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Standards Update: 1/30/18

Posted 1:30 PM by

The Financial Accounting Standards Board (FASB) regularly issues Accounting Standards Updates (ASUs) to make changes to the FASB Codification, the primary source of Accounting Principles Generally Accepted (GAAP) in the United States. Below are select ASUs that were recently issued.

 
ASU No. 2017-10, Service Concession Arrangements (Topic 853): Determining the Customer of the Operation Services

The Financial Accounting Standards Board issued Accounting Standards Update (ASU) No. 2017-10, Service Concession Arrangements (Topic 853): Determining the Customer of the Operation Services in 2017, which applies to the accounting for entities operating infrastructure under the terms of a service concession arrangement.

A service concession arrangement is one where a governmental entity (known as the grantor) grants an operating entity the right to operate and sometimes maintain infrastructure (for example, a toll road) for a specified period. ASU 2017-10 was issued to address diversity in how an operating entity determines the customer of the operation services for such transactions within the scope of Topic 853.

The amendments in the ASU stipulate that the operating entity should consider the grantor to be the customer of the operation services in all cases for service concession arrangements within the scope of Topic 853. An operating entity should account for revenue from service concession arrangements in accordance with Topic 605, Revenue Recognition, or Topic 606, Revenue from Contracts with Customers, as applicable.

It is important to note that ASU 2017-10 only applies to service concession arrangements that are within the scope of Topic 853. The scope is limited to service concession arrangements in which the grantor both:

  • controls or has the ability to modify or approve the services the operating entity must provide with the infrastructure, to whom it must provide them, and at what price; and
  • controls, through ownership, beneficial entitlement, or otherwise, any residual interest in the infrastructure at the end of the term of the arrangement.

Other transactions, which may use the term "service concession," fall outside of the scope of Topic 853 if the above criteria are not satisfied.

For an entity that had not early-adopted Topic 606, Revenue from Contracts with Customers, before the issuance of ASU 2017-10 on May 16, 2017, the effective date for ASU 2017-10 is the same as the effective date for Topic 606. Therefore, it is effective for all public business entities for years beginning after Dec. 15, 2017 and most nonpublic businesses for years beginning after Dec. 15, 2018. Earlier adoption is permitted for all entities.

 
ASU No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); and Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features and (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception

FASB also issued ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); and Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features and (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception in 2017. The ASU is broken down into two parts, each of which is explained below.

  • Part I:  Accounting for Certain Financial Instruments with Down Round Features

Part I of the ASU affects entities that issue financial instruments that include down round features. This feature is most common in warrants, convertible preferred shares, and convertible debt instruments. A financial instrument can include a down round feature which reduces the strike price of an issued financial instrument if the issuer sells shares of its stock for an amount less than the currently stated strike price of the issued financial instrument or issues an equity-linked financial instrument with a strike price below the currently stated strike price of the issued financial instrument. A down round feature can be structured in many different ways. Depending on the structure of the down round feature it may:

  • reduce the strike price of a financial instrument to the current issuance price,
  • limit the reduction of the strike price by a floor or on the basis of a formula that results in a price that is at a discount to the original exercise price but above the new issuance price of the shares, or
  • reduce the strike price to below the current issuance price.

Example. A company issues warrants to buy a certain number of common stock for $10 per share. The warrants contain a down round feature. The terms of the down round feature specify that if the entity issues additional shares of its common stock for an amount less than $10 per share or if it issues an equity-classified financial instrument with a strike price below $10 per share, the strike price of the warrants would be reduced to the most recent issuance price or strike price, but the terms of the down round feature are such that the strike price cannot be reduced below $8 per share (i.e., a floor).

The amendments in ASU 2017-11 change the classification analysis of certain equity-linked financial instruments with down round features (i.e., liability or equity). Under ASU 2017-11, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to a company’s own stock. As a result, a freestanding equity-linked financial instrument no longer would be accounted for as a derivative liability at fair value just because of a down round feature. Basically, ASU 2017-11 requires an entity to disregard the down round feature when assessing whether the financial instrument is indexed to its own stock, for purposes of determining whether this scope exception to derivative accounting applies.

Companies that provide earnings per share (EPS) data will adjust their basic EPS calculation for the effect of the feature when triggered (that is, when the exercise price of the related equity-linked financial instrument is adjusted downward because of the down round feature) and also will recognize the effect of the trigger within equity under the guidance of ASU 2017-11. It is important to note that the recognition of the down round feature is limited to only those entities which present EPS.

Under ASU 2017-11, convertible instruments with embedded conversion options that have down round features would be subject to the specialized guidance for contingent beneficial conversion features (in FASB ASC 470-20, Debt—Debt with Conversion and Other Options, including related EPS guidance (in FASB ASC 260)).

For public business entities, the amendments in Part I of ASU 2017-11 are effective for fiscal years beginning after Dec. 15, 2018. For all other entities, the amendments in Part I are effective for fiscal years beginning after Dec. 15, 2019. Early adoption is permitted for all entities.

  • Part II of ASU 2017-11

Topic 480, Distinguishing Liabilities from Equity, contains extensive pending content due to the indefinite deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests. The amendments in Part II of ASU 2017-11 replaces that indefinite deferral with a scope exception. The effects of Part II do not have a direct accounting effect and, therefore, are effective immediately.

 
ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities

ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, applies to any company that elects to apply hedge accounting in accordance with accounting principles generally accepted in the United States of America (GAAP). The main amendments by ASU 2017-12 can be broken down into changes that align hedge accounting more closely with a company’s risk management activities and changes that help to simplify the testing of hedge effectiveness.

The amendments that more closely align hedge accounting with a company's risk management activities are as follows:

  • Permits companies more flexibility in hedging interest rate risk for both variable interest rates and fixed interest rate financial instruments (i.e., interest rate swaps), and introduces the ability to hedge risk components for nonfinancial hedges.
  • Changes the guidance used for designating fair value hedges of interest rate risk and for measuring the change in fair value of the hedged item.
  • Now requires a company to present the earnings effect of the hedging instrument in the same income statement line item in which the earnings effect of the hedged item is reported (i.e., netting).
  • Introduces an approach that no longer separately measures and reports hedge ineffectiveness.
  • Expands and changes the reporting of amounts excluded from the assessment of hedge ineffectiveness to allow entities to use an amortization approach or to continue to use the current mark-to-market accounting approach.

The amendments that help to simplify the testing of hedge effectiveness are as follows:

  • Allows a company to perform subsequent assessments of hedge effectiveness qualitatively, if certain conditions are met as outlined in ASU 2017-12.
  • Allows companies more time to perform the initial quantitative hedge effectiveness assessment to be able to comply with the hedge accounting guidance.
  • Allows a company to apply the "long-haul" method for assessing hedge effectiveness when use of the shortcut method was not or is no longer appropriate if certain conditions are met as outlined in ASU 2017-12.

It is important to note that a company must still specify, at the inception of the hedge, which quantitative method it would use to assess effectiveness and measure hedge results if the shortcut method was not or is no longer appropriate during the life of the hedging relationship. Failure to specify this would disqualify a company from the relief provided in this ASU (this failure is common in private companies). The timing and content of the documentation at hedge inception has been reduced under ASU 2017-12 for certain private companies, as described below, in an effort to simplify the accounting for hedges for private companies. The goal of ASU 2017-12 is to better align the documentation requirements with the actual issuance of the financial statements. Note the following changes to documentation requirements for private companies:

  • Clarify that a company may apply the "critical terms match" method for a group of forecasted transactions if the transactions occur and the derivative matures within the same 31-day period or fiscal month, and the other requirements for applying the critical terms match method are satisfied.
  • Provide relief to private companies. Specifically, private companies that are not financial institutions and not-for-profit (NFP) entities (except for NFP entities that have issued, or are a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market) may select the method of assessing hedge effectiveness and perform the initial quantitative effectiveness assessment and all quarterly hedge effectiveness assessments before the date on which the next interim (if applicable) or annual financial statements are available to be issued. This incremental relief does not affect the simplified hedge accounting approach for private companies offered in ASU 2014-03.

At hedge inception, private companies will still have to identify the hedging instrument, the hedged item or transaction, and the nature of the risk being hedged. But companies will get more time to prepare the documentation of effectiveness testing.

The amendments in ASU 2017-12 also impact current disclosure requirements, as follows:

  • Requires a new tabular disclosures related to cumulative basis adjustments for fair value hedges.
  • Requires a new tabular disclosure related to the effect on the income statement of fair value and cash flow hedges.
  • Eliminates the requirement to disclose the ineffective portion of the change in fair value of hedging instruments.

The amendments in ASU 2017-12 are effective for public business entities for fiscal years beginning after Dec. 15, 2018. For all other entities, the amendments take effect for fiscal years beginning after Dec. 15, 2019. Early adoption is permitted.

About the Author
Ron Smith is a partner in Katz, Sapper & Miller’s Audit and Assurance Services Group. Ron advises clients and firm members on accounting, financial reporting, auditing, compliance, and internal control matters. He also oversees the firm’s quality control system. Connect with him on LinkedIn.

 

About the Author
Justin Hayes is a director in Katz, Sapper & Miller’s Audit and Assurance Services Group. Justin’s primary responsibilities include auditing and reviewing financial statements, as well as advising clients on accounting, reporting, compliance, and internal control-related matters. Connect with him on LinkedIn.

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