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Off Balance Sheet FEI Home Financial Executives by liaoqinmei


									September 29, 2003

Mr. Alan Beller, Director
Ms. Carol Stacey, Chief Accountant
Division of Corporation Finance
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Subject: FR-67, Disclosure in Management’s Discussion and Analysis about Off-Balance Sheet
        Arrangements and Aggregate Contractual Obligations

The Committee on Corporate Reporting of Financial Executives International and the Financial
Reporting Committee of the Institute of Management Accountants (the Committees) are writing to
make the Commission aware of significant issues that have arisen regarding certain requirements of
FR-67, Disclosure in Management's Discussion and Analysis about Off-Balance Sheet Arrangements
and Aggregate Contractual Obligations. As our members are working on implementing the new
rule, significant concerns have arisen regarding FR-67’s requirements to provide tabular disclosure
of contractual purchase obligations. Those concerns include whether the requirement is consistent
with the true objective of the Sarbanes-Oxley Act which prompted issuance of the rule, the costs of
compliance and the relevance of the resulting disclosure. We believe that clarification of the scope of
the requirement and inclusion of a materiality threshold for purchase obligations is not only
appropriate, but is crucial to an orderly and consistent implementation of the disclosure. We
therefore ask that the SEC Staff examine the language in FR-67 in light of the information presented
herein and provide interpretive guidance that is responsive to these concerns.
When the SEC issued the proposed rule (File No. S7-42-02) in late 2002, the objective was to put in
place disclosures that complied with Section 401(a) of the Sarbanes-Oxley Act, which required the
Commission to adopt final rules that require registrants to disclose:
      “…all material off-balance sheet transactions, arrangements, obligations (including
     contingent obligations), and other relationships of the issuer with unconsolidated
     entities or other persons, that may have a material current or future effect on
     financial condition, changes in financial condition, results of operations, liquidity,
     capital expenditures, capital resources, or significant components of revenues or
Securities and Exchange Commission                                                                Page 2
September 29, 2003

Included in that rule proposal was a requirement to provide tabular disclosure of contractual
obligations including “Unconditional Purchase Obligations” – a term that was left undefined in the
proposal. The Commission requested comment on whether it should provide a definition and, if so,
what that definition should include. The proposal provided no specific guidance on materiality
related to items included in the table. Other parts of the proposal provided comforting language that
led most respondents to assume that customary notions of materiality would apply to the tabular
disclosure. Those included statements like “…[off balance sheet obligations are required to be
disclosed when] they may have a current or future material effect on the company’s financial
condition, results of operations, revenues or expenses, liquidity, capital expenditures or capital
resources,” and the Staff’s concerns that “an overly broad definition [of off-balance sheet
arrangements] could elicit unnecessarily voluminous and repetitive disclosure.” The Commission’s
analysis of the costs of compliance also provided comfort that the disclosure obligations were not
intended to be onerous: the Staff concluded that the cost would average approximately $5,000 per
company. Accordingly, the proposed tabular disclosure did not attract significant attention from
companies and organizations that were in a position to respond to the rule.

In contrast to the proposal, the final rule provides an expansive and complex definition of purchase
obligations that, for most large companies, has the potential to capture hundreds of thousands of
executory contracts. Because FR-67 provides no materiality threshold for the aggregation of
purchase obligations, and provides no scope exception for executory contracts entered into in the
ordinary course of business, our members have struggled with how to implement the requirement
and many of them have raised significant concerns about this provision. In addition, this provision is
difficult to reconcile with other parts of the rule. For example, Section II B 4 states that "…the
definition of purchase obligations is designed to capture the registrant's capital expenditures for
purchases of goods or services over a five-year period.” In Section II B 1, the Staff notes “We agree
that certain modifications to the proposed definition [of off-balance sheet arrangements] are
necessary to eliminate disclosure of routine arrangements that could obscure more meaningful

The rule assumes that information about these contracts is readily available because “management
should be fully apprised of off-balance-sheet arrangements and contractual obligations in the
ordinary course of managing the company, maintaining adequate internal controls and preparing
financial statements.” While this may be true for purchase obligations that truly are material to the
registrant, it is an inaccurate characterization for the vast majority of the population of contracts
covered by this rule. These include ordinary course of business contracts for services (e.g., custodial,
food, maintenance, legal), non-inventoried goods (e.g., supplies, stationary), and utilities (e.g.,
electricity, telecom) that occur in large volumes but immaterial amounts. Such contracts are typically
managed in the aggregate and are very rarely included in any system that could provide for
systematic retrieval necessary to comply cost effectively with the requirements of FR-67. Rather,
much of this required analysis can only be conducted by opening file drawers, reading the contracts,
analyzing the obligations, developing estimates of required cash flows, and reporting that
information along with relevant details (e.g., significant terms, termination and renewal provisions,
etc.) to be aggregated across the consolidated entity. One of our members provided a sample of the
range of contracts covered by this disclosure, which is attached at the conclusion of this letter.
While that list is representative of the potential scope of the rule for one registrant, it is by no means
Securities and Exchange Commission                                                              Page 3
September 29, 2003

As issues began to surface regarding this requirement, FEI and IMA asked their members for
additional information about the difficulties they were having with this disclosure. The comments
we received from companies confirmed that the population of executory contracts covered by the
rule is indeed large and diverse. Moreover, the effort required to identify, analyze, review and
disclose will require a large-scale resource commitment to comply. Based on our review, we are
certain that the estimates that justified FR-67 as cost-effective are materially understated. The
following comments from two large public companies that responded are illustrative of these

    Registrant A:
    “We have over 1,000 reporting units and while we have a centralized procurement function,
    certain commitments are made outside of this function. In addition, there are numerous systems
    that are used. Many of our commitments are made on spot purchases that can have thousands of
    items outstanding at any point in time. Commitments can include a wide variety of purchases
    e.g., raw materials, insurance, legal retainers, leases, etc. These all have different handling and
    since the disclosure requires some separation, analysis would be required to ensure there is no
    double counting. Long-term commitments will have to be aged. Many of them have variable
    prices, which will have to be estimated. There is no centralized system that accumulates this
    information on a real-time basis.
    We believe that the best way to accumulate the information will be through each reporting unit.
    We don't think it is unreasonable to estimate one FTE working on this for a week at each
    reporting unit. For some units this may understate the level of effort required. This would
    amount to about 50,000 hours for the whole corporation. However, if it turns out that this
    estimate is grossly over-stated and we use the estimate of 5.5 hours assumed in the rule and
    apply that to each reporting unit, the total time would still be in excess of 5,000 hours. The
    assumption underlying the rule appears to be that companies maintain an aged ledger of open
    purchase commitments from which a total amount can be obtained and simply dropped into the
    disclosure table. Since there is no balancing amount from which to reconcile, it is impossible to
    determine whether all items have been included. In order to comply, we will need to begin
    developing procedures for capturing the information now. However, because the population of
    commitments is always different at any given point in time, the actual data gathering will need
    to take place after the end of the year at a time when resources are stretched the thinnest.”
    Registrant B:
    “As a global organization, we undertook a study to estimate the potential impact of this
    requirement. Our findings were as follows:
    Purchase Orders. There were approximately 250,000-300,000 open purchase orders at the end
    of the most recent quarter. Not all purchase orders are firm commitments. As such, each would
    need to be examined manually to determine whether it qualifies. We estimate this annual effort,
    assuming no systemic solution, would require approximately 100,000 person-hours of effort
    (approximately 20 min per purchase order) with a cost of $5,000,000 ($50/hour). Purchase
    orders are in multiple systems (capital, expense, supply chain, etc.), platforms, and geographies
    covering over 350 legal entities.
    Documentation, Training and Process Design (excluding time to gather data on a quarterly
    basis): 200 person-hours to understand and document requirements (initial process for
Securities and Exchange Commission                                                              Page 4
September 29, 2003

    accumulating data), 800 person hours of effort for training. This includes multi-functional
    training (e.g., purchasing), which creates additional challenges since the base familiarity with
    accounting requirements is lower. Over a one-month period, we received 15-20 questions per
    day on off-balance sheet related issues. Total estimated cost for training is approximately
    $100,000 and will need to be continued in subsequent years.”

Beyond data collection and analysis issues, there also is the difficulty of taking the aggregate data
and translating it into a meaningful disclosure. We cannot conceive of a way to provide insightful,
relevant disclosure about changes in cash flows associated with thousands of individually immaterial
transactions. We are similarly challenged as to how to describe, in a transparent and helpful way, the
key attributes (e.g., payments subject to market risk, material termination or renewal provisions) of
this population in accordance with the rule’s requirements. This basket of contracts will move up and
down with the acquisition of new businesses, divestitures of others, changes in the terms of
arrangements, and the discovery of deficiencies in the collection mechanisms established solely to
comply with this disclosure. The Committees note that the final disclosure requirements for purchase
obligations are inconsistent with other MD&A rules and, as previously noted, the approach to
materiality taken in other parts of the final rule. We are certain that the costs of tracking and
reporting purchase obligations under this broad definition will far exceed the benefits of providing
this information to investors.
We therefore believe that it is important that the Commission undertake immediate steps to remedy
this problem in a timely manner so that investor information needs are met in 2003 financial reports.
We encourage the Staff to consult with knowledgeable representatives of registrants to refine its
approach in a manner that is both cost-effective and consistent with the broader mandate of the
Sarbanes-Oxley Act. In that regard, we would support disclosures of FAS 47 unconditional purchase
obligations and other unconditional “take-or-pay” type obligations that are outside the ordinary
course of business. Because capital expenditures often follow an irregular pattern and usually are
unconditional, we believe such contracts should also be included. Although the approach we
propose will require the development of new systems and processes, we strongly believe that
restricting the scope to these areas will significantly moderate compliance costs while meeting the
need for disclosure about obligations that have significant liquidity implications.
The Committees understand the difficulties the Commission may have in implementing a change in a
timely manner if it were necessary to undertake a change through rulemaking. We therefore
recommend that the Staff consider the development of a Question and Answer document that could
address this and other issues that have arisen with respect to FR-67. For example, a number of
questions have been raised about the scope of the Long Term Liabilities line in the tabular
disclosure. Some of our members believe that pension and OPEB liabilities are intended to be
included, while others do not believe so; and if they are required to be included, it is not clear
whether the disclosure for the former relates to plan contributions or benefit payments from the
pension trust. A Q&A document would greatly assist implementation and improve the comparability
of the resulting disclosures.
Securities and Exchange Commission                                                         Page 5
September 29, 2003


The Committees welcome the opportunity to continue an open dialogue on these issues and would be
pleased to respond to any questions the Staff may have regarding this joint response. We note that
FEI’s Committee on Corporate Reporting has a liaison meeting with Staff scheduled for October 17th
and we would be pleased to discuss this matter further at that time.


Frank Brod                                              Mitchell A. Danaher
Chair, Committee on Corporate Reporting                 Chair, Financial Reporting Committee
Financial Executives International                      Institute of Management Accountants
(989) 636-1541                                          (203) 373-3563

cc: Mr. Donald Nicolaisen, SEC Chief Accountant
  Securities and Exchange Commission                                                                                  Page 6
  September 29, 2003

Contractual Obligations - Purchase Obligations

General & Administrative
Professional & consulting fees
Audit services
Valuation services
System security assessment services
Legal fee retainers
Janitorial and maintenance services for property & facilities
Catering services for employee cafeterias
Health care / benefit administrative fees and management costs
Office supplies contracts
Telephone and cell phone vendor contracts
Dues and memberships
Contracts with senior management
Costs to fulfill obligations from transactions resulting in deferred/unearned revenue

Cost of Products & Services
Network access contracts
Advertising and sponsorships
Affinity agreements
Product royalties
Union contracts with employees

Capital Expenditures
Information technology hardware and software infrastructure upgrades
Warehousing equipment
Warranty agreements
Licenses for technology use
Software licenses
Maintenance commitments for hardware and software licenses

Wholesale product for resale

Financing Services
Banking services - lockbox, line of credit etc.
Credit scoring services for receivables

Outsourcing Contracts
IT services
Administrative functions
Security services
Equipment maintenance and support
Copier and duplicating equipment support

The final regulation requires that a registrant disclose the significant terms and conditions of its obligating arrangements. This
is difficult to do in any summarized manner. Contracts in each of the above categories could have multiple factors that govern
the amount of payment obligations, the years in which such obligations arise, and the manner of calculating payment. By way
of example, contracts can have both minimum purchase requirements and maximum guaranteed quantities to be provided, as
well as either of these terms separately. Contracts can have minimum prices, maximum prices, variable pricing based on
quantity purchased or inflation factors or market pricing with discounts or premiums included. Contracts can extend for
several years with the obligations not defined to a specific year of the contract. Even within each type of contract above, there
may be multiple vendors with whom a registrant holds obligations, and each contract could have different terms.

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