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

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

  • SEC and Accounting Hot Topics June 6, 2008 Presenter: Stephen Sommerville, PricewaterhouseCoopers LLP
  • Agenda
    • SEC Hot Topics
    • FAS 141R
    • XBRL
    • IFRS
    • Committee on Reducing Financial Reporting Complexity
    • Questions
  • SEC Hot Topics
    • Credit Markets
    • Use of Experts
    • Stealth Restatements
    • Significant Acquisitions and Rule 3-05
  • “ 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 FASB Senator Jack Reed February 12, 2008 Market Reaction to Credit Markets and Fair Value
  • “ 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 Norris New York Times February 29, 2008 Market Reaction to Credit Markets and Fair Value
  • “… ‘ 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 Group Financial Times, February 29, 2008 Market Reaction to Credit Markets and Fair Value
  • 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
  • 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
  • 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
  • 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
  • FAS 157 – Disclosures
    • Driven by level within the hierarchy
    • Two categories:
      • Recurring
      • Nonrecurring
    • 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
    FAS 157 – Disclosures
  • FAS 157 – Disclosures
    • 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
  • 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.
  • 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.
  • 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.
  • 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.
  • 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.
  • 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.
  • 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.
    • FAS 141(R)
  • FAS 141(R) Provides new guidance on accounting for business combinations FAS 160 Provides new guidance on accounting for minority interests in consolidated financial statements Both standards effective January 1, 2009 for calendar year-end companies
  • FAS 141(R)
    • Fundamental principal: An acquired business should be recorded at fair value on acquisition date
    • More assets and liabilities will be recorded at fair value
    • Will create challenges for preparers and auditors
  • 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
  • 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
  • Transaction and restructuring costs Under FAS 141(R) Generally expensed Typically recorded as part of the cost of the acquisition Previous Accounting
  • Valuation of equity securities issued as part of the purchase price Under FAS 141(R) Valued at the acquisition date Generally valued by the acquirer when the terms were agreed to Previous Accounting
  • 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
    • 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)
  • 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
  • Adjustments to purchase accounting Under FAS 141(R) Up to one year Adjustments to purchase accounting applied retroactively Up to one year Adjustments to purchase accounting applied prospectively Previous Accounting
  • 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
  • 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).
  • 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.
  • 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.
  • 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.
  • 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
  • Questions