FASB proposes changes to simplify derivatives and revenue accounting rules

The FASB has taken a major step towards simplifying and clarifying financial reporting, unveiling on July 23, 2024, significant proposed changes to derivatives accounting and revenue recognition guidance.

For years, companies and investors have struggled with the complexity and inconsistencies of current practices, which have led to inaccurate reporting and poor decision-making. By addressing these long-standing issues, the FASB aims to provide stakeholders with a clearer picture of a company's financial health and performance.

The proposal tackles two major pain points: inconsistent application of derivative accounting and varying approaches to accounting for share-based payments from customers.

The amendments were released under Proposed Accounting Standards Update (ASU) No. 2024-ED100, Derivatives and Hedging (Topic 815) and Revenue From Contracts with Customers (Topic 606): Derivatives Scope Refinements and Scope Clarification for a Share-Based Payment From a Customer in a Revenue Contracts, to solicit public comment.

Companies have until Oct. 21 to weigh in.

Simplifying derivative accounting rules

The FASB proposes to streamline derivative accounting rules by excluding contracts with features based on the operations or activities of one of the parties to the contract. This change is expected to reduce the cost and complexity of evaluating whether these contracts are derivatives.

Additionally, the board suggests replacing the existing correlation assessment with a fair value assessment to determine the predominant characteristics of contracts with multiple underlying assets. This change is expected to simplify the evaluation process and reduce costs and complexity. Currently, companies must perform a correlation assessment to determine whether a contract qualifies as a derivative, which can be a time-consuming and complex process. By switching to a fair value assessment, companies will be able to evaluate the contract's value based on its underlying assets, making it easier to determine its overall fair value

Clarifying share-based payments from customers

The proposed amendments also aim to clarify the accounting treatment for share-based payments from customers that are consideration for the transfer of goods or services. Companies will be required to apply Topic 606, Revenue from Contracts with Customers, to these payments.

Furthermore, the guidance in Topics 815, Derivatives and Hedging, and 321, Investments-Equity Securities, which cover derivatives and equity, respectively, will not apply unless and until the share-based payment is recognized as an asset under Topic 606.

Expected benefits and costs

The proposed amendments could bring about several key benefits, including:

• A simplified evaluation process for determining whether contracts qualify as derivatives, reducing costs and complexity;

• Enhanced accuracy and relevance of financial information, more effectively capturing the economic essence of these contracts; and

• Promoting consistency in accounting practices for share-based payments from customers, reducing variability and improving comparability.

For in-depth analysis of the FASB's revenue recognition standard, please see Catalyst: US GAAP - Revenue Recognition, also on Checkpoint.

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