The Rundown: A Quick Update of Accounting Matters | 2022 Q3

Standard setters were relatively inactive this past quarter. The Financial Accounting Standards Board (FASB) issued one new Accounting Standard Update (ASU) and the Government Accounting Standards Board (GASB) did not issue any new Statements. The latest issue of the Rundown features a summary of the new ASU. In addition, we share some practice insight regarding a recently effective ASU concerning share-based compensation that has some potential pitfalls. Additionally, we highlight an ASU you should consider early adopting that could prevent “lost” revenue. We also include a reminder about changes to LIBOR and its impact. Lastly, we have put together a list of standards that are effective for upcoming reporting periods. To learn more, read our full issue now.

Third Quarter 2022 Accounting Standard Updates

Newly Issued ASUs

During the third quarter 2022, the Financial Accounting Standards Board (FASB) issued one new Accounting Standard Update (ASU). A brief summary of this standard follows:

Disclosure of Supplier Finance Program Obligations

The amendments in this ASU require that a buyer in a supplier finance program disclose sufficient information about the program to allow a financial statement user to understand the program’s nature, activity during the period, changes from period to period and potential magnitude. The buyer should disclose quantitative and qualitative information about the following:

1. Key terms: including payment terms, assets pledged as security and guarantees
2. Obligations outstanding: where those obligations are presented in the balance sheet and a roll forward of those obligations

For interim reporting, the buyer should disclose the amount of obligations outstanding as of the end of the interim period.

Effective Date (all entities): For fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on roll forward information, which is effective for fiscal years beginning after December 15, 2023.

Transition Requirements: Retrospectively, except for the amendment on roll forward information, which should be applied prospectively.

Early adoption is permitted.

Practice Insight: An Independent Appraiser Is Still Likely Necessary

Determining the Current Price of an Underlying Share for Equity-Classified Share-Based Awards (a Consensus of the Private Company Council)

ASU 2021-07

ASU 2021-07 was issued in October 2021 and is effective for grants of share-based compensation in fiscal years beginning after December 15, 2022. The ASU was a product of the Private Company Council aiming to provide nonpublic entities with a practical expedient to determine the current price of their shares when measuring share-based compensation. Share-based payments are measured at fair value and the most common valuation technique used to estimate fair value is the Black-Scholes-Merton model (BSM). This option pricing model requires various inputs, the most onerous of which for nonpublic entities is the current price of the entity’s underlying share. ASU 2021-07 introduced a practical expedient that allows nonpublic entities to determine the current price of their shares using a “reasonable application of a reasonable valuation method.” The ASU described the factors that would be considered when applying a “reasonable application of a reasonable valuation method” including:

1. The value of the entity’s tangible and intangible assets
2. The present value of the entity’s anticipated future cash flows
3. The market value equity interests in similar entities engaged in similar businesses
4. Recent arm’s-length transactions involving the sale or transfer of the entity’s equity interests
5. Other relevant factors, such as control premiums or discounts for lack of marketability
6. Consistent use of particular valuation methods

Critically, ASU 2021-07 stated that a valuation by an independent appraiser was not required and that valuations conducted by internal personnel could qualify if they met the characteristics described in the practical expedient. Some practitioners incorrectly interpreted this as a green light not to use a valuation expert. However, as ASU 2021-07 states, the characteristics used to describe a “reasonable application of a reasonable valuation method” are the same characteristics used for purposes of valuing share-based compensation for income tax purposes under IRC Section 409A. It’s important to note that the rules governing IRC Section 409a are complex and subjective. Mistakes can result in additional taxes and penalties and preparers should consult with their Cherry Bekaert tax professional. However, there are certain “safe harbor” valuation methods under IRC Section 409A, the most common of which is the use of an independent appraiser. Finally, and most importantly, ASU 2021-07 states that it is expected that an independent appraisal will often be the method used by nonpublic entities electing the practical expedient.

In addition, we sometimes see practitioners use outdated valuations. ASU 2021-07 explicitly states that a previous valuation by an independent appraiser is not reasonable as of the later if:

• The previous calculation fails to reflect subsequent information that may materially change the value (e.g., acquisition, material litigation, issuance of a patent).
• The previously calculated value was for a measurement date that is more than 12 months earlier than the current measurement date.

So, despite the Private Company Council’s best efforts to reduce the costs and complexity of accounting for share-based compensation, the need to obtain an independent appraiser is still likely necessary.

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Don’t “Lose” Revenue: Consider Early Adopting

Accounting for Contract Assets and Contract Liabilities From Contracts With Customers

Prior to the adoption of ASU 2021-08, whenever a business combination occurs, the acquirer is required to account for any pre-existing contract assets and liabilities related to revenue contracts acquired from the acquiree in accordance with ASC 805 Business Combinations, which requires the contract assets and liabilities be measured at fair value. Often this results in “lost revenue” because the fair value of deferred revenue is generally measured using the “cost build-up approach,” which estimates the costs incurred to satisfy the performance obligation, plus a normal profit margin. For entities with low variable costs to provide services to additional customers or for entities forced to defer revenue for services that have largely already been performed due to accounting rules (e.g., not distinct), this can result in a significant reduction or “haircut” to acquiree’s carrying value of deferred revenue. This is particularly impactful to the technology, software and telecommunication industries. When significantly reduced to fair value, deferred revenue is subsequently recognized into revenue and the originally recorded revenue is “lost.” The amendments in this Update require that an acquirer recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606. At the acquisition date, an acquirer should account for any contract asset or liability related to a pre-existing revenue contract of the acquiree in accordance with Topic 606, as though the acquirer had originated the contract. Generally, this should result in an acquirer recognizing and measuring the acquired contract assets and contract liabilities consistent with how they were recognized and measured in the acquiree’s financial statements. However, there may be circumstances in which the acquiree’s carrying value would not be used such as:

• The acquiree did use Generally Accepted Accounting Principles (GAAP)
• The acquirer is unable to assess or rely on how the acquiree applied Topic 606
• There were errors identified in the acquiree’s accounting
• Changes are required to conform with the acquirer’s accounting policies

Importantly, the amendments in this Update do not affect the accounting for other assets or liabilities acquired in a business combination (e.g., refund liabilities, customer-related intangible assets, intangible assets for off-market terms, etc.).

Effective Date and Transition Requirements:

Public business entities: For fiscal years beginning after December 15, 2022, including interim periods within those fiscal years.

All other entities: For fiscal years beginning after December 15, 2023.

The amendments in this Update should be applied prospectively to business combinations occurring on or after the effective date of the amendments.

Early application is permitted, including adoption in an interim period. An entity that early adopts in an interim period should apply the amendments retrospectively to all business combinations that occurred during that fiscal year and prospectively to all future business combinations.

Don’t Forget About LIBOR

Although several London Inter-Bank Offered Rates (LIBOR) were discontinued as of December 31, 2021, some of the rates most widely used in the US will continue to be published until June 30, 2023. Then LIBOR will no longer be used to issue new loans in the US and will be most commonly replaced by the Secured Overnight Financing Rate (SOFR). SOFR is based on the rates US financial institutions pay each other for overnight loans. If you have an adjustable-rate loan, check to see if it’s based on LIBOR. For loans based on LIBOR, find out what index your lender will switch to or the permanent “fallback” rate per the loan agreement, if applicable. A switch to a different index might mean a higher base rate in the future. It’s important for practitioners to be proactive and obtain a fair replacement rate.

Newly Effective Standards For This Coming Year-end

Calendar Year-end Public Companies

As a reminder, the following ASUs are effective for public companies for calendar year 2022:

• ASU  2020-06: Debt-Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging-Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity
• ASU  2020-07: Not-for-Profit Entities (Topic 958)-Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets
• ASU 2021-01: Reference Rate Reform (Topic 848): Scope
• ASU 2021-04: Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force)
• ASU 2021-05: Leases (Topic 842): Lessors—Certain Leases with Variable Lease Payments
• ASU 2021-10: Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance

Calendar Year-end Private Companies

As a reminder, the following ASUs are effective for private companies for calendar year 2022:

• ASU  2016-02: Leases (Topic 842)
• ASU  2018-01: Leases (Topic 842)-Land Easement Practical Expedient for Transition to Topic 842
• ASU  2018-10: Codification Improvements to Topic 842, Leases
• ASU  2018-11: Leases (Topic 842)-Targeted Improvements
• ASU  2018-20: Leases (Topic 842)-Narrow-Scope Improvements for Lessors
• ASU  2019-01: Leases (Topic 842): Codification Improvements
• ASU  2019-12: Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes
• ASU  2020-01: Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815): Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the Emerging Issues Task Force)
• ASU 2020-05: Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for Certain Entities
• ASU  2020-07: Not-for-Profit Entities (Topic 958)-Presentation and Disclosures by Not-for-Profit Entities for Contributed Nonfinancial Assets
• ASU  2020-08: Codification Improvements to Subtopic 310-20, Receivables—Nonrefundable Fees and Other Costs
• ASU  2020-10: Codification Improvements
• ASU 2021-04: Earnings Per Share (Topic 260), Debt—Modifications and Extinguishments (Subtopic 470-50), Compensation—Stock Compensation (Topic 718), and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force)
• ASU 2021-05: Leases (Topic 842): Lessors—Certain Leases with Variable Lease Payments
• ASU 2021-07: Compensation—Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share for Equity-Classified Share-Based Awards (a consensus of the Private Company Council)
• ASU 2021-10: Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance

Governmental Entities

As a reminder, the following GASB is effective for governmental entities for the soon to be issued June 30, 2022 year-ends:

• GASB Statement 87: Leases