Defining Issues January 2013, No. 13-5

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1 Defining Issues January 2013, No EITF Reaches Final Consensuses on Cumulative Translation Adjustments and Joint and Several Liability Arrangements The FASB s Emerging Issues Task Force (EITF) discussed seven issues at its January 17, 2013 meeting and reached final Consensuses on two issues: (1) accounting for the cumulative translation adjustment upon certain derecognition events; and (2) accounting for joint and several liability arrangements. The EITF reached a Consensus-for-Exposure on two issues: (1) the addition of the fed funds rate as a benchmark interest rate for hedge accounting purposes; and (2) the effect of net operating losses on the presentation of the tax effects of unrecognized tax benefits. The EITF also discussed accounting for certain personnel services received by a not-for-profit entity from an affiliate, potential guidance on the scope and application of pushdown accounting, and the accounting for public sector-toprivate-entity service concession arrangements. Contents Final Consensuses 1 Consensuses-for-Exposure 3 Other Issues Discussed 5 EITF Agenda 7 The final Consensuses and the Consensuses-for-Exposure must be ratified by the FASB before they become authoritative or issued for exposure. The FASB is scheduled to consider the final and proposed Consensuses for ratification at its January 30, 2013 meeting. Final Consensuses Parent s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (Issue 11-A). A parent entity may enter into a transaction to sell or transfer a subsidiary or a group of assets that is a nonprofit activity or a business within a consolidated foreign entity while retaining its ownership interest in the foreign entity. Current consolidation guidance states that when a parent sells a partial ownership interest in a subsidiary or a group of assets that is a nonprofit activity or a business (other than a sale of in-substance real estate or conveyance of oil and gas mineral rights), the accounting is determined by whether the parent maintains control after the transaction. 1 If the parent loses control, it deconsolidates the subsidiary or derecognizes the group of assets and equity components that some believe includes the related cumulative translation adjustment (CTA). Application of that guidance would result in entities reclassifying a portion of the CTA into earnings upon sale of a subsidiary or group of assets that is a nonprofit activity or a business within a consolidated foreign entity. 1 FASB ASC Subtopic , Consolidation Overall, available at

2 However, contradictory foreign currency guidance exists. 2 This guidance requires the CTA to remain in equity until the foreign entity is disposed of or it is completely or substantially completely liquidated. Entities that follow this guidance would not reclassify a portion of the CTA into earnings upon sale of a subsidiary or group of assets within a foreign entity unless the sale represented a complete or substantially complete liquidation of the foreign entity. At its January 2013 meeting, the EITF reached a final Consensus that, for transactions within a foreign entity, a parent should not reclassify into earnings an allocated portion of the CTA when its foreign entity sells a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business within the foreign entity, unless the sale represents a complete or substantially complete liquidation of the foreign entity. For sales or other transactions that result in the parent company s loss of control over the foreign entity, the EITF reached a final Consensus that the loss of controlling financial interest in a foreign entity, irrespective of any retained investment, would be accounted for as a sale under ASC Topic 830, which means that the entire CTA would be reclassified into earnings. The EITF also reached a final Consensus that a partial sale of an equity method investment in a foreign entity would result in a pro rata share of CTA being reclassified into earnings under ASC Topic 830. Consistent with the accounting for step acquisitions, the EITF also concluded that CTA should be reclassified into earnings when a parent obtains a controlling financial interest in a foreign entity that was previously an equity method investment. The final Consensus will be applied prospectively and will be effective for public entities for fiscal years beginning on or after December 15, 2013, and for nonpublic entities for the first annual period beginning on or after December 15, Early adoption will be permitted. Accounting for Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date (Issue 12-D). Under joint and several liability arrangements, the lender can demand payment of the total amount of the obligation from any one of the obligors or any combination of the obligors. Each obligor is primarily responsible and cannot refuse to pay on the basis that other parties also are obligated to perform. However, the paying obligor may have a right to pursue the other obligors for repayment, depending on the facts and circumstances. Although U.S. GAAP provides specific guidance for certain similar types of liabilities (e.g., contingencies, environmental remediation, and tax liabilities), there are diverse practices in how entities present fixed obligations with joint and several liability. Obligations where specific guidance exists under U.S. GAAP, such as contingencies, environmental remediation, and tax liabilities, are excluded from the scope of this issue. 2 FASB ASC Topic 830, Foreign Currency Matters, available at Defining Issues / January 2013 / No

3 The EITF reached a final Consensus that entities would record an obligation resulting from joint and several liability arrangements at the greater of the amount that the entity has agreed to pay or the amount the entity expects to pay. In the final Consensus, the Task Force eliminated a provision in the Consensus-for-Exposure that would have required an entity to account for an obligation from a joint and several liability arrangement under the guarantee guidance (including the requirement that the reporting entity record the fair value of any stand-ready obligation) if the primary role of the reporting entity in the arrangement was a guarantor. Consequently, all obligations with joint and several liability arrangements will be recorded using this Consensus. Additional disclosures about joint and several liability arrangements will be required. The final Consensus will be effective for public entities in fiscal years (and interim periods within those years) beginning after December 15, 2013 and will be effective for nonpublic entities in fiscal years ending after December 15, The guidance will be applied on a retrospective basis for obligations that exist at the beginning of an entity s fiscal year of adoption. Early adoption will be permitted. Consensuses-for-Exposure Inclusion of the Fed Funds Effective Swap Rate as a Benchmark Interest Rate for Hedge Accounting Purposes (Issue 13-A). Currently, the only acceptable benchmark rates for hedge accounting purposes in the U.S. markets are U.S. Treasury rates (UST) and LIBOR. 3 Because of the 2008 financial crisis, the demand for hedging products incorporating the fed funds rate has increased significantly. Factors driving that demand have been the increased focus by banks on their sources of funding, the widening spreads between LIBOR and the overnight index swap (OIS), and the collateralization of derivatives. The effect of this change is not confined to financial institutions. Other entities also are exposed to OIS via the return on collateral and the valuation of collateralized derivatives. Before the credit crisis, U.S. market participants commonly valued their derivative instruments using LIBOR as the discount rate, but now they have begun using OIS to value derivatives. For entities that apply hedge accounting, using OIS to value derivative hedging instruments instead of a benchmark rate can result in accounting ineffectiveness and earnings volatility, even if the pertinent features of a hedging derivative match those of the hedged item. Although an entity uses OIS for valuing hedging derivatives, accounting standards require a benchmark rate to determine the change in value of the items being hedged in a fair value hedge. 3 The Fed Funds Rate is the negotiated interest rate at which depository institutions actively trade balances held at the Federal Reserve with each other, usually overnight, to meet reserve requirements. The weighted average of this rate is the overnight fed funds effective rate. The related OIS (overnight index swap) rate is the fixed rate swapped in exchange for the overnight fed funds effective rate. A benchmark rate is a widely recognized and quoted rate in an active financial market that is broadly indicative of the overall level of interest rates attributable to high-credit-quality obligors in that market. It is a rate that is widely used in a financial market as an underlying basis for determining the interest rates of individual financial instruments and commonly referenced in interest-rate-related transactions. Defining Issues / January 2013 / No

4 Advocates of allowing the fed funds rate for hedge accounting believe that it better reflects current hedging strategies. They assert that when the Board decided on UST and LIBOR as the only acceptable benchmarks, the frequency of transactions using the fed funds rate was less than today s level, and they point to a statement in the accounting literature that indicates that the definition of a benchmark rate that may be hedged should be flexible enough to withstand potential future developments. Advocates also note that the fed funds rate is the most liquid and transparent overnight rate in the United States and that if it were permissible as a benchmark, hedgers would more readily use it, which could reduce the accounting ineffectiveness that currently results. The EITF reached a Consensus-for-Exposure that the fed funds rate could be used as a benchmark interest rate for hedge accounting purposes. The Consensus-for-Exposure will apply to both public and nonpublic entities and will likely be effective upon finalization of the guidance. The guidance will be applied prospectively to new hedge relationships and de-designated and re-designated hedge relationships. Presentation of a Liability for an Unrecognized Tax Benefit When a Net Operating Loss or Tax Credit Carryforward Exists (Issue 13-C). When an entity has an unrecognized tax benefit and a net operating loss carryforward (NOL) or tax credit carryforward exists in the same jurisdiction as the tax position, the loss of the tax position may reduce the NOL or tax credit carryforward instead of resulting in cash payment. The issue of gross versus net presentation of the deferred tax asset for the carryforward and the tax effect of the uncertain tax position is not specifically addressed under U.S. GAAP. The EITF discussed the following three alternatives for presenting the tax effects of the uncertain tax position: View A: Present the unrecognized tax benefit as a reduction of the deferred tax asset for an NOL or tax credit carryforward (rather than as a liability) when the uncertain tax position would reduce the NOL or tax credit carryforward under the provisions of the tax law. View B: Present the unrecognized tax benefit as a liability in the statement of financial position unless the unrecognized tax benefit is directly associated with a tax position taken in a tax year that results in, or that resulted in, the recognition of an NOL carryforward for that year (and the NOL carryforward has not yet been utilized). View C: An entity shall make an accounting policy election to apply either View A or View B. The EITF reached a Consensus-for-Exposure with View A that uncertain tax positions would reduce the deferred tax asset for the NOL or tax credit carryforward. The draft abstract for exposure will propose retrospective application, and will request comments from constituents to specifically address the difficulty of applying the guidance retrospectively. There were no new disclosures that the EITF determined were necessary. Defining Issues / January 2013 / No

5 Other Issues Discussed Not-for-Profit Entities: Personnel Services Received from an Affiliate for Which the Affiliate Does Not Seek Compensation (Issue 12-B). A not-forprofit entity (NFP) may operate under arrangements where an affiliated entity assigns employees to work for the recipient NFP entity. Under these arrangements, the contributing entity may continue to pay the personnel costs of the employees and may not seek reimbursement of the personnel costs. Under existing guidance, services received from employees of affiliated entities generally are accounted for based on the guidance for contributed services received from unrelated parties. Based on that guidance, the recipient NFP entity only recognizes contributed services from affiliates if the services either: (a) create or enhance nonfinancial assets; or (b) require specialized skills, which are provided by individuals possessing the skills, and would typically need to be purchased if they had not been donated. 4 Contributed services received that meet those criteria are measured at fair value. Previously during the June 2012 meeting, the EITF reached a Consensus-for- Exposure that an NFP would recognize personnel services that are performed by employees of an affiliated entity at actual cost to the affiliated contributing entity. The components of cost would depend on the nature and type of service provided and may vary by entity. However, at a minimum, costs should include all direct personnel costs (e.g., compensation and payroll-related fringe benefits) incurred by the affiliate providing the services to the recipient NFP. For NFPs that provide a performance indicator (such as NFP business-oriented health care entities), the receipt of contributed services from an affiliate would be presented as an equity transfer. For NFPs that do not present a performance indicator, the guidance would preclude contra-expense presentation but would not otherwise prescribe how the receipt of the services would be presented. During the January 2013 meeting, the EITF discussed how the proposed Consensus might impact the accounting by NFP entities for services contributed by for-profit corporations or individuals that establish NFP foundations. This issue will be discussed at future meetings. Recognition of New Accounting Basis (Pushdown) in Certain Circumstances (Issue 12-F). Under pushdown accounting, the acquirer s purchase accounting, or new basis in the acquiree, is pushed down to the acquiree s separate financial statements. Under current U.S. GAAP, there is limited guidance for determining when, if ever, pushdown accounting should be applied. The SEC staff has provided guidance for SEC registrants on pushdown accounting, which indicates that if a purchase transaction results in an entity becoming substantially wholly owned, its standalone financial statements should be adjusted to reflect the acquirer s basis of accounting. 4 FASB ASC Subtopic , Not-for-Profit Entities Revenue Recognition, available at Defining Issues / January 2013 / No

6 Three alternative views about whether and, if so, when pushdown accounting should be required in separate financial statements of a reporting entity were presented to the Task Force at its January 2013 meeting and included: View A: A new accounting basis should be established when an acquirer obtains substantially all of the controlling financial interest in a reporting entity and obtains control over the form of ownership of the reporting entity. View B: A new accounting basis should be established when an acquirer obtains control of the reporting entity. View C: A new accounting basis should not be established in an acquired entity s separate financial statements. The EITF requested that the staff further consider View B and related issues. The Task Force also noted that the conclusion on this issue may differ for private companies. This issue will be discussed at future meetings. Accounting for Service Concession Arrangements (Issue 12-H). Service concession arrangements (SCAs) are public-to-private contracts where a public sector entity grants a private entity (operating entity) the right to construct, operate, or maintain the public sector entity s infrastructure assets, such as roads, bridges, tunnels, airports, prisons, or hospitals. 5 In typical service SCAs: The operating entity provides initial consideration by constructing or upgrading the infrastructure, making a cash payment, or a combination of these actions; The contracted services must meet minimum performance requirements; and The public sector entity controls the residual interest in the infrastructure at the end of the contract term or specifies the minimum conditions the infrastructure must be in at the end of the term. U.S. GAAP does not specifically address accounting for public-to-private service concession arrangements; however, International Financial Reporting Standards address these arrangements in IFRIC The primary issue addressed by the EITF was how an entity should account for a SCA when both of the following conditions exist: The public sector entity controls or has the ability to modify or approve what services the operating entity must provide with the infrastructure, to whom it must provide them, and at what price; and 5 A public sector entity includes a governmental body or a private sector entity to which the responsibility for the service has been devolved. 6 IFRIC 12, Service Concession Arrangements. Defining Issues / January 2013 / No

7 The public sector entity controls any residual interest in the infrastructure at the end of the arrangement through ownership, beneficial entitlement, or another arrangement. The EITF reached a tentative conclusion that the operating entity s rights resulting from public-to-private service concession arrangements that meet the above conditions should be accounted for as a service arrangement rather than a lease. The arrangement may result in recognition of a financial asset, an intangible asset, or both. The EITF will discuss this issue at future meetings. EITF Agenda In addition to the various issues discussed at the January meeting, the following issues are also on the EITF s agenda for discussion at future meetings: Accounting for the Difference Between the Fair Value of the Assets and the Fair Value of the Liabilities of a Consolidated Collateralized Financing Entity (Issue12-G); and Accounting for Investments in Tax Credits (Issue 13-B). Contact us: This is a publication of KPMG s Department of Professional Practice Contributing authors: Mark M. Bielstein Sam O. Kerlin Rory S. Doheny Michael A. Gaiso Anthony Isaacson Jeffrey M. Knight Kevin P. Slama Earlier editions are available at: The descriptive and summary statements in this newsletter are not intended to be a substitute for the texts of the EITF s Consensuses, FASB pronouncements, FASB Codification, SEC regulations, official minutes, or any other potential or actual requirements. Companies applying U.S. GAAP or filing with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and consult their accounting and legal advisors. Defining Issues is a registered trademark of KPMG LLP KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative ( KPMG International ), a Swiss entity.