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FASB Update
MTSU Accounting Alumni
Appreciation Day
April 28, 2016
Paula B. Thomas, CPA, DBA
Deloitte Foundation Professor of Accounting
Middle Tennessee State University
Topics
 Extraordinary
 Debt
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Items
Issuance Costs
 Inventory
– Subsequent Measurement
 Classification
of Deferred Tax Items
 Classification
and Measurement of Equity
Investments
 Revenue
 Leases
Recognition
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Extraordinary
Items
Extraordinary Items
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 ASU
2015-01 issued as part of FASB’s
simplification initiative
 Extraordinary items eliminated from U.S. GAAP
 To
be considered an extraordinary item under
existing U.S. GAAP, an event or transaction must
be unusual in nature and must occur
infrequently.
 Stakeholders
questioned the decisionusefulness of labeling events as extraordinary
and indicated that it is difficult to ascertain
whether an event or transaction satisfies both
criteria.
Extraordinary Items
 Will
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no longer
 Segregate
operations
extraordinary items from ordinary
 Separately
present these items net of tax after
income from continuing operations
 Disclose
per-share data for extraordinary items
 Current
guidance for events that are
unusual or infrequent is retained
 Effective
for annual periods beginning after
December 15, 2015
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Debt Issuance
Costs
Debt Issuance Costs

ASU 2015-03 issued as part of FASB’s simplification
initiative

Under current GAAP, debt issuance costs are
reported on the balance sheet as a deferred
charge (asset)

New rules require debt issuance costs to be
reported on the balance sheet as a direct
reduction from the related debt liability


Amortization is recognized as interest expense
Effective for annual periods beginning after
December 15, 2015
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Inventory
Measurement
Inventory
Measurement

ASU 2015-11 issued as part of FASB’ simplification
initiative

Replaces today’s lower of cost or market test with a
lower of cost and net realizable value test

Applies only to inventories for which cost is
determined by methods other than last-in first-out
(LIFO) and the retail inventory method (RIM).


Entities that use LIFO or RIM will continue to use existing
impairment models.
When net realizable value is less than cost (due to
damage, physical deterioration, obsolescence,
changes in price levels or other causes), entities will
recognize the difference as a loss in earnings in the
period in which it occurs.
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Inventory
Measurement

Current GAAP requires consideration of “market,”
subject to a “floor” and a “ceiling.”


“Market” is initially deemed to be current
replacement cost, but it must be compared to a
“ceiling” (net realizable value), which it cannot
exceed, and to a “floor” (net realizable value, less
an approximately normal profit margin), which it
cannot fall below.
FASB determined that the multiple possible
outcomes that can result from applying current
GAAP make the subsequent measurement of
inventory unnecessarily complex.
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Inventory
Measurement

Entities already calculate net realizable value
when applying today’s lower of cost or market



Net realizable value is the estimated selling price in
the ordinary course of business, less reasonably
predictable costs of completion, disposal and
transportation.
No change in that calculation.
Effective in fiscal years beginning after December
15, 2016

Early adoption permitted
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Classification
of Deferred
Tax Items
Balance Sheet
Classification of
Deferred Tax Items
ASU 2015-17 issued as part of FASB’s simplification
project
 Companies will classify all deferred tax assets and
liabilities as noncurrent on the balance sheet instead
of separating deferred taxes into current and
noncurrent amounts.
 Effective dates:


Public business entities for annual periods beginning
after December 15, 2016

For all other entities for annual periods beginning after
December 15, 2017

Can early adopt
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Classification
and
Measurement
of Equity
Investments
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Equity Investments:
Current GAAP

Most equity investments are classified as either
held for trading or available for sale (AFS).

For AFS equity securities, any changes in fair value
are recognized in other comprehensive income
(OCI)

Investments in nonmarketable equity securities
other than equity method investments or those that
result in consolidation of the investee are measured
at cost (less impairment) unless the fair value option
has been elected.
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Equity Investments:
Changes

ASU 2016-01 requires entities to carry all investments
in equity securities, including other ownership
interests such as partnerships, unincorporated joint
ventures, and limited liability companies, at fair
value


Changes in fair value will be recognized in net income.
Does not apply

To investments accounted for by the equity method

When investee is consolidated

When the entity has elected the practicability
exception to fair value measurement
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Equity Investments:
Changes

Because equity securities will no longer be
accounted for as AFS securities or by using the
cost method, entities holding these investments
could see significant volatility in earnings.

For investments without a readily determinable
fair value, companies can elect a practicability
exception

investment will be measured at cost, less
impairment, plus or minus observable price changes
(in orderly transactions) of an identical or similar
investment of the same issuer.
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Equity Investments:
Changes

Current GAAP requirement to assess whether an
impairment is other than temporary is eliminated

Effective date

For public companies, the new standard is effective
for fiscal years beginning after December 15, 2017.

For all other entities, including not-for-profit entities
and employee benefit plans, the guidance is
effective for fiscal years beginning after December
15, 2018.

Early adoption permitted
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Revenue
Recognition
Revenue Recognition Overview

After much deliberation, the FASB and IASB
released a final standard, part of the move
toward a single set of global accounting
standards.

Companies in all industries will use a new five-step
model to recognize revenue from customer
contracts.

The intent is greater consistency and comparability
throughout the global capital markets and across
industries.
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Revenue Recognition –
Overview (continued)

The new guidance

Replaces virtually all current revenue guidance,
including industry-specific guidance

Has greatly enhanced disclosure requirements

Will require significant judgment (e.g., with variable
consideration and whether collectability is
probable)
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Revenue Recognition:
The Basics


Definitions:

Revenue is income from “ordinary activities”

A contract has enforceable rights and obligations
between two or more parties

A customer receives a good or service
Scope exclusions

Leases, insurance, financial instruments, certain
guarantee contracts and certain nonmonetary
exchanges
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Step 1: Identify
contract(s) with customer

The contract may be written, verbal, or implied by
customary business practice.

Contract must have commercial substance

Collectability must be probable at the inception of
the contract

Combine contracts when they are

entered into at or near the same time and are
negotiated as a package,

payment of one depends on the other

goods/services promised are a single performance
obligation.
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Step 2: Identify separate
performance obligations
in the contract(s)

Performance obligations are promises in a
contract to transfer goods or services.

Promises in a contract must be for distinct goods
or services to be a performance obligation

All promises for distinct goods or services must be
evaluated regardless of whether they are
inconsequential or perfunctory
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Step 3: Determine the
transaction price

Entity must determine the amount of consideration
to which it expects to be entitled in exchange for
the promised goods or services in the contract

Transaction price can be a fixed amount or can
vary because of discounts, rebates, performance
bonuses/penalties, contingencies, etc.

Include an estimate of variable consideration only
to the extent that it is probable (IFRS: highly
probable)

Noncash consideration measured at fair value
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Step 4: Allocate the
transaction price

Price must be allocated to separate performance
obligations

This may be the standalone selling price of a good or
service when sold separately to a customer in similar
circumstances and to similar customers.

If a standalone selling price is not directly observable,
estimate it by considering all information that is
reasonably available, such as market conditions,
specific factors, and class of customers.
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Step 5: Recognize revenue
when performance
obligation is satisfied


Point in Time

Recognize revenue when the promised goods or
services are transferred to the customer.

Performance obligation is deemed satisfied when
control of the underlying goods or services is
transferred to the customer
Control may transfer over time (e.g., as an entity
performs janitorial services)
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Where might your
company feel impact?

Compensation and bonus plans. Revenue
recognition can trigger bonus payments.

Consider how timing changes for revenue
recognition affect these and other internal
arrangements.

Contracts. Existing terms could take on new
meaning under the new standard, so you may
need to re-negotiate debt covenants or customer
contracts to maintain the original intent.

Technology. You may need to update your
current software to capture new information that
might not have been necessary before.
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Where might your
company feel impact?
(cont.)

Tax implications. The timing of cash tax payments
could be affected if, for example, you recognize
revenue sooner than in the past.

Controls and processes. The standard requires you
to make more estimates and disclosures, calling
for new controls and processes.

Investor relations. Stakeholders will want to know
how your revenue recognition will change and
how the new standard affects your company’s
financial picture.
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Effective dates


US GAAP – Public Companies

Annual periods beginning after December 15, 2017

Early adoption is permitted
US GAAP – Nonpublic Companies


Annual periods beginning after December 15, 2018
IFRS

Annual periods beginning after January 1, 2018
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Changes to
Lease
Accounting
The Big Changes

For lessees, most leases will be on the balance sheet

The asset will be an intangible “right-of-use” asset

Classification will drive expense recognition

Short-term lease exception


Lease term of 12 months or less and no
purchase option that the lessee is reasonably
certain to exercise
For lessors, the model is not significantly changed

Though there are some changes, including

Eliminating current GAAP’s real estatespecific guidance

Eliminating leveraged lease classification
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Background

ASU 2016-02 results from joint project by FASB and
IASB initiated in 2008

Current lease rules have been criticized for a
variety of reasons

Unnecessary complexity

Arbitrary bright line rules

Emphasis of form over substance

One of the biggest “culprits” in off balance sheet
financing
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Background, continued


Basic lease accounting model has not changed
in more than 30 years

Capital leases (meeting 1 of 4 criteria for lessee)

Operating leases (if none of those criteria are met)
FASB concluded that

A lessee’s obligation to make lease payments
meets the Concept 6 definition of a liability

A lessee’s right to use the underlying asset during
the lease term meets the Concept 6 definition of an
asset
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Scope

The new standard applies to leases of
all assets except
 Leases of intangible assets, including
licenses of internal-use software
 Leases to explore for or use minerals,
oil, natural gas, and similar nonregenerative resources
 Leases of biological assets, including
plants and living animals
 Leases of inventory
 Leases of construction in progress
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Definition
Whether a contract contains a lease
is determined at the inception of the
arrangement.
 Contract is determined to
be/contain a lease if it conveys
 Right to control the use of an

identified asset for a period of time in
exchange for consideration
 Specific rules for substitution rights
 Right to obtain substantially all of the
economic benefit
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Lease Term

Lease term
 Includes
periods
any non-cancelable
 Optional
periods included if
reasonably certain to extend
“reasonably
certain” is
considered to be a high
threshold
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Lease Payments

Lease payments

Fixed payments

Purchase option (if reasonably certain of
exercise)

Payments for penalties for terminating the
lease (unless reasonably certain not be to
exercised)

Variable lease payments that depend on an
index or rate

Residual value guarantees – amounts
probable of being owed (lessees only)
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Classification Criteria

Lease classification is determined at inception

Governed by 5 criteria (similar to current
guidance)

New rules consider whether a lease is
economically similar to the purchase of a
nonfinancial asset from the perspective of control

In contrast to the risks and rewards of ownership
approach used in current GAAP
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Classification Criteria

Lease transfers ownership of the underlying asset to the
lessee by the end of the lease term

Lease grants the lessee an option to purchase the
underlying asset that the lessee is reasonably certain to
exercise

Lease term is for the major part of the remaining economic
life of underlying asset

n/a for leases beginning at or near the end of the underlying
asset’s economic life

Present value of the sum of the lease payments and any
residual value guaranteed by the lessee (not already
reflected in the lease payments) equals or exceeds
substantially all of the fair value of the underlying asset

(new): Underlying asset is of such a specialized nature that
it is expected to have no alternative use to the lessor at the
end of the lease term
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0
Lease Classification

Lessees
 Lease
that meets any of the criteria is a
finance lease
 Lease
that does not meet any of the
criteria is an operating lease
 Short-term
 Lease
lease exception
term of 12 months or less and
no purchase option that the lessee
is reasonably certain to exercise
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Lessee Accounting

All leases (within scope) with lease terms
greater than 12 months must be recorded as
a right-of-use asset and a lease liability

Both finance and operating leases are initially
measured as the present value of the lease
payments

Principle distinction between the two types of
leases is the income statement impact

Financing leases have declining expense
during lease term

Operating leases have straight-line expense
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Lessee Accounting

Subsequent measurement

ROU asset
 Finance
lease

Amortize the right-of-use asset on a straightline basis over shorter of lease term or asset
useful life

Subject to impairment testing
 Operating
lease

Straight-line expense recognition presented
as a single income on the income
statement

Subject to impairment testing
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3
Lessee Accounting, cont.

Subsequent measurement

Liability
 Finance


lease
Increase liability based on effective interest
method using discount rate determined at
inception

Interest reported separately from
amortization on income statement

Results in “front-loaded” expense
Reduce liability by lease payments
 Operating

lease
Measure at present value of remaining
lease payments using discount rate
determined at lease inception
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Lease Classification

Lessors

Lease that meets any of the criteria is a
sales-type lease

Lease that does not meet any of the
criteria is either
 Direct
financing lease if control is
relinquished, as determined by:
 PV
of the sum of lease payments and
any residual value guaranteed by
lessee and/or any other unrelated third
party equals or exceeds substantially all
the fair value of the underlying asset
 Collectibility
 Operating
is probable
lease
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Lessor Accounting –
Sales-Type

Derecognize the underlying asset

Recognize net investment in the lease
and selling profit

Collectability of payments must be
probable
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Lessor Accounting
Direct Financing

Distinction between a sales-type and
direct financing lease is that in a salestype lease, the lessee obtains control of
the underlying asset and the lessor
recognizes selling profit and sales
revenue upon lease commencement

Accounting

Same as for sales-type leases, except that
any selling profit (not normal) would be
deferred and included in the net
investment in the lease
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Lessor Accounting
Operating Leases

Continue to recognize the underlying asset

Recognize lease payments as income over
the lease term
 Normally
on a straight-line basis
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Why is this important?

The proposed lease accounting guidance will
affect almost every company and for some, the
proposed changes may be significant.

Metrics such as EBITDA and net income will be
affected.


These in turn will likely affect loan covenants, credit
ratings, and other external measures of financial
strength.
Lessees will need to consider business process
changes in multiple areas, including finance and
accounting, IT, procurement, tax, treasury, legal,
operations, corporate real estate and HR.
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Effective date and
transition

Remember that existing leases are not
grandfathered


Public business entities (PBEs)


Effective for calendar year 2019 and interim periods
within that year
All other entities


Except existing leveraged leases
Effective for calendar year 2020 and interim periods
in 2021
Early adoption permitted
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Questions and
Discussion