SEC Trends & Developments - Summer 2011 - An Update On International Financial Reporting Standards
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (collectively, the Boards) are moving full steam ahead with their convergence project agenda. The impact of the nearly one dozen joint pronouncements designed to improve U.S. and international accounting standards may be far reaching and companies need to prepare -- some more than others. The input the Boards have received on standards issued for exposure draft has resulted in the boards taking a step back on their time line and committing to the issuance of quality standards as a priority over timing.
On April 21, 2011 the Boards published a "progress report" describing the progress made on the convergence project since the last report issued in November 2010. To follow are the updates included:
- There are three Memorandum of Understanding projects that will receive priority and they include: revenue recognition, financial instruments and leasing. Also, the Boards will continue to give priority to improve and align U.S. and international insurance accounting standards. Currently the Board's timing on revenue recognition and leasing are aligned. However, their timing differs for financial instruments and insurance.
- Five projects were completed. The Board pointed out that they were nearing the completion of joint standards on fair value measurement and the presentation of other comprehensive income and that those standards would be issued shortly. Both standards have since been issued. Additionally, the IASB will be issuing new standards on consolidated financial statements (including disclosure of interest in other entities), joint arrangements and post-employment benefits.
- The Boards have agreed to extend the timetable for the remaining priority convergence projects beyond June 2011 to permit further work and consultation with stakeholders in a manner consistent with an "open and inclusive" due process. The convergence projects are targeted for completion in the second half of 2011 (however, the U.S. insurance standard, which has not yet been exposed, is targeted for the first half of 2012). The FASB may also need more time for hedging and their timing is not yet clear.
This update will cover the latest development on the three projects the Boards have decided to give priority: revenue recognition, financial instruments and leasing. Also covered are three of the five "completed" projects, as they have since been issued.
THE BIG THREE
The Boards decided that certain projects should receive priority treatment and these projects are referred by some as "the Big Three." These projects are far reaching and expected to have a significant impact on many companies' current application of accounting pronouncements.
Revenue Recognition: On June 15, 2011, the Boards agreed to re-expose their revised proposals for a common revenue recognition standard. The decision to re-expose was significant and based on the amount of feedback received from constituents. The two fundamental topics are (1) when to separately account for performance obligations within a contract and (2) revenue recognition for services. The Boards tentatively decided that a single performance obligation exists when goods or services are integrated into a single item provided a customer. Separation would be required when a good or service has a distinct function and is transferred at a different time from other goods and services in the contract. The Boards decided to create separate criteria for determining when service revenue should be recognized continuously. The criteria differ depending on whether an asset is being created or being enhanced. The Boards plan to publish a re-exposure draft in the third quarter of 2011.
Financial Instruments: The IASB separated this project into phases (1) classification and measurement; (2) impairment methodology; and (3) hedge accounting. The FASB deliberates certain issues relevant to this project separately and disseminates proposals with topics similar to the IASB phases, however the FASB's approach is one comprehensive review and they will subsequently meet to reconcile differences in their technical decisions. When all is said and done, the project will replace the FASB's and IASB's respective financial instruments standard with a common standard. The most significant change from the original requirements is that the FASB backed away from requiring substantially all financial instruments to be measured at fair value. The new model would require financial assets and liabilities to be classified in to one of three categories (1) amortized cost; (2) fair value with changes recognized through other comprehensive income; or (3) fair value with changes recognized in net income. The classification would be based on the entity's business strategy and the instrument's characteristics which is a change from current practice. Debt securities may be classified in one of the three categories; however, equity securities (except for equity method accounting) will be measured at fair value with changes measured in net income whether the securities are marketable or not. For impairments, a new "good book/bad book" approach is applicable. For assets not performing and experiencing losses, the classification would be under "bad book" requiring the instrument to be fully reserved. For assets that are performing ("good book") the FASB wants the expected losses to be calculated in the period the loan is originated or acquired; whereas the IASB prefers the expected losses be calculated for the remaining life of the asset and recognized over the remaining life. For convergence purposes, entities would be required to recognize the higher of the two. The hedging element will pick up steam after the Boards address the comments received on the hedging discussion paper (comments were due April 25, 2011). The Boards plan to publish a re-exposure or review draft by phases during the third and fourth quarter of 2011.
Leasing: The final standard on leasing is expected in the fourth quarter of 2011. The Boards have backed down significantly on the far-reaching changes originally proposed in the new lease accounting model. The exposure draft implicitly treated all leases as financing transactions with an acceleration of profit and loss recognition. The Boards affirmed the application of the "right-of-use" model. Under this model, the lessee would (1) recognize an asset representing its right to use an underlying asset and a liability representing its obligation to make lease payments; (2) subsequently measure the liability using the effective interest method; (3) amortize the asset on a systematic basis reflecting the pattern of consumption. For lessor accounting, the exposure draft included a dual model and the board is currently redeliberating on whether there will be one approach or two approaches. Under one approach, the "financing" lease model, rent is effectively reported as principal and interest payments and the associated assets amortized. Under the second approach, the "other than financing" lease model, a straight line expense recognition pattern would apply as rent expense. The two main views that appear to be emerging are that either a single model should be applied or retain current lessor guidance (with the FASB moving to IAS 17 Leases). Due to the significance of the potential changes from the exposure draft, a wait and see approach may be best served when it comes to lease accounting. The Boards plan to publish a re-exposure or review draft in the third quarter of 2011.
RECENTLY ISSUED STANDARDS
Since the Board's progress report dated April 21, 2011, three standards were issued:
Fair Value Measurement: On May 12, 2011 the IASB issued IFRS 13 Fair Value Measurement which is effective from January 1, 2013, defines fair value, sets out a single IFRS framework for measuring fair value and requires disclosures about fair value measurement. This framework will be brand new for entities that report under IFRS with a lesser impact to entities reporting under U.S. GAAP. Companies with a significant amount of financial instruments at fair value will feel the effects. The ability to measure financial assets based on their "highest and best use" is no longer applicable and the inclusion of premiums and discounts in a fair value measurement is narrowed. Because of concerns raised about disclosure requirements for Level 3 uncertainty, final required disclosures have not been issued. In the interim, quantitative information about unobservable inputs and assumptions used, along with a narrative disclosure about sensitivity of measurements, is required.
Pension and Postemployment Benefits: On June 16, 2011 the IASB issued IAS 19 Employee Benefits which is effective from January 1, 2013. After changing courses a number of times, the IASB made a final decision to require actuarial gains and losses be reported in other comprehensive income. From a balance sheet perspective, this will converge with FASB guidance. However, under U.S. GAAP the gains and losses are subsequently amortized through net income whereas the IFRS does not permit this. The IASB also confirmed that settlement and curtailment gains and losses will be recognized in net income when the event occurs.
Presentation of Other Comprehensive Income: On June 16 2011, the FASB issued ASU No. 2011 – 05 Comprehensive Income (Topic 220). Under this new guidance, companies are permitted to present net income and other comprehensive income either in a single continuous statement or in two separate but consecutive statements. Presentation of other comprehensive income within the statement of equity will no longer be permitted. Currently, under U.S. GAAP, consecutive presentation of the statement of net income and other comprehensive income is not required and inclusion in the statement of equity is allowed. This amendment is consistent with what IFRS currently permits for presentation purposes.
For more information on other projects included in the convergence project and other proposed standards, please visit www.ifrs.org or www.fasb.org for a complete project update and related timeline.
SEC Trends & Developments - Summer 2011 Issue