This article, "Current Developments in the Private Sector," originally appeared on CPAJournal.com.
About the Panelists
Susan Cosper, technical director at FASB and recently appointed to be a member of the board; Robert Laux, region lead for North America at the International Integrated Reporting Council (IIRC); David Schmid, partner and U.S. and IFRS Standard Setting Leader at PricewaterhouseCoopers; and Alison Spivey, partner at Ernst & Young and member of the IASB/FASB Revenue Recognition Joint Transition Group, were the panelists. Norman Strauss, distinguished lecturer of accountancy at Baruch College, moderated the panel. The following is an edited and condensed summary of the panel discussion. The views expressed are the panelists’ own personal views and not necessarily those of their employers or those employers’ boards, management, or staff.
The panel began with Alison Spivey discussing private companies’ implementation of the new leasing and revenue recognition standards. She began by listing revenue topics that she has received frequent questions about, such as identifying performance obligations, variable consideration, and allocation of transaction prices, noting that these are the same questions seen during implementation by public companies. She focused on the accounting for multiple goods or services sold to a single customer.
“Even though a company may have packaged multiple goods and services together, and a customer wants to buy all of those because they were all part of a contract, that doesn’t necessarily mean that the company is asking for some integrated solution,” she said. “Sometimes it is, and you would have a single unit of account, but oftentimes it’s not, and so you have to have the revenue recognition appropriately associated with the individual units of account.” She continued with the example of when a company is transferring something to a customer at the inception of the contract and there are follow-on services attached. “Some companies may be accustomed to a revenue recognition model that lumps all of that together and you get an even revenue recognition pattern over a term of a contract. Under this standard, there’s certainly a challenge to determine whether there truly is a two-way dependency between those goods and services—the stuff that you transfer upfront and the things that are being delivered over time. In many instances, a company finds that they need to pull those apart. Anything that’s transferring upfront, revenue gets recognized then; anything that’s transferring over time, the revenue gets recognized over time. That can cause some changes in accounting, and I think private companies are just trying to get used to how to apply the framework.”
With regard to allocating a transaction price, Spivey added, “There are some specific guidelines in the standard to take variable amounts of a transaction price and allocate them specifically to certain goods and services in your contract to make sure you’re getting the right amount of revenue recognized at the right time.”
Spivey then turned to contract modifications, noting that public companies are dealing with SEC comment letters on the matter. “The volume hasn’t been that significant so far, but I anticipate that we’ll see that increase.” She also noted that the comment letters are in the public record and available for review. Spivey then outlined the guidance for contract modification, again stressing, “this is an area where there are very specific guidelines in terms of how an entity should evaluate a change to a contract.” Susan Cosper added that FASB does have an active agenda request on the topic, specifically license renewals, and the board planned to discuss it at its next meeting.
Regarding the new leasing standard, Spivey stressed the importance of transparent disclosures, saying, “It’s important for that information to be provided comprehensively so that investors can have a true understanding of what a company actually did with respect to its leasing activities.” In addition, she reminded the audience of the requirement to apply the new annual disclosures for leasing to all interim periods during the first year of adoption. “It’s brand-new; you can’t just fall back on last year’s annual report,” she added. Spivey also noted that lessees in particular need to make appropriate adjustments on the balance sheet when leases are modified, especially regarding the liability and right-of-use asset.
Asked by Robert Laux about the lack of a Transition Resource Group (TRG) for the lease standard, Cosper said that FASB’s main motivation for not creating a TRG was the more targeted nature of the standard as compared to the revenue recognition and credit losses standards. FASB did, of course, receive many questions on leases, Cosper said, but it addressed them through public forums and webcasts. Cosper also took the opportunity to mention FASB’s implementation web portal, technical inquiry service, and other implementation resources.
Identifiable Intangible Assets and Accounting for Goodwill
David Schmid then discussed FASB’s upcoming guidance on accounting for accounting. Firstly, FASB expected to finalize its standard on accounting for goodwill and certain other intangible assets for not-for-profit entities by the end of May. The second item, Schmid said, was a planned invitation to comment regarding accounting for goodwill and identifiable intangibles focused on decision-usefulness and cost-benefit.
Outlining the recent history of goodwill accounting updates, Schmid noted that FASB’s goal has been relieving the burden on preparers while still retaining decision usefulness for users. Improvements have included a qualitative screen to the impairment test for all entities, voluntary options for amortization, and elimination of the annual trigger test for goodwill impairment, among others. These alternatives have been “well liked” and “widely accepted” by public and private companies, Schmid said, and the upcoming ASU will extend them to nonprofits.
Schmid then discussed the central questions in FASB’s upcoming invitation to comment: “Should public companies be able to amortize goodwill? Over what period? Should it be optional? Should it be mandatory? Are there ways to further simplify the impairment test? What about intangibles in a business combination, can you subsume some of those into goodwill? … Can we simplify disclosures or will some of these changes actually require more disclosures?”
Balance Sheet Classification of Debt
Next, Cosper discussed FASB’s project to simplify the classification of debt on the balance sheet. FASB is currently working toward issuing a second exposure draft, Cosper said, describing the governing principle of the update as “you basically should follow the contract. If the liability is contractually due to be settled in more than one year or if the entity has a contractual right to defer settlement of the liability for at least one year after the balance sheet date, the debt arrangement should be classified as noncurrent.”
Cosper also described the guidance as “more simple, but not everyone actually likes the answer. And investors, from what we understand, really didn’t understand the classification principles that were out today because they’re not really fact-specific and there’s a number of nuances to them.” According to Cosper, one challenging aspect has been the classification of unused financing arrangements. “For example, if I have a long-term financial arrangement in place at the balance sheet date, should I be able to use that to cover what would be perceived to be a current liability and make it long-term? …As we stand, the board has decided not to allow that, but there is some discussion in the exposure draft that’s coming out,” Cosper said. Cosper also clarified that FASB planned to issue the exposure draft in mid-June.
The next topic was the efforts of FASB’s Private Company Council (PCC) to create an expedient for determining the current price of the underlying share of share-based payments to employees. Spivey explained the rationale behind simplifying this complex area of accounting. Because their shares are not constantly being traded as public shares are, private companies can have trouble accurately valuing their stock when accounting for share-based payments, and auditors can have trouble verifying that valuation. The PCC has been working on this with private company stakeholders for some time, Spivey said, and current efforts are focusing on whether the exercise price of the stock would be an accurate measure of fair value.
Questions surrounding this approach, Spivey said, center on how the company sets the exercise price in the first place: “How much diligence did the company put into that? What type of audit work would an auditor need to be doing to evaluate the company’s process and resulting conclusions on the exercise price?” Spivey also praised FASB’s efforts to recognize the different accounting needs of private companies versus public companies, and said that the PCC expected to discuss the topic further.
Cosper elaborated on FASB’s efforts, saying that a key question is whether using exercise price, or any other practical expedient, will actually provide relief to companies or just their auditors.
Distinguishing Liabilities from Equity
Cosper then moved on to FASB’s project on distinguishing liabilities from equity, saying it originated as a comprehensive look at liabilities and equity in total. “What we learned through the last invitation to comment was we should just focus on making some targeted improvements that would ease the burden for companies in terms of the cost and complexity,” she said, adding that initial deliberations are complete and FASB expects to issue an exposure draft in summer 2019.
Getting into the details of the upcoming draft, Cosper said that FASB’s goal is simplification. “What we’re doing is really increasing the simplification of accounting for convertible instruments by reducing the number of convertible instrument models. And we’re also reducing the bifurcation of conversion options. What that means is, more things will be reported as a single unit of account under the traditional debt model,” she said, explaining that the number of models will decrease from five to two.
The changes will benefit investors as well, Cosper said. “They didn’t really like that these things were bifurcated; they preferred one unit of account.” She also said that only a few changes will be made to disclosures, making them “slightly more granular than what was already required today.”
This project also includes FASB’s work surrounding the derivative scope exemption, of which Cosper said, “We’re increasing use of management’s judgment. We’re reducing the strict rules, we’re reducing the form-over-substance classifications of outcomes, and providing more use of management judgment in this area.” Rather than requiring reassessment of a derivative’s fair value by each of 20 measuring criteria for every reporting period, Cosper explained, the anticipated changes will allow companies to assess the probability of contingent events and exempt remote ones from evaluation, as well as require reassessment only on specific triggering events. In addition, the number of additional conditions for equity classification will decrease from seven to four. This exposure draft is also expected in summer 2019.
“Under this standard, there’s certainly a challenge to determine whether there truly is a two-way dependency between those goods and services—the stuff that you transfer upfront and the things that are being delivered over time.”
Reference Rate Reform
Cosper then discussed reference rate reform, calling it “one of the board’s most important projects and probably very understated in terms of what’s on the board’s agenda.” As banks move away from using the London Interbank Offered Rate (LIBOR) as a benchmark rate, hedge accounting will be affected. The likely alternative will be the Secured Overnight Financing Rate (SOFR), and FASB is working to smooth the transition for issuers. “We’re doing a lot of research with companies and banks internationally to try and understand all of the issues that are in this space, particularly as it relates to hedge accounting,” Cosper said. “What happens when debt is modified? Does it resolve in an extinguishment or does it result in some kind of a modification to the existing instrument?”
Schmid agreed on the importance of this project, saying, “If you start taking an inventory of where LIBOR appears in contracts, loans, or any type of activity that your corporate entity does, it is awe-inspiring.”
Accounting for Episodic TV Series
Spivey then spoke on the PCC’s project changing the accounting for episodic television series. The previous guidance, she said, was viewed as outdated, as it classified film and television productions separately and gave different thresholds for capitalization of production costs. As episodic TV production has become more like film production with programming designed to be “binge-watched” on streaming services like Netflix, the Emerging Issues Task Force (EITF) decided to align the two models. Impairment models for broadcaster content and presentation and disclosure requirements are also affected, Spivey said.
Contract Liabilities and Related Topics
Spivey also spoke about FASB’s invitation to comment regarding measurement of contract liabilities and related topics. She gave the example of licensing of intellectual property as an area where questions have arisen, specifically about the value of such a license when the licensor is acquired by another company. While the EITF has decided that companies should use the definition of a performance obligation from ASC Topic 606 to help determine the liability that should be recorded, Spivey said, other questions exist as to determining the fair value of that liability. The invitation to comment is an attempt to sound out views on all the various scenarios where such issues could arise.
Cosper took the floor to discuss disclosures about government assistance. “There’s no guidance in GAAP today. The proposed update that we issued back in 2015 did not provide recognition of measurement guides; it really just provided disclosures.” The many different types of government assistance available to business entities, Cosper explained, makes establishing a single recognition measurement model difficult, so FASB is currently focusing on disclosures.
“We exposed this update back in November of 2015,” Cosper said, continuing, “the board has been working on redeliberations for the last year and a half or so.” The effort has focused on setting a defined scope for the guidance, which currently covers all contracts in which a company receives a grant of assets, tax assistance or debt-related assistance, but excludes transactions in which the government is a customer, government assistance accounted for under the income tax standards in ASC Topic 740, employee benefit plans, and not-for-profit entities. The board is now doing research to determine the cost to companies and benefit to investors of these disclosures; while investors welcome any information on this topic, companies have said tracking this information is “very cost prohibitive,” Cosper said.
Financial Performance Reporting
Cosper’s next subject was financial performance reporting, which she described as “a project where we’ve spent quite a lot of time trying to frame the problem. The issue we’re working on right now is the aggregation of earnings into only a few line items, and specifically cost of sales and SG&A [selling, general, and administrative expenses], and potentially disaggregating some of those individual line items.” Field tests, Cosper said, revealed that companies’ consolidation systems make this kind of disaggregation “extremely challenging and costly,” although she also noted a significant difference between the capabilities of younger tech companies and older, ”mature” companies.
“The team is now looking at a different approach,” Cosper continued, saying that the next field test will focus on how management uses the line items internally. “Is there any sort of disaggregation that they do that might be useful in coming up with some kind of solution?” Cosper also voiced some concerns over complexity, prompting Laux to recall that a similar previous project had stalled out due to significant preparer opposition. Cosper clarified that this opposition had centered on the statement of cash flows and the balance sheet, which are not within the current scope.
“The team is now looking at a different approach. Is there any sort of disaggregation that they do that might be useful in coming up with some kind of solution?”
Schmid then spoke on segment reporting, which has been on FASB’s agenda since 2017. Efforts are currently focused on whether the right segments are being identified, the aggregation criteria are working well, and the right disclosures are being made. FASB has done “a lot of research,” Schmid said, including many of his own clients. “The results of the study are probably not that surprising: the cost-benefit analysis didn’t necessarily work,” Schmid said. “Users weren’t convinced that they would get the right information.” Of particular concern was a possible increase in segment changes from year to year, which would require restatement of prior years each time. Another study is planned for 2019, Schmid said, for discussion in late fall.
Laux asked Cosper whether FASB still plans to change aggregation criteria for segments. Cosper responded that it is not, saying, “Some of the feedback that we got was that it didn’t provide more useful information to investors. … The concerns always seem to be around the single-segment companies, and in many instances, there are valid reasons for them to be single-segment.” Laux shared his own experience of Microsoft’s resistance to the aggregation criteria used in segment reporting as an example of how management faces difficulties reconciling the way they want to run the business and the resulting accounting and disclosure ramifications.
Finally, Cosper spoke briefly on a few other noteworthy topics. One such topic was phase 3 of the business combinations project, harmonizing different items between asset acquisitions and business combinations, such as in-process R&D and contingent considerations. A second exposure draft on income tax disclosures was recently released, Cosper said, as was an exposure draft making some simplifications and improvements to ASC Topic 740. Phase 2 of the hedge accounting project is under way.
“Everyone asks about disclosures,” Cosper concluded. “We’re continuing to work on improving share-based payment disclosures. We keep hearing there’s too many disclosures and not the right disclosures. Inventory, an area where there’s very light disclosures, we’re in the process of reinvigorating that project. And, lastly, we’re starting to work on interim disclosures.”
Susan Cosper is technical director at FASB and was recently appointed to be a member of the board.
Robert Laux is region lead for North America at the International Integrated Reporting Council (IIRC).
David Schmid is a partner and U.S. and IFRS Standard Setting Leader at PricewaterhouseCoopers.
Alison Spivey is a partner at Ernst & Young and member of the IASB/FASB Revenue Recognition Joint Transition Group.
Norman Strauss is distinguished lecturer of accountancy at Baruch College.