Posted: February 18, 2011
Seven must-know accounting changes
Plus others to watch for in 2011Jim Brendel
There are a number of new rules that will have accounting and reporting implications for 2010 year end annual reports. They vary from changing the timing of financial results to adding to overall reporting expense.
Two new Financial Accounting Standards Board updates will have major impacts on accounting for sales contracts that contain multiple deliverables. What's a multiple deliverable? Say your company sells dishwashers and also provides the installation. Under the old rules, you had to demonstrate objective evidence of "fair value" for each undelivered item in order to recognize revenue for the delivered item. If you could not establish the fair value of the installation, revenue recognition for the dishwasher could be delayed, even though the customer had paid for it.
Under the new revenue recognition rule - ASU 2009-13 - companies don't need the "objective" proof of each service or good, they can estimate the selling price of the installation and warranty. So in our example, the vendor - say it's Sears or Appliance Factory - can recognize the revenue of the dishwasher - alone - at the point of sale without waiting a few weeks for the installation guys to do their thing. Then they can recognize the estimated value of the installation after it is complete.
The second major revenue recognition change for 2010 reporting , ASU 2009-14, covers software enabled devices. This has also been referred to as the iPhone rule because of the large effect that it has on Apple Computers' revenues. Although the iPhone is a piece of hardware, it depends on embedded software for its intended use. Under the old rules, this embedded software caused iPhone sales to be governed by the software revenue recognition rules, which are much more stringent than the rules related to other goods and services. As a result, Apple had to recognize all of the revenue from the sale of an iPhone over two years because it provides software updates over that period. ASU 2009-14 says that the software revenue recognition rules no longer apply to these types of software enabled devices, so they are now governed by ASU 2009-13, like other goods and services. The result of the change? Apple reported a record quarter when it elected to adopt this rule early for its first fiscal quarter 2010. Both of these new standards are effective for fiscal years beginning after June 15, 2010, but can be adopted earlier.
Here are five other changes for 2010 reporting:
Fair value disclosures. Companies will be required to provide additional disclosures about items measured at fair value in the financial statements for their 2010 financial statements. In particular, significant transfers in and out of Level 1(quoted market price) and Level 2 (valuation based on observable markets) must be disclosed separately, along with the reasons for the changes.
Fair value items classified as Level 3 (valuations based on internal information) will require additional disclosure of purchases and sales during the year. The FASB recently decided not to exempt private companies from these requirements. Investors have said that these new disclosures will give them better insight into the quality of reported earnings, but companies can expect to spend additional time gathering and summarizing all of this information.
Consolidation of variable interest entities. Several changes to the consolidation rules for variable interest entities, also known as special purpose entities, came into effect in 2010. The new rules require a qualitative, rather than a quantitative, analysis to determine the primary beneficiary of a variable interest entity, such as a corporation formed to hold real estate and lease it to an operating company. The primary beneficiary is the company that has the power to direct the activities and obligation to absorb the losses of the variable interest entity, which it will consolidate even though it may own less than a majority of the voting interests.
XBRL - eXtensible Business Reporting Language is a data-tagging technology that standardizes the way that financial statement items are identified, and has been frequently referred to as the next generation of EDGAR. The SEC has required the largest public companies (over $5 billion in market cap) to file financial statements with XBRL tagging since June 2009.
In June 2010, the remaining large public companies (over $700 million in market cap) were first required to provide XBRL tagging in their financial statements. Starting in June 2011, all of the remaining U.S. public companies must file financial information using XBRL. Companies will likely require outside assistance to match their accounting records with the standard XBRL classifications, and should consider an early start on this project. It can easily cost a small public company from $30,000 to $50,000 to implement.
Non-GAAP financial disclosures - Recent SEC staff interpretations allow more latitude for companies who provide non-GAAP financial disclosures, such as EBITDA, in SEC filings, as well as additional guidance in making those disclosures. These interpretations reduced the constraints on the exclusion of recurring items from the non-GAAP measure, and let companies know that management does not have to use the measure in operating the business in order to disclose it. The new interpretations can be found here: http://www.sec.gov/divisions/corpfin/guidance/nongaapinterp.htm. The effect of this change is mainly to provide more flexibility to companies in how they report non-GAAP measures of performance and won't necessarily add or subtract from earnings statements.
Loss contingencies disclosures - A FASB proposal that would require more disclosures about loss contingencies, such as litigation, has been sent back for more deliberation after concerns were raised that the level of disclosure would put public companies at a disadvantage in the courtroom. However, the SEC is questioning whether companies are adequately complying with the current rule, which requires disclosure of an estimate of the possible loss or range of loss. The SEC believes that in too many cases, no disclosure is made until the case is settled because companies assert that they are not able to make accurate estimates of the potential loss. Companies should expect additional scrutiny of their disclosures in 2010 annual reports.
Developments to watch in 2011:
Short-term borrowing disclosures - In response to concerns about companies window-dressing their balance sheets by paying down lines of credit before year- end, the SEC has proposed rules that would require additional disclosures, such as fluctuating borrowing during the year and a qualitative discussion of the business reasons for the debt. These rules are expected to be finalized in the first quarter of 2011. However, the SEC has reminded companies that they expect to see a thorough discussion of liquidity and capital resources in the management's discussion and analysis under the existing requirements.
Dodd-Frank Act - The Dodd-Frank Act is considered to be the most extensive overhaul of the U.S. financial system since the 1930s and will require the SEC to write over 100 rules and conduct numerous studies. You can follow the progress of these rules on the SEC's website at http://www.sec.gov/spotlight/dodd-frank/dfactivity-upcoming.shtml.
Of particular interest to public companies are the requirements for companies to establish policies to claw back incentive compensation paid to executives in the event of a financial statement restatement and to provide disclosures regarding the ratio of CEO compensation to median employee compensation.
Convergence - While the SEC continues its consideration of whether to adopt international accounting standards (IFRS), the FASB and its international counterpart, the IASB, have their own work plan to complete 11 major projects in 2011 to converge US GAAP and IFRS. Although the effective dates of these standards have not been determined, this level of standard setting activity in such a short time is unprecedented. The two projects that are getting most of the attention are a proposal to replace all industry-specific revenue recognition guidance with one comprehensive standard, and a proposal that would require all lease obligations to be recorded on the balance sheet.
James Brendel, CPA, CFE, is the national director of audit quality for Hein & Associates LLP, a full-service public accounting and advisory firm with offices in Denver, Houston, Dallas and Southern California. He specializes in SEC reporting and assists companies with public offerings and complex accounting issues. Brendel can be reached at firstname.lastname@example.org or 303.298.9600.