October 17, 2016

PwC commends the FASB for soliciting input on its future agenda. We believe a reassessment of the financial performance reporting model should be the Board’s top priority as it is critical to the continued relevance of GAAP.

October 17, 2016

Ms. Susan Cosper

Technical Director

Financial Accounting Standards Board

401 Merritt 7, P.O. Box 5116

Norwalk, CT 06856-5116

RE: File Reference No. 2016-290

Dear Ms. Cosper:

PricewaterhouseCoopers LLP appreciates the opportunity to provide feedback on the FASB’s Invitation to Comment, Agenda Consultation (ITC). We commend the Board for soliciting input on the future agenda. With the issuance of final standards on revenue, leases, financial instruments—both recognition and measurement and the allowance for credit losses—and the recent issuance of exposure drafts on hedging and long-duration insurance contracts, the time is right to broadly consider the future direction of the FASB’s efforts. While we believe there are some important issues for the FASB to address, we also caution the FASB to remain cognizant of the cost of change that is precipitated by new standards—to all constituents in the financial reporting supply chain—and that any potential project should be justified on the basis that the potential solution will significantly enhance the quality of financial reporting.

We rank the four potential projects described in the ITC in order of priority as follows:

We believe a reassessment of the financial performance reporting model should be the Board’s top priority. The performance reporting model is critical to the continued relevance of GAAP, which has been challenged of late by the proliferation of non-GAAP measures, for example EBITDA, and the evolution of the manner in which financial information is consumed. We believe the income statement could be enhanced through the identification and more transparent reporting of items that are unlikely to have a continuing effect on an entity’s business—remeasurements, nonrecurring transactions, and noncore activities—to aid analysis by users.

The presentation of other comprehensive income (OCI) should be considered concurrent with the performance statement. Many challenging standard setting debates seem to emanate from whether remeasurements should be included in net income (performance) or OCI rather than from fundamental questions of recognition and measurement of assets and liabilities. Although it may not eliminate the need for OCI, our proposal to redesign the performance statement, with more transparent reporting of gains and losses arising from remeasurements, could relieve some of that tension.

Another element of financial performance reporting, segments, is worthy of further consideration by the Board. We believe any changes to the income statement should be reflected in the segment disclosures, necessitating that a review of segments follow the re-examination of the income statement. Segment disclosures assist users in evaluating performance in the context of the primary financial statements, and in many cases, form the basis for accompanying commentary in MD&A and other communications. We believe the ability to disclose additional segment performance measures, if used by management to assess segment performance, would enhance the relevance of the segment disclosures. We also suggest reconsideration of the aggregation criteria, which are difficult to apply in practice.

The statement of cash flows would also benefit from a re-examination; it seems to suffer from an identity crisis. Users clearly need and value information about cash flows, but from potentially two different perspectives: (1) an ability to generate cash flows in the future for purposes of developing an enterprise value (performance/income statement focus) and (2) an ability to generate cash flows to service debt and meet other financial obligations as they come due (liquidity/balance sheet focus). As described in GAAP today, the statement of cash flows essentially serves as a reconciliation of the beginning and ending balance of cash and cash equivalents, a balance sheet line item. If the objective of the statement is to report performance on a cash basis, as implied by one potential solution in the ITC that would more closely link the income statement and the statement of cash flows, then the overall purpose and design of the statement needs to be reconsidered. The Board may also wish to consider whether the statement should be re-oriented to report an intermediate measure of cash flow, defined by GAAP, that would be similar to EBITDA, a prevalent non-GAAP measure that is a proxy for the ability to generate cash from operations. Reconciling from net income to cash flows using a measure of performance without regard to how the entity is capitalized or taxed could provide users with sufficient decision-useful information such that a non-GAAP alternative would not be necessary.

If the statement of cash flows is instead used to provide a measure of liquidity, then we believe cash flows should be addressed in a separate project.

While we believe distinguishing liabilities from equity is a significant issue that warrants further standard setting, we would prioritize it behind reporting financial performance because we believe decisions in that project could influence potential solutions, or the acceptability of potential solutions, to this problem. The determination of whether an instrument is a liability or equity is an important decision that affects not only balance sheet classification but the selection of its measurement attribute and whether any measurement changes or related cash flows from interest or dividends are recognized through the income statement. Making this determination has become very challenging as financial instruments have become increasingly complex, often containing characteristics of both liability and equity. Navigating the existing guidance is challenging, even for seasoned professionals, and different accounting outcomes can arise from differences in contractual terms that are often nonsubstantive.

Given the evolution of these instruments over time, it has been challenging for the accounting standards to keep pace. Numerous patches to the literature have led to a complicated system that is more dependent on legal form than substance, and, as a result, not always reflective of economic reality.

We believe the FASB should first address performance reporting, in particular how remeasurements of financial instruments should be reported, before undertaking a holistic reconsideration of the distinction between liabilities and equity. Until the performance reporting project is completed, we propose that the FASB make two specific targeted improvements: (1) enable preparers to disregard remote scenarios in the equity versus liability classification question and (2) rationalize the accounting models for convertible instruments to focus on a single model that more faithfully represents the true economic cost of the instrument.

With regard to intangible assets, we acknowledge the apparent disconnect between comprehensively recognizing them in a business combination and not recognizing internally-generated intangible assets. Some companies’ most vital assets—intellectual property, patented technology, brand names—do not appear on their balance sheets, thus raising questions about the relevance of the balance sheet. Recording certain intangibles on the balance sheet could be a first step in providing additional information about an entity’s financial position. However, we believe it would be challenging to identify the transition point, outside of a business combination, when an intangible asset, distinct from goodwill, has been created that should be recognized and measured. As a result, while we believe this is an area that warrants attention, especially given the number of existing models in GAAP for accounting for research and development costs, the Board should approach this area with some caution.

Which assets should companies record, and when? Given the wide range of intangible assets, it will likely be challenging to develop a new accounting model for all of them. As such, we recommend a phased approach, focusing first on software, which is arguably one of the more “tangible” intangible assets.

Finally, while we acknowledge the long-standing criticisms of the reporting model for pension and other postretirement benefits, we believe such arrangements are less prevalent than they were historically and, thus, would carry a lower priority. However, we also recognize that for many companies, pension and postretirement benefit arrangements are significant to their financial position, especially when viewed on a gross basis.

Therefore, until the reporting of financial performance is enhanced in such a way that remeasurements might be more easily distinguished from core operating performance, the Board may wish to consider providing a policy choice that would permit immediate recognition of plan amendments, along with the policy choice to immediately recognize actuarial gains and losses. In addition, we also observe that measurement guidance for some hybrid plans (e.g., cash balance plans) would be helpful in achieving greater consistency in measurement.

Notwithstanding our observation about the need to consider the cost of change in developing new standards, regardless of the major projects the Board decides to take on, it should continue to allocate sufficient resources to address practice issues as they arise.

Our answers to the specific questions in the ITC provide more detail on our views and are included in the Appendix. We also look forward to the opportunity to participate in the upcoming roundtable discussion on this topic in November.

If you have any questions regarding our comments, please contact Patrick Durbin at (973) 236-5152.

Very truly yours,

PricewaterhouseCoopers LLP

No. We do not believe that there are other major projects that need to be addressed at this time. We made this determination by considering how each project would impact the relevance of financial reporting to users. Although we are not recommending any additional projects, we believe it is necessary to continue to address practice issues as they arise.

We view reporting financial performance as the most important because of its importance to users, its critical role in the ongoing relevance of the GAAP reporting framework, and its potential influence on the alternatives considered in distinguishing liabilities from equity.

Yes. Determination of the form and content of the performance statement, particularly any disaggregation or reorganization of the components of net income and the interaction with remeasurements currently reported in OCI, should be the Board’s top priority.

Under current GAAP, the liability/equity distinction matters because liabilities flow through the income statement and equity does not. Certain income statement presentation alternatives may make that distinction less important. In addition, any changes to the income statement should be reflected in the segment disclosures.

Yes. We believe the accounting for intangible assets is a major financial reporting issue that the FASB should consider for improvement, but as stated in our cover letter, believe other projects should be prioritized before it.

Currently, the accounting for intangible assets is not addressed by an overarching framework. There are various accounting models in US GAAP and another in IFRS, some of which yield inconsistent results. Consider the inconsistencies, for example, in the treatment of internally-generated assets versus those acquired in a business combination, or the treatment of internal-use software and software for sale under US GAAP. In the case of software, the differences in accounting become more difficult to navigate as the line between software as a service and software sold to third parties becomes less distinct.

The inability to recognize internally-generated intangible assets is a gap in today’s financial reporting framework that leads to questions about the continued relevance of the balance sheet. Recording certain intangibles on the balance sheet would be a first step in alleviating this concern.

We recommend a phased approach to addressing the accounting for internally-generated intangibles. Because each type of intangible asset (e.g., intellectual property, customer relationship, trade name) may require a different accounting model to produce decision-useful information, and because of the inherent challenges in identifying the recognition threshold for each type, we suggest that the FASB begin with intangibles that are likely to arise as a direct result of an entity’s research and development activities (i.e., internally-generated intellectual property), specifically software.

We believe the FASB’s examination of research and development activities should consider whether:

We recommend a recognition approach based on the cost of research and development activities similar to Alternative B. As noted in our response to Question 1.2, we suggest starting with a subset of research and development activities—those related to software—using a cost accumulation approach. We acknowledge the challenges in identifying the recognition threshold—the point at which the activities produce something discrete that has the ability to generate future economic benefits—and the somewhat arbitrary assignment of costs to the asset, which may not bear any economic relationship to the value of the asset. Conversely, we would be concerned with a model that requires recognition of internally-generated intangible assets at fair value. Finally, we do not believe a disclosure-only approach would produce sufficient comparability to be helpful to users.

As noted in our response to Question 1.2, we are not in favor of a fair value recognition model. If one were adopted, performance reporting alternatives relative to remeasurement gains/losses should be explored.

In consideration of other FASB agenda items, we do not think pensions and other postretirement benefit plans is a major financial reporting issue. While the assets and liabilities associated with these plans often represent a material balance sheet account, especially when viewed on a gross basis, we observe that relatively few companies—public or private—are offering new pension plans. However, we would be supportive of considering targeted improvements in two areas: (1) providing a policy election for immediate recognition of plan amendments (see additional commentary in our response to Question 2.2) and (2) providing additional measurement guidance for obligations under so-called “hybrid” plans (see additional commentary in our response to Question 2.5).

We suggest a more targeted and narrow improvement in this area. We note that a number of companies have elected to recognize actuarial gains and losses immediately in net income. We recommend expansion of the accounting policy choice to plan amendments, which is not currently permissible under GAAP. In addition to allowing for immediate recognition of the income statement effects of changes in market conditions or plan terms, this would greatly simplify the accounting for certain defined events, such as curtailments and settlements, which we believe would enhance the understandability of reported results.

We do not support Alternative A. Although we favor convergence with IFRS when attainable, US GAAP currently requires recycling all elements of OCI, and IFRS does not recycle in this area. We believe all non-owner changes in equity should ultimately be reported in net income.

Please see our response to Question 2.2.

Although we acknowledge the criticisms of the existing measurement model for defined benefit pension plans, we believe the model is well understood and consistently applied in practice today. However, that model was developed for traditional pension arrangements in which employees are entitled to retirement benefits that are typically a function of years of service and/or wages over their careers.

The use of cash balance plans has significantly increased over the last decade. In these plans, the benefit is expressed in terms of an account balance rather than a monthly or annual annuity benefit. Because the existing measurement guidance does not specifically address these types of plans, we have observed diversity in practice. As such, we suggest that the FASB consider providing guidance on the measurement of the obligation for these types of plans. We caution against attempting to define a new category of plan (e.g., hybrid plans), but instead recommend that the FASB focus on the development of measurement guidance that could support alternative benefit structures.

We recommend targeted improvements only. Please see our responses to Questions 2.1, 2.2, and 2.5.

No. However, we refer to our comments on the exposure draft, Compensation–Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost, that would result in disaggregation of pension costs on the income statement. If the Board proceeds with that project, then we recommend adding a project to consider more holistically whether the single unit of account for all aspects of a pension plan is still appropriate.

Yes, distinguishing liabilities from equity is a major financial reporting issue. The determination of whether an instrument is a liability or equity affects not only a fundamental balance sheet classification distinction, but also the selection of a measurement attribute and whether any resulting measurement changes or related cash flows from interest or dividends are recognized through the income statement. Making this determination is challenging given the increasing complexity of financial instruments, often containing characteristics of both a liability and equity, and the complex patchwork of accounting standards that exist for these instruments, which tends to rely more on legal form than economic substance.

We believe distinguishing between liabilities and equity will likely require both a holistic approach and targeted improvements. Issues exist in practice today that can be resolved through targeted improvements in advance of a longer-term, holistic reconsideration. As noted in our cover letter, we believe that holistic reconsideration could depend on some of the decisions made in the project on reporting financial performance and should be sequenced following that project.

The holistic reconsideration is both a conceptual and standards-level challenge. Although the tension from the treatment of remeasurements of liability instruments in the income statement may be alleviated by changes to the performance reporting model, the fundamental question of how the elements of liability and equity are defined would still need to be addressed. However, the definitions of liability and equity elements are not distinct. Equity is the residual category (assets less liabilities), although many of the existing standards (and interpretations from regulators) attempt to prescribe equity classification for some instruments issued in the form of shares.

In terms of targeted improvements, we recommend the FASB begin with:

As described in our response to Question 3.2, we propose a different approach that does not depend on a “simple” versus “complex” designation of the underlying instruments.

As described in our response to Question 3.2, we propose a different approach that does not depend on a “simple” versus “complex” designation of the underlying instruments.

As described in our response to Question 3.2, we propose a different approach that does not depend on a “simple” versus “complex” designation of the underlying instruments.

Notwithstanding that view, Alternative B provides a better starting point for deliberations. Alternative A is overly restrictive in that only perpetual instruments would qualify as equity. However, we believe some nonperpetual instruments (e.g., a forward contract on the entity’s equity) that directly participate in earnings, losses, and residual net assets should be considered equity.

In addition, Alternative A is problematic for forms of organization other than corporations. A number of entity types, such as partnerships and cooperatives, do not have traditional capital structures. Many entities have various redemption or distribution mechanisms that View A would preclude from equity classification even though they directly participate in the earnings, losses, and residual net assets of the entity.

As described in our response to Question 3.2, we propose a different approach that does not depend on a “simple” versus “complex” designation of the underlying instruments.

This question may be best answered by users, who can provide insights as to whether fair value or intrinsic value would provide more decision-useful information.

Similar to our response to Question 3.7, we believe this question may be best answered by users.

Yes. We consider the project on reporting financial performance, in particular, income statement presentation, to be the highest priority project for the FASB’s future agenda. As we indicated in our cover letter, maintaining and enhancing the relevance and usefulness of the financial statements is of the utmost importance. The proliferation of non-GAAP measures and the evolution of the manner in which financial information is consumed requires a reassessment of whether the existing income statement model is suitable for today’s capital markets.

In addition, some of the presentation alternatives in the ITC (e.g., separately identifying remeasurements) could alleviate concerns with potential solutions in other projects, such as distinguishing liabilities from equity.

Many companies already present an income from operations, or operating income, subtotal. However, given the variety of industries and business models and the attendant variations in the manner in which operating income is determined, we believe it would be very challenging for the FASB to develop a definition of income from operations that could be broadly applied across industries. Rather than focusing on subtotals or categories of net income, we believe it would be more effective to consider disaggregation of the components of income (line items) between transactions and remeasurements, recurring and nonrecurring transactions, and core and noncore activities.

Please see our response to Question 4.2.

Please see our response to Question 4.2.

We believe Alternative B, distinguishing remeasurement gains and losses from other activities, would provide more useful information to financial statement users because it provides greater qualitative information that users may find helpful in assessing those elements that have predictive value.

In light of the expanded use of computer-automated consumption and analysis of financial information and users’ desire for proprietary arrangement of that information to suit their needs, we believe the challenge will be how to define elements of performance. In addition, establishing the boundary of the primary financial statements will be challenging given that based on the proliferation of non-GAAP measures, the traditional financial statements may not be fully meeting users’ needs. In our view, disaggregating line items between transactions, remeasurements, and core and non-core activities would provide the most decision-useful information. This would be a combination of Alternatives A and B.

While some users may find disclosure of the nature of expenses to be useful, we do not believe it would be broadly relevant. Therefore, we do not support Alternative C.

In general, financial statement users desire greater disaggregation. One relevant dimension of disaggregation is by segment. As a result, we believe segment reporting warrants continued focus. Segment disclosures assist users in evaluating performance in the context of the primary financial statements, and in many cases, form the basis for accompanying commentary in MD&A and other communications.

We believe Alternative A, presenting additional performance subtotals for segments (if used by the chief operating decision maker), would provide more decision-useful information to financial statement users. However, a rigid standardization of the presentation of segment disclosures is inconsistent with the flexibility inherent in the management approach and may be challenging to apply across a wide range of industries and business models.

(a) The aggregation criteria in ASC 280 have proven challenging to apply in practice and would benefit from re-examination. However, we are aware that users generally prefer greater disaggregation of information, which suggests that permitting aggregation or greater flexibility in aggregation may be viewed unfavorably by the user community.

(b) Implicit in the management approach to segment reporting is the notion that the information management uses internally to run the business is valuable to users. A board will generally receive information at a more aggregated level than that used by the chief operating decision maker to allocate resources and assess performance. As a result, we agree with the statement in the ITC that a governance approach would result in less information being provided to users. Rather than focusing on the information provided to a governance body, we recommend enhancing the guidance for identifying operating segments to specifically refer to other aspects of the organization’s structure besides the chief operating decision maker and discrete segment managers.

Overall, we believe any improvements to segment disclosures should be based on what users consider important to their decision making. Specific suggestions are outlined in our responses to Questions 4.8 and 4.9.

Yes. We believe that the presentation of OCI should be considered when the income statement is addressed. As noted in our cover letter, many challenging standard setting debates seem to emanate from the distinction between net income (performance) and other comprehensive income. A redesigned performance statement that clarifies the purpose of both net income and OCI could answer many questions in other projects, or at least determine that those questions are still valid and worthy of the Board’s attention.

We believe net income is the primary performance indicator and OCI is a reflection of those changes in assets and liabilities that are not recognized in net income. Because of the importance that most users place on net income, we believe all items of income and expense should ultimately be reported in net income once the reason for the initial exclusion from net income no longer applies. As a result, we do not support either alternative in the context of the existing reporting model.

In our experience, users focus on net income and earnings per share; they do not appear to be focused on comprehensive income or per-share measures of comprehensive income. Thus, the two-statement approach seems to be meeting the needs of users.

With respect to computing and reporting a per share amount for comprehensive income, we believe that any changes should be supported by feedback that users would find this information useful. Calculating diluted per share amounts involves a number of complications that would likely be equally challenging in the context of comprehensive income.

On these bases, in our view, neither of the proposed alternatives would enhance the usefulness of the financial statements. However, as noted in our response to Question 4.11, we believe that OCI should be considered as part of income statement presentation.

We have no other alternatives to suggest.

One of the fundamental objectives of general purpose financial reporting is to provide users with information to assess an entity’s ability to generate future cash flows. In addition, a key aspect of many questions of asset and liability recognition and measurement relates to the entity’s ability to produce cash flows or requirement to expend cash. The statement of cash flows is therefore presumptively critical to the ability of financial statements to serve their objective. However, the manner in which the statement of cash flows is presented and some of the recent decisions on how certain items should be classified in the statement raise a more fundamental question with regard to its purpose.

ASC 230 indicates that the objectives of the statement of cash flows, when combined with information in the other financial statements, are to help investors and creditors assess (1) liquidity, (2) the entity’s ability to generate positive future net cash flows, (3) the reasons for differences in net income and cash flows, and (4) the effects of cash and non-cash investing and financing transactions. These four objectives could lead to some confusion as to whether the primary purpose of the statement is focused on the balance sheet and liquidity or the income statement and performance.

Including the statement of cash flows in the discussion of reporting financial performance, and in particular a proposal to link cash flow presentation to the income statement, suggests that the emphasis of the statement is to assist users in projecting future cash-generating performance. Also, the recent exposure draft on the presentation chapter of the Conceptual Framework reinforces this notion by indicating that the statement helps to assess “profitability.”

Because the cash flow statement is currently prepared and presented as a reconciliation of the beginning and ending balance of cash and cash equivalents, a balance sheet line item, we observe that many users have sought a proxy for their version of operating or “performance” cash flow in the form of EBITDA or similar non-GAAP measures. Once the purpose of the statement is clarified, it may be worth exploring whether those sorts of non-GAAP proxies could be replaced with information obtained directly from the statement of cash flows.

Please see our response to Question 4.15.

Our experience suggests that sufficient disaggregation exists in the current investing and financing categories. In the operating section under the indirect method, the most prevalent method in practice, no actual cash payments or receipts are presented; it is simply a reconciliation of net income and changes in balance sheet captions. Further disaggregation of those items is not likely to produce useful information about cash flows. Therefore, we do not support further disaggregation.

Please see our response to Question 4.15. However, if the Board decides not to undertake a comprehensive reconsideration of the statement of cash flows, we are aware of a number of specific classification questions that have been provided to the FASB that indicate that additional interpretive guidance is needed.

Please see our response to Questions 4.15 for thoughts on the form and content of the statement of cash flows. Assuming the objective of the statement is to present cash flow-generating performance, Alternative C, which would establish a linkage between accounting performance and cash performance, would be most appropriate. Regardless of the outcome of the reconsideration of the purpose of the statement, we do not support Alternative A, which would result in a fourth “residual” category, or Alternative B, which would be based on internal management designations and as a result, would reduce comparability.

We do not support a management approach to classification within a primary financial statement as it would reduce comparability.

Similar to our view that defining operations on the income statement would be challenging given the variety of industries and business models, we do not believe it is worthwhile to define operating activities in the statement of cash flows. However, as described in our responses to Questions 4.15 and 4.19, if the objective of the statement of cash flows is to report performance, then the presentation of the statement of cash flows should be linked to the presentation in the income statement.

Given the evolution of treasury and cash management practices and the development of various products in the marketplace to absorb or create short-term liquidity, it may be worth revisiting the definition of cash equivalents.

Further, under the current reporting framework, we believe the decision-usefulness of the statement of cash flows would be enhanced by greater clarity about the impact of non-cash transactions. Currently, there is a specific requirement to disclose non-cash investing and financing activities, but it is not required on the face of the statement of cash flows and there is no similar requirement to report non-cash operating activities. Because non-cash transactions are not presented together with similarly classified cash flows, preparers sometimes impute cash flows for non-cash transactions in an attempt to understand the overall activity within each category. One suggestion would be to present non-cash transactions relevant to each classification category next to the subtotal of cash flows in that category to provide more transparency as to the impact of non-cash transactions.

We believe a holistic and comprehensive project is the best approach to improving financial performance reporting and the statement of cash flows. We understand this approach may be more challenging and take longer to complete, but it would consider the interactions between statements and we believe would ultimately result in a better outcome. In certain projects, we believe targeted improvements could provide some shorter-term relief until the primary projects, the income statement and OCI, are resolved.

Please see our responses to the other questions within Chapter 4.