GAAP - The Year in Review
The Financial Accounting Standards Board (FASB) had another busy year, issuing 18 Accounting Standards Updates (ASU). This article highlights five of the 18 U.S. Generally Accepted Accounting Principles (GAAP) standards, as well as a few earlier standards that now have approaching effective dates or that you may want to consider for early adoption.
Whether you work in the health care, financial institution, manufacturing, nonprofit, or another industry, many of these ASUs could potentially impact your organization and have a direct effect on your annual financial reporting.
New GAAP on the Horizon
No. 2016-01 Financial Instruments – Overall (Subtopic 825-10) – Recognition and Measurement of Financial Assets and Financial Liabilities
Year 2016 started off strong, with the issuance of ASU 2016-01 in January. ASU 2016-01 impacts all entities holding financial assets or owing financial liabilities and was designed to make targeted improvements to GAAP. The amendments in this ASU enhance and improve financial reporting disclosures for certain topics and simplify other areas of GAAP.
A few highlights include:
- Investments in marketable equity securities being recorded at fair value, with changes in fair value being recognized in net income. This is a change from the current practice of classifying equity securities as trading or available for sale. Currently, the change in fair value of available-for-sale equity securities is reported in other comprehensive income. The amendments in ASU 2016-01 will eliminate the need for other comprehensive income and accumulated other comprehensive income for many entities. Marketable debt securities will continue to be classified as trading, available for sale, or held to maturity, with the change in fair value of available-for-sale debt securities being recorded as other comprehensive income.
- Simplification of the impairment assessment of equity investments without readily determinable fair values. Only if impairment exists, based on the qualitative assessment, do entities need to calculate the fair value of the investment.
- Elimination of the requirement to disclose in the notes to the financial statements the fair value of financial instruments that have not been measured at fair value (for example, loans receivable and loans payable) for nonpublic business entities.
This ASU is effective for all public business entities for fiscal years beginning after December 15, 2017 (calendar year 2018) and for all other entities for fiscal years beginning after December 15, 2018 (calendar year 2019). Early adoption for nonpublic entities is permitted for fiscal years beginning after December 15, 2017, except for the provisions listed below, which can be adopted for any financial statements that have not been made available for issuance:
- Early adoption of the credit provision (presenting separately in income the total change in fair value of a liability resulting from a change in specific credit risk if measured at fair value) is available for public business entities and all other entities.
- Early adoption of the disclosure provision (eliminating the fair value disclosure of financial instruments not measured at fair value) is available for nonpublic business entities for any financial statements that have not been made available for issuance.
2016-02 Leases (Subtopic 842)
February 2016 brought the issuance of the much-discussed new leasing standard, applicable to all entities that enter into leases, with some specific scope limitations. This update is a complete rewrite of the leasing standards, thereby creating a new subtopic in the FASB Codification, Subtopic 842. While the lead time is lengthy, the universal applicability of the provisions may warrant an early look at how this ASU will impact your organization.
Some highlights for lessees are:
- Lease assets and lease liabilities will be recorded for virtually all leases. Currently, a lessee does not recognize an asset or liability on its balance sheet for leases classified as operating leases. Under this ASU’s amendments, a right-of-use asset and lease liability, initially measured at the present value of the lease payments, will be recognized in the balance sheet.
- The amendments do retain a distinction of two types of leases, finance leases and operating leases, with differing treatment in recognizing the expense of the lease. The classification criteria for recognizing a lease as an operating or financing lease are similar to the existing rules.
- An exception to recording lease assets and liabilities does exist for leases with terms of 12 months or less. A lessee is permitted to make an accounting policy election to not recognize lease assets and lease liabilities for short-term leases. If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term.
- In recording the lease assets and lease liabilities, a lessee will recognize payments made during optional periods only if the lessee is reasonably certain it will exercise its option to extend the lease. Reasonable certainty is a high threshold (potentially implying a probability of 75% to 80%). Purchase options should be treated similarly.
This ASU is effective for all entities other than public business entities for fiscal years beginning after December 15, 2019 (calendar year 2020). The amendments for public business entities are effective for fiscal years beginning after December 15, 2018. Early adoption is permitted.
For more on this new leasing standard, see the article, Understanding the New Lease Guidance.
2016-13 Financial Instruments – Credit Losses (Topic 326) – Measurement of Credit Losses on Financial Instruments
The FASB continues to focus on financial instruments, with the issuance of ASU 2016-13 in June 2016. This ASU is applicable to all entities holding financial assets and net investments in leases that are not accounted for at fair value through net income. Therefore, this standard will have far-reaching effects. Not only will it affect the banking and financial industry, but also virtually all operating entities with trade receivables and notes receivable, two of the more common financial instruments.
The main provision of this amendment is to change the basis of recording credit losses from an “incurred loss” methodology to a current expected credit loss model. Expected losses are required to be recorded at the time of recognition of the financial instrument (e.g., sale of product and recording in accounts receivable).
Under the revised guidance, financial assets measured at amortized cost basis (for example, loans receivable, trade receivables, off-balance-sheet credit exposures) are required to be presented at the net amount expected to be collected. The measurement of expected credit losses will be based on relevant information about past events, current conditions, and new in 2016-13, reasonably supportable forecasts that affect collectability. Many of the loss estimation techniques currently being used will continue to apply, although techniques will change to reflect forecasted information that captures an estimate of all expected credit losses. This is based on the premise that historical experience may not fully reflect expectations about future estimated expected credit losses; therefore, estimating credit losses based solely on historical experience is no longer permitted.
Credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses. This changes the existing accounting, which recognizes such losses as a write-down in value. Recording the credit loss as an allowance permits the potential recovery of the loss as circumstances change.
This ASU is effective for all entities, other than public business entities, for fiscal years beginning after December 15, 2020 (calendar year 2021), with early adoption permitted for fiscal years beginning after December 15, 2018 (calendar year 2019). For public business entities, it is effective for fiscal years beginning after December 15, 2019.
2016-14 Not-for-Profit Entities (Topic 958) – Presentation of Financial Statements for Not-for-Profit Entities
Mid-August saw the release of ASU 2016-14, the first in the FASB’s efforts to improve the financial statements of not-for-profit entities (NFP). This ASU applies to NFPs, which include nongovernmental entities such as foundations, colleges, health care providers, religious organizations, and others.
Some highlights include:
- Reduction of the number of net asset classes from three to two, resulting in the requirement for NFPs to present on the face of the statement of financial position amounts for net assets with donor restrictions and net assets without donor restrictions, as well as total net assets.
- A requirement to report expenses by both their natural classification and their functional classification and to disclose the methods used to allocate costs among program and support functions.
- Enhanced disclosures about amounts and purposes of board-designated funds.
- Provisions to improve the information presented in the financial statements and the notes to the financial statements that is useful in assessing an NFP’s liquidity, financial performance, and cash flow.
This ASU is effective for financial statements issued for fiscal years beginning after December 15, 2017 (calendar year 2018). Early application is permitted.
For more on this new not-for-profit financial statement standard, see the article, Simplifying and Improving Not-for-Profit Financial Statements.
2016-18 Statement of Cash Flows (Topic 230) – Restricted Cash
The most recent ASU, issued in November 2016, seeks to reduce diverse practices in the classification and presentation of changes in restricted cash transactions on the statement of cash flows. The amendments in this ASU apply to all entities that have restricted cash or cash equivalents and are required to present a statement of cash flows.
Some examples of restricted cash and cash equivalents include funds received with a donor-imposed restriction that limits use of that cash to long-term purposes and funds required to be set aside by contractual arrangement, such as a reserve for payment for certain insurance claims or for escrow accounts for financing arrangements.
Some highlights are:
- Accounts described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period cash reported on the statement. Therefore, activity within the restricted accounts will be recorded in the statement of cash flows.
- The financial statements will require disclosure about the nature of restrictions on cash.
- The statement of cash flows will now include, as applicable, the captions:
- Net increase (decrease) in cash, cash equivalents, and restricted cash
- Cash, cash equivalents, and restricted cash - Balance at beginning of period
- Cash, cash equivalents, and restricted cash - Balance at end of period
- When cash, cash equivalents, and restricted cash are presented on different line items on the balance sheet, a reconciliation of the total of the line items to the ending balance on the statement of cash flows should be included on the face of the statement of cash flows or in the notes to the financial statements.
This ASU is effective for all entities, other than public business entities, for fiscal years beginning after December 15, 2018 (calendar year 2019). Early application is permitted. The effective date for public business entities is fiscal years beginning after December 15, 2017.
Prior-Year ASUs With Rapidly Approaching Effective Dates
Now let’s turn to highlights from prior-issued ASUs, those with nearing effective dates or provisions you may want to adopt early.
2014-09 Revenue from Contracts with Customers (Topic 606)
This update, issued in 2014, has received revisions in both 2015 (No. 2015-14) and 2016 (No. 2016-08). For entities other than public business entities, the update, based on deferral provisions, is effective for fiscal years beginning after December 15, 2018 (calendar year 2019). Early application is permitted as of an annual reporting period beginning after December 15, 2016.
The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The update prescribes five steps to follow for recognizing revenue. The objectives of the standard are to remove inconsistencies and weaknesses, provide a more robust framework, improve comparability, provide more useful information, and simplify the preparation of financial statements by combining revenue recognition standards into one source.
Additional revisions to the standard are expected as industry groups, users, and preparers study and consider the application of the standard. This is definitely a standard to watch and stay up to date on in 2017 and 2018.
2014-15 Presentation of Financial Statements – Going Concern (Subtopic 205-40) – Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
This update applies to all entities and is effective for fiscal years beginning after December 15, 2016 (calendar year 2017). Early application is permitted.
This update adds guidance to GAAP concerning management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events indicate that it is probable an entity will be unable to meet its obligations as they become due. Management’s evaluation is required at every reporting period and is to extend for a period of one year after the date the financial statements are issued or available to be issued.
2015-03 Interest – Imputation of Interest (Subtopic 835-30) – Simplifying the Presentation of Debt Issuance Costs
For entities other than public business entities, the update is effective for fiscal years beginning after December 15, 2015 (calendar year 2016). Early adoption is permitted.
Presentation of debt issuance costs is another area where there is diverse practice. The amendments in this update require debt issuance costs to be presented on the balance sheet as a direct deduction from the carrying amount of the related debt liability. Therefore, under the new requirements, debt issuance costs will no longer be reported as deferred charges (assets) on the balance sheet. The recognition and measurement guidance for debt issuance costs remains unchanged.
2015-05 Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40) – Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement
For entities other than public business entities, the update is effective for fiscal years beginning after December 15, 2015 (calendar year 2016). Early adoption is permitted.
The amendments in this update provide guidance to customers about cloud computing arrangements and the related fees paid. Cloud computing arrangements include software as a service, platform as a service, infrastructure as a service, and other similar hosting arrangements. The amendments provide a basis for evaluating whether a cloud computing arrangement includes a software license. If the arrangement includes a license for internal-use software, the software license should be accounted for by the customer consistent with the acquisition of other software licenses. If an arrangement does not include a software license, the arrangement should be accounted for as a service contract.
2015-11 Inventory (Topic 330) – Simplifying the Measurement of Inventory
For entities other than public business entities, the update is effective for fiscal years beginning after December 15, 2016 (calendar year 2017). Early application is permitted as of the beginning of an interim or annual reporting period.
This update simplifies the requirement of recording inventory at the lower of cost or market. Currently, market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. The amendment establishes the valuation of inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The update is not applicable to inventory that is measured using the last-in, first-out (LIFO) method or the retail inventory method; however, the amendments do apply to inventory measured using the first-in, first-out (FIFO) method or the average cost method.
The ASUs reviewed above are only a highlighted representation of the updates. For further details, information, presentation, and disclosure requirements on any of the accounting standards, visit FASB.org. The website includes issued standards, standards in draft form, effective dates, comment letters, and much more! This is a valuable resource for staying up to date on U.S. GAAP.
In addition to the Accounting Standards Updates highlighted above, there have been numerous others over the past few years that are equally important and should be properly evaluated for applicability to your organization. Please contact your Wipfli relationship executive if you have any questions. We can help provide guidance on the applicability of any new standards for your organization.