LAW AND ACCOUNTING COMMITTEE SUMMARY OF CURRENT FASB DEVELOPMENTS 2015 Fall Meeting Washington, DC

Transcription

1 LAW AND ACCOUNTING COMMITTEE SUMMARY OF CURRENT FASB DEVELOPMENTS 2015 Fall Meeting Washington, DC Randall D. McClanahan Butler Snow LLP ACCOUNTING STANDARDS UPDATE NO BUSINESS COMBINATIONS MEASUREMENT PERIOD ADJUSTMENTS In September, 2015, the FASB issued Accounting Standards Update No , Business Combinations (Topic 505), Simplifying the Accounting for Measurement-Period Adjustments. This update eliminates the requirement of a retrospective adjustment to prior period statements for measurement period adjustments. Consequently, the acquiring company would recognize adjustments to provisional amounts in the reporting period in which the adjustments are determined. An entity must present separately on the face of the income statement or disclose in notes the amount that would have been recorded in previous reporting periods. The effective date for public entities will be for annual periods, and interim periods within such periods, beginning after December 15, For all other entities, the effective date will be for fiscal years beginning after December 15, 2016 and interim periods within fiscal years beginning after December 15, Early adoption will be permitted. ACCOUNTING STANDARDS UPDATE NO PRESENTATION OF DEBT ISSUANCE COSTS In August, 2015, the FASB issued Accounting Standards Update No , Interest Imputation of Interest (Subtopic ): Presentation and Subsequent Measurement of Debt Issuance Cost Associated with Line of Credit Arrangements, Amendments to SEC Paragraph Pursuant to Staff Announcement at June 18, 2015 EITF Meeting. This update amends SEC guidance regarding the presentation and subsequent measurement of debt issuance costs associated with line of credit arrangements. ACCOUNTING STANDARDS UPDATE NO REVENUE RECOGNITION DEFERRAL In August, 2015, the FASB issued Accounting Standards Update No , Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date. This update defers the effective date of Update No by one year. Accordingly, public entities should apply the guidance of Update No to annual reporting periods beginning after December 15, 2017, including interim periods within such period. Early application will be allowed only for reporting periods beginning after December 15, All other entities should apply the standard for periods beginning after December 15, 2018 and interim reporting periods within annual reporting periods beginning after December 15,

2 ACCOUNTING STANDARDS UPDATE NO DERIVATIVES AND HEDGING In August, 2015, the FASB issued Accounting Standards Update No , Derivatives and Hedging (Topic 815): Application of the Normal Purchase and Normal Sales Scope Exception to Certain Electricity Contracts with Nodal Energy Markets, a consensus of the FASB Emerging Issues Task Force. This update provides the use of locational marginal pricing by the independent system operator does not result in the contract s failure to meet the physical delivery criteria of the normal purchases and normal sales exception. Consequently, an entity may designate the contract as a normal purchase or sale if the physical delivery criterion is met. These amendments would be applied prospectively. ACCOUNTING STANDARDS UPDATE NO PLAN ACCOUNTING In August, 2015, the FASB issued Accounting Standards Update No , Plan Accounting: Defined Contribution Pension Plans (Topic 962); Health and Welfare Benefit Plans (Topic 965): Fully Benefit Responsive Investment Contracts; Plan Accounting; Defined Benefit Pension Plans (Topic 960); Health and Welfare Benefit Plans (Topic 965); Plan Investment Disclosures; Plan Accounting; Defined Benefit Pension Plans (Topic 960): Defined Contribution Pension Plans (Topic 962): Health and Welfare Benefit Plans (Topic 965): Measurement Date Practical Expedient; each a Consensus of the Emerging Issues Task Force. This update simplifies some aspects of pension plan accounting. It is effective for fiscal years beginning after December 15, 2015 for parts 1 and 2 with a retrospective application. Part 3 is also effective for fiscal years beginning after December 15, 2015, but on a prospective basis. ACCOUNTING STANDARDS UPDATE NO INVENTORY In July 2015, the FASB issued Accounting Standards Update No , Inventory (Topic 330)-Simplifying the Measurement of Inventory. The purpose of this update is to simplify the measurement of inventory by providing that the inventory will be measured at the lower of cost or net realizable value, for inventory measured at other than LIFO or the retail method. This eliminates the requirement that the other factors of replacement cost and net realizable value less normal profit margin should also be taken into account. The update is a response to criticisms that the definition of market often leads to different outcomes. The update will be applied prospectively and the effective date for public entities will be for annual periods beginning after December 15, 2016 and for interim periods within those annual periods. For all other entities, the effective date will be for fiscal years beginning after December 15, 2016, and for interim periods beginning after December 15, Early adoption is permitted. ACCOUNTING STANDARDS UPDATE NO TECHNICAL CORRECTIONS In June, 2015, the FASB issued Accounting Standards Update No , Technical Corrections and Improvements. This update provides some technical corrections and improvements to the codification. It is effective immediately. 2

3 ACCOUNTING STANDARDS UPDATE NO INSURANCE In May, 2015, the FASB issued Accounting Standards Update No , Financial Services Insurance (Topic 944): Disclosures about Short Duration Contracts. This update provides for insurance companies to enhance their disclosures concerning their liability for unpaid claims and claim adjustment expenses for short-term contracts. The update is effective for public entities for periods beginning after December 15, 2015, and for interim periods within annual periods beginning after December 15, For all other entities, the effective date is for annual periods beginning after December 15, 2016 and for interim periods beginning after December 15, ACCOUNTING STANDARDS UPDATE NO PUSHDOWN ACCOUNTING In May, 2015, the FASB issued Accounting Standards Update No , Business Combinations (Topic 805): Pushdown Accounting Amendments to SEC Paragraphs Pursuant to Staff Accounting Bulletin No This update removes all SEC guidance regarding pushdown accounting from the codification, consistent with Accounting Standards Update No and Staff Accounting Bulletin No ACCOUNTING STANDARDS UPDATE NO FAIR VALUE MEASUREMENT In May, 2015, the FASB issued Accounting Standards Update No , Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities that Calculate Net Asset Value Per Share (or its Equivalent), a Consensus of the Emerging Issues Task Force. This update provides that investments will no longer be categorized in the fair value hierarchy for which fair value is measured at net asset value, or its equivalent, pursuant to the practical expedient approach. Additionally, this update provides that an entity is only required to make applicable disclosures if the investment is measured at fair value (as opposed to being eligible for valuation at fair value under current standards). Update No should be applied for public entities for fiscal years beginning after December 15, 2015 and interim periods within those years, and, for all other entities, for fiscal years beginning after December 15, ACCOUNTING STANDARDS UPDATE NO EARNINGS PER SHARE In May, 2015, the FASB issued Accounting Standards Update No , Earnings Per Share (Topic 260): Effect on Historical Earnings Per Unit of Master Limited Partnership Dropdown Transactions, a consensus of the Emerging Issues Task Force. This update provides that in the context of calculating historical earnings per unit under the two-class method, earnings and losses of a transferred business before the dropdown date should be allocated entirely to the general partner s interest. This update is effective for fiscal years beginning after December 15, 2015 and for interim periods within those fiscal years. 3

4 ACCOUNTING STANDARDS UPDATE NO INTANGIBLES GOODWILL In April 2015, the FASB issued Accounting Standards Update No , Intangibles Goodwill and Other, Internal Use Software (Subtopic ) Customer s Accounting for Fees Paid in a Cloud Computing Arrangement. This update provides guidance concerning whether a cloud computing arrangement includes a software license. If a software license is included, then the software license element will be accounted for as an acquisition of a software license. If a software license is not included, then the arrangement would be accounted for as a service contract. This update does not change current accounting for software licenses or service contracts by a customer or vendor under current GAAP. The update will be effective for public entities for annual periods, including interim periods within such periods, beginning after December 15, For nonpublic entities, the amendments will be effective for annual periods beginning after December 15, 2015 and interim periods beginning after December 16, The amendments can be applied respectively or retroactively. ACCOUNTING STANDARDS UPDATE NO COMPENSATION PLAN ASSETS In April 2015, the FASB issued Accounting Standards Update No , Compensation-Retirement Benefits (Topic 715), Practical Expedient for the Measurement Date of an Employer s Defined Benefit Obligation and Plan Assets. The update allows an employer with a non-month-end fiscal year to measure defined benefit plan assets and obligations as of the month-end closest to such fiscal year end. The update is effective for public entities for fiscal years beginning after December 15, 2015 and for interim periods within such years. For all other entities, for fiscal years beginning after December 15, 2016, and interim periods within such years beginning after December 15, ACCOUNTING STANDARDS UPDATE NO DEBT ISSUANCE COST In April, 2015, the FASB issued Accounting Standards Update No , Interest- Imputation of Interest (Subtopic ), Simplifying the Presentation of Debt Issuance Cost. The update provides that debt issuance costs would be presented in the balance sheet as a direct deduction from the carrying amount of the liability. Currently, such costs are reported as a deferred charge. The update is effective for public business entities for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. For nonpublic entities, the effective date is for fiscal years beginning after December 15, 2015, and interim periods within fiscal years beginning after December 15,

5 ACCOUNTING STANDARDS UPDATE NO CONSOLIDATIONS On February 18, 2015, the FASB issued Accounting Standards Update No , Consolidations (Topic 810), Amendments to the Consolidation Analysis. This update rescinds the indefinite deferral of Update This update was issued primarily to respond to criticism that current guidance in some cases requires consolidating in situations where the reporting company appeared to be directing the legal entity on behalf of others. The primary modifications are as follows: The presumption that a general partner has to consolidate a limited partnership has been eliminated. Changes the evaluation of whether a limited partnership is a variable interest entity or a voting interest entity. A limited partnership is a voting interest entity if it provides partners with either substantiative kick-out rights or participating rights. Eliminates two applicable consolidation models, so that entities must apply either the voting interest entity model or the variable interest entity model. Three conditions for evaluating whether a fee paid to a decision maker represents a variable interest have been eliminated. Customary and commensurate fees paid to a decision maker are not included in the analysis. The indefinite deferral from VIE analysis for investment companies and certain other entities has been eliminated. Related party relationships are generally considered only on a proportionate basis. Exceptions are if the common control group has characteristics of a primary beneficiary or substantially all of the activities of the VIE are conducted on behalf of a single variable interest holder. A scope exception has been added for reporting entities that are required to comply with requirements similar to those for registered money market funds. 5

6 The update is effective for public entities for fiscal periods beginning after December 15, 2015, and for fiscal periods beginning after December 15, 2016 for non-public entities. Early adoption, however, is permitted. ACCOUNTING STANDARDS UPDATE NO EXTRAORDINARY ITEMS In January 2015, the FASB issued Accounting Standards Update, No , Income Statement Extraordinary and Unusual Items (Sub Topic ) Simplifying Financial Reporting by Eliminating the Concept of Extraordinary Items. The update eliminates the concept of extraordinary items from GAAP. The stated reason for the update is that constituents have expressed that the elimination would save time and cost in the preparation of financial statements and would also possibly eliminate auditor uncertainty. Update No adds two definitions: Infrequency of Occurrence an underlying event or transaction that would not be reasonably expected to recur in the foreseeable future. Unusual nature underlying event or transaction with a high degree of abnormality and of a type unrelated to or incidental to ordinary activities of the entity. An event or transaction that is unusual or infrequent should be separately disclosed on the face of the income statement as a component of income from operations. The effective date is for annual periods beginning after December 15, 2015 and for interim periods within those annual periods. Early adoption is permitted. ACCOUNTING STANDARDS UPDATE NO BUSINESS COMBINATIONS PRIVATE COMPANIES In December 2014, the FASB issued Accounting Standards Update , Business Combinations (Topic 805), Accounting for Indefinite Intangible Assets in a Business Combination, a Proposal of the Private Company Council. The update provides that private entities can elect not to recognize separately from goodwill (i) customer related intangible assets that are not capable of being sold separately from other assets of the business and (ii) non-compete agreements. This accounting may be elected: (i) applying the acquisition method to a business combination; (ii) applying the equity method of accounting and assessing the difference between the carrying amount and equity in net assets or (iii) fresh-start accounting. This amendment is effective for fiscal years beginning after December 16, If an entity elects this alternative accounting treatment, it must also adopt the alternative accounting treatment for goodwill provided in ASC , and amortize goodwill on a straight-line basis over ten years (or less than ten years if appropriate). The 6

7 election must be made for first qualifying transaction in fiscal years beginning after December 15, ACCOUNTING STANDARDS UPDATE NO PUSHDOWN ACCOUNTING On November 18, 2014, the FASB issued Accounting Standards Update No , Business Combinations (Topic 805), Pushdown Accounting, a consensus of the FASB Emerging Issues Task Force. The update applies to the separate financial statements of an acquired entity and its subsidiaries and provides guidance for the optional election of pushdown accounting. The update applies to both public and private companies, and will be optional for an acquiree once the acquiror obtains control in a business combination. Disclosure of the election will be required. If the acquiree does not make the election in the reporting period during which the change in control occurs, it will have the option to elect pushdown accounting in a subsequent reporting period as a change in accounting principle. The election is irrevocable. The update was effective on November 18, ACCOUNTING STANDARDS UPDATE NO DERIVATIVES AND HEDGING In November 2014, the FASB issued Accounting Standards Update No , Derivatives and Hedging (Topic 815), Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share is More Akin to Debt or Equity, a consensus of the FASB Emerging Issues Task Force. This update would apply to all reporting entities that are issuers of hybrid financial instruments issued in the form of a share. The purposes of this update are to eliminate diversity in the practice of determining whether the nature of a host contract with a hybrid financial instrument issued in the form of a share is more akin to debt or equity. This update provides that the determination would be based on a consideration of all economic characteristics and the risk of the entire hybrid financial instrument, including the embedded derivative function. Upon adoption, each issued hybrid share instrument must be evaluated. The amendments would be applied on a modified retrospective basis. Retrospective application and early adoption would both be permitted. The update is effective (i) for public entities for all fiscal years, and periods within those years, beginning after December 15, 2015, and (ii) for non-public entities, for fiscal years beginning after December 15, 2015 and interim periods within fiscal years beginning after December 15, REVENUE RECOGNITION On May 28, 2014, the FASB issued Accounting Standards Update, No , Revenue Recognition (Topic 605), Revenue from Contracts with Customers. The core objectives of this update are (i) eliminating inconsistencies in current rules; (ii) creating a single framework; (iii) standardizing revenue recognition practice; (iv) improving usefulness of disclosures; and (v) making financial statements easier to prepare. 7

8 The update only applies to contracts with customers. A customer is a contracts party for purposes of acquiring goods and services. The overriding principles are as follows: Revenue should be recognized in a manner that reflects the transfer of goods or services. The consideration expected to be received should be equal to the revenue recognized. The following five steps would be applied in analyzing revenue recognition: Step 1 - Identify the contract with a customer. Contracts are considered on an individual basis but would be combined if (i) they were negotiated as a package, (ii) the amount of consideration depends on the price or performance of the other, or (iii) all goods and services are considered part of a single obligation. A contract modification would be approved when it created enforceable rights and obligations. For example, before a change order would affect revenue recognition, the change order must create an enforceable right. A contract modification is a separate contract if the modification increases the scope because of the addition of distinct promised goods or services and the price of contract increases by an amount that reflects the standalone price of the additional goods or services. Step 2 - Identify the separate performance obligations in the contract. Each promised good or service is accounted for separately if it is distinct. A good or service is distinct if the entity regularly sells it separately, or the customer can benefit from the good or service on its own or with other resources available. If the good or service is not distinct, an entity would combine the good or service until the bundle of goods or services is distinct (obviously, this may mean that all contracted goods and services for a particular contract are treated as a single performance obligation). A good or service should be accounted for as a distinct good or service if the customer can benefit from the good or service on its own or together with other resources that are readily available to the customer. Factors in determining whether a good or service is distinct include: 8

9 Whether the entity provides a significant service of integrating the good or service into the bundle of goods or services that the customer has contracted. Whether the customer is able to purchase the good or service without affecting the other goods or services in the contract. Whether the good or service significantly modifies or customizes another good or service in the contract. Whether the good or service is part of a series of consecutively delivered goods or services promised in the contract, the performance obligations are satisfied over time and the entity uses the same method for measuring progress of the transfer of the goods or services. Step 3 - Determine the transaction price (the amount to which an entity expects to be entitled). The transaction price (and correspondingly, revenue) is not adjusted for customer credit risk. This is a reversal from the 2010 Exposure Draft Effect of credit risk (such as a price concession) must be considered in determining if there is an impairment loss. The transaction price is reassessed at each reporting date. The transaction price should include the minimum amount of variable consideration that is expected to be received and that would not result in a subsequent revenue reversal. If the contract has a financing component, then the consideration should be adjusted to reflect the time value of money. Non-cash consideration should be measured at fair value. If an entity expects to pay consideration to a customer, the entity would account for the consideration as a reduction of the transaction price (unless payment is in exchange for a distinct good or service). If a sale involves a loan, the entity would consider a customer s credit risk. 9

10 Step 4 - Allocate the transaction price to separate performance obligations in the contract. If there are multiple performance obligations, allocate the transaction price to each separate performance obligation based on relative standalone selling prices. If there are no separate observable selling prices, the entity should estimate them. Methods used to estimate would include: (i) adjusted market measurement approach; (ii) expected cost plus a margin approach; or (iii) a residual approach. If an entity gives discounts to a customer, and selling prices indicate evidence of a separate performance obligation to which discounts should be allocated, then the discount should be allocated to these performance obligations, as opposed to all performance obligations. The residual approach for allocating price of a good or service should be used if the stand-alone price is variable or uncertain and also for contracts when there are two or more goods or services that have highly variable prices, but at least one of the other goods or services has a stand-alone price that is not highly variable. Step 5 - Recognize revenue when (or as) the entity satisfies a performance obligation. Defined by when the customer obtains control of that good or service. Indications of transfer of control include the following: (i) the entity has the present right to payment for the asset; (ii) the customer has legal title to the asset; (iii) the entity has transferred physical possession of the asset; (iv) the customer has significant risks and rewards of ownership of the asset; (v) the customer has accepted the asset. If a performance obligation is satisfied over time, then a method of measuring progress, such as outputs or inputs, would be determined. For variable consideration, recognize revenue when the entity is reasonably assured of being entitled to the consideration in exchange for a performance obligation. Both of these criteria must be met for an entity to be reasonably assured of variable consideration: (i) the entity has experience with similar types of performance obligations and (ii) the entity s experience is predictive of the amount of consideration to which the entity is entitled. A performance obligation will be deemed satisfied over time (in such case, control is transferred over time) if at least one of the following tests is met. 10

11 The asset created does not have an alternative use and the entity has a contractual right to payment for performance to date. The assessment of alternative use will be made at the inception of the contract. The customer consumes the benefits of the service performance as throughout the process, and another entity would not have to substantially re-perform such work. The customer controls the asset as it is being produced or enhanced. If performance obligation is satisfied over time, the entity would be required to recognize revenue over time. This could result in an entity recognizing revenue before the product is delivered. The standard was supposed to apply to public entities for annual reporting periods beginning after December 15, 2016, including interim reporting periods therein. The effective date for nonpublic entities was supposed to be for annual reporting periods beginning after December 31, 2017 and interim periods after that date. Early application was prohibited, and the standard would be applied retrospectively. In subsequent rediliberations, the FASB has decided to clarify guidance for: Sales tax reporting Contract modifications Transition disclosures Non-cash consideration Collectability Identifying performance obligations Licenses The Boards have decided to keep the method for assessing the likelihood of collectability. The Board has also affirmed its decision that in determining whether a contract exists, collectively should be assessed. Accounting Standards Update No delayed the effective date for one year. At its October 15, 2015 meeting, the Board affirmed most of prior discussed proposed amendments to the Update. Additionally, the Board focused on technical decisions regarding (i) identifying performance obligations and (ii) licensing. The staff is drafting a final Accounting Standards Update. NOTES TO FINANCIAL STATEMENTS On September 24, 2015, the FASB issued Proposed Accounting Standards Update No , Notes to Financial Statements (Topic 235), Assessing Whether Notes are Material. The main provisions are as follows: 11

12 Omitting disclosures of material information would not constitute an accounting error. Materiality is defined in legal terms. Materiality is applied quantitatively and qualitatively, both individually and in the aggregate. These amendments would be effective upon issuance. Comments are due on December 8, CONCEPTUAL FRAMEWORK FOR FINANCIAL REPORTING On September 24, 2015, the FASB issued Proposed Accounting Standards Update No , Proposed Amendments to the Statement of Financial Accounting Conceptual Framework and Financial Reporting Chapter 3: Qualitative Characteristics of Useful Financial Information. The proposed amendments would eliminate any inconsistency between the framework and the legal definition of materiality by making it clear that the meaning of materiality is a legal concept. The U.S. Supreme Court s definition of materiality would be incorporated by reference to the codification. Comments are due on December 8, EQUITY METHOD OF ACCOUNTING In June, 2015, the FASB issued a Proposed Accounting Standards Update No , Investments Equity Method and Joint Ventures (Topic 323): Simplifying the Equity Method of Accounting. This proposed update eliminates the requirement that for an investment under the equity method, the entity must account for the difference between the investment cost and the investor s proportionate share of investee s net assets as an adjustment to investment income. Instead, the investment may be accounted for on a cost basis. Constituents expressed concern that the current method adds cost and complexity to financial statement reporting without a pertinent benefit. Comments were due August 4, SHARE-BASED PAYMENT TRANSACTIONS In June, 2015, the FASB issued Proposed Account Standards Update No , Accounting for Various Aspects of Share-Based Payment Transactions. This proposed update purports to simplify accounting for share-based payment arrangements for the following: (i) income tax accounting; (ii) classification of awards; (iii) classification of cash flows and the statement of cash flows; (iv) estimating the term of an award by non-public entities and (v) the use of intrinsic value by non-public entities for all awards classified as liabilities upon 12

13 initial adoption after final amendment. The comment deadline ended August 14, The Board is assessing feedback and then will begin rediliberations. REVENUE RECOGNITION NARROW SCOPE IMPROVEMENTS On September 30, 2015, the FASB issued Proposed Accounting Standards Update No , Revenue from Contracts with Customers (Topic 606), Narrow Scope Improvements and Practical Expedients. This proposed update provides clarifying guidance that the Transition Resource Group raised following the issuance of the Revenue Recognition Standard. Specifically, the guidance addresses: (i) objectives of the collectability criterion; (ii) presentation of sales taxes collected from customers; (iii) measurement and receipt of noncash consideration; (iv) contract modifications and complex contracts at transition and completed contracts at transition; and (v) disclosure of effects of the change in the period of adoption. The comment period ended November 16, The effective date would be identical with the effective date for Accounting Standards Update No REVENUE RECOGNITION CLARIFICATION PERFORMANCE OBLIGATIONS AND LICENSING In May, 2015, the FASB issued Proposed Accounting Standards Update No , Revenue from Contracts with Customers (Topic 606): Identify Performance Obligations and Licensing. This proposed update would clarify issues regarding guidance for (i) identifying promised goods or services in the context of identifying performance obligations within a contract and (ii) concerning the determination of whether an entity s promise to grant a license provides either the right to access or use the intellectual property. The comment deadline ended June 30, REVENUE RECOGNITION PRINCIPAL VERSUS AGENT CONSIDERATIONS On August 31, 2015, the FASB issued Proposed Accounting Standards Update No , Revenue from Contracts with Customers (Topic 606): Principal Versus Agent Considerations (Reporting Revenue Gross versus Net). The proposed update would amend current guidance for situations in which a second party is involved in providing goods or services to a customer. In such situations, the reporting entity must determine whether its promise constitutes a promise to provide the goods or services (acting as a principal) or to arrange from them to be provided (acting as an agent). A principal shall recognize the gross amount of consideration. An agent should recognize the fee or commission to which it is entitled. The determination must be made for each specified good or service. Comments were due October 31, DERIVATIVES AND HEDGING On August 6, 2015, the FASB issued an Exposure Draft, Proposed Accounting Standards Update, Derivatives and Hedging (Topic 815), Derivative Contract Novations on Existing Hedge 13

14 Accounting Relationships, a consensus of the FASB Emerging Issues Task Force. The proposed update clarifies that if there is a change in the counter-party to a derivative instrument that has been designated as a hedging instrument, this does not require a re-designation of that hedge accounting relationship if all other criteria are met. These amendments would be applied prospectively. An effective date has not been determined. Comments were due by October 5, LEASES The FASB and the IASB issued a Discussion Paper/Preliminary Views document on March 19, 2009, to examine and reconsider FAS 13, Accounting for Leases, and IAS 17, Leases. On August 17, 2010, the FASB issued an Exposure Draft, Leases (Topic 840). This document was deliberated over a period of years. On May 16, 2013, the FASB and IASB issued a revised Exposure Draft, Leases (Topic 840). Certain key provisions of the Exposure Draft include the following: Definition of a Lease Scope Leased asset must be specifically identifiable. A contract does not contain a lease if an asset is incidental to the delivery of specified services. A lease conveys the right to use the asset. The Exposure Draft does not provide guidance in distinguishing between a lease and a sale of an underlying asset. If the structure of the transaction does not constitute a lease, then its proper accounting is governed by another standard. An entity will determine whether a contract is a lease based on the substance of the contract, such as whether the fulfillment of the contract depends on the use of an asset and conveys the right to control the use of the asset. The following are within the scope of the standard: Right of use assets in a sublease Leases of noncore assets Long-term leases of land 14

15 The following are not within the scope of the standard: Lessee Accounting Leases for the right to explore for minerals, oil and gas, etc. Leases of biological assets Short-term leases Lessee will recognize a right of use asset for all leases except short-term leases. Lessees would apply one or two accounting approaches: (i) a financing approach or (ii) a straight-line approach. For leases of property; the straight-line approach should be used unless: The lease term is for the majority of the economic life of the underlying asset; or The present value of the fixed lease payments represents substantially all of the fair value of the underlying asset. For leases of assets other than property, the lease should be accounted for on a financing approach (i.e., interest and amortization) unless: The lease term represents an insignificant portion of the economic life of the underlying asset. The present value of the fixed lease payments is insignificant relative to the fair value of underlying asset. The lessee s general rule for assets other than property: Initially recognize a liability to make lease payments and a right of use asset. The liability will be subsequently measured using the effective interest method. Right of use asset will be amortized on a systematic basis that reflects the pattern of consumption, resulting in greater total expense in earlier years. 15

16 Recognize interest expense and amortization expense separately in the income statement. The lessee s general rule for leases of property: Lessor Accounting Initially recognize a liability to make lease payments and a right of use asset, both measured at present value of the lease payments. Measure the liability to make lease payments using the effective interest method. Measure the right of use asset as a balancing figure such that the total lease expense is recognized on a straight-line basis (i.e., effectively meaning that amortization is a plug figure ). Recognize lease expense as one amount in the income statement. Lessor would account for lease under one of two approaches: (i) receivable and residual; or (ii) operating lease. If the lessee acquires and consumes more than an insignificant portion of the leased asset, or the present value of lease payments accounts for substantially all of the value of the asset, a lessor would recognize a right to receive lease payments and a residual asset at the commencement of the lease. The right to receive lease payments would initially be measured as the sum of the present value of the lease payments, and subsequently measured at amortized cost. A residual asset would be measured as a combination of (i) the gross residual asset and (ii) the deferred profit. If the lessee acquires less than an insignificant portion of the leased asset, then the lessor should account for the underlying asset and recognize lease income over the lease term (i.e., similar to current operating lease format). Deferred profit is not recognized until the residual asset is sold or released to another lessee. A lessor s lease of investment property would not be treated under the receivable and residual approach. In such cases, the lessor should 16

17 Subleases Lease Term continue to recognize the underlying asset and recognize lease income over the lease term. The head lease and the sublease should be accounted for as separate transactions. Sublessors utilize lease accounting on the head lease and lessor accounting on sublease. The lease term would be the non-cancellable base period plus any periods for which there is a significant incentive to extend the lease term. Contract, asset, market and entity specific factors would be considered in determining the economic incentive for renewal. The lessor and lessee would only reassess the lease term when there is a significant change in relevant factors that would affect the lessee s decision to exercise or eliminate an option to extend the lease period. Accounting for Purchase Options The exercise of a purchase option should be included in the computation of a lessee s liability for lease payments if the lessee has a significant economic incentive to exercise the purchase option. If the lessee does have a significant economic incentive to exercise the purchase option, then the right of use asset should be amortized over the economic life of the asset, rather than the lease term. Short-Term Leases A short-term lease will be a lease with a maximum possible term of 12 months or less. The lessees and lessors will have the option to elect to account for all short-term leases of a portfolio asset class by recognizing lease payments in profit or loss on a straight line basis, rather than by recognizing a lease asset or liability, unless another rational basis is more representative. Residual Guarantees Lease payments should include the amount expected to be payable under residual value guarantees, except if provided by an unrelated third party. 17

18 The lessor should not recognize amounts to be received under a residual value guarantee until the end of the lease. Discount Rate The lessor uses the rate it charges the lessee. The lessee should use the rate the lessor charges the lessee, unless that rate is not available. In that case, the lessee should use its incremental borrowing rate. Nonpublic entities will have the election of using a risk-free discount rate for all leases. Contract Modifications If there is a substantive change to the existing contract, the modified contract should be accounted for as a new contract. A substantive change is a change in contractual terms that results in a different determination of whether the contract is or contains a lease. If there are changes other than to the contractual terms that affect the assessment of whether the contract is a lease, then the contract should be reassessed to determine whether it is a lease. Separating Lease and Non-Lease Components The lessor and lessee have to identify and separately account for the lease and non-lease components of a contract. Payments should be allocated in accordance with the guidance on revenue recognition. Each separate lease component should be accounted for as a separate lease. Sale and Leaseback If a sale has occurred, the transaction should be accounted for as a sale and then a separate leaseback. The revenue recognition guidance will be applied to determine whether a sale has occurred. If sale has not occurred, then the contract should be accounted for as a financing. 18

19 If the seller/lessee has the ability to direct the use of, and obtain substantially all of the remaining benefits from the asset, a sale has not occurred. Cancellable Leases If a lease is cancellable by both the lessor and lessee with minimum termination payments, then such lease meets the definition of a shortterm lease if the initial noncancellable period is less than one year. This analysis does not change the definition of short-term lease and lease term. Transition Guidance Lessees For capital leases, a lessee is not required to make any adjustments to the carrying amount of the lease assets and lease liability, and can reclassify such assets and liabilities as right-of-use assets and liabilities. Otherwise, the lessee may apply a full retrospective application. For operating leases subject to the interest and amortization method: (i) recognize liabilities for lease payments at the present value of remaining lease payments, discounted using the lessee s incremental borrowing rate; (ii) recognize right-of-use assets at an amount equal to the proportion of the liability to make lease payments calculated on the basis of the remaining lease payments; and (iii) record any difference to retained earnings. Otherwise, the lessee may apply a full retrospective application. For operating leases subject to straight line approach: (i) recognize a liability to make lease payments measured as present value of remaining lease payments, discounted by lessee s incremental borrowing rate; and (ii) recognize a right of use asset equal to the related liability to make lease payments. Transition Guidance Lessors Lessors may apply a full retrospective approach. For finance/sales and direct finance leases, a lessor can reclassify the carrying amount as a lease receivable. For operating leases: Recognize a right to receive lease payments equal to present value of the remaining lease payments. 19

20 Recognize a residual asset consistent with the measurement of the residual asset. De-recognize the underlying leased asset. Disclosures Nonpublic entities will be exempt from the requirement to provide a reconciliation of the opening and closing balance of the lease liability. Potential Effects of these Proposals: The lessee s balance sheet would grow due to the recognition of an asset and liability for all previously accounted for operating leases. Lessee s leverage ratios would decrease. Lessee s interest coverage ratios computed on an earnings basis would decrease. Any lessee measures involving EBIT or EBITDA would improve since portions of the lease payments would now be characterized as interest expense and depreciation expense. Operating cash flow for a lessee would improve since payments for leased assets would be classified as financing activities rather than operating activities. For leases previously accounted for as operating leases, the lessor s balance sheet would grow under the proposals. Consequently, the lessor s ratios would also be affected. For leases accounted for as finance leases, the effect on lessors would depend on the specific characteristics of the lease. Loan covenants, financing agreements, and regulatory requirements could be affected. The Boards have been redeliberating the Exposure Draft. During the redeliberations, the FASB has decided as follows: Private companies will follow the same accounting as public companies (except for the use of risk-free rate to measure liabilities). FASB and IASB have agreed to a converged definition of a lease, which will be the right to use an asset for a period of time in exchange for consideration. A customer must use and obtain substantially all of the benefits of an asset. 20

21 A dual approach will be used for lessee accounting, with existing capital/finance leases accounted for as Type A leases (i.e., interest and amortization) and most existing operating leases as Type B leases. For type A leases, lessee s would recognize the amortization of a right of use asset, and a single total lease expense for Type B leases. If a lease (i) does not transfer control of the underlying asset to the lessee and (ii) collectability is not probable, it should be classified as Type B lease. Leases that transfer control of the underlying amount to lessee shall be accounted for in accordance with the collectability guidance applicable to all sales of nonfinancial assets. A lessor must determine whether the lease is a sale or a financing (Type A or B), based on whether substantially all the risks and rewards incidental to ownership have been transferred. For a sale to occur in context of sale-leaseback, the sale must meet requirements for sale in the new revenue recognition standard. Lease guidance may be applied at a portfolio level by both lessees and lessors. Only incremental costs should qualify as initial direct costs. Final standard will include a disclosure objective to enable uses to assess the amount, timing, and uncertainty of cash flows arising from leases. Lessee will disclose a maturity analysis of its lease liabilities. Qualitative disclosure requirements will be retained. Lease options will only be considered in lease term if it is reasonably certain that the lessee will exercise the lease. The term reasonably certain is basically the same threshold as reasonably assured in existing GAAP. The short-term lease period will remain at 12 months. Lease modifications are accounted for as a new lease if: (i) the lease grants the lessee an additional right of use and (ii) the additional right of use is priced accordingly. If a modification is not accounted for as a separate new lease and changes the scope or consideration of the lease, the lessee should remeasure the lease liability using a discount rate determined at the effective date of the modification. 21

22 Companies with variable lease payments that depend on index or benchmark may only remeasure expenses when they must readjust liability for other reasons. Deliberations are continuing. The effective date is not expected to be before at least January 1, The staff is drafting a final standard. Members of the IASB s global advisory panel have expressed disappointment that the FASB and the IASB won t produce converged lease accounting standards. Additionally, at least one remaining issue is that there are parts of the lease standard that depend on provisions in the revenue standard that have not yet been written and/or clarified. On October 7, 2015, the Board met and considered redeliberations on fairly discrete topics. On November 11, 2015, the Board approved the publication of a final leases standard. The effective date for public companies will be for years beginning after December 15, The standard will be effective a year later for private companies. EFFECTIVE DATES PRIVATE COMPANY COUNSEL On September 30, 2015, the FASB issued Proposed Accounting Standards Update No. PCC-15-01, Intangibles Goodwill and Other (Topic 350), Business Combinations (Topic 805), Consolidations (Topic 810), Derivatives and Hedging (Topic 815), Effective Date and Transition Guidance, a proposal of the Private Company Counsel. The proposed amendments provide that the effective date for Update No , , and , are effective immediately (via the removal of their effective dates). Additionally, private companies would not have to perform a preferability assessment when they elect the accounting alternatives. Comments were due on November 16, INSURANCE CONTRACTS In July 2013, the FASB issued a Proposed Accounting Standards Update No , Insurance Contracts (Topic 834). This update represents a significant overhaul to the manner of accounting for insurance contracts. Insurance contracts would be measured by either (i) the building block approach or (ii) the premium allocation approach. The building block approach would typically apply to life annuity and long-term health contracts. The premium allocation approach would generally apply to property, liability and short-term health contracts. Modifications from current GAAP would include the following: Current insurance accounting applies only to insurance entities, whereas the proposed guidance would apply to any entity issuing an insurance contract. 22

23 Assumptions concerning the contract are usually fixed at inception under current GAAP, whereas the update would require expected cash flows to be measured each reporting period. Liability under the premium allocation approach would be based on probability weighted expected cash outflows, as opposed to best estimate of expected cash outflows under current GAAP. The margin for contracts accounted for in the building block approach would generally be presented in financial statements, as opposed to include as a part of the insurance contract liabilities under the current long duration model. Comments were due on October 25, The FASB held a series of public round tables in late The FASB subsequently began redeliberations and decided that the project s emphasis should be on targeted improvements to existing GAAP. Decisions during the rediliberations include: Requiring underwriters of property and casualty, healthcare and other shortterm insurance policies to disclose more information about their estimates of liabilities from incurred and paid claims. Disclosure about life insurance liabilities and assumptions used to calculate such liabilities. Requiring insurance entities to update all assumptions regarding calculations of liabilities for future benefits at least annually during the fourth quarter of each year. All years in claims development table and associated history of claims should be presented as supplementary information. For each year presented in the claims development table, the amount of IBNR plus expected developed and reported claims should be disclosed. On July 24, 2015, the FASB decided that cash flow assumptions should be updated using a retrospective approach and discount rate assumptions should be updated using an immediate approach. On October 28, 2015, the Board decided that the liability for future policy benefits for participating life insurance contracts would be calculated on basis of expected future cash flows. The Board is continuing redeliberations. FINANCIAL INSTRUMENTS CLASSIFICATION AND MEASUREMENT On April 12, 2013, the FASB issued a Proposed Accounting Standards Update, Financial Instruments Overall (Subtopic ), Recognition and Measurement of Financial Assets 23