In its first exercise of a new due process policy, the Financial Accounting Standards Board's Emerging Issues Task Force has issued three exposure drafts of proposed consensuses. The documents deal with accounting for contingently convertible, or CoCo, financial instruments, sabbaticals, and taxes.In the past, the task force has issued exposure drafts only when an issue seemed controversial or significant enough to warrant public comment. Under the new due process, all task force abstracts will be exposed for comment before being submitted to the board for final ratification.
"We understand the impact that the task force has on preparers, auditors, users and regulators," said FASB senior technical advisor Russell Golden. "We want to get their input so that we can make sure we're meeting all their needs."
EITF Issue 06-2, on sabbatical leave and similar benefits, is relatively simple. The question: whether the compensation cost associated with a sabbatical or other similar benefit arrangement should be accrued over the requisite service period.
The answer: Yes.
The complication is in the interpretation of FASB Statement 43, Accounting for Compensated Absences, where Paragraph Six refers to leaves of absence that "accumulate." In that many sabbaticals do not accumulate or grow but simply become available after a set period, the appropriateness of accruing compensation costs has been questioned by concerned accountants.
Golden said that the tentative consensus might change practice for some entities by clarifying the accounting for a practice that is becoming more common.
"Sabbaticals have become more prevalent in high-technology companies," Golden explained. "In the past, people thought that sabbaticals were somewhat isolated to academia, but we've become aware that it's more prevalent in the high-tech industry."
Taxation's complex nature
More complicated than the sabbatical issue is the question of "How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement," a.k.a. EITF Issue No. 06-3.
The proposal grapples with the famously complex nature of taxation and its myriad manifestations. They range from sales taxes that are applied to a broad class of transactions involving a wide range of goods and services, to excise taxes that are applied only to specific types of transactions or items. The characteristics of how these taxes are calculated, remitted and administered are difficult to summarize into simple, discernible models.
Golden said that often these taxes are embedded in the cost of products and services, invisible to consumers and often not clearly defined as "taxes."
User fees involved in cell phone service and airline tickets are examples of transactions that are new and less easily segregated in financial reports. "Often these fees act like sales taxes, but aren't really called sales taxes," Golden said.
The consensus also follows up on a task force consensus reached in 2000 on gross versus net reporting of revenue recognition. The EITF is suggesting that the presentation of any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer on either a gross or a net basis is an accounting policy decision that should be disclosed pursuant to APB Opinion 22.
For any such taxes reported on a gross basis, a company should disclose the amounts of those taxes in interim and annual financial statements for each period for which an income statement is presented, if those amounts are significant. The disclosure of those taxes can be done on an aggregate basis.
"The task force decided that the best thing to do for investors is to disclose your policy, but they felt that it was not necessary to change current practice," Golden said.
More complicated than taxes and sabbaticals, if only for the minuteness of its presence in the complex density of modern American equities, is the issue of contingently convertible instruments that contain an embedded issuer call option that permits conversion of an instrument by the holder even when the instrument's market price trigger has not been met.
These call options allow issuers to call the debt at any time. Upon exercise of the call option, the holder can opt to receive cash for the call price or a defined number of equity shares or, in some cases, a combination of cash and shares. Holders typically choose to receive equity if the value of the equity exceeds the cash call price of the debt.
In Issue 05-1, the EITF is proposing that the conversion of an instrument that became convertible upon the issuer's exercise of a call option be accounted for as a conversion if the debt instrument contained a substantive conversion feature as of its issuance date.
No gain or loss would be recognized related to the equity securities issued to settle the instrument. The issuance of equity securities to settle a debt instrument that became convertible upon the issuer's exercise of a call option should be accounted for as a debt extinguishment, if the debt instrument did not contain a substantive conversion feature as of its issuance date. The fair value of the equities would be considered a component of the reacquisition price of the debt.
The consensus follows a 2004 task force conclusion that CoCos that were triggered by market price would have to be calculated into diluted earnings per share.
"Issue 05-1 is a follow-up issue, because a lot of those instruments had specific call features that allow for the acceleration of that contingency to occur," Golden said. "I don't believe there have been many entities that have called these securities and thus accelerated the conversions."
The EITF has requested comments by May 4, 2006.
The task force will consider comments at a meeting scheduled for June 14-15, 2006. Pending approval, the issues will then be passed to the board for ratification.
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