Cnvergence: Preparing fr the Latest Financial Reprting Changes June 5, 2013
Preparing fr the Latest Financial Reprting Changes Althugh the jint bard meetings that have marked the cnvergence prjects are cming t an end, the FASB and IASB (the Bards) have cmmunicated their intentins t cntinue wrking tgether t achieve glbal cmparability in accunting standards and t minimize differences. As f mid-2013, there were three lnger-term pririty Memrandum f Understanding (MU) prjects remaining fr which the Bards have yet t finalize all f the technical decisins Financial instruments, Revenue Recgnitin and Leases. Financial Instruments The Financial Instruments standard has three cmpnents: Impairment, Classificatin and Measurement, and Hedging. An Expsure Draft (ED) fr Impairment was issued in December 2012. The cmment perid fr this ED ended n April 30, 2013. Tw related ED s fr Classificatin and Measurement were issued February 14, 2013 and April 12, 2013, respectively. The cmment perid fr these ED s ended n May 15, 2013. The ED related t the Hedging cmpnent f the Financing Instruments standard was issued in 2010 with the cmment perid cmplete in 2011. Key prvisins f each cmpnent include: The Bttm Line Cmpanies shuld remain engaged in the standard-setting prcess. A gd understanding f these financial reprting changes will be necessary t determine whether rganizatins will need new systems that can capture data, track cntracts, and supprt prcesses t develp and assess cmplex estimates. Investr and stakehlder cmmunicatin and educatin may be necessary. The new standards will impact sme cmpanies mre than thers, but all cmpanies will need t thughtfully cnsider them. 1) Impairment Additinally, while sme An allwance fr credit lsses is recgnized based n an entity s current estimate f cntractual cash flws implementatin timelines may seem lng, the level f detailed analysis, nt expected t be cllected. recrd keeping, cntract review, The prpsed mdel applies t financial assets system mdificatin and impacts t subject t credit lsses and nt recrded at fair value ther areas f a cmpany s thrugh net incme. This includes lans, debt businesses may result in the need t securities, lan cmmitments, reinsurance utilize much f the lng timelines receivables, and lease and trade receivables. A prvisin matrix may be used when estimating lsses prvided. Cmpanies may be n trade receivables. implementing multiple cmplex Assets accunted fr at fair value with changes standards simultaneusly, increasing thrugh OCI will be allwed a practical expedient. An the level f effrt. Stay up t date, initial credit lss will nt be required fr these assets if fair value is at r abve amrtized cst and the expected credit lsses n the individual asset are plan early and implement methdically t ensure a smth and issue-free implementatin f the new standards. insignificant. The allwance must reflect the time value f mney. A threshld is nt required t be met befre a lss is recgnized. 2) Classificatin and Measurement Debt investments (lans and debt securities) will be evaluated under a cash flw characteristics test and business mdel assessment. Instruments passing the cash flw characteristics test will be classified and measured at amrtized cst r fair value thrugh ther cmprehensive incme (OCI) depending n the entity s primary bjective fr hlding the investment. Fair value thrugh net incme will be the residual categry. Preparing fr the Latest Financial Reprting Changes 1
Reclassificatin will be required if the business mdel changes. If an investment is sld that had riginally been categrized in amrtized cst, this des nt taint the entity s stated bjective fr ther assets. Hwever, guidance has been prvided fr situatins when sales frm these prtflis are nt cnsistent with the amrtized cst businesss mdel. Equity investments i (nt accunted fr under the equity methd) will be measured at fair value thrugh net incme. Entities ther than investment cmpanies and brker-dealers can apply a practicability exceptin t measure equity investments withut readily determinable fair values at cst less impairment, adjusted fr bservable price changes. Equity methd investments that are held fr sale will be recrded at fair value thrugh net incme, unless the practicability exceptin is elected. Hybrid financial assets will n lnger be bifurcated, and the entire instrument will be evaluated under the new cash flw characteristics and business mdel assessment. Financial liabilities will generally be recrdedd at amrtizedd cst with limited exceptins. The fair value ptin will remain in limited circumstances; if elected, market adjustments related t an entity s wn credit will be recrded in OCI. Embedded derivatives will cntinue t be accunted fr separately and measured at fair value thrughh net incme. The accunting fr cnvertible debt remains unchanged. 3) Hedging This cmpnent includes the relaxatin f the rules pertaining t the assessment f hedge effectiveness by reducing the effectiveness threshld frm highly effective t reasnably effective. In additin, the shrt-cut methd and critical terms matchh methd as techniques t assess effectiveness have been eliminated. Recgnitin f hedge ineffectiveness resulting frm under-hedges f cash flws is nw active. Finally, the ability t vluntarily de-designate e hedging relatinships has been eliminated. Revenue Recgnitin The timelines n Revenue Recgnitin have been extended multiple times att the request f many stakehlders t ensure that their interests culd be given full cnsideratin. The Bards have reached substantially cnverged appraches fr revenue recgnitin, with a cnverged final revenue standardd expected t be issued by the end f Q2 2013. This standard will apply t all cntracts with custmers, including transactins with cllabratrs r partners if they are in substance a custmer in the transactin. Entities will be required t apply guidance in ther applicable standards first, and apply the guidance in this revenuee standard nly if ther applicable guidance des nt exist. The standard will require a single five-step cmprehensive revenue recgnitin mdel: Step 1: Identify the cntract with the custmer Step 2: Identify the separate perfrmance bligatins in the cntract Step 3: Determine the transactin price Step 4: Allcatee the transactin price t separate perfrmance bligatins Step 5: Recgnize revenue when (r as) each perfrmance bligatin is satisfied Althugh thesee steps might appear straight frward, significant judgment and resurces will be needed t understand and apply the underlying principles as prpsed under the new standard. Accunting persnnel will need t re-educate themselves abut revenue recgnitin and migrate frm an evaluatin f risk and rewards under existing guidance t an evaluatin f transfer f cntrl under the new standard. Preparing fr the Latest Financial Reprting Changes 2
Leases Similarly, the Lease standard has been under cnstructin fr an extended perid f time. The Bards released the revised Expsure Draft n Leases n May 16, 2013, with a cmment perid pen thrugh September 13, 2013. Key prvisins f this expsure draft are as fllws: 1) Lessee accunting A right-f-use asset and a liability t make lease payments will be recgnized n the balance sheet fr all leases (except shrt-term leases). The incme statement will reflect either a frnt-laded expense pattern (similar t tday s capital leases) r straight-line expense (similar t current perating leases). 2) Lessr accunting Lessrs will either recrd straight-line incme (similar t current perating leases) r fllw a new receivable and residual apprach under which a lessr will recgnize a lease receivable and a residual asset. Prfit n the receivable is recgnized immediately; prfit n the residual is deferred until the underlying asset is re-leased r sld. Interest incme n the receivable and residual asset is recgnized ver the lease term. 3) Dual mdel Incme statement recgnitin will depend n the nature f the underlying asset and whether the lessee acquires r cnsumes mre than an insignificant prtin f the asset. Prperty leases (e.g., real estate): Apply straight-line recgnitin unless the lease term is fr the majr part f the underlying asset s ecnmic life r the present value f fixed lease payments is substantially all f the fair value f the underlying asset. Other than prperty leases (e.g., equipment): Recgnize frnt-laded expense (lessees) r apply a receivable and residual apprach (lessrs) unless the lease term is insignificant cmpared t the underlying asset s ecnmic life r the present value f fixed lease payments is insignificant relative t the fair value f the underlying asset. Other Areas f Fcus Althugh the MU prjects have been given pririty, the Bards have als been wrking tgether n a number f areas, including much-needed imprvements t the accunting fr insurance cntracts. The prpsed mdel requires a current value discunted cash flw measurement fr insurance cntract liabilities, with assumptins updated each perid and discunting based n a liability rate rather than an investment r pricing rate. Any excess f expected premiums ver expected claims and expenses wuld be deferred as "margin" and amrtized int incme ver future perids based n the release frm risk. Expected lsses wuld be recgnized immediately. A mdified apprach wuld apply fr shrt-duratin cntracts (e.g., prperty/casualty cntracts) meeting specified criteria, similar t tday s unearned premium apprach. Hwever, unlike current U.S. GAAP, the prpsed guidance wuld require discunting f incurred lsses with limited exceptins. Revenue recgnitin and presentatin wuld als change. Fr example, premiums frm life insurance wuld n lnger be recgnized as revenue when due. The Bards are als bradly cnverged n classificatin and measurement f debt instruments, but have tentatively landed n different impairment mdels. The FASB expsed its impairment mdel in December 2012, while the IASB has targeted Q2 2013 fr the release f their mdel. Status f Jint Prjects Belw is the FASB s recent prject plan regarding these remaining prjects1, including: Estimated publicatin dates thrugh the end f 2013 [Discussin Papers (D), Expsure Drafts (E), and Final Accunting Standards Updates r Final Cnceptual Framewrk chapters (F)] Cmment perids expected t clse in the next three quarters (C) Rundtable meetings r ther public frums planned (R) 1 Obtained frm FASB.rg n May 14, 2013 and updated fr lease ED issued May 16, 2013 Preparing fr the Latest Financial Reprting Changes 3
Current Technical Plan 2013 Active jint FASB/IASB prjects 2Q 3Q 4Q Revenue Recgnitin Updated June 4, 2013 Investment Cmpanies Updated March 14, 2013 F F Leases Expsure Draft Issued May 16, 2013 C Accunting fr Financial Instruments Updated May 24, 2013 Classificatin and Measurement Expsure Drafts issued 02/14/13 and 04/12/13. Updated May 24, 2013 Impairment Expsure Draft issued 03/08/13. Updated May 2, 2013 C Hedging Updated February 20, 2013 Surce: FASB.cm At the Meeting f the G20 Finance Ministers and Central Bank Gvernrs in February 2013, the Bards published a high-level update n the status and timeline f the remaining cnvergence prjects. Achievements and challenges highlighted as part f the status update include: Mst f the shrt-term prjects and several f the lnger-term prjects have been cmpleted r are nearing cmpletin. In 2012 the Bards made significant prgress n the remaining jint prjects. Cnverged slutins fr Revenue Recgnitin accunting have been achieved. Cnverged prpsals allwing fr a revised expsure draft fr accunting fr Leases has been achieved. Fr the Impairment prject, it has been a challenge t bring tgether the different viewpints f the Bards respective stakehlders and the different markets in which such stakehlders cnduct their primary business activities. Regarding the Insurance Cntracts prject, the scpe f the questins t be received by the FASB related t the expsure dcuments and the need fr the IASB t issue timely first-time guidance (as IFRS des nt currently include accunting requirements fr insurance cntracts) will make achieving a fully cnverged slutin fr the Insurance Cntracts prject challenging. T G r Nt t G Glbal A single set f glbal accunting standards cntinues t be a gal f the IASB, but IASB Chairman Hans Hgervrst des nt see any indicatin that the SEC will act sn t require U.S. public cmpanies t use IFRS fr their financial reprting. Whereas the idea f achieving glbal cmparability in standards is being advanced by FASB in the absence f a decisin by the SEC n whether t require r allw public cmpanies t prepare their financial statements in accrdance with IFRS.2 Althugh the Securities and Exchange Cmmissin has fr many years been a strng leader in internatinal effrts t develp a cre set f accunting standards that culd serve as a framewrk fr financial reprting in crss-brder fferings, it nw appears unlikely that the SEC will require r allw IFRS fr dmestic public cmpanies in the near future. Despite the philsphically and culturally based differences in methdlgy between US GAAP and IFRS, certain steps have been taken in the standards cnvergence prcess, and have been prven successful s far, despite cntinued challenges. Bth the FASB and the IFRS cntinue t cllabrate n the develpment f new and 2 Jurnal f Accuntancy, January 10, 2013 Preparing fr the Latest Financial Reprting Changes 4
cnvergence f existing standards, including the area f business cmbinatins, which is an imprtant feature and cmpnent f the capital markets, as well as the areas f revenue recgnitin and the financial perfrmance f business enterprises. Lking Frward Cmpanies shuld remain engaged in the standard-setting prcess. A gd understanding f these financial reprting changes will be necessary t determine whether rganizatins will need new systems that can capture data, track cntracts, and supprt prcesses t develp and assess cmplex estimates. Investr and stakehlder cmmunicatin and educatin may be necessary. The new standards will impact sme cmpanies mre than thers, but all cmpanies will need t thughtfully cnsider them. Additinally, while sme implementatin timelines may seem lng, the level f detailed analysis, recrd keeping, cntract review, system mdificatin and impacts t ther areas f a cmpany s businesses may result in the need t utilize much f the lng timelines prvided. Cmpanies may be implementing multiple cmplex standards simultaneusly, increasing the level f effrt. Stay up t date, plan early and implement methdically t ensure a smth and issue-free implementatin f the new standards. Fr mre infrmatin n technical accunting and financial reprting impacts, cntact knwledge@experis.cm. Preparing fr the Latest Financial Reprting Changes 5
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