In this edition of the quarterly communication, we have provided information about financial reporting and accounting issues – some of which are currently being evaluated by regulatory agencies and not resolved at this time. We have also compiled a list of items for consideration in your financial reporting and disclosures for the third quarter and a summary of recently issued accounting pronouncements (see Appendices for summary of recently issued accounting pronouncements and the related effective dates).
This quarterly update is organized as follows:
The following selected Accounting Standards Updates (ASUs) were issued by the Financial Accounting Standards Board (FASB) during the third quarter. A complete list of all ASUs issued or effective in 2023 is included in Appendix A.
FASB Improves the Accounting for Joint Venture Formations
In August, the FASB issued ASU 2023-05, Business Combinations—Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement, which is intended to provide investors more information in a joint venture’s separate financial statements and reduce diversity in practice in this area of financial reporting.
The ASU applies to the formation of entities that meet the definition of a joint venture (or a corporate joint venture) as defined in the FASB Accounting Standards Codification (ASC) Master Glossary. While joint ventures are defined in the Master Glossary, there has been no specific guidance in the ASC that applies to the formation accounting by a joint venture in its separate financial statements, specifically the joint venture’s recognition and initial measurement of net assets, including businesses contributed to it. Stakeholders noted that the lack of guidance has resulted in diversity in practice in how contributions to a joint venture upon formation are accounted for by the joint venture. The amendments in this ASU provide information to a joint venture’s investors and reduce diversity in practice by requiring that a joint venture apply a new basis of accounting upon formation. As a result, a newly formed joint venture, upon formation, would initially measure its assets and liabilities at fair value (with exceptions to fair value measurement that are consistent with the business combinations guidance).
The amendments in this ASU are effective prospectively for all joint ventures with a formation date on or after January 1, 2025, and early adoption is permitted. Additionally, a joint venture that was formed before the effective date of the ASU may elect to apply the amendments retrospectively if it has sufficient information.
New cybersecurity rules from the Securities and Exchange Commission (SEC) take effect on December 15, 2023. The SEC’s cybersecurity rules, adopted in July 2023, require publicly listed companies to comply with numerous incident reporting and governance disclosure requirements. The rules join a host of other cybersecurity rules and standards from various government agencies and regulatory bodies. The new rules introduce mandatory cyber incident reporting requirements for all public companies. Domestic issuers must disclose material cybersecurity incidents in Form 8-K filings. Private foreign issuers must submit Form 6-K filings to disclose material cyber incidents.
The new rules state that issuers must disclose cybersecurity incidents that are determined to be material by the company. This standard is similar to the materiality standard utilized for other 8-K disclosure requirements under U.S. securities laws. Issuers must disclose the material impact of the incident on the company’s financial condition and operations. Disclosures must be filed within four business days after a company determines that it has experienced a material cyber incident.
Public companies will be required to disclose risk management and governance information in relation to cybersecurity, including board proficiency and oversight of cybersecurity risks, in their annual Form 10-K filings. These disclosure requirements will apply to fiscal years ending on or after December 15, 2023.
Although the rules primarily target publicly listed companies, other private and smaller companies should familiarize, prepare and monitor their operations for their security. Most public companies are reliant on many smaller third-party software and supply chain companies, and a cyberattack at any point along that chain could have a material impact. Therefore, such companies should also familiarize themselves with the new regulations.
SEC Staff Compliance Guide Explains New Cybersecurity Rules
The SEC’s Division of Corporation Finance (CorpFin) published a staff guide to help smaller public companies to comply with new cybersecurity rules adopted in July. CorpFin published Cybersecurity Risk Management, Strategy, Governance, and Incident Disclosure: A Small Entity Compliance Guide on the day the rulemaking release became effective—September 5, 2023. The new rules apply to domestic companies, foreign private issuers and business development companies.
The guide explains what is required by the rule as well as what it does not require. In particular, the rule does not require the company to disclose specific or technical information about its planned response to the incident or its cybersecurity systems, related networks and devices, or potential system vulnerabilities in such detail that would impede its response or remediation of the incident. Moreover, CorpFin stressed that Form 8-K filing is required not when the company discovers a cyber incident but when it determines that the incident was material. The materiality determination should be made without unreasonable delay. The guide explains an incident is material if there is a substantial likelihood that a reasonable shareholder would consider knowledge of the incident important in making an investment decision, or if it would have significantly altered the total mix of information made available. In terms of annual disclosure of risk management, strategy and governance related to cybersecurity, the release includes a non-exclusive list of disclosure items companies should provide based on their facts and circumstances.
The SEC provides phased-in compliance dates depending on the type of disclosure or categories of companies. For annual disclosures, all companies, including smaller reporting companies (SRCs) must provide the disclosures beginning with their annual reports for fiscal years ending on or after December 15, 2023. For material cybersecurity incident reporting, companies except for SRCs must begin complying by December 18, 2023. SRCs have an additional 180 days to comply by June 15, 2024.
House Democrat Reintroduces Pay Raise Ratio Bill
On September 14, 2023, Representative Nydia Velázquez of New York reintroduced a measure that would require public companies to disclose median annual compensation increases for their executive officers and rank-and-file workers along with a ratio comparing the two. H.R. 5519, The Greater Accountability in Pay Act, expands on the SEC’s pay ratio disclosure rules implemented under the Dodd-Frank Act. Emerging Growth Companies (EGCs) would be exempt from the bill’s requirements.
In 2015, the SEC finalized Release No. 33-9877, Pay Ratio Disclosure, requiring issuers to disclose a ratio comparing the total compensation of the CEO to that of the median employee. The disclosures have since then been used to highlight outsized CEO-to-worker pay disparities, most recently at Big Three automakers in the midst of a strike by United Auto Workers (UAW).
Senate Democrats Reintroduce Workforce Disclosure Bill
On September 11, 2023, two Senate Democrats reintroduced legislation to mandate sweeping new public company workforce disclosures. The legislation comes as the SEC prepares to launch its own human capital management disclosure rulemaking. Senator Mark Warner of Virginia originally introduced the Workforce Investment Disclosure Act in February 2020. He introduced the latest version (S. 2751) alongside Senate Banking Committee Chairman Sherrod Brown of Ohio. Representative Sylvia Garcia, a Texas Democrat, introduced the House version (H.R. 4578) in July.
The measure would amend the Securities Exchange Act of 1934 to direct the SEC to issue rules requiring annual disclosure of granular information on workforce demographics, turnover rates and other hiring and promotion data, diversity, skills and capabilities, health and safety, compensation and incentives, and recruiting. Among other disclosures, public companies would be required to provide data on benefits such as paid leave, health care and childcare; the frequency, severity, and lost time due to injuries, illness, and fatalities; and data on diversity – including racial, ethnic and gender composition – for both senior executives and individuals in the workforce. Under the bill, the SEC would be allowed to exempt Emerging Growth Companies (EGCs) from any of the disclosures.
Banking Regulators Push Back on FASB’s Proposal on Purchased Financial Assets
Senior accountants at four of the nation’s top banking regulatory agencies told the FASB they do not support the proposed changes for reporting purchased financial assets—provisions that would narrowly amend credit loss accounting rules banks recently adopted. According to an August joint comment letter to the FASB from chief accountants at the Board of Governors of the Federal Reserve System (the Fed), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA), and the Office of the Comptroller of the Currency (OCC), the proposed ASU, Financial Instruments—Credit Losses (Topic 326): Purchased Financial Assets, which was issued in June, comes too soon after new credit loss rules took effect and will introduce accounting results that are concerning. The proposal would expand the purchased credit deteriorated (PCD) accounting model to substantially all purchased financial assets, eliminating the immediate recognition of credit loss expense at acquisition and obscuring those expenses as a reduction of interest income (yield) over the lives of the loans, the agencies said. This would cause businesses to write off a purchased financial asset before the expected credit loss is fully expensed and incentivize them to buy financial assets instead of originating them to avoid immediate recognition of credit loss expense. In turn, this would result in different financial reporting outcomes despite the financial assets being economically similar.
The agencies are concerned that the gross-up accounting approach provides incentives to overstate expected credit losses at acquisition followed in later periods by overstatement of earnings when grossed-up allowances are reversed with a credit to provision expense (i.e., a negative provision).
The agencies said that because private banks just adopted the current expected credit losses (CECL) standard, implementing the proposal would create significant complexities and burden, including additional costs for financial and regulatory reporting borne by financial institutions, especially smaller, less complex institutions.
On the Horizon
The following selected FASB exposure drafts and projects are outstanding as of September 30, 2023.
Proposed ASU Related to Profits Interests Awards
In May, the FASB issued a proposed ASU that is intended to improve generally accepted accounting principles by adding illustrative guidance to help entities determine whether profits interest and similar awards should be accounted for as a share-based payment arrangement within the scope of ASC 718, Compensation—Stock Compensation.
Certain entities, typically private companies, provide employees and other service providers with profits interest and similar awards to align compensation with the company’s operating performance and provide those holders with the opportunity to participate in future profits and/or equity appreciation of the company. The Private Company Council (PCC) and other stakeholders have highlighted existing diversity in practice in accounting for these awards as a share-based payment arrangement under ASC 718 or similar to a cash bonus or profit-sharing arrangement (ASC 710, Compensation—General, or other Topics). As certain public business entities also may be required to account for profits interest awards, the PCC recommended that the Board add a project that would provide illustrative guidance for all reporting entities that account for profits interest and similar awards.
In March 2023, the FASB published a proposed ASU that addresses requests for improved income tax disclosures from investors, lenders, creditors, and other allocators of capital (collectively, “investors”) that use the financial statements to make capital allocation decisions. The FASB’s proposed enhancements to income tax disclosures, primarily related to the rate reconciliation and income taxes paid information, are intended to help investors better assess how an entity’s worldwide operations and related tax risks and tax planning and operational opportunities affect its tax rate and prospects for future cash flows.
During the FASB’s 2021 agenda consultation process and other stakeholder outreach, investors expressed concerns that existing income tax disclosures do not provide sufficient information to understand the tax provision for an entity that operates in multiple jurisdictions. Investors currently rely on the rate reconciliation table and other disclosures, including total income taxes paid in the statement of cash flows, to evaluate income tax risks and opportunities. While investors said they generally find these disclosures helpful, they suggested possible enhancements to better (1) understand an entity’s exposure to potential changes in jurisdictional tax legislation and the ensuing risks and opportunities, (2) assess income tax information that affects cash flow forecasts and capital allocation decisions, and (3) identify potential opportunities to increase future cash flows.
The amendments in this proposed ASU would address investor requests for more transparency about income tax information, including jurisdictional information, by requiring (1) consistent categories and greater disaggregation of information in the rate reconciliation and (2) income taxes paid disaggregated by jurisdiction.
Proposed ASU on Accounting for Crypto Assets
In March 2023, the FASB published a proposed ASU intended to improve the accounting for and disclosure of certain crypto assets. During the FASB’s recent agenda consultation process, stakeholders from all professional backgrounds identified digital assets as a top priority area for the Board to address. The FASB heard feedback that the accounting for crypto assets as indefinite-lived intangible assets, which is a cost-less-impairment model, does not provide investors with decision-useful information or reflect the underlying economics of those assets.
The amendments in this proposed ASU would improve the accounting for certain crypto assets by requiring an entity to measure those crypto assets at fair value each reporting period with changes in fair value recognized in net income. The proposed amendments also would improve the information provided to investors about an entity’s crypto asset holdings by requiring disclosure about significant holdings, restrictions, and changes in those holdings.
The amendments in this proposed ASU would apply to all entities holding crypto assets that meet all the following criteria:
- Meet the definition of intangible asset as defined in the FASB Accounting Standards Codification Master Glossary
- Do not provide the asset holder with enforceable rights to, or claims on, underlying goods, services, or other assets
- Are created or reside on a distributed ledger based on blockchain technology
- Are secured through cryptography
- Are fungible
- Are not created or issued by the reporting entity or its related parties
FASB Issues Proposal to Improve Disclosures about Reportable Segments
In October 2022, the FASB issued a proposed ASU that would improve the disclosures about a public entity’s reportable segments and address requests from investors and other allocators of capital for additional, more detailed information about a reportable segment’s expenses.
Investors and other allocators of capital have observed that segment information is critically important in understanding a public entity’s different business activities. That information enables investors to better understand an entity’s overall performance and assists in assessing potential future cash flows. In addition, investors have observed that although information about a segment’s revenue and measure of profit or loss is disclosed in an entity’s financial statements, there generally is limited information disclosed about a segment’s expenses.
The amendments in the proposed ASU respond to feedback received from investors and other allocators and would improve reportable segment disclosure requirements, primarily through enhanced disclosures about significant segment expenses. The key amendments in the proposed ASU would:
- Require that a public entity disclose, on an annual and interim basis, significant segment expenses that are regularly provided to the chief operating decision maker (CODM) and included within each reported measure of segment profit or loss
- Require that a public entity disclose, on an annual and interim basis, an amount for other segment items by reportable segment and a description of its composition. The other segment items category is the difference between segment revenue less the significant expenses disclosed and each reported measure of segment profit or loss
- Require that a public entity provide all annual disclosures about a reportable segment’s profit or loss and assets currently required by ASC 280, Segment Reporting, in interim periods
- Clarify that if the CODM uses more than one measure of a segment’s profit or loss, at least one of the reported segment profit or loss measures (or the single reported measure if only one is disclosed) should be the measure that is most consistent with the measurement principles used in measuring the corresponding amounts in a public entity’s consolidated financial statements
- Require that a public entity that has a single reportable segment provide all the disclosures required by the amendments in the proposed ASU and all existing segment disclosures in ASC 280
The amendments in the proposed ASU would apply to all public entities that are required to report segment information in accordance with ASC 280.
Potential GAAP Guidance on Government Grants
In June 2022, the FASB published an Invitation to Comment (ITC), Accounting for Government Grants by Business Entities: Potential Incorporation of IAS 20, Accounting for Government Grants and Disclosure of Government Assistance, into Generally Accepted Accounting Principles. The ITC gives stakeholders the opportunity to provide feedback on whether IAS 20 represents a workable solution for improving GAAP in the U.S. financial reporting environment for business entities as it relates to the accounting for government grants.
In 2021, the FASB issued the Invitation to Comment, Agenda Consultation, which gave all stakeholders the opportunity to provide input on what the Board’s future priorities should be. The 2021 ITC asked stakeholders to weigh in on a broad range of issues, including whether the FASB should pursue a project on the recognition and measurement of government grants—and, if so, whether it should leverage an existing grant or contribution model or develop a new accounting model. Approximately three-quarters of stakeholders who provided specific feedback on that question, including investors, practitioners, preparers, and state certified public accounting societies, preferred that the FASB leverage International Accounting Standard (IAS) 20, Accounting for Government Grants and Disclosure of Government Assistance.
In response to this feedback, the FASB added a project, Accounting for Government Grants, Invitation to Comment, to the research agenda. Published as part of that research project, the government grants ITC solicits additional feedback from stakeholders on relevant requirements in IAS 20 and includes specific questions for investors about the importance and utility of government grants information to their analysis of a company’s financial performance.
Projects on Environmental Credits, Consolidation, and KPIs
In May 2022, the FASB added a project to its technical agenda on the recognition, measurement, presentation and disclosure of environmental credits that are legally enforceable and tradeable, following a review of the staff’s initial research on accounting for environmental credits, including feedback that there is diversity in practice in this area. The project will address the accounting by participants in compliance and voluntary programs, as well as by creators of environmental credits. In addition, the FASB added a project on consolidation for business entities to its research agenda after removing its project on consolidation reorganization and targeted improvements from the technical agenda. The new project will explore whether a single consolidation model could be developed for business entities. In response to feedback received on the FASB’s Invitation to Comment, Agenda Consultation, the FASB also added a project on financial key performance indicators to the research agenda to explore standardizing the definitions of financial key performance indicators.
EITF Agenda Items
The Emerging Issues Task Force (EIFT) met on September 14, 2023, and deliberated the following topic:
- Issue No. 23-A, “Induced Conversions of Convertible Debt Instruments.” The Task Force reached a consensus-for-exposure to amend the induced conversions guidance to improve its relevance. The Task Force reached a consensus-for-exposure to:
- Pursue the preexisting contract approach for induced conversion assessment. Under this approach, only conversions that include the issuance of all the consideration (in form and amount) pursuant to conversion privileges included in the terms of the debt at issuance would be accounted for as induced conversions.
- Include clarifications that, under the preexisting contract approach, when evaluating whether the amount of cash (or combination of cash and shares) issuable under the original conversion privileges is preserved by the inducement offer:
- An entity should determine the amount of cash and number of shares that would be issued based on the fair value of the entity’s shares as of the offer acceptance date.
- If, within a year leading up to the offer acceptance date, the debt has been exchanged or modified without being deemed to be substantially different, then the debt terms that existed a year ago should be used in place of the terms of the debt at issuance.
- Apply induced conversion accounting to all convertible debt instruments, including instruments that are not currently convertible, so long as those instruments contained a substantive conversion feature as of the time of issuance and are within the scope of the guidance in Subtopic 470-20, Debt—Debt with Conversion and Other Options.
The Task Force also reached a consensus-for-exposure to permit either (a) prospective or (b) retrospective transition for convertible debt instruments settled after the adoption of the amendments in ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity. The Task Force also reached a consensus-for-exposure on certain transition disclosures.
The FASB will consider for ratification the consensus-for-exposure on Issue 23-A on October 4, 2023. The next EITF meeting has not been scheduled.
The Private Company Council (PCC) met on Thursday, June 22, and Friday, June 23, 2023. Below is a summary of topics addressed by the PCC at the meeting:
- Improvements to Income Tax Disclosures: FASB staff summarized the main proposed amendments for private companies in the proposed ASU, Income Taxes (Topic 740): Improvements to Income Tax Disclosures, and highlighted comment letter feedback pertaining to private companies. Overall, user PCC members expressed support for the enhanced disclosures in the proposed Update, stating that the disclosures would provide useful information. Some practitioner PCC members questioned the relevance of the proposed changes to the qualitative rate reconciliation disclosure for private companies, noting that it would impose additional costs, while acknowledging the current requirement for private companies to disclose qualitative information about the rate reconciliation. Some preparer PCC members stated that the disclosures would not impose significant additional costs to prepare. Some PCC members suggested aggregating state income taxes paid information and expressed concern with the interaction of materiality and the proposed 5 percent threshold for income taxes paid to individual jurisdictions. Other PCC members noted that aggregation of the taxes paid disclosure would diminish the utility of the information. Most PCC members supported providing private companies with additional time to implement the proposed amendments beyond the effective date for public business entities. User PCC members supported retrospective transition to assess trends but noted that they would support prospective transition to get the information sooner.
- Disclosure Improvements in Response to the SEC’s Release on Disclosure Update and Simplification: FASB staff summarized the Board’s recent decisions during redeliberation of SEC-referred disclosures included in the proposed ASU, Disclosure Improvements: Codification Amendments in Response to the SEC’s Disclosures Update and Simplification Initiative, including required disclosures for private companies, effective date, and transition. PCC members expressed support for the Board’s decisions applicable to private companies. PCC members asked clarifying questions about specific disclosures and the effective date for private companies.
- Credit Losses—Implementation: FASB staff provided an update on the Purchased Financial Assets project and asked PCC members for feedback on that project and on other credit losses implementation matters. Some PCC members discussed their observations on the scope of the credit losses guidance and the application of that guidance by entities that are not financial institutions.
- Scope Application of Profits Interest Awards: FASB staff discussed the amendments in the proposed ASU, Compensation—Stock Compensation (Topic 718): Scope Application of Profits Interest Awards. PCC members noted that the proposed illustrative guidance will help to reduce diversity in practice and indicated support for the proposed transition requirements. Some PCC members, including the PCC Chair, emphasized the importance of communicating the amendments in the proposed Update to relevant stakeholders.
- Accounting for and Disclosure of Software Costs: PCC members discussed certain elements of the single model being researched by the FASB staff that would apply to costs that a company incurs to acquire, internally develop, or modify software. Those elements include the probable threshold and related indicators, unit of account, costs incurred after the software project is substantially complete, and presentation and disclosure. Overall, PCC members were supportive of the single model. Several PCC members supported the probable threshold and related indicators. Some PCC members expressed concern with including compulsion as an indicator that supports the application of the probable threshold. PCC members discussed challenges with applying the single model in an agile environment, including the judgment involved in identifying the unit of account and determining when a project is substantially complete. Some PCC members stated that data conversion costs should be included in the costs eligible for capitalization.
- Stock Compensation Disclosures (PCC Research Project): FASB staff and members of the PCC’s stock compensation disclosures working group summarized the working group’s continued outreach with private company stakeholders, including practitioners and users, on research related to whether disclosures differences are warranted for private companies. Working group members thanked the staff for its efforts and noted that outreach participants have provided the working group with helpful feedback to continue its research.
- Definition of a Derivative: FASB staff summarized feedback received as part of the June 2021 Invitation to Comment, Agenda Consultation, and provided an overview of certain arrangements identified by stakeholders that generally meet the definition of a derivative (R&D funding arrangements, financial instruments with ESG-linked features, litigation funding arrangements, and certain variable consideration provisions in revenue arrangements). Several PCC members stated that the definition of a derivative is complex and, as a result, it can be difficult to evaluate whether an arrangement meets the definition. PCC members suggested solutions, including a derivative scope exception for arrangements that involve an entity’s performance. The PCC Chair noted that creating new scope exceptions for specific arrangements may necessitate additional standard setting in the future as new arrangements emerge.
- Leases Implementation: PCC members discussed recent observations from the implementation of ASC 842, Leases, and the feedback received during the PCC forum held at the June 2023 AICPA ENGAGE conference. PCC members discussed materiality thresholds, related party leases, embedded leases, the short-term lease recognition exception, and disclosures. User PCC members noted that previous concerns about the effect ASC 842 would have on debt covenants and financial ratios generally did not materialize.
Appendix A – Important Implementation Dates
The following table contains significant implementation dates and deadlines for standards issued by the FASB and others.
Appendix B – Illustrative Disclosures for Recently Issued Accounting Pronouncements
For the Quarter Ended September 30, 2023
The illustrative disclosures below are presented in plain English. Please review each disclosure for its applicability to your organization and the need for disclosure in your organization’s financial statements.
Appendix C – Recently Issued Accounting Pronouncements
NOTE: The disclosures in the previous appendix are not intended to be all inclusive. All pronouncements issued during the period should be evaluated to determine whether they are applicable to your Company. Through September 30, 2023, the FASB has issued the following Accounting Standard Updates during the year.
- ASU 2023-01, Leases (Topic 842) Common Control Arrangements
- ASU 2023-02, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method (a consensus of the Emerging Issues Task Force)
- ASU 2023-03, Presentation of Financial Statements (Topic 205), Income Statement—Reporting Comprehensive Income (Topic 220), Distinguishing Liabilities from Equity (Topic 480), Equity (Topic 505), and Compensation—Stock Compensation (Topic 718): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 120, SEC Staff Announcement at the March 24, 2022 EITF Meeting, and Staff Accounting Bulletin Topic 6.B, Accounting Series Release 280—General Revision of Regulation S-X: Income or Loss Applicable to Common Stock (SEC Update)
- ASU 2023-04, Liabilities (Topic 405): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 121 (SEC Update)
- ASU 2023-05, Business Combinations—Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement