FASB UPDATE Interpretive Guidance for Special- Purpose Entities Interpretive Guidance on Guarantor's Accounting for Guarantees SFAS 133 Issues Streamlining FASB'S Process New Q&A Added to SFAS 87 Guidance March 20-21, 2002 Meeting of the EITF SEC UPDATE SEC Chief Accountant Speaks on Audit Committees INTERNATIONAL UPDATE March 19-22, 2002 IASB Meeting Changes for IASB's Interpretations Committee IASB Standards Required for EU Companies D&T Book on International Accounting Standards FASB Discusses Interpretive Guidance for Special-Purpose Entities At its March 13, 2002 meeting, the Financial Accounting Standards Board (FASB or "the Board") continued its discussions regarding a proposed Interpretation of Accounting Research Bulletin (ARB) No. 51, Consolidated Financial Statements, and Statement of Financial Accounting Standards (SFAS) No. 94, Consolidation of All Majority-Owned Subsidiaries, which will address certain accounting issues relating to special-purpose entities (SPEs). The Board focused its discussions on multiseller/multilease SPEs that lack sufficient independent economic substance and in which a single primary beneficiary cannot be identified. The proposal would provide for multiple SPEs if the transferor/ lessee retained the same risks and rewards that they would have had in a single SPE. Accordingly, in such transactions the tranferor/lessee would record its own assets and related portion of the SPE's obligations. The Board acknowledged that additional guidance would be required to identify a primary beneficiary in multiseller/multilease SPEs prior to exposing the proposed Interpretation for comment. Further, the Board noted that a primary beneficiary might not be identifiable for certain SPEs in certain circumstances, such as in collateralized bond obligations. The proposed Interpretation will not address the primary beneficiary's financial statement classification of a consolidated SPE's liabilities and equity, because there already are appropriate existing accounting standards that address this. An Exposure Draft of the proposed Interpretation is expected to be issued at the end of April 2002. FASB Discusses Interpretive Guidance on Guarantor's Accounting for Guarantees At its March 13 and March 20, 2002 meetings, the Board discussed the scope of a proposed Interpretation on a guarantor's accounting for guarantees. The purpose of this publication is to briefly describe key regulatory and professional developments that have recently occurred in the field of accounting and to provide links to locations where additional information can be found on each topic. Readers seeking additional information about a topic should review the information referred to in the hyperlinks and not rely on the descriptions included in this communication. Deloitte & Touche LLP is not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte & Touche LLP shall not be responsible for any loss sustained by any person who relies on this publication. Proposed Scope The Board concluded that contracts with the following characteristics should be included in the scope of the proposed Interpretation: 1. Contracts that contingently require the guarantor to make payments, either in cash or in kind, to the guaranteed party based on changes in an underlying that is related to an asset or liability of the guaranteed party. However, if the guarantee contract stipulates that the guarantor's payment must be solely a fixed number of the guarantor's equity shares, the guarantee is not subject to the recognition and measurement requirements of the proposed Interpretation. 2. Contracts or performance guarantees that contingently require the guarantor to make payments, either in cash or in kind, including services, to the guaranteed party based on another entity's failure to perform under an obligating agreement. 3. Indemnification agreements that contingently require the indemnifying party (i.e., the guarantor) to make payments to the indemnified party based on the occurrence of a specified event or circumstance, such as an adverse judgment in a lawsuit or the imposition of additional taxes due to an adverse change or interpretation of tax law. 4. Contracts that are indirect guarantees of the indebtedness of others, as that phrase is used in FASB Interpretation No. 34, Disclosure of Indirect Guarantees of Indebtedness of Others, even though the payment to the guaranteed party is not based on changes in an underlying that is related to an asset or liability of the guaranteed party. continued on next page
The Board agreed that the characteristic-based approach detailed above would appropriately exclude subordination agreements and commercial letters of credit or other loan commitments from the scope of the proposed Interpretation. Entirely Excluded From Scope The Board concluded that, despite qualifying under the characteristic-based approach outlined above, the following contracts would be entirely excluded from the scope of the proposed Interpretation: 1. Product warranties, including separately priced extended warranties and product maintenance contracts 2. Guarantees issued by property and casualty or accident and health insurance companies and accounted for under SFAS No. 60, Accounting and Reporting by Insurance Enterprises 3. A lessee's guarantee of the residual value of the leased property at the expiration of a capital lease's term. Exemption From Recognition and Measurement Requirements Only The Board concluded that initial recording of (1) guarantees accounted for as derivatives and (2) guarantees to pay contingent consideration in a business combination are covered by other authoritative literature and should only be subject to the proposed Interpretation's disclosure requirements. Other Discussion The Board concluded that a lessee's guarantee of the residual value of leased property in an operating lease should be included in the scope of the proposed Interpretation. Transition The Board concluded that the disclosure requirements of the proposed Interpretation will be effective for the financial statements for the first interim or annual period ending after September 30, 2002. The initial recognition and measurement criteria will be effective for the first annual period beginning after September 15, 2002, and will be applied using a cumulative-effect-type adjustment. These dates are based on the anticipated distribution of a ballot draft to the Board in April 2002 and issuance of the final Interpretation before May 2002. FASB Considers SFAS 133 Issues At its March 13, 2002 meeting, the Board discussed the resolution of a long-standing Statement 133 Implementation Issue relating to loan commitments and two new Implementation Issues. Resolution of Issue on Loan Commitments The Board discussed SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, Implementation Issues A21, Existence of an Established Market Mechanism That Facilitates Net Settlement under Paragraph 9(b), A22, Application of the Definition of a Derivative to Certain Off-Balance-Sheet Credit Arrangements, and C13, When a Loan Commitment Is Included in the Scope of Statement 133. The majority of the constituents who responded to the request for comments opposed the conclusions in Issue A22 but did not object to conclusions in Issue C13. The Board concluded that the approach in Issue C13 should be used and that certain background information and the exclusion for the holder of the loan commitment in Issue A22 should be incorporated into Issue C13. The Board then cleared Issues A21 and C13. The transition guidance in Statement 133 Implementation Issue K5, Transition Provisions for Applying the Guidance in Statement 133 Implementation Issues, should be followed for the prospective application of these Issues. All Statement 133 Implementation Issues are available on the FASB's website at http://www.fasb.org (select Technical Projects in the left menu frame, then select Derivatives Implementation Group, then Guidance on Statement 133 Implementation Issues). Other SFAS 133 Issues The Board clarified that the scope exception in paragraph 10(d) of SFAS 133 applying to financial guarantees that reimburse the guaranteed party for amounts due but not collected is only operative if the guaranteed party demands 2 continued on next page
payment from the debtor and attempts collection. It does not apply to financial guarantees that pay on the occurrence of a "technical" default, such as failure of a debt covenant ratio or occurrence of a change in control. The Board decided not to amend SFAS 133 to permit hybrid instruments that require bifurcation to be reported at fair value with changes in fair value reported in earnings as an alternative to bifurcation. Streamlining FASB'S Process On March 14, 2002, the Financial Accounting Foundation (FAF), the body that oversees the FASB, announced that it would issue a press release discussing proposed changes to the organization and processes of the FASB, in response to a perceived need for the FASB to be "more flexible in responding to change and to increase the efficiency of its standardsetting process." Some of the proposals would reduce the Board's size from seven to five members and eliminate the "super majority" voting requirements. The press release and an electronic document outlining the FAF's proposed changes for public comment are available on the FASB's website, http://www.fasb.org. Comments must be received by April 17, 2002 in order to be considered at the FAF's April 23, 2002 meeting. New Q&A Added to SFAS 87 Guidance On March 22, 2002, the FASB posted to its website a new Q&A for inclusion in the FASB Staff Implementation Guidance for SFAS No. 87, Employers' Accounting for Pensions. The Q&A, "Impact of the Sunset Provision of the Economic Growth and Tax Relief Reconciliation Act," is available on the FASB's website, http://www.fasb.org. March 20-21, 2002 Meeting of the EITF At the March 20-21, 2002 meeting, the FASB's Emerging Issues Task Force (EITF or "the Task Force") addressed the following 11 Issues. The entire text of the Deloitte & Touche-prepared EITF minutes, including details of the consensuses reached and other viewpoints, is available at http://www.deloitte.com. Issue No. 00-18, Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than Employees This Issue has several aspects addressing an issuer's accounting for equity instruments issued to individuals other than employees, including when a grantee performance commitment exists and the manner in which the issuer should recognize the fair value of the equity instruments. The Task Force asked the FASB staff to continue to develop this Issue using the commitment date, as defined in EITF Issue No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, as the measurement date. The Task Force is expected to discuss this Issue again at a future meeting. Issue No. 00-19, Accounting for Derivative Instruments Indexed to, and Potentially Settled in, a Company's Own Stock Contracts that are indexed to a company's own stock are accounted for in accordance with the consensus previously reached in Issue 00-19. The Task Force was requested to clarify what disclosure requirements should be applied to contracts that are within the scope of this Issue. The Task Force reached consensus on disclosure requirements for contracts within the scope of Issue 00-19 at the March meeting. Further discussion of this Issue is not expected. Issue No. 00-21, Accounting for Revenue Arrangements with Multiple Deliverables This Issue addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue-generating activities. Three additional models for revenue recognition in arrangements with multiple deliverables were discussed at the March meeting. The Task Force did not reach a consensus and is expected to discuss this Issue further at a future meeting. 3 continued on next page
Issue No. 00-23, Issues Related to the Accounting for Stock Compensation under APB Opinion No. 25 and FASB Interpretation No. 44 On June 1, 2000, the SEC staff provided the FASB staff with a list of 31 practice questions related to accounting for stock compensation primarily under APB Opinion No. 25, Accounting for Stock Issued to Employees, and FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation. Additional questions have been subsequently raised by the SEC. The EITF formed a working group to address these issues. At the March meeting, six subissues were discussed: Issue 33(b): "Accounting for "Early Exercise" When the Call Option Held by the Employer is at a Strike Price Equal to the Original Exercise Price" Issue 40(b): "Profits Interest in an LLC" Issue 44: "Employee Options That Are Not Assumed (That Is, Acquired or Exchanged) by an Acquiring Entity in a Business Combination" Issue 46: "Accounting Consequence of a Modification of a Stock Option or Award to Remove Transferability Restrictions" Issue 48: "Accounting Consequence of Executing a Broker-Assisted Exercise Through a Brokerage Subsidiary (or Related Party) of the Grantor" Issue 50: "Accounting for the Conversion of a Recourse Note to a Nonrecourse Note." The Task Force reached consensus on all six subissues. The Task Force agreed to disband the Issue 00-23 working group because there are no further issues to be discussed. (Also see Issue 02-8, below, which was separated from Issue 00-23 at this meeting.) Issue No. 01-3, Accounting in a Purchase Business Combination for Deferred Revenue of an Acquiree This Issue addresses whether the acquiring entity should recognize a liability for deferred revenue previously recognized on the acquired entity's balance sheet when a business combination is initially recorded and, if so, how the fair value of that liability should be measured. The Task Force discussed the draft abstract prepared by the FASB staff based on tentative conclusions reached at the January 2002 EITF meeting. The Task Force reached consensus on this Issue, and further discussion is not expected. Issue 01-12, The Impact of the Guidance in Paragraphs 10(e)(2) and 58(c)(3) of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, on Residual Value Guarantees Accounted for in Accordance with FASB Statement No. 13, Accounting for Leases A consensus was reached on part of this Issue at the November 2001 EITF meeting, leaving one remaining tentative conclusion addressing whether a third-party residual value guarantee is within the scope of SFAS 133. The Task Force reached consensus on the remaining open item within this Issue at the March meeting. Further discussion of this Issue is not expected. Issue No. 02-4, Debtor's Accounting for an Exchange or Modification of Debt Instruments The Task Force reached consensus on this Issue at the January 2002 meeting, but requested the FASB staff to identify additional factors relating to whether a modification or an exchange is a troubled debt restructuring within the scope of SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings. The Task Force reached consensus on the indicators identified by the FASB staff and concluded that the consensus reached in this Issue nullifies EITF Issue No. 89-15, Accounting for a Modification of Debt Terms When the Debtor Is Experiencing Financial Difficulties. Further discussion of this Issue is not expected. Issue No. 02-5, Definition of "Common Control" in Relation to FASB Statement No. 141, Business Combinations SFAS 141 does not define the term common control in the context of when common majority ownership exists by an individual, a family or a group affiliated in some other manner. The SEC previously addressed this issue in a speech; however, the SEC staff has recently undertaken an initiative to remove staff speeches from its website. The FASB is 4 continued on next page
expected to define common control as part of its ongoing Business Combinations project, but the EITF agenda committee suggested that the Task Force provide interim guidance until the Business Combinations project is complete. The Task Force reached a consensus on this Issue that follows the views previously expressed by the SEC, with minor clarifications. Further discussion of this Issue is not expected. Issue No. 02-6, Classification in the Statement of Cash Flows of Payment Made to Settle an Asset Retirement Obligation Within the Scope of FASB Statement No. 143, Accounting for Asset Retirement Obligations This Issue arises because SFAS 143 and SFAS No. 95, Statement of Cash Flows, do not provide guidance regarding the classification within the statement of cash flows of the cash outflows incurred upon the settlement of an asset retirement obligation liability. The Task Force reached a consensus on this Issue. Further discussion at a future meeting is not expected. Issue No.02-7, Unit of Measure for Testing Impairment of Indefinite-Lived Intangible Assets SFAS No.142, Goodwill and Other Intangible Assets, requires that intangible assets not subject to amortization be tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. This Issue addresses what the unit(s) of measure should be for evaluating impairment of intangible assets that have indefinite lives. The Task Force reached consensus on this Issue. Further discussion is not expected. Issue No. 02-8, Accounting for Options Granted to Employees in Shares of an Unrelated Entity This Issue was previously included in Issue 00-23 as subissue 51 and was separated and renumbered as a standalone Issue at the March meeting. This Issue addresses how an employer should account for awards granted to employees that are indexed to the stock of an unrelated entity. These plans are frequently referred to as "KEYSOPS," and the awards generally meet the definition of a derivative under SFAS 133. The Task Force reached consensus on this Issue. Further discussion is not expected. SEC Chief Accountant Speaks on Audit Committees On March 7, 2002, Robert Herdman, the Chief Accountant of the SEC, spoke at the Tulane Corporate Law Institute about the effectiveness of audit committees. Excerpts of his speech are provided below. The entire speech is available on the SEC's website at http://www.sec.gov/news/speech/spch543.htm. The Chief Accountant said that the process of considering how to improve corporate governance in general, and the requirements for audit committees specifically, is likely to include a re-evaluation of two areas: (1) independence and (2) financial literacy of audit committee members. He said that the idea of audit committee members that are 100 percent independent deserves further consideration. The Chief Accountant outlined his "short list of tasks for an effective audit committee," as summarized below. Control the Agenda The 1999 report of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees said that auditors should consider the audit committee to be the client. Mr. Herdman said that one way to view this is that the audit committee "controls the agenda" in dealing with certain matters, such as: The audit committee should evaluate the competence and independence of the external auditors and, more particularly, the partner who is leading the efforts. The audit committee should "probe to find out the nature and extent of issues that management and the auditors gave considerable attention to. It's not enough to merely be told there were no reportable disagreements." Some audit committees have set limits on the number of personnel the company may hire from its audit firm. Mr. Herdman said that this topic has proven difficult to address by formal rule-making in the past and that "absolute prohibitions may not be necessary, or desirable... but common sense is" in these situations. 5 continued on next page
The audit committee's understanding of the company's internal control structure and its own assessment of the effectiveness of the internal audit function are "crucial." Audit committees should consider the "audit fee as a way to monitor whether the scope of work is sufficient." Mr. Herdman pointed out that with the new SEC requirement to disclose audit fees in proxy statements, a comparison with a "reasonably comprised peer group" should be "relatively easy." The audit committee should also focus on management and the corporate code of conduct. The audit committee should have "direct, unfettered, independent access to management, internal audit, and external auditors." Audit committee members "must" be able to "communicate with confidence with these three groups independently of each other." Diligence The Chief Accountant said that one of the most important aspects of diligence is being proactive. He said that audit committee members should ask "tough questions," for example, about critical accounting policies. He went on to say that asking the tough question is only half of the responsibility and that obtaining an understanding of the answer is equally, if not more, important. Take the Time Mr. Herdman said that audit committee members "must make the time and take the time" to achieve an appropriate understanding of the company's financial statements and to consult with outside counsel and other experts, if necessary, on the tough issues. He said that an "effective audit committee requires a commitment of quality and quantity time," and that may mean that "spending an hour together three or four times a year probably is not sufficient." Mr. Herdman closed his speech saying that "audit committee members should be independent, have requisite expertise, and they must control the agenda, be diligent, and spend the time." March 19-22, 2002 IASB Meeting At its March 19-22, 2002 meeting in Tokyo, the International Accounting Standards Board (IASB or "the Board") took the following actions: Approved issuance of Interpretation No. 32, Intangible Assets - Web-Site Costs. In a change from an earlier draft, the final document will require that initial graphic design costs be treated as website development costs and, therefore, be capitalized when certain conditions are met. Affirmed previous tentative conclusions that (1) all business combinations, as defined, should be accounted for by the purchase method and (2) goodwill should no longer be amortized but, instead, should be subject to an impairment test. Reaffirmed the provision in IAS No. 24, Related Parties Disclosures, that permits related-party disclosures to be omitted from the individual financial statements of parent companies or wholly owned subsidiaries that are issued concurrently with consolidated financial statements. Reached a number of tentative decisions on how first-time adopters of international financial reporting standards (IFRS) should account for financial instruments and hedging activities in their opening balance sheets. Considered a project plan on stock-based payments (i.e., how a company should report transactions in which it pays for goods and services with shares of its stock or with options on such shares). The Board also reviewed a staff-prepared analysis of option-pricing models and U.S. accounting standards in this area. An exposure draft of a proposed standard is expected to be issued for comment by the end of 2002. Discussed a portion of a draft statement of principles on insurance contracts, which addresses the fundamental reporting model for such contracts. Discussed issues related to how changes in the value of tangible fixed assets should be reported in a statement of financial performance (i.e., statement of income and comprehensive income). The next IASB meeting is scheduled for April 16-19, 2002 in London. 6 continued on next page
Changes for IASB's Interpretations Committee At its March 5, 2002 meeting, Trustees of the IASC Foundation approved certain revisions to the Board's Constitution relating to the Standing Interpretations Committee. They include (1) changing the committee's name to the International Financial Reporting Interpretations Committee (IFRIC), (2) broadening the committee's charge to include the development of timely guidance on issues not specifically covered in an existing IASB standard or IFRS, and (3) creating the position of a nonvoting committee chair. At the same time, the Trustees also approved formal committee operating procedures. The IFRIC consists of 12 members representing corporate accounting officers, accounting firm partners, analysts, and academicians from around the world, each appointed to a three-year term. Current committee members include Deloitte &Touche partner John T. Smith. IASB Standards Required for EU Companies On March 12, 2002, the European Parliament adopted a resolution requiring European Union (EU) companies with listed securities to follow standards issued by the IASB in preparing their financial statements, starting no later than 2005. The requirement would not apply, however, to companies preparing to be listed. Additionally, EU member countries would be permitted to delay the requirement, until 2007, for companies that (1) have only publicly traded debt securities or (2) are listed both in the EU and on a non-eu exchange and follow another set of internationally accepted accounting standards for their primary financial statements (e.g., EU companies listed in the United States that use U.S. generally accepted accounting principles for their primary financial statements). Deloitte & Touche Book on International Accounting Standards Available Free As a service to its clients and friends, Deloitte & Touche is making available, at no cost, the electronic version of its recently-published book, International Accounting Standards: A Practical Guide to Financial Reporting, second edition. The 224 page book, which includes summaries of all current standards, model financial statements, and a presentation and disclosure checklist, may be obtained at http://www.iasplus.com/resource/iasprac.pdf. Further information about the IASB can be obtained on the IASB's website at http://www.iasc.org.uk and on Deloitte & Touche's IASPlus website at http://www.iasplus.com. For further information contact your local Deloitte & Touche office. 2002 Deloitte & Touche LLP. Deloitte & Touche refers to Deloitte & Touche LLP and related entities. 7