A new accounting standard arising from regulatory action in the banking sector will have an impact on many different types of organizations, especially those with contracts and/or debt securities that utilize a reference to determine applicable interest rates. After more than 40 years as the reference for interest rates, the London Interbank Offered Rate (LIBOR) will be phased out on Dec. 31, 2024. With the sunsetting of this rate, the FASB introduced ASC Topic 848, Reference Rate Reform, through Accounting Standards Updates (ASUs) 2020-04, 2021-01 and 2022-06.
These publications have resulted in temporary optional expedients to relieve the accounting burden of the transition away from LIBOR. After the sunsetting date of this relief, the expedients would no longer be available.
The amendments in ASC Topic 848 are elective and apply to all entities (subject to meeting certain criteria) that have contracts, hedging relationships and other transactions that reference LIBOR. These amendments also apply when referencing a rate other than LIBOR that is expected to be discontinued because of the reference rate reform.
While the impacts of this reform range broadly, organizations should focus on two of the most common areas affected: contract modifications and held-to-maturity debt securities. Changes to accounting in these two areas can be complicated, but the FASB has provided guidance and relief to assist the transition. Read on to learn the impact of these areas.
Typically, the phasing out of LIBOR under the current GAAP would be considered a contract modification, and such a modification would require entities to evaluate whether the modifications create a new contract or continue an existing one. If a new contract is deemed to be created, a gain or loss may have to be recognized in the period the existing contract is terminated.
If the entity applies the ASC Topic 848 optional relief, contract modifications resulting from the reference rate reform transitions are accounted for prospectively, without having to perform such an evaluation.
ASC 848 allows for relief as follows for certain contracts:
- Contracts under Topic 210, Receivables and Topic 470, Debt:
- Modifications to these contracts should be accounted for prospectively by adjusting the effective interest rate.
- No gain or loss should be recognized because of the rate change.
- Contracts under Topic 842, Leases:
- Modifications should be accounted for as a continuation of the existing agreements with no reassessments or remeasurements otherwise required under Topic 842.
- Optional relief is also available for certain hedging and derivatives contracts.
When considering contract modifications that leverage Reference Rate Reform’s expedients, there are a few things to consider:
- Entities must disclose the nature and reason for electing to apply these optional expedients for derivatives, hedges or contract modifications.
- The expedients must be applied in the same way across all of an entity’s contracts.
HELD-TO-MATURITY DEBT SECURITIES
ASC 848 also creates a provision for a one-time election to sell and/or transfer eligible debt securities accounted for as “held to maturity” to “available for sale” or “trading” securities. This election may occur any time after March 12, 2020, through Dec. 31, 2024. Eligibility requirements are:
- Asset must be classified as held to maturity prior to Jan. 1, 2020.
- Reference a rate expected to be phased out due to the transition away from LIBOR or another discontinued reference rate.
This provision does not need to be applied to all held-to-maturity securities.
WHAT HAPPENS AFTER LIBOR IS SUNSETTED?
LIBOR in U.S. dollars will be sunset on June 30, 2023. ASC 848 does not include a list of the reference rates replacing LIBOR, but it does discuss some potential alternatives:
- Secured Overnight Financing Rate (SOFR)
- Singapore Overnight Rate Average (SORA)
- IBORs where the production method has changed (e.g., Euribor)
The transition away from LIBOR is a significant change, but the relief provided by the FASB can ease the accounting burden of its impacts. Additionally, GHJ is here to help organizations make the transition smoothly and effectively.
To learn more about reference rate reform and how your business should prepare for the change, contact GHJ’s Audit and Assurance Team.