Financial Reporting and Regulatory Update

First Quarter 2018

From the FASB

Final Standards

Financial Instruments – Classification and Measurement Clarifications

1. Technical Corrections

With the issuance of ASU No. 2018-03, “Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” on Feb. 28, 2018, the FASB clarified ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” Specifically, it clarified guidance for equity securities without a readily determinable fair value and financial liabilities for which the fair value option (FVO) is elected.

Equity securities without a readily determinable fair value

For equity securities without a readily determinable fair value, a measurement alternative is allowed under ASU 2016-01 – that is, cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. The clarifications in the recent ASU primarily relate to those securities for which the measurement alternative is applied as follows:

  • Another acceptable reason for discontinuing the measurement alternative for equity securities without a readily determinable fair value is provided. That is, an entity is allowed to change from the measurement alternative for these equity securities to a fair value method consistent with Topic 820, “Fair Value Measurement.” The election is irrevocable and must be applied to all identical or similar investments of the same issuer including future purchases. Gains or losses resulting from the election should be recognized in earnings.
  • Adjustments to the securities’ value that reflect observable transactions for a similar security should be made as of the date that the observable transaction took place.
  • Remeasurement of the entire value of forward contracts and purchased options is required when an observable transaction on the underlying equity investment occurs.
  • Because of potential difficulties in determining the last observable transaction price for equity securities without a readily determinable fair value, the prospective transition approach is required when the measurement alternative is applied. For all other amendments in ASU 2016- 01, the modified retrospective approach is required.

FVO financial liabilities

  • Presentation of financial liabilities for which the FVO has been elected is required, and the presentation guidance in Accounting Standards Codification (ASC) 825- 10-45-5 should be applied whether the FVO was elected under ASC 825-10 for financial instruments or ASC 815-15 for embedded derivatives.
  • The fair value change attributable to instrument-specific credit risk for FVO financial liabilities is required (by ASC 825-10-45-5) to be separately presented in other comprehensive income (OCI). For FVO financial liabilities denominated in a foreign currency, the fair value change for instrument-specific credit risk should first be measured in the currency of denomination when separately presented in OCI. Then, both fair value change components (for instrument-specific credit risk and for foreign currency) should be remeasured into the functional currency of the reporting entity.

Effective Dates

For public business entities (PBEs) with fiscal years beginning between Dec. 15, 2017, and June 15, 2018, adoption is not required until the interim period beginning after June 15, 2018, which first applies to the Sept. 30, 2018, interim financial statements, for calendar year-end PBEs. For PBEs with fiscal years beginning between June 15, 2018, and Dec. 15, 2018, adoption of this ASU is not required before ASU 2016-01. The board’s intention is to allow entities to continue with their current adoption plans for ASU 2016-01.

For all other entities, the effective date is the same as the effective date in ASU 2016-01.

Early adoption is allowed for fiscal years beginning after Dec. 15, 2017, including interim periods within, as long as ASU 2016-01 has been adopted.

2. SEC Guidance

On Nov. 29, 2017, the SEC staff issued Staff Accounting Bulletin (SAB) No. 117, to eliminate guidance in SAB Topic 5.M, “Other Than Temporary Impairment of Certain Investments in Equity Securities.” Because FASB ASC Topic 321, “Investments – Equity Securities” (codified by ASU 2016-01) eliminates the available for sale (AFS) classification for investments in equity securities, the SEC guidance in SAB Topic 5.M on classification and measurement for that security type is no longer applicable. Subsequent to an SEC registrant adopting ASC Topic 321, SAB Topic 5.M no longer will apply.

On March 9, 2018, the FASB codified SAB 117 by issuing ASU 2018-04, “Investments – Debt Securities (Topic 320) and Regulated Operations (Topic 980): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273 (SEC Update).”

Tax Reform

1. Reclassification of Stranded Tax Effects in AOCI

Under existing accounting guidance, deferred tax assets and liabilities (DTAs and DTLs) must be adjusted for tax law changes in the reporting period of the tax law’s enactment, and the effect must be included in income from continuing operations. This guidance is applicable even in situations in which the related income tax effects of items in accumulated other comprehensive income (AOCI) were originally recognized in other comprehensive income. After President Donald Trump signed the tax reform law known as the Tax Cuts and Jobs Act (H.R. 1) on Dec. 22, 2017, stakeholders raised the issue to the FASB that applying this guidance would cause the tax effects of items within AOCI not to reflect the appropriate tax rates, resulting in “stranded tax effects.”

In an expedited response on Jan. 18, 2018, the FASB issued a proposal, and on Feb. 14, it issued the final ASU 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects From Accumulated Other Comprehensive Income.” It allows entities to elect to reclassify the stranded tax effects from AOCI to retained earnings, limited only to amounts in AOCI that are affected by the tax reform law. This can include remeasuring DTAs (and related valuation allowances that were not originally charged to income from continuing operations) and DTLs related to items presented in AOCI at the newly enacted tax rate and other income tax effects on items remaining in AOCI.

Effective Dates

Early adoption is permitted, and it is expected that many institutions will early adopt the ASU because the tax rate change was effective on Dec. 22, 2017. For those institutions that do not elect to early adopt, the ASU is effective for fiscal years beginning after Dec. 15, 2018, and interim periods within, which is March 31, 2019, interim financial statements for calendar year-ends.

Certain disclosures are required in the period of adoption for all entities, whether they elect to apply this reclassification option or not.

2. SEC Guidance

After the president signed the tax reform law, the SEC’s Office of the Chief Accountant and Division of Corporation Finance (Corp Fin) staff issued SAB 118, which includes interpretive guidance for public companies, auditors, and other stakeholders to consider as they contemplate disclosures for the accounting impacts of the tax act.

The SEC staff acknowledges that evaluating tax changes and accompanying financial reporting impacts of the act will take time for some entities. To that end, the guidance addresses the various levels of uncertainty in measuring the impact and allows an issuer to recognize provisional amounts, subject to certain criteria. It also addresses the disclosures that should accompany provisional amounts.

It provides the following measurement model and disclosure considerations:

  • In scenarios where an entity’s measurement of accounting for changes in tax laws is:
    • Complete (in whole or in part) – the effects should be recorded in the reporting period.
    • Incomplete but can be reasonably estimated – the provisional effects (or changes in the provisional effects) should be recorded in the reporting period. The provisional amount should be adjusted during the measurement period when certain criteria are met, and the measurement period should not extend beyond one year.
    • Incomplete and cannot be reasonably estimated – the entity should not record provisional amounts based on the act and should continue to record the effects based on the tax laws that were in effect immediately prior to the act being enacted. For those income tax effects for which an entity is not able to determine a reasonable estimate, the entity should record the effects in the first reporting period in which a reasonable estimate can be determined.
  • Supplemental disclosures should accompany the provisional amounts, including the items recorded as provisional amounts, the reasons for the incomplete accounting, the additional information or analysis that still is required, other information relevant to why the registrant was not able to complete the accounting required under ASC 740 in a timely manner, and when the accounting is completed. Quantitative information also should be disclosed, including the provisional and incomplete tax amounts as well as the measurement period adjustments and their impact on the effective tax rate.

On March 13, 2018, the FASB issued ASU 2018-05, “Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update)” to codify SAB 118.

Lease Accounting – Practical Expedient in Transition for Land Easements (Rights-of-Way)

In its first standard of the year, issued Jan. 25, 2018, ASU 2018-01, “Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842,” the FASB simplified transition to the lease accounting guidance specifically for land easements. A land easement is “a right to use, access, or cross another entity’s land for a specified purpose,” often referred to as a “right-of-way.” The simplification is for entities that apply existing accounting guidance other than Topic 840, “Leases.” Some entities use Topic 350, “Intangibles – Goodwill and Other,” or Topic 360, “Property, Plant, and Equipment,” to account for land easements, and for those entities, assessing whether existing or expired land easements meet the definition of a lease under the new guidance in Topic 842 would be costly and complex.

With the simplification in ASU 2018-01, entities may elect a practical expedient in transition for land easements that were not previously accounted for under Topic 840. For those existing or expired land easements only, the practical expedient allows entities to forego the lease evaluation under Topic 842 and continue applying current accounting policies. New or modified land easements will be evaluated prospectively under Topic 842.

Effective Dates

This ASU is effective consistent with ASU 2016-02, “Leases (Topic 842),” which generally is first effective for calendar year-end PBEs in the March 31, 2019, interim financial statements, and for calendar year-end non-PBEs in the Dec. 31, 2020, annual financial statements.


Implementation Costs in Cloud Computing Arrangements (CCAs)

On March 1, 2018, the FASB issued a proposal, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract; Disclosures for Implementation Costs Incurred for Internal-Use Software and Cloud Computing Arrangements,” which is a follow-up to ASU 2015-05, “Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement.”

In ASU 2015-05, the FASB addresses whether fees paid in a CCA should be capitalized or expensed. The most common example of a CCA is software as a service, which uses internet-based application software hosted by a service provider or third party.

As a follow-up, stakeholders requested additional guidance on accounting for implementation costs associated with CCAs considered service contracts. Implementation costs include setup and other upfront fees to get the arrangement ready for use as well as training, creating, or installing an interface, reconfiguring existing systems, and reformatting data.

Under the proposal, the accounting for implementation costs for CCAs that are service contracts would align with the requirements in ASC Subtopic 350-40 for internal-use software, and implementation costs incurred in a CCA would be accounted for as follows:

  • Costs in the preliminary project and post-implementation operation stages would be expensed, so entities would need to determine the project stage for their CCAs.
  • Costs for integration with on-premise software, coding, and configuration or customization would be capitalized, and the capitalized amounts would be amortized over the term of the hosting arrangement. The amortization would run through the same income statement line item as the related fees, that is, in operating expense.
  • Data conversion and training costs would be expensed.

The definition of a hosting arrangement would be revised to replace “licensing of” with “accessing and using,” which is expected to broaden the scope of contracts that would need to be assessed under the guidance.

Disclosure about implementation costs would be required.

Comments were due April 30, 2018.

Hedge Accounting – Permissible U.S. Benchmark Interest Rates

On Feb. 20, 2018, the FASB issued an exposure draft, “Derivatives and Hedging (Topic 815): Inclusion of the Overnight Index Swap (OIS) Rate Based on the Secured Overnight Financing Rate (SOFR) as a Benchmark Interest Rate for Hedge Accounting Purposes.” Benchmark interest rates frequently are used in accounting hedge designations of existing or forecasted issuances or purchases of fixed-rate financial assets or liabilities. The proposal to add OIS based on SOFR as a benchmark rate was at the request of the Federal Reserve (Fed) Board and Bank Alternative Reference Rates Committee due to concerns for the sustainability of the London Interbank Offered Rate (Libor).

Existing benchmarks under Topic 815 include U.S. Treasury, the Libor swap rate, the OIS rate based on the Fed Funds Effective Rate, and the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate. The OIS rate based on SOFR would be the fifth U.S. benchmark rate. Similar to the Fed Funds OIS rate, which is a swap rate based on the underlying overnight Fed Funds Effective Rate, the OIS rate based on SOFR will be a swap rate based on the underlying overnight SOFR rate.

Including the OIS based on SOFR as a benchmark interest rate will help institutions transition away from Libor by providing an alternative rate.

The exposure draft does not yet include an effective date.

Comments were due March 30, 2018.

Lease Accounting Simplifications

On Jan. 5, 2018, the FASB issued a proposed ASU, “Leases (Topic 842): Targeted Improvements,” to simplify implementation of the leases standard by providing the following:

  • An optional transition method would allow an entity to apply the transition provisions at its adoption date rather than at the earliest comparative period presented in its financial statements. Under this transition method, an entity would initially apply the requirements to all leases that exist at the adoption date, with the cumulative effect recognized as an adjustment to retained earnings as of the adoption date. The FASB is proposing this additional transition method in response to preparers experiencing unanticipated costs and complexities associated with the modified retrospective transition method, particularly the comparative period reporting requirements.
  • For lessors, a practical expedient would allow them to not separate nonlease components from the related lease components if certain criteria are met (that is, the pattern of recognition must be the same and it must be an operating lease). Examples of nonlease components include equipment maintenance services, common area maintenance services in real estate, or other goods or services provided to the lessee apart from the right to use the underlying asset. The FASB is proposing this option in response to stakeholder observations that, except for presentation and disclosure, the timing and pattern of revenue recognition would be the same regardless of whether the nonlease components are separated from the lease component. It would be elected by class of underlying assets, and would require certain disclosures.

Comments were due Feb. 5, 2018.

Other Projects on Our Watch List

Tax Reform – Staff Q&As

At its Jan. 10, 2018, and subsequent meetings, the FASB discussed the financial reporting effects of the Tax Cuts and Jobs Act. The FASB addressed six implementation questions related to tax reform, resulting in the issuance of one ASU (2018-02), as previously noted, and five FASB Staff Q&As.

On Jan. 12, 2018, the FASB finalized the first Staff Q&A:

  • “Topic 740, No. 1: Whether Private Companies and Not-for-Profit Entities Can Apply SAB 118”
    • Based on the longstanding position of private companies electing to apply SABs, there is no objection to private companies and not-for-profit entities applying SAB 118. For more on SAB 118, see the previous “Tax Reform” section within “From the FASB.”

The remaining four FASB Staff Q&As were discussed at the Jan. 18, 2018, Emerging Issues Task Force (EITF) meeting, and the staff noted it received minor changes to the initial drafts. On Jan. 22, 2018, the FASB finalized those four Staff Q&As:

  • “Topic 740, No. 2: Whether to Discount the Tax Liability on the Deemed Repatriation”
    • The tax liability recorded for the one-time deemed repatriation of foreign earnings and profits, which can optionally be paid over eight years, should not be discounted.
  • “Topic 740, No. 3: Whether to Discount Alternative Minimum Tax Credits That Become Refundable”
    • The tax act made substantial changes to the corporate alternative minimum tax (AMT), and questions arose over whether AMT tax credits should be discounted. These amounts should not be discounted.
  • “Topic 740, No. 4: Accounting for the Base Erosion Anti-Abuse Tax”
    • Entities subject to the base erosion anti-abuse tax (BEAT) in future years should record it as a period cost. They should continue to record DTAs and DTLs at the regular statutory rate, even if they expect to be subject to BEAT indefinitely.
  • “Topic 740, No. 5: Accounting for Global Intangible Low-Taxed Income”
    • Entities required to include in taxable income their global intangible low-taxed income (GILTI) are allowed to make a policy choice of whether to recognize deferred taxes for temporary basis differences expected to reverse as GILTI in future years or to include the tax on GILTI as tax expense in the year incurred.

Tax Reform Resource

Refer to the Crowe Horwath LLP article “Financial Reporting for Tax Reform: The SEC and FASB Weigh In,” published Jan. 23, 2018.