4 Major Accounting Rules Changes on the 2018 Horizon-New SEC & GAAP Financial Reporting Taxonomies

New SEC & GAAP Financial Reporting Taxonomies Released

Since 2014, the Financial Accounting Standards Board (FASB) has elected to include four very impactful and critical updates to U.S. Generally Accepted Accounting Principles (GAAP.)  These sweeping alterations, which will be triggered and subsequently implemented over the following few years, on top of massive legislative plans embedded in a now officially reformed tax code and a Trump administration’s push for a reduction in regulations of the federal sort, have created an unpredictable environment for CFOs, finance leaders and controllers.

In late December 2017, the 2018 GAAP Financial Reporting Taxonomy, which includes updates for accounting standards, and a mirage of other suggested improvements, was announced by the FASB.  The announcement was accompanied by a copy of the 2018 GAAP Financial Reporting Taxonomy. FASB also introduced and distributed what is now known as the 2018 SEC Reporting Taxonomy (SRT). The SRT is a brand new set of principles and guidelines for 2018.

In order to meet SEC policy and standards, the SRT elaborates on required financial documents that are necessary, such as:

  • Financial schedules
  • Disclosures surrounding oil- and gas-product activities
  • Condensed financial data required from guarantors
  • Three-dimensional data regarding measurement and GAAP guidelines which are not specifically mandated to be included, but ordinarily are included by GAAP filers

Both  2018 Taxonomies are set to be accepted as put into law by the SEC in early 2018.

Based in Norwalk, Connecticut and established in 1973 and overseen by the Financial Accounting Foundation (FAF), the FASB is the independently operated private-sector and non-profit organization, which establishes and develops the financial accounting and reporting standards for private companies, public companies, and not-for-profit organizations, designated by the SEC to enforce GAAP.  FASB standards are developed and implemented in an inclusive and transparent manner. Deemed as authoritative by many organizations, FASB standards incorporate those standards also recognized by the American Institute of CPAs (AICPA) state Boards of Accountancy.  

In 2010, the FAF, and subsequently the FASB, assumed the responsibility of the maintenance and development for US GAAP Financial Reporting, otherwise known as Taxonomy.  Prior to 2010, the SEC was the organization to issue laws with respect to the preparation of financial statements and paperwork in accordance with U.S. GAAP.  The phasing in of Taxonomy for 2010 was also on the SEC’s agenda.  Probably the most important FAF and FASB  current responsibility is updating Taxonomies according to alterations in US GAAP.  

Critical Changes Included in Taxonomies for 2018

Four major policy updates have been identified an outlined in the 2018 GAAP Financial Reporting Taxonomy and 2018 SEC Reporting Taxonomy.  They are the:

  1. Non-profit Standard
  2. Revenue Recognition Standard
  3. Lease Standard
  4. Credit Loss Standard

Keep in mind that every standard has a different implementation date, and even those dates will be staggered.  Also keep in mind that the impact of each standard will have a different impact, and that not every change will necessarily affect every entity.  Impact is largely contingent on organizational specifics and the nature of a business organization.   What follows is a detailed summary of the four areas that are changing, when those respective changes must be implemented by and how financial statement reporting will be affected. 

FASB releases proposed 2018 reporting taxonomies#1: Not-for-profit Standard

Accounting Standards Update (ASU) No. 2016-14, Not-for-Profit Entities (Topic 958): Presentation of Financial Statements of Not-for-Profit Entities

Effective Date:

Required for annual financial statements in 2018, and one year after for interim periods. Early adoption is allowed.  

Applying to an extremely large group of companies, a variety of organizations, such as educational foundations and charities, along with religious and trade-related non-profits, the most pertinent and relevant change regarding in this area include:

    • A shift to two from three asset classes.  Those two asset classes are fairly straightforward; these two new classes are: 1) net assets without donor restrictions and 2) net assets with donor restrictions.  
    • Important financial statement changes.  The calculation, methodology and process for reporting cash flow, liquidity and financial performance has been revamped.
    • Disclosure presentation requirements.  More rigid and strict regulation of a company’s easily accessible cash will be the result of a of this change, as the reporting of data must be presented it two different ways:
  1. A narrative describing how funds to support daily needs are generated by the reporting entity, according to a company’s policy.
  2. Details of the numerical sort which provide insight into available liquid assets that will be used to afford basic expenses- all within one year of a balance sheet’s date.

Flexibility is permitted by the FASB when it comes to the procedure by which entities disclose the numerical data, assuming the methods are applied consistently and filed transparently.  Organizations, a top-level university being an example, might organize and deliver data in charts or tables, whereas smaller organizations sometimes only provide and report simple lines.  Also included in the update is the requirement to present an elaborate analysis of a company’s earnings according to nature and function.  For example, a majority of companies will be asked to separate expenses by employees and benefits.  Under the revised standard, most organizations will have to break out expenses at least by salaries and benefits for employees. Others will have separate line items for expenses for different programs or for employee travel.

When it comes to the presentation of the cash flow statement, the updated provision also gives non-profits more moving room when deciding between which cash flow method should be used: indirect or direct.  The standard no longer requires a business to reconcile the two reporting methods, very few entities have plans to use the less popular direct method.

Also, when the fair value of an endowment goes under the original endowed gift amount, the update mandates businesses to identify and classify these “underwater” endowments as net assets combined with donor restrictions, in addition to providing expanded disclosures about the dollar amount that’s underwater and how the company intends to address the shortcomings. As it stands currently, endowments that are considered underwater are labeled as unrestricted net assets.

#2: Revenue Recognition Standard

Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers

Effective Date:

Applicable to public companies beginning in 2018. Applicable to private companies and their annual statements in 2019. Applicable to private companies and their quarterly statements in 2020. Private entities have the option to adopt these changes in 2018.

The timing of revenue recognition is the focus of this standard. Predicted to have a large impact on organizations such as telecommunication providers, construction contractors, software companies, media companies, manufacturers, distributors and asset managers, the updated standard will also have a moderate effect on additional industries such as banking, insurance and healthcare.

Basically, the updated standard exchanges around 80 industry-specific revenue recognition laws with a single basic principle: entities must recognize revenue in order to depict the transfer of promised goods or services to clients and customers using an amount that accurately depicts the corresponding payment to which it is entitled.  A five-step method, when reporting such revenue, should be followed:

  1. Identification of the customer to a contract.
  2. Identification of the organization’s performance obligations/promises according to the contract.
  3. Determination of the transaction cost (taking into consideration any effects of variable payment or critical financing components).
  4. Allocation of the transaction cost to the performance promises in the contract.
  5. Recognition of the revenue when performance promises are reached.

Currently, the recognition of revenue is based on an “all events” test- this has not changed.  For some organizations though, this seemingly minor discrepancy could result in temporary tax-to-book differences. The IRS has been conducting research on this issue so it can decide whether, as businesses implement this new accounting standard, those businesses should automatically be permitted to use their book method of accounting for tax purposes.

The implementation of ASU 2014-09 may leave some companies bewildered as they may not notice any change to the top line of their income statements.  However, nearly all companies will be impacted by the standard’s broader disclosure requirements, which includes information about the timing, amount, nature and general uncertainty of revenue that’s recognized.

#3: Lease Standard

Accounting Standards Update (ASU) No. 2016-02, Leases

Effective Date:

Applicable to public companies in 2019.  Applicable to non-profit and private entities in 2019, with a deadline of 2020 to implement changes to respective interim reports.  Election to implement the lease standard early is possible.

New lease regulations are predicted to contribute over $1.2 trillion to off-balance sheet leases of public companies.  Current practice dictates that a majority of lease obligations, particularly those for real estate, equipment or vehicles, do not seem to impact the balance sheet.  This is because leases in those industries are considered to be operating costs and are summed up and reported on an entity’s income statement, with rent expense being disclosed in corresponding notes.

Leases with terms of more than 12 months will, according to the new standard, require right-to-use assets to be included in a company’s balance sheet section and any corresponding liabilities be listed at their present value.  It is speculated that the implementation of these changes could make lessees look far more leveraged, which would cause any businesses that were unprepared for this new standard to be in violation of their loan covenants.  

The way leases are classified by the revised and updated standard will affect measurements, recognition and presentations of cash flows and expenses.  A lease can be an operating lease or a capital lease.

Lessees with capital leases will amortize their right-to-use assets independently from interest related to leases on liability statements depicting comprehensive income.  Any repayments of a lease liability will be identified within financing activities, and any respective payments of interest on lease liabilities and variable payments will be reported on within operating activities, as far as a cash flow statement is concerned.  

Lessees with operating leases will have single total lease costs allocated over the term of the lease using the straight-line basis.  The operating activities within the statement of cash flows will include cash payments made on a lease.

In addition, the updated lease reporting guidelines make additional disclosures, all of which are intended to assist viewers of financial statements to have a more clear understanding of timing, amount and uncertainty concerning cash flow related to leases, required.  Also required is the disclosure of quantitative and qualitative requirements surrounding choices to terminate or renew a lease, as well as additional data about variable lease payments.  

The lease update standard continues as it requires that some leases, which are on the lengthy side because they include contracts with third-party manufacturers or service contracts, be mentioned.  This is difficult because it requires management to assess quite complex transactions with subjective judgments.  

#4: Credit Loss Standard

Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses: Measurement of Credit Losses on Financial Instruments

Effective Date:

CECL model is applicable to public companies by 2020.  Applicable to private entities by 2021. Election for application is available for all companies in 2019.

Narrow in scope, this standard is primarily aimed at companies which offer financing options to clients, such as credit unions and banks. Looking past traditional loans, the updated standard will impact such assets as net investment in leases, debt securities, trade receivables, reinsurance receivables and off-balance-sheet credit exposures.  Currently, GAAP requires entities to disclose amortized credit loss costs using a specific model, the “incurred loss” model.  This model postpones recognition of a loss to a date when it is likely that a loss has actually been incurred by a financial institution.

The revised standard uses a currently expected credit loss (CECL) model which mandates the immediate recording of the full amount of expected credit losses contained in a financial institution’s anticipated credit losses in their loan portfolios, rather than waiting until the losses qualify as “probable.” Using the CECL model to will produce more timely and relevant information, according to the FASB.  

Moreover, the updated standard does not mandate a particular method for the estimation of credit losses; instead, it permits businesses to use judgment when determining the rationale that’s appropriate for their circumstances. The standard’s updated guidance allows entities to continue the use of many loss estimation techniques already being employed, such as probability of default methods, loss rate methods, discounted cash flow methods and aging schedules. The input figures to those methods will, however, be altered to account for the entire amount of anticipated credit losses.

Conclusion

As organizations have begun to start implementing these updated standards, they are noticing that they must employ far more resources than management teams anticipated.  Going back in time and modifying the ways a company collects data and modifies it for reporting can be very cumbersome.  Begin the standards’ implementation processes and avoid headaches by contacting Thomas Huckabee, CPA in San Diego, California.  Our office will help your business understand and assist your business putting the new standards in place. Please contact us for further information.  

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