The Financial Accounting Standards Board posted an accounting standards update to address its stakeholders’ concerns about the application of derivative accounting and its scope.
The concerns involve contracts with features based on the operations or activities of one of the parties to the contract and the difference in accounting for share-based noncash consideration from a customer that is consideration for the transfer of goods or services.
Issue 1: Derivatives scope refinements
One of the issues involves derivatives scope refinements. During FASB’s 2021 agenda consultation and other outreach, its stakeholders indicated they faced challenges in applying guidance in FASB Accounting Standards Codification Topic 815, “Derivatives and Hedging.” Topic 815 sets accounting requirements for contracts that meet the definition of a derivative based on certain characteristics and are not otherwise excluded from its scope.
Due to the broad and evolving application of the definition of a derivative and changing business environment, many types of contracts are evaluated and potentially accounted for as derivatives. These contracts include certain emerging transactions, such as bonds in which interest payments may vary based on certain performance metrics, and certain longstanding transactions, such as research and development funding arrangements and litigation funding arrangements.
The accounting standards update addresses these constituents’ concerns by adding a derivative scope exception for some contracts with variables known as “underlyings” based on the operations or activities of one of the parties to the contract. FASB said this would (1) reduce the cost and complexity of evaluating whether these contracts are derivatives, (2) better portray the economics of those contracts in the financial statements, and (3) reduce diversity in practice resulting from the broad application of the current guidance and changing business environment.
Issue 2: Certain scope clarifications
The update also clarifies the applicability of Topic 606, “Revenue from Contracts with Customers,” and its interaction with other topics in the accounting standards codification (including Topic 815 on derivatives and hedging and Topic 321 on equity securities), in the accounting for share-based noncash consideration (such as warrants or shares) received from a customer for the transfer of goods or services.
This is anticipated to give investors more comparable information and decrease accounting complexity and related reporting costs for preparers and auditors.
