Activity from the Financial Accounting Standards Board (FASB) and other regulators during the first quarter of the year may set the stage for entities to obtain relief from certain accounting requirements. Below is a recap of the notable developments to keep on your radar that could affect financial reporting in 2021.
Loss of the LIBOR
Reference rate reform is one of the important changes to monitor. The London Interbank Offer Rate (LIBOR) is an interest rate average at which major global banks lend to one another for short-term loans. LIBOR is scheduled to sunset at the end of 2021, affecting financial service groups and lenders and, more broadly, companies with debt agreements, derivatives, lease agreements, or other contracts that reference LIBOR.
Many contracts reference LIBOR, or other reference rates that are being phased out, as a primary interest rate used or in penalty provisions. In order to maintain consistent economics and functionality, many banks, lessors, and companies are modifying their agreements to replace these references to LIBOR with other interest rates.
The accounting guidance that governs how companies evaluate and account for contract modifications was designed considering infrequent modifications, not broad changes to a portfolio of contracts due to a market-wide disruption such as LIBOR phase out. Thus, when a modification occurs, the revision of the agreement triggers accounting requirements for modifications, which can result in significant cost to evaluate the appropriate accounting, and may result in the recognition of gains, losses, or the cessation of hedge accounting.
In 2020, the FASB issued ASU 2020-04 to address operational challenges and concerns about the financial reporting impact of the modification of such a large number of contracts due to the market-wide transition. The relief provided by ASU 2020-04 applies through 2022 in the following scenarios:
- Your contract contains a reference rate that is expected to be discontinued (such as LIBOR);
- The modification to the debt agreement directly replaces the reference rate; and
- There are any other changes that relate to the replacement of the rate.
The general principle of the relief is that it will allow entities to modify an agreement without having to perform the normal requirement to re-measure or reassess the contract on the date of modification.
In the first quarter of 2021, the FASB issued accounting relief as part of ASU 2021-01 to expand the relief provided in ASU 2020-04 for changes related to the discounting transition that is occurring for derivative instruments as a result of the phase-out of LIBOR. The accounting relief includes an optional expedient within derivatives and hedging guidance for contract modifications resulting from changes to interest rates for margining, discounting, or contract price alignment caused by the transition from LIBOR or other reference rates that are being phased out.
If your company’s contracts have a LIBOR, or other reference rate that is being phased out, find an accounting provider experienced with hedge accounting and debt extinguishments to assist, as they may be able to guide you in the use of an alternative benchmark interest rate.
Revenue Recognition for Franchisors
Earlier this year, the FASB issued ASU 2021-02 in response to franchisors’ concerns about the cost and difficulty of applying ASC Topic 606. The new update creates a practical expedient that simplifies the process of identifying performance obligations for certain pre-opening services of private company franchisors, such as assistance in selecting a site, inspection and testing, training, and more.
The new standard simplifies step two of the typical 5-step revenue recognition process under Topic 606, identifying performance obligations in the contract.
It creates a practical expedient for franchisors that are not public business entities to treat certain predefined services as distinct from the franchise license. They may then chose to account for those services as a single performance obligation or evaluate if all or some of them should be separate performance obligations. Franchisors will still be required to apply step 2 to other services that do not meet the defined list. The other four steps in the model must be performed as usual, which includes the often challenging step four, to allocate the transaction price.
For entities that have already adopted Topic 606, this practical expedient may be adopted for financial statements issued on or after Dec. 15, 2020. Early adoption is permitted. Franchisors should use a retrospective application if Topic 606 has been adopted; otherwise, they may apply it in the same manner as the Topic 606 adoption.
Relief for Goodwill Impairment Triggering Events
The FASB has provided relief for private companies and not-for-profit entities that have goodwill by permitting the adoption of an accounting alternative to evaluate the existence of goodwill triggering events as of each annual or interim reporting date, rather than throughout a reporting period.
Entities that do not adopt the accounting alternative will test indefinite lived goodwill for impairment at their annual testing date and anytime a triggering event occurs. Entities that have adopted the accounting alternative for amortizing goodwill test goodwill for impairment anytime a triggering event occurs.
A new accounting alternative issued in ASU 2021-03 provides relief to private companies and not-for-profit entities for the requirement to assess triggering events for goodwill impairment throughout the period. Instead, entities adopting the new accounting alternative only need to evaluate the existence of a triggering event as of each annual or interim reporting date. Entities adopting the accounting alternative will need to determine when they report U.S. GAAP compliant information related to goodwill, as described in our earlier article here in order to determine the dates they must evaluate the existence of goodwill impairment triggering events.
The accounting alternative is effective for the calendar year end 2020. There is, however, a one-time optional election in future periods.
For More Insights
For more information on how these accounting changes might impact your business, contact us.
Published on May 11, 2021