SEC "Hot" Topics Seminar (June 2006) (Blue Background)

GLOBAL CAPITAL MARKETS

[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



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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



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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



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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

Documents

SEC "Hot" Topics Seminar (June 2006) (Blue Background)