The end of “development stage” entities, at least for accounting purposes

by Cydney Posner

FASB has approved a new accounting standard update to ASC 915, Development Stage Entities. This ASU (Update No. 2014-10), which could be very helpful for a number of companies that are not yet generating much revenue, is subject to early adoption.

FASB defines a “development stage entity” as an entity devoting substantially all of its efforts to establishing a new business and for which either of the following conditions exist:

  • Planned principal operations have not commenced; or
  • Planned principal operations have commenced, but there has been no significant revenue from those operations.

Currently, development stage entities are required, in addition to satisfying the usual financial statement requirements, to disclose the following information:

  • Present inception-to-date information on the statements of income, cash flows, and shareholder equity;
  • Label the financial statements as those of a development stage entity
  • Disclose a description of the development stage activities in which the entity is engaged; and
  • Disclose in the first year in which the entity is no longer a development stage entity that in prior years it had been in the development stage.

The ASU deletes the definition of “development stage entity” from the FASB “Master Glossary.”  As a result, the financial reporting distinction between development stage entities and other entities is eliminated.  In addition, the amendments eliminate the requirements for development stage entities to provide the additional disclosure identified above. The changes are intended to reduce the cost and complexity associated with providing the incremental information, as users of these financial statements advised FASB that the information has “limited relevance” and is generally not “decision useful.” As a result, FASB concluded that eliminating these requirements would provide “cost savings for preparers without reducing the relevance of information provided to users of financial statements.” In the context of an IPO, the requirement for inception-to-date information can certainly add to the expense, as, unless a waiver is obtained, the financial statements from inception through the latest audited balance sheet date are required to be audited and, in some situations, may require the existing auditor to rely on the work of a predecessor auditor or to audit prior periods that that auditor had not previously audited.

The ASU also eliminates an exception provided to development stage entities for determining whether an entity is a variable interest entity on the basis of the amount of investment equity that is at risk. This amendment was also adopted to simplify reporting by requiring that the same consolidation guidance apply to all reporting entities; however, FASB advises that “elimination of the exception may change the consolidation analysis, consolidation decision, and disclosure requirements for a reporting entity that has an interest in an entity in the development stage.”

In addition, in FASB ASC 275-10-55, FASB added sample risk and uncertainty disclosures for entities that have not commenced principal operations.  The ASU clarifies that this disclosure should be included for entities that formerly qualified as development stage entities.

The amendments related to the elimination of inception-to-date and other special disclosure requirements are to be applied retrospectively, except for the clarification to Topic 275, which is to be applied prospectively. For public companies, 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. Earlier implementation is allowed for any period where the reporting entity’s annual or interim financial statements have not yet been issued (public business entities) or made available for issuance (other entities). Upon adoption, entities will no longer disclose any information required by Topic 915.

Note that, in IPOs for early stage companies that have not received revenues from operations during specified periods, Reg S-K 101 requires disclosure of plans of operations and other matters. These requirements are not necessarily tied to the accounting concept of “development stage entity,” and that additional S-K disclosure requirement is not affected by the ASU. But perhaps the SEC will follow FASB’s lead and eliminate or streamline that requirements as part of its disclosure modernization project.

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