SEC "Hot" Topics Seminar (June 2006) (Blue Background)
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Transcript of SEC "Hot" Topics Seminar (June 2006) (Blue Background)
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[SB061670.291]
SEC and Accounting Hot Topics
June 6, 2008
Presenter: Stephen Sommerville, PricewaterhouseCoopers LLP
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Agenda
SEC Hot Topics
FAS 141R
XBRL
IFRS
Committee on Reducing Financial Reporting Complexity
Questions
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SEC Hot Topics
Credit Markets
Use of Experts
Stealth Restatements
Significant Acquisitions and Rule 3-05
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“While recent efforts of the FASB to remedy shortcomings in financial reporting for off balance sheet transactions are to be applauded, they appear so far to have fallen short of what investors need.”
Letter to FASBSenator Jack ReedFebruary 12, 2008
Market Reaction to Credit Markets and Fair Value
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“Haven’t we seen this movie before, involving a company called Enron? Didn’t Congress pass a law requiring that the problem of off-balance sheet mysteries be solved?”
“Should we blame the accountants?...If the accountants had forced better disclosures, it is at least possible that managements would have spent more time evaluating the risks they were taking, and then made wiser business decisions.”
Floyd NorrisNew York TimesFebruary 29, 2008
Market Reaction to Credit Markets and Fair Value
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“… ‘mark to market,’ an accounting and regulatory innovation of the early 1990s, has proved another of Washington’s fabulous failures -- that is, if the goal were curing market uncertainty through ‘improved’ accounting practices.”
Wall Street Journal, March 5, 2008
“… the introduction of accounting rules that required companies to state assets at the latest market prices had helped contribute to global financial market volatility.”
Claude Bebear, Chairman, Axa GroupFinancial Times, February 29, 2008
Market Reaction to Credit Markets and Fair Value
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FAS 157 – Background on the standard
Part of the convergence roadmap between US GAAP and IFRS
FAS 157 is part 1 of a two-part process
Issued in US in September 2006
IFRS exposure draft on fair value expected in 2009
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FAS 157 – Scope of the standard
FAS 157 amends definition of Fair Value throughout GAAP with limited exceptions
For example, FAS 123R is excluded from scope, as are some revenue recognition measurements based on vendor based payments
Two scoping exceptions
- Practicability exceptions are preserved
- Measures similar to fair value
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FAS 157 – Fair value
Definition
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
An exit price concept – the price an entity would receive to sell an asset or pay to transfer a liability
One company’s fair value may differ from another’s based on market access
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FAS 157 – Fair value hierarchy
Level 1 – Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets
Level 2 – Include other inputs that are directly or indirectly observable in the marketplace
Level 3 – Unobservable inputs(e.g., internal projections)
Distinguishes between observable and unobservable inputs in 3 levels
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FAS 157 – Disclosures
Driven by level within the hierarchy
Two categories:
Recurring
Nonrecurring
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Recurring Measurements
Amount of FV measurement at reporting date
Level within hierarchy
For Level 3 a roll-forward must be prepared and include total unrealized gains/losses in earnings due to assets and liabilities held at reporting date
Annually
Valuation techniques
Discussion of changes to techniques
FAS 157 – Disclosures
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FAS 157 – Disclosures
Nonrecurring Measurements
Amount of FV measurement at reporting date
Level within hierarchy
For Level 3 description of the inputs and information used to develop inputs
Annually
Valuation techniques
Discussion of changes to techniques
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FAS 157 – Considerations
Required adoption in first quarter of 2008 for calendar year-end companies.
Deferral for nonfinancial assets and liabilities recognized and measured on a recurring basis (FSP FAS 157-2).
Proposed FSP on measuring fair value of liabilities.
Annual financial statement disclosures are required in period of adoption.
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Impact of Credit Market Events
Credit market conditions continued to deteriorate during the first quarter of 2008.
Growing instances of failed auction rate securities, increasing credit spreads and margin calls.
Increasing situations where businesses are experiencing significant financial distress.
Current market has resulted in increased risk relating to companies or funds that may be highly leveraged.
Often, these companies may be financed by pledging certain assets as collateral.
As market events unfold, value of underlying collateral has decreased, which increases risk that creditors may request additional capital to collateralize debt.
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Disclosure Considerations
SEC focusing on adequacy of management’s disclosures surrounding credit market issues.
Significant changes to previous disclosures.
Material judgments and estimates.
Exposure of assets and impact on financial statements.
Disclosures surrounding sensitivity and risks.
Debt Covenant impacts and going concern considerations.
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Disclosure Considerations
SEC focusing on adequacy of management’s disclosures surrounding credit market issues.
Transparency surrounding timing of writedowns.
- Why Q1 and not year end?
- Why does this represent a change in estimate?
SEC intends to issue “Dear CFO” letters to encourage transparent disclosure.
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SEC Topics – Use of Experts
For filings under the 1933 Act, Rule 436 of Regulation C requires that registrants include a consent as an exhibit when any reference is made to a third-party valuation report. A consent is required even if management’s disclosure references
“consideration of” as opposed to “reliance on” the third-party report. No consent is required if management accepts responsibility for the
third-party’s work and does not reference the expert. In filings under the 1934 Act, consents do not need to be obtained,
unless the 1934 Act filing that references a third-party expert is incorporated by reference into a 1933 Act filing.
If a 1934 Act filing makes reference to a valuation firm or other expert, the registrant must provide the name of that expert.
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SEC Topics – Restatements
The requirements of Item 4.02 require that a Form 8-K be filed within four business days of the determination that past financial statements should no longer be relied upon because of an error.
In interpreting this requirement, the SEC staff, through existing SEC staff FAQ, has clarified that a separate Form 8-K is required even if the company discloses in a Form 10-Q or Form 10-K filed within the same four business day period that the prior statements cannot be relied upon.
The Government Accountability Office has recommended that the SEC staff codify its interpretation in order to reduce the opportunity for what some refer to as “stealth” restatements.
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SEC Topics – Rule 3-05
Rule 3-05 governs the financial statement requirements for acquired businesses.
Number of audited years required is governed by the significance of the acquisition:
>50% – 3 years income statement/cash flow, 2 years balance sheet
>40% – 2 years income statement/cash flow, 2 years balance sheet
>20% – 1 year income statement/cash flow, 2 years balance sheet
Previously relief from 3 year requirement if revenues of acquiree less than $25 million.
In January 2008 the SEC increased the threshold under Rule 3-05(b)(2)(iv) to $50 million.
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FAS 141(R)
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FAS 141(R)
Provides new guidance on accounting for business combinations
FAS 160Provides new guidance on accounting for minority
interests in consolidated financial statements
Both standards effective January 1, 2009 for calendar year-end companies
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FAS 141(R)
Fundamental principal: An acquired business should be recorded at fair valueon acquisition date
More assets and liabilities will be recorded at fair value
Will create challenges for preparers and auditors
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FAS 160
Changes the accounting for minority interests (“noncontrolling interests”)
Recorded as part of equity
Creates a new financial reporting relationship between majority and minority shareholders
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Key area of change
FAS 141 Recording acquisition
driven in large part by total costs incurred by acquirer
FAS 141(R) Record acquired entity
at fair value at acquisition date
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Transaction and restructuring costs
Under FAS 141(R)Generally expensed
Typically recorded as part ofthe cost of the acquisition
Previous Accounting
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Valuation of equity securities issuedas part of the purchase price
Under FAS 141(R)Valued at the acquisition date
Generally valued by the acquirerwhen the terms were agreed to
Previous Accounting
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Earn-Outs (contingent considerations)
Under FAS 141(R)Recorded at fair value on acquisition date as part of
fair value of acquired business
Not accounted for until contingency was resolved and then recorded as part of purchase price
Previous Accounting
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Recorded regardless of the likelihood of payment
Uncertainty of payment will be factored into determination of fair value
Will need to be remeasured at fair value in subsequent periods
Earn-Outs (contingent considerations)
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Accounting for In-process Research and Development (IPR&D)
Continue to measure at fair value at acquisition date
Record as indefinite lived intangible assets and subject to impairment testing
After completion of project, amortize asset through earnings
New guidance does not change accounting for R&D expense outside
a business combination
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Adjustments to purchase accounting
Under FAS 141(R)Up to one year
Adjustments to purchase accountingapplied retroactively
Up to one yearAdjustments to purchase accounting
applied prospectively
Previous Accounting
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Tax adjustments
Under FAS 141(R)Changes made after measurement period will be
recorded in earnings
Treated as an adjustment to purchase accounting (generally goodwill)
Previous Accounting
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FAS 141(R) Considerations
• Legal: involvement of legal counsel to assist in ensuring complete identification of contingencies, determining if they are contractual or noncontractual and whether specific thresholds are met.
• Due Diligence: companies may want to consider earlier and more extensive due diligence procedures.
• Existing acquisitions: even companies with no merger activity on the horizon may be affected (e.g., deferred tax valuation allowance, tax uncertainties and NCI related to prior acquisitions).
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XBRL – Regulatory Update
On May 14, the SEC proposed rule amendments that would mandate the use of interactive data in financial reporting.
Require XBRL (eXtensible Business Reporting Language), over a three-year phase-in period.
The largest filers would begin to submit financial statements in XBRL format as early as next spring.
Once released, the proposed rule amendments are expected to have a 60-day comment period. The SEC has indicated its intention to issue a final rule this fall.
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XBRL – Regulatory Update
Summary of SEC’s Expected Proposed Rule Amendments
US GAAP Domestic and foreign large accelerated filers with a worldwide public float > $5 billion, would begin submitting financial statements in XBRL format for fiscal periods ending on or after December 15, 2008.
All other domestic and foreign large accelerated filers (i.e., issuers with a worldwide public float of $700 million or more) that use US GAAP would submit financial statements in XBRL format for fiscal periods ending on or after December 15, 2009.
All remaining smaller domestic filers as well as those foreign private issuers using IFRS would begin submitting financial statements in XBRL format for fiscal periods ending on or after December 15, 2010.
The proposal is not expected to require that auditors provide assurance on the exhibit that includes the XBRL-formatted financial statements.
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IFRS – US Regulatory Update
Foreign Private Issuers
Elimination of US GAAP reconciliation for FPIs effective March 2008.
SEC proposed rulemaking expected in the near future.
Will likely allow a certain subset of the domestic registrant population the option of using IFRS.
May be allowed as early as 2009.
Concurrent with proposed rulemaking, it’s expected that SEC will also issue a roadmap for moving to mandatory use of IFRS.
Timing of rule mandating use of IFRS still to be determined.
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Advisory Committee on Improvements to Financial Reporting
The Committee’s objective is to examine the US financial reporting system in order to make recommendations intended to increase the usefulness of financial information to investors while reducing the complexity of the financial reporting system to investors, companies and auditors.
Five subcommittees have been established:
Substantive complexity
Standard-setting process
Audit process and compliance
Delivering financial information
International coordination
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Questions