The Financial Accounting Standards Board (FASB) voted unanimously on October 16 to ratify its August proposal to delay the implementation of new standards for private, nonprofit and certain public businesses.
In all, FASB is delaying four standards updates: lease accounting, covered by ASC 842; hedging, under ASC 815; currently expected credit loss, governed by ASC 326; and long term insurance contracts, under ASC 944.
In aggregate, the updates seek to improve clarity and transparency in each of the affected standards. The decision to delay implementation for selected companies comes based on concerns that the new rules would unduly burden smaller entities with limited accounting resources.
Generally, the SEC defines smaller reporting companies as having less than $250 million of public float or less than $100 million in annual revenues for the previous year and no public float.
Christopher Miller, a global financial architect for NetSuite points out the FASB constituency is largely preparers who are finding themselves swamped by the new requirements coming so fast on the heels of the updated revenue recognition standards (ASC 606).
“Take lease accounting,” says Miller. “You’ve got embedded leases in a lot of places that the FASB probably didn’t anticipate. For example, logistics companies often paper use of their trucks as a lease for dedicated hauling. Foreign leases add more complexity, and often accounting software hasn’t come up to speed quickly enough to get the job done, forcing teams to turn to Excel in first year. It all makes the job of compliance harder than first anticipated.”
A number of industries have been significantly impacted by ASC 606. Carrie Augustine, senior product manager for the software vertical at NetSuite adds, “The software industry has been particularly impacted by 606 due to the additive nature of Software contracts. So, many companies are just now getting to the point of operationalizing or systematizing their policy. The FASB understands this and is giving companies a chance to catch their breath before throwing more changes at them.”
The delay isn’t without its detractors. In August, Moody’s registered a warning that the delay will harm bankers and investors’ ability to fairly compare public and private companies. Moody’s objection was primarily based on the new lease accounting standard, which calls for all leases — not just capital leases — to show up in financial reporting. That includes embedded leases, some of which businesses might not even be aware of.
The FASB is seeking to lighten the burden on small companies, but Moody’s points out that there are plenty of large private companies, and that until lease accounting (and the other updates) is standardized across the board, apples to apples comparisons become impossible for investors. Miller largely agrees with the concern, pointing out that starting with revenue recognition, the FASB has created a six-year period of variability, particularly because it has also allowed for various means of handling required retrospective assessments.
The current expected credit loss (CECL) rule which is delayed by two years also met with objections from the likes of the American Bankers Association. The rule requires that expected losses be accounted for at loan origination rather than as they occur, which could lead to banks and other lending institutions needing more funds in reserve. The ABA argues that the new rule could lead to scarcer loan funding if the economy slows down. However, a Federal Reserve study shows that’s unlikely.
The new insurance rules (ASC 944) affect long duration contracts, mostly life and annuities. KPMG says of the disclosure requirements: ASU 2018-12 requires an entity to disclose quantitative information in disaggregated rollforwards for the liability for future policy benefits, policyholder account balances, market risk benefits, separate account liabilities and deferred acquisition costs. Entities should also disclose information about significant inputs, judgments, assumptions and methods used in measurement.
PWC calls the changes to measurement models and disclosure rules the most significant for the insurance industry in 40 years. PWC says that new data is required, and that the rule includes a retrospective component that calls for data collection to have begun already.
The hedge accounting rules are a welcome change because hedge accounting complexity and errors are a leading cause of restatements. Hedge accounting is optional, and because of the complexity of existing rules, many opt not to use it. In order for the old rules to apply, hedges and derivatives must be shown to be “highly effective”, and a measure of ineffectiveness has to be included. These had to be updated annually; the combination has proven to be confusing to investors and a common point of error.
The new rules call for a calculation of effectiveness in the first year with simplified qualitative adjustments in successive years. They also relax the highly effective standard and allow for nonfinancial hedges.
All of the standards updates will require changes to systems, processes and controls, which, as Miller points out, has been slow to come as use cases have required clarifications from FASB.