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Sony Pictures Entertainment US GAAP, Sony CAP and SPE Accounting Policies and Procedures - Training Course September 5, 2006 International Finance Directors Conference Rome, Italy 1 Agenda Welcome and Agenda US GAAP, Sony Corporate Accounting Policies (CAP) and SPE accounting policies and procedures Q&A and Closing 2 Welcome and Agenda Objective Re-fresh current US GAAP topics and gain understanding of Sony CAP and SPE accounting policies and procedures Introduce SPE Technical Support and Compliance Group resources and links 3 AGENDA Cash and Cash Equivalents Accounts Receivable Inventory Film Costs Broadcast Rights Fixed Assets Software and Website Development Costs Investments Investments in Unconsolidated Subsidiaries Goodwill and Intangibles Other Assets 4 AGENDA Accounts Payable Accrued Expenses and Other Liabilities Contractual Obligations Deferred Revenue Debt Equity and Retained Earnings Revenue Recognition Barter Revenue Expenses Income Taxes Pensions Consolidation and Financial Reporting 5 CASH AND CASH EQUIVALENTS 6 Cash and cash equivalents Topics Cash and Cash Equivalents Restricted Cash Overdrafts Minimum Internal Controls 7 Cash and cash equivalents Cash equivalents are investments that: have an original maturity date of three months or less from the date of purchase are readily convertible into a known cash amount and are so near maturity that there is very little risk that the cash value will change If the above criteria is not met, investments should be classified as short-term or longterm investments depending on maturity Questions: 1. 2. 3. Does a three-month Treasury Bill purchased three months from maturity date qualify as cash equivalent? Does a three-year Treasury note purchased three months from maturity date qualify as cash equivalent? Does a three-year Treasury note purchased three years ago qualify as cash equivalent? 8 Cash and cash equivalents Answers: 1. Yes, because original maturity is three months from the date of purchase 2. Yes, because original maturity is three months from the date of purchase 3. No, because original maturity is three years from the date of purchase 9 Restricted Cash Compensating balances with legal restriction as to withdrawal Current vs. non-current classification of restricted cash: Relate to current liabilities – Restricted cash in current assets Relate to non-current liabilities – Restricted cash in non-current assets 10 Overdrafts Bank overdrafts: Book overdrafts: total of checks honored by the bank without sufficient funds in the account to cover them should be classified as a current liability more common outside of the the United States overdrafts on ZBA accounts are evaluated at the “parent” account level for possible reclassification due to legal right of offset represent outstanding checks in excess of funds on deposit should be classified as a current liability except for ZBA accounts which are evaluated at the “parent” account level for possible reclassification due to legal right of offset Checks written but not Released: Checks drawn but not released (e.g., not mailed) by the end of accounting period should not be deducted from the cash balance but should be included with accounts payable or other appropriate liability accounts 11 Overdrafts Questions: 1. Should Cr balance in a/c 100230 be re-classified to current liability? 2. Should Cr balance in a/c 100170 be re-classified to current liability? 3. Should Cr balance in a/c 100219 be re-classified to current liability? 12 Overdrafts Answers: No, because this account is ZBA but should be evaluated at the parent account level No, because this account is ZBA but should be evaluated at the parent company account level Depends. If there are no cash accounts at Wells Fargo which this a/c has legal rights to be offset with, then it should be re-classed to current liability. 13 Minimum Internal Controls Responsibilities for receiving, disbursing and reconciling cash should be segregated Bank accounts can only be opened or closed with the approval of the SPE Treasurer or Assistant Treasurer Bank and investment statements should be reconciled to the G/L on a timely basis (before the end of the next calendar month) each month for all accounts (except for impressed accounts that should be reconciled on a quarterly basis), and reviewed by at least a Manager in the Finance Department. Any exceptions to timing of reconciliations should be pre-approved by Treasury and Technical Compliance and Support Department All suspense accounts should be analyzed and cleared on a monthly basis and reviewed by at least a Manager in the Finance Department Any restrictions on the availability of cash balances should be disclosed to Corporate Reporting 14 ACCOUNTS RECEIVABLE 15 Accounts Receivable Topics Recording and Classification Doubtful Accounts Sales Discounts and Reserves Minimum Internal Controls 16 Recording and Classification To be recorded when they are both measurable and earned SOP 00-02 receivables (refer to Revenue section) Non-SOP 00-02 receivables (refer to Revenue section) Percentage-of-Completion Receivables should be recorded based on the ratio of current direct costs to total estimated direct costs Long-Term Receivables – any receivable within a maturity date or expected collection date greater than one year. Should be classified as long term and discounted 17 Doubtful Accounts Specific Reserve: Determined based upon a specific account-by-account review Should include both billed and unbilled receivables General Reserve: Made for the remaining pool of receivables (after deducting receivables covered by specific allowance) Requires aging of current period customer accounts. Historical data plus current trends can be used for determination of allowance percentage for each of the categories (i.e. 130, 31-60, etc.) Category Days Past Due Percentage of Allowance * Approval from Corporate of allowance percentage from I 1 - 30 Corporate. Needs to be revised II 31-60 III 61-90 every three years or covered as IV 91-180 part of Balance sheet review process V 180+ Should be documented and retained * Each individual reporting unit needs to determine the percentage of allowance 18 Sales Discounts and Reserves Questions: 1. How is sales returns allowance calculated and when it should be recorded? 2. Should the bad debt expense be recorded in operating expenses or contrarevenue? 3. When should sales discounts be recorded? When should an allowance for sales discounts be recorded? 4. Can one allowance cover both sales returns and doubtful accounts? 19 Sales Discounts and Reserves Answers: 1. The amount of the allowance should be a percentage of sales based on the division’s past experience and current market conditions. The allowance should be recorded at the time the associated accounts receivable are recorded 2. Bad debt expense should be classified as contra-revenue. It should be passed to the “producing” entity similar to distribution related expenses in order to match revenue and expenses and the producing entity/product 3. Sales discounts offered to customers in exchange for early payment should be recorded at the time the discount is taken. The allowance for sales discounts should be established at the time of billing to reflect the amount of potential discounts 4. No, two separate allowances should be established 20 Minimum Internal Controls Accounts Receivable sub-systems, as applicable, should be reconciled to the G/L at least quarterly Aging reports should be updated and reviewed on a monthly basis and any significant changes in the aging, past due accounts and credit balances should be investigated The allowance for doubtful accounts, returns and other allowances should be assessed for adequacy at least quarterly and adjustments approved by the Controller or higher All receivables should be reviewed on at least quarterly to ensure that they have been properly classified between current and noncurrent Any employee loans are generally prohibited. Exceptions must be approved by SPE General Counsel 21 INVENTORY 22 Inventory Topics Definition Acquisition Costs Valuation Minimum Internal Controls 23 Definition and Acquisition Costs Purchased or manufactured items for the purpose of resale including but not limited to video cassettes, DVD’s, blue-ray disks, packaged software/games, etc Acquisition costs = invoiced cost + total of all incidental costs (e.g., freight-in, insurance, duty, etc.) – purchase returns and allowances Receiving, inspection, storage, handling and interest costs are not included in acquisition costs Incidental costs that are less than 3% of total purchased inventory or manufacturing costs may be excluded from acquisition costs 24 Valuation Inventory shall be valued at standard full absorption cost (full costing). Includes direct materials, direct labor, both variable and fixed manufacturing overheads Cost variances (the differences between standard costs and actual costs, or previous standard costs and current standard costs) shall be allocated between inventory and costs of sales. Total net variances less than 1% of total manufacturing cost or total purchasing cost may be charged or credited against cost of sales. This is a Sony Corporation policy based on materiality 25 Valuation Inventory shall be valued at the lower of cost or market. “Market” refers to either net realizable value (NRV) or repurchasing cost, defined as follows: Net realizable value = (Net selling price) – (Direct sales expenses) Repurchasing cost is the “actual purchasing unit price” or “contract unit price” at the time of valuation The following limits are placed on “market”: Ceiling – selling price minus estimated cost of completion and sale Floor – selling price minus estimated cost of completion and sale, and a normal gross profit 26 Valuation Example of applying the “ceiling” and “floor” tests : 27 Valuation Establish inventory reserve for slow-moving items: Reserve is established based on past returns experience and current and expected market conditions Once an inventory item has been written down, this lower value is considered cost for future comparisons with “market” Any purchases or sales of inventory from/to SPE entities (intercompany) and Sony affiliates should be identified and reported to the Home Office for elimination 28 Minimum Internal Controls Physical inventories each half-year or cycle counts on a rotational basis should be performed and reconciled to the inventory system and G/L Inventory held by third parties should be reported or confirmed by the third party and reconciled to the inventory system and G/L at least annually NRV test should be performed at least quarterly Obsolescence reserves or write-offs should be reviewed and approved by management in accordance with COFA 29 FILM COSTS 30 Film Costs Topics Definitions Capitalization of Film Costs Amortization of Film Costs Ultimate Revenues Valuation of Film Costs Minimum Controls 31 Definitions Statement of Position 00-2 (SOP 00-2), Accounting by Producers or Distributors of Films Film - feature films, television series, television specials, on any medium (e.g. film, videotape, digital) The costs of producing a film and bringing that film to market consists of film costs, participation costs, exploitation costs, and manufacturing costs 32 Definitions Film costs – Direct negative costs, allocated production overhead, and capitalized interest (if applicable) of physical production of film or television properties Participation costs – parties involved in the production of a film may be compensated in part by contingent payments based on the financial results of a film pursuant to contractual formulas (participations) and by contingent amounts due under provisions of collective bargaining agreements (residuals). Such parties are collectively referred to as participants, and such costs are referred to collectively as participation costs. Participations may be given to creative talent, such as actors and writers, or to entities from whom distribution rights are licensed 33 Definitions Exploitation costs – all direct costs (including marketing, advertising, publicity, promotion, and other distribution expenses) incurred in connection with the distribution of a film Manufacturing costs - costs of manufacturing or duplicating products, including film prints, videocassettes and digital video discs. Not included in film costs Film prints – those materials, produced on behalf of a film distributor for delivery to a theatre or other similar venue, that contain the completed audio and video elements of a film. Such materials are used by the theatre or other similar venue to exhibit the film to its customers 34 Definitions Ultimates represent the estimated lifetime revenues of the exhibition or sale of a film or television product in all markets and territories, including revenues from the sale of title-related products Ultimates are used to determine the amount by which film costs should be amortized each accounting period 35 Capitalization of Film Costs Should be recorded as a non-current asset Film costs consist of 1) the production or “negative” costs of a film or television product, including direct production costs such as ATL and BTL payroll, set construction, wardrobe, sound, postproduction costs, etc. 2) development costs that are directly related to a title, and 3) allocated production overhead Production overhead includes allocable costs of individuals or departments with exclusive or significant responsibility for production of films. Production overhead should not include G&A costs, the costs of certain overall deals Overall deals (e.g. the exclusive right to a writer’s creating product) should not be included in film costs unless costs can be directly associated with the acquisition, adaptation or development of specific projects Interest related to production of a film can be capitalized. SPE’s practice – not to capitalize the interest 36 Capitalization of Film Costs If a project is not expected to be ultimately used in the production of a film or television property, a loss should be recorded immediately Any project that has not been “set for production” within three years from its capitalization should be expensed A property is set for production when (a) management has implicitly or explicitly committed to fund the production, i.e. greenlight (b) the property has entered active pre-production and c) principal photography is set to start within six months 37 Capitalization of Film Costs Episodic television series costs can be capitalized only to the extent of revenue contracted for the respective episode until its future secondary market revenues can be estimated. An entity should expense as incurred film costs in excess of this limitation on an episode-by-episode basis, and an entity should not restore such amounts as film cost assets in subsequent periods. An entity should expense all capitalized costs (including set costs) for each episode as it recognizes the related revenue for each episode. Once secondary market revenues can be estimated, costs may be capitalized to the extent supported by the ultimates In cases of an episodic television series over multiple seasons, where secondary market revenue can be estimated, the series can be counted as a single film in calculating amortization 38 Capitalization of Film Costs Example – Accounting for costs of episodic television production prior to the establishment of secondary market revenue estimates Assumptions: An episodic TV series is in first year of production Secondary market revenue estimate – none Cost of production, per episode after the first episode - $500,000 (assume that the most of the set costs were accounted for as part of the first episode) Exploitation costs, per episode - $5,000 Estimated ultimate revenue per episode: contracted $200,000 39 Amortization of Film Costs Individual-film-forecast-computation method Individual-film-forecast-computation method is calculated as: Actual revenue for current period x Unamortized film costs Future ultimate revenue starting from Beginning of current fiscal year Change in amortization due to change in ultimates – charge or credit to income statement 40 Amortization of Film Costs Example - Illustration of the Individual-Film-Forecast Method of Amortization, for a Film in Its Initial Year of Release Assumptions: Film cost - $50,000 Estimated ultimate revenue - $100,000 Actual revenue earned in Year 1 - $60,000 Estimated ultimate participation costs - $10,000 Question 1 – What is film cost amortization in Year 1? Question 2 – What amount of participation costs is accrued in Year 1? 41 Amortization of Film Costs 1. Film cost amortization in Year 1: $60,000 earned revenue * $50,000 film cost = $30,000 $100,000 ultimate revenue 2. Participation costs accrued in Year 1: $60,000 earned revenue $100,000 ultimate revenue * $10,000 ultimate participation costs = $6,000 42 Amortization of Film Costs Example - Illustration of the Individual-Film-Forecast Method of Amortization, for an Episodic Television Series Question 1 – What is the amount of amortization for season 4 and 5? Question 2 – What is the amount of accrual of participation costs for season 4 and 5? Assumptions: An entity produces and distributes an episodic television series. Five seasons of the series are ultimately produced. The entity's fiscal year end corresponds directly with the completion of each production season. The beginning of Season 4 is when secondary market revenue estimates are initially established. Costs of production are the following: 1. 2. 3. 4. Seasons 1 to 3 - $36,000 (fully expensed prior to Season 4) Season 4 - $16,000 Season 5 - $18,000 43 Amortization of Film Costs Assumptions (cont’d): 5. Earned and remaining ultimate revenues are the following: As of Season 4 Earned and reported in Season 4 Earned and reported in Season 5 Remaining ultimate revenue, Seasons 1 to 4 $40,000 Remaining ultimate revenue, Season 5 As of Season 5 Earned and reported in Season 4 Earned and reported in Season 5 Remaining ultimate revenue, Seasons 1 to 4 Remaining ultimate revenue, Season 5 6. Ultimate participation costs are as follows: As of Seasons 1 to 3 As of Season 4 As of Season 5 $ 8,000 N/A N/A $48,000 N/A $11,000 $40,000 $10,000 $61,000 $ 0 $2,000 $3,000 44 Amortization of Film Costs 1. Amortization of series costs: Season 4 Season 5 2. $8,000 /$48,000 x $16,000 = $2,667 $11,000 /$61,000 x $31,333 = $5,650 Accrual of participation costs: Season 4 $8,000/$48,000 x $2,000 = $333 Season 5 $11,000/$61,000 x $2,667 = $481 45 Ultimate Revenues Most Properties Revenues should be estimated for up to the tenyear period following the initial release for noncatalog and non-episodic television series properties Episodic Television Series Revenues should include estimates of revenue over a period not to exceed ten years from the date of delivery of the first episode or, if still in production, five years from the date of delivery of the most recent episode, if later. Revenue estimates for secondary markets should be included only if an entity can demonstrate through its experience or industry norms that the number of episodes already produced, plus those for which a firm commitment exists and the entity expects to deliver, can be licensed successfully in the secondary market 46 Ultimate Revenues Catalog Properties Revenues for films acquired for the film library should be estimated over a period of up to twenty years from acquisition date Film-Related Products Revenues from licensing deals for the marketing of film-related products should be included only if either a) a contract for a nonrefundable amount exists or b) there is a history of revenues from similar deals. In the case of film-related product sales revenues, revenues should be included only if there is a history of revenues from similar products for similar types of films. 47 Valuation of Film Costs Film costs must be recorded at the lower of cost or net realizable value (NRV). The fair value of the film should be evaluated using discounted cash flows. In cases where the fair value of a film is expected to be less than its unamortized film costs, the film must be written down to fair value, with the difference recorded as a loss. In no case can a film’s recorded value be written up Subsequent events Need for a write-down occurred after the date of the balance sheet but before issuance of financial statements – film costs have to be adjusted for the write-down 48 Minimum Internal Controls NRV testing should be performed at least quarterly for all significant titles Amortization expense should be reconciled from the sub-system/schedule to the G/L quarterly “Catalog” balances should be reviewed at least quarterly to determine all exploitation costs have been expensed as incurred Production overhead costs should be reviewed annually to determine a) that capitalized costs are still appropriate and b) whether any portion of non-capitalized overhead costs should be capitalized Capitalizable overhead should be allocated on a by-title basis at least quarterly Ultimates should be prepared/updated for all significant titles at least quarterly in consultation with operating management 49 BROADCAST RIGHTS 50 Broadcast Rights Topics Definition Of Broadcast Rights Capitalization and Classification of Broadcast Right Amortization Of Broadcast Rights Valuation Illustration of Accounting for License Agreements For Program Material Minimum Internal Controls 51 Definition of Broadcast Rights Statement of Position 00-2 (SOP 00-2), Accounting by Producers or Distributors of Films and FAS 63, Financial Reporting by Broadcasters Broadcast Rights consist of 1) 2) 3) rights to existing programming acquired under a license agreements programming produced internally principally for broadcast by owned stations or networks and rights to live programming acquired under license agreements and related amortization thereof 52 Capitalization and Classification of Broadcast Rights Broadcast/Program rights and the related liability should be recorded on the balance sheet when all of the following conditions have been met: Current and non-current classification: The license period has begun The cost of each program is known or is reasonably determinable The material is acceptable to SPE in accordance with the license agreement The program is available for first showing or telecast Asset – based upon the estimated accounting period in which the programming will be aired Liability – payment terms Amounts paid to a licensor before the license period begins should be classified as a prepaid expense 53 Capitalization and Classification of Broadcast Rights Key issue is the allocation of programming rights to individual programs when they are purchased as part of a package. Costs should be allocated to individual titles based upon the relative value to the programmer. Generally, the cost of the individual programs is set out in the contract. If not, the programmer must employ a systematic and rational allocation of the costs on a by-title basis US GAAP allows licensed program rights to be recorded either at gross or net (NPV). SPE policy is to record at gross value 54 Amortization of Broadcast Rights Purchased rights (package) – allocation to individual programs based on the relative values of the films or series, which is commonly stated in the contract. If the value of the first airing is significantly greater than subsequent airings, an accelerated method of amortization should be used. Exception - cartoons, which allow for unlimited airing over a license period - amortization over the period of the agreement Feature product - on a program-by-program basis Program series and other syndicated products - allocation needs only to be made to the series level and not to the individual episode level. If the value of the first airing is significantly greater than subsequent airings, an accelerated method of amortization should be used Internally developed programs - individual film forecast computation method 55 Valuation of Broadcast Rights Should be reported at the lower of unamortized cost or estimated net realizable value on a program-by-program, series, package, or daypart basis, as appropriate Management should compare projected revenues to the carrying value . The projected revenue should take into consideration the anticipated airing pattern for the property and the ad revenue associated with the airing pattern. Subscription and affiliate fees need to be evaluated if they can be included in projected revenue A write-down from unamortized cost to a lower estimated net realizable value establishes a new cost basis 56 ILLUSTRATION OF ACCOUNTING FOR LICENSE AGREEMENTS FOR PROGRAM MATERIAL Assumptions: a. End of Fiscal Year-December 31 b. Contract Execution Date-July 31, 19X1 c. Number of Films and Telecasts Permitted-4 films, 2 telecasts each d. Payment Schedule-$1,000,000 at contract execution date, $6,000,000 on January 1, 19X2, 19X3, and 19X4 e. Appropriate Interest Rate for Imputation of Interest-12 percent per year 57 ILLUSTRATION OF ACCOUNTING FOR LICENSE AGREEMENTS FOR PROGRAM MATERIAL f. Fees, License Periods, and Film Availability Dates: g. Telecast Dates and Revenues 58 ILLUSTRATION OF ACCOUNTING FOR LICENSE AGREEMENTS FOR PROGRAM MATERIAL Asset and Liability Recognition (Gross Approach) Expense Recognition (Gross Approach) 59 Minimum Internal Controls NRV testing should be performed at least quarterly for all programs Amortization expense should be reconciled from the sub-system/schedule to the G/L at least quarterly Production overhead costs should be reviewed annually to determine a) that capitalized costs are still appropriate and b) whether any portion of non-capitalized overhead costs should be capitalized Capitalizable overhead should be allocated on a by-title basis at least quarterly If estimates are used for allocations, under/overapplied overhead should be properly reclassified to Film Costs or as a P/L item Ultimates should be prepared/updated for all significant titles at least quarterly in consultation with operating management 60 FIXED ASSETS 61 Fixed Assets Topics Capitalization Depreciation Impairment Leases Minimum Internal Controls 62 Capitalization SPE policy - fixed assets with useful lives of more than one year and acquisition costs greater than $5,000 individually or as a group should be capitalized The capitalization dollar threshold can be adjusted if local standards would require a lower amount but this fact should be brought to the Corporate Finance attention Free of charge assets with useful life of greater than one year and >$5,000 should be recorded at fair value as fixed assets. Assets received through exchanges or purchased by insurance, shall be recorded at fair value. The difference between fair value and book value shall be charged /credited to income Acquisition cost = asset cost (invoice value) + costs incurred to get the asset ready for use (e.g. installation, freight, etc.). After acquisition, expenditures that increase the value of the asset (e.g., adding new functions, improvements, or increasing useful life) should be capitalized. Repair and maintenance costs or transfer costs of an asset shall be expensed as incurred The interest cost on specific borrowing made for long term construction projects maybe capitalized and amortized over its useful life if certain conditions are met 63 Depreciation Straight-line method to be used The following is a guideline for estimated useful lives. However, significant variances from these lives should be discussed with Corporate Finance: Buildings steel and/or concrete - 30 years, others -10 years Building improvements 10 years Leasehold improvements shorter of 10 or term of lease Machinery 5-7 years Tools, equipment, furniture & other fixtures 5 years Automobiles 3 years 64 Impairment There are two steps in determining if a long-lived asset is impaired: Step 1 – determine if carrying amount of a long-lived asset is not recoverable. If yes, move to step 2 Step 2- determine if carrying amount of a long-lived asset exceeds its fair value. If yes, Not recoverable if net book value exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset (asset group) Fair value is the amount at which that asset could be bought or sold in a current transaction between willing parties. Use quoted market price. If not available, fair value estimate should be based on prices for similar assets or, on the discounted estimated future cash flows The impairment loss is measured as the difference between fair value and carrying amount of a long-lived asset Asset is impaired 65 Impairment When to test for recoverability Whenever events or changes in circumstances indicate that its carrying amount may not be recoverable. The following impairment indicators are examples of such events or changes in circumstances: A significant decrease in the market price of a long-lived asset (asset group). A significant change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator. An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group). A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group). A current expectation that it is more likely than not (greater than 50%) that a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The existence of other factors which indicates asset impairment. 66 Leases Leases Lease - an agreement conveying the right to use property, plant, or equipment (land and/or depreciable assets) usually for a stated period of time Two main classes of leases from the standpoint of the lessee: Capital leases – leases that meet one of more criteria discussed further Operating leases – all other leases SFAS No. 13, Accounting for Leases, establishes requirements for accounting for leases Accounting can be complex due to: Amortization of leasehold improvements (lease term plus lease renewals) Rent holidays Landlord/tenant improvements 67 Leases Capital lease – need to meet one of the criteria Ownership is transferred to lessee by the end of the lease term Lease contains a bargain purchase option Lease term is 75% or more of useful life of leased property PV of minimum lease payments is 90% or more of fair value of leased property Capital lease is recorded as a tangible fixed asset subject to depreciation, with a corresponding amount recorded as obligation If the lease does not meet any of the criteria, it should be classified as an operating lease, with lease payments charged to expense (straight-line basis versus cash basis of amortization) 68 Leases Amortization of operating lease Some operating leases include lease payments that are not of equal amounts, but escalate during the life of the lease. Straight-line basis should be used for amortization Lease incentives (e.g., up-front cash payment to the lessee, payment of costs for the lessee such as moving expenses, or the assumption by the lessor of the lessee's preexisting lease, etc.) should be amortized over the term of the lease using the straight- line basis Rent holidays should be included in term of the lease when calculating amortization Rent expense should be recognized once the lessee has the legal right to use the property irrespective of when rents are due (payable) under the lease agreement 69 Leases Accounting for capital lease Interest rate for determining present value - Ordinarily, the interest rate (as applied to borrowings from a bank, etc.) that, at the inception of the lease, the lessee would have incurred. If the lessor's rate is specified and is lower than the lessee's incremental borrowing rate, then the lessor’s rate shall be applied The amount of an asset and obligation to be recorded for a leased asset at the inception of the lease, the lessee shall record the lower of the present value of the total lease payments or the fair value of the leased asset. The lease payments capitalized shall exclude any executory costs (e.g., insurance, maintenance, and taxes in connection with the leased property) to be paid by the lessor. An estimate shall be used for the executory costs if the amounts cannot be determined from the lease contract 70 Minimum Internal Controls Fixed Assets roll-forward schedule should be prepared and updated on at least a quarterly basis At a minimum, a physical inventory count shall be made at least once within a fiscal year verifying the existence of all fixed assets, excluding assets under construction Fixed Assets should be reviewed at least annually for any indications of impairment The use of other than straight-line method of depreciation must be approved by SPE Corporate SPE Insurance and Tax Departments should be notified of all significant acquisitions and disposals 71 SOFTWARE AND WEBSITE DEVELOPMENT COSTS 72 Software and Website Development Costs Topics Software Development Costs Internal Use Software Software for Sale Website Development Costs Minimum Internal Controls 73 Software Development Costs Key distinction is between: Internal use software – one acquired, internally developed or modified solely to meet SPE’s needs, for which no substantive plan exists or is being developed to market the software externally and Software for sale – one developed for external sale, consisting of the creative development of computer programs, processes and other related materials Only direct costs (such as wages of internal IS staff involved directly in developing the software) of development should be capitalized Research and development costs should be expensed when incurred 74 Internal Use Software Decision to capitalize or expense internal-use software development costs depends on the stage of the development effort. Red – expense, green – capitalize. Preliminary project stage (Analysis) - Needs evaluation - Requirements analysis and documentation - Evaluation of alternatives - Technology gap analysis - Initial charter and ROI formulation - Final selection of alternatives Application Development Stage - Application design - Coding - Installation of hardware - Testing and QA - License fees for purchased software components - Payroll costs for persons working directly on the project Post Implementatio n Stage - User training - Application and hardware maintenance Upgrades and Enhanceme nts - Upgrades that add new functionality 75 Software for Sale Technical feasibility has to be established in order to capitalize Capitalization must cease when the product is available for general release to customers Capitalization vs. expense is similar to internal-use software costs. Specific requirement that maintenance and customer support be expensed when related revenue is recognized or when those costs are incurred, whichever occurs first Amortization on a product-by-product basis, starting at the time the software is released to customers Amortization is calculated as the greater of (1) the ratio of the product’s current gross revenues to the total of current and expected revenues or (2) the straight-line method. The estimated useful life for software typically ranges from 3 to 7 years The unamortized capitalized costs for each product must be compared to the net realizable value annually, with the excess costs written off 76 Website Development Costs Decision to capitalize or expense internal-use website development costs depends on the stage of the development effort. Red – expense, green - capitalize Planning Stage •Develop business/ project plan •Determine website functionalities •Determine existence of needed technology •Formulate conceptual graphics and content •Identify and evaluate alternatives •Select alternatives Web application/ Infrastructur e •Procuring software tools Development for coding Stage •Coding applications and security features •Installation of website application to hardware •Internet connection /hosting •Creating initial links •Testing •Crating graphics/user interface Operation Stage •Training •Website launch •User administration •Update graphics and content •Create links •Maintain/upgrade links •Security review/user analysis 77 Minimum Internal Controls Software and Website costs should be reviewed at least annually for any indications of impairment Entries for software accounts in the G/L should be reviewed for significant or unusual items at least quarterly Significant capital expenditures should be compared to the budget/forecast and significant variances investigated For internally developed software, assess the project stage and nature of expenditures to determine that the capitalization or expensing of expenditures is appropriate. 78 INVESTMENTS 79 Investments Topics Types of Securities Classification of Securities Valuation of Securities Impairment of Securities Minimum Internal Controls 80 Types of Securities Debt securities – securities which carry obligations for the issuer to pay a certain sum plus interest at a specified rate (e.g. government bonds, local government bonds, debentures, convertible bonds, commercial paper, etc) Equity securities – securities representing ownership rights in the issuer’s business (e.g. common stock, preferred stock, warrants, call options, put options, etc.). Income may be received on such equities through the payment of dividends 81 Classification of Securities Held-to-maturity – debt securities with management’s positive intent and ability to hold to maturity Trading – securities (either debt or equity securities with readily determinable fair values) that are bought and held principally for the purpose of selling them in the near term. Trading generally reflects active and frequent buying and selling, and trading securities are generally used with the objective of generating profits on short-term differences in price Available-for-sale – investments that are not classified as trading or as held-tomaturity securities 82 Valuation of Securities Held-to-maturity securities are reported at amortized cost, subject to an impairment test. Realized gains and losses for these securities are reported to earnings. Dividend and interest income, including amortization of premium and discount, should also be included in earnings Trading securities are reported at fair value with unrealized gains and losses included in earnings. Dividends and interest should also be included in earnings. Available-for-sale securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a net amount in a separate component of shareholders’ equity. Unrealized gains and losses are reported net of the related tax effect in other comprehensive income (“OCI”). Upon sale, realized gains and losses are reported in earnings. Dividend and interest income, including amortization of the premium and discount arising at acquisition, should also be included in earnings. 83 Impairment of Securities For held-to-maturity or available-for-sale securities, a company should determine whether a decline in fair value below the amortized cost basis is other than temporary. If the decline is other than temporary, the cost basis of the individual security should be written down to fair value as a new cost basis, and the amount of the write-down should be included in earnings as a realized loss. The new cost basis should not be changed for subsequent recoveries in fair value. A recovery in fair value should not be recorded in earnings until the security is sold Each individual security should be evaluated for impairment, and as such, the practice of providing a general allowance for unidentified impairment in a portfolio is not appropriate. For trading securities, unrealized holding losses are included in earnings. It is not necessary to evaluate trading securities for impairment. 84 Minimum Internal Controls Entries to the investment accounts in the G/L should be reviewed at least quarterly for significant or unusual items Investment schedules or statements of investments held by third parties should be reconciled to the G/L quarterly All purchases and sales of investments should be reviewed and authorized in accordance with the COFA . Any significant related gains or losses should be calculated and the Tax and SPE Corporate should be notified Significant investments should be reviewed at least annually to determine if there are any indications of impairment Appropriate consideration should be given to the classification of investments between current and noncurrent, and to the difference between the cost and market value of investments 85 INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES 86 Investments in Unconsolidated Subsidiaries Topics Definitions Equity vs Cost Method Variable Interest Entities (VIE) Impairment Minimum Internal Controls 87 Definitions The nature of the relationship between SPE and the subsidiary, in terms of influence, ownership percentage and control, determines the appropriate accounting treatment for SPE’s accounting of its investment in the subsidiary The following are general guidelines for the categorizing of investments in subsidiaries: Less than 20% - cost method 20% - 50% - equity method More than 50% - consolidation If SPE owns less than 20% but holds significant influence over subsidiary – equity method If SPE is a primary beneficiary (has majority of risks and rewards compared to other investors) in the subsidiary, irrespective of % of investment – consolidation. 88 Cost versus Equity Method Cost Method The investment in the subsidiary is recorded at its original acquisition cost, and is not adjusted. The only investment activity recorded is income from any dividends received from the subsidiary Equity Method Portion of the subsidiary’s income (loss) is recognized as investment income (loss), and the original investment cost is adjusted for the subsidiary’s periodic income (loss). Any dividends declared by the subsidiary are treated as reductions to the investment balance Share of losses in an investee may equal or exceed the carrying amount of the investment accounted for the equity method plus advances made. Equity adjustments should be discontinued if the investment balance becomes zero unless the investor has guaranteed obligations of the investee or is otherwise committed to provide further financial support to the investee . If the investee becomes profitable again, income cannot be recorded on the investment until SPE’s share of income covers previously unrecorded losses 89 Variable Interest Entities (VIE) In early 2002, the FASB launched a project on the consolidation of specialpurpose entities (SPEs), after Enron’s collapse exposed a number of worrisome accounting issues FIN 46 issued in January 2003 and reissued in December 2003 as FIN 46R Applying FIN 46 is COMPLEX PwC generally recommends to pre-clear with the SEC the significant transactions involving FIN 46 issues Highly complicated area and any potential transaction of concern should be discussed with Technical Support and Compliance Group 90 Variable Interest Entities (VIE) Under GAAP, a company must consolidate any entity in which it has a “controlling financial interest.” (>50% ) FIN 46 makes two critical changes: Defines when a company should base “controlling financial interest” on factors other than voting rights, including even things as distribution fees Requires that a new “risk and rewards” model be applied Consequently, GAAP now prescribes two accounting models for consolidation: 1. 2. The voting interest model where the investor owning more than 50 percent of an entity’s voting interests consolidates The risk and rewards model where the party who participates in the majority of the entity’s economics consolidates. This party could be an equity investor, other capital provider, or a party with contractual arrangements 91 Variable Interest Entities (VIE) Variable Interest Entity (VIE) – an entity that possesses one of the following characteristics: The entity is thinly capitalized Residual equity holders do not control the entity Equity holders do not participate fully in entity’s residual economics The entity was established with non-substantive voting interests To identify potential VIEs, reporting enterprises must review all arrangements with an entity to determine whether they: Hold economic interests, voting rights or similar rights in the entity, or obligations with an entity (e.g., in the form of derivatives) Issue guarantees with respect to the entity’s assets and/or liabilities Transfer assets to the entity Manage the assets of the entity Lease assets from an entity or provide it with financing 92 Impairment Step 1: Determine Whether an Investment is Impaired - An investment is considered impaired if the fair value of the investment is less than its amortized cost basis (the carrying amount) Step 2: Determine Whether Impairment is Other Than Temporary - An impairment shall be deemed other than temporary unless positive evidence indicating that the investment's carrying amount is recoverable within a reasonable period of time outweighs any evidence to contrary Step 3: Recognize an Other-Than-Temporary Impairment Loss Equal to the Difference between the Investment's Carrying Amount and its Fair Value - An other-than-temporary impairment loss should be recognized in earnings and the fair value of the investment would then become the new cost basis of the investment and it should not be adjusted for subsequent recoveries in fair value. 93 Impairment Indicators of other-than temporary impairment: The investee's financial condition and quality of assets are deteriorating, with no immediate prospect of recovery The investee has sustained significant losses in the current year The regulatory, economic, or technological environment has changed in a way that is expected to adversely affect the investee's profitability There has been a significant decline in fair value of publicly traded securities of comparable entities The investee has announced, or the investor has become aware of, adverse changes or events such as changes or planned changes in senior management, restructurings, or a sale of assets The general market conditions in either the geographic region or the industry in which the investee operates have weakened, with no immediate prospect of recovery Factors that raise significant concerns about the investee's ability to continue as a going concern, such as negative cash flows from operations, working-capital deficiencies, investment advisors' recommendations, or non-compliance with statutory capital requirements or debt covenants 94 Minimum Internal Controls A permanent closing binder should be maintained for the acquisition and disposition of all investments in a subsidiary Entries to the investment accounts in the G/L should be reviewed at least quarterly for significant or unusual items Schedules supporting SPE’s share of investee financial statements should be reconciled to the G/L All acquisitions or dispositions of any investment in a subsidiary should be reviewed and authorized in accordance with the COFA. The Tax and SPE Corporate Departments should be notified for all transactions greater than $5 million Significant investments should be reviewed at least annually to determine if there are any indications of impairment SPE and subsidiary financial information should be reviewed for items that should be eliminated such as inter-company payables/receivables, loans, minority interest, etc Internal controls of the investee company must be reviewed annually to determine the viability and accuracy of the subsidiary’s financial information 95 GOODWILL AND INTANGIBLES 96 Goodwill and Intangibles Topics Business Combinations And Goodwill Intangible Assets Other Than Goodwill Minimum Internal Controls 97 Business Combinations and Goodwill Goodwill - excess of price paid for a business over fair value of its assets Goodwill is not amortized Goodwill should be tested for impairment on an annual basis, and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of goodwill below its carrying amount. Examples of reasons to test for impairment include the following: A significant adverse change in the legal or business climate An adverse action or assessment by a regulator Unanticipated competition Loss of key personnel 98 Intangible Assets Other Than Goodwill Intangible assets other than goodwill may include: Marketing related Assets: Customer related Assets: Artistic related Assets: Trade marks Trade names Non-compete agreements Customer lists Non-contractual customer relationships Motion pics TV programs Music videos Contract based assets Licensing and royalty agreements Broadcast Rights Non Compete agreements Technology-based assets Computer software Databases Some intangible assets carry with them discrete useful lives. For example, a patent legally expires 17 years from issuance. An intangible asset with a finite useful life is amortized; an intangible asset with an indefinite useful life is not amortized Intangible assets shall be tested for impairment on an annual basis, and between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of intangibles below its carrying amount The area of purchase price allocation is a complicated area and should be discussed with Home office and SPE Technical Support and Compliance group 99 Minimum Internal Controls The basis for and method of determining the purchase price of an acquired entity and decision factors for the acquisition should be documented at the time of purchase Transactions involving goodwill and other intangible assets should be approved in accordance with COFA. Goodwill should be reviewed for any indications of impairment, and the estimated useful lives of intangible assets should be reviewed for changes, at least annually. If there are indications of impairment or changes in useful lives, a further analysis should be performed in coordination with the SPE Corporate Entries for goodwill and other intangible asset accounts should be reviewed at least quarterly in the G/L for significant or unusual items Significant acquisitions should be reviewed for accuracy and the Tax and SPE Corporate Departments should be notified 100 OTHER ASSETS 101 Other Assets Topics Definitions Minimum Internal Controls 102 Definitions Other assets represent assets not classified elsewhere, can include prepaid expenses, rent or other deposits, trust funds, insurance claims, debt issuance costs, etc., both short- and long-term Prepaid expense – payment (s) made for expenses not yet incurred Expenses should be recognized as incurred (accrual basis versus cash basis), e.g. audit fees, professional services, etc. Other assets should be recorded at cost. The assets should be reviewed on a quarterly basis to determine if changes need to be made to the carrying values as a result of the following: The asset should be amortized or charged to expense based on the nature of the asset and the activities associated with the asset The asset should be reclassified between long-term and short-term The asset should be reviewed for any indication of impairment 103 Minimum Internal Controls Deposits should be monitored to ensure they are returned timely to SPE when the related deposit activity is concluded Significant movements should be identified, and any unexpected or unusual relationships between current month and prior month should be investigated Significant additions or deletions to other assets should be properly classified between current and non-current and also reviewed against underlying documents supporting the amounts and nature of the transactions Other assets should be reviewed at least annually for any indications of impairment 104 ACCOUNTS PAYABLE 105 Accounts Payable Topics Definitions Minimum Internal Controls 106 Definitions All purchases should be initiated with a properly approved, complete purchase order, or contract Payment should not be made without evidence of receipt of goods or services, and a written invoice or contact Payment timing should be managed to allow for payment within stated terms but not significantly before then Accrued liabilities not generally invoiced should be classified as accrued expenses A significant debit balance in accounts payable should not be offset against other accounts payable, but instead treated as a receivable. 107 Minimum Internal Controls All purchase commitments and payment requests must be approved in accordance with the COFA Checks should be mailed directly to vendors, if applicable Vendors granting early payment discounts should be identified and such discounts utilized New vendors must be approved by at least the Director or Manager of the Accounts Payable Department All data relating to a new vendor must be entered into the accounts payable system before issuing payment (i.e. name, address, phone number, contact, Tax Payer ID number, etc) Invoices must be properly authorized and matched to a purchase order and receiving report, if applicable, before payment Proper system controls should be in place to ensure there are no duplicate payments of invoices Individuals in the Accounts Payable Dept should not be allowed to authorize invoices for payment, sign checks or reconcile bank accounts. 108 Minimum Internal Controls If there are any significant accounts being disputed with vendors, the proper adjustments/accruals should be made Significant movements should be identified, and any unexpected or unusual relationships between current month and prior month should be investigated. If the entity is part of the SPE Corporate Services Accounts Payable Group, this analysis will be done only on a consolidated basis The accounts payable sub-system, as applicable, should be reconciled to the G/L at least quarterly. If the entity is part of the SPE Corporate Services Accounts Payable Group, this analysis will be done only on a consolidated basis The accounts payable G/L accounts should be reviewed for significant or unusual postings The nature and significance of accounts payable cut-off accruals should be reviewed at least quarterly and the proper reversing entry should be subsequently booked Significant purchase commitments should be reviewed on at least a quarterly basis to determine if any such commitments have become adverse 109 Minimum Internal Controls Aging reports should be reviewed on a monthly basis and any significant changes in past due accounts, debit balances, individually significant payables, unmatched receiving reports and vendor invoices, items returned for which a credit has not been received, and differences reported by vendors should be investigated. If the entity is part of the SPE Corporate Services Accounts Payable Group, this analysis will be done only on a consolidated basis The Goods Receipt/Invoice Receipt account should be reconciled for any unmatched receiving reports and/or vendor invoices and adjustments should be recorded as appropriate Any intercompany transactions should be reported to Corporate Reporting to determine the need for any elimination of intercompany profit or loss, sales, and balances including other SPE and other Sony related entities All suspense accounts should be analyzed and cleared on a monthly basis and reviewed by at least a Manager in the Finance Department Any collateralized liabilities should be disclosed to Corporate Reporting Any payables to employees or related parties should be disclosed to Corporate Reporting 110 ACCRUED EXPENSES AND OTHER LIABILITIES 111 Accrued Expenses and Other Liabilities Discussion Topics Definitions Exploitation Accruals Employee-Related Liabilities Loss Contingencies Minimum Internal Controls 112 Definitions Accrued expenses and other liabilities represent expenses incurred but not yet paid. They include goods or services that have been received but not invoiced, interest, payroll taxes, rent, deferred compensation, pension liabilities, deferred taxes, etc., both short- and long-term Exploitation accruals include accruals for marketing, advertising, publicity, promotion, and other distribution expenses incurred in connection with the distribution of a film. Exploitation costs should be accrued when incurred but not when committed 113 Employee-Related Liabilities Most employees are entitled to vacation, holiday an sick pay (“compensated absences”) If all of the following conditions are met, a liability for employees’ compensation for future absences must be accrued: 1. 2. 3. 4. SPE’s obligation relating to employees’ rights to receive compensation for future absences is attributable to employees’ services already rendered. The obligation relates to employees’ rights that vest or accumulate. Payment of the compensation is probable. The amount can be reasonably estimated If conditions 1-3 are met, but the amount cannot be estimated, disclosure is required 114 Loss Contingencies FAS No. 5 Accounting for Contingencies establishes the guidelines for recording a loss contingency. Some examples of loss contingencies include: Obligations related to product warranties Risk of loss of or damage to property by fire, explosion, or other hazards Threat of expropriation of assets Pending or threatened litigation Actual or possible claims and assessments Guarantees of indebtedness of others The loss contingency should be accrued as a charge to earnings and reserve in the current period if: (1) If it is probable that a loss or liability is incurred at balance sheet date (at the end of each quarter) and (2) the amount can be reasonably estimated Accrual of minimum amount in the range when no single amount within the range is a better estimate than another 115 Minimum Internal Controls Estimates used in the booking of significant accruals should be approved by a Director or higher Accrued liability amounts must be supported, with invoices, contracts, computations, etc Prior period accruals should be reviewed to determine if adjustments/reversals are needed Significant accrued liabilities must be examined and approved by the Accounting Manager Costs such as legal, accounting and consulting fees, should be reviewed for the existence of additional accruals Cash disbursements subsequent to “Cost Cutoff” should be reviewed for potential accrual adjustments All accrued liabilities should be examined to determine the term (long vs. short) by which it should be classified 116 CONTRACTUAL OBLIGATIONS 117 Contractual Obligations Topics Definitions and Classification Participation and Residual Accruals Minimum Internal Controls 118 Definitions and Classification Contractual obligations represent amounts due to individuals or entities for the performance of services or provision of goods that are enforceable under legal documents. Contractual obligations include long-term debt and leases, purchase obligations, pension and employee related payments, legal settlements, royalty contracts, participations and residuals, etc. Sony Corporation (Tokyo) requirement for semi-annual and annual footnotes submission. Contractual obligations must be disclosed in a table that presents the amounts of payments due in the current year, 1-3 years, 3-5 years, and more than 5 years. Obligations must be presented in the following categories, although additional detail may be presented: Long-term debt obligations Capital lease obligations Operating lease obligations Purchase obligations Other long-term liabilities reflected on the balance sheet Material contract provisions, including termination or renewal provisions, must also be disclosed Current (due within one year) versus non current (due within more than one year) classification 119 Participation and Residual Accruals Participation accruals relate to costs associated with payments to talent for their contractual or union-required share of film revenues Participation costs should be accrued (expensed) using the individual-filmforecast-computation method: Unaccrued (that is, not yet expensed) ultimate participation costs at the beginning of the current year Current period actual revenue x Estimated remaining unrecognized ultimate revenue as of the beginning of the current fiscal year In the absence of changes in estimates, participation costs are accrued in a manner that yields a constant rate of profit over the ultimate period for each film before exploitation costs, manufacturing costs, and other period expenses 120 Participation and Residual Accruals At each balance sheet date, accrued participation costs should not be less than the amounts that an entity is obliged to pay as of that date Begin to accrue participation costs when a film is released and it begins to recognize revenue from that film Review and revise estimates of ultimate revenue and participation costs as of each reporting date If estimates are revised, new denominator should be calculated that includes only the ultimate revenue from the beginning for the fiscal year of change. The numerator is unaffected by the change. Revised fraction should be applied to the film’s unaccrued ultimate participation costs as of the beginning of the fiscal year. Difference between expenses determined using the new estimates and any amounts previously expensed during that fiscal year should be charged or credited to the income statement in the period (for example, the quarter) during which the estimates are revised 121 Minimum Internal Controls Any significant, unexpected, or unusual relationships between current month, prior month, and budgeted amounts should be investigated and explained Contractual Obligation statements should be reconciled to the actual payments Supporting statements/calculations should be prepared and reviewed by at least an Accounting Manager Contractual obligation advances must be approved in accordance with the COFA and properly reflected as a prepaid asset if significant 122 DEFERRED REVENUE 123 Deferred Revenue Topics Definitions Minimum Internal Controls 124 Definitions Deferred revenue represents the receipt of cash or other assets in advance of the sale of goods, “availability” of products, or performance of services. Sometimes called unearned revenue Payment is made to secure future performance (e.g. the future rent of a facility) and is legally refundable – classify as a deposit, no revenue is recognized Payment is made with the intent of applying it against future amounts due – classify as deferred revenue, income recognized as it is earned Deferred revenues should be properly classified between long-term and short-term 125 Minimum Internal Controls Significant movements and any unexpected or unusual relationships between current month and prior month should be identified and investigated for deferred revenue and the recognition of deferred revenue in income Entries in the deferred revenue accounts in the G/L should be reviewed for significant or unusual items When applicable, deferred revenue should be supported with invoices, contracts, computations/system reports and other supporting documentation The Deferred Revenue sub system, if applicable, should be reconciled to the G/L by contract or customer and reviewed for unusual items at least quarterly 126 DEBT 127 Debt Topics Definitions Minimum Internal Controls 128 Definitions Debt represents an obligation owed to another entity that is required to be paid by a specified date or on demand, and is generally collateralized or guaranteed by assets of the company. Examples of debt include bonds, mortgages and notes Key concerns include the proper calculation of carrying amount and amortization, compliance with legal agreement terms, and complete disclosure Before recording the obligation or retirement of any debt and debt related costs, there should be a consultation with the Treasury Department, Legal Department and Corporate Finance Department Debt discounts or premiums: Direct reduction or addition to the face amount of the debt Should not be reported as deferred charges or deferred credits Use effective interest method, or straight-line method if not materially different, to amortize 129 Minimum Internal Controls All debt payments should be properly approved in accordance with the COFA SPE Corporate should be consulted on any new issuance or extinguishment of debt in excess of $5 million Reconciliations of statements from lending institutions and other partners to the G/L should be completed at least quarterly Corporate Reporting should be informed of any new debt for possible disclosure Any violations of restrictive loan covenants that have been waived by lenders should be documented A list including all short-term notes payable, their due dates, and interest accrued and paid during the period should be maintained 130 EQUITY AND RETAINED EARNINGS 131 Equity and Retained Earnings Topics Definitions Minimum Internal Controls 132 Definitions Common stock, additional paid-in capital (APIC), preferred and treasury stock, unrealized gains and losses on marketable securities, cumulative translation adjustments (CTA) Equity reflects the ownership interest of a company. Retained earnings is a component of equity, and refers to accumulated net income or loss; each period’s income or loss is transferred to retained earnings There is no ‘appropriation of profits’ concept in the US GAAP 133 Definitions Additional paid-in capital – Paid-in capital in excess of par or stated value of common stock Common stock - A unit of ownership in a company, typically allowing voting rights and the right to receive dividends when declared Cumulative translation adjustment – An equity account that captures the changes resulting from foreign currency fluctuations Preferred stock - Stock that does not carry ownership rights but carries a specified dividend Treasury stock - Stock reacquired by the issuing company; carries no ownership or dividend rights. 134 Minimum Internal Controls An equity roll forward schedule, including a reconciliation of shares authorized, issued and outstanding, should be prepared and reconciled to the G/L on at least a quarterly basis All transactions affecting equity should be approved in accordance with the COFA, should be in writing and should be in compliance with SPE’s by-laws, corporate charter and requirements of regulatory agencies Any significant, unexpected, or unusual relationships between current period, prior period, and budgeted amounts should be investigated 135 REVENUE RECOGNITION 136 Revenue Recognition Topics Definitions Revenue Recognition Under Motion Picture Accounting Revenue Recognition Of Broadcast Rights Revenue Recognition Examples Consideration Paid To Customers and Sales Incentives Gross Vs Net Presentation Minimum Internal Controls 137 Definitions Sale of goods and the performance of services such as licensing of film and other intellectual properties, sale of products, rental of equipment and facilities, subscriptions, distribution services, production services and advertising revenues The major source of SPE revenue is the production and sale, licensing or exhibition of its film, television and home entertainment products Revenue offsets, such as sales discounts, returns and allowances, should be distinguished from expenses and, in general, be deducted from gross revenue, as they truly represent revenue that is never realized Revenue should be realized and earned. The following four criteria should be met: Persuasive evidence of an arrangement exists Delivery has occurred or services have been rendered The seller’s price to the buyer is fixed or determinable, and Collectibility is reasonably assured 138 Revenue Recognition Under Motion Picture Accounting Revenue from a sale or licensing arrangement of a film or television product is to be recognized when the following conditions are met: 1. 2. 3. 4. 5. Persuasive evidence of a sale or licensing arrangement with a customer exists; The film is complete and, in accordance with the terms of the arrangement, has been delivered or is available for immediate and unconditional delivery; The license period of the arrangement has begun and the customer can begin its exploitation, exhibition or sale; The arrangement fee is fixed or determinable; and Collection of the arrangement fee is reasonably assured. 139 Revenue Recognition Under Motion Picture Accounting Revenue from the theatrical exhibition of motion pictures is recognized as the customer exhibits or exploits the film. Revenue from television licensing arrangements for film and television product is recognized when the product is available and any restrictions regarding the exhibition or exploitation of the product lapse. Revenue from home video/DVD sales is recognized upon the street date, that is, the date when home video products may be sold or displayed for rental. 140 Revenue Recognition of Broadcast Rights Ad Revenues – as a general rule, should be recognized when the ads are aired or delivery has occurred. If advertising is sold in multiple-spot packages that may span multiple periods, the total license fee should be allocated to the individual spots using a rational, systematic and consistent process; ad revenues should ultimately be recorded at fair market value, rather than the billing value Subscriber Revenues –should be recognized as services are provided and accrued at month end if not yet billed and the other general requirements of SAB 104 have been met Affiliate Revenues – should be recognized on subscriber fees each month when the service is provided and collectibility is reasonably assured. Since revenues are often based on the number of subscribers and the actual number of subscribers may not be known for one to three months, an estimate should be made at least quarterly and trued up when actual payments are received. The estimate should generally be based on the most recent payment actually received unless better information is available. 141 Revenue Recognition Examples Example 1 - Allocation of Revenue for a Fixed Fee, Multiple Film Arrangement Assumptions: a. An entity grants to a customer the cable television broadcast rights to three films under a single licensing arrangement in a particular market and territory. The arrangement calls for a fixed license fee of $30,000. The arrangement provides for a pro-rata reduction in the license fee if Film 3 is not completed and made available for delivery b. At the date of the arrangement, Films 1 and 2 are complete; Film 3 is yet to be produced. An evaluation of the relative fair values of the licensed rights to Films 1 and 2 indicate that Film 1 should be assigned 55 percent of the fixed license fee and Film 2 should be assigned 45 percent of the fee. The amount potentially refundable if Film 3 is not completed and delivered is $10,000 The entity should allocate the license fee as follows: Film 1 = $11,000 ($30,000 license fee, less $10,000 potentially refundable for one incomplete film, multiplied by 55 percent) Film 2 = $9,000 ($30,000 license fee, less $10,000 potentially refundable for one incomplete film, multiplied by 45 percent) Film 3 = $10,000 (the refundable amount due if the film is not completed and made available for delivery) 142 Revenue Recognition Examples Example 2 - Revenue Recognition for a Variable Fee, Single Film Arrangement With a Nonrefundable Minimum Guarantee Assumptions: a) An entity licenses to a customer the home video rights to one film for a period of two years. The licensing arrangement provides for a variable fee to the entity equal to 30 percent of the customer's gross receipts from the exploitation of this film during the license period. The licensing arrangement also requires the customer to pay the entity a $50,000 nonrefundable minimum guarantee against the variable fee b) For purposes of this example, assume that the customer generates gross receipts from the exploitation of the film equal to $100,000 in Year 1 and $80,000 in Year 2. Also, assume that the entity has met all other revenue recognition conditions of this SOP The entity should recognize revenue as follows: 143 Revenue Recognition Examples Revenue should be recognized as follows: 144 Revenue Recognition Examples Example 3 - Revenue Recognition for a Variable Fee, Multiple Film Arrangement With a Nonrefundable Minimum Guarantee Assumptions: a) An entity licenses to a customer the home video rights to five films for a period of three years. The licensing arrangement provides for a variable fee to the entity equal to 30 percent of the customer's gross receipts from the exploitation of the films during the license period. The licensing arrangement also requires the customer to pay the entity a $50,000 nonrefundable minimum guarantee against the variable fees for the five films. The variable fees are cross-collateralized for purposes of determining any amounts due in excess of the $50,000 nonrefundable minimum guarantee. b) For purposes of this example, assume the customer generates revenue as follows: 145 Revenue Recognition Examples Revenue should be recognized as follows: 146 Consideration Paid to Customers and Sales Incentives Consideration (including sales incentives, free products, slotting fees, cooperative advertising, and buydowns) paid should be recorded as a reduction of revenue unless both of the following conditions are met: SPE has received, or will receive, a benefit in exchange for the consideration that is sufficiently separable from the customer’s purchase of products and services (sufficient documentation must be provided by the purchaser to support the benefit received by SPE) A reasonable estimate of the fair value of this benefit is available If the amount of consideration exceeds the estimated fair value of the benefit received, that excess amount should be characterized as a reduction of revenue. If the consideration recorded as a reduction of revenue results in negative revenue for a specific customer on a cumulative basis, the amount of the cumulative shortfall may be recharacterized as an expense. 147 Consideration Paid to Customers and Sales Incentives A sales incentive offered to customers voluntarily and without charge that is exercisable by a customer as a result of a single exchange transaction should be recognized at the later of the following: The date at which the related revenue is recorded The date at which the sales incentive is offered If the amount of future rebates or refunds cannot be reasonably estimated, a liability should be recognized for the maximum potential amount of the refund or rebate 148 Gross versus Net Presentation Gross - the amount billed to a customer because it has earned revenue from the sale of the goods or services Net - the net amount retained (that is, the amount billed to the customer less the amount paid to a supplier) because it has earned a commission or fee Gross versus Net revenue recognition is a matter of judgment that depends on the relevant facts and circumstances 149 Gross versus Net Presentation Indicators of Gross Revenue Recognition: The company is the primary obligor in the arrangement The company has general inventory risk (before customer order is place or upon customer return) The company has latitude in establishing price The company changes the product or performs part of the service The company has discretion in supplier selection The company is involved in the determination of product or service specifications The company has physical loss inventory risk (after customer order or during shipping) The company has credit risk Indicators of Net Revenue Recognition: The supplier (not the company) is the primary obligor in the arrangement The amount the company earns is fixed The supplier (and not the company) has credit risk 150 Minimum Internal Controls Any significant, unexpected, or unusual relationships between current month, prior month and the budget/forecast should be investigated from a P&L perspective Revenues from sales of products and services should be recognized in the appropriate period, and accruals should be made for “lag” and system cut-off issues Entries in the revenue G/L accounts should be reviewed for significant or unusual items All suspense accounts should be analyzed and cleared on a monthly basis and reviewed by at least a Manager in the Finance Department 151 BARTER REVENUE 152 Barter Revenue Topics Definitions General Barter Transactions Advertising Barter Transactions Minimum Internal Controls 153 Definitions Barter transactions are those transactions where goods or services are exchanged for other goods or services, or for credit; little to no cash is involved in such transactions Important considerations when accounting for barter activity include: 1) identifying that a transaction represents a barter activity 2) properly accounting for the value of barter transactions 154 General Barter Transactions Exchange should be based on fair value of assets (services) The cost of a nonmonetary asset acquired in exchange for another nonmonetary asset is the fair value of the asset surrendered to obtain it, and a gain or loss should be recognized on the exchange The fair value of the asset received should be used to measure the cost if it is more clearly evident than the fair value of the asset surrendered 155 General Barter Transactions A nonmonetary exchange shall be measured at cost, and not on the fair value of the exchanged assets, if any of the following conditions apply: Fair value is not determinable: neither the fair value of the asset(s) received nor the asset(s) relinquished is determinable within reasonable limits Exchange transaction to facilitate sales to customers: the transaction is an exchange of a product or property held for sale in the ordinary course of business for a product or property to be sold in the same line of the business to facilitate sales to customers other than the parties to the exchange Exchange transaction that lacks commercial substance 156 General Barter Transactions A transaction should be considered monetary (i.e. not a barter transaction) if the boot received is "significant." "Significant" is defined as at least 25 percent of the fair value of the exchange If the consideration consists of barter or non-monetary exchange such as a “free” product or service, the cost of the consideration should be characterized as a cost of sales when recognized in the income statement The key concept in bartered or non-monetary transactions is that sufficient evidence of the fair value of the items being exchanged must exist 157 Advertising Barter Transactions Barter of unsold advertising time for products or services Record barter at estimated fair value of the product or service Barter revenue should be reported when: Commercials are broadcast Merchandise or services received or used If merchandise or services are received prior to the broadcast of the commercial – report liability If the commercial is broadcast first – report receivable Exchange of advertising for advertising: record at the carrying value of the advertising surrendered, which is generally zero record at fair market value – if it can be demonstrated that the time exchanged has a determinable market value through the historical practice of receiving cash, marketable securities or other consideration that is readily convertible to a known amount of cash 158 Minimum Internal Controls All recorded barter revenue must be supported by adequate documentation of the fair value basis for recording Assets related to barter transactions should be reviewed for impairment at least quarterly and adjusted if necessary. 159 EXPENSES 160 Expenses Topics: Cost of Goods Sold Selling Expenses Advertising Expenses Research & Development Expenses Overhead, General and Administrative expenses Restructuring charges Employee Costs Minimum Internal Controls 161 Cost of Goods Sold and Selling Expenses Cost of Goods Sold Repair and maintenance, utilities, rent, labor, materials, supplies, rights to book/stage plays/original screenplays, insurance, taxes, and pension contributions, film prints, videocassettes and digital video discs, etc. Selling Expenses Exploitation costs, including marketing, advertising, publicity, promotion and other distribution expenses in connection with the distribution of a film-related product should be expensed as incurred 162 Advertising Expenses Advertising activities have two primary components: Producing advertisements, such as the costs of idea development, writing advertising copy, artwork, printing, audio and video crews, actors and other costs Communicating advertisements that have been produced, such as the costs of magazine space, television airtime and distribution Advertising expenses shall be expensed either a) as incurred or b) deferred and expensed the first time the advertising takes placed. In the case of direct-response advertising, costs are capitalized and amortized over the expected period of future benefits 163 Advertising Expenses The costs of producing advertising shall be expensed the first time the advertising takes place. Costs of communicating advertising are not incurred until the item or service has been received and should not be reported as expenses before the item or service has been received. For instance, the costs of television airtime and magazine advertising space should not be reported as advertising expenses before the airtime is used or the space is used Some activities, such as product endorsements and sponsorships of events, may be performed pursuant to executory contracts. Costs incurred under executory contracts generally are recognized as performance under the contract is received 164 Advertising Expenses Promotion materials, such as brochures and catalogues should be accounted for as prepaid supplies, until they no longer are owned or expected to be used, in which case their cost would be a cost of advertising. In case of such promotion materials are expensed when purchased, unused materials should be picked up and accounted for as prepaid supplies at least each quarter-end In cases where SPE shares in the cost of a retailer’s advertising, costs should be expensed if SPE could obtain the advertising provided by the retailer from another source and the value of the benefit can be estimated. Otherwise, the costs should be recorded as a reduction to sales revenue 165 Research and Development Expenses All costs must be expensed when incurred Examples of research or development activities: Laboratory research for discovery of new knowledge Searching for applications of new research findings or other new knowledge Conceptual formulation and design, investigation, testing or evaluation, or modification or improvement of product or process (including manufacturing equipment) alternatives Design, construction and testing of preproduction prototypes and models Engineering activity to advance a new product or process to a point where it meets specific functional and economic requirements 166 Overhead, General and Administrative (G&A) Expenses Overhead, G&A and Other Expenses represent non-capitalized costs incurred for operating activities including but not limited to salaries, bonuses, utilities, repair & maintenance, general insurance, postage, travel and entertainment and rent All expenses shall be recorded when incurred. Under no circumstances shall the following ever be deferred: Organization costs, pre-opening expenditures, plant opening expenses Research and development costs Market development costs Cash Discounts. If a cash discount is calculated based on a normal interest rate and days of early payment of accounts receivable, then it shall be recorded as a non-operating expense. If a cash discount is not calculated based on the reasons above, and can be characterized as a sales allowance, then it shall be treated as a deduction from the sales amount 167 Restructuring Charges Costs associated with an exit or disposal activity (hereinafter referred to as “restructuring charges”) shall be recognized in the period in which the related liability is incurred Restructuring charges shall be recorded as an operating expense (Cost of Sales, Selling, General & Administrative Expenses or other General Expense) in the income statement A liability for restructuring charges should be recognized and measured initially at fair value in the period the liability is incurred. Fair value should be measured by discounting future expected payments using the credit-adjusted risk free rate in accordance 168 Restructuring Charges Restructuring charges include, but are not limited to, the following: Termination benefits provided to current employees that are involuntarily terminated under the terms of a benefit arrangement that, in substance, is not an ongoing benefit arrangement or an individual deferred compensation contract (referred to as one-time termination benefits) Loss on disposal, sale or impairment of long-lived assets Inventory disposal or write-down Costs to terminate a contract that is not a capital lease Other associated costs including costs to consolidate facilities or relocate employees. 169 Employee Costs Employee costs represent expenses for payments and future benefits to employees for services rendered including but not limited to wages, pensions, medical benefits, compensated absences, payroll processing fees, and employers’ portion of payroll taxes A key consideration of employee-related costs is accurate calculation and account coding. Inaccuracies not only impact the efficiency of payroll and benefit processing, but can subject SPE to penalties imposed by the unions and guilds representing certain employee groups 170 Minimum Internal Controls All expenditures should be approved in accordance with the COFA All period-end accruals should be properly calculated and approved by a Manager or above on at least a quarterly basis Purchases and expenses should be recognized in the appropriate period and properly classified, and adjustments should be made for “lag” and system cut-off issues Plans to enter into restructuring activity must be authorized in accordance with the COFA and communicated to Legal and Corporate Finance All overhead accruals should be properly calculated and reconciled on a monthly basis Reconciliations of the payroll register or similar report to the g/l and cash disbursement records should be reviewed for gross and net pay on a monthly basis. If the entity is part of the SPE Corporate Services Payroll Group, this analysis should be done only on a consolidated basis 171 INCOME TAXES 172 Income Taxes Topics Definitions Accounting Minimum Internal Controls 173 Definitions Income taxes – national, local and foreign (including franchise taxes) based on income. Total tax expense or benefit is the sum of a company’s current income tax expense or benefit and the company’s deferred income tax expense or benefit Current tax expense (or benefit) – the amount of income taxes paid or payable (or refundable) for a year as determined by applying the provision of the enacted tax law to the taxable income Current tax payable – the accumulated balance sheet amount of income taxes currently payable as of specified date Deferred tax expense (or benefit) – the change during the year in a company’s deferred tax assets and liabilities 174 Definitions Deferred taxes – tax effects that are postponed for allocation (either as increases or decreases) to income taxes expense in future accounting periods Deferred tax asset – the deferred tax consequences attributable to deductible temporary differences and carryforwards. A deferred tax asset is measured using the applicable enacted tax rate and provisions of the enacted tax law Deferred tax liability – the deferred tax consequences attributable to taxable temporary differences. A deferred tax liability is measured using the applicable enacted tax rate and provisions of the enacted tax law 175 Definitions Permanent differences – the differences between pre-tax accounting income and taxable income arising from transactions which, under applicable tax laws and regulations, will not be offset by corresponding differences or reversals in the future periods Temporary differences – the differences between the tax basis of assets or liabilities and their reported amounts in financial statements that will result in taxable income or deductions upon its reversal at some future date Taxable temporary differences – temporary differences that result in taxable amounts in future years when the related asset or liability is recovered or settled, respectively Valuation allowance – the portion of a deferred tax asset for which it is more likely than not that a tax benefit will be realized 176 Accounting FAS 109, Accounting for Income Taxes Accounting for income taxes requires the recognition of current income taxes due or refundable, as well as deferred income taxes, in the financial statements FAS 109 mandates an asset and liability method for computing deferred income taxes. The deferred income tax amount is a calculable liability or asset, and future tax effects, rather than past or current tax effects, are the basis of the deferred tax computation 177 Accounting Steps to calculate deferred taxes: 1. Identify the types and amounts of existing temporary differences and the nature and amount of each type of tax loss carry-forward or tax credit carry-forward 2. Calculate the total deferred tax liabilities for taxable temporary differences using the applicable tax rate 3. Calculate the total deferred tax assets for deductible temporary differences and tax loss carry-forwards using the applicable tax rate 4. Calculate the deferred tax assets for each type of tax credit carryforward 5. Reduce deferred tax assets by a valuation allowance 178 Accounting Example – Year 1 - Company A has $500,000 in taxable temporary differences, $200,000 in deductible differences, and no loss or credit carryforwards. Applicable federal tax rate is 35%. No valuation allowance is needed Year 2 – same as Year 1, except that taxable temporary differences are $300,000 Year 1: Deferred tax liability - $500,000 x 35% $175,000 Deferred tax asset - $200,000 x 35% (70,000) Valuation allowance 0 $105,000 Year 2: Deferred tax liability - $300,000 x 35% $105,000 Deferred tax asset - $200,000 x 35% (70,000) Valuation allowance 0 $35,000 Question – What is the amount of deferred tax expense or benefit in Year 2? 179 Accounting Answer - Deferred tax benefit is $70,000 ($105,000 - $35,000) 180 Accounting Examples of common temporary differences: Revenues or gains that are taxable after they are recognized in the US GAAP financial statements (FS) – e.g., receivable from installment sales Expenses or losses that are tax-deductible after they are recognized in FS – e.g., a product warranty liability Revenues or gains that are taxable before they are recognized in FS – e.g., subscriptions received in advance Expenses and losses that are deductible before they are recognized in FS – e.g., depreciable property A reduction in the tax basis of depreciable assets because of tax credits – e.g., amounts received upon future recovery of the amount of the asset for financial reporting will exceed the remaining tax basis of the asset, and the excess will be taxable when the asset is recovered Business combinations 181 Accounting Examples of common permanent differences: Financial expenses that are not deductible for tax purposes – e.g., premiums paid on life insurance policies for which the company is the beneficiary, certain penalties Financial income that is not taxable or tax-free income – e.g., interest received on state or municipal bonds, life insurance proceeds received by the company on death of its officers 182 Accounting If a deferred tax asset is not expected to be realized, a valuation allowance shall be recorded for the relevant amount. A tax planning strategy is essential to reduce the amount of the aforementioned valuation allowances Deferred tax liabilities/assets and related valuations shall be classified as either current or non-current, based on when the reversal of temporary differences will occur. Within the current or non-current classification, tax liabilities/assets owed to the same tax authority may be offset and presented net. Deferred liabilities/assets owed to different tax authorities may not be offset Accounting for income taxes may be complex and consultations with SPE tax department are required 183 Minimum Internal Controls An income tax roll-forward schedule to properly adjust the deferred tax asset/liability based on current P&L activity should be prepared at least quarterly Tax account balances should be reconciled to supporting detail (tax returns, schedules of differences between taxable income and accounting income) at least quarterly Tax filing and payment due dates, claims for refunds are monitored on a regular basis Any quarterly or year end accruals and top side adjustments should have applicable tax related entries. Any such significant tax entries should be provided to SPE tax department for their review and approval by both domestic and, especially international territories 184 Pensions 185 Pensions Topics Definitions Accounting Disclosure 186 Definitions FAS 87, Employers’ Accounting for Pensions, and FAS 88, Employers’ Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits Two common types of plans: Defined benefit plan – one that defines an amount of pension benefit to be provided, usually as a function of one or more factors such as age, years of service, or compensation. For example, upon retirement participants may receive monthly benefits of $10 for each year of service or annual benefit payments of one percent of the final year’s pay for each year of service Defined contribution plan – provides an individual account for each participant, and specifies how contributions to the individual’s account are to be determined instead of specifying the amount of benefits the individual is to receive. For an example, each year the employer may contribute three percent of pre-tax income to the plan. A 401(k) plan is an example of a defined contribution plan 187 Definitions Accumulated benefit obligation - The actuarial present value of benefits (whether vested or nonvested) attributed by the pension benefit formula to employee service rendered before a specified date and based on employee service and compensation (if applicable) prior to that date. The accumulated benefit obligation differs from the projected benefit obligation in that it includes no assumption about future compensation levels. For plans with flat-benefit or non-pay-related pension benefit formulas, the accumulated benefit obligation and the projected benefit obligation are the same Projected benefit obligation - The actuarial present value as of a date of all benefits attributed by the pension benefit formula to employee service rendered prior to that date. The projected benefit obligation is measured using assumptions as to future compensation levels if the pension benefit formula is based on those future compensation levels (pay-related, final-pay, final-averagepay, or career-average-pay plans) 188 Definitions Net periodic pension cost comprises of: Service cost Interest cost Expected return on plan assets Amortization of unrecognized prior service cost Amortization of deferred gains and losses Amortization of transition amount Service cost - The actuarial present value of benefits attributed by the pension benefit formula to services rendered by employees during that period. The service cost component is a portion of the projected benefit obligation and is unaffected by the funded status of the plan Interest cost - The increase in the projected benefit obligation due to passage of time 189 Definitions Expected return on plan assets - An amount calculated as a basis for determining the extent of delayed recognition of the effects of changes in the fair value of assets. The expected return on plan assets is determined based on the expected long-term rate of return on plan assets and the market-related value of plan assets Prior service cost - the cost of retroactive benefits granted in a plan amendment Gain or loss - a change in the value of either the projected benefit obligation or the plan assets resulting from experience different from that assumed or from a change in an actuarial assumption 190 Accounting Immediate recognition of a liability (the minimum liability) when the accumulated benefit obligation exceeds the fair value of plan assets. A liability (unfunded accrued pension cost) is recognized if net periodic pension cost exceeds amounts the employer has contributed to the plan. An asset ( prepaid pension cost) is recognized if net periodic pension cost is less than amounts the employer has contributed to the plan If the accumulated benefit obligation exceeds the fair value of plan assets, the employer shall recognize a liability (including unfunded accrued pension cost) that is at least equal to the unfunded accumulated benefit obligation. Recognition of an additional minimum liability is required if an unfunded accumulated benefit obligation exists and (a) an asset has been recognized as prepaid pension cost, (b) the liability already recognized as unfunded accrued pension cost is less than the unfunded accumulated benefit obligation, or (c) no accrued or prepaid pension cost has been recognized Need to recognize a minimum liability is based on estimated obligations and assets as of their measurement date. Obligations are estimated as of that date based on a roll-forward of the beginning-of-the-year actuarial valuation 191 Accounting Company A has a prepaid cost of $100 at year-end prior to calculation of the additional liability. The accumulated benefit obligation (ABO) is $1,000 and the fair value of the assets is $900 Question – What is the amount of additional liability, if any, to be recorded the required minimum liability? 192 Accounting Answer – the additional liability is $200. A minimum liability of $100 = $1,000 (ABO) - $900 (fair value of the assets) plus $100 (prepaid asset) In this case, the company should present in its financial statements an accrued pension liability of $100 ($100 prepaid asset minus $200 additional liability) 193 Disclosure FAS 132(R), Employers’ Disclosure about Pensions and Other Postretirement Benefits, issued in December 2003 Requires new disclosure (very robust) about the assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefits plans. Accounting and disclosure of pensions is very complex and require consultation with SPE Technical Support and Compliance group Any pension plans should be communicated to SPE Corporate Finance and Technical Support and Compliance group 194 CONSOLIDATION AND FINANCIAL REPORTING 195 Consolidation and Financial Reporting Topics Consolidation Foreign Currency Translation Intercompany Transactions Material Event Disclosure Minimum Internal Controls 196 Consolidation Consolidation is the process of combining the assets, liabilities and operations of companies under common control, and presenting the result as if it was one company SPE consolidation is performed at the Home Office level Hyperion is currently used as consolidation tool. Moving towards new consolidation tool – BCS (Business Consolidation System) 197 Foreign Currency Translation The initial step in foreign currency translation is to determine each entity’s functional currency. There are two main steps in the foreign currency translation: Step 1 – Revaluation of transactions in other than local currency to local (functional) currency financial statements Step 2 – Translation of financial statements in local (functional) currency to reporting (group) currency. 198 Foreign Currency Translation Step 1 - Revaluation of Foreign Currency Transactions For other than forward exchange contracts, the following shall apply to all foreign currency transactions: At the date the transaction is recognized, each asset, liability, revenue, expense, gain, or loss arising from transaction shall be measured and recorded in the functional currency of the entity by using the exchange rate in effect at that date At each balance sheet date, recorded balances that are denominated in a currency other than the functional currency shall be adjusted to reflect the current exchange rate The exchange gains and losses should be included in net income (loss) for the period. The exceptions are hedging instruments and intercompany transactions of a long-term investment nature which gains and losses are included in cumulative translation adjustment (CTA) account, a component of equity 199 Foreign Currency Translation Step 2 - Translation of Foreign Currency Statements The functional (local) currency financial statements should be translated into the reporting (group) currency utilizing period-end (for assets and liabilities), daily or period average (for income statement accounts), and historical (for equity accounts) exchange rates. As a result of these translation procedures, a Cumulative Translation Adjustment (CTA) account will be created The rate in the SAP system as of A/R and A/P cut off date should be used to revalue and translate the assets and liabilities 200 Intercompany Transactions Transactions between SPE consolidated entities and are required when transaction impacts more than one company code (legal entity) belonging to SPE One step intercompany (I/C) transactions - primarily executed between domestic consolidated companies. The company originating the entry has the ability to directly record the offset entry in the trading partner’s general ledger Two step I/C transactions - generally occur between Home Office and international territories and between territory and territory: Is used in order for both parties to approve intercompany transaction Automated two-step (“park and post’) – SPE preferred method Manual two-step – should be used in very limited situations (clearing conversion and creating transactions with non-SAP entity) Five business days for receiving entity to approve or dispute the transaction 201 Intercompany Transactions Settlement – remittance of cash and, in rare cases, non-monetary offset. In SAP system, settlement occurs on the account/trading partner level. However, it is not offset on the transactional level and therefore, even if settled SAP will continue to treat the transaction as ‘open’. All ‘open’ transactions are revalued by the system. Clearing – process of matching settled transactions on the transactional level. The clearing process will ‘close’ items on the transactional level. In this case the transaction is not considered ‘open’ by the system and will not be revalued. Note: the SAP ‘clearing’ functionality is not yet fully in place. 202 Intercompany Transactions Major push to be in-balance on a line item basis by September 2006 close Must use the SAP automated “two-step process” to ensure all new activity is in-balance as posted by both parties in the same accounting period Must have direct-relationship on all transactions with correct Company Code and Profit Center Must record all inter-company activity in “Transaction Currency” and let SAP make conversion to the “local currency” Must confirm all inter-company balances monthly in “transaction currency” with the SAP Report “SP70A” and remain in-balance at every period-end Must revalue inter-company balances denominated in foreign currencies at month-end (system A/R – A/P cutoff rates) on your books with offset entries to unrealized gain / loss on foreign exchange account (P&L) Must use SAP’s A/R – A/P clearing function to maintain month-end balance of “open-items” only to allow SAP’s “revaluation program” to work properly 203 Material Event Disclosure Complete and timely disclosure of material events – within 24 hours to SPE Corporate Materiality level is updated by Sony Corporation (Tokyo) on a periodic basis. SPE events are considered material if they exceed $10 million Examples of material events: Any mergers and acquisitions (M&A), joint venture or other strategic alliance transaction Any acquisition or sale of any property, plant or equipment Any impairment or write-off of assets or restructuring charges Any event triggering direct or contingent financial obligations Any lawsuit or potential lawsuit with possible monetary damage Execution or termination of any material contact outside the ordinary course (including nonbinding letters or intent), which includes the following: Any contract for the sale of products or services Any licensing agreement (except for cross-license) regarding particular intellectual property rights indispensable to the business of a particular product or service 204 Minimum Internal Controls Significant changes in internal accounting controls or accounting systems should be discussed with the SPE Corporate prior to implementation A checklist of standard company forms submitted by each group company (or other method) should be used to determine all required disclosures have been summarized, and should be maintained and reviewed by Corporate Reporting If foreign subsidiaries are recorded on a lag basis, a determination of the potential impact on the financial statements should be performed quarterly and accruals made if differences are material 205 SPE Technical Support and Compliance Resources and Links David Mastalski, Vice President, Technical Support and Compliance, SPE Corporate Finance E-mail: [email protected] Phone: 1-310-244-8538 Svetlana Tyuleneva, Director, Technical Support and Compliance, SPE Corporate Finance E-mail: [email protected] Phone: 1-310-244-6509 206 SPE Technical Support and Compliance Resources and Links SPE Accounting Policies and Procedures will be posted to: MySPE/Departments/Corporate/Finance/Compliance/Compliance Resources/SPE Accounting Policies and Procedures Significant Accounting Pronouncements from January 2003 to September 2006 will be posted to: MySPE/Departments/Corporate/Finance/Compliance/Compliance Resources/Significant Accounting Pronouncements Q&A and Closing 207 SPE Technical Support and Compliance Resources and Links SPE Accounting Policies and Procedures are/will be posted to: MySPE/Departments/Corporate/Finance/Compliance/Compliance Resources/SPE Accounting Policies and Procedures Significant Accounting Pronouncements from January 2003 to September 2006 are/ will be posted to: MySPE/Departments/Corporate/Finance/Compliance/Compliance Resources/Significant Accounting Pronouncements Q&A and Closing 208