Despite the enormity of accounting change occurring at public companies, some might spare themselves a little grief by adopting certain rules even before they are mandatory.
Companies are already wrapping up some significant implementations for standards that took effect in 2018, not the least of which are the massive new requirements for when and in what amounts to recognize revenue in financial statements.
Also new in 2018, companies are following more narrow rules for how to recognize and measure financial instruments, how to reflect unredeemed gift cards, how to show gains and losses from the de-recognition of non-financial assets, changes in cash flow classification, intra-entity transfers under income tax guidance, business combinations, pension cost, stock compensation, and service concession arrangements.
In addition to those more scheduled accounting exercises, companies also had the accounting implications of the Tax Cuts and Jobs Act layered on at the end of 2017. The tax reform legislation produced significant financial reporting implications for companies, which are now required to make major adjustments to their deferred tax positions and explain the effects of repatriating foreign earnings, among other things.
As they move past the year-end reporting season, public companies will be facing more big changes, most notably new rules that bring lease obligations out of footnotes and onto the face of the primary financial statements. And with the leases standard, companies also are required to implement new rules on benefit plan accounting, receivables, earnings per share, hedging, and the reclassification of certain tax effects from accumulated other comprehensive income.
“If you adopt early, you can try to drive or influence practice. If you wait, you let yourself be informed by whatever ongoing developments there are or what others do.”
Eric Knachel, Senior Consulting Partner, Deloitte & Touche
Even further on the horizon, companies will face new rules in 2020 on accounting for credit losses and goodwill impairments.
Accounting experts say most companies have their hands full just trying to meet the mandatory effective dates. Yet some are also pointing out opportunities to simplify accounting or to make implementations more efficient by adopting even more new rules on the horizon sooner than required.
“There is a lot of change still coming, but some of the standards will actually simplify accounting,” says Beth Paul, a partner at PwC. New rules on how to account for hedging, for example, were specifically intended by the Financial Accounting Standards Board to make the accounting a little easier on companies than it has been for the past several years.
Companies are not required to adopt the new standard on hedging before Jan. 1, 2019, but many are looking to do so to take advantages of some of the simplifications it offers. Most notably, the new rules make it easier for companies to undertake hedges that qualify for hedge accounting, which reduces volatility in the income statement.
Depending on a company’s specific facts and circumstances, that could make it attractive to go through the implementation exercise sooner so as to benefit from those simplifications that much earlier. “There are certainly parts of the hedging standard that will be helpful to companies because it allows more things to be hedged, so it is more aligned with companies’ risk management strategies,” says Paul. The standard also will simplify the administration of hedging activities and the documentation, she says.
New rules on how to test goodwill for impairment also do not take effect until 2020 but can be adopted early. The new rules significantly simplify the testing for goodwill impairment.
Adopting early will require companies to go through the steps of changing their controls and their testing process, but the carrot for enduring that stick is a much simpler test if the initial assessment of goodwill on the balance sheet suggests it may need to be marked down.
Meeting the definition of down round
The new guidance effectively makes an exception to the base model for determining when an instrument or an embedded feature is considered solely indexed to an entity’s own stock. Care should be taken when evaluating adjustment provisions to determine whether they meet the definition of a down round. ASU 2017-11 adds a definition of a down round feature to the Master Glossary as follows:
A feature in a financial instrument that reduces the strike price of an issued financial instrument if the issuer sells shares of its stock for an amount less than the currently stated strike price of the issued financial instrument or issues an equity-linked financial instrument with a strike price below the currently stated strike price of the issued financial instrument.
A down round feature may reduce the strike price of a financial instrument to the current issuance price, or the reduction may be limited by a floor or on the basis of a formula that results in a price that is at a discount to the original exercise price but above the new issuance price of the shares, or may reduce the strike price to below the current issuance price. A standard anti-dilution provision is not considered a down round feature.
If a feature does not meet the definition of a down round, the instrument must be evaluated under the base model to determine whether it is solely indexed to an entity’s own stock.
A third pending new standard that will simplify accounting is a rule on the accounting for warrants or other convertible debt instruments that include a “down round” feature, which reduces the strike price of such instruments when an issuer sells shares of its stock for less than the current strike price. The new rule provides relief to companies that issue such instruments because it no longer precludes equity classification, and it no longer requires fair-value accounting solely because of the existence of a down round feature.
In addition to the incentive of easier accounting, companies might also consider adopting pending new standards earlier just to minimize the frequency of change in future periods. “You have to think about what systems need to change and what processes need to change,” says Paul. “If you can group changes and do them at once, it reduces disruption.”
While it’s hard to dispute the efficiencies in adopting new rules in groups rather than individually, that’s a hard pill for some companies to swallow given how many new rules they are slogging through and how significant some of them are.
The strain on resources is one concern, says Dean Bell, a partner at KPMG. Companies were allowed to adopt revenue recognition and leases early, but few have done so just because of the sheer volume of work involved and the lack of trained accounting personnel to get it done. Especially for implementation projects for revenue recognition and leasing, “it’s challenging to take on two projects at the same time,” he says.
Early movers, or those who want to be the first to market with new accounting pronouncements, are typically the largest companies with the greatest depth of resources, says Bell. Companies might also want to adopt rules at THE same time as their peers in their industry sector, so that’s sometimes a motivator for companies to follow new rules sooner rather than later.
Eric Knachel, a senior consulting partner at Deloitte & Touche, says one reason companies sometimes like to adopt standards early is to help drive interpretations. Especially for standards that require considerable judgment, companies often look to others to see how they’ve interpreted new rules, which might affect positions they will take in their own implementation. That makes early adopters trend setters, to some extent.
“If you adopt early, you can try to drive or influence practice,” says Knachel. “If you wait, you let yourself be informed by whatever ongoing developments there are or what others do.”
Of course, the flip side of that coin is going out on a limb with a particular interpretation that is then rejected by the masses along the normal implementation timeline. “There is some risk of being second guessed by regulators while the standard is subject to more interpretation,” he says. “You could find yourself a bit of an outlier while others coalesce to a different view.”
Companies might also want to consider adopting rules early if it would affect their go-to-market strategy in a way that’s beneficial, says Knachel. That’s a factor that came into consideration when companies were adopting revenue recognition, and it’s a big reason some companies now want to adopt hedging rules early.
Adam Brown, a partner at BDO USA, says another reason to adopt standards early is to get to a place of confidence where new rules provide a more explicit way of doing things. Such is the case with a new rule expected soon on accounting for certain costs associated with cloud computing, he says. “If that goes final, and it likely will, people might want to adopt it early to reduce uncertainty,” he says. “They’ll have clarity versus a lack of clarity in their accounting, so putting yourself on better footing when there’s a clear standard is desirable.”
Brown says he certainly sees the logic in companies wanting to adopt certain standards early in certain circumstances. “To the extent companies can or want to consider adopting things together, it certainly minimizes change,” he says. “My guess is the vast majority of companies won’t do it. It’s labor intensive, and a lot of companies are fully taxed.”