Defining Issues. EITF Reaches Two Final Consensuses and Three Consensuses-for-Exposure. March 2015, No Key Facts.

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1 Defining Issues March 2015, No EITF Reaches Two Final Consensuses and Three Consensuses-for-Exposure The FASB s Emerging Issues Task Force (EITF) discussed five issues at its March 19, 2015, meeting and reached two final consensuses and three consensuses-for-exposure. The EITF s decisions must be ratified by the FASB before they are issued or become authoritative. The FASB is scheduled to consider those decisions at its April 7, 2015, meeting. Contents Final Consensuses... 2 Consensuses-for-Exposure... 4 Future Agenda Items... 8 Key Facts Final consensuses were reached on the following issues. Effects on Historical Earnings per Unit of Master Limited Partnership Dropdown Transactions (Issue 14-A) Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (Issue 14-B) Consensuses-for-exposure were reached on the following issues. Application of the Normal Purchases and Normal Sales Scope Exception to Certain Electricity Contracts within Nodal Energy Markets (Issue 15-A) Recognition of Breakage for Prepaid Stored-Value Cards (Issue 15-B) Employee Benefit Plan Simplifications (Issue 15-C) Key Impacts Master Limited Partnership Dropdown Transactions. The final consensus would require a Master Limited Partnership to allocate net income (loss) of the transferred business entirely to the general partner when computing earnings per unit for prior periods. Investments Measured at Net Asset Value. The final consensus would exclude investments whose fair value is measured at net asset value under the practical expedient from the fair value hierarchy disclosure requirements.

2 Final Consensuses Effects on Historical Earnings per Unit of Master Limited Partnership Dropdown Transactions (Issue 14-A) The EITF reached a final consensus on presenting earnings per unit (EPU) of a master limited partnership (MLP) for comparable periods prior to the date of a common-control dropdown transaction. In this scenario, an MLP would be required to allocate net income (loss) of the transferred business entirely to the general partner (GP) when computing EPU for prior periods. The final consensus would require an MLP to describe the impact of the dropdown transaction on EPU for the periods before and after the dropdown transaction occurred. The Task Force also decided on retrospective transition with no additional transition disclosure other than what is currently required for accounting changes. 1 The effective date would be for annual and interim periods in fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption would be permitted. Background and Observations. MLPs often issue multiple classes of securities consisting of common units held by limited partners, a GP interest, and incentive distribution rights available to the GP. Distributed and undistributed earnings are allocated to each class of security according to the partnership agreement. Therefore, MLPs use the two-class method to calculate EPU under ASC Subtopic A GP will often convey a business to the MLP in exchange for cash or an additional ownership interest, which is referred to as a dropdown transaction. These transactions are generally accounted for as a reorganization of entities under common control, with the MLP retrospectively adjusting financial statements of prior periods as if the dropdown occurred at the beginning of the earliest period in which the entities were under common control. No current guidance addresses how to calculate EPU for periods prior to the date of a dropdown transaction that occurs subsequent to the formation of the MLP, which leads to diversity in practice. Next Steps. The FASB will consider ratification of this final consensus at a meeting in April. Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (14-B) The EITF reached a final consensus that would remove the requirement to categorize within the fair value hierarchy investments in certain funds whose fair values are measured at net asset value (NAV) under the practical expedient in Topic Reporting entities would be required to disclose the amount of investments measured at NAV under the practical expedient to allow users to reconcile the fair value hierarchy to the line items presented in the statement of 1 FASB ASC paragraphs through 50-3, available at 2 FASB ASC Subtopic , Earnings Per Share Overall, available at 3 FASB ASC Topic 820, Fair Value Measurement, available at 2

3 financial position. The new guidance also would limit the scope of current disclosure requirements to investments in which the practical expedient is applied, instead of all eligible investments. In addition, the EITF decided to make conforming amendments to other standards. Statement of Cash Flows Exemption for Certain Investment Companies. The amendments would continue to exempt certain investment companies from the requirement to prepare a statement of cash flows. 4 Specifically, an investment company would be eligible for this exemption if substantially all of its investments were measured at fair value and classified as Level 1 or Level 2 measurements, or were measured using the practical expedient and are redeemable in the near term at all times. Disclosures for Pension Plan Investments. The amendments would clarify that pension plan assets can be valued using the practical expedient. These investments would not be categorized within the fair value hierarchy in the plan sponsors financial statements. 5 The new guidance would require retrospective adoption. The effective date for public business entities would be for annual periods beginning after December 15, 2015, and interim periods within those annual periods. The effective date for all other entities would be deferred by one year. Early adoption would be permitted for all entities. Background and Observations. Reporting entities are generally permitted to use NAV as a practical expedient to estimate the fair value of an investment when: The investment does not have a readily determinable fair value; and The investment is in an investment company within the scope of Topic In current practice, categorization within the fair value hierarchy of an investment to which the practical expedient is applied is dependent on the redemption attributes of the investment. Those that are redeemable at NAV on the measurement date are currently categorized as Level 2. Investments that will never be redeemable, or if future redemption dates are unknown, are currently categorized as Level 3. For those investments redeemable at a future date, reporting entities need to determine if the investment is redeemable in the near term, in which case it is classified as Level 2. However, near term is not defined in Topic 820, and preparers have interpreted it differently (e.g., as the ability to redeem quarterly or semi-annually). This has resulted in diversity in practice. Some reporting entities recategorize investments between Level 2 and Level 3 at different dates because, on certain measurement dates, the investment is redeemable in the near term while on other reporting dates it is not. Reporting entities with different fiscal year-ends also may categorize identical (or similar) investments differently, depending on how their fiscal year-end aligns with the investments redemption dates. 4 FASB ASC Topic 230, Statement of Cash Flows, available at 5 FASB ASC Topic 715, Compensation Retirement Benefits, available at 6 FASB ASC Topic 946, Financial Services Investment Companies, available at 3

4 Next Steps. The FASB will consider ratification of the final consensus at a meeting in April. Consensuses-for-Exposure Application of the Normal Purchases and Normal Sales Scope Exception to Certain Electricity Contracts within Nodal Energy Markets (Issue 15-A) The EITF discussed whether certain forward contracts for physical delivery of electricity in nodal energy markets in which one of the counterparties incurs location marginal pricing (LMP) charges (or credits) payable to (or receivable from) an Independent System Operator (ISO) qualify for the normal purchases and normal sales (NPNS) scope exception. This issue is intended to eliminate diversity in practice. The EITF considered two alternative approaches. Alternative 1. Amend GAAP to clarify that forward contracts for physical delivery of electricity within nodal energy markets do not meet the physical delivery criterion of the NPNS scope exception. Alternative 2. Amend GAAP to create an exception that allows electricity contracts for physical delivery within nodal energy markets to qualify for the NPNS scope exception. The EITF reached a consensus-for-exposure on Alternative 2. Members of the Task Force believe extending the NPNS scope exception to such contracts is consistent with the FASB s intent to provide the exception for contracts for physical delivery of nonfinancial assets. The EITF also reached a consensus-for-exposure on prospective transition. Background and Observations. The transmission of electricity has evolved over time from power companies owning and operating their own transmission systems to the formation of interconnection groups where several companies in the same geographic region connected their transmission systems. Changes in U.S. energy policy have promoted greater access to the grid with a goal of lowering the cost of electricity. That goal was achieved in part by encouraging companies to join Regional Transmission Organizations within which day-to-day grid operations are managed by an ISO. ISOs do not generate, market, or trade electricity for their own account. Rather, their activities are profit neutral and quantity balanced. However, ISOs generally take title to electricity as it is transmitted through the grid. The price an ISO charges market participants to use the grid includes a transmission system charge for use of the lines, a charge to cover administrative and operating costs, and the difference between LMPs at the delivery and withdrawal locations. Under LMP methodology, the ISO assigns prices for electricity at locations (referred to as nodes) on the grid where electricity can be delivered and withdrawn. LMPs are based on supply, demand, capacity, and congestion; therefore, the differences can be either positive or negative. Nodes are located at generation sites, consumer sites, and aggregation points. 4

5 Example 1: Forward Contract for Electricity Delivery Facts: PowerCo is a retail electric utility with customers in the PJM Interconnection Group (PJM). PowerCo does not own generation facilities in PJM and, therefore, must purchase wholesale power for resale to its customers. PowerCo s customer load zone is Location A. PowerCo enters into a fixed-price forward contract to purchase 100,000 megawatt hours (MWh) from GenCo for $45 / MWh for physical delivery at Location B, because Location A has relatively illiquid forward prices compared to Location B. PowerCo takes physical title at Location B and sells it to its end customers at Location A; PJM takes title between Location B and A. Assume LMPs of $44.50 at Location B and $46 at Location A when electricity is delivered; the cash flows are: Cash paid by PowerCo to GenCo = $45 x 100K MWh = $4,500,000 Cash paid by PowerCo to ISO = ($46 - $44.50) x 100K MWh = $150,000 Under Alternative 1, PowerCo would be required to mark-to-market the forward contract each reporting period. Under Alternative 2, if PowerCo elects NPNS, the forward contract would be treated similar to an executory contract with no accounting required until the electricity is delivered. KPMG Observations Forward contracts for the physical delivery of electricity in nodal energy markets bear similarities to contracts for the physical delivery of commodities in other industries. However, in other industries companies generally have other available options to arrange for physical delivery at a specific location. In the nodal energy markets there are no available options that eliminate the ISO. Making these contracts eligible for the NPNS scope exception does not necessarily make the exception available because the Issue only addresses the physical delivery criterion. Companies will continue to need to evaluate other NPNS criteria to determine whether the scope exception can be elected. Next Steps. The FASB will consider ratification of this consensus-for-exposure at a meeting in April. 5

6 Recognition of Breakage for Prepaid Stored-Value Cards (Issue 15-B) Consumers may never redeem certain prepaid stored-value cards (prepaid cards) that are eligible to be redeemed only for goods and services at a third party such as a retailer or restaurant. However, the prepaid card issuer recognizes a liability on its balance sheet at issuance. Four alternatives were discussed including how this liability should be derecognized when some portion of the prepaid cards are not expected to be redeemed. Alternative 1. The liability meets the definition of a financial liability, and accordingly, an entity should follow the derecognition guidance in ASC Subtopic , which states that the liability is derecognized when either the debtor pays the creditor, or the debtor is legally released from being the primary obligor. 7 Alternative 2. Similar to Alternative 1, the liability meets the definition of a financial liability. However, a narrow-scope exception would be made to the derecognition guidance in ASC Subtopic to require the recognition of breakage in the same manner as revenue transactions if an entity expects to be entitled to a breakage amount. Alternative 3. The liability does not meet the definition of a financial liability. Therefore, the card issuer should follow the breakage guidance for revenue transactions in ASC Topic Alternative 4. Similar to Alternative 1, the liability meets the definition of a financial liability. However, unlike Alternative 1, an entity would be given the option to make a one-time policy election to measure prepaid card liabilities at fair value using ASC Topic The EITF reached a consensus-for-exposure on Alternative 2. Members of the Task Force believed the liability is financial because the substance of the arrangement is a transaction between the card issuer and the consumer that ultimately is settled in cash through a third party. However, members of the Task Force also agreed that recognition of the liability (potentially in perpetuity) when a consumer has no expectation of performance from the card issuer and, when settlement of that liability is remote, does not provide useful information. Similar to the breakage guidance in ASC Topic 606, the consensus-for-exposure would require a card issuer that expects to be entitled to a breakage amount to recognize it as revenue in proportion to the pattern of rights exercised by the consumer. If the card issuer does not expect to be entitled to a breakage amount, it should recognize breakage as revenue when the likelihood of the consumer exercising its remaining rights becomes remote. The consensus-for-exposure would require a modified retrospective transition approach, with a cumulative catch-up adjustment to opening retained earnings in the period of adoption. Entities also would be required to disclose the methodology used to calculate breakage, the judgments, and changes in judgments used in determining the timing of satisfaction of performance obligations. An explanation of why the methods used provide a faithful depiction 7 FASB ASC Subtopic , Liabilities Extinguishments of Liabilities, available at 8 FASB ASC Topic 606, Revenue from Contracts with Customers, specifically paragraphs through 55-49, available at 9 FASB ASC Topic 825, Financial Instruments, available at 6

7 of the transfer of goods or services would be included. Entities would need to disclose the nature of and reason for the change in accounting principle in the first interim and annual period of adoption. Background and Observations. Except for certain jurisdictions where prepaid cards are subject to escheat laws, this EITF issue may apply to open-loop or semi-closed loop cards that may be redeemed for goods and services from a third party or for cash. This EITF issue does not apply to arrangements in which a card issuer directly provides goods or services to the consumer through closedloop cards (i.e., cards are only redeemable at that retail chain or its affiliates, which would be covered by revenue recognition guidance). These open-loop or semi-closed loop prepaid cards: Do not expire; Are redeemable for goods and services only at designated content providers (i.e., only at content providers that accept prepaid cards on a specific card network); Are not directly attached to a segregated bank account such as a debit card or a checking account; and Are settled by the card issuer when it pays cash to a third party for providing goods or services, or when allowable, when it pays cash to the cardholder. In a 2005 SEC speech on breakage, the SEC staff indicated that a vendor should apply the derecognition guidance in ASC Subtopic in an arrangement in which a customer makes a payment in advance of vendor performance. However, the SEC staff acknowledged that derecognition may be acceptable in certain circumstances if the vendor can demonstrate that it is remote that a customer will require performance. Although the SEC staff views do not specifically address cards that may be redeemed only from a third party, and are not included in the FASB s Codification, some entities have applied those views in the absence of other specific authoritative guidance. During the meeting, some Task Force members questioned whether the scope of the issue should be broadened to include other similar arrangements, such as customer loyalty programs where points/miles can be redeemed for goods or services from a third party. However, the Task Force decided to move forward with the current scope, and include questions in the Exposure Draft to identify and evaluate other similar arrangements. Next Steps. The FASB will consider ratification of this consensus-for-exposure at a meeting in April. Employee Benefit Plan Simplifications (Issue 15-C) The EITF discussed three issues that would simplify benefit plan disclosure and reporting requirements: Fully Benefit Responsive Investment Contracts (FBRICs). The EITF reached a consensus-for-exposure that would allow employee benefit plans to measure FBRICs at contract value and exempt them from fair value disclosure requirements. 7

8 Topic 820 Disclosures for Plan Assets. The EITF reached a consensus-forexposure that would change disclosure requirements for plan assets. Plans would only need to disclose assets by type (consistent with the Plan Accounting Topics) and not by their nature, risks, and characteristics (as required by Topic 820). 10 Self-directed brokerage accounts would be considered a type of asset. These disclosures could be presented on the face of the financial statements or in the notes. The Plan Accounting Topics requirement to disclose individual investments over five percent would be eliminated. The Topic 820 requirement to disclose investment strategies would be eliminated for all funds that file a Form 5500 as a direct filing entity. The Plan Accounting Topics requirement to show net appreciation or depreciation by general type would be eliminated. Measurement Date Practical Expedient. The EITF reached a consensus-forexposure that would allow plans to use a practical expedient when measuring assets when the fiscal period does not coincide with a month-end. In those instances, the plan would use the month-end values and disclose the date and financial effects of contributions, distributions, and significant events. Background and Observations. The primary objective of employee benefit plan financial reporting is to provide financial information that is useful in assessing a plan s present and future ability to pay benefits as they become due. The users of plan financial statements include the Department of Labor, the IRS, the Pension Benefit Guaranty Corporation, the SEC, plan sponsors, trustees, and plan participants. Benefit plan accounting is addressed by ASC Topics 960, 962, and 965, which were primarily derived from FASB Statement No. 35 (issued in 1980). 11 Very few changes have been made to Statement 35 since 1980, but as other standards have been issued or updated, new disclosure requirements have been added. This project s objective is to simplify certain measurement and disclosure requirements in a way that still provides the users of plan financial statements with relevant and useful information. Future Agenda Items The FASB recently added the following issues to the EITF Agenda for the June 18, 2015 meeting: Issue 15-D, Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships Issue 15-E, Evaluation of Contingent Put and Call Options Embedded in Debt Instruments 10 FASB ASC Topics 960, 962, and 965, available at 11 FASB ASC Topics 960, Plan Accounting Defining Benefit Pension Plans; 962, Plan Accounting Defined Contribution Pensions Plans; 965, Plan Accounting Health and Welfare Benefit Plans; and FASB Statement No. 35, Accounting and Reporting by Defined Benefit Pension Plans, all available at wwwl.fasb.org. 8

9 Contact us: This is a publication of KPMG s Department of Professional Practice Contributing authors: Mark M. Bielstein, Daniel Amat, Paul Fayad, Ryan Marquez, John M. Strausser, Robin E. Van Voorhies Earlier editions are available at: Legal The descriptive and summary statements in this newsletter are not intended to be a substitute for the potential requirements of the proposed standards or any other potential or applicable requirements of the accounting literature or SEC regulations. 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. 9