The Financial Accounting Standards Board has added five more projects to its agenda for simplifying accounting standards, including short-term projects related to debt and tax accounting.
Last month, FASB proposed two projects for simplifying the process of inventory measurement and eliminating the requirements for extraordinary items (see FASB Proposes to Simplify Inventory Measurement). The goal of the simplification initiatives, according to FASB, is to reduce cost and complexity in financial reporting while improving or maintaining the usefulness of the information reported to investors. At a board meeting last week, FASB added five more projects to the agenda and discussed a number of others.
“The FASB’s simplification initiative is focused on identifying areas of GAAP that can be addressed quickly and effectively, without diminishing the quality of information provided to investors,” said FASB spokesperson Christine Klimek. “The board selected the initial simplification agenda projects based on feedback received from our stakeholders, who told us what aspects of GAAP they think can be improved. The initiative builds upon progress we already have made in reducing complexity, which includes the issuance of our new revenue recognition standard, our ongoing work with the Private Company Council, and our efforts to complete our conceptual and disclosure framework projects.”
One of the new projects, related to the presentation of debt issuance costs, is expected to simplify the accounting by aligning the presentation of debt discount or premium and issuance costs.
Another project, pertaining to the measurement date of defined benefit plan assets, is expected to reduce costs by aligning the measurement date of defined benefit plan assets with the date that valuation information and the fair values of plan assets are provided by third-party service providers. An entity with a fiscal year-end that does not fall on the end of a month would be eligible to measure its defined benefit plan assets and liabilities as of the month-end that is closest to the employer’s fiscal year-end.
A third project, for balance sheet classification of debt, is expected to reduce cost and complexity by replacing the fact-pattern specific guidance in GAAP with a principle to classify debt as current or noncurrent based on the contractual terms of a debt arrangement and an entity’s current compliance with debt covenants.
A fourth project, related to accounting for income taxes, is expected to simplify accounting for income taxes by eliminating the requirement in GAAP for entities that present a classified statement of financial position to classify deferred tax assets and liabilities as current and noncurrent, and instead requiring that they classify all deferred tax assets and liabilities as noncurrent in the statement of financial position.
A related area of the same project involves eliminating the prohibition in GAAP on the recognition of income taxes for the intra-entity differences between the tax basis of the assets in a buyer’s tax jurisdiction and their cost as reported in the consolidated financial statements, and instead requiring recognition of the income tax consequences associated with an intra-entity transfer when the transfer occurs.
Some of the changes contemplated will increase convergence with International Financial Reporting Standards and be consistent with IFRS, while others will not.
Debt Accounting Improvements
The basic way that companies classify debt and other items as current or non-current is based on whether it will convert to cash in the next 12 months or not. Over the years, stakeholders asked FASB different questions about gray areas. For example, if they have a debt arrangement where the debt is due in three years, but the arrangement includes a clause that says if there is an adverse change in the business, the lender can call the debt, or if it’s a debt arrangement where the debt is not due for 10 years, but there are financial debt covenants and if Earnings Before Interest and Taxes is not a specific amount this year, then the lender may be able to call in the debt.
Over the years people have asked questions of FASB and its Emerging Issues Task Force about what happens when classifying debt if there is a subjective clause such as an adverse change in the business, or if there are covenants where the company thinks it is questionable whether or not they’ll be able to pass the covenant, and how those different items should be considered.
FASB and the EITF tried to respond over the years to those specific questions but decades later, when the board looked back at all the guidance it realized there was not a principle running through all the guidance. Instead the guidance dealt with narrow fact patterns.
As part of FASB’s simplification initiative stakeholders reported to the board that the determination of whether debt should be classified as current or noncurrent is complex because of all of the narrow-scope guidance. The board is now proposing to eliminate all of the narrow fact pattern guidance that has been developed over decades of time and instead replace it with a principle that can be applied to all situations when an entity is classifying debt.
Debt on the Balance Sheet
In a related simplification project, U.S. GAAP includes guidance on how different types of debt issuance costs should be presented on the balance sheet. For example, if a company issues a $10 million note, the debt itself would be presented as a liability, but in order to enter into that transaction, an entity may have incurred accounting costs and legal costs that were directly related to being able to issue that debt.
Under current guidance, an entity has to evaluate all those different items, and depending on what the item is, sometimes the item is presented as an asset, so the costs of attorneys’ fees may be capitalized, and then other items are presented as an adjustment on the debt balance itself.
Stakeholders reported to FASB as part of the board’s simplification initiative that there are extra costs and effort associated with analyzing what all the different debt issuance costs are and figuring out how they should be presented. FASB has decided to eliminate all that specific guidance and replace it with guidance that says that all debt issuance costs would be presented on the same line item as debt.
Tax Accounting Simplification
FASB evaluated a number of ideas that were raised in the simplification initiative in area of accounting for income taxes, and at this point the board has decided to address two of the simplification ideas. The first involves balance sheet presentation of income taxes.
Under current guidance, as with the debt issue, this is a case where there is some specific GAAP guidance a company would follow to determine whether deferred tax assets or liabilities should be presented as current or noncurrent. Stakeholders reported to FASB that there is some cost and complexity associated with going through that classification exercise and investors reported to the board that the classification of something like a deferred tax isn’t that meaningful to them.
Since it’s not that meaningful to investors and since there are reported costs with the classification, the board decided that all deferred taxes—whether an asset or a liability—would be presented as noncurrent, so entities wouldn’t have to go through the exercise of determining how to classify it when users apparently don’t think the classification is that useful.
Tax Effects of Moving Assets Across Borders
A second area of tax accounting that FASB decided to simplify relates to the income tax effects of moving an asset such as inventory across national borders. Under current GAAP, an entity is supposed to defer the tax consequences until the inventory is actually sold to a third party. The company still has to track all the taxes that it would have to pay when it eventually transfers the inventory, but the taxes are deferred.
FASB is proposing that entities would recognize the tax consequences for an asset transfer at the time that the transfer occurs. By doing that, a company wouldn’t have to incur the costs to track those tax items on an ongoing basis. Stakeholders said they thought that would provide better information, for example, when a U.S. division sells inventory to a Canadian division. It would be common in such a case for the U.S. entity to have to pay U.S. income taxes. Stakeholders told FASB that if the company actually has to pay U.S. income taxes, then it would be better to record those taxes when they become payable at the time of the transaction.
Pension Measurement Dates
FASB also discussed simplifying the matter of pension measurement dates. If a company has a defined-benefit pension plan and an off-month year-end, such as January 3, under U.S. GAAP it has to go through a process of measuring the assets that it has in the pension plan and the liability to employees in the plan.
The difficulty that some companies reported to FASB as part of the simplification initiative was that the statements that they receive from their asset managers and trustees are as of the month-end. They then end up in a situation where they have statements as of, for example, December 31, but because their year-end is January 3, they have to go through an exercise of determining the value and measurement as of January 3, or perhaps demonstrating that the difference in value between December 31 and January 3 is trivial.
FASB if proposing to add an amendment to the guidance that would say, in effect, if a company has an off-month year-end such as January 3, it could use the asset balances and liability balances that are reported to it as of the nearest month-close, for example December 31.
To date FASB has received about 70 ideas for the simplification initiative. The staff is in the process of evaluating all the ideas and already has issued exposure drafts for some of them. Over the course of the coming months and probably the foreseeable future the staff plans to bring more of these narrow-scope simplification ideas to the board and ask them to vote if they want to make the improvement or not, depending on what it is.