Even the simplest accounting issues, it seems, can be anything but simple.
Regulators and rulemakers got a taste of that recently when they tried to simplify the way companies show the cost of securing debt in financial statements. Questions and confusion ensued, and only a recent signal from the Securities and Exchange Commission could calm the rising tide around what ostensibly was an effort at simplification.
Under current U.S. Generally Accepted Accounting Principles, costs associated with issuing debt might be reflected on the asset side of the balance sheet, or they might be presented as an offset or reduction of the debt liability; the decision depends primarily on the nature of the cost. Those costs associated with issuing debt (fees paid to lenders or other outside service providers in securing the debt, for example), are presented under current rules on the asset side of the balance sheet, where they are capitalized or written down over time. Debt discounts or premiums, on the other hand, are presented on the liability side as a direct offset to the debt amount.
“Most people get confused by it,” says Diana Gilbert, senior consultant at RoseRyan. “People get wrapped around the axle on that.”
In practice, says Rick Day, a partner with McGladrey, some companies took “shortcuts” and put all the costs on the asset side. “Both are amortized over the life of the debt, so it’s just a balance sheet presentation,” he says.
As part of its drive to simplify accounting standards, the Financial Accounting Standards Board decided to take a look at the existing rule and see how it could be made simpler for practitioners, without losing information that would be important to investors and others who rely on financial statements. In studying the issue, FASB determined the GAAP requirement was different than that under International Financial Reporting Standards. It differed even from FASB’s own “concept statements,” which are the principles meant to underpin all accounting pronouncements to promote consistency.
“FASB indicated it didn’t provide guidance because in practice people defer it as an asset and reclassify it when the debt is issued, but that’s not generally the case for revolving lines of credit. For those, people generally classify it as an asset and amortize it over the term of the arrangement.”
Mark Scoles, Partner, Grant Thornton
So FASB issued a new rule: Present all the costs associated with issuing debt along with any debt discount or premium on the liability side, FASB said. Show them as an offset to the debt amount.
That was FASB’s instruction to companies in Accounting Standard Update No. 2015-03, which takes effect for fiscal years beginning after Dec. 15, 2015. The new rule did nothing to change other accounting provisions around debt, such as how debt would be measured or classified. “The new standard is just moving where it is sitting on the balance sheet,” Gilbert says.
As changes to accounting standards go, they don’t get much more straightforward than this one. FASB took up the project in August 2014, issued its proposal in October, received only 28 comment letters, and issued a final pronouncement in April. The explanation ran a slim 12 pages. What could go wrong?
Then companies began digging into adoption, and questions began to surface. What about revolving debt, like a line of credit? In such instances, companies might incur costs to open or establish debt accounts without actually having an outstanding liability against which to offset those fees. “You pay the fees, but your borrowing might go down to zero,” Day says. “What do you do? Is it a negative liability?”
FASB expected that question might arise. In its “basis for conclusions” in the new standard, FASB acknowledged that costs may be incurred before a liability is recorded in financial statements, such as with an undrawn line of credit.
REVOLVING DEBT ARRANGEMENTS
Below PwC describes the issues around the treatment of costs related to revolving debt arrangements, and how the SEC intends to fix them.
At the June 18, 2015 Emerging Issues Task Force (“EITF”) meeting, the SEC observer made an announcement on the presentation and subsequent measurement of costs associated with revolving debt arrangements in light of the new guidance in Accounting Standard Update (ASU) 2015-03, Simplifying the Presentation of Debt Issuance Costs.
In April, FASB issued ASU 2015-03 to simplify the presentation of debt issuance costs. Debt issuance costs are specific incremental third-party costs—other than those paid to the lender—that are directly attributable to issuing a debt instrument. Under the new guidance, debt issuance costs will be presented as a direct deduction from the carrying value of the associated debt, consistent with the existing presentation of a debt discount. Before the FASB issued this simplification, debt issuance costs were capitalized as an asset (i.e., a deferred charge). Debt issuance costs are incurred for all types of debt; however, the new guidance was framed around how to account for outside costs related to term debt. It did not address how to present fees paid to lenders or other costs to secure revolving lines of credit, which are, at the outset, not associated with an outstanding borrowing. This has generated questions about whether or how to apply the new guidance to these types of fees and costs.
In our view, the commitment fees paid by the company to the lender represent the benefit of being able to access capital over the contractual term, and therefore are not in the scope of the new guidance. We believe it continues to be appropriate to present such fees as an asset on the balance sheet, regardless of whether or not there are outstanding borrowings under the revolver.
SEC staff announcement
At the June 18, 2015, EITF meeting, the SEC observer stated that given the absence of authoritative guidance within ASU 2015-03 for debt issuance costs related to revolving debt arrangements, the SEC staff would not object to an entity deferring and presenting such costs as an asset and subsequently amortizing them ratably over the term of the revolving debt arrangement.
Why is this important?
Costs associated with revolving debt arrangements can be significant. The SEC observer’s announcement confirms that revolver arrangement costs are not in the scope of the new guidance.
For public business entities, ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. For all other entities, ASU 2015-03 is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within fiscal years beginning after December 15, 2016. Early adoption is permitted for financial statements that have not been previously issued.
The new guidance should be applied on a retrospective basis.
“The Board did not consider providing explicit guidance in circumstances in which the proceeds have not yet been received, because it observed that in practice entities defer issuance costs and apply them against the proceeds when they are received,” FASB wrote. “For example, the accounting treatment for issuance costs associated with equity instruments is that the costs generally are deferred and charged against the gross proceeds of the offering.”
FASB went on to say that it considered ideas for different ways to recognize the debt issuance cost, but those ideas would have opened other areas of GAAP to be reconsidered beyond the objective of this particular standard. “The board concluded that the new guidance is limited to simplifying the presentation of debt issuance costs,” FASB wrote. “The recognition and measurement guidance for debt issuance costs is not affected by the amendments.”
For U.S. preparers accustomed to explicit guidance that language was perhaps not explicit enough. FASB’s example speaks to equity instruments, not specifically lines of credit.
“FASB indicated it didn’t provide guidance because in practice people defer it as an asset and reclassify it when the debt is issued, but that’s not generally the case for revolving lines of credit,” says Mark Scoles, a partner with Grant Thornton. “For those, people generally classify it as an asset and amortize it over the term of the arrangement.”
That inspired staff at the Securities and Exchange Commission to get involved. SEC observers to the FASB’s Emerging Issues Task Force took a spot on the EITF’s agenda at its most recent meeting and made an announcement.
SEC staff acknowledged “the absence of authoritative guidance” on revolving debt. In light of it, “the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the revolving debt arrangement.”
Says Scoles: “So the SEC kind of blessed what people are currently doing.”
It’s still not authoritative; right now the SEC statement is provided in a draft document circulated by FASB. FASB and the SEC are, however, expected to codify the guidance so companies can safely rely on it.
Jeffrey Ellis, a senior managing director at FTI Consulting, says following the guidance strictly as written would have left companies to move their debt issuance costs back and forth across the balance sheet each time they borrowed and paid down a line of credit.
“That doesn’t make a lot of sense,” he says. “What you’re paying for in a revolving line of credit is the access to that liquidity at any point in time,” which helps explain why it should be classified as an asset. “Maybe they thought people would get to this conclusion, but there were enough questions that the SEC felt compelled to clarify.”