by Glenn Cheney
Under pressure from a host of cooperative ventures, small CPA firms and limited partnerships, the Financial Accounting Standards Board has put off the effective date of parts of Financial Accounting Statement 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.”
The deferral, issued as FASB Staff Position 150-3, applies to mandatorily redeemable financial instruments of certain non-public entities and certain mandatorily redeemable non-controlling interests. The effective date for instruments that are mandatorily redeemable on fixed dates for fixed amounts has been extended by one year to apply to fiscal periods beginning after Dec. 15, 2004. For all other mandatorily redeemable instruments of private companies, the classification, measurement and disclosure provisions are deferred indefinitely.
The decision frees, at least temporarily, small companies and partnerships from the need to reclassify a partner or shareholder’s equity as a liability upon death or separation.
The Technical Issues Committee of the American Institute of CPAs lobbied hard for a change to the requirements of Statement 150, and Bill Balhoff, chair of the institute’s PCPS committee, which defends the interests of small CPA firms, said that the statement, as it stood, was evidence that the board was writing standards that applied principally to public companies at the expense of nonpublic companies.
“We met with FASB in October, and FAS 150 was No. 1 on the list of items we were concerned about,” said Stephen McEachern, TIC chair and president of Fitts Roberts & Co. “We cautioned them that it was going to have a very negative impact. Although it looked like it was too late, they came back and reconsidered it.”
McEachern termed the deferrals “a step in the right direction,” but added that the next step would be to simply decide that the rules do not apply to private companies.
Financial Executives International also objected, citing similar reasons. In a comment letter to FASB, Robert A. Orben, chair of FEI’s committee on private companies, wrote, “Non-public entities have operated successfully for many years with redemption agreements in place, without having to recognize the effects of these arrangements directly on their balance sheets, and without creating any disclosure or other problems as to their financial conditions. The practical effect of these requirements is to wipe out the net worth of the entities which are parties to agreements with their owners obligating the entity to redeem shares when their owners die or terminate their employment.”
The FEI letter foresaw companies contriving organizational structures solely to avoid the application of the statement. Shareholders would have to be convinced that such financial contortions did not indicate fundamental economic change.
Accounting firms also pleaded for change.
Big Four firm Ernst & Young outlined several justifications for a longer transition period, among them the need of many companies to determine the fair value of assets, calculate the resettlement value of liabilities, perform complex calculations for limited-life subsidiaries, and develop new internal controls. Auditors, the firm’s comment letter said, would need to review a whole new set of estimates and assumptions, and the users of financial information would need to be educated about the effects of the change.
“We believe that the remarkably brief 45-day transition period is without precedent and, for companies with limited-life subsidiaries, will require an extraordinary effort to implement the standard,” the letter stated. “We also believe that this brief transition period will create an extremely high risk of restatement for companies that are making a good faith effort to comply with the standard. This would be an unfortunate result in the current environment, in which the credibility of reported results is subject to extraordinary scrutiny.”
Of the 112 comment letters posted on FASB’s Web site, over 70 were from food, electric and telephone cooperatives that feared that the reclassification of member equity as a liability would result in a legal obligation to redeem that equity, seriously impairing a crucial tool for raising capital.
Heather Schmidt Albinger, CPA, president of the board of Outpost Natural Foods in Milwaukee, asked for a two-year deferral of the effective date and a clarification that co-op member equity is not mandatorily redeemable when the board of directors retains the authority to redeem that equity.
“Members of a cooperative join primarily to receive the benefit from patronizing the business, not to receive a return on their investment,” Albinger wrote. “Members provide equity capital to the cooperative to finance its business operations, but they recognize that this equity is risk capital.”
Albinger pointed out that member equity retains the character of equity, and that the board has the discretion to redeem it or not. It does not have that discretion for the co-op’s debt. In bankruptcy, creditors are paid before member equity is redeemable.
FASB senior project manager Halsey Bullen said that the board plans to reconsider implementation issues and, perhaps, classification or measurement guidance for non-controlling interests during the deferral period, in conjunction with its ongoing projects on liabilities and equity and business combinations. Staff will use the deferral period to write disclosure and transition guidance.
“During the deferral, we are going to re-look at these provisions as part of the second phase of our project on liability and equity, where we hope to finish off the things we hadn’t gotten to in Statement 150,” Bullen said.
