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First Quarter Developments from the Emerging Issues Task Force

April 5, 2016
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The Financial Accounting Standards Board (FASB) marked a few additional items off its list of Emerging Issues Task Force (EITF) projects in the first quarter of 2016. It approved accounting standard changes for three EITF topics and released a proposed accounting standard for another.

The EITF agenda continues to be flexible based on the direction of its discussions, and this flexibility has resulted in the EITF expanding one of its existing projects. The complexity of the proposed changes to cash flow recently led the EITF to split cash flows into two separate issues, the original EITF Issue No. 15-F, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments and EITF Issue No. 16-A, Restricted Cash.

Accounting Standards Updates

ASU 2016-04 Liabilities—Extinguishments of Liabilities (Subtopic 405-20): Recognition of Breakage for Certain Prepaid Stored-Value Products

Third parties that issue prepaid stored-value products (gift cards, traveler’s checks, etc.) historically were divided about whether to classify the liability associated with the stored-value products as financial or nonfinancial. The classification affects the methodology used to account for breakage, or the dollar amount of the prepaid product that the product holder never redeems.

Accounting for liabilities for prepaid stored-value products became more pressing with the changes made to Topic 606 Revenue from Contracts with Customers. The revisions to the revenue recognition standard exclude financial liabilities from the breakage guidance. As a result of a consensus of the EITF, the FASB issued ASU 2016-04, which states that liabilities related to prepaid stored value products are financial liabilities and should be treated consistently with Topic 606’s breakage guidance.

Following the guidance of Topic 606, if the issuing entity expects to be entitled to breakage it recognizes the expected breakage amount into revenue in proportion of the use of the prepaid stored-value products by the customer. If there is not an expectation of being entitled to breakage, then unredeemed amounts would be recognized into income when it is a remote possibility that the customer will use the product. In order to evaluate whether the issuing entity is entitled to breakage, the issuing entity uses the constraint on variable consideration. Therefore, breakage revenue would be recognized proportionally to the customer’s usage of the prepaid stored-value products when it is probable that a significant reversal in cumulative revenue recognized will not occur when the uncertainty around breakage is resolved.

The changes are effective for public business entities and certain not-for-profit entities and employee benefit plans for financial statements for fiscal years and interim periods beginning after December 15, 2017 (calendar year 2018). All other entities adopt for fiscal years beginning after December 15, 2018 (calendar year 2019), and interim periods beginning after December 15, 2019 (calendar year 2020). Early adoption is permitted. When adopted, the new guidance is applied using either a modified retrospective or retrospective transition approach.

ASU 2016-05—Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships

Another consensus of the EITF led to changes to Derivatives and Hedging (Topic 815) related to derivative contract novations.

Financial institution mergers, intercompany transactions, business exits and numerous other situations may result in one party replacing another in a contract that contains a hedging instrument (novation). U.S. generally accepted accounting principles (GAAP) did not indicate whether novation would signal that the instrument affected by the change would become ineligible for hedge accounting, causing diversity in practice. Commonly a novation was viewed as either a termination of the existing hedging relationship or a change in critical terms, resulting in a dedesignation of a hedging relationship. After a novation an entity may have been unable to re-establish a hedging relationship. The ASU clarifies that a novation in a contract containing a hedging instrument does not on its own affect the instrument’s accounting, provided that the contract meets all the other hedge accounting criteria.

The changes are effective for public business entities for fiscal years and interim periods beginning after December 15, 2016. All other entities will adopt ASU 2016-05 for fiscal years beginning after December 15, 2017, and interim periods beginning after December 15, 2018. Early adoption is permitted. When adopted, the new guidance is applied using either a prospective or modified retrospective transition approach. Under the modified retrospective approach, an entity that reverses a dedesignation upon adoption is required to perform the assessments and measurements of effectiveness for each period for which the assessment was not previously performed as a result of the prior dedesignation.

Update 2016-06 —Derivatives and Hedging (Topic 815): Contingent Put and Call Options in Debt Instruments
The EITF identified contingent put and call options as another area where accounting could be improved. Two practices exist in GAAP related to determining whether embedded contingent put and call options in debt instruments were clearly and closely related to the host contract. The ASU clarifies and stipulates that entities assessing put or calls that accelerate the payment of the debt instrument’s principal must follow a four-step decision sequence to determine whether the option is clearly and closely related to the host contract. The four-step sequence includes determining whether the payoff of the instrument is adjusted to reflect changes in the index; the payoff is indexed to an underlying other than interest rates or credit risk; the debt involves a substantial premium or discount and the put or call option is contingently exercisable.

Public business entities adopt the ASU for fiscal years and interim periods beginning after December 15, 2016. All other entities adopt for fiscal years beginning after December 15, 2017, and interim periods beginning after December 15, 2018. Early adoption is permitted. When adopted, the new guidance is applied using a modified retrospective transition approach. Entities are provided a one-time option to elect to measure a debt instrument in its entirety at fair value when it is no longer required to bifurcate an embedded derivative upon adoption.

Open Issues

EITF Issue No.15-F Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments became a proposed ASU in early February 2016. Several elements of Topic 230 were earmarked for change including: debt prepayment; settlement of zero-coupon bonds; contingent consideration payments made after a business combination; settlement of insurance claims; settlement of corporate-owned life insurance policies; distributions received from equity method investees; beneficial interest in securitization transactions; and separately identifiable cash flows and the application of the predominance principle. Entities had until March 29, 2016, to submit their comments on the proposed ASU to the FASB. To learn more about the proposed ASU, please see Eight Changes Proposed to Accounting for Cash Flows.

Changes to restricted cash flows were originally part of EITF Issue No. 15-F. The EITF identified the definition of restricted cash, classification of changes in restricted cash and presentation of cash payments and cash receipts that directly affect restricted cash as areas that needed further guidance. In subsequent meetings, however, the EITF could not reach a consensus on the changes that needed to be made, and so it decided to break restricted cash into a separate issue, EITF Issue No. 16-A: Restricted Cash. The EITF continues to research potential solutions to the accounting issues identified.

For More Information

If you have specific comments, questions or concerns, please contact your MHM professional.

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