PCC picks four issues for possible FASB updates

An advisory body for the Financial Accounting Standards Board (FASB) has chosen four key business accounting rules to scrutinize and determine whether relief measures or other changes are needed.

The Private Company Council (PCC) and its 12-member board, which advises the FASB on accounting issues faced by private companies, compiled a list of 16 topics that stood out after its annual survey of private company stakeholders earlier this year. In April, it agreed to research four of the most critical areas and determine whether action is needed by the FASB. PCC members also considered whether these issues have an identifiable scope and whether technically feasible solutions are achievable before the end of 2025.

PCC Chair Jere Shawver said the group will have its opinions ready to present to the FASB in 12-18 months.

The four topics being studies are:

1. Credit losses: Short-term trade receivables and contract assets

Accounting Standards Update (ASU) No. 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, requires an entity to estimate an allowance for credit losses (ACL) on financial assets based on current expected credit losses (CECL) at each reporting date. Under prior accounting rules, a credit loss wasn’t recognized until it was probable the loss had been incurred, regardless of whether an expectation of credit loss existed beforehand.

Under CECL methodology, the initial ACL is a measurement of total expected credit losses over the asset’s contractual life. The estimate is based on historical information, current conditions, and reasonable and supportable forecasts. The ACL is remeasured at each reporting period and is presented as a contra-asset account. The net amount reported on the balance sheet equals the amount expected to be collected.

The updated guidance was designed to be scalable for entities of all sizes. While banks and other financial institutions tend to hold more financial assets within the scope of CECL, nonfinancial entities with financial instruments, such as trade accounts receivables and contract assets, also must apply the CECL model.

Many private companies question whether the benefits of applying CECL to these assets justify the costs. For example, trade receivables are generally short term, and the amount collectible is rarely affected by macroeconomic conditions or the time value of money decay.

The PCC is considering a private company practical expedient or alternative to the application of CECL to short-term trade receivables and contract assets. One possible solution would be to allow the use of historical cost to estimate credit losses, without the evaluation of reasonable and supportable forecasts.

2. Debt modifications and extinguishments

During its September and December 2023 meetings, the PCC discussed the accounting and reporting requirements of Accounting Standards Codification (ASC) Subtopic 470-50, Debt — Modifications and Extinguishments. During those meetings, some PCC members said that applying the guidance in Subtopic 470-50 can be complex and costly when transactions involve multiple lenders. They also questioned whether the benefits of the different reporting outcomes justify the costs. This was identified as a particularly pressing concern as rising interest rates are causing many companies to renegotiate their debt terms.

Under the existing guidance, companies must assess whether a modification or extinguishment of debt has occurred when an entity either modifies the terms of an existing debt instrument or issues a new debt instrument and concurrently satisfies an existing debt instrument.

The assessment is based on a comparison of two factors:

• The present value of the cash flows from the terms of the new debt instrument
• The present value of the remaining cash flows from the original debt instrument on a lender-by-lender basis

If the difference is greater than 10%, the transaction is accounted for as an extinguishment of the original debt instrument. When debt is extinguished, the original debt is derecognized and a gain or loss equal to the difference between the carrying amount of the original debt and the fair value of the new debt is recognized. Any new fees paid to, or received from, lenders are expensed, and any new fees paid to third parties are capitalized and amortized as debt issuance costs.

If the difference in the present value of the cash flows is less than 10%, the transaction is accounted for as a modification of the original debt. When debt is modified, no gain or loss is recognized, and any new fees paid to, or received from, the existing lender are capitalized and amortized.

The PCC is considering a private company alternative to simplify the guidance. For example, some PCC members have suggested allowing private companies to bypass the required assessment and account for the transaction as a debt extinguishment. Additionally, some members have questioned whether it’s necessary to have different guidance for term debt and line-of-credit or revolving-debt arrangements when evaluating debt modifications and extinguishments.

3. Lease accounting

In 2016, the FASB issued updated guidance that requires companies to report on their balance sheets their leased assets (such as office space, vehicles, and equipment) and the rent they pay for them as liabilities. It also calls for detailed disclosures about the terms and assumptions used to estimate lease obligations, including information about variable lease payments, options to renew and terminate leases, and options to purchase leased assets. The rules took effect in 2019 for public companies and 2022 for private entities.

In some cases, deciding whether to report leases on the balance sheet requires complex judgment calls. Management must review data not just from rental agreements for real estate and equipment, but also from service arrangements and third-party outsourcing contracts. Plus, certain areas of guidance in ASC Topic 842, Leases, can be costly and complex to apply.

After evaluating PCC concerns, the FASB issued ASU No. 2021-09, Leases (Topic 842): Discount Rate for Lessees That Are Not Public Business Entities. The update allows private companies to elect to use the risk-free rate, as opposed to an incremental borrowing rate, at an underlying asset class level rather than having to elect it for their entire portfolio of leases.

The PCC is now considering whether additional practical expedients or alternatives for private companies should be considered. One area of particular concern is lease modifications.

4. Retainage and overbillings as contract assets and liabilities

Under ASC Topic 606, Revenue from Contracts with Customers, when either party has performed work on a long-term contract, the entity must present the contract on the balance sheet as a contract asset or a contract liability, depending on the relationship between the entity’s performance and the customer’s payment. Any unconditional rights to consideration are reported separately as a receivable.

Some private company stakeholders noted that Topic 606 changes the presentation of retainage in the construction industry and results in diversity in practice. Retainage is a construction industry concept, rather than a GAAP concept. It generally refers to a portion of consideration held back by the customer until project completion. For example, a company may invoice a customer 100% of the fee, but the customer holds back, say, 5% until a later date. In practice, companies could appropriately classify retainage as a receivable or a contract asset — or it could be allocated between the two, depending on the terms under which the right to consideration is conditional.

Before the adoption of Topic 606, companies presented conditional retainage separately from billings in excess of costs. Under Topic 606, conditional retainage is required to be netted with related contract liabilities on the balance sheet. Some stakeholders have suggested two possible alternatives for construction companies:

1. Grossing up the balance sheet, rather than netting the contract assets and contract liabilities
2. Providing additional disclosures about conditional retainage and billings in excess of costs

The PCC is considering whether these options could provide better transparency about retainage for companies in the construction industry.

PCC abandons study of share-based payment transactions

After two years of study, the PCC decided to remove the issue of stock compensation disclosures from its agenda. The PCC had discussed aspects of the guidance in Accounting Standards Codification Topic 718, Compensation — Stock Compensation, since 2014. It formed a working group in 2022 to discuss stock compensation disclosures for private companies in greater depth.

However, feedback from practitioners indicated that companies with share-based payment transactions are largely owned by private equity firms or are venture capital-backed start-ups. Because stock compensation disclosure issues aren’t broadly pervasive for private companies, PCC members agreed to focus on other topics identified by private companies.

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