July 29, 2014

FASB Simplifies Financial Reporting For Development Stage Companies

By Andrew Kleeman, Assurance Services Senior

FASB Simplifies Financial Reporting For Development Stage Companies Assurance

A development stage company was defined as an entity devoting substantially all of its efforts in establishing a new business for which either (a) operations have not commenced or (b) the operations have commenced, but there is no significant revenue yet being generated. Due to these companies being in a position where their cash flows and liquidity positions are extremely critical, the Financial Accounting Standards Board (“FASB”) has updated the accounting standards to ease the burden on these companies by passing Accounting Standards Update 2014-10 (the “ASU”). FASB Chairman Russell Golden recently discussed that the Board passed the ASU to address concerns about the cost and limited relevance of the previous presentation and disclosure requirements. The general goal of the FASB was to improve financial reporting for these early-stage companies by reducing the cost and complexity associated with the incremental reporting requirements. Mr. Golden was also quoted saying “The update should also help foster more consistent consolidation analyses and decisions among public and private development-stage entities.1

The major changes as a result of the ASU eliminate the requirements for these entities to (a) present inception-to-date information in the statements of income, cash flows, and shareholder’s equity, (b) label the financial statements as those of a development stage company, (c) disclose a description of the development stage activities in which the entity is engaged in the financial statement footnotes, and (d) disclose in the financial statements the first year in which the entity exits the development stage. For public business entities, these amendments are effective for annual reporting periods beginning after December 15, 2014, and interim periods therein. For other entities, the amendments are effective for annual reporting periods beginning after December 15, 2014, and interim reporting periods beginning after December 15, 2015. For either the public or non-public entities, the entity must apply these amendments retrospectively to maintain consistency. In addition, the ASU states that early application may be permitted for any annual reporting period or interim period for which the entity’s financial statements have not yet been issued or made available for issuance. Therefore, it is expected that many entities will continue to implement the early adoption application.

An additional change included in ASU 2014-10 is the elimination of the previous exception provided to development stage entities for determining whether a development stage entity is a variable interest entity. Prior to the ASU, development stage companies had additional conditions to comply with in order to be considered a variable interest entity. Beforehand, the literature stated that a development stage could not be a variable interest entity if (a) the entity can demonstrate that the equity invested in the legal entity is sufficient to permit it to finance the activities that it is currently engaged in and (2) the entity’s governing documents and contractual arrangements allow additional equity investments. Due to the development stage entity standards and accounting literature being eliminated in whole, the above conditions are no longer inclusive in the accounting literature. For public companies, this change should be applied retrospectively for annual reporting periods beginning after December 15, 2015, and interim periods therein.

Despite the changes discussed above, the ASU does require additional disclosure in the Risks and Uncertainties (Topic 275) section to illustrate that an entity that has not begun planned principal operations and provide other information about the risks and uncertainties related to the entities current activities, which shall be applied prospectively.

As stated in the ASU there have been numerous discussions with investors and other users of financial statements, indicating that the previous required development stage entity disclosures mentioned above did not help investors decisions. The FASB believes that these updates to the ASU promote cost savings for these early stage companies as it relates to the time and work required for preparing the financial statements yet does not impact users of the financial statements. Therefore, this change is viewed as a benefit not only to the companies, but to the investors and the auditors, whom can now reduce their procedures as it relates to the review procedures performed of development stage disclosures and financial information.

1 http://www.journalofaccountancy.com/News/201410306.htm

John Rushford and John Hughes contributed to this article

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