Remarks before the 2014 AICPA Conference on Current SEC and PCAOB Developments
Carlton E. Tartar
Associate Chief Accountant, Office of the Chief Accountant
Dec. 8, 2014
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues upon the staff of the Commission.
Good morning everyone. Today I would like to discuss three topics, beginning with some observations on spinoff accounting. Then I will discuss changes in goodwill impairment testing dates and the presentation of expenses that are contingent upon a business combination when pushdown financial statements are presented.
Over the past few years, the staff has received a number of questions relating to the application of the guidance on spinoff accounting in Subtopic 505-60, and such transactions appear to be increasing based on published reports. Typically these questions involve the determination of whether a proposed transaction should be accounted for as a forward spin or a reverse spin, and in many cases there are also questions regarding the appropriate financial statement presentation. Some of you may remember a staff speech at the 2000 AICPA conference, which indicated that the staff believed that tax-planning consequences would be an indicator that reverse spin treatment may be appropriate. However, consistent with our earlier remarks on the utility of speeches, when a speech is followed by an action of the standard setter, the concepts of the speech may no longer be as relevant, and this is a good example of that situation. While tax-planning considerations are discussed in the background of Subtopic 505-60, they are not one of the explicit indicators on which the assessment of the accounting spinnor should necessarily be made. Those indicators are: the relative size of the entities, the relative fair value of the entities, which entity will retain the majority of the senior management of the current reporting entity, and the length of time each entity will be held after the spinoff. When evaluating those criteria, keep in mind that the guidance contains a rebuttable presumption that a spinoff should be accounted for based on its legal form. Accordingly, when those indicators are mixed, significant judgment will be required to determine whether the presumption has been overcome and the substance of the transaction is a reverse spin. Another observation that the staff has noted is that when the spinoff is determined to be a reverse spin under Subtopic 505-60, some registrants have assumed that this conclusion dictates the financial statements that are presented in a registration statement that is filed to effect the spinoff. Specifically, some registrants have concluded that when a transaction is accounted for as a reverse spin, the financial statements of the existing registrant (i.e. – the legal spinnor) can be used to satisfy the financial statement requirements of the entity that will be spun off (i.e. – the accounting spinnor/legal spinnee). On this point, our colleagues in the Division of Corporation Finance view this as an assessment that is based on the unique facts and circumstances of each transaction, and there may be situations in which carveout financial statements are required for the accounting spinnor/legal spinnee in a registration statement relating to a reverse spin. Overall, the separation of an existing registrant into two or more registrants in a spinoff transaction may present a number of reporting questions, both with respect to the registration statement as well as the subsequent Exchange Act reports for each continuing entity. Given the significant judgments involved in determining the accounting spinnor as well as the appropriate financial statement presentation, the staff encourages registrants to continue to consult on their accounting and reporting conclusions relating to spinoffs, particularly when the transaction is expected to be accounted for as a reverse spin.
Goodwill impairment testing date
Next I’d like to discuss when a registrant elects to change the date for its annual goodwill impairment test. SFAS 142, Goodwill and Other Intangible Assets, now codified in Topic 350, became effective for fiscal years beginning after December 31, 2001, and required registrants to select a date on which their annual goodwill impairment test would be performed. Shortly thereafter, the staff began to receive questions regarding whether a change in the annual goodwill impairment testing date would be viewed as a change in accounting principle, and if so, whether a preferability letter would be required. Through a staff speech at the 2002 AICPA conference and related discussions at several SEC Regulations Committee meetings the following year, the staff expressed its views that a change in goodwill impairment testing date would be viewed as a change in accounting principle, and a preferability letter should be provided, unless goodwill was not material to the reporting entity.
The staff notes that when SFAS 142 became effective, the use of fair value measurement in US GAAP was relatively new, with SFAS 141R and SFAS 142 representing a significant expansion of fair value measurement to financial statement line items other than financial instruments and derivatives. The staff notes that since these standards were originally issued, registrants, auditors and regulators have developed more experience in applying fair value based measurement to business combinations in particular as well as the financial statements as a whole.
The staff observes that goodwill is required to be tested at the same date each year in Topic 350, while indefinite lived intangible assets do not have a similar requirement. This difference was the rationale for the staff historically requesting a preferability letter for a change in goodwill impairment testing date, since a change in testing date was viewed to be a change in the method of applying an accounting principle. As the FASB has requested input regarding potential areas where US GAAP can be simplified, this may be an area where stakeholders may want to comment. Absent any changes to US GAAP, the staff has observed that some registrants may view a change in goodwill impairment testing date to not represent a material change to a method of applying an accounting principle, even if goodwill is material to the financial statements, because the change in impairment testing date is not viewed to have a material effect on the financial statements in light of the registrant’s internal controls and requirements under Topic 350 to assess goodwill impairment upon certain triggering events. The staff acknowledges that judgment is required when assessing materiality and the assessment of whether a change in accounting principle is material may include considerations beyond the quantitative significance of the financial statement line items. Accordingly, if a registrant determines that a change in goodwill impairment testing date does not represent a material change to its method of applying an accounting principle, the staff will no longer request a preferability letter to be obtained and filed, provided that such change is prominently disclosed in the registrant’s financial statements. The staff also reserves the right to ask questions based on the registrant’s specific facts and circumstances, which may include situations where it appears that a registrant’s goodwill impairment testing date is frequently changed.
Blackline expense presentation
Finally I’d like to discuss an issue that relates to presentation of certain expenses when pushdown financial statements are presented. On November 18, 2014, ASU 2014-17 was issued, which allows entities the option to apply pushdown accounting in their standalone financial statements for their most recent change-in-control event. On the same date, Staff Accounting Bulletin (SAB) No. 115 was issued, which rescinded staff guidance for pushdown accounting which was formerly contained in SAB Topic 5.J.
The staff has received a number of questions regarding the appropriate presentation of expenses that are incurred contingent upon a business combination, when financial statements reflecting the application of pushdown are presented. The staff understands that such presentation typically includes predecessor and successor income statement periods, with a “blackline” separating the periods to visually illustrate the change in basis resulting from the change-in-control event. The staff encourages registrants to evaluate whether it is appropriate to record expenses that are related to the business combination in either the predecessor or successor periods as appropriate, based on the specific facts and circumstances underlying each individual transaction.
The staff has also become aware that certain expenses that are incurred contingent upon a change-in-control event are in some cases reflected in neither the predecessor or successor income statement periods, but instead are presented “on the line”. When registrants have demonstrated that certain expenses were contingent upon the change-in-control event, the staff has not objected to such presentation, provided that transparent and disaggregated disclosure of the nature and amount of such expenses was made. If such presentation is elected, registrants should ensure that all disclosed amounts were fully contingent on the consummation of the change-in-control event.
To summarize, when pushdown financial statements are presented, registrants should determine whether each expense relating to the change-in-control event is most appropriately reflected in the predecessor period, successor period or “on the line”, and disclose the amounts recorded in each period and the basis for determining the amounts included in each category.
Thank you and that concludes my prepared remarks.