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0906REPORT
Emerging Issues Task Force Agenda Committee Report August 3, 2006

Pages Decisions on Proposed Issues 1. Accounting for Stock Options and Warrants in the Determination of Basic Earnings per Share Pursuant to Paragraph 10 of FASB Statement No. 128, Earnings per Share Reporting the Elimination of Previously Existing Differences between the Fiscal Year-End of a Parent Company and Those of Its Consolidated Subsidiaries Application of the Assessment of a Continuing Investment in Paragraph 12 of FASB Statement No. 66, Accounting for Sales of Real Estate, to a Sale of a Condominium Application of FASB Statement No. 123 (revised 2004), Share-Based Payment, to Book Value Employee Stock Purchase Plans When a Nonpublic Entity Becomes a Public Entity Application of AICPA Audit and Accounting Guide, Brokers and Dealers in Securities, to Entities That Engage in Commodity Trading Activities Accounting for Joint Development, Manufacturing, and Marketing Arrangements in the Biotechnology and Pharmaceutical Industries Subsequent Accounting for Executory Contracts Acquired in a Business Combination Initially Recorded at Fair Value under EITF Issue No. 0317, "Subsequent Accounting for Executory Contracts That Have Been Recognized on an Entity's Balance Sheet" Accounting for the Deferred Compensation and Postretirement Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements 16
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Other Matters o o Agenda for the September 7, 2006 EITF Meeting Status of Open Issues and Agenda Committee Items 5556 5764
EITF Agenda Committee Report
August 3, 2006
0906REPORT Emerging Issues Task Force Agenda Committee Decisions on Proposed Issues
1. Accounting for Stock Options and Warrants in the Determination of Basic Earnings per Share Pursuant to Paragraph 10 of FASB Statement No. 128, Earnings per Share Background Companies issue stock options and warrants with very low exercise prices for a variety of reasons. Companies may issue "at-the-money" instruments when their company's stock price is low, and those instruments may later become valuable due to increases in their company's stock price. Other times, companies issue options or warrants that are significantly "in-the-money" as a way of rewarding employees or as a method of payment to third parties for services or products. Deep "in-the-money" warrants may be issued instead of shares for tax purposes or to impact the voting rights of the holders.
Basic earnings per share (EPS) is computed by dividing the income available to common shareholders by the weighted-average number of common shares outstanding. "Common shares outstanding" reflects shares actually issued, outstanding, and paid for, and includes adjustments for certain contingently issuable or contingently returnable shares, shares to be repurchased under physically settled forward contracts, and shares to be redeemed for mandatorily redeemable instruments. Paragraph 10 of Statement 128 states, in part:
Shares issuable for little or no cash consideration upon the satisfaction of certain conditions (contingently issuable shares) shall be considered outstanding common shares and included in the computation of basic EPS as of the date that all necessary conditions have been satisfied (in essence, when issuance of the shares is no longer contingent). Questions have arisen regarding the application of paragraph 10 of Statement 128 in the determination of basic EPS when an entity has stock options and warrants with nominal exercise prices.
Issue 1: Whether stock options and warrants with nominal exercise prices should be considered in the determination of basic EPS pursuant to paragraph 10 of Statement 128.
EITF Agenda Committee Report (Decisions on Potential New Issues)
August 3, 2006, p. 1
View A: Stock options and warrants with nominal exercise prices should be included in the computation of basic EPS.
Proponents of View A believe that since holders are only required to pay a nominal exercise price (per warrant or per option), the warrants and options represent shares issuable for "little consideration" and therefore should be considered in basic EPS pursuant to paragraph 10 of Statement 128. Paragraph 92 further supports the conclusions reached by the Board in paragraph 10 of Statement 128, and states, in part:
"vested" contingently issuable shares should be considered in the computation of basic EPS because consideration for those shares has been received. Therefore, the Board believes that all substantive consideration has been received from the counterparty by the time the instrument vests (that is, services have been performed or a lower interest rate on the debt has been received). Proponents of View A consider stock options and warrants with nominal exercise prices to be economically equivalent to shares that will be issued in the future. Although the issuance of the shares is still contingent upon the holders exercising the stock options or warrants, proponents of View A believe that there is little or no risk that the options will be exercised and that the shares will be issued.
View B: Stock Options and warrants with nominal exercise prices should not be included in the computation of basic EPS.
Proponents of View B believe that stock options and warrants do not meet the definition of contingently issuable shares (in the context of paragraph 10 of Statement 128) and therefore should not be included in the computation of basic EPS, regardless of how low the exercise price is in relation to the market value of the stock. The Board, in its Basis for Conclusions in paragraph 91 of Statement 128, describes contingently issuable shares as it relates to the computation of basic EPS and stated:
Contractual agreements (usually associated with purchase business combinations) sometimes provide for the issuance of additional common shares
August 3, 2006, p. 2
contingent upon certain conditions being met. The Board concluded that (a) consistent with the objective that basic EPS should represent a measure of the performance of an entity over a specific reporting period, contingently issuable shares should be included in basic EPS only when there is no circumstance under which those shares would not be issued. That is, the Board supported only including contingently issuable shares when all conditions had been met for issuance. Proponents of View B draw an analogy to warrants and stock options that must be exercised by the holders (contingent condition) in order for shares to be issued. View B proponents also point out that there is specific guidance in Statement 128, paragraphs 17-23, on the treatment of warrants and options, but only in the context of diluted EPS; the guidance includes no distinction between "deep-in-the-money" warrants and options and other options and warrants (that is, the guidance does not suggest treating these instruments differently if the exercise price is nominal). In addition, proponents of View B believe that the guidance in paragraphs 20-23 of Statement 128 should always be followed for stock options issued to employees.
Proponents of View B also highlight the guidance in paragraph 64 of Statement 128 in relation to partially paid shares, which states:
If an entity has common shares issued in a partially paid form and those shares are entitled to dividends in proportion to the amount paid, the common-share equivalent of those partially paid shares shall be included in the computation of basic EPS to the extent that they were entitled to participate in dividends. Partially paid stock subscriptions that do not share in dividends until fully paid are considered the equivalent of warrants and shall be included in diluted EPS. [Emphasis added and footnote reference omitted.] View B proponents believe that the phrase "equivalent of warrants" indicates that the Board did not believe warrants should be included in basic EPS, and, further, that basic EPS should only include those instruments currently entitled to share in dividends in their current form. This view is also consistent with the framework in EITF Issue No. 03-6, "Participating Securities and the Two-Class Method under FASB Statement No. 128."
August 3, 2006, p. 3
Proponents of View B believe that the stated objective of Statement 128 is to simplify the computation of EPS. Statement 128 replaced APB Opinion No. 15, Earnings per Share, which included common stock equivalents (CSEs) in the primary EPS number. Opinion 15 defined a CSE in paragraph 25 as:
a security which is not, in form, a common stock but which usually contains provisions to enable its holder to become a common stockholder and which, because of its terms and the circumstances under which it was issued, is in substance equivalent to a common stock. Under Opinion 15, stock options and warrants were considered CSEs. Opinion 15 took a substance-based approach to calculating primary EPS (that is, Opinion 15 considered what is more economically likely to happen) and incorporated methodologies such as (1) projecting performance-based share outcomes and (2) including convertible securities as CSEs if their cash yields were less than a specified percentage of then-current interest rates. The computations in Statement 128 in determining potential shares are comparatively more objective, but mechanical. For example, in paragraph 116 of Statement 128, the Board "concluded that making assumptions about future earningswould be inconsistent with a 'historic' objective." Furthermore, Issues 35 of Issue 03-6 all use the phrase "objectively determinable" when discussing the participating security's contractual terms.
Potential Sub-Issues If a consensus is reached on View A for Issue 1, several practical implementation issues will need to be considered in the computation of basic EPS.
A.
Scope
One sub-issue is whether this guidance should apply to all rights to receive shares that are exercisable for little to no cash consideration. For example, questions have arisen as to whether this model should be applied to non-contingent warrants and options with a nominal exercise price since paragraph 10 of Statement 128 only discusses contingently issuable shares. And, alternatively, whether the model would only apply to instruments initially issued with a contingent exercise event for which the contingency has subsequently been resolved.
August 3, 2006, p. 4
In addition, whether warrants issued to third parties (such as investors) and stock options issued as a compensation arrangement to employees should be treated similarly under this model. Stock options usually have vesting provisions, while warrants to investors and lenders typically do not. Although the two instruments are economically similar once the specified service is provided by the employee, there is a distinction drawn in the diluted EPS literature. That is, share-based payment arrangements are discussed in paragraphs 20-23 of Statement 128, while non-employee options and warrants are discussed in paragraphs 17-19.
B.
Definition of "little or no" cash consideration and timing of measurement
Another issue is how "little or no cash consideration" under paragraph 10 of Statement 128 should be defined. Whether the measurement of "little or no" cash consideration should be based on the significance of the strike price (that is, absolute terms) or based on the relationship between the fair value of the underlying common stock and the strike price of the warrant or option (that is, relative terms). These two approaches may provide a different EPS treatment for the same instrument. For example, if the stock price was low and the exercise price of the warrants and options is "at-the-money," an absolute terms approach would include the options and warrants with a nominal exercise price in the basic EPS computation. Conversely, a relative terms approach would not include these instruments in the basic EPS computation.
Furthermore, the use of the relative terms approach would require additional consideration surrounding the timing of measurement. Unlike the absolute terms approach for which the basis of measurement is the strike price, which does not fluctuate, the relative terms approach looks at the relationship between the exercise price and the fair value of the underlying common stock, which will vary over time. Under the relative terms approach, the assessment of "little or no cash consideration" at the end of each reporting period may yield a different EPS treatment than making this assessment only at issuance. For example, if warrants or options are issued "at-themoney" but later become deep "in-the-money," the warrants and options would be included in basic EPS once they became deep in-the-money. But, if the assessment were made only at the date of issuance, the warrants and options would not be included in the basic EPS calculation at all. It is worth noting that under Opinion 15, entities were required to present both "primary"
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and "fully diluted" EPS; CSEs were included in primary EPS and the determination of whether a security qualified as a CSE was made at issuance only. However, Statement 128 moved away from the CSE concept to an independent test conducted each period about whether potential common shares should be included in EPS.
Finally, although paragraph 10 of Statement 128 specifies cash consideration, employee stock options have consideration beyond the cash exercise price since the employees had to complete a certain service period in order to receive and/or vest in the options. It may be appropriate to include all forms of consideration rather than just proceeds in the determination of "little or no" cash consideration.
C. Treatment of windfall tax benefits Another issue would be how to treat windfall tax benefits associated with the assumed exercise of the options if employee instruments are included in basic EPS under the View A model. Paragraph 21 of Statement 128 includes the windfall tax benefit as additional proceeds in the diluted EPS calculation, which reduces the number of shares included in diluted EPS since there are more proceeds to repurchase shares under the treasury stock method. Paragraph 8 of
Statement 128 does not appear to support a treasury stock method calculation in basic EPS (that is, it does not appear to support including windfall tax benefits in basic EPS), in which case, those benefits would not be included in the basic EPS calculation. This would cause a mismatch between basic and diluted EPS. For example, if there are 100 shares in basic EPS, there could be 90 shares in diluted EPS because of the effect of the windfall tax benefit. However, if the treasury stock method concept is applied to basic EPS in order to remove the mismatch, then this introduces a diluted EPS concept into the basic EPS calculation.
Agenda Committee Decisions: The Agenda Committee agreed to defer making a decision on this potential new issue pending a decision on the Committee's recommendation that the FASB and the IASB consider including this issue as part of the short-term international convergence project on earnings per share.
August 3, 2006, p. 6
2. Reporting the Elimination of Previously Existing Differences between the Fiscal YearEnd of a Parent Company and Those of Its Consolidated Subsidiaries Background Historically, companies have utilized several methods to report the elimination of an existing difference between a parent company's fiscal year-end and the fiscal year-ends of its consolidated subsidiaries. For illustrative purposes, assume a company with a December 31 year-end consolidates its subsidiaries based on the subsidiaries' fiscal year-ends (which are November 30). Further assume that in fiscal 2005, the company makes a decision to conform the year-ends of its subsidiaries to December 31.
Accounting Issues and Alternatives How a company should recognize the effect of the elimination of an existing difference between a parent company's fiscal year-end and the fiscal year-ends of its consolidated subsidiaries.
View A: Report the subsidiaries' results of operations and cash flows for December 2004 in the parent's December 31, 2005 consolidated statements of income and cash flows, respectively, as a change in accounting principle through retrospective application pursuant to the provisions of FASB Statement No. 154, Accounting Changes and Error Corrections.
AU 332, "Auditing Derivative Instruments, Hedging Activities, and Investments in Securities," paragraph .32 states:
There may be a time lag in reporting between the date of the financial statements of the investor and that of the investee. A time lag in reporting should be consistent from period to period. If a time lag between the date of the entity's financial statements and those of the investee has a material effect on the entity's financial statements, the auditor should determine whether the entity's management has properly considered the lack of comparability. The effect may be material, for example, because the time lag is not consistent with the prior period in comparative statements or because a significant transaction occurred during the time lag. If a change in time lag occurs that has a material effect on the investor's financial statements, an explanatory paragraph should be added to the auditor's report because of the change in reporting period. [Footnote references omitted.]
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Paragraph .32 references (in footnote 15) AU 508, "Reports on Audited Financial Statements," paragraphs .16.18. AU 508 addresses the implications of a lack of consistency/comparability in the financial statements on the auditor's report, especially as it relates to changes in accounting. Proponents of View A believe that the express linkage between these two sections appears to support the view that a change in or elimination of a "lag" in reporting is a change in accounting. Although AU 332 does not specifically address accounting for consolidated subsidiaries, proponents of this method believe that the reporting for the elimination of previously existing differences between the fiscal year-ends of a parent and those of its consolidated subsidiaries should be no different than for the elimination of a difference between the fiscal year-ends of a parent and an equity investee of the parent.
Proponents of View A also point out that the term "accounting principle," as defined in paragraph 7 of APB Opinion No. 20, Accounting Changes, includes "not only accounting principles and practices but also the methods of applying them." In this instance, the change (reporting the results on a 1 month lag versus reporting the results on a 12 month cycle consistent with that of the parent) represents a different method (both of which are acceptable) of applying the same accounting principle. The principle is defined as reporting 12 months of results of the subsidiary in the parent's consolidated financial statements. In addition, a similar definition is included in paragraph 2(c) of FASB Statement No. 154, Accounting Changes and Error Corrections.
View B: Report the subsidiaries' results of operations for December 2004 as a direct adjustment to retained earnings.
The utilization of a "lag period" to consolidate the results of a subsidiary's operations is permitted by AICPA Accounting Research Bulletin No. 51, Consolidated Financial Statements, paragraph 4, and by SEC Regulation S-X, Rule 3A-02(b)(1), and is applied in practice as a "convenience" procedure to allow for more timely preparation of consolidated financial statements. Proponents of View B believe that a change in the reporting period or, as in this example, the elimination of the lag period, is just that, a change in reporting period. It is not a
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change in the way that the results of operations or financial position of the consolidated enterprise are measured. Proponents of View B believe that a change in accounting principle must include a change in the principles or practices (or in the methodology of applying those principles) that changes the way the results of operations, financial position, or cash flows are measured. As this criterion is not met, this example did not represent a change in accounting principle.
Reporting elimination of the "lag" as an adjustment to retained earnings is consistent with the approach contemplated by Regulation S-X Rule 3A-02(b)(2) in combinations of entities under common control (and, previously, for a business combination accounted for as a pooling of interests) where the combining companies' fiscal years do not end within 93 days of each other, and the financial statements for the latest year need to be recast to dates that do not differ by more than 93 days. In those situations, the net income or loss of any interim periods excluded from or included more than once in results of operations as a result of such recasting, is recorded directly to retained earnings.
Other proponents of View B believe that elimination of the "lag" is a change in accounting principle for the reasons described above, but nevertheless believe that a direct charge or credit to retained earnings is an acceptable convention for reporting the cumulative effect of eliminating the "lag," based on long-standing practice. CCH's Accounting Research Manager1 states the following regarding this issue:
When a parent and subsidiary have different fiscal year-ends, the parent has the option of changing the fiscal year-end of the subsidiary. The SEC staff has confirmed that when a parent makes this election, the SEC permits no more than 12 months of operations of the subsidiary to be included in the consolidated statements. The staff further requires that if such a change is made, any income or loss of the subsidiary for any periods in excess of 12 months be charged or credited directly to retained earnings. Disclosure must be made of the change in consolidation policy, the periods consolidated and the amount of sales or
1
This guidance is believed to have been written at the time when Arthur Andersen LLP published Accounting Research Manager and to have been based on a conversation with a member of the staff of the SEC's Division of Corporation Finance.
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revenues, income before extraordinary items, and net income for the period represented by the charge or credit to retained earnings. Separately, no preferability letter or modification of the auditors' report is required for this change in the method of consolidation.
Agenda Committee Decisions: The Agenda Committee agreed to add this issue to the EITF Agenda.
August 3, 2006, p. 10
3. Application of the Assessment of a Continuing Investment in Paragraph 12 of FASB Statement No. 66, Accounting for Sales of Real Estate, to a Sale of a Condominium Background Many homebuilders and lodging companies are entering into the condominium development market. Since condominium projects are generally long term in duration, individual units of the condominium are sold during the construction phase. FASB Statement No. 66, Accounting for Sales of Real Estate, provides the guidance for accounting for real estate sales and states, in paragraph 5:
Profit on real estate transactions shall not be recognized by the full accrual method until all of the following criteria are met: a. b. c. d. A sale is consummated (paragraph 6). The buyer's initial and continuing investments are adequate to demonstrate a commitment to pay for the property (paragraphs 8-16). The seller's receivable is not subject to future subordination (paragraph 17). The seller has transferred to the buyer the usual risks and rewards of ownership in a transaction that is in substance a sale and does not have a substantial continuing involvement with the property (paragraph 18).
Paragraphs 19-43 describe appropriate accounting if the above criteria are not met. Statement 66 provides guidance on two of the general criteria discussed in paragraph 5 that may not be met for individual condominium units sold during the construction phase of the project because of the long term nature of condominium development projects. First, for certain types of long term projects including condominiums, a certificate of occupancy is not required for the sale to be consummated (under paragraph 5(a)). Specifically, paragraph 20 of Statement 66 states:
The deposit method of accounting described in paragraphs 65-67 shall be used until a sale has been consummated (paragraph 6). "Consummation" usually requires that all conditions precedent to closing have been performed, including that the building be certified for occupancy. However, because of the length of the construction period of office buildings, apartments, condominiums, shopping centers, and similar structures, such sales and the related income may be recognized during the process of construction, subject to the criteria in paragraphs
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41 and 42, even though a certificate of occupancy, which is condition precedent to closing, has not been obtained. Second, the continuing involvement that a developer has during construction is addressed (under paragraph 5(d)), and as long as certain criteria are met, profit can be recognized during the construction phase. Specifically, paragraph 37 of Statement 66 states:
If individual units in condominium projects or time-sharing interests are being sold separately and all the following criteria are met, profit shall be recognized by the percentage-of-completion method on the sale of individual units or interests: a. b. c. Construction is beyond a preliminary stage. The buyer is committed to the extent of being unable to require a refund except for nondelivery of the unit or interest. Sufficient units have already been sold to assure that the entire property will not revert to rental property. In determining whether this condition has been met, the seller shall consider the requirements of state laws, the condominium or time-sharing contract, and the terms of the financing agreements. Sales prices are collectible (paragraph 4). Aggregate sales proceeds and costs can be reasonably estimated. Consideration shall be given to sales volume, trends of unit prices, demand for the units including seasonal factors, developer's experience, geographical location, and environmental factors.
d. e.
If any of the above criteria is not met, proceeds shall be accounted for as deposits until the criteria are met. [Footnote references omitted.] With regard to individual condominium units sold during construction, most agree that the percentage of completion method is applicable when these criteria are met. Questions, however, have been raised in determining whether the collectibility of the sales price (paragraph 37(d)) requires an assessment of the "continuing investment" of the buyer under paragraph 12.
Accounting Issues and Alternatives Issue 1: Whether the continuing investment provisions of paragraph 12 of Statement 66 apply during the construction period when applying the percentage of completion method of accounting.
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As an example, consider a condominium project that commences on March 1, 2006, and is expected to be completed in June 2009. The condominium developer has a history of meeting the expected completion date. One condominium unit is sold on April 1, 2006, and the buyer, who will be using the property as a secondary residence, makes a non-refundable 10 percent down payment. The initial investment criterion is met by the down payment (Appendix A of Statement 66). The condominium project is beyond the preliminary stage of construction, sufficient units have been sold such that the project will not revert to rental property, and the developer can reasonably estimate the sales proceeds and costs. The condominium developer will not receive the certificate of occupancy until the project is complete.
View A: The continuing investment test in paragraph 12 of Statement 66 does not apply until the sale is consummated.
Proponents of View A believe that the continuing investment test is only applicable once the sale is consummated (that is, a post-closing assessment). Pursuant to paragraph 5 of Statement 66, consummation is one of the general criteria that must be met before profit may be recognized under the full accrual method. Proponents of View A interpret paragraph 20 of Statement 66 to allow profit recognition during the construction phase because of the length of the construction period even though the certificate of occupancy has not been obtained.
Proponents of this View believe that in these arrangements the consummation criterion has not been met and, therefore, the test for continuing involvement is not requirement to be met. Proponents of View A believe that paragraph 16 of Statement 66 supports this view and states:
Tests of adequacy of a buyer's initial and continuing investments described in paragraphs 8-15 shall be applied cumulatively when the sale is consummated and annually afterward. If the initial investment exceeds the minimum prescribed, the excess shall be applied toward the required annual increases in the buyer's investment. Proponents of View A believe that since paragraph 20 of Statement 66 allows for profit recognition on long term construction projects during the construction phase, companies should apply the criteria in paragraph 37 of Statement 66 when applying the percentage of completion
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method. In determining the collectibility of the sales price, paragraph 37(d) of Statement 66 references paragraph 4. Paragraph 4 of Statement 66 states, in part:
In accounting for sales of real estate, collectibility of the sale price is demonstrated by the buyer's commitment to pay, which in turn is supported by substantial initial and continuing investments that give the buyer a stake in the property sufficient that the risk of loss through default motivates the buyer to honor its obligation to the seller. Proponents of this view acknowledge that paragraph 4 is parenthetically referenced in paragraph 37(d), however, they believe that if the continuing investment test in paragraph 12 was intended to be applied, the parenthetical reference would have been included in paragraph 37(d) of Statement 66. Supporters of View A believe that paragraph 12 was not referenced because consummation is a condition precedent to the continuing investment test. Supporters of this view believe that the measures of collectibility described in paragraph 4 should be considered. That is, the continuing investment test in paragraph 12 should not be used because the consummation condition precedent is not met, but the other measures should be used to assess collectibility when the percentage of completion method is applied.
Proponents of View A further note that the decision trees included as Appendix F to Statement 66 provide support for this view because the portion of the decision tree dealing with the percentage of completion method (paragraph 37) does not reference paragraph 4 or any other paragraphs in Statement 66.
In the example, proponents of View A believe that profits from the sale of the individual condominium unit should be recognized during construction when the developer believes the sales price is collectible and all other criteria have been met. Supporters of this view also believe that because the certificate of occupancy will not be received until the completion of the condominium project, the sale has not been consummated and the continuing investment test (in paragraph 12) should not be applied until the sale has been consummated.
Opponents of View A believe paragraphs 6 and 20 of Statement 66 simply waive the requirement of a certificate of occupancy as a condition precedent to closing in evaluating
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whether consummation of a sale has occurred. Opponents of View A believe that all profit recognition requirements must be met except for the consummation criterion with respect to the receipt of the certificate of occupancy.
Opponents of View A believe that paragraph 20 of Statement 66 supports their view that for certain long term construction projects, the certificate of occupancy is not required to consummate a sale. Paragraph 6 states:
A sale shall not be considered consummated until (a) the parties are bound by the terms of a contract, (b) all consideration has been exchanged, (c) any permanent financing for which the seller is responsible has been arranged, and (d) all conditions2 precedent to closing have been performed. Usually, those four conditions are met at the time of closing or after closing, not when an agreement to sell is signed or at a preclosing. ___________
2
Paragraph 20 provides an exception to this requirement if the seller is constructing office buildings, condominiums, shopping centers, or similar structures.
Opponents of View A believe that view A is inherently flawed because it is predicated upon the absence of a certificate of occupancy, which prevents consummation and results in the inapplicability of the continuing investment test. Under View A, the consummation criterion is a condition precedent to both the initial and continuing investment tests, which would result in the initial investment test also not being required before profit is recognized under the percentage of completion method. This would allow for the percentage of completion method of profit
recognition to be applied even when no initial payment is received from the buyer.
View B: The continuing investment test in paragraph 12 of Statement 66 must be met prior to recognizing profit under the percentage of completion method of accounting during the construction project.
Proponents of View B believe that paragraph 37(d) of Statement 66 requires an assessment of collectibility prior to recording profit under the percentage of completion method and that the parenthetical reference to paragraph 4 explicitly requires the use of the continuing investment test.
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Proponents of View B acknowledge that the percentage of completion area of the decision tree (paragraph 37) does not point to other areas of Statement 66 to assess collectibility. However, proponents of View B believe that before considering the area of the decision tree related to percentage of completion, the continuing investment test would have been considered such that the continuing investment test would have been satisfied.
In the example, proponents of View B believe that if the buyer meets the continuing investment test by making an additional payment in an amount equal to the level annual payment to fund principal and interest on or before April 1 in each of the subsequent years as required by paragraph 12 of Statement 66, then all the criteria of the percentage of completion method are met and profit for the sale of the individual condominium unit would be recognized under the percentage of completion method.
Opponents of View B believe that paragraph 37 of Statement 66 addresses only the continuing involvement that the developer has with the condominium project and is not intended to address the criterion related to the consummation of the sale or the continuing investment of the buyer. Opponents of View B believe that while paragraph 37 parenthetically references paragraph 4, collectibility is not required to be assessed by the continuing investments test during construction.
If a conclusion is reached that view B is appropriate, additional discussion of how to apply the continuing investment test is required (that is, based on costs to date or selling price).
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4. Application of FASB Statement No. 123 (revised 2004), Share-Based Payment, to Book Value Employee Stock Purchase Plans When a Nonpublic Entity Becomes a Public Entity Background Many nonpublic entities, as defined in Statement 123(R), sponsor book value employee stock purchase plans (the Plans). The Plans grant employees the right to purchase the entity's shares using a formula price generally based on the book value of the company. Under the provisions of the Plans, six months after retirement or separation from the Company, the employees are required to sell the shares back to the Company for cash at a price determined using the same book value formula used to establish the purchase price. The shares issued under the plan are equity-classified because the employees bear the risks and rewards of ownership for a reasonable period of time as described in paragraph 31 of Statement 123(R) and as a result of the indefinite deferral of FASB Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, provided to nonpublic entities by FASB Staff Position FAS 150-3, "Effective Date, Disclosures, and Transition for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests under FASB Statement 150." However, if the Company does not eliminate the requirement that employees are required to sell the shares back to the Company for cash prior to becoming a public entity, then when the Company becomes a public entity, it will be required to reflect shares under the plan as a liability since the Company will no longer be eligible for the indefinite deferral of Statement 150 provided by FSP FAS 150-3. Additionally, under the circumstances described in Illustration 21 of Statement 123(R), the formula price is deemed to be the fair value of the shares.
For purposes of applying Statement 123(R), a nonpublic entity becomes a public entity when it first makes a filing with a regulatory agency in preparation for the sale of any class of equity securities in a public market. However, Statement 123(R) does not provide guidance about how a nonpublic entity with a book value stock purchase plan should transition from Illustration 21 (which is applicable only to nonpublic entities) to accounting for the Plans it provides as a public entity. Previously, EITF Issue No. 88-6, "Book Value Stock Plans in an Initial Public Offering," provided guidance on the accounting for such plans under APB Opinion No. 25, Accounting for Stock Issued to Employees, in connection with an initial public offering (IPO). Statement 123(R)
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superseded Opinion 25 and related guidance, including Issue 88-6. Statement 123(R) does not address the accounting for book value plans once an entity becomes a public entity.
Accounting Issues and Alternatives Issue 1: If shares purchased under a book value employee stock purchase plan will be converted to market value stock after an IPO, what the appropriate method for a nonpublic entity to transition from Illustration 21 of Statement 123(R) should be when it becomes a public entity.
View A: No accounting consequence results from the transition.
Proponents of View A believe that the circumstances contemplated in Illustration 21 are intended to reflect situations in which book value constitutes the fair value of the shares because all transactions (both to buy and to sell the shares) are conducted at book value. Further, equity classification continues to be appropriate provided that employees bear the risks and rewards of ownership for a reasonable period of time as defined in Statement 123(R) assuming that the requirement for employees to sell back their shares to the company six months after retirement or separation has been eliminated (prior to the entity becoming public). Accordingly, when the shares are converted from book value shares to market value shares, any change in value is attributable to those normal risks and rewards of ownership. This view is consistent with the consensus on Issue 3(a) of Issue 88-6.
View B: No accounting consequence results from the transition except that the company should evaluate share-based payments that occurred in contemplation of the transition to becoming a public entity.
This view is intended to address situations in which companies that expect a significant increase in the value of the shares once the company completes its IPO, permit employees to purchase shares just prior to the initial filing with a regulatory agency while the company still meets the definition of a nonpublic entity.
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Proponents of View B believe that this concern can be addressed by adapting aspects of the guidance in Issue 88-6 for share options (Issue 2(a)) and for share purchase plans (Issue 3(b)). They believe compensation cost should be measured on the IPO date as the excess of the IPO price of the shares over the price paid pursuant to the formula, but only for the share based payments that were issued in contemplation of the IPO.
Proponents of View B believe that neither the approach in Issue 2(a) nor the approach in Issue 3(b) can be directly applied in Statement 123(R)'s fair value-based accounting model. Issue 2(a) (for share options) applied to all share options outstanding at the IPO date and required a onetime measurement for the difference between market value and the book value of the underlying shares. Issue 3(b) (for share purchase plans) resulted in no compensation measurement except for those shares determined to have been issued in contemplation of the IPO. Best practice for companies that applied Issue 3(b) anticipated the IPO date and obtained contemporaneous evidence of the fair value of the underlying shares and recorded compensation cost for any difference between fair value and the formula price. However, this approach would be contrary to the guidance of Illustration 21 of Statement 123(R). Proponents of View B believe that using Issue 2(a)'s one-time measurement approach and Issue 3(b)'s "in contemplation model" is an appropriate adaptation of the guidance in Issue 88-6 to Statement 123R.
If the Task Force concludes that View B is appropriate, it also would need to address whether the resulting compensation cost should be recorded at the IPO date (as specified in Issue 88-6, Issue 2(a)) or treated similar to a modification (as specified in paragraph 51 of Statement 123R) and recorded as compensation cost over the remaining requisite service period.
View C: The conversion of the book value shares to market value shares is accounted for as a modification of the award.
Proponents of View C reference the guidance in paragraph 51 of Statement 123(R), which states, in part:
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A modification of the terms or conditions of an equity award shall be treated as an exchange of the original award for a new award. In substance, the entity repurchases the original instrument by issuing a new instrument of equal or greater value . . . . [Footnote reference omitted.] In this situation, the entity has, in effect, exchanged the book value shares for market value shares. While both instruments are equity-classified (assuming that the requirement for
employees to sell back their shares to the company six months after retirement or separation has been eliminated (prior to the entity becoming public)), the entity must compute the fair value of the book value shares immediately before the exchange and the fair value of the market value shares immediately after the exchange and recognize additional compensation expense for the incremental value conveyed to the holders by the modification.
Opponents of View C point out that unless some other limitations are placed on this view, it would apply to all of the shares under the plan that are outstanding at the date of the IPO, including those that employees purchased in periods in which fair value was determined to have been the formula price and the employee has been subject to the risks and rewards of ownership for extended periods of time.
Agenda Committee Decisions: The Agenda Committee decided not to add this issue to the EITF's agenda. Based on a request from the Committee, the FASB staff agreed to pursue the issuance of a FASB Staff Position to provide guidance on this Issue.
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5. Application of AICPA Audit and Accounting Guide, Brokers and Dealers in Securities, to Entities That Engage in Commodity Trading Activities Background The market for commodities trading activities continues to expand both in number and in diversity of market participants. These commodity trading activities include market making, speculation, providing risk management solutions to producers and end users, and developing physical assets for storage or generation.
Financial intermediaries have become increasingly active in commodity trading markets (including energy) with several entities offering a wide range of product offerings. Many of these commodity-based financial products are marked-to-market because they meet the definition of a derivative, while those that do not are prohibited from being marked-to-market.1
Recently, financial intermediaries have expanded their portfolios to incorporate purchases and sales of physical commodities, both in the spot market and to settle commodity derivative contracts by taking physical delivery of the underlying commodity. The consensus in Issue 02-3 notes that prior to the consensus in Issue 02-3, industry practice was to carry inventories at fair value. However, Issue 02-3 eliminated "any basis for recognizing physical inventories at fair value, except as provided by other guidance under higher categories of the GAAP hierarchy."2
As a result of those activities, questions have arisen regarding the appropriate interpretation of the applicability of the AICPA Audit and Accounting Guide, Brokers and Dealers in Securities (the Guide), to entities that engage in physical commodity trading activities (including energy). Questions have also arisen as to whether entities that are within the scope of the Guide should be accounting for physical inventory at fair value. At the May 5, 2006 EITF Agenda Committee meeting, the staff was asked to perform additional research to identify possible scope alternatives
Paragraph 17 of EITF Issue No. 02-3, "Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities," notes that the consensus "prohibiting mark-to-market accounting for nonderivative energy trading contracts is equally applicable to brokers and dealers, as the Guide for brokers and dealers in securities does not afford brokers and dealers special treatment in that regard." 2 Paragraph 15 of Issue 02-3.
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for applying the "Guide," as well as the types of inventory that may be accounted for at fair value. Issue 1 of this memorandum contains two views on the application of the scope of the Guide.
The staff understands that certain financial institutions had been accounting for physical commodities at fair value by analogizing to the Guide. These financial institutions were
subsequently denied this treatment by certain regulators on the basis that their organizations were predominantly banks that were regulated by banking regulators and conducted banking activities (with broker-dealer activities being a much smaller portion of their total activity). The
commercial banks responded that there were several financial institutions that were applying the Guide to non-regulated subsidiaries and that the banks should not be held to a higher standard than, say, an entity that holds itself out as predominantly a broker-dealer when not all of its subsidiaries are regulated as broker-dealers under the Securities Exchange Act of 1934.
Based on an informal survey of practitioners, preparers, and regulators, the staff believes that certain entities had been applying the Guide to non-regulated subsidiaries under the view that the activities contained within a specific legal entity were similar to those of regulated broker dealers and therefore items considered to be trading inventory were being accounted for at fair value.
The staff's research focused on the applicability of the Guide to entities conducting broker-dealer activities (Issue 1). The staff notes that, if the question of whether a physical commodity can be accounted for at fair value (Issue 2) were answered in an EITF Issue, additional questions could be raised on many other items for which the accounting may be unclear (for example, mortgage whole loans, loan commitments, non-marketable equity securities) that have been accounted for at fair value in practice by entities applying (or making analogies to) the Guide. In addition, the staff highlights that specific guidance on these issues will be addressed in Phase 2 of the FASB's Fair Value Option project. As such, the staff believes that the Board action would more
appropriately address this issue within the Fair Value Option Standard's Phase 2 proceedings. If the Committee feels that some guidance is warranted, the staff believes that an approach similar to the one taken in EITF Abstracts, Topic No. D-74, "Issues Concerning the Scope of the AICPA Guide on Investment Companies," should be considered. That approach would allow companies
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to continue to follow their internal accounting policies on fair value until Phase 2 of the Fair Value Option project has been completed.
Topic D-74 states, in part:
AcSEC plans to add to its agenda a separate Statement of Position project to clarify the scope of the proposed Guide [on investment companies]. Until that project is finalized, an entity should consistently follow its current accounting policies for determining whether the provisions of the current Guide apply. Should the Committee reject this approach, the following accounting issues and alternatives should be considered.
Accounting Issues and Alternatives Issue 1: Identify the scope of the Guide.
View A: The Broker-Dealer Guide should be applied to all entities registered as broker-dealers under the Securities Exchange Act of 1934 and to their foreign subsidiaries that are regulated under comparable foreign regulators.
Proponents of View A refer to the Preface Section of the Guide, which states that the Guide applies to the
financial statements of entities that are broker-dealers in securities. Operations of such entities are subject to the rules and regulations of the Securities and Exchange Commission and other regulatory bodies. Brokerdealers in securities are subject to regulation under the Securities Exchange Act of 1934. Some broker-dealers are also futures commission merchants for commodity futures and commodity option contracts subject to regulation under the Commodity Exchange Act. View A proponents assert that the scope of the Guide, as discussed in the Preface, is sufficiently clear. Therefore, entities that conduct business activities that are consistent with those of a broker dealer but that are not subject to these regulations should not apply the Guide by analogy.
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Opponents of View A assert that the scope of the Guide is unclear. Holders of this view believe that changes in the regulatory landscape have blurred the scope of the Guide. These individuals also note that, frequently, these entities are subject to regulatory oversight by other regulatory entities such as the Board of Governors of the Federal Reserve System. Other opponents of View A assert that the characteristics of the operations of an entity are more relevant in determining whether the entity is within the scope of the Guide, regardless of whether it is subject to regulation.
Proponents of View A believe that the accounting methodology for each separate legal entity should be determined by the regulatory status of that entity without regard to whether similar activities are conducted elsewhere in the consolidated entity. Accordingly, View A proponents believe that a consolidated entity can have similar activities with different accounting bases, dependent upon in which legal entity activities are conducted.
Proponents of View A also believe that entities regulated by "comparable" foreign regulators are also within the scope of the Guide. For example, in the U.K., any entity that conducts brokerdealer activities is regulated by the U.K. Financial Services Authority (FSA).
Opponents of View A are concerned about the consistency in application of this method especially as it relates to non-U.S. entities. View A opponents note that in Europe, entities that have memberships with exchanges are eligible to act in a broker-dealer capacity. This is not dependent on how they are regulated. Some entities may be registered as banks and still hold memberships with exchanges and act as broker-dealers. Those opposing View A believe that a consistent method of application should exist for both U.S. and non-U.S. jurisdictions that can only be achieved by the model set forth in Views B below.
Opponents of View A are also concerned with the emphasis that View A places on the form of the transactions. In particular, View A could be manipulated by structuring transactions with a particular subsidiary to achieve a desired accounting result. As such, they are concerned that the same transaction could potentially receive different accounting treatment depending on whether or not it was transacted by a registered broker dealer or another subsidiary that conducts business
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activities that are consistent with those of the broker dealer. Economically, the transaction would have the same result for the holding company.
View B: The Guide should be applied based on the activity of an entity and should not be determined by its regulator or the industry it operates in.
View B proponents believe that the Guide should be applied to activities within entities that meet the definition, characteristics, and intent of broker, dealer, and trader activities, regardless of the entity's registration status. Proponents of View B believe that entities do not need to be
specifically regulated by the Securities Exchange Act of 1934 or the Commodity Exchange Act to fall within the scope of the Guide provided that the entities conduct business activities that are consistent with those of a broker-dealer as described in Chapter 1 of the Guide. Whether or not these entities are regulated under some other form of regulation (for example, the Federal Reserve System) is also not relevant to the determination of the applicability of the Guide.
Proponents of View B believe that a view that supports a characteristics-based approach could be defined and applied in several ways including, but not limited to: a. If the predominant characteristics of the consolidated entity are those of a broker-dealer, apply the Guide to all entities within a consolidated entity, except those subsidiaries specifically subject to other industry guidance b. If the predominant characteristics of an individual entity within a consolidated entity are those of a broker-dealer, apply the Guide only to the individual entity c. If the consolidated entity has characteristics of a broker-dealer (regardless to whether it is the predominant characteristic), apply the Guide to all entities within a consolidated entity, except those subsidiaries specifically subject to other industry guidance d. If an individual entity within a consolidated entity has characteristics of a broker-dealer (regardless to whether it is the predominant characteristic), apply the Guide only to the individual entity.
The staff will need to research the application of an activities-based approach to determine whether the application should be at the consolidated level or the entity level, and whether it is
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relevant to the application of View B whether the characteristics (discussed further below) should apply based on the predominant activity of the entity.
In determining whether the characteristics of the consolidated entity or individual entity are those of a broker-dealer, proponents of View B believe that the characteristics to be considered should include, but not be limited to, the following:
a.
The activities of the consolidated entity or individual entity and the extent to which those activities are consistent with the activities of a broker-dealer set forth in the Guide.
b.
In defining predominant, the relative amount and significance over time of total assets and firm inventory owned3 that are held by entities within the consolidated group that are: (i) registered as broker-dealers under the Securities Exchange Act of 1934 or are regulated by comparable foreign regulators versus (ii) other specialized industries subject to separate accounting guidance (for example, banking and insurance entities).
c.
The extent to which business units that conduct broker-dealer activities are managed and organized on a fully integrated basis across the consolidated entity with or without regard to specific legal entities within the consolidated group (including those entities that are registered broker dealers with the SEC or a comparable foreign regulator).
d.
The extent to which risk management, credit, finance, operations, technology, legal, compliance, internal audit, human resources, and any other business support functions are fully integrated across the consolidated entity with or without regard to specific legal entities within the consolidated group (including those entities that are registered broker dealers with the SEC or a comparable foreign regulator).
e.
Whether the consolidated entity is subject to group-wide supervision by the SEC and whether the ultimate holding company and its affiliates is one consolidated supervised entity or consolidated supervised entities (CSEs).
f.
The consolidated entity's segment reporting structure under FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information, and the extent to which reported segments reflect broker-dealer activities.
Firm inventory owned would include financial instruments and physical commodities.
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The staff will need to research the above characteristics, other factors that may be relevant to the analysis, and the weight of the evidence on which the entity shall reach a conclusion about whether the characteristics of (or predominant characteristics of) the consolidated entity or individual entity are those of a broker-dealer.
While proponents of View B acknowledge that an activities-based approach would increase the number of companies that would likely apply the Guide and its fair value provisions, they believe that fair value information would be more useful to investors and would be a more representationally faithful measure of the entity's activities.
Proponents of View B also believe that consistent application of fair value accounting to all broker-dealer activities is fundamental to the accurate presentation of the results of such business activities, the way the business and its associated risks are managed, and the way the consolidated entity is regulated as a CSE. Furthermore, they believe that if a broker-dealer were to account for the same (or similar) activity using different accounting models (depending on the underlying legal entity), that inconsistent accounting framework would result in financial information that lacked comparability and consistencytwo important characteristics of the conceptual framework. Finally, they believe that a reporting entity engaging in a wide array of financial services (including, for example, commercial banking, insurance, and investment banking) should not be able to selectively apply the Guide to some, but not all, of its brokerdealer activities. For that reason, they believe broader application of the Guide should be permitted.
Opponents maintain that View B is too broad and would allow the application of the Guide to a wide variety of entities. These opponents believe that the Guide represents a narrow exception for a defined population of entities. This defined population of entities is subject to additional regulation, which makes it unique. Opponents of View B believe that oversight by other regulatory bodies (for example, the Federal Reserve Board) is not the same as oversight under the Securities Exchange Act of 1934 or the Commodity Exchange Act.
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Issue 2: Whether entities within the scope of the Guide should record commodity inventory at fair value.
View A: Inventory, as discussed in the Guide, refers to investment securities or positions that are held for trading purposes. Physical inventory positions are not contemplated by the Guide and, therefore, the provisions of AICPA Accounting Research Bulletin No. 43, Restatement and Revision of Accounting Research Bulletins, Chapter 4, "Inventory Pricing," must be applied.
Proponents of View A note that, in general, the Guide provides for specialized industry accounting that may represent an exception to the accounting required by higher level GAAP. As such, if the Guide intended for physical inventories to be accounted for at fair value under any circumstance other than under ARB 43, the Guide would have provided for that exception explicitly. Proponents of View A note that throughout the Guide, the term "inventory" is used to refer to inventories of securities or a group of security transactions. There is no explicit use of the term inventory in reference to a physical inventory of goods. Since the Guide does not explicitly state that physical inventory should be recorded at fair value, higher level GAAP (ARB 43) should be evaluated to determine if there is a basis to mark inventory to market.
View B: Inventory, as discussed in the Guide, incorporates commodity inventory held. The Guide requires that those positions be recorded at fair value.
Proponents of View B interpret inventory, as contemplated in the Guide, to include physical commodity positions. Proponents of View B point to paragraph 7.19, which references physical commodities, and the example provided for in the Guide (Exhibit 4.3), which reflects "Spot commodities owned, at market value," to support this view. Proponents of this view note that while the Guide does not specify what items may be considered "inventory," it provides references to commodities in the references noted previously.
Other proponents of View B also assert that holding the commodity inventory is analogous to holding securities. The Guide provides for the securities held to be recorded at fair value and
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that, by analogy, commodity inventory held for the purposes of trading should also be recorded at fair value.
Opponents of View B would note that the Guide generally uses the term "inventory" in reference to an inventory of securities. While inventories of certain commodities may have economic characteristics that are similar to securities, they are not financial instruments and should not be fair valued unless the criteria in ARB 43 are met. These opponents believe that the references provided in the guide noted above do not infer that commodity inventory should be measured at fair value (or market value) if they do not meet the requirements to recognize them under fair value under ARB 43. Rather, this inventory could have been reflected at market value because it qualified under ARB 43 to be accounted for at fair value.
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6. Accounting for Joint Development, Manufacturing, and Marketing Arrangements in the Biotechnology and Pharmaceutical Industries Summary At the May 5, 2006 Agenda Committee meeting, the Committee was asked to consider whether to add a project to the EITF agenda on the accounting for joint development, manufacturing, and marketing arrangements in the biotechnology and pharmaceutical industries. The Agenda
Committee agreed to defer making a decision on this potential new issue pending the FASB staff's additional research to date on the structures of these arrangements for determining the scope of this issue and whether there are any other additional accounting issues that should be included in this issue. The purpose of this memorandum is to provide the Agenda Committee with the results of the staff's research on the structures of these arrangements for consideration in the proposed scope of the issue.
Background In the biotechnology and pharmaceutical industries, the time required to develop a drug candidate into a commercially viable product can take many years (it is not uncommon for the research and development stage to last between 7 and 10 years). During that stage, the
development activities generate significant costs but generally do not generate product revenues. Due to the uncertainties inherent in the development process, many drug candidates are discontinued for various reasonsincluding the failure to satisfy the safety or efficacy requirements of the United States Food and Drug Administration. candidates never generate product revenues. As such, many drug
Additionally, during the early commercialization periods of those drug candidates that are approved for sale, pharmaceutical and biotechnology companies may experience losses because, in many cases, the introductory marketing costs and continued development costs for other uses of the product may exceed the product revenues. For example, a drug candidate will be
approved for a specific and narrow use and the partners will continue to develop the drug candidate to support a wider application of the drug. These additional development costs can significantly outweigh the product revenues on sales of the drug for this specific and narrow use. However, companies invest in research and development activities in the biotechnology or
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pharmaceutical industries with the expectation that a successful product could ultimately enjoy a substantial revenue stream and profits to be shared with the partners that were involved in the research and development effort.
Because of the considerable amount of resources required to develop a product and the financial risks involved, companies in the biotechnology or pharmaceutical industries may enter into agreements with other companies to collaboratively develop, manufacture, and market a drug candidate (Collaboration Agreements). In some cases, Collaboration Agreements are entered into between a smaller biotechnology or pharmaceutical company that is conducting research and development activities on a particular drug candidate and a large, established pharmaceutical company. In other cases, two large established pharmaceutical companies will enter into a Collaboration Agreement to mitigate the risk or combine two existing drugs into a new single dose drug.
In the vast majority of instances, the activities conducted pursuant to these agreements are conducted by partners to a Collaboration Agreement without the creation of separate legal entities (that is, the agreement is operated as a "virtual joint venture"). The agreements generally provide that the partners will share, based on contractually defined calculations, the profits or losses from these activities. These arrangements typically also involve the licensing of specific technology, a drug candidate, or a molecule by the partners to the Collaboration Agreement for the length of the agreement. The license frequently has upfront payments and additional
payments based on the achievement of certain milestones. The licensor typically maintains the title to the drug candidate; however, any new products that are co-developed as part of the arrangement are co-licensed between the partners.
The types of activities conducted under Collaboration Agreements may include research and development, marketing, general and administrative, and manufacturing. The agreement may provide that one partner has sole or primary responsibility for certain activities, or that both partners have shared responsibility for certain activities. For example, an agreement may
provide for one partner to provide research and development related to the drug candidate, but the other partner may have primary responsibility for commercialization of the drug candidate.
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Under existing industry practice, any revenues generated, and costs incurred, by each partner pursuant to such an arrangement have typically been reported in each company's respective income statements on a gross basis. Periodically, the partners share financial information related to joint costs and product revenues (if any). Generally, a payment is then made by one party to the other in accordance with the contractually specified calculations for the sharing of the joint profits or losses related to the arrangement, such that each party receives its share of the profits or losses of the arrangement.
Typically, the Collaboration Agreement will establish a steering committee that is responsible for the oversight of the activities conducted by the partners. The steering committee is
administered by from four to eight people and participation is split between all of the partners to the Collaboration Agreement. There is also a set of procedures established in the Collaboration Agreement to escalate issues to the upper management of the partners if the steering committee is unable to reach a decision on an issue.
Application to Other Industries Based on feedback the staff received, the staff has learned that a consensus on this issue would likely be applicable to other industries including software development, computer hardware, aerospace, construction, manufacturing, certain banking activities, healthcare, and other industries that may have Collaboration Agreements. However, the staff was provided with very few real examples of current fact patterns of Collaboration Agreements in these industries.
Revenue Recognition Lastly, the staff was also informed that there is diversity related to the recognition of revenue for Collaboration Agreements that may be within the scope of this issue. Revenue recognition on these types of arrangements has not been included within the scope of this issue.
Accounting Issues and Alternatives Issue 1: In evaluating whether an arrangement is within the scope of this Issue, a Collaborative Agreement is one in which (a) both parties are actively participating in all aspects of the arrangement and sharing in the risks and rewards, (b) each party may only
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be participating in certain activities of the arrangement but sharing in the risks and rewards of the entire arrangement, or (c) one party has a disproportionate share of the risks and rewards and is responsible for directing and approving the activities of the other partner (a so called "one-way" transaction).
In Issue 1, the Task Force is being asked to define what a Collaboration Agreement is to determine if they are with the scope of the remaining issues. In evaluating Issue 1, it is beneficial to use examples to illustrate those types of arrangements that would be within the scope of Issue 1. The following scenarios will be used in the discussion of the accounting issues and alternatives.
Scenario 1Big Pharma and Biotech agree to equally participate in the results of R&D activities for a drug candidate, and in the commercialization if and when the drug candidate is approved for sale, pursuant to a Collaboration Agreement (a 50 percent/50 percent arrangement). Further, assume that Big Pharma and Biotech both agree to provide resources during the R&D and commercialization activities. A steering committee made up equally of representatives of Big Pharma and Biotech is established to direct and approve the activities under the Collaboration Agreement. On a quarterly basis, Big Pharma and Biotech provide financial information about the R&D and commercialization activities under the Collaboration Agreement and one partner is required to make a payment to the other partner for a proportionate share of the excess of the companies' combined expenditures pursuant to their Collaboration Agreement.
Scenario 2Big Pharma and Biotech agree to equally participate in the results of R&D activities for a drug candidate, and in the commercialization if and when the drug candidate is approved for sale, pursuant to a Collaboration Agreement (a 50 percent/50 percent arrangement). Further assume that Biotech is responsible for conducting R&D activities relating to the drug candidate and Big Pharma is responsible for the commercialization activities if and when the drug candidate is approved for sale. A steering committee made up equally of representatives of Big Pharma and Biotech is established to direct and approve the activities under the Collaboration Agreement. On a quarterly basis, Big Pharma and Biotech provide financial information about the R&D and commercialization activities under the Collaboration Agreement
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and one partner is required to make a payment to the other partner for a proportionate share of the excess of the companies' combined expenditures pursuant to their Collaboration Agreement.
Scenario 3Big Pharma contracts with Biotech to perform R&D on a drug candidate. Biotech is paid a specified rate per full time employee that is assigned to the arrangement and payments are not dependant on a successful development of a drug. Big Pharma is responsible for directing and approving the activities of Biotech during the R&D phase. During the R&D phase, Biotech has an option to buy into the arrangement to share expenses for the remaining R&D and commercialization if and when the drug candidate is approved for sale. Biotech's purchase into the Collaboration Agreement is in a form that surrenders the rights to the license payments of the drug candidate to Big Pharma for the remaining part of the arrangement. If the option is excercised, Big Pharma is responsible for the commercialization of the drug candidate and pays Biotech a royalty on the product revenues of the drug candidate.
Scenario 4 Biotech provides a license for the drug candidate to Big Pharma. Big Pharma contracts with Biotech to perform R&D on the drug candidate and contract manufacturing for Big Pharma. Biotech is paid a specified rate per full time employee that is assigned to the arrangement and payments are not dependant on a successful development of a drug. Biotech is paid cost plus for any contract manufacturing that is performed on a successful drug candidate.
View A: The scope of this Issue should include only those arrangements in which the partners to the arrangements are actively participating in all aspects of the agreement and sharing in the risks and rewards of the entire arrangement.
Supporters of View A believe that the scope should be kept very narrow and that the issue should only address Scenario 1. These supporters believe that unless both parties are actively
participating in the performance under the Collaboration Agreement, the arrangement should be accounted for as a performance contract. These supporters believe that there is existing
accounting guidance for performance contracts and that the active participation by both parties during the performance is unique and therefore should be within the scope of any consensus reached by the Task Force.
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Opponents to View A believe that there is current diversity in practice in the accounting for the fact patterns presented for all four scenarios. These opponents believe that limiting the scope in such a manner will allow for that diversity to continue to exist.
View B: The scope of this Issue should also include those arrangement in which the partners to the agreement are sharing in the risks and rewards under the Collaboration Agreement but not necessarily actively participating in all phases of the activities under the Collaboration Agreement.
Supporters of View B believe that the scope should include Collaborative Agreements in which the partners to the arrangement may be participating in only certain activities under the arrangement but sharing in the risks and rewards of the entire arrangement. This differs from View A because it does not require the active participation of both partners in the performance under the Collaboration Agreement. Under View B, Scenarios 1 and 2 would be within the scope of Issue 1. Scenario 3 may be within the scope of Issue 1 depending on the conclusions reached on subsequent issues. Examples of some of these subsequent issues would include whether the determination of participation levels is at inception or ongoing, and how to evaluate an option to buy-in to an arrangement. These supporters believe that any guidance should focus on arrangements in which there is a sharing of the risks and rewards between the partners to the arrangements. They believe that the current accounting guidance for these fact patterns is not sufficiently clear to address the issue that exists when the partners share the risks and rewards. Frequently, two partners will enter into a Collaboration Agreement because each partner has specialized skills in particular areas and they will work together to mitigate the risk to each partner and increase profitability of the arrangement because the effort will be more streamlined. Supporters of View B reject the assertion that this represents a performance contract with a purchase of a royalty stream. These supporters believe that the sharing of risks and rewards, existence of a steering committee, and other qualitative factors supports the notion that this is more than a performance contract.
View C
The scope of this Issue should include so called "one way" arrangements in which one
partner has a disproportionate share of the risks and rewards and is responsible for directing
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and approving the actions of the other partner but both partners are participating in the Collaboration Agreement.
Supporters to View C believe that the scope should be very broad. They believe that current practice is diverse for Scenarios 1, 2, 3, and 4. These supporters believe that narrowing the scopes in Views A and B will not improve financial reporting because a number of arrangements will be outside the scope and preparers will have to determine what literature to analogize to in order to determine the reporting requirement under those arrangements.
Issue 2: How costs incurred and revenue generated on sales to third parties should be reported by the partners to joint development agreements in each of their' respective income statements.
The following fact pattern will be used to illustrate the reporting of the differing views under Issue 2. When the drug candidate is commercialized, the parties would share equally in the combined results of manufacturing and marketing the drug, as well the costs of any continued R&D activities (similar to Scenario 1 above). For example, if in the first quarterly period subsequent to commercialization of the drug candidate, Biotech incurred R&D expenses of $10 million and Big Pharma had sales of $50 million and related manufacturing expenses of $20 million and marketing expenses of $10 million, Big Pharma would make a payment to Biotech of $15 million, such that each partner realizes $5 million, net (sales of $50 million in total, less total expenses of $40 million, divided by 2), from sales of the drug.
View A: Costs incurred and revenue generated by partners to the Collaboration Agreement should be reported in their entirety on the appropriate line item in each company's respective financial statement based on a determination of primary obligor pursuant to Issue 99-19.
Supporters of View A believe that the Task Force previously answered the question of gross versus net reporting in EITF Issue No. 99-19, "Reporting Revenue Gross as a Principal versus Net as an Agent." These supporters believe that the primary obligor should report revenues and expenses gross because that represents the substance of the Collaboration Agreement. These
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supporters note that the application of Issue 99-19 is consistent with industry practice. However, these supporters acknowledge that additional indicators may be necessary to better identify the primary obligor because of the unique nature of the arrangements and the fact that these arrangements were not explicitly contemplated by Issue 99-19. This potential sub-issue may be expanded if the Agenda Committee agrees to add the Issue to the 'EITF agenda.
Opponents to View A believe that because partners to these arrangements frequently share the risks and rewards, it is difficult to determine who is the primary obligor. Those opponents believe that the application of the indicators to this fact pattern ignores the economic reality of the Collaboration Agreements.
If View A were applied to the example above, the income statements of Biotech and Big Pharma would appear as follows (excluding the net sharing payment between the partners, which is addressed in Issue 3):
$000 Sales Costs of goods sold Selling, general & administrative Research and development Net profit (loss)
Biotech $ 10,000 $(10,000)
Big Pharma $ 50,000 20,000 10,000 $ 20,000
Total $ 50,000 20,000 10,000 10,000 $ 10,000
View B: The Collaboration Agreement should be considered a "virtual" joint venture and accounted for by application of the literature for joint ventures. This will typically result in the application of equity method accounting in accordance with APB Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock.
Supporters of View B believe that these Collaboration Agreements are economically the same as many joint venture arrangements and, therefore, should be accounted for in a similar manner. They do not believe that the lack of a legal entity should result in different accounting. These supporters believe that applying joint venture accounting to these fact patterns will improve
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comparability amongst entities with similar arrangements. Supporter of View B believe that this view avoids having to determine who the primary obligor is, which can be difficult in many of these arrangements. Supporters note that paragraph 11 of AICPA Statement of Position 78-9, Accounting for Investments in Real Estate Ventures, requires equity method accounting even though the arrangement does not include a legal entity.
Opponents to View B believe that because the arrangements lack a legal entity, they should not use joint venture accounting. They believe that joint venture accounting is only appropriate when there is ownership of equity. Supporters of View B note that in many cases these joint ventures have little or no equity and the only basis for the existence of the a legal structure is for tax purposes or local statutory requirements. Furthermore, opponents to this view believe that the application of a virtual joint venture would require an analysis of whether the entity's venturers are the primary beneficiaries under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities.
If View B were applied to the example above, the income statements of Biotech and Big Pharma would appear as follows:
$000 Equity Income from collaboration agreements Net profit (loss)
Biotech
Big Pharma
Total
$ 5,000 $ 5,000
$ 5,000 $ 5,000
$ 10,000 $ 10,000
Issue 3: If the Task Force reaches a consensus on View A of Issue 2, how sharing payments made to, or received by, a partner pursuant to a Collaboration Agreement should be presented in the income statement.
This issue was initially presented to the Committee as two separate issues, pre and post commercialization. However, the staff consolidated the issue because the partners are frequently in both phases at the same time and because the staff concluded that the classification of the sharing payments should be determined consistent with the unit of account and not the phase of EITF Agenda Committee Report (Decisions on Potential New Issues) August 3, 2006, p. 38
the arrangement.
Any consensus reached on this issue would apply to both pre and post
commercialization net sharing payments
View A: Sharing payments received from/made to a partner pursuant to a Collaboration Agreement should be reflected within revenue in the income statement. That is, payments received from a partner should be reflected as revenue and payments made to that partner should be reflected as a reduction of revenue unless such payments represent a cumulative payment to the other partner.
Proponents of View A believe that payments made to a partner generally should be recorded on the same line item as payments received from that partner, and characterized as a reduction of revenue, unless such payments represent a cumulative payment to the other partner (that is, if the amounts paid after commercialization is achieved and sales begin to exceed the amounts received from the other partner on a cumulative basis). In such cases, they believe that the amount of the cumulative shortfall of payments made versus received should be classified as an expense.
Those holding this view point to paragraph 83 of FASB Concepts Statement No. 5, Recognition and Measurement in Financial Statements of Business Enterprises, which states: "An entity's revenue-earning activities involve delivering or producing goods, rendering services, or other activities that constitute its ongoing major or central operations" (footnote reference omitted). They believe that an earnings process commences as the partners begin to realize sales upon the commercialization of the drug candidate. That process, which will be conducted pursuant to the terms of the Collaboration Agreement, will generally be a central part of the companies' ongoing operations. Accordingly, supporters believe that the presentation of payments made to or
received from the partner pursuant to a Collaboration Agreement as a component of revenues is appropriate.
Supporters of this view also believe that the accounting for the net profits sharing payment is analogous to the presentation required by paragraph 19(c) of Opinion 18, which provides that an investor's share of an investee's earnings or losses be displayed as a single amount in the
August 3, 2006, p. 39
investor's income statement when the investment is accounted for using the equity method of accounting. Supporters note that although the activities conducted by partners pursuant to a Collaboration Agreement may not be conducted through a legal entity, payments made or received are generally computed as if the company holds an equity interest in a joint venture conducted through a legal entity. Supporters also note that these arrangements are generally significantly integral to the operations of partners to allow for classification of the net profits sharing payment within operations, similar to how a public registrant may present income from equity investees that are operationally integral to its operations.
Supporters also note that expense classification for the excess cumulative payments made over payments received is analogous to the accounting for payments made by a vendor to a reseller pursuant to the consensuses for Issues 1 and 2 of EITF Issue No. 01-9, "Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor's Products)." Paragraph 17 of Issue 01-9 states that if a vendor demonstrates that characterization of amounts paid to a reseller as a reduction of revenue would result in "negative revenue for a specific customer on a cumulative basis (that is, since the inception of the overall relationship between the vendor and the customer), then the amount of the cumulative shortfall may be recharacterized as an expense." However, on the question of whether a series of payments represents a cumulative payment, supporters of View A hold divergent opinions. Some believe that the determination should be made on an agreement-by-agreement basis while others support making the determination on a partner-by-partner basis (for example, multiple Collaboration Agreements have been entered into with the same partner).
If View A were applied to the example above, the income statements of Biotech and Big Pharma would appear as follows (including the net sharing payment between the partners, which is addressed in Issue 3):
August 3, 2006, p. 40
Biotech $ 15,000 10,000 $ 5,000
Big Pharma $ 35,000 20,000 10,000 $ 5,000
Total $ 50,000 20,000 10,000 10,000 $ 10,000
View B: All payments received from a partner pursuant to a Collaboration Agreement should be reported as revenue and all payments made to a partner should be presented as expenses.
Supporters of this view believe that this presentation best reflects the substance of the arrangement between the partners. That is, proponents of View B believe that all receipts from a partner under these agreements represent revenue for a service earned while all payments made to the partner represent costs for services received from the partner and should be reflected in the income statement accordingly.
Opponents of this view disagree with the assertion that this represents the substance of the arrangement. They believe that determining presentation based on the results of operations for one period will provide misleading financial reporting because it does not represent the substance of the entire arrangement. They note that in some situations an entity will be a payer one period and a payee in another, which will result in confusing financial reporting. These opponents also note that the results of the combined Collaboration Agreement may be overstated (see below).
Opponents of this view generally object based on the analogies to Opinion 18 and Issue 01-9 discussed above. They also note that such presentation is inconsistent with recent comments made by the SEC staff at the 2005 AICPA National Conference on Current SEC and PCAOB Developments. In those comments, the staff cited R&D reimbursements as one area that
registrants have not consistently and transparently presented and disclosed. Some registrants have presented R&D reimbursements in revenue while others have accounted for such payments
August 3, 2006, p. 41
as a contra R&D expense. The SEC staff also observed that some registrants may be "cherry picking" when determining how to present R&D reimbursements. That is, those registrants might include R&D reimbursements with a net debit (the amount of R&D expenditures less the amount of reimbursements) as a reduction of R&D expense while R&D reimbursements with a net credit are grossed up to show revenue for the reimbursement and R&D expense for the costs.
If View B were applied to the example above, the income statements of Biotech and Big Pharma would appear as follows (excluding the net sharing payment between the partners, which is addressed in Issue 3):
Biotech $ 15,000 10,000 $ 5,000
Big Pharma $ 50,000 20,000 10,000 15,000 $ 5,000
Total $ 65,000 20,000 10,000 25,000 $ 10,000
View C: All payments either made to or received from a partner should be recorded as an adjustment to expense(s) incurred, and no payments should be classified as revenues.
Those holding this view believe that the payments are not a component of the company's revenue generating operations and, thus, should not be included in revenues.
Opponents of this view believe that this presentation would not adequately take into consideration the earnings process resulting from the delivery of a commercialized product, as discussed above, and believe that it would obfuscate reporting the continuing rate of the company's underlying expenses. They also note that it is possible that this presentation could lead to a net negative expense presentation in certain periods, which could be misleading and confusing to users of the financial statements.
August 3, 2006, p. 42
If View C were applied to the example above, the income statements of Biotech and Big Pharma would appear as follows:
$000 Sales Costs of goods sold Payments (received) made pursuant to collaboration agreement Selling, general & administrative Research and development Total expense Net profit (loss)
Biotech $ (15,000) 10,000 (5,000) $ 5,000
Big Pharma $ 50,000 20,000 15,000 10,000 45,000 $ 5,000
Total $ 50,000 20,000 10,000 10,000 40,000 $ 10,000
Issue 4: The disclosures that should be required, if any, related to the combined sales and expenses of the partners to a Collaboration Agreement that are used to compute the payments made/received.
View A: To the extent that sales and expenses associated with a Collaboration Agreement are significant to a company, disclosure relating to the combined sales and expenses of the partners is meaningful to users of the financial statements.
Those holding this view believe that disclosures analogous to those required for an investment in a significant equity method investee pursuant to Opinion 18 and SEC Regulation S-X 4-08(g) should be required in the footnotes to the financial statements of companies with significant involvement in Collaboration Agreements. Opponents to this view have expressed concern that the disclosure of such information in the footnotes to the financial statements may expose companies to additional Section 404 requirements with respect to that information.
August 3, 2006, p. 43
View B: The pertinent terms of the Collaboration Agreement, and the accounting afforded to payments made or received pursuant to such agreements, should be disclosed in the footnotes to the financial statements, but combined sales and expense information should not be presented.
Those holding this view primarily are concerned with the Section 404 requirements as discussed above. Opponents believe that such disclosures will not provide meaningful information to users of the financial statements.
Potential Sub-Issues: A potential sub-issue exists regarding the interaction of EITF Issue No. 88-18, "Sales of Future Revenues," and FASB Statement No. 68, Research and Development Arrangements, which will be considered if this Issue is added to the agenda.
Another potential sub-issue relates to the application of EITF Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." These arrangements typically have multiple
elements (R&D, license of technology or drug candidate, joint marketing agreement, and so forth) that must be evaluated under Issue 00-21 to determine if they should be separately accounted for by the partners. Under Issue 00-21, each partner will determinate the unit of account and whether individual Collaboration Agreements entered into with the same counterparty should be aggregated. Questions have arisen on how to determine the unit of account and whether the Collaboration Agreements should be aggregated. However, some believe that the determination of the appropriate unit of account and the aggregation of Collaboration Agreements is currently being performed as part of the evaluation of multiple elements under Issue 00-21 and the determination of the unit of account and the aggregation of Collaboration Agreements should be applied to this Issue. For example, if an entity determines that an arrangement has multiple elements that should be accounted for separately (for example, accounting for R&D activities should be accounted for separately from commercialization), the consensus would be applied to each element and the classification of any sharing payment made would be determined on each individual element.
August 3, 2006, p. 44
Another potential sub-issue that arose related to this issue is whether an entity should follow the existing accounting guidance for an individual element within the Collaboration Agreement when such guidance exists. The staff believes that a partner to the agreement should apply existing accounting guidance to an element when there is separate guidance that addresses that element.
August 3, 2006, p. 45
7. Subsequent Accounting for Executory Contracts Acquired in a Business Combination Initially Recorded at Fair Value under EITF Issue No. 03-17, "Subsequent Accounting for Executory Contracts That Have Been Recognized on an Entity's Balance Sheet" Background At the November 1213, 2003 EITF meeting, the Task Force instructed the staff to develop views on Issue 03-17 in conjunction with EITF Issue No. 03-9, "Determination of the Useful Life of Renewable Intangible Assets under FASB Statement No. 142, Goodwill and Other Intangible Assets." The Task Force was unable to reach a consensus on Issue 03-9 and
subsequently dropped it from the agenda at the September 2930, 2004 EITF meeting. At that time, the Task Force asked the Board to consider a project to address the issues identified in Issue 03-9. At the November 10, 2004 Board meeting, the Board decided to add this issue to the FASB agenda at the recommendation of the Task Force. On December 21, 2005, the Board issued proposed FSP FAS 142-d, "Amortization and Impairment of Acquired Renewable Intangible Assets." During redeliberations, the Board was unable to reach a consensus on certain issues that were raised during the comment letter process and, consequently, at the May 31, 2006 Board meeting, decided to drop this project from the FASB agenda.
At the direction of the Task Force, the staff put Issue 03-17 on hold pending the outcome of Issue 03-9. In the intervening period, at the 2003 AICPA National Conference on Current SEC Developments, Mr. Chad Kokenge, SEC Professional Accounting Fellow, stated the following in a speech:
Lastly, I also want to emphasize that Statement 142 states that to follow a method of consumption other than straight-line, that method must be reliably determinable. Accordingly, the pattern should be based on supportable assumptions. We recognize that this determination is naturally subject to judgment. In general, we believe the analysis of a pattern of consumption for a finite-lived intangible asset is not significantly different from that of a physical, tangible asset. The FASB staff understands that for a majority of executory contracts (other than energy contracts), entities have interpreted the above speech to indicate that using an amortization methodology other than straight-line for finite-lived intangible assets would not be acceptable.
August 3, 2006, p. 46
For energy contracts, however, the FASB staff has been informed that diversity in practice in amortizing these assets still exists; and entities typically utilize either the pattern of economic benefit approach or the straight-line method.
Due to the period of time that has elapsed since this Issue was first discussed by the Task Force, and since the Board dropped from its agenda the project meant to address Issue 03-9, the staff is seeking a recommendation from the Agenda Committee as to whether this Issue should remain on the Task Force's agenda. If the Agenda Committee recommends that the Issue be removed from the Task Force's agenda, the recommendation must also be approved by the Task Force at the next meeting. Issue 03-17 is described below.
Scope The original submission to the Agenda Committee was focused on the amortization of energy contracts in a business combination that met the normal purchases and sales criteria in paragraph 10 of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. The Agenda Committee agreed to add the issue to its agenda, but believed that the scope should be expanded to include all executory contracts acquired in a business combination (for example, this would include network affiliation agreements as described in Issue 03-9). The scope of this issue is limited to the amortization of an executory contract whereby an entity has not defaulted to using the straight-line method of amortization and, therefore, is amortizing the asset based upon the pattern in which the economic benefits are consumed or otherwise used up.
Additionally, the assumptions utilized for the pattern of economic benefit would result in both positive and "negative" amortization in respective periods. For illustrative purposes, consider the following example related to the acquisition of an energy contract in a business combination.
Company A buys Company B in a purchase business combination and pays a net premium (consisting of a gross premium and a gross discount) for a power sales contract. The contract, acquired on January 1, 2005, provides for sale of 1 mWh per month at a fixed rate of $10 per mWh over a 1-year contract term. An observable market transaction was not
August 3, 2006, p. 47
available to value this contract.1 At the time of the purchase, the forward power curve in the respective delivery region suggested market rates that resulted in a net premium of $18 paid for the contract determined as follows (for simplicity purposes, illustration excludes discounting):
Forward Price Premium/(Discount) with at Acquisition Associated Contract Period Date Delivery Month January May June August September December Net Premium for Entire Contract Period
$5/mWh $15/mWh $8/mWh
$25 $(15) $8 $18
Accounting Issue and Alternatives Issue: How an entity should amortize an executory contract initially recognized at fair
value in a business combination based on the pattern in which the economic benefits are consumed or otherwise used up pursuant to Statement 142 (assuming that that an entity has not defaulted to the straight line method under Statement 142).
View A: The executory contract should be amortized in a manner that is consistent with the fair value determination.
View A proponents believe that this view is consistent with paragraph 12 of Statement 142, which states:
The method of amortization shall reflect the pattern in which the economic benefits of the intangible asset are consumed or otherwise used up. If that pattern cannot be reliably determined, a straight-line amortization method shall be used.
1
In the above example, assume that a market transaction was not available to use as a reference in determining fair value. However, if an observable strip transaction existed with terms that mirrored those predicted by Company A's forward curve (that is, the instrument was priced at a fixed-rate but the rates fluctuated over the delivery period based on expected prices at execution), the amortization of the value recorded based on the comparison of the strip pricing to the contractual rates would be identical to the amortization pattern discussed above.
August 3, 2006, p. 48
They believe that amortization should be consistent with the fair value determination, which, in the fact pattern above, would inherently include both periods of positive and negative amortization. View A proponents note that this reflects the economic consumption of the asset and ultimately results in the same amount of total amortization that would have resulted had the net premium been used. Accordingly, under this view, Company A would record $25 of
amortization for the JanuaryMay period. As a result, the premium account has flipped to a liability account (deferred revenue) at May 31 of $7 ($18 premium recorded at January 1 less the $25 amortized to earnings through May 31). For the period JuneAugust, Company A would record incremental revenue over billings of $15 and the liability flips again to an asset of $8. The $8 premium at September 1 would be amortized to zero over the remaining contract term (SeptemberDecember) resulting in an appropriate level of income over those months.
View B: The executory contract should be amortized over the periods that gave rise to the asset.
Following the example cited above, Company A should amortize the net premium of $18 over the periods of the contract that gave rise to gross premiums. Two periods within the contract term gave rise to gross premiums; the JanuaryMay period resulted in a gross premium of $25 and the SeptemberDecember period resulted in a gross premium of $8 for a total gross premium of $33. Proponents of View B believe that the net premium of $18 should be amortized as follows: JanuaryMay: Amortize $13.50 ($18 25/33) ratably2 over the 5-month period SeptemberDecember: Amortize $4.50 ($18 8/33) ratably over the 4-month period No amortization would occur in the JuneAugust timeframe.
Supporters of View B contend that, when the Forward Curve is used to measure fair value, the amortization methodology proposed by View A could result in a credit to the income statement in one period and a debit to the income statement in the next period. They believe that this
2
The ratable amortization is appropriate as the value ascribed to each month within each distinct delivery period is the same (that is, the difference between contract rate and market rate is the same for each month).
August 3, 2006, p. 49
methodology is inconsistent with generally accepted accounting principles, which do not allow for the write up of an amortizable asset. Supporters of View B also point out that the
amortization methodology in View A may, at some point during the term of the contract, result in a reclassification of the same contract from an asset to a liability. For example, a contract that was originally established as an asset becomes a liability as the net difference for the remaining portion of the contract, at some period of time after the acquisition date, results in a credit. Supporters of View B contend that there is no current accounting model that has a similar financial statement impact as View A and this significant change in practice was not contemplated by the Board in FASB Statement No. 141, Business Combinations, and Statement 142.
Agenda Committee Decisions: The Agenda Committee agreed to continue deliberations on this potential new issue.
August 3, 2006, p. 50
8. Accounting for the Deferred Compensation and Postretirement Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements Summary At the June 15, 2006 EITF meeting, the Task Force reached a tentative conclusion on EITF Issue No. 06-4, "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements," that for a split-dollar life insurance arrangement that is in substance an endorsement type of policy, an employer should recognize a liability for future benefits in accordance with FASB Statement No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, or APB Opinion No. 12, Omnibus Opinion 1967, (depending on whether a substantive plan is deemed to exist). The original submission to the Agenda Committee on Issue 06-4 included both endorsement and collateral assignment types of arrangements. Based upon the FASB staff's research, it appeared that diversity in practice only existed in accounting for endorsement type of policies. At the June 15, 2006 EITF meeting, however, a Task Force member requested that the staff research, for consideration by the Agenda Committee, whether the tentative conclusion reached on Issue 06-4 should also apply to collateral assignment types of arrangements.
Background Companies purchase life insurance for various reasons that may include protecting against the loss of "key" employees, funding deferred compensation and postretirement benefit obligations, and providing an investment return. One form of this insurance is split-dollar life insurance. The structure of split-dollar life insurance arrangements can be complex and varied.
The two most common types of arrangements are endorsement split-dollar life insurance policies and collateral assignment split-dollar life insurance policies. Generally, the difference between these arrangements is the ownership and control of the life insurance policy. For an endorsement split-dollar life insurance policy, the company owns and controls the policy, whereas in a collateral assignment split-dollar life insurance policy, the employee owns and controls the policy. The terms of a typical collateral assignment split-dollar life insurance arrangement is as
August 3, 2006, p. 51
follows (refer to Issue 06-4 for the terms of a typical endorsement split-dollar life insurance arrangement):
An employer purchases a life insurance policy to insure the life of an employee and transfers ownership of the policy to the employee. The employee (or the employee's estate or trust) owns the insurance policy and controls all rights of ownership. The employer usually pays all or a substantial part of the premium. The employee (or the employee's estate or trust) irrevocably assigns a portion of the death benefits to the employer as collateral for the employer's interest in the policy. Amounts due to the employer vary but, typically, the employer is entitled to receive a portion of the death benefits equal to the premiums paid by the employer or premiums paid plus an additional fixed or variable return on those premiums. Upon retirement, the employee may have an option to buy the employer's interest in the insurance policy.
The FASB staff has been informed that the use of these arrangements has greatly diminished since the introduction of the Sarbanes Oxley Act of 2002 because many entities believed that these arrangements would be considered employee loans, which are expressly prohibited under the Act. Entities that continue to maintain these policies typically account for these policies as employee loans and apply the provisions of APB Opinion No. 21, Interest on Receivables and Payables. Accordingly, an employer would record a receivable from the employee at a
discounted amount for the premiums paid.
Accounting Issue and Alternatives Issue: Whether an entity should record a liability for the death benefit associated with a
collateral assignment split-dollar life insurance arrangement in accordance with either Statement 106 or Opinion 12.
View A: An employer should not recognize a liability for the future death benefits related to a collateral assignment split-dollar life insurance arrangement.
August 3, 2006, p. 52
View A proponents believe that consistent with the tentative conclusion in Issue 06-4, "an employer should recognize a liability for future benefits in accordance with Statement 106 or Opinion 12based on the substantive agreement with the employee." They argue that under a collateral assignment split-dollar life insurance arrangement, the substantive agreement with the employee is that the employer will pay the premiums under the policy. However, under these arrangements, the employer is legally entitled to recover the premiums paid through either the death benefit or the cash surrender value upon cancellation of the policy by the employee. Therefore, View A proponents believe that the only postretirement benefit that would need to be accrued during the employee's active service relates to any premium payments that would be paid during the employee's retirement. However, since a majority of these policies are either single premiums or front-loaded premiums, an employer typically will not be required to pay a premium that extends into the employee's retirement.
Additionally, View A proponents believe that a collateral assignment policy is substantively different from an endorsement policy and, therefore, the accounting should not be the same. For example, under an endorsement split-dollar life insurance arrangement, the employer owns and controls the policy. As noted by the Task Force in Issue 06-4, under these arrangements, an employer remains subject to the positive and negative experience of the insurance company. Therefore, a settlement of the benefit promised to the employee has not occurred. Under a collateral assignment arrangement, View A proponents believe that even if a death benefit reflects the substantive agreement with the employee, an obligation would not have to be recorded since the collateral assignment policy would effectively settle the postretirement benefit obligation in accordance with Statement 106 or Opinion 12. That is because the purchase of the policy is irrevocable (that is, the employer cannot cancel the policy) and the employee, not the employer, is subject to the positive and negative experience of the insurance company.
View B: An employer should recognize a postretirement benefit obligation for the death benefit in accordance with either Statement 106 or Opinion 12.
View B proponents believe that there is no economic difference between an endorsement splitdollar life insurance arrangement and a collateral assignment policy and, therefore, the
August 3, 2006, p. 53
accounting should be the same. For example, they note that in either case, both the employer and the employee will receive the same benefit. That is, the employer will typically recover its premiums (plus an investment return) and the employee will receive a stated death benefit.
Additionally, View B proponents believe that similar to an endorsement split dollar life insurance arrangement, the employer remains subject to the positive and negative experience of the insurance company. That is, the employer is obligated to pay the premium under the policy and if the employee were to default under its "loan" with the employer, the cash surrender value may not be sufficient to cover the premiums paid. Accordingly, proponents of View B believe that similar to the tentative conclusion reached by the Task Force in Issue 06-4, the postretirement obligation would not be settled in accordance with either Statement 106 or Opinion 12.
Agenda Committee Decisions: The Agenda Committee agreed to defer making a decision on this potential new issue pending the outcome of EITF Issue No. 06-4, "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements."
August 3, 2006, p. 54
FASB EMERGING ISSUES TASK FORCE Proposed September 7, 2006 Meeting Agenda
Issue Number
Issue Transition Guidance Harmonization
Proposed Time 8:00-8:30
Staff Assigned Jolla/ Cosper Cosper/ Beswick
06-1
Accounting for Consideration Given by a Service Provider to Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive Service from the Service Provider Application of EITF Issue No. 05-7, "Accounting for Modifications to Conversion Options Embedded in Debt Instruments and Related Issues" * * * BREAK * * *
8:30-9:00
06-6
9:00 10:15
Stevens/ Jacobs
10:15-10:30 10:30-11:45 Roberge/ Stevens
06-E
Accounting for a Previously-Bifurcated Conversion Option in Convertible Debt That No Longer Meets the Bifurcation Criteria in Paragraph 12 of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities Administrative Matters New Issues Other Matters
11:45-12:00
Cosper
* * * LUNCH * * * 06-4 Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements
12:00-1:00 1:00-2:00 Moss/ Trench
EITF Agenda Committee (Proposed Agenda)
August 3, 2006, p. 55
Issue Number 06-F
Issue Application of the Assessment of a Continuing Investment in Paragraph 12 of FASB Statement No. 66, Accounting for Sales of Real Estate, to a Sale of a Condominium * * * BREAK * * *
Proposed Time 2:00-2:45
Staff Assigned Akinlade/ Beswick
2:45-3:00 3:00-3:30 Beswick/ Trench
06-5
Accounting for Purchases of Life Insurance Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4 Reporting the Elimination of Previously Existing Differences between the Fiscal YearEnd of a Parent Company and Those of Its Consolidated Subsidiaries
06-G
3:30-4:00
Cosper/ Moss
EITF Agenda Committee (Proposed Agenda)
August 3, 2006, p. 56
Status of Open Issues and Agenda Committee Items The following represents the FASB staff's assessment of the status and immediate plans with respect to the open Issues on the Task Force's agenda. The Issues on the proposed agenda for the September 7, 2006 meeting are considered either high priority issues or issues on which meaningful progress can be made within the staff's given complement of resources. The staff's prioritization of issues is based primarily on the FASB staff's understanding of the level of diversity in practice created by each respective Issue, the financial reporting implications of that diversity, the current interaction, if any, of the Issues with active Board projects, and current resource availability among the staff (with respect to both time and relevant technical expertise). Due Date Next Deliverable September 2006 EITF meeting
Issue No. 06-1
Description Accounting for Consideration Given by a Service Provider to Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive a Service from the Service Provider Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements
Date Added 10/05
Date(s) Discussed 3/06, 6/06
Next Meeting 9/06
EITF Liaison Hauser
FASB Staff Cosper/ Beswick
Immediate Plans The FASB staff will prepare an Issue Summary Supplement for the next meeting.
06-4
11/05
3/06, 6/06
9/06
Holman
Moss/ Trench
The FASB staff will prepare an Issue Summary Supplement for the next meeting.
September 2006 EITF meeting
EITF Agenda Committee Report (Status of Open Issues and Agenda Committee Items)
August 3, 2006, p. 57
Issue No. 06-5
Description Accounting for Purchases of Life InsuranceDetermining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance Application of EITF Issue No. 05-7, "Accounting for Modifications to Conversion Options Embedded in Debt Instruments and Related Issues" Accounting for a PreviouslyBifurcated Conversion Option in Convertible Debt That No Longer Meets the Bifurcation Criteria in Paragraph 12 of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities
Date Added 2/06
Date(s) Discussed 6/06
Next Meeting 9/06
EITF Liaison Schroeder
FASB Staff Beswick/ Trench
Immediate Plans The FASB staff will prepare an Issue Summary Supplement for the next meeting.
Due Date Next Deliverable September 2006 EITF meeting
06-6
6/06 and 5/06
6/06
9/06
Holman
Stevens/ Jacobs
The FASB staff will prepare an Issue Summary Supplement for a future meeting. The FASB staff will prepare an Issue Summary for a future meeting.
06-E
5/06
N/A
9/06
Johnson
Roberge/ Stevens
August 3, 2006, p. 58
Issue No. 06-G
Description Reporting the Elimination of Previously Existing Differences between the Fiscal Year-End of a Parent Company and Those of Its Consolidated Subsidiaries Application of the Assessment of a Continuing Investment in Paragraph 12 of FASB Statement No. 66, Accounting for Sales of Real Estate, to a Sale of a Condominium Application of AICPA Audit and Accounting Guide, Brokers and Dealers in Securities, to Entities That Engage in Commodity Trading Activities Accounting for Joint Development, Manufacturing, and Marketing Arrangements in the Biotechnology and Pharmaceutical Industries
Date Added 8/06
Date(s) Discussed N/A
Next Meeting 9/06
EITF Liaison TBD
FASB Staff Cosper/ Moss
Immediate Plans The FASB staff will prepare an Issue Summary for a future meeting.
Due Date Next Deliverable September 2006 EITF meeting
06-F
8/06
N/A
9/06
TBD
Akinlade/ The FASB staff will Beswick prepare an Issue Summary for a future meeting.
06-H
8/06
N/A
11/06
TBD
Fanzini/ Jacobs
The FASB staff will prepare an Issue Summary for a future meeting.
November 2006 EITF meeting
06-I
8/06
N/A
11/06
TBD
Beswick/ Bolash
The FASB staff will prepare an Issue Summary for a future meeting.
November 2006 EITF meeting
August 3, 2006, p. 59
Issue No. 06-J
Description Subsequent Accounting for Executory Contracts Acquired in a Business Combination Initially Recorded at Fair Value under EITF Issue No. 03-17, "Subsequent Accounting for Executory Contracts That Have Been Recognized on an Entity's Balance Sheet"
Date Added 8/06
Date(s) Discussed N/A
Next Meeting 11/06
EITF Liaison TBD
FASB Staff
Immediate Plans The FASB staff will prepare an Issue Summary for a future meeting.
Due Date Next Deliverable November 2006 EITF meeting
Other EITF Issues including Inactive Issues Pending Developments in Board Projects Issue No. 00-18 Date Added 5/00 Date(s) Discussed 7/00, 7/01, 11/01, 1/02, 3/02 Next Meeting N/A FASB Staff Sarno Due Date Next Deliverable Future Agenda Committee Meeting
Description Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees
Immediate Plans Phase II of the Board's sharebased payments project will not be initiated in the foreseeable future and, therefore, the FASB staff will bring this issue to the Agenda Committee at a future meeting to determine whether to begin discussions on this Issue or to request that the Task Force remove this Issue from the agenda.
August 3, 2006, p. 60
Other EITF Issues including Inactive Issues Pending Developments in Board Projects Issue No. Due Date Date Date(s) Next FASB Next Description Added Discussed Meeting Staff Immediate Plans Deliverable The remaining issue in Issue 00-18 is Issue 3: For transactions that include a grantee performance commitment, how the grantee should account for the contingent right to receive, upon performing as specified in the arrangement, grantor equity instruments that are the consideration for the grantee's future performance. The Task Force asked the FASB staff to focus on improving the guidance (originally from Issue 96-18) used to determine the date at which a commitment for counterparty performance to earn the equity instruments is reached. Application of EITF Issue No. 98-5, "Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios," to Certain Convertible Instruments The Effect of Dual-Indexation both to a Company's Own Stock and to Interest Rates and the Company's Credit Risk in Evaluating the Exception under Paragraph 11(a)(1) of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities 5/00 11/00, 1/01 Not scheduled Richards Pending further progress on Phase II of the Board's liabilities and equity project. N/A
00-27
02-D
3/02
N/A
Not scheduled
Jacobs
Pending further progress on Phase II of the Board's liabilities and equity project.
N/A
August 3, 2006, p. 61
Other EITF Issues including Inactive Issues Pending Developments in Board Projects Issue No. 03-15 Date Added 11/02 Date(s) Discussed N/A Next Meeting Not scheduled FASB Staff Lusniak Due Date Next Deliverable Future Agenda Committee Meeting
Description Interpretation of Constraining Conditions of a Transferee in a Collateralized Bond Obligation Structure
Immediate Plans The Board's project on QSPE's is not expected to address this Issue and, therefore, the FASB staff will bring this Issue to the Agenda Committee at a future meeting to determine whether to begin discussions on this Issue or to request that the Task Force remove this Issue from the agenda. Issue addresses the amortization of a recognized executory contract that has periods of both positive and negative cash flows. This issue was pending the Board's consideration of how the factors in paragraph 11(d) of Statement 142 should be evaluated in determining the useful life of an intangible asset (formerly EITF Issue 03-9). The Board has dropped this project from the FASB agenda.
03-17
Subsequent Accounting for Executory Contracts That Have Been Recognized on an Entity's Balance Sheet
5/03
11/03
9/06
Moss
Future Agenda Committee Meeting
August 3, 2006, p. 62
Other EITF Issues including Inactive Issues Pending Developments in Board Projects Issue No. 05-4 Date Added 2/05 Date(s) Discussed 6/05, 9/05 Next Meeting N/A FASB Staff Thuener/ Jacobs/ Richards Due Date Next Deliverable N/A
Description The Effect of a Liquidated Damages Clause on a Financial Instrument Subject to EITF Issue No. 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock"
Immediate Plans Pending further progress on a DIG Issue for determining whether a registration rights agreement is a derivative
August 3, 2006, p. 63
Issues Pending Further Consideration by the Agenda Committee Issue No. N/A Date Added 9/00 Date(s) Discussed N/A Next Meeting Not scheduled FASB Staff Jacobs Due Date Next Deliverable Future Agenda Committee Meeting
Description Application of EITF Issue No. 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets," When a Special-Purpose Entity Holds Equity Securities and Whether an Investment That Is Redeemable at the Option of the Investor Should Be Considered an Equity Security or Debt Security
Immediate Plans Statement 155 did not address this Issue. Therefore, the FASB staff will bring this Issue to the Agenda Committee at a future meeting to determine whether to begin discussions on this Issue or to request that the Task Force remove this Issue from the agenda.
August 3, 2006, p. 64

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0906REPORT

Emerging Issues Task Force Agenda Committee Report August 3, 2006

EITF Agenda Committee Report

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

Definition of "little or no" cash consideration and timing of measurement

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

View A: No accounting consequence results from the transition.

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

Topic D-74 states, in part:

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

Biotech $ 10,000 $(10,000)

Big Pharma $ 50,000 20,000 10,000 $ 20,000

Total $ 50,000 20,000 10,000 10,000 $ 10,000

EITF Agenda Committee Report (Decisions on Potential New Issues)

$000 Equity Income from collaboration agreements Net profit (loss)

commercialization net sharing payments

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)

Biotech $ 15,000 10,000 $ 5,000

Big Pharma $ 35,000 20,000 10,000 $ 5,000

Total $ 50,000 20,000 10,000 10,000 $ 10,000

EITF Agenda Committee Report (Decisions on Potential New Issues)

Biotech $ 15,000 10,000 $ 5,000

Big Pharma $ 50,000 20,000 10,000 15,000 $ 5,000

Total $ 65,000 20,000 10,000 25,000 $ 10,000

EITF Agenda Committee Report (Decisions on Potential New Issues)

Biotech $ (15,000) 10,000 (5,000) $ 5,000

Big Pharma $ 50,000 20,000 15,000 10,000 45,000 $ 5,000

Total $ 50,000 20,000 10,000 10,000 40,000 $ 10,000

EITF Agenda Committee Report (Decisions on Potential New Issues)

EITF Agenda Committee Report (Decisions on Potential New Issues)