the specified good or service to the customer. 4. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements of Update ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

41 Update Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing Before a reporting entity can identify its performance obligations in a contract with a customer, that entity must first identify the promised goods or services in the contract. An entity is This ASU is intended to reduce the cost and complexity of applying the guidance on identifying promised goods or services by adding the following provisions: 1. Not required to assess whether promised goods or services are performance obligations if they are immaterial in the context of the contract with the customer. 2. Permitted, as an accounting policy election, to account for shipping and handling activities that occur after the customer has obtained control of a good as an activity to fulfill the promise to transfer the good rather than as an additional promised service. To identify performance obligations in a contract, an entity evaluates whether promised goods and services are distinct. Topic 606 includes two criteria for assessing whether promises to transfer goods or services are distinct. One of those criteria is that the promises are separately identifiable. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

42 Update Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing This ASU is intended to improve the operability and understandability of licensing implementation guidance by clarifying the following: An entity s promise to grant a customer a license to 1. Intellectual property that has significant standalone functionality does not include supporting or maintaining that intellectual property during the license period. A. The nature of the entity s promise is to provide a right to use the entity s intellectual property as that intellectual property exists at the point in time the license is granted unless the entity is expected to undertake activities (that do not transfer service to the customer) that will change the functionality of the intellectual property to which the customer has rights. B. An entity s promise to provide a customer with a right to use the entity s intellectual property is satisfied at the point in time the customer is able to use and benefit from the license, because the entity s promise in granting the license is solely to make the underlying intellectual property available for the customer s use and benefit. C. Functional intellectual property includes software, biological compounds or drug formulas, and completed media content (for example, films, television shows, or music). 2. Symbolic intellectual property (that is, intellectual property that does not have significant standalone functionality) includes A. Supporting or maintaining that intellectual property B. During the license period. ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

43 Update Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing The nature of the entity s promise to its customer is both to 1. Grant the customer rights to use and benefit from the entity s intellectual property and make that underlying intellectual property available for the customer s use and benefit and 2. Support or maintain the intellectual property during the license period (or over the remaining economic life of the intellectual property, if shorter). 3. Consequently, a license to symbolic intellectual property is satisfied over time. Symbolic intellectual property includes brands, team or trade names, logos, and franchise rights. 4. An entity considers the nature of its promise in granting a license, regardless of whether the license is distinct, in order to apply the other guidance in Topic 606 to a single performance obligation that includes a license and other goods or services ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

44 Update Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing This ASU also clarifies its scope and applicability, as follows: 1. An entity should not split a sales based or usage based royalty into a portion subject to the recognition guidance on sales based and usage based royalties and a portion that is not subject to that guidance. That requirement does not affect allocation of the transaction price to performance obligations. 2. The guidance on sales based and usage based royalties applies to a sales based or usagebased royalty whenever the predominant item to which the royalty relates is a license of intellectual property. The amendments in this ASU clarify that contractual provisions that, explicitly or implicitly, require an entity to transfer control of additional goods or services to a customer should be distinguished from contractual provisions that, explicitly or implicitly, define the attributes of a single promised license. Attributes of a promised license define the scope of a customer s right to use or right to access an entity s intellectual property and, therefore, do not define whether the entity satisfies its performance obligation at a point in time or over time and do not create an obligation for the entity to transfer any additional rights to use or access its intellectual property. The effective date and transition requirements for the amendments in this Update are the same as the effective date and transition requirements in Topic 606 (and any other Topic amended by Update ). Accounting Standards Update , ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

45 Auditing Update Matters ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

46 Areas to be Addressed in Today s Session 1. Recently Issued Statements on Auditing Standards A. SAS No. 130, An Audit of Internal Control Over Financial Reporting That Is Integrated With an Audit of Financial Statements B. SAS No. 131, Amendment to Statement on Auditing Standards No. 122 Section 700, Forming an Opinion and Reporting on Financial Statements 2. Internal Control in the Risk Based Audit, and 3. Root Cause (Systemic) Analysis in a Risk Based Audit ANNUAL ACCOUNTING & AUDITING UPDATE A RealisticApproach Conference Presentation

47 Internal Control Components 1. Control Environment Principles 1. Commitment to integrity and ethical values, 2. Performance of Oversight Responsibility, 3. Establishment of organizational structure, authority, and responsibility, 4. Organizational commitment to competence, 5. Enforcement of accountability. A RealisticApproach Seminar Presentation

48 Internal Control Components 1. Control Environment 2. Risk Assessment Principles Identify: 1. Suitable control objectives, 2. And Analyze Entity Risk(s), 3. Fraud Risk, and 4. And Analyze significant changes within the organization A RealisticApproach Seminar Presentation

49 1. Control Environment 2. Risk Assessment Internal Control Components 3. Control Activities Principles 1. Select and Develop control activities (Policies and/or Procedures) 2. Select and Develop General Controls over Technology, and 3. Deploy Selected Control Activities A RealisticApproach Seminar Presentation

50 1. Control Environment 2. Risk Assessment Internal Control Components 3. Control Activities are Client Policies and/or Procedures that Establish and/or Monitor 1. Checks and/or Edits 2. Authorization 3. Segregation of Duties 4. Restrictions regarding Access to Assets and Accounting Records 5. A Document Trail A RealisticApproach Seminar Presentation

51 Internal Control Components 1. Control Environment 2. Risk Assessment 3. Control Activities Risk Assessment Responsibility for 1. Procedures/Policies encountered in the Risk Assessment phase, and 2. Holes identified (potentially from ICQ) during the Risk Assessment phase A RealisticApproach Seminar Presentation

52 Internal Control Components 1. Control Environment 2. Risk Assessment 3. Control Activities A.Check identified procedures for the appropriate Design and Implementation for the purpose of 1. Preventing, 2. Detecting, and/or 3. Correcting misstatements A RealisticApproach Seminar Presentation

53 Internal Control Components 1. Control Environment 2. Risk Assessment 3. Control Activities 4. Information and Communication Principles 1. Identifies and uses relevant information, 2. Effectively communicates Internally, and 3. Effectively communicates Externally A RealisticApproach Seminar Presentation

54 Internal Control Components 1. Control Environment 2. Risk Assessment 3. Control Activities 4. Information and Communication addresses Risk as it relates to 1. Significant classes of transactions 2. How transactions are initiated, authorized, recorded, processed and reported 3. Accounting records reflecting transactions 4. Information system processing 5. Reporting process to include estimation A RealisticApproach Seminar Presentation

55 Internal Control Components 1. Information and Communication addresses Risk as it relates to Procedures to prepare financial statements 1. How summarized totals migrate to general ledger (G/L) 2. Initiation, authorization, recording, and processing of journal entries to G/L 3. Summarization of G/L amounts, and 4. Preparation of financial statements A RealisticApproach Seminar Presentation

56 Internal Control Components 1. Control Environment 2. Risk Assessment 3. Control Activities 4. Information and Communication 5. Monitoring Principles 1. The conduct of on going and/or separate evaluations, and 2. Evaluation and Communication of Identified Deficiencies A RealisticApproach Seminar Presentation

57 Internal Controls in the Informal Environment 1. Control Environment A. Probably no written code of conduct, or other formal documentation of elements of the control environment, B. Integrity and/or Ethical values communicated 1) Orally and 2) By management example C. Oversight body (those charged with governance) may be dominated by owners and management 1) Internal 2) May not be independent of the entity A RealisticApproach Seminar Presentation

58 Internal Controls in the Informal Environment 2. Risk Assessment A. Less formal and/or structured, B. Probably not documented, C. Risk related to reporting objective may be identified implicitly, rather than explicitly, D. Great likelihood that risk is identified reactively in an informal environment through 1) Management s personal involvement within the organization and/or 2) Inputs from parties external to the entity A RealisticApproach Seminar Presentation

59 Internal Controls in the Informal Environment 3. Control Activities A. Less formal documentation, B. Greater management (personal) involvement with performance of policies and/or procedures in areas such as 1) Authorization and 2) Checks and edits C. Personnel circumstances may limit segregation of duties, which might be mitigated through 1) Management overview, or 2) Use of external resources A RealisticApproach Seminar Presentation

60 Internal Controls in the Informal Environment 4. Information and Communication A. Less formal, affecting areas such as 1) Documentation of accounting procedures, 2) Accounting records, 3) Written policies and procedures. B. Communication lines within such organizations 1) May be less formal, but is mitigated by 2) Greater access to management, as well as 3) Fewer layers of authority to work with and through A RealisticApproach Seminar Presentation

61 Internal Controls in the Informal Environment 5. Monitoring A. Generally, will lack a formal monitoring plan, B. Conducted, mainly, by management on an ongoing basis as management becomes aware of 1) Holes in effectiveness, or existence, of policies and/or procedures, and 2) Deficiencies in the financial reporting process C. Enhanced by inputs from external sources such as auditors. A RealisticApproach Seminar Presentation

62 Internal Control and the Auditor When the Auditor Does Not Intend to Rely on Internal Control 1. Auditor should obtain and document an understanding of each of the five components of the reporting objective sufficient to enable the auditor to A. Assess the risk of material misstatement of the financial statements, and B. Evaluate the design and implementation of certain internal controls A RealisticApproach Seminar Presentation

63 Risk Assessment Procedures 1. Inquiry of management, and/or persons other than management within the organization, 2. Inspection, and/or 3. Observation 4. Re tracing transactions 5. Analytic procedures A RealisticApproach Seminar Presentation

64 Objectives of Risk Assessment Inquiry Similar inquiries may be posed to different individuals for the multiple risk identification purposes. For example, inquiries should be posed to the following categories of individuals: 1. Those Charged With Governance: Tone at the Top considerations, 2. Internal Auditors: Effectiveness/Monitoring concerns. 3. Accounting Staff, and Others within the Organization: Knowledge and/or application of relevant internal control policies and/or procedures 4. Legal Counsel: Compliance with laws and/or regulations, Fraud risk matters, Identification of uncertainties A RealisticApproach Seminar Presentation

65 Internal Control and the Auditor When the Auditor Does Not Intend to Rely on Internal Control 2. For the purpose of gleaning information regarding the A. Types of potential misstatements that could occur in this client s circumstances, B. Factors that affect risk in the financial reporting process, and C. Identify the approach to be taken in the risk reduction phase of planning 1) Potentially, relying on internal control, or 2) Use of a substantive risk reduction approach A RealisticApproach Seminar Presentation

66 Internal Control and the Auditor When the Auditor Does Not Intend to Rely on Internal Control 3. Not necessary to assess all controls (policies and procedures) in order to properly plan an audit, 4. A matter of professional judgment 5. Auditor should consider significant areas of risk from the perspective of A. Existence of procedures, or B. Lack of controls effectively addressing areas of significant risk. A RealisticApproach Seminar Presentation

67 Internal Control and the Auditor When the Auditor Does Not Intend to Rely on Internal Control 6. Factors to be considered in determining which control activities will be considered in the risk identification phase of the engagement: A. Magnitude/materiality, B. Entity size, C. Business unit characteristics, D. Sophistication of the entity s product(s) or services, E. Legal and/or regulatory environment, and F. Internal and external financial reporting systems A RealisticApproach Seminar Presentation

68 Internal Control and the Auditor When the Auditor Does Not Intend to Rely on Internal Control 7. For those policies and procedures identified, auditors should: A. Ascertain that procedure has been properly designed to achieve its intended objective of 1) Prevention, or 2) Detection, and/or 3) Correction B. Determine if a properly designed control procedure has been effectively implemented, through the use of risk assessment procedures A RealisticApproach Seminar Presentation

69 Internal Control and the Auditor When the Auditor Does Not Intend to Rely on Internal Control 8. Limitations of any internal control procedure and/or system A. Management over ride, B. Collusion, C. Fallibility of human judgment, D. Lack of segregation of duties, E. Mechanical issues, such as 1) Poorly trained personnel, or 2) Ineffective IT applications F. Management attitude toward control A RealisticApproach Seminar Presentation

70 Internal Control and the Auditor When the Auditor Does Not Intend to Rely on Internal Control 9. Requirement to Assess Risk at the A. Financial statement level, and B. Management assertion level 10.Risk Assessment is done for the purpose of A. Identifying of risks that constitute significant (audit) risks, and B. Determining the risk reduction approach that will be used to address all identified risks A. Control B. Substantive, or C. Mixed A RealisticApproach Seminar Presentation

71 Internal Control and the Auditor When the Auditor Does Not Intend to Rely on Internal Control 11. Assertions By Activity A. Classes of Transactions and Events 1) Occurrence 2) Completeness 3) Accuracy 4) Cutoff 5) Classification B. Ending Account balances 1) Existence 2) Completeness 3) Rights and Obligations 4) Valuation and Allocation C. Presentation and Disclosure Occurrence (plus) and Rights and Obligations 1) Completeness 2) Classification and Understandability 3) Accuracy and 4) Valuation A RealisticApproach Seminar Presentation