The Financial Accounting Standards Board (FASB) isn’t planning to issue any major accounting standards updates in 2017, because it wants companies to focus on implementing the new leasing and revenue recognition standards. Instead, the board is fine-tuning certain narrow-range topics in financial reporting, such as hedging and consolidation. Here’s what’s been decided on those topics and why the board recently refused to clarify the definition of “readily determinable fair value.”
In March, the Financial Accounting Standards Board (FASB) issued a proposal to expand the scope of its guidance for stock-based compensation awards to include nonemployees.
The proposal would scrap the guidance that calls for businesses that give stock awards to independent contractors and consultants to apply an accounting treatment that differs from the guidance for stock awards to employees. The superseded guidance was developed in 1996, under the assumption that independent contractors and consultants have greater freedom to move from company to company and, in theory, watch stock price movements to determine where to work. The FASB now believes this assumption is overstated — and full-time employees have similar freedoms to move from job to job.
Aligning employee and nonemployee stock compensation guidance would simplify U.S. Generally Accepted Accounting Principles for investors and creditors. It’s also likely to reduce costs for businesses, because they no longer would have to implement separate processes to grant and track awards to nonemployees.
Comments on Proposed Accounting Standards Update (ASU) No. 2017-220, Compensation — Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, are due on June 5.
Businesses use derivatives and hedge accounting to protect themselves from a range of economic circumstances, including changes in interest rates, currency exchange rates, securities prices or the prices of raw materials. In September, the FASB issued Proposed Accounting Standards Update (ASU) No. 2016-310, Derivatives and Hedging (Topic 815) — Targeted Improvements to Accounting for Hedging Activities. The proposal calls for several changes to hedge accounting, including allowing more risk management activities to qualify for the specialized accounting method.
In March, the FASB addressed two key questions related to the hedge accounting proposal:
Should the “market yield” test be eliminated? This test would have required an entity to use the total contractual coupon cash flows to determine the fair value of a hedged item attributable to interest rate risk if, at hedge inception, the market yield of the hedged item was less than the benchmark interest rate.
The FASB has decided to eliminate the market yield test from the final update. So, for all fair value hedges of interest rate risk, companies will have the option of using either 1) the total contractual coupon cash flows, or 2) the benchmark rate component cash flows determined at hedge inception.
Should the “last of layer” approach be required for fair value hedges of interest rate risk of prepayable assets? This approach would allow an entity to designate as the hedged item the last dollar amount of either: 1) a prepayable asset, such as a prepayable mortgage-backed security, or 2) a closed portfolio of prepayable assets, such as residential mortgage loans.
An entity would be able to assume that, if prepayments occur, they’re first applicable to the portion of the prepayable asset or to a closed portfolio of prepayable assets that isn’t part of the designated hedged layer. On each hedge effectiveness assessment date, an entity would use its expected performance of the asset(s) to determine if the amount remaining at hedge maturity is still expected to exceed or be equal to the last of layer.
The FASB has decided to incorporate the last of layer approach in the current hedge accounting project for fair value hedges of interest rate risk of prepayable assets.
Although the FASB made headway on its hedging project in March, it hasn’t yet approved a final update. The board will continue deliberating this proposal in the coming months.
For several years, the FASB has been looking for ways to simplify the consolidated reporting standard, which determines when a company should consolidate, or report on its balance sheet, holdings it has in other entities. After the Enron scandal, the FASB revised the standard to limit the opportunities for hiding liabilities in off-balance-sheet vehicles. The standard remains one of the more complicated topics in financial reporting.
In March, the FASB directed its staff to draft a proposed update that would replace Accounting Standards Codification (ASC) Topic 810, Consolidation, with a new topic. ASC Topic 812 would be divided into subtopics for voting interest entities (VOEs) and variable interest entities (VIEs).
Proponents say the change would make the accounting literature easier to navigate and conform with how Big Four firms advise clients on this aspect of U.S. Generally Accepted Accounting Principles (GAAP). This proposal would apply to both public and private companies.
In addition, the FASB has decided to propose an amendment that would let private companies opt out of following the common control requirements in U.S. GAAP. Accounting for VIEs for businesses under common control has long been a source of frustration for private companies and their auditors.
Private companies complain that the VIE guidance is overly complicated for privately held businesses trying to determine whether to consolidate affiliated entities with the same parent company. Many companies err on the side of consolidating multiple affiliated and subsidiary businesses onto a parent’s balance sheet. The practice frustrates lenders and creditors, who generally prefer simpler, cleaner balance sheets.
The Private Company Council asked the FASB’s research staff to develop practical examples that relate specifically to private companies to include in the consolidated reporting standard. But after the staff drew up a relatively straightforward example, staff members couldn’t agree on how to apply the accounting requirements.
The main sticking point relates to the assessment of power: Whoever is in power is the parent entity and must report on its balance sheet its holdings. In private company transactions — such as those between friends or relatives — there often are no formalized arrangements, the parent can change and there’s rarely documentation to back up decisions.
Going forward, the FASB plans to propose additional changes to consolidated reporting for public companies, too. The board considers the changes to be targeted improvements as opposed to a wholesale rewrite of the standard.
During a March meeting, the FASB rejected a request to clarify the definition of “readily determinable fair value.” The board had previously amended this definition in the 2015 edition of its technical corrections. But some venture capital funds, limited partnerships and employee benefit plans said the definition was inappropriately altered in the 2015 technical corrections, leading to confusion about the required disclosures for measurements of some investments.
An equity security has a readily determinable fair value if its sales price or bid-and-ask quotation is available on a public stock exchange or in the over-the-counter market. For an equity security traded only in a foreign market, the fair value is readily determinable only if the foreign market is comparable, in terms of breadth and scope, to one of the U.S. markets.
The 2015 amendment added that an equity security that’s an investment in a mutual fund “or in a structure similar to a mutual fund (that is, a limited partnership or a venture capital entity) is readily determinable if the fair value per share is determined and published and is the basis for current transactions.”
By adding “structures similar to mutual funds” to the definition and calling out limited partnerships and venture capital entities as examples, critics said the FASB expanded the population of securities that must be evaluated for readily determinable fair value. But the funds that criticized the 2015 amendment couldn’t cite any specific examples of financial reporting problems caused by the revised definition. So, the board voted 6-1 to not take up the project.
These are just a few topics currently on the FASB’s technical agenda. U.S. GAAP is constantly evolving to address the concerns of businesses, investors and other users of financial statements. The FASB plans to conduct additional research and is beginning initial deliberations on many other areas of financial reporting. Contact your CPA for more information on the latest proposals and updates to the financial reporting guidance.
The Securities and Exchange Commission (SEC) has approved a final rule requiring public companies to include hyperlinks to the exhibits in regulatory filings. Here are the details, including how the new requirement will help investors search through a public company’s previous filings.
Currently, investors who want to find exhibits to filings must check the exhibit index and search through the company’s previous filings to find and review the exhibit in the SEC’s Electronic Data Gathering, Analysis and Retrieval (EDGAR) filing system. The exhibits may supplement a company’s registration statement or quarterly and annual reports with information about, say, a significant contract, tax opinion or merger.
Many investors find this search process to be cumbersome and time-consuming. So, last August, the SEC proposed a rule that would require public companies to include hyperlinks to the exhibits of their financial statements and other regulatory filings. On March 1, 2017, the SEC finalized its new rule, based on positive feedback from investors and other stakeholders.
“Today’s action will bring the commission further into the 21st Century by harnessing technology to improve the manner in which investors can access public company disclosure,” said SEC Acting Chairman Michael Piwowar. “For any person using the Internet, it is nearly unthinkable for a Web page to indicate that more information is available and not to include a hyperlink to such information.”
The SEC’s new requirement will mean that exhibits are always just one click away, no matter which registration statement or report they were filed with or how long ago the filing was made. The hyperlinks must be incorporated into registration statements and financial reports submitted through the EDGAR filing system and formatted in the HyperText Markup Language (HTML), not the American Standard Code for Information Interchange (ASCII) text format. The latter has been in use by some companies, but it doesn’t support hyperlinks.
For now, these requirements don’t apply to the electronic exhibits for asset-backed securities offerings filed on the SEC’s Form ABS-EE, “Form for Submission of Electronic Exhibits for Asset-Backed Securities,” or exhibits filed in the eXtensible Business Reporting language (XBRL). The SEC specifically excluded the exhibits filed with Form ABS-EE because the form doesn’t currently permit exhibits to be incorporated by reference and is filed in unconverted code. Likewise, XBRL exhibits are similarly filed in unconverted code.
The SEC’s final rule goes into effect on September 1, 2017. But companies classified as nonaccelerated filers (with publicly traded shares worth less than $75 million) won’t have to meet the requirements until September 1, 2018.
In addition, the SEC plans to upgrade the EDGAR system so that it can accept hyperlinks in filings for a Form 10-D or Form ABS-EE. The agency plans to publish a separate notice in the Federal Register once it makes the necessary modifications to EDGAR.
What is eXtensible Business Reporting Language (XBRL)? It’s a machine-readable format that allows regulators and investors to analyze and compare companies’ financial results more efficiently.
Under final rules adopted by the Securities and Exchange Commission (SEC) in 2009, companies have been required to submit XBRL statements as separate exhibits to financial statements. Companies have also been required to post interactive data files on their websites. The two-stage financial statement process contributes to tagging errors, inconsistencies and other problems that undermine the quality of the data.
On March 1, the SEC approved a proposal that would require public companies to use inline XBRL. In other words, they must embed interactive data directly into their financial statements. The proposal would also call for the use of inline XBRL in mutual fund risk and return summaries.
The SEC hopes that inline XBRL will give companies more control over the presentation of the XBRL disclosures within a filing formatted in the HyperText Markup Language (HTML), as well as help investors review XBRL data more efficiently. “This one format should improve data quality while reducing the cost and burden of preparing public reports,” SEC Commissioner Kara Stein said.
If the rules are adopted, there will be a phased-in approach depending on the company’s size. Large accelerated filers (companies with more than $700 million in public float) will have to begin complying in the second year after changes become effective. Smaller public companies will get extra time to implement the changes to their reporting systems.
In May 2016, the Securities and Exchange Commission (SEC) began allowing private companies to raise as much as $1 million per year from everyday investors. How? The SEC approved the use of online “crowdfunding” platforms run by intermediaries to carry out the mandate under the Jumpstart Our Business Startups (JOBS) Act. Here’s a closer look at the mechanics of crowdfunding, the reporting requirements based on the size of the company and the market’s response to crowdfunding in its first year.
Historically, the SEC has allowed private companies to solicit capital only from “accredited” investors, which are people with net worth of at least $1 million (excluding the value of their primary residences) or annual income of more than $200,000 per individual (or $300,000 for married couples). Online solicitations to these wealthy individuals were required to come from SEC-registered intermediaries.
In October 2015, the SEC approved final crowdfunding rules that establish a registration exemption for companies raising up to $1 million a year through online funding portals. They also created a registration process for intermediaries and add a new incentive for them by allowing intermediaries to take ownership stakes in the issuers as compensation.
Investors don’t need to be accredited to participate in these offerings. The rules do, however, limit how much investors can purchase in an offering. Investors earning less than $100,000 annually can invest the higher amount of:
Investors with both net worth and annual income above $100,000 can invest the lesser amount of:
Additionally, no one is allowed to invest more than $100,000 in crowdfunding deals in any one year. The SEC also requires a one-year holding period before securities purchased through a crowdfunding deal can be resold.
Companies that sell securities through an online crowdfunding portal must provide some basic information, such as a description of the business and the names of its officers, directors and primary owners. Issuers must also comply with three tiers of disclosure, based on the size of the offering:
In addition, all issuers must prepare their financial statements in accordance with U.S. Generally Accepted Accounting Principles (GAAP).
So, how has the market responded to online crowdfunding? Young companies are increasingly participating in the nascent crowdfunding market to fund up-and-coming businesses like bakeries and craft breweries. Through the end of 2016, 156 companies made 163 offerings seeking a total of $18 million from investors. The average offering was only $110,000.
The SEC has been monitoring the crowdfunding market to ensure that issuers aren’t misleading investors. Although some issuers clearly understand and follow the assurance and disclosure rules, many companies haven’t fully adhered to them. Some omissions of disclosures or departures from GAAP are more egregious than others. So far, the SEC hasn’t found enough noncompliance to warrant pulling the plug on crowdfunding.
But the SEC cautions investors to review crowdfunding deals carefully. The process for an initial public offering (IPO) of common stock incorporates a relatively strong set of investor protections. Conversely, crowdfunding is classified as an exempt offering, and the SEC doesn’t supervise the offerings. Instead, the JOBS Act contemplated the market to use the wisdom of the crowd to act as protection against potential fraud.
Before considering raising capital through online crowdfunding portals, it’s important for companies to understand the reporting requirements, so they won’t inadvertently mislead investors by providing inconsistent, erroneous or incomplete financial data. At the same time, investors should perform in-depth due diligence to avoid investing in ventures that don’t follow GAAP or provide adequate disclosures. An accounting and auditing professional can help issuers and investors objectively evaluate a crowdfunding deal.