accounting update september 2010. page 1 presenters josh paul, securities & exchange commission...

Accounting updateSeptember 2010

Presenters

► Josh Paul, Securities & Exchange Commission► Chris Holmes, Ernst & Young► James Barlow, Allergan

Agenda

► Interacting with SEC Office of the Chief Accountant► Current accounting matters► FASB/IASB joint projects► SEC hot buttons

Interacting with SEC Office of the Chief Accountant

► Office of the Chief Accountant (OCA)

► Avenues for consultation

► Considerations in evaluating accounting issues

Office of the Chief Accountant (OCA)

► Chief Accountant: James L. Kroeker► Main groups in OCA

Accounting (Deputy Chief Accountant Paul Beswick) Professional Practice (Audit and Independence) (Deputy Chief Accountant

Brian Croteau) International Affairs (Deputy Chief Accountant Julie Erhardt)

► Responsibilities Rulemaking, interpretive guidance and reports Oversight of standard setting Consultations

Avenues for consultations

► Pre-filing basis – requests from registrants Guidance posted on the SEC’s website:

http://www.sec.gov/info/accountants/ocasubguidance.htm

► Post-filing basis Internal consultations from Divisions of Corporation Finance and

Enforcement Requests from registrants

► Informal discussion with OCA staff members (202) 551-5300

OCA considerations in evaluating accounting issues

► Faithful application of accounting literature ► Where accounting literature does not address the situation:

Provide information useful to investors and creditors in their decision-making process

Professional judgment SEC staff will accept reasonable differences in judgment,

coupled with transparent disclosure Concurrent documentation enhances credibility of judgment

Economic substance Problems arise when transactions are designed around

accounting literature Often not consistent with principles of standard

Transparent disclosures

Current accounting matters

► Accounting implications of health care reform for life sciences companies

► Revenue recognition

► Consolidation

Accounting implications of health care reform for life sciences companies

► In March 2010, the Patient Protection and Affordable Care Act was signed into law along with the related Health Care and Education Reconciliation Act of 2010 (collectively, the Act)

► The Act represents a major overhaul of the nation’s health system and also includes a number of provisions that have significant accounting implications

► Drug manufacturers’ fee – non-deductible annual fee on certain prescription drug manufacturers beginning 1 January 2011 Entity will be required to pay the annual fee if it sells branded prescription drugs to a

specified government program (e.g., Medicare, Medicaid, etc.) in a given calendar year

The fee is calculated based on the entity’s relative market share of certain domestic sales for the preceding calendar year

The fee is recognized in the calendar year in which it is payable (e.g., the fee payable in 2011 would be recognized in 2011)

Proposed ASU specifies that upon recognition of the liability, the annual fee should be recognized over the benefit period using a straight-line method of allocation unless another method better allocated the fee over the calendar year

Accounting implications of health care reform for life sciences companies (cont’d)

► Excise tax on medical device manufacturers – imposes an excise tax equal to 2.3 percent of the sales price of certain medical devices, beginning 1 January 2013 We believe such taxes should be presented on the income statement either on a gross (included in

both revenues and costs) or net (excluded from revenues) basis, depending on the entity’s accounting policy election

► Medicare Part D coverage gap – requires prescription drug manufacturers to provide a 50-percent discount to Medicare Part D beneficiaries for brand-name drugs and biologics purchased during the coverage gap (“donut hole”), beginning in 2011 Coverage gap rebates plus manufacturers’ rebates could exceed selling price

► Medicaid drug rebates – increases the rebates paid by prescription drug manufacturers for certain drugs dispensed to Medicaid beneficiaries, effective 1 January 2010

► Medicare Part D tax benefits – reduces the tax benefits available to an employer that receives the Medicare Part D subsidy, effective for taxable years beginning after 31 December 2012

Revenue recognition

► Multiple Elements: Double the pleasure, double the fun ASU 2009-13, “Revenue Arrangements with Multiple Deliverables”

(formerly EITF Issue No. 08-1) Supersedes Issue 00-21– requires allocation of consideration on a basis of

relative selling price, eliminates residual method Selling price is determined by (in order):

o VSOE, if it existso Third party evidence of selling price, if it existso Vendor’s best estimate of selling price

Must be adopted by all entities no later than fiscal years beginning on or after 15 June 2010; early adoption allowed

Entities may elect to adopt the revised guidance through either of the following methods:o Prospective application to all revenue arrangements entered into or

materially modified after the date of adoption o Retrospective application to all revenue arrangements for all periods

presented

Revenue recognition (cont’d)

ASU 2009-14, “Applicability of SOP 97-2 to Certain Arrangements that Include Software Elements” (formerly EITF Issue No. 09-3) Amends scope of SOP 97-2 Excludes from SOP 97-2 tangible products (e.g., hardware) and software

components of tangible products when the tangible and software components function together to deliver tangible products essential functionality

Required to be adopted in the same period and using the same transition method as ASU 2009-13; therefore, entities need to adopt the guidance in both ASUs at the same time and in the same manner

Revenue recognition (cont’d)

► R&D Milestone Payments: Haven’t you earned it? ASU 2010-17, “Milestone Method of Revenue Recognition” (formerly EITF

Issue No. 08-9) Milestone method is an acceptable application accounting policy election

under the proportional performance model, but is not required and is not the only acceptable method of revenue recognition for milestone payments in R&D arrangements

If milestone is substantive, recognize contingent consideration earned in its entirety in the period in which the milestone is achieved

Effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010

Early adoption is permitted

Consolidation

► Simplification? – ASC 810, “Consolidations” (includes what was formerly SFAS No. 167), amended complex, quantitative nature of the application of the Variable Interest Model for determining the primary beneficiary (PB)

► VIE determination The amendments to FIN 46(R) changed the provisions regarding decision

making and whether the equity holders have the characteristics of a controlling financial interest

Criteria for whether an entity is a VIE As a group, the holders of the equity investment at risk lack:

o The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entity’s economic performance. The investors do not have that power through voting rights or similar rights if no owners hold voting rights or similar rights (such as those of a common shareholder in a corporation or a general partner in a partnership)

Kick-out or participating rights not considered unless a single enterprise (and its related parties and de facto agents) has the unilateral ability to exercise them

Consolidation (cont’d)

► PB determination: qualitative analysis PB determination is now based upon a qualitative analysis

Power to direct activities that most significantly impact VIE’s economic performance (“power”), AND

Obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant (“benefits”)

Eliminates quantitative analysis for determining PB Quantitative analysis may still be necessary in applying other provisions

within the Variable Interest Model (e.g., VIE determination) Power may be shared (consent is required)


► PB determination: development stage companies Variable Interest Model provides that a development stage enterprise’s

equity investment at risk is sufficient if (1) it can be demonstrated that the equity invested in the entity is sufficient to permit it to finance its current activities and (2) provisions in the entity’s governing documents and contractual arrangements allow additional equity

► PB determination: related party provisions Variable Interest Model amended so that the power/benefits principle is

considered before applying the related party provisions De facto agency exemption for substantive mutual transfer restrictions

agreed to by parties


► Other VIE determination is reevaluated based on specific events

Provision added: “changes in facts and circumstances occur such that the holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance”

Troubled debt restructuring exemption removed PB determination is now continuous Only substantive terms, transactions, and arrangements should be

considered

FASB/IASB joint projects

► Status update► Revenue recognition► Leases► Financial presentation

FASB/IASB joint projects status update

Change is inevitable - except from a vending machine ► Eleven joint convergence projects of the FASB and the IASB

Accounting for financial instruments Statement of comprehensive income Fair value measurement Reporting discontinued operations Consolidation Financial instruments with characteristics of equity Financial statement presentation Leases Revenue recognition Insurance contracts Emissions trading schemes

FASB/IASB joint projects status update

► FASB and IASB renewed their formalized commitment to convergence in a 2006 Memorandum of Understanding (MoU)

► Updated in 2008, establishing mid-2011 as target completion date► Updated in June 2010 to address challenges in improving/converging

certain areas and stakeholder concerns Prioritizes projects that the Boards believe will bring significant improvement

and convergence to IFRS and US GAAP Phases EDs to enable high-quality input from stakeholders Separate document will seek stakeholder input about effective

dates/transition

► Delay in issuance dates for certain EDs and final guidance as a result of modified strategy

► Convergence of some standards uncertain► SEC stated that delay would not affect SEC IFRS decision in 2011

SEC IFRS Work Plan progress report expected in October 2010

FASB/IASB joint projects – revenue recognition

► Let’s try singing from the same hymnal Exposure draft issued Q2 2010, Final standard expected in 2011 Joint proposal to adopt a single revenue recognition model for most revenue

transactions Identify contract(s) with customers (written, oral or implied) Identify separate performance obligations in each contract Determine the transaction price Allocate consideration to identified performance obligations based on relative

standalone selling prices Recognize revenue as performance obligations are satisfied through the transfer of

control of goods or services to customero If onerous (i.e., a loss is expected on satisfaction of a performance obligation), the

entity recognizes a liability and corresponding expense Proposal includes increased disaggregated disclosures about (1) revenue

(e.g., major product lines, geography), (2) contracts with customers and (3) changes in aggregate balances of contract assets and liabilities (potentially requiring accounting system changes)

Proposal requires full retrospective application of the new standard

FASB/IASB joint projects – leasing

► Operating Leases: Another one bites the dust Exposure draft issued in Q3 2010, final standard expected in 2011 Proposed model for lessees to record all leases on the balance sheet,

a significant change Record an asset (right to use the item for the lease term) and a liability

(obligation to make rental payments) Initially measure asset and obligation at the present value of the expected

lease payments (including contingent rentals and residual value guarantees)

Amortize asset over shorter of the lease term or economic life of the leased asset

Lease payments reduce obligation with interest expense using the effective yield method

At each reporting date, reassess lease obligation and remeasure if necessary using revised assumptions

FASB/IASB joint projects – financial statements presentation

► Oh, what a tangled web we weave Increased disaggregation by function, nature and measurement basis in

the statements of financial position, comprehensive income and cash flows

Other key changes Remeasurement information required in notes Direct method presentation of operating cash flows Analysis of changes in balances of select asset and liability line items For each reportable segment, disclosure of

o Operating cash flow, reconciling to the sum of operating cash flow in the statement of cash flows

o Measure of operating assets and liabilitieso Measure of liabilities if used by CODM

► Non-GAAP financial measures

► Goodwill impairment

► Segments

SEC hot buttons

Welcome back, welcome back, welcome back► If presented, a non-GAAP financial measure must be accompanied by the disclosures

required by Item 10(e)(1)(i) of Regulation S-K: Present, with equal or greater prominence, the most directly comparable GAAP measure Numerically reconcile the non-GAAP measure to the GAAP measure Why management believes the non-GAAP measure provides useful information to investors Any additional material uses by management of the non-GAAP measure

► SEC staff issued new Compliance and Disclosure Interpretations (C&DIs) in January 2010 to interpret but not modify Item 10 of Regulation S-K

Non-GAAP C&DIs supersede the former non-GAAP FAQs Remove many of the challenges and uncertainties in the presentation of a non-GAAP

performance measure that excludes a recurring item Clarify that a non-GAAP financial measure may be disclosed even if it is not used by

management in managing the business Generally inappropriate to present a full non-GAAP income statement for purposes of

reconciling non-GAAP measures to the most directly comparable GAAP measures

Non-GAAP financial measures

► Intent of the non-GAAP C&DIs is to make it easier to include a non-GAAP financial measure in SEC filings and permit more consistency with disclosures outside of SEC filings (e.g., in press releases and analyst presentations)

► Intent of the non-GAAP C&DIs is not to require a company to disclose in its SEC filings every non-GAAP financial measure that it discloses outside of its SEC filings (unless omission is misleading)

► SEC comment letters are asking why a company chose not to disclose a non-GAAP financial measure in its SEC filings that it had publicly disclosed elsewhere A company should not assume that the SEC staff is requesting the company to disclose the

non-GAAP financial measure in its SEC filings A company should respond to such an inquiry by clearly articulating why the company chose

not to include the non-GAAP financial measure in its SEC filing

► Increased SEC staff focus on non-GAAP financial measures disclosed in press releases, company websites and earnings calls for compliance with Regulation G

Non-GAAP financial measures (cont’d)

Here today, gone tomorrow?► Recent market conditions have highlighted goodwill impairment risk disclosures► For a company with goodwill as a critical accounting estimate, the SEC expects the

registrant’s MD&A to disclose the following for each reporting unit with a material amount of goodwill that is “at risk”: The percentage by which fair value of the reporting unit exceeds its carrying value at the date

of the last impairment test (i.e., cushion) The amount of goodwill allocated to the reporting unit A description of the methods and key assumptions that drive the fair value of the reporting unit

and how the key assumptions were determined (i.e., the SEC staff encourages, but does not require, disclosure of the key numerical assumptions or a quantitative sensitivity analysis)

Any uncertainties surrounding the key valuation assumptions (e.g., the valuation model assumed recovery from a business downturn within a defined period of time)

Events that could have a negative effect on the fair value of the reporting unit

► No bright lines exist and registrants must apply judgment to determine whether a reporting unit’s goodwill is considered “at risk”

► The SEC staff acknowledges that the need for these disclosures decreases as the cushion increases

Goodwill impairment

► For a company with goodwill as a critical accounting estimate, but immaterial goodwill at risk or no reporting units that are at risk of failing the impairment test, the SEC staff expects disclosure of that fact in MD&A If a company concludes that there is a low risk of goodwill impairment and does not identify

goodwill impairment as a critical accounting estimate, the SEC staff would not expect the noted disclosures

► If an impairment was recorded, disclose: The fact and circumstances that led to the charge The timing of the “triggering event” The effect of the impairment on the business, including future expectations What went wrong?

► The SEC staff has aggressively probed the method of estimating the fair value of reporting units Expects registrants to validate valuations by comparing the aggregate fair value of goodwill

reporting units to the market capitalization of the consolidated entity Objective evidence must support implied control premiums

Goodwill impairment (cont’d)

Segments

Let the sunshine in► SEC staff continues to question registrants regarding the determination and

aggregation of operating segments Reviews public information available, including public filings, registrant websites

and industry or analyst presentations Questions perceived inconsistencies

► Identification of operating segments (“management approach”) At what levels within an entity are revenue earned and expenses incurred Who is entity’s chief operating decision maker (CODM) What operating performance information is available for review by the CODM to

make performance decisions and allocate resources► If the CODM regularly receives reports that present discrete operating results for

components of the entity, SEC staff presumes the CODM uses these reports to assess performance and allocate resources

SEC staff challenges registrant assertions that conclude otherwise

Segments (cont’d)

► Key elements to segment aggregation criteria Aggregation consistent with objectives and basic principles of segment accounting

literature (ASC 280, “Segments” (formerly SFAS No. 131)) Operating segments must be economically similar (based on future prospects of

gross margin and sales trends and not solely on current indicators) Operating segments must have similar characteristics (e.g., nature of products and

services, types or class of customer, methods used to distribute products or provide service, nature of regulatory environment)

Thank you

accounting update september 2010. page 1 presenters josh paul, securities & exchange commission...

Documents

accounting update

chief accountant office

calendar year slide

allergan slide

chief accountant oca

manufacturers rebates

fee payable

sec office