December 2004 Financial Reporting Update

BDO SEIDMAN, LLP’S

December 2004 FINANCIAL REPORTING UPDATE

SEC Matters

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FASB Activities

Statement 151, Inventory Costs

• Amends ARB 43 to clarify that abnormal amounts of idle facility expense, freight, handling costs, and spoilage are current period costs

• Effective for inventory costs incurred during fiscal years beginning after June 15, 2005

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FASB Activities

Statement 123R, Share-Based Payment

Requirements

Use fair value-based method of accounting for transactions in which employee services received are exchanged for either:– Equity, or– Liabilities based on FV of company’s equity or that

may be settled by issuance of such equity

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FASB Activities


Current Literature to be ImpactedCurrent Literature to be Impacted

• Supersedes APB 25 and related interpretations • Amends SFAS 123, however, does not change accounting

for transactions with nonemployees (EITF 96-18 still applies)

• Does not change accounting for ESOP plans under AICPA Statement of Position 93-6

• Amends SFAS 95 with respect to excesstax benefits

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FASB Activities

Statement 123R, Share-Based PaymentChanges from Exposure DraftChanges from Exposure Draft

• Effective for quarters after 6/15/05 for public companies, quarters after 12/15/05 for S-B filer

• Reverts to original Statement 123 conclusions– No preference for particular option-pricing models– Limited offset of excess and deficient tax benefits – Straight-line amortization OK for awards with graded vesting– Conditions for noncompensatory plans

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FASB Activities


TransitionTransitionPublic Companies• Modified prospective method• Apply new accounting to all

awards granted after effective date

• Apply Statement 123 to awards granted after 1994 but not vested as of effective date

• Restatement of prior years permitted, but not required

Private Companies• Pure prospective method• Apply new accounting to

all awards granted after effective date (fiscal years beginning after 12/15/05)

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FASB Activities


Planning ConsiderationsPlanning Considerations

• Carefully weigh the consequences of accelerating vesting

• Consider alternative compensation strategies--shift to restricted stock versus options

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FASB Activities

Statement 152, Accounting for Real Estate Time-Sharing Transactions—an amendment of FASB Statements No. 66 and 67

• Amends Statements 67 and 68, to refer to the guidance in SOP 04-2

• Effective for financial statements for fiscal years beginning after June 15, 2005

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FASB Activities

Statement 153, Exchanges of Nonmonetary Assets—an amendment of APB Opinion No. 29

• Eliminates the APB 29 exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance

• Effective for nonmonetary asset exchanges in fiscal periods beginning after June 15, 2005

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EITF Consensus Position Reached in November

03-13 -- Applying the Conditions in Para.42 Statement 144 in Determining Whether to Report Discontinued Operations

Classification as a discontinued operation is appropriate only if the ongoing entity:

– Has no continuing direct cash flows

– Does not retain an interest, contract, or other arrangement sufficient to enable it to exert significant influence over the disposed component’s operating and financial policies after the disposal transaction

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Section 404 Reporting Update

• 3rd round of PCAOB FAQs (11-22-04)• Framework for evaluating deficiencies• Further acceleration deferred for one year• 45 day deferral of 404 reporting for

accelerated filers – If public equity float < $700 million and– Fiscal Y/E from 11/15/04 – 2/28/05– Rest of 10-K due at “regular” date

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Acceleration Deferral

Revised accelerated filing deadlines for Forms 10-K and 10-Q by accelerated filers

For Fiscal Years Ending On or After

Form 10-K Deadline Subsequent Form 10-Q Deadline

December 15, 2002 90 days after fiscal year end

45 days after fiscal quarter end







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Other SEC/PCAOB Activities

• SEC staff FAQ – New 8-K rules(http://www.sec.gov/divisions/corpfin/form8kfaq.htm)

• SEC staff FAQ – Independence rules (http://www.sec.gov/info/accountants/ocafaqaudind121304.htm)

• Securities Act reform proposal – Communications– Registration process– Final prospectus delivery

• PCAOB tax services proposal – would prohibit:– Tax shelter work– Tax services to officers

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AICPA SEC Conference – Themes

• We’ve improved but need to do better• Financial reporting should be a communication

exercise – not a compliance exercise– Rules are the floor – not the ceiling– Preparers can enhance quality without more rules

• Staff recognizes many requirements are new– Do not expect perfection– Do expect total commitment to the change process

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Communication Exercise

• Contingencies– No disclosure before the charge– Zero accrued until settlement

• Financial instruments disclosures– Disjointed, cover pieces, spread out, don’t tie to F/S– Hard to relate disclosures to F/S– Message: Say what’s needed to communicate, even if

not specifically required

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Communication Improvement Ideas

• Direct method – cash flows reporting• Pensions – don’t use smoothing mechanisms• Disclose expense by nature (salaries, etc.)• Depreciable lives (stratify cost by life)• MD&A – Tables, real insight• Reasons for structured transactions

Would you have what you need to invest?

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Internal Control Reporting (Section 404)

• Benefits (fewer restatements) outweigh the costs

• Open dialog in the spring – identify best practices and ways to streamline

• Concern re cost to small companies• Expect material weaknesses

– Should not prompt severe reactions– Keys are full disclosure and remediation

• Implementing new accounting standards

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Accounting Consultations

• Generally permitted, provided not construed to be bookkeeping

• A/S-2 raises concerns as to whether:– Providing advice pre-empts a company from demonstrating it

has adequate controls over accounting and F/S preparation– Failure to perform flawlessly indicates a significant deficiency

or material weakness

• Firms have adopted a variety of approaches• PCAOB did not intend to stop accounting discussions

between companies and their auditors

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404 Reporting – Material Weaknesses

• Disclose identified M/Ws in 10-K (don’t wait until 10-K/A)

• M/W in ICFR = ineffective DCPs? (usually)• Revise Item 307 and 308(c) if necessary

– New M/W in 10-K/A– Restatement

• Disclose (in plain English)– What the problem is and what it impacts– How and when you plan to remediate

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404 Reporting – 45 Day Deferral – 10-K/As

• Two 404 reports• Revised (full) 302 certifications• Revised Item 307/308(c) if necessary• Consent if necessary• S-2/S-3 – ineligible until 10-K/A filed• Can file S-8 and rely on Rule 144 before 10-

K/A filed

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SEC Staff Hot Buttons

• Materiality project– Won’t affect 2004 reporting– Material out of period adjustments – require

restatement

• Pension accounting– Substantive plan– Discount rate– Mortality tables

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SEC Staff Hot Buttons (Cont.)

Modifications of Conversion Options in Convertible Debt

• Under EITF 96-16, if the the present value of the cash flows of modified debt differs from the present value of the cash flows of the original debt by more than 10%, the modification should be treated as an extinguishment

• The analysis should compare the fair value (not just the intrinsic value) of the conversion option immediately before and after the modification

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SEC Staff Hot Buttons (Cont.)Statement 115, Accounting for Certain Investments in Debt and Equity Securities

NOT ACCEPTABLE• To enact a change in an

investment strategy• To achieve accounting

results more closely matching economic hedging strategies

• To reposition portfolio due to expected economic outlook

ACCEPTABLE• Upon the adoption of a new

standard• Change in statutory

requirements• A significant business

combination that alters investing strategy

• An unusual situation highly unlikely to recur in near term

Transfers to and from the trading account should be rare

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SEC Staff Hot Buttons (Cont.)Statement 115, Accounting for Certain Investments in Debt and Equity Securities

Accounting for Other Than Temporary Impairments of Certain Investments

The effective date of recognition and measurement provisions of EITF 03-1 is deferred

Continue to follow GAAP including SAB Topic 5.M, until FASB completes project

Assessment and disclosure provisions of EITF 03-1 remain effective

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• Conceptual Differences Between Statements 141 and 142– The determination of fair value under 141 differs from the useful

life under 142.– 141 bases valuation on traditional notion of fair value, e.g.,

marketplace participants (willing buyer and seller, etc.).– 142 bases the intangible’s assumed life on its utility to the

company.– SEC staff accepts this difference:

• Valuation of the intangible should not be changed under 141 even if the useful life was limited to its company-specific utility under 142.

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• Accounting for Contingent Tax Benefits– Companies should disclose amount of recorded and

unrecorded tax liabilities pursuant to Statement 5. • The Staff does not consider potentially alerting the IRS to

uncertain deductions via these disclosures to be an acceptable reason for non-compliance with GAAP and SEC rules.

– The FASB will soon expose, for public comment, an interpretation on this topic.


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• Changes in Circumstances and the Impact on Revenue Recognition– Companies must continually assess whether their current

accounting policies properly reflect the economics of their sales transactions.

• Software example: Repeated software upgrades to existing products may change conclusion that the software is only incidental.

– Companies should have procedures and controls in place to ensure accounting policies evolve concurrently with the business.

– This will improve financial statement reliability and comparability for industries with complex revenue models such as the technology sector.


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• Nonmonetary Exchange Transactions That Culminate the Earnings Process– Two main issues to be determined: timing of recognition and

income statement classification.– Timing: based on Concept Statement 5 and SAB Topic 13

criteria, e.g., earned and realizable, delivery or performance, etc.

– Classification: based on Concept Statement 6, e.g., revenue treatment is only appropriate if the inflow is derived from “activities that constitute …ongoing major or central operations.” Otherwise, classify as gain.


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• Accelerated Vesting of Option Grants Prior to the Adoption of Statement 123R– Under APB 25, accelerated vesting of underwater options

generally does not result in additional expense. • However, any unrecognized compensation on the date of

acceleration of “in-the-money” options would be recognized immediately.

– Under FAS 123, the company would be required to disclose the effect of accelerating the unamortized portion of unvested underwater options in their pro forma footnotes.

– Upon adoption of 123R using the MPA, compensation expense would be reduced or eliminated since acceleration mitigated the impact of existing underwater, unvested options.


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• Accelerated Vesting of Option Grants Prior to the Adoption of Statement 123R (Cont.)– The SEC staff views this treatment consistent with previously

expressed views regarding “structured transactions” which are specifically designed to achieve certain accounting goals.

– Accordingly, the staff expects disclosures of such transaction to be robust and transparent. Language to the effect of “during fiscal 2004 certain of the company’s stock options were modified to accelerate vesting…” would be considered insufficient.


Documents

December 2004 Financial Reporting Update