Academic journal article Journal of Accountancy

Understanding the FASB's New Basis Project: When Should a Reporting Entity Adopt a New Basis of Accounting for Assets and Liabilities?

Academic journal article Journal of Accountancy

Understanding the FASB's New Basis Project: When Should a Reporting Entity Adopt a New Basis of Accounting for Assets and Liabilities?

Article excerpt

Accountants hear with increasing frequency that the usefulness of financial statements prepared according to generally accepted accounting principles is declining. One reason for this may be reliance on the historical cost model and its requirement that the original purchase price (or the amount borrowed) be used to report most assets (liabilities). Recent Financial Accounting Standards Board requirements in Statement no. 107, Disclosures About Fair Value of Financial Instruments, may lead to an overhaul of some aspects of the historical cost model.

Another FASB initiative addresses potential departures from the original acquisition cost by entities experiencing a change in control, borrowing significant amounts of money or undergoing major capital structure modifications. In December 1991, the FASB addressed this initiative in a Discussion Memorandum, New Basis Accounting. As part of the FASB's project on consolidations and related matters, the DM examines the circumstances in which a reporting entity should adopt a new basis of accounting for assets and liabilities.

This article analyzes the new basis project. The specific issue the FASB faces is illustrated in exhibit 1, page 87, by the difference between NBP's stockholders' equity, currently carried at $1,000, and its fair value, $2,500, as shown in the condensed balance sheets. The new basis project will determine the circumstances calling for NBP's separate balance sheet to report the fair value amounts. The project also must determine the accounting treatment of the new basis revaluation-recognition of gain or loss in income or as a direct adjustment to stockholders' equity.

EXISTING NEW BASIS SCENARIOS

Existing scenarios in which an entity adopts a new basis in its financial statements are described in the sidebar on page 88. Except for business combinations, the new basis project includes reevaluations of each one of these scenarios.

CATEGORIES OF POTENTIAL

While grappling with situations that could give rise to a new basis of accounting, the FASB focused first on scenarios in which (1) a new reporting entity is created or (2) the existing entity's book values are irrelevant. The FASB later decided the four scenarios described below permit a better grasp of new basis issues.

A. Purchases of a majority of an entity's stock by outsiders. Although this category includes situations currently covered by push downs, the DM expands the potential transactions and asks: Should new basis (or push down) also apply to any majority acquisition? Should new basis amounts be reported on an acquired entity's separate balance sheet according to the same rules used for reporting new basis amounts in consolidated financial statements? If so, the conclusions the FASB reaches in its consolidation project will dictate the push down amounts.

Note: The FASB's Consolidation Policy and Procedures DM addresses whether assets and liabilities of a minority interest should be reported at the carryover basis or at the basis implied by the parent's acquisition cost. Reporting a minority interest at its implied fair value is accepted practice in some countries, but not in the United States.

Even if there is agreement new basis is appropriate for majority stock acquisitions, does a secondary offering, an initial offering or the exchange of a majority of an entity's stock in the market over a short time qualify? Must the change in majority ownership be accompanied by a new control group? Can a new control group arise when an existing shareholder group purchases a minority of the stock? These are difficult questions the FASB will need to answer.

B. Significant borrowing transactions. Underlying scenario A is the premise one or more stockholders are risking substantial resources on the entity's performance. Can that premise be extended to third-party lenders who put substantial resources at risk by granting credit to the entity or to others, based on the lenders' estimate of the entity's fair value? …

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