By Rachel Guan
FASB issued the Accounting Standards Update 2020-04 to ease the potential burden in accounting for reference rate reform on financial reporting. This update responds to concerns on structural risks of interbank offered rates (IBORs) and the dangers of cessation of the LIBOR. Additionally, it is intended to resolve challenges regarding contract modifications and hedge accounting due to the reference rate reform. The amendments are elective and will affect all relevant entities subject to meeting specific criteria.
The update offers optional expedients and exceptions for applying generally accepted accounting principles to contracts and hedging relationships that are affected by the reference rate reform. The update is only applicable to agreements, hedging relationships, and other transactions that reference LIBOR or another reference rate. The expedients and exceptions offered do not apply to contract modifications and hedging relationships established after December 31, 2022, and hedging relationships existing as of December 31, 2022 will be an exception. The amendments are effective for all entities from March 12, 2020 to December 31, 2022.
The optional expedients for contract modifications are:
- Modification to receivable and debt contracts should be accounted for prospectively,
- Modifications to lease contracts should be accounted for as a continuation of the existing lease with no reassessment of the lease classification nor the discount rate,
- No reassessment about original conclusion whether the contract contains an embedded derivative, and
- General principle that contract modification due to reference rate reform do not require:
- Contract remeasurement at the modification date
- Reassessment of a previous accounting determination
If elected, an entity must apply for all eligible contracts, and the expedient is not applied if modification is made to a term that changes the amount or timing of contractual cash flows and is unrelated to the replacement of a reference rate.
The optional expedients for hedging modifications are:
- Related to the systematic and rational method used to recognize in earnings the components excluded from the assessment of effectiveness,
- Regarding the rate to discount cash flows associated with the hedged item and any adjustment to the cash flows for the designated term or the partial term of the designated hedged item in a fair value hedge, and
- To not periodically evaluate certain conditions when using the shortcut method for a fair value hedge.