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The Next Big Wave in Accounting Change: Debt vs. Equity and Performance Reporting – FEI

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Just as companies are starting to see the light at the end of the tunnel on implementation of the new revenue recognition standard, they are being faced with the challenges involved in operationalizing the new lease accounting standard. There is no doubt about it—accounting policy groups are hard at work to keep up with the changes the FASB is making to accounting guidance. And there is little indication that the FASB will be slowing the pace of accounting change. The Board just added two new projects to their agenda, which will require the attention of financial executives in the months and years to come.

At the FASB’s September 20th decision making meeting, the Board considered stakeholder feedback on projects outlined in their Agenda Consultation, and ultimately decided to add projects under two broad categories; (1) distinguishing liabilities from equity, and (2) financial performance reporting.

Liabilities vs. Equity
Distinguishing liabilities from equity is an area of financial reporting that has been a point of contention for over thirty years. As financial instruments have evolved and have become more complex, the guidance for accounting has failed to keep up in a clear and meaningful way. The result: a patchwork of guidance that is often improperly applied in practice.

This is evidenced by the fact that “debt, quasi-debt, warrants” and other securities with beneficial conversion features have been identified as the number one area of restatement for over ten consecutive years, according to a recent report from Audit Analytics.

In a comment letter to the FASB, the New York State Society of CPAs (NYSSCPA) wrote, “…Distinguishing Liabilities from Equity is the highest priority issue discussed in the Agenda Consultation. The topic needs an updated framework for analysis and potentially has the most wide-reaching impact on financial statement users and preparers. Financial instruments are one of the more complex accounting topics for users of financial statements to understand.”

This reaffirms the importance of the Board’s objective of the project—to improve understandability and reduce complexity in this area, without loss of information for users. The project will focus on indexation and settlement (in the context of the derivative scope exception), convertible debt, disclosures, and earnings-per-share.

A Focus On Financial Performance Reporting

Financial performance reporting (FPR) also has a long standard setting history. In 2001, the FASB added a project on FPR to its agenda, and worked on the project jointly with the International Accounting Standards Board for many years. As the project progressed, both Boards realized that significant staff resources would be needed to complete the project, more resources than were available. The Boards decided to focus on higher priority projects and to readdress FPR once such resources became available.

However, U.S. stakeholders continued to express support improvements to the financial statement presentation. CFA Institute, an advocate of the investor perspective, ranked FPR as the top priority for the FASB to tackle in their comment letter on the Agenda Consultation, writing, “Improving the presentation of financial statement line items has been a long-standing investor priority for the overall improvement of financial reporting information as it can help investors to better assess the performance, liquidity and financial condition of reporting entities…” At last week’s meeting, the FASB voted to …

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