Remarks before the 2016 AICPA Conference on Current SEC and PCAOB Developments
Jonathan Wiggins, Associate Chief Accountant, Office of the Chief Accountant
Dec. 5, 2016
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, individual Commissioners, or of the author’s colleagues upon the staff of the Commission.
Good morning. I would like to share some observations with you this morning related to the accounting for joint ventures and other strategic alliances. I will then share an observation regarding the definition of a public business entity and its effect on certain equity method investees of SEC registrants, and will end on an observation regarding measurement period adjustments in business combinations.
Joint Ventures, Strategic Alliances, and Other Collaborative-type Arrangements
The first topic I would like to address is the growing prevalence and increasing complexity of various types of strategic alliances. A recent global survey of over 1,400 CEOs indicated that 49% of those CEOs plan to enter into a new strategic alliance or joint venture in the following 12 months. These highly structured arrangements can raise issues across various accounting topics, including consolidation, gain recognition, revenue recognition, derivatives, and leases. Whether an arrangement is a joint venture, partnership, long-term contract, or other type of structure, you should carefully evaluate the characteristics of the arrangement because they can have a significant impact on accounting conclusions.
For arrangements in which activities are conducted partially or entirely within a legal entity, you must first determine whether you should consolidate the entity. Under both the voting interest and variable interest consolidation models, I believe you should carefully consider whether your conclusion regarding decision-making authority is consistent with the substance of the underlying arrangements and the objective of the consolidation guidance. Among other consolidation issues, OCA has consulted with registrants on conclusions related to decision-making authority, including the determination of which activities most significantly impact the economic performance of a variable interest entity.
For those arrangements where the entity is not consolidated or those arrangements that are outside of a legal entity, you should carefully identify the applicable accounting guidance. For example, the determination of whether an arrangement meets the definition of a joint venture can have significant accounting consequences. For those arrangements that do not meet the definition of a joint venture, you should consider whether the guidance on collaborative arrangements is applicable. In addition, certain arrangements may include a contract with a customer within the scope of the FASB’s new revenue guidance. In this regard, it is important to distinguish between arrangements where the other party obtains the output of your ordinary activities, and arrangements where you participate in an activity with another party and share in the related risks and benefits (such as developing an asset in a collaboration arrangement).
The consolidation, revenue recognition, and other accounting conclusions for these strategic alliances should be based on the facts and circumstances of each arrangement, and I believe that registrants should dedicate sufficient time and resources to work through the related accounting and internal control over financial reporting considerations. These assessments often require a significant degree of judgment and OCA is available for consultation on these issues.
Equity Method Accounting and the Definition of “Public Business Entity”
Next, I would like to discuss an interaction between the accounting and reporting for equity method investments and the FASB’s definition of “public business entity.” The definition of public business entity includes, in part, business entities that file or furnish financial statements with the SEC (including other entities whose financial statements or financial information are included in a filing with the SEC). Under this definition, some entities that are not SEC registrants, such as a registrant’s equity method investees that are significant under Regulation S-X, are considered public business entities solely because their financial statements or financial information are included in the registrant’s SEC filing. In those cases, the entity is only a public business entity for purposes of the financial statements or financial information included in the SEC filing.
Whether an entity is a public business entity can have a significant impact on financial reporting, particularly since certain FASB guidance, including the new revenue, leases, and financial instruments standards, have different effective dates for public business entities. You should ensure that all entities that meet the definition of a public business entity adopt such guidance using the effective dates for public business entities for purposes of the financial statements or financial information included in a filing with the SEC.
OCA has received related questions regarding the accounting for equity method investees that do not otherwise meet the FASB’s definition of a public business entity. Specifically, some have questioned whether these investees’ financial statements must be prepared using the public business entity effective dates of new accounting standards for purposes of the registrant’s recognition of its share of the earnings or losses of the investee. I believe that amounts recognized by a registrant in applying the equity method of accounting would not be considered financial information included in a filing with the SEC under the FASB’s definition of public business entity. Therefore, I believe that the equity method investee would not be required to use the effective dates for public business entities solely for purposes of the registrant’s equity method accounting. However, for equity method investees that meet the definition of a public business entity, I would expect the registrant’s equity method accounting to be based on the investees’ financial statements prepared using the public business entity effective dates.
Measurement Period Adjustments in Business Combinations
My next topic relates to the accounting for a business combination. An acquirer in a business combination is required to report provisional amounts if the initial accounting for the business combination is incomplete by the end of the reporting period covering the business combination (for example, when the valuation of an intangible asset is incomplete). The acquirer must recognize adjustments to those provisional amounts to reflect new information obtained within the measurement period about facts and circumstances that existed as of the acquisition date. I would like to remind registrants that the measurement period is not one year, but rather ends as soon as the acquirer receives the information it was seeking about facts and circumstances that existed as of the acquisition date or learns that more information is not obtainable, and shall not exceed one year.
In 2015, the FASB issued guidance that eliminates the requirement to retrospectively reflect these measurement period adjustments, with such adjustments now recorded in the current reporting period and separately reported or disclosed. I think it is important to note that this guidance does not change the measurement period or apply when an adjustment represents the correction of an accounting error. While it has never been appropriate to include a correction of an error as part of a measurement period adjustment, prior to adoption of this new guidance both accounting errors and measurement period adjustments were retrospectively reflected. Under the new guidance, the timing of recognition differs, since only accounting errors, where material, require restatement of prior periods. Accordingly, I believe that registrants should ensure they have sufficient internal control over financial reporting to identify and account for measurement period adjustments appropriately and separately identify accounting errors. Finally, I’d like to remind registrants that if the initial accounting for a business combination is incomplete at the reporting date, the disclosures regarding provisionally recorded amounts are required.
Thank you for your kind attention.
 See “19th Annual Global CEO Survey: Redefining business success in a changing world” available at http://www.pwc.com/gx/en/ceo-survey/2016/landing-page/pwc-19th-annual-global-ceo-survey.pdf.
 See Accounting Standards Codification (“ASC”) 323-10-20, ASC 323-30-15-3, and ASC 845-10-S99-2.
 See ASC 808.
 ASC Topic 606, Revenue from Contracts with Customers.
 See ASC 606-10-15-3 and paragraph BC54 of the Background Information and Basis for Conclusions of Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606).
 See ASC Master Glossary, “Public Business Entity.”
 See ASC 606-10-65-1.
 See ASC 842-10-65-1.
 See ASC 825-10-65-2 and ASC 326-10-65-1. Per ASC 326-10-65-1, ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments has different effective dates for public business entities that meet the definition of a Securities and Exchange Commission (SEC) filer, public business entities that that do not meet the definition of an SEC filer, and all other entities.
 See ASC 805-10-25-13.
 See ASC 805-10-25-14.
 See ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments.
 See ASC 805-10-65-3.
 See ASC 805-20-50-4A.