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Tax Reform – Get the Details and Begin Dealing with the Changes!

01/08/2018Hot TopicTrendingadmin

By: George M. Wilson, SEC Institute

The new Tax Cuts and Jobs Act creates massive changes in taxation with deep, complex accounting and reporting ramifications. PLI is offering two programs to help you begin dealing with these changes.

First, on January 22, 2018 we will offer “The Tax Cuts and Jobs Act of 2017: Navigating the New Landscape”. This half-day program will be offered live in our New York training center and also via webcast.

For this program PLI has invited representatives from the Internal Revenue Service, the Department of the Treasury, the Senate Finance Committee and the House Ways and Means Committee to join our panel of tax experts and share their thoughts on the international and domestic implications of the tax reform package.

Topics discussed will include:

Transitions tax on deferred foreign income
New inclusion and deduction rules for “GILTI”
New deduction for foreign-derived intangible income (“FDII”)
New limitation on the deductibility of business interest
New deduction for individuals owning qualified businesses, REITs and MLPs
Other changes to the U.S. taxation of business income

As a follow-on to this program we will also offer a one-hour briefing on February 26, 2018 – “Tax Reform – Getting the Accounting and Disclosure Right!”

This One-Hour Briefing will help you effectively deal with the accounting and SEC reporting implications of the new Tax Act. Our panel will review the detailed requirements of the FASB’s Accounting Standards Codification to determine the timing and process for recording the effect of the new Act as well as the related new SEC guidance about recording provisional amounts with appropriate disclosures. They will also discuss in-depth the SEC reporting issues involved in making complex judgments about appropriate disclosures in Forms 10-K and 10-Q for all aspects of the Act.

Jay Hanson, former PCAOB Board Member and George M. Wilson, a Director at SEC Institute, will address topics including:

SEC reporting and other disclosure considerations, including MD&A, risk factors and business-related disclosures
The “enactment date” provisions of Accounting Standards Codification 740
The provisions of Staff Accounting Bulletin No. 118 and the related new C&DI’s
How the new law affects deferred tax assets and liabilities at the date of enactment
How the new tax law affects income in the year of enactment
Other possible financial statement impacts of the Act

As always, your thoughts and comments are welcome!

SEC Help with Tax Act Accounting

01/05/2018Hot TopicTrendingadmin

By: George M. Wilson, SEC Institute

One of the major challenges in 2017 year-end accounting arose late last year when President Trump signed the new Tax Act. In this post, we began outlining some of the accounting challenges created by this new Act.

To help us all along this path, on December 22, 2017, the SEC staff issued guidance after previewing it at various public forums and conferences. The guidance has two pieces:

Staff Accounting Bulletin (SAB) No. 118

Compliance and Disclosure Interpretation 110.02 – Item 2.06 of Form 8-K

SAB 118 discusses the staff’s views about applying the provisions of U.S. GAAP in initial accounting for the income tax effects of the Act. If a company’s accounting for the Act is not complete when issuing financial statements, the SAB provides for the use of “provisional amounts” with an appropriate “limited” measurement period to complete the accounting. Supplemental disclosures would also be required.

The new C&DI provides the following guidance clarifying that an adjustment to deferred tax assets as a result of the Act does not require an Item 2.06 Impairment Form 8-K. The C&DI does have some incremental guidance if companies use the measurement period approach in SAB 118.

Question 110.02

Question: Does the re-measurement of a deferred tax asset (“DTA”) to incorporate the effects of newly enacted tax rates or other provisions of the Tax Cuts and Jobs Act (“Act”) trigger an obligation to file under Item 2.06 of Form 8-K?

Answer: No, the re-measurement of a DTA to reflect the impact of a change in tax rate or tax laws is not an impairment under ASC Topic 740. However, the enactment of new tax rates or tax laws could have implications for a registrant’s financial statements, including whether it is more likely than not that the DTA will be realized. As discussed in Staff Accounting Bulletin No. 118 (Dec. 22, 2017), a registrant that has not yet completed its accounting for certain income tax effects of the Act by the time the registrant issues its financial statements for the period that includes December 22, 2017 (the date of the Act’s enactment) may apply a “measurement period” approach to complying with ASC Topic 740. Registrants employing the “measurement period” approach as contemplated by SAB 118 that conclude that an impairment has occurred due to changes resulting from the enactment of the Act may rely on the Instruction to Item 2.06 and disclose the impairment, or a provisional amount with respect to that possible impairment, in its next periodic report. [December 22, 2017]

To learn more about the accounting and SEC reporting implications of the new Tax Act, join us on January 26 as we present a One-Hour Briefing titled, “Tax Reform – Getting the Accounting and Disclosure Right!”

As always, your thoughts and comments are welcome!

Another RevRec Trailblazer Provides Insights for Us All

01/02/2018New Revenue Recognition StandardTrendingadmin

By: George M. Wilson, SEC Institute

As we posted back in May, several companies have early adopted the new revenue recognition accounting of ASC 606, blazing a trail for those in this process. And, as part of the learning curve, as we reviewed in this October post and this November post, some of these companies have received comments from the SEC.

In mid-August, General Dynamics (one of the early adopters) received a comment letter with several interesting revenue recognition comments. As you read the comments below, notice how often the issues raised by the Staff focuses on disclosures and how the company has made judgments:

Note B. Revenue, page 10 General

Please tell us and disclose, if material, how the adoption of ASC Topic 606 has impacted your accounting for costs to obtain or fulfill a contract, including commissions, bidding cost, and/or pre-production costs. We refer you to the disclosure requirements of ASC 340-40-50-1 through 50-5.

Performance Obligations, page 10

We note some of your contracts have multiple performance obligations. Please tell us and revise to disclose the nature of these performance obligations pursuant to ASC 606- 10-50-12(c). For maintenance, support, and warranty services, please provide us with your analysis as to why these services were not separately identifiable in accordance with the guidance of ASC 606-10-25-21, as applicable.
Given that the majority of your revenue is generated from long-term contracts, please provide us with your analysis on if they contain a significant financing component. If a material portion of your contracts contain a significant financing component, please revise to disclose this information pursuant to ASC 606-10-50-12(b). If you relied upon the practical expedient based pursuant to ASC 606-10-32-18, disclose this pursuant to ASC 606-10-50-22 and confirm the timing between progress payments and transfer of control and payment was not expected to exceed one year.
You disclose you recognize revenue over time using an input measure (e.g., costs incurred to date relative to total estimated costs at completion). Revise to disclose why this method is a faithful depiction of the transfer of goods or services pursuant to ASC 606-10-50-18(b).
We note that you recognize revenue at a point in time for the manufacture of business-jet aircraft in your Aerospace group, which is generally when the customer accepts the fully outfitted aircraft. Please tell us, and revise to disclose, what significant judgments were evaluated in determining that this was the appropriate point to recognize revenue. Refer to ASC 606-10-25-30 and 606-10-50-19. In addition, please provide us with your analysis regarding whether revenue for your business-jet aircraft should be recognized over time in accordance with ASC 606-10-25-27 through 29. In this regard, please specifically address your consideration of customer deposits and customer specific specifications.

Contract Estimates, page 11

With a view towards future disclosures, please help us better understand the general nature of your contract modifications and whether modifications typically add distinct goods or services. Reference is made to ASC 605-10-25-10 through 13 and ASC 606-10- 50-12(c).

Interestingly, in this new revenue recognition world, none of these comments required revision of a prior filing. Each was resolved with a discussion of the judgments involved and several resulted in a commitment by General Dynamics to provide more disclosure in future filings.

These comments are very consistent with those received by other early adopters. They provide us all with a message to thoughtfully and carefully make and document our judgments in applying the new standard, and then make appropriate disclosures! You may have read our post about how much the new standard affected General Dynamics’ disclosures, perhaps thinking the new disclosures were almost too much. In this new principles-based world, we may need to disclose more than we thought we would!

If you hear of any other early adopters and related news, please feel free to share it in a response to our post. As we say in our workshops, we all learn together!

As always, your thoughts and comments are welcome!

Regulation S-X 3.13 – You Can Ask for a Break!

12/19/2017SEC Hot TopicTrendingadmin

By: George M. Wilson, SEC Institute

Many of us have likely been in the position of reviewing an SEC disclosure requirement and thinking that the exact form of the requirement may not fit our particular circumstances. Sometimes we may believe such situations could create incremental work and cost while not providing particularly meaningful information to investors.

Is there any way to seek a discussion and discover a potentially better way to provide useful information to investors? It turns out, yes!

At the SEC’s conference in Washington, D.C. in early December, both Chair Jay Clayton and CorpFin Director William Hinman emphasized that the SEC is encouraging companies to consider using an historically little mentioned rule to avoid potentially complex costly disclosures that don’t provide material information to investors.

Regulation S-X Rule 3.13

210.3-13 Filing of other financial statements in certain cases.

The Commission may, upon the informal written request of the registrant, and where consistent with the protection of investors, permit the omission of one or more of the financial statements herein required or the filing in substitution therefor of appropriate statements of comparable character. The Commission may also by informal written notice require the filing of other financial statements in addition to, or in substitution for, the statements herein required in any case where such statements are necessary or appropriate for an adequate presentation of the financial condition of any person whose financial statements are required, or whose statements are otherwise necessary for the protection of investors.

Such requests will certainly require judgment, and both Chair Clayton and CorpFin Director Hinman emphasized that requests will be granted only when they are consistent with the goals of investor protection. That said, if an alternative to a formal rule will provide the information investors need Rule 3.13 can help avoid delay and unnecessary costs.

Director Hinman and CorpFin Chief Accountant Mark Kronforst (who you have likely heard will be leaving the SEC soon) discussed these process related issues:

First, all fact patterns are different, and it is important to not make any assumptions about how the process will work.

If you have a simple question you could begin by using the contact information in the CorpFin Financial Reporting Manual to get an initial plan in place.

The staff prefers that a formal request begin with email.

In your communication with the staff it is very important to explain all facts concisely and completely.

You should support you position with a clear explanation of why is it consistent with investor protection.

Early involvement of auditors also makes these requests proceed more smoothly.

The staff is working to respond promptly to each request and you should hear back in about 10 days unless the request is made during one of the periods when CorpFin is very busy.

Examples of areas where requests may arise include:

Significance tests – if one of the three parts of this test seems out of the norm then there may be other, more appropriate, considerations in making a determination whether separate financial statements are useful.

Pre-and post-acquisition periods for rule 3.05 – when appropriate it may be best to use an analysis that is less mechanical and focuses on trend issues that are meaningful and helps assess how the acquisition may impact on post-acquisition results.

Predecessor/Successor issues – relevance of stub periods may not be as relevant or reliable carve out F/S may not be possible to build. For example, it may be that abbreviated financial statement may provide the information that investors need.

IFRS financial statements may be acceptable for some acquisitions and equity method investees – if company could be a foreign private issuer the staff may accept IFRS financial statements.

Mechanical compliance with a rule sometimes is not the best way to provide investors with the information they need. It is a good thing to know that there are alternatives. So, when you think you are in this situation, go talk to the staff!

As always, your thoughts and comments are welcome!

Getting an Early Start on the Accounting Implications of Tax Reform

12/15/2017Hot TopicTrendingadmin

By: George M. Wilson, SEC Institute

Amidst all the activity and uncertainty about tax reform is the additional, potentially complex question: “How will this affect financial reporting?”

It is not too early to begin preparing to answer this question!

The starting point in this assessment is this part of ASC 740-10:

Changes in Laws or Rates

25-47 The effect of a change in tax laws or rates shall be recognized at the date of enactment.

25-48 The tax effect of a retroactive change in enacted tax rates on current and deferred tax assets and liabilities shall be determined at the date of enactment using temporary differences and currently taxable income existing as of the date of enactment.

For existing deferred tax assets and liabilities this change may have a significant impact because of this requirement in ASC 740-10-30-2:

30-2

The following basic requirements are applied to the measurement of current and deferred income taxes at the date of the financial statements:

The measurement of current and deferred tax liabilities and assets is based on provisions of the enacted tax law; the effects of future changes in tax laws or rates are not anticipated.

In other words, what this means is that at the date of enactment of the new tax law all deferred tax accounts will be remeasured to the new rates. The impact of this remeasurement will flow through current period tax expense. This impact on current period tax expense will even include remeasurment of deferred taxes related to items classified on OCI. As a result, it is likely that deferred tax assets will be reduced, resulting in higher tax expense, and deferred tax liabilities will also be reduced, resulting in lower tax expense.

Other areas that could be affected include:

How much disclosure will be appropriate at year end, especially in this uncertain environment?

How will the potential movement to a territorial system affect existing tax accounts and valuation allowances?

Will these changes result in repatriation of cash and if so what should be disclosed?

The legal profession is also focusing on this issue. In this post from TheCorporateCounsel.net there is mention of the potential write down of deferred tax assets and even discussion about whether this event may trigger in Item 2.05 Impairment 8-K.

We should all stay tuned to how the legislative process proceeds, and be ready with appropriate disclosures when it concludes.

As always, your thoughts and comments are welcome!

Oh What a Relief – FASB Makes Changes to the New Lease Standard!

12/01/2017FASB NEW LEASE ACCOUNTING STANDARDTrendingadmin

By: George M. Wilson, SEC Institute

On November 29, 2017, after input from many constituents, an exposure draft and extensive consideration, the FASB decided to make several changes to its new lease accounting standard (ASC 842) to provide transition relief and make certain other changes. As you can read in this Media Advisory the Board announced their conclusions in advance of posting details on their website.

According to the Media Advisory, the FASB decided to issue a proposed ASU to make changes to ASC 842, including:

Comparative Financial Statements in Transition

The proposal will include adding a transition option to allow companies to not provide comparative period financial statements with adoption. Instead, the transition provisions of the leases standard would be applied at its effective date, that is the most recent period presented only.

Lessor accounting for separation of non-lease components from lease components

The proposal will also include adding a practical expedient that would permit lessors to not separate non-lease components from the related lease components if certain conditions are met. This practical expedient would be elected by a class of underlying assets, and if elected, would require incremental disclosures.

Land Easements

The FASB decided to proceed with the issuance of a final ASU that provides an optional transition practical expedient for land easements that are not currently accounted for using existing lease guidance under ASC 840. Companies would not have to reconsider accounting for these land easements. This new standard will also clarify that after its effective date companies would use the new standard to evaluate new and modified land easements.

The FASB plans to make the details of the meeting available on their website within a week, so stay tuned!

As always, your thoughts and comments are welcome!

How Much Does the New RevRec Model Increase Disclosures?

11/29/2017New Revenue Recognition StandardTrendingadmin

By: George M. Wilson, SEC Institute

You have likely heard much about how adopting ASC 606 will substantially increase the volume of disclosures about revenue recognition. The new disclosure requirements include a number of qualitative disclosures including information about performance obligations, estimates and related issues. They also include a significant number of new quantitative disclosure requirements, including disaggregated information about revenues.

Here, courtesy of General Dynamic, one of the early adopters of ASC 606, is an interesting example. This example compares the disclosures in General Dynamics’ Form 10-Q for March 31, 2016 using old GAAP to the disclosures in their first Form 10-Q using new GAAP, the quarter ended March 31, 2017.

In their Form 10-Q for the first quarter of 2016 (Old GAAP) General Dynamic’s revenue disclosures were comprised of the following three items:

The top line of the income statement:

This accounting policy:

Revenue Recognition. We account for revenue and earnings using the percentage-of-completion method. Under this method, contract costs and revenues are recognized as the work progresses, either as the products are produced or as services are rendered. We estimate the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognize that profit over the life of the contract. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the loss in the quarter it is identified.

We review and update our contract-related estimates regularly. We recognize changes in estimated profit on contracts under the reallocation method. Under the reallocation method, the impact of a revision in estimate is recognized prospectively over the remaining contract term. The net impact of revisions in contract estimates on our operating earnings (and on a diluted per-share basis) totaled favorable changes of $104 ($0.22) and $63 ($0.12) for the three-month periods ended April 3, 2016, and April 5, 2015, respectively. No revisions on any one contract were material to our unaudited Consolidated Financial Statements in the first quarter of 2016 or 2015.

These operating segment disclosures:

Compare that with these disclosures from the first Form 10-Q after General Dynamics adopted ASC 606, that is the first quarter of 2017:

REVENUE

The majority of our revenue is derived from long-term contracts and programs that can span several years. We account for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers, which we adopted on January 1, 2017, using the retrospective method. See Note Q for further discussion of the adoption, including the impact on our 2016 financial statements.

Performance Obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in ASC Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of our contracts have a single performance obligation as the promise to transfer the individual goods or services is not separately identifiable from other promises in the contracts and, therefore, not distinct. For contracts with multiple performance obligations, we allocate the contract’s transaction price to each performance obligation using our best estimate of the standalone selling price of each distinct good or service in the contract. The primary method used to estimate standalone selling price is the expected cost plus a margin approach, under which we forecast our expected costs of satisfying a performance obligation and then add an appropriate margin for that distinct good or service.

Our performance obligations are satisfied over time as work progresses or at a point in time. Revenue from products and services transferred to customers over time accounted for 70 percent and 73 percent of our revenue for the three-month periods ended April 2, 2017, and April 3, 2016, respectively. Substantially all of our revenue in the defense groups is recognized over time. Typically, revenue is recognized over time using an input measure (e.g., costs incurred to date relative to total estimated costs at completion) to measure progress. Contract costs include labor, material, overhead and, when appropriate, G&A expenses.

Revenue from goods and services transferred to customers at a single point in time accounted for 30 percent and 27 percent for the three-month periods ended April 2, 2017, and April 3, 2016, respectively. The majority of our revenue recognized at a point in time is for the manufacture of business-jet aircraft in our Aerospace group. Revenue on these contracts is recognized when the customer accepts the fully outfitted aircraft.

On April 2, 2017, we had $60.4 billion of remaining performance obligations, which we also refer to as total backlog. We expect to recognize approximately 30 percent of our remaining performance obligations as revenue in 2017, an additional 45 percent by 2019 and the balance thereafter.

Contract Estimates. Accounting for long-term contracts and programs involves the use of various techniques to estimate total contract revenue and costs. For long-term contracts, we estimate the profit on a contract as the difference between the total estimated revenue and expected costs to complete a contract and recognize that profit over the life of the contract.

Contract estimates are based on various assumptions to project the outcome of future events that often span several years. These assumptions include labor productivity and availability; the complexity of the work to be performed; the cost and availability of materials; the performance of subcontractors; and the availability and timing of funding from the customer.

The nature of our contracts gives rise to several types of variable consideration, including claims and award and incentive fees. We include in our contract estimates additional revenue for submitted contract modifications or claims against the customer when we believe we have an enforceable right to the modification or claim, the amount can be estimated reliably and its realization is probable. In evaluating these criteria, we consider the contractual/legal basis for the claim, the cause of any additional costs incurred, the reasonableness of those costs and the objective evidence available to support the claim. We include award or incentive fees in the estimated transaction price when there is a basis to reasonably estimate the amount of the fee. These estimates are based on historical award experience, anticipated performance and our best judgment at the time. Because of our certainty in estimating these amounts, they are included in the transaction price of our contracts and the associated remaining performance obligations.

As a significant change in one or more of these estimates could affect the profitability of our contracts, we review and update our contract-related estimates regularly. We recognize adjustments in estimated profit on contracts under the cumulative catch-up method. Under this method, the impact of the adjustment on profit recorded to date is recognized in the period the adjustment is identified. Revenue and profit in future periods of contract performance is recognized using the adjusted estimate. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the total loss in the quarter it is identified.

The impact of adjustments in contract estimates on our operating earnings can be reflected in either operating costs and expenses or revenue. The aggregate impact of adjustments in contract estimates increased our revenue and operating earnings (and diluted earnings per share) by $72 and $50 ($0.11) for the three-month period ended April 2, 2017, and $68 and $58 ($0.12) for the three-month period ended April 3, 2016, respectively. No adjustment on any one contract was material to our unaudited Consolidated Financial Statements for the three-month periods ended April 2, 2017, and April 3, 2016.

Revenue by Category. Our portfolio of products and services consists of over 10,000 active contracts. The following series of tables presents our revenue disaggregated by several categories.

Each of these contract types presents advantages and disadvantages. Typically, we assume more risk with fixed-price contracts. However, these types of contracts offer additional profits when we complete the work for less than originally estimated. Cost- reimbursement contracts generally subject us to lower risk. Accordingly, the associated base fees are usually lower than fees earned on fixed-price contracts. Under time-and-materials contracts, our profit may vary if actual labor-hour costs vary significantly from the negotiated rates. Also, because these contracts can provide little or no fee for managing material costs, the content mix can impact profitability

Contract Balances. The timing of revenue recognition, billings and cash collections results in billed accounts receivable, unbilled receivables (contract assets), and customer advances and deposits (contract liabilities) on the Consolidated Balance Sheet. In our defense groups, amounts are billed as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals (e.g., biweekly or monthly) or upon achievement of contractual milestones. Generally, billing occurs subsequent to revenue recognition, resulting in contract assets. However, we sometimes receive advances or deposits from our customers, particularly on our international contracts, before revenue is recognized, resulting in contract liabilities. These assets and liabilities are reported on the Consolidated Balance Sheet on a contract-by-contract basis at the end of each reporting period. In our Aerospace group, we generally receive deposits from customers upon contract execution and upon achievement of contractual milestones. These deposits are liquidated when revenue is recognized. Changes in the contract asset and liability balances during the three-month period ended April 2, 2017, were not materially impacted by any other factors.

Revenue recognized for the three-month periods ended April 2, 2017, and April 3, 2016, that was included in the contract liability balance at the beginning of each year was $1.7 billion and $1.4 billion, respectively, and represented primarily revenue from the sale of business-jet aircraft.

The incremental length of the new disclosures is startling enough, but as you read the details about how the new model applies to General Dynamics and the significant amount of detail in the quantitative disclosures you can get a sense for how the new model increases the information available to investors!

Our next post will do this same process for a service business.

As always, your thoughts and comments are welcome!