June 14, 2005, Meeting Highlights

 Topic: Applying the Guidance in EITF 03-13 to Discontinued Operations

 Question: Should companies apply retrospective application to its historical financial statements included or incorporated by reference in a 1933 Act filing or proxy statement for significant events or circumstances occurring after the latest balance sheet date but before the effective date of the 1933 Act filing or the mailing date of the proxy statement when those events or circumstances will change the assessment of discontinued operations pursuant to paragraph 42 of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (Statement 144), for components that were previously disposed of or classified as held for sale?

 Background:  Statement 144 requires a company to reclassify prior period financial statements for a discontinued operation once financial statements are issued including the date of sale, or the date of classification as held for sale. However, Statement 144 precludes a company from reporting discontinued operations when the date of sale, or classification as held for sale, occurs after the balance sheet. For changes in discontinued operations classifications, the SEC staff has insisted on retrospective application of historical financial statements to be included or incorporated by reference in a 1933 Act filing or proxy statement once the company has filed subsequent interim period financial statements that reflect the discontinued operations treatment. When the date of sale, or classification as held for sale, occurs after the latest balance sheet included in a 1933 Act filing or proxy statement, Article 11 pro forma financial statements should be presented for all periods to give effect to the actual or probable disposition, if significant.

 Discussion: EITF Issue No. 03-13, Applying the Conditions in Paragraph 42 of FASB Statement No. 144 in Determining Whether to Report Discontinued Operations (EITF 03-13), which became effective for components disposed of or classified as held for sale in fiscal periods beginning after December 15, 2004, requires companies to assess whether the criteria in paragraph 42 of Statement 144 have been met from the date the component initially meets the criteria to be classified as held for sale or is disposed of through one year after the date the component is actually disposed of. During this assessment period, reclassification into and out of discontinued operations for all periods presented may be required. EITF 03-13 also requires that the evaluation of whether the criteria in paragraph 42 of Statement 144 are expected to be met for a component that is either disposed of or classified as held for sale at the balance sheet date should include significant events or circumstances that occur after the balance sheet date but before the issuance of the financial statements. For example, if a significant event occurs after the latest balance sheet date but before the issuance of the financial statements that results in an expectation that the criteria in paragraph 42 of Statement 144 will be met by the end of the assessment period, the component's operations should be presented as discontinued operations in those financial statements.

 View A: Companies should apply retrospective application to its historical financial statements included or incorporated by reference in a 1933 Act filing or proxy statement for significant events or circumstances occurring after the latest balance sheet date but before the effective date of the 1933 Act filing or proxy statement when those events or circumstances will change the assessment of discontinued operations pursuant to paragraph 42 of Statement 144 for components that were previously disposed of or classified as held for sale. Because the company's financial statements must comply with GAAP at the time of effectiveness or mailing of the registration statement or proxy statement, retrospective application is required.

 View B: Because the change to the discontinued operations treatment has not yet been reflected in the most recent period for which historical financial statements are included or incorporated by reference in the 1933 Act filing or proxy statement, the company should not apply retrospective application to those historical financial statements for significant events or circumstances occurring after the issuance of those financial statements but before the effective date of the 1933 Act filing or the mailing date of the proxy statement. However, if the pending retrospective application to reclassify discontinued operations is significant at the 10% level under S-X Rule 1-02(w), pursuant to Article 11-01(b)(2) companies should provide supplemental Article 11 pro forma financial information for the latest interim period and prior three annual periods.

 Committee Recommendation: The committee supports View B. In adopting View B as its recommendation, the Committee discussed whether the application EITF 03-13 should result in a different model for determining whether previously issued annual financial statements should apply retrospective application in connection with a 1933 Act filing or proxy statement than is generally followed when subsequent events occur. In the Committee's deliberations, a consensus was reached that the application of EITF 03-13 should follow the model of certain other subsequent events such as a change in reportable segments, adoption of certain new accounting principle requiring retrospective application of prior periods as well as initially reporting discontinued operations under paragraph 42 of FAS 142; that is, previously issued annual financial statements would not apply retrospective application in connection with a 1933 Act filing or proxy statement unless the accounting for those subsequent events is reflected in interim financial statements that have already been issued at the effective date of the 1933 Act filing or the mailing date of the proxy statement.

 The Committee also believes it is important to focus on the fact that the fact pattern addressed by this paper is one where the subsequent event occurs after the financial statements are first issued (i.e., the event occurs between the date of the first issuance and a reissuance). (If the subsequent event occurred before the financial statements were first issued, EITF 03-13 is clear that the financial statements must reflect the effect of the subsequent event.)

 Section AU 560.08 of the Codification of Statements on Auditing Standards states "When financial statements are reissued, for example, in reports filed with the Securities and Exchange Commission or other regulatory agencies, events that require disclosure in the reissued financial statements to keep them from being misleading may have occurred subsequent to the original issuance of the financial statements." Under View B, this would be accomplished through footnote disclosure and pro forma information. Section AU 560.08 continues, "Events occurring between the time of original issuance and reissuance of financial statements should not result in adjustment of the financial statements unless the adjustment meets the criteria for the correction of an error or the criteria for prior period adjustments set forth in Opinions of the Accounting Principles Board." Based on this literature, events that would have been considered in the preparation of the financial statements, had they occurred before the date of first issuance, do not require adjustment to the financial statements when they occur between the original issuance date and the reissuance date. Examples of such events include (a) learning new information about the status of a contingency and (b) the refinancing of short-term obligations on a long-term basis (applying paragraph 11 of FASB Statement 6, which requires the consideration of events through the date the balance sheet is issued). The Committee believes that the requirement in paragraph 15 of EITF 03-13 to consider "significant events or circumstances that occur after the balance sheet date but before the issuance of the financial statements" (emphasis added) should be applied in the same manner.

 The Committee believes that requiring a different model for the application of EITF 03-13 would place an additional burden on registrants to potentially apply retrospective application to their annual financial statements on a more frequent basis and, in addition, would call into question the existing model for accounting for other subsequent events such as those outlined above.

 Provided below are two illustrative examples (for a calendar year-end registrant) of the application of View B for the Staff's consideration:

 

 In this example, the September 2005 registration statement will need to either include or incorporate by reference the audited financial statements for each of the three years in the period ended December 31, 2004 as well as the unaudited financial statements for the six months ended June 30, 2005 and 2004. Under View B, because the discontinued operation was reported in the June 30, 2005 and 2004 interim financial statements, the registrant is required to apply retrospective application to its annual financial statements for each of the three years in the period ended December 31, 2004 included/incorporated by reference in the registration statement to reflect the component as a discontinued operation.

 

 In this illustration, the most recent financial statements included in the registration statement were first issued before the date of the subsequent event affecting discontinued operations accounting. The registration statement was filed before financial statements reflecting the component as a discontinued operation were issued (i.e., June 30, 2005 interim financial statements). Under View B, the registrant would not be required to apply retrospective application to its prior period annual financial statements. It would be required to do so only after financial statements reflecting the component as a discontinued operation are issued. Instead, the registrant would provide pro forma information reflecting the effect of the discontinued operations.

 Staff Response: The Staff recognizes the practical difficulties associated with View A. Accordingly the Staff will not object to View B.

 Topic: Applying Rules 3-09 and 4-08(g) When an Investor Adopts EITF 02-14 for an Investment in In-Substance Common Stock

 Background: EITF Issue No. 02-14, Whether an Investor Should Apply the Equity Method of Accounting to Investments Other Than Common Stock (EITF 02-14), requires an investor that has the ability to exercise significant influence over the operating and financial policies of the investee to apply the equity method of accounting only when it has an investment(s) in common stock and/or an investment that is in-substance common stock. The Task Force believes that in-substance common stock is an investment in an entity that has risk and reward characteristics that are substantially similar to that entity's common stock. For investments that are in-substance common stock but were not accounted for under the equity method of accounting prior to the consensuses in EITF 02-14, the equity method of accounting should be applied for reporting periods beginning after September 15, 2004. The effect of adopting the consensuses in EITF 02-14 should be reported in the beginning of the reporting period of adoption similar to a cumulative effect of a change in accounting principle pursuant to Opinion 20. Pro forma disclosure of the effect of the change in accounting principle in periods presented prior to the initial application of these consensuses is not required.

 Rule 3-09 of Regulation S-X requires that the registrant's Form 10-K contain separate financial statements, prepared in accordance with Regulation S-X for investees accounted for by the equity method when such entities are individually significant (i.e., the equity investee meets either the investment or income test at the 20% level). The Staff Training Manual (III.A of Topic 2) states that "the financial statements required should be for the same annual audited periods as required by SX 3-01 and 3-02." The Staff Training Manual also indicates that "financial statements are not required for periods prior to the registrant's ownership of the investment." Rule 4-08(g) of Regulation S-X requires the registrant's consolidated financial statements in annual reports on Form 10-K to include disclosure in the notes to the financial statements of summarized financial information about equity investees if, individually or in the aggregate, they are significant at the 10% level under any one of the three significant subsidiary tests.

 Question: When a registrant adopts EITF 02-14 for investments that are in-substance common stock but were not previously accounted for under the equity method (and would not be considered a correction of an error), how should the significant test under S-X 3-09 be computed and what Rule 3-09 financial statements should be included in the registrant's Form 10-K?

 View A: The significance test under S-X 3-09 would be computed using the registrants' ownership percentage of the results of the equity investee as if the investment was accounted for under the equity method of accounting for the full fiscal year. If the equity investee would have been significant for any period presented had the company applied the equity method in those periods, insofar as practicable, the registrant should provide separate financial statements (audited for those periods in which the equity investee is significant) of the equity investee for the same dates and for the same periods as the registrant's audited financial statements.

 View B: Notwithstanding the fact that the registrant had a prior ownership interest in the equity investee, the adoption of EITF 02-14 should be treated similar to the acquisition of an equity investee. As such, the significance test would be computed using the results from the date of adoption (i.e., commencement of equity method accounting) through the end of the fiscal year and, if significant, separate audited financial statements of the equity investee would only be required in the year of adoption as well as in subsequent years (i.e., separate financial statements of the equity investee would not be required prior to the initial adoption of EITF 02-14).

 Committee Recommendation: The committee supports View B. Committee offers the following example to outline its view:

 Facts: A calendar year-end registrant adopts EITF 02-14 effective October 1, 2004 for an investment and, as a result, commences equity method accounting on that date. In preparation of the registrant's 2004 Form 10-K, the following test is performed to determine whether the investment in significant under Rule 3-09 of Regulation S-X:

 

 The Committee believes that a literal application of Rule 3-09 of Regulation S-X indicates that the significance test would be computed using only the results of the investee from the period of time beginning when the investment was accounted for under the equity method through the end of the reporting period. This application is consistent with historical practice of Rule 3-09. Regarding the cumulative catch-up adjustment upon adoption of EITF 02-14, the Committee believes that such adjustment would be excluded from the computation of significance under Rule 3-09. Regarding the financial statement requirements, the Committee believes that a literal application of Rule 3-09 only requires financial statements from the period of time beginning when the investment was accounted for under the equity method and that should the preparation of those financial statement not be practicable, then registrants should discuss the issue with the Staff. The Committee believes that this is consistent with historical practice as well.

 The Committee also believes that providing investee financial statements for any period prior to the time the investment was accounted for by the equity method is conceptually more analogous to providing pre-acquisition financial statements to comply with Rule 3-05. The Committee notes that changing the approach to consolidating entities due to changes in accounting standards (e.g., upon adoption of FIN 46) has historically not been considered the type of extraordinary corporate event that triggered the need for Rule 3-05 financial statements, and the Committee believes that that is the appropriate approach in this situation as well.

 Staff Response: The Staff takes View B and does not object to the conclusion in the Committee's example outlined above.

 Topic: Applying Rule 3-09 in the year a formerly consolidated subsidiary becomes an equity method investee

 Question: How should a registrant apply the income test in Rule 1-02(w) in determining significance in the year a formerly consolidated wholly-owned or majority-owned subsidiary becomes an equity method investee?

 Background: Under Rule 3-09, the significance of a registrant's equity investee is determined by reference to the significance tests in Rule 1-02(w). The income test requires the comparison of income from continuing operations before income taxes, extraordinary items, and cumulative effect of a change in accounting principle of the equity method investee with such income of the registrant. Although not specified in Rule 1-02(w), the SEC staff also believes that the income test should include the gain/loss from the disposition of an equity method investee.

 View A — The registrant should calculate the income test based on the registrant's equity in the investee's pretax earnings for the period of the fiscal year in which it was accounted for by the equity method. In addition, any gain or loss arising from the transaction that caused the former subsidiary to become an equity investee should not be included in the significance test.

 View B — The registrant should calculate the income test based on the registrant's equity in the investee's pretax earnings for the full fiscal year. That is, the significance test would be based on the actual ownership interest for the respective periods of the fiscal year. In addition, any gain or loss related to changes in ownership of the subsidiary/investee would be included in the significance test.

 View C — The registrant should calculate the income test based on the registrant's equity ownership interest applied to the gross pretax earnings of the subsidiary/investee for the full fiscal year. View C essentially represents a pro forma computation as if the equity interest had been held since the beginning of the year. View C attempts to approximate the likely results of the income test in subsequent years. Any gain or loss arising from the transaction that caused the former subsidiary to become an equity investee should not be included in the significance test.

 Committee Recommendation: The committee supports View A.

 Staff Response: The Staff takes View A, with modification. The Staff stated that any gain or loss related to changes in ownership of the subsidiary/investee should be included in the significance test (the Committee's view under View A was that any gain or loss should not be included). The Staff further commented that if the equity investee would be determined to be significant under View B, then the Staff would expect robust disclosure in the registrant's Management Discussion and Analysis in its Form 10-K since such significance would indicate that the results of operations of the former wholly-owned subsidiary was material to the registrant and should be discussed.

 Note: See discussion document B for additional discussion of the determination of significance under S-X 3-09.

 Question 2: If significant, what Rule 3-09 financial statements should be presented in the registrant's Form 10-K in the year a formerly consolidated wholly-owned or majority-owned subsidiary becomes an equity method investee?

 Background: Under Rule 3-09, equity investees are considered to be individually significant if they meet either the investment test or the income test at the 20% level. Insofar as practicable, the separate financial statements of the equity investee should be as of the same dates and for the same periods as the registrant's audited consolidated financial statements. However, the SEC Staff Training Manual ("STM") states "Audited or unaudited SX 3-09 financial statements are not required for periods prior to the registrant's ownership of the investment . . ." The SEC STM does not address the situation where the registrant had a prior majority ownership interest and previously consolidated the equity investee.

 The March 20, 2001 SEC Regulations Committee Meeting ("March 2001 Meeting") addressed the issue of Rule 3-09 financial statements in the year in which an investee is acquired. However, this issue assumed that the registrant had no prior ownership interest in the equity investee. The SEC Staff indicated that if financial statements specified by Rule 3-09 could not be obtained without undue difficulty or cost then it would favorably consider the inclusion of equity investee financial statements for the entire year in lieu of financial statements from the date of acquisition.

 View A — The registrant only should provide audited financial statements of the equity method investee for the period of the fiscal year in which it was accounted for by the equity method. If it is impractical to obtain audited financial statements only for this period, the registrant should consider the relief provided in the March 2001 Meeting.

 View B — The registrant should provide financial statements of the equity method investee/former subsidiary for all periods (i.e., three years). Only the most recent year would be required to be audited. Periods in which the business was consolidated would not be required to be audited.

 View C — The registrant should provide financial statements of the equity method investee/former subsidiary for all periods (i.e., three years). Because of the significance test, the most recent year would be required to be audited. Further, the registrant should determine whether the subsidiary was significant in earlier years to determine whether those years must be separately audited.

 Committee Recommendation: The committee supports View A.

 Staff Response: The Staff takes View A.

 Topic: Clarification of Instruction 4 of Item 2.01 of Form 8-K

 Question: How should companies apply the guidance in Instruction 4 of Item 2.01 of Form 8-K to the acquisition or disposition of a business for purposes of determining whether and how that acquisition or disposition must be reported in Form 8-K?

 Background: Companies must file an Item 2.01 Form 8-K when the company or any of its majority owned subsidiaries has completed an acquisition or disposition of a significant amount of assets not in the ordinary course of business. Instruction 4 of Item 2.01 of Form 8-K states "An acquisition or disposition shall be deemed to involve a significant amount of assets: (i) if the registrant's and its other subsidiaries' equity in the net book value of such assets or the amount paid or received for the assets upon such acquisition or disposition exceeded 10% of the total assets of the registrant and its consolidated subsidiaries; or (ii) if it involved a business (see 17 CFR 210.11-01(d)) that is significant (see 17 CFR 210.11-01(b))." For purposes of condition (ii), an acquisition or disposition of a business is significant if any of the significance tests pursuant to Rule 1-02(w) (i.e., the asset, income, or investment test) are met at the 20% or 10% level, respectively.

 The issue is what reporting under Items 2.01 and 9.01 is required for an acquisition or disposition of a business that does not meet the 20% / 10% thresholds, but where the asset acquisition or disposition embedded in the transaction meets the significance tests in Item 2.01 that apply to asset acquisitions and dispositions. The following examples illustrate such transactions.

 Example 1—A company acquires a business. The significance of the business acquired under Rule 1-02(w) is less than 20%. The purchase price is equal to 19% of the company's total assets as of it latest fiscal year-end.

 Example 2—A company sells a business. The significance of the business sold under Rule 1-02(w) is less than 10%. The amount received is equal to 19% of the company's total assets as of its latest fiscal year-end. (See Question 2 below for further discussion regarding the significance of this disposition. It is presumed to be an insignificant business disposition for purposes of the discussion in Question 1.)

 View A—For purposes of determining whether the acquisition or disposition of a business involves a significant amount of assets, both conditions (i) and (ii) are applicable. Notwithstanding the fact that condition (ii) only applies to the acquisition or disposition of a business, condition (i) applies to the acquisition or disposition of all assets, including assets acquired or disposed of in businesses acquisition or disposition transactions.

 The effect of applying this view in the examples above is as follows. The company must report the transaction under Item 2.01. The company must also consider the requirements of Item 9.01. Since neither transaction constitutes the acquisition of a significant business, no historical financial statements are required pursuant to Item 9.01(a). Since the asset acquisition/disposition aspect of the transaction must be described in answer to Item 2.01, Item 9.01(b) applies, and the company must determine whether pro forma information required by Article 11 of Regulation S-X is required. Rule 11-01(a) calls for pro forma information when the conditions listed in the Rule exist. Rules 11-01(a)(1), (2), and (4) call for pro forma information if a significant acquisition or disposition of businesses has occurred. That is not the case here, so these rules do not apply. However, Rule 11-01(a)(8) calls for pro forma information if "[c]onsummation of other events or transaction has occurred … for which disclosure of pro forma financial information would be material to investors." Therefore, the company must consider whether pro forma information would be material to investors and provide whatever pro forma information it thinks would be material. Since the business acquired/sold is not significant, the company might conclude that only pro forma balance sheet information needs to be provided. In addition, since the significant aspects of the transactions (e.g., the disbursement or receipt of a significant amount of cash) are easily understood, the company might conclude that only a narrative description of the pro forma effects of the transaction needs to be furnished (as permitted by Rule 11-02(b)(1)).

 View B—For purposes of determining whether the acquisition or disposition of a business involves a significant amount of assets, only condition (ii) is applicable. Because condition (ii) specifically relates to the acquisition or disposition of a business, condition (i) is not applicable. Under this approach, although the example transactions might need to be reported under other items (e.g., Item 1.01 if the transaction involved a material definitive agreement) or might voluntarily be reported under Item 8.01, the company is not required to report it under Item 2.01, and no pro forma information called for by Item 9.01(b) is required.

 Committee Recommendation: The Committee agrees that View B is a reasonable interpretation of the existing rules, but that View A appears to be the more appropriate result consistent with timely disclosure and investor protection. In either case, the committee recommends that the Staff provide guidance to clarify the intent and application of the Form 8-K instruction.

 Staff Response: Staff believes that View B is consistent with the existing rules.

 June 2005 Update — Additional Committee Question:

 Question 2: When a business is disposed of, how should the significance percentage under the investment test be calculated?

 View A — In a disposition of a business, the numerator for the investment test should be the proceeds received. (Under this view, the disposition transaction in Example 2 in Question 1 above would be considered significant.)

 In an acquisition transaction, the investment test is essentially a purchase price test, designed to identify transactions that are significant, notwithstanding the fact that the historical accounts of the business acquired (measured based on assets or pretax income) may not be significant. A similar approach should be used to identify significant business dispositions. If the historical accounts of a business that was sold are not significant, the business disposition is nonetheless significant if the proceeds were significant.

 View B — In a disposition of a business, the numerator for the investment test should be the historical/book value of the net assets of the business sold. (Under this view, the disposition transaction in Example 2 in Question 1 above would not be considered significant.)

 Using the historical book value, rather than the proceeds, represents the literal application of Rule 1-02(w). In addition, if the business sold had historically been insignificant, pro forma income statements reflecting the removal of that business would not differ significantly from the historical income statements or be particularly relevant.

 Committee Recommendation: The Committee supports View B. The Committee believes that View B is the approach consistently used in practice.

 Staff Response: The Staff takes View A.

 (See September 13, 2005 Joint Meeting Highlights)

 The Staff noted that the chart is finalized and would be sent to the committee in the immediate future. Note: The chart was approved and issued subsequent to the meeting — see Section VI.A. of the June 15, 2004 Joint Meeting Highlights (as amended on June 17, 2005) at the following URL:

 http://cpcaf.aicpa.org/NR/rdonlyres/EA72D25D-4C98-46F3-A2A5-E39D8FF7D8FB/0/2004_0615_highlights.pdf

 (Topic deferred and to be readdressed with the SEC Staff at a later date)