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Banks, insurers and others getting relief from complex accounting analysis over rate reform

The Financial Accounting Standards Board (FASB) on June 19, 2019, said a change in a contract’s reference rate as a result of the marketwide shift away from certain inter-bank offered rates, including the London Interbank Offered Rate (LIBOR), would not create a new contract but would be accounted for as a continuation of that contract.

The decision would apply to loans, debt, leases, embedded derivatives and other arrangements impacted by reference rate reform.

The relief would provide ease to an accounting analysis companies would have had to perform, which would have been costly and complex, the FASB’s discussions indicated. Companies when making a change to accounting terms, for example, have to assess how much future cash flows change – a detailed assessment under general accepted accounting principles (GAAP).

“Reference rate reform is a top priority for the Board, and we’re committed to ensuring standards help stakeholders successfully adapt to the changes ahead,” FASB Chairman Russell Golden said in a press release. “Today’s decisions will ease, from an accounting standpoint, the transition to a new reference rate for all organizations, thereby reducing accounting cost and complexity.”

The board’s decision specifically means companies would get relief from having to reassess: whether modification to a loan or debt instrument is a troubled debt restructuring pursuant to Topic 310, Receivables, and Topic 470, Debt; the lease modification requirements in Topic 840 and Topic 842, Leases; and, embedded derivatives pursuant to Topic 815, Derivatives and Hedging.

Companies would also get a “catch all” principle to provide relief from contract modification requirements in other topics not explicitly specified but qualify for the changes, the discussions indicated.

Board members flagged, for example, contracts carried by insurance companies. “It’s not out of the ordinary to have reinsurance products or annuities with LIBOR based payment structures,” FASB Vice Chairman James Kroeker said.

Kroeker suggested the board ask a question when it issues a public comment proposal about whether there are “other areas more prevalent than anticipated.”

The board’s discussion is part of phase two of its work to facilitate the effects on financial reporting due to rate reform. Whether or not to get more prescriptive rules for companies trying to figure out terms in a contract was considered during board discussions.

Board member Christine Botosan, who favored more prescriptive rules, said she viewed it as a way to facilitate and mitigate costs that would be incurred from following a principle.

“In my mind this situation is a little bit different than the environment in which we’re normally setting standards and why we’re setting standards,” Botosan said. “First of all it’s a very unique situation – the entire marketplace trying to transition from a reference rate to a new set of reference rates,” she said.

The reason why the board is doing the work is that LIBOR is going away, Botosan said. “Let’s just be upfront about that and say ‘LIBOR and all of its variations qualify’ and then we can have the principle that follows that that says ‘if you’re dealing with some other rate then you need to consider whether it meets this requirement,’” she said.

The FASB’s discussions stem from global concerns about the sustainability of LIBOR and other IBORs, which has led to an effort to identify alternative reference rates. In the U.S. the Alternative Reference Rates Committee convened by the Federal Reserve identified the Secured Overnight Financing Rate (SOFR) as its preferred alternative reference rate to U.S. dollar LIBOR.

Concurrent with adding SOFR as a benchmark interest rate for hedge accounting purposes in 2018, the board decided to add a project to its agenda to broadly consider changes to GAAP as triggered by the marketwide transition away from certain inter-bank offered rates, including LIBOR.

The FASB said will address hedge accounting, among other items, at a future meeting.

For more information on this topic, or to learn how Baker Tilly accounting and assurance specialists can help, contact our team.

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