By Denise Lugo
U.S. companies that have to adjust millions of contracts to facilitate the effects of the shift from the use of the London Interbank Offered Rate (LIBOR) to other rates, will get some relief from having to do costly and complex accounting analyses to comply with the changes, according to a FASB proposal.
The FASB on September 5, 2019, proposed accounting revisions to provide temporary optional guidance to ease the potential burden in accounting for, or recognizing the effects of, reference rate reform on financial reporting. The proposal addresses operational challenges companies raised and ultimately will help simplify the transition process while reducing related costs.
Trillions of dollars in loans, derivatives, and other financial contracts reference LIBOR, the benchmark interest rate banks use to make short-term loans to each other.
“We’re looking forward to the comment letters that will come in, but we think it’s important that the FASB stand ready to evaluate how to improve accounting for emerging issues, and clearly the transformation from LIBOR to SOFR is an emerging issue,” FASB Chairman Russell Golden told Thomson Reuters at a September 5 liaison meeting of the board and the Institute of Management Accountants. “So that’s why we devoted substantial resources to this, so that we can help our stakeholders as they transition.”
In the U.S., the Federal Reserve identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative reference rate to U.S. dollar LIBOR.
The board proposes to simplify the accounting evaluation of a contract modification and allow for that modification to be considered a continuation of the contract for accounting purposes. This accounting relief could be applied to loans, debts, leases, or any other type of contracts affected by reference rate reform, according to the main tenets of the document.
The proposal would also simplify the assessment of hedge effectiveness and allow hedging relationships affected by reference rate reform to continue. This relief is intended to minimize the disruption of reference rate reform on financial reporting and provide users with more decision-useful information. Application of the hedge accounting relief would be optional on a hedge-by-hedge basis. The proposed accounting relief could be applied up until January 1, 2023, a year after the expected discontinuation of LIBOR.
“One thing to be mindful of is this relief FASB’s providing is only applicable if the change you make is to make a very narrow scope amendment to switch from LIBOR to SOFR,” Rob Anderson, a CPA at Chatham Financial in Kennett Square, Pennsylvania, said.
“It’s really tempting to say ‘well if I’m in the contract anyway I might as well fix everything that I can.’ If you do that you won’t qualify for the relief that FASB is granting,” Anderson said. “It still might be worth it for you to go through all the modification analysis, you just need to understand you’re setting yourself up to not take advantage of that relief.”
Companies have until October 7 to comment on the changes, issued as Proposed Accounting Standard Update (ASU) No. 2019-770, Reference Rate Reform (Topic 848) Facilitation of the Effects of Reference Rate Reform on Financial Reporting.
Eliminating Market Uncertainty
After banks were fined billions of dollars for trying to rig interest rates tied to trillions of dollars in loans and other financial products, regulators moved to end the use of LIBOR by December 2021.
The change created a level of uncertainty among companies worldwide over how to account for outstanding LIBOR-based contracts as they transition to new rates.
The interbank offered rate changes require companies to have to modify the contracts they carry that have LIBOR references, and under GAAP companies would have had to do individual assessments to loan and lease contracts as to whether the modification qualifies as an extinguishment or a troubled debt restructuring, or whether specific derivative accounting may be continued.
The FASB proposal would enable companies to avoid that complex process, which for some companies would have meant going through millions of contracts.
The second part of the issue, related to hedge accounting rules, typically would have required hedge accounting relationships to end when a derivative contract is modified. The FASB proposal would enable companies to continue their hedge accounting relationships by disregarding the impact of the modification on the accounting designation.
“Absent this guidance, companies would have had to forecast when the derivative and its hedged item are going to transition to SOFR, and those might be at different times, and those are very judgmental, very subjective considerations,” Anderson said. “The results of what guess that you make about that timing could drive whether your hedging relationship qualifies or not. And so FASB is wiping that away saying ‘you don’t have to consider that.’ They’re making it very easy for hedge accounting to continue.”
After Accounting Hurdles, What Next?
Accounting professionals said they believe the relief the FASB provides will wipe away any financial reporting issues companies might have as a result of rate reform. Once they clear that hurdle, however, companies need to figure out whether they have the staff and resources they need to work their way through those contracts, Anderson said. Some companies need to also factor in whether they “negotiate an amendment with their counterparties, and how much will that distract [them] from doing [their] regular work – that’s concern number one,” he said.
Concern number two is potential transfer of value as all those contracts get amended.
“We can have a lot of value change hands that wouldn’t be transparent—firms that are in this market all the time have greater access to information,” Anderson said. “Is there an opportunity for value to change hands?” he said. “Can be.”
This article originally appeared in the Friday, September 6, 2019 edition of Accounting & Compliance Alert, available on Checkpoint.