Accounting Ch-Ch-Changes

More research, less noiz.

Topic

The Standard

Issue Date

Effective Date1

Our Take

Sector(s) Likely to be Most Impacted

Our Most Recent Research

Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity (i.e., convertible debt)

The Proposal - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40)

20300201

*Out for public comment (then Board will deliberate exposure draft, i.e., still a work in process)*

20300201

*Out for public comment (then Board will deliberate exposure draft, i.e., still a work in process)*

What’s Changin’: A “simplification” of convertible debt accounting, to just two approaches (down from the five used today): (1) traditional convertible debt model (no bifurcation, single instrument) and (2) embedded derivative model (bifurcate, i.e., split the convert in two, a bond and derivative measured at fair value). Additionally, only the if-converted method will be used when calculating diluted EPS; no more treasury stock method.

Impact: The traditional convertible debt model would apply to most converts, increasing the amount of debt on the balance sheet and reducing interest expense (which would bring it closer to cash interest but move it further away from the economic cost of the debt). Additionally, the transition from treasury stock to if-converted method should result in more EPS dilution (assuming interest expense added back to the numerator is less than the impact from an increase in shares; keep in mind, interest expense would not be added back if the principal must be paid in cash). We appreciate the switch to the if-converted method, but think the FASB missed the mark as we’d prefer to scrap the bifurcate/don’t bifurcate debate and just fair value convertible debt so that investors have a more accurate picture of the convert claim on the balance sheet (that said, companies will be required to disclose the fair value).

  • Communication Services

  • Financials

  • Health Care

  • Information Technology

Government Assistance

The Proposal - Disclosures by Business Entities about Government Assistance

20300101

*Re-deliberating exposure draft (i.e., still a work in process)*

20300101

*Re-deliberating exposure draft (i.e., still a work in process)*

What’s Changin’: A whole bunch of new disclosures on government assistance (e.g., grants, property tax reductions, low-interest loans, etc.), including: nature of assistance (e.g., a cash grant received), accounting policy (e.g., recognize it as a reduction in expense when received), and the financial statement line items impacted. Today, this type of info is hit or miss since the FASB didn’t have rules (some companies looked to IFRS standards, IAS 20, for guidance). It’s worth noting income taxes and contracts in which the government is the customer are excluded.

Impact: We’re all for the increase in transparency. Added info on the terms of government assistance, such as duration and contingencies, should help with your models/forecasts, assuming such agreements are material and the disclosures aren’t boilerplate (big assumption).

  • Communication Services

  • Consumer Discretionary (notably Autos)

  • Energy

  • Health Care

  • Industrials

  • Information Technology

Insurance Accounting

Financial Services – Insurance: Targeted Improvements to the Accounting for Long-Duration Contracts (ASU 2018-12, Topic 944)

20180828

August 15, 2018

20201215

December 15, 2020
(1Q 2021, though the FASB may push the effective date back a year)

What’s Changin’: Insurance accounting (two words that make most people want to get up and dance).

Updating Liability Assumptions: Insurance liability assumptions, such as mortality rates, are reviewed and updated at least annually, with changes reflected in earnings. Old GAAP locks assumptions in at contract inception, only to update when a premium deficiency (future payouts > future premiums) exists.

The New Discount Rate: Insurance liability discounted at upper-medium grade corporate bond yield (i.e., single A) with any changes due to discount rate (updated annually) reflected in OCI. Old GAAP requires companies to use their expected investment yield as the discount rate, the rosier the forecast, the lower the liability.

Marking Market Risk Benefits (MRB): MRB (protect contract holders from “capital market risk”, think guaranteed minimum death benefits) are measured at fair value with changes in fair value run thru earnings (unless due to changes in the company’s own credit risk, which go to OCI).

Simplifying Deferred Amortization Costs (DAC): DAC will be amortized on a “constant level basis” (i.e., straight line amortization vs. Old GAAP allowing multiple approaches) over the term of the related contracts.

Lots of New Disclosures: Which include rollforwards of the insurance liability, info on significant inputs (e.g., discount rate) and judgements/assumptions used, etc.

Impact: Wow, that’s a lot to digest. Expect to see more volatility in earnings and book value (we hope that’s a beter reflection of the underlying economics). Additionally, the standardization of the liability discount rate and simplified amortization of DAC should result in better comparability across companies (we’ll have to wait and see).

  • Financials (Insurance)

  • Health Care (Managed Health Care)

Debt: Classification

The Proposal - Debt: Simplifying the Classification of Debt in a Classified Balance Sheet (Current versus Noncurrent, Topic 470)

20300101

*Drafting a revised exposure draft (i.e., still a work in process)*

20300101

*drafting a revised exposure draft (i.e., still a work in process)*

What’s Changin’: Multiple clarifications regarding debt classification, most notably that current debt refinanced on a long-term basis after the balance sheet date (in accounting lingo, that’s a “subsequent event”) is considered current debt until the next balance sheet date (vs. non-current under old GAAP).

Impact: Current debt may increase for some companies and refinancing could get more costly and complex, possibly impacting earnings, working capital and ratios such as leverage.

  • Communication Services

  • Consumer Discretionary

  • Industrials

  • Utilities

Pensions: Disclosures

Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans (ASU 2018-14)

20180828

August 28, 2018

20201215

December 15, 20202
(2020 10-K)

What’s Changin’: Additions and eliminations to existing pension/OPEB disclosures, including a new disclosure on drivers of significant gains/losses from Pension/OPEB plans and the removal of the disclosure on the impact of a 1% change in health care cost trends.

Impact: A net negative to transparency. We expect accounting fluff for the new disclosures on significant gains and losses related to pension/OPEB plans (e.g., changes in interest rates and mortality rates). We’re also disappointed to see the removal of the disclosure on deferred gains/losses expected to be reversed out of AOCI and the effect of a 1% change in health care cost trends, both were useful in forecasting pension/OPEB expense. Sad!

  • Communication Services

  • Consumer Discretionary

  • Industrials

Fair Value: Disclosures

Disclosures Framewor - Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13)

20180828

August 28, 2018

20201215

December 15, 2020
(1Q 2021, though the FASB may push the effective date back a year)

What’s Changin’: Additions and eliminations to existing fair value disclosures, including a new disclosure on movements in OCI from level 3 assets/liabilities and the removal of the disclosure on the valuation process for level 3 assets/liabilities.

Impact: All about that transparency. Insight into changes to OCI should help investors better understand the potential impact to the income statement and future cash flows. The removal of valuation process description for level 3 assets/liabilities (the most difficult to value stuff) is partially offset by a new requirement to disclose the range and wtd. average of “significant unobservable inputs” used to value level 3 assets/liabilities (e.g., discount rate used in cash flow model).

  • Consumer Discretionary

  • Financials

  • Industrials

Costs for Episodic TV Series

Intangibles - Goodwill and Other: Improvements to Accounting for Episodic Television Series (ASU 2019-02)

20190306

March 6, 2019

20191215

December 15, 2019
(1Q 2020)

What’s Changin’: Similar to guidance for film production costs, episodic content production costs are capitalized (and amortized) without being subject to a constraint.

Impact: Capitalizing more costs means a bigger balance sheet and likely a temporary boost to earnings.

  • Consumer Discretionary

  • Information Technology

Cloud Computing Costs

Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement (ASU 2015-05)

20180829

August 29, 2018

20191215

December 15, 2019
(1Q 2020)

What’s Changin’: Cloud computing implementation costs (e.g., customizing software to customer’s needs) are eligible for capitalization. Under Old GAAP, such costs are only eligible for capitalization if a customer acquires the software license (which doesn’t happen with cloud computing arrangements).

Impact: Temporary boost to margins and potential smoother earnings profile. Also provides a boost to EBITDA and maybe non-GAAP earnings (for those that add back amortization).

  • Communication Services

  • Consumer Discretionary

  • Information Technology

Goodwill Impairment Testing

Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment (ASU 2017-04, Topic 350)

20170126

January 26, 2017

20191215

December 15, 2019
(1Q 2020)

What’s Changin’: Step 2 of the goodwill impairment test is eliminated. Under Topic 350, if the fair value of a reporting unit is less than its carrying value, the difference between the two is the impairment charge (up to the amount of goodwill on the balance sheet).

Impact: Impairments should happen faster and amounts could differ from Old GAAP.

  • Financials

  • Health Care

  • Industrials

  • Information Technology

Credit Losses

Measurement of Credit Losses on Financial Instruments (ASU 2016-13, Topic 326)

20160616

June 16, 2016

20191215

December 15, 2019
(1Q 2020)

What’s Changin’: Companies will book an allowance for loan losses based on the expected credit losses (CECL = Current Expected Credit Losses), meaning the potential recognition of a loss and a reduction in carrying value of a loan on Day 1. No more waiting until the loss is “probable”. Also applies to debt securities, trade receivables, etc.

Impact: Expect increased loan loss reserves, which will put pressure on earnings and book value.

  • Consumer Discretionary

  • Financials (notably Banks)

  • Industrials

Hedge Accounting

Derivatives and Hedging (ASU 2017-12, Topic 815)

20170818

August 28, 2017

20181215

December 15, 2018
(1Q 2019)

What’s Changin’: Easier to get hedge accounting treatment as the accounting rules are “simplified". Other changes include no longer requiring companies to separately measure and record hedge ineffectiveness. All changes in the fair value of derivatives eventually show up on the same income statement line item as hedged item.

Impact: Smoother earnings and fewer non-GAAP adjustments. Watch out for more hedging losses/gains hiding in OCI and more earnings management.

  • Energy

  • Financials

  • Industrials

  • Materials

Leases

Leases (ASU 2016-02, Topic 842)

20160225

February 25, 2016

20181215

December 15, 2018
(1Q 2019)

What’s Changin’: Most leases (excluding those with terms of one year or less) are coming on the balance sheet. No change to the income statement as operating leases will result in rent expense and finance leases (Topic 842’s version of capital leases) will result in interest expense and amortization.

Impact: Look for balance sheets to grow (the amounts may surprise you). Minimal expected impact on earnings.

  • Communication Services

  • Consumer Discretionary (notably Retail)

  • Industrials (notably Airlines)

Cash Flows: Restricted Cash

Statement of Cash Flows - Restricted Cash (ASU 2016-18)

20161117

November 17, 2016

20171215

December 15, 2017
(1Q 2018)

What’s Changin’: Transfers between restricted cash/cash equivalents and (unrestricted) cash/cash equivalents are no longer presented in the statement of cash flows. Prior to this ASU, the FASB wasn’t clear on this, meaning transfers between restricted cash/cash equivalents and (unrestricted) cash/cash equivalents would show up in different places on the cash flow statement (e.g., operating, investing or financing) for different companies.

Impact: Possible changes to cash flow metrics, such as FCF.

  • Financials

  • Health Care

  • Information Technology

Cash Flows: Classification

Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15, Topic 230)

20160826

August 26, 2016

20171215

December 15, 2017
(1Q 2018)

What’s Changin’: New guidance that clarifies the classification and location of specific cash receipts/payments in the statement of cash flows. Most notably, moving some of the proceeds received from receivable securitizations (the beneficial interest portion) from operating to investing cash flow.

Impact: Potential changes to cash flow from ops, free cash flow, free cash conversion, etc. Could see more non-GAAP cash flow metrics.

  • Communication Services

  • Consumer Discretionary

  • Financials (notably Banks)

  • Industrials

Financial Instruments

Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01)

20160105

January 5, 2016

20171215

December 15, 2017
(1Q 2018)

What’s Changin’: Changes in the fair value of equity securities (typically where company owns greater than 20%) now run through earnings. For non-marketable equity securities (e.g., pre-IPO), companies can choose to apply a new valuation method similar to cost. Changes in the fair value of liabilities (if elected) due to company’s own credit risk go to OCI.

Impact: Increased earnings volatility and more non-GAAP adjustments (watch out for those that only add back losses) for companies that invest in equities. It’s the opposite (less volatility, less non-GAAP) for own credit marks on liabilities.

  • Financials

  • Information Technology

Definition of a Business

Clarifying the Definition of a Business (ASU 2017-01, Topic 805)

20170105

January 5, 2017

20171215

December 15, 2017
(1Q 2018)

What’s Changin’: Narrows the definition of a business, which is used to determine whether a transaction is an asset acquisition or business combination.

Impact: Expect more transactions to be treated as asset acquisitions. Meaning less goodwill (less accretive), less disclosure but more deal costs capitalized.

  • Energy

  • Health Care

  • Information Technology

Pensions: Income Statement

Improving the Presentation of Net Periodic Pension Costand Net Periodic Postretirement Benefit Cost (ASU 2017-07, Topic 715)

20170310

March 10, 2017

20171215

December 15, 2017
(1Q 2018)

What’s Changin’: Only service cost stays in operating income while the remaining pieces (e.g., interest cost, expected return, amortization of gains/losses/prior service) need to go somewhere else. Additionally, only service cost is eligible for capitalization as part of inventory or PP&E.

Impact: Changes to operating and gross margins.

  • Communication Services

  • Consumer Discretionary

  • Industrials

    Contract Costs (e.g., sales commissions)

    Other Assets and Deferred Costs (ASU 2014-09 subtopic ASC 340-40)

    20140528

    May 28, 2014

    20171215

    December 15, 2017
    (1Q 2018)

    What’s Changin’: Accompanying Topic 606 (new revenue standard), ASC 340-40 brought changes to accounting for contract costs, resulting in most incremental costs of obtaining a contract (e.g., sales commissions) being capitalized.

    Impact: Capitalizing contract costs means bigger balance sheets and a boost to margins.

    • Industrials

    • Information Technology (notably Software)

        Revenue Recognition

        Revenue from Contracts with Customers (ASU 2014-09, Topic 606)

        20140528

        May 28, 2014

        20171215

        December 15, 2017
        (1Q 2018)

        What’s Changin’: One revenue standard for all sectors/industries. New five-step process that determines the amount and timing of revenue recognition. Contracts are broken into separate components (“performance obligations”) and revenue is recognized when “control” is transferred to the customer. New disclosures should help you assess management judgment calls (we have not been too impressed so far).

        Impact: Causes revenue to be recognized faster in many cases (for others it slowed) and the patterns become lumpier for some and smoother for others. Brings more judgment to the top line.

        • Consumer Discretionary (notably Retail)

        • Health Care

        • Industrials

        • Information Technology (notably Software)

          Going Concern

          Disclosure of Uncertainties about an Entity’s Going Concern (ASU 2014-15)

          20140827

          August 27, 2014

          20151215

          December 15, 20162
          (2016 10-K)

          What’s Changin’: Evaluating a company’s ability to continue as a going concern isn’t just an auditor thang anymore. Management must disclose if “substantial doubt” (>70% chance) exists about a company’s ability to continue as a going concern within one year after the date the financial statements are issued.

          Impact: Having an insider (management) and outsider (auditor) perspective on a company’s ability to continue as a going concern is a net positive. Though, we don’t expect to see many of these new disclosures and investors (hopefully) already knew about the company’s dim prospects prior to reading them.

          Stock Comp Tax Benefits

          Improvements to Employee Share-Based Payment Accounting (ASU 2016-09, Topic 718)

          20160330

          March 30, 2016

          20161215

          December 15, 2016
          (1Q 2017)

          What’s Changin’: All stock comp related tax benefits now run through the income statement and cash flow from operations (no more “excess” tax benefit).

          Impact: Increase in earnings and operating cash flow volatility. Low quality boost to earnings and free cash flow. Higher diluted share count.

          • Health Care

          • Information Technology

          Debt: Issuance Costs

          Imputation of Interest - Simplifying the Presentation of Debt Issuance Costs (ASU 2015-03)

          20150407

          April 7, 2015

          20151215

          December 15, 2015
          (1Q 2016)

          What’s Changin’: Debt issuance costs (e.g., fees or commissions paid to banks, lawyers, etc.) are no longer an amortizable asset, instead treated as direct reduction of debt (like how equity issuance costs are treated).

          Impact: No income statement impact as the amortization of debt issuance costs continues to be treated as interest expense. Ratios such as ROA (increase) and leverage (decrease) may change minimally.

          • Communication Services

          • Consumer Discretionary

          • Industrials

          • Utilities


          Most Recent Addition(s)/Update(s)

          1. Unless otherwise noted, for public companies' fiscal periods (i.e., 10-K’s) beginning after the listed effective date, including interim reporting periods (i.e., 10-Q’s).

          2. For public companies' fiscal periods (i.e., 10-K's) ending after the listed effective date and for annual periods and interim periods thereafter.

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