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March 2013 Essential Briefings FASB PROPOSES A NEW MODEL FOR CLASSIFICATION AND MEASUREMENT OF FINANCIAL INSTRUMENTS

FINANCIAL REPORTING ____________________________________________________________ Proposed Framework: Financial Reporting Framework for Small- and Medium-Sized Entities


Contents March 2013

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ESSENTIAL BRIEFINGS 2 FA SB P ROP O SE S A N E W MOD E L F OR C L A S S IF IC AT IO N A N D ME A SUR E ME N T OF F I N A N C I A L I N S T RUME N T S The FASB issued a revised proposal for the classification and measurement of financial instruments in February 2013. The FASB’s proposal outlines either fair value or amortized cost related to the measurement approach for financial assets and financial liabilities.

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FINANCIAL REPORTING 4 P ROP O SE D F R A ME WOR K : F I N A N C I A L R E P OR T I NG F R A ME WOR K F OR SM A L L- A N D ME D IUM - S I Z E D E N T I T IE S Recent concerns raised by stakeholders of privately-held companies regarding the complexity of financial reporting prompted the AICPA to issue the Proposed Financial Reporting Framework for Small- and Medium-Sized Entities (the “Framework”) in November 2012.

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ESSENTIAL BRIEFINGS

FASB PROPOSES A NEW MODEL FOR CLASSIFICATION AND MEASUREMENT OF FINANCIAL INSTRUMENTS BY HARMEET SINGH | PARTNER

hsingh@singerlewak.com | 408.294.3924

The FASB issued a revised proposal for the classification and measurement of financial instruments in February 2013. The FASB’s proposal outlines either fair value or amortized cost related to the measurement approach for financial assets and financial liabilities. In general, the proposal applies to financial instruments with certain exceptions and addresses both initial and subsequent classification and measurement. The following is a summary of the key provisions as outlined in the proposal. D E BT I N V E ST MENTS Debt investments, whether loans and debt securities, will be classified into one of three measurement categories: • Amortized cost • Fair value with changes in fair value recognized in other comprehensive income • Fair value with changes in fair value recognized in net income.

that give rise on specified dates to cash flows that represent solely payments of principal and interest.

The classification and measurement of a debt investment is determined at the acquisition date or origination, as follows:

The proposal applies to financial instruments with certain exceptions and addresses both initial and subsequent classification and measurement • Amortized cost – The debt investment is held in a business model with a primary objective of holding to collect contractual cash flows, and has terms

• Fair value through other comprehensive income – The debt investment is held in a business model with a primary objective of holding to collect contractual cash flows and to realize changes in fair value through sale, and has terms that give rise on specified dates to cash flows that represent solely payments of principal and interest. • Fair value through net income – The debt investment does not meet the eligibility criteria for either the amortized cost or the fair value through other comprehensive income approach. In addition, the FASB proposed that hybrid financial assets will not be bifurcated between embedded derivatives and the financial instrument host contract as is done today. Instead, the entire instrument will be evaluated and classified based on the above criteria.

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EQ UI T Y I N V E S TM ENTS Equity investments excluding investments accounted for in the equity method of accounting (unless these investments are held for sale) will be measured at fair value through net income. However, companies, not including broker-dealers and investment companies, can elect a practicability exception to measure equity investments without a readily determinable fair value at cost. The proposal simplifies the method for assessing impairment for equity investments that qualify for the practicability exception, as well as equity investments accounted for under the equity method. FIN A N C I A L L I AB I L I TI ES Financial liabilities will generally be measured at amortized cost, and the current embedded 3 | SingerLewak

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derivative bifurcation requirements for hybrid financial liabilities will be retained unless intent is to subsequently transact at fair value. Nonrecourse financial liabilities that must be settled with only the cash flows from specified financial assets will be measured

The proposal simplifies the method for assessing impairment for equity investments that qualify for the practicability exception, as well as equity investments accounted for under the equity method on the same basis as the financial assets. A fair value option is available in certain limited circum-

stances and if elected the company will recognize the change in fair value due to a change in the company’s own credit risk in other comprehensive income. PRE SE NTATION AND DISCLOSURE Public companies will present fair values parenthetically on the face of the balance sheet for financial assets and financial liabilities measured at amortized cost. Only demand deposit liabilities and receivables and payables that are due within one year are excluded from this requirement. Nonpublic companies will not be required to present or disclose fair value information for these instruments. HARMEET SINGH CAN BE REACHED AT HSINGH@SINGERLEWAK.COM OR 408.294.3924


FINANCIAL REPORTING

PROPOSED FRAMEWORK: FINANCIAL REPORTING FRAMEWORK FOR SMALLAND MEDIUM-SIZED ENTITIES BY JOSH CROSS | MANAGER

jcross@singerlewak.com | 408.294.3924

Recent concerns raised by stakeholders of privately-held companies regarding the complexity of financial reporting prompted the AICPA to issue the Proposed Financial Reporting Framework for Small- and Medium-Sized Entities (the “Framework�) in November 2012. This exposure draft was written because the traditional financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP) were not always the best solution for small- and mediumsized companies (SMEs). The recent push in fair value accounting under GAAP has proven to be less beneficial for SMEs than it is for publicly traded companies, especially given the increasing costs that are associated with compliance to the new standards. The Framework was developed by a working group of CPA professionals and AICPA staff who have years of experience serving SMEs and provides a blend of

1. Individuals that own a controlling interest in the company are the same individuals that run and operate the company on a daily basis

accrual income tax methods and traditional methods of accounting to create a more relevant, less complex and cost effective framework to be used. Accounting professionals who serve SMEs have heard the increasingly common question about the relevance of certain accounting treatment and footnote disclosure requirements under GAAP. Many companies have found that the most costly and time consuming accounting requirements are often the least relevant to management and to the users of the financial statements.

2. Internal and external users of the financial statements have direct access to the owner/ manager of the company 3. GAAP financials are not required W HAT IS A SME ? Currently there has been no standard definition developed by the AICPA or any other regulatory body to define SMEs. SMEs can be comprised of any size operations and operate in any type of industry group. The identification of a SME will be largely based on the corporate structure, operational management structure and by the users of the financial statements. It is estimated that there are approximately 20 million SMEs in the United States.

The Framework is geared towards closely-held companies where: March 2013

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K E Y D I F F E R E NCES B ETWEEN T HE F R A M E WORK AND GA AP The main difference between the Framework and GAAP is that the Framework is based mainly on historical cost and does not use fair value except for a few cases of assets which are held for sale. Other significant differences between the Framework and GAAP are as follows: • Income Taxes – allows the use of either an income tax payable or deferred income tax method and does not contain provisions around uncertain tax positions. • Variable Interest Entities – under the Framework variable interest entities would not be required to be consolidated. • Goodwill – goodwill would not require an annual assessment of impairment, rather it would be amortized. 5 | SingerLewak

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• Reversal of Losses – inventory write-downs, other-than-temporary-impairments of investments, and long-lived asset impairments would be allowed to be reversed in subsequent years if circumstance change. • Investments – there would be no provision for recognizing fair value changes through other comprehensive income. As accountants and trusted business advisors to our clients, we need to be aware that the Framework is not for everyone. Due to the key differences stated above, the Framework should not be used by companies that do not know the full user base of the financial statements or the potential impacts that omitting these items would have on those users. Also, companies that do have complex transactions with

significant impacts to the financial statements under GAAP would be discouraged from using the Framework. The implementation of the Framework will take a collaborative effort between management, the users of the financial statements, and the accountants to ensure it works effectively while also providing the company with the cost-benefit savings they are requesting. The comment period has been closed and the AICPA expects to issue the final exposure draft in late spring 2013.

JOSH CROSS CAN BE REACHED AT JCROSS@SINGERLEWAK.COM OR 408.294.3924


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CFO Essentials Newsletter - March 2013