2020 offered an extraordinary moment in history and unfortunately, the economy is not out of the woods yet with regard to the pandemic. Both private and public companies alike have had to deal with myriad challenges to keep the lights on as well as understand how larger trends such as supply chain disruption affect the bottom line operations. On top of that, there are the more traditional matters to consider as the books close on 2020, such as adopting changes to accounting standards.
The following recaps some of the most significant factors for year end accounting.
Accounting for Financial Hardship
The disruption brought by the COVID-19 pandemic may raise questions surrounding asset impairment, discontinued operations, inventory valuation, revenue recognition, significant estimates, credit losses, subsequent events, going concern evaluations and other matters. For a look at some of these, see our earlier article on accounting related to COVID-19 here.
If your organization had changes to its debt arrangements, those changes may also have repercussions on accounting matters.
Debt Modifications and Restructurings
Troubled debt restructuring is a process that happens when a borrower who is experiencing financial hardship receives a concession from its lender. A troubled debt restructuring has not occurred when the borrower has been servicing the debt and can obtain debt from another lender at the current market rate, and the lender has agreed to restructure only to consider decreases in current market interest rates or to adjust for improvements in the borrower’s creditworthiness.
For modifications that are not troubled debt restructurings, the accounting for term debt requires a test of the change in cash flows for the debt. Generally speaking, a modification would be minor, and the borrower would apply modification accounting to the loan, if the present value of cash flows under the new terms, including fees, are less than 10% different from those of the original loan. Under modification accounting, the borrower computes a new effective interest rate that includes the existing debt issuance costs and new debt costs that are amortized over the new term of the debt.
If the change in the present value of cash flows is greater than 10%, the borrower applies extinguishment accounting and recognizes a gain or loss based on:
- The carrying amount of old debt
- Previously capitalized debt issuance costs,
- Fair value of new debt, and
- Principal repayments
For revolving debt arrangements when there has been a decrease in borrowing capacity, the borrower will write off existing capitalized debt issuance costs in proportion to the decrease, and amortize the remaining over the new term. New debt issuance costs are capitalized and amortized over the new term.
If there hasn’t been a decrease in borrowing capacity, the existing capitalized debt issuance costs are amortized over the new term, and new debt issuance costs are capitalized and amortized over the new term.
Paycheck Protection Program
This stimulus for small businesses came with significant complications as both the IRS and Small Business Administration (SBA) clarify guidance and seek to harmonize processing Paycheck Protection Program (PPP) loan forgiveness. A variety of accounting considerations will be present for organizations who sought funding though this program as most recipients will not know the status of their loan forgiveness at year end. The selection of an accounting method will determine the amount and nature of documentation that will be required to support the year-end financial statement accounting and the amount of income from PPP loan forgiveness, if any, recognized in calendar year 2020.
Despite the challenges with addressing the pandemic there were several major and many minor accounting standards that became effective for public companies in 2020.
Originally effective for all public business entities for calendar year 2020, the effective date was delayed for one year for public business entities except for those that are SEC Filers that are not smaller reporting companies (SRC). Financial institutions also received permission to delay the effective date for their filings under the CARES Act.
ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments applies to companies holding financial assets and net investment in leases that are not accounted for at fair value through net income. Therefore, the provision will not just affect financial institutions that make loans, but will also affect other forms of receivables. Companies that have accounts receivable will need to consider and implement changes required by the new guidance.
The most significant change in the accounting update is the establishment of the Current Expected Credit Loss (CECL) impairment model for loans measured at amortized cost. ASU 2016-13 also amends the credit loss model for available-for-sale debt securities.
Intangibles & Goodwill
Another accounting change that affects 2020 may make some reporting elements a little easier. A public company that is an SEC filer that is not an SRC will be required to adopt the standard in 2020. ASU 2017-04, Intangibles – Goodwill and Other (Topic 350) Simplifying the Test for Goodwill Impairment eliminates Step 2 of the traditional goodwill impairment model. Goodwill impairment is recognized when the computed fair value of the reporting entity is less than the carrying amount. The change comes at a time when goodwill impairment may be more critical to review than ever due to the disruption caused by the COVID-19 pandemic. It could help reduce costs of evaluating the goodwill for impairment for those companies that are required to adopt the standard or choose to early adopt the standard in 2020.
Reference Rate Reform
The phasing out of LIBOR and other rates commonly used in debt agreements, lease agreements, and derivatives will potentially require organizations to rewrite a large number of contracts triggering the accounting for modifications. To ease the burden of accounting for those changes the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting to provide elections to simplify the accounting for qualifying changes to such agreements. Modifications entered into between March 12, 2020 and Dec. 31, 2022 that are done solely to address the phasing out of a reference rate are eligible for elections that will greatly simplify the accounting for those changes.
Accounting for Cloud-Based Software
The proliferation of cloud-based software has caused the FASB to release an accounting standard update that helps companies track the cost of their investment. ASU 2018-15, 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 helps clarify how to account for implementation costs: by capitalizing qualifying costs in the same manner as when a company purchases a software license for internal use.
Fair Value Accounting
ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement eliminates and modifies some disclosures, which may prompt early adoption concerning changes for their upcoming third quarter and year-end financial reporting. The update:
- Eliminates required disclosures for transfers measured on a reoccurring basis between Level 1 and Level 2 of the fair value hierarchy, as well as disclosures about the processes used to measure valuations of assets and liabilities categorized at Level 3 of the fair value hierarchy.
- Modifies disclosure of timing of a liquidation of an investee’s assets in certain scenarios.
- Requires public companies to make additional disclosures about changes in unrealized gains or losses that are included in other comprehensive income for recurring Level 3 fair value measurements held at the end of reporting periods.
- Public companies will also be required to include more quantitative information about significant unobservable inputs held at the end of the reporting period, including the range that the company used to develop fair value measures, and the weighted average of those inputs.
Other Accounting Changes for Public Companies
Several other minor-impact accounting changes in 2020 also affected public companies:
- Consolidation Relief: ASU 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities address challenges with related parties when applying the consolidation guidance under the variable interest entity (VIE) model. The changes in this update will benefit investment management companies and sponsors the most, and was intended to reduce the cost and complexity of financial reporting associated with consolidation of variable interest entities.
- Collaborative Arrangements: ASU 2018-18, Collaborative Arrangements (Topic 808): Clarifying the Interaction between Topic 808 and Topic 606 helps companies that are heavily invested in research and development activities, such as biotech companies clarify how some components of the new revenue recognition standard apply to their collaborative arrangements.
- Retirement Benefits Disclosures: ASU 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans modifies the required disclosures for sponsors of defined benefit plans and other postretirement plans to make the disclosures more effective. This includes removal of certain requirements and the addition of some disclosure requirements.
- Collections: ASU 2019-03, Not-for-Profit Entities (Topic 958): Updating the Definition of Collections updates the definition of a collection is aligned with the definition used by the American Alliance of Museums Code assisting not-for-profit entities and other entities that hold collections of artwork and similar assets for public use.
- Film Costs: ASU 2019-02, Entertainment—Films—Other Assets—Film Costs (Subtopic 926-20) and Entertainment—Broadcasters—Intangibles—Goodwill And Other (Subtopic 920-350): Improvements to Accounting for Costs of Films and License Agreements for Program Materials aligns the accounting for production costs of episodic television series with the accounting for production costs of films and clarifies the accounting for impairment.
- Financial Instruments: ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments is applicable in 2020 to SEC filers that are not smaller reporting companies, ASU 2019-04 addressed several narrow scope issues related to recently issued financial instrument standards.
- Improvements to Leases: modifies the guidance in the new leasing guidance in three ways: 1) provides an expectation to determining fair value of the underlying asset by lessors that are no manufacturers or dealers, 2) clarifies that lessors that are depository and lending institutions within the scope of ASC Topic 942 Financial Services-Depository and Lending will present all principal payments received under leases within investing activities, and 3) provides an exception to requirements to provide identical disclosures for a new accounting principle when adopted for interim periods after the date of adoption.
- Share-Based Consideration Payable to a Customer: ASU 2019-08, Compensation—Stock Compensation (Topic 718) and Revenue from Contracts with Customers (Topic 606): Codification Improvements—Share-Based Consideration Payable to a Customer requires share-based payment awards granted to a customer to be accounted for by applying the guidance in ASC Topic 718, Compensation-Stock Compensation, with the amount recorded as a reduction of the transaction price measured on the basis of the grant-date fair value of the award.
The biggest news coming out of 2020 for private companies was a deferral of the leasing standard, revenue recognition, and other accounting changes. Other minor accounting standards updates are still in effect.
Leasing & Revenue Recognition
ASU 2020-05 delays the leasing standard until 2022 for private companies and non-public not-for-profit organizations, an indication of the compounding economic impact of the COVID-19 pandemic. ASC Topic 606, Revenue from Contracts with Customers, (Topic 606) was also been deferred to calendar year 2020 for companies that had not yet had financial statements available to be issued with Topic 606 applied.
Reference Rate Reform
The phasing out of LIBOR and other rates commonly used in debt agreements, lease agreements, and derivatives will potentially require organizations to rewrite a large number of contracts triggering the accounting for modifications. To ease the burden of accounting for those changes the FASB issued ASU 2020-04 to provide elections to simplify the accounting for qualifying changes to such agreements. Modifications entered into between March 12, 2020 and Dec. 31, 2022 that are done solely to address the phasing out of a reference rate are eligible for elections that will greatly simplify the accounting for those changes.
Derivatives & Hedging
Under ASU 2017-12, private companies will have more streamlined guidance for elements of derivative and hedge accounting, including an expanded number of strategies that qualify for hedge accounting, changes to the measurement of an hedged item in a fair value hedge, provisions for qualitative testing of ongoing hedge effectiveness, and elimination of requirements to separately measure and reporting of hedge ineffectiveness.
Other Accounting Changes
Several other narrow scope accounting changes also will take effect in 2020 for private companies.
- Stock Compensation: ASU 2018-07 simplifies accounting for non-employee share-based payment awards.
- Down Round Features: Under ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part Ii) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments Of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a scope Exception, an entity will recognize the value of the effect of a down round feature in an equity-classified freestanding financial instrument (that is, instruments that are not convertible instruments) when the down round feature is triggered. That effect shall be treated as a dividend and as a reduction of income available to common stockholders in basic earnings per share.
- Callable Debt Securities: ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities addressed concerns about losses recognized by a bond holder recording accounting losses when call options are exercised by issuers by modifying the amortization period for callable debt securities.
- Fair Value Disclosure: Disclosures over fair value will be easier due to a change in ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. Various disclosure requirements are eliminated for private companies as discussed above.
- Collections: ASU 2019-03 updates the definition of a collection is aligned with the definition used by the American Alliance of Museums Code assisting not-for-profit entities and other entities that hold collections of artwork and similar assets for public use.
The Road Ahead
For more information about the accounting standards changes and considerations for 2020 year ends, please contact Mark Winiarski of MHM’s Professional Standards Group or another member of our team.
Published on January 05, 2021