While a majority of the media in the US continue to stay focused on the vociferous public discourse taking place over the future of capitalism, it is noteworthy to point out the rule which states that once a private company in the US has more than 499 shareholders, the Securities and Exchange Commission [SEC] requires it to make financial disclosures as if it were a public company. A potential new regulation will lift the 499 shareholder limit, which will make it easier for companies to remain private. According to this article, proponents of the new regulation argue that fees and financial statement disclosure requirements preclude companies from forming the capital that is necessary for innovation. Opponents argue that the regulations favor private companies remaining private, thus keeping their investors “in the dark” regarding their finances and operations. Additionally, it is argued that lifting the 499 shareholder rule denies the investing public the opportunity to derive an economic benefit from an initial public offering of stock [IPO].
OECD Secretary General, Angel Gurria, discusses 21st Century Multilateralism and Global Governance
Founded in 1948 to help administer the Marshall Plan for the reconstruction of Europe after World War Two, the OECD has morphed into a global organization whose primary goal is to promote democracy and market economies. Lately, the OECD has been involved in the controversial subject of tax havens. Peer reviews have revealed deficiencies from tax authorities related to a lack of information for the ownership of trusts, companies, and partnerships. The OECD gained notoriety in 2008, when Germany and France requested that the OECD add Switzerland to a blacklist of countries which encourage tax fraud because they allegedly encourage tax evasion that is detrimental to their revenues. The issue of the sovereign rights of a country is a key criticism of the tax haven actions of the OECD.
@29:55, Stanford professor, Darrell Duffie, explains how clearinghouses may exacerbate the problem of CDS.
For example, AIG derivatives were “exotic”, i.e., not easily marketable.
Section 764(a) of Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act requires the Securities and Exchange Commission [SEC] to issue rules to provide for the registration of security-based swap dealers. Swap dealers will be subject to capital and margin requirements in an effort to lower risk, and dealers will be required to register with the SEC in an effort to regulate swap dealers.
Credit default swaps [CDS] are insurance policies that are used as a hedge against risky bonds. Prior to the near-collapse of American International Group [AIG], there was no clearing house, which is an intermediary between buyers and sellers. The purpose of a clearing house is to ensure that trades are settled and margin requirements are met, and Title VIII of the Dodd-Frank Act gives the Board of Governors of the Federal Reserve new authority with respect to the risk management of clearing agencies for CDS.
Announced on July 1, 2009, the FASB accounting standards codification is the organization of authoritative, non-governmental US generally-accepted accounting principles
Measuring the fair value of an equity interest in an acquired entity has become more complex not only in terms of the presentation of financial statements, but also combined interests have profound tax consequences which one must also take into consideration. Accounting consolidation rules have expanded to include Financial Interpretation 46, or FIN 46 for short, which replaces the term special purpose entity with the term Variable Interest Entities, or VIE’s. The rules evolved in the wake of the Enron scandal, however, before FIN 46 the guidance for consolidation accounting came from ARB No. 51, which was issued in 1958 and simply set consolidation guidance based upon voting interest of greater than 50 percent.
Rules for consolidation accounting reflect a trend away from defining control of another entity quantitatively and instead in terms of risks-and-rewards in a more qualitative approach for assessing control. There are now essentially two models for determining an entity should be consolidated for accounting purposes in which the rules assume that consolidated financial statements are more meaningful than separate statements and in which consolidated entities are defined not by what constitutes VIE’s but rather by what excludes them from qualifying as being consolidated under a risks and rewards model.
Codification of the VIE rules came into being in July 2009 with the advent of accounting standards codification, or ASC 810, in which an entity is deemed not to have a variable interest in which the following characteristics exist:
1. The power to direct the activities of a VIE that most significantly impact the VIE’s economic performance, and
2. The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.
While accounting rules have been broadened to require consolidation when equity interests alone are not sufficient to require it, by contrast, the Internal Revenue Code simply defines an affiliated group of corporations as ownership of at least 80 percent of the total voting power of another corporation and having a value of at least 80 percent of the total value of the stock of the corporation. Thus, it is more likely now that a company can be required to consolidate for accounting purposes, however, it will not be combined for tax purposes giving rise to a host of book-tax differences. It is the maintenance of the book-tax differences which constitutes an additional clerical burden on top of the myriad of VIE tests for determining whether an entity is consolidated or not.
A compelling argument for relying upon the relatively simple rules of ARB 51 and having a controlling voting interest is the many benefits of filing consolidated tax returns, especially in which the benefit of offsetting the profits of one entity against the losses of another is probably most notable. In the start-up arena for example, in which there are multiple investors each holding equal shares but who do not exercise equal control, provided there is one controlling financial interest which possesses significant decision-making ability, has the obligation to absorb expected losses, and has the right to receive expected residual returns then the entity is a VIE and is generally consolidated for financial statement presentation purposes, however, for tax purposes the entity will not be consolidated if the controlling interest is less than 80 percent.
Essentially, even if equity investors do not have an at-risk financial interest and do not direct the activities of the entity then the entity may be a VIE. On the other hand, if an entity is not thinly capitalized, meaning equity is sufficient and the investors meet the criteria of a control, the entity is generally not a VIE and is not consolidated. Nonetheless, it would be consolidated under the voting interest entity test if a single equity investor holds a majority voting interest or has a controlling financial interest in some other manner.
Perhaps a pragmatic way of approaching the application of the rules is by viewing them through the prism of whether key decisions are being made by non-equity interests, and whether backstopping losses and denying the right to receive returns identify nontraditional equity interests. However, the responsibility of determining whether consolidated financial statements are required also must take into consideration the tax benefits. Additionally, the aspect of record keeping of book versus tax differences must be balanced with the risks associated with an increased voting equity interest.
FATCA, or the Foreign Account Tax Compliance Act, was enacted in 2010 as part of the HIRE Act. FATCA requires that US taxpayers holding financial assets outside the US are required to report those assets to the Internal Revenue Service. FATCA also requires foreign financial institutions to report directly to the IRS information about accounts held by US taxpayers.
Additionally under the provisions of FATCA, payments of US-source income, including interest, dividends, and other investment income made to non-US individuals are subject to US withholding tax of 30%, unless the withholding agent can establish that the owner of the amount is eligible for exemption from withholding or is subject to tax at a reduced rate under an income tax treaty.
Gains from the sale of property by a nonresident alien or foreign corporation are exempt from US tax, unless they are effectively connected with the conduct of a US trade or business. Gains are subject to US taxation only if the individual meets the requirements of the substantial presence test, which generally means the individual is present in the US for 183 days or more during the year.
The IRS Tax Code sections enacted by the new law are 1471, 1472, 1473, and 1474, and in order to avoid being withheld upon under FATCA, a foreign financial institution [FFI] will have to enter into an agreement with the IRS to:
1. Identify U.S. accounts,
2. Report certain information to the IRS regarding U.S. accounts, and
3. Withhold a 30-percent tax on certain payments to non-participating FFIs and account holders who are unwilling to provide the required information.
FFIs that do not enter into an agreement with the IRS will be subject to withholding on certain types of payments, including U.S. source interest and dividends, gross proceeds from the disposition of U.S. securities, and passthru payments. The phase-in guidance for FATCA under Notice 2011-53 are as follows:
1. An FFI must enter an agreement with the IRS by June 30, 2013, to ensure that it will be identified as a participating FFI in sufficient time to allow withholding agents to refrain from withholding beginning on January 1, 2014.
2. Withholding on U.S. source dividends and interest paid to non-participating FFIs will begin on Jan. 1, 2014, and withholding on all withholdable payments (including on gross proceeds) will be fully phased in on Jan. 1, 2015.
3. Reporting requirements for “high-risk accounts”, i.e., those with a balance equal to or greater than $500,000 will begin in 2013.
The form for reporting foreign financial assets will be Form 8938. To view a draft of the form, you can go here.
In conjunction with the Clarity Project, in 2010, the Accounting Standards Board [ASB] issued reporting standards for supplementary information that is presented with financial statements. Statements on Auditing Standards [SAS] numbers 118, 119, and 120 were issued by the senior technical body of the AICPA in advance of the December 2012 effective date. They deal with audit compliance with respect to supplemental information disclosed in financial statements, which includes both accounting and non-accounting information.
SAS 118 deals with the subject of “Other Information”, and includes retirement plan information, statistical data, employment data, and expected future capital expenditures. These are termed “additional analysis” and are not a required part of financial statements. An additional paragraph is added to the audit report, which disclaims responsibility of the information, because no auditing procedures are applied to them. However, the auditor is required to read the other information in order to determine whether there are any material inconsistencies between the audited financial statements and the other information, and management may include both accounting and non-accounting other information as long as they are not directly related to the financial statements.
SAS 119 defines “Supplementary Information” as that being related to the financial statements, however, it is not required to be presented. Key among the criteria for determining whether information is supplemental is whether it is related to the underlying accounting procedures employed to prepare the financial statements and that the information relates to the same time period of the financial statements. In such cases, the auditor must obtain management’s written acknowledgment of its responsibility of the supplementary information. The auditor should apply auditing procedures used for the financial statements to the supplementary information, and a paragraph is added to the audit report, which states that the information has been compared and reconciled to the accounting records that were used to prepare the financial statements.
SAS 120 sets forth guidance on supplemental information that is required to be presented with the financial statements. An example would be multiple year comparisons on consolidated financial statements, which fall under the category of MD&A, or management’s discussion and analysis. Material changes in financial statements, trends, contractual commitments, or uncertainties that can be reasonably expected to have a material impact on the financial statements are examples of supplemental information required to be presented. In this case, the auditor’s report should include a description of the responsibility of the auditor for the required supplemental information based upon management’s written representations acknowledging responsibility for the supplemental information and whether the presentation has changed from year to year. However, the fairness of the presentation of the financial statements is not affected by the required supplemental information, and the auditor’s report does not express an opinion on the information.
For more on other redrafts taking place on SAS’s in conjunction with the Clarity Project, you can go here.
Steve Harding, CFO of privately-held, commercial real estate investment and development firm, Transwestern, gives an overview of the debate over the presentation of leases under FAS 13.
Though the debate rages on as to the recognition of a capital or financing lease on the balance sheet, one must bear in mind that accounting rules continue to be debated within the conceptual framework of accounting. No debate about leases would be complete without taking into consideration the following traditional benchmark concepts, and regardless of there being other lease characteristics that are akin to operating leases, substance over form is tantamount: (a) whether title transfers at the end of the lease, (b) whether there is the presence of a bargain purchase option, (c) whether the lease term is 75% or greater of the asset’s useful life, and (d) and if the present value of the lease is at least 90% of the value of the asset at the inception of the lease.
It cannot be emphasized adequately that accounting rules are being debated vigorously, the ultimate goal being of streamlining and simplifying financial reporting standards. The debate rages over the valuation and recognition of an equally contentious and complicated topic, which is stock options. It would be advisable for anyone interested in the topic to view this review of FAS 123(R), which addressed the valuation issue of options. You can also brush up on FAS 123 here.
It is clear that the impact made by the debate over accounting rules has far-reaching implications on financial reporting. Though industry standards weigh on the debate, the effects of changes on earnings and shareholder’s equity can be material. Webtaxcpa reminds its readers that an understanding of the background and history of accounting rules is key to understanding the current financial reporting framework, and readers are encouraged to avail themselves of the handy research links located on the sidebar.
