0
0
753620
Chapter 0 - Overview
Recent events in the financial markets and the current economic environment may affect companies' operations and financial reporting and, in turn, may have implications for audits of financial statements and internal control over financial reporting. Audit risks that may have been identified previously may become more significant or new risks may exist due to current events (e.g., those affecting the economy, credit and liquidity). Among other things, the current uncertainties in the market and economy may create questions about the valuation, impairment, or recoverability of certain assets and the completeness or valuation of certain liabilities reflected in financial statements.
This course is intended to
• Provide auditors and other accountants with an overview of recent economic, industry, technical, regulatory, and professional developments that may affect audits, other engagements they perform, and other accounting practices.
• Assist auditors in identifying matters related to the current economic environment that might affect audit risk and require additional emphasis.
• Assist accountants in industry in identifying matters related to the current economic environment that might affect their areas of responsibility.
While the course highlights certain areas, it is not intended to identify all areas that might affect audit risk or other business risks in the current economic environment or serve as a substitute for the relevant auditing or accounting standards.
The course is organized as follows:
• Chapter 1 - Economic, Legislative, and Regulatory Developments
• Chapter 2 - Fair Value Accounting Issues and Developments
• Chapter 3 - Related Fair Value Accounting Issues and Developments
• Chapter 4 - Auditing Considerations for Issuers and Non-issuers
• Chapter 5 - Fraud - Audit and Management Implications
• Chapter 6 - What You Can Do to Help Your Clients
• Chapter 7 - On the Horizon and In the Pipeline
Emergency Economic Stabilization Act of 2008
The Emergency Economic Stabilization Act of 2008 (EESA), commonly referred to as a bailout of the U.S. financial system, is a law enacted in response to the global financial crisis of 2008 authorizing the United States Secretary of the Treasury to spend up to $700 billion to purchase distressed assets, especially mortgage-backed securities, and make capital injections into banks. Both foreign and domestic banks are included in the bailout. The Act was proposed by Treasury Secretary Henry Paulson during the global financial crisis of 2008.
The primary components of this bill, among others, follow:
• Allocation of $700 billion to stabilize the financial system, called Troubled Asset Relief Program (TARP)
• Creation of rules for entities that receive this aid, including limits on executive compensation and the creation of an oversight board
• Increase of $1.3 trillion in the public debt limit
• Increase in FDIC insurance limits to $250,000
• Measures directed at revision or suspension of Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 820, Fair Value Measurements and Disclosures (SFAS No. 157)
TARP was originally intended to be used to buy the inappropriately named "toxic assets." These securities, for which no market seemed to exist, had engendered huge write-downs which, in turn, created a "self-fulfilling prophecy" as investor confidence was further eroded. However, as early as October 3, 2008, Treasury Secretary Paulson indicated that he believed that merely creating a market for these securities would not be sufficient to create assets for lending. Instead, he recommended and it was decided to use the resources to purchase equity in banks.
This injection of capital into banks was announced on October 14, 2008. This plan had an allocated budget of $250 billion and was named the Capital Purchase Program (CPP). Half of the funds for this program were distributed to nine of the largest financial institutions in the nation, which together held approximately 55% of U.S. banking assets. The other half of the funds were allocated for smaller financial institutions. All participating institutions would have the same terms under this program. However, there is a sense of uncertainty by many about how the banks will actually use this $250 billion. The clear intent is for them to increase lending. The worry is that they will hoard the funds for possible tough times ahead. The full effects of the CPP have yet to be realized and only time will reveal how banks used this government cash injection and which benefits were provided to the economy.
This $250 billion has also been used to purchase senior preferred shares of the participating entities. These shares are senior to common stock and carry equal force with existing preferred shares. The only exception to this status would be any preferred shares, which by their terms, rank junior to existing preferred shares. These preferred shares pay a cumulative dividend of 5% per annum for the first five years with the rate reset to 9% after year five. The shares are nonvoting (other than on matters that could adversely affect the shares) and are callable at par after three years. Simultaneously, the U.S. Treasury will receive warrants to purchase common stock with an aggregate market value equal to 15% of the senior preferred investment. These warrants have a ten year term and the exercise price will be the market price of the institution's common stock at the time of issuance, calculated on a twenty trading day trailing average. Any participating entities must adopt the standards on executive compensation and corporate governance created by the EESA for the period the Treasury holds equity issued under this program.
After the announcement of this plan, practitioners started to consider the accounting implications of these warrants. For warrants in general, depending on the terms of warrants, some are accounted for as liabilities as they represent a future obligation which will be settled by an outflow of assets and some are accounted for as equity because they can only be converted to equity. If the warrants received by the Treasury under the plan are accounted for by the issuer as liabilities, their intended benefits may be somewhat diminished. As liabilities, the warrants are required to be accounted for at fair value, thereby possibly increasing earnings volatility.
To address this concern, the SEC and FASB issued a letter on October 24, 2008, that noted, "we would not object if the Warrants...were to be classified as permanent equity under applicable U.S. GAAP, provided that the issuer of such Warrants has sufficient authorized but unissued shares of the class of stock that may be required upon settlement and any other necessary shareholder approvals have been obtained." The letter went on to state that as long as these approvals were obtained prior to the end of the fiscal quarter in which the warrants were issued, immediate classification as permanent equity would be appropriate as well.
It is unclear whether the remaining allocation of money to stabilize the economy will be directed at repurchasing troubled mortgage-related assets, though many banks are still hoping that will happen. According to a survey conducted by the Securities Industry and Financial Markets Association and four other advocacy groups in November 2008, 53% of 445 eligible banks said they would expect to participate if this program was carried out. The lack of clarity on whether this method will ever be implemented has had numerous effects on the market. Many institutions were hoping these purchases would provide some price discovery on these troubled assets, which they could then leverage in pricing their own assets. Additionally, some institutions would consider transferring assets to held-to-maturity status (and, therefore, generally not subject to fair value measurement) but will not if there is a possibility that the U.S. Treasury may become a buyer.
Late in November 2008, the Federal Reserve announced the creation of the Term Asset-Backed Securities Loan Facility (TALF). The Federal Reserve Bank of New York will lend up to $200 billion to holders of certain AAA-rated asset backed securities (ABS) backed by newly and recently originated consumer and small business loans through December 31, 2009. The first $20 billion for this facility will be provided by the EESA to the Federal Reserve Bank of New York. The intent of this facility is to increase credit availability for student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. The date that TALF will commence operations was scheduled to be announced in March 2009.
In December 2008, the Government Accountability Office (GAO), as mandated by the EESA, published its first report on TARP to Congress. This report noted specific "areas that warrant Treasury's ongoing attention," which consist of the following nine recommendations for the Treasury to implement:
• Develop a system to determine whether participating institutions' activities are consistent with the underlying purpose of the CPP.
• Develop a method to ensure that participating entities of the CPP comply with the requirements of the program, such as executive compensation limits and dividend payments.
• Formalize communications with the key stakeholders (the public and Congress) to ensure an understanding of the program's current strategy and the underlying rationale.
• Develop a definitive transition plan for the new incoming presidential administration.
• Continue building a base of employees to carry out and oversee TARP.
• Ensure that appropriate amounts of personnel are assigned to oversee the performance of all contractors hired to execute TARP.
• Continue to develop a comprehensive system of internal controls over TARP activities.
• Issue final regulations on any conflicts of interest concerning contractors and financial agents.
• Institute a system to effectively manage and monitor the mitigation of conflicts of interest.
Overall, the U.S. Treasury agreed with the recommendations of the GAO; however, the Treasury had a different opinion on how best to monitor the activities of participants of the CPP. The Treasury's method consisted of developing general metrics for evaluating the overall success of the CPP, instead of working with bank regulators to establish a systematic method for determining whether entities' use of CPP funds was consistent with the purpose of the program, as recommended by the GAO.
The full report can be viewed at www.gao.gov/new.items/d09161.pdf.
753620
Customer Service
Customer Service
Customer Service
Back to Browsing Products