United States: On The Horizon - July 2, 2013

Current reporting issue

Implementing certain disclosure requirements under ASU 2011-04

FASB Accounting Standards Update (ASU) 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, requires, in part, that public and nonpublic entities subject to its guidance disclose

  • A description of the valuation technique(s) and the inputs used in fair value measurements
  • An unobservable inputs table (quantitative) for measurements using Level 3 inputs
  • A description of valuation processes for measurements using Level 3 inputs
  • All transfers between levels of the fair value hierarchy must be separately reported and described (except disclosure of transfers between Level 1 and Level 2 are not required for nonpublic entities), with the description including the reasons for the transfers and the entity's policy for determining when those transfers occur
  • A narrative (qualitative) description of the fair value measurements' sensitivity to changes in unobservable inputs (public entities only) and a description of the interrelationships between those unobservable inputs, if any, for recurring fair value measurements.

Complying with the disclosure requirements of ASU 2011-04 may be challenging in situations where the reporting entity uses the so-called net asset value (NAV) practical expedient for measuring fair value and where the entity receives valuation information from outside service providers, such as valuation information received regarding insurance company products measured at fair value.

As indicated in the Basis for Conclusions section of ASU 2011-04, the quantitative disclosures about fair value of assets and liabilities subject to the NAV practical expedient would not be meaningful because the determination of the level in the hierarchy is made on the basis of the reporting entity's ability to redeem its investments, rather than on the basis of whether the inputs used in the measurement are observable or unobservable. As such, the requirement to disclose the significant unobservable inputs for Level 3 measurements and the sensitivity of such measurements to changes in unobservable inputs is not required for assets and liabilities subject to the practical expedient. However, the reporting entity is required to describe its valuation processes even if the quantitative unobservable input disclosures are not required.

ASU 2011-04 also indicates that a reporting entity is not required to create quantitative information to comply with the disclosure requirement if quantitative unobservable inputs are not developed by the reporting entity when measuring fair value (for example, when a reporting entity uses prices from prior transactions or third-party pricing information without adjustment). However, when providing these disclosures, a reporting entity cannot ignore quantitative unobservable inputs that are significant to the fair value measurement and are reasonably available to the reporting entity.

The valuation and reporting of investments in accordance with GAAP is the responsibility of the reporting entity's management. Management may use outside service providers to assist in the valuation of investments, and as such may not have full insight into the valuation methods and assumptions used by such providers. However, management should obtain sufficient information to evaluate the valuations they receive from service providers to meet their reporting responsibilities in accordance with GAAP and relevant internal control requirements.

For example, it is not uncommon for employee benefit plans to invest in insurance company general account products for which the issuing insurance company provides pricing information asserting that the fair value of certain of these products approximates their contract value, with limited transparency to the information needed to support that assertion. Although the valuation of plan investments and related GAAP disclosures is the benefit plan management's responsibility, it often relies on the insurance company to assist in the process. Understanding the nature of these investment arrangements and how their associated fair values are determined can be challenging. However, management is responsible for undertaking efforts to obtain quantitative information about Level 3 inputs before making an assertion that the quantitative inputs are not reasonably available and taking advantage of the third-party pricing exception described above. If management is unable to obtain the information underlying the valuation, the measurement of that investment at fair value, and not just the particular disclosure, may be called into question.


Proposal would require management to assess going concern

The FASB recently released a proposed ASU, Disclosure of Uncertainties about an Entity's Going Concern Presumption, to address concerns over diversity in financial statement disclosures regarding an organization's ability to continue as a going concern.

Currently U.S. auditing standards and federal securities law require an auditor to evaluate whether there is substantial doubt about an organization's ability to continue as a going concern for a reasonable period of time. However, there is no guidance in U.S. GAAP on management's responsibilities for evaluating going concern uncertainties or on when or how to disclose those uncertainties in the financial statements.

Under the proposed guidance, management would be required to assume the following responsibilities:

  • Evaluate going concern uncertainties and assess the likelihood that the entity would be unable to meet its obligations as they become due within 24 months of the financial statement date
  • Perform the assessment at each interim and annual reporting period
  • Provide disclosures when management determines that without taking actions "outside the ordinary course of business," it is either (1) more likely than not that the entity will be unable to meet its obligations within 12 months of the financial statement date or (2) known or probable that the entity will be unable to meet its obligations within 24 months after the financial statement date. Actions considered to be "outside the ordinary course of business" would be defined as those of a nature, magnitude, or frequency that are inconsistent with actions customary in carrying out an entity's ongoing business activities.

Under the proposed guidance, when determining whether disclosures about going concern uncertainties are necessary, an entity would assess conditions and events, including mitigating conditions and events, that exist at the date the financial statements are issued (or are available to be issued for a nonpublic company). However, when determining whether disclosures are necessary, an entity would not consider the potential mitigating effects of management's plans that are outside the ordinary course of business.

In addition, an SEC filer would be required to evaluate whether there is "substantial doubt" about its going concern presumption. "Substantial doubt" would exist if, after assessing existing conditions and events and considering all of management's plans, including those outside the ordinary course of business, the entity concludes that it is known or probable that it will be unable to meet its obligations within 24 months after the financial statement date.

The proposed guidance was tailored from existing U.S. auditing standards and would be applied prospectively.

The comment period on the proposed ASU ends on September 24.

For more information, refer to FASB In Focus, "Proposed Accounting Standards Update Presentation of Financial Statements (Topic 205): Disclosure of Uncertainties about an Entity's Going Concern Presumption."

Board proposes guidance to improve accounting for insurance contracts

The FASB also recently released the proposed ASU, Insurance Contracts, to enhance the comparability of accounting and reporting among insurance entities and other entities that issue insurance and reinsurance contracts, and to improve the decision-usefulness of information about an entity's insurance liabilities. Although the proposed guidance is the result of a joint project with the IASB to develop converged guidance on accounting for insurance contracts, there are differences between the two Boards' proposals.

Existing U.S. GAAP on accounting for insurance contracts applies only to insurance entities, resulting in inconsistent accounting for similar contracts issued by insurance entities and by other entities. The proposed guidance would apply to all entities that issue insurance contracts, as defined, regardless of whether the issuer is an insurance entity. For example, guarantors, service providers, and other entities that issue product warranties, financial guarantees, performance bonds, or other contracts qualifying as insurance contracts would be required to apply the proposed guidance.

The proposed guidance would define an "insurance contract" as an arrangement where the issuer accepts significant insurance risk from another party by agreeing to compensate the other party if it is adversely affected by an insured event. Insurance risk consists of uncertainties about the amount of net cash flows from premiums, commissions, claims, and claim-settlement expenses paid under a contract.

The proposal would replace multiple product-specific accounting models that currently exist under U.S. GAAP with two new models: the premium allocation approach and the building block approach.

An entity would apply the premium allocation approach to an insurance contract if it has a coverage period less than or equal to one year or if significant variability in the expected value of the net cash flows required to fulfill the contract is unlikely during the period before a claim is incurred. This approach would apply to most property, liability, and short-term health insurance contracts, as well as to certain fixed-fee service contracts and guarantee contracts. Under this approach, an entity would initially measure its liability as the contractual premiums within the boundary of the insurance contract. Subsequently, an entity would reduce its liability, and recognize revenue, based on the expected timing of incurred claims. An entity would also recognize a liability for claims as they are incurred based on the expected future cash flows to settle the claims and related expenses.

The building block approach would apply to all insurance contracts not covered by the premium allocation approach, including most life insurance, annuity, and long-term health insurance contracts, as well as some investment contracts. An entity's initial measurement of an insurance contract subject to the building block approach would consist of two components:

  1. The present value of the unbiased, probability-weighted mean of expected future cash flows
  2. A margin representing profit at risk.

Subsequently, an entity would remeasure the first component based on updated expected cash flows, with changes reflected in net income or other comprehensive income, depending on whether the change is due to variations in the discount rate and whether a contract is linked to underlying assets. The second component would subsequently be recognized as income as the uncertainty of the expected cash flows decreases.

The comment period on the proposed ASU ends on October 25.

For more information, refer to two separate issues of FASB In Focus titled "Proposed Accounting Standards Update – Insurance Contracts (Topic 834)" and "Proposed Accounting Standards Update – Insurance Contracts (Topic 834): It's Not Just for Insurance Companies! Banks, Guarantors, Service Providers and Others—Take Note." In addition, a videocast explaining the proposed ASU is available on the FASB website.

FASB ratifies EITF decisions

All decisions reached at Board meetings are tentative and may be changed at future meetings. Decisions are included in an Exposure Draft only after a formal written ballot. Decisions reflected in Exposure Drafts are often changed in redeliberations by the Board based on information received in comment letters, at public roundtable discussions, and from other sources. Board decisions become final after a formal written ballot to issue a final Accounting Standards Update.

At its June 26 meeting, the Board ratified the following final consensuses reached by the EITF on June 11:

  • Issue 13-A, "Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes"
  • Issue 13-C, "Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists".

In addition, the Board ratified the following EITF consensuses-for-exposure also reached on June 11:

  • Issue 12-G, "Accounting for the Difference between the Fair Value of the Assets and the Fair Value of the Liabilities of a Consolidated Collateralized Financing Entity"
  • Issue 12-H, "Accounting for Service Concession Arrangements"
  • Issue 13-E, "Reclassification of Collateralized Mortgage Loans upon a Troubled Debt Restructuring".

For more information on these issues, refer to the June 25 edition of the EITF Update.

AICPA updates construction contractors guide.

The AICPA has updated the Audit and Accounting Guide, Construction Contractors, to provide guidance on accounting and auditing issues in the construction industry.

GASB releases implementation guidance for pension plans

The GASB recently published an Implementation Guide, Implementation Guide, "Guide to Implementation of GASB Statement 67 on Financial Reporting for Pension Plans," as an authoritative resource for preparers and auditors of financial reports for state and local government pension plans.

The guide is written in a question and answer format with illustrative examples that will assist preparers implementing GASB Statement 67, Financial Reporting for Pension Plans, which is effective for periods beginning after June 15, 2013.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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