Standards Update: 11/28/16
ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
The Financial Accounting Standards Board (FASB) hopes to improve financial reporting related to credit losses on loans and other financial instruments by requiring the losses to be recorded more timely with the issuance of Accounting Standards Update (ASU) No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.
The ASU, which was issued in June 2016, will require entities to present a financial asset (or a group of financial assets) net of an allowance for credit losses when measured based on an amortized cost methodology. The allowance for credit losses would be calculated based on historical experience, current conditions, and reasonable and supportable forecasts. The objective is that better information will be provided to users of financial statements on credit loss estimates by using forward-looking information, which would allow credit losses to be recorded sooner than under current guidance. Current guidance generally delays the recognition of the full amount of credit losses until the losses are considered probable of occurring.
Most of the current loss estimation methods used prior to the issuance of this ASU will still be permitted. However, the inputs used in those methods will change to reflect the full amount of expected credit losses. Management will still need to use its best judgment to determine which loss estimation method is most appropriate for each situation.
The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating the allowance for credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio.
In addition, the ASU amends the accounting treatment for credit losses on available-for-sale (AFS) debt securities by now requiring credit losses on AFS debit securities to be recorded through the allowance for credit losses. The allowance for credit losses on AFS debt securities will be limited to the amount by which the fair value is below the amortized cost of the AFS debt securities. The change is considered an improvement because entities will be able to reverse credit losses into current period net income when the estimate of credit losses declines, which is prohibited under current guidance.
The ASU is effective for public companies that are SEC filers for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2019. For public companies that are not SEC filers, the ASU is effective for fiscal years beginning after Dec. 15, 2020, and interim periods within those fiscal years. For all other organizations, the ASU on credit losses will take effect for fiscal years beginning after Dec. 15, 2020, and for interim periods within fiscal years beginning after Dec. 15, 2021.
Early adoption is permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after Dec. 15, 2018.
ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments
In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The ASU was issued to eliminate diversity in practice related to how certain items are presented and classified on the statement of cash flows. ASU No. 2016-15 addresses eight specific cash flow items and applies to all entities required to present a statement of cash flows under Topic 230.
The ASU provides the following guidance:
- Debt prepayment fees or debt extinguishment costs are to be presented in the financing activities on the statement of cash flows.
- The settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing will be split between cash flows from operating and financing activities. The portion of the cash payment attributable to the accreted interest related to the debt discount will be classified as cash outflows for operating activities, and the portion of the cash payment related to the principal as cash outflows for financing activities.
- Payments for contingent consideration made after a business combination will also be split based on certain characteristics of the payments. Payments not made soon after the acquisition date will be classified as financing activities up to the amount of the contingent consideration liability recognized at the acquisition date (including measurement-period adjustments). Any excess should be classified as operating activities. Cash payments made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability will be classified as cash outflows for investing activities.
- Receipts from the settlement of insurance claims will be classified based on the nature of the loss. For insurance proceeds that are received in a lump-sum settlement, an entity should determine the classification on the basis of the nature of each loss included in the settlement.
- Proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, will be classified as cash inflows from investing activities. Note that the cash payments for premiums on corporate-owned policies may be classified as cash outflows for investing activities, operating activities, or a combination of investing and operating activities.
- An accounting policy election is needed for an entity to determine the classification of distributions received from equity method investees. An entity would make an election to apply one of two approaches: the cumulative earnings approach or the nature of the distribution approach.
Under the cumulative earnings approach, distributions received are considered returns on investment and classified as cash inflows from operating activities, unless the investor’s cumulative distributions received less distributions received in prior periods that were determined to be returns of investment exceed cumulative equity in earnings recognized by the investor. When such an excess occurs, the current-period distribution up to this excess should be considered a return of investment and classified as cash inflows from investing activities.
Using the nature of the distribution approach, distributions received should be classified on the basis of the nature of the activity or activities of the investee that generated the distribution as either a return on investment (classified as cash inflows from operating activities) or a return of investment (classified as cash inflows from investing activities) when such information is available to the investor.
If an entity elects to apply the nature of the distribution approach and the information to apply that approach to distributions received from an individual equity method investee is not available to the investor, the entity should report a change in accounting principle on a retrospective basis by applying the cumulative earnings approach for that investee. In such situations, an entity should disclose that a change in accounting principle has occurred with respect to the affected investee(s) due to the lack of available information and should provide the disclosures required for a change in accounting principle, as applicable. This amendment does not address equity method investments measured using the fair value option.
- A transferor’s beneficial interest obtained in a securitization of financial assets should be disclosed as a noncash activity, and cash receipts from payments on a transferor’s beneficial interests in securitized trade receivables should be classified as cash inflows from investing activities.
- The classification of cash receipts and payments that have aspects of more than one class of cash flows should be determined first by applying specific guidance in the generally accepted accounting principles (GAAP) of the United States. In the absence of specific guidance, an entity should determine each separately identifiable source or use within the cash receipts and cash payments on the basis of the nature of the underlying cash flows. An entity should then classify each separately identifiable source or use within the cash receipts and payments on the basis of their nature in financing, investing, or operating activities. Finally, in situations in which cash receipts or payments have aspects of more than one class of cash flows and cannot be separated by source or use, the appropriate classification should depend on the activity that is likely to be the predominant source or use of cash flows for the item.
The amendments in ASU No. 2016-15 are effective for public business entities for fiscal years beginning after Dec. 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after Dec. 15, 2018, and interim periods within fiscal years beginning after Dec. 15, 2019.
Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period.
The amendments in ASU No. 2016-15 should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable.
ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory
As part of its simplification initiative, the FASB issued ASU No. 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, in October 2016 to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. Under current GAAP, the recognition of current and deferred income taxes for intra-entity asset transfers is not allowed until the asset has been sold to an outside party. This prohibition on recognition is an exception to the principle of comprehensive recognition of current and deferred income taxes in GAAP.
This ASU eliminates this prohibition for intra-entity transfers of assets; however, it does retain the prohibition for intra-entity transfers of inventory. As such, an entity is required to recognize the current and deferred income taxes resulting from an intra-entity transfer of assets other than inventory when the transfer occurs, the most common of which would be the transfer of property, plant and equipment and the transfer of intellectual property.
For public business entities, the amendments in ASU No. 2016-16 are effective for annual reporting periods beginning after Dec. 15, 2017, including interim reporting periods within those annual reporting periods. For all other entities, the amendments are effective for annual reporting periods beginning after Dec. 15, 2018, and interim reporting periods within annual periods beginning after Dec. 15, 2019.
Early adoption is permitted for all entities as of the beginning of an annual reporting period for which financial statements (interim or annual) have not been issued or made available for issuance. That is, earlier adoption should be in the first interim period if an entity issues interim financial statements.
The amendments in ASU No. 2016-16 should be applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption.
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