ASSURANCE AND ADVISORY
BUSINESS SERVICES
A&A News in Review
A Compendium of U.S. Developments
FASB ............................................................................................2
Final Statements...................................................................................................................2
Interpretation 45 on Guarantor Accounting........................................................2
FASB Statement 148 Amends Statement 123 on
Stock-Based Compensation ............................................................................2
FASB Statement 147 on Acquisitions of Financial Institutions ................3
E&Y FRD on Statement 143 on Asset Retirement Obligations ..................4
Statement 142—Current Market Conditions May Require
Interim Goodwill Impairment Test.................................................................4
FASB Statement 133..........................................................................................................5
E&Y Surveys.............................................................................................................................6
Survey of Assumptions Used in Calculating the Fair Value of
Employee Stock Options under Statement 123 ....................................6
Survey of Assumptions Used for Pension/OPEB Reporting under
Statement 87 and Statement 106...............................................................6
Proposals...................................................................................................................................6
Liabilities and Equity Instruments ............................................................................6
SPE Consolidations-Renamed Consolidation of
Variable Interest Entities ..................................................................................7
Amendment to Statement 133 on Derivatives and Hedging....................11
Other Projects .....................................................................................................................13
Business Combinations—Purchase Method Procedures ............................13
Business Combinations—Not-for-Profit Organizations................................14
Revenue Recognition ...................................................................................................16
Fair Value of Financial Instruments ......................................................................16
Financial Performance Reporting by Business Enterprises.......................17
Convergence....................................................................................................................17
Potential Agenda Projects ........................................................................................18
FASB Clearance of AcSEC Documents....................................................................18
SEC ............................................................................................ 19
Sarbanes-Oxley Section 303: Improper Influence on Audits....................19
Sarbanes-Oxley Section 404: Internal Controls..............................................20
Sarbanes-Oxley Section 406: Code of Ethics...................................................21
Sarbanes-Oxley Section 407: Disclosure About Audit
Committee Financial Experts .......................................................................21
O CTOBER 1–D ECEMBER . 31, 2002
Sarbanes-Oxley Section 401(a): Off-Balance Sheet Transactions........ 22
Sarbanes-Oxley Section 401(b): Pro Forma Financial Information........ 24
Sarbanes-Oxley Section 306: Benefit Plan Blackout Period
Trading Restrictions......................................................................................... 26
Sarbanes-Oxley Section 302: Management Certification ......................... 26
Sarbanes-Oxley Section 307: Professional Responsibilities
of Attorneys ......................................................................................................... 27
Sarbanes-Oxley Section 802: Record Retention by Auditors................... 28
Sarbanes-Oxley—Title II—Auditor Independence .......................................... 28
2002 SEC Conference Compendium Now Available..................................... 31
AcSEC ....................................................................................... 34
Chairman’s Report—Transition of Certain Projects to the FASB................ 34
Final Statements ...............................................................................................................36
Proposals ............................................................................................................................... 36
Exposure Draft on PP&E............................................................................................. 36
Nontraditional Long-Duration Contracts............................................................ 37
Other Projects..................................................................................................................... 38
EITF ........................................................................................... 40
Consensuses........................................................................................................................ 40
Issue 00-21—“Accounting for Revenue Arrangements
with Multiple Deliverables” ........................................................................... 40
Issue 02-3—“Accounting for Contracts Involved in
Energy Trading and Risk Management Activities”.............................. 40
Issue 02-16—“Accounting by a Customer (including a Reseller)
for Cash Consideration Received from a Vendor”.............................. 41
Issue 02-17—“Recognition of Customer Relationship
Intangible Assets Acquired in a Business Combination”................ 42
Other Issues ......................................................................................................................... 43
Audit Committees................................................................... 45
Audit Committee Toolkit Update ............................................................................... 45
Knowledge Tools/Other Publications and Studies .......... 46
Effective Date Reminders ..................................................... 47
1
FASB
Final Statements
Interpretation 45 on Guarantor Accounting
On November 25, 2002, the FASB issued Interpretation
No. 45, Guarantor’s Accounting and Disclosure Require-
ments for Guarantees, Including Indirect Guarantees of
Indebtedness of Others (the Interpretation) which
expands on the accounting guidance of Statements No. 5,
57, and 107 and incorporates without change the provi-
sions of FASB Interpretation No. 34, which is being
superseded.
The Interpretation, which is applicable to public and non-
public entities, will significantly change current practice
in the accounting for, and disclosure of, guarantees. Each
guarantee meeting the characteristics described in the
Interpretation is to be recognized and initially measured
at fair value, which will be a change from current practice
for most entities. In addition, guarantors will be required
to make significant new disclosures, even if the likeli-
hood of the guarantor making payments under the guar-
antee is remote, which represents another change from
general current practice.
The Interpretation’s disclosure requirements are effective
for financial statements of interim or annual periods
ending after December 15, 2002, while the initial recog-
nition and initial measurement provisions are applicable
on a prospective basis to guarantees issued or modified
after December 31, 2002.
FASB Statement 148 Amends Statement 123 on Stock-
Based Compensation
On December 31, 2002, the Financial Accounting
Standards Board issued FASB Statement No. 148,
Accounting for Stock-Based Compensation—Transition
and Disclosure. Statement 148 amends FASB Statement
No. 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition to Statement
123’s fair value method of accounting for stock-based
employee compensation. Statement 148 also amends the
disclosure provisions of Statement 123 and APB Opinion
No. 28, Interim Financial Reporting, to require disclo-
sure in the summary of significant accounting policies of
the effects of an entity’s accounting policy with respect
to stock-based employee compensation on reported net
income and earnings per share in annual and interim
financial statements. While the Statement does not amend
Statement 123 to require companies to account for
2 A&A NEWS IN REVIEW APRIL 1
employee stock options using the fair value method, the
disclosure provisions of Statement 148 are applicable to
all companies with stock-based employee compensation,
regardless of whether they account for that compensation
using the fair value method of Statement 123 or the
intrinsic value method of Opinion 25.
Following are some of the Statement’s details regarding
transition methods, disclosure provision, and the effective
date:
Transition Methods
Statement 148 provides three transition methods for
entities that adopt the fair value recognition provisions of
Statement 123 for stock-based employee compensation.
In addition to the prospective method originally provided
under Statement 123, Statement 148 provides for a modi-
fied prospective method and a retroactive restatement
method. These transition alternatives are described more
fully below:
Prospective Method:
This method requires that companies apply the recogni-
tion provisions of Statement 123 to all employee awards
granted, modified, or settled after the beginning of the
fiscal year in which the recognition provisions are first
applied. This is the transition method originally provided
for in Statement 123. Due to concerns raised by constitu-
ents regarding the lack of comparability caused by multi-
ple transition methods, Statement 148 does not permit the
use of this transition method by companies that adopt
Statement 123’s fair value method in fiscal years begin-
ning after December 15, 2003.
Retroactive Restatement Method:
This method requires that companies restate all periods
presented to reflect stock-based employee compensation
cost under the fair value accounting method in Statement
123 for all employee awards granted, modified, or settled
in fiscal years beginning after December 15, 1994.
Restatement of periods prior to those presented is
permitted, but not required. Statement 148 requires
restated net income and earnings per share of prior
periods to be determined in a manner consistent with the
pro forma effects of applying the fair value method that
were required to be disclosed previously under the
provisions of Statement 123 (assuming, of course, that
the requirements of Statement 123 were appropriately
applied in preparing the pro forma disclosures).
TO JUNE 30, 2002
Modified Prospective Method:
Under this method companies would recognize stock-
based employee compensation cost from the beginning of
the fiscal year in which the recognition provisions are
first applied as if the fair value based accounting method
in Statement 123 had been used to account for employee
awards granted, modified, or settled in fiscal years begin-
ning after December 15, 1994. For periods prior to adop-
tion, the financial statements are unchanged. For periods
subsequent to adoption, the impact of this transition
method is exactly the same as if the retroactive restate-
ment method were applied. Accordingly, the statements
of operations will be presented on a comparable basis for
all periods after the adoption of Statement 123’s fair
value method, but those periods will not be comparable to
periods prior to the adoption of Statement 123’s fair
value method.
Disclosure Provisions of Statement 148
As noted above, Statement 148 amends the disclosure
provisions of Statement 123 to require expanded disclo-
sure of the effects of a company’s accounting policy for
stock-based employee compensation. These disclosures
are incremental to the existing disclosure requirements of
Statement 123 that require a description of a company’s
option plans, detailed information of option grants and
information regarding the assumptions used to estimate
fair value. Under Statement 148, companies are required
to disclose the following information in the “Summary of
Significant Accounting Policies” or its equivalent in its
annual financial statements:
a. The method used—either the intrinsic value method
or the fair value method—to account for stock-based
employee compensation in each period presented
b. For an entity that adopts the fair value recognition
provisions of Statement 123, a description of the
method of reporting the change in accounting
principle if the financial statements include the
period of adoption
c. If awards of stock-based employee compensation
were outstanding and accounted for under the
intrinsic value method of Opinion 25 for any period
in which an income statement is presented, a tabular
presentation of the following information for all
periods presented:
1) Net income and basic and diluted earnings per
share as reported
2) Stock-based employee compensation cost, net of
the related tax effects, included in the determina-
tion of net income as reported
3) Stock-based employee compensation cost, net of
related tax effects, that would have been included
in the determination of net income if the fair
value method had been applied to all awards
4) Pro forma net income and pro forma basic and
diluted earnings per share as if the fair value
method had been applied to all awards.
Statement 148 amends Opinion 28 to require disclosure
of the information required by paragraphs c(1)—c(4),
above, in condensed consolidated interim financial
information for any period in which stock-based
employee awards are outstanding and accounted for using
the intrinsic value method of Opinion 25.
Appendix B of Statement 148 includes illustrative exam-
ples of the interim and annual disclosure requirements of
Statement 148.
Effective Date
Statement 148’s amendment of the transition and annual
disclosure requirements of Statement 123 are effective
for fiscal years ending after December 15, 2002, with
earlier application permitted for entities with fiscal years
ending prior to December 15, 2002, provided that
financial statements for the 2002 fiscal year were not
issued prior to the issuance of Statement 148 (December
31, 2002).
Statement 148’s amendment of the disclosure require-
ments of Opinion 28 is effective for financial reports
containing condensed consolidated financial statements
for interim periods beginning after December 15, 2002.
FASB Statement 147 on Acquisitions of Financial
Institutions
In early October 2002, the FASB issued FASB Statement
No. 147, Acquisitions of Certain Financial Institutions.
The Statement provides guidance on the accounting for
the acquisition of a financial institution, which had
previously been addressed in FASB Statement No. 72,
Accounting for Certain Acquisitions of Banking or Thrift
Institutions. The provisions of Statement 147 are effec-
tive October 1, 2002, so we encourage affected compa-
nies to review the final Statement as soon as possible to
assess the impact of the new rules. It should be noted that
the provisions of Statement 72, as amended by Statement
147, continue to apply to transactions between financial
institutions that are mutual enterprises.
3
The following summarizes the significant provisions of
Statement 147.
The accounting required in paragraph 5 of Statement 72
will not apply after September 30, 2002. Statement 72
required that the excess of the fair value of liabilities
assumed over the fair value of tangible and identifiable
intangible assets be recognized as an unidentifiable
intangible asset. That asset was to be amortized over a
period no greater than the life of the long-term interest-
bearing assets acquired. Statement 147 states that this
excess, if acquired in a business combination, represents
goodwill that should be accounted for in accordance with
FASB Statement No. 142, Goodwill and Other Intangible
Assets.
The balance of previously recognized unidentifiable
intangible assets arising from a business combination
should be reclassified to goodwill as of the date the
company initially adopted Statement 142. Companies that
reclassify goodwill in accordance with the Statement are
then required to restate previously issued financial state-
ments to present the balance sheet and income statement
as if the unidentifiable intangible asset had been reclassi-
fied as of the date the company adopted Statement 142.
For example, a calendar year-end company adopting
Statement 142 as of January 1, 2002, would retroactively
reclassify the unidentifiable intangible asset to goodwill
as of January 1, 2002. Additionally, previously issued
income statements should be restated to remove the effect
of any amortization of the unidentifiable intangible asset
recognized in 2002. This provision is effective October 1,
2002, however, early application is permitted.
Long-term customer-relationship intangible assets, such
as depositor-relationship and borrower-relationship
intangible assets and credit cardholder intangible assets,
will be required to be tested for impairment in accordance
with FASB Statement No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. The scope
of Statement 144 will be amended to include these intan-
gible assets. This provision also applies to long-term
customer-relationship intangible assets recognized in a
transaction between mutual enterprises.
E&Y FRD on Statement 143 on Asset Retirement
Obligations
In December 2002, Ernst & Young released its latest
Financial Reporting Developments booklet, Accounting
for Asset Retirement Obligations—FASB Statement 143.
The FRD updates and supersedes our January 2002
4 A&A NEWS IN
Client Summary, Summary of Statement of Financial
Accounting Standards No. 143, Accounting for Asset
Retirement Obligations, to address additional practice
problems and to provide enhanced implementation
guidance.
Under Statement 143, a liability for an asset retirement
obligation should be recognized in the period in which it
is incurred and should be initially measured at fair value.
The offset to the liability should be capitalized as part of
the carrying amount of the related long-lived asset.
Changes in the liability due to the passage of time should
be recognized as an operating item in the income state-
ment referred to as accretion expense. Revisions to future
cash flows should be recognized by increasing or
decreasing the liability with the offset adjusting the
carrying amount of the related long-lived asset.
Statement 143 is effective for financial statements for
fiscal years beginning after June 15, 2002 (January 1,
2003 for calendar year-end companies). Earlier applica-
tion is encouraged. The impact of adopting the Statement
is recognized as a cumulative effect of a change in
accounting principle as of the beginning of a company’s
fiscal year in which the Statement is first applied.
Statement 142—Current Market Conditions May Require
Interim Goodwill Impairment Test
Paragraph 28 of FASB Statement No. 142, Accounting
for Goodwill, requires an interim test of goodwill for
impairment “if an event occurs or circumstances change
that would more likely than not reduce the fair value of a
reporting unit below its carrying amount.” One of the
examples given of such events or circumstances is a sig-
nificant adverse change in the business climate. While a
decline in stock price and market capitalization is not
specifically cited as a goodwill impairment indicator,
companies should consider whether current business and
market conditions suggest that the fair value of any
reporting unit has likely declined below its carrying
value. If so, the company should complete the first step of
the goodwill impairment test for that reporting unit, and
if necessary step two.
Goodwill must be tested for impairment under Statement
142, even if the company believes that the decline in the
fair value of a reporting unit below its carrying value may
be temporary. That is, the Statement 142 standard for
recognizing an impairment of goodwill is not based on an
“other than temporary” impairment test. Instead, goodwill
must be tested for impairment between the required
REVIEW APRIL 1 TO JUNE 30, 2002
annual testing dates if it is more likely than not that the
current fair value of the reporting unit is less than its
current carrying value.
Current stock price levels and a company’s current
market capitalization should be considered in determining
whether it is more likely than not that the fair value of a
reporting unit is less than its carrying value. A significant
decline in a company’s stock price may suggest that an
adverse change in the business climate may have caused
the fair value of one or more reporting units to fall below
their carrying value. Similarly, declines in the stock
prices of companies in a reporting unit’s industry may
suggest that an interim test for goodwill impairment may
be required.
On the other hand, the fact that a company’s market
capitalization is less than its book value does not neces-
sarily require an interim test for goodwill impairment.
Statement 142 acknowledges that a company’s (or a
reporting unit’s) market capitalization (which is based on
the fair value of a minority interest in its equity securities
excluding any control premium) may be less than the fair
value of the enterprise (or reporting unit). In addition, for
a company with multiple reporting units, the factors
affecting the market capitalization of the enterprise may
not necessarily indicate that the fair value of a reporting
unit with a material amount of goodwill has likely
declined below its carrying amount.
In addition, Statement 142 allows the use of valuation
measures other than market capitalization in determining
the fair value of a reporting unit. For example, a valua-
tion method based on discounted cash flows based on
supportable projections of the company’s (or a reporting
unit’s) performance may result in a fair value for the
company (or reporting unit) that differs from the market
capitalization. However, a sustained decline in a com-
pany’s (or a reporting unit’s) market capitalization below
its book value could call into question the validity of the
assumptions and results of other valuation methodologies
that result in a significantly higher valuation than the
market capitalization. Accordingly, we recommend that
the results of any valuation method should be assessed in
relation to the value indicated the market capitalization.
If a company is required to complete step two of the
goodwill impairment test but is unable to do so before
interim financial statements are issued, paragraph 22 of
Statement 142 requires the company to recognize its best
estimate if a goodwill impairment loss is probable and
can be reasonably estimated. If a company is unable to
determine whether a goodwill impairment loss is prob-
able and reasonably estimable, the company should con-
sider disclosure of the potential range of impairment loss,
and the factors influencing the range (e.g., uncertainties
regarding the fair value of fixed assets, net pension assets
or liabilities, significant intangible assets).
Consultation with the PPD is recommended if the market
capitalization of an entity (or a reporting unit) is less than
its book value but an interim test for goodwill impairment
is not considered necessary, or if the company is unable
to complete the second step of the goodwill impairment
test before the interim financial statements are issued.
FASB Statement 133
Updated FRD on FAS 133
Ernst & Young has updated its Financial Reporting
Developments (FRD) booklet, Accounting for Derivative
Instruments and Hedging Activities—An Executive
Overview of FASB Statement 133. The FRD updates and
supersedes our previously issued FRD, Accounting for
Derivative Instruments and Hedging Activities—An
Executive Overview of FASB Statement 133, as amended
by FASB Statements 137 and 138, released in July 2000.
The revised FRD provides a condensed discussion of the
major precepts of Statement 133.
The updated Executive Overview FRD reflects, where
applicable, additional guidance issued by the Derivatives
Implementation Group (DIG) since July 2000, guidance
addressing other frequently observed practice problems,
and the removal of transition guidance, which is no
longer applicable.
RMRP Introduces Enhanced Derivative Valuation Services
to Augment Audit Quality
In an effort to assist Ernst & Young assurance teams in
their review of more sophisticated derivative product
valuations and valuation issues relating to our clients’
financial reporting and disclosure requirements, the
Financial Services Office’s Risk Management and
Regulatory Practice (“RMRP”) has established the
Derivatives Valuation Center (“the DVC”).
The purpose of the DVC is to provide a point of refer-
ence for audit teams with derivative valuation concerns
related to their clients’ derivative activities. The DVC is
staffed by analytical personnel from RMRP’s Risk
Analytics and Research Group with extensive derivative
valuation experience and academic backgrounds.
5
Due to the significant audit risk associated with the
valuation of derivatives, audit teams should consider
contacting the DVC for all derivative transactions that are
either beyond the valuation capabilities of ey.fincad.com,
E&Y’s internet-based derivatives valuation tool, or that
may have a material impact on financial results. Audit
teams should carefully review transaction confirmations
to ensure that there are no embedded clauses that repre-
sent additional layers of complexity. Because the firm has
encouraged consultation for more complex instruments,
ey.fincad.com was intentionally designed to address only
plain vanilla derivatives.
Since many companies use derivative products that are
outside the intended application of ey.fincad.com, audit
teams should consider the DVC as an integral component
of their service delivery. In this regard, the DVC is
intended to complement the capabilities of ey.fincad.com
and should be considered an extension of that tool.
E&Y Surveys
Survey of Assumptions Used in Calculating the Fair Value
of Employee Stock Options under Statement 123
Ernst & Young has completed its survey of assumptions
used in calculating the fair value of employee stock
options under Statement 123. The key assumptions used
for 2001 reporting purposes did not change significantly
from the assumptions used in 2000, other than a decrease
in the risk-free rate of return, which is consistent with the
decrease in interest rates throughout 2001.
The results of the survey may be helpful in evaluating
your assumptions in applying Statement 123. While many
of the assumptions required under Statement 123 are
highly subjective and entity-specific, the survey provides
useful benchmarks for comparing your assumptions
against those used by other companies. We encourage
you to meet with your Ernst & Young representative to
discuss your assumptions for the upcoming year-end
and also to discuss any questions you may have regarding
the Exposure Draft of the proposed amendment to
Statement 123.
Survey of Assumptions Used for Pension/OPEB Reporting
under Statement 87 and Statement 106
Ernst & Young has completed its survey of 2001 10-K
financial reporting under FASB Statement No. 87,
Employers’ Accounting for Pensions, and under FASB
Statement No. 106, Employers’ Accounting for Postre-
tirement Benefits Other Than Pensions. The results of the
surveys should be used in evaluating our clients’
6 A&A NEWS IN
assumptions in applying Statements 87 and 106 and again
provides us with an excellent opportunity to meet with
them to discuss their key pension and OPEB assumptions
and other employee benefit matters.
In 2001, the average rate used to discount both pensions
and OPEBs (7.2%) decreased about 0.3% from that used
in 2000. At September 30, 2002, the yield on Moody’s
Average Aaa-Rated Corporate Bonds index was
approximately 6.1%, a decrease of approximately 1.1%
from the comparable September 30, 2001 Moody’s rate.
As a result of the decline in the interest rates, we expect
that most companies will decrease their discount rates for
2002 financial reporting purposes. In addition, the 2001
average current health care cost trend rate increased .8%
from the prior year and we recommend that companies
continue to carefully monitor their assumptions about the
impact of future health care cost inflation on their postre-
tirement health benefit plans.
The Dow Jones Industrial Average (DJIA) has been
volatile during the year. For the period beginning October
1, 2001 through September 30, 2002, the DJIA declined
approximately 14% (and 25% from the period 1/1/02-
9/30/02). The average expected long-term rate of return
on plan assets used for 2001 reporting was approximately
9.1%. Because the rate of return is a long-term assump-
tion, generally there is less need for annual revisions.
However, because of the recent declines in the stock
market, we recommend that companies re-evaluate the
expected growth rates of their plan assets and consider
whether a downward revision in the rate might be appro-
priate for 2002 financial reporting purposes.
Proposals
Liabilities and Equity Instruments
At the October 16, 2002 meeting, the FASB met to dis-
cuss earnings per share issues with regard to its proposed
limited scope Statement on differentiating liability from
equity instruments. (phase I). The FASB also considered
a summary of decisions reached to date, including a
comparison of those decisions with current and proposed
international accounting standards. The FASB is planning
to issue a final Statement by the end of the year or early
in 2003.
The FASB staff provided members of the Board with dis-
cussion papers, which highlighted some of the key differ-
ences between the international and U.S. accounting
literature regarding financial instruments. These discus-
sion papers were not made available to the public. One
REVIEW APRIL 1 TO JUNE 30, 2002
of the key differences discussed is the FASB’s view
regarding financial instruments with an “ownership rela-
tionship”. The IASB has no similar concept.
The FASB noted that certain of the differences are out-
side the limited scope portion of the Liabilities and
Equity project (phase I) and will be deliberated in the
future (phase II). The FASB will work jointly with the
IASB regarding differences within phase I in an effort to
have as many of the inconsistencies resolved as possible.
The IASB is currently having similar discussions
regarding financial instruments that are anticipated to be
resolved in the fourth quarter.
At the October 30, 2002 meeting, the FASB discussed,
but did not reach a final decision on, whether to continue
with the issuance of a “fast-track” limited scope State-
ment by year-end. The FASB also discussed but reached
no decisions on (a) whether to include the additional
equity criteria in paragraphs 12-32 of EITF Issue No. 00-
19, “Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company’s Own
Stock,” in the limited-scope Statement and (b) the appli-
cation of the ownership relationship model to certain
freestanding financial instruments
Previously, the FASB tentatively agreed to scope out
certain financial instruments with characteristics of
liabilities or equity from the project’s scope (such as
convertible debt) and issue a limited-scope Statement that
would address the classification of (a) mandatorily
redeemable preferred stock, (b) derivative financial
instruments that are indexed to and potentially settled in
an entity’s own stock, and (c) financial instruments not
containing derivative features that embody obligations
that require (or permit at the issuer’s discretion) settle-
ment by issuance of the issuer’s equity shares.
At the November 13, 2002 meeting, the FASB reviewed
the scope and decisions reached to date in phase one of
the liabilities and equity project and authorized the FASB
staff to proceed to a final Statement (final Statement most
likely to be issued by the end of the year). The following
financial instruments will be included in the limited-
scope Statement:
• Freestanding derivative financial instruments to
repurchase an entity’s own equity instruments (for
example, written put options and forward purchase
contracts).
• Mandatorily redeemable instruments.
• Financial instruments embodying obligations that the
issuer must or could choose to settle by issuing a
variable number of its shares or other equity instru-
ments that (a) equals a fixed monetary amount known
at inception or (b) are indexed fully or mostly to
something other than its own equity instruments.
At the meeting, the FASB decided to exclude from the
scope derivative financial instruments embodying obli-
gations that the issuer must or could choose to settle by
issuing its own equity instruments, but that are indexed
partly to something other than its own equity instruments
(dual-indexed derivatives). The staff will develop word-
ing (based on the language in the Exposure Draft) to
clarify that the addition of inconsequential items to make
the instrument dual-indexed will not exclude the instru-
ment from the scope of the Statement.
The FASB agreed that term extension options and
adequate liquidity clauses in mandatorily redeemable
instruments will not affect the classification of these
instruments as liabilities, and that contract modifications
should be considered new contracts.
Discussing transition issues, the FASB agreed that
private enterprises with mandatorily redeemable pre-
ferred stock may need additional time for implementa-
tion. Therefore, for mandatorily redeemable preferred
stock held by private enterprises, the Statement will be
effective for fiscal years beginning after December 15,
2003. This effective date will apply to new and existing
mandatorily redeemable preferred stock.
The FASB staff discussed how the FASB’s decisions on
instruments within the proposed limited-scope Statement
compare with the IASB’s positions on the same instru-
ments. The Board observed that substantial convergence
will be achieved with issuance of the limited-scope
Statement.
SPE Consolidations-Renamed Consolidation of Variable
Interest Entities
In response to user demands to understand how the new
consolidation model will work, the FASB summarized
the Interpretation that it expects to issue by mid-January
2003. The summary includes:
• the basic criteria for identifying those entities to be
evaluated for consolidation based on variable
interests
• how to compute expected losses and expected
residual returns
7
• how related parties impact the consolidation decision,
and
• disclosure requirements and transition guidance.
Calendar year-end companies should carefully review the
Board’s disclosure requirements, because calendar year-
end companies with significant variable interests in a
variable interests entity (VIE) will likely be required to
disclose in this year’s financial statements the nature,
purpose, size, and activities of the VIE and the enter-
prise’s maximum exposure to loss as a result of involve-
ment with the entity. This disclosure requirement applies
whether or not the enterprise is the primary beneficiary of
the VIE.
The following summarizes by date the FASB’s delibera-
tion during the fourth quarter:
At the October 16, 2002 meeting, the Board decided the
following:
• To classify entities into two categories (1) entities for
which the consolidation decision should be based on
voting interests and (2) entities for which the consoli-
dation should be based on variable interests.
• To remove references to subsidiaries of substantive
operating enterprises from paragraph 8(c). Thus, a
group of assets and liabilities that are held within a
separate corporation, partnership, trust, or other
structure will be classified into one of the two catego-
ries discussed above.
• To include scope exceptions for registered invest-
ment companies subject to the Investment Company
Act of 1940 and for transferors to formerly qualifying
SPEs as described in paragraph 25 of FASB State-
ment No. 140, Accounting for Transfers and Servic-
ing of Financial Assets and Extinguishments of
Liabilities.
• To include discussion of common types of variable
interest in the final Interpretation.
• That the evaluation of variable interests will be
primarily based on expected losses but also will
consider the ability to receive or obtain benefits from
the enterprise’s activity.
• That an enterprise should be deemed the primary
beneficiary of an entity subject to consolidation
based on variable interests if it holds a majority of
the variable interests.
8 A&A NEWS IN
• That all parties involved with an entity subject to
consolidation based on variable interests should
reconsider consolidation if the governing documents
or contractual arrangements among the parties
change. The primary beneficiary also should recon-
sider consolidation if it reduces its interest in the
entity. Also, if another entity acquires some or all of
the primary beneficiary’s interest, it should recon-
sider consolidation.
• That for nonqualifying SPEs, a transferor that holds a
subordinated retained interest in the assets transferred
to an entity is considered to be a variable interest
holder.
At the October 30, 2002 meeting, the Board reached the
following decisions:
• The Board decided that transferors’ retained interests
should not be considered variable interests in trans-
feree entities unless the transferred assets constitute
all or substantially all of the entity’s assets.
• The Board decided to eliminate the special provisions
for certain entities that hold financial assets (para-
graphs 22 and 23 of the Exposure Draft). However,
the Board decided to retain the three conditions in
paragraph 23 as a means to identify the primary
beneficiary of an entity subject to the Interpretation.
An enterprise that satisfies two of the three condi-
tions would be the primary beneficiary. Enterprises
that have the authority to purchase or sell assets for
the entity and have sufficient discretion in exercising
that authority to significantly affect the revenues,
expenses, gains, and losses of the entity would
undergo additional scrutiny in demonstrating that
they do not satisfy either the second or the third
condition of paragraph 23.
• The Board decided not to extend the transferor’s
exemption under paragraph 8(a) of the proposed
Interpretation to other parties with interests in a
qualifying SPE. A party other than the transferor
might be required to consolidate a qualifying SPE if
it holds an interest that would not require the trans-
feror to consolidate.
• The Board decided to modify the provisions of para-
graph 17 to require treatment of portions of an entity
as separate silos only if an enterprise’s rights and
obligations relate to specific assets and liabilities.
The proposed Interpretation would have required that
same treatment even if liabilities were not specifi-
cally associated with specific assets.
REVIEW APRIL 1 TO JUNE 30, 2002
• The Board decided to retain the presumption that an
equity investment of less than 10 percent is insuffi-
cient for an entity to finance itself. The Board
decided to replace the provisions of paragraph 12 for
overcoming that presumption with a discussion
emphasizing the overriding principle that an entity
must be able to finance its activities and include
certain indicators that would support that principle.
• The Board requested that the staff provide examples
to facilitate discussion of consolidation procedures at
its November 6, 2002 Board meeting.
At the November 6, 2002 meeting, the Board reached
the following decisions:
• The Board decided that transferors’ retained interests
should be considered variable interests in transferee
entities even if the retained interests relate only to
specific assets in those entities. In doing so, the
Board reversed a previous decision from its October
30, 2002 Board meeting. The Board confirmed that
transferors’ retained interests would be considered
variable interests only in entities that actually hold
the transferred assets. A transferor does not have a
variable interest in an entity that holds beneficial
interests in the transferred assets. For example, a
transferor to a qualifying SPE does not have a
variable interest in a conduit entity that holds benefi-
cial interests issued by the qualifying SPE. The
Board will consider some additional information to
be provided by the staff at the next meeting.
• The Board decided that when enterprises evaluate
entities subject to consolidation based on variable
interests (“variable interest entities”), they should
first determine if any party is a decision maker. A
decision maker is any party that has the authority to
purchase or sell assets or makes other operating deci-
sions that significantly affect the revenues, expenses,
gains, and losses of the variable interest entity. If
there is a decision maker and that party either holds
variable interests that would absorb a majority of the
expected losses or holds variable interests that allow
the decision maker to obtain a majority of the resid-
ual benefits from the entity’s operations, that party is
the primary beneficiary. If there is no decision maker,
consolidation will be required for a party to a vari-
able interest entity if its variable interests will absorb
a majority of the expected losses if they occur and
if it is entitled to a majority of the residual benefit,
if any.
• The Board decided to revise the market-based fee
provisions in paragraph 19 of the proposed Interpre-
tation by (1) noting that a fee that is market based at
inception and becomes nonmarket because of market
changes should not result in consolidation, (2) elimi-
nating the presumption that a fee from a variable
interest entity is not market based, (3) indicating that
the ability to replace a service provider without cause
suggests that a fee is market based, and (4) replacing
references to “market-based fees” with “fees com-
mensurate with the services provided.”
• The Board decided to emphasize the identification of
an agency relationship in the related party provisions
rather than focusing on the significance of the
services provided or other factors. The Board also
decided that an enterprise with a variable interest in a
variable interest entity should include variable
interests held by the enterprise’s employees and
board members as its own interests for purposes of
determining whether or not it is the primary benefici-
ary. The Board confirmed that, in situations in which
a group of related parties is deemed to be the primary
beneficiary of a variable interest entity, only one
party should consolidate that entity and the parties
should apply the tiebreaker provisions of paragraph
16 to decide which party should consolidate. In a
related decision, the Board decided to eliminate
subparagraphs (a) and (d) of that paragraph, which
stated that only substantive operating enterprises and
parties with the largest variable interests could be
primary beneficiaries.
• The Board decided that not-for-profit organizations
should be excluded from the scope of the final
Interpretation. A not-for-profit organization should
not consolidate or be consolidated by another enter-
prise as a result of applying the Interpretation. How-
ever, the Board noted that not-for-profit organizations
would still be subject to the related party provisions
of that Interpretation.
• The Board decided not to exclude private businesses
from the scope of the final Interpretation. The Inter-
pretation will require that if one enterprise in a group
of commonly controlled enterprises consolidates
another member of the group, the consolidating enter-
prise should follow the requirements in paragraphs
11 and D12 of FASB Statement No. 141, Business
Combinations, and initially measure the consolidated
assets and liabilities at their carrying amounts.
9
• The Board decided to expand paragraph 24 of the
proposed Interpretation to require that the primary
beneficiary disclose the nature, purpose, size, activi-
ties, and potential risks of the consolidated variable
interest entity. If the variable interest entity received
a transfer of financial assets that qualified for sale
treatment under FASB Statement No. 140, Account-
ing for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities, the primary
beneficiary should include the relevant Statement 140
disclosures in the same note to its financial state-
ments that describes the entity.
• The Board decided that an enterprise that holds vari-
able interests in a variable interest entity that absorbs
a significant amount of expected losses, but that is
not the primary beneficiary, should disclose the
nature, purpose, size, and activities of the variable
interest entity as well as its maximum exposure to
losses from that entity.
• The Board decided that the final Interpretation would
be effective immediately for variable interest entities
created after the issuance date and that the Interpre-
tation would be effective for existing entities (those
created before the issuance date and still outstanding
as of the effective date) as of fiscal periods beginning
after June 15, 2003. The Board also decided that,
upon issuance of the final Interpretation, an enter-
prise should evaluate whether it is reasonably
possible that at the effective date it will be required
to either consolidate or disclose its involvement with
a variable interest entity. If so, the enterprise will be
required to disclose its involvement with and certain
other information about the variable interest entity.
At the November 13, 2002 meeting, the Board discussed
the expected losses and transition provisions related to
the proposed Interpretation and reached the following
decisions:
• The Board decided to require restatement of previ-
ously issued financial statements upon initial appli-
cation of the provisions of the Interpretation unless it
is impractical to do so. The cumulative effect of the
accounting change should be reported as of the
beginning of the earliest period restated or, if
restatement is not practicable, as of the beginning of
the period in which the Interpretation is initially
applied.
10 A&A NEWS IN
• The Board decided that no party would be required to
consolidate a qualifying SPE unless the party has
rights or obligations or both that would have pre-
vented it from derecognizing the assets had it been
the transferor. In doing so, the Board reversed a
previous decision from its November 6, 2002 Board
meeting.
• The Board decided that expected losses should be
based on fair value for purposes of applying the
variable interest approach.
• The Board concluded that the changes to the pro-
posed Interpretation would not require reexposure
prior to issuing the final Interpretation.
• The Board directed the staff to proceed to a draft of a
final Interpretation for vote by written ballot.
At the November 20, 2002 meeting, the Board discussed
the expected loss and transition provisions related to the
proposed Interpretation and reached the following
decisions:
• The Board decided that the Interpretation should be
applied prospectively with a cumulative effect
adjustment as of the beginning of the period in which
the Interpretation is first applied or by restating pre-
viously issued financial statements of one or more
years with a cumulative effect adjustment as of the
beginning of the first year restated. Restatement
would be encouraged but not required.
• The Board decided that at transition a primary benefi-
ciary should initially measure the assets, liabilities,
and noncontrolling interests of a newly consolidated
variable interest entity at their carrying amounts (the
amounts at which they would have been carried if the
Interpretation had been effective when the enterprise
first became the primary beneficiary) at the beginning
of the period in which the Interpretation is first
applied. If the consolidating enterprise is unable to
determine the carrying amounts, it should initially
measure the assets, liabilities, and noncontrolling
interests of the consolidated entity at fair value.
• The Board decided that no party would be required
to consolidate a qualifying SPE unless the party has
rights or obligations or both that would have pre-
vented it from derecognizing the assets had it been
the transferor. In doing so, the Board reversed a
previous decision from its November 6, 2002 Board
meeting.
REVIEW APRIL 1 TO JUNE 30, 2002
• The Board decided that expected losses should be
based on fair value for purposes of applying the vari-
able interest approach.
• The Board concluded that the changes to the pro-
posed Interpretation would not require reexposure
prior to issuing the final Interpretation.
• The Board directed the staff to proceed to a draft of a
final Interpretation for vote by written ballot.
At the December 11, 2002 meeting, the Board reached
the following decisions:
• The Board decided that the ability to make decisions
about the activities of a variable interest entity is an
indication that the decision maker is the primary
beneficiary of the entity.
• The Board decided that variable interests in selected
assets are variable interests in the entity if the assets
represent a majority of the entity’s assets.
• The Board confirmed its prior decision that a holder
of variable interests in a variable interest entity is the
primary beneficiary of that entity if the holder will
either (1) absorb a majority of the entity’s expected
losses if they occur or (2) receive a majority of the
entity’s expected residual returns if they occur.
• The Board decided that separate accounts of life
insurance companies as described in the AICPA
Audit and Accounting Guide, Life and Health
Insurance Entities, should not be considered variable
interest entities.
• The Board decided that, in addition to other required
disclosures, a primary beneficiary should disclose
(1) the carrying amount and classification of consoli-
dated assets that are collateral for the variable interest
entity’s obligations and (2) the lack of recourse by
creditors (or beneficial interest holders) of a consoli-
dated variable interest entity to the general credit of
the primary beneficiary, where applicable.
• The Board decided that an enterprise should deter-
mine whether an entity is a variable interest entity on
the date at which the enterprise becomes involved
with the entity, rather than at the inception of the
entity.
• The Board decided that privately held enterprises
should apply the Interpretation to preexisting variable
interest entities as of the end of the first fiscal year
beginning after June 15, 2003.
• The Board decided that all enterprises should imme-
diately apply the Interpretation to variable interest
entities with which they become involved after a date
approximately two weeks after the issuance date of
the Interpretation.
• The Board decided that all enterprises should apply
the transition disclosure requirements in financial
statements issued after a date approximately two
weeks after the issuance date of the Interpretation.
Amendment to Statement 133 on Derivatives and
Hedging
At the October 9, 2002 meeting, the FASB continued
redeliberations of the Board’s proposed amendment to
FASB Statement No. 133, Accounting for Derivatives
and Hedging Activities. At the meeting, a technical plan
was approved which would call for the issuance of the
Statement 133 Amendment during the first quarter of
2003, rather than the fall of 2002 as originally expected.
This delay seemed likely when at the September 11, 2002
meeting, the Board directed the staff to take a fresh look
at whether or not paragraph 6b (no initial net investment
aspect of the definition of a derivative) should be
amended. The manner in which the Board eventually
addresses paragraph 6b will determine how the FASB’s
proposed model to reconcile Statement 133’s and State-
ment 140’s often contradictory accounting for beneficial
interests resulting from a securitization will proceed.
Originally the Statement 133 amendment was being
targeted to go into effect January 1, 2003 for calendar
year-end companies.
Not all of the Statement 133 Amendment is focused on
the accounting for beneficial interests. The amendment
includes many “technical corrections” to Statement 133
as well as codifications of already effective DIG issues
(Statement 133 Implementation Issues). One such DIG
issue is C13, “When a Loan Commitment is Included in
the Scope of Statement 133.” Issue C13 generally
excluded loan commitments from the scope of Statement
133 except for those mortgage loan commitments related
to loans which when acquired or originated were to be
held for sale under Statement 65. All other loan commit-
ments between potential borrowers and potential lenders
would not be considered derivatives under Statement 133,
even if they seemed to meet all the characteristics of
paragraph 6 to be defined as a derivative. Since C13 was
cleared in March 2002, there has been some confusion as
to the applicability of C13 (and by extension, the State-
ment 133 amendment) to commitments by mortgage
11
lenders and non-mortgage lenders to sell loans to The Board decided to give qualitative guidance to the
purchasers to the “secondary” market. meaning of the phrase an initial net investment that is
smaller than would be required for other types of
The Board approved the staff’s recommendation to clar-
contracts that would be expected to have a similar
ify further that C13 and paragraph 10(i) of the Exposure
response to changes in market factors in paragraph 6(b)
Draft is not to apply, and was never intended to apply, to
of FASB Statement No. 133, Accounting for Derivative
any commitments to sell loans, either mortgage loans or
Instruments and Hedging Activities. The Board asked the
non-mortgage loans, into the secondary market. C13 only
staff to draft language to be used in the standard to indi-
is intended to address commitments made between
cate that the paragraph 6(b) criterion is met if the initial
potential borrowers and potential lenders. It is not appli-
net investment is smaller than would be required to
cable to the secondary market that may or may not exist
acquire the underlying asset or incur the obligation
for such a loan once it is originated. Commitments
related to the underlying. In that regard, the Board also
between the lender and loan purchasers should be
decided that the references to little or no net investment
analyzed like any other contract to ascertain whether or
in paragraph 59(c) and (d) should be corrected to better
not such contracts are derivatives as defined in paragraph
mirror the criterion in paragraph 6(b) that a derivative
6. Often this analysis is based on whether or not the
require “no initial net investment or an initial net invest-
underlying loan is readily convertible to cash.
ment that is smaller than would be required for other
At the November 20, 2002 meeting, the FASB focused on types of contracts that would be expected to have a
what constituted a short-cut qualified hedge of callable similar response to changes in market factors.”
debt and revised its decision reached at the September 11,
The Board decided that any additional disclosures relat-
2002 meeting.
ing to derivative instruments and hedging activities
Under the decision reached at the September 11, 2002 should be included as part of a future Board project
meeting, the Board believed that the type of cancelable rather than as part of this amendment.
swap needed to “short cut hedge” callable debt would be
At December 18, 2002 meeting, the Board considered a
a swap whose fixed leg was NOT adjusted to account for
constituent’s request to modify the scope exception in
the “premium” that must pass from the swap counterparty
paragraph 10(d) for certain financial guarantee contracts.
to the callable debt issuer but which paid the premium in
The Board decided not to modify that exception and
the form of cash. Reversing its position, the Board now
reiterated that all the criteria in that exception are neces-
agrees that the most effective hedging instrument in this
sary to avoid credit derivatives qualifying for the scope
case is an interest rate swap (bond issuer receives fixed;
exception.
counterparty receives floating) whose fixed leg has been
increased by an amount which compensates the bond The Board decided that except for amendments relating
issuer for the counterparty’s ability to cancel the swap for to Statement 133 Implementation Issues, a final State-
no value. There was no further discussion of any other ment will be effective for transactions and hedging rela-
aspects of the Statement 133 Amendment project. tionships entered into after March 31, 2003, and should
be applied prospectively. Early application is encouraged.
At the December 4, 2002 meeting, the Board identified
The Board decided that Statement 133 Implementation
two characteristics often associated with derivatives that
Issues that have been cleared by the Board and have been
contain financing elements: up-front cash payments and
effective for fiscal quarters that began prior to March 15,
off-market terms (for example, terms, rates, or prices that
2003, should continue to be applied in accordance with
are not consistent with the current market for that type of
their respective effective dates and transitions. However,
contract). The Board decided that entities should use
Statement 133 Implementation Issue No. C13, “When a
those characteristics in conjunction with qualitative
Loan Commitment Is Included in the Scope of Statement
judgment to determine whether financing elements are
133,” will be modified in accordance with the decisions
present in derivatives. The Board decided that if signifi-
made as part of the amendment process, and entities
cant financing elements are present in derivatives, all
should apply the revised guidance prospectively to
cash inflows and outflows associated with those deriva-
contracts entered into after March 31, 2003.
tives should be reported as cash flows from financing
activities.

12 A&A NEWS IN REVIEW APRIL 1 TO JUNE 30, 2002

Other Projects
Business Combinations—Purchase Method Procedures
At the October 30, 2002 meeting, the FASB considered
the following two threshold issues related to noncon-
trolling interests:
1. In the acquisition of less than a 100% interest in an
entity, should goodwill be recognized based on the
purchased goodwill or full goodwill method?
— Under the purchased goodwill method, only the
amount of goodwill purchased by the acquirer is
recognized in the consolidated financial state-
ments. Under this method, goodwill is calculated
as the difference between the consideration paid
and the acquirer’s proportionate interest in the
fair values of the acquired entity’s identifiable
assets acquired and liabilities assumed. This
alternative recognizes no goodwill pertaining to
the noncontrolling interest.
— Under the full goodwill method, all of the good-
will of the acquired entity, not just the acquirer’s
share, is recognized at the time control is
obtained. Under this method, goodwill is meas-
ured as the difference between the fair value of
the acquired entity as a whole and the fair values
of its identifiable asset acquired and liabilities
assumed at the acquisition date.
— FASB Board members generally agreed that the
full goodwill method is consistent with the
principle of the purchase method procedure
project. Certain members recognized that the full
goodwill method is a significant change in prac-
tice and consideration should be given to any dif-
ficulties that may arise in applying this method.
2. What is the nature and classification of noncontroll-
ing interests in a consolidated balance sheet?
— The FASB reconfirmed its previous decision,
reached during its redeliberation of the October
2000 Exposure Draft, Accounting for Financial
Instruments with Characteristics of Liabilities,
Equity, or Both, that noncontrolling interest
should be reported in the consolidated financial
statement as a separate component of equity.
At the December 4, 2002 meeting, the Board continued
its discussion of issues associated with the accounting
and reporting of noncontrolling interests, which includes
redeliberating certain of the proposals in the October
2000 Exposure Draft, Accounting for Financial
Instruments with Characteristics of Liabilities, Equity,
or Both. The Board reached the following decisions:
• If an acquirer obtains control of an acquiree through
a series of acquisitions of two or more investments in
the acquiree (a business combination referred to as a
step acquisition), preacquisition investments held by
the acquirer at the acquisition date (the date control is
obtained) should be remeasured at their fair value and
any unrealized holding gains or losses on those
preacquisition investments should be recognized in
consolidated net income for the period. The cumula-
tive amount of unrealized holding gains or losses on
preacquisition investments that have been recognized
in other comprehensive income for investments
classified as available-for-sale securities under FASB
Statement No. 115, Accounting for Certain Invest-
ments in Debt and Equity Securities, which are
measured at fair value, should be reversed out of
accumulated other comprehensive income and
reported as a reclassification adjustment (deduction)
from other comprehensive income into net income
for the period.
• After a parent acquires control of a subsidiary, subse-
quent increases or decreases in the ownership inter-
ests in the subsidiary by members of the consolidated
group while the parent controls the subsidiary should
be accounted for as capital transactions (investments
by owners and distributions to owners) in the consoli-
dated financial statements. Premiums or discounts, if
any, for amounts paid (or received) for subsequent
investments purchased from (or sold to) noncontroll-
ing shareholders in excess (or deficit) of the carrying
basis of the ownership interest purchased (or sold)
should be recognized directly in equity (paid-in-
capital).
• If a parent disposes of a subsidiary through a sale of
ownership interests in that subsidiary by the parent or
members of the consolidated group (a decrease in
ownership that results in a loss of control by a
parent), any gain or loss on the sale should be recog-
nized in consolidated net income of the period. The
gain or loss should be calculated as the difference
between (1) the proceeds from the sale that resulted
in the loss of control and (2) the carrying amount of
the subsidiary’s net assets in the consolidated finan-
cial statements, less the carrying amount of any non-
controlling interests in the consolidated financial
13
 statements, and less the fair value of any investment
remaining in the entity sold.
• The Board also discussed the guidance for the subse-
quent recognition of deferred tax benefits acquired in
a business combination provided by paragraph 30 of
FASB Statement No. 109, Accounting for Income
Taxes, that require the reduction of goodwill, other
noncurrent intangible assets, and income tax expense.
The Board decided to amend Statement 109 to
require the subsequent recognition of deferred tax
benefits as a reduction of income tax expense.
At the December 11, 2002 meeting, the Board continued
its discussion of issues involving the accounting and
reporting of controlling and noncontrolling (minority)
interests in consolidated financial statements. The Board
also discussed certain project scope issues and the
proposed clarifications to the fair value measurement
guidance for measuring assets acquired and liabilities
assumed in a business combination.
For an entity with one or more less-than-wholly-owned
subsidiaries, the Board reached the following decisions:
• Amounts for both net income attributable to noncon-
trolling interests and net income attributable to the
controlling interest should be presented on the face of
the consolidated income statement in addition to pre-
senting consolidated net income. Further, the Board
decided that in presenting those amounts, net income
attributable to the noncontrolling interests should be
presented as a reduction of consolidated net income
to arrive at the amount attributable to the controlling
interest. The staff was directed to explore whether the
effects of capital transactions for purchases (and
sales) of subsidiary shares from (to) noncontrolling
shareholders that generally are shown in a statement
of changes in shareholders’ equity should be required
to be displayed on the face of the consolidated
income statement.
• Amounts for both comprehensive income attributable
to the controlling interest and comprehensive income
attributable to the noncontrolling interests should be
reported on the face of the financial statement in
which comprehensive income is presented in addition
to presenting consolidated comprehensive income.
• Individual line items in the consolidated income
statement and components of other comprehensive
income should be presented on a consolidated basis
on the face of the financial statements. Presentation
14 A&A NEWS IN
of amounts attributable to the controlling and non-
controlling interests for those individual line items on
the face of the consolidated financial statements
would not be required.
• Losses of a subsidiary should be attributed to both
the controlling and the noncontrolling interests on the
basis of their ownership interests and contractual
rights and obligations, if any, even if the losses
exceed the noncontrolling interests’ investment. The
staff was directed to further explore whether the
existence of a guarantee or other type of agreement
should change the way losses are attributed between
controlling and noncontrolling interests.
The Board decided to address certain issues previously
excluded from the scope of this joint project with the
objective of determining whether convergence with the
IASB is possible. Those issues include the accounting for
in-process research and development, acquired construc-
tive obligations, and certain employee benefit issues.
The Board decided to clarify and modify the hierarchical
guidance for measuring the fair value of assets acquired
and liabilities assumed in a business combination. This
revised guidance is included in the update to this project
on www.fasb.org. Several Board members acknowledged
that this level of fair value measurement guidance does
not address certain important questions regarding fair
value measurement. Those Board members also noted
that those questions are not unique to the business
combinations project. The Board directed the staff to
develop a plan for addressing those questions through a
separate effort outside the Board’s project on business
combinations.
Business Combinations—Not-for-Profit Organizations
At the November 20, 2002 meeting, the FASB discussed
the initial and subsequent recognition of goodwill in
combinations in which a not-for-profit organization
(NFP) is the acquiring organization. The Board decided
that when a not-for-profit organization acquires a busi-
ness enterprise that will continue to be operated as a
business enterprise, the goodwill should be recognized
and accounted for subsequent to acquisition in accor-
dance with FASB Statement No. 142, Goodwill and
Other Intangible Assets. The Board did not reach agree-
ment on the recognition and subsequent accounting for
goodwill arising in combinations in which the acquired
entity is another not-for-profit organization (or is a
business entity that is subsequently converted to a not-
for-profit organization). Some Board members favor an
REVIEW APRIL 1 TO JUNE 30, 2002
alternative in which the acquiring organization would
write off recognized goodwill immediately upon
recording the acquisition. Other Board members support
recording goodwill as an asset and identifying specific
events that, should they occur, would result in the write-
off of the recorded goodwill. The Board directed the staff
to investigate the operationality of the latter alternative
At the December 18, 2002 meeting, the Board discussed
several issues related to the scope of the proposed State-
ment and the accounting for goodwill.
With respect to the scope of the proposed Statement, the
Board decided that:
• The scope should include combinations in which no
combining entity dominates the process of selecting a
voting majority of the combined entity’s governing
board (transactions which are sometimes referred to
as mergers of equals).
• The following transactions should be excluded from
the scope:
• A transaction in which control is obtained through
means other than an acquisition by purchase or gift of
net assets or equity interests
• The formation of a joint venture
• The acquisition of noncontrolling interests
• A transfer of net assets or exchange of equity inter-
ests between entities under common control.
• Combinations of not-for-profit organizations should
be distinguished from acquisitions of assets subject to
certain liabilities based on whether the transferred set
of processes and assets represents an activity. The
Board decided to define an activity as an integrated
set of processes conducted and assets managed for
the purpose of providing goods and services to bene-
ficiaries, customers, or members that fulfill the pur-
pose or mission for which an organization exists. An
activity consists of (1) inputs, (2) processes applied
to those inputs, and (3) resulting outputs that are used
to provide goods and services to beneficiaries,
customers, or members. For a transferred set of
processes and assets to be an activity, it must contain
all of the inputs and processes necessary for it to
continue to conduct normal operations after the
transferred set is separated from the transferor.
• The project should provide general guidance to
describe the accounting for an acquisition of assets
subject to certain liabilities.
• Although the definition of a combination transaction
is based on a notion of control, control would not be
defined in the standards section of the proposed
Statement. The Board decided, however, that the
basis for conclusions would provide existing GAAP
definitions of control.
• The proposed Statement would include name and size
of the parties to the combination as possible indica-
tors for identifying the acquiring organization but
will not require that those indicators be considered in
all combinations.
• With respect to accounting for the impairment of
goodwill, the Board directed the staff to analyze the
merits of the following two alternatives:
• If the acquired not-for-profit organization (and the
reporting unit into which it is integrated) is identified
as previously supported by fees and charges to third
parties for goods and services provided by the not-
for-profit organization, goodwill of that reporting unit
would be tested for impairment using the fair value
method described in FASB Statement No. 142,
Goodwill and Other Intangible Assets. If the acquired
organization (and the reporting unit into which it is
integrated) is supported primarily by contributions,
goodwill would be tested for impairment using a
trigger-based approach. Under that approach, good-
will would be written off in its entirety when certain
triggering events occur.
• If the fair value of the acquired entity and the report-
ing unit into which that acquired entity is integrated
can be measured with sufficient reliability, goodwill
would be tested for impairment under Statement 142
(that is, it would be tested for impairment using the
fair value approach). Organizations that are unable to
reliably determine the fair value of the acquired
entity would test goodwill for impairment using the
trigger-based approach (that is, write off goodwill in
its entirety when certain triggering events occur).
• Under either alternative, the Board acknowledged
that if an organization is able to apply the fair value
approach to testing goodwill for impairment required
by Statement 142, it also should be able to determine
the acquired entity’s fair value at the date of acquisi-
tion. Thus, the Board plans to reconsider its earlier
decision that goodwill not be recognized in an acqui-
sition by gift.
15
Revenue Recognition
Based on constituent comments, including those of E&Y,
the FASB decided in May 2002 to add to its agenda a
project on revenue recognition. The FASB decided that
the revenue recognition Statement would (a) eliminate
the inconsistencies in the existing authoritative literature
and accepted practices, (b) fill the voids that have
emerged in revenue recognition guidance in recent years,
and (c) provide guidance for addressing issues that arise
in the future. The FASB also agreed to undertake this
project jointly with the International Accounting
Standards Board.
At the October 9, 2002 meeting, the FASB began consid-
ering conceptual criteria underlying revenue recognition.
The discussion focused on a set of preliminary “working
criteria” developed by the staff that will be used for sub-
sequent discussions of case examples. The staff also
presented an inventory of current authoritative revenue
recognition guidance to the Board. The Board discussed
the “working criteria” but no formal conclusions were
reached.
At the November 13, 2002 FASB meeting, the Board
explored a revenue recognition approach that focuses on
changes in assets and liabilities as defined in FASB
Concepts Statement No. 6, Elements of Financial State-
ments. Agreeing that the relevant attribute for measuring
assets or liabilities at initial recognition or for fresh-start
measurements is fair value, the FASB discussed the asset
and liability approach to revenue recognition and the
effects of this approach by applying them to cases
involving revenue recognition.
The FASB staff provided the FASB members with exam-
ples discussed in Appendix 00-21B of the Draft Abstract
for EITF Issue 00-21, “Revenue Arrangements with
Multiple Deliverables” (Issue 00-21). These examples
contrasted the asset and liability approach with the earn-
ings process/allocation of the relative fair value approach
used in Issue 00-21.
The FASB agreed that the fair value of the remaining
obligation to perform should be based on the amount the
enterprise would have to pay a third party to assume the
obligation. The Board discussed refund rights and noted
that the asset and liability approach takes into considera-
tion the probability of the refund and in the cases dis-
cussed by the staff, revenue recognition would have
occurred earlier than under Issue 00-21. The FASB
concluded that the refund right should be considered in
the measurement of the performance obligation.
16 A&A NEWS IN
The FASB authorized the staff to continue with the asset
and liability approach to revenue recognition. The Board
recognized that there will be challenges such as measure-
ment, subsequent accounting and gross versus net pres-
entation. Among concerns of some FASB members were:
• Under the asset and liability approach, revenue would
be recognized upon signing of a contract, i.e., an
asset would be established for the value of the con-
tract and related customer intangible.
• There may be certain situations where the use of
entity-specific information would be preferable to
requiring market-based information to measure the
obligation.
At the December 18, 2002 meeting, the Board continued
its discussions of the conceptual guidance underlying
revenue recognition. The Board discussed cases involv-
ing issues related to revenue recognized in conjunction
with obligations to customers that are performed by
others and EITF Issue No. 99-19, “Reporting Revenue
Gross as a Principal versus Net as an Agent.” The Board
reached the following decisions:
• A reporting entity should not recognize revenues for
the performance by third parties of its obligations to
deliver goods or render services to its customers if
those obligations are legally assumed by those
parties.
• A reporting entity should initially measure its obliga-
tions for performance guarantees at their fair value
and should recognize revenue from the satisfaction or
expiration of those guarantees.
• The Board directed the staff to explore further
(1) issues related to whether a reporting entity should
recognize revenues for the performance by a third
party of its obligations to deliver goods or render
services if those obligations are not legally assumed
by that party and (2) whether the working definition
of revenues should be refined to incorporate the
notions of revenue-generating activities and the
performance of those activities.
Fair Value of Financial Instruments
At the October 16, 2002 meeting, as part of its project to
replace FASB Statement 107 on fair value disclosures,
the FASB discussed options for presentation of changes
in the fair value of financial instruments in the notes to
the financial statements. No decisions were reached with
regard to the presentation options. The FASB tentatively
REVIEW APRIL 1 TO JUNE 30, 2002
agreed that a final standard should provide a framework
for fair value disclosure but be flexible enough to provide
entities with a means to identify industry (or other)
specific fair value risks. The FASB tentatively concluded
that the fair value disclosures of the standard would be
required on an annual basis. The FASB plans to issue an
Exposure Draft early in 2003.
The Board decided that it would ask members of the
AICPA’s Block Discount Task Force to continue their
work on block discounts as part of the Board’s project to
replace FASB Statement No. 107. The Board also
decided to broaden the scope of the project to include
development of guidance related to measuring the fair
value of financial instruments for purposes of disclosure
and recognition in financial statements. Thus, the fair
value measurement guidance developed in this project
would supersede existing guidance relating to measuring
the fair value of financial instruments.
Financial Performance Reporting by Business Enterprises
The Board decided that the principal objective of the
project should be to enhance the predictive and feedback
value of the information that is presented in the statement
of comprehensive income. That objective is similar to the
objective identified by the International Accounting
Standards Board (IASB) in its project on reporting finan-
cial performance that is being conducted jointly with the
UK’s Accounting Standards Board. The Board directed
the staff to develop additional objectives, consistent with
that principal objective, which would serve as a basis for
making decisions in this project. The Board also dis-
cussed decisions reached by the IASB in its project on
reporting financial performance, in particular, the IASB’s
tentative decision to present the statement of comprehen-
sive income with a columnar distinction that separates
revenues, expenses, gains, and losses into income flows
and remeasurements. The Board directed the staff to
develop for its consideration other methods of aggregat-
ing and displaying items of comprehensive income as an
alternative to the IASB approach.
Convergence
The FASB and the International Accounting Standards
Board (IASB) have issued a memorandum of under-
standing regarding their commitment to the convergence
of U.S. and international accounting standards.
In the memorandum, the two Boards agree, as a matter of
high priority, to undertake a short-term project aimed at
removing a variety of differences between U.S. GAAP
and International Financial Reporting Standards (IFRS),
and to remove other differences that will remain at
January 1, 2005, through coordination of their future
work programs.
The Boards also agreed to use their best efforts to issue
an Exposure Draft of proposed changes to U.S. GAAP
and IFRS that reflect common solutions to some, and
perhaps all, of the differences identified for inclusion in
the short-term project during 2003.
At the November 13, 2002 meeting, the FASB discussed
the issues that initially are to be included in the scope of
the short-term convergence project with the International
Accounting Standards Board (IASB), the sequencing of
those issues, and which issues will be included in the first
Exposure Draft. As part of the convergence research
project, the FASB staff (in cooperation with the staffs of
the IASB and SEC) has developed a list of differences
that potentially meet the criterion for inclusion in the
short-term convergence project. The goal is to issue an
Exposure Draft by June of 2003.
The FASB staff asked the Board’s members to consider
each of the differences in the list and determine which of
those items should initially be included in the project
scope. The items included in the project scope would be
individually deliberated by the Board and the IASB to
determine whether a common high-quality solution could
be identified that would be acceptable to both Boards.
1. Classification of liabilities upon a refinancing
2. Classification of liabilities payable on demand due to
breach of borrowing agreement
3. Voluntary changes in accounting principles
4. Distinction between changes in accounting principles
and changes in accounting estimates
5. Inventories related to idle capacity and spoilage costs
6. Nonmonetary asset exchanges
7. Financial Instruments: disclosure, presentation,
recognition, and measurement
8. Interim reporting
9. Research and development
10. Segment reporting
11. Discontinued operations
12. Costs associated with exit or disposal activities
13. Government grants
14. Depreciation on assets held for disposal or idle assets
17
15. Income taxes
16. Long-term construction contracts
17. Financial reporting in hyperinflationary economies
18. Joint ventures and the proportionate consolidation
method
19. Post-employment benefits
Note 1: Items 1-10 represent issues where the FASB staff
would lead the research and the FASB members would
deliberate the issue first. Items 11-19 represent issues
where the IASB staff would lead the research and their
members would deliberate the issue first.
Note 2: The FASB agreed that segment reporting and
post-employment benefits (listed in bold) will require
more time and will not fit into the short timeframe. Thus,
these two issues will be deleted from the list. Items 1-6
are targeted to be completed for the first Exposure Draft
and the Board agreed also to try to complete items 7-9 for
inclusion.
Potential Agenda Projects
The FASB considered written requests received from
constituents in the past year suggesting that it reexamine
certain effective Statements of Financial Accounting
Standards. With respect to those requests, the Board
decided:
• To direct the staff to explore further the meaning of
the phrase legally released from being the primary
obligor as it is used in various areas of U.S. GAAP
literature and consider the potential scope of a
broader project on debt extinguishment. Both of
those will be discussed at a Board meeting in late
January 2003, with the objective of deciding whether
to add a narrow scope project to the agenda to
interpret the meaning of the phrase and whether to
instruct the staff to develop a proposal for a project
that would address broadly the issue of debt
extinguishments.
• To defer a decision on whether to add a project to its
agenda to reconsider some or all of the current guid-
ance on accounting for stock-based compensation
until February 2003. The Board agreed an agenda
decision should be made after it has reviewed and
analyzed comments received on the FASB Invitation
to Comment, Accounting for Stock-Based Compen-
sation: A Comparison of FASB Statement No. 123,
Accounting for Stock-Based Compensation, and Its
Related Interpretations, and IASB Proposed IFRS,
Share-based Payment.
18 A&A NEWS IN
• Not to add to its agenda a project to reconsider the
accounting for purchased options under FASB
Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities.
• Not to add to its agenda a project to reconsider the
definition of discontinued operations under FASB
Statement No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets.
• To direct the staff to conduct research to more
comprehensively identify perceived deficiencies in
the current accounting and reporting requirements
relating to accounting for pensions and other postem-
ployee compensation costs and approaches to
addressing them.
• Not to add an agenda project to reconsider certain
aspects of the accounting for leases.
• Not to add to its agenda a project on accounting for
executory contracts at this time. However, recogniz-
ing the importance of this issue to several existing
and potential projects (such as revenue recognition
and leasing), the Board directed the staff to com-
mence preagenda research activities related to such a
project as resources permit.
FASB Clearance of AcSEC Documents
Exposure Draft of a Proposed Statement of Position,
Accounting by Insurance Enterprises for Deferred
Acquisition Costs
The Board met with representatives of the AICPA’s
Accounting Standards Executive Committee (AcSEC)
and discussed clearance of the Exposure Draft of a
proposed Statement of Position, Accounting by Insurance
Enterprises for Deferred Acquisition Costs on Internal
Replacements Other Than Those Specifically Described
in FASB Statement No. 97. The Board did not object to
issuance of that Exposure Draft subject to certain changes
being made.
Exposure Draft of a Proposed AICPA Statement of
Position (SOP), Accounting for Real Estate Time-Sharing
Transactions
The Board met with representatives of AcSEC and
discussed clearance of an exposure draft of a proposed
AICPA Statement of Position (SOP), Accounting for Real
Estate Time-sharing Transactions. The Board did not
object to issuance of that exposure draft subject to certain
changes being made.
REVIEW APRIL 1 TO JUNE 30, 2002
In addition, the Board directed the staff to proceed to a
draft of a proposed Statement for vote by written ballot
that would amend FASB Statements No. 66, Accounting
for Sales of Real Estate, No. 67, Accounting for Costs
and Initial Rental Operations of Real Estate Projects,
and No. 135, Rescission of FASB Statement No. 75 and
SEC
Sarbanes-Oxley Section 303: Improper Influence on Audits
On October 21, the SEC published a proposed rule,
Improper Influence on Conduct of Audits, to implement
Section 303 of the Sarbanes-Oxley Act (the “Act”). The
proposed rule would prohibit any officer or director of an
issuer, and persons acting under their direction, from
improperly influencing auditors performing their reviews
and audits of financial statements. The proposed rule
would apply to all public companies, including small
business issuers and foreign private issuers.
Section 303 of the Act requires the SEC to adopt a final
rule by April 26, 2003.
Exchange Act Rule 13b2-2 currently prohibits officers
and directors from directly or indirectly making or caus-
ing to be made a materially false or misleading statement,
or omitting to state any material fact necessary in order to
make statements made not misleading, to the issuer’s
auditor in connection with any audit of the financial
statements or the filing of any Exchange Act document or
report.
The SEC proposal would amend Rule 13b2-2 to also
prohibit officers or directors of the issuer, or any person
acting under the direction thereof, from directly or
indirectly taking any action “to fraudulently influence,
coerce, manipulate, or mislead” the issuer’s auditor “if
that person knew or was unreasonable in not knowing
that such action could, if successful, result in rendering
such financial statements materially misleading.”
The prohibited actions would not be required to have
been successful in affecting the audit or review in order
to violate the proposed rule. The prohibited actions
would include, but not be limited to:
• Offering or paying bribes or other financial incen-
tives (e.g., future employment or service contracts),
• Providing an auditor with inaccurate or misleading
legal analysis,
Technical Corrections, to exclude from each Statement’s
scope the accounting for real estate time-sharing transac-
tions. The accounting for those activities would be sub-
ject to the guidance in the proposed SOP. The FASB
proposed Statement would be issued contemporaneously
with the issuance of the AICPA proposed SOP.
• Threatening to cancel or canceling existing engage-
ments with the auditing firm,
• Seeking to have a partner removed from the audit
engagement because the partner objects to the
issuer’s accounting, and
• Blackmail or physical threats.
The prohibited actions could include, but would not be
limited to, improperly influencing the auditor to:
• Issue an inappropriate audit report, including acquies-
cence to the use of inappropriate accounting or not
proposing necessary adjustments,
• Not perform audit or review procedures that might
identify material misstatements,
• Not withdraw a previously issued audit report when
such withdrawal would be appropriate, and
• Not communicate matters to the audit committee.
The proposing release interprets the phrase “any person
acting under the direction thereof” to encompass a
broader category of behavior than “supervision” and a
broader range of persons than those under the “control”
of the officer or director. For example, the proposing
release indicates that such persons could include not only
employees of the issuer, but also customers, vendors or
creditors who provide false or misleading confirmations
(or other information) to auditors, or who enter into “side
agreements.” Such persons also could include attorneys,
securities professionals, and other advisors (including
other employees of the issuer’s independent auditing
firm, such as consultants or forensic accountants). In the
past, the SEC has brought action against such persons for
improperly influencing the audit under other provisions
of the federal securities laws.
19
The proposing release indicates that the prohibitions
would extend beyond the term of the audit engagement.
That is, the scope of the proposed rule would extend to
the exercise of improper influence over the conditions for
entering into an audit engagement, as well as following
termination of an audit engagement in connection with
providing consents to the use of previously issued audit
reports.
For violations of Exchange Act Rule 13b2-2, the SEC
could bring an administrative action seeking a cease-and-
desist order, or a civil action seeking an injunction and/or
civil money penalties.
Sarbanes-Oxley Section 404: Internal Controls
On October 22, 2002, the SEC published a proposed rule
to implement Section 404 of the Sarbanes-Oxley Act (the
“Act”). The proposed rule would require management of
a public company to present an internal control report in
each annual report. That internal control report would
provide management’s conclusions about the effective-
ness of the company’s internal controls and procedures
for financial reporting as of the end of its fiscal year. The
proposal also would require the company to file a report
from its independent auditor providing an opinion as to
whether management’s assessment is fairly stated in all
material respects. As proposed, management and auditor
reporting on internal control would be required in annual
reports for fiscal years ending on or after September 15,
2003.
In addition, the proposed rule would modify the
management certifications and related disclosures
recently adopted by the SEC under Section 302 of the
Act. Those changes, which would take effect upon the
company’s initial annual internal control report, would
require the quarterly evaluation, and the related disclo-
sure of management’s conclusions as to effectiveness, to
explicitly address internal controls and procedures for
financial reporting, as well as disclosure controls and
procedures. This is consistent with the view expressed by
the SEC that controls over financial reporting are a subset
of the broader concept of disclosure controls and proce-
dures. In addition, the proposed changes would require
management’s evaluation to be performed as of the end
of the fiscal period, as opposed to the current requirement
to perform the evaluation of disclosure controls and
procedures within 90 days of the filing date of the
periodic report. Finally, the proposal would require
periodic reports to disclose all significant changes in
20 A&A NEWS IN
internal controls and procedures for financial reporting
during the period covered by that periodic report.
The proposed rule would require a company’s annual
report to include an internal control report of manage-
ment that includes:
• A statement of management’s responsibilities for
establishing and maintaining adequate internal
controls and procedures for financial reporting,
• Conclusions about the effectiveness of the company’s
internal controls and procedures for financial report-
ing based on management’s evaluation of those
controls and procedures, as of the end of the fiscal
year, and
• A statement that the independent auditor of the
company’s financial statements has attested to, and
reported on, management’s evaluation of the
company’s internal controls and procedures for
financial reporting.
The proposed amendments do not specify the exact
content of the internal control report of management.
According to the proposing release, the SEC believes that
management should tailor the form of the internal control
report to the company’s circumstances. The proposing
release indicates the SEC expects that companies and
their auditors will require substantial time to develop
processes under relevant standards and train appropriate
personnel to assure compliance with the proposed
internal control reporting requirements.
According to the proposing release, the SEC believes
that the purpose of internal controls and procedures for
financial reporting is to ensure that companies have
processes designed to provide reasonable assurance that
(1) transactions are properly authorized, (2) assets are
safeguarded against unauthorized or improper use, and
(3) transactions are properly recorded and reported to
permit the preparation of the registrant’s financial state-
ments in conformity with generally accepted accounting
principles. The SEC believes that these objectives are
embodied in the definition of the term “internal controls”
in the current auditing standards (AU Section 319), and
that such definition is consistent with Section 103 of the
Act. Accordingly, the SEC proposes to refer to AU
Section 319 to define internal controls and procedures for
financial reporting, subject to any subsequent action of
the Public Company Accounting Oversight Board.
REVIEW APRIL 1 TO JUNE 30, 2002
Sarbanes-Oxley Section 406: Code of Ethics
On October 22, 2002, the SEC published a proposed rule
to implement Section 406 of the Sarbanes-Oxley Act (the
“Act”). The proposed rule would require a public
company to disclose annually whether it has adopted a
code of ethics that covers its CEO and senior financial
officers. If so, the issuer would be required to file the
code of ethics as an exhibit. If the issuer has not adopted
such a code of ethics, it would have to disclose why it has
not. In addition, the issuer would be required to report
any changes to its code of ethics, as well as any waivers
granted with respect to those officers.
Section 406 of the Act requires the SEC to adopt a final
rule by January 26, 2003. The rule proposal does not
address any transition provisions. The proposed rule
would apply to all public companies, including small
business issuers and foreign private issuers.
As proposed, annual reports would be required to
disclose, or incorporate by reference disclosure from a
timely-filed proxy statement, whether the company has
adopted a written code of ethics that applies to its princi-
pal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing
similar functions. If the company has not adopted such a
code of ethics, it would have to disclose the reasons it has
not done so. The SEC proposal goes beyond the require-
ments of Section 406 of the Act by including the CEO
within the scope of the disclosure, in addition to the
company’s senior financial officers.
The SEC’s proposed rule also broadens the definition of
“code of ethics” in Section 406 of the Act. As proposed,
“code of ethics” means a codification of such standards
that is reasonably designed to deter wrongdoing and to
promote:
1. Honest and ethical conduct, including the ethical
handling of actual or apparent conflicts of interest
between personal and professional relationships;
2. Avoidance of conflicts of interest, including disclo-
sure to an appropriate person or persons identified in
the code, of any material transaction or relationship
that reasonably could be expected to give rise to such
a conflict;
3. Full, fair, accurate, timely, and understandable
disclosure in reports and documents that a company
files with, or submits to, the Commission and in other
public communications made by the company;
4. Compliance with applicable governmental laws, rules
and regulations;
5. The prompt internal reporting, to an appropriate
person or persons identified in the code, of violations
of the code; and
6. Accountability for adherence to the code.
The proposing release includes the SEC’s view that an
effective code of ethics should describe the company’s
system for internal reporting of code violations and that a
comprehensive code should provide guidelines for
avoiding material transactions or relationships involving
potential conflicts of interest without proper approval.
Otherwise, the SEC proposal does not prescribe specific
language for the code of ethics, procedures for ensuring
compliance, or sanctions for violations. However, a com-
pany with an existing code of ethics would need to assess
whether it satisfies the requirements of the final rule.
Domestic issuers would be required to use Form 8-K to
report within two business days any changes to the code
of ethics and any waivers granted with respect to the
specified officers. The report would be required to briefly
describe the nature of the amendment or waiver, the date
of any waiver and the name of the person to whom the
waiver was granted. As an alternative, a company could
timely report such information on its website, provided
its annual report disclosed that intention and the website
address. In that case, the website disclosure would have
to be maintained on-line for at least 12 months, and the
company would have to retain the disclosures for at least
5 years. A foreign private issuer would be required to
report such changes and waivers in its annual report,
unless it made such disclosures in a Form 6-K or on its
website.
Sarbanes-Oxley Section 407: Disclosure About Audit
Committee Financial Experts
On October 22, 2002, the SEC published a proposed rule
to implement Section 407 of the Sarbanes-Oxley Act
(the “Act”). The proposed rule would require a public
company to disclose annually the number and names of
audit committee members that the board of directors has
determined to be “financial experts,” and whether those
persons are independent. Otherwise, the company would
have to explain why it does not have such an independent
financial expert.
21
Section 407 of the Act requires the SEC to adopt a final
rule by January 26, 2003. The rule proposal does not
address any transition provisions. The proposed rule
would apply to all public companies, including small
business issuers and foreign private issuers.
The scope of the SEC proposal goes beyond the require-
ments of Section 407 of the Act by requiring disclosure
of the number and names of audit committee financial
experts and whether those experts are independent.
Section 407 only required the SEC to adopt disclosure of
whether at least one member of the audit committee is a
financial expert. The proposed disclosures would be
included in the company’s annual report, or incorporated
by reference from a timely-filed proxy statement.
The SEC’s proposed rule also broadens the definition of
“financial expert” in Section 407. As proposed, “financial
expert” means a person who has, through education and
experience as a public accountant or auditor, or a princi-
pal financial officer, controller, or principal accounting
officer of a public company, or experience in one or more
positions that involve the performance of similar func-
tions (or that results, in the judgment of the company’s
board of directors, in the person’s having similar exper-
tise and experience), the following attributes:
a. An understanding of generally accepted accounting
principles and financial statements;
b. Experience applying such generally accepted
accounting principles in connection with the
accounting for estimates, accruals, and reserves that
are generally comparable to the estimates, accruals
and reserves, if any, used in the registrant’s financial
statements;
c. Experience preparing or auditing financial statements
that present accounting issues that are generally
comparable to those raised by the registrant’s
financial statements;
d. Experience with internal controls and procedures for
financial reporting; and
e. An understanding of audit committee functions.
A company would need to assess whether audit members
who are considered “financial experts” under existing
listing standards would satisfy the definition of the final
SEC rule. When applicable, the proposed rule would
require disclosure of the basis for the determination of
the board of directors that an audit committee member
has similar expertise or experience to an auditor, CFO or
22 A&A NEWS IN
controller of a public company, and it provides a list of
factors that the board of directors should consider in
making that evaluation. Any person suspended or barred
from practicing before the SEC generally would not
qualify to be designated as a financial expert.
The proposing release includes the SEC’s view that the
designation of a financial expert should not impose a
higher degree of individual responsibility or obligation on
a member of the audit committee. Also, the SEC does not
intend the designation to decrease the duties and obliga-
tions of other audit committee members or the board of
directors. Further, a “financial expert” would not be
considered an “expert” for purposes of liability under
Section 11 of the Securities Act.
Sarbanes-Oxley Section 401(a): Off-Balance Sheet
Transactions
On November 4, 2002, the SEC issued a proposed rule
to implement Section 401(a) of the Sarbanes-Oxley Act
(the “Act”). The proposed rule would require all public
companies to disclose material off-balance sheet arrange-
ments in a separate section of MD&A. Public companies,
other than small business issuers, also would be required
to provide in MD&A a tabular presentation of their
aggregate contractual obligations (i.e., both on- and off-
balance sheet obligations), as well as either narrative or
tabular disclosure of contingent liabilities and
commitments.
In some cases, the proposed rules go beyond the views
the SEC expressed in FR-61, Commission Statement
about Management’s Discussion and Analysis of Finan-
cial Condition and Results of Operations. For example,
while FR-61 largely addressed arrangements with struc-
tured finance or special purpose entities, the SEC’s
proposed definition of off-balance sheet arrangements
would include residual value guarantees in leasing
arrangements, equity derivatives accounted for as equity
instruments and many loss contingencies. However, the
proposed rules would not codify portions of FR-61
related to either transactions with related and certain
other parties or trading activities involving non-exchange
traded commodity contracts accounted for at fair value.
The rules propose to lower the threshold for MD&A
disclosure relating to off-balance sheet arrangements.
Currently, disclosure in MD&A is required when a
known event, trend or uncertainty is “reasonably likely”
to have a material effect on the company’s financial
condition or results of operations. The proposed rule
REVIEW APRIL 1 TO JUNE 30, 2002
would require MD&A disclosure if the likelihood of the
arrangement having a material effect on the company is
more than “remote.”
Section 401(a) of the Act requires the SEC to adopt a
final rule by January 26, 2003. The rule proposal does not
address any transition provisions. However, calendar
year-end companies should plan to make these disclo-
sures in their 2002 annual report.
Off-Balance Sheet Arrangements
The proposing release defines the term “off-balance sheet
arrangement” as any transaction, agreement or other
contractual arrangement to which an entity that is not
consolidated with the registrant is a party, under which
the registrant, whether or not a party to the arrangement,
has or in the future may have:
• any obligation under a direct or indirect guarantee or
similar arrangement;
• a retained or contingent interest in assets transferred
to an unconsolidated entity, or a similar arrangement;
• derivatives, to the extent that their fair value is not
fully reflected as a liability or asset on the face of
the registrant’s financial statements (e.g., derivatives
that are indexed to the registrant’s own stock and
accounted for as equity instruments); or
• any obligation or liability, including a contingent
obligation or liability, to the extent that it is not fully
reflected on the face of the registrant’s financial
statements (e.g., contingent liabilities, other than
those arising from litigation, arbitration or regulatory
action, that are (1) probable but not reasonably
estimable, or (2) reasonably possible, including loss
exposures beyond a probable amount accrued.)
The proposed disclosure would exclude liabilities
recorded in the financial statements at fair value (i.e., the
amount at which the liability could be settled), even
though the liability ultimately may be settled for a differ-
ent amount (e.g., derivatives, recourse obligations).
Disclosure of the following items would be required in a
separate section of MD&A to the extent necessary for an
understanding of the arrangement:
• nature and business purpose of the arrangement;
• significant terms and conditions of the arrangement;
• nature and amount of the total assets, total obliga-
tions and liabilities (including contingencies) of the
off-balance sheet entities;
• amounts of revenues, expenses and cash flows of the
registrant arising from the arrangements;
• nature and amount of any interests retained, securities
issued and other indebtedness incurred by the regis-
trant; and,
• the nature and amount of any other obligations or
liabilities (including contingencies) of the registrant
arising from the arrangements that are, or may
become, material (e.g., provisions for early payment,
additional collateral support, changes in terms, addi-
tional firm or contingent obligations) and the trigger-
ing events or circumstances that could cause them to
arise (e.g., adverse changes in the registrant’s credit
rating, financial performance or ratios, stock price,
the value of underlying or indexed assets).
Accompanying these disclosures, management would
provide an analysis necessary for an understanding of the
effect of the off-balance sheet arrangement on the regis-
trant’s financial statements. These disclosures could be
quite substantial. The proposed rule allows for the aggre-
gation of similar off-balance sheet arrangements for dis-
closure purposes, but the registrant would be required to
discuss any important distinctions among aggregated
arrangements. Registrants would be required to disclose
the degree to which they rely on off-balance sheet
arrangements for liquidity and capital resources, or
market risk or credit risk support. If it is reasonably likely
that a material off-balance sheet arrangement will be
terminated or materially reduced, the registrant would
be required to describe those circumstances and the
expected effects.
Some of the proposed disclosures would include forward-
looking information. The proposed rules explicitly extend
the statutory safe harbor for forward-looking information
to any forward-looking information that would be
required about off-balance sheet arrangements in MD&A.
Contractual Obligations, Contingent Liabilities and
Commitments
The rule proposal also would require a registrant, other
than a small business issuer, to provide a tabular
summary as of the latest balance sheet date of its aggre-
gate contractual obligations whether on- or off-balance
sheet. These registrants also would be required to sum-
marize contingent liabilities and commitments in either a
23
textual or tabular format. Contractual obligations might
include long-term debt, capital and operating leases,
unconditional purchase obligations and other long-term
obligations. Contingent liabilities and commitments
might include lines of credit, standby letters of credit,
guarantees and standby repurchase obligations.
The tabular presentation for contractual obligations,
which is consistent with that suggested in FR-61, would
require disclosure of payments due in less than one year,
one to three years, three to five years and more than five
years. In addition, footnotes to the table would be
required, if necessary, to describe provisions that create,
increase, or accelerate obligations, and other pertinent
data.
The proposed rule also would require disclosure of
contingent liabilities and commitments that are expected
to expire in less than one year, from one to three years,
from three to five years and more than five years. The
registrant would be required to disclose whether the
amount disclosed is either an expected amount or maxi-
mum amount if a range of amounts is not presented.
Unlike the disclosure of off-balance sheet arrangements
that would be required to be segregated under a separate
caption within MD&A, the summaries of contractual
obligations, contingent liabilities and commitments could
be provided in any MD&A location considered appropri-
ate. As proposed, registrants would not be required to
repeat the new MD&A disclosures in quarterly reports,
but only would be required to disclose material changes
since year-end.
Sarbanes-Oxley Section 401(b): Pro Forma Financial
Information
On November 5, 2002, the SEC proposed rules to imple-
ment Section 401(b) of the Sarbanes-Oxley Act (the
“Act”) pertaining to pro forma financial information. The
proposed rule adopts the term “non-GAAP financial
measures” versus “pro forma financial information” to
eliminate confusion with pro forma disclosures that are
required under existing SEC rules and regulations. The
proposed rule goes beyond the requirements of the Act by
proposing restrictions on the presentation of non-GAAP
financial measures in SEC filings.
As required by the Act, the proposal addresses non-
GAAP financial measures that are included in any public
disclosure, such as a press release. When a company
presents a non-GAAP financial measure, the proposed
rule would require presentation of a numerical recon-
24 A&A NEWS IN
ciliation to the corresponding measurement based on
GAAP. The proposed rules also would explicitly prohibit
the presentation of inaccurate or misleading non-GAAP
financial measures.
For SEC filings, the proposed rules would impose addi-
tional requirements and limitations. For example, a com-
pany would be required to disclose the purpose of a non-
GAAP financial presentation and defend why the com-
pany believes that it would be useful to investors. The
proposed rules also would prohibit, among other things,
the presentation of performance measures excluding
“non-recurring, infrequent or unusual” charges or gains
that are “reasonably likely to recur.”
The proposed rules also would require companies to file
a Form 8-K within two business days of earnings press
releases, regardless of whether they present a non-GAAP
financial measure. The earnings release would be
required to be filed as an exhibit to the Form 8-K. A
material update to an earlier release also would be
required to be reported.
Section 401(b) of the Act requires the SEC to adopt a
final rule by January 26, 2003. The SEC release does not
address a proposed effective date for the new rules.
Definition: The proposed SEC rules would define “non-
GAAP financial measure” as a numerical measure of a
company’s historical or future financial performance,
financial position or cash flows that excludes (includes)
amounts, or is subject to adjustments that have the effect
of including (excluding) amounts, that are included
(excluded) in the comparable measure calculated in
accordance with GAAP used in the financial statements
of the issuer.
As defined, non-GAAP financial measures would not
include certain statistical and operating measures. How-
ever, to the extent that a ratio includes a financial statistic
that is itself a non-GAAP financial measure, the ratio also
would be considered a non-GAAP financial measure. For
example, if “same store sales” were not calculated using
sales revenue determined under GAAP, the statistic
would be considered a non-GAAP financial measure for
purposes of the proposed rules. Similarly, forward-look-
ing information would not be considered a non-GAAP
financial measure as long as the information is deter-
mined using GAAP-based measurement principles.
Public Disclosures: The SEC is proposing a new regula-
tion, Regulation G, which would apply to public disclo-
sures of non-GAAP financial measures other than in
REVIEW APRIL 1 TO JUNE 30, 2002
filings with the SEC. Regulation G would apply to all
public companies, except registered investment compa-
nies. Regulation G would apply to foreign private issuers,
subject to a limited exception.
When a company presents a non-GAAP financial meas-
ure, Regulation G also would require the company to
(a) present the most comparable financial measure
calculated and presented in accordance with GAAP,
and (b) numerically reconcile the non-GAAP financial
measure to that corresponding GAAP measure (unless
such a reconciliation for a forward-looking non-GAAP
financial measure would involve “unreasonable efforts”).
If a non-GAAP financial measure is released orally,
telephonically, in a web cast or broadcast or by similar
means, Regulation G would permit a registrant to comply
by posting the required reconciliation on its website.
The registrant would be required to disclose the location
and availability of the reconciliation as part of its
presentation.
SEC Filings: The proposal also would amend
Regulations S-K and S-B to address the use of non-
GAAP financial measures in filings with the SEC. The
requirements for filed information are proposed to be
more restrictive than those proposed in Regulation G,
and in many cases reflect historical SEC staff positions.
In SEC filings, the presentation of a non-GAAP financial
measure would require:
• a presentation, with equal or greater prominence, of
the most directly comparable financial measure
calculated and presented in accordance with GAAP;
• a quantitative reconciliation (by schedule or other
clearly understandable method) of the non-GAAP
financial measure to the most directly comparable
GAAP measure;
• a statement disclosing the purposes for which the
registrant’s management uses the non-GAAP finan-
cial measure presented; and
• a statement describing the reasons that the registrant’s
management believes such non-GAAP financial
measures provide useful information to investors.
(However, the proposing release states that the
justification for presenting a non-GAAP financial
measure cannot be based solely on its use by, or
usefulness to, financial analysts.)
In presenting non-GAAP financial measures in SEC
filings, the proposed rules would prohibit:
• presenting a non-GAAP financial measure in a
manner that would give it greater authority or promi-
nence than the comparable GAAP financial measure
or measures;
• excluding charges or liabilities that required, or will
require, cash settlement, or would have required cash
settlement absent an ability to settle in another
manner, from non-GAAP liquidity measures;
• adjusting a non-GAAP performance measure to
eliminate or smooth items identified as non-recurring,
infrequent or unusual, when the nature of the charge
or gain is such that it is reasonably likely to recur;
• presenting non-GAAP financial measures on the face
of the registrant’s GAAP financial statements or in
the accompanying notes;
• presenting non-GAAP financial measures on the face
of any pro forma financial information required to be
disclosed by Article 11 of Regulation S-X;
• using titles or descriptions of non-GAAP financial
measures that are the same as, or confusingly similar
to, titles or descriptions used for GAAP financial
measures; and
• presenting a non-GAAP per-share measure.
All Earnings Releases: The rule proposal also would
amend Form 8-K and require registrants to report within
two business days any public announcement or release
disclosing material non-public information about the
company’s results of operations or financial condition for
an annual or quarterly fiscal period that has ended.
Accordingly, earnings or other performance guidance
about a current or future period would not be required to
be reported in a Form 8-K, so long as such guidance is
not provided as part of a release about a completed
period.
Currently, the SEC does not require registrants to issue
earnings releases or similar announcements, and the
proposed rules would not change that. However, commu-
nications about financial performance are, and will
remain, subject to Regulation FD. While the SEC
currently does not require earnings releases to be filed,
some companies have a practice of filing their earnings
releases under Item 5 of Form 8-K. The proposed rules
would add a new item to Form 8-K, which would require
companies to (a) report that an earnings release has
occurred, and (b) file the release as an exhibit.
25
An earnings release included as an exhibit to Form 8-K
would be considered to be filed information and subject
to incorporation by reference in 1933 Act registration
statements. Also, filing false or misleading information
could subject the registrant, corporate management,
directors, or possibly others to civil liabilities as well as
criminal and/or administrative sanctions. The proposed
rule points out that safe harbors may be available under
the Exchange Act to the extent that companies provide
forward looking statements.
Sarbanes-Oxley Section 306: Benefit Plan Blackout Period
Trading Restrictions
On November 6, 2002, the SEC issued a proposed rule,
Insider Trades During Pension Fund Blackout Periods.
Section 306 of the Sarbanes-Oxley Act (the “Act”)
prohibits an issuer’s directors and executive officers from
trading the issuer’s equity securities acquired in connec-
tion with their service or employment during a benefit
plan “blackout period,” as defined. Section 306 of the Act
becomes effective January 26, 2003. Section 306 also
requires the SEC, in consultation with the Secretary of
Labor, to issue rules to clarify and interpret these
restrictions.
The SEC has proposed new Regulation BTR—Blackout
Trading Restriction. The proposed regulation would
apply to all public companies, including foreign private
issuers, banks and savings associations, small business
issuers, and in certain circumstances, registered invest-
ment companies. Special provisions would apply to
foreign issuers.
Under amendments that the SEC proposed in June, a
company would be required to file a Form 8-K within
two business days of becoming aware of an impending
blackout period.
As proposed, the SEC would exempt the following types
of transactions from the Act’s trading prohibition:
• Acquisitions under broad-based dividend and interest
reinvestment plans;
• Transactions under written plans for the future pur-
chase or sale of the company’s equity securities
(under Rule 10b5-1 of the Exchange Act) provided
the plan was not adopted or modified with knowledge
of an impending blackout period;
• Purchases or sales, other than discretionary transac-
tions, pursuant to qualified employee benefit plans
(e.g., purchases under advance payroll withholding
elections); and
26 A&A NEWS IN
• Changes in holdings resulting from a stock split,
stock dividend, or pro rata rights distribution.
Otherwise, the SEC proposal would first attribute any
securities sold or otherwise transferred to any equity
securities acquired in connection with the officer’s
employment or director’s service (including “directors’
qualifying shares” acquired to meet the company’s mini-
mum standards for stock ownership by board members).
That is, the proposed regulation would not allow specific
identification of the source of individual securities sold
or transferred in order to avoid the restrictions and
remedies of the Act.
Regulation BTR also would apply to acquisitions or dis-
positions of equity securities, in which the director or
executive officer has an indirect pecuniary interest, by
immediate family members, partnerships, corporations,
limited liability companies, or trusts. Also, the proposal
would apply to transactions involving derivatives (e.g.,
exercise of an employee stock option, sale or purchase of
a call or put option).
Sarbanes-Oxley Section 302: Management Certification
On November 8, 2002, the SEC’s Division of Corpora-
tion Finance published a “Frequently Asked Questions”
document about certain provisions of the Sarbanes-Oxley
Act of 2002 (the “Act”). The majority of the 28 FAQs
address the management certifications the SEC adopted
in August as required by Section 302 of the Act.
The FAQ clarifies that “some elements of internal
controls” are included in the Exchange Act definition of
“disclosure controls and procedures.” However, the FAQ
does not specify which elements of internal control the
SEC staff considers to fall within disclosure controls and
procedures.
The FAQ makes clear that management should evaluate
the associated portion of internal controls as part of their
periodic evaluation of disclosure controls and procedures.
The SEC staff expects companies generally also would
evaluate the other aspects of internal control (e.g., in
connection with preparing the financial statements or
evaluating compliance with the books and records provi-
sions of Section 13(b) of the Exchange Act).
The FAQ makes clear that the disclosure of significant
changes to internal controls under Item 307(b) of Regu-
lations S-K and S-B applies to all internal controls, not
just internal controls that are part of “disclosure controls
and procedures.” If there have been no significant
REVIEW APRIL 1 TO JUNE 30, 2002
changes to any element of internal controls, the FAQ
states that no disclosure is required under Item 307(b).
The FAQ clarifies that a periodic SEC report may be
filed initially without the required management certifica-
tions, provided those certifications are filed subsequently
in an amendment. However, if the management certifica-
tion were not filed by the report’s due date, the report
would not be considered a timely filing.
The FAQ clarifies that the specified form of the
management certifications may be modified to refer to
the “other certifying officer” when only two officers
provide certifications.
The FAQ clarifies that the CEO and the CFO as of the
filing date must sign the certifications, regardless of the
length of their tenure with the company or in their
respective roles.
The FAQ clarifies that an issuer who only files Exchange
Act reports voluntarily (e.g., in order to comply with a
debt covenant or indenture) must provide the manage-
ment certifications called for by the SEC form, as well
as the disclosures about controls and procedures under
Item 307 of Regulations S-K and S-B.
The FAQ notes that the meaning of “internal controls and
procedures for financial reporting,” “internal controls,”
“significant deficiencies,” and “material weaknesses”
under the SEC’s management certification rules should
be determined by reference to existing generally accepted
auditing standards, including AU Section 319, Consid-
eration of Internal Control in a Financial Statement
Audit, and AU Section 325, Communication of Internal
Control Related Matters Noted in an Audit.
Sarbanes-Oxley Section 307: Professional Responsibilities
of Attorneys
On November 21, the SEC issued a proposed rule to
implement Section 307 of the Sarbanes-Oxley Act (the
“Act”). The proposed rule would prescribe standards of
professional conduct that would require an attorney,
either employed in-house or retained externally, to inform
at least the issuer’s chief legal officer (“CLO”) of any
evidence regarding a material violation of the securities
laws, a material breach of fiduciary duty, or a material
similar violation.
Reporting to the CLO, and perhaps the chief executive
officer (“CEO”) as well, would be required when an
attorney “reasonably believes” that a material violation
is about to occur, is occurring, or has occurred. Upon
notice of a possible violation, the CLO would be
obligated to conduct a reasonable inquiry to ascertain the
facts. If there is evidence of a violation, the CLO also
would be required to take reasonable steps to ensure that
the company (a) adopts appropriate remedial measures
and/or sanctions, and (b) provides appropriate disclosure.
Further, the CLO would be required to report actions
taken in response to the notice “up the ladder” within
the company (i.e., to the CEO, audit committee, or board
of directors).
A reporting attorney who receives an “appropriate
response,” as defined, from the CLO or CEO within a
reasonable time would have satisfied his or her obliga-
tions under the proposed rule. If an appropriate response
is not received within a reasonable time, the reporting
attorney would be required to report the matter “up the
ladder” within the company (i.e., to the company’s audit
committee, a designated committee of the board, or the
full board of directors).
If the reporting attorney does not receive an appropriate
response, the proposed rules would require a reporting
attorney to take additional steps if the attorney reasonably
believes that (a) the suspected violation is occurring or is
about to occur, and (b) the violation is likely to substan-
tially injure the financial interests of investors or the
issuer. In those circumstances, the reporting attorney,
other than an attorney employed by the issuer, would be
obligated to withdraw from representing the issuer and
promptly notify the SEC (a “noisy withdrawal”). In those
circumstances, all reporting attorneys, in-house or out-
side, would be required to disaffirm any SEC filing that
they believe to be materially false or misleading. The
proposed rule would not require the reporting attorney to
take any additional action if the suspected violation has
already occurred and has no ongoing effect.
Section 307 of the Act requires the SEC to adopt a final
rule by January 26, 2003.
The proposed rule would cover any attorney “appearing
and practicing before” the SEC. This term is broadly
defined to include attorneys participating in the process
of preparing or presenting reports, filings, submissions or
communications to the SEC and also attorneys represent-
ing an issuer during the course of an investigation or
inquiry conducted by the Commission. The scope of the
proposed rule would include in-house legal counsel,
attorneys in foreign jurisdictions, and attorneys retained
by a company to investigate evidence of a possible viola-
tion. Under the proposal, a supervising attorney (includ-
ing the CLO) would be obligated to make reasonable
27
efforts to ensure a subordinate attorney complies with the
proposed rules. A reporting attorney would be obligated
to document his/her findings to the CLO and retain such
documentation for a “reasonable” period of time.
The proposed rule explicitly states that an attorney is
obligated to act in the best interests of the issuer (and its
shareholders), which the attorney represents, rather than
the officers or employees with whom the attorney inter-
acts with during the course of providing services. The
proposed rule would not apply to an attorney who repre-
sents officers or directors of an issuer, as individuals.
An issuer may, but would not be required, to establish a
“qualified legal compliance committee” (“QLCC”)
consisting of at least one member of the audit committee
and at least two independent members of the board of
directors. A standing QLCC would receive reports from
the CLO or directly from a reporting attorney. Where the
issuer has established a QLCC, the attorney who reports a
material violation to the QLCC would not be required to
take further action. The QLCC, however, would be
required to conduct an appropriate inquiry; notify the
board, CLO and CEO of the results of the inquiry and
recommended remedial actions; and notify the Commis-
sion of the material violation if the issuer fails to take the
recommended remedial action. Also, a CLO who receives
a report of a material violation could refer the report to
the QLCC in lieu of conducting his or her own inquiry.
The proposed rule provides that the attorney/client privi-
lege would not be violated when the SEC is notified of a
material violation. Further, an attorney would be permit-
ted to reveal confidential information to the SEC to the
extent necessary to prevent an illegal act or perpetration
of fraud. Finally, an issuer would not waive any applica-
ble privileges by sharing confidential information with
the SEC regarding misconduct under a confidentiality
agreement.
Sarbanes-Oxley Section 802: Record Retention by
Auditors
On November 21, 2002, the SEC issued a proposed rule
to implement Section 802 of the Sarbanes-Oxley Act (the
“Act”). The proposed rule would require accountants
who audit or review an issuer’s financial statements to
retain specified records for a period of five years from the
end of the fiscal year in which an audit or review was
concluded.
In the proposing release, the SEC acknowledges that
Section 103 of the Act directs the Public Company
28 A&A NEWS IN
Accounting Oversight Board to require auditors to retain
audit workpapers for seven years. However, at this time,
the SEC is only proposing a five- year retention require-
ment as specified in Section 802 of the Act.
Section 802 of the Act requires the SEC to adopt a final
rule by January 26, 2003. The proposing release does not
specify a proposed effective date for the new rule, but we
expect that compliance with Ernst & Young’s current
retention of records policies should satisfy the final rule.
The proposed rule would apply to the audits and reviews
of all companies that file reports with the SEC or that
have filed a 1933 Act registration statement. Accord-
ingly, the proposed rules would apply to auditors of for-
eign private issuers and registered investment companies.
Sarbanes-Oxley—Title II—Auditor Independence
On December 2, 2002, the SEC made public its rule
proposals on auditor independence that are available on
the SEC’s website (www.sec.gov). The 100+ page release
will be published in the Federal Register, and will be
subject to a 30-day comment period ending on or about
January 7, 2003. The Act requires that the rulemaking be
finalized by January 26, 2003.
The rulemaking deals with non-audit services, disclosure
of fees paid to auditors, audit committee pre-approval of
services, partner rotation, certain reports to audit commit-
tees, employment by clients of members of the audit
team, and, although not required by the Act, a prohibition
on compensation to a partner on the audit engagement
team based on non-audit service revenue. With respect to
effective dates and transition provisions, the proposal is
not specific. However, it appears that the intent is to have
certain parts of the proposal go into effect upon adoption
of the final rules, while other parts of the proposal would
have delayed effective date(s) to provide for an orderly
transition as a result of the new requirements imposed by
the proposals. For example, based on the wording of the
rulemaking release and on discussions with the SEC staff,
we believe that the required implementation dates for
partner rotation, to the extent that the final rules exceed
the statutory requirements, will be substantially extended
to allow for a staggered implementation over a period of
as much as a couple years.
With respect to non-audit services, the SEC’s existing
rules prohibit bookkeeping, appraisal and valuation, actu-
arial, and legal services, but have certain exceptions to
those prohibitions. The SEC proposal would eliminate
those specific exceptions, but would not preclude certain
REVIEW APRIL 1 TO JUNE 30, 2002
services within these categories that did not violate
certain principles (i.e., not auditing the firm’s own work,
not performing management functions, and not acting as
an advocate for the client). For example, bookkeeping,
valuation and actuarial services where it is not reasonably
likely that the results of such services will be subject to
audit procedures during the audit, such as valuations done
for non-financial reporting purposes, continue to be per-
mitted. There would be no significant change in the rules
regarding management functions, human resources
(which are basically executive-recruiting type services),
broker-dealer, investment adviser, or investment banking
services. As expected, internal audit outsourcing and
financial information system design and implementation
would be prohibited. With respect to expert services, the
proposal would restrict providing expert opinions or act-
ing as an advocate for an audit client in connection with
legal, administrative or regulatory proceedings. Impor-
tantly, the rulemaking release emphasizes: “Nothing in
these proposed rules is intended to prohibit an accounting
firm from providing tax services to its audit clients when
those services have been pre-approved by the client’s
audit committee.”
Section 202 of the Act requires the issuer’s audit commit-
tee, or one or more designated members, to pre-approve
all audit and permitted non-audit services. Section 202
also requires the issuer to disclose approved non-audit
services in periodic reports. The SEC rule proposals do
not set forth specific pre-approval procedures, but instead
require that issuers either (1) expressly pre-approve
specific engagements or (2) adopt detailed pre-approval
policies and procedures. In the latter case, the proposal
indicates that the audit committee should be informed of
each service rendered pursuant to such policies and pro-
cedures on a timely basis.
The proposed rules would revise the proxy fee disclo-
sures to show the following four categories for the two
most recent fiscal years (instead of the most recent year
as currently required). The SEC will consider whether
retroactive disclosure would be required in the initial
year. The categories are:
• Audit Fees
• Audit-Related Fees
• Tax Fees
• All Other Fees
Registrants would describe the nature of services pro-
vided that are categorized as Audit-Related and All Other
Fees categories. The Audit Fees category would be
expanded to include not only direct fees for audit and
review services, but other services that only the issuer’s
auditor can reasonably provide (such as comfort letters,
statutory audits, consents, Section 404 attest reports on
internal accounting controls, and assistance with review
of documents filed with the SEC). Audit-related fees
would include assurance and related services that are
traditionally performed by the independent accountant.
More specifically, these services would include, among
others: employee benefit plan audits, due diligence
related to mergers and acquisitions, accounting assistance
and audits in connection with proposed or consummated
acquisitions, internal control reviews, and consultation
concerning financial accounting and reporting standards.
The audit committee’s policies and procedures for pre-
approving audit and non-audit services would be dis-
closed in the proxy together with the related fee disclo-
sure. To meet the statutory requirement for disclosure of
pre-approvals in periodic reports, the disclosure of the
audit committee’s policies and procedures would be
required in the annual report on Form 10-K (Part III
which can be incorporated by reference from the proxy).
Section 203 of the Act requires that the partner in charge
of the audit and the independent reviewer must rotate off
the engagement after five years of service in that role.
The proposed rules would exceed the requirements of the
Act by requiring that all partners on the audit engagement
team for the issuer or any significant subsidiary (i.e., one
that accounts for 10% or more of the assets or income of
the registrant) providing audit, review or attest services in
each of the five previous fiscal years to rotate. Once
rotated off, there would be a five-year cooling-off period.
The rulemaking release indicates that partners who are
involved on a continuous basis in the audit of material
balances in the financial statements would be subject to
the rotation requirement. For example, actuarial special-
ists who assist in auditing the loss reserves for an insur-
ance company would be subject to the rotation rules.
Partners providing only tax services to the audit client
would not be subject to the rotation rules but those
involved in auditing tax provisions and related accounts
would be subject to the rotation rules.
With respect to the SEC’s investment company complex
rules, the proposal indicates that the complex would be
treated as one audit client for purposes of the rotation
29
rules. Therefore, partners could not rotate between enti-
ties within the investment company complex beyond a
five-year period.
Sections 204 and 206 which deal with various reports to
audit committees and restrictions on employment with
audit clients by members of the audit engagement team.
Ernst & Young submitted a public comment letter to
the SEC on auditor independence on January 6, 2003.
(The letter is available on the SEC’s website, and on
Ernst & Young Online.)
Public Companies Accounting Oversight Board (PCAOB)
On October 25, 2002, the SEC announced the appoint-
ment of the five members of the new Public Company
Accounting Oversight Board (“PCAOB”):
• William H. Webster, Chairman (2007)– former
director of the FBI and CIA (subsequent to the
appointment, Mr. Webster resigned)
• Daniel L. Goelzer (2006)– former SEC general
counsel;
• Kayla J. Gillan (2005)– former general counsel of
CalPERS;
• Willis D. Gradison Jr. (2004)– former U.S. represen-
tative from Ohio; and
• Charles D. Niemeier (2003)– current chief account-
ant of the SEC’s Division of Enforcement.
As required by the Sarbanes-Oxley Act (the “Act”), the
SEC appointed the PCAOB members following consul-
tation with the Chairman of the Federal Reserve and the
Secretary of the Treasury. The initial PCAOB members
will be appointed for staggered five years terms, which
expire as indicated above.
Section 101 of the Act mandated the establishment of the
PCAOB to oversee the audit of public companies. The
PCAOB is charged with establishing auditing, quality
control and independence standards. The PCAOB also
will perform periodic inspections of registered public
accounting firms, as well as investigations of potential
violations and related disciplinary proceedings. Under the
Act, the SEC must approve that the PCAOB is opera-
tional by April 26, 2003, after which auditors of public
companies have 180 days to register with the PCAOB.
Webster, 78, currently is a senior partner in the
Washington office of Milbank, Tweed, Hadley &
McCloy LLP, which he joined in 1991. From 1987 until
30 A&A NEWS IN
1991, Webster served as Director of Central Intelligence,
and from 1978 to 1987 he served as Director of the
Federal Bureau of Investigation. Previously, Webster
served as Judge of the U.S. Court of Appeals for the
Eighth Circuit (1973-78), Judge of the U.S. District Court
for the Eastern District of Missouri (1970-73), and U.S.
Attorney for the Eastern District of Missouri (1960-61).
(Note: Subsequently Judge Webster resigned as
Chairman of the new PCAOB).
Goelzer currently is a partner in the Washington office of
Baker & McKenzie. Previously, he served as the general
counsel of the U.S. Securities & Exchange Commission
(1983-90). Goelzer also is an accountant.
Gillan, 43, joined the California Public Employees’
Retirement System in 1986, and served as general coun-
sel from 1996 until 2002. Recently, she left CalPERS to
serve as vice president of Independent Fiduciary Services
in Washington, D.C.
Gradison, 73, currently is a senior public policy coun-
selor in the Washington office of Patton Boggs LLP,
which he joined in 1999. From 1993 until 1999, Gradison
served as president of the Health Insurance Association
of America. From 1975 until 1993, Gradison served in
the U.S. House of Representatives.
Niemeier, 45, currently serves as the chief accountant in
the Division of Enforcement of the U.S. Securities &
Exchange Commission, a position he has held since 2000.
Previously, Niemeier had been a partner in the
Washington office of Williams & Connolly LLP, which
he joined in 1989. Before that, Niemeier had practiced as
a certified public accountant since 1979.
Bush Nominates Bill Donaldson To Chair the SEC
On December 10, 2002 President Bush nominated
William (Bill) H. Donaldson to be Chairman of the SEC,
subject to Senate confirmation. Donaldson co-founded
the investment banking firm Donaldson, Lufkin &
Jenrette and previously served as Chairman and CEO of
the New York Stock Exchange.
Donaldson currently serves as chairman and chief
executive officer of Donaldson Enterprises, a private
investment company that he founded in 1981. In April
2001, Donaldson retired as chairman, president and chief
executive officer of Aetna. Prior to joining Aetna in
2000, Donaldson had served as Senior Advisor of
Donaldson, Lufkin & Jenrette since September 1995.
From 1990 to 1995, Donaldson served as chairman and
chief executive officer of the New York Stock Exchange.
REVIEW APRIL 1 TO JUNE 30, 2002
Donaldson was the founding Dean of Yale University’s
the Graduate School of Organization and Management
and held a tenured chair as the William S. Beinecke
Professor of Management from 1975 to 1980. He served
during 1975 as counsel to Vice President Nelson
Rockefeller, and he served as United States Undersecre-
tary of State under Henry Kissinger from 1973 to 1975.
Donaldson co-founded the investment banking firm
Donaldson, Lufkin & Jenrette in 1959, and served as
chairman and chief executive officer of the firm.
Donaldson also co-founded the firm’s subsidiary,
Alliance Capital Management Corporation, and served as
its chairman and chief executive.
Donaldson served in the U.S. Marine Corps from 1953 to
1955. He received a BA from Yale University and an
MBA with Distinction from Harvard Business School. He
is a Chartered Financial Analyst (CFA). Donaldson
serves as a director or trustee of a number of civic and
philanthropic organizations.
2002 SEC Conference Compendium Now Available
Ernst & Young’s compendium summarizing the remarks
made by SEC officials at the 30th Annual AICPA
National Conference on Current SEC Developments is
now available. The three-day program, held December
11-13, 2002 in Washington, D.C., featured presentations
and panel discussions by senior SEC officials, FASB
representatives, a newly appointed member of the Public
Company Accounting Oversight Board, and leading
accounting professionals. Below is a summary of
important matters that were discussed by SEC officials at
the Conference:
Final Rule on MD&A Disclosure of Critical Accounting
Estimates Deferred to 2003
The SEC staff indicated that the SEC will not issue a
final rule related to its proposal, Disclosure in Manage-
ment’s Discussion and Analysis about the Application of
Critical Accounting Policies, in time to be effective for
2002 Form 10-Ks. However, the SEC staff still expects
MD&A to discuss critical accounting estimates in
response to FR-60, Cautionary Advice Regarding Disclo-
sure About Critical Accounting Policies.
The SEC staff expressed general disappointment with
MD&A disclosures provided last year in response to FR-
60. In many cases, companies simply repeated portions of
their significant accounting policy footnote in MD&A.
The SEC staff directed companies to the SEC’s rule pro-
posal on critical accounting estimates for clarification
about the intent and objectives of FR-60.
SEC Staff Expects More Detailed Accounting Policy
Disclosures in Footnotes
The SEC staff believes that companies should provide
more detailed explanations of their significant accounting
policies, particularly with respect to revenue recognition
and consolidated financial reporting.
Revenue Recognition: The SEC staff expects accounting
policy disclosures to cover the revenue recognition poli-
cies for all material revenue streams. The SEC staff also
called for greater specificity in revenue recognition pol-
icy disclosures (e.g., acceptance provisions, methods of
allocating revenue in multiple element arrangements, the
basis for conclusions with respect to gross versus net
presentation of revenues). The SEC staff provided the
following questions that a company should ask when
preparing its revenue recognition accounting policy
disclosure:
• Does it address all material sources of income?
• Are the sources identified consistent with those
discussed in the business section of the filing?
• Have explicit or implicit conditions, contingencies, or
circumstances been described that would impact the
timing and amount of revenue recognized?
• Is the accounting policy description sufficiently
precise?
Basis of Presentation/Consolidation: In the “basis of
presentation” or “consolidation” accounting policy dis-
closure, the SEC staff believes that better disclosures are
needed about both “50% or less owned” entities and
“special purpose” entities. The SEC staff noted that for
“50% or less owned” entities, a company should describe
its equity and voting rights and why it believes it either
does or does not have significant influence over that
entity. With respect to “special purpose” entities, the SEC
staff stated the need to address the conditions under
which a company consolidates or does not consolidate
such entities.
SEC Staff Challenges Segment Reporting Under
FAS 131
The SEC staff continues to see circumstances where, in
its view, FASB Statement No. 131, Disclosures about
Segments of an Enterprise and Related Information, has
not been applied properly. The most common issue iden-
31
tified was the inappropriate aggregation of operating
segments. The SEC staff noted that two common rebut-
tals companies use when defending their determination of
reportable segments are “competitive harm” and “consis-
tency with competitors.” The SEC staff noted that the
FASB considered the argument of competitive harm and
rejected it in paragraph 111 of Statement 131. Further-
more, the SEC staff indicated that consistency with com-
petitors is not relevant since compliance with Statement
131 is based on how management runs its business and
not on how competitors manage their businesses.
Revenue Recognition—Accounting for “Breakage” of
Nonrefundable Fees
The SEC staff has recently addressed a number of
arrangements where a customer makes a nonrefundable
cash payment in exchange for goods or services to be
delivered at a future unspecified date. Revenue is
deferred in these transactions because performance is not
typically within the control of the vendor. In many such
arrangements, delivery will not occur until the customer
takes some future action. Further, there are instances
where a customer either will not require any
performance, or will require less than the maximum
performance to which they are entitled. The SEC staff
refers to this as “breakage.”
No Performance Required: The SEC staff addressed
arrangements where an individual customer ultimately
does not require performance. An example would include
a company that issues gift certificates, which do not
expire, are not refundable, and are not subject to
escheatment. Because some holders of gift certificates
may never redeem them, no performance will be required
for those gift certificates. FASB Statement No. 140,
Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities, specifies that a
liability may be derecognized only when the obligor is
legally released from its obligation, which theoretically
could result in the deferral of nonrefundable payments
forever. If the vendor lacks the legal mechanism to be
released from its obligation and the vendor has sufficient
customer experience, the SEC staff would not object to
derecognizing the liability by analogy to FASB Statement
No. 5, Accounting for Contingencies, when it is remote
that the customer will require performance. The SEC
staff also has not objected to this conclusion where the
identification of individual customers was not possible,
but, where there is a large pool of homogeneous transac-
tions, and the amount of breakage may be reasonably,
32 A&A NEWS IN
reliably, and objectively determined. In these circum-
stances, breakage may not be recognized at inception of
the arrangement but, rather, at the point when it becomes
remote that performance will not be required for an esti-
mable portion of the transactions in the pool.
In these circumstances, because the recognition of break-
age with respect to non-refundable deposits is not associ-
ated with vendor performance, the SEC staff stated that
breakage should not be recorded as revenue but should be
reported as a gain.
Performance Required at Less than the Maximum
Contractual Obligation: The SEC staff also addressed
arrangements where a customer makes a nonrefundable
cash payment in exchange for goods or services, but does
not require full performance under the terms of the
contractual arrangement. In these arrangements, the SEC
staff has not objected to vendor recognition of revenue,
with respect to the portion of the non-refundable payment
related to contractual elements which will not be
performed, over the greater of the expected term of the
arrangement or the expected period of performance of the
other contractual elements, provided the vendor has
sufficient experience (i.e., a large pool of homogeneous
historical transactions) and the amount of breakage can
be reasonably, reliably, and objectively determined. In
this type of arrangement, the SEC staff indicated that
breakage may be recorded as revenue since it is associ-
ated with vendor performance of some elements of the
arrangement.
SEC Staff Expects Income Statement Presentation by
Products and Services
The SEC staff continues to evaluate whether income and
expenses are appropriately classified according to their
character or nature as required by Regulation S-X.
Product and service revenues and their related costs
should be separately stated on the face of the income
statement, pursuant to Rules 5-03.1 and 5-03.2 of
Regulation S-X, to allow investors the ability to calculate
a measure of gross margin or loss for each product or
service category. For example, cellular phone sales (i.e.,
product sales revenue) should be separated from sales of
cellular airtime (i.e., service revenue). However, the SEC
staff observed that in certain circumstances the presenta-
tion of gross margin or loss may be misleading (e.g.,
instances where there is no cost of sales related to a par-
ticular revenue source, or where for a particular revenue
source separating the cost of sales from operating
expenses is impracticable). In these circumstances, a one-
REVIEW APRIL 1 TO JUNE 30, 2002
step income statement format that excludes any measure
of gross margin or loss would be more appropriate.
SEC Staff Challenges Pension Returns and MD&A
Pension Disclosures
In light of the recent performance of the equity markets
and investor concerns about pension accounting, the SEC
staff reminded companies to consider MD&A disclosures
about pension accounting assumptions and practices. The
SEC staff encouraged companies to challenge the appro-
priateness of their significant pension assumptions,
particularly the expected long-term rate of return on plan
assets. The SEC staff also encouraged companies to
discuss in MD&A the uncertainties associated with the
underlying significant estimates, and the potential for
material impacts on either the results of operations or
cash flows (e.g., additional pension plan funding, whether
expected or required). MD&A disclosure considerations
should include whether the expected return on plan assets
was based on the fair value or calculated value of plan
assets, the impact on future pension expense or income of
net unrealized gains/losses, whether the arithmetic or
compound method is used to calculate the expected
return on plan assets, reasonably likely changes in the
expected long-term rate of return assumption, assumed
asset allocation and the sensitivity of pension expense or
income to changes in the expected long-term rate of
return.
The SEC staff indicated that the starting point for esti-
mating the expected long-term rate of return on plan
assets should be the historical rate of return that a portfo-
lio with a similar asset allocation would have earned. In
this regard, the SEC staff noted that a study from 1926
through September 2002 indicated a portfolio comprised
primarily of U.S. equity securities had a historical aver-
age annual return of 10%, while a portfolio comprised
primarily of U.S. debt securities averaged 6% annually.
By implication, the SEC staff suggested that the expected
rate of return should fall somewhere within that range,
depending on the composition of the plan’s investment
portfolio. The SEC staff indicated that it likely would
challenge expected rates of return in excess of 9%.
SEC Staff Addresses Accounting for Goodwill
Impairment
Changes in Annual Testing Date: Paragraph 26 of State-
ment 142 requires the annual assessment of goodwill
impairment to be performed as of the same date each
year for the respective reporting units. The SEC staff
addressed the issue of whether a company could change
a reporting unit’s annual date for testing goodwill for
impairment. The SEC staff does not believe that the
FASB intended for the annual assessment date to be so
rigid that it could not be changed. As a result, the SEC
staff does not consider this type of change to be a change
in accounting method, which otherwise would require a
preferability letter from the company’s auditor. However,
in the SEC staff’s view, if a company elects to change a
reporting unit’s annual goodwill impairment testing date,
the time period between assessments cannot exceed
twelve months and the change cannot be made with the
intent to either “accelerate or delay” an impairment
charge.
Period of Recognition: The SEC staff also noted that
questions have arisen as to the timing of recording a
goodwill impairment charge as a result of performing an
annual impairment assessment. For example, if a calendar
year company’s assessment date is January 1 and the
assessment indicates an impairment charge must be
recorded as of January 1, 2003, in what period should the
impairment charge be recorded—the first quarter of 2003
or the fourth quarter of 2002? In these circumstances, the
SEC staff noted that a company should assess whether
events or circumstances (see paragraph 28 of Statement
142) indicated that an interim impairment test should
have been performed as of the balance sheet date (i.e.,
December 31, 2002 in the example above). If so, the SEC
staff would expect the impairment to be recorded under
the interim impairment test (i.e., the fourth quarter of
2002 in the above example). Regardless of which period
the impairment charge is recorded, the SEC staff would
expect informative disclosure in MD&A.
Interim Impairment Testing: The SEC staff noted that
questions have arisen in practice as to whether a decline
in the market value of a company’s equity securities
might suggest that an interim assessment of goodwill
impairment would be required, even though this type of
event is not specifically included in the list of events and
circumstances included in paragraph 28 of Statement 142.
The SEC staff noted that this circumstance may or may
not require an interim test for goodwill impairment. In
order to conclude whether an interim impairment assess-
ment would be required under paragraph 28, the SEC
staff stated that a company should consider the underly-
ing reasons for the decline in the value of the securities
(e.g., adverse change in the business climate, an adverse
change by a regulator) as well as the significance of the
decline and the length of time the securities were trading
at a depressed value.
33
Impairment Immediately Following Acquisition: The
SEC staff addressed the question of whether it would be
possible to have an immediate impairment of goodwill of
an acquired business either on or shortly after the con-
summation of a business combination. The question has
arisen in practice where the fair value of an acquired
business at the consummation date may be less than the
fair value assigned to consideration issued in the
purchase, particularly as a result of EITF 99-12, “Deter-
mination of the Measurement Date for the Market Price
of Acquirer Securities Issued in a Purchase Business
Combination.” Alternatively, a decline in the fair value of
an acquired business may occur after the business combi-
nation due to other factors. The SEC staff noted that,
while not impossible, they would expect it to be infre-
quent to have an impairment of goodwill either on or
shortly after the consummation date. The SEC staff indi-
cated that, in their view, goodwill from an acquisition
should not be tested for impairment prior to “integrating”
the newly acquired business into the appropriate report-
ing units of the acquirer. In order to test goodwill from an
acquisition before the next annual assessment date, the
SEC staff would expect a company to document the
underlying events and changes in circumstances that
contributed to the decrease in fair value of the respective
reporting unit(s) below its (their) carrying value (i.e.,
indications of a required interim assessment for goodwill
impairment, such as a significant change in expected cash
flows between the measurement date and the consumma-
tion date, or the subsequent assessment date). The SEC
staff indicated that it would expect those events and
circumstances to involve more than simply a decline in
the market value of the stock issued in the purchase
transaction.
SEC Staff Views on Other-Than-Temporary
Impairment of Debt Securities
With respect to other-than-temporary impairments of
marketable debt securities, the SEC staff stated that, in
general, a decline in the market value of a debt security
that is solely attributable to an increase in market interest
AcSEC
Chairman’s Report—Transition of Certain Projects to the
FASB
The FASB Chairman in an early November speech to a
major financial reporting conference indicated that sig-
nificant changes were going to occur with the roles of
34 A&A NEWS IN
rates would not trigger an other-than-temporary impair-
ment charge if the holder intends and has the ability to
hold the debt security until recovery. The SEC staff
stated that if a debt security is exposed to credit risk (i.e.,
if the issuer of the debt security is other than the U.S.
government), the company would be required to demon-
strate through objective evidence that the decline in the
market value of the debt security was solely attributable
to an increase in interest rates, in order to avoid recogni-
tion of an other-than-temporary impairment.
The SEC staff also pointed out that the considerations
discussed above relate to direct investments in debt
securities, and as such, would not be applicable when
evaluating an investment in a mutual fund that holds debt
securities (i.e., a bond fund). The SEC staff believes that
an investment in a bond fund should be evaluated for
other-than-temporary impairment similar to a marketable
equity security. The SEC staff stressed that a company
could not assert that it intends and has the ability to hold
the underlying investments in a bond fund until their
value recovers, because those decisions are solely within
the control of the fund manager, not the investor.
SEC Staff Wants Full Compliance with FAS 140
Disclosures About Securitizations
The SEC staff emphasized that securitization disclosures
(e.g., accounts receivable securitizations) should ade-
quately describe the securitization activity and the degree
of potential risk retained by the company. The SEC staff
noted that some companies have argued that the retained
interest sensitivity disclosures required by paragraph 17g
of Statement 140 are not meaningful because the assets
are already carried at fair value and because the disclo-
sures place undue emphasis on a single balance sheet
estimate (i.e., valuation of retained interests in a securiti-
zation). The SEC staff stated that it, as well as the FASB
staff, is not sympathetic to this view when securitization
activity and the associated retained interests are material.
The SEC staff reminded companies to provide all of the
disclosures required by paragraph 17 of Statement 140.
AcSEC and the EITF and their relationships with the
FASB. With the move towards principles-based stan-
dards, coupled with the need to work more closely with
the IASB, the FASB believed there was a need to require
the consolidation of U.S. standard-setting authority
REVIEW APRIL 1 TO JUNE 30, 2002
within one body: the FASB. In light of the accounting
and auditing developments over the past year, the FASB
also noted the desire to bring clarity to the potential
confusion and complexity of the literature caused by the
number of standard-setting organizations and the various
types of accounting guidance produced by those various
standard-setting organizations. Therefore, after a transi-
tion period to allow AcSEC to complete certain projects,
the FASB requested that AcSEC cease issuing Statements
of Position. The AICPA and AcSEC would still be
responsible for the various industry Accounting and
Auditing Guides. The extent to which such guides would
contain industry-specific implementation accounting
guidance remains an issue that AcSEC and the FASB
expect to resolve on a case-by-case basis. Changes in the
operations of the EITF were announced at the November
21, 2002 EITF meeting.
AcSEC performed a comprehensive review of projects
currently on its agenda, as well as projects that had been
set-aside for future consideration, in order to determine
which projects should remain on AcSEC’s agenda and
completed during the transition period and those that
should be transitioned to the FASB. In discussing a
transition plan with the FASB, AcSEC considered the
following:
• AcSEC’s current agenda includes projects for which
constituents have expressed a need for guidance. The
projects should be addressed by either AcSEC or the
FASB, but not dropped completely by either body.
AcSEC recognizes for projects transitioned to the
FASB that there would be competing demands for
such projects to be added to the FASB’s agenda.
• As much as possible, AcSEC projects that could be
completed before the end of 2003 should be
completed by AcSEC. Handing projects over to the
FASB that have already been exposed by AcSEC
could create an undue delay in finalizing the project
because the FASB would need to expose the guid-
ance as an FASB document due to the FASB’s rules
of procedures.
In November, members of the Planning Subcommittee
(“PSC”) met with the FASB staff to discuss the transition
of projects and agreed to the following transition plan:
1. Projects to be completed by AcSEC (SOPs to be
completed and document issuance targeted by end of
2003):
— Accounting for Derivative Instruments and Hedg-
ing Activities by Not-for-Profit Health Care
Organizations, and Clarification of the Perform-
ance (SOP—to be issued December 27, 2002)
— Accounting for Loans or Certain Debt Securities
Acquired in a Transfer (SOP)
— Non-traditional long duration insurance contracts
(SOP)
— DAC on internal replacements (SOP)
— Investment companies guide scope clarification
(SOP)
— Nonpublic investment partnership and separate
account financial highlights issues (SOP)
— Potential amendment to SOP 93-7 for direct
response advertising (SOP)
— Valuation of privately held company equity
securities issued in other than a business combi-
nation (AICPA Practice Aid)
— Financial institutions and lending guide (Audit
Guide)
2. Projects for which AcSEC will issue an Exposure
Draft but the FASB rather than AcSEC may assume
the project depending on issues raised in the
comment letters and FASB progress on its revenue
recognition project:
— Allowance for loan losses
— Accounting for real estate time-sharing
transactions
3. Projects to be discontinued by AcSEC and transi-
tioned by the FASB:
— Accounting for Certain Costs and Activities
Related to Property, Plant, and Equipment (in
progress by AcSEC-but see subsequent discus-
sion in which FASB staff indicated that the
FASB may be receptive to AcSEC concluding
certain narrow portions of the project)
— Blockage factor discounts (in progress by
AcSEC)
— Equity method investments
— Accounting for certain customer acquisition costs
— Insurance purchase accounting
Regarding those projects in category (2), the FASB staff
noted that issuance of a final SOP will depend on the
nature of issues raised in the comment letters, as well as
the progression of current FASB projects. For instance,
35
the FASB may not want AcSEC to proceed to a final SOP
for accounting for real estate time-sharing transactions if
the FASB has made significant progress on its revenue
recognition project.
For projects in category (3) that are currently in progress
by AcSEC, AcSEC will wrap up its discussions and pro-
vide the FASB with its work product regarding the direc-
tion of the projects (see below for further information).
AcSEC also discussed the need to update the approxi-
mately 25 industry accounting and auditing guides.
Because updating the guides usually does not require
creating new accounting guidance, but rather interpreting
existing guidance, it does not appear to be in conflict
with the FASB’s desire to have one general purpose
standard-setter. However, to the extent that the need
would arise, the extent to which the guides would contain
new accounting guidance would be discussed with the
FASB on a case-by-case basis. The need for additional
industry guides will also be assessed.
Final Statements
Accounting for Derivatives in Not-For-Profit Entities
At the November 6, 2002 meeting, the FASB cleared for
final issuance the AICPA’s Accounting Standards
Executive Committee’s (AcSEC’s) proposed SOP,
Accounting for Derivative Instruments and Hedging
Activities by Not-for-Profit Health Care Organizations
and Clarification of the Performance Indicator.
At the end of December, AcSEC issued SOP 02-2. This
SOP requires the following:
• Not-for-profit health care organizations should apply
the provisions of Statement 133 (including the provi-
sions pertaining to cash flow hedge accounting) in
the same manner as for-profit enterprises.
• Not-for-profit health care organizations should
provide all the disclosures required by paragraph 45
of Statement 133, including disclosures related to
reclassifications into earnings of gains and losses that
are reported in accumulated other comprehensive
income. Although those organizations are not other-
wise required to report changes in the components of
comprehensive income pursuant to paragraph 26 of
FASB Statement No. 130, Reporting Comprehensive
Income, such organizations should separately dis-
close the beginning and ending accumulated deriva-
tive gain or loss that has been excluded from the
performance indicator (earnings measure), the related
36 A&A NEWS IN
net change associated with current period hedging
transactions, and the net amount of any reclassifica-
tions into the performance indicator in a manner
similar to that described in paragraph 47 of Statement
No. 133.
The SOP also amends the Guide to clarify that the
performance indicator (earnings measure) reported by
not-for-profit health care organizations is analogous to
income from continuing operations of a for-profit
enterprise.
The provisions of the SOP are effective for fiscal years
beginning after June 15, 2003. Earlier application of this
SOP is encouraged but is permitted only as of the begin-
ning of any fiscal quarter that begins after issuance of this
SOP. The provisions of the SOP should be applied pro-
spectively. Not-for-profit health care organizations that
reported derivative gains or losses in a manner inconsis-
tent with the conclusions of the SOP in financial state-
ments issued prior to adoption of the SOP are not per-
mitted to reclassify those gains or losses upon adoption.
Proposals
Exposure Draft on PP&E
At its December 5, 2002 meeting, AcSEC discussed its
plan to transition the project on the proposed SOP,
Accounting for Certain Costs and Activities Related to
Property, Plant, and Equipment, to the FASB.
At the meeting, the FASB staff indicated that while the
FASB did not want AcSEC to complete this entire project
as an SOP, some FASB Board members had indicated
that they might be receptive to AcSEC addressing in
smaller scope SOPs portions of the PP&E project.
AcSEC directed the Task Force to provide a summary of
the project to date, including Exposure Draft issues that
have not yet been addressed by AcSEC and a list of
specific issue(s) within the original proposed SOP that
could be “carved out” and narrower scope SOP(s) issued.
Further discussion with the FASB staff is planned.
Prior to the January 2003 meeting, AcSEC would discuss
with the FASB the potential for AcSEC pursuing any
narrower-defined SOPs that would be finalized by the
end of 2003.
AcSEC will finalize discussions on the remaining
Exposure Draft issues at its January 2003 meeting, with
the intent of sending a final transition document to the
FASB shortly thereafter (excluding any issues that may
be carved out).
REVIEW APRIL 1 TO JUNE 30, 2002
Nontraditional Long-Duration Contracts
Our comment letter (dated 10/31/02) on the Accounting
Standards Executive Committee of the American Institute
of Certified Public Accountants (“AcSEC”) Proposed
Statement of Position, Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-
Duration Contracts and for Separate Accounts, now is
available. We support efforts by AcSEC to issue inter-
pretative guidance regarding separate account classifica-
tion and reporting, accounting for sales inducements, and
accounting for nontraditional contract features and
support the issuance of the final Statement of Position
(“SOP”).
At its December 5, 2002 meeting, AcSEC discussed sig-
nificant comments received from constituents as follows:
Interest in Separate Accounts
The proposed SOP concluded that assets underlying an
insurance enterprise’s proportionate interest in a separate
account do not represent contract holder funds, and thus
do not qualify for separate account accounting and
reporting. The ED proposed that an insurance enterprise
should “look through” the separate account for purposes
of accounting for its interest therein, and account for and
classify the assets underlying that interest based on their
nature as if the assets underlying the insurance
enterprise’s proportionate interest were held directly by
the general account rather than through the separate
account structure.
Many respondents noted that the “look through” concept
would create a significant accounting burden to deter-
mine seed money’s proportionate interest in investment
results. Some recommended that an insurance enter-
prise’s proportionate interest in a separate account should
be accounted for at the unit level, similar to an invest-
ment in a mutual fund. The Task Force proposed a
“Short-Cut” Method when an insurance enterprise’s
interest is less than 20% of the separate account. Under
this method, an insurance enterprise’s portion of separate
account units would be accounted for as if the interest
were an investment in mutual fund securities and would
be measured at fair value. The Short-Cut Method views
the separate account as if it were a separate legal entity
and looks through to the substance of the holding as if the
insurance enterprise owned a portion of the units and the
contract holder owned the remainder of units. The Task
Force noted that the proposed SOP accounting is still
appropriate when seed money represents significant
influence (over 20%) of the separate account interest and
when the underlying investments are other than securities
subject to FASB Statement No. 115, such as mortgage
loans and real estate. This restriction would avoid allow-
ing an enterprise to account for an investment at fair
value when GAAP would preclude such accounting if the
investment were held in the general account.
The Task Force noted that the accounting method in
the proposed SOP is the technically correct version,
but acknowledged the need for an alternative method
when considering a cost-benefit criterion. Cost/benefit
is the only reason that supports the Short-Cut method
as an acceptable alternative. AcSEC voted to approve
(9 (E&Y) to 2, 2 abstentions) use of the Short-Cut
Method and the Task Force will revise the ED.
Annuitization Options
The proposed SOP concluded that no liability should be
established during the accumulation phase related to the
potential effect of annuitization options, even if the
annuitization rates are favorable to the contract holder. A
majority of respondents noted that a liability should be
recognized during the accumulation phase related to the
potential effect of annuitization options as revenues are
implicitly or explicitly collected during the accumulation
phase to compensate the insurer for the cost of the
expected benefits.
Task Force recommended that the guidance be changed
to allow for the accrual of an additional liability for the
extra benefit cost arising from annuitization incentives,
with appropriate adjustments for expected persistency
and utilization. The liability for annuitization options
would parallel the accounting method for Minimum
Guaranteed Death Benefits (MGDBs).
AcSEC voted to approve (12 to 1 (E&Y)) the Task Force
recommendation and the ED will be revised.
Sales Inducements to Contract Holders
The proposed SOP concluded that sales inducements that
meet specific criteria should be deferred and amortized
using the same methodology and assumptions used to
amortize capitalized acquisition costs. The insurance
enterprise should demonstrate that such amounts are
(a) incremental to amounts credited on similar contracts
without sales inducements; and (b) higher than the
contract’s expected ongoing crediting rates for periods
after the inducement, as applicable. Several respondents
questioned whether the proposed SOP required that a
“similar product” without a sales inducement be offered
by the insurance enterprise, in order to qualify for
deferral.
37
The Task Force noted that there are generally three main
types of sales inducements:
• Day One Bonus: increase account value at inception
(Example: Deposit $100, immediately credit $103 to
account value).
• Persistency Bonus: increase account value at end of
specified period (Example: Credit of 3% of account
value at end of year 5).
• Enhanced Interest Rate: Generally offered on fixed
annuities only, credits interest for specified period in
excess of rates currently being offered for other
similar contracts (Example: Additional 2% credited
to account balance from inception to 3rd anniversary
of contract).
AcSEC discussed the merits of requiring similar products
for only some of the types of bonuses indicated above, or
not requiring a similar product at all. AcSEC voted to
conclude (10 (E&Y) to 2) that a similar product should
be required and reached a consensus that a similar
product is required for all types of bonuses, with the
exception of the Day One bonus. The revised AcSEC
conclusion is consistent with our comment letter.
Separate Account Presentation for International
Products
Some respondents commented that insurance products
similar to variable annuities that are sold in international
markets do not meet the criteria in the SOP for separate
account reporting principally because the legal isolation
criterion is not met. AcSEC discussed whether the
criteria for separate account accounting in the SOP
should be changed to accommodate such products.
AcSEC determined that the SOP should not be revised.
Return Based on a Contractually Referenced Pool of
Assets or Index
Several respondents did not agree with the SOP’s
provisions that for a contract that provides a return based
on the total return of a contractually referenced pool of
assets, the accrued account balance should be based on
the fair value of the referenced pool of assets at the
balance sheet date even if the referenced assets are not
recognized at fair value. The sense of AcSEC was that
the SOP should not be changed but AcSEC asked the
Task Force to consider if an analogy to the accounting for
participating mortgages could be pursued. The Task
Force will discuss this issue with AcSEC at the January
2003 meeting.
38 A&A NEWS IN
Further discussion of the ED is scheduled for the January
2003 and March 2003 AcSEC meetings.
Other Projects
Accounting for Real Estate Timeshares
At the November 20, 2002 meeting, the FASB met with
representatives of the AICPA’s Accounting Standards
Executive Committee (AcSEC) to consider an Exposure
Draft of a proposed AICPA Statement of Position (SOP),
Accounting for Real Estate Time-Sharing Transactions,
for clearance for public comment. The FASB discussed
whether the proposed ED should be issued given the
FASB’s current project on revenue recognition. AcSEC
observed that there is significant diversity in practice in
accounting for real estate time-sharing transactions and
stated its belief that the proposed ED should be issued.
The FASB agreed to issuance of the proposed ED, but
suggested that the proposed ED reference the current
FASB project on revenue recognition and alert constitu-
ents that the guidance in the proposed ED could change
upon the completion of the Board’s project.
The FASB staff identified three issues for discussion:
• The proposed ED requires that changes in estimates
be accounted for prospectively. The staff noted that
the proposed ED is retrospective in its approach to
revenue recognition and that changes in estimates
should likewise be done retrospectively (cumulative
change). The majority of the Board agreed with the
retrospective adjustment for changes in estimates and
encouraged AcSEC to use this approach in the
proposed ED.
• The proposed ED accounts for sales incentives differ-
ently than that prescribed in EITF Issue No. 01-9,
“Accounting for Consideration Given by a Vendor to
a Customer (Including a Reseller of the Vendor’s
Products).” The proposed ED would not differentiate
between cash and non cash sales incentives for pur-
poses of revenue recognition. The staff proposed that
the ED should follow the EITF model for time-share
sales incentives. Some Board members agreed that
the proposed ED should not create a new model for
accounting for time-share sales incentives, but they
did not object to retaining the proposed ED model.
The Board asked AcSEC to note in the ED that the
model is a departure from the accounting guidance in
Issue 01-9 and to ask constituents to comment on this
change. AcSEC agreed to include this observation
and question in the final ED.
REVIEW APRIL 1 TO JUNE 30, 2002
• The staff observed that one of the paragraphs in the
proposed ED implies guidance for not consolidating
owner’s associations. The staff recommended and the
Board agreed that the paragraph should be revised so
as to not imply guidance on consolidation. AcSEC
noted that it was not its intention to provide any con-
solidation guidance in the document and that it had
already worked with the staff to revise the paragraph.
The staff noted that several minor clarifications to exist-
ing FASB Statements would need to be made as a result
of issuance of a final SOP. Minor clarifications will be
made to FASB Statements No. 66, Accounting for Sales
of Real Estate, No. 67, Accounting for Costs and Initial
Rental Operations of Real Estate Projects, and No. 135,
Rescission of FASB Statement No. 75 and Technical
Corrections. The staff had distributed to the Board a
proposed FASB ED that would amend this literature and
the Board agreed to proceed to a ballot draft.
Accounting by Insurance Enterprises for Deferred Acquisi-
tion Costs on Internal Replacements Other Than FAS 97
At the December 18, 2002 FASB meeting, the Board met
with representatives of the AICPA’s Accounting
Standards Executive Committee (AcSEC) and discussed
clearance of the Exposure Draft of a proposed Statement
of Position, Accounting by Insurance Enterprises for
Deferred Acquisition Costs on Internal Replacements
Other Than Those Specifically Described in FASB State-
ment No. 97. The Board did not object to issuance of that
Exposure Draft subject to certain changes being made.
Use of a Blockage Factor to Value an Unrestricted
Investment That Has a Quoted Market Price
At its December 5, 2002 meeting, AcSEC discussed the
document summarizing AcSEC’s work on this project to
be provided to the FASB in conjunction with the transi-
tion of the project, Use of a Blockage Factor to Value an
Unrestricted Investment that has a Quoted Market Price.
Highlights of the document include:
• Under certain circumstances, a security with a quoted
market price might be sufficiently illiquid that the
computation its fair value based on the product of
that price and the quantity of shares could overstate
the value of the security. Therefore, the use of a
block discount is appropriate under certain
circumstances.
• AcSEC observed that block premiums are not based
solely on the inherent economics of blocks, but
rather, are based principally on the actions of a party
that is seeking to obtain a position that would either
convey influence or control. Therefore, block premi-
ums should be prohibited when determining fair value
of an unrestricted security with a quoted market price
and therefore excluded from the scope of the project.
• Due to the lack of any perceived formal methodology
for determining the amount of a block discount,
AcSEC concluded that block discounts should be
measured based on a factors based approach. That
approach would identify factors or indicators that
when present would require the financial statement
preparer to evaluate the need for and the amount of
an appropriate block discount.
• AcSEC concluded that fixed income securities should
be excluded from the scope of the project.
The Task Force will update the summary document as
directed by AcSEC and the final transition documents
will be sent to the FASB. AcSEC does not intend to
discuss this project any further.
Valuation of Privately-Held-Company Equity Securities
Issued in Other than a Business Combination
At the December 6, 2002 AcSEC meeting, the AICPA
Accounting Standards Team presented a draft of a
proposed Technical Practice Aid, Valuation of Privately-
Held-Company Equity Securities Issued in other than a
Business Combination. The Project Team was soliciting
AcSEC members’ input on the draft. Due to the practice
aid’s nonauthoritative status, AcSEC approval is not
needed to issue an exposure of the Technical Practice Aid
(TPA). However, the Task Force believed AcSEC input
would be beneficial before the comment period.
The goal of the TPA is not to require new standards, but
rather to clarify and improve upon existing guidance. The
draft document includes characteristics that would affect
the quality of the valuation. The document indicates that
an externally prepared valuation would be preferable to
one that is internally prepared, and would favor a
contemporaneous calculation over a retrospective one.
The document also includes a detailed explanation of
items that should be considered in the valuation and notes
that the valuation of a company is related to its stage of
development.
Further discussion of the draft TPA is scheduled for the
January 2003 AcSEC meeting.
39
EITF
Consensuses
Issue 00-21—“Accounting for Revenue Arrangements with
Multiple Deliverables”
At the November 21, 2002 meeting, the Task Force
reached a consensus on Issue 00-21, which addresses how
to account for arrangements that may involve the delivery
or performance of multiple products, services, and/or
rights to use assets. The final consensus will be applica-
ble to agreements entered into in fiscal periods beginning
after June 15, 2003 with early adoption permitted.
Additionally, companies will be permitted to apply the
consensus guidance to all existing arrangements as the
cumulative effect of a change in accounting principle in
accordance with APB Opinion No. 20, Accounting
Changes.
It was noted that, in certain instances, the model would
impact the application of SEC Staff Accounting Bulletin
No. 101, Income Recognition. An SEC observer comment
will be included in the final guidance clarifying that Issue
00-21 is the governing model in circumstances where the
guidance in Issue 00-21 conflicts with the guidance in
SAB 101. The SEC observer indicated that the SEC
would revise the SAB FAQ document at a future date.
The model approved by the Task Force is the result of
over two years of discussion and numerous revisions. The
model addresses some of the concerns raised in the 22
comment letters received from constituents prior to the
October 25, 2002 EITF meeting and the additional com-
ment letters received prior to the November 21, 2002
meeting. The Task Force approved the latest Draft
Abstract but made minor changes in response to certain
concerns raised by Task Force members.
Application of the model is likely to have a significant
effect on current accounting practices in a variety of
industries and may require changes to current policies
and methods of gathering information used in reporting
revenue. Accordingly, we strongly encourage our clients
to review the guidance and assess its impact as soon as
possible.
Following is a brief summary of the final model approved
by the Task Force.
• Revenue arrangements with multiple deliverables
should be divided into separate units of accounting if
the deliverables in the arrangement meet the follow-
ing criteria:
40 A&A NEWS IN
— The delivered item(s) has value to the customer
on a standalone basis. That item(s) has value on a
standalone basis if it is sold separately by any
vendor or the customer could resell the deliver-
able on a standalone basis. In the context of a
customer’s ability to resell the deliverable, the
Task Force observed that this criterion does not
require the existence of an observable market.
— There is objective and reliable evidence of the
fair value of the undelivered item(s).
— If the arrangement includes a general right of
return, delivery or performance of the undeliv-
ered item(s) is considered probable and substan-
tially in the control of the vendor.
• Arrangement consideration should be allocated
among the separate units of accounting based on their
relative fair values. The amount allocated to the
delivered item(s) is limited to the amount that is not
contingent on the delivery of additional items or
meeting other specified performance conditions.
• Applicable revenue recognition criteria should be
considered separately for separate units of
accounting.
Issue 02-3—“Accounting for Contracts Involved in Energy
Trading and Risk Management Activities”
At the October 25, 2002 meeting, the EITF reached a
consensus to rescind EITF Issue No. 98-10, “Accounting
for Contracts Involved in Energy Trading and Risk
Management Activities.” As a result, only energy
contracts that meet the definition of a derivative in FASB
Statement No. 133, Accounting for Derivative Instru-
ments and Hedging Activities, will be carried at fair
value. Energy trading contracts that do not meet the
definition of a derivative (e.g., a transportation or tolling
contract) must be accounted for as an executory contract
(i.e., on an accrual basis), even by broker/dealers that
account for financial instruments at fair value. In addi-
tion, certain other decisions were made with regard to
related accounting issues as summarized below:
• The consensus reached in Issue 02-3 at the June 2002
meeting requiring all gains and losses (realized and
unrealized) on energy trading derivative contracts to
be presented net in the income statement (whether or
not such contracts are settled physically) was
REVIEW APRIL 1 TO JUNE 30, 2002
 expanded to include all derivative contracts that are
entered into for trading purposes.
• The Task Force clarified that with the rescission of
Issue 98-10, it would no longer be an acceptable
industry practice to account for energy inventory held
for trading purposes at fair value when fair value
exceeds cost, unless explicitly provided for by other
authoritative literature.
• The previous consensus reached at the June 2002
meeting requiring certain disclosures of energy trad-
ing activities in annual financial statements ending
after July 15, 2002 was rescinded.
• The FASB agreed to address the valuation issues
raised in Issue 02-3 as well as disclosures regarding
fair value as part of its Fair Value project.
The consensus rescinding Issue 98-10 must be applied to
all contracts that existed as of October 25, 2002 and must
be recognized as a cumulative effect of a change in
accounting principle in accordance with APB Opinion
No. 20, Accounting Changes, beginning the first day of
the first fiscal period (interim or annual period) beginning
after December 15, 2002 (e.g., January 1, 2003 for calen-
dar quarter companies). The consensus also must be
applied immediately to all new contracts entered into
after October 25, 2002.
Adoption of the consensus related to inventory valuation
must be recognized as a cumulative effect of a change in
accounting principle beginning the first day of the first
fiscal period (interim or annual period) beginning after
December 15, 2002 unless it is not practicable to do so
(e.g., a company is not able to determine the cost basis of
the inventory). In that case, the application of the consen-
sus to inventory may be prospective (with the carrying
value of the inventory on the transition date becoming the
inventory’s cost basis).
The consensus relating to the presentation of gains and
losses on derivative instruments held for trading purposes
is effective for financial statements for periods beginning
after December 15, 2002.
(NOTE: Subsequent to the October 25th meeting and the
issuance of the final minutes, several Task Force mem-
bers questioned the accuracy of those minutes and
requested that additional clarification be provided for
certain matters. In an effort to address these concerns the
FASB staff made certain revisions and clarifications to
the minutes and the Task Force discussed these matters
in more detail at the November 21, 2002 EITF meeting.)
Issue 02-16—“Accounting by a Customer (including a
Reseller) for Cash Consideration Received from a Vendor”
At the November 21, 2002 meeting, the Task Force
reached a consensus on Issue 02-16 addressing the
accounting for:
• “Cash consideration” (which the FASB staff defined
as including credits against amounts due and equity
instruments of the vendor) received by a customer
from a vendor (e.g., slotting fees, cooperative adver-
tising payments, buydowns),
• Rebates or refunds from a vendor that is payable only
if the customer completes a specified cumulative
level of purchases or remains a customer for a speci-
fied time period.
The Task Force decided not to address under what
circumstances up-front nonrefundable cash consideration
given by a vendor to a customer should be recognized
immediately by the customer rather than as a deferred
credit.
With regard to the treatment of cash consideration
received by a customer, the Task Force agreed that the
consideration received should be presumed to be a reduc-
tion of the prices of the vendor’s products or services and
should therefore be shown as a reduction of cost of sales
in the income statement of the customer. That presump-
tion could be overcome if either one of the following
conditions is met:
• The vendor receives, or will receive, an identifiable
benefit in exchange for the consideration. That iden-
tifiable benefit must be sufficiently separable from
the customer’s purchase of the vendor’s products
such that the customer would have entered into an
exchange transaction with a party other than the
vendor to provide that benefit and the customer can
reasonably estimate the fair value of the benefit
provided. If these conditions are met, the cash
consideration represents revenue and should be
characterized as such in the income statement of the
customer. The customer should consider any consid-
eration received in excess of the fair value of the
identifiable benefit a reduction of cost of sales.
• The consideration represents a reimbursement of a
specific incremental identifiable cost incurred by the
customer in selling the vendor’s product or service. If
41
 this condition is met, the cash consideration should
be characterized as a reduction of those costs in the
income statement of the customer. The customer
should consider any consideration received in excess
of the costs incurred in selling the vendor’s products
or services a reduction of cost of sales.
This consensus should be applied to fiscal periods begin-
ning after December 15, 2002. Upon application of this
consensus, income statements for prior periods presented
should be reclassified to comply with that consensus,
provided that the recasting of prior-period financial
statements does not result in a change to net income of
those prior periods. If it is impracticable to reclassify
prior-period financial statements, disclosure should be
made of the reasons therefore and the effect of the reclas-
sification on the current period. Early application of this
consensus is permitted only if a change to previously
reported net income would not occur as a result of
changes to prior period financial statements. At its
January 23, 2003 meeting, the Task Force intends to
further discuss transition for entities in which previously
reported net income would be changed as a result of
recasting prior-period financial statements for compara-
tive purposes.
The Task Force also reached a consensus on the account-
ing for a rebate or refund of a specified amount of cash
consideration that is payable if the customer completes a
specified cumulative level of purchases or remains a
customer for a specified period. Under the consensus, if
the customer can reasonably estimate the amount of the
rebate or refund, such rebates or refunds should be
recognized as a reduction of the cost of sales based on a
systematic and rationale allocation of the consideration to
be received relative to the transactions that mark the
progress of the customer toward earning the rebate or
refund. However, if a customer is not able to reasonably
estimate the amount of future cash rebates or refunds, the
consideration should only be recognized after the target
or milestone is achieved.
Issue 02-17—“Recognition of Customer Relationship
Intangible Assets Acquired in a Business Combination”
At the October 25, 2002 meeting, the EITF reached a
consensus on issues related to the recognition of certain
customer-related intangible assets acquired in a business
combination. The consensus in general represents a broad
interpretation of the intangible asset recognition criteria
in paragraph 39 of FASB Statement No. 141, Business
Combinations, as discussed further below. The consensus
42 A&A NEWS IN
is to be applied to purchase business combinations
consummated after the date of the consensus. The
consensus also applies to the completion of Step 2 of
goodwill impairment tests completed after the date of the
consensus.
The Task Force reconfirmed the conclusion reached at
the September meeting that when an entity recognizes a
customer-related intangible asset in accordance with the
recognition criteria in Statement 141 (because either the
contractual-legal or the separability criteria are met), the
determination of the fair value of that intangible asset
should consider all aspects of the relationship. For
example, a customer relationship intangible asset may be
recognized because of a single contract for a single prod-
uct. However, if the customer also regularly purchases
other products, that aspect of the relationship also must
be considered in determining the fair value of the
customer-relationship intangible asset, even though that
aspect of the relationship is not evidenced by a contract
and is not separable.
The Task Force agreed to include language clarifying that
the application of this interpretation often will result in
the recognition of two separate assets. That is, the value
of the contract would be recognized as an asset (or
potentially a liability if the terms of the contract are
unfavorable to the seller) and a separate asset would be
recognized representing the value of the customer rela-
tionship. Each asset or liability would be amortized over
its respective useful life.
The Task Force reached a consensus on the interpretation
of the guidance in paragraph A20 of Statement 141,
which states that a customer relationship meets the
contractual-legal criterion for recognition if an entity
establishes relationships with its customers through
contracts. The Task Force agreed that a contract need not
be in place at the date of acquisition to result in the
recognition of a customer relationship intangible asset.
That is, if a contract is not in place at the date of acquisi-
tion, but the (target) company normally establishes
relationships with its customers through contracts, that
customer relationship is deemed to meet the contractual-
legal criterion and should be recognized as an asset apart
from goodwill. Task Force members, and the FASB staff,
noted that in industries in which current sales contracts
may provide little or no benefit in obtaining future
contracts (e.g., certain commodities industries), the value
of a customer relationship would likely be negatively
impacted.
REVIEW APRIL 1 TO JUNE 30, 2002
The Task Force also reconfirmed as a consensus its
earlier tentative conclusion that an order arising from a
contract such as purchase or sales order (even if the
purchase or sales order is cancelable) as described in
paragraph A19 of Statement 141 is considered a contract
subject to paragraph A20. Therefore, the requirement to
recognize a “related customer relationship” is applicable
to these arrangements.
The consensuses are effective immediately and should be
applied to purchase business combinations consummated
after October 25, 2002. The guidance also should be
applied in the completion of Step 2 of the goodwill
impairment test if that step is completed after the date of
the consensus.
Other Issues
Issue 02-9—“Accounting for Changes That Result in a
Transferor Regaining Control of Financial Assets Sold”
At the November 21, 2002 meeting, the EITF continued
its discussion of following issues:
• How a transferor should account for retained benefi-
cial interests when the underlying assets are re-
recognized under the provisions of paragraph 55 of
Statement 140 because the transferor’s contingent
right (for example, a “ROAP” or other contingent call
option on the transferred financial assets) becomes
exercisable, and, in particular, how much gain or loss
should the transferor recognize when paragraph 55 of
Statement 140 is applied (Issue 1).
• How assets of an SPE that was formerly considered
qualifying should be accounted for when the entire
SPE becomes non-qualifying under the provisions of
paragraph 55 of Statement 140, including whether the
transferor should recognize a gain or loss when para-
graph 55 of Statement 140 is applied (Issue 2).
The following new issue was also addressed:
• How re-recognition under paragraph 55 of Statement
140 of assets sold affects the accounting for the
related servicing asset (Issue 4).
The Task Force reached a consensus on Issue 1 that upon
application of paragraph 55 of Statement 140, that no
gain or loss should be recognized in earnings with respect
to any beneficial interests retained by the transferor and
that a gain or loss could be recognized only with respect
to the assets previously sold (for example, upon the trans-
feror’s exercise of a default ROAP). No consensus was
reached on Issues 2 and 4.
A consensus had previously been reached on Issue 3
(whether under any circumstances a loan loss allowance
should initially be recorded for loans that do not meet the
definition of a security when they are re-recognized under
the provisions of paragraph 55 of Statement 140) at the
September 2002 meeting. As a result, it was not dis-
cussed. That consensus was that reserves should never
be recorded when an asset is initially purchased and
recorded at its fair value, unless specifically permitted
under GAAP.
The Task Force did not reach a consensus on Issue 2
because it was concerned that there would be instances
where the fair value of the transferred assets did not equal
the fair value of the beneficial interests of the QSPE held
by third parties upon re-recognition of the those assets.
As a result, the view expressed by the FASB staff (that
the fair value of the assets to be recognized by the trans-
feror is equal to the fair value of the beneficial interests
(liabilities) issued to third parties and that no gain or loss
should be recognized upon a QSPE becoming disquali-
fied) was challenged. After discussing the issue further, it
was agreed that the FASB staff would provide a more
detailed analysis with examples illustrating the account-
ing that could potentially result from the disqualification
of a formerly qualifying SPE. It was also agreed that
these illustrations would address the other issues that
arise upon re-recognition of the previously sold assets,
including classification under Statement 115 among other
matters.
No consensus was reached on Issue 4 because several
Task Force members wanted more time to analyze the
different views. It was clear that some of the Task Force
members came to the meeting with the view that a
servicing asset would automatically be derecognized
upon re-recognition of the underlying assets. However,
after discussing the issue in more detail, the FASB staff
demonstrated that Statement 140 requires that servicing
become a distinct asset or liability when contractually
separated from the underlying assets by sale or securiti-
zation of the assets with servicing retained.
We expect these issues to be discussed again at the
January 2003 EITF meeting.
Issue 02-12—“Permitted Activities of a Qualifying
Special-Purpose Entity in Issuing Beneficial Interests
under FASB Statement 140
At the November 21, 2002 meeting, the EITF continued
its discussions regarding the permitted activities of a
qualifying special-purpose entity (QSPE) in issuing
43
beneficial interests (BI) under FASB Statement No. 140,
Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities. This issue
addresses the extent to which a qualifying SPE (or its
affiliate or agent) is permitted to determine the terms of
BI issued after the inception of the QSPE. No consensus
was reached.
We expect that this issue will be discussed again at the
January 2003 meeting.
No consensus was reached because a majority of the
Task Force members could not get comfortable with an
approach to resolve the issue. Some members favor an
approach that would specifically limit the discretion that
a QSPE can have based on a range of terms of BI that can
be issued after a QSPE’s inception (Approach A); others
favor an approach that limits discretion of issuing BI
based on whether the BI are “well supported” by the
underlying assets, among other criteria (Approach B);
while others favor an approach that allows a QSPE to
have discretion in setting the terms of commercial paper
issuances that are refinancing existing commercial paper
(Approach C).
Six of the Task Force members favored the conceptual
basis of Approach B over Approach A or Approach C,
while the others seemed to favor Approach C. As a result,
the FASB staff agreed to refine the Approach B to
incorporate some of the elements of Approach A and
Approach C.
The FASB members present clearly support Approach B
because they view it to be the most principles-based
approach. FASB Chairman Bob Herz also articulated his
concern that any interpretive guidance that is issued
regarding QSPEs should consider the original intent of
creating QSPEs (that is, the entity is passive, on “auto-
pilot”, has limited discretion).
Issue 02-14—“Whether the Equity Method of Accounting
Applies When an Investor Does Not Have an Investment in
Voting Stock of an Investee”
At the November 21, 2002 meeting, the EITF continued
its discussion of issues related to the application of the
equity method of accounting, as described in APB
Opinion No. 18, The Equity Method of Accounting for
Investments in Common Stock, in situations in which an
investor exercises significant influence over the investee
but does not have an investment in the voting common
stock of the investee. At the October 25, 2002 meeting,
the Task Force requested that the FASB staff explore the
44 A&A NEWS IN
development of two possible approaches to address some
of the current practice issues.
• The development of methodology to evaluate for
impairment certain investments not accounted for at
historical cost.
• The development of a definition of “in-substance
common stock” that could be applied in determining
whether to apply the equity method of accounting.
Based on the discussion at the November 21, 2002 meet-
ing, the FASB staff will continue the development of
these approaches. This issue will be discussed further at
a future meeting.
Issue 02-18—“Accounting for Subsequent Investments in
an Investee After Suspension of Equity Method Loss
Recognition”
The EITF continued the discussion of the accounting for
subsequent investments in an investee after suspension of
equity method loss recognition, as addressed in APB
Opinion No. 18, The Equity Method of Accounting for
Investments in Common Stock, and EITF Issue No. 98-13,
“Accounting by an Equity Method Investor for Investee
Losses When the Investor Has Loans to and Investments
in Other Securities of the Investee.” The issue is whether
an investor should (a) use step acquisition accounting or
(b) recognize losses to the extent of previously suspended
losses, when accounting for a subsequent investment in
an investee that does not result in the ownership interest
increasing from one of significant influence to one of
control.
The Task Force indicated that the application of either
alternative might depend on the facts and circumstances
associated with the investment and asked the FASB staff
to develop an approach that would include factors to
consider in making the determination of the appropriate
accounting. This issue will be discussed further at a
future meeting.
Topic D-106: FASB Staff Announcement Clarifying
Minimum Pension Liability Q&A No. 37
The FASB staff has received inquires regarding the
application of the guidance for the recognition of an
additional minimum pension liability under FASB
Special Report, A Guide to Implementation of Statement
87 on Employers’ Accounting for Pensions, Q&A No. 37.
Q &A No. 37 provides guidance for calculating the
additional minimum liability that must be recognized by
entities with a December 31 financial report date that use
REVIEW APRIL 1 TO JUNE 30, 2002
a September 30 valuation date for pension plan assets and
liabilities. The FASB staff will revise Q&A No. 37 and
clarify that the minimum liability must be determined as
of the measurement date—September 30. As a result, it is
not appropriate to conclude that a fourth quarter contri-
bution to the pension plan can mitigate or eliminate the
need to recognize an additional minimum liability pursu-
ant to paragraph 36 of Statement 87.
New Issues and Removal of Issues from the Agenda
As part of the project to prioritize open issues, the Task
Force agreed to remove a number of issues from the
agenda. The issues that have been removed from the
agenda are listed below. Summaries of the issues are
included in the Agenda Committee Report.
00-22 “Accounting for ‘Points’ and Certain Other
Time-Based or Volume-Based Sales Incentive
Offers, and Offers for Free Products or Services
to Be Delivered in the Future”
00-24 “Revenue Recognition: Sales Arrangements That
Include Specified-Price Trade-in Rights”
02-G “Recognition of Revenue from Licensing
Arrangements on Intellectual Property”
01-4 “Accounting for Sales of Fractional Interests in
Equipment”
00-x2 “Accounting for Front-End and Back-End Fees
00-x3 “Accounting for Access, Maintenance, and
Publication Fees
00-x4 “Accounting for Advertising or Other Arrange-
ments Where the Service Provider Guarantees a
Specified Amount of Activity”
No Issue No. Assigned “Revenue Attribution in an
Arrangement Including More-Than-Incidental
Software and the Sale or Lease of Property, Plant
and Equipment
Audit Committees
Audit Committee Toolkit Update
The update of our Audit Committee Toolkit is now
available in our Audit Committee Library, on Ernst &
Young Online. The revised Toolkit materials should be
No Issue No. Assigned “Accounting for Post-Contract
Customer Support-Related Services on Software
that is Incidental to a Product or Service Offered
By a Vendor
02-1 “Balance Sheet Classification of Assets Received
in Exchange for Equity Instruments”
99-14 “Recognition by a Purchaser of Losses on Firmly
Committed Executory Contracts”
00-26 “Recognition by a Seller of Losses on Firmly
Committed Executory Contracts”
00-20 “Accounting for Costs incurred to Acquire or
Originate Information for Database Content and
Other Collections of Information”
00-x1 “Accounting for the Costs of Computer Files that
Are Essentially Films, Music, or Other Content”
Administrative Matters
A number of changes to the EITF process were
announced at the November 21, 2002 meeting. Two
Board members (Ed Trott and Katherine Schipper) will
become members of the Task Force’s Agenda Committee
effective for the December meeting of the Agenda
Committee, bringing the number of Agenda Committee
members to five. Additionally, all EITF consensuses
beginning with the January 2003 meeting must be ratified
by the Board. It is expected that the ratification of EITF
consensuses will take place at the Board meeting two
weeks after the EITF meeting at which the consensus is
reached. This will delay the effective date of the consen-
sus by two weeks to the date of ratification.
Jim Johnson (Deloitte & Touche) replaced John Smith on
the EITF. John Smith recently was appointed to the
International Accounting Standards Board.
Jack Ciesielski of R.G. Associates, Inc., the publisher of
The Analyst’s Accounting Observer will be joining EITF.
Jack was asked to join the EITF in connection with the
FASB’s goal of adding financial statement users to the
Task Force’s membership.
used in conjunction with our new publication, Corporate
Reform: Implications for Audit Committees, which
provides additional content to assist audit committees.
45
Knowledge Tools/Other Publications and Studies
Hyperinflationary Economies-IMF Status at August 2002
Paragraph 11 of FASB Statement 52 defines a highly
inflationary economy as one that has cumulative inflation
of approximately 100 percent or more over a 3-year
period. At the November 15, 1996, meeting of the
Emerging Issues Task Force (EITF), the FASB staff
issued in D-55 the following interpretation of how the
determination of the cumulative inflation rate and the
exercise of judgment should affect the final assessment of
whether an economy is highly inflationary.
The FASB staff believes the determination of a highly
inflationary economy must begin by calculating the
cumulative inflation rate for the three years that precede
the beginning of the reporting period, including interim
reporting periods. If that calculation results in a cumula-
tive inflation rate in excess of 100 percent, the economy
should be considered highly inflationary in all instances.
However, if that calculation results in the cumulative rate
being less than 100 percent, the staff believes that histori-
cal inflation rate trends (increasing or decreasing) and
other pertinent economic factors should be considered to
determine whether such information suggests that classi-
fication of the economy as highly inflationary is
appropriate.
Countries that may be considered hyperinflationary using
information published by the International Monetary
Fund, Volume LV, Number 8, August 2002, are:
Afghanistan Myanmar
Angola Romania
Belarus Sierra Leone
Congo, D.R. of Sudan
Ecuador Mozambique
Congo, D.R. of Suriname
Ghana Turkey
Malawi Ghana Zambia
Moldova Zimbabwe
The three-year cumulative rate of inflation in Russia is
expected to fall below 100% in December 2002. At a
meeting of the AICPA International Practices Task Force
on November 25, 2002, the issue of when Russia should
cease being considered a hyperinflationary economy for
purposes of FASB Statement No. 52 was discussed. The
Task Force concluded that, absent a significant increase
in inflation between now and the end of the year, Russia
will no longer be considered highly inflationary effective
January 1, 2003.
46 A&A NEWS IN
Ukraine and Azerbaijan have also been removed from
the list of hyperinflationary economies.
There may be additional countries with cumulative infla-
tion of 100 percent or more, because the cited source only
includes inflation data for approximately 95 countries
and not all of those countries have reported data for 2002.
In certain countries, the official index may be unrealistic
(i.e., items with controlled prices are included in govern-
ment calculations). A company is then permitted to dem-
onstrate that it operates in or does not operate in a highly
inflationary economy through the use of an internally
generated inflation index, in which case the Professional
Accounting Director is consulted.
Thought Center Webcast 11/15/02 on Stock Options and
Statement 123
As you are aware, there has been increased scrutiny by
shareholders and the general public regarding the use and
accounting treatment for stock options. As a result, some
companies have recently decided to adopt the fair value
recognition and measurement principles of FASB
Statement No. 123, Accounting for Stock-Based Compen-
sation, for their stock-based awards.
On November 15, 2002, Ernst & Young held an account-
ing standards update and a review of the steps companies
should be taking now, whether they have decided to make
the transition to Statement 123’s fair value recognition
provisions for stock options, or not. Ernst & Young
partners Dave Johnson and Carlo Pippolo joined by
Citigroup’s George Schleier to talk about preparing for
the transition and to answer questions on the business
implications of adopting Statement 123, including the
restructuring of compensation programs.
Thought Center Webcast 12/3/02 on Year End Financial
Reporting Update
On December 3, 2002, Ernst & Young’s Thought Center
Webcasts, in conjunction with Financial Executives Inter-
national (FEI), presented an executive overview of the
Financial Reporting Update. The web cast covered the
most important new standards and rule proposals (from
the SEC and FASB) that will need to be implemented in
the near future and will likely change the financial report-
ing landscape for our clients. The panelists for the program
included Dave Holman, Mike Joseph and Chris Holmes.
In case you missed any of these live programs, you can
view them on the Thought Center Webcast archive.
REVIEW APRIL 1 TO JUNE 30, 2002
Effective Date Reminders
The following is a summary of the effective dates of
certain recent FASB, AcSEC and EITF standards:
FASB
FAS 141, Business Combinations, effective for all
business combinations initiated after June 30, 2001. The
provisions also are applicable to all business combina-
tions accounted for by the purchase method (regardless of
the date initiated) for which the acquisition date is July 1,
2001, or later. However, for combinations of mutual
enterprises, the effective date is deferred until additional
interpretive guidance related to the application of the
purchase method to business combinations of mutual
enterprises is issued.
FAS 142, Goodwill and Other Intangible Assets, effec-
tive for fiscal years beginning after December 15, 2001,
except for mutual enterprises and not-for-profit organiza-
tions. However, certain provisions are applicable to
goodwill and intangible assets acquired in transactions
completed after June 30, 2001.
FAS 143, Accounting for Asset Retirement Obligations,
effective for financial statements issued for fiscal years
beginning after June 15, 2002.
FAS 144, Accounting for the Impairment or Disposal of
Long-lived Assets, effective for financial statements
issued for fiscal years beginning after December 15,
2001, and interim periods within those fiscal years.
FAS 145, Rescission of FASB Statements No. 4,44, and
64, Amendment of FASB Statement 13, and Technical
Corrections, the provisions of Statement 145 related to
the rescission of Statement 4 are effective for financial
statements issued for fiscal years beginning after May 15,
2002. Any gain or loss on extinguishment of debt that
was classified as an extraordinary item in prior periods
presented that does not meet the criteria in APB 30 for
classification as an extraordinary item should be reclassi-
fied. Certain provisions of this Statement related to
Statement 13 are effective for transactions occurring after
May 15, 2002. All other provisions of this Statement will
be effective for financial statements issued on or after
May 15, 2002.
FAS 146, Accounting for Costs Associated with Exit or
Disposal Activities, the provisions of Statement 146 are
effective for exit or disposal activities that are initiated
after December 31, 2002, with early application
encouraged.
FAS 147, Acquisitions of Certain Financial Institutions,
the provisions of Statement 147 are effective October 1,
2002. It should be noted that the provisions of Statement
72, as amended by Statement 147, continue to apply to
transactions between financial institutions that are mutual
enterprises.
FAS 148, Accounting for Stock-Based Compensation-
Transition and Disclosure-an Amendment of FASB
Statement 123, is effective for fiscal years ending after
December 15, 2002 (i.e., this year for a calendar year
company) and early application is permitted for the tran-
sition provisions. Interim pro forma disclosures are
required for interim periods beginning after December
15, 2002 (i.e., first quarter 2003). (Note-the FASB plans
to issue this document in early January with the afore-
mentioned effective dates.)
FASI 45, Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others. The Interpreta-
tion’s disclosure requirements are effective for financial
statements of interim or annual periods ending after
December 15, 2002. The Interpretation’s initial recogni-
tion and initial measurement provisions are applicable on
a prospective basis to guarantees issued or modified after
December 31, 2002, irrespective of the guarantor’s fiscal
year-end. The guarantor’s previous accounting for
guarantees issued prior to the date of the Interpretation’s
initial application should not be revised or restated to
reflect the Interpretation’s provisions.
FASI 46, Consolidation of Variable Interest Entities:
In January, the FASB plans to issue an Interpretation
discussing the consolidation of variable interest entities
(formerly the consolidation of SPEs) the will have
reporting/disclosure implications for calendar year-end
companies:
The following transition requirements would apply:
• All enterprises will be required to apply the transition
disclosure requirements in financial statements issued
two weeks after the issuance of the Interpretation.
• All enterprises will be required to immediately apply
the Interpretation to entities with which they become
involved two weeks after the Interpretation is issued.
• Enterprises required by securities regulations to issue
interim financial statements (i.e., public companies)
47
 will be required to apply the Interpretation to pre-
existing entities as of the beginning of the first
interim period beginning after June 15, 2003.
• Enterprises not required by securities regulations to
issue interim financial statements will be required to
apply the Interpretation to pre-existing entities as of
the end of the first fiscal year beginning after June
15, 2003 (that is, December 31, 2004 for calendar
year non-public companies).
AcSEC
SOP 00-3, Accounting by Insurance Enterprises for
Demutualizations and Formations of Mutual Insurance
Holding Companies and for Certain Long-Duration
Participating Contracts, entities must apply the SOP to
financial statements no later than the end of the fiscal
year that begins after December 15, 2000.
SOP 01-1, Amendment to Scope of Statement of Position
95-2, Financial Reporting by Nonpublic Investment
Partnerships, to Include Commodity Pools, effective for
financial statements issued for periods ending after
December 15, 2001.
SOP 01-5, Amendments to Specific AICPA Pronounce-
ments for Changes Related to the NAIC Codification,
effective for annual financial statements for fiscal years
ending on or after December 15, 2001, and complete sets
of interim financial statements for periods beginning on
or after that date and audits of those financial statements.
Retroactive application is not permitted.
SOP 01-6, Accounting by Certain Entities (Including
Entities With Trade Receivables) That Lend to or
Finance the Activities of Others, effective for financial
statements issued for fiscal years beginning after
December 15, 2001.
SOP 02-2, Accounting for Derivative Instruments and
Hedging Activities by Not-for-Profit Health Care
Organizations, and Clarification of the Performance
Indicator. The provisions of the SOP are effective for
fiscal years beginning after June 15, 2003. Earlier appli-
cation of this SOP is encouraged but is permitted only as
of the beginning of any fiscal quarter that begins after
issuance of this SOP. The provisions of the SOP should
be applied prospectively. Not-for-profit health care
organizations that reported derivative gains or losses in a
manner inconsistent with the conclusions of the SOP in
financial statements issued prior to adoption of the SOP
are not permitted to reclassify those gains or losses upon
adoption
48 A&A NEWS IN
EITF
EITF issue consensuses should be applied prospectively
unless otherwise indicated. Please see EY/AART or the
A&A Developments Database (EITF section—) for more
information on these consensuses.
EITF 87-24—“Allocation of Interest to Discontinued
Operations”—new consensus reached June 20, 2002—
the revised provisions of this consensus are applicable to
discontinued operations related to disposal activities
initiated by an entity’s commitment to a plan after June
2002. Additionally, companies would be permitted to
apply this consensus to discontinued operations initiated
in the fiscal year that includes the date of the consensus.
EITF 90-19—“Convertible Bonds with Issuer Options to
Settle for Cash Upon Conversion”—new consensus
reached January 2002—the new consensuses on Issues
90-19 and 00-19 are applicable to instruments issued after
January 24, 2002.
EITF 95-23—“The Treatment of Certain Site Restora-
tion/Environmental Exit Costs When Testing a Long-
Lived Asset for Impairment”—new consensus reached
June 20, 2002—the revised consensus is to be applied
prospectively from date of issuance.
EITF 00-19—“Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in, a
Company’s Own Stock”—at the March 21, 2002 meet-
ing, the EITF clarified how the disclosure requirements
of FAS 129 and FAS 133 apply to freestanding contracts
that are within the scope of 00-19. The EITF noted that
although the FAS 129/FAS 133 disclosures are required
for annual financial statements, SEC registrants should
consider the adequacy of their disclosures in their previ-
ous Form 10-K and evaluate the need for additional dis-
closures in their next filing on Form 10-Q.
EITF 00-21—“Accounting for Revenue Arrangements
with Multiple Deliverables”—the consensus is applicable
to agreements entered into in fiscal periods beginning
after June 15, 2003 with early adoption permitted.
Additionally, companies will be permitted to apply the
consensus guidance to all existing arrangements as the
cumulative effect of a change in accounting principle in
accordance with APB Opinion No. 20, Accounting
Changes.
EITF 00-23—“Issues Related to the Accounting for
Stock Compensation under APB Opinion No. 25,
Accounting for Stock Issued to Employees, and FASB
Interpretation No. 44, Accounting for Certain
REVIEW APRIL 1 TO JUNE 30, 2002
Transactions Involving Stock Compensation”—various
consensuses reached during the January and March
meetings.
EITF 01-3—“Accounting in a Purchase Business
Combination for Deferred Revenue of an Acquiree”—the
consensus reached March 21, 2002 should be applied
prospectively.
EITF 01-7—“Creditor’s Accounting for a Modification
or Exchange of Debt Instruments”—the consensus
reached at the January 24, 2002 meeting should be
applied prospectively.
EITF 01-12—“The Impact of the Requirements of FASB
Statement No. 133, Accounting for Derivative Instru-
ments and Hedging Activities, on Residual Value Guar-
antees in Connection With a Lease”—the consensus
reached at the March 20-21, 2002 meeting should be
applied prospectively.
EITF 01-14—“Income Statement Characterization of
Reimbursements Received for ‘Out-of-Pocket’ Expenses
Incurred”—This Issue was originally addressed in FASB
Staff Announcement Topic D-103, but the Task Force in
January 2002 agreed to recharacterize it as Issue 01-14.
The announcement must be applied in financial reporting
periods beginning after December 15, 2001. Upon appli-
cation of the announcement, comparative financial state-
ments for prior periods should be reclassified to comply
with the guidance. If it is impracticable to reclassify prior
period financial statements, disclosure should be made of
both the reasons why reclassification was not made and
the effect of this income statement characterization guid-
ance on the current period.
EITF 02-3—”Accounting for Contracts Involved in
Energy Trading and Risk Management Activities”—At
the October 25, 2002 meeting, the EITF reached a
consensus to rescind EITF Issue No. 98-10, “Accounting
for Contracts Involved in Energy Trading and Risk
Management Activities.”As a result, only energy
contracts that meet the definition of a derivative in FASB
Statement No. 133, Accounting for Derivative Instru-
ments and Hedging Activities, will be carried at fair
value. Energy trading contracts that do not meet the
definition of a derivative (e.g., a transportation or tolling
contract) must be accounted for as an executory contract
EITF 02-4—“Debtor’s Accounting for a Modification or
(i.e., on an accrual basis), even by broker/dealers that
an Exchange of Marketable Debt Instruments”—the
account for financial instruments at fair value. In addi-
consensus reached March 21, 2002 should be applied
tion, certain other decisions were made with regard to
prospectively. For further information about the consen-
related accounting issues as summarized below:
sus, please access the EITF infobase on EY/AART.
The consensus reached in Issue 02-3 at the June 2002
meeting requiring all gains and losses (realized and
unrealized) on energy trading derivative contracts to
be presented net in the income statement (whether or
not such contracts are settled physically) was
expanded to include all derivative contracts that are
entered into for trading purposes.
The Task Force clarified that with the rescission of
Issue 98-10, it would no longer be an acceptable
industry practice to account for energy inventory held
for trading purposes at fair value when fair value
exceeds cost, unless explicitly provided for by other
authoritative literature.
The previous consensus reached at the June 2002
meeting requiring certain disclosures of energy
trading activities in annual financial statements
ending after July 15, 2002 was rescinded.
The consensus rescinding Issue 98-10 must be
applied to all contracts that existed as of October 25,
2002 and must be recognized as a cumulative effect
of a change in accounting principle in accordance
with APB Opinion No. 20, Accounting Changes,
beginning the first day of the first fiscal period
(interim or annual period) beginning after December
15, 2002 (e.g., January 1, 2003 for calendar quarter
companies). The consensus also must be applied
immediately to all new contracts entered into after
October 25, 2002.
Adoption of the consensus related to inventory
valuation must be recognized as a cumulative effect
of a change in accounting principle beginning the
first day of the first fiscal period (interim or annual
period) beginning after December 15, 2002 unless it
is not practicable to do so (e.g., a company is not able
to determine the cost basis of the inventory). In that
case, the application of the consensus to inventory
may be prospective (with the carrying value of the
inventory on the transition date becoming the inven-
tory’s cost basis).
The consensus relating to the presentation of gains
and losses on derivative instruments held for trading
purposes is effective for financial statements for
periods beginning after December 15, 2002.
49
EITF 02-6—“Classifications in the Statement of Cash
Flows of Payments Made to Settle an Asset Retirement
Obligation Within the Scope of FASB Statement No.
143, Accounting for Asset Retirement Obligations”—the
consensus reached March 21, 2002 should be applied
prospectively. FAS 143, Accounting for Asset Retirement
Obligations, is effective for financial statements issued
for fiscal years beginning after June 15, 2002.
EITF 02-7—“Unit of Measure for Evaluating Impair-
ment of Intangible Assets That Have Indefinite Lives”—
consensus reached in March 2002 is effective upon the
initial application of Statement 142. However, for entities
that early applied Statement 142— the consensus is
effective after March 21, 2002. For further information
about the consensus, please access the EITF infobase on
EY/AART.
EITF 02-8—“Accounting for Options Granted to
Employees in Unrestricted, Publicly Traded Shares of an
Unrelated Entity”—the consensus reached March 21,
2002 should be applied prospectively.
EITF 02-11—“Accounting for Reverse Spinoffs”—the
consensus reached at the September 11-12, 2002 meeting
should be applied prospectively.
EITF 02-13—“Deferred Income Tax Considerations in
Applying the Goodwill Impairment Test under FAS
142”—the consensus reached at the September 11-12,
2002 meeting is applicable prospectively beginning with
the first occasion when a company performs either Step 1
or Step 2 of the goodwill impairment test after the date of
the consensus.
EITF 02-15—“Determining Whether Certain Conver-
sions of Convertible Debt to Equity Securities Are
Within the Scope of FASB Statement No. 84, Induced
Conversions of Convertible Debt”—the consensus
reached at the September 11-12, 2002 meeting must be
applied prospectively to all applicable inducements that
close after the date of the consensus.
EITF 02-16—“Accounting by a Customer (including a
Reseller) for Cash Consideration Received from a
Vendor”—with regard to the treatment of cash consid-
eration received by a customer, the Task Force reached a
consensus that the consideration received generally
should be presumed to be a reduction of the prices of the
50 A&A NEWS IN
vendor’s products or services and should therefore be
shown as a reduction of cost of sales in the income state-
ment of the customer. This consensus should be applied
to fiscal periods beginning after December 15, 2002.
Upon application of this consensus, income statements
for prior periods presented should be reclassified to
comply with that consensus, provided that the recasting
of prior-period financial statements does not result in a
change to net income of those prior periods. If it is
impracticable to reclassify prior-period financial state-
ments, disclosure should be made of the reasons therefore
and the effect of the reclassification on the current
period. Early application of this consensus is permitted
only if a change to previously reported net income would
not occur as a result of changes to prior period financial
statements. At its January 23, 2003 meeting, the Task
Force intends to further discuss transition for entities in
which previously reported net income would be changed
as a result of recasting prior-period financial statements
for comparative purposes.
The Task Force also reached a consensus on the
accounting for a rebate or refund of a specified amount of
cash consideration that is payable if the customer
completes a specified cumulative level of purchases or
remains a customer for a specified period. Under the
consensus, if the customer can reasonably estimate the
amount of the rebate or refund, such rebates or refunds
should be recognized as a reduction of the cost of sales
based on a systematic and rational allocation of the
consideration to be received relative to the transactions
that mark the progress of the customer toward earning the
rebate or refund. However, if a customer is not able to
reasonably estimate the amount of future cash rebates or
refunds, the consideration should only be recognized
after the target or milestone is achieved. This guidance is
effective for arrangements entered into after November
21, 2002.
EITF 02-17—“Recognition of Customer Relationship
Intangible Assets Acquired in a Business Combination”.
The consensus reached at the October 25, 2002 meeting
should be applied prospectively to purchase business
combinations consummated after the date of the
consensus. The consensus also applies to the completion
of Step 2 of goodwill impairment tests completed after
October 25, 2002.
REVIEW APRIL 1 TO JUNE 30, 2002
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