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Accounting update September 2010. Page 1 Presenters Josh Paul, Securities & Exchange Commission Chris Holmes, Ernst & Young James Barlow, Allergan.

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Presentation on theme: "Accounting update September 2010. Page 1 Presenters Josh Paul, Securities & Exchange Commission Chris Holmes, Ernst & Young James Barlow, Allergan."— Presentation transcript:

1 Accounting update September 2010

2 Page 1 Presenters Josh Paul, Securities & Exchange Commission Chris Holmes, Ernst & Young James Barlow, Allergan

3 Page 2 Agenda Interacting with SEC Office of the Chief Accountant Current accounting matters FASB/IASB joint projects SEC hot buttons

4 Page 3 Interacting with SEC Office of the Chief Accountant Office of the Chief Accountant (OCA) Avenues for consultation Considerations in evaluating accounting issues

5 Page 4 Office of the Chief Accountant (OCA) Chief Accountant: James L. Kroeker Main groups in OCA Accounting (Deputy Chief Accountant Paul Beswick) Professional Practice (Audit and Independence) (Deputy Chief Accountant Brian Croteau) International Affairs (Deputy Chief Accountant Julie Erhardt) Responsibilities Rulemaking, interpretive guidance and reports Oversight of standard setting Consultations

6 Page 5 Avenues for consultations Pre-filing basis – requests from registrants Guidance posted on the SECs website: Post-filing basis Internal consultations from Divisions of Corporation Finance and Enforcement Requests from registrants Informal discussion with OCA staff members (202)

7 Page 6 OCA considerations in evaluating accounting issues Faithful application of accounting literature Where accounting literature does not address the situation: Provide information useful to investors and creditors in their decision-making process Professional judgment SEC staff will accept reasonable differences in judgment, coupled with transparent disclosure Concurrent documentation enhances credibility of judgment Economic substance Problems arise when transactions are designed around accounting literature Often not consistent with principles of standard Transparent disclosures

8 Page 7 Current accounting matters Accounting implications of health care reform for life sciences companies Revenue recognition Consolidation

9 Page 8 Accounting implications of health care reform for life sciences companies In March 2010, the Patient Protection and Affordable Care Act was signed into law along with the related Health Care and Education Reconciliation Act of 2010 (collectively, the Act) The Act represents a major overhaul of the nations health system and also includes a number of provisions that have significant accounting implications Drug manufacturers fee – non-deductible annual fee on certain prescription drug manufacturers beginning 1 January 2011 Entity will be required to pay the annual fee if it sells branded prescription drugs to a specified government program (e.g., Medicare, Medicaid, etc.) in a given calendar year The fee is calculated based on the entitys relative market share of certain domestic sales for the preceding calendar year The fee is recognized in the calendar year in which it is payable (e.g., the fee payable in 2011 would be recognized in 2011) Proposed ASU specifies that upon recognition of the liability, the annual fee should be recognized over the benefit period using a straight-line method of allocation unless another method better allocated the fee over the calendar year

10 Page 9 Accounting implications of health care reform for life sciences companies (contd) Excise tax on medical device manufacturers – imposes an excise tax equal to 2.3 percent of the sales price of certain medical devices, beginning 1 January 2013 We believe such taxes should be presented on the income statement either on a gross (included in both revenues and costs) or net (excluded from revenues) basis, depending on the entitys accounting policy election Medicare Part D coverage gap – requires prescription drug manufacturers to provide a 50-percent discount to Medicare Part D beneficiaries for brand-name drugs and biologics purchased during the coverage gap (donut hole), beginning in 2011 Coverage gap rebates plus manufacturers rebates could exceed selling price Medicaid drug rebates – increases the rebates paid by prescription drug manufacturers for certain drugs dispensed to Medicaid beneficiaries, effective 1 January 2010 Medicare Part D tax benefits – reduces the tax benefits available to an employer that receives the Medicare Part D subsidy, effective for taxable years beginning after 31 December 2012

11 Page 10 Revenue recognition Multiple Elements: Double the pleasure, double the fun ASU , Revenue Arrangements with Multiple Deliverables (formerly EITF Issue No. 08-1) Supersedes Issue 00-21– requires allocation of consideration on a basis of relative selling price, eliminates residual method Selling price is determined by (in order): o VSOE, if it exists o Third party evidence of selling price, if it exists o Vendors best estimate of selling price Must be adopted by all entities no later than fiscal years beginning on or after 15 June 2010; early adoption allowed Entities may elect to adopt the revised guidance through either of the following methods: o Prospective application to all revenue arrangements entered into or materially modified after the date of adoption o Retrospective application to all revenue arrangements for all periods presented

12 Page 11 Revenue recognition (contd) ASU , Applicability of SOP 97-2 to Certain Arrangements that Include Software Elements (formerly EITF Issue No. 09-3) Amends scope of SOP 97-2 Excludes from SOP 97-2 tangible products (e.g., hardware) and software components of tangible products when the tangible and software components function together to deliver tangible products essential functionality Required to be adopted in the same period and using the same transition method as ASU ; therefore, entities need to adopt the guidance in both ASUs at the same time and in the same manner

13 Page 12 Revenue recognition (contd) R&D Milestone Payments: Havent you earned it? ASU , Milestone Method of Revenue Recognition (formerly EITF Issue No. 08-9) Milestone method is an acceptable application accounting policy election under the proportional performance model, but is not required and is not the only acceptable method of revenue recognition for milestone payments in R&D arrangements If milestone is substantive, recognize contingent consideration earned in its entirety in the period in which the milestone is achieved Effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010 Early adoption is permitted

14 Page 13 Consolidation Simplification? – ASC 810, Consolidations (includes what was formerly SFAS No. 167), amended complex, quantitative nature of the application of the Variable Interest Model for determining the primary beneficiary (PB) VIE determination The amendments to FIN 46(R) changed the provisions regarding decision making and whether the equity holders have the characteristics of a controlling financial interest Criteria for whether an entity is a VIE As a group, the holders of the equity investment at risk lack: o The power, through voting rights or similar rights, to direct the activities of an entity that most significantly impact the entitys economic performance. The investors do not have that power through voting rights or similar rights if no owners hold voting rights or similar rights (such as those of a common shareholder in a corporation or a general partner in a partnership) Kick-out or participating rights not considered unless a single enterprise (and its related parties and de facto agents) has the unilateral ability to exercise them

15 Page 14 Consolidation (contd) PB determination: qualitative analysis PB determination is now based upon a qualitative analysis Power to direct activities that most significantly impact VIEs economic performance (power), AND Obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant (benefits) Eliminates quantitative analysis for determining PB Quantitative analysis may still be necessary in applying other provisions within the Variable Interest Model (e.g., VIE determination) Power may be shared (consent is required)

16 Page 15 Consolidation (contd) PB determination: development stage companies Variable Interest Model provides that a development stage enterprises equity investment at risk is sufficient if (1) it can be demonstrated that the equity invested in the entity is sufficient to permit it to finance its current activities and (2) provisions in the entitys governing documents and contractual arrangements allow additional equity PB determination: related party provisions Variable Interest Model amended so that the power/benefits principle is considered before applying the related party provisions De facto agency exemption for substantive mutual transfer restrictions agreed to by parties

17 Page 16 Consolidation (contd) Other VIE determination is reevaluated based on specific events Provision added: changes in facts and circumstances occur such that the holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entitys economic performance Troubled debt restructuring exemption removed PB determination is now continuous Only substantive terms, transactions, and arrangements should be considered

18 Page 17 FASB/IASB joint projects Status update Revenue recognition Leases Financial presentation

19 Page 18 FASB/IASB joint projects status update Change is inevitable - except from a vending machine Eleven joint convergence projects of the FASB and the IASB Accounting for financial instruments Statement of comprehensive income Fair value measurement Reporting discontinued operations Consolidation Financial instruments with characteristics of equity Financial statement presentation Leases Revenue recognition Insurance contracts Emissions trading schemes

20 Page 19 FASB/IASB joint projects status update FASB and IASB renewed their formalized commitment to convergence in a 2006 Memorandum of Understanding (MoU) Updated in 2008, establishing mid-2011 as target completion date Updated in June 2010 to address challenges in improving/converging certain areas and stakeholder concerns Prioritizes projects that the Boards believe will bring significant improvement and convergence to IFRS and US GAAP Phases EDs to enable high-quality input from stakeholders Separate document will seek stakeholder input about effective dates/transition Delay in issuance dates for certain EDs and final guidance as a result of modified strategy Convergence of some standards uncertain SEC stated that delay would not affect SEC IFRS decision in 2011 SEC IFRS Work Plan progress report expected in October 2010

21 Page 20 FASB/IASB joint projects – revenue recognition Lets try singing from the same hymnal Exposure draft issued Q2 2010, Final standard expected in 2011 Joint proposal to adopt a single revenue recognition model for most revenue transactions Identify contract(s) with customers (written, oral or implied) Identify separate performance obligations in each contract Determine the transaction price Allocate consideration to identified performance obligations based on relative standalone selling prices Recognize revenue as performance obligations are satisfied through the transfer of control of goods or services to customer o If onerous (i.e., a loss is expected on satisfaction of a performance obligation), the entity recognizes a liability and corresponding expense Proposal includes increased disaggregated disclosures about (1) revenue (e.g., major product lines, geography), (2) contracts with customers and (3) changes in aggregate balances of contract assets and liabilities (potentially requiring accounting system changes) Proposal requires full retrospective application of the new standard

22 Page 21 FASB/IASB joint projects – leasing Operating Leases: Another one bites the dust Exposure draft issued in Q3 2010, final standard expected in 2011 Proposed model for lessees to record all leases on the balance sheet, a significant change Record an asset (right to use the item for the lease term) and a liability (obligation to make rental payments) Initially measure asset and obligation at the present value of the expected lease payments (including contingent rentals and residual value guarantees) Amortize asset over shorter of the lease term or economic life of the leased asset Lease payments reduce obligation with interest expense using the effective yield method At each reporting date, reassess lease obligation and remeasure if necessary using revised assumptions

23 Page 22 FASB/IASB joint projects – financial statements presentation Oh, what a tangled web we weave Increased disaggregation by function, nature and measurement basis in the statements of financial position, comprehensive income and cash flows Other key changes Remeasurement information required in notes Direct method presentation of operating cash flows Analysis of changes in balances of select asset and liability line items For each reportable segment, disclosure of o Operating cash flow, reconciling to the sum of operating cash flow in the statement of cash flows o Measure of operating assets and liabilities o Measure of liabilities if used by CODM

24 Page 23 Non-GAAP financial measures Goodwill impairment Segments SEC hot buttons

25 Page 24 Welcome back, welcome back, welcome back If presented, a non-GAAP financial measure must be accompanied by the disclosures required by Item 10(e)(1)(i) of Regulation S-K: Present, with equal or greater prominence, the most directly comparable GAAP measure Numerically reconcile the non-GAAP measure to the GAAP measure Why management believes the non-GAAP measure provides useful information to investors Any additional material uses by management of the non-GAAP measure SEC staff issued new Compliance and Disclosure Interpretations (C&DIs) in January 2010 to interpret but not modify Item 10 of Regulation S-K Non-GAAP C&DIs supersede the former non-GAAP FAQs Remove many of the challenges and uncertainties in the presentation of a non-GAAP performance measure that excludes a recurring item Clarify that a non-GAAP financial measure may be disclosed even if it is not used by management in managing the business Generally inappropriate to present a full non-GAAP income statement for purposes of reconciling non-GAAP measures to the most directly comparable GAAP measures Non-GAAP financial measures

26 Page 25 Intent of the non-GAAP C&DIs is to make it easier to include a non-GAAP financial measure in SEC filings and permit more consistency with disclosures outside of SEC filings (e.g., in press releases and analyst presentations) Intent of the non-GAAP C&DIs is not to require a company to disclose in its SEC filings every non-GAAP financial measure that it discloses outside of its SEC filings (unless omission is misleading) SEC comment letters are asking why a company chose not to disclose a non-GAAP financial measure in its SEC filings that it had publicly disclosed elsewhere A company should not assume that the SEC staff is requesting the company to disclose the non-GAAP financial measure in its SEC filings A company should respond to such an inquiry by clearly articulating why the company chose not to include the non-GAAP financial measure in its SEC filing Increased SEC staff focus on non-GAAP financial measures disclosed in press releases, company websites and earnings calls for compliance with Regulation G Non-GAAP financial measures (contd)

27 Page 26 Here today, gone tomorrow? Recent market conditions have highlighted goodwill impairment risk disclosures For a company with goodwill as a critical accounting estimate, the SEC expects the registrants MD&A to disclose the following for each reporting unit with a material amount of goodwill that is at risk: The percentage by which fair value of the reporting unit exceeds its carrying value at the date of the last impairment test (i.e., cushion) The amount of goodwill allocated to the reporting unit A description of the methods and key assumptions that drive the fair value of the reporting unit and how the key assumptions were determined (i.e., the SEC staff encourages, but does not require, disclosure of the key numerical assumptions or a quantitative sensitivity analysis) Any uncertainties surrounding the key valuation assumptions (e.g., the valuation model assumed recovery from a business downturn within a defined period of time) Events that could have a negative effect on the fair value of the reporting unit No bright lines exist and registrants must apply judgment to determine whether a reporting units goodwill is considered at risk The SEC staff acknowledges that the need for these disclosures decreases as the cushion increases Goodwill impairment

28 Page 27 For a company with goodwill as a critical accounting estimate, but immaterial goodwill at risk or no reporting units that are at risk of failing the impairment test, the SEC staff expects disclosure of that fact in MD&A If a company concludes that there is a low risk of goodwill impairment and does not identify goodwill impairment as a critical accounting estimate, the SEC staff would not expect the noted disclosures If an impairment was recorded, disclose: The fact and circumstances that led to the charge The timing of the triggering event The effect of the impairment on the business, including future expectations What went wrong? The SEC staff has aggressively probed the method of estimating the fair value of reporting units Expects registrants to validate valuations by comparing the aggregate fair value of goodwill reporting units to the market capitalization of the consolidated entity Objective evidence must support implied control premiums Goodwill impairment (contd)

29 Page 28 Segments Let the sunshine in SEC staff continues to question registrants regarding the determination and aggregation of operating segments Reviews public information available, including public filings, registrant websites and industry or analyst presentations Questions perceived inconsistencies Identification of operating segments (management approach) At what levels within an entity are revenue earned and expenses incurred Who is entitys chief operating decision maker (CODM) What operating performance information is available for review by the CODM to make performance decisions and allocate resources If the CODM regularly receives reports that present discrete operating results for components of the entity, SEC staff presumes the CODM uses these reports to assess performance and allocate resources SEC staff challenges registrant assertions that conclude otherwise

30 Page 29 Segments (contd) Key elements to segment aggregation criteria Aggregation consistent with objectives and basic principles of segment accounting literature (ASC 280, Segments (formerly SFAS No. 131)) Operating segments must be economically similar (based on future prospects of gross margin and sales trends and not solely on current indicators) Operating segments must have similar characteristics (e.g., nature of products and services, types or class of customer, methods used to distribute products or provide service, nature of regulatory environment)

31 Page 30 Thank you

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