FASB Update
For Acct 592 – Spring 2006
1
What I’m Covering

Some things we’ll talk about later
46 (Revised) – related to consolidations of
special purpose entities
 FIN

Some standards relate to specialized industries
No. 147 – Acquisitions of Certain Financial
Institutions (October 2002)
 SFAS

These institutions are no longer excluded from coverage of
FASB 141 and 142 and FASB 144
No. 152 – Accounting for Real Estate TimeSharing (December 2004)
 SFAS

Amends SFAS Nos. 66 & 67
2
What I’m Covering

Some things are just too technical for in-depth
coverage!
 SFAS
No. 149 - Amendment of FAS 133 on Derivative
Instruments and Hedging Activities (April 2003)

Clarifies earlier standards and settle implementation issues
particularly with respect to “embedded” derivatives
 SFAS
No. 155 - Accounting for Certain Hybrid
Financial Instruments (Feb 2006)

Amends FAS 133 on derivatives and FAS 140 on
securitization of certain derivatives
3
Additional Pension
Disclosures
FAS 132 (revised 2003)
4
New Disclosures for Public Entities

Percentage of total plan assets by categories
like equity securities and debt securities
 More
detailed categories are encouraged if it would
help assess risk and long-term expected rate of return



Narrative discussion of investment policies and
strategies
Narrative discussion of how the expected rate of
return was determined
Accumulated benefit obligation
5
New Disclosures for Public Entities



Benefits expected to be paid to retirees in each
of the next five years and in aggregate thereafter
(presumably NOT the present value of benefits)
Estimated employer contribution that will be
made during next fiscal year
Weighted averages for assumptions in tabular
form
 Discount
rates, rates of compensation increase,
expected long-term rate of return, etc.

Measurement dates used to determine PBO,
etc.
6
Examples
Appendix C provides illustrations that
should be useful in doing the footnote for
the Peachbee project (Spring 2006)
 Illustration 1 is probably your “best bet”
 You should now be able to find “real
examples” of the new disclosures since
the rules were effective for fiscal years
beginning after 12/15/03

7
More to come on pensions


November 10, 2005, FASB decided to add a
comprehensive project to its technical agenda on
accounting for postretirement benefits including pensions
and to conduct that project in two phases.
Phase 1 (by 2nd half of 2006)


Require that funded or unfunded status be recognized on
blaance sheet (e.g., difference between PBO and Plan Assets for
pensions)
Phase 2 (multi-year project in collaboration with IASB)

Comprehensively consider measurement & display of various
elements of post-retirement benefits
8
Exchanges of
Nonmonetary Assets
SFAS No. 153 – Exchanges of
Nonmonetary Assets
9
Commercial 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 different
The 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.
10
SFAS 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.
11
Changes in Principles,
Estimates, Entities &
Corrections of Errors
SFAS No. 154 - Accounting
Changes and Error
Corrections
12
Accounting Changes & Corrections

SFAS No. 154 discusses 3 types of
accounting changes plus correction of
errors
 Changes
in Accounting Principle
 Changes in Accounting Estimates
 Changes in Reporting Entity
 Errors in Financial Statements
13
SFAS No. 154 - Accounting
Changes and Error Corrections


Issued May 2005 – effective for fiscal years
beginning after 12/15/2005
Applies to VOLUNTARY changes in choice of
accounting principle
 No
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

Change previously reported numbers so that they now
represent what the numbers would have been had the new
principle been in use during that time period
14
Some changes in principle = a
change in estimate

A change in depreciation method is now
considered a change in estimate and would not
require retroactive restatement of prior years
 We
already had the rule that if a change in principle
cannot be distinguished from a change in estimate, it
would be treated as a change in estimate
 Example: Switch bad debt accounting from
percentage of sales method to aging of accounts
receivable (allowance) method
15
Restatement Example
SFAS No. 154, Appendix A
 Illustration 1 - detailed example of a
change from LIFO to FIFO inventory
method
 Shows extensive disclosures that would
be needed to communicate impact on
balance sheet, income statement, and
statement of cash flows

16
A simplification?

Now all types of accounting changes are
handled the same way – retroactive
restatement
 Only
exception is when it is not practicable to
determine impact on prior periods
17
Asset Retirement
Obligations
FIN 47 - Accounting for
Conditional Asset Retirement
Obligations: an interpretation of
FASB Statement No. 143
18
Do we need to review FAS 143?

If so, I’ll come back to this interpretation
later in the semester!
19
Asset retirement obligations

FIN 47 (March 2005) would clarifies 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.
20
ARO Examples

Telephone company uses wood poles that
are chemically treated
 No
legal requirement to remove poles from
ground
 However, if and when poles are removed from
the ground, special disposal procedures are
mandated by law
 An asset retirement obligation should be
estimated at date of purchase
21
ARO Example

Facility currently owned contains asbestos
 Since
acquisition, regulations are put into
place that require special handling if building
is renovated or demolished
 ARO should be recognized when regulations
go into effect, if entity can reasonably
estimate fair value of the liability
22
New rules on
redeemable preferred
stock
SFAS No. 150 – Accounting for
Certain Financial Instruments with
Characteristics of both Liabilities
and Equity (May 2003)
23
Redeemable financial instruments
Mandatorily redeemable financial instrument
shall be classified as liability
 Exceptions

 Redemption
is contingent
Required only upon liquidation or termination of the
reporting entity
 Required only if an uncertain future event occurs


Becomes liability only when the event becomes certain to
occur
Certain not
probable!
24
Other redeemable securities

Classify as liability:
Obligation to repurchase equity
Obligations to issue variable number of
shares
25
Measurement of liability
Financial instruments that meet these
requirements are initially measured at fair
value
 Most are then re-measured at fair value
and the subsequent changes in fair value
are recognized in earnings

26
Reporting 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”
27
Disclosures

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)
28
Example 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)
29
Example financial instrument

Trust-preferred securities
 Under
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
30
New rules on
guarantees of debt
FIN No. 45 – Guarantor’s Accounting
and Disclosure Requirements for
Guarantees, Including Indirect
Guarantees of Indebtedness of Others
(November 2002)
31
FIN45 Covers guarantee contracts that have
any 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 obligation
Market value guarantee of asset owned by the guaranteed party
Guarantee of the market price of common stock of the guaranteed
party
Guarantee 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
32
Covers guarantee contracts that have
any 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.
33
THE 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 obligation
New Disclosure – FIN 45
34
Key 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.
35
Measurement 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
36
Measurement 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.
37
The 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.
38
Disclosures 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.
39
Disclosures 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
40
Example from Recent F/S
41
ST Convergence
with IASB
42
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.
43
Coming soon
Earnings per Share - Minor change to
determination of earnings per share – due
out 1st Quarter 2006
 Income Taxes – exposure draft due 2nd
Quarter 2006
 Research and Development - ?

44
What’s Next?
45
Forthcoming – first half 2006



Earnings per Share—an amendment of FASB
Statement No. 128 (Proposed Statement of
Financial Accounting Standards) - December 15,
2003
Fair Value Measurements (Proposed
Statement of Financial Accounting Standards) June 23, 2004
Accounting for Uncertain Tax Positions—an
interpretation of FASB Statement No. 109
(Proposed Interpretation) - July 14, 2005
46
Forthcoming – first half 2006

Statement 140 Issues:
 Accounting
for Transfers of Financial Assets—an
amendment of FASB Statement No. 140 (Proposed
Statement of Financial Accounting Standards)
August 11, 2005
 Accounting for Servicing of Financial Assets—an
amendment of FASB Statement No. 140 (Proposed
Statement of Financial Accounting Standards)
August 11, 2005
47
Longer term projects

Business & not-for-profit combinations (2007)
 We
are still waiting for clear definition of control
 Eliminate parent co. method in favor of the economic
entity approach



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
48