The Financial Accounting Standards Board (FASB) unanimously voted on July 17 to propose a sweeping set of split deferrals for certain entities. The proposal, anticipated to be released in August, would delay new accounting regulations for 1) leases, 2) credit losses on loans, 3) long-term insurance contracts and 4) hedge accounting.
The delays would provide much-needed relief from implementation burdens for smaller reporting companies, private companies and not-for-profit entities as they adopt some of the most significant new accounting rules in decades. The details are as follows.
Rather than being disclosed in the financial statement footnotes, operating leases will move to the face of the balance sheet under Accounting Standards Update (ASU) No. 2016-02, Leases. (See Weaver’s infographic or podcast for explanations.) Based on these new regulations, the updated guidance requires that right-to-use assets be added to the balance sheet’s assets section and lease obligations included in the liabilities section. The lease implied rate or the incremental borrowing rate of the lessee must be discounted to its present value.
Lessees currently account for operating lease payments on their income statements, but they don’t account for future obligations on their balance sheets. In 2005, the Securities and Exchange Commission (SEC) estimated that approximately $1.25 trillion in operating leases wasn’t being recognized on public company balance sheets.
For calendar-year-end private companies and nonprofits, the FASB has voted to propose delaying the effective date for ASU No. 2016-02 by one year, from 2020 to 2021. A year after having to adopt sweeping new revenue recognition rules, these entities have reported stresses related to implementing the new lease standard. A delay would help them accumulate resources and technological expertise to set up internal systems that comply with the new lease guidance.
The lease standard went into effect this year for public companies with a December 31 year-end; therefore, the FASB cannot delay the effective date for those companies.
Portfolio Investment Losses
To address the 2007-2008 global financial crisis, ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments was developed. It will require financial institutions to immediately record the full amount of expected credit losses in their loan portfolios, rather than waiting.
Companies must report the amortized cost of credit losses using an “incurred loss” model under existing guidance. Until it is probable that the financial institution has incurred a loss, that model delays recognition. The FASB expects that the adoption of the current expected credit loss (CECL) model will provide more timely and relevant information.
Implementation of this standard has already been delayed and its implementation phased in. For smaller reporting companies, the FASB will propose changing the effective date of ASU 2016-13 from 2021 to 2023, and from 2022 to 2023 for private companies and nonprofits. These dates refer to calendar-year-end filers.
Calendar-year-end SEC filers that aren’t smaller reporting companies as defined by the SEC would keep the current January 1, 2020, effective date. Smaller reporting companies are those that have either a public float of less than $250, or annual revenue of less than $100 million and no public float or a public float of less than $700 million.
The FASB has faced significant controversy after generating the new credit loss standard. It has even been subjected to legislative censure, with some in Congress calling for the board to stop and do further study. Some trade organizations remain critical, claiming that the FASB’s soon-to-be proposed delays don’t go far enough. The American Bankers Association said that a delay “offers further proof that the required efforts to implement this costly standard are far greater than the board has previously led bankers to believe.”
Insurance contracts for the long-term
ASU No. 2018-12, Financial Services — Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts aims to provide investors and other financial statement users with better, more timely and transparent information about life insurance and annuity contracts. After more than 10 years of extensive outreach by the FASB to a diverse group of companies, organizations and regulatory bodies, the changes were issued.
The changes target four areas:
- The timeliness of recognizing changes in the liability for future policy benefits and the rate used to discount future cash flows
- Accounting for certain market-based options or guarantees associated with deposit (or account balance) contracts
- Deferred acquisition costs amortization
- The effectiveness of required disclosures
The FASB agreed that for smaller reporting companies, private companies and nonprofits, ASU No. 2018-12 would be deferred two years, from 2022 to 2024, and one year, from 2021 to 2022, for calendar-year-end public companies.
Insurers fear that these changes are more substantive than they expected. For example, the updated guidance requires insurers to regularly review and update the assumptions they use to measure the liability of future policy benefits, which were previously locked at contract inception and held constant over the contract term.
Assumptions used to measure discounted cash flows must also be reviewed at least annually. And the discount rate assumption must be updated at each reporting date based on a standardized, market-observable discount rate.
A delay would provide additional time for software vendors to modify their systems to support new reporting models. It would also give insurers time to educate the sector and put new systems properly in place.
Hedge accounting strategies
ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, expands the strategies that are eligible for hedge accounting to include:
- Hedges of the benchmark rate component of the contractual coupon cash flows of fixed-rate assets or liabilities
- Hedges of the portion of a closed portfolio of prepayable assets not expected to prepay
- Partial-term hedges of fixed-rate assets or liabilities
In addition, the updated standard allows for hedging of nonfinancial components, such as corrugated material in a cardboard box or rubber in a tire. For instance, with the update, companies will be able to isolate the risk associated with variability in cash flows due to a raw ingredient used to create a final product. However, there is a catch: to qualify for hedge accounting, the price of the component must be specifically carved out in a purchase (or sale) contract.
The updated standard also eliminated what critics called an onerous penalty in the “shortcut” hedge accounting method.
For calendar-year private companies and nonprofits, the FASB has agreed that its proposal would delay the implementation date for ASU 2017-12 by one year, from 2020 to 2021. The hedging rules are already in effect for public companies, so no date change would be made for those companies.
“The result of [the July 17 FASB meeting] shows the commitment the FASB has to helping small reporting companies, not-for-profits, and private companies have a high-quality implementation,” said FASB Chairman Russell Golden. “By giving them more time, they can learn from the public companies.”
Once the proposal is issued, it will be subjected to a 30-day comment period. Only positive feedback is expected to be received from business owners and accounting professionals who have been clamoring for a little extra breathing room from the looming implementation dates.
Contact Weaver to learn how this proposed delay could give your private company or nonprofit the benefit of understanding how public companies are implementing the standards.
Large public companies that have already implemented the new lease standard are reporting that it takes much more legwork than they’d…