With net debt reaching about $3,832 billion for U.S. companies over the past year—46 percent of the total corporate debt worldwide, according to Janus Henderson Investors’ 2021 report, it would have been reasonable to assume that the FASB’s proposal to simplify the classification of debt would have been sufficiently well received to be finalized, even narrowly.
But the accounting profession was ‘ho hum’ on the changes it initially asked for, and the board had to discard two proposals and seven years of work.
A swath of accounting professionals in September said that complexity in debt classification rules just is not a high priority matter – they have bigger fish to fry.
“I don’t think that we had a big appetite for simplifications that were proposed, we just didn’t have very much feedback into changing issues we do not consider to be broken,” Moody’s Investors Service senior analyst David Gonzales said on September 9.
No One-Size-Fits-All Approach with Debt
For years, before addressing the debt classification topic, the FASB heard that the rules were complex and the board added the project via its “simplification initiative” a process a prior chair established to quickly tackle complex accounting topics.
Following its due process, the FASB sought public comment on Proposed (ASU) No. 2017-200, Debt (Topic 470): Simplifying the Classification of Debt in a Classified Balance Sheet (Current versus Noncurrent), in 2017, and then after concerns were raised revised the proposal and issued Proposed ASU (ASU) No. 2019-780, Debt (Topic 470): Simplifying the Classification of Debt in a Classified Balance Sheet (Current versus Noncurrent), in 2019.
The proposals were to simplify the determination of when debt should be classified as a current liability or a noncurrent liability in a classified balance sheet. To reduce complexity, the current guidance would have been replaced with principles-based guidance.
In April, the FASB voted by 5 to 2 to completely drop the project after reviewing all of the public comment letters the proposals generated – about 64 between the two. Ultimately, a majority of the board said the changes would not achieve the objective of the project and would replace the current cost and complexity with new cost and complexity. Board members in favor of finalizing the proposal felt it would have resulted in better information for financial statement users.
Accountants observed that debt is not a cut and dry topic.
“With debt classification, you run into a couple of issues as you really don’t have a one-size-fits-all approach,” said Michael Stevenson, Accounting & Reporting Advisory Services National Practice Leader, BDO USA LLP, on September 8.
“You have different types of debt, whether you have term loans, revolving credit agreements or something else altogether,” he said. “Where you have revolving credit agreements, you have items such as subjective acceleration clauses and lock box arrangements to be considered that can also impact classification.”
While not speaking for the FASB, said Stevenson, the FASB likely found that there is a host of different types of instruments whereby it could tackle each one of the classification issues.
“For one of those particular instruments you may arrive at an answer, but when you try to apply the same principle to a completely different instrument, that answer may be inconsistent with the first,” he said. “So, until someone actually sits back and says what the actual project should look like and what instruments should be scoped into that particular project, I think you’re always going to run into inconsistencies.”
28 Percent of Corporate Bonds Held by Non-U.S. Investors
In general, reporting issues related to debt generates a lot interest because the numbers tend to be huge.
Currently, U.S. companies owe more corporate net debt than those in Europe, the U.K., Japan, Asia Pacific, and emerging markets (i.e. China, India, and others), according to Janus’s July 2021 corporate debt index. The Index is a study into trends in company indebtedness around the world, the investment opportunities this provides and the risks it presents.
And a study by data company Statista states that in 2018, around 28 percent of U.S. corporate bonds was held by non-U.S. investors; a very similar number to the 27 percent of corporate bonds held by non-U.S. investors in 2007.
The FASB has not closed the door on the debt topic because its June Invitation to Comment (ITC) No. 2021-004, Agenda Consultation, says the board is seeking feedback on whether it should prioritize a project on current and noncurrent classification of assets and/or liabilities in a classified balance sheet.
The project would fall under simplifications to get rid of complexity in U.S. GAAP. Comments on the ITC are due by September 22.
In a September 13 letter in response to the ITC, the AICPA’s Technical Issues Committee (TIC) said it “does not believe that there are significant issues with application of existing guidance related to balance sheet classifications,” and suggested the board “evaluate research and feedback from the balance sheet classification of debt project which was removed.”
TIC would support targeted improvements of existing guidance to better reflect how certain debt agreements operate in practice.
Specifically, TIC suggested that the board “consider modifying the guidance when debt agreements include material adverse change (MAC) and subjective acceleration clauses (SAC),” as the panel found “these clauses are rarely, if ever, enforced by the lender.”
Similarly, accountants said they would be interested in other subject matters such as debt arrangements settled in equity.
“We have seen a lot of our clients that are early-stage companies enter into arrangements that are not traditional financing arrangements, and that may be settled in equity versus cash,” Ryan Brady, partner at Grant Thornton LLP said on September 8. “It might be a loan arrangement that’s settled in a variable number of the borrower’s stock if and when the borrower completes another equity raise,” he said. “These bring up some interesting accounting questions. ”
One threshold question is what codification topic applies to the arrangement, Brady said. There is ASC 470, Debt, which deals with traditional debt arrangements and then there is ASC 480, Distinguishing Liabilities from Equity, which deals with instruments that are potentially settled in the entity’s stock. “The question is what topic do share settled loans belong in – is it 470 or 480?”
Another area companies are running into is debt arrangements that have various features embedded in them that might acquire separate accounting from the debt arrangement itself.
“And if these share settled debt arrangements I mentioned earlier are accounted for under ASC 470 – they often have features embedded within them that need to be pulled out and accounted for separately,” said Brady. “The process of assessing embedded features can be complex,” he said. “The more creative people get with how they structure these arrangements the more complicated the accounting gets.”