chattanooga accounting seminar gaap update
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Chattanooga Accounting Seminar GAAP Update
Russ Madray Scholar-in-Residence May 12, 2015
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC
This material was used by Elliott Davis Decosimo during an oral presentation; it is not a complete record of the discussion. This presentation is for informational purposes and does not contain or convey specific advice. It should not be used or relied upon in regard to any particular situation or circumstances without first consulting the appropriate advisor. No part of the presentation may be circulated, quoted, or reproduced for distribution without prior written approval from Elliott Davis Decosimo.
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 2
GAAP Update
• Private company accounting alternatives • New revenue recognition standard • Other FASB standards • On the horizon
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 3
Private Company Accounting Alternatives
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC
Private Company Accounting Alternatives
• ASU 2014-02, Accounting for Goodwill • ASU 2014-03, Accounting for Certain Receive-
Variable, Pay-Fixed Interest Rate Swaps—Simplified Hedge Accounting Approach
• ASU 2014-07, Applying Variable Interest Entities Guidance to Common Control Leasing Arrangements
• ASU 2014-18, Accounting for Identifiable Intangible Assets in a Business Combination
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 5
Who Can Elect the Alternatives?
• Following types of entities cannot apply any private-company accounting alternatives:
• ASU 2014-03 not available for financial institutions
Public Business Entities
Not-for-Profit Entities
Employee Benefit Plans
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Is the Reporting Entity a Public Business Entity?
• Is it required by the SEC to file or furnish financial statements, or does it file or furnish financial statements with the SEC?
- Includes voluntary filers - Includes other entities where financial statements or
financial information are required to be or are included in a filing
- Would not apply to stand-alone financial statements of subsidiary/investee
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 7
Is the Reporting Entity a Public Business Entity?
• Is it required to file or furnish financial statements with a regulatory agency by the Securities Exchange Act of 1934, as amended, or rules or regulations promulgated under the Act?
- Broker-dealers are considered PBEs
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 8
Is the Reporting Entity a Public Business Entity?
• Is it required to file or furnish financial statements with a regulatory agency in preparation for the sale of securities or for the purposes of issuing securities
• Has it issued (or is it a conduit bond obligor for) unrestricted securities that are traded or can be traded on an exchange or an OTC market?
- Includes an interdealer quotation or trading system for securities that are not listed on an exchange
- OTC Pink Markets - OTC Bulletin Board
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 9
Is the Reporting Entity a Public Business Entity?
• Does it (1) have one or more securities that are not subject to contractual restrictions on transfer, and (2) is it is required by law, contract, or regulation to prepare U.S. GAAP financial statements and make them publicly available on a periodic basis?
- Must meet both criteria - Must be full set of U.S. GAAP financial statements
(including footnotes) - Call reports are not financial statements - Restrictions may be contained in buy-sell, shareholder, or
other agreements
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Accounting for Goodwill
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• Current U.S. GAAP - No amortization - 2-step impairment test applied at least annually at
the reporting unit level • Alternative
- Amortize over 10 years (or less) - Impairment testing only if triggering event - Policy choice for impairment – entity or reporting unit
ASU 2014-02, Accounting for Goodwill
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 12
• Impairment - When a triggering event indicates that fair value of an
entity (or a reporting unit) may be below its carrying amount
- One-step impairment test would be performed - Amount of the impairment would be measured by
calculating the difference between the carrying amount of the entity (or reporting unit, as applicable) and its fair value
- Hypothetical purchase price allocation to isolate the change in goodwill (i.e., step two) would no longer be required
ASU 2014-02, Accounting for Goodwill
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 13
ASU 2014-02, Accounting for Goodwill
General economic conditions
Industry and market
considerations
Increases in costs that have a negative
effect on earnings and cash flows
Negative or declining cash
flows or revenue
Entity-specific events
Triggering events
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 14
ASU 2014-02, Accounting for Goodwill
• Transition - Existing goodwill - New goodwill
• Amortization period
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 15
FAQ: Amortization Requirement
• Are private companies required to amortize goodwill going forward or does it have the option to do so?
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FAQ: Level of Impairment Assessment
• Does the new guidance allow assessment at the entity level, even if we know this yields a different accounting result – perhaps materially different – in the year of adoption?
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 17
FAQ: Amortization of Less Than 10 Years
• What kind of justification/documentation is needed to amortize goodwill over a period of less than 10 years?
- ASC 350-20-35-63 states “…or less than 10 years if the entity demonstrates that another useful life is more appropriate.”
- In the Basis for Conclusions, “That provides an opportunity for a reporting entity to identify a shorter useful life than 10 years, if it chooses to do so, when a shorter useful life is more appropriate based on its own specific facts and circumstances.”
- The only thing that’s made clear in multiple places is that 10 years is the maximum
- In other words, their primary concern appears to be the upper limit and not the ability to use a shorter life
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FAQ: Implementation Question
• Facts: 2 years ago the company had an acquisition—didn’t really allocate the purchase price – dumped all into goodwill.
• They can go back and fix to properly allocate the purchase price. • Will the goodwill alternative be allowed? • Here’s what they would need to do:
1. Properly allocate the purchase price and determine the proper starting point for goodwill.
2. Determine if any impairment existed in each year subsequent to the acquisition and record accordingly (this will require application of the existing 2-step impairment test each year subsequent to the acquisition).
3. Once the goodwill balance is correct and up to date, the PCC alternative could be elected.
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 19
Note Disclosure for Adoption
Change in Accounting Principle In January 2014, the FASB amended the Intangibles –Goodwill and Other topic of the Accounting Standards Codification. Under the amended guidance, a nonpublic entity may elect to amortize goodwill on a straight-line basis over a period of ten years or over a shorter period if the company demonstrates that another useful life is more appropriate. Goodwill would be subject to impairment testing only upon the occurrence of a triggering event. The Company adopted the amended guidance and elected to amortize existing goodwill at the beginning of the period of adoption, [January 1, 2014]. The Company will assess goodwill for impairment at an [entity] [reporting unit] level. There was no material impact on the Company’s results of operations or financial condition upon adoption of the new guidance.
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 20
Plain Vanilla Interest Rate Swaps
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ASU 2014-03, Accounting for Certain Receive Variable, Pay Fixed Interest Rate Swaps– Simplified Hedge Accounting Approach
• Current U.S. GAAP – derivative = hedge accounting - Changes in FV of swap go to OCI - Must evaluate/document effectiveness of hedge
• Alternative - Simplified short cut approach for plain vanilla swaps - Not available for financial institutions
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 22
Variable rate on the swap and borrowing based on same index
and reset period
Terms of swap are typical and there is no
floor or cap on variable interest rate
of swap unless borrowing has a
comparable floor or cap
Re-pricing and settlement dates for swap and borrowing match or differ by no more than a few days
Swap’s fair value at inception is at or near
zero
Notional amount of swap matches
principal amount of borrowing being
hedged (may be less than total principal
amount of borrowing)
All interest payments designated as hedged
in total or in proportion to
principal amount of borrowing being
hedged
ASU 2014-03, Accounting for Certain Receive Variable, Pay Fixed Interest Rate Swaps– Simplified Hedge Accounting Approach
• Conditions:
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 23
• Can wait until financial statements are issued to have documentation in place and elect to apply simplified hedge accounting approach
• Allows swap to be measured at settlement value instead of fair value
• Settlement value may be estimated by applying a present value calculation of swap’s remaining estimated cash flows using a valuation technique that is not adjusted for nonperformance risk
ASU 2014-03, Accounting for Certain Receive Variable, Pay Fixed Interest Rate Swaps– Simplified Hedge Accounting Approach
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 24
• Must continue to account for the interest rate swap and the variable-rate debt separately on the face of the balance sheet
• However, able to assume no ineffectiveness in the hedging relationship
• Essentially the same income statement effects as if it had issued fixed-rate debt
ASU 2014-03, Accounting for Certain Receive Variable, Pay Fixed Interest Rate Swaps– Simplified Hedge Accounting Approach
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 25
FAQ: Definition of Financial Institution
• Would the alternative for interest rate swaps apply to a consumer finance company (private and generally unregulated obviously)?
• More specifically, is the term financial institution defined in the literature?
• ASU 2014-03refers the definition of financial institutions included in FASB ASC 942-320-50-1:
- …the term financial institutions includes banks, savings and loan associations, savings banks, credit unions, finance companies, and insurance entities
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 26
Note Disclosure for Adoption
Change in Accounting Principle In January 2014, the FASB amended the Derivatives and Hedging topic of the Accounting Standards Codification. Under the amended guidance, a nonpublic entity may elect to use a simplified hedge accounting approach for its receive-variable, pay-fixed interest rate swaps. Under this approach, the income statement charge for interest expense will be similar to the amount that would result if the company had directly entered into a fixed-rate borrowing instead of a variable-rate borrowing and an interest rate swap. Furthermore, the simplified hedge accounting approach allows the swap to be measured at its settlement value, which measures the swap without non-performance risk, instead of fair value. The Company adopted the amended guidance and elected to apply the simplified hedge accounting approach [retrospectively] [using a modified retrospective approach] in [2014]. There was no material impact on the Company’s results of operations or financial condition upon adoption of the new guidance.
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 27
Common Control Leasing Arrangements
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ASU 2014-07, Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements
• Current U.S. GAAP – consolidate a VIE when the reporting entity is considered the primary beneficiary
Is the reporting entity the primary beneficiary of the VIE?
Power to direct activities of the VIE Absorb losses or receive benefits significant to VIE
Does the reporting entity have a variable interest (explicit or implicit) in the VIE (loans, leases, guarantees, etc.)?
Is the legal entity a VIE?
Total equity at risk not sufficient Total equity at risk doesn’t possess “normal” characteristics
Voting rights are not proportionate
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 29
• Example – current U.S. GAAP - Owner of a construction company decides to buy a
building - Through his LLC, securing a loan from a local bank, he
purchases a building - His LLC leases the building to his company
• Is the LLC a VIE? • Does the construction company have a variable interest
in the VIE? • Is the construction company the primary beneficiary of
the VIE?
ASU 2014-07, Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 30
Conditions for electing alternative:
• Still apply other guidance (e.g., ASC 840, Leases; ASC 460, Guarantees; etc.)
• Additional disclosures about the leasing arrangement • Applicable to all similar leasing arrangements
ASU 2014-07, Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements
(a) Lessor entity and private company lessee under common
control
(b) Private company lessee has a leasing arrangement with lessor
(c) Substantially all activity between the two entities is
related to the leasing activity of lessor entity
(d) If private company lessee explicitly guarantees or provides
collateral for any obligation of lessor related to the leased
asset, principal amount of the obligation at inception does not
exceed value of leased asset
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 31
ASU 2014-07, Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements
A guarantee or collateral provided by the private company lessee to the lender of the lessor for debt
that is secured by the asset(s) leased by the private company
lessee
A joint and several liability arrangement for debt of the lessor,
for which the private company lessee is one of the obligors, that is secured by the asset(s) leased by
the private company lessee
Paying property taxes, negotiating the financing, and maintaining the
asset(s) leased by the private company lessee
Paying income taxes of the lessor when the only asset owned by the lessor is being leased either by only the private company or by both the
private company lessee and an unrelated party
Examples of Leasing Activities
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Example 1
Assume the following:
• Private manufacturing company
• Pledged assets as collateral for LESS’s mortgage
• Leases its manufacturing facility from LESS
• Pays prop taxes and maintenance on facility
MFG, Inc. (Lessee)
• Owns manufacturing facility; value: $1 million
• Mortgage on facility: $800,000
• Leases entire facility to MFG • No other assets
Less, Inc. (Lessor)
I own MFG, Inc. and LESS, Inc.
I personally guaranteed
LESS’ mortgage.
Can MFG elect the
PCC alternative? © Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 33
Can MFG elect the PCC alternative?
(a) MFG and LESS are under
common control
(b) MFG has a lease
arrangement with LESS
(c) Substantially all the activities between MFG and LESS are related to the lease of the manufacturing facility •Providing collateral, paying
property taxes, and maintaining the facility considered to be leasing activities
(d) Value of the
manufacturing facility leased by MFG exceeds
principal amount of LESS’s mortgage at
inception of the mortgage
Yes!
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 34
2 years later….
• Private manufacturing company
• Pledged assets as collateral for LESS’s mortgage
• Leases its manufacturing facility from LESS
• Pays prop taxes and maintenance on facility
MFG, Inc. (Lessee)
• Owns manufacturing facility; value: $700,000
• Mortgage on facility: $790,000
• Leases entire facility to MFG • No other assets
Less, Inc. (Lessor)
Oh my!
The value of the facility has declined!
Can MFG continue to apply the
PCC alternative?
Yes—assuming no other changes.
If LESS refinances or enters into new obligation that requires collateralization or guarantee by MFG, reassess whether criterion (d) met at the inception of the new obligation
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 35
Example 2
Assume the following:
•Private manufacturing company
•Pledged assets as collateral for LESS’s entire mortgage
• Leases 3 floors of facility from LESS
MFG, Inc. (Lessee)
•Owns manufacturing facility; value: $1 million
•Mortgage on plant: $800,000
• Leases remaining 7 floors to unrelated party
•No other assets
Less, Inc. (Lessor)
I own MFG, Inc. and LESS, Inc.
I personally guaranteed LESS’ entire mortgage.
Can MFG elect the
PCC alternative? © Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 36
Can MFG elect the PCC alternative?
(a) MFG and LESS are under
common control
(b) MFG has a lease
arrangement with LESS
(c) Substantially all the activities between MFG and LESS are related to the lease of the manufacturing facility •Even though part of the
manufacturing facility is also leased to unrelated parties
(d) Value of the
manufacturing facility leased by MFG exceeds
principal amount of LESS’s mortgage at
inception of the mortgage
Yes!
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 37
2 years later…
•Private manufacturing company •Pledged assets as collateral for
both of LESS’s mortgages •Leases Facility 1 from LESS
MFG, Inc. (Lessee)
•Owns 2 manufacturing facilities •Facility 1 •Value: $1 million •Mortgage: $800,000 •Facility 2 •Value: $1 million •Mortgage: $500,000
Less, Inc. (Lessor)
•Leases Facility 2 from LESS
UNRELATED, Inc.
I own MFG, Inc. and LESS, Inc. LESS purchased another facility.
I personally guaranteed both
of LESS’ mortgages.
Can MFG continue to apply the
PCC alternative?
No. MFG is engaging in substantial activity outside its leasing activity with LESS by providing a guarantee on a mortgage secured by an asset that is not being leased by MFG
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 38
Case Study 1 – Common Control Leasing Activity
•Private manufacturing company •Pledged assets as collateral for LESS’s mortgage on Facility 1 •Leases manufacturing Facility 1 from LESS
MFG, Inc. (Lessee)
•Owns 2 manufacturing facilities •Facility 1 •Value: $1 million •Mortgage: $800,000 •Facility 2 •Used to manufacture chemicals •Value: $1 million •Mortgage: $0
Less, Inc. (Lessor)
Can MFG elect the
PCC alternative?
I own MFG, Inc. and LESS, Inc.
I personally guaranteed
LESS’ mortgage on Facility 1
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 39
FAQ: Selective Consolidation
• If a company has 2 VIEs that qualify for the exception but they just wanted to consolidate the one and not consolidate the other one, can they do that?
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Note Disclosure for Adoption
Change in Accounting Principle In March 2014, the FASB amended the Consolidation topic of the Accounting Standards Codification. Under the amended guidance, a nonpublic entity has the option to exempt itself from applying the VIE consolidation model to a qualifying common control leasing arrangement. The Company adopted the amended guidance and elected to exempt itself from applying the VIE consolidation model to qualifying common control leasing arrangements in [2014]. The Company applied a full retrospective approach in which the financial statements for the year ended [December 31, 2013] have been adjusted to reflect the period-specific effects of applying the amendments.
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 41
ASU 2014-18, Accounting for Identifiable Intangible Assets in a Business Combination
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC
ASU 2014-18, Accounting for Identifiable Intangible Assets in a Business Combination
• Current U.S. GAAP: - Recognize and measure at fair value intangible assets
that are identifiable: • Arises from contractual or other legal rights • Separable – capable of being separated or divided from the
entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability, regardless of whether the entity intends to do so
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 43
• A private company would no longer recognize the following intangible assets separately from goodwill:
- Customer-related intangible assets that are not capable of being sold or licensed independently from the other assets of the business
- Non-compete agreements • Result = recognize fewer intangible assets and,
correspondingly, recognize more goodwill
ASU 2014-18, Accounting for Identifiable Intangible Assets in a Business Combination
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 44
FAQ: Selective Application
• Can a company elect not to breakout from goodwill certain intangibles (e.g. breakout non-compete contracts as separately identified intangible assets, but include customer related intangibles within goodwill)?
• In other words, is this an “all or nothing” election with respect the intangibles covered by this private company option?
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 45
Note Disclosure for Adoption Change in Accounting Principle In December 2014, the FASB amended the Business Combinations topic of the Accounting Standards Codification. Under the amended guidance, a nonpublic entity may elect to not recognize separately from goodwill (1) customer-related intangible assets that are not capable of being sold or licensed independently from the other assets of the business and (2) noncompetition agreements. This alternative generally will result in recognizing fewer intangible assets in a business combination and, correspondingly, more goodwill. The Company elected this accounting alternative in [2014] and will apply it to all eligible transactions thereafter. The alternative is applied on a prospective basis. In addition, when this alternative is elected, the Company also is required to adopt the alternative accounting related to goodwill which requires that goodwill be amortized on a straight-line basis over a period of ten years or over a shorter period if the Company demonstrates that another useful life is more appropriate. Goodwill would be subject to impairment testing only upon the occurrence of a triggering event. The alternative is applied on a prospective basis, with amortization of existing goodwill commencing at the beginning of the period of adoption [January 1, 2014]. The Company will assess goodwill for impairment at the [entity] [reporting unit] level. There was no material impact on the Company’s results of operations or financial condition upon adoption of the new guidance.
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Other FAQs about PCC Alternatives
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FAQ: Entity Ownership
• If the entity is foreign or private equity owned, does that have an impact on electing any of the PCC alternatives?
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FAQ: Adoption Questions
• Is a private company required to adopt these alternatives?
• If a private company adopts one alternative does it have to adopt all of them?
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New Revenue Recognition Standard
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Background
• ASU 2014-09, Revenue from Contracts with Customers
• Issued on May 28 • Replaces virtually all existing US GAAP guidance on
revenue recognition • Virtually every industry is affected • Includes 63 application examples • Requires companies to make more estimates and use
more judgment than under current guidance
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 51
Scope
• In scope - Contracts with customers - Sale of some nonfinancial assets that are not an output of the
company’s ordinary activities (e.g., property, plant and equipment, intangibles)
• Not in scope - Leasing contracts - Insurance contracts - Financial instruments contracts - Certain nonmonetary exchanges - Certain put options on sale and repurchase agreements - Guarantees within the scope of ASC 460
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 52
Effective Date
• Public entities - Annual reporting periods beginning after December
15, 2016, including interim periods within that reporting period
• Nonpublic entities - Annual reporting periods beginning after December
15, 2017, and interim periods within annual periods beginning after December 15, 2018
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 53
Deferral of the Effective Date
• Effective date deferred until 2018 for public companies
• Effective date deferred until 2019 for all other entities
• Early adoption allowed as of original effective date for public entities (2017 for calendar-year entities)
• Early adoption prior to that date would not be permitted
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 54
Current U.S. GAAP
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Current U.S. GAAP
• Recognition based on two concepts: - Earned - Realized
• Focus is on transfer of risks and rewards of ownership
• Over 180 different pieces of authoritative guidance issued
- Complex - Detailed - Differs by industry and type of transaction
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Current U.S. GAAP
• SEC issued SAB 101 in 1999 to provide interpretive guidance
- Persuasive evidence of an arrangement exists - Delivery has occurred or services have been rendered - Seller’s price to the buyer is fixed or determinable - Collectibility is reasonably assured
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The Five-Step Model
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Overview
• Core principle - Recognize revenue to depict the transfer of promised
goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services
Identify the contract with a customer
Identify the performance obligations
in the contract
Determine the
transaction price
Allocate the transaction price to the
performance obligations
in the contract
Recognize revenue
when (or as) a
performance obligation is
satisfied
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 59
Step 1: Identifying the Contract with the Customer
• Contract defined as an agreement between two or more parties that creates enforceable rights and obligations
- Can be written, oral or implied - Does not exist if both parties can cancel without penalty
Collection of consideration is
probable
Rights to goods or services and payment
terms can be identified
It has commercial substance
It is approved and the parties are committed
to their obligations
A contract exists if…
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Combining Contracts
• Must combine contracts entered into at or near the same time with the same customer (or related parties of the customer) if one or more of the following criteria are met:
Contracts are negotiated as a package with a single commercial objective
Amount of consideration to be paid in one contract depends on the price or
performance of the other contract
Goods or services promised in the contracts (or some
goods or services promised in each of the contracts) are
a single performance obligation
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 61
Contract Modifications
• Approval of a contract modification can be in writing, by oral agreement, or implied by customary business practices
• Contract modification is considered approved when it creates new or changes existing enforceable rights or obligations
• May result in - Separate (additional) contract - Termination of old contract and creation of new contract - Cumulative catch-up adjustment to existing contract
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 62
Contract Modifications
Additional goods/services
distinct?
Consideration reflects standalone selling
price?
Separate contract.
Termination of old contract and creation
of new contract.
Treat as part of original contract.
Cumulative catch-up adjustment.
YES
YES
NO
NO
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Example 1—Change Order
• Single performance obligation to build an office building
• Change order for goods that are necessary part of contractor’s service to construct the building
• Parties agree on price before work begins
• How would you account for this change order?
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Example 1—Change Order
• Goods/services associated with change order are not distinct
• Treat as part of the original contract • Account for change order using a cumulative catch-
up adjustment • That is, “catch up” the amount of revenue recognized
as if this change order were part of the original contract
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 65
Step 2: Identifying Performance Obligations
• A performance obligation is each promise to transfer either of the following to a customer:
- A good or service (or a bundle of goods or services) that is distinct
- A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 66
Identifying Performance Obligations
• A promised good or service is distinct (and therefore a performance obligation) if both of the following criteria are met:
Criterion 1: The customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer.
Criterion 2: The entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract.
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 67
Performance Obligation Distinct?
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Step 3: Determining the Transaction Price
• Transaction price is the amount of consideration a company expects to be entitled to in exchange for transferring a good or service
• Transaction price reflects the effects of the following:
Variable Consideration
Consideration Payable to the
Customer
Noncash Consideration
Significant Financing Component
Transaction Price
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Variable Consideration
• Transaction price may vary because of items such as bonuses, discounts, rebates, refunds, credits, price concessions or incentives
• The transaction price is estimated using the technique that better predicts the amount the company will receive
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Variable Consideration
• Expected value - Sum of the probability-weighted amounts in a range of
possible outcomes - Most predictive when the transaction has a large number
of possible outcomes - Can be based on a limited number of discrete outcomes
and probabilities
• Most likely amount - The single most likely amount in a range of possible
outcomes - Most predictive when the transaction will produce few
outcomes
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 71
Example 2: Variable Consideration
RussCo enters into a contract and will receive a $100,000 performance bonus if specified performance targets are met. RussCo estimates an 80% likelihood it will receive entire performance bonus and a 20% likelihood it will receive none of the bonus. Requirements: 1. Which estimation technique would be most appropriate? 2. How much of the performance bonus should be included in
the transaction price?
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 72
Example 3: Variable Consideration
• Company enters into a contract and will receive a performance bonus up to $100,000 if it meets specified performance targets. It estimates the likelihood of achieving the targets as follows:
• Expected value approach is determined to be the best method – $59,000 is calculated amount under this method
• However, Company must consider whether any of the $59,000 should be constrained © Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 73
Constraining Estimates of Variable Consideration
• Required to evaluate whether to “constrain” amounts of variable consideration included in transaction price
• Objective of the constraint – include variable consideration in the transaction price only to the extent it is “probable” it will not result in a significant revenue reversal
The risk of a reversal arising from an uncertain future event
The magnitude of the reversal if the uncertain event occurs
Qualitative Assessment
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Other Issues Related to Transaction Price
• Significant financing component - The time value of money is considered when significant, and the
primary purpose of the payment terms is to provide financing to counterparty
- Evaluation not required if customer is expected to pay within one year of when control of the goods or services is transferred
• Noncash consideration - Measured at the fair value of the consideration received or promised
• Consideration payable to a customer - Determine whether such amounts are:
• A reduction of the transaction price and revenue • A payment for distinct goods and services • A combination of the two
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Step 4: Allocating the Transaction Price to the Performance Obligations
• Transaction price allocated to each separate performance obligation in proportion to standalone selling prices
• When a standalone selling price is not observable, an entity is required to estimate it
• Maximize the use of observable inputs • Apply estimation methods consistently in similar
circumstances • Use of a residual technique is allowed in limited
situations
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Step 5: Recognize Revenue when (or as) the Performance Obligations are Met
• Revenue recognized upon satisfaction of a performance obligation by transferring a good or service to a customer
• A good or service is generally considered to be transferred when (or as) the customer obtains control
• Control may be transferred either at a point in time or over time
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Transfer of Control
First, assess whether control is transferred over time, using the following criteria:
The customer simultaneously
receives and consumes the benefits provided by the entity’s
performance as the entity performs.
Routine or recurring services.
The entity’s performance creates or enhances an asset that the
customer controls as the asset is created or enhanced.
Building an asset on a customer’s site.
The entity’s performance does not create an asset with an
alternative use to the entity and the entity has an enforceable
right to payment for performance completed to date.
Building a specialized asset that only the
customer can use, or building an asset to a
customer order.
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Transfer of Control
• If none of the three criteria are met, recognize revenue at the point in time at which control of the good or service is transferred to the customer
Indicators that control has transferred
include a customer having…
…a present obligation to pay.
…physical possession.
…legal title.
…risks and rewards of ownership.
…accepted the asset.
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Example 4: Point in Time vs. Over Time
• Contractor is developing a multi-unit residential complex
• Customer enters into a binding sales contract with contractor for a specified unit that is under construction
• Each unit has a similar floor plan and is of a similar size, but other attributes of the units are different (for example, the location of the unit within the complex)
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Scenario A
• Customer pays a deposit upon entering into the contract
• Deposit is refundable only if contractor fails to complete construction of the unit
• Remainder of contract price payable on completion when customer obtains physical possession
• If customer defaults before completion of the unit, contractor only has the right to retain the deposit
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Scenario A
• How should the contractor account for the sale? - Because the contractor does not have a right to
payment for work completed to date, the contractor’s performance obligation is not satisfied over time
- Contractor accounts for the sale of the unit as a performance obligation satisfied at a point in time
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Scenario B
• Customer pays nonrefundable deposit upon entering into the contract and will make progress payments during construction of the unit
• Contract has substantive terms that preclude the contractor from being able to direct the unit to another customer
• Customer does not have the right to terminate the contract unless the contractor fails to perform as promised
• If customer defaults by failing to make progress payments as and when they are due, contractor would have a right to all of the consideration promised in the contract if it completes the construction of the unit
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Scenario B
• How should the contractor account for this sale? - The asset (unit) does not have an alternative use because
the contract precludes the contractor from transferring the specified unit to another customer
- The terms of the contract and the practices in the legal jurisdiction indicate that there is a right to payment for performance completed to date
- Consequently, the contractor has a performance obligation that it satisfies over time
- To recognize revenue for that performance obligation satisfied over time, the contractor measures its progress toward complete satisfaction of its performance obligation
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Measuring Progress Toward Completion
• Objective is to faithfully depict company’s performance • Select a single method for a particular performance obligation
- Output methods - Input methods
• Apply consistent method for similar performance obligations in similar circumstances
• If unable to reasonably estimate progress, revenue should not be recognized until progress can be estimated
• If company can determine no loss will be incurred, can recognize revenue up to costs incurred
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Disclosures
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Disclosures
• Key principle – to help users of financial statements understand the amount, timing and uncertainty of revenue and cash flows arising from contracts with customers
• Present both qualitative and quantitative information about: - Contracts with customers - Significant judgments and changes in judgments made in
applying the guidance to those contracts - Assets recognized from costs to obtain or fulfill a contract - Fewer disclosure requirements for nonpublic companies
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Disclosure Relief for Nonpublic Entities
Disclosure Requirement Practical Expedient for Nonpublic Entities
Present or disclose revenue and any impairment losses recognized separately from other sources of revenue or impairment losses from other contracts.
None.
A disaggregation of revenue to “depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors” (the ASU also provides implementation guidance).
An entity may elect not to provide the quantitative disclosure but should, at a minimum, provide revenue disaggregated according to the timing of transfer of good or services (for example, goods transferred at a point in time and services transferred over time).
Information about contract assets and liabilities (including changes in those balances) and the amount of revenue recognized in the current period that was previously recognized as a contract liability and the amount of revenue recognized that is related to performance obligations satisfied in prior periods.
An entity may elect not to provide the disclosures but should disclose the opening and closing balances of receivables, contract assets, and contract liabilities (if not separately presented or disclosed).
Information about performance obligations (e.g., types of goods or services, significant payment terms, typical timing of satisfying obligations, and other provisions).
None.
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Disclosure Relief for Nonpublic Entities Disclosure Requirement Practical Expedient for Nonpublic Entities
Information about an entity’s transaction price allocated to the remaining performance obligations, including (in certain circumstances) the “aggregate amount of the transaction price allocated to the remaining performance obligation” and when the entity expects to recognize that amount as revenue.
An entity may elect not to provide these disclosures.
A description of the significant judgments, and changes in those judgments, that affect the amount and timing of revenue recognition (including information about the timing of satisfaction of performance obligations, the determination of the transaction price, and the allocation of the transaction price to performance obligations).
An entity generally must provide these disclosures but may elect not to provide any or all of the following disclosures:
• An explanation of why the methods used to recognize revenue provide a faithful depiction of the transfer of goods or services to the customer.
• For performance obligations satisfied at a point in time, the significant judgments used in evaluating when a customer obtains control.
• The methods, inputs, and assumptions used to determine the transaction price, except that an entity must disclose the methods, inputs, and assumptions used to assess whether an estimate of variable consideration is constrained.
Information about an entity’s accounting for costs to obtain or fulfill a contract (including account balances and amortization methods).
An entity may elect not to provide these disclosures.
Information about the entity’s policy decisions (i.e., whether the entity used the practical expedients allowed by the ASU).
An entity may elect not to provide these disclosures.
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Proposed Amendments
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Summary of Proposed Amendments
FASB IASB
Two proposed Accounting Standards Updates (ASUs)
One package of proposed amendments
1. Proposed ASU: • Amend licenses guidance • Amend guidance for identifying
performance obligations and add examples
• Amend licenses guidance • Provide additional examples for
identifying performance obligations • Provide two new practical expedients
for application of new standard upon adoption
2. Proposed ASU: • Provide new practical expedients
for contract modifications upon transition and sales tax presentation
• Amend guidance on noncash consideration
• Amend guidance on collectibility © Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 91
Other FASB Standards
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Discontinued Operations
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ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
• Current U.S. GAAP:
Component is disposed of or has been classified as held for sale
Elimination of component’s operations and cash flows from the entity’s ongoing operations has occurred (or will occur)
Significant continuing involvement by the entity in the component’s operations does not exist after the disposal transaction
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 94
ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
• New guidance:
Component is disposed of or has been classified as held for sale
Disposal represents a strategic shift in operations
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•Strategic shifts should have a major effect on the organization’s operations and financial results
ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 96
• Other differences from current U.S. GAAP include the following:
- Business or nonprofit activity that, on acquisition, meets the criteria to be classified as held for sale is reported in discontinued operations
• Currently, U.S. GAAP does not include a business or nonprofit activity in the definition of discontinued operation
- Disposal of an equity method investment that meets the definition of discontinued operation is reported in discontinued operations
• Currently, disposals of equity method investments are not in the scope of the discontinued operations guidance
ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 97
• Effective date - Public business entities (and not-for-profit entities
that issue securities or are conduit bond obligors) • Annual periods beginning on or after December 15, 2014,
and interim periods within those annual periods
- All other entities • Annual periods beginning on or after December 15, 2014,
and interim periods beginning on or after December 15, 2015
- Early implementation permitted for new disposals
ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
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Going Concern Disclosures
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC
• Going Concern Continuum
Going Concern Basis
Uncertainty =
Disclosures about risks, uncertainties,
or contingencies
Substantial Doubt
???
Liquidation Basis
Liquidation is Imminent
ASU 2014-15, Disclosure of Uncertainties About and an Entity’s Ability to Continue as a Going Concern
Smoo
th
Saili
ng!
Cease to Exist
???
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• Management evaluation • Conditions or events, considered in the aggregate,
that raise substantial doubt about the entity’s ability to continue as a going concern
• One year after the date that the financial statements are issued
ASU 2014-15, Disclosure of Uncertainties About and an Entity’s Ability to Continue as a Going Concern
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• Substantial doubt - When relevant conditions and events, considered in
the aggregate - Indicate that it is probable that the entity will be
unable to meet its obligations as they become due - Within one year after the date that the financial
statements are issued (or available to be issued)
ASU 2014-15, Disclosure of Uncertainties About and an Entity’s Ability to Continue as a Going Concern
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ASU 2014-15, Disclosure of Uncertainties About and an Entity’s Ability to Continue as a Going Concern
• Mitigating effect of management’s plans should be considered only to the extent that:
- Probable that the plans will be effectively implemented and, if so,
- Probable that the plans will mitigate the conditions or events that raise substantial doubt
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• Disclosure requirements if management’s plans effectively alleviate substantial doubt
• Disclosure requirements if management’s plans do not alleviate substantial doubt
ASU 2014-15, Disclosure of Uncertainties About and an Entity’s Ability to Continue as a Going Concern
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 104
Going Concern Basis
Uncertainty =
Disclosures about risks, uncertainties,
or contingencies
Substantial Doubt
= probable that the
entity will be unable to meet its
obligations as they become due within one year after the
date that the financial statements
are issued
Liquidation Basis
Liquidation is Imminent
Going Concern Continuum
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 105
Difference in ASU and Auditing Standards
Financial Statement Date
12/31/2014
Financial Statement
Issuance Date 3/15/2015
Current audit standard
requirement: one year from
financial statement date
12/31/2015
ASU’s requirement: one year from
financial statement
issuance date
3/15/2016 © Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 106
ASU 2014-15, Disclosure of Uncertainties About and an Entity’s Ability to Continue as a Going Concern
• Effective date and transition - Annual period ending after December 15, 2016, and
for annual periods and interim periods thereafter - Early application is permitted
• Auditing Standards Board and PCAOB will need to make changes
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Pushdown Accounting
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ASU 2014-17, Pushdown Accounting
• Pushdown accounting - An acquired entity’s separate financial statements
reflect the acquirer’s new basis of accounting for the acquiree’s assets and liabilities
• Acquired entity has option to apply pushdown accounting upon occurrence of an event in which an acquirer obtains control of the acquired entity
• Acquirer may be another entity or an individual
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ASU 2014-17, Pushdown Accounting
• Effective date and transition - Effective immediately - Acquired entities may elect to apply it to any future
transaction or to their most recent event in which an acquirer obtains or obtained control of them
- If the financial statements have already been issued, application of pushdown accounting will be accounted for retrospectively as a change in accounting principle
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Debt Issuance Costs
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ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs
• Under current guidance, an entity reports debt issuance costs in the balance sheet as deferred charges (i.e., as an asset)
• ASU specifies - Debt issuance costs related to a note should be
reported in the balance sheet as a direct deduction from the face amount of that note
- Amortization of debt issuance costs should be reported as interest expense
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 112
ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs
• Amendments do not affect the current guidance on the recognition and measurement of debt issuance costs
© Elliott Davis Decosimo, LLC © Elliott Davis Decosimo, PLLC 113
• On January 1, 2015, an entity issues a debt security with a face amount of $10,000,000 to an investor
• On the same date, the entity incurs and pays incremental, direct issuance costs of $50,000 to parties other than the investor
• The debt security matures in five years (on December 31, 2020) • Journal Entry 1
Cash $ 10,000,000 Debt — long term $ 10,000,000 To record $10,000,000 note payable on January 1, 2015.
• Journal Entry 2 Deferred issuance cost (asset) $ 50,000 Cash $ 50,000 To record $50,000 debt issuance cost on January 1, 2015
Example – Previous Guidance
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• After adopting the guidance in the ASU, the entity would record the $50,000 in debt issuance costs on January 1, 2015, as follows:
• Journal Entry Cash $ 9,950,000 Debt — long term $ 9,950,000 To record $9,950,000 note payable on January 1, 2015.
Example – New Guidance
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• Public business entities - Effective for fiscal years, and interim periods within those
fiscal years, beginning after December 15, 2015 • All other entities
- Effective for fiscal years beginning after December 15, 2015, and interim periods beginning after December 15, 2016
• Early adoption allowed for financial statements that have not been previously issued
• Apply the new guidance retrospectively to all prior periods
Effective Date and Transition
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• Disclose in the first fiscal year after adoption date: - Nature of and reason for the change in accounting
principle - Transition method - Description of the prior-period information that has
been retrospectively adjusted - Effect of the change on the financial statement line
item (debt issuance cost asset and debt liability)
Disclosures
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On the Horizon
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Leases
• May 2013 – FASB issued a proposed ASU, Leases, which was a revision of the 2010 proposed ASU
• Core principle is that an entity should recognize assets and liabilities arising from a lease.
• Lessee would recognize assets and liabilities for leases with a maximum possible term of more than 12 months
• Lessee would recognize a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the leased asset (the underlying asset) for the lease term
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Leases
• Recognition, measurement, and presentation of expenses and cash flows would depend on whether the lessee is expected to consume more than an insignificant portion of the economic benefits embedded in the underlying asset
• For practical purposes, this assessment would often depend on whether the underlying asset is property or assets other than property
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Leases
• 2014 meetings, FASB and the IASB have begun to back away from the May 2013 proposal
• IASB supports a single on-balance sheet model (similar to 2010 proposal)
• FASB supports a dual on-balance sheet model that would use the IAS 17, Leases, classification principles
• Final standard expected by the end of 2015
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Financial Statements of Not-for-Profits
• Proposed ASU, Presentation of Financial Statements of Not-for-Profit Entities, issued in April
• Affects substantially all NFPs - Charities - Foundations - Private colleges and universities - Nongovernmental health care providers - Cultural institutions - Religious organizations - Trade associations
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Financial Statements of Not-for-Profits
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Providing Additional Resources to Meet Your Needs
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Russ Madray Email: rmadray@elliottdavis.com Phone: 864.370.5640 Website: www.elliottdavis.com
Elliott Davis Decosimo ranks among the top 30 CPA firms in the U.S. With sixteen offices across seven states, the firm provides clients across a wide range of industries with smart, customized solutions. Elliott Davis Decosimo is an independent firm associated with Moore Stephens International Limited, one of the world's largest CPA firm associations with resources in every major market around the globe. For more information, please visit elliottdavis.com.
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