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Third Quarter Accounting and Financial Reporting Update

October 27, 2015

While we continue to await final standards for financial instruments and leasing as well as clarifications to revenue recognition, the third quarter marked another period of relatively narrow changes from the Financial Accounting Standards Board (FASB). The majority of the sixteen Accounting Standards Updates (ASUs) that have been finalized during 2015 relate to narrow scope projects identified by the FASB. ASUs issued in the third quarter include narrow scope changes to inventory, derivative instruments, business combinations and more widely applicable changes to benefit plan presentations and disclosures.

The deferral of the effective date for the implementation of Accounting Standards Codification (ASC) Topic 606 was also finalized. Activity at the Public Company Accounting Oversight Board (PCAOB) consisted of approval of the reorganization of PCAOB Auditing Standards and certain requests for comment and discussion papers.

The following provides a brief overview of these accounting developments during the third quarter. 

Financial Accounting Standards Board

Inventory Changes

FASB ASU 2015-11, Inventory (Topic 330), Simplifying the Measurement of Inventory establishes a streamlined approach for how companies measure inventory. Upon implementation (effective date for years beginning after December 15, 2016 with early adoption permitted), companies will be required to record inventory at the lower of cost or net realizable value. This change replaces current U.S. generally accepted accounting principles (GAAP), which requires entities to measure inventory at the lower of cost or market. The change to inventory measurement does not apply to companies that have adopted a last-in, first-out (LIFO) accounting policy or companies that use the retail method. See Modifications Coming to Inventory Measurement for more information.

Employee Benefit Plans

FASB ASU 2015, Plan Accounting: Defined Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), Health and Welfare Benefit Plans (Topic 965): (Part I) Fully Benefit-Responsive Investment Contracts, (Part II) Plan Investment Disclosures, (Part III) Measurement Date Practical Expedient (EITF Issue 15-C) includes several changes to the presentation and disclosure requirements for employee benefit plans. The ASU eliminates the requirement to record fully benefit-responsive investment contracts at fair value, reduces plan investment disclosures and creates a measurement date practical expedient for reporting periods that do not end on the last day of a calendar month. The ASU is effective for years beginning after December 15, 2015, however, early adoption is permitted. Fully benefit responsive investment contracts will be recorded at contract value rather than fair value, therefore, the fair value disclosure requirements will no longer apply to these instruments. An important adoption point is to distinguish between direct investments in fully benefit responsive contracts and indirect investments, such as through a stable value fund. The contract value reporting provisions are only applicable to direct investments in such contracts. See FASB's New Employee Benefit Plans Reporting Simplification Rules for more information.

Derivative Financial Instruments

The Emerging Issues Task Force finalized its project deliberations on electricity contracts in nodal energy markets, resulting in the issuance of ASU 2015-13, Derivatives and Hedging (Topic 815): Application of the Normal Purchases and Normal Sales Scope Exception to Certain Electricity Contracts within Nodal Energy Markets. The ASU clarifies that electricity contracts for nodal energy markets can qualify for the normal purchases and normal sales scope exception to Topic 815. The normal purchases and normal sales scope exception states that qualifying contracts do not violate the physical settlement criteria and therefore, are eligible for application of the normal purchase and normal sale scope exception, assuming all other criteria are also met. This clarification is intended to eliminate diversity in practice for such contracts. As a reminder, companies must elect to apply the scope exception to qualifying contracts. See Changes to the Accounting for Derivatives and Other Updates at the EITF for additional discussion. The provisions of the ASU are effective immediately and must be applied prospectively.

Business Combinations

The FASB addressed concerns regarding the retrospective application of adjustments related to provisional amounts originally recorded in the application of the accounting for business combinations in ASU 2015-16, Business Combinations (Topic 815): Simplifying the Accounting for Measurement Period Adjustments. The amendments require the acquirer in a business combination to recognize adjustments to provision amounts that are identified during the measurement period in the reporting period in which the adjustment amount is determined. The acquirer should also recognize the effect of earnings, if any, that occur because of the change to the provisional amounts. This effect should be calculated as if the accounting had been completed at the acquisition date. The ASU is effective for periods beginning after December 15, 2015, for public entities and for years beginning after December 15, 2016, for all other companies.

Revenue Recognition

During the third quarter, the FASB officially deferred the effective date of ASU 2014-09, Revenue from Contracts with Customers (Topic 606) by one year. The FASB also released exposure drafts to address narrow scope improvements and principal versus agent considerations that had been identified by the Transition Resource Group. The latter clarifies that the principal versus agent consideration occurs below the contract level; that is, each specified good or service must be evaluated to determine whether the reporting entity is acting as a principal or agent. The narrow scope improvements clarify collectability and add a criterion to the alternative recognition model for situations in which collectability is not probable.

Coming Soon

Derivatives and Hedging

The FASB has continued to deliberate its project on hedging and derivative instruments. Recent final decisions have included: some additional time to prepare hedge documentation, an elimination of the requirement to perform a quarterly effectiveness test, which is only required if facts and circumstances change, and the elimination of the requirement to quantify ineffectiveness (changes in fair value of the hedging derivative would no longer be required to be split between effective and ineffective portions). Besides the effectiveness threshold, the FASB has also reached decisions related to component hedging, disclosures, hedge documentation, de-designation, benchmark interest rates and use of the short cut method. Further updates are expected in the fourth quarter.

Materiality

The FASB released an exposure draft related to assessing the materiality of financial statement disclosures (Notes to Financial Statements (Topic 235) - Assessing Whether Disclosures are Material). The materiality evaluation presents challenges because it is widely considered a local concept, not one defined by the FASB, and it often appears in an auditing context-performance materiality, material weakness, etc. In a recent proposed accounting standard update, the FASB clarifies that materiality is applied quantitatively and qualitatively to individual disclosures or in aggregate to the financial statement as a whole. An omission of an immaterial disclosure should not be considered an accounting error. Comments on the proposed accounting standards update are due by December 8, 2015.

Public Companies and Issuers

In August 2015, the Securities and Exchange Commission (SEC) finalized a requirement that entities must disclose the ratio of the CEO's total compensation to the median compensation for all employees of the company. The rule takes effect for the 2017 calendar year. Other compensation policies are also being considered, including a clawback rule that would require companies to recover erroneously distributed incentive-based benefits paid to executives and a pay vs. performance requirement that would require companies to disclose the relationship between company performance and executive compensation. See Final and Proposed SEC Rules Target Executive Compensation for more information.

Additionally, the SEC is weighing revisions to the audit committee disclosures to give investors a better understanding of the audit committee's activities and evaluate its performance. The SEC is also exploring the use of audit quality measures to evaluate audit professionals, the audit process and the audit results.

For specific comments, questions or concerns about how these final and proposed standards changes affect your company, please contact Mike Loritz or Mark Winiarski of MHM's Professional Standards Group. Mike can be reached at mloritz@cbiz.com or 816.945.5611. Mark can be reached at mwiniarski@cbiz.com or 816.945.5614.

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