If you’re a corporate accounting or audit executive who simply doesn’t have enough stress in your life, fear not—the Financial Accounting Standards Board has got your back.
Not only will companies feel more pressure in the coming year on FASB’s new rule for revenue recognition, slated for full adoption in 2018 (and a project many corporate accounting departments are stalling on). Now you will also face potentially huge new requirements in 2018 and 2019 for leases and financial instruments.
First, the new standard on leases. FASB is nearly done with its significant new accounting rules for how to get leases onto corporate balance sheets. In winding down its decision-making process about changes to earlier drafts of those rules, the board determined it will set an adoption date for the new leasing standard for 2019, one year after the new standard on revenue recognition goes into effect for public companies.
As for financial instruments, FASB determined the new requirements around how to classify and measure financial instruments will take effect in 2018. And a new standard on impairment, or how to reflect expected losses in those instruments, will take effect in 2019.
Companies got their first full look at the new revenue recognition rules in May 2014 when FASB issued the long-awaited final standard. The board extended the original 2017 effective date to 2018 as companies learned of the complexities they will face in adopting the new standard, plus the changes FASB is still making to the standard to answer questions raised during implementation efforts.
The bottom line, then, is that even as companies face enormous implementation challenges around revenue recognition already, the final standards on leasing and financial instruments will land on your desks by early 2016, and pile on the work.
Companies would be wise to use the “quiet period” between now and the end of the year to understand what lies ahead, says John McGaw, leader of accounting change in the Americas for EY. “Get the right team, the right governance and structure, so when you come out of your year-end reporting period, you are ready to get moving quickly,” he says. “Begin to plan so you can execute earlier in 2016.” As companies finish their budgeting processes, there might still be time to weigh in with requests if the initial assessment indicates a need for more resources, he says.
“The earlier you start planning to determine the extent you will be impacted by the new standards, the more effective and efficient the results will be.”
Christine McAlarney, Member, Professional Standards Group, Mayer Hoffman McCann
Who Feels the Pain
Just as the standard on revenue recognition affects different companies in different ways, the new rules on leasing and financial instruments will also have varied effects on companies, depending on what sector they are in, how many financial instruments they carry on their balance sheets, and whether they tend to lease or buy assets.
The subject matter experts at audit firm RSM (formerly McGladrey) have been considering how the concurrent adoption of such major standards will affect financial institutions, for example. Says Faye Miller, a partner in the national standards group focused on financial instruments: “Entities most impacted by the new credit impairment model are financial institutions, and they are impacted the least by the revenue recognition standard.” Adds Rich Stuart, another RSM partner focused on the leasing standard: “But some financial institutions have a lot of leases. Depending on the size of the institution, they may lease a lot of properties for their branches.”
Below, FASB outlines their plans for amendments to financial instruments and lease accounting standards and provides effective dates for both.
Financial Instruments—Classification and Measurement. The Board continued redeliberating the February 2013 proposed Accounting Standards Update, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, specifically discussing the summary of external review comments, effective date and early application of the final standard, and permission to begin drafting the final Update for vote by written ballot.
Summary of External Review Comments
The Board agreed with the staff’s analysis of the significant areas of external review comments and the approach taken to address those comments.
Effective Date and Early Application
The guidance in the final standard will be effective as follows:
Public business entities will be required to apply the guidance for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.
Entities that are not public business entities including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting will be required to apply the guidance for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early application of the final Accounting Standards Update by these entities is permitted for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.
Leases. The Board continued redeliberating the proposals in the May 2013 Exposure Draft, Leases, specifically discussing the following topics:
Sweep issue—remaining economic life lease classification criterion
Consideration of benefits and costs.
Remaining Economic Life Lease Classification Criterion
The Board’s current decisions would classify a lease as a finance lease (for lessees) or a sales-type lease (for lessors) if the term of the lease is for the major part of the remaining economic life of the underlying asset (the lease term criterion). The Board decided to provide an exception to the lease classification test whereby entities will not consider the lease term criterion when performing the lease classification test for leases that commence “at or near the end” of the underlying asset’s economic life. The Board also decided that the final leases standard should include implementation guidance that one reasonable approach to determining the applicability of this exception would be to conclude that a lease that commences in the final 25 percent of an asset’s economic life is “at or near the end” of the underlying asset’s economic life.
The Board decided that for public business entities, the final leases standard will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years; for nonpublic business entities, the final leases standard will be effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early application will be permitted for all public business entities and all nonpublic business entities upon issuance of the final standard.
Consideration of Benefits and Costs
The Board decided that it has received sufficient information and analysis to make an informed decision on the perceived benefits and related costs of the changes to GAAP that will result from the final leases standard. The Board concluded that the benefits of those changes justify the related costs and directed the staff to draft a final Accounting Standards Update for vote by written ballot.
The changes in classification and measurement of financial instruments will be significant well beyond financial institutions, Miller warns. “Any entity that holds equity securities that they have accounted for as available for sale is going to be significantly impacted,” she says. “That could affect entities across various industries.”
As for the changes to impairment, the hit will be hardest on financial institutions, which must overhaul the way they reflect expected losses on long-term credit arrangements to make far greater use of historical data and forecasting, Miller says. But any business that carries trade receivables on its business balance sheet will be swept into the new approach. “It will be a notable change in transitioning to an upfront recognition of expected losses rather than incurred losses,” she says.
The leasing standard will hit home most in sectors that are heavy users of leased properties, such as retail, restaurants, and transportation, McGaw says. Those types of entities may have already tuned into the changes coming and may have already started to assemble their contracts to prepare for the standard. Another group that will be hit, he says, are companies in any sector that might make meaningful use of leasing to acquire real estate or equipment, but may not view leasing as core to their business strategy. “Those companies may not have an existing infrastructure for managing and administering leases in a way that will make adoption of the standard easier,” he says.
Keeping It Together
At audit firm Mayer Hoffman McCann, experts are advising companies to start thinking comprehensively about how they can adopt such potentially significant accounting changes along similar time lines. “The earlier you start planning to determine the extent you will be impacted by the new standards, the more effective and efficient the results will be,” says Christine McAlarney, a member of the firm’s professional standards group. “FASB has provided a long lead time, longer than usual, which makes sense considering these are significant standards.”
Mark Winiarski, a shareholder in the professional standards group at Mayer Hoffman McCann, says the first thing companies should do—even before the final standards are issued, and remember that right now, the leasing and financial instrument standards aren’t—is to identify the right accounting, financial reporting, and operational people in the organization who need to be part of the adoption process. “Put them in a room together and start talking about what the process is going to be,” he says. “If you don’t have a process for dealing with this effectively, you’re going to be caught flat-footed.”
Depending on what companies may have already accomplished to prepare for the new revenue recognition standard, they may or may not be well positioned to piggyback new implementation efforts on existing efforts. “It’s a mixed bag as far as what level of effort companies have put into it so far,” says Brian Marshall, a partner at RSM. Some companies are still waiting for FASB to finish its planned revisions and clarifications to the standard before moving forward. “Certainly others are moving down that path of developing an implementation plan,” he says.