FASB/IASB – Progress Towards Conversion

1. FASB/IASB – Progress Towards Conversion Memorandum of Understanding Revenue Recognition Financial Statement Presentation Leases Other Projects in the Works Debt vs. Equity Pensions IASB FASB

2. Memorandum of Understanding (2006 Norwalk agreement updated in September 2008) Wouldn’t it be nice for FASB & IASB to agree (converge) on all the major projects? Work together, leverage off each other, and share staff to develop the same quality standards If US switched to IFRS someday, progress in convergence could make it all a lot easier Is it possible – can they agree or is it too idealistic? Where are we today? Is it working?

3. Revenue Recognition FASB and IASB have issued their Preliminary Views Discussion Paper on how to recognize revenue(comments due 6/19/09) Asset/liability view (in) - revenue/expense view (out) “ Earnings process is complete” – gone! Eventually, this project could replace SAB 104 and all FASB Statements, AcSEC SOP’s & Guides, and EITF’s on revenue recognition (About 180 pieces of guidance exist today – crazy!)

4. Revenue Recognition – The new model Contract Based – right to receive payment/performance obligation results in a net contract position The performance obligation to provide goods and services is a liability not deferred revenue. Recognize revenue when there is a decrease in the performance obligation (i.e., an increase in the net contract position) If the estimate of the cost of performance obligation goes up, this may make contract “onerous” – record contract loss! What if contract has multiple elements?

5. Multiple Element Arrangements • Allocate customer consideration (e.g., $900 in the example) to each performance obligation • Base it on the proportion of the stand-alone selling price of each: SPConsideration • Machine $800 80% $720 –rev 1st qtr • Installation 200 20% 180–rev 2nd qtr • Total selling price 900 What if there’s NO reliable evidence to support stand-alone price – Estimate it anyway!

6. How are performance obligations satisfied? When entity transfers the promised goods or service to the customer That is, when the customer obtains control and it is the customer’s (e.g., customer takes physical possession of the good) Then company reduces performance obligation (dr) and recognizes revenue (cr) in income! Is this better than trying to determine when the “earnings process is complete”? Will this new model change practice? How?

7. Possible Changes? • Percentage of completion – does customer “control” the item as it is constructed (e.g., 1st 6 of 10 floors)? • Warranties would be a performance obligation • Using estimates to allocate (rather than, say VSOE for software multiple element contracts) • What about costs – could a sales commission be capitalized to “better match costs and revenues”? • Does this proposal impact reserve for sales returns? What are the FASB/IASB’s plans?

8. Financial Statement Presentation FASB & IASB’s goal – improve usefulness of financial statements – major changes may be coming! Today’s financial statement package according to users: Too many alternative type presentations Information is highly aggregated and inconsistently presented Difficult to understand the relationships A new Preliminary Views Discussion Paper has been issued to require detailed information to clearly communicate an integrated (cohesive) financial picture (Comments were due 4/09)

9. The “Cohesiveness” Principle Categories for each of the financial statements: -Business – operating and investing -Financing -Income taxes -Discontinued operations -Other comprehensive income -Equity (for the balance sheet) Goal – financial statements should be clear and articulate! Management judgment to decide what goes where.

10. STATEMENT OF COMPREHENSIVE INCOME Sales $1,000 Costs 800 Net income (business & financing shown separately) 200 Other Comprehensive income (after tax) Available for sale securities 30 Cash flow hedges (20) Unfunded accumulated benefit obligation (15) Foreign translation adjustment (10) Total OCI (15) Total Comprehensive income $185 EPS – net income $2.00 Would this be an improvement? __________

11. More Decisions • Cash flow statement – mandate direct method – Expensive? Practical? • More “function” and “nature” type disclosures • No more extraordinary items • Financial statements just won’t look the same anymore plus lets add a reconciliation too!

12. The reconciliation – understanding uncertainty Cash flowsAccruals & Alloc. FV changes*Comp income Sales $xxx $xxx C of GS xxx xxx SG&A xxx xxx Taxes xxx xxx Disc Op xxx xxx OCI xxx xxx *By recurring and non recurring The objective – reconcile each line item on the statement of cash flows to the same line item on the statement of comprehensive income Will the reconciliation be useful? Will users benefit from this whole new approach? Status?

13. Leases - are they going on the balance sheet (over $1 trillion)? • Off-balance sheet leasing is an industry (legitimate but often structured) under FAS 13 (and many, many amendments and interpretations) – a truly rules based standard! Red lines – 75%, 90% - all or nothing –hmmm?? • FASB and IASB jointly issued a Preliminary Views Discussion Paper – principles based! (Comments are due 7/17/09) • If adopted– Under the model all leases(unless immaterial) would be capitalized: Asset - - - Right to use an asset during the lease term Liability - Obligation to pay rentals

14. Measurement of Leases • Obligation – Present value of rentals discounted at the incremental borrowing rate then amortized cost (not FV) • Asset – Cost – same present value amount and amortize over shorter of term or economic life (thus income different) • Term – if there are options, use “most likely” term – reassess each period and adjust balance sheet if necessary for changes in estimates • Contingent rent – record estimate at inception and keep reassessing (FASB & IASB have different approaches) IS THIS NEW APPROACH A BIG IMPROVEMENT?

15. Issues! • Will users really be better off with all leases on the Balance Sheet? • What will the impact be of recording lease liabilities – the obligation to pay rent- on the perceived health of the company? • Will many companies be in default on covenants? • Other issues – Lessor accounting? What about other executory obligations (employment contracts, purchase orders)? What if all liabilities are accounted for at Fair Value someday – leases too? What will happen next?

16. Liabilities & Equity –Which is it? FAS 150 (2003), in phase 1, addressed, for example: - Redeemable preferred stock - Forward purchase contracts - Obligations payable in shares These are LIABILITIES!! But (6 years later) what about everything else? The FASB/IASB are still developing the new model

17. Tentative decisions Equity: Preferred stock that lacks a settlement requirement Stock that’s redeemable upon retirement (e.g., partner’s capital) Redeemable at company’s option Liability: Mandatorily redeemable stock Redeemable at the option of holder Derivatives in an entity’s own stock (an asset or liability) Open: Employee stock options, convertible debt – bifurcate? When will this project ever end?

18. Criticisms of pension accounting Record expected return on plan assets – not actual (e.g., expect to make 7% but lose 40%) Spread actuarial gains and losses Pension expense – one number vs. several on income statement Unfunded liability may not have been on Balance Sheet (but it is now thanks to FAS 158 – over $500 Billion and getting much bigger today) (Otherwise the pension expense model is OK!) Smoothing vs. Volatility! The solution?

19. Phase II – Fix the Accounting Model Possible Big Changes (FASB & IASB each working separately): -No more smoothing – run it through income (notOCI) - Changes in interest rates, fair value of plan assets, etc. – but lots of volatility? -Gross up on income statement - Service costs, interest, investment results? - Consolidate the plan (like a VIE)? Nothing is likely to change soon (and when it does will there be any defined benefit plans left?) How is FASB/IASB dividing up the work load?

20. Conversion vs. Just Adopting IFRS? • Someday maybe we will all follow IFRS? • If we converge on all the major topics first, won’t it be a lot easier? • What should the FASB be doing: Push ahead to converge, Work towards switching to IFRS, Just do its own thing, or All of the above at the same time?