If remarks by the Securities and Exchange Commission are any indication of the complexities, the entanglement of business units can be difficult to explain to investors.
At a recent national accounting conference on regulatory issues, staff members at the Securities and Exchange Commission offered lots of advice on how companies can better explain to investors the intricacies of joint ventures, spinoffs, pushdown accounting, and segment reporting in their financial statements.
Christopher Rogers, a professional accounting fellow at the SEC, said U.S. accounting rules do not address the formation of a joint venture, so companies have no specific guidance to follow on the appropriate accounting in the stand-alone financial statements of a joint venture for the assets and businesses contributed to the joint venture. That has led to differences in how joint ventures are recognized, even with the economics of specific transactions are similar.
The staff would like to see the Financial Accounting Standards Board provide some clarity, Rogers said. In the meantime, “the staff continues to believe that joint control is not the only defining characteristic of a joint venture,” he said. Companies should refer to the definition of a joint venture in Accounting Standards Codification Topic 323, assuring each characteristic is met for an entity to be a joint venture, including the purpose of the entity and the joint venture.
“The staff has seen recent fact patterns where the primary purpose of a transaction is to combine two or more existing operating businesses in an effort to generate synergies such as economics of scale or cost reductions and/or to generate future growth opportunities,” he said. That raises questions about whether the purpose of purpose is consistent with the definition of a joint venture, or whether it’s more like a business combination. “We encourage registrants and auditors to come in and talk to us as they consider the appropriate accounting for joint venture formation transactions,” he said.
Spinoffs are becoming a common area of discussion, said Carlton Tartar, associate chief accountant at the SEC, perhaps because they are occurring more frequently. Companies often question whether the application of spinoff accounting guidance suggests a company should report a forward spin or a reverse spin, and how it should be presented in financial statements. Tax planning considerations are a factor, he said, but “they are not one of the explicit indicators on which the assessment of the accounting spinnor should necessarily be made.” Indicators include the relative size and fair value of the entities, which entity retains the majority of senior management, and the length of time each entity will be held after the spinoff. When indicators are mixed, judgment is critical, and the staff is happy to consult, he said.
Tartar said the staff has also received a number of questions lately on the application of pushdown accounting after a change-in-control event following recently issued guidance by both the FASB and the SEC to make the option more available. Questions revolve around the appropriate presentation of expenses that are incurred contingent upon a business combination when financial statements reflect the application of pushdown accounting, he said.
“The staff understands that such presentation typically includes predecessor and successor income statement periods, with a ‘black line’ separating the periods to visually illustrate the change in basis resulting from the change-in-control event,” he said. “The staff encourages registrants to evaluate whether it is appropriate to record expenses that are related to the business combination in either the predecessor or successor periods as appropriate, based on the specific facts and circumstances underlying each individual transaction.”
Finally, the SEC staff addressed a perennial topic—segment reporting. Dan Murdoch, deputy chief accountant, said the SEC staff’s thinking on segment reporting has evolved, “particularly as we have seen situations where our comments have become a substitute for more fulsome, principles-based analysis.” He encouraged companies to take a fresh look at who the chief operating decision maker is, taking care not to default to the CEO but to consider who is truly making key operating decisions for the segment. Companies should take a careful look as well at identifying and aggregating operating segments, he said. “Consider this your notice,” he said. “The staff will be taking a refreshed approach when reviewing operating segment disclosures. I encourage you to adopt a similarly refreshed mindset now.”