The Financial Accounting Standards Board (FASB) isn’t planning to issue any major accounting standards updates in 2017, because it wants companies to focus on implementing the new leasing and revenue recognition standards. Instead, the board is fine-tuning certain narrow-range topics in financial reporting, such as hedging and consolidation. Here’s what’s been decided on those topics and why the board recently refused to clarify the definition of “readily determinable fair value.”
Businesses use derivatives and hedge accounting to protect themselves from a range of economic circumstances, including changes in interest rates, currency exchange rates, securities prices or the prices of raw materials. In September, the FASB issued Proposed Accounting Standards Update (ASU) No. 2016-310, Derivatives and Hedging (Topic 815) — Targeted Improvements to Accounting for Hedging Activities. The proposal calls for several changes to hedge accounting, including allowing more risk management activities to qualify for the specialized accounting method.
In March, the FASB addressed two key questions related to the hedge accounting proposal:
Should the “market yield” test be eliminated? This test would have required an entity to use the total contractual coupon cash flows to determine the fair value of a hedged item attributable to interest rate risk if, at hedge inception, the market yield of the hedged item was less than the benchmark interest rate.
The FASB has decided to eliminate the market yield test from the final update. So, for all fair value hedges of interest rate risk, companies will have the option of using either 1) the total contractual coupon cash flows, or 2) the benchmark rate component cash flows determined at hedge inception.
Should the “last of layer” approach be required for fair value hedges of interest rate risk of prepayable assets? This approach would allow an entity to designate as the hedged item the last dollar amount of either: 1) a prepayable asset, such as a prepayable mortgage-backed security, or 2) a closed portfolio of prepayable assets, such as residential mortgage loans.
An entity would be able to assume that, if prepayments occur, they’re first applicable to the portion of the prepayable asset or to a closed portfolio of prepayable assets that isn’t part of the designated hedged layer. On each hedge effectiveness assessment date, an entity would use its expected performance of the asset(s) to determine if the amount remaining at hedge maturity is still expected to exceed or be equal to the last of layer.
The FASB has decided to incorporate the last of layer approach in the current hedge accounting project for fair value hedges of interest rate risk of prepayable assets.
Although the FASB made headway on its hedging project in March, it hasn’t yet approved a final update. The board will continue deliberating this proposal in the coming months.
For several years, the FASB has been looking for ways to simplify the consolidated reporting standard, which determines when a company should consolidate, or report on its balance sheet, holdings it has in other entities. After the Enron scandal, the FASB revised the standard to limit the opportunities for hiding liabilities in off-balance-sheet vehicles. The standard remains one of the more complicated topics in financial reporting.
In March, the FASB directed its staff to draft a proposed update that would replace Accounting Standards Codification (ASC) Topic 810, Consolidation, with a new topic. ASC Topic 812 would be divided into subtopics for voting interest entities (VOEs) and variable interest entities (VIEs).
Proponents say the change would make the accounting literature easier to navigate and conform with how Big Four firms advise clients on this aspect of U.S. Generally Accepted Accounting Principles (GAAP). This proposal would apply to both public and private companies.
In addition, the FASB has decided to propose an amendment that would let private companies opt out of following the common control requirements in U.S. GAAP. Accounting for VIEs for businesses under common control has long been a source of frustration for private companies and their auditors.
Private companies complain that the VIE guidance is overly complicated for privately held businesses trying to determine whether to consolidate affiliated entities with the same parent company. Many companies err on the side of consolidating multiple affiliated and subsidiary businesses onto a parent’s balance sheet. The practice frustrates lenders and creditors, who generally prefer simpler, cleaner balance sheets.
The Private Company Council asked the FASB’s research staff to develop practical examples that relate specifically to private companies to include in the consolidated reporting standard. But after the staff drew up a relatively straightforward example, staff members couldn’t agree on how to apply the accounting requirements.
The main sticking point relates to the assessment of power: Whoever is in power is the parent entity and must report on its balance sheet its holdings. In private company transactions — such as those between friends or relatives — there often are no formalized arrangements, the parent can change and there’s rarely documentation to back up decisions.
Going forward, the FASB plans to propose additional changes to consolidated reporting for public companies, too. The board considers the changes to be targeted improvements as opposed to a wholesale rewrite of the standard.
During a March meeting, the FASB rejected a request to clarify the definition of “readily determinable fair value.” The board had previously amended this definition in the 2015 edition of its technical corrections. But some venture capital funds, limited partnerships and employee benefit plans said the definition was inappropriately altered in the 2015 technical corrections, leading to confusion about the required disclosures for measurements of some investments.
An equity security has a readily determinable fair value if its sales price or bid-and-ask quotation is available on a public stock exchange or in the over-the-counter market. For an equity security traded only in a foreign market, the fair value is readily determinable only if the foreign market is comparable, in terms of breadth and scope, to one of the U.S. markets.
The 2015 amendment added that an equity security that’s an investment in a mutual fund “or in a structure similar to a mutual fund (that is, a limited partnership or a venture capital entity) is readily determinable if the fair value per share is determined and published and is the basis for current transactions.”
By adding “structures similar to mutual funds” to the definition and calling out limited partnerships and venture capital entities as examples, critics said the FASB expanded the population of securities that must be evaluated for readily determinable fair value. But the funds that criticized the 2015 amendment couldn’t cite any specific examples of financial reporting problems caused by the revised definition. So, the board voted 6-1 to not take up the project.
For more information
These are just a few topics currently on the FASB’s technical agenda. U.S. GAAP is constantly evolving to address the concerns of businesses, investors and other users of financial statements. The FASB plans to conduct additional research and is beginning initial deliberations on many other areas of financial reporting. Contact your CPA for more information on the latest proposals and updates to the financial reporting guidance.