Module 1 1. ADP CPE Webinar Powered by. Forthcoming Changes in U.S. GAAP: Impact on California i Businesses. Presented by Powered by.

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1 ADP CPE Webinar Presented by Forthcoming Changes in U.S. GAAP: Impact on California i Businesses May 24, 2011 Bruce Pounder MBA, CMA, CFM, DipIFR (ACCA) VP, Accounting Programs SmartPros Ltd. CFO of private company for 20 years Consultant to Fortune 500 corporations Host: This Week in Accounting webinar series Columnist: Strategic Finance magazine Columnist: CFO.com Author: The Convergence Guidebook (Wiley) Author: 2011 U.S. Master GAAP Guide (CCH) Lead Contributor: FASB Learning Guide for the Codification Research System Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 1 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 2 Introduction CPE Specifics This webinar will help you understand and prepare for several forthcoming changes in U.S. Generally Accepted Accounting Principles (GAAP). These changes will have a disproportionately large impact on California businesses due to the state's industry concentrations and other unique economic conditions. Level: Update Prerequisite: Basic knowledge of U.S. GAAP Advance Preparation: None Recommended CPE Credit: 1 Hour Field of Study: Accounting Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 3 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 4 To Receive CPE Credit Learning Objectives This Webinar qualifies for 1 CPE credit To earn CPE credit, you must enter 4 words / phrases within 24 hours of the Webinar At conclusion of webcast, go to: See instructions under AFTER THE WEBINAR After this webinar, you will be able to Identify the Financial Accounting Standards Board's (FASB's) major standard-setting projects Describe how those projects will change accounting and reporting practices under U.S. GAAP Explain the impact of forthcoming changes on businesses that play significant roles in California's economy Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 5 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 6 Module 1 1

2 Major FASB Projects BACKGROUND: Financial Instruments Financial Instruments Leases Revenue Recognition Since March 2006, the FASB and the International Accounting Standards Board (IASB) have worked together to improve and converge the financial-instruments provisions of U.S. GAAP and International Financial Reporting Standards (IFRS). The objective of this project is to improve the decision-usefulness of financial statements by simplifying the classification and measurement requirements for financial instruments. The global economic crisis caused the Boards to reconsider the priority of their financial-instruments projects relative to the many other pressing standard-setting issues on their agendas. As a result, in late 2008, the Boards began to invest an unprecedented amount of effort into overhauling financialinstruments accounting. Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 7 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 8 ED: Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities Summary of Tentative Decisions On May 26, 2010, the FASB issued a 214-page exposure draft (ED) of a proposed Accounting Standards Update (ASU), Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities. The proposed ASU would amend Topics 825, Financial Instruments, and 815, Derivatives and Hedging, of the FASB's Accounting Standards Codification (ASC). The ED comment period ended Sep. 30, ED: Financial instruments are defined broadly so as to include debt and equity securities, loans, trade receivables/payables, etc., subject to certain scope exceptions On the balance sheet, financial instruments would be displayed in separate classifications on the basis of how they are measured Dec. 21, 2010 FASB meeting: There should be three measurement-based categories for financial assets: 1. Fair Value measurement with all changes in Fair Value recognized in Net Income (FV-NI) 2. Fair Value measurement with qualifying changes in Fair Value recognized in Other Comprehensive Income (FV-OCI) 3. Amortized Cost (AC) Two criteria should be used to determine the measurement and classification of a financial asset: 1. The reporting entity's business strategy 2. The characteristics of the financial asset Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 9 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 10 Summary of Tentative Decisions (continued) SD: Impairment Jan. 25, 2011 FASB meeting: A business-activity approach should be used in applying the business-strategy criterion "Plain vanilla" financial assets managed through a "lending" or "customer-financing" activity that an entity holds for the collection of contractual cash flows should be measured at AC Financial assets for which an entity's business activity is "trading" or "holding for sale" should be classified in the FV-NI category Financial assets for which an entity's business activity is "investing with a focus on managing risk exposures and maximizing total return" should be classified in the FV- OCI category (e.g., held-to-maturity debt securities) Reclassifications among the three categories of financial assets would not be permitted Subsequent sales of financial assets classified in the AC category would not "taint" an entity's remaining financial assets classified in the AC category On Jan. 31, 2011, the FASB issued a "Supplementary Document" (SD) that proposes an expected loss approach to accounting for the impairment of certain financial assets. The SD amends the FASB's May 2010 ED of a proposed ASU on accounting for financial instruments. The SD comment period ended April 1, Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 11 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 12 Module 1 2

3 Focus on California Business BACKGROUND: Capital vs. Operating Leases Banks and Other Lending Institutions Very large sector of California economy California has more home foreclosures than any other state Increased application of FV measurement to financial assets could lead to significant write-downs, especially for financial assets linked to residential-mortgage loans. Use of an expected loss model would generally Result in earlier recognition of credit losses Alter the measurement of interest revenue Under ASC Topic 840, Leases, Leases that transfer substantially all of the benefits and risks of ownership from the lessor to the lessee are classified as Capital Leases. All other leases are classified as Operating Leases. For accounting purposes, Capital Leases are treated as seller-financed sales of property by lessors to lessees (i.e., "financing" transactions rather than "rental" transactions) Operating Leases are treated as simple rentals of property Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 13 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 14 ED: Leases ED: Major Provisions On Aug. 17, 2010, the FASB issued a 128-page ED of a proposed ASU, Leases. The proposed ASU would profoundly change ASC Topic 840. On the same day, the IASB issued an ED proposing similar and equally profound changes to IFRS. The ED comment period ended Dec. 15, For each lease, a lessee would recognize A liability to make lease payments AND A "right-of-use" asset representing the entity's right to use the underlying asset for the lease term For each lease, a lessor would Recognize an asset representing its right to receive lease payments AND EITHER Recognize a lease liability while continuing to recognize the underlying asset OR Derecognize the rights in the underlying asset that it transfers to the lessee and continue to recognize a residual asset representing its rights to the underlying asset at the end of the lease term Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 15 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 16 Short-Term Leases Direct Implications At their March 15, 2011 joint meeting, the FASB and the IASB tentatively decided that A short-term lease, for both lessees and lessors, should be defined as: "A lease that, at the date of commencement of the lease, has a maximum possible term, including any options to renew, of f12 months or less." Lessees and lessors may elect, as an accounting policy for a class of underlying asset(s), to account for all short-term leases by not recognizing lease assets or lease liabilities and by recognizing lease payments in profit or loss on a straight-line basis over the lease term, unless another systematic and rational basis is more representative of the time pattern in which use is derived from the underlying asset. Fewer opportunities for entities to keep lease-related assets and liabilities off of the balance sheet Initial capitalization of lease-related assets and liabilities likely higher than under current capital-lease treatment Lessees' financial leverage metrics will change (e.g., liabilities-to-equity to equity ratio will increase) Recharacterization from rent to amortization/interest Expense-recognition patterns likely to change Measures of lessees' financial performance will change (e.g., EBITDA, ROA) No grandfathering of existing leases Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 17 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 18 Module 1 3

4 Expected Indirect Implications Focus on California Business Shortening of lease terms Fewer options to renew / cancelation penalties More risk / uncertainty for lessees and lessors Operational Financial Higher turnover of leased property Higher lease rates? Budgeting Compensation plans Real-estate charge-back methodologies Compliance with loan and other contractual covenants IT systems Transportation and Utility Companies California's San Pedro Bay Ports complex is the largest trade gateway in the United States California ranks #2 among the states in total energy consumption Definition of a lease (lease or service contract?) Shipping-vessel charters (bareboat, time, voyage) Power purchase arrangements (PPAs) Other issues Cost-plus contract pricing Rate-setting in regulated industries Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 19 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 20 Revenue Recognition under U.S. GAAP ED: Revenue from Contracts with Customers The revenue-recognition provisions of U.S. GAAP are Unique to the United States In many cases, industry-specific specific and/or arrangementspecific Often inconsistent with the general revenuerecognition principle of U.S. GAAP Documented in ASC Topic 605, Revenue Recognition On June 24, 2010, the FASB issued a 164-page ED of a proposed ASU, Revenue from Contracts with Customers. The proposed ASU would profoundly change ASC Topic 605. On the same day, the IASB issued an ED that proposed profound changes to IFRS so as to fully converge with what the FASB proposed. The ED comment period ended Oct. 22, Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 21 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 22 ED: Objectives ED: Core Principle The objectives of the proposed changes are to Clarify the principles for recognizing revenue Develop a common revenue standard for U.S. GAAP and difrsth that: t Removes inconsistencies and weaknesses in existing revenue recognition standards and practices Provides a more robust framework for addressing revenue recognition issues Improves comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets Simplifies the preparation of financial statements by reducing the number of requirements to which entities must refer An entity shall recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration the entity receives, or expects to receive, in exchange for those goods or services. Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 23 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 24 Module 1 4

5 ED: Applying the Core Principle Summary of Post-ED Tentative Decisions To apply the core principle, an entity would: 1. Identify contracts with customers 2. Identify separate performance obligations within each contract 3. Determine the transaction price of each contract 4. For each contract, allocate the transaction price to the separate performance obligations 5. Recognize revenue when the entity satisfies each performance obligation Jan , 2011 joint FASB-IASB meeting: Eliminate the proposed requirement in the ED to account for one contract as two or more contracts if the price of some goods or services in the contract is independent of the price of other goods or services in the contract. Feb. 1-2, 2011 joint FASB-IASB meeting: A selling entity should recognize a performance obligation for some warranties (akin to the current "sales" approach) while recognizing a warranty obligation for other warranties (akin to the current "expense" approach) A selling entity should recognize an asset for the incremental costs of obtaining a contract to the extent that the entity expects to recover the costs Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 25 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 26 Focus on California Business What's Next for the FASB's Major Projects? High-Tech Companies Silicon Valley Largest concentration of high-tech companies in the world 15x the national concentration of jobs in computer and electronic products manufacturing California ranks #1 among the states in number of High-tech companies High-tech workers Revenue recognition issues: Multiple-element arrangements Long-term service contracts Capitalization of costs Software license fees Many more issues for the FASB and IASB to redeliberate The FASB expects to issue final ASUs in 3Q2011 The IASB will finalize changes to IFRS within the same timeframe If retrospective application is required, preparation by reporting entities must begin ASAP Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 27 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 28 Focus on California Business The Need for "Bilingual" CPAs Multinational Parents and Subsidiaries California ranks #1 among the states in attracting foreign direct investment California ranks #2 among the states in total exports Over time, there will be fewer differences between U.S. GAAP and IFRS Examples of Employers and Clients That Need CPAs Who Have IFRS Competencies In Addition to (Not Instead of) U.S. GAAP Competencies Multinational companies that are based in California California companies that acquire or seek to acquire foreign subsidiaries California subsidiaries of multinational companies that are based outside the United States California companies that are acquired by or seek to be acquired by foreign parents Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 29 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 30 Module 1 5

6 Concluding Thoughts To Receive CPE Credit What Is Most Likely to Happen Multi-lateral standard-level convergence between U.S. GAAP and IFRS will continue, eventually resulting in profound changes to both sets of standards, but not to the point where the two sets of standards will be identical Country-to-country variations in the adoption, interpretation, and application of IFRS will persist The SEC will allow U.S. registrants to choose between future U.S. GAAP and future IFRS In the United States, the private-company standard-setting process will remain closely coupled with the public-company standard-setting process, but private U.S. companies will continue to have many choices of standards U.S. companies that participate in the global economy will start using IFRS while continuing to use U.S. GAAP This Webinar qualifies for 1 CPE credit To earn CPE credit, you must enter 4 words / phrases within 24 hours of the Webinar At conclusion of webcast, go to: See instructions under AFTER THE WEBINAR Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 31 Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 32 ADP CPE Webinar Thank You! Forthcoming Changes in U.S. GAAP: Impact on California Businesses 2011 SmartPros Ltd. Slide 33 Module 1 6