As we have previously discussed in other venues and publications, an FASB Exposure Draft was issued in 2010 that would significantly change lease accounting. Briefly, virtually all leases would be considered a form of financing and even today’s operating leases would become capital leases. An intangible asset consisting of the “right of use” of the asset equal to the lease liability is recorded at inception. Because debt would go up and what is presently rent expense would become interest and depreciation expenses, there is a controversial front-loading to the cost pattern of leases under the proposal.
A revised Exposure Draft is expected before the end of 2012 or in early 2013, with a short comment period and a likely effective date of 2016. To address the significant negative feedback received from constituents, the revised Exposure Draft will include definitions that may qualify some leases for some sort of an exemption.
The significant elements of the revised Exposure Draft are expected to be:
- A concept of whether an equipment lease consumes “more than an insignificant portion” of the leased asset will likely be used to determine if the straight line “rent expense” pattern can be used, even if the balance sheet is grossed up for the right of use / lease obligation initial entry.
- Similar definitions and accounting would apply in the case of real estate leases if the lease term is a majority of the economic life of the building or the present value of the lease payments is substantially all of the fair value of the underlying asset.
- Companies will have to make judgments about the expected term of the lease (including likely renewal options to be exercised). When these estimates change, businesses will have a change in estimate that will be accounted for in the current year.
- Because capitalized lease computations require the use of an incremental borrowing rate, the FASB is likely to include a nonpublic entity practical expedient where a risk-free (treasury) rate will be able to be used in the computations.
When the new Exposure Draft is actually issued, we can provide further guidance as necessary.
Because the new standard will be adopted retrospectively with a charge to retained earnings in the year of adoption, companies are encouraged to make sure their data base on current leases is accurate and begin to assess the likely financial statement impact of the expected new standard on financial statements, key ratios (such as EBITDA) and debt covenants.
The FASB issued an Exposure Draft in June 2010 and a revised Exposure Draft in November 2011 which would supersede the majority of US GAAP’s current revenue recognition guidance, which is primarily industry specific. The revised Exposure Draft is expected to be issued as a final standard in late 2012 or early 2013, to become effective in 2016 for nonpublic entities. It would require that each contract between a vendor and a customer for the provision of goods and services be analyzed to identify the exchange of rights and obligations between the parties, as follows:
- Identify the contract with the customer.
- Identify the separate performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the separate performance obligations in the contract.
The construction industry has been watching this standard carefully, because in many situations the continued use of the percentage of completion method is at risk under the proposal. A critical issue in construction will be whether indicators such as physical possession and customer acceptance have occurred.
Other significant changes include a requirement to impute a time value of money into the accounting for multi-year contracts where a cash advance is paid up front, as well as a requirement that bad debt expense be shown as a contra-revenue reduction caption rather than an operating expense. In some situations, assets not shown under current GAAP will be recognized as costs incurred to obtain or fulfill contracts. Expanded footnote disclosures on the nature of customer contracts, judgments (or changes) in how performance obligation allocations will be required.
If a business sells items that could be considered to include discrete performance obligations (e.g., a cell phone with a two year service agreement), they should begin to consider the potential impact of the proposal. In many cases, the way in which marketing is done or legal documents are drafted will affect revenue recognition patterns under the new standard. When the standard is actually issued, we can provide further guidance as necessary.
Liquidity and Interest Rate Risk
The FASB issued a financial instrument Exposure Draft in June 2012 that would require some disclosures related to liquidity risk for all commercial and nonprofit organizations, even those that are not banks/financial institutions. Additional disclosures on interest rate risk would apply to banks. An effective date for the proposal has not been announced.
Other Comprehensive Income
In another revocation of an existing final rule, in June 2012, the FASB suspended the effective date of a final rule on other comprehensive income (“OCI”), pending a more complete evaluation of the entire concept, especially the “reclassification adjustment” element of OCI, which in common practice usually arises when marketable securities for which an unrealized gain/loss was recognized in a prior year are sold, resulting in realized gain/loss in the current year. This rather confusing requirement under US GAAP is done to avoid double counting of items. The new Exposure Draft is dated August 2012 and would actually expand required disclosures in the form of mandatory footnote tables. The Exposure Draft was silent as to an effective date.
Other Accounting Frameworks (IFRS / FRF-SME or “Little GAAP”)
Other accounting frameworks on which CPA’s can currently report include OCBOA (cash, modified cash, income tax basis) as well as international standards (IFRS and IFRS – SME for small and medium enterprises).
IFRS-SME is a self-contained set of standards (only 230 pages in length) that are revised about once in five years. The next revision will be exposed in mid-2013 and become effective in 2015.
The SEC seems to have signaled a slow-down in their timetable for possible acceptance of IFRS as a replacement for US GAAP for registrants. A July 2012 staff report simply says additional analysis and consideration of IFRS is appropriate, with no timeline given. Various FASB watchers seem to also suggest that after the “big three” FASB – IFRS convergence projects (leases, revenue recognition and financial instruments) are completed, the FASB will become increasingly reluctant to further share its standard setting responsibility with the international group.
The FASB has created the Private Company Council (PCC) with a mission to influence the existing FASB standard setting process to reflect the needs of private stakeholders, including exceptions or modifications to existing GAAP. The creation of PCC, headed by a PricewaterhouseCoopers partner, is generally seen as falling far short of what is required. Accordingly, the AICPA has begun work on its own Financial Reporting Framework for Small and Medium sized entities (FRF-SME).
The creation of FRF-SME seems to offer the best hope for the creation of an accounting framework that could produce financial statements that provide useful financial reporting benefits without excessive costs and complexities for leases, fair value reporting, revenue recognition issues, tax accounting and consolidation matters.
An Exposure Draft of the FRF-SME was issued in early November 2012 and runs 250 pages. An early read of this document suggests the following key changes from traditional GAAP:
- Policy elections will be permitted to select alternatives, such as no deferred taxes, investments reported at amortized costs (subject to impairment) rather than fair value, selectivity as to whether to consolidate a subsidiary even if control exists.
- Goodwill generally amortized on the same basis as for taxes.
- Start-up costs accounted for on the same basis as for taxes.
- No “other comprehensive income” in the equity section.
In many other areas, traditional GAAP is retained, including LIFO, operating lease accounting, industry specific revenue recognition policies, use of the indirect method for the cash flow statement, and a requirement to separate intangibles from goodwill in a business combination. This last matter is disappointing.
FRF-SME would be a self-contained set of principles-based standards that would be subject to revision only every 3-4 years. Professional judgment would significantly impact the magnitude of footnote disclosures. The policy footnote would have the following statement:
The Exposure Draft comment period is only three months and it did not have a proposed effective date because the AICPA has no authority to require anyone to use it. Accordingly, although the Exposure Draft is encouraging, we may still be some time away from any likelihood of having such a framework either available as a final document or accepted by lenders and stakeholders.
We hope that you find these updates helpful. If you have any questions, please feel free to contact Pete Metzloff or Jim Suttie in our accounting and auditing department at 440-449-6800.