Quarterly Accounting Roundup: An Update of Important Developments

The Dbriefs Financial Reporting series presents: Quarterly Accounting Roundup: An Update of Important Developments Bob Uhl, Deloitte & Touche LLP Joe DiLeo, Deloitte & Touche LLP Lyndsey McAlister, Deloitte & Touche LLP Jason Nye, Deloitte & Touche LLP September 25, 2013

Agenda Joint projects update Other topics EITF update Other standard setters Question and answer

Keep in mind This webcast does not provide official Deloitte & Touche LLP interpretive accounting guidance Check with a qualified advisor before taking any action See later slides for information on obtaining written summaries of issues discussed today

Learning objective To enhance participants understanding of important accounting issues and developments pertaining to recent actions of the FASB, IASB, EITF, and others.

Poll question #1 Which of the joint projects are you most interested in? Financial instruments [Impairment, Classification & Measurement, Hedge Accounting] Insurance Leases Revenue recognition

Joint projects Overview

Joint projects Projects Expected date 2013 Q3 2013 Q4 Leases R Revenue recognition F Financial instruments: Classification and measurement Impairment Hedge accounting General (IASB) Hedge accounting Macro (IASB) R R R R F DP Other joint projects Insurance contracts FASB (IASB s ED issued in Q2 of 2013) E Exposure Draft F Final Standard DP Discussion Paper R Re-deliberations E

Financial Instruments Classification and Measurement

Classification and measurement Summary of comments and outreach Solely payments of principal & interest (SPPI) - Mixed views some recommend removing completely; others recommend retaining but suggest significant revisions to the implementation guidance - A majority of respondents suggest (1) removing the credit-risk analysis for beneficial interests and (2) that the look-through concept would be impractical Business model test - Respondents generally agree that business model should drive classification - The overwhelming majority of respondents commented that the criteria for permitted sales from the amortized cost (AC) classification are too stringent Fair value option (FVO) - Most banks recommended that the FASB expand the situations in which election of the FVO would be permitted - Either converge with IFRS 9 or make unconditional

Classification and measurement Summary of September redeliberations* - SPPI Confirmed principal is amount transferred by current holder at initial recognition Tentative decisions related to interest include: SPPI test is to identify instruments that provide a basic-lending type return Disregard features that would only have a de minimis effect on cash flows Interest includes several components: Compensation for credit risk Time value of money; however clarified that relates only to passage of time Others may include profit, costs associated with the lending, or liquidity Tentative decisions related to contingent features include: Nature of contingent triggering event is not determinative Consider both nature of the triggering event and its effect on cash flows No distinction between prepayment terms, extension options, and other features FASB and IASB split on how to assess contingent features that could result in non- SPPI cash flows FASB Would permit features if likelihood of contingent event s occurrence is remote IASB Basis is on the nature of the feature without consideration of contingent event s likelihood; however would permit non-genuine features * All decisions are tentative.

Financial Instruments Impairment

Impairment of financial instruments Summary of comments and outreach Boards encouraged to converge Many disagree with FASB s proposals related to: Recognizing current expected credit losses on day one Projecting expected credit losses over the life of an instrument Uncertainty inherent in long-term projections Concerns about the cost and complexity of these estimates Other concerns expressed about debt securities Model does not work well when insufficient information exists to develop the current expected credit loss Questions about usefulness of the proposed practical expedient

Impairment of financial instruments Summary of September redeliberations* Boards made all tentative decisions separately FASB clarified several elements of its model: Historical average loss for periods after those determined by reasonable and supportable forecasts Contractual cash flow projections Should consider (1) prepayments and (2) TDRs if reasonably expected to be executed Exclude renewals, extensions, and modifications Consideration of risk of loss Always considered; even if remote Do not recognize credit loss if amount of loss is zero for an asset with nonpayment risk that is greater than zero (e.g., collateralized assets) The IASB tentatively decided to: Retain the dual-measurement approach and bucket 1 Clarified the definition of default Requires application to be consistent with credit risk management practices Rebuttable presumption of default when 90 days past due * All decisions are tentative.

Poll question #2 Under the FASB s tentative decisions on impairment, would an entity consider expected prepayments when determining the contractual cash flow projections? Yes No

Private Company Council

Private company standard setting Private Company Council Role of the PCC Evaluating whether alternatives to existing and proposed U.S. GAAP may be warranted Advising the FASB by identifying private company concerns and communicating these to the FASB during its agenda- and standard- setting activities NOTE: Proposed modifications to U.S. GAAP are subject to PCC vote and FASB endorsement.

Private company standard setting Proposed definition of a public business entity (PBE) Overview FASB issued proposed ASU on August 7, 2013 PBE s not eligible to apply approved private company alternatives Comments on proposed ASU were due on September 20, 2013 Redeliberations expected to occur at the October 1, 2013 PCC meeting PBE is defined as an entity meeting the following criteria: 1. Required to or does file/furnish financial statements with the SEC 2. Required to file/furnish financial statements with a regulatory agency in accordance with the 1934 Act 3. Required to file/furnish financial statements with a regulatory agency for the purpose of preparing for the sale or issuance of securities 4. It has (or is a conduit bond obligor for) unrestricted securities that are or can be traded on an exchange or over-thecounter 5. Its securities are unrestricted and it is required to provide U.S. GAAP financial statements to be made publicly available on a periodic basis to meet a legal or regulatory requirement NOTE: Not-for-profit entities and employee benefit plans would not meet the definition of a PBE; however these are outside of the scope of the private-company decision-making framework and not automatically eligible for PCC alternatives

Private company standard setting Proposed alternative consolidation requirements Background Private companies may establish separate entities to hold assets Potential accounting concerns/complexities with model PCC s conclusion that improved variable interest entities (VIE) guidance needed Path forward FASB issued a proposed ASU on August 22, 2013 Comments on proposed ED are due by October 14, 2013 Final proposal subject to PCC approval and FASB endorsement Effective date dependent upon issuance of final standard Retrospective application required with an adjustment to opening earliest-period-presented balances Early adoption permitted

Private company standard setting Proposed alternative consolidation requirements (cont d) Proposed alternative: Private companies can opt out of applying ASC 810 VIE guidance if lease arrangement meets certain conditions: Private company and legal entity under common control Private company has a lease arrangement with legal entity Substantially all activities between private company and legal entity are related to leasing activities of the legal entity ASC 810 voting interest model would be applied in lieu of VIE consolidation guidance Alternative would need to be applied to all lease arrangements meeting conditions Additional disclosures would be required Proposed ASU also removes Example 4 from ASC 810-10

Private Company Council Continued

Private company standard setting Alternative accounting proposed Background The FASB issued three proposed ASUs on July 1, 2013, recommending alternatives for private companies based on PCC proposals related to: Intangible assets acquired in a business combination Goodwill Certain types of interest rate swaps Comments were due August 23 and the PCC is expected to discuss the feedback on September 30

Private company standard setting Intangible assets acquired in a business combination Proposed alternative Entities would only be required to recognize intangible assets meeting the contractual-legal criterion arising from noncancellable contractual terms or other legal rights. Intangibles that only meet the separability criterion would not be recognized as a separate intangible asset, but rather as part of goodwill. What s in scope Contractual-legal intangibles such as trademarks or trade names, domain names, franchises, order backlogs, patented technology, licensed software, trade secrets, and customer contracts would be recognized under the proposed alternative accounting. What s not Customer lists, non-contractual relationships, unpatented technology and unregistered trade secrets, processes, or recipes that only meet the separability criterion under current U.S. GAAP would not be separately recognized at fair value.

Private company standard setting Goodwill Proposed alternative Entities could elect simplified accounting for: Amortization of goodwill Amortize goodwill on a straight-line basis over the useful life (not to exceed 10 years) of the primary asset acquired in a business combination Frequency of impairment test Test goodwill for impairment only when a triggering event occurs instead of having to perform the test annually (or more frequently if indicators of impairment exist), as is required currently Method of impairment testing Test goodwill for impairment at the entity level rather than the reporting unit level, applying only Step 1 Disclosure requirements related to amortizable goodwill Prospective application (early adoption permitted)

Private company standard setting Interest rate swaps Proposed alternative Private companies that are not financial institutions will be provided with two alternatives to the hedge accounting requirements of ASC 815: Combined Instruments Variable-rate debt and interest rate swap accounted for as combined instrument on balance sheet. Must meet certain qualifying criteria Presented at amortized cost Subject to specific disclosure requirements If approach is elected, it must be applied to all existing and future swaps meeting the qualifying criteria Simplified Hedge Accounting Company can continue to account for the interest rate swap and the variable-rate debt separately on the face of the balance sheet, assume no hedge ineffectiveness in the hedging relationship, and is permitted to measure the interest rate swap at its settlement value rather than its fair value. Must meet certain qualifying criteria Can be elected on an instrument-byinstrument basis Subject to hedge documentation requirements Transition and disclosure considerations

Going Concern Project

Going concern project Objectives and timeline Provide guidance on assessing uncertainties about an entity s going concern presumption and related disclosures Reduce diversity in the timing, nature, and extent of disclosures in the financial statement footnotes 2008 ED 9/24/13 Comments due 2013 ED Issuance and effective date?

Going concern project Disclosure thresholds Does not consider management s actions outside the normal course of business Considers ALL management s actions MLTN (12 months) Known/probable (24 months) Substantial doubt (24 months) (SEC filers only) Liquidation is imminent Going Concern Disclosures Required Liquidation Basis of Accounting

Going concern project Required disclosures Conditions and events that give rise to the entity s potential inability to meet its obligations Possible effects of those conditions and events Management s evaluation of the significance of those conditions and events and any mitigating factors Management s plans to address the entity s potential inability to meet its obligations Mitigating conditions and events Substantial doubt SEC filers only

Poll question #3 How long is the going concern time horizon under the FASB s proposal? 12 months (same as current auditing literature) 24 months Indefinite (converged with IFRS) None of the above

Revenue Project

Revenue project Overview Core principle: Recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services Identify the contract with a customer (Step 1) Identify the performance obligations in the contract (Step 2) Determine the transaction price (Step 3) Allocate the transaction price to performance obligations (Step 4) Recognize revenue when (or as) the entity satisfies a performance obligation (Step 5) Revenue recognition under the above model is control based.

Revenue project Effective date/transition Effective date Public entities: annual reporting periods beginning after December 15, 2016 including interim (early application not permitted) Nonpublic entities: annual reporting periods beginning after December 15, 2017 including interim (early application permitted, but no earlier than public entities) Transition Apply retrospectively by applying ASC 250 (with certain optional practical expedients) OR Modified approach Apply revenue standard to contracts not completed as of adoption of standard and record cumulative catch up Do not apply standard to completed contracts

Revenue project Current status and what s ahead Issues discussed at last week s joint board meeting: Collectability Constraint Licenses Final standard expected by the end of the year Implementations groups (FASB, IASB, AICPA) Potential involvement from SEC and EITF Entities need to evaluate and plan for impact and then implement the new standard Industry specific practices may develop as entities adopt and implement the standard

Poll question #4 What is the proposed transition method for the revenue recognition standard? Prospective Retrospective Modified retrospective Retrospective or modified retrospective

EITF Update

Issue 13-B: Investments in tax credits Background Consensus-for-Exposure reached in March would make it easier for investments in affordable housing projects (or Low-Income Housing Tax Credit (LIHTC) investments) to qualify for the effective yield method under ASC 323-740 In September, the Task Force reached tentative decisions to further modify the qualifying criteria and to change the method of amortizing the original cost of the investment The issue will come back in November

Issue 13-B: Investments in tax credits Tentative decisions reached New decision would further modify one criterion Consensus-for-exposure The investor retains no operational influence [other than certain protective rights] over the investment, and substantially all of the projected benefits are from tax credits and other tax benefits Tentative decision The investor retains no [significant ability to influence the operating and financial policies of the limited liability entity], and substantially all of the projected benefits are from tax credits and other tax benefits And, it would permit other transactions between the investor and investee (e.g., loans) if certain conditions are met (limited to LIHTC): The reporting entity is in the business of entering into such other transactions The transactions are entered into at market rates The reporting entity does not acquire [a significant ability to influence the operating and financial policies of the limited liability entity] as a result of such other transaction

Issue 13-B: Investments in tax credits Tentative decisions reached Scope Investments in affordable housing projects (i.e., consistent with the current scope of ASC 323-740), but only if all qualifying conditions are met, including for transactions other than the equity investment Other tax credit investments by analogy, but not if the entity entered into other transactions with the investee Measurement: Apply a proportionate amortization approach (effective yield method is eliminated) Presentation: Investments are combined with other deferred tax assets in the statement of financial position Disclosure: Disclose the impact of LIHTC investments on the entity s financial statements

Issue 13-D: Post-service performance targets Consensus-for-Exposure Performance targets that can be met after the requisite service period should be treated as a performance condition that affects vesting Example Employee must work 2 years (not retirement eligible) Award only transfers if IPO within 4 years Grant-date FV = $100 Discount at grant date for probability of IPO = $20 January 20X3 December 20X5 September 20X7 Grant Date Service Ends IPO Completed View A Target is a performance condition that affects vesting $0 Compensation (comp) expense $0 comp expense $0 comp expense $100 Grant date FV

Issue 13-G: Nature of a hybrid host Background Scope: Hybrid financial instruments issued in the form of a share An embedded derivative must be accounted for separately from a host contract if: It is not clearly and closely related (CCR) to the host The hybrid instrument is not re-measured at fair value under other GAAP It is a derivative as defined in ASC 815-10-15 Whether an embedded derivative is CCR depends on the nature of the host An embedded derivative that meets the conditions above and does not meet any of the scope exceptions in ASC 815-10-15 is accounted for separately from the hybrid host and re-measured at fair value each reporting period

Issue 13-G: Nature of a hybrid host Background Issue: How do you determine the nature of a host contract in a financial instrument issued in the form of a share for purposes of determining if an embedded derivative is clearly and closely related to a host? Common practice: Whole instrument approach: consider all economic characteristics and risks of the instrument (i.e., all embedded features) Chameleon approach: exclude the terms and features pertaining to the individual embedded derivative being evaluated

Issue 13-G: Nature of a hybrid host Example Convertible preferred share with fixed-price redemption, and: Dividend rights Voting rights When evaluating whether the conversion feature (an equitylike feature) is CCR to the host, an entity first determines if the host is more akin to equity or debt Whole instrument approach: consider all features, but there is diversity in practice Redemption is debt-like Conversion is equity-like Do these features offset, indicating the host is equity-like, because it is issued in the form of a share and contains other equity-like features? Does the redemption feature, which is debt-like, indicate the host is also debt-like, because the holder is not exposed to downside risk of a residual interest? Generally no diversity under the chameleon approach (i.e., debt)

Issue 13-G: Nature of a hybrid host Consensus-for-exposure The Task Force reached a consensus-for-exposure that: Entities should apply the whole-instrument approach when determining the nature of a hybrid financial instrument issued in the form of a share (chameleon would not be permitted) There is no rebuttable presumption that a redemption feature is determinative in concluding a convertible preferred share with a fixed-price redemption feature is more akin to debt; instead, all features should be evaluated and weighted based on facts and circumstances Transition: Cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption for instruments (and derivatives) held at the effective date. Early adoption and retrospective transition permitted. Could diversity persist???

Poll question #5 Under the FASB s consensus-for-exposure related to 13-G, can an entity apply the chameleon approach to determine the nature of the host in a hybrid financial instrument issued in the form of a share? Yes No

IASB Conceptual Framework

IASB conceptual framework Project background and discussion paper Project background 1989 Original IASB framework published 2004 IASB and FASB work jointly to develop an improved, conceptual framework 2010 Boards finalize two chapters of a new framework in September, replacing existing related guidance. Boards discontinue work on joint project late in 2010. 2012 IASB restarts project as an IASB-only project 2013 IASB publishes DP on its Conceptual Framework for Financial Reporting Next steps Comments on the discussion paper are due by January 14, 2014 IASB expected to publish an exposure draft of a revised framework by the end of 2014 IASB expected to finalize the framework by the end of 2015 DP does not discuss the concept of a reporting entity because the boards already issued an ED on this topic in March 2010

IASB conceptual framework Framework overview Assets and liabilities Role of probability in the definitions of assets and liabilities Control of an economic resource Constructive obligations and economic compulsion Obligations depending on an entity s future actions Liabilities and equity Distinguishing between liabilities and equity Presentation of equity claims Presentation of profit or loss/oci Profit and loss presentation requirements Income and expense presentation considerations Other framework elements Measurement Recognition and derecognition Presentation and disclosure

PCAOB Proposed Standards Auditor Reporting Model

Overview On August 13, 2013 PCAOB proposed changes to: The auditor s reporting model; and The auditor s responsibilities for other information included in annual reports filed with the SEC and information incorporated by reference in annual reports ( other information ) Responding to feedback that the current auditor s report contains little or no information specific to that particular audit Proposal includes input from various outreach efforts, including: Discussion with its SAG and IAG Holding a roundtable Issuing a concept release The IAASB has also recently proposed similar changes to its auditor s report New requirements would be effective for audits of financial statements for fiscal years beginning on or after December 15, 2015 Timing is subject to PCAOB standard setting process and the SEC s approval process

Significant aspects of the proposal Requires a new section in the auditor s report describing critical audit matters Critical audit matters are those that: Involved the most difficult, subjective, and complex auditor judgments; Posed the most difficulty to the auditor in obtaining sufficient appropriate evidence; or Posed the most difficulty to the auditor in forming an opinion on the financial statements In this new section of the auditor s report, the auditor would: Identify the specific critical audit matters; Describe the considerations that led to each matter being considered a critical audit matter; and Refer to the related financial statement accounts and disclosures in the financial statements (if applicable)

Significant aspects of the proposal The proposal also requires new elements to be included in the auditor s report regarding: Auditor independence Stating that the auditor is required to be independent in accordance with federal securities laws and applicable rules and regulations of the SEC and PCAOB Auditor responsibilities Incorporating statements regarding the auditor s responsibilities related to fraud and the notes to the financial statements Auditor tenure Stating the year the auditor began serving consecutively as the company s auditor

Significant aspects of the proposal The proposal also includes new auditor responsibilities to read and evaluate other information for: Consistency of amounts with the financial statements; Consistency of qualitative statements with the financial statements; Comparability with relevant audit evidence obtained and conclusions reached; and Mathematical accuracy The auditor s report would include new language to: Describe the auditor s responsibilities for other information; and Based on the relevant audit evidence obtained and conclusions reached during the audit, state whether the other information contains: Material inconsistencies Material misstatements of fact Both The proposal states that other information includes information (other than the audited financial statements and related auditor s report) Contained in the annual report that is filed with the SEC, and Information incorporated by reference in the annual report

Next steps Comments are due to the PCAOB by December 11, 2013 The PCAOB is considering holding a public roundtable in 2014 to discuss the proposal and comments received

Poll question #6 Have you been following the PCAOB s Auditor Reporting Model proposed auditing standard? Yes No Somewhat

PCAOB Other Developments

PCAOB inspections Audit committee guidance On August 1, 2012, the PCAOB issued Release No. 2012-003 Information for Audit Committees about the PCAOB Inspection Process The Release is intended to assist audit committees in: Better understanding the PCAOB s inspections of their audit firms; and Gathering information from their audit firms about those inspections International inspections (China) PCAOB entered into an MOU with China to share information for investigative and enforcement purposes (The SEC was not a party to this MOU) The PCAOB has not yet reached an agreement with China on joint inspections of PCAOB-registered accounting firms located in China

PCAOB standard setting Project Action Recent board actions Auditor s Reporting Model Auditor s Responsibilities Regarding Other Information Related Parties, Significant Unusual Transactions and Other Amendments Framework for Reorganization of PCAOB Auditing Standards Proposal comments due 12/11/13 Proposal comments due 12/11/13 Re-proposal issued for public comment - due 7/8/13 Proposal issued for public comment comments were due 5/28/13 Expected actions Audit Transparency: Identification of the Engagement Partner Audits of Brokers and Dealers 1 Going Concern 2 Auditor Independence and Audit Firm Rotation Adoption or re-proposal Adoption or re-proposal Proposal Concept release 1 On July 30, 2013, the SEC s adopted applicable amendments to Rule 17a-5; two roundtables have been scheduled to solicit public feedback. 2 The timing of this project depends on the timing of the FASB s going-concern project.

Poll question #7 Do you plan to submit comments to the PCAOB on its proposed standard regarding the Auditor Reporting Model? Yes No Not applicable to me

Question and answer

Join us November 19 at 2 PM ET as our Financial Reporting series presents: EITF Roundup: Highlights from the November Meeting

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Contact info Bob Uhl Joe DiLeo Lyndsey McAlister Jason Nye ruhl@deloitte.com jodileo@deloitte.com lmcalister@deloitte.com jnye@deloitte.com

Acronyms used in presentation ASC: FASB Accounting Standards Codification ASU: Accounting Standards Update EITF: Emerging Issues Task Force FASB: Financial Accounting Standards Board GAAP: Generally Accepted Accounting Principles IAG: PCAOB Investor Advisory Group IAASB: International Auditing and Assurance Standards Board MOU: Memorandum of Understanding PCAOB: Public Company Auditor Oversight Board PCC: Private Company Council SAG: PCAOB Standing Advisory Group SEC: Securities and Exchange Commission SPPI: Solely Payments of Principal and Interest

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