On the Horizon: FASB amends consolidation guidance and discusses possible changes to revenue standard

FASB amends consolidation guidance
FASB posts highlights of February 18 meeting
      Simplifying the presentation of debt issuance costs
      Customer’s accounting for fees in a cloud computing arrangement
      Conceptual framework – measurement
      Fair value measurement disclosure framework
      Targeted improvements to the accounting for long-duration insurance contracts
FASB and IASB discuss possible changes to the new revenue standard
      Licenses of intellectual property
      Sales-based and usage-based royalties
      Identifying performance obligations
      Other clarifications and technical corrections
PCC posts highlights of February 13 meeting

FASB amends consolidation guidance

The Board recently released ASU 2015-02, Amendments to the Consolidation Analysis, which changes the guidance for evaluating whether to consolidate certain legal entities.

The amendments affect all reporting entities that are required to evaluate whether they should consolidate certain legal entities and all legal entities that will be subject to reevaluation under the revised consolidation model. The new guidance in ASU 2015-02

  • Modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities
  • Eliminates the presumption that a general partner should consolidate a limited partnership
  • Modifies the consolidation analysis for all reporting entities associated with VIEs, particularly those that have fee arrangements and related party relationships
  • Provides a scope exception from the consolidation guidance for reporting entities with interests in legal entities that are similar to investment companies as defined in the Investment Company Act of 1940.

Limited partnerships and similar legal entities
ASU 2015-02 eliminates the consolidation model created specifically for limited partnerships. Accordingly, the new guidance presents a single model for evaluating consolidation by all entities, which is expected to simplify the process. The amended guidance requires limited partnerships or similar legal entities to provide partners with either substantive kick-out rights or substantive participating rights over the general partner in order to qualify as voting interest entities. The ASU also eliminates the presumption that the general partner should consolidate the partnership.

Fee arrangements
The new guidance clarifies when fees paid to a decision maker should be considered in determining whether to consolidate a variable interest entity (VIE). The amendments in ASU 2015-02 remove three of the six criteria under current U.S. GAAP for making this assessment. If the fees are determined to be a variable interest, the reporting entity consolidates the VIE only if it has a controlling financial interest.

Related party transactions
ASU 2015-02 reduces the circumstances in which entities must apply the existing related party assessment guidance for consolidating VIEs, as outlined in the following three changes:

  1. Single decision makers will now assess related party relationships indirectly on a proportionate basis rather than in their entirety. If neither of the conditions in bullets 2 and 3 exists, the consolidation analysis ends with this step.
  2. For entities under common control, related party relationships should be considered in their entirety only if the common control group has the characteristics of a primary beneficiary (the common control group collectively has a controlling financial interest).
  3. If the entities are not under common control but substantially all of the VIE’s activities are conducted on behalf of a single variable interest holder (excluding the decision maker) in a related party group that has the characteristics of a primary beneficiary, then the single variable interest holder should consolidate the VIE.
Current U.S. GAAP guidance remains in effect for situations where power is shared between two or more entities that hold variable interests in a VIE.

Investment funds and similar legal entities
Lastly, ASU 2015-02 rescinds the indefinite deferral of FASB Statement 167, Amendments to FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, that was included in ASU 2010-10, Certain Investment Funds. However, ASU 2015-02 exempts reporting entities from consolidating legal entities that are investment companies or that operate in accordance with requirements that are similar to those in Rule 2a-7 of the Investment Company Act of 1940 (for example, money market funds).

Effective date
The guidance in ASU 2015-02 is effective for public business entities for annual and interim periods beginning after December 15, 2015. For all other entities, the effective date is for annual periods beginning after December 15, 2016 and for interim periods within annual periods beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period.

For more information on ASU 2015-02, refer to FASB in Focus, “Accounting Standards Update, Consolidation (Topic 810).”

FASB posts highlights of February 18 meeting
All decisions reached at Board meetings are tentative and may be changed at future meetings. Decisions are included in an Exposure Draft only after a formal written ballot. Decisions reflected in Exposure Drafts are often changed in redeliberations by the Board based on information received in comment letters, at public roundtable discussions, and from other sources. Board decisions become final after a formal written ballot to issue a final Accounting Standards Update.

The FASB met on February 18 to continue its redeliberations on simplifying the presentation of debt issuance costs, a customer’s accounting for cloud computing fees, the conceptual framework for measurement, the fair value measurement disclosure framework, and targeted improvements in accounting for long-duration insurance contracts. Highlights of these discussions are featured below.
Simplifying the presentation of debt issuance costs
The Board considered stakeholder feedback on the proposed ASU, Simplifying the Presentation of Debt Issuance Cost, and affirmed that entities would be required to present debt issuance costs in the balance sheet as a reduction in the carrying amount of debt. Accordingly, the Board requested the staff to draft a final ASU.

The final ASU will be effective for public business entities with annual periods, and interim periods within those annual periods, beginning after December 15, 2015. The effective date for all other entities would be annual periods beginning after December 15, 2015 and interim periods within annual periods beginning after December 15, 2016. Early adoption would be permitted. Retrospective application will be required.

Customer’s accounting for fees in a cloud computing arrangementThe Board affirmed the guidance in the proposed ASU, Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, that would require customers to use the same guidance that cloud service providers use to determine if a contract is either a software license or a service contract. The proposed ASU would incorporate the guidance in ASC 985-605-55-121 through 55-123, Software: Revenue Recognition, into ASC 350-40, Intangibles – Goodwill and Other: Internal-Use Software.

In addition, the Board tentatively reached the following decisions:

  • Not to expand the scope of the final ASU to include accounting for upfront costs in a cloud computing arrangement
  • Not to provide additional guidance about the criteria in ASC 350-40-15-4A through 15-4B
  • To supersede the existing guidance in ASC 350-40-25-16 analogizing to the guidance in ASC 840, Leases, to determine the asset acquired in a software licensing arrangement. Instead, the accounting by customers for the acquired software licenses would be consistent with the accounting for other acquired intangible assets.

The Board also affirmed that entities will have the option to apply the proposed guidance retrospectively or prospectively. An entity choosing prospective transition would apply the guidance to all cloud computing arrangements entered into, or materially modified, after the proposed effective date, as follows:

  • For public business entities: In annual and interim periods beginning after December 15, 2015
  • For all other entities: In the first annual period beginning after December 15, 2015 and in interim periods thereafter

Conceptual framework – measurement

The Board discussed various methods of determining carrying amounts and changes in carrying amounts, and tentatively decided that the measurement chapter in FASB Concepts Statement 8, Conceptual Framework for Financial Reporting, should contain the following general categories of measurement methods:

  • Prices in transactions the entity participated in
  • Current prices observed or estimated by the entity
  • Discounted or undiscounted estimates of future cash flows (other than estimates of market prices)
  • Other adjustments to carrying amount, such as accruals, systematic allocations, and allowances for impairments

At a future meeting, the Board will consider circumstances in which the different methods would be appropriate and ways to improve the descriptions of the methods.

Fair value measurement disclosure framework
The Board discussed how to promote more discretion in applying disclosure requirements about fair value measurements and tentatively decided that the disclosure sections of ASC Topics should

  • State that required disclosures must be provided only to the extent that they are material
  • Omit language that would limit the use of discretion (for example, “An entity shall at a minimum provide…”)
  • Refer to ASC 235, Notes to Financial Statements, which the Board intends to modify to include the following additional guidance on applying materiality to note disclosures:

    • Materiality would be applied to disclosures individually and in the aggregate; it is possible that only some or none of the disclosure requirements in the ASC Topic would be material.
    • A disclosure would be material if it meets the U.S. Supreme Court’s description of “materiality.”
    • The evaluation of materiality would be done on a quantitative and qualitative basis, including consideration of whether there is a substantial likelihood that the omitted disclosure could be reasonably viewed as having significantly altered the total mix of information made available.
    • An omission would not be considered an accounting error if an entity omits the disclosure because it is deemed immaterial.

The Board tentatively decided that the guidance would not explicitly address the variations in the legal concept of materiality by jurisdiction. In addition, the Board tentatively decided that it would not distinguish between a minimum and expanded set of disclosures.

The Board also tentatively decided that the objective for the disclosures in ASC 820, Fair Value Measurement, would be “to provide users of financial statements with information useful” in assessing the following information:

  • The different ways an entity arrives at its fair value measures, including judgments and assumptions that it makes
  • The effects of changes in fair value on the amounts reported in financial statements
  • The uncertainty in the fair value measurement of assets and liabilities
  • How fair value measurements change from period to period

Targeted improvements to the accounting for long-duration insurance contracts

The Board discussed alternative methods for simplifying how entities amortize deferred acquisition costs and tentatively decided that

  • Deferred acquisition costs pertaining to certain investment contracts would continue to be amortized using an effective interest method.
  • Deferred acquisition costs for all other types of long-duration contracts would be amortized over the expected life of a book of contracts in proportion to the amount of insurance in force. If the amount of insurance in force is variable or cannot be reasonably determined, then the deferred acquisition costs would be amortized on a straight-line basis in proportion to the number of outstanding contracts.

FASB and IASB discuss possible changes to the new revenue standard
The FASB and IASB met on February 18 to decide whether to amend certain guidance in ASU 2014-09 and IFRS 15, both titled Revenue from Contracts with Customers, regarding intellectual property licenses, the sales-based and usage-based royalties exception, the identification of performance obligations, and other clarifications and technical corrections. The highpoints of these discussions are summarized below.

The FASB tentatively decided to make changes to all areas discussed and directed its staff to begin drafting a proposed ASU, with a goal of obtaining comments by June 30, 2015.

The IASB tentatively decided to add only targeted changes to its technical agenda and to issue a single Exposure Draft at a future date after considering whether discussions at the Joint Transition Resource Group for Revenue Recognition meeting in March necessitate additional clarifications to the revenue standard. The IASB expects to approve clarifications to be included in its Exposure Draft during its June 2015 meeting.

If both Boards act in accordance with their tentative decisions, the now-converged revenue guidance may start to diverge, and its application may differ between those applying U.S. GAAP and IFRS.

The Boards will continue their outreach activities to assess stakeholders’ preparedness in implementing the new revenue standard and expect to decide on a possible deferral of the effective date of the revenue guidance early in the second quarter of 2015.

Licenses of intellectual property
In discussing intellectual property licenses, the Boards tentatively decided

  • To clarify the guidance on determining the nature of an entity’s promise to grant a license for intellectual property, which determines whether an entity recognizes revenue at a point in time or over time
  • To clarify that an entity’s promise is to provide a right to access the entity’s intellectual property (which it satisfies over time) when the contract requires, or the customer reasonably expects, the entity to undertake activities that significantly affect the utility of the intellectual property the customer has rights to, but do not transfer a good or service to the customer

The FASB tentatively decided to replace the three criteria in the new revenue standard for determining the nature of an entity’s promise in granting a license with the following two categories of intellectual property:

  • Functional intellectual property: Because functional intellectual property derives a substantial portion of its utility from its stand-alone functionality (for example, films, television shows, or music), the licensor’s ongoing activities that do not change that functionality do not significantly affect the utility.
  • Symbolic intellectual property: Because the licensor’s past or ongoing activities drive substantially all of the utility of symbolic intellectual property (for example, a brand, trade name, or sports team), the licensor’s promise to the customer presumably includes undertaking activities that significantly affect the utility of the intellectual property.

The FASB views the two categories as an operable and understandable way of determining when a contract requires, or a customer reasonably expects, an entity to undertake activities that significantly affect the utility of the intellectual property rights.

The IASB tentatively decided to select an alternative approach to make these targeted clarifications.

Sales-based and usage-based royalties

Regarding sales-based and usage-based royalties, the Boards tentatively decided to clarify that an entity should not split a single royalty into a portion that is subject to the sales-based and usage-based royalties exception and a portion that is not subject to the exception (and is therefore subject to the general guidance on variable consideration) when it earns a single royalty for two or more performance obligations. The Boards also tentatively agreed to clarify that the exception applies whenever the predominant item related to the royalty is a license of intellectual property.

Identifying performance obligations
The FASB tentatively decided to make the following amendments to ASC 606 to improve the guidance on identifying performance obligations.

Promised goods or services. The FASB tentatively decided that an entity is not required to identify promises made to a customer that are immaterial at the contract level or to assess aggregated immaterial items at the financial statement level.

‘Distinct’ in the context of the contract. The FASB tentatively decided to provide additional illustrative examples and to clarify when a promised good or service is “separately identifiable” from other promises in the contract (in other words, “distinct” within the context of the contract) by

  • Expanding upon the articulation of the principle of “separately identifiable” in the Codification
  • Revising the factors in ASC 606-10-25-21 to align with the re-articulated separately identifiable principle

Shipping and handling services. The FASB tentatively decided to clarify that an entity would account for shipping and handling costs performed before the customer obtains control of the good as fulfillment costs and to permit, as an accounting policy election, entities to account for shipping and handling costs performed after the customer obtains control of the good as a fulfillment cost.

The IASB tentatively decided to add illustrative examples to clarify the principle of “separately identifiable” but not to make further changes to the new revenue standard for the other areas discussed under identifying performance obligations.

Other clarifications and technical corrections
The FASB tentatively decided to make other targeted clarifications to the licensing guidance and technical corrections related to identifying performance obligations in a contract.

PCC posts highlights of February 13 meeting
The Private Company Council (PCC), which met on February 13 to discuss a variety of topics, tentatively decided not to amend the existing definitions of “nonpublic entity” that currently exist in U.S. GAAP.

In addition, the PCC expressed significant concerns about the FASB’s project on classifying debt in the balance sheet, encouraging the Board to conduct further outreach, and expressed concerns about the Board’s project on simplifying the presentation of debt issuance costs. The Council also directed the FASB staff to conduct research on alternative accounting for share-based payments by private companies.

The PCC added a project to its agenda to consider whether to allow entities to elect to adopt existing PCC accounting alternatives after their effective dates.

The Council also discussed the disclosure of open tax years when there are no material uncertain tax positions, as well as the classification and measurement of financial instruments, but reached no tentative agreements.

The next PCC meeting will be held on May 5.