Statement 5 and 141R webinar

SEGMENT 1: Lewis Ferguson, Partner, Gibson, Dunn & Crutcher LLP Procedural and Contextual Background of the FASB FAS 5 and 141R reform proposals. 1. What is the FAS 5 and 141R reform proposal? In general, will require disclosure and quantitative (i.e. valuation) and qualitative discussion of loss contingencies that are more than remote (FAS 5) and fair valuation of assets and liabilities acquired in business combinations (FAS 141R). Original proposed effective date was for FYs ending after December 15, 2008. 2. What led FASB to adopt proposals? A. Investor group complaints about existing disclosure regime. B. General movement in accounting toward fair value accounting and increasing emphasis on balance sheet accuracy and relevance. C. Perceived pressure to align GAAP with IFRS which is fair value based. 3. What the FASB Proposal does and does not do. A. Does change footnote disclosure standard for loss contingencies requiring quantitative (i.e. valuation) and qualitative disclosures of contingencies that are more than remote (and even some remote contingencies). B. Does not change financial statement standard for financial statement accrual of liability – loss still must be probable for liability accrual to be required. 4. Responses to the FASB proposal. A. FASB received more than 235 comment letters – an unusually large number. Financial statement users were generally supportive, financial statement preparers and professionals were generally opposed. B. Objections. i. Preparers – valuations would be difficult, compliance costly and time consuming, information of dubious value, and effective dates unrealistic. ii. Attorneys – proposal raises attorney/client privilege waiver issues, threatens the continued viability of the ABA/AICPA Treaty on Accountant/Attorney communications, may inhibit attorney/client communication, and will spur additional litigation if disclosures turn out to be wrong. iii. Auditors – concerned with auditability of disclosures and valuations, and with the absence of specific auditing standard guidance for these matters. 5. Evolution of the Proposal. Presently FASB is rethinking at least the FAS 5 proposal. A. Effective date for FAS 5 proposal put off until at least FYs beginning after December 15, 2009. B. In November & December 2008, FASB will field test two proposals: i. Present proposal ii. A FASB staff developed proposal that may eliminate the quantitative disclosure requirements. iii. FASB may also look more broadly at disclosure practices under existing FAS 5. C. FASB is exploring with the SEC, PCAOB and ABA the effects of the proposals on the ABA/AICPA Treaty. D. FASB will hold roundtable discussion in early 2009 and reconsider the standard in March or April 2009. SEGMENT 2: Linda L. Griggs, Partner, Morgan Lewis 1. Various accounting standards and other financial reporting developments suggest that additional disclosures about loss contingencies will be required, either by the FASB or the SEC. 2. The FASB determined to review FAS 5 in a two-phase process on September 6, 2007 in connection with its consideration of FAS 141R and in recognition of concerns that FAS 5 results in a delayed recognition of assets and liabilities and is not consistent with more recent FASB pronouncements. – FAS 141R imposes a different recognition and disclosure scheme from that of FAS 5 on loss contingencies. – Other accounting standards require the recognition of assets and liabilities earlier than under FAS 5 and at fair value. – The FASB’s proposed revisions to the FASB 5 disclosure provisions were issued in the first phase of the FASB’s two phase process to review FAS 5. 3. FAS 141R, which is effective for annual periods beginning after December 15, 2008 and will apply to all transactions in which an acquirer obtains control of one or more businesses (a “business combination”), will require entities to account for all assets and liabilities at fair value unless the entity cannot conclude that a loss from a noncontractual loss contingency is more likely than not. – After the initial recognition of a loss contingency at fair value, changes in the assessment of the outcome of the loss contingency will be recognized at the higher of the FAS 5 amount or the acquisition date fair value – With respect to loss contingencies assumed or acquired in connection with a business combination that occurs during the reporting period, FAS 141R will require the following disclosures: the amounts recognized at the acquisition date or an explanation of why no amount was recognized, the nature of recognized and unrecognized contingencies and an estimate of the range of outcomes for both recognized and unrecognized contingencies, or, if a range cannot be estimated, that fact and the reasons why a range cannot be estimated. 4. Other accounting standards that take a different approach than the approach in FAS 5 include: – FAS 143, “Accounting for Asset Retirement Obligations,” and FASB Interpretation 47, “Accounting for Conditional Asset Retirement Obligations,” require the recognition of the fair value of a liability for the retirement of an asset at the time that the entity incurs a legal obligation to retire the asset. – FAS 146, “Accounting for Costs Associated with Exit or Disposal Activities,” requires the recognition of the fair value of a liability for a cost associated with an exit or disposal activity in the period in which the liability is incurred unless the fair value cannot be reasonably estimated at that time. – FASB Interpretation 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,” requires recognition of a tax position when it is more likely than not that the tax position will be sustained. The amount recognized is measured at the largest amount of benefit that is greater than 50% likely of being realized upon settlement. 5. The FASB’s proposed disclosure requirements would require disclosures that are similar to those that are now required by the comparable accounting requirements adopted by the International Accounting Standards Board (the “IASB”), International Accounting Standard No. 37, “Provisions, Contingent Liabilities and Contingent Assets” (“IAS 37”). – IAS 37 requires the following disclosures about each class of provision relating to a liability, including a loss contingency that is recognized in the income statement and balance sheet: a reconciliation of the provision from the beginning to end of the period; a brief description of the nature of the obligation and the expected timing of any resulting outflows, a brief description of the uncertainties that affect the timing of the outflows and, where necessary, disclosure about major assumptions, and the amount of any expected reimbursement. – IAS 37 requires the following disclosures about loss contingencies that are not recognized in the financial statements and are not remote: a description of the nature of the contingency, by class of provision; a best estimate of the amount required to settle the contingency, an indication of the uncertainties relating to the amount or timing of any cash outflows and disclosure about the possibility of reimbursement. In extremely rare cases, if disclosure about a dispute with other parties can be expected to seriously prejudice the entity’s position in the dispute, the entity would be required to only disclose the general nature of the dispute. 6. In 2005, the FASB exposed for comment the IASB’s proposal to amend IAS 37 to require the recognition of all liabilities at fair value. – The IASB’s proposal observed that all pending and threatened litigation would meet the definition of a liability. – The IASB has not taken final action on its proposal 7. The SEC decided on August 27, 2008 to propose a roadmap toward the use of International Financial Reporting Standards by U.S. companies. – The FASB may have believed that proposing revisions to the FAS 5 disclosure requirements that are substantially similar to those required by IAS 37 might help the effort to converge the recognition requirements for loss contingencies. – The SEC’s decision to issue a roadmap suggests that convergence is even more important. 8. The SEC’s Advisory Committee on Improvements to Financial Reporting (“CIFiR”) recommended enhanced disclosures about uncertainties that may impact a company’s business. It recommended that the SEC and the FASB develop a disclosure framework to, among other things, require disclosures of the principal assumptions, estimates, and sensitivity analyses that may impact an entity’s business, as well as a qualitative discussion of the key risks and uncertainties that could significantly change these amounts over time.” 9. CIFiR’s recommendation and the FASB’s goal of requiring better disclosures to investors to assist users in assessing the likelihood, timing and amounts of cash flows associated with loss contingencies may be achievable in a way that avoids the risks that the proposal presents. – The MD&A now requires disclosure about trends and uncertainties that are reasonably likely to have a material affect an entity’s future performance. – In addition, the SEC requires entities to provide disclosures about critical accounting estimates to provide “greater insight into the quality and variability of information regarding financial condition and operating performance.” – The SEC could revise its MD&A provision to more clearly require disclosures about loss contingencies that are designed to enhance an understanding of the loss contingencies without requiring disclosures that would adversely affect an entity’s ability to seek to limit its loss from such contingencies. SEGMENT 3: Thomas White, Partner, Wilmerhale - Scope of the proposal - General standard - What contingencies must be disclosed? - What information about contingencies must be disclosed? - Exemption where disclosure of information may be prejudicial SEGMENT 4: Michael L. Hermsen, Partner, Mayer Brown International LLP - Comments received by the FASB - Arguments in favor of the proposal - Arguments in favor of the proposal with some modifications - Arguments against the proposal