July 2006 Financial Reporting Update

BDO SEIDMAN, LLP’S

July 2006

FINANCIAL REPORTING UPDATE

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• Speakers– Ben Neuhausen– Jan Herringer– Jeff Lenz

• Replay Access– www.bdo.com/about/publications/assurance

Speakers and Replay Information

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• GAAP Update• Internal Control Reporting Update• SEC Update• Questions and Answers

Agenda

GAAP Update

July 2006

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Agenda

• New Texas Margin Tax• FASB Interpretation No. 48• FASB Invitations to Comment• FASB Staff Positions• Proposed FASB Staff Positions• EITF Consensuses• EITF Open Issues

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New Texas State Margin Tax

• New state tax enacted May 18, 2006 • Applied to entities that do business in Texas, or that are

chartered or organized in Texas • Existing franchise tax is a hybrid while new tax law is a margin

tax– New tax computed as 1% (0.5% for retailers and wholesalers) of

taxable margin, which is the lesser of:1. 70% of revenue;2. Revenue minus cost of goods sold; or3. Revenue minus compensation

• New tax treated as income tax under Statement 109– Requires adjustment of existing deferred tax assets/liabilities as

of May 18, 2006 (enactment)• Effective for existing deferred taxes NOW (e.g., for calendar

year companies – quarter ended June 30)

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FASB Interpretation No. 48

• Deals with accounting for uncertain tax positions—recognition, measurement, and disclosure

• An uncertain tax position is a deduction or credit with an uncertainty about whether it would be sustained upon examination

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• Recognition threshold—more likely than not to be sustained upon examination

• Presume that position would be examined• Same threshold—more likely than not—for

derecognition

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• Measurement of positions that meet recognition threshold

• Largest amount of benefit that is greater than 50 percent likely of being realized

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• Effect is to compute income tax provision and current and deferred tax assets/liabilities as though tax returns had been filed with positions meeting the recognition and measurement tests of Interpretation 48

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• Effective date and transition– Fiscal years beginning after December 15, 2006– Inventory all uncertain tax positions for all open

years for all tax jurisdictions– Apply recognition and measurement criteria of

Interpretation 48, adjust current and deferred assets and liabilities and opening retained earnings

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• Disclosure– Rollforward of total unrecognized tax benefits at

beginning and end of year– Other items

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• Other issues addressed– Quarterly financial statements– Balance sheet classification (current/noncurrent)– Interest and penalties

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Invitations to Comment

• Accounting for insurance policies—should insurance and financing elements be bifurcated?

• Accounting standards process for private companies

• Conceptual framework

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FASB Staff Positions--Final

• FAS 13-2: Timing of tax payments in leveraged lease transactions

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FASB Staff Positions--Proposed

• FAS 126-a: Revision to the Definition of a Public Entity to Include an Obligor for Conduit Debt Securities

• AUG AIR-a: Accounting for Planned Major Maintenance– Accrue in advance method no longer acceptable. Defer and

amortize, expense as incurred, or built-in overhaul method continue to be acceptable

• FAS 123R-e: Amendment of FASB Staff Position FAS 123(R)-1– Addresses whether a modification of an instrument in connection

with an equity restructuring or a business combination should be considered a modification for purposes of applying FSP FAS 123(R)-1

• Registration Rights Agreements

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EITF Update

SELECTED EITF ISSUES

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Final Consensus

• 05-1, Convertible debt that becomes convertible upon issuer’s call– Latest of several convertible debt issues discussed by EITF

in last year – Need to assess substance of conversion right—at issuance

is it considered reasonably possible that the conversion right will become exercisable absent the issuer’s call

– If so, then conversion upon call is accounted for as a conversion with no gain or loss

– If not, then conversion upon call is accounted for as an extinguishment with gain or loss

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Final Consensus

• 06-2, Accounting for Sabbaticals– Sabbatical for which an employee becomes eligible

after a period of years are considered to accumulate as that term is used in FAS 43 and 112

– As a result, accrue estimated cost over service period

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Final Consensus

• 06-3, Accounting for Sales, Use, Value Added, or Excise Taxes– Whether taxes should be presented gross as

revenues and costs, or net– Presentation gross or net is a policy decision– If gross presentation, disclose amount included in

revenues and costs– Change would be a change in accounting

principle

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Tentative Consensus

• 06-1, Consideration paid by service provider to an intermediary rather than to a customer– Is debit revenue reduction or an expense?– Generally consistent with EITF 01-9 guidance for

consideration paid to customer

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Tentative Consensus

• 06-4, Endorsement Split-dollar life insurance– Employer has a postretirement obligation to

employee– Purchase of insurance does not settle the

employer’s obligation

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Tentative Consensus

• 06-5, Company-owned life insurance– Asset should be measured by considering all

consideration that company would receive upon surrender

– Each policy should be measured individually

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Open EITF Issues

• 05-4, Liquidated damages in equity derivative contracts

• 06-6, Application of EITF 05-7 to reduction or elimination of a conversion right

• 06-E, Application of AICPA Broker-Dealer Guide to energy traders

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Future EITF Issues

• Accounting for previously bifurcated conversion option in convertible debt that no longer meets the bifurcation criteria

• Joint development, manufacturing, and marketing arrangements in biotechnology and pharmaceutical industries

Internal Control Reporting

Update

July 2006

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404 Matters - Agenda

• PCAOB and SEC Roundtable– Next Steps

• Expected AS 2 Amendments

• SEC Concept Release– Expected Rulemaking

• Recently Released COSO Guidance

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PCAOB and SEC Roundtable Results

• PCAOB and SEC Roundtable on Second-Year Experiences with ICFR Requirements (held May 10, 2006)

• Participants

• Consensus– ICFR reporting and auditing results in benefits– But costs still too high

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• Improvements made in Year 2

– Improved quality in financial reporting– Standardization of processes / elimination of redundancy– Cost reductions– Investor confidence restored

• Improvements still to come– Determining appropriate mix of controls – Further distinction between management and auditor roles– Implementation guidance for smaller companies

• Roundtable transcript and replay are available at:• http://www.sec.gov/spotlight/soxcomp/soxcomp-transcript.txt• http://www.connectlive.com/events/secicr2006/

PCAOB and SEC Roundtable Results

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PCAOB’s Four-Point Plan

1. Amend Auditing Standard No. 2

2. Reinforce auditor efficiency through PCAOB inspections

3. Provide guidance and education for auditors of small companies

4. Continue PCAOB Forums on auditing within the small business environment

PCAOB announcement is accessible at:

http://www.pcaobus.org/News_and_Events/News

/2006/05-17.aspx

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Expected Revisions to AS No. 2

Clarify definitions of SD and MW

Reconsider “strong indicators of a material weakness” to allow for more judgment in determining whether a deficiency exists

Guide auditors to increase their use of work of others where appropriate

Clarify materiality and scoping decisions

Emphasize integration of the audit of internal control with the audit of the F/S

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SEC’s Next Steps

• SEC will not exempt smaller companies from SOX 404

• Expects to issue a short postponement of effective date for implementation

• Intends to issue assessment guidance for management

• Oversight of PCAOB inspection program • SEC announcement is accessible at:

http://www.sec.gov/news/press/2006/2006-75.htm

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SEC’s Concept Release

• SOX 404 guidance for companies– SEC seeks public input– 35 questions posed

• Guidance expected to cover– Risk and control identification– Management’s evaluation– Documentation requirements

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SEC’s Concept Release

• Smaller companies’ unique characteristics include:– Limited number of personnel– Top management’s wider span of control– Dynamic and evolving nature of smaller

companies

• Results in unique differences in achieving effective internal control over financial reporting

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COSO Guidance for Smaller Public Companies

• Issued on July 11, 2006

• 20 fundamental principles

• Provides…– Guidance– Examples– Tools

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COSO Guidance for Smaller Public Companies

• Neither replaces nor modifies the Framework• Provides guidance on how to apply this

Framework• Directed to smaller companies - although

applicable to all companies• Guidance provided to assist in design and

implementation of cost-effective internal control

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COSO - Three Volumes

• Executive Summary- High level summary for BOD and Senior Management

• Guidance

• Evaluation Tools

Available for purchase through the AICPA at:

https://www.cpa2biz.com/stores/coso3

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Challenges to Attaining Cost-Effective Internal Control

• Obtaining sufficient resources to achieve adequate segregation of duties

• Recruiting individuals with requisite financial reporting and skill in accounting

• Increased management focus on accounting and financial reporting

• Maintaining appropriate control over computer information systems

SEC UPDATE

July 2006

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SEC Update – Agenda

• Expected Rulemaking• Other SEC Activities• SEC Practice Issues

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Expected RulemakingThis Summer

• Internet Availability of Proxy Materials (Release 34-52926)– http://www.sec.gov/rules/proposed/34-52926.pdf

• Amendments to the Tender Offer Best-Price Rule (Release 34-52968)– http://www.sec.gov/rules/proposed/34-52968.pdf

• Allowing foreign private issuers to exit the Exchange Act reporting system (Release 34-53020)– http://www.sec.gov/rules/proposed/34-53020.pdf

• Executive Compensation and Related Party Disclosure (Release 33-8665)– http://www.sec.gov/rules/proposed/33-8655.pdf

• Internal Control Reporting– Management reporting– Deferral for non-accelerated filers

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Other SEC Activities

• New Commissioner – Kathleen Casey replaces Cynthia Glassman

• New Chief Accountant – coming soon?• Materiality SAB

– Rollover vs. iron curtain method of evaluating the materiality of errors

– Could come soon or not at all

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SEC Practice IssuesRetrospective Application

• Issues arising from retrospective accounting changes (Statement 154) and retrospective adoption of Statement 123(R)

• Information required in registration statements– Facts: Company discloses impending retrospective change

(e.g., via Form 8-K or SAB 74 disclosure in 10-K) and then files a registration statement before Q1 10-Q is filed

Only requires disclosure in the registration statement

– Facts: Registration statement filed after 10-Q reflecting a retrospective change

Restated audited financial statements need to be included (incorporated by reference) in the registration statement

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SEC Practice IssuesStatement 123(R) Adoption

• Facts: Company adopts Statement 123(R) in 2006 using the prospective method. Company files 2005 pro forma P/L. Does the 2005 pro forma P/L need to reflect the Statement 123 stock comp expense?– No

• Facts: Company makes an acquisition in 2006 and grants options to target’s employees as part of the transaction. New options will be accounted for as compensation in the post-acquisition period. Does the Statement 123(R) comp expense need to be reflected in the 2005 pro forma P/L?– SEC staff undecided – stay tuned

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SEC Practice IssuesStatement 123(R) AdoptionInterim Disclosures• All Statement 123(R) disclosures are required in the 10-Q for the

first quarter of application. Should they also be included in subsequent 10-Qs?

– Yes

• Should disclosures in subsequent 10-Qs be made on a YTD basis, or both YTD and current quarter?

– YTD is required; current quarter is optional

• Is prior period comparable Statement 123(R) information required?– No

• Should prior period Statement 123/148 disclosures be made?– Yes – both YTD and current quarter disclosures, except minimum value

disclosures are not permitted

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SEC Practice Issues

• New SEC staff hot button– Compliance with Rule 5-03 – P/L format

• PCAOB staff FAQ: Adjustments to prior period financial statements audited by a predecessor auditor– http://www.pcaobus.org/Standards/Staff_Questions_and_

Answers/2006/QA_Adjustments.pdf

Documents

July 2006 Financial Reporting Update