SEC Accounting Issues

SEC Accounting Issues & Financial Reporting

Niki Krutop, ModeratorPanelists:Roel C. CamposJoshua S. ForgioneChristopher M. Holmes



► International Financial Reporting Standards

► Fair Value Accounting

► New Purchase Accounting Standards

International Financial Reporting Standards


Momentum for a single set of high quality global GAAP

Global

GAAP

Enhances Transparency and

Comparability

Facilitates Accounting and

Reporting

Reduces Cost of Capital


SEC activities around IFRS

The Roadmap

2006

SEC Review of IFRS Filings by FTAs

2007 2008 Future

SEC Rule Proposal Eliminate GAAP Rec.

SEC Observations

SEC Roundtable

SEC Concept ReleaseU.S. Issuers & IFRS

IFRS or U.S. GAAP?

Filing date of IFRS accounts

Fair Value Accounting


Recently issued FASB statements related to fair value measurements

► Statement 157, Fair Value Measurements (Issued in Sept. 2006)

► Statement 159, Fair Value Option for Financial Assets and Liabilities (Issued in Feb. 2007)

Effective Dates ► SFAS 157 and 159 have the same effective date – fiscal years

beginning after November 15, 2007► Effective January 1, 2008 for calendar-year entities► FSP FAS 157-2 defers effective date for nonfinancial assets and nonfinancial

liabilities (other than those recognized or disclosed at fair value) until years beginning after November 15, 2008.

Focus ► SFAS 157 is MANDATORY and affects HOW to fair value and adds

disclosure requirements► SFAS 159 is ELECTIVE and affects WHAT is fair valued and adds

disclosure requirements


SFAS 157 – single definition of FV

Single definition of fair value

“The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

► Clarifies a number of key points:► Fair value is an exit price (conceptually different from a transaction price which is an entry

price)► An exit price in the principal market (or most advantageous market) in which the reporting

entity would transact► Fair value is a market-based measurement, not an entity specific measurement► The exit price objective applies regardless of the reporting entity’s intent and/or ability to sell

the asset or transfer the liability at the measurement date (current value)► Determined by reference to the price received in an orderly transaction for the asset at the

measurement date – not a forced liquidation transaction


“New” concepts under SFAS 157

Issue

“New” Guidance

Existing

Guidance

Exchange Price Notion

Market Participant Perspective

Exit versus Entry Price

Principal versus Most Advantageous Market

Fair Value Hierarchy

Assumption of Highest and Best Use by Market Participants

Premise of Value (In-Use versus In-Exchange)

Use of Market, Income, and Cost Approaches


Levels of the fair value hierarchy

Level Characteristic Example

Level 1

Quoted prices in active markets for identical assets / liabilities (unadjusted); no blockage factors (i.e., Price X Quantity).

►Listed equity / fixed income securities traded on an active exchange

►Exchange traded derivatives

Level 2

Other observable inputs – including quoted prices for similar assets / liabilities (adjusted) and market corroborated inputs; discounts for liquidity can be applied

►OTC derivative with value based upon observable LIBOR forward interest rate curves

Level 3

Unobservable inputs – entity’s own assumptions about market participant assumptions, including assumptions about risk, developed based on the best information available in the circumstances (subject to the cost-benefit constraint); may include the entity’s own data; discounts for liquidity can be applied

►Private equity investment►Intangible asset ►Long dated financial

instrument


Implementation and disclosure considerations► Implementation considerations

► Recognition of day 1 gains and losses ► Unit of account considerations► Credit adjustment for liabilities measured at fair value► Consideration of counterparty credit risk ► Transaction costs► Restrictions► Illiquid markets► Other judgment areas

► Hypothetical exit market► Hierarchy levels


Implementation and disclosure considerations, continued► Disclosure Requirements

► SFAS 157 disclosures are meant to provide additional transparency regarding the effect of FV measurements on earnings

► Information about fair value amounts► How FV amounts are determined► Effect of remeasurements on earnings► Other? - March 2008 SEC “Dear CFO” Letter

► MD&A disclosures on fair value

► Valuation resource group► SEC roundtable

New Purchase Accounting Standards


Business combinations

► Business Combinations (FASB Statement No. 141(Revised), and Noncontrolling Interests in Consolidated Financial Statements (FASB Statement No. 160)

► Issued December 2007Will be effective for annual periods beginning after December 15, 2008

► Prospective adoption ► Early adoption not permitted for U.S. GAAP► Concurrent adoption with new consolidation and noncontrolling interests

standard


Key changes

► Definition of business and business combinations► Transaction costs► Valuing stock issued in acquisition► Contingent consideration► Measurement period adjustments► Preacquisition contingencies► Acquired in-process R&D► Restructuring costs► Income taxes► Intangibles the acquirer does not intend to use► Noncontrolling interests

AppendixBusiness combinations – key areas with rule changes


Broadened definition of a business

► Current rules ► Under EITF 98-3, a business is a

self-sustaining integrated set of activities and assets conducted/managed to provide a return to investors

► Consists of (a) inputs, (b) processes applied to inputs and (c) outputs to generate revenue

► Must contain all of the above to conduct normal operations after separation from transferor

►New rules ► Business – An integrated set of

activities that is capable of being conducted and managed for the purpose of providing (a) a return to investors, or (b) lower costs or other economic benefits directly and proportionately to owners, members, or participants

► Consists of (a) inputs and (b) processes applied to those inputs

► Perspective of a market participant

► Development stage company can be a business


Transaction costs

► Current rules ► Fees/costs of raising acquisition

debt capitalized separately and amortized

► Fees/costs of raising new equity netted against proceeds received

► But no fees are allocated to equity when shares are used as acquisition consideration

► External transaction related costs (advisory, legal, due diligence, accounting) added to purchase price (and thus generally to goodwill)

► New rules ► No change for debt and equity

raising fees/costs► Transaction-related costs charged

to expense as incurred even if paid by seller


Valuing stock issued in acquisition

► Current rules ► Date used to determine the value-

per-share in purchase accounting depends on the terms of the exchange offer

► If fixed exchange ratio, per-share value is computed at announcement of the deal

► If variable exchange ratio (e.g., adjusts for movements in the Acquirer’s stock price), per-share value is computed when the ratio ceases to float (i.e., at closing or perhaps earlier if cap/floor/collar in place)

► New rules► The value-per-share will be

determined at the date the Acquirer gains control (e.g., on closing)


Contingent consideration arrangements

► Current rules ► Recorded when “beyond a

reasonable doubt”► Additional purchase price if based

on earnings or similar factors► No effect on purchase price if

based on security price ► Complicated rules if contingency

is embedded in a security or is a separate security

► EITF 95-8 analysis if payout is linked to continuing employment

► New rules► Recorded at acquisition date fair

value with subsequent accounting based on form

► If classified as equity, no “day 2” remeasurement

► If classified as a liability, “day 2” remeasurements to fair value

► Remeasurement through earnings with possible FAS 133 exception

► Compensation if payout is linked to employment, otherwise analysis is similar to EITF 95-8


Preacquisition contingencies

► Current rules ► Use FV of contingency if

determinable at closing or becomes determinable during the allocation “window”

► If not determinable, apply FAS 5 probable and reasonably estimable criteria

► New Rules ► Requires the use of FV on the

acquisition date for (1) all contractual pre-acquisition contingencies and (2) non-contractual pre-acquisition contingencies that are determined to be “more-likely-than-not” of materializing.


Preacquisition contingencies (cont’d.)

► Subsequent accounting► Adjustments made only when new information about the possible outcome is

obtained► Contingent liabilities measured at higher of (1) acquisition-date fair value or (2)

Statement 5 amount► Contingent assets measured at lower of (1) acquisition-date fair value or (2) best

estimate of future settlement amount► All adjustments (outside the “window” or resulting from changes in circumstances)

to pre-acquisition contingencies should be recorded by charges or credits to the results of operations

► Non-contractual pre-acquisition contingencies that are not determined to be more likely than not of materializing are not recognized on the acquisition date and are recorded by charges or credits to the results of operations when they become probable (FAS 5)


Acquired in-process R&D

► Current rules► EITF 86-14, FAS 2 and FIN 4► Purchase price should be

allocated to R&D projects in process that have fair value

► If project has “no alternativefuture use” amount allocatedshould be expensed

► New rules► IPR&D assets acquired recorded

as intangible assets► Generally indefinite life intangibles

until completion or abandonment

► Subsequent expenditures expensed

► Upon completion – assign a useful life and amortize


Restructuring costs

► Current rules► Recordable pursuant to EITF

95-3 in purchase accounting if three conditions are met:

► Relates to the Target’s (not the Acquirer’s) people or facilities

► Meet definition of “exit costs” (severance, facility closings, moving of personnel, cancellation of redundant contracts)

► Acquirer formulates a plan and carries it out within a reasonable time period

► New rules ► No purchase accounting

adjustment unless FAS 146 definition of a liability is met at acquisition date.

► Transaction or event occurs that leaves an entity little or no discretion to avoid the future transfer or use of assets to settle the liability

► The liability must exist at the target and not depend on the business combination


Income taxes

► Current rules► Reduction in Target’s valuation

allowance after the acquisition date shall be applied to reduce to zero

► Any goodwill related to the acquisition, then

► Other non-current intangible assets related to the acquisition, then

► Income tax expense

► Income tax uncertainties that pre-date or result from the acquisition:

► Reductions applied similarly to reduction in valuation allowance

► Increases recorded to goodwill

► New rules► Reduction in Target’s valuation

allowance after the acquisition date is recorded as a reduction of income tax expense

► All adjustments to income tax uncertainties that pre-date or result from the acquisition are recorded as an element of the income tax provision


Intangibles the acquirer does not intend to use

► Current rules ► In practice the Acquirer allocates

little or no value to intangible assets (e.g. a brand name) that it does not intend to support or utilize after the acquisition

► New rules ► All intangible assets and all other

assets (for which there is not a specific exception), are to be measured at fair value, as defined in FAS 157. That is, value based on the highest and best use by a market participant


Noncontrolling interests

► Current rules► Remaining minority interest is recorded at historical cost

► New rules► Fair value at acquisition date in U.S. GAAP

► Derive the value directly; or► IFRS Alternative

► Proportionate share of net identifiable assets (i.e., no share of goodwill)

► Exchange price might not be the best indication of noncontrolling interest fair value in a less than 100% acquisition► Effect on future goodwill impairments


Share-based payment awards

► Current rules► FV of equity granted in excess

of equity relinquished is compensation

► FV of equity issued subject to future service is recorded as compensation expense over the future service period

► Future service period is based on the ratio of the future service period to the total service period

► FV of equity issued related to past service included as purchase price

► New rules► Same as current except:

► Acquirer must be “obligated” to replace the awards

► Future service period is based on the ratio of the past service period to the greater of the total service period or the original service period

► Results in more compensation cost in post-combination financial statements when replacement awards have shorter service period than target awards


Acquirer’s deferred tax valuation allowance

► Current rules► A reduction in the Acquirer’s

valuation allowance for a DTA that results from a change in the Acquirer’s circumstances due to a business combination generally is accounted for as a reduction to goodwill

► For example, an Acquirer buys a profitable Target and determines it is able to utilize the benefit of its own NOL’s it formerly believed would expire

► New rules

► A change in the Acquirer’s valuation allowance for a DTA that results from a change in the Acquirer’s circumstances upon a business combination should be accounted for as an event separate from the business combination (i.e., through the income tax provision)


Excess of tax deductible goodwill over financial goodwill

► Current rules► No DTA recorded at the

acquisition date. Any tax benefits are recognized when realized and shall be applied to reduce to zero

► Any goodwill related to the acquisition, then

► Other non-current intangible assets related to the acquisition, then

► Income tax expense

► New rules► Amends FAS 109 to require the

recognition of a DTA in purchase accounting, similar to other temporary differences

► Requires solving an equation due to the iterative nature of the calculation


Negative goodwill

► Current rules ► First, adjust all Target’s

assets/liabilities to fair values (with any related deferred tax effects)

► If negative goodwill results, first proportionately reduce the carrying value of long-term, non-financial assets unless future contingent purchase price may be paid

► If any negative goodwill remains, record an immediate extraordinary gain

► New rules► First step remains the same—adjust

all assets/liabilities to FV including contingent purchase price

► If negative goodwill results, challenge purchase price allocation

► Any resulting negative goodwill is immediately recorded as a gain (but not extraordinary)


A business combination achieved in stages

► Current rules ► Cost accumulation model

► Each asset/liability adjusted proportionately

► Minority interest recorded at historical cost

► New rules► Revaluation of previously owned

equity interests upon obtaining control

► Gains and losses recognized in income

► Generally, all assets/liabilities/noncontrolling interest are fully adjusted to fair value

Thank you

SEC Accounting Issues

Documents

Transcript of SEC Accounting Issues