Topic 5: Miscellaneous Accounting
- Removed by SAB 103
- Removed by SAB 103
- Removed by SAB 112
- Removed by SAB 70
- Removed by SAB 115
- Removed by SAB 95
- P. Restructuring Charges
- Removed by SAB 103
- Removed by SAB 103
- Removed by SAB 103
- Removed by SAB 112
- Removed by SAB 103
- Accounting and Disclosure Regarding Discontinued Operations
- Removed by SAB 103
- Removed by SAB 103
-
Removed by SAB 103
- Removed by SAB 103
AA. Removed by SAB 103
A. Expenses of Offering
Facts: Prior to the effective date of an offering of
equity securities, Company Y incurs certain expenses related to the offering.
Question: Should such costs be deferred?
Interpretive Response: Specific incremental costs
directly attributable to a proposed or actual offering of securities may properly be deferred
and charged against the gross proceeds of the offering. However, management salaries or other
general and administrative expenses may not be allocated as costs of the offering and deferred
costs of an aborted offering may not be deferred and charged against proceeds of a subsequent
offering. A short postponement (up to 90 days) does not represent an aborted offering.
B. Gain or Loss From Disposition of Equipment
Facts: Company A has adopted the policy of treating
gains and losses from disposition of revenue producing equipment as adjustments to the current
year’s provision for depreciation. Company B reflects such gains and losses as a separate item
in the statement of income.
Question: Does the staff have any views as to which
method is preferable?
Interpretive Response: Gains and losses resulting
from the disposition of revenue producing equipment should not be treated as adjustments to the
provision for depreciation in the year of disposition, but should be shown as a separate item in
the statement of income.
If such equipment is depreciated on the basis of group of composite accounts
for fleets of like vehicles, gains (or losses) may be charged (or credited) to accumulated
depreciation with the result that depreciation is adjusted over a period of years on an average
basis. It should be noted that the latter treatment would not be appropriate for (1) an
enterprise (such as an airline) which replaces its fleet on an episodic rather than a continuing
basis or (2) an enterprise (such as a car leasing company) where equipment is sold after limited
use so that the equipment on hand is both fairly new and carried at amounts closely related to
current acquisition cost.
C.
1. Removed by SAB 103
2. Removed by SAB 103
D. Organization and Offering Expenses and Selling Commissions--Limited Partnerships Trading in Commodity Futures
Facts: Partnerships formed for the purpose of
engaging in speculative trading in commodity futures contracts sell limited partnership
interests to the public and frequently have a general partner who is an affiliate of the
partnership’s commodity broker or the principal underwriter selling the limited partnership
interests. The commodity broker or a subsidiary typically assumes the liability for all or part
of the organization and offering expenses and selling commissions in connection with the sale of
limited partnership interests. Funds raised from the sale of partnership interests are deposited
in a margin account with the commodity broker and are invested in Treasury Bills or similar
securities. The arrangement further provides that interest earned on the investments for an
initial period is to be retained by the broker until it has been reimbursed for all or a
specified portion of the aforementioned expenses and commissions and that thereafter interest
earned accrues to the partnership.
In some instances, there may be no reference to reimbursement of the broker
for expenses and commissions to be assumed. The arrangements may provide that all interest
earned on investments accrues to the partnership but that commissions on commodity transactions
paid to the broker are at higher rates for a specified initial period and at lower rates
subsequently.
Question 1: Should the partnership recognize a
commitment to reimburse the commodity broker for the organization and offering expenses and
selling commissions?
Interpretive Response: Yes. A commitment should be
recognized by reducing partnership capital and establishing a liability for the estimated amount
of expenses and commissions for which the broker is to be reimbursed.
Question 2: Should the interest income retained by
the broker for reimbursement of expenses be recognized as income by the partnership?
Interpretive Response: Yes. All the interest income
on the margin account investments should be recognized as accruing to the partnership as earned.
The portion of income retained by the broker and not actually realized by the partnership in
cash should be applied to reduce the liability for the estimated amount of reimbursable expenses
and commissions.
Question 3: If the broker retains all of the interest
income for a specified period and thereafter it accrues to the partnership, should an equivalent
amount of interest income be reflected on the partnership’s financial statements during the
specified period?
Interpretive Response: Yes. If it appears from the
terms of the arrangement that it was the intent of the parties to provide for full or partial
reimbursement for the expenses and commissions paid by the broker, then a commitment to
reimbursement should be recognized by the partnership and an equivalent amount of interest
income should be recognized on the partnership’s financial statements as earned.
Question 4: Under the arrangements where commissions
on commodity transactions are at a lower rate after a specified period and there is no reference
to reimbursement of the broker for expenses and commissions, should recognition be given on the
partnership’s financial statements to a commitment to reimburse the broker for all or part of
the expenses and commissions?
Interpretive Response: If it appears from the terms
of the arrangement that the intent of the parties was to provide for full or partial
reimbursement of the broker’s expenses and commissions, then the estimated commitment should be
recognized on the partnership’s financial statements. During the specified initial period
commissions on commodity transactions should be charged to operations at the lower commission
rate with the difference applied to reduce the aforementioned commitment.
E. Accounting for Divestiture of a Subsidiary or Other Business Operation
Facts: Company X transferred certain operations
(including several subsidiaries) to a group of former employees who had been responsible for
managing those operations. Assets and liabilities with a net book value of approximately $8
million were transferred to a newly formed entity — Company Y — wholly owned by the former
employees. The consideration received consisted of $1,000 in cash and interest bearing
promissory notes for $10 million, payable in equal annual installments of $1 million each, plus
interest, beginning two years from the date of the transaction. The former employees possessed
insufficient assets to pay the notes and Company X expected the funds for payments to come
exclusively from future operations of the transferred business. Company X remained contingently
liable for performance on existing contracts transferred and agreed to guarantee, at its
discretion, performance on future contracts entered into by the newly formed entity. Company X
also acted as guarantor under a line of credit established by Company Y.
The nature of Company Y’s business was such that Company X’s guarantees were
considered a necessary predicate to obtaining future contracts until such time as Company Y
achieved profitable operations and substantial financial independence from Company X.
Question: If deconsolidation of the subsidiaries and
business operations is appropriate, can Company X recognize a gain?
Interpretive Response: Before recognizing any gain,
Company X should identify all of the elements of the divesture arrangement and allocate the
consideration exchanged to each of those elements. In this regard, we believe that Company X
would recognize the guarantees at fair value in accordance with FASB ASC Topic 460, Guarantees;
the contingent liability for performance on existing contracts in accordance with FASB ASC Topic
450, Contingencies; and the promissory notes in accordance with FASB ASC Topic 310, Receivables,
and FASB ASC Topic 835, Interest.
F. Accounting Changes Not Retroactively Applied Due to Immateriality
Facts: A registrant is required to adopt an
accounting principle by means of retrospective adjustment of prior periods’ financial
statements. However, the registrant determines that the accounting change does not have a
material effect on prior periods’ financial statements and, accordingly, decides not to
retrospectively adjust such financial statements.
Question: In these circumstances, is it acceptable to
adjust the beginning balance of retained earnings of the period in which the change is made for
the cumulative effect of the change on the financial statements of prior periods?
Interpretive Response: No. If prior periods are not
retrospectively adjusted, the cumulative effect of the change should be included in the
statement of income for the period in which the change is made. Even in cases where the total
cumulative effect is not significant, the staff believes that the amount should be reflected in
the results of operations for the period in which the change is made. However, if the cumulative
effect is material to current operations or to the trend of the reported results of operations,
then the individual income statements of the earlier years should be retrospectively
adjusted.
G. Transfers of Nonmonetary Assets by Promoters or Shareholders
Facts: Nonmonetary assets are exchanged by promoters
or shareholders for all or part of a company’s common stock just prior to or contemporaneously
with a first-time public offering.
Question: Since FASB ASC paragraph 845-10-15-4
(Nonmonetary Transactions Topic) states that the guidance in this topic is not applicable to
transactions involving the acquisition of nonmonetary assets or services on issuance of the
capital stock of an enterprise, what value should be ascribed to the acquired assets by the
company?
Interpretive Response: The staff believes that
transfers of nonmonetary assets to a company by its promoters or shareholders in exchange for
stock prior to or at the time of the company’s initial public offering normally should be
recorded at the transferors’ historical cost basis determined under GAAP.
The staff will not always require that predecessor cost be used to value
nonmonetary assets received from an enterprise’s promoters or shareholders. However, deviations
from this policy have been rare applying generally to situations where the fair value of either
the stock issued1 or assets acquired is objectively measurable and the transferor’s stock ownership
following the transaction was not so significant that the transferor had retained a substantial
indirect interest in the assets as a result of stock ownership in the company.
H. Removed by SAB 112
I. Removed by SAB 70
J. Removed by SAB 115
K. Removed by SAB 95
L. LIFO Inventory Practices
Facts: On November 30, 1984, AcSEC and its Task Force
on LIFO Inventory Problems (task force) issued a paper, “Identification and Discussion of
Certain Financial Accounting and Reporting Issues Concerning LIFO Inventories.” This paper
identifies and discusses certain financial accounting and reporting issues related to the
last-in, first-out (LIFO) inventory method for which authoritative accounting literature
presently provides no definitive guidance. For some issues, the task force’s advisory
conclusions recommend changes in current practice to narrow the diversity which the task force
believes exists. For other issues, the task force’s advisory conclusions recommend that current
practice should be continued for financial reporting purposes and that additional accounting
guidance is unnecessary. Except as otherwise noted in the paper, AcSEC generally supports the
task force’s advisory conclusions. As stated in the issues paper, “Issues papers of the AICPA’s
accounting standards division are developed primarily to identify financial accounting and
reporting issues the division believes need to be addressed or clarified by the Financial
Accounting Standards Board.” On February 6, 1985, the FASB decided not to add to its agenda a
narrow project on the subject of LIFO inventory practices.
Question 1: What is the SEC staff’s position on the
issues paper?
Interpretive Response: In the absence of existing
authoritative literature on LIFO accounting, the staff believes that registrants and their
independent accountants should look to the paper for guidance in determining what constitutes
acceptable LIFO accounting practice.7 In this connection, the staff considers the paper to be an accumulation of existing
acceptable LIFO accounting practices which does not establish any new standards and does not
diverge from GAAP.
The staff also believes that the advisory conclusions recommended in the
issues paper are generally consistent with conclusions previously expressed by the Commission,
such as:
1. Pooling-paragraph 4-6 of the paper discusses LIFO inventory pooling and
concludes “establishing separate pools with the principal objective of facilitating inventory
liquidations is unacceptable.” In Accounting and Auditing Enforcement Release 35, August 13,
1984, the Commission stated that it believes that the Company improperly realigned its LIFO
pools in such a way as to maximize the likelihood and magnitude of LIFO liquidations and thus,
overstated net income.
2. New Items-paragraph 4-27 of the paper discusses determination of the cost
of new items and concludes “if the double extension or an index technique is used, the objective
of LIFO is achieved by reconstructing the base year cost of new items added to existing pools.”
In ASR 293, the Commission stated that when the effects of inflation on the cost of new products
are measured by making a comparison with current cost as the base-year cost, rather than a
reconstructed base-year cost, income is improperly increased.
Question 2: If a registrant utilizes a LIFO practice
other than one recommended by an advisory conclusion in the issues paper, must the registrant
change its practice to one specified in the paper?
Interpretive Response: Now that the issues paper is
available, the staff believes that a registrant and its independent accountants should
re-examine previously adopted LIFO practices and compare them to the recommendations in the
paper. In the event that the registrant and its independent accountants conclude that the
registrant’s LIFO practices are preferable in the circumstances, they should be prepared to
justify their position in the event that a question is raised by the staff.
Question 3: If a registrant elects to change its LIFO
practices to be consistent with the guidance in the issues paper and discloses such changes in
accordance with FASB ASC Topic 250, Accounting Changes and Error Corrections, will the
registrant be requested by the staff to explain its past practices and its justification for
those practices?
Interpretive Response: The staff does not expect to
routinely raise questions about changes in LIFO practices which are made to make a company’s
accounting consistent with the recommendations in the issues paper.
M. Other Than Temporary Impairment of Certain Investments in Equity Securities
Facts: FASB ASC paragraph 320-10-35-33 (Investments —
Debt and Equity Securities Topic) does not define the phrase “other than temporary” for
available-for-sale equity securities. For its available-for-sale equity securities, Company A
has interpreted “other than temporary” to mean permanent impairment. Therefore, because Company
A’s management has not been able to determine that its investment in Company B’s equity
securities is permanently impaired, no realized loss has been recognized even though the market
price of Company B’s equity securities is currently less than one-third of Company A’s average
acquisition price.
Question: For equity securities classified as
available-for-sale, does the staff believe that the phrase “other than temporary” should be
interpreted to mean “permanent”?
Interpretive Response: No. The staff believes that
the FASB consciously chose the phrase “other than temporary” because it did not intend that the
test be “permanent impairment,” as has been used elsewhere in accounting practice.8
The value of investments in equity securities classified as
available-for-sale may decline for various reasons. The market price may be affected by general
market conditions which reflect prospects for the economy as a whole or by specific information
pertaining to an industry or an individual company. Such declines require further investigation
by management. Acting upon the premise that a write-down may be required, management should
consider all available evidence to evaluate the realizable value of its investment in equity
securities classified as available-for-sale.
There are numerous factors to be considered in such an evaluation and their
relative significance will vary from case to case. The staff believes that the following are
only a few examples of the factors which, individually or in combination, indicate that a
decline in value of an equity security classified as available-for-sale is other than temporary
and that a write-down of the carrying value is required:
a. The length of the time and the extent to which the market value has been
less than cost;
b. The financial condition and near-term prospects of the issuer, including
any specific events which may influence the operations of the issuer such as changes in
technology that may impair the earnings potential of the investment or the discontinuance of a
segment of the business that may affect the future earnings potential; or
c. The intent and ability of the holder to retain its investment in the
issuer for a period of time sufficient to allow for any anticipated recovery in market
value.
Unless evidence exists to support a realizable value equal to or greater than
the carrying value of the investment in equity securities classified as available-for-sale, a
write-down to fair value accounted for as a realized loss should be recorded. Such loss should
be recognized in the determination of net income of the period in which it occurs and the
written down value of the investment in the company becomes the new cost basis of the
investment.
N. Discounting by Property-Casualty Insurance Companies
Facts: A registrant which is an insurance company
discounts certain unpaid claims liabilities related to short-duration9 insurance contracts for purposes of reporting to state regulatory authorities, using
discount rates permitted or prescribed by those authorities (“statutory rates”) which
approximate 3 1/2 percent. The registrant follows the same practice in preparing its financial
statements in accordance with GAAP. It proposes to change for GAAP purposes, to using a discount
rate related to the historical yield on its investment portfolio (“investment related rate”)
which is represented to approximate 7 percent, and to account for the change as a change in
accounting estimate, applying the investment related rate to claims settled in the current and
subsequent years while the statutory rate would continue to be applied to claims settled in all
prior years.
Question 1: What is the staff’s position with respect
to discounting claims liabilities related to short-duration insurance contracts?
Interpretive Response: The staff is aware of efforts
by the accounting profession to assess the circumstances under which discounting may be
appropriate in financial statements. Pending authoritative guidance resulting from those efforts
however, the staff will raise no objection if a registrant follows a policy for GAAP reporting
purposes of:
-
Discounting liabilities for unpaid claims and claim adjustment expenses at the same rates that it uses for reporting to state regulatory authorities with respect to the same claims liabilities, or
-
Discounting liabilities with respect to settled claims under the following circumstances: (1) The payment pattern and ultimate cost are fixed and determinable on an individual claim basis, and (2) The discount rate used is reasonable on the facts and circumstances applicable to the registrant at the time the claims are settled.
Question 2: Does the staff agree with the
registrant’s proposal that the change from a statutory rate to an investment related rate be
accounted for as a change in accounting estimate?
Interpretive Response: No. The staff believes that
such a change involves a change in the method of applying an accounting principle, i.e.,
the method of selecting the discount rate was changed. The staff therefore believes that the
registrant should reflect the cumulative effect of the change in accounting by applying the new
selection method retroactively to liabilities for claims settled in all prior years, in
accordance with the requirements of FASB ASC Topic 250, Accounting Changes and Error
Corrections. Initial adoption of discounting for GAAP purposes would be treated similarly. In
either case, in addition to the disclosures required by FASB ASC Topic 250 concerning the change
in accounting principle, a preferability letter from the registrant’s independent accountant is
required.
O. Research and Development Arrangements
Facts: FASB ASC paragraph 730-20-25-5 (Research and
Development Topic) states that conditions other than a written agreement may exist which create
a presumption that the enterprise will repay the funds provided by other parties under a
research and development arrangement. FASB ASC subparagraph 730-20-25-6(c) lists as one of those
conditions the existence of a “significant related party relationship” between the enterprise
and the parties funding the research and development.
Question 1: What does the staff consider a
“significant related party relationship” as that term is used in FASB ASC subparagraph
730-20-25-6(c)?
Interpretive Response: The staff believes that a
significant related party relationship exists when 10 percent or more of the entity providing
the funds is owned by related parties.10 In unusual circumstances, the staff may also question the appropriateness of treating a
research and development arrangement as a contract to perform service for others at the less
than 10 percent level. In reviewing these matters the staff will consider, among other factors,
the percentage of the funding entity owned by the related parties in relationship to their
ownership in and degree of influence or control over the enterprise receiving the funds.
Question 2: FASB ASC paragraph 730-20-25-5 states
that the presumption of repayment “can be overcome only by substantial evidence to the
contrary.” Can the presumption be overcome by evidence that the funding parties were assuming
the risk of the research and development activities since they could not reasonably expect the
enterprise to have resources to repay the funds based on its current and projected future
financial condition?
Interpretive Response: No. FASB ASC paragraph
730-20-25-3 specifically indicates that the enterprise “may settle the liability by paying cash,
by issuing securities, or by some other means.” While the enterprise may not be in a position to
pay cash or issue debt, repayment could be accomplished through the issuance of stock or various
other means. Therefore, an apparent or projected inability to repay the funds with cash (or debt
which would later be paid with cash) does not necessarily demonstrate that the funding parties
were accepting the entire risks of the activities.
P. Restructuring Charges
1. Removed by SAB 103
2. Removed by SAB 103
3. Income statement presentation of restructuring charges
Facts: Restructuring charges often do not relate to
a separate component of the entity, and, as such, they would not qualify for presentation as
losses on the disposal of a discontinued operation. Additionally, since the charges are not
both unusual and infrequent11 they are not presented in the income statement as extraordinary items.
Question 1: May such restructuring charges be
presented in the income statement as a separate caption after income from continuing operations
before income taxes (i.e., preceding income taxes and/or discontinued operations)?
Interpretive Response: No. FASB ASC paragraph
225-20-45-16 (Income Statement Topic) states that items that do not meet the criteria for
classification as an extraordinary item should be reported as a component of income from
continuing operations.12 Neither FASB ASC Subtopic 225-20, Income Statement — Extraordinary and Unusual Items, nor
Rule 5-03 of Regulation S-X contemplate a category in between continuing and discontinued
operations. Accordingly, the staff believes that restructuring charges should be presented as a
component of income from continuing operations, separately disclosed if material. Furthermore,
the staff believes that a separately presented restructuring charge should not be preceded by a
sub-total representing “income from continuing operations before restructuring charge” (whether
or not it is so captioned). Such a presentation would be inconsistent with the intent of FASB
ASC Subtopic 225-20.
Question 2: Some registrants utilize a classified or
“two-step” income statement format (i.e., one which presents operating revenues,
expenses and income followed by other income and expense items). May a charge which relates to
assets or activities for which the associated revenues and expenses have historically been
included in operating income be presented as an item of “other expense” in such an income
statement?
Interpretive Response: No. The staff believes that
the proper classification of a restructuring charge depends on the nature of the charge and the
assets and operations to which it relates. Therefore, charges which relate to activities for
which the revenues and expenses have historically been included in operating income should
generally be classified as an operating expense, separately disclosed if material. Furthermore,
when a restructuring charge is classified as an operating expense, the staff believes that it
is generally inappropriate to present a preceding subtotal captioned or representing operating
income before restructuring charges. Such an amount does not represent a measurement of
operating results under GAAP.
Conversely, charges relating to activities previously included under “other
income and expenses” should be similarly classified, also separately disclosed if material.
Question 3: Is it permissible to disclose the effect
on net income and earnings per share of such a restructuring charge?
Interpretive Response: Discussions in MD&A and
elsewhere which quantify the effects of unusual or infrequent items on net income and earnings
per share are beneficial to a reader’s understanding of the financial statements and are
therefore acceptable.
MD&A also should discuss the events and decisions which gave rise to the
restructuring, the nature of the charge and the expected impact of the restructuring on future
results of operations, liquidity and sources and uses of capital resources.
4. Disclosures
Beginning with the period in which the exit plan is initiated, FASB ASC
Topic 420, Exit or Disposal Cost Obligations, requires disclosure, in all periods,
including interim periods, until the exit plan is completed, of the following:
a. A description of the exit or disposal activity, including the facts and
circumstances leading to the expected activity and the expected completion date
b. For each major type of cost associated with the activity (for example,
one-time termination benefits, contract termination costs, and other associated
costs): (1) The total amount expected to be incurred in connection with
the activity, the amount incurred in the period, and the cumulative amount incurred to
date (2) A reconciliation of the beginning and ending liability
balances showing separately the changes during the period attributable to costs incurred and
charged to expense, costs paid or otherwise settled, and any adjustments to the liability with
an explanation of the reason(s) therefor
c. The line item(s) in the income statement or the statement of activities
in which the costs in (b) above are aggregated
d. For each reportable segment, the total amount of costs expected to be
incurred in connection with the activity, the amount incurred in the period, and the cumulative
amount incurred to date, net of any adjustments to the liability with an explanation of the
reason(s) therefor
e. If a liability for a cost associated with the activity is not recognized
because fair value cannot be reasonably estimated, that fact and the reasons therefor
Question: What specific disclosures about
restructuring charges has the staff requested to fulfill the disclosure requirements of FASB
ASC Topic 420 and MD&A?
Interpretive Response: The staff often has requested
greater disaggregation and more precise labeling when exit and involuntary termination costs
are grouped in a note or income statement line item with items unrelated to the exit plan. For
the reader’s understanding, the staff has requested that discretionary, or decision-dependent,
costs of a period, such as exit costs, be disclosed and explained in MD&A separately. Also
to improve transparency, the staff has requested disclosure of the nature and amounts of
additional types of exit costs and other types of restructuring charges13 that appear quantitatively or qualitatively material, and requested that losses relating
to asset impairments be identified separately from charges based on estimates of future cash
expenditures.
The staff frequently reminds registrants that in periods subsequent to the
initiation date that material changes and activity in the liability balances of each
significant type of exit cost and involuntary employee termination benefits14 (either as a result of expenditures or changes in/reversals of estimates or the fair
value of the liability) should be disclosed in the footnotes to the interim and annual
financial statements and discussed in MD&A. In the event a company recognized liabilities
for exit costs and involuntary employee termination benefits relating to multiple exit plans,
the staff believes presentation of separate information for each individual exit plan that has
a material effect on the balance sheet, results of operations or cash flows generally is
appropriate.
For material exit or involuntary employee termination costs related to an
acquired business, the staff has requested disclosure in either MD&A or the financial
statements of:
-
When the registrant began formulating exit plans for which accrual may be necessary,
-
The types and amounts of liabilities recognized for exit costs and involuntary employee termination benefits and included in the acquisition cost allocation, and
-
Any unresolved contingencies or purchase price allocation issues and the types of additional liabilities that may result in an adjustment of the acquisition cost allocation.
The staff has noted that the economic or other events that cause a
registrant to consider and/or adopt an exit plan or that impair the carrying amount of assets,
generally occur over time. Accordingly, the staff believes that as those events and the
resulting trends and uncertainties evolve, they often will meet the requirement for disclosure
pursuant to the Commission’s MD&A rules prior to the period in which the exit costs and
liabilities are recorded pursuant to GAAP. Whether or not currently recognizable in the
financial statements, material exit or involuntary termination costs that affect a known trend,
demand, commitment, event, or uncertainty to management, should be disclosed in MD&A. The
staff believes that MD&A should include discussion of the events and decisions which gave
rise to the exit costs and exit plan, and the likely effects of management’s plans on financial
position, future operating results and liquidity unless it is determined that a material effect
is not reasonably likely to occur. Registrants should identify the periods in which material
cash outlays are anticipated and the expected source of their funding. Registrants should also
discuss material revisions to exit plans, exit costs, or the timing of the plan’s execution,
including the nature and reasons for the revisions.
The staff believes that the expected effects on future earnings and cash
flows resulting from the exit plan (for example, reduced depreciation, reduced employee
expense, etc.) should be quantified and disclosed, along with the initial period in which those
effects are expected to be realized. This includes whether the cost savings are expected to be
offset by anticipated increases in other expenses or reduced revenues. This discussion should
clearly identify the income statement line items to be impacted (for example, cost of sales;
marketing; selling, general and administrative expenses; etc.). In later periods if actual
savings anticipated by the exit plan are not achieved as expected or are achieved in periods
other than as expected, MD&A should discuss that outcome, its reasons, and its likely
effects on future operating results and liquidity.
The staff often finds that, because of the discretionary nature of exit
plans and the components thereof, presenting and analyzing material exit and involuntary
termination charges in tabular form, with the related liability balances and activity (e.g.,
beginning balance, new charges, cash payments, other adjustments with explanations, and ending
balances) from balance sheet date to balance sheet date, is necessary to explain fully the
components and effects of significant restructuring charges. The staff believes that such a
tabular analysis aids a financial statement user’s ability to disaggregate the restructuring
charge by income statement line item in which the costs would have otherwise been recognized,
absent the restructuring plan, (for example, cost of sales; selling, general, and
administrative; etc.).
Q. Increasing Rate Preferred Stock
Facts: A registrant issues Class A and Class B
nonredeemable preferred stock15 on 1/1/X1. Class A, by its terms, will pay no dividends during the years 20X1 through
20X3. Class B, by its terms, will pay dividends at annual rates of $2, $4 and $6 per share in
the years 20X1, 20X2 and 20X3, respectively. Beginning in the year 20X4 and thereafter as long
as they remain outstanding, each instrument will pay dividends at an annual rate of $8 per
share. In all periods, the scheduled dividends are cumulative.
At the time of issuance, eight percent per annum was considered to be a
market rate for dividend yield on Class A, given its characteristics other than scheduled cash
dividend entitlements (voting rights, liquidation preference, etc.), as well as the registrant’s
financial condition and future economic prospects. Thus, the registrant could have expected to
receive proceeds of approximately $100 per share for Class A if the dividend rate of $8 per
share (the “perpetual dividend”) had been in effect at date of issuance. In consideration of the
dividend payment terms, however, Class A was issued for proceeds of $79 3/8 per share. The
difference, $20 5/8, approximated the value of the absence of $8 per share dividends annually
for three years, discounted at 8%.
The issuance price of Class B shares was determined by a similar approach,
based on the terms and characteristics of the Class B shares.
Question 1: How should preferred stocks of this
general type (referred to as “increasing rate preferred stocks”) be reported in the balance
sheet?
Interpretive Response: As is normally the case with
other types of securities, increasing rate preferred stock should be recorded initially at its
fair value on date of issuance. Thereafter, the carrying amount should be increased periodically
as discussed in the Interpretive Response to Question 2.
Question 2: Is it acceptable to recognize the
dividend costs of increasing rate preferred stocks according to their stated dividend
schedules?
Interpretive Response: No. The staff believes that
when consideration received for preferred stocks reflects expectations of future dividend
streams, as is normally the case with cumulative preferred stocks, any discount due to an
absence of dividends (as with Class A) or gradually increasing dividends (as with Class B) for
an initial period represents prepaid, unstated dividend cost.16 Recognizing the dividend cost of these instruments according to their stated dividend
schedules would report Class A as being cost-free, and would report the cost of Class B at less
than its effective cost, from the standpoint of common stock interests (i.e., for
purposes of computing income applicable to common stock and earnings per common share) during
the years 20X1 through 20X3.
Accordingly, the staff believes that discounts on increasing rate preferred
stock should be amortized over the period(s) preceding commencement of the perpetual dividend,
by charging imputed dividend cost against retained earnings and increasing the carrying amount
of the preferred stock by a corresponding amount. The discount at time of issuance should be
computed as the present value of the difference between (a) dividends that will be payable, if
any, in the period(s) preceding commencement of the perpetual dividend; and (b) the perpetual
dividend amount for a corresponding number of periods; discounted at a market rate for dividend
yield on preferred stocks that are comparable (other than with respect to dividend payment
schedules) from an investment standpoint. The amortization in each period should be the amount
which, together with any stated dividend for the period (ignoring fluctuations in stated
dividend amounts that might result from variable rates,17 results in a constant rate of effective cost vis-a-vis the carrying amount of the
preferred stock (the market rate that was used to compute the discount).
Simplified (ignoring quarterly calculations) application of this accounting
to the Class A preferred stock described in the “Facts” section of this bulletin would produce
the following results on a per share basis:
Carrying amount of preferred stock
|
|
Beginning of Year (BOY)
|
Imputed Dividend (8% of Carrying Amount at BOY)
|
End of year
|
|---|---|---|---|
|
Year 20X1
|
$79.38
|
6.35
|
85.73
|
|
Year 20X2
|
85.73
|
6.86
|
92.59
|
|
Year 20X3
|
92.59
|
7.41
|
100.00
|
During 20X4 and thereafter, the stated dividend of $8 measured against the
carrying amount of $10018 would reflect dividend cost of 8%, the market rate at time of issuance.
The staff believes that existing authoritative literature, while not
explicitly addressing increasing rate preferred stocks, implicitly calls for the accounting
described in this bulletin.
The pervasive, fundamental principle of accrual accounting would, in the
staff’s view, preclude registrants from recognizing the dividend cost on the basis of whatever
cash payment schedule might be arranged. Furthermore, recognition of the effective cost of
unstated rights and privileges is well-established in accounting, and is specifically called for
by FASB ASC Subtopic 835-30, Interest — Imputation of Interest, and Topic 3.C of this
codification for unstated interest costs of debt capital and unstated dividend costs of
redeemable preferred stock capital, respectively. The staff believes that the requirement to
recognize the effective periodic cost of capital applies also to nonredeemable preferred stocks
because, for that purpose, the distinction between debt capital and preferred equity capital
(whether redeemable19 or nonredeemable) is irrelevant from the standpoint of common stock interests.
Question 3: Would the accounting for discounts on
increasing rate preferred stock be affected by variable stated dividend rates?
Interpretive Response: No. If stated dividends on an
increasing rate preferred stock are variable, computations of initial discount and subsequent
amortization should be based on the value of the applicable index at date of issuance and should
not be affected by subsequent changes in the index.
For example, assume that a preferred stock issued 1/1/X1 is scheduled to pay
dividends at annual rates, applied to the stock’s par value, equal to 20% of the actual
(fluctuating) market yield on a particular Treasury security in 20X1 and 20X2, and 90% of the
fluctuating market yield in 20X3 and thereafter. The discount would be computed as the present
value of a two-year dividend stream equal to 70% (90% less 20%) of the 1/1/X1 Treasury security
yield, annually, on the stock’s par value. The discount would be amortized in years 20X1 and
20X2 so that, together with 20% of the 1/1/X1 Treasury yield on the stock’s par value, a
constant rate of cost vis-a-vis the stock’s carrying amount would result. Changes in the
Treasury security yield during 20X1 and 20X2 would, of course, cause the rate of total reported
preferred dividend cost (amortization of discount plus cash dividends) in those years to be more
or less than the rate indicated by discount amortization plus 20% of the 1/1/X1 Treasury
security yield. However, the fluctuations would be due solely to the impact of changes in the
index on the stated dividends for those periods.
Question 4: Will the staff expect retroactive changes
by registrants to comply with the accounting described in this bulletin?
Interpretive Response: All registrants will be
expected to follow the accounting described in this bulletin for increasing rate preferred
stocks issued after December 4, 1986.20 Registrants that have not followed this accounting for increasing rate preferred stocks
issued before that date were encouraged to retroactively change their accounting for those
preferred stocks in the financial statements next filed with the Commission. The staff did not
object if registrants did not make retroactive changes for those preferred stocks, provided that
all presentations of and discussions regarding income applicable to common stock and earnings
per share in future filings and shareholders’ reports are accompanied by equally prominent
supplemental disclosures (on the face of the income statement, in presentations of selected
financial data, in MD&A, etc.) of the impact of not changing their accounting and an
explanation of such impact (e.g., that dividend cost has been recognized on a cash
basis).
R. Removed by SAB 103
S. Quasi-Reorganization
Facts: As a consequence of significant operating
losses and/or recent write-downs of property, plant and equipment, a company’s financial
statements reflect an accumulated deficit. The company desires to eliminate the deficit by
reclassifying amounts from paid-in-capital. In addition, the company anticipates adopting a
discretionary change in accounting principles21 that will be recorded as a cumulative-effect type of accounting change. The recording of
the cumulative effect will have the result of increasing the company’s retained earnings.
Question 1: May the company reclassify its capital
accounts to eliminate the accumulated deficit without satisfying all of the conditions
enumerated in Section 21022 of the Codification of Financial Reporting Policies for a quasi-reorganization?
Interpretive Response: No. The staff believes a
deficit reclassification of any nature is considered to be a quasi-reorganization. As such, a
company may not reclassify or eliminate a deficit in retained earnings unless all requisite
conditions set forth in Section 21023 for a quasi-reorganization are satisfied. 24
Question 2: Must the company implement the
discretionary change in accounting principle simultaneously with the quasi-reorganization or may
it adopt the change after the quasi-reorganization has been effected?
Interpretive Response: The staff has taken the
position that the company should adopt the anticipated accounting change prior to or as an
integral part of the quasi-reorganization. Any such accounting change should be effected by
following GAAP with respect to the change. 25
FASB ASC paragraph 852-20-25-5 (Reorganizations Topic) indicates that,
following a quasi-reorganization, an “entity’s accounting shall be substantially similar to that
appropriate for a new entity.” The staff believes that implicit in this “fresh-start” concept is
the need for the company’s accounting principles in place at the time of the
quasi-reorganization to be those planned to be used following the reorganization to avoid a
misstatement of earnings and retained earnings after the reorganization.26 FASB ASC paragraph 852-20-30-2 states, in part, “. . . in general, assets should be
carried forward as of the date of the readjustment at fair and not unduly conservative amounts,
determined with due regard for the accounting to be subsequently employed
by the entity.” (emphasis added)
In addition, the staff believes that adopting a discretionary change in
accounting principle that will be reflected in the financial statements within 12 months
following the consummation of a quasi-reorganization leads to a presumption that the accounting
change was contemplated at the time of the quasi-reorganization.27
Question 3: In connection with a
quasi-reorganization, may there be a write-up of net assets?
Interpretive Response: No. The staff believes that
increases in the recorded values of specific assets (or reductions in liabilities) to fair value
are appropriate providing such adjustments are factually supportable, however, the amount of
such increases are limited to offsetting adjustments to reflect decreases in other assets (or
increases in liabilities) to reflect their new fair value. In other words, a
quasi-reorganization should not result in a write-up of net assets of the registrant.
Question 4: The interpretive response to question 1
indicates that the staff believes that a deficit reclassification of any nature is considered to
be a quasi-reorganization, and accordingly, must satisfy all the conditions of Section 210.28 Assume a company has satisfied all the requisite conditions of Section 210, and has
eliminated a deficit in retained earnings by a concurrent reduction in paid-in capital, but did
not need to restate assets and liabilities by a charge to capital because assets and liabilities
were already stated at fair values. How should the company reflect the tax benefits of operating
loss or tax credit carryforwards for financial reporting purposes that existed as of the date of
the quasi-reorganization when such tax benefits are subsequently recognized for financial
reporting purposes?
Interpretive Response: The staff believes FASB ASC
Subtopic 852-740, Reorganizations — Income Taxes, requires that any subsequently recognized tax
benefits of operating loss or tax credit carryforwards that existed as of the date of a
quasi-reorganization be reported as a direct addition to paid-in capital. The staff believes
that this position is consistent with the “new company” or “fresh-start” concept embodied in
Section 210,29 and in existing accounting literature regarding quasi-reorganizations, and with the FASB
staff’s justification for such a position when they stated that a “new enterprise would not have
tax benefits attributable to operating losses or tax credits that arose prior to its
organization date. 30
The staff believes that all registrants that comply with the requirements of
Section 210 in effecting a quasi-reorganization should apply the accounting required by FASB ASC
paragraph 852-740-45-3 for the tax benefits of tax carryforward items.31, 32 Therefore, even though the only effect of a quasi-reorganization is the elimination of a
deficit in retained earnings because assets and liabilities are already stated at fair values
and the revaluation of assets and liabilities is unnecessary (or a write-up of net assets is
prohibited as indicated in the interpretive response to question 3 above), subsequently
recognized tax benefits of operating loss or tax credit carryforward items should be recorded as
a direct addition to paid-in capital.
Question 5: If a company had previously recorded a
quasi-reorganization that only resulted in the elimination of a deficit in retained earnings,
may the company reverse such entry and “undo” its quasi-reorganization?
Interpretive Response: No. The staff believes FASB
ASC Topic 250, Accounting Changes and Error Corrections, would preclude such a change in
accounting. It states: “a method of accounting that was previously adopted for a type of
transaction or event that is being terminated or that was a single,
nonrecurring event in the past shall not be changed.” (emphasis added.) 33
T. Accounting for Expenses or Liabilities Paid by Principal Stockholder(s)
Facts: Company X was a defendant in litigation for
which the company had not recorded a liability in accordance with FASB ASC Topic 450,
Contingencies. A principal stockholder34 of the company transfers a portion of his shares to the plaintiff to settle such
litigation. If the company had settled the litigation directly, the company would have recorded
the settlement as an expense.
Question: Must the settlement be reflected as an
expense in the company’s financial statements, and if so, how?
Interpretive Response: Yes. The value of the shares
transferred should be reflected as an expense in the company’s financial statements with a
corresponding credit to contributed (paid-in) capital.
The staff believes that such a transaction is similar to those described in
FASB ASC paragraph 718-10-15-4 (Compensation — Stock Compensation Topic), which states that
“share-based payments awarded to a grantee by a related party or other holder of an economic
interest35 in the entity as compensation for goods or services provided to the reporting entity are
share-based payment transactions to be accounted for under this Topic unless the transfer is
clearly for a purpose other than compensation for goods or services to the reporting entity.” As
explained in this paragraph, the substance of such a transaction is that the economic interest
holder makes a capital contribution to the reporting entity, and the reporting entity makes a
share-based payment to its grantee in exchange for goods or services provided to the reporting
entity.
The staff believes that the problem of separating the benefit to the
principal stockholder from the benefit to the company cited in FASB ASC Topic 718 is not limited
to transactions involving stock compensation. Therefore, similar accounting is required in this
and other36 transactions where a principal stockholder pays an expense for the company, unless the
stockholder’s action is caused by a relationship or obligation completely unrelated to his
position as a stockholder or such action clearly does not benefit the company.
Some registrants and their accountants have taken the position that since
FASB ASC Topic 850, Related Party Disclosures, applies to these transactions and requires only
the disclosure of material related party transactions, the staff should not analogize to the
accounting called for by FASB ASC paragraph 718-10-15-4 for transactions other than those
specifically covered by it. The staff notes, however, that FASB ASC Topic 850 does not address
the measurement of related party transactions and that, as a result, such transactions are
generally recorded at the amounts indicated by their terms.37 However, the staff believes that transactions of the type described above differ from the
typical related party transactions.
The transactions for which FASB ASC Topic 850 requires disclosure generally
are those in which a company receives goods or services directly from, or provides goods or
services directly to, a related party, and the form and terms of such transactions may be
structured to produce either a direct or indirect benefit to the related party. The
participation of a related party in such a transaction negates the presumption that transactions
reflected in the financial statements have been consummated at arm’s length. Disclosure is
therefore required to compensate for the fact that, due to the related party’s involvement, the
terms of the transaction may produce an accounting measurement for which a more faithful
measurement may not be determinable.
However, transactions of the type discussed in the facts given do not have
such problems of measurement and appear to be transacted to provide a benefit to the stockholder
through the enhancement or maintenance of the value of the stockholder’s investment. The staff
believes that the substance of such transactions is the payment of an expense of the company
through contributions by the stockholder. Therefore, the staff believes it would be
inappropriate to account for such transactions according to the form of the transaction.
U. Removed by SAB 112
V. Certain Transfers of Nonperforming Assets
Facts: A financial institution desires to reduce its
nonaccrual or reduced rate loans and other nonearning assets, including foreclosed real estate
(collectively, “nonperforming assets”). Some or all of such nonperforming assets are transferred
to a newly-formed entity (the “new entity”). The financial institution, as consideration for
transferring the nonperforming assets, may receive (a) the cash proceeds of debt issued by the
new entity to third parties, (b) a note or other redeemable instrument issued by the new entity,
or (c) a combination of (a) and (b). The residual equity interests in the new entity, which
carry voting rights, initially owned by the financial institution, are transferred to outsiders
(for example, via distribution to the financial institution’s shareholders or sale or
contribution to an unrelated third party).
The financial institution typically will manage the assets for a fee,
providing necessary services to liquidate the assets, but otherwise does not have the right to
appoint directors or legally control the operations of the new entity.
FASB ASC Topic 860, Transfers and Servicing, provides guidance for
determining when a transfer of financial assets can be recognized as a sale. The interpretive
guidance provided in response to Questions 1 and 2 of this SAB does not apply to transfers of
financial assets falling within the scope of FASB ASC Topic 860. Because FASB ASC Topic 860 does
not apply to distributions of financial assets to shareholders or a contribution of such assets
to unrelated third parties, the interpretive guidance provided in response to Questions 1 and 2
of this SAB would apply to such conveyances.
Further, registrants should consider the guidance contained in FASB ASC Topic
810, Consolidation, in determining whether it should consolidate the newly-formed entity.
Question 1: What factors should be considered in
determining whether such transfer of nonperforming assets can be accounted for as a disposition
by the financial institution?
Interpretive Response: The staff believes that
determining whether nonperforming assets have been disposed of in substance requires an
assessment as to whether the risks and rewards of ownership have been transferred.38 The staff believes that the transfer described should not be accounted for as a sale or
disposition if (a) the transfer of nonperforming assets to the new entity provides for recourse
by the new entity to the transferor financial institution, (b) the financial institution
directly or indirectly guarantees debt of the new entity in whole or in part, (c) the financial
institution retains a participation in the rewards of ownership of the transferred assets, for
example through a higher than normal incentive or other management fee arrangement,39 or (d) the fair value of any material non-cash consideration received by the financial
institution (for example, a note or other redeemable instrument) cannot be reasonably estimated.
Additionally, the staff believes that the accounting for the transfer as a sale or disposition
generally is not appropriate where the financial institution retains rewards of ownership
through the holding of significant residual equity interests or where third party holders of
such interests do not have a significant amount of capital at risk.
Where accounting for the transfer as a sale or disposition is not
appropriate, the nonperforming assets should remain on the financial institution’s balance sheet
and should continue to be disclosed as nonaccrual, past due, restructured or foreclosed, as
appropriate, and the debt of the new entity should be recorded by the financial institution.
Question 2: If the transaction is accounted for as a
sale to an unconsolidated party, at what value should the transfer be recorded by the financial
institution?
Interpretive Response: The staff believes that the
transfer should be recorded by the financial institution at the fair value of assets transferred
(or, if more clearly evident, the fair value of assets received) and a loss recognized by the
financial institution for any excess of the net carrying value40 over the fair value.41 Fair value is the amount that would be realizable in an outright sale to an unrelated
third party for cash.42 The same concepts should be applied in determining fair value of the transferred assets,
i.e., if an active market exists for the assets transferred, then fair value is equal to
the market value. If no active market exists, but one exists for similar assets, the selling
prices in that market may be helpful in estimating the fair value. If no such market price is
available, a forecast of expected cash flows, discounted at a rate commensurate with the risks
involved, may be used to aid in estimating the fair value. In situations where discounted cash
flows are used to estimate fair value of nonperforming assets, the staff would expect that the
interest rate used in such computations will be substantially higher than the cost of funds of
the financial institution and appropriately reflect the risk of holding these nonperforming
assets. Therefore, the fair value determined in such a way will be lower than the amount at
which the assets would have been carried by the financial institution had the transfer not
occurred, unless the financial institution had been required under GAAP to carry such assets at
market value or the lower of cost or market value.
Question 3: Where the transaction may appropriately
be accounted for as a sale to an unconsolidated party and the financial institution receives a
note receivable or other redeemable instrument from the new entity, how should such asset be
disclosed pursuant to Item III C, “Risk Elements,” of Industry Guide 3? What factors should be
considered related to the subsequent accounting for such instruments received?
Interpretive Response: The staff believes that the
financial institution may exclude the note receivable or other asset from its Risk Elements
disclosures under Guide 3 provided that: (a) the receivable itself does not constitute a
nonaccrual, past due, restructured, or potential problem loan that would require disclosure
under Guide 3, and (b) the underlying collateral is described in sufficient detail to enable
investors to understand the nature of the note receivable or other asset, if material, including
the extent of any over-collateralization. The description of the collateral normally would
include material information similar to that which would be provided if such assets were owned
by the financial institution, including pertinent Risk Element disclosures.
The staff notes that, in situations in which the transaction is accounted for
as a sale to an unconsolidated party and a portion of the consideration received by the
registrant is debt or another redeemable instrument, careful consideration must be given to the
appropriateness of recording profits on the management fee arrangement, or interest or dividends
on the instrument received, including consideration of whether it is necessary to defer such
amounts or to treat such payments on a cost recovery basis. Further, if the new entity incurs
losses to the point that its permanent equity based on GAAP is eliminated, it would ordinarily
be necessary for the financial institution, at a minimum, to record further operating losses as
its best estimate of the loss in realizable value of its investment. 43
W. Contingency Disclosures Regarding Property-Casualty Insurance Reserves for Unpaid Claim Costs
Facts: A property-casualty insurance company (the
“Company”) has established reserves, in accordance with FASB ASC Topic 944, Financial Services —
Insurance, for unpaid claim costs, including estimates of costs relating to claims incurred but
not reported (“IBNR”).44 The reserve estimate for IBNR claims was based on past loss experience and current trends
except that the estimate has been adjusted for recent significant unfavorable claims experience
that the Company considers to be nonrecurring and abnormal. The Company attributes the abnormal
claims experience to a recent acquisition and accelerated claims processing; however, actuarial
studies have been inconclusive and subject to varying interpretations. Although the reserve is
deemed adequate to cover all probable claims, there is a reasonable possibility that the
abnormal claims experience could continue, resulting in a material understatement of claim
reserves.
FASB ASC Topic 450, Contingencies, requires, among other things, disclosure
of loss contingencies.45 However, FASB ASC paragraph 450-10-05-6 notes that “[n]ot all uncertainties inherent in
the accounting process give rise to contingencies.”
FASB ASC Topic 275, Risks and Uncertainties,46 also provides disclosure guidance regarding certain significant estimates.
Question 1: In the staff’s view, do FASB ASC Topics
450 and 275 disclosure requirements apply to property-casualty insurance reserves for unpaid
claim costs? If so, how?
Interpretive Response: Yes. The staff believes that
specific uncertainties (conditions, situations and/or sets of circumstances) not considered to
be normal and recurring because of their significance and/or nature can result in loss
contingencies47 for purposes of applying FASB ASC Topics 450 and 275 disclosure requirements. General
uncertainties, such as the amount and timing of claims, that are normal, recurring, and inherent
to estimations of property-casualty insurance reserves are not considered subject to the
disclosure requirements of FASB ASC Topic 450. Some specific uncertainties that may result in
loss contingencies pursuant to FASB ASC Topic 450, depending on significance and/or nature,
include insufficiently understood trends in claims activity; judgmental adjustments to
historical experience for purposes of estimating future claim costs (other than for normal
recurring general uncertainties); significant risks to an individual claim or group of related
claims; or catastrophe losses. The requirements of FASB ASC Topic 275 apply when “[i]t is at
least reasonably possible that the estimate of the effect on the financial statements of a
condition, situation, or set of circumstances that existed at the date of the financial
statements will change in the near term due to one or more future confirming events ... [and]
the effect of the change would be material to the financial statements.”
Question 2: Do the facts presented above describe an
uncertainty that requires disclosures under FASB ASC Topics 450 and 275?
Interpretive Response: Yes. The staff believes the
judgmental adjustments to historical experience for insufficiently understood claims activity
noted above results in a loss contingency within the scope of FASB ASC Topics 450 and 275. Based
on the facts presented above, at a minimum the Company’s financial statements should disclose
that for purposes of estimating IBNR claim reserves, past experience was adjusted for what
management believes to be abnormal claims experience related to the recent acquisition of
Company A and accelerated claims processing. It should also be disclosed that there is a
reasonable possibility that the claims experience could be the indication of an unfavorable
trend which would require additional IBNR claim reserves in the approximate range of $XX-$XX
million (alternatively, if Company management is unable to estimate the possible loss or range
of loss, a statement to that effect should be disclosed).
Additionally, the staff also expects companies to disclose the nature of the
loss contingency and the potential impact on trends in their loss reserve development
discussions provided pursuant to Property-Casualty Industry Guides 4 and 6. Consideration should
also be given to the need to provide disclosure in MD&A.
Question 3: Does the staff have an example in which
specific uncertainties involving an individual claim or group of related claims result in a loss
contingency the staff believes requires disclosure?
Interpretive Response: Yes. A property-casualty
insurance company (the “Company”) underwrites product liability insurance for an insured
manufacturer which has produced and sold millions of units of a particular product which has
been used effectively and without problems for many years. Users of the product have recently
begun to report serious health problems that they attribute to long term use of the product and
have asserted claims under the insurance policy underwritten and retained by the Company. To
date, the number of users reporting such problems is relatively small, and there is presently no
conclusive evidence that demonstrates a causal link between long term use of the product and the
health problems experienced by the claimants. However, the evidence generated to date indicates
that there is at least a reasonable possibility that the product is responsible for the problems
and the assertion of additional claims is considered probable, and therefore the potential
exposure of the Company is material. While an accrual may not be warranted since the loss
exposure may not be both probable and estimable, in view of the reasonable possibility of
material future claim payments, the staff believes that disclosures made in accordance with FASB
ASC Topics 450 and 275 would be required under these circumstances.
The disclosure concepts expressed in this example would also apply to an
individual claim or group of claims that are related to a single catastrophic event or multiple
events having a similar effect.
X. Removed by SAB 103
Y. Accounting and Disclosures Relating to Loss Contingencies
Facts: A registrant believes it may be obligated to
pay material amounts as a result of product or environmental remediation liability. These
amounts may relate to, for example, damages attributed to the registrant’s products or
processes, clean-up of hazardous wastes, reclamation costs, fines, and litigation costs. The
registrant may seek to recover a portion or all of these amounts by filing a claim against an
insurance carrier or other third parties.
Question 1: Assuming that the registrant’s estimate
of an environmental remediation or product liability meets the conditions set forth in FASB ASC
paragraph 410-30-35-12 (Asset Retirement and Environmental Obligations Topic) for recognition on
a discounted basis, what discount rate should be applied and what, if any, special disclosures
are required in the notes to the financial statements?
Interpretive Response: The rate used to discount the
cash payments should be the rate that will produce an amount at which the environmental or
product liability could be settled in an arm’s-length transaction with a third party. Further,
the discount rate used to discount the cash payments should not exceed the interest rate on
monetary assets that are essentially risk free48 and have maturities comparable to that of the environmental or product liability.
If the liability is recognized on a discounted basis to reflect the time
value of money, the notes to the financial statements should, at a minimum, include disclosures
of the discount rate used, the expected aggregate undiscounted amount, expected payments for
each of the five succeeding years and the aggregate amount thereafter, and a reconciliation of
the expected aggregate undiscounted amount to amounts recognized in the statements of financial
position. Material changes in the expected aggregate amount since the prior balance sheet date,
other than those resulting from pay-down of the obligation, should be explained.
Question 2: What financial statement disclosures
should be furnished with respect to recorded and unrecorded product or environmental remediation
liabilities?
Interpretive Response: FASB ASC Section 450-20-50,
Contingencies — Loss Contingencies — Disclosure, identify disclosures regarding loss
contingencies that generally are furnished in notes to financial statements. FASB ASC Section
410-30-50, Asset Retirement and Environmental Obligations — Environmental Obligations —
Disclosure, identifies disclosures that are required and recommended regarding both recorded and
unrecorded environmental remediation liabilities. The staff believes that product and
environmental remediation liabilities typically are of such significance that detailed
disclosures regarding the judgments and assumptions underlying the recognition and measurement
of the liabilities are necessary to prevent the financial statements from being misleading and
to inform readers fully regarding the range of reasonably possible outcomes that could have a
material effect on the registrant’s financial condition, results of operations, or liquidity. In
addition to the disclosures required by FASB ASC Section 450-20-50 and FASB ASC Section
410-30-50, examples of disclosures that may be necessary include:
-
Circumstances affecting the reliability and precision of loss estimates.
-
The extent to which unasserted claims are reflected in any accrual or may affect the magnitude of the contingency.
-
Uncertainties with respect to joint and several liability that may affect the magnitude of the contingency, including disclosure of the aggregate expected cost to remediate particular sites that are individually material if the likelihood of contribution by the other significant parties has not been established.
-
Disclosure of the nature and terms of cost-sharing arrangements with other potentially responsible parties.
-
The extent to which disclosed but unrecognized contingent losses are expected to be recoverable through insurance, indemnification arrangements, or other sources, with disclosure of any material limitations of that recovery.
-
Uncertainties regarding the legal sufficiency of insurance claims or solvency of insurance carriers.49
-
The time frame over which the accrued or presently unrecognized amounts may be paid out.
-
Material components of the accruals and significant assumptions underlying estimates.
Registrants are cautioned that a statement that the contingency is not
expected to be material does not satisfy the requirements of FASB ASC Topic 450 if there is at
least a reasonable possibility that a loss exceeding amounts already recognized may have been
incurred and the amount of that additional loss would be material to a decision to buy or sell
the registrant’s securities. In that case, the registrant must either (a) disclose the estimated
additional loss, or range of loss, that is reasonably possible, or (b) state that such an
estimate cannot be made.
Question 3: What disclosures regarding loss
contingencies may be necessary outside the financial statements?
Interpretive Response: Registrants should consider
the requirements of Items 101 (Description of Business), 103 (Legal Proceedings), and 303
(MD&A) of Regulation S-K. The Commission has issued interpretive releases that provide
additional guidance with respect to these items.50 In a 1989 interpretive release, the Commission noted that the availability of insurance,
indemnification, or contribution may be relevant in determining whether the criteria for
disclosure have been met with respect to a contingency.51 The registrant’s assessment in this regard should include consideration of facts such as
the periods in which claims for recovery may be realized, the likelihood that the claims may be
contested, and the financial condition of third parties from which recovery is expected.
Disclosures made pursuant to the guidance identified in the preceding
paragraph should be sufficiently specific to enable a reader to understand the scope of the
contingencies affecting the registrant. For example, a registrant’s discussion of historical and
anticipated environmental expenditures should, to the extent material, describe separately (a)
recurring costs associated with managing hazardous substances and pollution in on-going
operations, (b) capital expenditures to limit or monitor hazardous substances or pollutants, (c)
mandated expenditures to remediate previously contaminated sites, and (d) other infrequent or
non-recurring clean-up expenditures that can be anticipated but which are not required in the
present circumstances. Disaggregated disclosure that describes accrued and reasonably likely
losses with respect to particular environmental sites that are individually material may be
necessary for a full understanding of these contingencies. Also, if management’s investigation
of potential liability and remediation cost is at different stages with respect to individual
sites, the consequences of this with respect to amounts accrued and disclosed should be
discussed.
Examples of specific disclosures typically relevant to an understanding of
historical and anticipated product liability costs include the nature of personal injury or
property damages alleged by claimants, aggregate settlement costs by type of claim, and related
costs of administering and litigating claims. Disaggregated disclosure that describes accrued
and reasonably likely losses with respect to particular claims may be necessary if they are
individually material. If the contingency involves a large number of relatively small individual
claims of a similar type, such as personal injury from exposure to asbestos, disclosure of the
number of claims pending at each balance sheet date, the number of claims filed for each period
presented, the number of claims dismissed, settled, or otherwise resolved for each period, and
the average settlement amount per claim may be necessary. Disclosures should address historical
and expected trends in these amounts and their reasonably likely effects on operating results
and liquidity.
Question 4: What disclosures should be furnished with
respect to site restoration costs or other environmental remediation costs? 52
Interpretive Response: The staff believes that
material liabilities for site restoration, post-closure, and monitoring commitments, or other
exit costs that may occur on the sale, disposal, or abandonment of a property as a result of
unanticipated contamination of the asset should be disclosed in the notes to the financial
statements. Appropriate disclosures generally would include the nature of the costs involved,
the total anticipated cost, the total costs accrued to date, the balance sheet classification of
accrued amounts, and the range or amount of reasonably possible additional losses. If an asset
held for sale or development will require remediation to be performed by the registrant prior to
development, sale, or as a condition of sale, a note to the financial statements should describe
how the necessary expenditures are considered in the assessment of the asset’s value and the
possible need to reflect an impairment loss. Additionally, if the registrant may be liable for
remediation of environmental damage relating to assets or businesses previously disposed,
disclosure should be made in the financial statements unless the likelihood of a material
unfavorable outcome of that contingency is remote.53 The registrant’s accounting policy with respect to such costs should be disclosed in
accordance with FASB ASC Topic 235, Notes to Financial Statements.
Z. Accounting and Disclosure Regarding Discontinued Operations
1. Removed by SAB 103
2. Removed by SAB 103
3. Removed by SAB 103
4. Disposal of operation with significant interest retained
Facts: A Company disposes of its controlling
interest in a component of an entity as defined by the FASB ASC Master Glossary. The Company
retains a minority voting interest directly in the component or it holds a minority voting
interest in the buyer of the component. Controlling interest includes those controlling
interests established through other means, such as variable interests. Because the Company’s
voting interest enables it to exert significant influence over the operating and financial
policies of the investee, the Company is required by FASB ASC Subtopic 323-10, Investments —
Equity Method and Joint Ventures — Overall, to account for its residual investment using the
equity method.54
Question: May the historical operating results of
the component and the gain or loss on the sale of the majority interest in the component be
classified in the Company’s statement of operations as “discontinued operations” pursuant to
FASB ASC Subtopic 205-20, Presentation of Financial Statements — Discontinued Operations?
Interpretive Response: No. A condition necessary for
discontinued operations reporting, as indicated in FASB ASC paragraph 205-20-45-1 is that an
entity “not have any significant continuing involvement in the operations of the component
after the disposal transaction.” In these circumstances, the transaction should be accounted
for as the disposal of a group of assets that is not a component of an entity and classified
within continuing operations pursuant to FASB ASC paragraph 360-10-45-5 (Property, Plant, and
Equipment Topic).55
5. Classification and disclosure of contingencies relating to discontinued operations
Facts: A company disposed of a component of an
entity in a previous accounting period. The Company received debt and/or equity securities of
the buyer of the component or of the disposed component as consideration in the sale, but this
financial interest is not sufficient to enable the Company to apply the equity method with
respect to its investment in the buyer. The Company made certain warranties to the buyer with
respect to the discontinued business, or remains liable under environmental or other laws with
respect to certain facilities or operations transferred to the buyer. The disposition satisfied
the criteria of FASB ASC Subtopic 205-20 for presentation as “discontinued operations.” The
Company estimated the fair value of the securities received in the transaction for purposes of
calculating the gain or loss on disposal that was recognized in its financial statements. The
results of discontinued operations prior to the date of disposal or classification as held for
sale included provisions for the Company’s existing obligations under environmental laws,
product warranties, or other contingencies. The calculation of gain or loss on disposal
included estimates of the Company’s obligations arising as a direct result of its decision to
dispose of the component, under its warranties to the buyer, and under environmental or other
laws. In a period subsequent to the disposal date, the Company records a charge to income with
respect to the securities because their fair value declined materially and the Company
determined that the decline was other than temporary. The Company also records adjustments of
its previously estimated liabilities arising under the warranties and under environmental or
other laws.
Question 1: Should the writedown of the carrying
value of the securities and the adjustments of the contingent liabilities be classified in the
current period’s statement of operations within continuing operations or as an element of
discontinued operations?
Interpretive Response: Adjustments of estimates of
contingent liabilities or contingent assets that remain after disposal of a component of an
entity or that arose pursuant to the terms of the disposal generally should be classified
within discontinued operations.56 However, the staff believes that changes in the carrying value of assets received as
consideration in the disposal or of residual interests in the business should be classified
within continuing operations.
FASB ASC paragraph 205-20-45-4 requires that “adjustments to amounts
previously reported in discontinued operations that are directly related to the disposal of a
component of an entity in a prior period shall be classified separately in the current period
in discontinued operations.” The staff believes that the provisions of FASB ASC paragraph
205-20-45-4 apply only to adjustments that are necessary to reflect new information about
events that have occurred that becomes available prior to disposal of the component of the
entity, to reflect the actual timing and terms of the disposal when it is consummated, and to
reflect the resolution of contingencies associated with that component, such as warranties and
environmental liabilities retained by the seller.
Developments subsequent to the disposal date that are not directly related
to the disposal of the component or the operations of the component prior to disposal are not
“directly related to the disposal” as contemplated by FASB ASC paragraph 205-20-45-4.
Subsequent changes in the carrying value of assets received upon disposition of a component do
not affect the determination of gain or loss at the disposal date, but represent the
consequences of management’s subsequent decisions to hold or sell those assets. Gains and
losses, dividend and interest income, and portfolio management expenses associated with assets
received as consideration for discontinued operations should be reported within continuing
operations.
Question 2: What disclosures would the staff expect
regarding discontinued operations prior to the disposal date and with respect to risks retained
subsequent to the disposal date?
Interpretive Response: MD&A57 should include disclosure of known trends, events, and uncertainties involving
discontinued operations that may materially affect the Company’s liquidity, financial
condition, and results of operations (including net income) between the date when a component
of an entity is classified as discontinued and the date when the risks of those operations will
be transferred or otherwise terminated. Disclosure should include discussion of the impact on
the Company’s liquidity, financial condition, and results of operations of changes in the plan
of disposal or changes in circumstances related to the plan. Material contingent
liabilities,58 such as product or environmental liabilities or litigation, that may remain with the
Company notwithstanding disposal of the underlying business should be identified in notes to
the financial statements and any reasonably likely range of possible loss should be disclosed
pursuant to FASB ASC Topic 450, Contingencies. MD&A should include discussion of the
reasonably likely effects of these contingencies on reported results and liquidity. If the
Company retains a financial interest in the discontinued component or in the buyer of that
component that is material to the Company, MD&A should include discussion of known trends,
events, and uncertainties, such as the financial condition and operating results of the issuer
of the security, that may be reasonably expected to affect the amounts ultimately realized on
the investments.
6. Removed by SAB 103
7. Accounting for the spin-off of a subsidiary
Facts: A Company disposes of a business through the
distribution of a subsidiary’s stock to the Company’s shareholders on a pro rata basis in a
transaction that is referred to as a spin-off.
Question: May the Company elect to characterize the
spin-off transaction as resulting in a change in the reporting entity and restate its
historical financial statements as if the Company never had an investment in the subsidiary, in
the manner specified by FASB ASC Topic 250, Accounting Changes and Error Corrections?
Interpretive Response: Not ordinarily. If the
Company was required to file periodic reports under the Exchange Act within one year prior to
the spin-off, the staff believes the Company should reflect the disposition in conformity with
FASB ASC Topic 360. This presentation most fairly and completely depicts for investors the
effects of the previous and current organization of the Company. However, in limited
circumstances involving the initial registration of a company under the Exchange Act or
Securities Act, the staff has not objected to financial statements that retroactively reflect
the reorganization of the business as a change in the reporting entity if the spin-off
transaction occurs prior to effectiveness of the registration statement. This presentation may
be acceptable in an initial registration if the Company and the subsidiary are in dissimilar
businesses, have been managed and financed historically as if they were autonomous, have no
more than incidental common facilities and costs, will be operated and financed autonomously
after the spin-off, and will not have material financial commitments, guarantees, or contingent
liabilities to each other after the spin-off. This exception to the prohibition against
retroactive omission of the subsidiary is intended for companies that have not distributed
widely financial statements that include the spun-off subsidiary. Also, dissimilarity
contemplates substantially greater differences in the nature of the businesses than those that
would ordinarily distinguish reportable segments as defined by FASB ASC paragraph 280-10-50-10
(Segment Reporting Topic).
AA. Removed by SAB 103
BB. Inventory Valuation Allowances
Facts: FASB ASC paragraph 330-10-35-1 (Inventory
Topic), specifies that: “[a] departure from the cost basis of pricing the inventory is required
when the utility of the goods is no longer as great as its cost. Where there is evidence that
the utility of goods, in their disposal in the ordinary course of business, will be less than
cost, whether due to physical deterioration, obsolescence, changes in price levels, or other
causes, the difference shall be recognized as a loss of the current period. This is generally
accomplished by stating such goods at a lower level commonly designated as market.”
FASB ASC paragraph 330-10-35-14 indicates that “[i]n the case of goods which
have been written down below cost at the close of a fiscal year, such reduced amount is to be
considered the cost for subsequent accounting purposes.”
Lastly, the FASB ASC Master Glossary provides “inventory obsolescence” as one
of the items subject to a change in accounting estimate.
Question: Does the write-down of inventory to the
lower of cost or market, as required by FASB ASC Topic 330, create a new cost basis for the
inventory or may a subsequent change in facts and circumstances allow for restoration of
inventory value, not to exceed original historical cost?
Interpretive Response: Based on FASB ASC paragraph
330-10-35-14, the staff believes that a write-down of inventory to the lower of cost or market
at the close of a fiscal period creates a new cost basis that subsequently cannot be marked up
based on changes in underlying facts and circumstances.59
CC. Impairments
Standards for recognizing and measuring impairment of the carrying amount of
long-lived assets including certain identifiable intangibles to be held and used in operations
are found in FASB ASC Topic 360, Property, Plant, and Equipment. Standards for recognizing and
measuring impairment of the carrying amount of goodwill and identifiable intangible assets that
are not currently being amortized are found in FASB ASC Topic 350, Intangibles — Goodwill and
Other.
Facts: Company X has mainframe computers that are to
be abandoned in six to nine months as replacement computers are put in place. The mainframe
computers were placed in service in January 20X0 and were being depreciated on a straight-line
basis over seven years. No salvage value had been projected at the end of seven years and the
original cost of the computers was $8,400. The board of directors, with the appropriate
authority, approved the abandonment of the computers in March 20X3 when the computers had a
remaining carrying value of $4,600. No proceeds are expected upon abandonment. Abandonment
cannot occur prior to the receipt and installation of replacement computers, which is expected
prior to the end of 20X3. Management had begun reevaluating its mainframe computer capabilities
in January 20X2 and had included in its 20X3 capital expenditures budget an estimated amount for
new mainframe computers. The 20X3 capital expenditures budget had been prepared by management in
August 20X2, had been discussed with the company’s board of directors in September 20X2 and was
formally approved by the board of directors in March 20X3. Management had also begun soliciting
bids for new mainframe computers beginning in the fall of 20X2. The mainframe computers, when
grouped with assets at the lowest level of identifiable cash flows, were not impaired on a “held
and used” basis throughout this time period. Management had not adjusted the original estimated
useful life of the computers (seven years) since 20X0.
Question 1: Company X proposes to recognize an
impairment charge under FASB ASC Topic 360 for the carrying value of the mainframe computers of
$4,600 in March 20X3. Does Company X meet the requirements in FASB ASC Topic 360 to classify the
mainframe computer assets as “to be abandoned?”
Interpretive Response: No. FASB ASC paragraph
360-10-35-47 provides that “a long-lived asset to be abandoned is disposed of when it ceases to
be used. If an entity commits to a plan to abandon a long-lived asset before the end of its
previously estimated useful life, depreciation estimates shall be revised in accordance with
FASB ASC Topic 250, Accounting Changes and Error Corrections, to reflect the use of the asset
over its shortened useful life.”
Question 2: Would the staff accept an adjustment to
write down the carrying value of the computers to reflect a “normalized depreciation” rate for
the period from March 20X3 through actual abandonment (e.g., December 20X3)? Normalized
depreciation would represent the amount of depreciation otherwise expected to be recognized
during that period without adjustment of the asset’s useful life, or $1,000 ($100/month for ten
months) in the example fact pattern.
Interpretive Response: No. The mainframe computers
would be viewed as “held and used” at March 20X3 under the fact pattern described. There is no
basis under FASB ASC Topic 360 to write down an asset to an amount that would subsequently
result in a “normalized depreciation” charge through the disposal date, whether disposal is to
be by sale, abandonment, or other means. FASB ASC paragraph 360-10-35-43 requires the asset to
be valued at the lower of carrying amount or fair value less cost to sell in order to be
classified as “held for sale.” For assets that are classified as “held and used” under FASB ASC
Topic 360, an assessment must first be made as to whether the asset (asset group) is impaired.
FASB ASC paragraph 360-10-35-17 indicates that an impairment loss shall be recognized only if
the carrying amount of a long-lived asset (asset group) is not recoverable and exceeds its fair
value. The carrying amount of a long-lived asset (asset group) is not recoverable if it exceeds
the sum of the undiscounted cash flows expected to result from the use and eventual disposition
of the asset (asset group). The staff would object to a write down of long-lived assets to a
“normalized depreciation” value as representing an acceptable alternative to the approaches
required in FASB ASC Topic 360.
The staff also believes that registrants must continually evaluate the
appropriateness of useful lives assigned to long-lived assets, including identifiable intangible
assets and goodwill. In the above fact pattern, management had contemplated removal of the
mainframe computers beginning in January 20X2 and, more formally, in August 20X2 as part of
compiling the 20X3 capital expenditures budget. At those times, at a minimum, management should
have reevaluated the original useful life assigned to the computers to determine whether a seven
year amortization period remained appropriate given the company’s current facts and
circumstances, including ongoing technological changes in the market place. This reevaluation
process should have continued at the time of the September 20X2 board of directors’ meeting to
discuss capital expenditure plans and, further, as the company pursued mainframe computer bids.
Given the contemporaneous evidence that management’s best estimate during much of 20X2 was that
the current mainframe computers would be removed from service in 20X3, the depreciable life of
the computers should have been adjusted prior to 20X3 to reflect this new estimate. The staff
does not view the recognition of an impairment charge to be an acceptable substitute for
choosing the appropriate initial amortization or depreciation period or subsequently adjusting
this period as company or industry conditions change. The staff’s view applies also to selection
of, and changes to, estimated residual values. Consequently, the staff may challenge impairment
charges for which the timely evaluation of useful life and residual value cannot be
demonstrated.
Question 3: Has the staff expressed any views with
respect to company-determined estimates of cash flows used for assessing and measuring
impairment of assets under FASB ASC Topic 360?
Interpretive Response: In providing guidance on the
development of cash flows for purposes of applying the provisions of that Topic, FASB ASC
paragraph 360-10-35-30 indicates that “estimates of future cash flows used to test the
recoverability of a long-lived asset (asset group) shall incorporate the entity’s own
assumptions about its use of the asset (asset group) and shall consider all available evidence.
The assumptions used in developing those estimates shall be reasonable in relation to the
assumptions used in developing other information used by the entity for comparable periods, such
as internal budgets and projections, accruals related to incentive compensation plans, or
information communicated to others.”
The staff recognizes that various factors, including management’s judgments
and assumptions about the business plans and strategies, affect the development of future cash
flow projections for purposes of applying FASB ASC Topic 360. The staff, however, cautions
registrants that the judgments and assumptions made for purposes of applying FASB ASC Topic 360
must be consistent with other financial statement calculations and disclosures and disclosures
in MD&A. The staff also expects that forecasts made for purposes of applying FASB ASC Topic
360 be consistent with other forward-looking information prepared by the company, such as that
used for internal budgets, incentive compensation plans, discussions with lenders or third
parties, and/or reporting to management or the board of directors.
For example, the staff has reviewed a fact pattern where a registrant
developed cash flow projections for purposes of applying the provisions of FASB ASC Topic 360
using one set of assumptions and utilized a second, more conservative set of assumptions for
purposes of determining whether deferred tax valuation allowances were necessary when applying
the provisions of FASB ASC Topic 740, Income Taxes. In this case, the staff objected to the use
of inconsistent assumptions.
In addition to disclosure of key assumptions used in the development of cash
flow projections, the staff also has required discussion in MD&A of the implications of
assumptions. For example, do the projections indicate that a company is likely to violate debt
covenants in the future? What are the ramifications to the cash flow projections used in the
impairment analysis? If growth rates used in the impairment analysis are lower than those used
by outside analysts, has the company had discussions with the analysts regarding their overly
optimistic projections? Has the company appropriately informed the market and its shareholders
of its reduced expectations for the future that are sufficient to cause an impairment charge?
The staff believes that cash flow projections used in the impairment analysis must be both
internally consistent with the company’s other projections and externally consistent with
financial statement and other public disclosures.
DD. Written Loan Commitments Recorded at Fair Value Through Earnings
Facts: Bank A enters into a loan commitment with a
customer to originate a mortgage loan at a specified rate. As part of this written loan
commitment, Bank A expects to receive future net cash flows related to servicing rights from
servicing fees (included in the loan’s interest rate or otherwise), late charges, and other
ancillary sources, or from selling the servicing rights to a third party. If Bank A intends to
sell the mortgage loan after it is funded, pursuant to FASB ASC paragraph 815-10-15-83
(Derivatives and Hedging Topic), the written loan commitment is accounted for as a derivative
instrument and recorded at fair value through earnings (referred to hereafter as a “derivative
loan commitment”). If Bank A does not intend to sell the mortgage loan after it is funded, the
written loan commitment is not accounted for as a derivative under FASB ASC Subtopic 815-10,
Derivatives and Hedging — Overall. However, FASB ASC subparagraph 825-10-15-4(c) (Financial
Instruments Topic) permits Bank A to record the written loan commitment at fair value through
earnings (referred to hereafter as a “written loan commitment”). Pursuant to FASB ASC Subtopic
825-10, Financial Instruments — Overall, the fair value measurement for a written loan
commitment would include the expected net future cash flows related to the associated servicing
of the loan.
Question 1: In measuring the fair value of a
derivative loan commitment accounted for under FASB ASC Subtopic 815-10, should Bank A include
the expected net future cash flows related to the associated servicing of the loan?
Interpretive Response: Yes. The staff believes that,
consistent with the guidance in FASB ASC Subtopic 860-50, Transfers and Servicing — Servicing
Assets and Liabilities, 60 and FASB ASC Subtopic 825-10, the expected net future cash flows related to the associated
servicing of the loan should be included in the fair value measurement of a derivative loan
commitment. The expected net future cash flows related to the associated servicing of the loan
that are included in the fair value measurement of a derivative loan commitment or a written
loan commitment should be determined in the same manner that the fair value of a recognized
servicing asset or liability is measured under FASB ASC Subtopic 860-50. However, as discussed
in FASB ASC paragraph 860-50-25-1, a separate and distinct servicing asset or liability is not
recognized for accounting purposes until the servicing rights have been contractually separated
from the underlying loan by sale or securitization of the loan with servicing retained.
The views in Question 1 apply to all loan commitments that are accounted for
at fair value through earnings. However, for purposes of electing fair value accounting pursuant
to FASB ASC Subtopic 825-10, the views in Question 1 are not intended to be applied by analogy
to any other instrument that contains a nonfinancial element.
Question 2: In measuring the fair value of a
derivative loan commitment accounted for under FASB ASC Subtopic 815-10 or a written loan
commitment accounted for under FASB ASC Subtopic 825-10, should Bank A include the expected net
future cash flows related to internally-developed intangible assets?
Interpretive Response: No. The staff does not believe
that internally-developed intangible assets (such as customer relationship intangible assets)
should be recorded as part of the fair value of a derivative loan commitment or a written loan
commitment. Such nonfinancial elements of value should not be considered a component of the
related instrument. Recognition of such assets would only be appropriate in a third-party
transaction. For example, in the purchase of a portfolio of derivative loan commitments in a
business combination, a customer relationship intangible asset is recorded separately from the
fair value of such loan commitments. Similarly, when an entity purchases a credit card
portfolio, FASB ASC paragraph 310-10-25-7 (Receivables Topic) requires an allocation of the
purchase price to a separately recorded cardholder relationship intangible asset.
The view in Question 2 applies to all loan commitments that are accounted for
at fair value through earnings.
EE. Income Tax Accounting Implications of the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act (the "Act") changes existing United
States tax law and includes numerous provisions that will affect businesses. The Act, for
instance, introduces changes that impact U.S. corporate tax rates, business-related exclusions,
and deductions and credits. The Act will also have international tax consequences for many
companies that operate internationally. The Act has widespread applicability to registrants.
ASC Topic 740 provides accounting and disclosure guidance on accounting for
income taxes under generally accepted accounting principles ("U.S. GAAP"). This
guidance addresses the recognition of taxes payable or refundable for the current year and the
recognition of deferred tax liabilities and deferred tax assets for the future tax consequences
of events that have been recognized in an entity’s financial statements or tax returns.61 ASC Topic 740 also addresses
the accounting for income taxes upon a change in tax laws or tax rates.62 The income tax accounting effect of a
change in tax laws or tax rates includes, for example, adjusting (or re-measuring) deferred tax
liabilities and deferred tax assets, as well as evaluating whether a valuation allowance is
needed for deferred tax assets.63
The guidance in ASC Topic 740 does not, however, address certain
circumstances that may arise for registrants in accounting for the income tax effects of the
Act. The staff understands from outreach that registrants will potentially encounter a
situation in which the accounting for certain income tax effects of the Act will be incomplete
by the time financial statements are issued for the reporting period that includes the
enactment date of December 22, 2017. Questions have arisen regarding different approaches to
the application of the accounting and disclosure guidance in ASC Topic 740 to such a situation.
Accordingly, the SEC staff believes clarification is appropriate to address any uncertainty or
diversity of views in practice regarding the application of ASC Topic 740 in situations where a
registrant does not have the necessary information available, prepared, or analyzed (including
computations) in reasonable detail to complete the accounting under ASC Topic 740 for certain
income tax effects of the Act for the reporting period in which the Act was enacted.
The staff's views have been informed by guidance issued after enactment of
the American Jobs Creation Act of 2004.64 The staff's views also have been informed by the guidance in
ASC Topic 805, Business Combinations, which addresses the accounting for certain items
in a business combination for which the accounting is incomplete upon issuance of the financial
statements that include the reporting period in which the business combination occurred.
The staff believes the guidance in this staff accounting bulletin
("SAB") will assist registrants and address any uncertainty or diversity of views in
applying ASC Topic 740 in the reporting period in which the Act was enacted. Specifically, the
staff is issuing this SAB to address situations where the accounting under ASC Topic 740 is
incomplete for certain income tax effects of the Act upon issuance of an entity's financial
statements for the reporting period in which the Act was enacted.
Facts: The Act was signed into law prior to the end
of Company A's reporting period and will affect Company A's current and deferred taxes. Company
A determined that the accounting for certain income tax effects of the Act under ASC Topic 740
will be completed by the time it issues its financial statements that will include the
reporting period in which the Act was enacted. However, there are other income tax effects of
the Act for which Company A may not be able to complete the accounting under ASC Topic 740 by
the time it issues its financial statements that include the reporting period in which the Act
was enacted.
Question 1: If the accounting for certain income tax
effects of the Act is not completed by the time Company A issues its financial statements that
include the reporting period in which the Act was enacted, what amounts should Company A
include in its financial statements for those income tax effects for which the accounting under
ASC Topic 740 is incomplete?
Interpretive Response: To the extent that Company
A's accounting for certain income tax effects of the Act is incomplete, but Company A can
determine a reasonable estimate for those effects, the staff would not object to Company A
including in its financial statements the reasonable estimate that it had determined.
Conversely, the staff does not believe it would be appropriate for Company A to exclude a
reasonable estimate from its financial statements to the extent a reasonable estimate had been
determined. The reasonable estimate should be included in Company A’s financial statements in
the first reporting period in which Company A was able to determine the reasonable estimate.
The reasonable estimate would be reported as a provisional amount65 in Company A's financial statements66 during a "measurement period."67 The measurement period is described in further detail
below.
The staff believes reporting provisional amounts for certain income tax
effects of the Act will address circumstances in which an entity does not have the necessary
information available, prepared, or analyzed (including computations) in reasonable detail to
complete the accounting under ASC Topic 740.
An entity may not have the necessary information available, prepared, or
analyzed (including computations) for certain income tax effects of the Act in order to
determine a reasonable estimate to be included as provisional amounts. The staff would expect
no related provisional amounts would be included in an entity's financial statements for those
specific income tax effects for which a reasonable estimate cannot be determined. In
circumstances in which provisional amounts cannot be prepared, the staff believes an entity
should continue to apply ASC Topic 740 (e.g., when recognizing and measuring current and
deferred taxes) based on the provisions of the tax laws that were in effect immediately prior
to the Act being enacted. That is, the staff does not believe an entity should adjust its
current or deferred taxes for those tax effects of the Act until a reasonable estimate can be
determined.
Therefore, to summarize the above and for the avoidance of doubt, in Company
A's financial statements that include the reporting period in which the Act was enacted,
Company A must first reflect the income tax effects of the Act in which the accounting under
ASC Topic 740 is complete. These completed amounts would not be provisional amounts. Company A
would then also report provisional amounts for those specific income tax effects of the Act for
which the accounting under ASC Topic 740 will be incomplete but a reasonable estimate can be
determined. For any specific income tax effects of the Act for which a reasonable estimate
cannot be determined, Company A would not report provisional amounts and would continue to
apply ASC Topic 740 based on the provisions of the tax laws that were in effect immediately
prior to the Act being enacted. For those income tax effects for which Company A was not able
to determine a reasonable estimate (such that no related provisional amount was reported for
the reporting period in which the Act was enacted), Company A would report provisional amounts
in the first reporting period in which a reasonable estimate can be determined.
Measurement period timeframe
The measurement period begins in the reporting period that includes the
Act's enactment date and ends when an entity has obtained, prepared, and analyzed the
information that was needed in order to complete the accounting requirements under ASC Topic
740. During the measurement period, the staff expects that entities will be acting in good
faith to complete the accounting under ASC Topic 740. The staff believes that in no
circumstances should the measurement period extend beyond one year from the enactment date.
Changes in subsequent reporting periods
During the measurement period, an entity may need to reflect adjustments to
its provisional amounts upon obtaining, preparing, or analyzing additional information about
facts and circumstances that existed as of the enactment date that, if known, would have
affected the income tax effects initially reported as provisional amounts. Further, an entity
may also need to report additional tax effects during the measurement period, based on
obtaining, preparing, or analyzing additional information about facts and circumstances that
existed as of the enactment date that was not initially reported as provisional amounts. Any
income tax effects of events unrelated to the Act should not be reported as measurement period
adjustments.
Reporting
Any provisional amounts or adjustments to provisional amounts included in an
entity's financial statements during the measurement period should be included in income from
continuing operations as an adjustment to tax expense or benefit in the reporting period the
amounts are determined.
Applicability
This staff guidance is only applicable to the application of ASC Topic 740
in connection with the Act and should not be relied upon for purposes of applying ASC Topic 740
to other changes in tax laws.
Examples
Example 1 – Prior to the reporting period in which the Act was
enacted, Company X did not recognize a deferred tax liability related to unremitted foreign
earnings because it overcame the presumption of the repatriation of foreign earnings.68 Upon enactment, the Act
imposes a tax on certain foreign earnings and profits at various tax rates. Based on Company
X's facts and circumstances, it was not able to determine a reasonable estimate of the tax
liability for this item for the reporting period in which the Act was enacted by the time that
it issues its financial statements for that reporting period; that is, Company X did not have
the necessary information available, prepared, or analyzed to develop a reasonable estimate of
the tax liability for this item (or evaluate how the Act will impact Company X's existing
accounting position to indefinitely reinvest unremitted foreign earnings). As a result, Company
X would not include a provisional amount for this item in its financial statements that include
the reporting period in which the Act was enacted, but would do so in its financial statements
issued for subsequent reporting periods that fall within the measurement period, beginning with
the first reporting period falling within the measurement period by which the necessary
information became available, prepared, or analyzed in order to develop the reasonable
estimate, and ending with the first reporting period within the measurement period in which
Company X was able to obtain, prepare, and analyze the necessary information to complete the
accounting under ASC Topic 740.
Example 1a – Assume a similar fact pattern as Example 1; however,
Company Y was able to determine a reasonable estimate of the income tax effects of the Act on
its unremitted foreign earnings for the reporting period in which the Act was enacted. Company
Y, therefore, reported a provisional amount for the income tax effects related to its
unremitted foreign earnings in its financial statements that included the reporting period the
Act was enacted. In a subsequent reporting period within the measurement period, Company Y was
able to obtain, prepare and analyze the necessary information to complete the accounting under
ASC Topic 740, which resulted in an adjustment to Company Y's initial provisional amount to
recognize its tax liability.
Example 2 – Company Z has deferred tax assets (assume Company Z was
able to comply with ASC Topic 740 and re-measure its deferred tax assets based on the Act’s new
tax rates) for which a valuation allowance may need to be recognized (or released) based on
application of certain provisions in the Act. If Company Z determines that a reasonable
estimate cannot be made for the reporting period the Act was enacted, no amount for the
recognition (or release) of a valuation allowance would be reported. In the next reporting
period (following the reporting period in which the Act was enacted), Company Z was able to
obtain, prepare and analyze the necessary information in order to determine that no valuation
allowance needed to be recognized (or released) in order to complete the accounting under ASC
Topic 740.
Question 2: If an entity accounts for certain income
tax effects of the Act under a measurement period approach, what disclosures should be
provided?
Interpretive Response: The staff believes an entity
should include financial statement disclosures to provide information about the material
financial reporting impacts of the Act for which the accounting under ASC Topic 740 is
incomplete, including:
(a) Qualitative disclosures of the income tax effects of the Act for which the accounting
is incomplete;
(b) Disclosures of items reported as provisional amounts;
(c) Disclosures of existing current or deferred tax amounts for which the income tax
effects of the Act have not been completed;
(d) The reason why the initial accounting is incomplete;
(e) The additional information that is needed to be obtained, prepared, or analyzed in
order to complete the accounting requirements under ASC Topic 740;
(f) The nature and amount of any measurement period adjustments recognized during the
reporting period;
(g) The effect of measurement period adjustments on the effective tax rate; and
(h) When the accounting for the income tax effects of the Act has been completed.
FF. Accounting for Obligations to Safeguard Crypto-Assets an Entity Holds for Its Platform Users
The interpretations in this SAB express views of the staff regarding the accounting for
entities that have obligations to safeguard crypto-assets held for their platform users.69 In recent years, the staff has observed an increase in the number of entities that
provide platform users with the ability to transact in crypto-assets. In connection with these
services, these entities and/or their agents may safeguard the platform user’s crypto-asset(s)
and also maintain the cryptographic key information necessary to access the crypto-asset. The
obligations associated with these arrangements involve unique risks and uncertainties not
present in arrangements to safeguard assets that are not crypto-assets, including
technological, legal, and regulatory risks and uncertainties. Specifically:
- Technological risks – there are risks with respect to both safeguarding of assets and rapidly-changing crypto-assets in the market that are not present with other arrangements to safeguard assets for third parties;
- Legal risks – due to the unique characteristics of the assets and the lack of legal precedent, there are significant legal questions surrounding how such arrangements would be treated in a court proceeding arising from an adverse event (e.g., fraud, loss, theft, or bankruptcy); and
- Regulatory risks – as compared to many common arrangements to safeguard assets for third parties, there are significantly fewer regulatory requirements for holding crypto-assets for platform users or entities may not be complying with regulatory requirements that do apply, which results in increased risks to investors in these entities.
These risks can have a significant impact on the entity’s operations and financial condition.
The staff believes that the recognition, measurement, and disclosure guidance in this SAB will
enhance the information received by investors and other users of financial statements about
these risks, thereby assisting them in making investment and other capital allocation
decisions.
Facts: Entity A’s70 business includes operating a platform that allows its users to transact in
crypto-assets.71 Entity A also provides a service where it will safeguard the platform users’
crypto-assets,72 including maintaining the cryptographic key information73 necessary to access the crypto-assets. Entity A also maintains internal recordkeeping of
the amount of crypto-assets held for the benefit of each platform user. Entity A secures these
crypto-assets and protects them from loss or theft, and any failure to do so exposes Entity A
to significant risks, including a risk of financial loss. The platform users have the right to
request that Entity A transact in the crypto-asset on the user’s behalf (e.g., to sell the
crypto-asset and provide the user with the fiat currency (cash) proceeds associated with the
sale) or to transfer the crypto-asset to a digital wallet for which Entity A does not maintain
the cryptographic key information. However, execution and settlement of transactions involving
the platform users’ crypto-assets may depend on actions taken by Entity A.
Question 1: How should Entity A account for its obligations to safeguard crypto-assets
held for platform users?
Interpretive Response: The ability of Entity A’s platform users to obtain future
benefits from crypto-assets in digital wallets where Entity A holds the cryptographic key
information is dependent on the actions of Entity A to safeguard the assets. Those actions
include securing the crypto-assets and the associated cryptographic key information and
protecting them from loss, theft, or other misuse. The technological mechanisms supporting how
crypto-assets are issued, held, or transferred, as well as legal uncertainties regarding
holding crypto-assets for others, create significant increased risks to Entity A, including an
increased risk of financial loss.74 Accordingly, as long as Entity A is responsible for safeguarding the crypto-assets held
for its platform users, including maintaining the cryptographic key information necessary to
access the crypto-assets, the staff believes that Entity A should present a liability on its
balance sheet to reflect its obligation to safeguard the crypto-assets held for its platform
users.
As Entity A’s loss exposure is based on the significant risks associated with safeguarding
the crypto-assets held for its platform users, the staff believes it would be appropriate to
measure this safeguarding liability at initial recognition and each reporting date at the fair
value75 of the crypto-assets that Entity A is responsible for holding for its platform users. The
staff also believes it would be appropriate for Entity A to recognize an asset76 at the same time that it recognizes the safeguarding liability, measured at initial
recognition and each reporting date at the fair value of the crypto-assets held for its
platform users.77
Question 2: Assume the same facts as Question 1.What disclosures would the staff
expect Entity A to provide regarding its safeguarding obligations for crypto-assets held for
its platform users?
Interpretive Response: In light of the significant risks and uncertainties associated
with safeguarding crypto-assets, including the risks of loss associated with holding the
cryptographic key information necessary to secure and transact in the crypto-asset, the staff
believes the notes to the financial statements should include clear disclosure of the nature
and amount of crypto-assets that Entity A is responsible for holding for its platform users,
with separate disclosure for each significant crypto-asset, and the vulnerabilities Entity A
has due to any concentration in such activities.78 In addition, because the crypto-asset safeguarding liabilities and the corresponding
assets are measured at the fair value of the crypto-assets held for its platform users, the
entity would be required to include disclosures regarding fair value measurements.79 The accounting for the liabilities and corresponding assets should be described in the
footnotes to the financial statements.80 In providing these disclosures, Entity A should consider disclosure about who (e.g., the
company, its agent, or another third party) holds the cryptographic key information, maintains
the internal recordkeeping of those assets, and is obligated to secure the assets and protect
them from loss or theft.
Disclosures regarding the significant risks and uncertainties associated with the entity
holding crypto-assets for its platform users may also be required outside the financial
statements under existing Commission rules, such as in the description of business, risk
factors, or management’s discussion and analysis of financial condition and results of
operation.81 For example, to the extent it is material, Entity A may need to provide disclosure
describing the types of loss or additional obligations that could occur, including customer or
user discontinuation or reduction of use of services, litigation, reputational harm, and
regulatory enforcement actions and additional restrictions. A discussion of the analysis of the
legal ownership of the crypto-assets held for platform users, including whether they would be
available to satisfy general creditor claims in the event of a bankruptcy should be considered.
Further, Entity A may need to provide disclosure of the potential impact that the destruction,
loss, theft, or compromise or unavailability of the cryptographic key information would have to
the ongoing business, financial condition, operating results, and cash flows of the entity. As
part of this disclosure, Entity A should also consider including, to the extent material,
information about risk-mitigation steps the entity has put in place (e.g., insurance coverage
directly related to the crypto-assets held for platform users).
Question 3:How and when should Company A initially apply the guidance in this Topic in
its financial statements?
Interpretive Response: The staff would expect an entity that files reports pursuant to
Section 13(a) or Section 15(d) of the Exchange Act, or an entity required to file periodic and
current reports pursuant to Rule 257(b) of Regulation A, to apply the guidance in Topic 5.FF no
later than its financial statements covering the first interim or annual period ending after
June 15, 2022, with retrospective application as of the beginning of the fiscal year to which
the interim or annual period relates.
The staff expects all other entities, including but not limited to entities conducting an
initial registration of securities under the Securities Act or Exchange Act, entities
conducting an offering of securities under Regulation A, and private operating companies
entering into a business combination transaction with a shell company, including a special
purpose acquisition company, to apply the guidance in Topic 5.FF beginning with their next
submission or filing with the SEC (e.g., the initial or next amendment of the registration
statement, proxy statement, or Form 1-A), with retrospective application, at a minimum, as of
the beginning of the most recent annual period ending before June 15, 2022, provided the filing
also includes a subsequent interim period that also reflects application of this guidance.82 If the filing does not include a subsequent interim period that also reflects application
of this guidance, then the staff expects it to be applied retrospectively to the beginning of
the two most recent annual periods ending before June 15, 2022.
For all entities, in the financial statements that reflect the initial application of this
guidance, the effect of the initial application should be reported in the carrying amounts of
assets and liabilities as of the beginning of the annual period specified above. Entities
should include clear disclosure of the effects of the initial application of this guidance.83
Footnotes
1
Estimating the fair value
of the common stock issued, however, is not appropriate when the stock is closely held and/or
seldom or ever traded.
7
In
ASR 293 (July 2, 1981) see Financial Reporting Codification §205, the Commission expressed its
concerns about the inappropriate use of Internal Revenue Service (IRS) LIFO practices for
financial statement preparation. Because the IRS amended its regulations concerning the LIFO
conformity rule on January 13, 1981, allowing companies to apply LIFO differently for
financial reporting purposes than for tax purposes, the Commission strongly encouraged
registrants and their independent accountants to examine their financial reporting LIFO
practices. In that release, the Commission acknowledged the “task force which has been
established by AcSEC to accumulate information about [LIFO] application problems” and noted
that “This type of effort, in addition to self-examination [of LIFO practices] by individual
registrants, is appropriate . . .”
8
[Original footnote removed by SAB 114.]
9
The term “short-duration” refers to the period of
coverage (see FASB ASC paragraph 944-20-15-7 (Financial Services — Insurance Topic)),
not the period that the liabilities are expected to be outstanding.
10
Related parties as used herein are as defined in the FASB ASC Master Glossary.
11
See FASB ASC paragraph 225-20-45-2.
12
FASB ASC
paragraph 225-20-45-16 further provides that such items should not be reported on the income
statement net of income taxes or in any manner that implies that they are similar to
extraordinary items.
13
Examples of common components of exit costs and other
types of restructuring charges which should be considered for separate disclosure include,
but are not limited to, involuntary employee terminations and related costs, changes in
valuation of current assets such as inventory writedowns, long term asset disposals,
adjustments for warranties and product returns, leasehold termination payments, and other
facility exit costs, among others.
14
The staff would expect similar disclosures for
employee termination benefits whether those costs have been recognized pursuant to FASB ASC
Topic 420, FASB ASC Topic 712, Compensation — Nonretirement Postemployment Benefits, or FASB
ASC Topic 715, Compensation — Retirement Benefits.
15
“Nonredeemable” preferred stock, as used in this SAB, refers to preferred stocks which are not
redeemable or are redeemable only at the option of the issuer.
16
As described in the “Facts” section of this issue, a registrant would
receive less in proceeds for a preferred stock, if the stock were to pay less than its
perpetual dividend for some initial period(s), than if it were to pay the perpetual dividend
from date of issuance. The staff views the discount on increasing rate preferred stock as
equivalent to a prepayment of dividends by the issuer, as though the issuer had concurrently
(a) issued the stock with the perpetual dividend being payable from date of issuance, and (b)
returned to the investor a portion of the proceeds representing the present value of certain
future dividend entitlements which the investor agreed to forgo.
17
See Question 3 regarding variable increasing rate preferred stocks.
18
It should be
noted that the $100 per share amount used in this issue is for illustrative purposes, and is
not intended to imply that application of this issue will necessarily result in the carrying
amount of a nonredeemable preferred stock being accreted to its par value, stated value,
voluntary redemption value or involuntary liquidation value.
19
Application of the
interest method with respect to redeemable preferred stocks pursuant to Topic 3.C results in
accounting consistent with the provisions of this bulletin irrespective of whether the
redeemable preferred stocks have constant or increasing stated dividend rates. The interest
method, as described in FASB ASC Subtopic 835-30, produces a constant effective periodic rate
of cost that is comprised of amortization of discount as well as the stated cost in each
period.
20
The staff first publicly expressed its view as to the appropriate accounting at the December
3-4, 1986 meeting of the EITF.
21
Discretionary accounting changes require the filing of a preferability
letter by the registrant’s independent accountant pursuant to Item 601 of Regulation S-K and
Rule 10-01(b)(6) of Regulation S-X, respectively.
22
ASR 25.
23
Section 210 (ASR 25) indicates the following conditions under which a quasi-reorganization can
be effected without the creation of a new corporate entity and without the intervention of
formal court proceedings:
1. Earned surplus, as of the date selected, is exhausted;
2. Upon consummation of the quasi-reorganization, no deficit exists in any
surplus account;
3. The entire procedure is made known to all persons entitled to vote on
matters of general corporate policy and the appropriate consents to the particular
transactions are obtained in advance in accordance with the applicable laws and charter
provisions;
The procedure accomplishes, with respect to the accounts, substantially
what might be accomplished in a reorganization by legal proceedings — namely, the restatement
of assets in terms of present considerations as well as appropriate modifications of capital
and capital surplus, in order to obviate, so far as possible, the necessity of future
reorganization of like nature.
24
In addition, FASB ASC Subtopic 852-20, Reorganizations —
Quasi-Reorganizations, outlines procedures that must be followed in connection with and after
a quasi-reorganization.
25
FASB ASC Topic 250 provides accounting principles to be followed when
adopting accounting changes. In addition, many newly-issued accounting pronouncements provide
specific guidance to be followed when adopting the accounting specified in such
pronouncements.
26
Certain newly-issued accounting standards do not
require adoption until some future date. The staff believes, however, that if the registrant
intends or is required to adopt those standards within 12 months following the
quasi-reorganization, the registrant should adopt those standards prior to or as an integral
part of the quasi-reorganization. Further, registrants should consider early adoption of
standards with effective dates more than 12 months subsequent to a quasi-reorganization.
27
Certain accounting changes require restatement of prior
financial statements. The staff believes that if a quasi-reorganization had been recorded in a
restated period, the effects of the accounting change on quasi-reorganization adjustments
should also be restated to properly reflect the quasi-reorganization in the restated financial
statements.
28
See footnote 27.
29
Section 210 (ASR 25)
discusses the “conditions under which a quasi-reorganization has come to be applied in
accounting to the corporate procedures in the course of which a company, without creation of
new corporate entity and without intervention of formal court proceedings, is enabled to
eliminate a deficit whether resulting from operations or recognition of other losses or both
and to establish a new earned surplus account for the accumulation of earnings subsequent to
the date selected as the effective date of the quasi-reorganization.” It further indicates
that “it is implicit in a procedure of this kind that it is not to be employed recurrently, but only under circumstances which would justify an actual reorganization or
formation of a new corporation, particularly if the sole purpose of the
quasi-reorganization is the elimination of a deficit in earned surplus resulting from
operating losses.” (emphasis added)
30
FASB ASC paragraph
852-740-55-4 states in part: “As indicated in paragraph 852-20-25-5, after a
quasi-reorganization, the entity’s accounting shall be substantially similar to that
appropriate for a new entity. As such, any subsequently recognized tax benefit of an operating
loss or tax credit carryforward that existed at the date of a quasi-reorganization shall not
be included in the determination of income of the “new” entity, regardless of whether losses
that gave rise to an operating loss carryforward were charged to income before the
quasi-reorganization or directly to contributed capital as part of the quasi-reorganization. A
new entity would not have tax benefits attributable to operating losses or tax credits that
arose before its organization date.”
31
[Original footnote removed by SAB 114.]
32
FASB ASC paragraph 852-740-45-3
states: “[t]he tax benefit of deductible temporary differences and carryforwards as of the
date of a quasi reorganization as defined and contemplated in FASB ASC Subtopic 852-20,
ordinarily are reported as a direct addition to contributed capital if the tax benefits are
recognized in subsequent years.”
33
FASB ASC paragraph 250-10-45-12.
34
The FASB ASC Master Glossary defines principal owners as “owners of record or known beneficial
owners of more than 10 percent of the voting interests of the enterprise.”
35
The FASB ASC Master Glossary defines an economic interest in an entity as
“any type or form of pecuniary interest or arrangement that an entity could issue or be a
party to, including equity securities; financial instruments with characteristics of equity,
liabilities or both; long-term debt and other debt-financing arrangements; leases; and
contractual arrangements such as management contracts, service contracts, or intellectual
property licenses.” Accordingly, a principal stockholder would be considered a holder of an
economic interest in an entity.
36
For example, SAB Topic 1.B
indicates that the separate financial statements of a subsidiary should reflect any costs of
its operations which are incurred by the parent on its behalf. Additionally, the staff notes
that AICPA Technical Practice Aids §4160 also indicates that the payment by principal
stockholders of a company’s debt should be accounted for as a capital contribution.
37
However, in some circumstances it is necessary to reflect, either in the
historical financial statements or a pro forma presentation (depending on the circumstances),
related party transactions at amounts other than those indicated by their terms. Two such
circumstances are addressed in Staff Accounting Bulletin Topic 1.B.1, Questions 3 and 4.
Another example is where the terms of a material contract with a related party are expected to
change upon the completion of an offering (i.e., the principal shareholder requires
payment for services which had previously been contributed by the shareholder to the
company).
38
[Original footnote removed by SAB
114.]
39
The staff recognizes that the
determination of whether the financial institution retains a participation in the rewards of
ownership will require an analysis of the facts and circumstances of each individual
transaction. Generally, the staff believes that, in order to conclude that the financial
institution has disposed of the assets in substance, the management fee arrangement should not
enable the financial institution to participate to any significant extent in the potential
increases in cash flows or value of the assets, and the terms of the arrangement, including
provisions for discontinuance of services, must be substantially similar to management
arrangements with third parties.
40
The carrying value should be reduced by any allocable
allowance for credit losses or other valuation allowances. The staff believes that the loss
recognized for the excess of the net carrying value over the fair value should be considered a
credit loss and this should not be included by the financial institution as loss on
disposition.
41
The staff
notes that FASB ASC paragraph 942-810-45-2 (Financial Services — Depository and Lending Topic)
provides guidance that the newly created “liquidating bank” should continue to report its
assets and liabilities at fair values at the date of the financial statements.
42
FASB ASC paragraph
845-10-30-14 (Nonmonetary Transactions Topic) provides guidance that an enterprise that
distributes loans to its owners should report such distribution at fair value.
43
Typically, the financial institution’s claim on the new
entity is subordinate to other debt instruments and thus the financial institution will incur
any losses beyond those incurred by the permanent equity holders.
44
FASB ASC
paragraph 944-40-30-1 prescribes that “[t]he liability for unpaid claims shall be based on the
estimated ultimate cost of settling the claims (including the effects of inflation and other
societal and economic factors), using past experience adjusted for current trends, and any
other factors that would modify past experience.” [Footnote reference omitted]
45
FASB ASC
paragraphs 450-20-50-3 through 450-20-50-4 provide guidance that if no accrual is made for a
loss contingency because one or both of the conditions in FASB ASC paragraph 450-20-25-2 are
not met, or if an exposure to loss exists in excess of the amount
accrued pursuant to the provisions of FASB ASC paragraph 450-20-25-2, disclosure of the
contingency shall be made when there is at least a reasonable possibility that a loss or an
additional loss may have been incurred. The disclosure shall indicate the nature of the
contingency and shall give an estimate of the possible loss or range of loss or state that
such an estimate cannot be made.” [Footnote reference omitted and emphasis added.]
46
FASB ASC Topic 275 provides that disclosures regarding
certain significant estimates should be made when certain criteria are met. The guidance
provides that the disclosure shall indicate the nature of the uncertainty and include an
indication that it is at least reasonably possible that a change in the estimate will occur in
the near term. If the estimate involves a loss contingency covered by FASB ASC Topic 450, the
disclosure also should include an estimate of the possible loss or range of loss, or state
that such an estimate cannot be made. Disclosure of the factors that cause the estimate to be
sensitive to change is encouraged but not required.
FASB ASC Topic 275 requires disclosures regarding current vulnerability due
to certain concentrations which may be applicable as well.
47
The loss contingency
referred to in this document is the potential for a material understatement of reserves for
unpaid claims.
48
As described in Concepts Statement 7, Using Cash Flow Information and
Present Value in Accounting Measurements.
49
The
staff believes there is a rebuttable presumption that no asset should be recognized for a
claim for recovery from a party that is asserting that it is not liable to indemnify the
registrant. Registrants that overcome that presumption should disclose the amount of
recorded recoveries that are being contested and discuss the reasons for concluding that the
amounts are probable of recovery.
50
See Securities Act Release No. 6130, FR 36, Securities Act Release No. 33-8040,
Securities Act Release No. 33-8039, and Securities Act Release 33-8176.
51
See, e.g., footnote 30 of FR 36 (footnote 17 of Section 501.02 of the
Codification of Financial Reporting Policies).
52
Registrants are reminded that FASB ASC Subtopic 410-20,
Asset Retirement and Environmental Obligations — Asset Retirement Obligations, provides
guidance for accounting and reporting for costs associated with asset retirement
obligations.
53
If the company has a guarantee as defined by FASB ASC Topic 460, Guarantees,
the entity is required to provide the disclosures and recognize the fair value of the
guarantee in the company’s financial statements even if the “contingent” aspect of the
guarantee is deemed to be remote.
54
In some circumstances,
the seller’s continuing interest may be so great that divestiture accounting is
inappropriate.
55
However, a plan of
disposal that contemplates the transfer of assets to a limited-life entity created for the
single purpose of liquidating the assets of a component of an entity would not necessitate
classification within continuing operations solely because the registrant retains control or
significant influence over the liquidating entity.
56
Registrants are reminded that FASB ASC Topic 460, Guarantees, requires recognition and
disclosure of certain guarantees which may impose accounting and disclosure requirements in
addition to those discussed in this SAB Topic.
57
Item 303 of Regulation S-K.
58
Registrants also should
consider the disclosure requirements of FASB ASC Topic 460.
59
See
also disclosure requirement for inventory balances in Rule 5-02(6) of Regulation
S-X.
60
FASB ASC
Subtopic 860-50 permits an entity to subsequently measure recognized servicing assets and
servicing liabilities (which are nonfinancial instruments) at fair value through earnings.
61See ASC paragraph 740-10-10-1.
62See ASC paragraph 740-10-25-47.
63See ASC paragraph
740-10-35-4.
64In 2004, the FASB
issued limited guidance to address the income tax accounting effects of the American Jobs
Creation Act of 2004. See FASB Staff Position ("FSP") FAS 109-2, Accounting and
Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs
Creation Act of 2004.
65Provisional amounts would include, for example, reasonable estimates that
give rise to new current or deferred taxes based on certain provisions within the Act, as well
as adjustments to existing current or deferred taxes that existed prior to the Act’s enactment
date.
66The staff
would also not object to a Foreign Private Issuer reporting under International Financial
Reporting Standards applying a measurement period solely for purposes of completing the
accounting requirements for the income tax effects of the Act under International Accounting
Standard 12, Income Taxes.
67The staff was informed, in part, by the measurement period
guidance applied in certain situations when accounting for business combinations under ASC
Topic 805, Business Combinations. The measurement period guidance in ASC paragraph
805-10-25-13 addresses situations where the initial accounting for a business combination is
incomplete upon issuance of the financial statements that include the reporting period the
business combination occurred.
68See ASC paragraph 740-30-25-17.
69
This SAB expresses no view with respect to any other questions that these activities may
raise for any of the entities involved, including the applicability of the registration or
other provisions of the federal securities laws or any other federal, state, or foreign
laws.
70
References throughout this SAB to “Entity A” are inclusive of the entity as well as any
agent acting on its behalf in safeguarding the platform users’ crypto-assets.
71
For purposes of this SAB, the term “crypto-asset” refers to a digital asset that is issued
and/or transferred using distributed ledger or blockchain technology using cryptographic
techniques.
72
The service may be provided by Entity A or by an agent acting on Entity A’s behalf.
73
The guidance in this SAB is applicable regardless of whether the cryptographic key remains
in the name of the platform user or is in the name of the Entity.
74
See generally Report of the Attorney General’s Cyber Digital Task Force:
Cryptocurrency Enforcement Framework (Oct. 2020), at 15-16, available at https://www.justice.gov/ag/page/file/1326061/download.
75
For U.S. generally accepted accounting principles (“U.S. GAAP”), refer to glossary
definition provided in Financial Accounting Standards Board (“FASB”) Accounting Standards
Codification (“ASC”) Topic 820. For International Financial Reporting Standards (“IFRS”),
refer to glossary definition provided in IFRS 13.
76
The asset recognized is similar in nature to an indemnification asset as described in FASB
ASC 805 and IFRS 3. The measurement of the asset is on the same basis as the crypto-asset
safeguarding liability assumed by the entity. The asset recognized by the entity is separate
and distinct from the crypto-asset itself that has been transferred to and then held for the
platform user.
77
Similar to the guidance in FASB ASC 805 and IFRS 3, Entity A would need to evaluate whether
any potential loss events, such as theft, impact the measurement of the asset.
78
For U.S. GAAP, see FASB ASC 275-10-50. For IFRS, see IAS 1.
79
For U.S. GAAP, see FASB ASC 820. For IFRS, see IFRS 13.
80
For U.S. GAAP, see FASB ASC 235-10-50. For IFRS, see IAS 1.
81
See, e.g.,Item 101 of Regulation S-K; Item 105 of Regulation S-K; Item 303 of
Regulation S-K.
82
For example, a calendar year-end company that submits a registration statement in January
2023 including financial statements as of and for the fiscal year ending December 31, 2021
and as of and for the nine months ended September 30, 2022 would apply the SAB to those
periods.
83
For U.S. GAAP, see FASB ASC 250-10-50-1 through 50-3; for IFRS, see IAS 8.
See also, e.g., Item 302 of Regulation S-K and PCAOB Auditing Standard 2820 (par.
8).