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Speech by SEC Staff:
Remarks before the 2008 AICPA National Conference on Current SEC and PCAOB Developments


Adam Brown

Professional Accounting Fellow, Office of the Chief Accountant
U.S. Securities and Exchange Commission

Washington, D.C.
December 8, 2008

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 afternoon. Today, I will discuss a question related to the impairment of long-lived assets held for sale, and a measurement issue for liability-classified share-based payment awards. In addition, I’ll highlight one potential debt-equity sleeper that may have a significant impact for some registrants next year.

By way of background, I spent most of my first year at the Commission supporting the Advisory Committee on Improvements to Financial Reporting, or “CIFiR” for short. The Committee members I worked with most closely had the task of sorting out “substantive complexity” – what I call “the things that make US GAAP harder than it needs to be.” The mixed measurement attribute model is arguably the thorniest issue they addressed, particularly the role of fair value accounting. The Committee recognized the challenge of building a consensus on when fair value should be applied in GAAP. Some wanted more assets and liabilities carried at fair value through earnings, while others wanted less. In fact, that debate informs our study of the effects of mark-to-market accounting, which is due back to Congress next month. But moving beyond the pros and cons of fair value, CIFiR settled on a recommendation to improve the clarity of fair value’s impact in the financial statements for investors.1 The Committee agreed that additional transparency was in everyone’s interest.

That idea—seeking common ground through clarity and simplicity—has stayed with me. In OCA, we regularly receive interpretive questions on US GAAP that don’t lend themselves to easy answers. In the time that I have remaining, I’ll share how CIFiR’s influence has been helpful in working through two recent questions.

Impairment of long-lived assets under Statement 144

The first issue deals with the impairment or disposal of long-lived assets under Statement 144.2 Consider a fact pattern in which a disposal group held for sale was established that consisted of long-lived assets in the form of property & equipment, as well as other assets such as trade receivables, and inventory. An estimate of the group's fair value, less its costs to sell, was lower than the group's carrying value. Further, the difference between the disposal group’s fair value and its carrying value exceeded the existing net book value of long-lived assets. This might lead you to a question: "Should you recognize a liability for the loss in excess of the carrying amount of the long-lived assets, and, if so, what does it represent?"

I can think of two views for this particular fact pattern. One approach is to record the loss in excess of the carrying amount of the long-lived assets as a reduction to the carrying value of the entire group, effectively reducing trade receivables and inventory. A second approach is to limit the impairment to the carrying value of the long-lived assets in the disposal group.

The first view interprets paragraph 34 of Statement 144 to redefine the unit of account as the disposal group and to record it at the lower of its carrying amount or fair value less cost to sell. In effect, individual assets lose their identity, even though the recoverability of AR and inventory are addressed by other GAAP.

The second view looks at paragraph 37 of Statement 144, which indicates a "loss…shall adjust only the carrying amount of a long-lived asset, whether classified as held for sale individually or as part of a disposal group.” This approach would limit the loss to the carrying value of the long-lived assets. There seems to be an additional level of simplicity in the second view in that it does not result in the recognition of what, in effect, is a liability created by an asset impairment model. In addition, it appears more consistent with the change from Opinion 303 to Statement 144. That evolution eliminated prior guidance which stated that “if a loss is expected from [a] proposed sale, the estimated loss should be provided for at the measurement date.”4 We note other applicable GAAP, such as Statements 5,5 143,6 and 1467 (among others) provide guidance for recording liabilities. Finally, the simplicity of this view is that it also interprets Statement 144's scope to address the impairment or disposal of long-lived assets, and that it isn't intended to address the recognition of liabilities.

After considering these two views, we ultimately concluded that we would not object to either interpretation of the literature. If companies expect to incur a loss on sale in excess of the impairment associated with long-lived assets, it may be an indicator that other assets such as AR and inventory are impaired. In any event, we believe that registrants who use the first view should clearly disclose where such amounts are reflected in the financial statements and whether additional losses are expected in the future.

Measurment of liability-classified awards under Statement 123(R)

Moving on to a share-based payment topic: consider the measurement of an outstanding liability award under Statement 123(R)8 in the context of an IPO. Assume in this case that there are several subsidiaries owned by a parent company that’s going public. Further assume that concurrent with the IPO, ownership interests in one subsidiary that can be cash-settled are going to be exchanged for common stock of the parent. The exchange triggers a step-up in basis for tax purposes that increases the value of the subsidiary’s ownership interests. And as I alluded a moment ago, this fact pattern presumes the instruments were originally issued under a compensation arrangement as an award to a number of key employees.

Under 123(R), these awards are classified as liabilities due to their cash settlement features. As such, they are required to be remeasured to fair value each period until settlement.9

Similar to my first case, I can envision two potential approaches to this situation. The first approach would not incorporate the likelihood of completing the IPO or the related tax attributes in its remeasurement of the subsidiary’s liability awards each period. Based on an analogy to EITF 96-5,10 this view believes no change in the assumptions related to the tax attributes of the awards is required until the IPO is consummated. While we are aware of an existing practice to defer the recognition of performance awards that do not vest until a business combination occurs, we do not view the first approach similarly.

Under a second approach—and in contrast to the initial recognition of a contingent award—we believe the fair value measurement objective of an outstanding liability award should not exclude the effects of significant contingencies that affect its value. Rather, these contingencies should be incorporated in each period’s remeasurement. However, in this particular case, one might reasonably conclude that the uncertainty of the IPO in prior periods significantly impacts (reduces) the value of the tax attributes in the awards. But more importantly, and similar to CIFiR’s notion of clarity, we believe full consideration of the fair value measurement objective in Statement 123(R) is a more natural application of the compensation literature than an analogy to specific guidance for recognizing employee termination costs under EITF 96-5.

Contracts indexed to the company’s own stock

The last item I’ll touch on today is an area of GAAP that would likely take longer to clarify than CIFiR’s one-year term allowed: that is, debt and equity financing arrangements. Instead of sharing views, my aim in this section is to alert registrants that issue call options—whether embedded in other instruments or freestanding—to a potential sleeper issue in 2009. EITF 07-511 provides new guidance for determining whether equity-linked financial instruments are indexed to a company’s own stock, and as a result, whether those contracts should be marked-to-market each period. Issue 07-5 contains 20 examples illustrating its application. In particular, example 8 addresses an exercise price reset feature that’s common in many arrangements. It describes warrants that permit the holder to buy 100 shares of common stock for $10 per share, exercisable at any point for 10 years. However, the terms of the warrants specify that (a) if the company sells shares of its common stock for an amount less than $10 each, the strike price of the warrants is reduced to equal the issuance price of those shares, and (b) if the company issues an equity linked financial instrument with a strike price below $10, the strike price of the warrants is also reduced accordingly. Example 8 concludes that because of the reset feature, these warrants are not considered indexed to the company’s own stock. Therefore, the warrants should be adjusted to fair value each period through earnings. We understand this treatment differs from many companies’ past practice. As a result, I would encourage issuers of these instruments to review their contracts and consider whether prior conclusions about mark-to-market accounting should be updated in 2009 and future periods.

Thank you for you attention, and with that, I’ll turn the microphone over to the next speaker.




Modified: 12/08/2008