Several of the FASB’s significant accounting standards take effect for the first time this year for businesses, including new rules for reporting life and annuities insurance contracts which took the board more than a decade to create.
The rules come into effect at a time of economic speculation about inflation, recession, interest rates and the Ukraine situation, among other issues, accountants said.
Especially key is Accounting Standards Update (ASU) No. 2018-12, Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts, which large public insurance companies have to adopt starting Jan. 1, 2023. The standard was issued in 2018 but the effective date was deferred twice.
“This is a completely wholesale system software change,” Michael Monahan, Senior Director of Accounting Policy for the American Council of Life Insurer’s (ACLI), said on Jan. 5. “The old systems were siloed and they didn’t talk to each other; the new system – and it’s all new; it’s a brand new chassis and the systems are integrated – they talk to each other,” he said. “It’s a huge benefit for everybody involved.”
Companies should expect the initial cost to be expensive, Monahan said. “I did hear from a lot of people it was very expensive.”
A major effort was made to educate not only financial statement preparers but investors in the insurance sector. “We were signaling to investors and other users of financial statements where we were heading and what they should expect and what do we think that the impact’s going to be,” Monahan explained. “So that mitigates the surprises because in the last couple of quarters we’ve been telling them ‘this is coming, this is coming – it’s here’ and as we get closer and closer to the implementation date you get finer and finer data.”
Some of the issues that companies will need to pay close attention to include areas in the standard around how to create market risk benefits when a company has benefits that move as the market moves, and in relation to liability per policy benefit.
“Working with the experts, we were able to get those huge issues into a manageable place. Was it perfect? No. Is it workable? Yes,” said Monahan. “The last thing that we did, we spent at least a year on this – were disclosures because that’s where the investors get their information,” he said. “We worked on a forum where companies can bring their ideas or their challenges because at the end of the day if every company does something differently to get to the same information, that’s not helpful to investors.”
He noted that since private companies do not have to implement the rules until 2025, they have a great opportunity to learn from large filers this year.
Four Other Accounting Rules to Hit
Outside of the insurance sector, others in the accounting profession flagged four other ASUs that take effect this year, offering the following insights:
- ASU No. 2022-04, Liabilities–Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations. This standard is a disclosure-only standard, focused on entity agreements with finance providers to settle its obligation with a supplier. Financial statement users will be provided with better information about the nature of the arrangement, the activity during the period and the potential magnitude of the program on the company’s operations. One challenge for companies might be ensuring that their controls are operating at the right level of precision to capture the new information – particularly the quantitative information, Angie Storm, a partner in KPMG LLP’s professional practice group, said on Jan. 6. Another relates to the idea that companies that engage in supplier finance programs may do so with lots of different intermediaries and thus “there may be a question about how much disaggregation or aggregation to do in the footnote,” she said. “There’s going to be some judgment there on just the presentation of the disclosure.” Also notable is the scope of the guidance. “There are some indicators in the standard as to what’s in scope because that could be tricky depending on the individual details of the contract,” said Storm. “So I think companies will be spending some time thinking through whether their arrangement meet those indicators.”
- ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers. The guidance is important for companies involved in acquisitions, accountants said. The standard requires companies to measure contract assets and liabilities acquired in a business combination as if they had originated the contract. That is a departure from the current requirement where companies measured those contract assets and liabilities at fair value. “And it’s a pretty big change because what is happening today with the current requirement is that when companies are fair valuing those contract assets or liabilities, they’re typically doing a very complex calculation that results in a fair value hair cut because of the discounting,” said KPMG’s Storm. “And so if a company acquires a contract liability for $100 worth of services it then has to provide, then the fair value of that $100 is likely less because that money will be coming in over time and the services will be performed over time,” she said. The standard can impact revenues in a good way. “Post-acquisition revenue figures will increase,” Storm explained. “What we’ve been hearing is this is being received pretty positively in terms of the effects and providing more transparent and more intuitive results in the revenue line.”
- ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was already adopted by public companies but takes effect on Jan. 1 this year for private companies. Essentially, any private company that has receivables (e.g., trade A/R, notes receivables), investments in held-to-maturity debt securities, or contract assets will have to apply ASC 326 this year. “The biggest thing is forecast,” Mike Lundberg, National Director of Financial Institutions and Partner at RSM US LLP, said. “The foundational change with CECL is we’re going from under the old incurred model we were looking at current conditions and under CECL we’re making forecasts of future conditions,” he said. “In times of instability or uncertainty it’s likely that we’re going to be looking to shorten that forecast period.” Companies should be mindful of the importance of disclosure of the methodology and the approach so that investors can make informed comparisons. “If you’re looking at two entities and one has a higher reserve than the other, you’d want to understand why,” said Lundberg. The impact of inflation is also something that companies should look at. “In the U.S., most of the accountants have not worked in an inflationary environment,” he said. “So that’s something that’s going to have an impact on credit quality that we maybe didn’t have built into the initial models.”
- ASU No. 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging—Portfolio Layer Method. It enables financial institutions to create macro level portfolios of assets of a mixture of prepayable, nonprepayable type instruments into one large portfolio and then place hedges against those over time or all at the same time to fit with their interest rate hedging needs. “This is a strategy that would be used by institutions that are liability sensitive – they want to protect themselves against rising interest rates and they’re in a position where their liabilities price faster than their assets,” Eri Panoti, a managing director at Chatham Financial, said. Entities should also pay attention to the rule’s transition requirements, Panoti said. The new guidance prohibits allocation of the basis adjustment while an entity is in an active hedging relationship, which means that institutions do not have the ability to allocate to the individual assets. “So think of a closed portfolio of fixed rate loans. They cannot allocate gains and losses associated with the hedge to the individual loans while the hedge is active,” she said. Once the hedge is no longer active whether it’s electively dedesignated or terminated or just fails hedge accounting, then at that point institutions have the ability to allocate that lifetime gain or loss and amortize it through earnings. “So that’s the biggest change in terms of the accounting impact and that would require – for institutions that were doing that – an adjustment now that the guidance is effective.” The standard also bridged the gap between hedge accounting and the CECL standard to clarify that an entity is prohibited from including hedge accounting impact in the credit loss calculations. Also notable is that it provides a one-time ability to transfer securities from held-to maturity (HTM) to available-for-sale (AFS). “The caveat here is that it needs to be done in the first 30 days which means that they would have those assets once they get moved from held to maturity and available for sale, they have to be part of a hedge within 30 days of transfer,” Panoti said. “So that’s something to keep in mind.”
Special Mention: Leases and Pension Disclosures
Accountants mentioned two other standards – lease accounting and pension disclosures – as worth highlighting. Though ASC 842, Leases, officially took effect in 2022 for private companies, many will actually really adopt this year, Adam Brown, national managing partner, accounting and auditing at BDO, said. “There was a lot of optimism and denial in the system around ‘this will be delayed; this will deferred’ and so at least in some places private companies have not done a lot of implementation of the leasing standard yet,” he said.
Similarly, ASU 2018-14, Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans, was issued in 2018 but private companies had to adopt in 2022 and many will do so this year. The new disclosures provide the weighted average interest crediting rate for cash balance plans which is simply the amount of interest being earned. An entity would also disclose the reasons behind any significant gains or losses related to changes in a benefit obligation of a pension plan. “The standard was finalized several years ago,” said Brown. “We’ve got interest rate movements now, so I can envision disclosures about the Fed rates changing and impacting some of these disclosures.”
This article originally appeared in the January 18, 2023 edition of Accounting & Compliance Alert, available on Checkpoint.
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