June 2013 EITF Update EITF meeting highlights June 2013 meeting highlights In this issue: Final consensuses... 2 Issue 13-A: Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes... 2 Issue 13-C: Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward or Tax Credit Carryforward Exists... 3 Consensuses-for-exposure... 4 Issue 12-G: Accounting for the Difference between the Fair Value of the Assets and the Fair Value of the Liabilities of a Consolidated Collateralized Financing Entity... 4 Issue 12-H: Accounting for Service Concession Arrangements... 5 Issue 13-E: Reclassification of Collateralized Mortgage Loans upon a Troubled Debt Restructuring... 6 Issue discussed without final conclusion... 7 Issue 13-D: Determination of Whether a Performance Target That Is Allowed to Be Met after the Requisite Service Has Been Provided by the Employee Is a Vesting Condition or a Condition That Affects the Grant-Date Fair Value of the Awards... 7 Members of the Emerging Issues Task Force (EITF or Task Force) reached final consensuses on two issues and consensuses-for-exposure on three issues. The Task Force discussed a sixth issue without final conclusion. The final consensuses and consensuses-for-exposure are subject to ratification by the Financial Accounting Standards Board (FASB) at its 26 June 2013 meeting. The EITF may further clarify the consensuses during the drafting process. The Task Force reached final consensuses on the following issues: Issue 13-A The EITF concluded that the federal funds effective rate is an acceptable US benchmark rate for hedge accounting purposes. Issue 13-C The EITF concluded that an unrecognized tax benefit should be presented as a reduction of a deferred tax asset for a net operating loss (NOL) carryforward or other tax credit carryforward when settlement in this manner is available under the tax law. The Task Force reached consensuses-for-exposure on the following issues: Issue 12-G The EITF concluded that a reporting entity that measures the financial assets and financial liabilities of a consolidated collateralized financing entity (CFE) at fair value should use the fair value of the financial assets to measure the value of the financial liabilities. Issue 12-H The EITF concluded that public-to-private service concession arrangements meeting certain criteria would not be considered leases. Issue 13-E The EITF concluded that a creditor should be considered to have physical possession of a real estate property that is collateral for a loan (and therefore should reclassify the loan to other real estate owned, or OREO) when (1) it obtains legal title to the collateral or (2) the borrower voluntarily conveys all interest in the property to the lender to satisfy the loan even though legal title may not have passed (i.e., deed in lieu of foreclosure agreement).
The Task Force discussed how to account for the terms of a share-based payment that includes a performance condition that may be met after the requisite service has been provided by the employee (Issue 13-D) but didn t reach a final conclusion. Final consensuses Issue 13-A: Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes Topic 815 provides guidance on the risks that are permitted to be hedged in a fair value or cash flow hedge, including the risk of changes in a hedged item s fair value or a hedged transaction s cash flows attributable to changes in the designated benchmark interest rate (i.e., benchmark interest rate risk). Paragraph 815-20-25-6A states that, in the US, only the interest rates on direct Treasury obligations of the US government (UST) and the London Interbank Offered Rate (LIBOR) swap rate are considered benchmark interest rates. Recently, demand for hedging products referencing the federal funds effective rate has increased significantly (e.g., overnight index swaps, or OISs). An OIS is an interest rate swap for which a fixed rate of interest (OIS swap rate) is exchanged for a floating overnight rate (in the US, this is the effective federal funds rate). The demand globally for OIS products has grown due to the increased volatility and the widening of the spread between LIBOR and OIS rates as well as regulatory measures to curb systematic risks (e.g., increased collateralization of derivatives). Globally, the move away from LIBOR to OIS rates is most evident in collateralized derivative markets where OIS rates (federal funds in the US) are now widely used instead of LIBOR to calculate interest earned or due on cash collateral. The issue is whether the federal funds effective rate and the associated tenor swap rates should be permissible US benchmark interest rates for hedge accounting purposes. In the final consensus, the EITF affirmed its consensus-for-exposure to recognize the federal funds effective rate as an acceptable US benchmark rate in addition to UST and LIBOR. In addition, the EITF agreed to remove language from paragraph 815-20-25-6 that specified the use of different benchmark interest rates for similar hedges shall be rare and shall be justified because of concerns that it could potentially limit the flexibility of risk managers in hedging their interest rate risks. Companies that seek to swap their fixed rate debt for a floating rate using a centrally cleared or fully collateralized swap transaction may be able to achieve the best hedge results by swapping for the fed funds effective rate rather than LIBOR so that the forward curve and discount curve used to value that swap would be the same OIS-based curve. However, the use of the fed funds effective rate as a benchmark rate would not resolve the ineffectiveness issues in existing LIBOR interest rate swaps when OIS is used to discount future cash flows. The final consensus would be applied on a prospective basis for qualifying new or redesignated hedging relationships entered into on or after the effective date, which will be the issuance date of the Accounting Standards Update (ASU). The FASB is expected to issue the ASU by mid-july 2013. 2 EITF Update June 2013
Issue 13-C: Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward or Tax Credit Carryforward Exists In certain circumstances, the settlement of a liability for an unrecognized tax benefit does not result in a cash payment because it is settled by reducing an NOL or tax credit carryforward. ASC 740 1 does not provide explicit guidance on whether and when an entity should present an unrecognized tax benefit as a liability or as a reduction of NOL carryforwards or other tax credits that are of the same character and related to the same jurisdiction. The issue is how a liability for an unrecognized tax benefit should be presented in the financial statements when settlement of the liability with the taxing authority would otherwise reduce a deferred tax asset for an NOL or tax credit carryforward under the provisions of the tax law. Some believe that an unrecognized tax benefit should be presented as a reduction of a deferred tax asset (i.e., on a net basis) when settlement in this manner is available under the tax law. Others believe the unrecognized benefit should be presented as a liability (i.e., on a gross basis) unless the benefit is directly associated with a tax position taken in a tax year that results in the recognition of an NOL carryforward for that year (and such an NOL carryforward has not yet been used). The EITF affirmed its consensus-for-exposure that an unrecognized tax benefit should be presented as a reduction of a deferred tax asset for an NOL or other tax credit carryforward when settlement in this manner is available under the tax law. The Task Force clarified that the assessment of whether settlement is available under the tax law would be based on facts and circumstances as of the balance sheet reporting date and would not consider future events (e.g., upcoming expiration of related NOL carryforwards). The Task Force also clarified that this classification should not affect an entity s analysis of the realization of its deferred tax assets and that gross presentation in the rollforward of unrecognized tax positions in the notes to the financial statements would still be required. Many companies currently present these uncertain tax positions as liabilities as a result of a long-standing FASB staff position. The change to the net presentation will require more effort for companies that have numerous entities with cumulative NOL or tax credit carryforwards. These companies will need to work expeditiously to prepare for implementation of the final consensus in the first quarter of 2014 (for calendar year-end public companies). The final consensus would be effective for public companies for annual periods beginning after 15 December 2013, and interim periods within those periods. For nonpublic entities, the final consensus would be effective for annual periods beginning after 15 December 2014, and interim periods within those periods. The final consensus would be applied on a prospective basis to all unrecognized tax benefits that exist at the effective date. Entities would have the option to apply it retrospectively. Early adoption also would be permitted. 3 EITF Update June 2013
Consensuses-for-exposure Issue 12-G: Accounting for the Difference between the Fair Value of the Assets and the Fair Value of the Liabilities of a Consolidated Collateralized Financing Entity Reporting entities are often required to consolidate CFEs. Many reporting entities elect to measure all eligible financial assets and financial liabilities of CFEs at fair value. In many instances, the aggregate fair value of the assets of the CFE exceeds the aggregate fair value of the CFE s beneficial interests (liabilities). The issue is how a reporting entity should initially and subsequently account for the difference between the fair value of assets and the fair value of liabilities of a CFE. Some reporting entities record both the initial difference and subsequent changes in fair value as gains or losses in the consolidated statement of comprehensive income. These amounts are allocated to the noncontrolling beneficial interest holders in arriving at net income (loss) available to common shareholders and then reclassified to appropriated retained earnings in the statement of changes in equity. As a result, the changes in fair value are excluded from the reporting entity s earnings-per-share calculation. Other reporting entities initially record the difference as a direct adjustment to appropriated retained earnings in the statement of changes in equity. The Task Force amended its prior final consensus to remove the requirement to separately measure the fair value of a reporting entity s net risk exposure at the measurement date. The revised consensus-for-exposure would require a reporting entity that measures the financial assets and financial liabilities of a consolidated CFE at fair value to use the fair value of financial assets to measure the value of the financial liabilities. In its revised consensus-for-exposure, the Task Force concluded that a reporting entity would be required to provide the fair value disclosures in ASC 820 for financial assets and qualitative disclosures for financial liabilities to explain the basis of measurement (i.e., that the liabilities have been recognized at an amount that is equal to the fair value of the financial assets). The Task Force plans to seek constituent feedback on the various measurement and disclosure alternatives discussed at the meeting. We support the Task Force s decision to re-expose this Issue. It is important for constituents to provide feedback on the measurement and disclosure principles in the consensus-for-exposure, even if they agree with the proposed changes. The revised consensus-for-exposure would address current diversity in the initial accounting for the difference between the fair value of assets and the fair value of liabilities of a CFE. However, the FASB s current proposal on consolidation 2 may require many CFEs to be deconsolidated, which would reduce the number of entities affected by the consensus-for-exposure. The revised consensus-for-exposure would be applied on a modified retrospective basis (with a cumulative effect adjustment recognized as of the beginning of the period of adoption) with an option to apply a retrospective approach. Early adoption would be permitted. 4 EITF Update June 2013
Issue 12-H: Accounting for Service Concession Arrangements Service concession arrangements are contracts under which a public sector entity (grantor) grants a private entity (operating entity) the right to operate or maintain the grantor s infrastructure assets. The asset may already exist or may be constructed by the operating entity during the term of the service concession arrangement. The grantor controls any residual interest in the assets at the end of the term of the arrangement. The issue is how an operating entity should account for a service concession arrangement. Some believe the operating entity should account for its rights to operate or maintain the infrastructure as a lease and apply the guidance in ASC 840. 3 Others believe the entity should apply the principles in IFRIC 12 4 by analogy and account for its rights as an intangible asset, financial asset or both. The Task Force reached a consensus-for-exposure to clarify that a public-to-private service concession arrangement that meets both of the following conditions would not be subject to the leasing guidance in ASC 840: The grantor controls or has the ability to modify or approve the services the operating entity must provide with the infrastructure, to whom it must provide the services and at what price. The grantor controls, through ownership, beneficial entitlement or other means, any residual interest in the infrastructure at the end of the term of the arrangement. The consensus-for-exposure would require an operating entity to account for an arrangement that meets these conditions in accordance with relevant guidance (e.g., ASC 605 5 ) in US GAAP. The consensus-for-exposure modifies the Task Force s previous tentative conclusion to require an operating entity to account for its rights under a service concession arrangement as an intangible asset, a financial asset or both, similar to the guidance in IFRIC 12. The consensus-for-exposure would be applied on a modified retrospective basis to all contracts existing at the beginning of the period of adoption and all contracts entered into thereafter. 5 EITF Update June 2013
Issue 13-E: Reclassification of Collateralized Mortgage Loans upon a Troubled Debt Restructuring Loans are required to be reclassified from a creditor s loan portfolio to OREO when there is in substance a repossession or foreclosure by the creditor, that is, the creditor receives physical possession of the debtor s assets regardless of whether formal foreclosure proceedings take place 6 The issue is when a creditor should be considered to have taken physical possession of a real estate property collateralizing a loan and therefore should reclassify the loan. Some believe that the loan should be reclassified when legal title is transferred. Others believe the reclassification should occur when a creditor s primary risk is real estate risk because, in substance, a repossession or foreclosure has taken place. There also is diversity in practice for the classification of foreclosed loans that are fully guaranteed by the Federal Housing Administration (FHA). This aspect of the issue is expected to be discussed at the September EITF meeting. The Task Force reached a consensus-for-exposure that a creditor should be considered to have physical possession of a real estate property and thus would reclassify the loan to OREO when (1) it obtains legal title to the collateral or (2) the borrower voluntarily conveys all interest in the real estate property to the lender to satisfy that loan even though legal title may not have passed (i.e., deed in lieu of foreclosure agreement). At the suggestion of a FASB member, the EITF proposed incremental financial statement disclosures relating to the amount of nonperforming loans not yet reflected in OREO for one to four-family residential real estate properties for which the foreclosure process has begun. These disclosures are currently required for US regulated financial institutions in their quarterly call reports. The Task Force s consensus-for-exposure should increase uniformity in practice and mitigate the extent to which judgment enters into the reclassification assessment. The consensus-for-exposure would be applied on a modified retrospective basis to any loans existing as of the beginning of the period of adoption. Any offsetting adjustments would be made to the opening balance of retained earnings for that period on a cumulative effect basis. An effective date has not yet been determined. 6 EITF Update June 2013
Issue discussed without final conclusion Issue 13-D: Determination of Whether a Performance Target That Is Allowed to Be Met after the Requisite Service Has Been Provided by the Employee Is a Vesting Condition or a Condition That Affects the Grant-Date Fair Value of the Awards Performance conditions that affect only vesting of an award are not reflected in the estimate of the grant-date fair value of an award, but nonvesting conditions are included in such an estimate. ASC 718 7 states that a condition meets the definition of a performance condition only if the employee must provide service to the employer for a specified period of time. However, ASC 718 does not specify that the employee must be rendering service when the performance target is achieved. The issue is how to account for the terms of a share-based payment that includes a performance condition that may be met after the requisite service has been provided by the employee. Some believe the terms are a performance condition that affects the vesting of the award. Others believe the terms are a nonvesting condition that affects the grant-date fair value of the award. Still others believe that the terms are an other condition that requires the award be classified as a liability and remeasured at fair value. The Task Force directed the FASB staff to perform additional research so it can better understand the types of share-based payments that may fall within the scope of the Issue. The Task Force also asked the FASB staff to perform outreach with users of financial statements on the relevance of the financial information that would be reported under each of the views the Task Force is considering. Several FASB members requested that the FASB staff analyze how the views the Task Force is considering align with the IFRS Interpretations Committee s proposal to clarify the definition of vesting conditions in Appendix A of IFRS 2 8 by separately defining a performance condition and a service condition. Based on past discussions of the Statement 123(R) Resource Group, we believe that all of the views the Task Force is considering are supportable within existing literature and currently acceptable in practice. That said, we support the EITF s decision to thoroughly consider the potential effects of the views before reaching a consensus-for-exposure. The Task Force will discuss transition and an effective date at a future meeting. 7 EITF Update June 2013
Endnotes: 1 2 3 4 5 6 7 8 ASC 740, Income Taxes Proposed Accounting Standards Update, Consolidation (Topic 810): Principal versus Agent Analysis ASC 840, Leases IFRIC Interpretation 12, Service Concession Arrangements ASC 605, Revenue Recognition ASC 310-40, Receivables Troubled Debt Restructurings by Creditors ASC 718, Compensation Stock Compensation IFRS 2, Share-based Payment Ernst & Young Assurance Tax Transactions Advisory 2013 Ernst & Young LLP. All Rights Reserved. SCORE No. BB2560 About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. This publication has been carefully prepared but it necessarily contains information in summary form and is therefore intended for general guidance only; it is not intended to be a substitute for detailed research or the exercise of professional judgment. The information presented in this publication should not be construed as legal, tax, accounting, or any other professional advice or service. Ernst & Young LLP can accept no responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. You should consult with Ernst & Young LLP or other professional advisors familiar with your particular factual situation for advice concerning specific audit, tax or other matters before making any decision. 8 EITF Update June 2013