FASB/IASB – Progress Towards
Conversion
Memorandum of Understanding
Revenue Recognition
Financial Statement Presentation
Leases
Other Projects in the Works
Debt vs. Equity
Pensions
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Memorandum of Understanding
(2006 Norwalk agreement updated in September 2008)
Wouldn’t it be nice for FASB & IASB to agree
(converge) on all the major projects?
Work together, leverage off each other, and share
staff to develop the same quality standards
If US switched to IFRS someday, progress in
convergence could make it all a lot easier
Is it possible – can they agree or is it too idealistic?
Where are we today? Is it working?
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Revenue Recognition
FASB and IASB have issued their Preliminary Views
Discussion Paper on how to recognize revenue
(comments due 6/19/09)
Asset/liability view (in) - revenue/expense view (out)
“ Earnings process is complete” – gone!
Eventually, this project could replace SAB 104 and all
FASB Statements, AcSEC SOP’s & Guides, and
EITF’s on revenue recognition
(About 180 pieces of guidance exist today – crazy!)
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Revenue Recognition – The new model
Contract Based – right to receive payment/performance
obligation results in a net contract position
The performance obligation to provide goods and services is a
liability not deferred revenue.
Recognize revenue when there is a decrease in the performance
obligation (i.e., an increase in the net contract position)
If the estimate of the cost of performance obligation goes up,
this may make contract “onerous” – record contract loss!
What if contract has multiple elements?
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Multiple Element Arrangements
• Allocate customer consideration (e.g., $900 in the
example) to each performance obligation
• Base it on the proportion of the stand-alone selling
price of each:
SP
Consideration
– Machine
$800 80% $720 –rev 1st qtr
– Installation
200 20%
180 –rev 2nd qtr
– Total selling price
900
What if there’s NO reliable evidence to support
stand-alone price – Estimate it anyway!
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How are performance obligations satisfied?
When entity transfers the promised goods or service
to the customer
That is, when the customer obtains control and it is
the customer’s (e.g., customer takes physical
possession of the good)
Then company reduces performance obligation (dr)
and recognizes revenue (cr) in income!
Is this better than trying to determine when the
“earnings process is complete”?
Will this new model change practice? How?
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Possible Changes?
• Percentage of completion – does customer “control”
the item as it is constructed (e.g., 1st 6 of 10 floors)?
• Warranties would be a performance obligation
• Using estimates to allocate (rather than, say VSOE
for software multiple element contracts)
• What about costs – could a sales commission be
capitalized to “better match costs and revenues”?
• Does this proposal impact reserve for sales returns?
What are the FASB/IASB’s plans?
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Financial Statement Presentation
FASB & IASB’s goal – improve usefulness of financial statements
– major changes may be coming!
Today’s financial statement package according to users:
Too many alternative type presentations
Information is highly aggregated and inconsistently presented
Difficult to understand the relationships
A new Preliminary Views Discussion Paper has been issued to
require detailed information to clearly communicate an
integrated (cohesive) financial picture (Comments were due 4/09)
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The “Cohesiveness” Principle
Categories for each of the financial
statements:
-Business – operating and investing
-Financing
-Income taxes
-Discontinued operations
-Other comprehensive income
-Equity (for the balance sheet)
Goal – financial statements should be clear and articulate!
Management judgment to decide what goes where.
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STATEMENT OF COMPREHENSIVE INCOME
Sales
Costs
Net income (business & financing shown separately)
Other Comprehensive income (after tax)
Available for sale securities
Cash flow hedges
Unfunded accumulated benefit obligation
Foreign translation adjustment
Total OCI
Total Comprehensive income
EPS – net income
$1,000
800
200
30
(20)
(15)
(10)
(15)
$185
$2.00
Would this be an improvement ? __________
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More Decisions
• Cash flow statement – mandate direct method
– Expensive? Practical?
• More “function” and “nature” type
disclosures
• No more extraordinary items
• Financial statements just won’t look the same
anymore plus lets add a reconciliation too!
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The reconciliation – understanding uncertainty
Cash flows Accruals & Alloc. FV changes* Comp income
Sales
$xxx
C of GS xxx
SG&A
xxx
Taxes
xxx
Disc Op xxx
OCI
xxx
$xxx
xxx
xxx
xxx
xxx
xxx
*By recurring and non recurring
The objective – reconcile each line item on the statement of cash flows
to the same line item on the statement of comprehensive income
Will the reconciliation be useful?
Will users benefit from this whole new approach? Status?
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Leases - are they going on the
balance sheet (over $1 trillion)?
• Off-balance sheet leasing is an industry (legitimate but often
structured) under FAS 13 (and many, many amendments and
interpretations) – a truly rules based standard!
Red lines – 75%, 90% - all or nothing –hmmm??
• FASB and IASB jointly issued a Preliminary Views
Discussion Paper – principles based! (Comments are due 7/17/09)
• If adopted– Under the model all leases (unless immaterial) would
be capitalized:
Asset - - - Right to use an asset during the lease term
Liability - Obligation to pay rentals
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Measurement of Leases
• Obligation – Present value of rentals discounted at the
incremental borrowing rate then amortized cost (not FV)
• Asset – Cost – same present value amount and amortize
over shorter of term or economic life (thus income different)
• Term – if there are options, use “most likely” term –
reassess each period and adjust balance sheet if necessary
for changes in estimates
• Contingent rent – record estimate at inception and keep
reassessing (FASB & IASB have different approaches)
IS THIS NEW APPROACH A BIG IMPROVEMENT?
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Issues!
• Will users really be better off with all leases on the
Balance Sheet?
• What will the impact be of recording lease liabilities –
the obligation to pay rent- on the perceived health of
the company?
• Will many companies be in default on covenants?
• Other issues – Lessor accounting? What about other
executory obligations (employment contracts,
purchase orders)? What if all liabilities are accounted
for at Fair Value someday – leases too?
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What will happen next?
Liabilities & Equity –Which is it?
FAS 150 (2003), in phase 1,
addressed, for example:
- Redeemable preferred stock
- Forward purchase contracts
- Obligations payable in shares
These are LIABILITIES!!
But (6 years later) what about everything
else?
The FASB/IASB are still developing the new model
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Tentative decisions
Equity:
Preferred stock that lacks a settlement requirement
Stock that’s redeemable upon retirement (e.g., partner’s capital)
Redeemable at company’s option
Liability:
Mandatorily redeemable stock
Redeemable at the option of holder
Derivatives in an entity’s own stock (an asset or liability)
Open:
Employee stock options, convertible debt – bifurcate?
When will this project ever end?
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Criticisms of pension accounting
Record expected return on plan assets – not actual
(e.g., expect to make 7% but lose 40%)
Spread actuarial gains and losses
Pension expense – one number vs. several on income
statement
Unfunded liability may not have been on Balance
Sheet (but it is now thanks to FAS 158 – over $500
Billion and getting much bigger today)
(Otherwise the pension expense model is OK!)
Smoothing vs. Volatility! The solution?
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Phase II – Fix the Accounting Model
Possible Big Changes
:
(FASB & IASB each working separately)
-No more smoothing – run it through income (not
OCI) - Changes in interest rates, fair value of plan
assets, etc. – but lots of volatility?
-Gross up on income statement - Service costs,
interest, investment results?
- Consolidate the plan (like a VIE)?
Nothing is likely to change soon (and when it does will
there be any defined benefit plans left?)
How is FASB/IASB dividing up the work load?
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Conversion vs. Just Adopting IFRS?
• Someday maybe we will all follow
IFRS?
• If we converge on all the major topics
first, won’t it be a lot easier?
• What should the FASB be doing:
Push ahead to converge,
Work towards switching to IFRS,
Just do its own thing, or
All of the above at the same time?
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