GAAP Matters – will debt classification change…will AICPA independence rules change?

Groups oppose the change proposed by the FASB, and…

New Lease GAAP accounting prompts a change in the AICPA’s auditor independence standard

Both the Private Company Council (PCC) and the Investor Advisor Committee (IAC) have recommended that the FASB reconsider and change its decision on a proposed GAAP standard dealing with debt classification (ASC Topic 470)

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The FASB has proposed and considered a change to GAAP that would affect the classification of debt. This proposal affects when debt can be classified as a non-current liability.  Classification as current vs non-current affects some key financial statement measures.

Generally, classification of debt as “long-term” is not available to instruments which will mature and become due within one year of the balance sheet date.  Under the proposal, debt “should” be classified as long-term (i.e. noncurrent) if “The entity has a contractual right to defer settlement of the liability for at least one year (or operating cycle, if longer) after the balance sheet date. If, before the balance sheet date, an arrangement is in place with a third party (for example, a line of credit) that would result in the entity avoiding the transfer of current assets within 12 months from the balance sheet date, the debt should be classified as noncurrent because the entity has a contractual right to defer settlement.”

The PCC requested that the FASB reconsider its prior decision to allow companies to classify debts due within 12 months as long-term debt if the company has unused long-term financing arrangements at the balance sheet date.  The PCC stated that the FASB decision to consider unused long-term financing arrangements adds complexity and is therefore not in line with its intent to simplify balance sheet classification of debt.

The IAC recommended the Board change its tentative decision to reclassify current debt as a non-current liability based sole on unused long-term financing arrangements – such as a line of credit.  The groups consider the analysis of whether the entity can use the line of credit to effectively extend the repayment of the debt to be somewhat complex as it could potentially include assessing the reasonableness that the line of credit will not be needed for other liquidity needs along with an assessment of terms and conditions of the credit line.

We have here an example where both the PCC and IAC, despite their varying  stakeholders and perspectives, have provided somewhat similar feedback to the FASB. According to the FASB website, the PCC is the primary advisory body to the FASB on private company matters. The PCC uses the Private Company Decision-Making Framework to advise the FASB on the appropriate accounting treatment for private companies for items under active consideration on the FASB’s technical agenda. According to the FASB’s website, the IAC is a standing committee that is expected to work closely with the FASB in an advisory capacity to ensure that investor perspectives are effectively communicated to the FASB on a timely basis in connection with the development of financial accounting and reporting standards.

And speaking of debt…AICPA Code of Conduct interpretation change is on the horizon for CPAs who have lease arrangements with clients

At its upcoming meeting the AICPA’s Professional Ethics Executive Committee (PEEC) will consider adopting a change to the independence interpretation that affects CPAs who have lease arrangements with their clients. This proposed revision was originally considered and exposed for comment by PEEC while I was a member of the PEEC.

The existing “Leases” independence interpretation provides that a lease between the CPA and the attest client does not impair independence if the lease is an operating lease – and – the lease terms are comparable with leases of a similar nature, and all amounts are paid in accordance with the lease terms and provisions. This existing interpretation also provides that a capital lease impairs independence because it is considered be a prohibited loan with the attest client.

The FASB has since adopted authoritative GAAP that when effective will significantly affect the operating versus capital lease interpretation which iscodified in ASC 842, Leases. Calendar year-end public business entities will adopt the new leases standard on January 1, 2019. Thus, PEEC determined it needed to consider how that GAAP change affects the Code of Professional Conduct.

The proposed revision to the Code of Conduct replaces the extant GAAP categorization approach with a conceptual framework approach, allowing for the consideration of factors that PEEC believes truly affect the CPA’s objectivity and professional skepticism. PEEC has stated that it does not believe that objectivity and professional skepticism are affected by whether a lease is an operating lease or a capital lease, per se, but believes that other factors related to the lease and the relationship should be considered in arriving at a conclusion on independence.

While the GAAP lease categorization requirements have been proposed to be eliminated from the revised interpretation, the other requirements remain in the proposed revised interpretation as minimum safeguards. Once these minimum safeguards are met (where applicable), the CPA is required to use a threats and safeguards approach, evaluating any other threats identified and applying safeguards when necessary.

PEEC is set to take up the final adoption of its proposal in the summer of 2018…I will follow its progress and provide additional analysis as information becomes available.

Shocking! New GAAP standard for revenue recognition is now effective. Tesla reports increased sales…by adopting new standard!

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Down the road: Look for more companies to report changes.

GAAP are the rules companies are supposed to use when preparing their financial reports. Although revenue is a fundamental concept that one might think would have been ironed out by the accounting rule-makers years ago – it wasn’t.  GAAP evolved with somewhat different revenue recognition concepts for different industries or situations. Accounting rule makers have been grappling with resolving these concepts.  In the USA, it is the Financial Accounting Standards Board (FASB) that develops these rules.  The FASB’s new accounting standard for revenue recognition is now effective for public companies. For many companies the new rules will not create major changes, but for some others, it will.  Among the more notable is Tesla…

and Tesla has reported increased car sales thanks to these rules.

Tesla’s reported automotive sales increased about $300 million – Instead of reporting “Automotive Sales” of $2.3 billion, as it would have under the old rules Tesla reported automotive sales of $2.6 billion, under the new rules, as announced its Form 10Q for its fiscal quarter ended March 31, 2018.  That’s an increase of $.3 billion…or about $300 million…from a rulechange.

Was that “increase” due to an increase its underlying activities?   NO

Did it “sell” more cars?  Well…

The $300 million increase was not caused by a change in the level customer of “transaction” but rather a change in that certain “leasing” activities heretofore reported as “Automotive Leasing” revenue are now – considered by the accounting rules – as automotivesales.  Indeed, under the new rules Tesla reported about $165 million lessAutomotive Leasing revenue…thus offsetting a bit more than half of the increase it reported in its Automotive Sales.

Tesla described the increase is its Automotive Sales was due to “vehicles leased through our leasing partners… with a resale value guarantee… now generally qualify to be accounted for as sales with a right of return”. While, on the other hand, “for certain vehicles sales with a resale value guarantee and vehicles leased through leasing partners prior to 2018, we have ceased recognizing lease revenue starting in 2018”. Thus, these transactions – vehicles leased with resale value guarantees – now qualify under GAAP as sales revenue transactions, not leasing revenue transactions; so that revenue stream has been diminished.

The new GAAP standard defines revenue as: Inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations. (Source ASC 606-10-20).

What are the rules?

The level of complexity for implementing the new rules will vary. The new rule has five over-arching steps – but each of these steps has entity and circumstance specific implications.

    • Identify the contract
    • Identify performance obligation(s)
    • Determine price
    • Allocate the price, if appropriate
    • Recognize revenue

To people who follow the development of accounting rules the new FASB revenue recognition standard has been a hot topic for years – the process of issuing a new accounting standard like this one takes a lot of time – with exposure drafts, public roundtables, deliberation and re-deliberation of comments provided by interest parties along with an attempt to unify the standards with international accounting rules…the process has gone on for years.  And with concerns over whether companies will be able to re-tool their bookkeeping systems to keep up with the new rules the effective date was pushed back.

Some surveys had suggested that many companies were behind in their implementation efforts.  GAAP changes typically don’t attract headlines – the Tesla announce did shine a spotlight on the change. Not all companies will report a material change – and not all will report a change due to the same reasons reported by Tesla.  The financial reports of the companies should provide details and background as to the nature and scope of any changes.

Some changes might impact compliance with restrictive covenants or amounts due under existing agreements.

If you read financial statements you should be on the lookout for further announcements of the implementation of the new GAAP standard for companies that you are interested in.

Andrew M. Mintzer, CPA is a forensic accounting with the Los Angeles office of Hemming Morse, LLP.  He is a past chair of the California Society of Certified Public Accountants.