Topics

1. AccountingStandards UpdateMTSU Accounting Alumni Appreciation DayMay 1, 2014Paula B. Thomas, CPA, DBADeloitte Foundation Professor of AccountingMiddle Tennessee State University

2. Topics • Leases • Revenue Recognition • Standard Setting Environment • International Issues • Private company reporting • Other Topics: • Discontinued Operations • Liquidation Basis of Accounting • Fair Value Hierarchy for Nonpublic Entities

3. 3 Proposed Changes to Lease Accounting

4. The Big Changes • On March 18 and 19, 2014, the FASB and IASB (the boards) re-deliberated aspects of the joint leasing project including: • the lessee and lessor accounting models • lease term • exemptions and simplifications • The boards voted on a number of items but were unable to reach consensus on certain key issues.

5. Background • Basic lease accounting model has not changed in more than 30 years • Capital leases (meeting 1 of 4 criteria for lessee) • Operating leases (if none of those criteria are met) • Current lease rules have been criticized for a variety of reasons • Unnecessary complexity • Arbitrary bright line rules • Emphasis of form over substance • One of the biggest “culprits” in off balance sheet financing

6. Lessee Accounting Model:Current Status • At least inception: • The boards agree that lessees would need to reflect substantially all leases as a right-of-use asset and a liability, • This includes most leases currently accounted for as operating leases • Subsequent accounting: • Should be based on the nature of the underlying asset • Property (land, building, part of a building, or both) leases (Type B lease) OR • Other than property (Type A lease) • The boards could not come to agreement on the income statement treatment.

7. Lessee Accounting Model: Current Status (continued) • Subsequent accounting (continued): • The FASB members support a dual model, but without the bright lines. (Type A leases) • Amortization of the right-of-use asset is recognized separately from interest on the lease liability • Most operating leases under current GAAP would retain a straight-line expense recognition pattern (Type B leases) • Expense would be recognized in a single line in the income statement. • The IASB members, on the other hand, support the Type A approach for most leases, resulting in a financial reporting model similar to financing leases today. • They believe this approach has more conceptual merit, and that all leases contain an inherent financing element.

8. Lessor Accounting Model • IASB supports a model that determines if a lease is effectively a financing/sale (Type A) or not. • A lessor would determine the lease classification by assessing if the lease transfers substantially all of the risks and rewards of ownership • The FASB members support a similar model, except that for Type A leases, they would permit a lessor to recognize a sale at lease commencement only if control of the underlying asset was transferred to the lessee.

9. Lease Term • The boards agreed that both lessees and lessors would include extension options in the lease term if: • a lessee had a significant economic incentive to exercise such options. • The boards also agreed that a lessee would reassess the lease term only upon the occurrence of triggering events (significant events or changes in circumstances) that were under the lessee’s control. A lessor would not reassess the lease term.

10. Exemptions and Simplifications • The boards affirmed short term leases as 12 months or less • Both boards considered adding language that allows lessees to account for similar leases at a portfolio level • Would alleviate some cost and complexity • Differing views on implementation • “Small Ticket” exemption considered, unsure as of now

11. Why is this important? • The proposed lease accounting guidance will affect almost every company and for some, the proposed changes may be significant. • Metrics such as EBITDA and net income will be affected. • These in turn will likely affect loan covenants, credit ratings, and other external measures of financial strength. • Lessees will need to consider business process changes in multiple areas, including finance and accounting, IT, procurement, tax, treasury, legal, operations, corporate real estate and HR.

12. What’s next? • Deliberations are expected to continue in the coming months. • It is not clear how the boards will resolve their differences or how their current lack of consensus will impact the timing of a final standard. • No expected completion date announced

13. Revenue Recognition • The new standard: One model, potentially multiple changes for your business • After much deliberation, the FASB and IASBare set to release a final standard, part of the move toward a single set of global accounting standards. • Companies in all industries will use a new five-step model to recognize revenue from customer contracts. • The intent is greater consistency and comparability throughout the global capital markets and across industries.

14. How the 5 step model works • Step 1: Identify contract(s) with customer • May be written, verbal, or implied by customary business practice. • Contract must have commercial substance • Combine contracts when they are • entered into at or near the same time and are negotiated as a package, • payment of one depends on the other • goods/services promised are a single performance obligation.

15. How the 5 step model works • Step 2: Identify separate performance obligations in the contract(s) • Performance obligations are promises in a contract to transfer goods or services. • Good or service will represent a separate performance obligation if it is both of the following • Capable of being distinct • Distinct in the context of the contract • Similar to determining stand-alone value under current US GAAP

16. How the 5 step model works • Step 3: Determine the transaction price • Entity must determine the amount of consideration to which it expects to be entitled in exchange for the promised goods or services in the contract • Transaction price can be a fixed amount or can vary because of discounts, rebates, performance bonuses/penalties, contingencies, etc. • Contingent consideration is only included in the transaction price when an entity has a “high level of certainty” that the amount of revenue to be recognized would not be subject to future reversals • Additional guidance exists to help make this determination

17. How the 5 step model works • Step 4: Allocate the transaction price • Price must be allocated to separate performance obligations • This may be the standalone selling price of a good or service when sold separately to a customer in similar circumstances and to similar customers. • If a standalone selling price is not directly observable, estimate it by considering all information that is reasonably available, such as market conditions, specific factors, and class of customers.

18. How the 5 step model works • Step 5: Recognize revenue when the performance obligation is satisfied • Recognize revenue when the promised goods or services are transferred to the customer. • Performance obligation is deemed satisfied when control of the underlying goods or services is transferred to the customer • More guidance given on making that determination

19. Where might your company feel impact? • Compensation and bonus plans. Revenue recognition can trigger bonus payments. • Consider how timing changes for revenue recognition affect these and other internal arrangements. • Contracts. Existing terms could take on new meaning under the new standard, so you may need to re-negotiate debt covenants or customer contracts to maintain the original intent. • Technology. You may need to update your current software to capture new information that might not have been necessary before.

20. Where might your company feel impact? • Tax implications. The timing of cash tax payments could be affected if, for example, you recognize revenue sooner than in the past. • Controls and processes. The standard requires you to make more estimates and disclosures, calling for new controls and processes. • Investor relations. Stakeholders will want to know how your revenue recognition will change and how the new standard affects your company’s financial picture.

21. No more special treatment • “A major milestone in our eleven-year effort to create greater comparability in an area of financial reporting that affects all industries.”—Russell Golden, FASB chairman, November 6, 2013. • The main objective is to have no industry specific revenue recognition, but that could still change.

22. Standard Setting Environment:International Issues

23. Key Questions Regarding IFRS • Whether to adopt • Despite years of discussion, no final decision • How to adopt • Possible approaches include • full adoption of IFRS without any U.S. endorsement • Little support for this approach • U.S. endorsement of IFRS • option for U.S. issuers to apply IFRS • SEC reports “substantial support” for exploring other methods of incorporating IFRS

24. How Are IFRS Different than U.S. GAAP? • More “principles-based” • Thus will require more judgment, and perhaps greater diversity in practice • Could pose challenges for auditors • Less extensive • Provides limited industry-specific guidance • Provides less detailed application guidance • Greater use of fair value

25. Current Status • In July, 2012, SEC issued final staff report related to 2010 work plan. • Report emphasizes that SEC has not made any policy decision regarding • Whether or not IFRS should be incorporated for U.S. issuers • How any such incorporation, if it occurred, should be implemented • SEC says that before making a decision, it must further analyze “the fundamental question of whether transitioning to IFRS is in the best interests of U.S. securities markets generally and U.S. investors specifically”

26. Current Status, continued • The SEC staff report on the Work Plan (July 2012) did not provide details as to next steps • Discussions in the U.S. have recently focused on incorporating IFRS through FASB endorsing new and existing international accounting standards. • This approach would merge IFRS into U.S. GAAP over a period of years, gradually making the two sets of standards more similar, if not substantially the same. • FASB and IASB are continuing work toward finalizing standards on revenue, leasing, and financial instruments. • These standards will impact virtually all companies, whether they report under U.S. GAAP or IFRS.

27. Standard Setting Environment:Private Company Financial Reporting

28. Concerns with GAAP • FASB’s increased use of fair value and perceived focus on public companies • Financial statements may lack relevance to private company users • Increased complexity of FASB standards • Costs of GAAP compliance may exceed benefits • Increase in qualified opinions and use of OCBOA • Problematic standards • income taxes/uncertain tax positions • variable-interest entities

29. Background • Decades old debate about “Big GAAP/Little GAAP” • More current terminology is “differential standards” or “private company standards” • Playing field changed with differential auditing standards resulting from SOX • More recent efforts to explore private company standards: • Private Company Financial Reporting Committee formed by AICPA and FASB in 2007 • Blue Ribbon Panel formed jointly by AICPA, FAF, and NASBA in late 2009

30. Process • Blue Ribbon Panel issued its recommendations to FAF in January, 2011. Recommendations included: • Creation of a new private-company standards board that would focus on making exceptions and modifications to U.S. GAAP for private companies • Would report to FAF, similar to FASB and GASB • Creation of a new differential accounting framework that would allow the FASB to make appropriate and justifiable exceptions and modifications • Did not recommend developing separate set of private company GAAP from scratch

31. FAF Response • On October 4, 2011, FAF issued a proposal to create the Private Company Standards Improvement Council (PCSIC) that would work toward improving the accounting standard-setting process for private companies • Council would establish criteria for determining whether exceptions or modifications to standards are needed for private companies • Based on those criteria, Council would propose and vote on specific exceptions or modifications to GAAP • All proposed changes would be subject to FASB ratification

32. FAF Response, continued • On May 23, 2012, FAF approved formation of the Private Company Council (PCC) • Primary PCC responsibilities • To determine whether exceptions or modifications to existing non-govermentalU.S. GAAP would benefit private company financial statement users • To advise FASB re consideration of private company issues on FASB technical agenda • Any GAAP modifications/exceptions developed by PCC (with 2/3 majority vote) will become final if endorsed by FASB • NASBA has discouraged the use of private company standards

33. Private Company Framework • On April 15, 2013, FASB and Private Company Council jointly issued an invitation to comment on a proposed private company decision-making framework • The Framework provides guidance for the Board and Council to determine whether and in what circumstances to modify US GAAP for private companies.

34. Private Company Framework, continued • The framework identifies six differentiating factors between public and private companies: • Types and number of financial statement users • Access to management • Investment strategies • Ownership and capital structures • Accounting resources • Learning about new financial reporting guidance

35. Private Company Framework, continued • The framework also identifies five areas where financial accounting and reporting guidance might differ between public and private companies: • Recognition and measurement • Disclosures • Display (presentation) • Effective date • Transition method

36. Private companies mull adoption of accounting alternatives • To date, PCC has granted three exceptions • Some private companies—both family-owned and private-equity owned—are showing significant interest in early adopting one or all of the new alternatives.

37. The basics of the accounting alternatives • The first alternative simplifies accounting for goodwill. • It allows a private company to amortize goodwill on a straight-line basis over a period of up to ten years • Also apply a trigger-based, single-step impairment test at either the entity level or the reporting unit level • The second alternative allows private companies (but not financial institutions) to apply simplified hedge accounting to their receive-variable, pay-fixed interest rate swaps, as long as the swaps meet certain criteria. • The third alternative exempts private companies from consolidating VIEs under common-control leasing arrangements

38. Benefits of Alternatives? • Private companies can elect to apply one or both of the alternatives in their 2013 financial statements

39. Issues with choosing alternatives • Private companies considering one or more alternatives cite two primary motivations: • Simplifications will save time and expense, and • Existing accounting guidance provides little perceived benefit to users of their financial statements. • Companies that adopt any of these alternatives would need to "unwind" them if they become an SEC-registered company, or are otherwise required to have their financial statements included in an SEC filing.

40. Proposed AICPA SME Framework • On November 1, 2012, the AICPA issued an exposure draft on its proposed special-purpose financial reporting framework for small and medium-sized entities (FRF for SMEs) • Intended for use by SMEs not required to prepare financial statements in accordance with GAAP • Comment period has ended, and AICPA anticipates releasing its final framework late this spring • Framework was published in late 2013 and chaired by David Morgan of LBMC • The framework is downloadable at no charge on the AICPA website.

41. Proposed AICPA SME Framework, continued • The AICPA notes that the FRF for SMEs draws on a blend of traditional methods of accounting with some income tax methods • Excerpt from AICPA website • “The FRF for SMEs™ accounting framework is designed for America's small business community. It delivers financial statements that provide useful, relevant information in a simplified, consistent, cost-effective way. The FRF for SMEs™ framework may be used when GAAP financial statements are not required. • Applicable across a wide variety of industries • Note: This is a non-GAAP approach

42. Examples under Proposed AICPA Framework • No separate reporting for OCI or extraordinary items • Push-down accounting permitted under specified circumstances • Goodwill and other intangibles would be amortized

43. 43 Other Topics

44. 44 Discontinued Operations

45. Background for Changes 45 • Major point of the newly issued ASU is to substantially converge the definition of a discontinued operation under US GAAP and IFRS • Goal is to report as discontinued operations only disposals that represent significant strategic shifts • FASB concern with current GAAP • Allows too many disposals of assets to qualify for discontinued operations presentation, resulting in financial statements that are not decision useful • Inconsistency with current practice

46. Key Aspects 46 • Expands the disclosure requirements for disposals • Discontinued operation defined as either of the following • A component of an entity that meets all of the following criteria: • It meets either of the following conditions: • It has been disposed of • It meets all of the criteria in ASC 360-10-45-9 to be classified as held for sale • It is part of a single coordinated plan to dispose of any of the following: • A separate major line of business • A separate major geographical area of operations • A business that, on acquisition, meets all of the criteria in ASC 360-10-45-9 to be classified as held for sale

47. Key Aspects, continued 47 • Guidance does not change requirements for presentation of discontinued operations in the financial statements • Guidance requires additional disclosures • Effective dates: • For public entities and some not-for-profits: for annual periods beginning on or after December 15, 2014 and interim periods within that year • For other entities: annual periods beginning on or after December 15, 2014 and interim periods within annual periods beginning on or after December 15, 2015

48. 48 Liquidation Basis of Accounting ASU 2013-07

49. Overview 49 • ASU issued in late 2013 • Provides guidance on when and how to apply the liquidation basis of accounting • Provides disclosure guidance • Entities generally will be required to prepare financial statements on the liquidation basis of accounting is liquidation is “imminent” • Liquidation will be considered “imminent” when • A liquidation plan has been approved by those with the authority to do so and the likelihood that either of the following will occur is remote: • Execution of the plan will be blocked by other parties (e.g., shareholders) • The entity will return from liquidation • A liquidation plan is imposed by other forces (e.g., involuntary bankruptcy)

50. Recognition and Measurement 50 • Entities using liquidation basis of accounting will measure assets at the amount they expect to collect upon sale • This includes assets previously unrecognized under U.S. GAAP, but the company expects to either sell in liquidation or use in settling liabilities • Example - trademarks • Liabilities continue to be recognized at amounts required by GAAP, and are not re-measured • Companies should not anticipate being legally released as the primary obligor • Entities must accrue • Costs to sell • Income anticipated during liquidation, if there is a reasonable basis for estimation • Costs that will be incurred through the end of liquidation (e.g., payroll, legal fees), if there is a reasonable basis for estimation