The effective date for the new guidance on the definition of a business and goodwill impairment guidance is approaching, but companies can adopt now. To help navigate the transition, we share some tips.
Calendar year-end public companies must adopt the new definition of a business as of January 1, 2018. Companies may early adopt the guidance at any time in 2017. For example, a calendar year-end company can adopt the new guidance for transactions in Q2 2017, even if it used the old guidance for similar acquisitions in Q1 2017. That is, companies may account for similar transactions in 2017 differently. The new definition is expected to result in more asset acquisitions. A transaction before the adoption of the guidance may be a business combination while a similar transaction after adoption may be considered an asset acquisition.
The new guidance is applied prospectively. Transactions accounted for under the old guidance cannot be re-evaluated under the new guidance. This could result in an acquisition of a group of assets being treated as a business combination under the old guidance, but the disposal of the same group of assets after adoption of the new standard being treated as an asset disposal.
The guidance includes a screen test that determines whether “substantially all” of the fair value of the gross assets is concentrated in a single asset or group of similar assets. If it is, the acquired group is considered an asset acquisition. “Substantially all” is not defined. However, it is interpreted as approximately 90% in other areas of GAAP (e.g., revenue, leases).
The assets used for the screen test can be different than the assets recorded for financial reporting. This is because assets that are attached and inseparable are considered a single asset for the screen test. For example, land, a building, and the related lease intangible asset would be a single asset for the screen test. However, three assets would be presented in the company’s financial statements, and the assets would be accounted for under their respective accounting guidance.
Whether a transaction involves a business or a group of assets is important as there are several differences in how to account for each. For example, goodwill is not recognized in an asset acquisition. Any excess purchase price over the fair value of the assets acquired is allocated to the identifiable assets based on their relative fair values. Additionally, transaction costs are capitalized in an asset acquisition, but expensed in a business combination.
For more information, read In depth US2017-01, The FASB’s new definition of a business.
The new goodwill impairment guidance eliminates time and effort by removing step 2 of what was previously a two-step impairment test. However, the guidance does not impact the timing or order of impairment testing.
Companies that adopt the guidance for their annual impairment test must also apply it to any interim testing. For example, assume a calendar year-end company expects to early adopt the new goodwill impairment test in Q4 2017 for its annual test. If there is a triggering event in any interim periods in 2017, the company must use the new guidance. Conversely, if the company performs a trigger-based interim test under the current guidance, it must perform its annual test using the same guidance.
This interim date rule does not apply to companies that were unable to early adopt the new standard because it was not issued. For example, a company with a June 30, 2017 year end could not have applied the new guidance to interim periods prior to January 5, 2017 (i.e., the date the standard was issued). However, the company can apply the new guidance to any test on or after January 5, 2017, even if it had an interim test during the first half of its fiscal year under the current guidance.
For more information, read In depth US2017-03, Measuring goodwill impairment to get easier.
The SEC staff continues to review company disclosures regarding the impact of adopting new accounting standards (SAB 74). The importance of SAB 74 disclosures was emphasized at the 2017 Baruch College Financial Reporting Conference, including the need to provide information on (1) the status of a company’s analysis, (2) the impact on disclosures, and (3) the qualitative impact of the standard.
Preparers were cautioned that when assessing the impact of the new standard, the assessment should reflect consideration of the full scope of the standard, which covers recognition, measurement, presentation, and disclosure. Accordingly, they should remember to consider the impact on disclosures before concluding that the effects of the standard will not be material.
Below is a summary of the potential impact of adopting the credit loss, leasing, and revenue standards as disclosed in annual and quarterly filings by the Fortune 500 between April 1, 2017 to May 26, 2017.
Below is a summary of the expected method of adoption of the revenue standard as disclosed by the same companies.
The following comment is representative of comments issued by the SEC staff regarding SAB 74 disclosures. We expect a continued focus by them on the sufficiency and development of these disclosures.
You state that you are in the process of evaluating the impact that the amended revenue recognition guidance in Topic 606 will have on your consolidated financial statements. Please revise your future filings, beginning with your next Form 10-Q, to provide qualitative financial statement disclosures of the potential impact that this standard will have on your financial statements when adopted. In this regard, include a description of the effects of the accounting policies that you expect to apply, if determined, and a comparison to your current revenue recognition policies. Describe the status of your process to implement the new standard and the significant implementation matters yet to be addressed. In addition, to the extent that you determine the quantitative impact that adoption of Topic 606 is expected to have on your financial statements, please also disclose such amounts. Please refer to ASC 250-10-S99-6 and SAB Topic 11.M.
Treasury operations of multi-national corporations often use intercompany loans. Intercompany loans denominated in a currency other than the corporation’s functional currency may generate transaction gains or losses in consolidated net income.
However, if management asserts that settlement of the intercompany loan is not planned or anticipated in the foreseeable future, transaction gains or losses are reported in equity similar to cumulative translation adjustments (CTA). In this case, management is asserting that while the loan is legally debt, it is in substance a capital contribution because repayment is not expected.
Care should be taken when making this assertion. When repayment of an intercompany loan is anticipated, but its timing is uncertain, the loan does not qualify for this exception. If repayment is anticipated, transaction gains and losses should be reflected in net income.
Although rare, when unforeseen circumstances occur, intercompany loans that were asserted to be capital contributions may be considered for repayment. When this occurs, transaction gains or losses previously treated as translation adjustments remain in CTA. Prospectively, transaction gains or losses would be included in net income.
It can be challenging to identify when repayment of an intercompany loan becomes foreseeable. However, there is an expectation that a reasonable period of time exists between the determination that a loan will be repaid and the date when it is paid.
In addition, when an assertion is changed, contemporaneous documentation should specify the circumstances that have changed and why those were not foreseen at the time of the original designation. Furthermore, management should ensure that assertions made for tax purposes and financial reporting purposes are consistent.
For more information, read Section 7.5 of the Foreign Currency Guide, Accounting for long term intercompany loans and advances.
In July 2017, the International Ethics Standards Board for Accountants’ standard, Responding to Non-Compliance with Laws and Regulations, will be effective. The standard includes guidance for professional accountants (PAs) on how to respond when they become aware of, or suspect, non-compliance with laws and regulations. The standard applies to PAs in public and private practice.
The AICPA’s Professional Ethics Executive Committee has proposed a similar standard. The comment period ended in May. Once finalized, this standard will apply to AICPA members.
The past year has seen an increase in the focus on non-GAAP measures. But at the 2017 Baruch College Financial Reporting Conference, Wes Bricker, SEC Chief Accountant, discussed how other key operating metrics and forecasts could be subject to distortion and bias – intentional or not – similar to non-GAAP measures.
He said preparers should apply the lessons learned from the use of non-GAAP measures to other metrics. Specifically, companies should understand the metrics used and have disclosure controls and procedures in place related to the reporting of them. In addition, these procedures may need more steps than the procedures in place for reporting GAAP measures because other metrics do not have the benefit of a standard-setting due process. For example, GAAP measures benefit from a standard-setting due process that solicits stakeholder views on the types of disclosures needed by users.
Finally, he suggested that perspectives on the procedures for reporting other metrics from those outside of finance and investor relations might be useful in identifying risks and maintaining effective controls.
On May 4, 2017, Jay Clayton was sworn in as the Chairman of the SEC. Watch our video for insights into the expected impact of the appointment on capital formation.
A Chief Audit Executive (CAE) has a handful of opportunities each year to engage with the audit committee. These interactions play a role in the committee’s view of the CAE’s abilities. Only 44% of respondents to PwC’s 2017 State of the Internal Audit Profession believe that internal audit contributes significant value to the organization, down from 54% in 2016. This decrease may be a result of the rising number of risks organizations manage and the belief that internal audit could do more. It may also be driven by perceptions of the CAE’s performance during audit committee meetings. It is critical that CAEs maximize each interaction with the board.
The following five tips will help CAEs optimize time with the board:
There are a number of practical and actionable steps CAEs can take to stand out. For example, to know the audience, CAEs can engage in a regular dialogue with the audit committee chair to effectively present key messages. In addition, a CAE can use these steps to understand the committee’s preferences on subjects discussed and the format of pre-read materials.
Learning more about the audit committee, investing time in preparing written materials, and rehearsing presentations can enhance a CAE’s professional brand.
To learn more about how to put these tips into action, refer to PwC’s Engaging with the Board: Five ways for Chief Audit Executives to stand out. This upcoming report is the first in a three-module series that will explore how various senior management functions can enhance the effectiveness of their interactions with the board. This report will be available soon on PwC's Governance Insights Center.