Discussion of FASB/IASB Financial Reporting Issues Conference

1. Discussion of FASB/IASBFinancial Reporting Issues Conference Slides borrow heavily from materials prepared for the conference by FASB personnel and the planning committee

2. Main Issues • How and when is the concept of control applied in accounting? • What are the appropriate conditions for derecognizing assets or liabilities? • Net presentation (not addressed today)

3. Concept(s) of Control • Entity has an asset if it controls the future benefits • Control of an entity leads to consolidation instead of equity method accounting • Customer must gain control over goods or services for revenue recognition to occur (proposed accounting) • Is the concept of control in these examples the same, related, or almost independent?

4. Control of an Asset • “Assets are probable future economic benefits obtained or controlled by a particular entity . . . .” (FASB Con 6 ¶ 25) • “An asset is a resource that is controlled by the entity . . . .” (IASB framework ¶ 4.4) • Entity controlling the asset can “exchange it, use it to produce goods or services, exact a price for others’ use of it, use it to settle liabilities, hold it, or perhaps distribute it to owners.” (Con 6 ¶184)

5. Control of an Entity • “An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, ie the activities that significantly affect the investee’s returns.” (IFRS-10 ¶ 10) • FASB sees a controlling financial interest as • the power to direct the activities that most significantly effect the investee’s performance, and • the obligation to absorb losses and/or right to receive benefits significant to the investee.

6. Control of an Entity Control of an entity seems to consist of both • Power • Outcomes (losses or benefits) Additional wrinkle – timing of the power • Entity currently has majority voting rights vs • Entity has options to obtain majority voting rights

7. Control of Goods and Services • “An entity shall recognize revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (that is, an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset.” (Revenue Recognition ED ¶ 31) • Current revenue recognition guidance often refers to transfer of risks or rewards of ownership. Boards like transfer of control instead of R&R

8. Control of Goods and Services Notion of control in the Rev Rec ED • Customer has present right to direct useof and obtain substantially all remaining benefits from an asset. • Direct use: customer can deploy asset in its activities, allow another entity to deploy that asset in its activities, or restrict another entity from deploying that asset. • Obtain benefits: customer can obtain substantially all the remaining benefits

9. Concept(s) of Control • Are the notions of control the same or different in these three circumstances? • Is the notion of control well understood and consistently used in accounting? • If the answers are “no,” is this okay or does it create problems for users and preparers? • If it creates problems, can standard setters improve their guidance?

10. Derecognizing an Asset Consider 2 alternatives: • Symmetric recognition and derecognition: whatever level of control was needed to initially record the asset, derecognize the asset when that level of control no longer exists. • Asymmetric recognition and derecognition: derecognize the asset only when all continuing involvement by the seller has ended.

11. Derecognition of an Asset Continuing involvement is a continuum. Ends points: • Seller gives up any and all rights to the asset and retains no asset-related obligationsderecognition pretty obvious • Seller allows another entity to consume some benefit from the asset but seller retains significant power over and benefits from the assetderecognition is unlikely

12. Derecognition of an Asset • What about middle ground? FASB/IASB exhibit an inability to conclude what level or form of continuing involvement in the asset is sufficient to preclude derecognition • Standard setting code words: • history matters when determining derecognition • obtaining control easier than relinquishing it

13. Illustrative Case 1 • Entity does not own any cars. It enters into a forward contract to buy 100 cars at $20K per car. Does the entity presently control the 100 cars? • Entity owned 100 cars but then transferred them to XYZ Co. for $19K each. Entity enters into a forward contract to purchase 100 cars from XYZ Co. for $20K each. Does the entity presently control the 100 cars? • What if entity held an option instead of a forward?

14. Illustrative Case 2 • ABC Co. has option to acquire a piece of land. Option is immediately exercisable. Does ABC control the land? • ABC Co. holds 49% of the voting stock of Land Co. which invests solely in undeveloped land. ABC Co. holds options to acquire another 2% of Land Co. shares. Does ABC control the land owned by Land Co.? • Can holding an option provide control over an asset? Over an entity?

15. Illustrative Case 3 • US Motors transfers a car to consumer on 12/1/12. Consumer has legal title to the car. Consumer can return the car for any reason by 1/15/13. • As of 12/31/12 (US Motors’ fiscal year end), • Does consumer control the car? • Does US Motors recognize revenue in December? • What if US Motors is required to repurchase the car on 1/15/13?

16. Research Issues • Does existing research tell us anything about the notion of control? • Can existing research help us with derecognition? • If not, can we think of future research projects that might help standard setters?

17. Research Issues Chircop, Kiosse, and Peasnell, “Should Repurchase Transactions be Accounted for as Sales or Loans?” December 2012 Accounting Horizons. • Examines legal structures underlying financial asset repurchase transactions (similar to part 2 of case 1) • Purpose of repo is financing, therefore accounting is usually secured borrowing. • CKP: legal rights control is transferred

18. Questions? Other issues? Thanks for attending today!