FASB Issues an Accounting Standards Update Relating to the Reference Rate Reform

On 12 March 2020, the US Financial Accounting Standards Board (FASB) issued Accounting standards update (ASU) no. 2020-04 “Facilitation of the Effects of Reference Rate Reform on Financial Reporting”. Equally to what the International Accounting Standards Board (IASB) did in September 2019, FASB responds to the planned reform of IBOR rates and the planned termination of the use of the LIBOR reference rate at the end of 2021 and to the impact of the changes on financial accounting. The ASU become effective since 12 March 2020 and will apply for a definite period of time, specifically until 31 December 2022.

As financial markets divert from references to LIBOR and other inter-bank reference rates and intend to transfer to alternative risk-free rates that should be easier to determine and less prone to manipulation, the FASB started considering impacts of the changes on companies under the existing accounting principles and decided to simplify the transition period by issuing practical expedients and exceptions for contract modifications resulting from the above-mentioned reference rate reform.

The above-mentioned Accounting Standards Update allows companies to apply optional expedients and exceptions to generally accepted accounting principles as regards modifications of contracts and hedging relationships if these are connected to LIBOR or other reference rates, which are to be terminated.

The changes in the existing guidance only represent a temporary accounting relief if certain conditions are met and relate to the following areas:

  • Contract modifications

The changes apply to contract modifications as related to Accounting Standards Codification topics 310, Receivables, 470, Debt, 840 and 842, Leases. Extensive evaluations resulting from contract modifications are replaced by simplified accounting evaluations. For example, modifications of leases due to a change in the reference rate do not require reassessment of the lease classification, the discount rate and re-measurement of lease payments that would normally be needed. In addition, modifications of loans and debts may be accounted for prospectively.

  • Hedge accounting (topic 815)

There is a number of simplifications in the hedge accounting area. Hedge accounting would normally be discontinued if a contract is modified, while in case of modifications arising from changes in the rates, the hedge accounting may be retained.  Similarly, if a hedging relationship changes due to a change in rates, ineffectiveness may occur in the transition period. The practical expedient allows preserving the hedge accounting during the transition period even if there is a temporary mismatch.

Specific details of the ASU and its provisions allowing simplified treatment and the listed practical expedients can be found in ASU 2020-04 published on, section Standards, Accounting Standards Updates Issued.

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