This edition of The quarter close provides timely accounting and reporting information that can help you prepare for this quarter's reporting. Get up to speed on the top issues for financial reporting this quarter — accessible on our CFOdirect webpage — easy to read on your phone, tablet, or computer.
The FASB issued new guidance to defer the effective dates for certain standards, we provide a summary of the companies and standards impacted. Get additional insights and reminders about the new credit losses standard, considerations for principal versus agent assessments under the revenue standard, accounting for lease incentives, accounting for lease remeasurements, terminations and modifications, standard setting and more.
Learn on the go while listening to our audio version of The quarter close publication.
Did you like listening to the audio version? Subscribe to PwC's accounting podcast to hear more PwC professionals share perspectives on today's key technical accounting matters, business issues, current standard setting, and regulatory updates.
In November 2019, the FASB issued new guidance to defer the effective dates for several major accounting standards and provide implementation relief to certain types of entities (ASU 2019-09 and ASU 2019-10). The amendments provide at least an additional year to certain companies that have not yet adopted these standards. The major standards impacted by the deferral include:
For credit losses, hedging, and leases, the amendments defer the effective dates for certain companies. For insurance, the amendments defer the effective dates for all companies. Additionally, the amendments align the effective dates of the new guidance for goodwill impairment with the amended credit losses effective dates.
The amendments also create a framework for future standard setting whereby two “buckets” may be used for major standards, allowing at least a two year difference in the effective dates. The “buckets” are: (1) public business entities (PBEs) that are SEC filers other than smaller reporting companies (SRCs, as defined by the SEC) and (2) all other companies, including SRCs.
For an overview of the effective dates, refer to Appendix - FASB guidance effective dates.
The credit losses standard introduces a new model for recognizing credit losses on certain financial instruments. The scope of the current expected credit losses (CECL) model applies to a broad range of financial instruments, including financial assets measured at amortized cost (e.g., held-to-maturity debt securities, trade receivables), net investments in leases, and certain off-balance sheet credit exposures. While available-for-sale (AFS) debt securities are not within the scope of the new CECL model, the standard made several notable changes to the AFS impairment guidance.
CECL is a principles-based model and its application requires a number of judgments relating to modeling methodologies and accounting policy decisions. Key judgments should be documented, adequately supported, subject to robust internal controls, challenged internally, and subject to board oversight.
The new standard is effective on January 1, 2020 for calendar year-end SEC filers, excluding SRCs. Companies that will soon be adopting the standard should be finalizing their models and processes, while refining the precision of their estimates used to determine their expected credit losses. As the adoption date approaches, companies should also be completing the implementation and testing of key controls over the end-to-end process, including processes and controls around the required disclosures. One of the more challenging aspects of adoption will be explaining the CECL estimate to stakeholders and helping them understand key drivers, and how changes to assumptions and inputs may impact the estimate.
Third-party data, vendors, and models that companies rely upon to determine their estimates should also be subject to a company’s controls and processes. Some companies may use third parties for data (e.g., macroeconomic forecasts, historical data on asset performance), models to calculate estimated credit losses, or systems platforms. Establishing the division of roles and responsibilities between management and third parties is critical. These roles and responsibilities should be monitored as they may evolve as companies gain more experience applying CECL. Management’s processes and controls should enable them to “own” or take responsibility for any third-party deliverables and ultimately the final estimate. For example, management should understand the data, key assumptions, and models that the third-party used and be able to demonstrate their appropriateness relative to the company’s portfolio and estimate. Management will need to understand and may need to test the third party’s controls and processes around those data inputs, key assumptions, and models. Companies should also determine whether third parties are acting as “experts” or “service providers,” and consider if System and Organization Controls (SOC) reports are available.
Moving forward, companies should keep in mind that adopting the standard is not the end of the CECL journey. After adoption, companies should maintain an ongoing financial reporting process for developing their estimates for credit losses and related disclosures that is systematic, disciplined, and consistently applied. Companies also should be testing their models, estimates, and processes assuming different economic scenarios.
Although the effective date was delayed, impacted companies should continue their implementation efforts and take into account lessons learned from those that have previously adopted the new standard. Companies not adopting the standard until after 2020 should not underestimate the effort required to adopt CECL and should continue their efforts to gather data, build models, implement systems, and design and test internal controls.
We have a number of resources that can help as companies adopt the new credit losses standard. Our podcasts, Implementing the CECL standard: 5 things you need to know, and The CECL standard - 5 things you need to know, outline the CECL model and its impact on companies as they prepare for adoption. Further resources are available in our Loans and investments guide, which was updated in November 2019.
Leases often include incentives to reimburse amounts spent by the lessee to furnish or improve the leased property up to a maximum dollar amount. The amount and timing of the incentive may depend on when the lessee furnishes or improves the leased asset. When a lessee pays for an improvement to the leased property, it must determine whether the improvement is a lessee asset or a lessor asset. The leasing guidance does not define a lessee or lessor asset. We believe if a lease does not specifically require a lessee to make an improvement, the improvement is most likely a lessee asset. If the lease requires the lessee to make an improvement, then the lessee will need to consider the uniqueness of the improvement to the lessor’s intended use. Improvements would likely be considered lessor assets if they are not specialized and it is probable that they could be utilized by a subsequent tenant. Other factors to consider in determining whether the improvement is a lessee or lessor asset include whether the improvement increases the fair value of the underlying asset from the standpoint of the lessor, and the duration of the economic life of the improvement relative to the lease term.
If a lessor reimburses a lessee for a lessee asset, the cash received by the lessee is a lease incentive. The incentive is recorded at the maximum nonrefundable amount that is probable of receipt, as in most cases it is unlikely that a lessee would forgo any of the incentives it had negotiated to receive from the lessor. The lessee should treat the incentive as an "in substance fixed payment" from the lessor by estimating the timing of the maximum nonrefundable contractual incentive not yet received and record the incentive as a reduction to fixed lease payments. This will reduce the lease cost, may impact lease classification, and reduce the amount recognized for the lease liability and the right-of-use asset at lease commencement. If the actual receipt of cash from the lessor differs from the original estimate used to record the lease, in either timing or amount, the lessee should analogize to the remeasurement guidance by remeasuring the lease liability and the right-of use asset without adjusting the discount rate. After remeasurement, the liability will amortize to zero by the end of the lease term.
Irrespective of the amount of reimbursement by the lessor, a lessee should record the full cost of a lessee asset as a leasehold improvement and amortize it over the shorter of its useful life or the lease term. However, if the lessee is reasonably certain of exercising an option to purchase the underlying asset, the lessee should amortize the leasehold improvement over its useful life.
In the statement of cash flows, payments made by a lessee for lessee assets are reflected as an investing activity. Lease incentive payments that the lessee receives from the lessor for a lessee asset are treated the same as any other lease payment. For example, lease incentives for operating leases are reflected as an operating activity in the statement of cash flows.
If a lessor reimburses a lessee for a lessor asset, the lessee’s payment to purchase the asset is accounted for as prepaid rent and the subsequent reimbursement by the lessor is recorded as a reduction to prepaid rent. If the lessee will not be fully reimbursed by the lessor, the difference between the cost incurred and the reimbursement received is included in lease payments at lease commencement.
For payments made by a lessee that are accounted for as prepaid rent, we believe that the statement of cash flows presentation will depend on the expected lease classification at commencement. If there is clear evidence that the lease would be classified as a finance lease, the prepayment should be reflected in the investing section of the statement of cash flows. Otherwise, the prepayment should be reflected in the operating section of the statement of cash flows. After the commencement date, any payments made by a lessee and any subsequent reimbursement by the lessor should follow the classification of any other lease payments in the statement of cash flows.
For further discussion, listen to our podcast, Ongoing lease accounting: 5 things you need to know. For additional information regarding lease accounting refer to PwC’s Leases guide.
Leases are classified and measured on the lease commencement date. Subsequent to the commencement date, the lease may be remeasured, terminated, or modified due to the occurrence of certain events.
A lessee-controlled remeasurement event may occur that affects whether the lessee is reasonably certain to exercise a lease renewal option, termination option, or option to purchase the underlying leased asset. For example, a lessee may build significant leasehold improvements subsequent to lease commencement with a useful life that is longer than the initial estimate of the lease term, which generally indicates that the lessee is reasonably certain to exercise a renewal or purchase option. This is a remeasurement event under the new leasing standard and requires the lessee to:
A remeasurement event may also occur if there is a change in the amount probable of being owed by the lessee under a residual value guarantee, or there is a resolution of a contingency upon which variable lease payments become fixed. The accounting for such remeasurement events is similar to a lessee-controlled remeasurement event except that the lessee should not reclassify the lease or determine a new discount rate at the remeasurement date.
Sometimes a lease may be terminated early and the lessee may be required to pay an early termination penalty. If the termination is immediate, the lessee should remove the lease liability and right-of-use asset from its balance sheet at the termination date and record any difference in the income statement as a gain or loss. Any payment for a termination penalty should be included in the gain or loss on termination.
In some cases, a termination may be treated as a modification. For example, in a lease of real estate (such as office space), a lessee typically does not intend to move out immediately after giving notice of early termination, but plans to continue to use the property for a short period of time after giving notice. This transaction is accounted for as a modification of an existing lease and the accounting by the lessee is similar to the accounting for a lessee-controlled remeasurement event.
An area of revenue recognition that continues to require significant judgment is determining whether a company is a principal or agent when more than one party is involved in providing goods or services to a customer. A principal recognizes the "gross" amount paid by the customer for goods or services as revenue while an agent recognizes the commission or fee earned for facilitating the transfer of goods or services (the "net" amount retained). ASC 606 altered the principal versus agent assessment to focus on whether the entity controls the good or service, rather than focusing solely on indicators of risks and rewards used under the previous guidance.
ASC 606 provides a two-step approach for principal versus agent assessments.
In contracts with multiple performance obligations, a separate assessment is performed for each, and the company could be the principal for some goods or services and an agent for others. Thus, proper identification of performance obligations is critical to appropriately performing the principal versus agent assessment.
It will not always be clear whether the company controls the specified good or service; additional analysis will often be required. In performing this additional analysis, the revenue standard provides three indicators of control: primary responsibility for fulfillment, inventory risk, and pricing discretion. None of the indicators are weighted more heavily than any others nor are they individually determinative. It is important to remember that the indicators are intended to support the company’s conclusion about whether it controls the specified goods or services. That is, the company should not view the indicators in isolation or use them as a checklist, and, importantly, the indicators do not “override” or replace the assessment of control.
Even with the additional guidance provided by the indicators, principal versus agent assessments often require significant judgment, especially when the underlying performance obligation is a service that may be fulfilled virtually (for example, via some online marketplaces). There may be fact patterns when multiple parties have some responsibility for fulfillment or take on some amount of financial risk in the arrangement. A company that takes on financial risk by agreeing to receive a variable fee or incur variable costs is not necessarily the principal; financial risk may not, on its own, support a conclusion that the company controls the good or service before it is transferred to the end consumer.
Principal versus agent assessments require a detailed understanding of the contractual arrangements between the parties. Thus, they often require involvement of company personnel outside of the accounting function (e.g., legal, sales, or operations personnel), especially when contractual language is unclear regarding the party that is primarily responsible for fulfilling an obligation to an end consumer. When significant judgments are involved in the assessment, a company should ensure that it provides clear and transparent disclosure of those judgments and conclusions reached. For example, disclosures are particularly important when (1) a company concludes it is an agent, but takes on certain financial risks related to a transaction or (2) a company concludes it is a principal but makes significant payments to a third party contemporaneous with the revenue transaction.
For additional discussion and examples on this topic, refer to Chapter 10 in our Revenue from contracts with customers guide.
In November 2019, the FASB issued guidance on the accounting for share-based consideration payable to a customer (ASU 2019-08). Previously, there was a lack of guidance within the revenue standard regarding the measurement of share-based payments to a customer. The new guidance clarifies that an entity should follow the stock compensation standard to measure the awards at the grant date and classify the awards as equity or liability. Additionally, any performance or market conditions that affect the vesting or fair value of the share-based awards should also be evaluated under the stock compensation standard. Once the grant date fair value of the award is determined, it will be evaluated as a payment to a customer under the revenue standard, in order to determine if it should reduce the transaction price (and revenue) or be reflected as the purchase of distinct goods and services. Any changes in the fair value of a liability-classified award subsequent to the grant date would not be recorded as an adjustment to revenue but rather will be recorded elsewhere in the income statement. Calendar year-end public companies will be required to adopt this new guidance on January 1, 2020; early adoption is permitted.
For more information, refer to In depth US2019-16, Shared-based awards issued to a customer.
In November 2019, the EITF affirmed its consensus-for-exposure on EITF Issue 19-A, which provides clarifications to certain interactions between the guidance in Investments - Equity Securities (ASC 321), Investments - Equity Method and Joint Ventures (ASC 323), and Derivatives and Hedging (ASC 815). The amendments could impact companies that hold equity instruments or equity method investments. The amendments state that observable transactions that result in a company applying or discontinuing the equity method of accounting for an investment should be considered when applying the measurement alternative in ASC 321. In addition, forward or option contracts for the purchase of equity instruments that will be accounted for under the equity method will be subject to ASC 321 prior to settlement.
The amendments will be effective on January 1, 2021 for calendar year-end PBEs; early adoption will be permitted. Adoption of the amendments will be prospective. The FASB ratified the amendments and directed the staff to draft an Accounting Standards Update. For further information, refer to our article, Accounting for certain equity instruments (EITF Issue 19-A), included in the third quarter 2019 edition of The quarter close.
During the November 2019 meeting, the EITF also discussed Issue 19-B, Revenue Recognition - Contract Modifications of Licenses of Intellectual Property. The EITF did not reach consensus on accounting for modifications to licenses of IP that extend the contract term for existing rights while adding additional rights. The EITF also did not reach consensus on a second issue related to the accounting for the revocation of licensing rights, including the conversion of term software licenses to SaaS arrangements. Further research will be performed on both issues.
In response to feedback regarding the cost-benefit of the goodwill impairment model, the FASB issued an Invitation to Comment (ITC) in July 2019. The intent was to determine if the subsequent accounting for goodwill and certain intangible assets could be simplified without impacting any decision-useful information provided in the financial statements.
The comment period for the ITC ended in October 2019 with the FASB receiving over 100 responses. The FASB also held a public roundtable in November 2019 to gather additional feedback. The respondents and those participating at the roundtable included companies across multiple sectors, educational institutions, accounting firms, consultants, individuals, and professional societies. The feedback received generally supported the simplification initiative, albeit there were mixed views regarding the adoption of a goodwill amortization model, with some questioning how such a model would be implemented.
We recognize the challenges faced by preparers in the current impairment model, and support the FASB’s continued outreach and their consideration as to whether changes to the current model would be beneficial.
For more information, listen to our podcasts, The responses are in. FASB's goodwill project: 5 things to know, and The FASB's goodwill accounting project: 5 things you need to know.
Non-GAAP measures continue to be an area of SEC staff focus and frequent subject of staff comment letters, sometimes resulting in requests to remove or substantially modify the measures and associated disclosures. One area of focus relates to the use of individually-tailored accounting principles, or “ITAPs,” particularly those relating to revenue. Adjustments to GAAP revenue that may be considered ITAPs include a shift from an accrual basis to another basis of accounting (e.g., cash basis) or presentation of a transaction in a manner that is inconsistent with its underlying economics.
The SEC staff has also emphasized the following with respect to non-GAAP measures included in documents furnished or filed with the SEC:
For reminders on the definition and application of SEC Rules governing non-GAAP measures, and for questions to consider before reporting non-GAAP measures, refer to our In the loop, Non-GAAP measures and the ongoing dialogue: What you should know, and our podcast, Non-GAAP financial measures: 5 things you need to know.
Recent PCAOB regulations require the inclusion of critical audit matters (CAMs) in the audit report. CAMs are the matters in the current year’s audit that involved especially challenging, subjective, or complex auditor judgment from the auditor’s point of view. The requirements first became effective for large accelerated filers with year ends on or after June 30, 2019, and will be effective for most other public companies for their 2020 year ends. So far we have seen an average of about two CAMs per audit report, although the number of CAMs varies based in part on whether there are non-recurring matters during the year. Thus far, the most common types of CAMs relate to auditing:
By the end of February 2020, investors will have access to a near-complete population of large accelerated filer audit reports that highlight CAMs. As more audit reports that include CAMs become available, investor relations departments should be prepared to answer questions related to CAMs. A best practice would be for management to ensure investor relations understand the intent of CAMs and the basis for CAM disclosures to facilitate communications with stakeholders. While it is still in the early days, the PCAOB and SEC are closely monitoring the implementation of CAMs. Matters the auditor has identified as CAMs could be areas of greater focus in the Division of Corporation Finance’s review of public company filings, including review of the company’s accounting and disclosure of specific matters.
For insights into the PCAOB’s expectations regarding CAM reporting, refer to the PCAOB staff’s implementation web page: New auditor’s report. To hear more about the PCAOB’s strategic plan, its research and standard setting agenda, and its expectations for CAM reporting, listen to our podcast, What’s on the PCAOB’s agenda? 5 things you need to know.
PCAOB leadership changes
In November 2019, Rebekah Goshorn Jurata was sworn in as a new PCAOB Board member, replacing Kathleen Hamm. The SEC also announced that Commissioner Hester Peirce has agreed to lead the Commission’s coordination efforts with the Board of the PCAOB, in coordination with the SEC’s Chief Accountant, Sagar Teotia, and others in the Office of the Chief Accountant. Read the SEC’s press release for further information.
Individual countries have begun to enact new “digital taxes” in an effort to tax the origination of profits and where digital value is created. Virtual supply chains, online stores, voluminous amounts of consumer data, and other similar developments are making digital taxation more relevant, and not just for technology companies. In addition, the Organization for Economic Cooperation and Development intends to set forth a long-term, consensus-based solution in 2020 using its current proposed framework to taxing this new environment. Obtaining international consensus on the appropriate methods of taxing the digital economy will not be without challenges. Given the fact that unilateral measures continue to be introduced, including enacted law in France and proposed laws in Great Britain, Spain, Italy, and other countries, companies should be prepared for the potential modifications to the international tax framework by monitoring developments and evaluating the potential impacts.
While the scope of the income taxes guidance may appear self-explanatory, the unique characteristics of the various tax regimes across the world can create complexity when determining whether a particular digital tax is based on income. As it impacts the accounting for and presentation of such taxes in the income statement, careful consideration will need to be given to the various digital tax laws and proposals to determine whether each of the tax regimes are, in substance, taxes based on income.
For more information, refer to our publication, Financial reporting analysis of taxing the digitalizing economy.
Corporate governance insights
Finance transformation areas of focus
Finance functions are transforming to become more strategic players that deliver greater value across the company. Transformation is happening through the adoption of innovative technologies, the push for automation, and demand for faster, more real-time, and greater data-backed insights. Key areas that companies should be thinking about as they transform their finance function include, strategic planning, the impact of automation and technology on operations and processes, their talent and people strategy, and how to monitor outcomes, performance, and benefits. For a look at what companies and their audit committees should be considering as the finance function evolves, refer to our Governance Insights publication, Finance transformation: four areas of focus for the audit committee.
Data privacy in 2020
Companies today are focusing on how to get the most value from their data. They also have to understand the risks that come with it. Data privacy regulations in the United States (e.g., California Consumer Protection Act (CCPA)) and around the world (e.g., General Data Protection Regulation) are mounting, and expectations around data use and privacy are evolving. In getting ready for 2020 companies should be asking themselves: (1) Are we ready for CCPA? (2) Are we building global privacy capabilities for the regulatory future? (3) How effective is our data strategy? (4) Are we building privacy and data ethics into new technologies? and (5) Are privacy and security prominently included in our deals process? For further considerations on data strategy and data privacy risks for companies and their audit committee, refer to our Governance Insights publication, Five questions boards should ask about data privacy in 2020.
Year-end financial reporting
Our Governance Insights publication, written for audit committees, highlights financial reporting matters, SEC actions, and other developments to consider as companies prepare for the 2019 calendar year-end financial reporting season. This is also a useful resource as management prepares for discussions with the audit committee, and provides insight into some of the questions that are top of mind.
The following identifies the FASB's recently released guidance, grouped by effective date for calendar year-end PBEs.
(a) Effective in 2020 for SEC filers other than SRCs; effective in 2023 for all other companies, including SRCs.
(b) Effective in 2022 for SEC filers other than SRCs; effective in 2024 for all other companies, including SRCs.
For further information on the new accounting guidance for public companies, including available PwC resources, refer to: Effective dates for new FASB guidance for calendar year-end public companies.
For further information on the new accounting guidance for nonpublic companies, including available PwC resources, refer to:
Effective dates for new FASB guidance for calendar year-end nonpublic companies.
Partner, National Professional Services Group, PwC US
Director, National Professional Services Group, PwC US