Reference rate reform is one of the important changes to monitor. The London Interbank Offer Rate (LIBOR) is an interest rate average at which major global banks lend to one another for short-term loans. LIBOR was originally scheduled to sunset at the end of 2021, affecting financial service groups and lenders and, more broadly, companies with debt agreements, derivatives, lease agreements or other contracts that reference LIBOR. However, the UK Financial Conduct Authority extended the cessation date for the overnight 1-, 2-, 6- and 12-month tenors of US dollar-based LIBOR to June 30, 2023. The FASB had previously issued optional relief under Topic 848 Reference Rate Reform to simplify the accounting for contracts that are modified to replace LIBOR due to the cessation of the rate and has now extended the expiration date that relief to address that the rates will be published for a longer period than originally anticipated.
Many contracts reference LIBOR, or other reference rates that are being phased out, as a primary interest rate used or in penalty provisions. In order to maintain consistent economics and functionality, many banks, lessors and companies are modifying their agreements to replace these references to LIBOR with other interest rates.
The accounting guidance that governs how companies evaluate and account for contract modifications was designed considering infrequent modifications, not broad changes to a portfolio of contracts due to a market-wide disruption such as LIBOR phase out. Thus, when a modification occurs, the revision of the agreement triggers accounting requirements for modifications, which can result in significant cost to evaluate the appropriate accounting, and may result in the recognition of gains, losses or the cessation of hedge accounting.
The FASB previously issued ASU 2020-04 and ASU 2021-01 to address operational challenges and concerns about the financial reporting impact of the modification of such a large number of contracts due to the market-wide transition. In general relief provided includes scenarios where:
- Your contract contains a reference rate that is expected to be discontinued (such as LIBOR);
- The modification to the qualifying agreement directly replaces the reference rate; and
- There are any other changes that relate to the replacement of the rate.
The general principle of the relief is that it will allow entities to modify an agreement without having to perform the normal requirement to remeasure or reassess the contract on the date of modification.
The accounting relief includes an optional expedient within derivatives and hedging guidance for contract modifications resulting from changes to interest rates for margining, discounting or contract price alignment caused by the transition from LIBOR or other reference rates that are being phased out.
With the issuance of ASU 2022-06 entities may continue to apply the expedients until Dec. 31, 2024, after which entities will no longer be permitted to apply the relief.
If your company’s contracts have a LIBOR, or other reference rate that is being phased out, find an accounting provider experienced with hedge accounting and debt extinguishments to assist, as they may be able to guide you in the use of an alternative benchmark interest rate.
Published on January 10, 2023