Other Recent Developments in Accounting and Reporting

Highlights of new reporting requirements for private companies:

• The final part of FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, dealing with instruments that are mandatorily redeemable on fixed dates for amounts that are fixed or determinable, takes effect for periods beginning after December 15, 2004.
• FASB Interpretation No. 46 (Revised), Consolidation of Variable Interest Entities, is effective for fiscal years beginning after December 15, 2004, for variable interest entities created before January 1, 2004.

Additional guidance issued in 2004 is described below.

EITF Consensuses

Consensuses reached by the FASB's Emerging Issues Task Force in 2004 include the following:

Issue No. 02-14, "Whether an investor should apply the equity method of accounting to investments other than common stock if the investor has the ability to exercise significant influence over the operating and financial policies of the investee."

After nearly two years of discussion, the Task Force reached a consensus on Issue 02-14. This consensus indicates that if an investor has the ability to exercise significant influence over an investee, the equity method should be used not only for investments in common stock, but also for investments in "in substance common stock."

An investment in an entity would be considered in substance common stock if it has risk and reward characteristics that are substantially similar to that entity's common stock. If the results of the risk and reward analysis are not clear, the acid test is whether the changes in the fair value of the investment are expected to be highly correlated with the changes in the fair value of the common stock. If they are, then the investment is in substance common stock and the equity method should be applied if the investor has ability to exercise significant influence over the investee.

Examples of features that create risk and reward characteristics different from common stock include mandatory redemption provisions, dividend or liquidation preferences over common stock, or situations in which the investor does not participate in earnings or capital appreciation in a manner similar to common stock.

Issue No. 03-1, "The meaning of 'other-than-temporary impairment' and its application to certain investments."

The Task Force reached a consensus on the disclosure guidance of Issue 03-1 in 2003 and on the accounting guidance in 2004. The effective date of the accounting guidance of the consensus was subsequently delayed by the FASB in FSP EITF 03-1-1. New accounting guidance is expected to be issued in 2005.

Until the new guidance is issued, companies should follow the existing literature for determining when a decline in fair value is other-than-temporary. This literature includes SEC SAB Topic 5-M (SAB 59) and the FASB Staff Implementation Guide to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities.

Additional guidance for public companies:

• The SEC staff has indicated that SAB 59 requires companies to evaluate whether impairments due to interest rate increases are other-than-temporary.
• If a company sells a security at a loss after previously basing its accounting on the assumption that the security will be held until its value recovers, this can raise concerns about other securities designated as held to recovery. In these cases, the staff has indicated companies should consider the individual facts and circumstances when determining the validity of assertions that other securities will be held to recovery.

Issue No. 03-16, "Accounting for investments in limited liability companies."

Issue 03-16 affects companies that have noncontrolling interests in limited liability companies (LLCs). These companies are business entities with characteristics of both a corporation and a partnership. The issue addresses how to account for an investment in an LLC.

The Task Force reached a consensus that the accounting treatment should depend on whether the investors have specific ownership accounts:

• If the investors have specific ownership accounts, companies should follow the guidance for partnership investments, that is, a noncontrolling interest should generally be accounted for using the equity method.
• Other investments should follow the guidance for corporate investments. That means a noncontrolling interest should be accounted for using the equity method if the investor has the ability to exercise significant influence over the investee.

Issue No. 04-1, "Accounting for pre-existing contractual relationships between the parities to a purchase business combination."

Issue 04-1 establishes guidance for recognizing gains or losses for settlement of relationships (e.g., distribution, franchise or supply agreements) that existed between the parties to a business combination prior to the combination.

This consensus requires that settlement of the pre-existing relationship be accounted for as a separate element of the business combination.

The amount of the settlement gain or loss on executory contracts and reacquired rights should be the lesser of: (a) the amount by which the contract or right is favorable or unfavorable to market terms from the perspective of the acquirer, or (b) the amount of any stated settlement provisions of the contract available to the counterparty to which the contract is unfavorable.

Disclosures are required of the nature of the preexisting relationship, the fair value of the assets and liabilities settled and the amount of the settlement gain or loss.

Issue No. 04-2, "Whether mineral rights are tangible or intangible assets."

Issue 04-2 establishes that mineral rights of mining companies should continue to be accounted for as tangible rather than intangible assets. The FASB staff issued similar guidance establishing that the mineral and drilling rights of oil- and gas-producing entities are tangible assets in FSP FAS 141-1 and 142-1 and FSP FAS 142-2.

Issue No. 04-3, "Mining assets: Impairment and business combinations."

The Task Force reached a consensus on Issue 04-3 that a measure known as "value beyond proven and probable reserves" should be considered when allocating the purchase price of a business combination to mining assets and when testing for impairment.

Issue No. 04-10, "Applying paragraph 19 of FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, in determining whether to aggregate operating segments that do not meet the quantitative thresholds."

The Task Force reached a consensus regarding the characteristics necessary for combination of operating information for operating segments that do not individually meet the quantitative thresholds provided in FASB Statement 131 for reportable segments.

To qualify for combination, the operating segments must have similar economic characteristics and they must be similar in a majority of the following five aggregation criteria:

1. The nature of their products and services.
2. The nature of their production processes.
3. The type or class of customer for their products and services.
4. The methods used to distribute their products or provide their services.
5. If applicable, the nature of the regulatory environment, (e.g., banking or insurance).

If the operating segments do not qualify for combination, separate disclosures are required for each segment, regardless of materiality. This consensus will be effective concurrently with an FSP on the meaning of similar economic characteristics. Early application is permitted.

EITF Announcements

The SEC Observer made two announcements in 2004.

Topic No. D-98, "Classification and measurement of redeemable securities."

The SEC Observer announced the staff's position regarding the interaction of Topic D-98 and Statement 150 for conditionally redeemable preferred shares:

• If a company issues preferred shares that are conditionally redeemable, the shares are outside the scope of Statement 150.
• If the required condition is met, then the shares become mandatorily redeemable under Statement 150 and would require reclassification to a liability.

Topic No. D-108, "Use of the residual method to value acquired assets other than goodwill."

The SEC Observer announced the SEC staff's view that the residual method does not meet the requirements of FASB Statement 141, Business Combinations, for valuing identifiable intangible assets.

Some SEC registrants have used the residual method in the past to value intangibles arising from legal and contractual rights (identifiable intangible assets) on the grounds that these assets could not be directly and separately valued. This method involves assigning a purchase price to other identifiable assets and liabilities, then recognizing the residual amount as an indistinguishable intangible asset.

SEC registrants that have used this method should perform an impairment test on the affected intangible assets using the direct value method no later than the beginning of the first fiscal year after December 15, 2004. Early adoption is encouraged.

FASB Staff Positions

In addition to the FSPs mentioned elsewhere in this letter, the FASB issued the following:

FSP FAS 106-2, Accounting and disclosure requirements related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003

This FSP establishes that the subsidy available under the Medicare Act of 2003 is treated as an actuarial gain under FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. This means the effects of the Act on the employer's accumulated postretirement benefit obligation is combined with all other actuarial gains and losses rather than recorded as a one-time gain.

FSP FAS 129-1, Disclosure requirements under FASB Statement No. 129, Disclosure of Information about Capital Structure, relating to contingently convertible securities.

This FSP establishes disclosure requirements for issuers of contingently convertible securities. The disclosures include the circumstances of the contingency and the potential impact of conversion.

AICPA Statements of Position

The Accounting Standards Executive Committee (AcSEC) of the AICPA released a final SOP in 2004.

SOP No. 04-2, Accounting for Real Estate Time-Sharing Transactions

AcSEC issued SOP 04-2 to address the diversity in practice caused by a lack of guidance specific to real estate time-sharing transactions. Areas of diversity in practice have included accounting for uncollectibles, recovery or repossession of time-sharing intervals, selling and marketing costs, operations during holding periods, developer subsidies to interval owners associations, and upgrade and reload transactions.

GASB Pronouncements

The Governmental Accounting Standards Board released the following:

Accounting and Reporting for Other Post Employment Benefits (OPEB)

GASB Statement No. 43, Financial Reporting for Postemployment Benefit Plans Other Than Pension Plans, establishes the accounting guidance for OPEB plans that are included as trust funds in the financial reports of plan sponsors or employers, or issued in standalone financial reports.

GASB Statement No. 45, Accounting and Financial Reporting by Employers for Postemployment Benefits Other Than Pensions, establishes accounting guidance on how to account for and report the costs and obligations related to postemployment healthcare and other forms of OPEB. The accounting requirements are based on actuarial determined amounts similar to requirements for pensions. The OPEB cost is generally the actuarial determined amount that, if paid on an ongoing basis, would provide sufficient resources to pay benefits as they come due.

GASB Technical Bulletin No. 2004-2, "Recognition of Pension and Other Postemployment Benefit [OPEB] Expenditures/Expense and Liabilities by Cost-Sharing Employers," provides guidance on questions that may arise in applying GASB Statements 27 and 45 to cost-sharing employers. Cost-sharing refers to the practice of pooling by employers of their benefit obligations and assets under a pension or OPEB plan.

Other GASB Statements

GASB Statement No. 44, Economic Condition Reporting - The Statistical Section, enhances and updates the statistical section that accompanies a state or local government's basic financial statements.

GASB Statement No. 46, Net Assets Restricted by Enabling Legislation, provides that a government's net assets should be reported as restricted when their use is limited by an external party, constitutional provision, or enabling legislation, (i.e., a law that authorizes new resources but imposes limits on the use of the resources).

Continue Reading - Calendar of Key Accounting and Reporting Dates 2005

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