Standard setters have been relatively inactive this year. The Financial Accounting Standards Board (FASB) has issued only two new Accounting Standard Updates (ASUs) and the Government Accounting Standards Board (GASB) has not issued any new GASB Statements in 2023. The latest issue of the Rundown features a summary of the new standards issued 2023. Continue reading to learn more about summaries of the standards issued in the first two quarters and our practice insights. In addition, we’ve got a comprehensive listing of all standards newly effective for calendar year-end December 31, 2023 for public business entities, private entities and for June 30th and December 31st year-end governments. Lastly, we’ve included some practice insights we’ve obtained assisting clients with CECL implementation.
2023 Newly Issued Standards
Leases (Topic 842): Common Control Arrangements
Terms and Conditions to Be Considered
Background
Under the old lease standard (ASC 840), entities were required to classify and account for a lease based on economic substance, which is not necessarily the same as the written terms, especially when there is a related party relationship between the lessee and lessor. Under the new lease standard (ASC 842), entities are required to classify and account for leases based on legally enforceable terms and conditions, which could be written or oral. Stakeholders observed that determining the legally enforceable terms and conditions of a common control arrangement can be difficult and costly because often the terms are not written, have expired, or do not reflect an arms-length transaction. Many stakeholders believed that determining the legally enforceable terms and conditions for those arrangements could necessitate obtaining a formal legal opinion, which would be overly burdensome.
Changes
The amendments to this Update provide a practical expedient for private companies to use only the written terms and conditions of a common control arrangement when determining whether a lease exists and, if so, the classification and accounting for that lease. If no written terms and conditions exist and if the entity has not documented the existing unwritten terms and conditions upon adoption of ASC 842 or lease commencement, then an entity is prohibited from applying the practical expedient and must evaluate the legally enforceable terms and conditions, which may include unwritten terms and conditions.
The terms and conditions practical expedient may be applied on an arrangement-by-arrangement basis.
The terms and conditions practical expedient is available to entities that are not:
- Public business entities,
- Not-for-profit conduit bond obligors,
- Employee benefit plans that file or furnish financial statements with or to the U.S. Securities and Exchange Commission (SEC).
Entities adopting the terms and conditions practical expedient concurrently with adopting the new lease standard are required to follow the same transition requirements used to apply Topic 842. All other entities are required to apply the terms and conditions practical expedient either:
- Prospectively to arrangements that commence or are modified on or after the date that the entity first applies the practical expedient, or
- Retrospectively to the beginning of the period in which the entity first applied Topic 842 for arrangements that exist at the date of adoption of the practical expedient.
Accounting for Leasehold Improvements
Background
In addition to the above changes, the Update also amended how leasehold improvements under common control leases are amortized. Both the old and new lease standards generally require leasehold improvements to be amortized over the shorter of the remaining lease term or the useful life of the improvements. Stakeholders noted that often leases under common control are short-term (e.g., month-to-month) and amortizing leasehold improvements over a period shorter than the expected useful life of the leasehold improvements may result in financial reporting that does not faithfully represent the economics of those leasehold improvements.
Changes
The amendments in this Update require that leasehold improvements associated with common control leases be:
- Amortized over the useful life of the leasehold improvements (regardless of the lease term). However, if the lessor obtained the right to control the use of the underlying asset through a lease with another entity not within the common control group, the amortization period may not exceed the life of the lease with the other party not within the common control group.
- Accounted for as a transfer between entities under common control through an adjustment to equity if, and when, the lessee no longer controls the use of the underlying asset.
The leasehold improvement changes are effective for all entities and all leases under common control.
Effective Dates
Both the terms and conditions practical expedient and the changes to leasehold improvements are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted for both interim and annual financial statements that have not yet been made available for issuance. If an entity adopts the amendments in an interim period, it must adopt them as of the beginning of the fiscal year that includes that interim period.
Practice Insights
Early Adoption
Most private entities with common control leases will want to adopt this Update because it will simplify the accounting and reduce cost.
Common Control vs. Common Ownership
Common control is not the same as common ownership. This is a common oversight that has caused problems with other standards that are dependent upon common control, such as accounting for variable interest entities under common control. Common control requires that all entities under the common control umbrella are controlled by a single shareholder, which includes any holdings by their immediate family members, or controlled by a group of shareholders who have written agreement to vote in concert. On the other hand, common ownership exists when two or more entities have the same or similar shareholders but no one shareholder controls the entities.
It’s important to note that ASU 2023-01 is only applicable to common control relationships. If a lessee and lessor are not controlled by a common individual or entity, then the Update cannot be applied.
Month-to-Month or “Evergreen” Leases
One of the most common difficulties when applying the new lease standard is how to apply the standard to month-to-month or “evergreen” leases. The determination of the lease term for month-to-month or “evergreen” leases will depend on what termination or renewal periods are legally enforceable as follows:
| Period | Impact on Lease Term |
| Either party can terminate or choose not to renew | There are no longer any legally enforceable rights and obligations when both the lessee and the lessor each have the right to terminate or not renew the lease without permission from the other party and with no significant penalty. Therefore, these periods are not within the scope of ASC 842 and should not be included in the lease term. |
| Only the lessee can terminate or choose not to renew | Legally enforceable rights and obligations exists and the lessee should consider if these periods are “reasonably certain” (generally considered > 75% likely) to be exercised. If so, then these periods should be included in the lease term. |
| Only the lessor can terminate or choose not to renew | Legally enforceable rights and obligations exists and there is a rebuttable presumption that options to renew that are in control of the lessor. |
Notice Provisions
A minimum notice requirement is effectively a noncancelable period. For example, if the lease requires a 90-day notice period to terminate, then that lease creates legally enforceable rights and obligations during the 90-day notice period and effectively there would be an enforceable term on a rolling 90-day basis.
Month-to-Month Leases and Change in Estimate
What happens if the original/previously estimated lease term for a month-to-month lease turns out to be incorrect? For example, what happens if the lessee originally believed that a month-to-month lease would only be renewed for nine months (i.e. met the short-term lease exception), but decides during the ninth month that it will be renewed for an additional nine months (i.e. 18 months in total). If a lessee has determined that the lease term originally/previously estimated should be extended, only the remaining lease term (which includes renewals that were previously not included in the lease term but are now “reasonably certain” of exercise) should be considered. In this example, although the total lease term from the original commencement date is now 18 months, because the remaining lease term is only nine months, the lease would still qualify for the short-term lease exception. In the basis for conclusion paragraphs, the FASB noted that application of the short-term lease exception could result in, “a lease that ultimately extends for 10 years or more could be structured as a 1-year lease with a series of 1-year renewal options, which could result in the lease never being recognized on a lessee’s statement of financial position.”
Importance of Frequently Writing and Updating Agreements or Documentation
The terms and conditions practical expedient in ASU 2023-01 require the lease terms to be written or, if unwritten, the terms and conditions should be contemporaneously documented upon adoption of ASC 842 or the lease commencement, if later. If a “month-to-month” lease expires, an entity would find that written terms no longer exist and, therefore, the lease would be disqualified from the practical expedient. However, if the lease is written and renewal clauses are added to avoid the aforementioned consequences, then the lessee must determine what renewal periods are “reasonably certain” of exercise and that could disqualify the entity from the short-term lease exception. Therefore, to both apply the terms and conditions practical expedient and maintain the short-term lease exception, the private company would need to regularly maintain written leases without renewal options controlled by the lessee that could cause the lease term to exceed one year. Accordingly, entities will need to remember to enter a new lease upon each expiration date.
Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method
Background
ASU 2014-01, Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects, introduced the option to apply the proportional amortization method to account for investments in low-income-housing tax credit (LIHTC) structures. If the proportional amortization method is not used, then ASC 323-740 provides specialized accounting.
The LIHTC provides a tax incentive to construct or rehabilitate affordable rental housing for low-income households. The federal government issues tax credits to state and territorial governments. State housing agencies then award the credits to private developers of affordable rental housing projects. Developers generally sell the credits to private investors to obtain funding. Once the housing project is placed in service, investors can claim the LIHTC over a 10-year period. Investments in LIHTC entities for the purpose of receiving the tax credit are economically different than typical equity investments and thus the impetus for ASU 2014-01.
The proportional amortization method results in the cost of the investment being amortized in proportion to the income tax credits and other tax benefits received, with the amortization being presented net in the income statement as a component of income tax expense (benefit). Whereas typical equity investments are accounted for at fair value or, if “significant influence” is achieved, under the equity method, whereby the cost of the investment is adjusted based on the investor’s portion of income or loss of the investee. Stakeholders asserted that other investments, besides those in LIHTC entities, are economically similar because they are made primarily for the purpose of receiving income tax credits and other tax benefits and therefore should have the same election as LIHTC investors to account for those investments using the proportional amortization method.
Changes
The amendments in this Update expand the use of the proportional amortization method and permits investors to apply the proportional amortization method to all equity investments in which substantially all of the projected benefits are from income tax credits and other tax benefits, regardless of the tax credit program. In addition, the Update removes the specialized guidance for LIHTC investments that are not accounted for using the proportional amortization method.
To qualify for the proportional amortization method, all of the following conditions must be met:
- It is probable that the income tax credits allocable to the equity investor will be available.
- The equity investor does not have the ability to exercise significant influence over the operating and financial policies of the underlying project.
- Substantially all of the projected benefits are from income tax credits and other income tax benefits.
- The equity investor’s projected yield based solely on the cash flows from the income tax credits and other income tax benefits is positive.
- The equity investor is a limited liability investor.
The accounting policy election to apply the proportional amortization method should be applied on a tax credit program by tax credit program basis. A reporting entity that applies the proportional amortization method must account for the receipt of the investment tax credits using the flow-through method under Topic 740, Income Taxes.
The Update also provides specific disclosure requirements including the nature of the tax equity investments and the effect on the financial position and result of operations.
Effective Dates
For public entities, the Update is effective for fiscal years, including interim periods within, beginning after Dec. 15, 2023. For all other entities the Update is effective for fiscal years, including interim periods within, beginning after Dec. 15, 2024. Early adoption is permitted and the amendments are applied either on a modified retrospective or retrospective basis.
List of Newly Effective Standards
Calendar Year-end Public Companies
The following ASUs are effective for public companies for calendar year 2023:
- ASU 2016-13: Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
- ASU 2017-04: Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
- ASU 2018-12: Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts
- ASU 2018-19: Codification Improvements to Topic 326, Financial Instruments—Credit Losses
- ASU 2019-04: Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments
- ASU 2019-05: Financial Instruments—Credit Losses (Topic 326) Targeted Transition Relief
- ASU 2019-09: Financial Services—Insurance (Topic 944): Effective Date
- ASU 2019-11: Codification Improvements to Topic 326, Financial Instruments—Credit Losses
- ASU 2020-03: Codification Improvements to Financial Instruments
- ASU 2020-11: Financial Services—Insurance (Topic 944): Effective Date and Early Application
- ASU 2021-01: Reference Rate Reform (Topic 848): Scope
- ASU 2021-08: Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers
- ASU 2022-01: Derivatives and Hedging (Topic 815): Fair Value Hedging—Portfolio Layer Method
- ASU 2022-02: Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures
- ASU 2022-04: Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations
- ASU 2022-05: Financial Services—Insurance (Topic 944): Transition for Sold Contracts
- ASU 2022-06: Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848
Calendar Year-end Private Companies
The following ASUs are effective for private companies for calendar year 2023:
- ASU 2016-13: Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
- ASU 2017-04: Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
- ASU 2018-19: Codification Improvements to Topic 326, Financial Instruments—Credit Losses
- ASU 2019-04: Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments
- ASU 2019-05: Financial Instruments—Credit Losses (Topic 326) Targeted Transition Relief
- ASU 2019-11: Codification Improvements to Topic 326, Financial Instruments—Credit Losses
- ASU 2020-03: Codification Improvements to Financial Instruments
- ASU 2021-01: Reference Rate Reform (Topic 848): Scope
- ASU 2022-02: Financial Instruments—Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures
- ASU 2022-04: Liabilities—Supplier Finance Programs (Subtopic 405-50): Disclosure of Supplier Finance Program Obligations
- ASU 2022-06: Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848
Calendar Year-end Governmental Entities
The following GASB standards are effective for governmental entities with June 30th and December 31st year ends:
- GASB Statement 96: Subscription-Based Information Technology Arrangements
- GASB Statement 94: Public-Private and Public-Public Partnerships and Availability Payment Arrangements
Practice Insight for Newly Effective Standards
Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
(Current Expected Credit Loss or CECL)
Effective for non-public business entities (including SRCs) for fiscal years beginning after December 15, 2022
For private entities and SRCs, prior to the adoption of CECL, impairment of financial instruments was recognized once a loss became probable (i.e., “incurred credit losses”). For example, a loan receivable becoming significantly overdue. CECL eliminates the probable recognition threshold and requires an estimate of the expected losses over the life of the financial instrument to be recorded at the time the instrument is initially recorded. CECL also states that an entity shall not rely solely on the past to estimate losses. An entity shall consider if historical information should be adjusted to reflect current conditions and forward-looking data such as expected GDP, unemployment rates, property values, commodity values or other factors that are associated with credit losses for that type of financial instrument. In addition, CECL requires an entity to evaluate financial assets that share similar risk on a collective basis, rather than individually.
Practice Insights
Not Just Financial Institutions
There is a common misconception that CECL only impacts financial institutions. While CECL impacts financial institutions more acutely, CECL will impact virtually all entities. The most common example of this is trade receivables. Trade receivables are financial instruments and thus CECL must be applied to them. For entities that currently do not have a general reserve applied to all receivables, regardless of their delinquency status, the adoption of CECL will most likely result in an increase in the allowance for uncollectable accounts. This is true even if the entity has historically not experienced any write-offs. This is because CECL requires an entity to consider some possibility of default, even if that risk is remote.
Difficult to Assert Zero Allowance
While an entity may have no history or expectation of a loss for a particular customer, corporate bond default studies demonstrate that there is always a risk of default, even for highly rated customers. We and other firms believe that it will be challenging for an entity to assert a zero expected credit loss. ASU 2016-13 included an example (326-20-55-48 Example 8) of when a zero expected credit loss might be appropriate. That example assessed that a zero expected loss might be appropriate for an entity which invested in U.S. treasuries. Although the example states that it is not only applicable to U.S. treasuries, the example included several criteria that U.S. treasuries met, but are not present in most other financial instruments and thus would suggest that under CECL, most receivables would require some amount of allowance.
For example, the entity in Example 8 concluded that its U.S. treasuries had a zero expected credit loss because U.S. treasuries:
- Receive a consistently high credit rating by rating agencies
- Have a long history with no credit losses
- Are explicitly guaranteed by a sovereign entity, which can print its own currency
- Have currency that is routinely held by central banks, used in international commerce and commonly viewed as a reserve currency
What we have seen in practice is that in certain limited situations the trade receivable allowance might not be zero, but is immaterial. If an entity has historically experienced limited or no losses, currently there are no material significantly past due accounts, the current customer type and aging is similar to historical experience, customers are large financially stable institutions where there is no indication of inability to pay, and similar public entities have immaterial allowances, then an immaterial allowance might be appropriate. For example, in the pharmaceutical industry many public entities are reporting an immaterial allowance. This is because they meet many of the aforementioned criteria including the fact that often times the only receivables are due from the “Big 3” wholesale distributors, which are large financially stable institutions and there is no indication of inability to pay
Mostly Likely Allowance Methodology for Trade Receivables
ASU 2016-13 does not require a specific methodology but does provide examples of several different methodologies. We believe that for short-term trade receivables the most appropriate methodologies are likely to be either the Loss Rate Method or the Aging Analysis.
