On July 17, the Financial Accounting Standards Board (FASB) unanimously voted to propose a sweeping set of split deferrals for certain entities. The proposal, which is expected to be published in August, would delay new accounting rules for 1) leases, 2) credit losses on loans, 3) long-term insurance contracts, and 4) hedge accounting.
The delays would provide smaller reporting companies, private companies and not-for-profit entities much-needed relief from implementation burdens as they adopt some of the most significant new accounting rules in decades. Here are the details.
Accounting Standards Update (ASU) No. 2016-02, Leases, will move operating leases to the face of the balance sheet, rather than simply being disclosed in financial statement footnotes. Specifically, the updated guidance requires right-to-use assets to be added to the assets section of the balance sheet and lease obligations to be added to the liabilities section. A lease obligation must be discounted to its present value by the rate implicit in the lease or the lessee’s incremental borrowing rate.
Under current practice, lessees account for operating lease payments on their income statements, but they don’t account for future obligations on their balance sheets. The Securities and Exchange Commission (SEC) estimated in 2005 that about $1.25 trillion in operating leases wasn’t being recognized on public company balance sheets.
The FASB has voted to propose deferring the effective date for ASU No. 2016-02 by a year, from 2020 to 2021, for calendar-year-end private companies and nonprofits. These entities have reported stresses related to implementing the new lease standard only a year after having to adopt sweeping new revenue recognition rules. A delay would help them accumulate resources and technological expertise to set up internal systems to comply with the new lease guidance.
The lease standard went into effect for calendar-year public companies this year. So, the FASB can’t make any date changes for those companies.
ASU 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was developed to address the 2007–2008 global financial crisis. It will require financial institutions to immediately record the full amount of expected credit losses in their loan portfolios.
Under the existing guidance, companies must report the amortized cost of credit losses using an “incurred loss” model. That model delays recognition until it’s probable that the financial institution has incurred a loss. The FASB expects that the adoption of the current expected credit loss (CECL) model will provide more timely and relevant information.
The FASB will propose changing the effective date of ASU 2016-13 from 2021 to 2023 for smaller reporting companies, and from 2022 to 2023 for private companies and nonprofits. These dates refer to calendar-year-end filers.
Calendar-year-end SEC filers (typically larger public companies) that aren’t smaller reporting companies as defined by the SEC would keep the current January 1, 2020, effective date. The SEC defines smaller reporting companies as those that have either a public float of less than $250 million, or annual revenue of less than $100 million and no public float or a public float of less than $700 million.
The new credit loss standard has generated significant controversy for the FASB. It has even come under legislative censure, with some in Congress calling for the board to stop and do further study. Some trade organizations remain critical and say 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.”
Long-term insurance contracts
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. The changes were issued after more than 10 years of extensive outreach by the FASB to a diverse group of companies, organizations and regulatory bodies.
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,
- Amortization of deferred acquisition costs, and
- The effectiveness of the required disclosures.
The FASB agreed that ASU No. 2018-12 would be deferred two years, from 2022 to 2024, for smaller reporting companies, private companies and nonprofits, and one year, from 2021 to 2022, for calendar-year-end public companies.
Insurers told the FASB the changes are more substantive than they expected, and some insurers fear that the changes could introduce earnings swings that will deter investors. For example, the updated guidance requires insurers to regularly review and update the assumptions they use to measure the liability for 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 give software vendors extra time to modify their systems to support the new reporting models. It would also give insurers time to educate the sector and put new systems properly in place.
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, and
- 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. With the update, companies will, for example, be able to isolate the risk associated with variability in cash flows attributable to a raw ingredient used to make a final product. There is a catch, however: 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 have called an onerous penalty in the “shortcut” method of hedge accounting.
The FASB has agreed that its proposal would delay the implementation date for ASU 2017-12 by a year, from 2020 to 2021, for calendar-year private companies and nonprofits. Like the lease standard, the hedging rules are already in effect for public companies, so no date changes 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. But it’s expected to receive only positive feedback from business owners and accounting professionals who have been clamoring for a little extra breathing room from the looming implementation dates.