Action Alert No. 03-38
September 24, 2003

NOTICE OF MEETINGS

OPEN BOARD MEETING

Wednesday, October 1, 2003, 9:00 a.m.

  1. Permitted activities of qualifying special-purpose entities (SPEs). The Board will discuss issues related to two-step transfers of financial instruments, including the distinction between undivided interests and beneficial interests, transition and effective date, and any matters discussed but not resolved at the September 24, 2003 Board meeting. (Estimated 2-hour discussion.)

  2. Agenda decision: loan commitments. The Board will consider adding a limited-scope project to its agenda to clarify how an issuer should determine the fair value of a loan commitment that is accounted for as a derivative and whether a written loan commitment can be recorded as an asset. (Estimated 30-minute discussion.)

  3. Equity-based compensation. The Board will discuss certain issues relating to attribution and grant date. The Board also will discuss valuation guidance related to discounts for lack of marketability (including contractual or governmental restrictions) when estimating the grant-date fair value of employee equity-based compensation awards. (Estimated 2-hour discussion.)

  4. Financial instruments: liabilities and equity. The Board will discuss the economic characteristics and other features of various freestanding and compound financial instruments. The meeting will be educational, and no Board decisions are expected. (Estimated 90-minute discussion.)

  5. Open discussion. If necessary, the Board will allow time to discuss minor issues with staff members on technical projects or administrative matters. Those discussions are held following regular Board meetings as topics come up.

OPEN EDUCATION SESSIONS

Monday, September 29, 2003, 9:30 a.m.
Wednesdary, October 1, 2003, immediately following the Board meeting

The Board will hold educational, non-decision-making sessions to discuss topics that are anticipated to be discussed at the October 8 and October 10 Board meetings. Those topics will be posted to the FASB calendar four days prior to the education sessions.

BOARD ACTIONS

The Board Actions are provided for the information and convenience of constituents who want to follow the Board’s deliberations. All of the conclusions reported are tentative and may be changed at future Board meetings. Decisions are included in an Exposure Draft for formal comment only after a formal written ballot. Decisions in an Exposure Draft may be (and often are) changed in redeliberations based on information provided to the Board in comment letters, at public hearings, and through other communication channels. Decisions become final only after a formal written ballot to issue a final Statement or Interpretation.

September 17, 2003 Board Meeting

Revenue recognition. The Board continued its discussion of the proposed conceptual model for analyzing assets and liabilities arising from contracts and contractual rights and obligations. Specifically, the Board discussed illustrations of the application of the proposed conceptual model to a long-term construction contract, various wireless service arrangements, and select real estate transactions. The Board generally agreed that the proposed model is conceptually sound and workable. However, several Board members questioned whether reliable measures of the “wholesale” fair values of liabilities in many revenue transactions could be obtained or estimated.

In addition, the Board supported the concept that assets and liabilities arising from unconditional contractual rights and obligations should be remeasured subsequent to their initial recognition at fair value. However, the Board noted the practical difficulties in obtaining a reliable measure for partially performed obligations.

The Board generally agreed that, in concept, certain customer relationships might meet the definition of assets. However, the Board tentatively agreed that accounting for internally developed intangible assets should be outside the scope of the revenue recognition standard.

Finally, the Board agreed that a rebuttable presumption should be made that the unit of account for an executory contract involving subjects that are unique (including real estate) is the contract as a whole, absent evidence to the contrary.

Consolidation of variable interest entities. The Board decided to modify FASB Interpretation No. 46, Consolidation of Variable Interest Entities, as follows:

  1. Clarify that the scope exception provided in paragraph 4(a) of Interpretation 46 applies to all entities that meet the definition of not-for-profit organizations in FASB Statement No. 117, Financial Statements of Not-for-Profit Organizations, which includes not-for-profit health care organizations.

  2. Make the last sentence of paragraph 5 more effective by (a) applying footnote 6 only to part (ii) of that sentence and (b) changing footnote 6 to define related parties as those parties identified in paragraph 16, except for de facto agents under item 16(d).

  3. Clarify that paragraph 11 provides guidance on the application of the equity sufficiency condition in paragraph
    5(a) for development stage enterprises but does not exempt development stage enterprises from the requirements of paragraph 5(b) relating to the characteristics of equity.

  4. Require an enterprise that holds a variable interest in a variable interest entity but is not the primary beneficiary of that entity to reconsider whether it is the primary beneficiary whenever the enterprise acquires additional interests in the variable interest entity.

  5. Exclude a decision maker’s fees from the paragraph 8(c) component of expected residual returns if (a) the fees are fixed in amount and timing and have no expected variability and (b) the decision maker has no other interest that would provide subordinated financial support to that entity or the right to receive expected residual returns of the entity.

  6. Provide a limited-scope exception to the application of Interpretation 46 to a reporting entity’s interest in a variable interest entity, or potential variable interest entity, when both of the following conditions exist:

    1. The interest in the variable interest entity or potential variable interest entity was acquired before February 1, 2003.

    2. The reporting entity, after making exhaustive efforts, is unable to obtain information necessary to determine if the entity is a variable interest entity or to determine whether the reporting entity is the primary beneficiary of the variable interest entity.

  7. Clarify that a de facto agency relationship is created under paragraph 16(d)(1) if the approval rights effectively constrain the interest holder’s ability to control the economic risks or rewards of its interests by the sale, transfer, or encumbrance of such interests. If the approval cannot be unreasonably withheld, the de facto agency relationship is not established.

  8. Change paragraph 17 guidance on determining which party in a related party group is the primary beneficiary to give primacy to the objective of identifying the party with activities that are most closely associated with the entity as the primary beneficiary.

The proposed Interpretation to modify Interpretation 46 would be applied retroactively as of the date Interpretation 46 was first applied and would require restatement. The proposed Interpretation would be exposed for a 30-day comment period.

Also, a majority of the Board directed the staff to issue a proposed FASB Staff Position (FSP) to defer the effective date of Interpretation 46 until the end of the first interim or annual period ending after December 15, 2003, for certain interests held by a public entity. All of the following conditions must be met to qualify for the deferral:

  1. The public entity acquired its interests in a variable interest entity or potential variable interest entity before February 1, 2003.

  2. The assets of the variable interest entity or potential variable interest entity are predominantly nonfinancial.

  3. The variable interest entity or potential variable interest entity was not specifically created by or for the public entity to undertake a narrow well-defined objective, for example, to effect a lease or securitization of financial assets.

  4. The determination of whether the entity is a variable interest entity or whether the public entity is the variable interest entity’s primary beneficiary has not been completed as of the issuance of the financial statements for the interim or annual period beginning after June 15, 2003.

A public entity that defers application of Interpretation 46 to variable interests in one or more variable interest entities or potential variable interest entities under the provisions of this FSP would be required to make certain disclosures about such entities during the deferral period. (See the link below for proposed FSP FIN 46-e, "Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, for Certain Interests Held by a Public Entity.")

Equity-based compensation (formerly stock-based compensation). The Board continued its discussion of accounting for modifications and settlements of employee equity-based compensation (EBC) awards, classified as equity, and reached the following decisions:

  1. Certain principles would guide the accounting for modifications:

    1. Modifications represent a transaction between the employer and the option holder as an employee.

    2. Modifications generally represent a transfer of value (incremental value) from the employer to the employee, except when there is clear evidence to the contrary, for example, when the modification does not follow an adverse change related to the factors considered at the grant date used to measure fair value.

    3. An employer may never recognize less than the grant-date fair value of an equity-settled EBC award unless the employee fails to vest under the terms of the original award. Therefore, the total cumulative compensation cost associated with a modified award is equal to the grant-date fair value of the original award plus the incremental value of the modified award.

  2. Incremental compensation cost would be measured by comparing the fair value of the modified award with the fair value of the original award immediately preceding the modification. This is consistent with the method proposed by the IASB in ED2, Share-based Payment.

  3. If an entity is accounting for EBC awards at intrinsic value because it was not possible to reasonably estimate the fair value of the award at the grant date, then incremental compensation cost would be measured by comparing the intrinsic value of the modified award with the intrinsic value of the original award immediately preceding the modification date. A decrease in negative intrinsic value as a result of a modification would not result in incremental compensation cost.

  4. Changes in vesting conditions of certain EBC awards (time-, performance-, or nonservice-based, but not market-based) would be accounted for consistently in accordance with the principles and method above. That means that changes in vesting conditions would not result in an entity’s recognizing less than the original award’s grant-date fair value except if original vesting conditions are not satisfied.

  5. If vesting acceleration provisions included in the original terms of the EBC award are triggered, that event would not result in a modification; rather, the entity would be required to recognize all unrecognized compensation cost. Modifications that do result in vesting acceleration would be accounted for as other changes in vesting conditions.

  6. Changes in the classification of EBC awards as a result of modifications would be accounted for as modifications rather than settlements. Modifications of EBC awards with multiple settlement features that change the awards’ classification would be accounted for similar to awards with one settlement feature that change their classification as a result of a modification.

  7. An equity restructuring would be defined as a nonreciprocal transaction between an entity and its shareholders, such as a stock dividend, spinoff, stock split, rights offering, or recapitalization through a special, large nonrecurring dividend that causes the market value per share of the stock underlying the option or award to change.

  8. A cancellation of an EBC award would occur for accounting purposes if the award was legally cancelled (when all legal and regulatory requirements for cancellation have been met). The Board also considered a transaction in which an equity award is replaced with an award for a fixed monetary amount payable in the future based on meeting the equity award’s original vesting conditions. The Board concluded that the transaction is a settlement of the original award and issuance of a new award because the new award’s risk profile is distinct from the original award’s risk profile.

  9. In certain tax jurisdictions, an employer might be able to transfer a tax obligation to the employee via reimbursement or legal transfer. That tax obligation is based on a stock option’s exercise-date intrinsic value. In those circumstances, the reimbursement or transfer would be deemed to represent additional exercise periods.

  10. For long-term inducements, all facts and circumstances must be evaluated to determine the substance of the transaction. If a long-term inducement exists, incremental compensation would be measured for all EBC awards subject to the inducement, regardless of whether the employee elects to participate or not.

  11. The removal of transferability restrictions on EBC awards would be evaluated as modifications.

  12. In the event that the terms and conditions of an EBC award cease to be mutually understood, an EBC award would be measured at its fair value at each reporting date through vesting or exercise date, depending on the nature of the award. That concept would be similar to the notion of tainting introduced in FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities.

  13. An entity’s failure to adjust an EBC award, if that adjustment is required in connection with an equity restructuring, would be evaluated as a modification.

  14. If the terms of an entire plan are modified, the new terms would be considered part of an EBC award’s original terms only for awards granted after the plan modification date.

PROPOSED FASB STAFF POSITIONS AVAILABLE

A majority of the Board directed the FASB staff to release the proposed FSP FIN 46-e, "Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, for Certain Interests Held by a Public Entity," for public comment. That proposed FSP was posted to the FASB website on September 19, 2003, and comments are requested by October 20, 2003.

Also, a majority of the Board did not object to the release of proposed FSP FAS 144-a, “Determination of Cost Basis for Foreclosed Assets under FASB Statement No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings, and the Measurement of Cumulative Losses Previously Recognized under Paragraph 37 of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets,” for public comment. That proposed FSP was posted to the FASB website on September 24, 2003, and comments are requested by October 24, 2003.

FUTURE OPEN MEETINGS

The following is a list of open meetings tentatively scheduled through October. Because schedules may change, please check the FASB calendar before finalizing your plans. Revisions to this list since the last issue of Action Alert are highlighted in bold.

Tuesday, October 7, 2003—User Advisory Council Meeting, New York City
Wednesday, October 8, 2003—FASB Board Meeting
Wednesday, October 8, 2003—FASB Education Session
Thursday, October 9, 2003—Liaison Meeting with the National Investor Relations Institute
Friday, October 10, 2003—Liaison Meeting with the AICPA Private Companies Practice Section Technical Issues Committee
Friday, October 10, 2003—FASB Board Meeting
Wednesday, October 15, 2003—FASB Board Meeting
Wednesday, October 15, 2003—FASB Education Session
Wednesday, October 22, 2003—Joint FASB/IASB Meeting, Canada
Thursday, October 23, 2003—Joint FASB/IASB Meeting, Canada
Wednesday, October 29, 2003—FASB Board Meeting
Wednesday, October 29, 2003—FASB Education Session