GAAP UPDATE: What next? Where do we go from here?

GAAP UPDATE
What Next? Where Do We Go From Here?

Jake Vossen
January 29, 2013

Agenda
• FASB Developments – Selected Projects and Initiatives
– Revenue Recognition
– Leases
– Impairment of Intangible Assets Other than Goodwill
– Other
• Proposed Financial Reporting Framework for Small and
Medium-Sized Entities (FRF for SME’s)
• Common SEC Review Comments/ PCAOB tone at the
Top
• AICPA Clarified and Converged Standards for Auditing
and Quality Control

© 2013 Hein & Associates, LLP. All rights reserved.

Revenue Recognition
• Joint project between FASB and IASB
• Objective: To develop a single, principle-based
revenue standard for US GAAP & IFRSs
• Revenue standard aims to improve accounting for
contracts with customers by:
– Providing a more robust framework for addressing revenue
issues as they arise
– Increasing comparability across industries & capital
markets
– Requiring better disclosure

© 2013 Hein & Associates LLP. All rights reserved.

Revenue Recognition cont’d

• US GAAP
– Many standards (over 100)
– Significant industry specific guidance
• IFRS
– Two key standards: IAS 18, Revenue, and IAS 11,
Construction Contracts
– Little industry guidance



• Applies to:
– Contracts with customers
– Gain/loss recognition on sale of some nonfinancial assets
(intangibles and PP&E)
– Certain nonmonetary exchanges
– Many industry-specific transactions such as real estate
sales



• Core principle of revised proposals:
Recognize revenue to depict the transfer of goods or services to
customers in an amount that reflects the consideration to which the entity
expects to be entitled in exchange for those goods or services.

Identify Identify separate
Determine
contract(s) with performance
transaction price
the customer obligations

Recognize revenue
Allocate transaction when performance
price obligation is
satisfied


Revenue Recognition – Differences from
Existing Standards

• Collectability:
– Revenue is still recognized “gross” but probability of
collection is no longer a revenue recognition criterion
– Entity should present any initial and subsequent
impairment of customer receivables, to the extent material,
as an operating expense
– Original proposal required expected losses to be netted
against revenues


Existing Standards cont’d

• Allocation of transaction price:
– If stand-alone selling price not available, an estimate may
be made
– New guidance is less restrictive than current guidance
applicable to software revenue recognition (VSOE
considerations), and may result in earlier recognition of
revenue in some cases
– Time value of money should be incorporated into amount
of consideration, if it is significant and exceeds one year



• “Constraint” on recognizing revenue on variable
consideration (fixed and determinable – N/A):
– An entity should recognize revenue as performance
obligations are satisfied only up to the amount that the
entity is confident will not be subject to significant reversal
in the future
– Adjusted in transaction price



• Bill and Hold Transactions:
– Not previously discussed in GAAP, but part of SEC
guidance
– New guidance is very similar to SEC guidance
– May impact private companies that were aggressive in
recording certain bill and hold transactions as revenue


Implications of Revenue Changes

• Any contract tied to GAAP revenue will be impacted
– Earn-outs on purchase agreements
– Compensation agreements
– Buy/sell arrangements, etc.
• Debt covenants may be impacted – Some debt
agreements are being drafted currently to require
“good faith” renegotiation of covenants based on any
new accounting pronouncements


Revenue Recognition – Redeliberations &
Next Steps
Key Decisions
• Constraining the amount of revenue recognized
• Collectability of the sales price
• Accounting for licenses
• Onerous contracts
• Other matters
Still To Be Discussed
• Disclosures
• Transition and effective date


Lease Exposure Draft

Why a Leases Project?
• Existing lease accounting does not meet users’ needs
– Accounting depends upon classification
– Contractual rights and obligations (assets and liabilities) are off-
balance sheet
– Many users adjust financial statements
• Structuring opportunities
– Current lease classification often based on bright lines
– Significant difference in accounting on either side of
operating/finance lease line


Lease Exposure Draft cont’d

Who does this apply to?
• All leases (with limited exceptions of leases of intangibles)
• Includes capital and operating leases



What are the major provisions?
• Proposed Right-of-Use Model: A lease contract is one in
which the right to control the use of an asset (for a period
of time) is transferred to the lessee
• All leases (except certain short-term leases) would be
presented on the balance sheet
Dr. Right of Use Asset
Cr. Liability
• Short-term leases would be defined as a lease with a
potential maximum period of 12 months or less



Two Types of Leases:
• Accelerated Leases – Lessee consumes more than insignificant
portion of leased asset
– Lease term is major part of economic life of asset
– PV of lease payments is substantially all of FV of asset

– Examples: Airplane with a 10-year lease; vehicle lease, equipment, etc.

• Straight-Line Leases – Lessee does not consume more than
insignificant portion of leased asset
– Lease term is insignificant relative to economic life of asset
– PV of lease payments is insignificant relative to FV of asset
– Examples: Land or building


Lease Exposure Draft – Lessee Model

Balance Income
Sheet Statement

Lessee consumes
Amortization expense
more than insignificant
portion of leased asset Interest expense
Dr. ROU asset 2
Cr. Lease liability 1
Lessee does not
consume more than
insignificant portion of Lease expense
leased asset

1 Measured at present value of lease payments
2 Initially
measured at same amount as liability, plus prepayments and initial direct costs


Lease Exposure Draft – Initial Exposure Draft
Expense Recognition is Front Loaded
9.00
8.00
7.00
Original ED Front-
6.00 Loads Expense
Recognition
5.00 Existing GAAP
4.00 Expense Recognition is
SL
3.00 Actual Cash Rent
Payments
2.00
1.00
-
1 2 3 4 5 6 7 8 9 10


Lease Exposure Draft – Initial Exposure Draft
Expense Recognition is Front Loaded
• The boards discussed various ways to resolve the
expense recognition issue
– FASB and IASB had divergent preferences for how to resolve
• Compromise was reached on recognition pattern
• Dual model approach
– A pragmatic solution… a compromise between conceptual purity
and practical application
– Preserves the primary objective of requiring lessees to recognize
lease assets and liabilities on balance sheet
– Allows for a distinction in expense recognition pattern
• Straight-line for certain leases
• Front-loaded pattern for other leases


Lease Exposure Draft – Disclosures

• Additional quantitative and qualitative disclosures will be
required to understand the timing and amount of cash
flows on leases
• Maturity schedule of all lease payments
• Disclose a maturity analysis of future contractual
commitments associated with services and other non-
lease components that are separated from a lease
contract


Lease Exposure Draft – Potential Impacts

• Balance sheet will be grossed up with ROU assets and
liabilities
• Operating leases will either be charged to amortization
expense or lease expense
• EBITDA and other financial statement ratios could be
impacted


Lease Exposure Draft –
Where Are We Now

2010 2013 2013 TBD

August 2010 Q1 2013 Consultation TBD
Exposure Draft 2nd Exposure Draft Final Standard
Leases Leases Leases
Comment period: Re-expose proposals Outreach Effective date: TBD
4 months (likely 2015 or 2016 at
earliest)
786 comment letters Comment period: Working group Will contain guidance
received 120 days meetings for both lessees and
lessors
Contained proposals for Focus on revisions to Redeliberations
both lessees and 2010 proposals
lessors
Will contain proposals
for both lessees &
lessors


Impairment of Intangible Assets Other
Than Goodwill

Impairment of Intangible Assets Other Than
Goodwill

• Impairment of indefinite-lived assets other than
goodwill
– Simplifies the impairment testing for indefinite-lived
intangible assets other than goodwill
– Applies to indefinite-lived assets such as:
• Customer lists, trademarks, licenses, distribution agreements, etc.


Goodwill cont’d

• Previous Guidance
– Required intangible assets to be tested for impairment at
least annually
– Compare the book value or carrying value to the fair value
– Impairment = loss in realizable value
• Preparer feedback was to allow for a qualitative
approach for testing impairment
– Reduce testing costs
• New Guidance – Allows for a qualitative evaluation of
the likelihood of impairment


Goodwill cont’d

• STEP 1 – Assess qualitative factors (e.g., industry
trends, revenues, cash flows, etc.)
• STEP 2 –
– Not more likely there is an impairment – STOP
– Is more likely there is an impairment
• Calculate the fair value of the asset and compare to book value

• New guidance does not change how an impairment
loss is recognized


Goodwill cont’d

• When is this guidance effective?
– Fiscal years beginning on or after September 15, 2012.
Early adoption is permitted.


Other Selected FASB Projects
• Financial Instruments: Classification and Measurement,
Impairment, and Hedging
• Insurance Contracts
• Disclosure Framework
• Accounting for Repurchase Agreements
• Liquidity & Interest Rate Risk Disclosure
• Balance Sheet Offsetting
• Going Concern
• Comprehensive Income
• Investment Companies


Other FASB Initiatives

• Private Company Council
• Private Company Decision Making Framework
• Implementation Initiatives
• Pre-agenda Research
• Complexity Initiatives


Proposed Financial Reporting Framework
for Small and Medium-Sized Entities
(FRF for SME’s)

Proposed Financial Reporting Framework for
Small and Medium-Sized Entities (FRF for SME’s)

• Major Problems With Big GAAP:
– Maintaining two sets of books – GAAP & Tax
– Costly appraisals to mark assets to market
– Self-reporting of tax uncertainties
– Consolidations (VIE’s, etc.)


Proposed FRF for SME’s cont’d

• What is FRF for SME’s?
– Reporting system developed by the AICPA
– Expected to be released in mid-2013
– Available for use in every industry
– Available to incorporated and unincorporated entities
– Not a required framework
– Blends traditional accounting method with tax methods


Proposed FRF for SME’s cont’d

• Key Features of New Framework:
– Use taxes payable method for income tax reporting – no deferred
taxes
– Use historical costs, as opposed to FMV, for valuing assets
– No “mark-to-market” for derivatives
– No “comprehensive income”
– All leases treated as operating leases
– No VIEs
– Departure from GAAP on Goodwill and Intangibles
• Goodwill – Follow tax amortization of 10 years
• Intangibles – Best estimate of amortization period or 10 years
• FASB is working on its own framework


Common SEC Review Comments and
PCAOB Tone at the Top

PCAOB Tone at the Top
Attitude Towards Consulting (James Doty, Chairman):
– Consulting fees are growing rapidly at large firms.
– Audit revenues are stagnant.
– Threat to strength of audit practices.
Attitudes Toward Audit Firms (Chief Auditor):
– Audit staff hear too often the importance of “client service”.
– Focus should be on “audit quality” not “client service”.
– The term “Relationship Partner” is problematic.
– Regulators conduct examinations without a focus on
“relationship”.
– “Trust but verify” approach is unacceptable.


PCAOB Tone and the Top

Audit Quality (James Doty):
– Consistent finding of auditing deficiencies
– Explicit finding of audits priced below cost to establish long-term
relationships.
– Insufficient “professional skepticism” most common finding.
– Audit firms should compete on quality not price.
– Want firms to hire and retain top graduates committed to public
service.


Common SEC Review Comments

• Management’s Discussion and Analysis (MD&A)
– Results of operations – Deficiencies:
• Boiler plate language
• Over simplifications
• Causes and effects omitted
• Performance metrics omitted (e.g., same store sales)
• Offsetting changes not disclosed
– Liquidity – Deficiencies:
• Inaccurate or incomplete descriptions
• Contractual obligations table is incomplete
• Obligations subject to uncertainty not included or disclosure is
incomplete (e.g., uncertain tax positions, variable interest payments,
OPEB plans)


Common SEC Review Comments cont’d

• Segment Information – Deficiencies:
– Segment information inappropriately aggregated
– Lack of on-going analysis
– Suggestions from staff:
• Registrants should provide a comprehensive response to staff’s
comments, including how CODM makes resource allocations and
assesses performance, in aberrations
• Continually monitor facts and circumstances


• Income Taxes – Deficiencies:
– Reversals of valuation allowances:
• Consider all evidence, both positive and negative
• Degree to which positive evidence is verifiable
• Current state of economy
• Consistency of assumptions (e.g., DTA reversal with a goodwill
impairment)
– Deferred tax assets in loss years:
• Economic slowdown is not an aberration
• Magnitude and duration of losses
• Drivers of losses
• Registrant’s ability to make accurate forecasts
• Consistency of assumptions



• Goodwill Impairment – Deficiencies:
– Reporting units at risk of failing Step 1:
• Staff recommends disclosure
• Disclosure should include changes in circumstances and
assumptions that could affect potential impairment
• Interim impairment tests should be disclosed
– Goodwill Impairment Charges:
• Disclose changes in circumstances that led to change
• Why now?



• Revenue Recognition – Deficiencies:
– Collectability reasonably assured
• Customer’s credit worthiness
• Payment terms
• Collection practices, including history of modifying terms, or making
other concessions
• Write-off history

• Non-GAAP Disclosures:
– Do not present a full non-GAAP income statement for
purposes of reconciling non-GAAP financial measures to
U.S. GAAP measures


AICPA Clarified and Converged
Standards for Auditing and Quality
Control

Key Changes Impacting Audits

• Explicitly requires determination whether applicable
reporting framework is acceptable
• Explicitly requires management acknowledgement of their
responsibilities at onset of audit engagement
• Changes to wording of the auditor’s report, including the
use of paragraph headings and expansion of the
description of management’s responsibilities
• Requires more specific procedures to detect illegal acts
• Additional requirements related to opening balances in
initial audits


Questions


GAAP UPDATE: What next? Where do we go from here?

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