In recent years, FASB has made a priority of removing unnecessary complexity from FASB’s accounting standards. The author gives a detailed accounting of completed and ongoing projects in FASB’s Simplification Initiative, along with an assessment of its future.
Conducting business in today’s global environment has become increasingly difficult and complex, and accounting standards are no different. Indeed, both financial statement preparers and users have expressed views that current generally accepted accounting principles (GAAP) are often unnecessarily complex. Preparers complain of overload and excessive costs, and investors and creditors argue that complex financial statements obscure important information and inhibit sound investment and credit decisions. These concerns have been echoed by many, including FASB Chairman Russell Golden, who recently stated that “complexity in accounting is costly for both investors and companies” (Remarks at the AICPA Conference on the SEC, PCAOB, and FASB in Washington, D.C., Dec. 9, 2014).
To address these concerns, FASB has undertaken an initiative to reduce the costs and complexity of GAAP while maintaining or enhancing the quality and usefulness of information. This Simplification Initiative was launched in May 2014 and entails making narrow-scope simplifications that can be accomplished relatively quickly. By tackling targeted areas of complexity, FASB hopes to provide cost savings to both preparers and auditors. In addition, more straightforward guidance may improve the usefulness and relevance of information to financial statement users by making it easier to understand and compare information across companies.
In the past year, FASB has completed nine different simplification projects. These projects, along with their expected effective dates, are shown in the Exhibit and detailed below.
Completed Simplification Initiative Projects
One of the first issues addressed was the elimination of the concept of extraordinary items from GAAP. This is expected to save preparers both time and money by avoiding the extraordinary item assessment process and alleviating uncertainty for auditors and regulators. In addition, there should be no loss of information, because the requirement that items of an unusual or infrequent nature be presented separately from continuing operations was retained. Thus, financial statement users should still be able to identify relevant events or transactions without the extraordinary item classification. In addition, no significant effect on financial reporting is expected due to the small number of companies that actually report extraordinary items.
Subsequent measurement of inventory.
FASB simplified the subsequent measurement of inventory by requiring most inventory to be measured at the lower of cost or net realizable value (NRV), defined as the estimated selling price less reasonably predictable costs of completion, disposal, and transportation. By removing the requirement to determine replacement cost and evaluate it relative to a ceiling (NRV) and a floor (NRV less a normal profit margin), the time, effort, and overall complexity involved will be reduced. In addition, there should be increased comparability, because only one measure of market value will be reported. It should be noted, however, that this requirement does not apply to inventories measured using either the last-in, first-out (LIFO) or retail inventory methods. Nevertheless, FASB believes the reduced complexity for companies that do not use the LIFO or retail inventory methods will outweigh any costs.
Debt issuance costs.
Previously, the specific incremental, third-party costs directly attributable to issuing a debt instrument had to be presented as a deferred asset and amortized into interest expense over the life of the debt. The new standard requires such debt issuance costs to be presented as a direct deduction from the carrying value of the debt. Because debt issuance costs effectively reduce the proceeds of the borrowing and increase the effective interest rate, FASB believes that this new guidance better aligns the accounting with the underlying economics of the transaction. Questions have subsequently arisen, however, regarding the presentation and measurement of costs associated with revolving debt arrangements. The SEC has clarified that the guidance on debt issuance costs does not apply to revolving debt arrangements, and that it would not object to companies continuing to defer these costs as an asset and amortizing them over the term of the debt agreement.
Employer retirement obligations.
To simplify the accounting for defined benefit pension or other postretirement benefit plans, FASB issued guidance that provides a practical expedient for companies whose fiscal year-end does not coincide with a month-end. Because the information obtained from third parties is often reported as of month-end, companies may now elect to measure defined benefit plan assets and obligations using the month-end closest to the fiscal year-end. This policy election and the date used must be disclosed. In addition, if a significant event caused by the company (e.g., plan amendment, settlement, or curtailment) occurs between the month-end measurement date and the year-end, a remeasurement is required. This practical expedient is expected to reduce compliance costs.
While not part of the Simplification Initiative, related guidance from FASB simplifies certain aspects of employee benefit plan accounting:
- It eliminates the requirement that fully benefit-responsive investment contracts (FBRIC) be measured at fair value. Instead, FBRICs are measured, presented, and disclosed only at contract value.
- It eliminates the requirements to disclose 1) individual investments representing 5% or more of the net assets available for benefits and 2) the net appreciation/depreciation for investments by general type, although this disclosure must still be presented in the aggregate.
- It allows a measurement date practical expedient similar to the one previously discussed.
FASB eliminated the requirement for an acquirer in a business combination to restate prior periods for adjustments made to previously recognized provisional amounts as if they were recognized on the acquisition date. Instead, the cumulative effect of these adjustments will be recognized in the period in which the adjustment is identified. This cumulative effect on earnings will be recognized within the line item affected (e.g., the cumulative change in depreciation expense will be reflected in the depreciation expense line item).
Cloud computing arrangements.
Because existing GAAP did not include explicit guidance regarding accounting for fees paid in a cloud computing arrangement, significant diversity has resulted in practice. In an effort to reduce the cost and complexity of evaluating these fees, FASB issued guidance regarding whether a cloud computing arrangement contains a software license. If such a license is determined to exist, it should be accounted for in the same manner as of other software licenses; if not, the arrangement should be accounted for as a service contract.
FASB now requires that all deferred tax assets and liabilities, along with any related valuation allowance, be classified as noncurrent. Thus, the requirement to allocate any valuation allowance on a pro rata basis between current and noncurrent deferred tax assets is eliminated. Companies are still prohibited from offsetting deferred tax liabilities from one jurisdiction against deferred tax assets from another. A single, net noncurrent deferred tax asset or liability will be reported for each jurisdiction.
Equity method accounting.
FASB has eliminated the requirement to retrospectively apply the equity method in cases where ownership has increased to a level that qualifies for it. Instead, the cost of acquiring the additional interest in the investee is added to the carrying value of the existing investment, and the equity method is applied prospectively.
FASB has simplified many aspects of the accounting for stock compensation to employees. One of the most significant proposals is the treatment of deferred tax effects resulting from the difference between the tax deduction and the compensation cost recognized in the financial statements. Currently, any excess tax benefit is recognized in additional paid-in capital (APIC), and tax deficiencies are recognized either in the income tax provision or APIC. Under the new standard, all deferred tax effects would be recognized through the income tax provision on the income statement. Note that this treatment would affect a company’s effective tax rate and introduce volatility into a company’s income tax expense. In addition, all excess tax benefits would be classified as operating activities, rather than their current treatment as financing activities, on the statement of cash flows.
Other provisions of the standard—
- permit a policy election to either estimate the number of forfeitures of share awards or recognize the forfeitures as they occur;
- allow companies to withhold shares to satisfy the employer’s tax withholding requirement up to the highest marginal tax rate applicable to employees, rather than the employer’s minimum statutory rate, without triggering liability classification;
- allow nonpublic companies a onetime election to change the measurement of liability-classified awards from fair value to intrinsic value;
- allow nonpublic companies an election to estimate the expected term for share-based awards with performance or service conditions that meet certain conditions as the midpoint between the vesting term and the contractual term of the award.
In addition to the completed projects, several other simplification projects have been added to FASB’s agenda. These projects are briefly summarized below.
FASB has proposed that the tax consequences of intra-entity asset transfers be recognized when the transfer occurs, rather than deferring the tax consequences as required by current GAAP. This proposal could have a significant effect on a company’s tax provision both when the transfer occurs and in future periods.
Equity method accounting.
Under the equity method of accounting, a company must analyze the difference between the purchase price of an investment and its share of the underlying fair value of the investee’s net assets. This difference is attributed to the identifiable assets and liabilities whose fair values differ from their book values, with any excess cost considered equity method goodwill. Subsequently, an investor must adjust its share of the investee’s earnings for this basis difference. FASB has proposed eliminating the requirement to separately identify, allocate, and disclose these basis differences.
Liabilities and equity.
FASB has tentatively decided that, in determining whether an equity-linked financial instrument with a down-round feature should be classified as liability or equity, a company should not consider the downround feature when assessing if the instrument is indexed to its own stock.
FASB has proposed to remove step 2 of the goodwill impairment test. A company will not be required to perform a hypothetical purchase price allocation to calculate an implied fair value of goodwill. Instead, the impairment loss would be the difference between the fair value of the reporting unit and its carrying amount. In addition, FASB is also considering other changes to the accounting for goodwill (e.g., whether to permit or require the amortization of goodwill).
Balance sheet classification of debt.
In this project, FASB has proposed that debt be classified as noncurrent if it is contractually due to be settled in more than 12 months after the balance sheet date or if the company has a right to defer settlement for at least 12 months after the balance sheet date.
Net periodic pension and postretirement benefit cost.
FASB has proposed to require companies to present service cost in the same line item as other current employee compensation costs. The remaining components of net pension or postretirement benefit cost would be reported in a separate line item outside of the operating section of the income statement. In addition, the components of net benefit cost eligible to be capitalized to service cost would also be limited.
Simplification Going Forward
With the actions taken to date, FASB has clearly made reducing complexity a priority. In addition to the projects undertaken as part of the Simplification Initiative, FASB has adopted a policy to review standards prior to issuance to determine if they are more complex than they need to be. Whether this goal has been achieved in all cases (e.g., the new standard on revenue recognition) is certainly debatable. It is clear, however, that simplification is not confined to the narrowscope projects previously discussed, but rather is a broad concept whose influence is being felt across FASB’s agenda.
It should be noted that the completed simplification projects converge with International Financial Reporting Standards (IFRS). For example, the projects related to extraordinary items, the subsequent measurement of inventory, debt issuance costs, and income taxes all align U.S. GAAP more closely with IFRS. Thus, these simplification projects should not only result in less complex standards, but also support FASB’s commitment to converge U.S. GAAP with IFRS.
Completely eliminating complexity may be an impossible task. Sometimes, complex business transactions require complex accounting. In addition, the various proposals presented are likely to encounter resistance, and their effects are likely to vary from one organization to the next. While some standards may increase complexity in certain areas (e.g., the use of different valuation measures of inventory for LIFO and non-LIFO companies), the goal of the project is to reduce overall cost and complexity. Thus, FASB must carefully weigh the costs and benefits of each proposal in its decision-making process.