GAAP, SEC, and IFRS Update

Ed Crater

September 2008

Agenda

Principles – the “P” in GAAP

Statement 141(R), Business Combinations

Financial Instruments Hot Topics

Revenue Recognition Issues

SEC & IFRS Update

G A A R

Getting back to Getting back to “P”rinciples…“P”rinciples…

How difficult How difficult can it be?can it be?

Principles – the “P” in GAAP

• What’s the buzz?

– SEC initiated a “complexity project”

– FASB & IASB convergence

• Why now?

– “Today's rules can produce financial statements that virtually no one understands.”, Global Capital Markets and the Global Economy, November 2006

– 800 pages of implementation guidance on FAS 133

– Statement 159 transition issues

Principles – the “P” in GAAP

• Clamping down

• Benefits– Enhance consistency & comparability

– Eliminate complexity

– Professional judgment

• Challenges– Agreement on what “principles” look like

– Limited exceptions (a.k.a. rules)

– Implementation guidance balance

– Structuring: “show me where it says…”

– Professional judgment

Statements 141(R) : An Overview of New Guidance on

Accounting for Business Combinations

Content

• Statement 141(R) – Business Combinations

– Background

– What’s Really Changing?

Statement 141(R) - Background

• Multi-phase project– Phase One

• Resulted in Statements 141 and 142 in 2001

• Eliminated poolings (except for certain not-for-profit combinations and mutual enterprises)

• Eliminated amortization of goodwill

• Created new category called indefinite-lived intangibles

– Phase Two – Joint Phase with the IASB

• Reconsideration of purchase accounting guidance that Statement 141 and IFRS 3 carried forward

• Reconsideration of accounting for non-controlling interests

• FASB and IASB received 282 comment letters on Business Combinations and 144 comment letters on Non-controlling Interests

Statement 141(R) – Effective Date and Transition

• Effective date– Fiscal years beginning after December 15, 2008– Early adoption is prohibited

• Transition– Prospective application for transactions consummated

after the effective date, with one exception for income taxes

Fundamental Principles of Statement 141(R)

• Main Principles for Applying the Acquisition Method– Recognition Principle: The acquirer recognizes all of

the assets acquired and all of the liabilities assumed

– Measurement Principle: The acquirer measures each recognized asset acquired and each liability assumed and any noncontrolling interest at its acquisition date fair value

• Definition of a Business– An integrated set of activities and assets that is capable

of being conducted and managed for the purpose of providing a return in the form of dividends, lower costs, or other economic benefits

– The entity does not have to be producing units; it just has to be capable of producing outputs (i.e. developmental stage entities)

Areas of Significant Changes in Practice

• Scope

• Definition of a Business

• Measurement Date for Equity Securities

• Measurement Period

• Income Taxes

Acquisition Costs Assets Acquired and Liabilities Assumed Restructuring Costs Reacquired Rights IPR&D Contingencies Contingent Consideration Indemnification Assets

Financial Instruments - HOT TOPICS

Financial Instrument Hot Topics

• SFAS 157/159

• On the horizon - FASB:

– FAS 133 Hedge Accounting Reconsideration

– FAS 140 Overhaul: Possible Extinction of QSPE

SFAS 157

• Not just applicable to financial instruments

• Fair value = exit price

• Transaction costs expensed as incurred

• Day 1 Gains:

– EITF 02-3 prohibition on day 1 gains rescinded

– SEC Staff: “Not open season”

– Paragraph 17 criteria for day one P&L

• Significant new disclosure requirements

SFAS 157

• Alternative investments

• Limited or no market activities – Auction Rate Securities

• Levels 1, 2, and 3 inputs need to be documented

• Level 3 is not a default category

SFAS 159

• Fair Value Option – instrument by instrument

• Adoption strategies inconsistent with principle – no significant ongoing MTM through earnings

• Restrictions on when fair value may be elected

On the Horizon - FASB

• FAS 133 Hedge Accounting

– Hedge Accounting Clarification Project

– Scope may increase to reconsideration of hedge accounting model

– Stay tuned!

• FAS 140 – QSPEs

– Going the way of the dinosaur?

– Maybe replaced with linked presentation

Time for aNew Model?

Sources of Revenue Recognition Guidance

• There are many sources of revenue recognition guidance – over 200

but

• We do not have a comprehensive revenue recognition model

Multiple Element Transactions

• EITF 00-21

– Identify “Deliverables” (par. 8)

– Determine Units of Accounting (par. 4 and 9)

– Determine Appropriate Revenue Recognition Model to Follow for Each Unit of Accounting

Revenue Recognition Model

• For each Unit of Accounting

– Determine Revenue Recognition Model to Follow

– May be Difficult in Situations the Unit of Accounting includes Deliverables that would use different revenue recognition models if sold separately

• Last deliverable?

• Predominate deliverable?

• Default to SAB 104?

Accounting Outcomes That Do Not Make Friends

• Recognition over Life of Arrangement or Expected Customer Relationship

• Recognition Deferred until Final Deliverable

– Over remaining term of final deliverable, or

– Upon completion of last act

FASB Codification

FASB Codification

• Does NOT change GAAP

• Will reorganize pronouncements into roughly 90 accounting topics

• SEC guidance will follow a similar topical structure

• New structure designed to:– Reduce the amount of time and effort required to solve an

accounting research issue

– Improve usability of the literature, thereby mitigating the risk of noncompliance with standards

– Provide real-time updates as new standards are released

– Assist the FASB with the research and convergence efforts required during the standard-setting process

– Become the authoritative source of literature for the completed XBRL taxonomy

FASB Codification

• One-year verification phase complete

• After addressing issues raised during the verification phase, the FASB is expected to formally approve the Codification as the single source of authoritative U.S. GAAP, other than guidance issued by the SEC

• FASB expects to approve and make authoritative in April 2009

• To improve useability, the Codification will include:– Authoritative content issued by the SEC

– Selected SEC staff interpretations

FASB Codification

• All accounting standards (other than the SEC guidance) used to populate the Codification will be superseded

• With the exception of any SEC or grandfathered guidance, all other accounting literature not included in the Codification will become nonauthoritative

Most Frequently Issued SEC Comments

Most Frequently Issued SEC Comments

• Financial statement classification

• Revenue

• Reserves-Impairments, Loss Contingencies, Income Taxes

• Financial instruments

• Segments

• Stock Compensation

• Business Combinations /Intangible Assets

• Discontinued Operations

• Asset Retirement Obligations

• Fair Value Measurements

• MD&A (Non-GAAP measures)

• Disclosure Controls

Classification

• Income Statement– Revenues

• Components• Products versus services

– Components of cost of sales• Inclusion of depreciation and amortization

– Gross profit• Disclosure in quarterly summarized information

– Operating versus non-operating• Equity earnings• Gains / losses on sale of assets

• Statement of Cash flows– Operating, investing or financing

SEC Reporting Issues

SEC Reporting Issues

• Retrospective accounting changes

– SFAS 154, Discontinued operations, Segments

– Restatement of a prior Form 10-K for an error when there is a discontinued operations in the subsequent interim period

• Equity investees

– Failure to file required financial statements

– Impact of gain / loss on sale and impairments in the significance test

– Requirement to re-perform significance test if a subsequent discontinued operations

SEC Reporting Issues

• Businesses acquired

– Acquisition of a business or assets• EITF 98-3 versus Article 11 of S-X

– Significance tests

– Probable acquisitions

– Inability to obtain audited financial statements

• Pro forma financial statements

– Factually supportable adjustments

– Elimination of infrequent or nonrecurring items

– Three years pro forma income statements for a discontinued operations

SEC Reporting Issues

• Financial statements of guarantors of public debt (Rule 3-10 of S-X)– http://www.aicpa.org/caq/download/Rule_3-10_Document.pdf

• Financial statements of affiliates whose securities collateralize a security registered or being registered (Rule 3-16 of S-X)– http://www.aicpa.org/caq/download/Rule_3-16 16_Document.pdf

• Financial statements of entities under common control– http://www.sec.gov/news/speech/2006/spch121206lao.htm

Recent SEC Guidance

Recent Guidance

• Final Rules and Guidance

– SOX 404

– XBRL

– Backdating of Stock Options

– Materiality (SAB No. 108)

– Executive Compensation

• Proposed Rules

– Small Business

– IFRS

Proposed Modernization of Smaller Company Rules

• On May 23rd, proposed 6 measures to improve smaller company capital raising and reporting requirements1. Smaller reporting company relief and simplification2. Revisions to eligibility requirements for offerings on Forms

S-3 and F-33. Exemption of Compensatory Employee Stock Options

from registration under Section 12(g) of the Exchange Act4. New Regulation D limited offering exemption5. Electronic filing of Form D6. Revisions to Securities Act Rules 144 and 145

• Comments on the above proposals will be due 60 days after publication in the Federal Register

SEC and IFRS

• Targeted toward foreign private issuers

• Eliminates the US GAAP reconciliation requirement for foreign companies using IFRS

SEC IFRS Concept Release

• Targeted toward U.S. companies

• Possible optional IFRS application for Form 10-K in December 2009

• Rule change targeted to mandate IFRS for December 2014

“It may be a very long time indeed before the world’s 6.5 billion people can all speak in the same tongue. Fortunately, we won’t have to wait nearly as long for the language of business and finance to converge.”

— SEC Chairman Christopher Cox

IFRS Implementation Considerations

A Perspective on IFRS Implementation– Will require a change in mindset

• More of a focus on “thinking” about the answer versus researching the answer

– Less detailed guidance to consider • More of a focus on the “substance” of transactions

• Evaluate whether the accounting presentation reflects the “economic reality”

– Greater use of professional judgment • More of a focus on the “process” around making judgments

• CIFR recommendations

– Impact on risk• Possibility of “second-guessing” by regulators?

• Will litigation increase?

Overview of IFRS ImplementationChallenges Best Practices

• Meeting consistency requirements

• Cultural bias in application of principle based standards

• Timely data capture for opening balance sheet

• Cooperation from non-controlled entities to adopt IFRS

• Capture interdependencies with other FT initiatives

• Considering ongoing changes to standards

• Steering committee to oversee IFRS activities

• Full-time dedicated PMO to carry out IFRS implementation

• Early training and awareness building

• Replicate learning from early conversions

• “Business as usual implementation”

• Ready by Transition Date

• Multidisciplinary strategic approach

• Regular communication with auditor

Key Impacts of IFRS Implementation

• Tax structures• Treasury and cash

management• Legal and debt

covenants• People issues,

including education and training, compensation structures

• Internal communications

• External and shareholder communications

OrganizationalIssues

TechnologyInfrastructure

• General ledger and chart of account structure, including performance metrics

• Global consolidation

• Sub-system issues related to configuration and data capture

• Capabilities to manage multiple GAAP accounting during transition

Process and Statutory Reporting

• Internal controls and processes, including documentation and testing

• Management and internal reporting packages

• Global reporting packages

• Statutory reporting, including “opportunities” around IFRS adoption

Technical Accounting

• Overall approach to IFRS implementation

• First time adoption policy considerations, including reporting dates and use of exemptions

• Ongoing policy considerations, including alternatives and approach to “principles”

ReportingDate

TransitionDate

2009

2008

2012

2011

2010

• Statutory Implementation

• Select Exemption• Preparation IFRS

Opening BS• “Dry Runs”

• US GAAP & IFRS opening balance

• Quarterly IFRS• Investor

Communications• Audit Procedures• Change Standards

• Transition to IFRS• Quarterly Reporting• Investor

Communications• SOX 404 IFRS• Convert Systems

Rationalization and standardization of statutory reporting

IFR

S C

om

pe

ten

ce

Alignment with other initiatives and training for appropriate personnel

• Targeted StatutoryImplementation

• Systems Implementation• Impact Analysis

• Assessment• Strategic Implementation Roadmap• Technical Accounting• Technology & Processes• Organizational Issues

Illustrative IFRS Adoption Strategy

Thoughts on the EU Experience

Observations Lessons Learned

• Overall approach was to minimize differences from local GAAP

• Increased disclosure in financial statements (e.g., judgments made and assumptions used)

• Variety of performance measures

• Areas of significant impact

• Asset impairment

• “Components” approach

• Deferred income taxes

• “Split accounting”

• Derivatives

• More leases on balance sheet

• Effort was often underestimated

• Often a lack of a holistic approach, taking collateral effects into consideration

• Late start often result in escalation of costs, especially after transition date

• Many companies did not achieve “business as usual” state for IFRS reporting

• Was hard to get it right the first time

• Several companies are only now starting to explore benefits from IFRS implementation

IFRS Complexity -- Tax Considerations– Tax accounting issues

• No FIN 48 under IFRS

– Tax costs and benefits of conversions• LIFO

• Distributable reserve computation

– Starting point for many tax adjustments will change• Is IFRS method permissible? Is it optimal? Is a tax method

change required?

• Has a new adjustment been created?

• Has data supporting current adjustment changed?

– Catalyst for global tax planning

– Tax department processes and systems must adapt

Illustrative IFRS Implementation Roadmap

Illustrative Implementation Roadmap

Technical AccountingProcess and Statutory

ReportingTechnology

Infrastructure

Develop and plan delivery of a detailed training program for deployment

Consider executive briefing sessions, workshops and other means to build awareness and consensus

Develop and execute a stakeholder communication program

OrganizationalIssues

Identify implications to the general ledger and chart of account structure

Identify sub-system issues related to configuration, data issues or other causes

Assess system capabilities to manage multiple GAAP accounting during transition

Understand current reporting of statutory entities by country

Harmonize accounting policies where IFRS is already adopted

Identify options to adopt IFRS at statutory locations

Identify process improvement options

Assess impact on controls

Evaluate appropriate IFRS accounting and consider alternatives

Evaluate the extent and scope of technical accounting differences on a consolidated basis and at key statutory locations

Determine likely differences related to income tax accounting

Determine likely impacts on treasury

• IFRS Financial Reporting Country Road Map

• Implementation Options Analysis

• Timeline

• Contingency plan

•Technical Accounting and Tax Impact Analysis

•Recommendations for Reporting Process Changes

•Evaluation of Technical Architecture Issues

•Organization readiness/training plan

•Communication plan

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