FASB UpdateFASB Update

For Acct 592 – Spring 2005

To be covered later in courseTo be covered later in course

Related to consolidations FIN 46 (as revised) – related to

consolidations of special purpose entitiesWe’ll cover later and I’ll distribute a “readable”

discussion from our advanced textbook author

SFAS No. 123 (revised 2004)SFAS No. 123 (revised 2004)

Related to Stock Compensation I believe the revised standard does away

with the need for FIN 44, SFAS No. 148, APB Opinion 20

We’ll get into details later in course

Financial Institutions Financial Institutions

SFAS No. 147 – Acquisitions of Certain Financial Institutions (October 2002)

These institutions are no longer excluded from coverage of FASB 141 and 142 and FASB 144.

Probably not coveredProbably not covered

FAS 149 – an amendment of FAS 133 on DerivativesObjective: To clarify early standards and

settle implementation issues particularly with respect to “embedded” derivatives

Derivatives are covered in Acct 415/515 so we probably won’t be able to spend that kind of time on this complex topic this semester

New rules on New rules on redeemable preferred redeemable preferred stockstock

FAS150

FAS 150FAS 150

SFAS No. 150 – Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity (May 2003)Applies to “freestanding financial instruments”

onlyDoes not apply to features “embedded” in a

financial instrument that is not a derivative in its entirety (i.e., stock-based compensation and, as best I can tell, convertible bonds)

FAS 150FAS 150

Defines obligation as “conditional or unconditional duty or responsibility to transfer assets or to issue equity shares In the past, redeemable preferred stock have

been treated as equity or shown in the “mezzanine” level of balance sheet (between liabilities and owners’ equity). This statement removes the mezzanine!

Redeemable financial instrumentsRedeemable financial instruments

Mandatorily redeemable financial instrument shall be classified as liabilityExceptionsThe redemption is contingent on future event

Treat as liability when the event occurs, the condition is resolved, or the event becomes certain to occur

In this case, the liability is measured at fair value when reclassified to the liability section.

Equity is reduced and no gain or loss is recognized.

Certain not probable!

Redeemable financial instrumentsRedeemable financial instruments

Mandatorily redeemable financial instrument shall be classified as liabilityExceptionsThe redemption is contingent on the occurrence

of an uncertain future eventThe redemption is required only upon liquidation

or termination of the reporting entity Do not classify as liability

Reporting on StatementsReporting on Statements

Balance sheet required description:“Shares subject to mandatory redemption”Should be on separate line and not

commingled with other liabilities Income statement transition

Through “cumulative effect of a change in accounting principle”

DisclosuresDisclosures

Nature and terms of the financial instruments including rights and obligations Amount that would be paid or number of shares that

would be issued and their fair value “as if settled” at reporting date

How changes in fair value of issuer’s equity shares impact the settlement amount

Maximum amount issuer could be required to pay Maximum number of shares that might have to be

issued And several more items (see paragraph 27)

Example financial instrumentExample financial instrument

Trust-preferred securities A financial institution establishes a trust or other entity that is

consolidated with the financial institution The trust issues mandatorily redeemable preferred stock and

uses the proceeds to purchase from the financial institution an equivalent amount of junior subordinated debt

The financial institution pays interest to the trust, the trust uses the funds to pay the dividends

Why they exist Upon consolidation, the intercompany transaction (payment of

interest) disappears along with the debt (and the receivable on the trust’s books)

Example financial instrumentExample financial instrument

Trust-preferred securitiesUnder the new rules, the financial institution

will have to report INTEREST EXPENSE and DEBT instead of dividends and redeemable preferred stock

FAS 150 Appendix A includes other examples to aid implementation of the new rules

New rules on New rules on guarantees of debtguarantees of debt

FIN 45

FIN 45FIN 45

FIN No. 45 – Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (November 2002) An interpretation of FASB No. 5, 57, 107. This interpretation

REPLACES FIN No. 34 Scope: Covers disclosures to be made in interim and

annual reports regarding guarantees of indebtedness of others (disclosed under FASB No. 5 even though the probability is generally “remote”

Covers guarantee contracts that have Covers guarantee contracts that have any of the following 4 characteristicsany of the following 4 characteristics 1. Contracts that contingently require the guarantor to

make payments to the guaranteed party based on an “underlying” Examples:

Irrevocable standby letter of credit which guarantees payment of a specified obligationMarket value guarantee of asset owned by the guaranteed partyGuarantee of the market price of common stock of the guaranteed partyGuarantee of the collection of cash flows from assets held by special purpose entity

2. Performance standby letter of credit or similar arrangements in which guarantor must make payments to the guaranteed party in the event of another entity’s failure to perform under a nonfinancial contract

Covers guarantee contracts that have Covers guarantee contracts that have any of the following 4 characteristicsany of the following 4 characteristics

3. Indemnification agreements that require guarantor to make payments to the indemnified party (guaranteed party) based on changes in an “underlying” such as an adverse judgment in a lawsuit, imposition of additional taxes due to adverse interpretation of the law

4. Indirect guarantees of the indebtedness of others even though the payment to the guaranteed party may not be based on an underlying asset, liability, etc., of the guaranteed party.

THE INTERPRETATIONTHE INTERPRETATION

The issuance of a guarantee obligates the guarantor (issuer) in two respects: 1. The guarantor undertakes an obligation to stand

ready to perform over the term of the guarantee if the event that the specified triggering events or conditions occur

This is the noncontingent part of the obligation 2. The guarantor undertakes a contingent obligation

to make future payments if those triggering events or conditions occur

This is the contingent part of the obligationNew Disclosure – FIN 45

Key point of FIN 45Key point of FIN 45

FASB 5 should not be interpreted as prohibiting the guarantor from initially recognizing a liability for a guarantee even though it is not probable that the payments will be required under that guarantee.

Measurement of obligationMeasurement of obligation

a. The premium received or receivable – when the guarantee is issued in a standalone arm’s-length transaction with an unrelated party

b. When the guarantee is part of a transaction with multiple elements, estimate the fair value of the guarantee. Consider the premium which would be required by the guarantor

to issue a standalone guarantee with an unrelated party In the absence of observable transactions for identical or similar

guarantees, use expected present value measurement techniques

Measurement of obligationMeasurement of obligation

c. If a guarantor must recognize a guarantee at inception because it is probable and can be estimated (FASB 5), the amount to initially recognize is the GREATER of the fair value of the guarantee (as measured above) or the contingent liability amount required under paragraph 8 of Statement 5.

d Not for profit situation: guarantees provided as a contribution to an unrelated party (like a loan guarantee by a community foundation to a nonprofit entity), the guarantee (gift) should be measured at the fair value of the guarantee and NOT considered merely a conditional promise to give.

The debit side is not prescribedThe debit side is not prescribed

Some examples provided in FIN 45 include: a. If a premium is received, the debit would be to cash or

receivable. b. If the fair value of the premium is an allocation of the

receivable or cash received on a transaction that involves other assets, liabilities, etc., the allocation to the guarantee will affect the calculation of the gain or loss on the transaction.

c. If the guarantee is associated with the acquisition of a business accounted for under the equity method, the guarantee would increase the carrying value of the investment.

d. In an operating lease situation, the guarantee would affect prepaid rent.

e. If no consideration is received, the offsetting entry would be to expense.

Disclosures Required – FIN 45Disclosures Required – FIN 45

a. Nature of the guarantee including, the approximate term, how the guarantee arose, and the event or circumstance that would require the guarantor to perform under the guarantee.

b. Maximum potential amount of future payments c. Current carrying amount of the liability d. Nature of (1) any recourse provisions that would

enable guarantor to recover from third parties any of the amounts paid under the guarantee and (2) any assets held either as collateral or by third parties that the guarantor would be able to liquidate to recover any of the amounts paid.

Disclosures Required – con’tDisclosures Required – con’t

e. FOR PRODUCT WARRANTIES. The disclosure of the maximum amount of future payments requirement above is waived. Instead: 1. The accounting policy and methodology used to determine its

liability for product warranties including any deferred revenues associated with extended warranties.

2. A tabular reconciliation of the changes in the guarantor’s aggregate product warranty for the reporting period.

Beginning balance Aggregate reduction for payments made or services provided Aggregate increase for new warranties issued during period Aggregate changes in the liability related to pre-existing warranties

(changes in estimate) Ending balance

Example from Recent F/SExample from Recent F/S

New Pension New Pension DisclosuresDisclosures

FAS 132 (revised 2003)

Low interest rates = pension Low interest rates = pension difficultiesdifficulties Remember back to our computations for

pensions and other post-retirement benefitsWe use a discount rate to determine the

present value of future payments In recent years, very LOW interest rates have

lead to VERY HIGH pension liabilities As a response, FASB is adding new

disclosure requirements

New disclosuresNew disclosures

I counted about 9 new or expanded disclosures for public entitiesBig change is expanded disclosures for

quarterly (interim) reports Nonpublic entities don’t have to disclose

as much as public entities, but I also counted 9 new or expanded disclosures for them

Revised FAS 132Revised FAS 132

This revision should be on your FARS disk since it came out in December 2003.

You can download a copy from the FASB web site

You will need the revised standard to do the project for the semester

ExamplesExamples

Appendix C provides illustrations that should be useful in doing the footnote for the ADQ Inc. project (Spring 2005)

Illustration 1 is probably your “best bet” Remember, you may not be able to find

any “real examples” of the new disclosures yet since the rules are so new

SFAS No. 151-153SFAS No. 151-153

Added Jan 2005

SFAS No. 151 – Inventory Costs SFAS No. 151 – Inventory Costs

Part of the “international convergence” project. Clarifies that abnormal costs of idle facilities

should not be capitalized as product costs. Companies should use “normal capacity” for the

allocation of overhead. Any unallocated overhead is expensed during the

period in which they are incurred. Other abnormal handling costs or abnormal levels of

spoilage might also need to be expensed.

SFAS No. 152 – Accounting for SFAS No. 152 – Accounting for Real Estate Time-Sharing Real Estate Time-Sharing Amends SFAS Nos. 66 & 67 Special industry accounting practices are

clarified.

SFAS No. 153 – Exchanges of SFAS No. 153 – Exchanges of Nonmonetary Assets Nonmonetary Assets APB Opinion No. 29 generally required

that exchanges of nonmonetary assets would be based on the fair values of the assets exchanged Exception for exchanges of similar productive

assets. This standard changes the exception to a

“lack of commercial substance” rule

Commercial SubstanceCommercial Substance

A nonmonetary exchange has commercial substance if the entity’s future cash flows are expected to significantly change as a result of the exchange.

A significant change in future cash flows is defined to be meeting one or both of the following two conditions:1. Configuration of cash flows is different

The configuration (risk, timing, and amount) of the future cash flows of the asset received differs significantly from the configuration of the future cash flows of the asset transferred.

2. The entity-specific value is differentThe entity-specific value of the asset received differs from the entity specific value of the asset transferred, and the difference is significant in relation to the fair values of the assets exchanged.

SFAS No. 153, continuedSFAS No. 153, continued

Nonmonetary exchanges are recognized at the fair value of the nonmonetary asset relinquished UNLESS:

1. Fair value is not determinable for either asset 2. Exchange Facilitates Sales to Customers.

The transaction is an exchange of a product or property held for sale in the ordinary course of business for a product or property to be sold in the same line of business to facilitate sales to customers other than the parties to the exchange.

3. The exchange lacks commercial substance.

Forthcoming – first half 2005Forthcoming – first half 2005

Accounting Changes and Error Corrections—a replacement of APB Opinion No. 20 and FASB Statement No. 3 (Proposed Statement of Financial Accounting Standards)December 15, 2003

Earnings per Share—an amendment of FASB Statement No. 128 (Proposed Statement of Financial Accounting Standards)December 15, 2003

Accounting for Conditional Asset Retirement Obligations—an interpretation of FASB Statement No. 143 (Proposed Interpretation)June 17, 2004

Accounting changes and estimatesAccounting changes and estimates

Still in the exposure draft stage but expected to be issued first quarter 2005No more cumulative effect of change in

accounting standards at bottom of income statement

All changes in accounting principles would be handled through retroactive restatement of prior years

Accounting changes and estimatesAccounting changes and estimates

A change in depreciation method would now be classified as a change in estimate and would not require retroactive restatement of prior years

Earnings per share changeEarnings per share change

Part of the “international convergence” project. Seems to be a minor point to me – fairly

technical We can discuss when we cover EPS Expected 2nd Qtr 2005

Asset retirement obligationsAsset retirement obligations

The proposed Interpretation [planned for 1st Qtr 2005] would clarify that a legal obligation to perform an asset retirement activity that is conditional on a future event is within the scope of FASB Statement No. 143 Uncertainty surrounding the timing and method of settlement

that may be conditional on events occurring in the future would be factored into the measurement of the liability rather than the recognition of the liability.

If there is insufficient information to estimate the fair value, the liability would be initially recognized in the period in which sufficient information is available for an entity to make a reasonable estimate of the liability’s fair value.

Longer term projectsLonger term projects

Fair value measurement Definition of liability vs. equity Revenue recognition

Looking toward an asset/liability approach so it may be quite different than current GAAP

Business & not-for-profit combinations We are still waiting for clear definition of control Eliminate parent co. method in favor of the economic

entity approach