In response to the planned discontinuation of major interbank reference rates, including the London Interbank Offered Rate (LIBOR), the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2020-04, Facilitation of the Effects of Reference Rate Reform on Financial Reporting (Topic 848). The purpose of ASU 2020-04 is to provide companies with optional guidance to alleviate the potential accounting burden associated with transitioning away from LIBOR and other reference rates that are expected to be discontinued by the end of 2021.
ASU 2020-04 became effective for all entities as of March 12, 2020, and will continue through December 31, 2022. It is important to note that contract modifications made after December 31, 2022, new hedging relationships entered into after December 31, 2022, and certain hedging relationships evaluated for periods after December 31, 2022, will be excluded from ASU 2020-04.
Several outstanding loan agreements, lease agreements, and derivative instruments currently refer to LIBOR or another reference rate that is expected to be discontinued. If you find your organization has entered into contracts that use one of these reference rates, ASU 2020-04 provides the following practical expedients to account for the contract modification.
- Modification of contracts within the Scope of Topic 310- Receivables and Topic 470- Debt should be accounted for by prospectively adjusting the effective interest rate.
- Modification of contracts within the scope of Topics 840- Leases and 842- Leases should be accounted for as a continuation of the existing contract with no reassessments of the lease classification and the discount rate or re-measurements of lease payments.
- Contract modifications do not require a reassessment of its original conclusion about whether embedded derivatives are considered clearly and closely related to the host contract under Subtopic 815-15, Derivatives and Hedging- Embedded Derivatives.
It is important to note that ASU 2020-04 stipulates when elected, the optional practical expedients must be applied consistently to all eligible contracts or eligible transactions within the relevant Topic or Industry Subtopic within the Codification, except for hedging instruments. The optional expedients for hedge accounting relationships promulgated under ASC 815 may be elected on a hedge-by-hedge basis.
ASU 2020-04 has been considered a big win for many organizations given reference rate reform was determined not to be a triggering event that would require re-measurement and reassessment of previous accounting determinations. If you have not done so already, now may be a good time to examine existing contracts for mention of LIBOR or certain other reference rates expected to be discontinued and consider the practical expedients offered in ASU 2020-04. As always, your trusted advisors at Anderson ZurMuehlen are available with any questions or concerns you may have.
This article was written by Dylan Dahl, CPA and Supervisor in our Billings office location.