The FASB Update Private Company Edition highlights recent Exposure Drafts on accounting for financial instruments, revenue recognition, and accounting for leases. Because of the far-reaching effects of those proposals, input on them is critically important.
Three Far-Reaching Exposure Drafts—a Call for Input
Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities.
The FASB’s objective in proposing a new financial instruments standard is to provide financial statement users with a more timely, transparent, and representative depiction of an entity’s exposure to risk from financial instruments. The proposal would also modify hedge accounting with the intent to improve and simplify hedge accounting requirements.
The proposed standard would have the greatest effect on financial institutions, such as banks and credit unions. Most private financial institutions, however, would be eligible for a four-year delay in the effective date for the measurement provisions on loans and core deposits. The proposed standard would also allow short-term receivables and payables and, in many instances, an entity’s own debt to continue to be measured at amortized cost. Therefore, the effect of the proposed standard would likely be less significant for many commercial and industrial entities. An entity’s business model is considered when determining how to account for an entity’s financial instruments. The IASB has a similar project on its agenda; the two Boards are working collaboratively to both improve and converge their standards.
The comment period for the financial instruments Exposure Draft ended September 30, 2010. However, the Board and staff are seeking additional input through various outreach activities. A nonpublic entity (private company and not-for-profit organization) roundtable on the proposal was held on October 12, 2010, in Norwalk.
Revenue Recognition—Revenue from Contracts with Customers
In June, the FASB and the IASB published common Exposure Drafts of a proposed revenue recognition standard. The goal of the proposal is to improve comparability and consistency in revenue recognition across various industries and capital markets. The proposed principles would replace the existing U.S. GAAP patchwork of various industry-and transaction-specific requirements that can result in different accounting for economically similar transactions.
The comment period for the revenue recognition Exposure Draft ended October 22, 2010. However, the Board and staff are seeking additional input through roundtables currently being held, as well as other private-company-focused discussions with groups such as the Technical Issues Committee of the AICPA Private Companies Practice Section.
Leases
The FASB and the IASB are also working together to improve and converge existing accounting standards for leases (by both lessees and lessors). While existing U.S. GAAP and IFRS requirements are similar in most respects, both sets of standards often are criticized for their failure to provide a complete and comparable picture of an entity’s leverage, operating capacity, and return on capital.
Because of the bright-line tests used in U.S. GAAP to distinguish between an operating and finance lease, small differences in lease terms can produce dramatically different financial reporting. This affects whether leased assets and obligations are reported on or off lessee balance sheets.
The leases Exposure Draft proposes one method of accounting by lessees that would recognize on company balance sheets the assets and liabilities arising from all lease contracts. A single method of accounting by lessees would produce more complete and comparable financial reporting and would significantly reduce the opportunity to structure transactions to achieve a desired accounting outcome.
The on-balance-sheet treatment of leases by lessees also means that users of financial statements would no longer need to estimate the effects of operating leases when calculating financial metrics such as leverage ratios. Financial statements also would provide users with a more accurate view of a company’s liabilities and future cash flows.
While a lessee’s leverage would increase under the proposed accounting, the lessee’s calculation of non‐GAAP EBITDA also would increase because of the reclassification of rent expense as interest expense and amortization expense on the income statement.
The accounting by a lessor would reflect its exposure to the risks or benefits of the underlying leased asset. A lessor that does not retain exposure to the significant risks or benefits in the leased asset would recognize a lease receivable, recognize revenue and expense upon lease commencement and derecognize a portion of the leased asset. When the lessor retains exposure to significant risks or benefits in the leased asset, it would recognize a lease receivable, recognize a liability representing its obligation to permit the lessee to use the leased asset, and recognize income over the lease
term.
The FASB is looking for comments on the leasing Exposure Draft by December 15, 2010. A nonpublic entity roundtable on the proposal will be held on Wednesday, January 5, 2011, in Chicago from 1:00 p.m.–4:00 p.m. CST.
Another Exposure Draft
Disclosure about an Employer’s Participation in a Multiemployer Plan
Under the amendments in this proposed Accounting Standards Update, employers participating in multiemployer pension and postretirement benefit plans would be required to provide additional quantitative and qualitative disclosures about their participation in the plans. The FASB’s goal is to enhance current disclosure requirements to help users of financial statements assess the future cash flow implications relating to an employer’s participation in multiemployer pension plans. Previously, this information was limited to the historical contributions made to the plan.
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