If you were confused over the complexity of derivative and hedging rules as it relates to recent chaos in credit markets, perhaps the latest clarification from the Financial Accounting Standards Board will help clear things up.

FASB published Accounting Standards Update No. 20101-11 – Derivatives and Hedging (Topic 815): Scope Exception Related to Embedded Credit Derivatives to try to clarify how embedded credit derivative features should be treated in such exotic financial instruments as collateralized debt obligations and synthetic CDOs. FASB heard a flurry of questions and confusion over how to treat certain embedded credit derivatives as credit markets tanked and companies struggled with how to value toxic, debt-based instruments such as CDOs and others.

The guidance is intended to address uncertainty over a scope exception that is already provided for embedded credit derivatives in existing hedge accounting rules (specifically, paragraphs 815-15-15-8 through 15-9 of the Accounting Standards Codification). The guidance tries to explain in what kind of contracts the embedded credit derivative scope exception applies and in what kind of contracts it does not apply. The difference is important because in some cases the embedded credit derivative is subject to bifurcation, or extraction from the host contract, so that it gets separate accounting treatment.

The new rule calls out three specific instances where the embedded credit derivative likely still requires separate accounting, despite any apparent exceptions that are provided in Generally Accepted Accounting Principles. The three instances focus attention on establishing where there may be risk and who may be exposed to it.

FASB said it is providing the clarifications and related additional examples to help resolve potential ambiguity about the breadth of the embedded credit derivative scope exception provided elsewhere in GAAP. The guidance is effective for the first quarter beginning after June 15, 2010, with early adoption permitted.

The Financial Accounting Standards Board has finalized a deferred effective date for investment companies in complying with new consolidation rules intended to bring more assets on to corporate balance sheets.

FASB recently added Accounting Standards Updated No. 2010-10 to its Accounting Standards Codification to defer the effective date of the consolidation requirements of Financial Accounting Statement No. 167, which have been folded into the Codification under Topic 810 Consolidation. The deferral applies only to companies that meet the criteria of an investment company, however, meaning it does not apply to a reporting unit that has either a direct or in indirect obligation to fund any losses that could potentially be significant to the entity.

FASB said the deferral does not apply to interests in securitization entities, asset-backed financing entities, or entities that once held the designation of qualifying special-purpose entities. Those, in fact, are precisely the vehicles FASB had in mind for bringing on the balance sheet when it wrote FAS 167 to curb off-balance-sheet abuses.

After FASB approved the original standard, it started hearing concerns that it produced a different outcome for investment companies than the International Accounting Standards Board likely would pursue for international rules. In addition, and perhaps even more importantly, the new rule also produced some unintended consequences for investment companies, whose investment managers would be required under the new rule to consolidate onto their corporate balance sheets investment funds that they manage.

That’s because the new standard requires consolidation based on a control concept, said Jay Hanson, national director of accounting for McGladrey & Pullen. “That just didn’t make any sense,” he said, so the board agreed to carve investment companies out of the requirement for at least a year while it re-examines how to address the concern.

“The deferral is quite limited,” Hanson said, applying only to entities that have all the attributes of investment companies. Every other entity – where the standard was aimed in the first place – is required to comply with the original effective date, which is for all interim and annual periods beginning after Nov. 15, 2009.

Accounting rulemakers are putting the finishing touches on a report that will update capital markets on their efforts to converge U.S. and international accounting standards.

The Financial Accounting Standards Board and the International Accounting Standards Board are expected to publish the first of what will become a series of quarterly reports to document their progress in making U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards more consistent with one another. The two boards announced in November they would provide quarterly updates on their convergence progress given the implications on some important policy fronts.

For one, the Securities and Exchange Commission has hinged its plan for moving U.S. capital markets to IFRS on the ability of the two boards to eliminate substantial differences between GAAP and IFRS. The SEC published a work plan this week updating where it stands on adopting IFRS in the United States, and the plan focuses on the convergence movement as a key criteria for when and how the Commission ultimately will transition U.S. registrants over to IFRS.

Even further, the Group of Twenty nations are watching the convergence effort, hoping it will eliminate differences in accounting standards that it believes may have played a role in the economic crisis.

A spokesman for IASB said the two boards are expected to issue their first joint quarterly progress report very soon. A spokesman for FASB said the various project updates posted by the two boards demonstrates “quite a bit of progress” in recent months.

“We remain committed to working with IASB,” said spokesman Chris Klimek. “(We) appreciate the SEC’s leadership and additional guidance on this important matter, and like everyone, we will be studying the work plan carefully in the days ahead and discussing what it means for us.”

Public companies now have a new requirement to follow in accounting for events that take place after a financial statement period ends but before the statements are issued.

The Financial Accounting Standards Board published Accounting Standards Update No. 2010-09 to amend Accounting Standards Codification Topic 855, Subsequent Events, which describes how entities should treat “subsequent events.” That refers to significant events that might be of interest to investors taking place after a financial statement period closes but before results of the period are disclosed to investors and regulators.

The new guidance clarifies which entities are required to evaluate subsequent events through the issuance of financial statements and the scope of the disclosure requirements related to subsequent events. FASB adopted the original standard as Financial Accounting Standard No. 165: Subsequent Events before it was folded into the Codification under Topic 855.

FASB developed the standard on subsequent events along with a proposed new standard on going concerns, to update and clarify accounting requirements that have long been observed under auditing standards. While the subsequent event standard was finalized in May 2009, FASB is still deliberating comments and making changes to the going concern proposal, hoping to provide a revised exposure draft before the end of the first quarter.

In an alert to its clients, PricewaterhouseCoopers said FASB amended the guidance to remove the requirement for filers subject to regulation under the Securities and Exchange Commission to disclose the date through which an entity has evaluated subsequent events. That change is intended to assure FASB’s requirement is consistent with current SEC guidance, PwC said.

The board says the new guidance on subsequent events has the potential to change reporting for both public and private companies, but the nature of any reporting changes will depend on how companies have treated subsequent events under old literature.

The guidance is effective immediately for any entity subject to the requirements of U.S. Generally Accepted Accounting Standards, except conduit bond obligors, who will be required to apply the guidance for fiscal years ending after June 15, 2010.

Facing a tidal wave of new accounting requirements that are coming on board, a committee of Financial Executives International is appealing to rulemakers to think carefully about when and how a host of new standards will take effect.

Arnold Hanish, chairman of FEI’s Committee on Corporate Reporting and chief accounting officer at Eli Lilly, wrote to the chairmen of the Financial Accounting Standards Board and the International Accounting Standards Board to ask them to consider the big picture as they set effective dates for some substantial new accounting requirements.

Hanish was referring specifically to FASB’s and IASB’s projects on financial statement presentation, leases, pensions, revenue recognition, financial instruments, and liability and equity, all of which are key to the two boards’ efforts to converge U.S. Generally Accepted Accounting Standards with International Financial Reporting Standards.

The boards are acting under a tight timeline to seek convergence on some key areas in the two accounting rulebooks by mid-2011, in part to satisfy the Group of Twenty nations that identified differences in accounting standards as at least a contributing factor to the economic crisis.

Hanish called on FASB and IASB to “deliberate the effective dates and transition of the major convergence standards holistically, rather than on a standard-by-standard basis,” he wrote, to reflect how significant the transition will be for companies adopting the new standards and how interrelated some of the new requirements will be.

In his letter, Hanish described some of the interdependencies among the new requirements that will impact how companies will implement them. New requirements for financial statement presentation, for example, will impact what information must be gathered, which will have an impact on other convergence standards. Likewise, a new definition for a liability will impact what types of assets and liabilities would be accounted for under a new standard for financial instruments, he wrote.

As such, Hanish called on the boards to consider an aggregated effective date for the final converged standards with a three-year implementation period, giving companies the option to adopt early if they’re prepared to do so. “Providing adequate time for the body of converged standards will allow companies to thoughtfully identify the impacts, develop approaches that respond to the change, implement and test solutions, and conduct the necessary training to impacted internal and external individuals specific to their company and industry needs,” he wrote.

FASB and IASB continue to make substantial progress on the core convergence standards, meeting monthly in extensive sessions to reach dozens of preliminary decisions. The boards expect to issue an exposure draft on a new method of financial statement presentation in April 2010.

They’re also identifying areas, however, where they can’t agree and will issue standards that differ. In the financial statement presentation project, for example, FASB plans to require entities to disclose operating assets, liabilities, and cash flows by reportable segment while IASB will not require such a breakdown. IASB meanwhile plans to require the presentation of net debt information as part of the analysis of change and will include minimum line item requirements for the statement of financial position while FASB will not.

The Financial Accounting Standards Board and its overseer, the Financial Accounting Foundation, are forming a team to take over responsibility for managing XBRL taxonomies for U.S. financial reporting purposes.

XBRL (eXtensible Business Reporting Language) is a technical language for communicating business information electronically. Taxonomies represent the dictionary for the language, mapping bits of information based on reporting standards to their proper destination. The taxonomy for U.S. Generally Accepted Accounting Principles is a list of computer-readable tags in XBRL that allows companies to label precisely the thousands of pieces of financial data that are included in typical long-form financial statements and related footnote disclosures.

The 2009 taxonomy currently in use for public company financial reporting was developed by XBRL US, the non-profit organization that has driven the development and adoption of XBRL for tagging business reports. The FASB provided technical accounting standards support to XBRL US during the development of the 2009 taxonomy. 

Since FASB writes the accounting standards that govern public company financial reporting, it’s the logical body to maintain the taxonomies going forward, said XBRL US representative Michelle Savage. “We are responsible for the technical quality, consistency and interoperability of taxonomies,” she said. “We leave the process and decisions around disclosure content to public policy and regulatory processes.”

The FAF said the new team will work toward releasing a taxonomy update in early 2011. The transition of responsibility follows several months of discussion between the FAF and the staff of the Securities and Exchange Commission, which has responsibility over filing requirements and therefore over the use and final content of any taxonomy required in filings.

“The FASB’s new role will help ensure that tagging standards remain closely aligned with the U.S. accounting standards they describe,” said SEC Chief Accountant James Kroeker. “This will be a benefit to investors and companies alike.”

The Financial Accounting Standards Board has finalized some minor changes to the Accounting Standards Codification in Update 2010-8. While none of them are expected to result in significant changes in accounting practice, clarifications regarding embedded derivatives and hedging may require some close attention.

The changes represent minor updates to accounting rules to eliminate things that are outdated, to shore up inconsistencies, or to clarify the original intent behind a given requirement. FASB says the changes are “generally non-substantive in nature,” though they affect a number of broad topics within the Codification, including the statement of cash flows, changing prices, investments, intangibles, consolidation, non-monetary transactions, income taxes, business combinations, derivatives and hedging, and reorganizations.

FASB is calling special attention to the changes to derivatives and hedging rules, under Topic 815 in the Codification, because the changes may cause entities to rethink how they currently apply the rules. The new guidance likely will drive entities to think about whether embedded derivatives must be accounted for separate from the host contract into which they are embedded. As such, that may lead to some analysis regarding whether the entity may want to elect the fair-value option for measuring those contracts, FASB said.

The amendments generally are effective for annual reporting periods beginning after Dec. 15, 2008, which means the 2009 reporting year for calendar-year-end companies. However, FASB is allowing companies to adopt the derivative and hedging amendments for the following year to facilitate any transition companies may undertake.

The Financial Accounting Standards Board and the International Accounting Standards Board reached some key agreements this week to finalize a proposed new approach for explaining income information to investors.

The two boards reached some verbal agreements in their joint project on how companies would be required—or in some cases allowed—to present information in a “statement of comprehensive income,” a new financial statement that would replace the existing income statement.

The idea is to provide a more comprehensive view of an entity’s income, in part to scuttle the almighty reliance currently placed on the “net income” figure that becomes the bottom line on existing income statements. The new statement is aimed at giving a more balanced view of not only profit-and-loss figures but also other comprehensive income, which reflects gains and losses that have not yet been realized. That often includes things like gains or losses on securities or derivatives, pension costs, or foreign investments and currency hedges.

At a joint meeting, the two boards agreed that an entity would be required to display total comprehensive income and its components in the new statement of comprehensive income, but it will have some flexibility to name the two key sections. One section has to display profit-or-loss figures, and the other has to display other comprehensive income as it is defined in current accounting standards.

The boards agreed they’ll retain existing requirements that give entities an option to display components of other comprehensive income before or after related income tax expense has been factored in, but they have to provide one amount for the aggregate income tax effects on the face of the statement. Entities can decide if they will link income tax effects related to each component of other comprehensive income on the face of the statement or in the footnotes.

The new standard will not redefine what goes into other comprehensive income or what goes into each of its components, the boards determined. Staff at FASB and IASB are preparing the draft standard that will be voted on by both boards. The boards are projecting an exposure draft to be published at the end of the first quarter.

Where companies are required to measure assets and liabilities at fair value, they’ll have some new disclosures to provide regarding changes in how they measure those values.

The Financial Accounting Standards Board has finalized Accounting Standards Update No. 2010-06 to amend Accounting Standards Codification Topic 820 in a way that elicits new disclosures about how fair value is measured and synchronizes the disclosure requirements with international rules. It takes effect for the 2010 reporting year for calendar-year companies.

The new rule requires companies to disclose where they transfer items in and out of “Level 1” and “Level 2” measurement methods under the three-level hierarchy for measuring fair value. Level 1 measurements rely solely on objective market evidence of fair value, while Level 2 measurements are based on a mixture of market evidence and internally development assumptions or estimates.

The new rules also require companies to describe activity that takes place in Level 3 measurements, where fair values are established based solely on models and other internal estimates and assumptions. For instruments measured at Level 3, companies will be required to present separate information, not final net numbers, on purchases, sales, issuances, and settlements.

David Larsen, managing director for Duff & Phelps, said the update clarifies that fair-value measurements for major classes of assets and liabilities should be disclosed separately. It also clarifies the required disclosure of the techniques and inputs companies use to estimate fair value, he said.

“The update will require some additional effort by companies to prepare,” said Larsen. “However, all required data should be readily available.”

The final rule does not include any new requirements for a “sensitivity analysis,” said Larsen, or disclosure of the impacts if the company were to use other possible alternative inputs. FASB proposed some requirements around sensitivity analysis but dropped the requirement from the final guidance.

Larsen said FASB and the International Accounting Standards Board are working jointly on how to harmonize fair-value requirements, including whether and how to require some kind of sensitivity analysis.

As they promised, accounting standard setters are stepping up the pace and length of dialogue on some of the most vexing accounting issues in hope of achieving common approaches to U.S. and international rules sooner rather than later.

The Financial Accounting Standards Board and the International Accounting Standards Board met in London for an all-day and two half-day sessions this week to wade deeper into how to get converged standards on fair value measurement, leasing, revenue recognition, financial instruments, consolidation, derecognition, and financial statement presentation. They also worked through issues related to hedge accounting, discontinued operations, insurance contracts and post-employment benefits.

The two boards promised the Group of Twenty leaders they will pick up the pace of standard setting to narrow the differences between International Financial Reporting Standards and U.S. Generally Accepted Accounting Principles. The Financial Crisis Advisory Group reported to the G20 that weaknesses and differences in accounting standards were at least a contributing factor to the financial crisis that brought chaos to the global economy.

With respect to fair value, the boards decided to retain a notion that fair value is the same as an exit price in a hypothetical transaction, but they didn’t discuss or decide how to address gains or losses that might arise when a live transaction is different from the fair value of the transaction. They agreed that the fair value of a liability includes the effect of nonperformance risk, and that they will provide clarification on what that might include besides just credit risk.

As for revenue recognition, the boards tentatively decided they will require entities to disclose the nature of contracts and related accounting policies, the principal judgments involved, a reconciliation of beginning and ending net contract positions, a total amount of outstanding performance obligations as well as the expected timing for their resolution, and information about onerous contracts.

The two boards will meet jointly again five times in February via videoconfernce.