Market concerns have led to the ending of the London Interbank Offered Rate (LIBOR) in 2021. LIBOR is one of the most widely used reference rates in the world when accounting for debt, securities, derivatives and other financial instruments. The impact of the transition from LIBOR to other reference rates will be far reaching. To address this transition within contracts, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.
ASU No. 2020-04 provides several optional expedients and exceptions for accounting for contract modifications, held-to-maturity debt securities and hedging relationships meant to ease the challenges of updating contracts for reference rate changes. ASU No. 2020-04 is effective for all entities as of March 12, 2020, through December 31, 2022. The amendments do not apply to contracts modified after December 31, 2022, or for hedging relationships entered after December 31, 2022.
There’s much to know about upcoming FASB standards.
Contract Modifications
As companies transition away from using LIBOR and into using new reference rates, there will be many contract modifications. Accounting standards generally require companies to assess whether contract modifications result in a continuation of the existing contract or the establishment of a new contract.
ASU 2020-04 provides optional expedients and exceptions to companies that have contract modifications due to a change in reference rate that is expected to be discontinued because of reference rate reform. The optional expedients apply to contract modifications that directly replace, or have the potential to replace, a reference rate with another interest rate index, but they do not apply to other terms that are contemporaneously modified and are unrelated to the change in reference rate.
In addition to providing principles for the accounting for contract modifications in topics not specifically addressed in the guidance, ASU 2020-04 specifically addresses modifications of contracts falling within the scope of the following topics:
| Topic with Contract Modification | Effect of Optional Expedients |
|---|---|
| Receivables (Topic 310) | Account for modifications as if the modification was only minor by prospectively adjusting the effective interest rate. |
| Debt (Topic 470) | Prospectively adjust the effective interest rate and account for the modification as if the modification was not substantial. |
| Leases (Topics 840 and 842) | No reassessment of lease classification and discount rate, no remeasurement of lease payments, and no performance of other reassessments or remeasurements that would otherwise be required. |
| Derivatives and Hedging – Embedded Derivatives (Subtopic 815-15) | No reassessment of the original conclusion of whether the contract contains an embedded derivative that is clearly and closely related to the economic characteristics and risks of the host contract. |
Held-to-Maturity Classification
ASU No. 2020-04 allows companies to make a one-time election to sell or transfer certain debt securities that were classified as held-to-maturity before January 1, 2020. The sale or transfer of the held-to-maturity debt securities would not require the transfer of all the company’s held-to-maturity debt securities or call into question the company’s prior assertions that it had the intent and ability to hold the securities until maturity.
Hedging
ASU No. 2020-04 provides several optional expedients and exceptions related to Topic 815 on Derivatives and Hedging if certain criteria are met. Those optional expedients and exceptions include the following:
| Area of Change within Topic 815 |
|---|
| Exceptions to Topic 815 Guidance Related to Changes in Critical Terms of a Hedging Relationship |
| Optional Expedients for Excluded Components |
| Optional Expedients for Fair Value Hedges |
| Optional Expedients for Cash Flow Hedges |
Next Steps for Navigating the Removal of LIBOR
As you negotiate changes to contract terms as a result of the transition from LIBOR to other reference rates, it will be important to consider the impact of ASU 2020-04 and evaluate if its optional expedients and exceptions will be helpful for your accounting and financial reporting.
Have questions about how this or other FASB updates will impact your business?