ASU 2022-06: Deferral of Reference Rate Reform Relief

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2022-06, a targeted revision to existing financial reporting rules. This update serves a single primary function: to extend the time frame during which companies can use certain accounting accommodations. These accommodations, or reliefs, were created to help businesses manage the accounting complexities arising from a global shift away from long-established benchmark interest rates. This update does not introduce new reliefs but defers the expiration date of the existing ones.

Background on Reference Rate Reform

For decades, the global financial system relied on reference rates to set interest rates on a vast number of financial products. The most prominent of these was the London Interbank Offered Rate (LIBOR). However, after the global financial crisis, it became apparent that LIBOR was not based on a high volume of actual market transactions, leaving it vulnerable to manipulation. This led to a market-wide transition known as reference rate reform.

In the United States, the Alternative Reference Rates Committee (ARRC) was convened to identify a successor to U.S. dollar LIBOR. The committee recommended the Secured Overnight Financing Rate (SOFR), which is based on a massive volume of observable daily transactions, making it a more transparent and resilient benchmark. The formal phase-out of the original panel-based U.S. dollar LIBOR settings concluded on June 30, 2023. The publication of certain synthetic U.S. dollar LIBOR rates continued until their permanent cessation on September 30, 2024.

Key Reliefs Under Topic 848

The transition from LIBOR to new rates like SOFR created accounting challenges for companies. Modifying a contract to change the reference rate could, under standard accounting principles, be treated as the termination of the old contract and the creation of a new one. This treatment, called derecognition, can be complex and may force a company to recognize an immediate gain or loss. To ease this burden, the FASB introduced a set of optional reliefs under Accounting Standards Codification (ASC) Topic 848.

The guidance in Topic 848 provides two main areas of relief: contract modifications and hedge accounting. For contract modifications, the relief allows an entity to account for the change in the reference rate as a continuation of the existing contract, prospectively adjusting the effective interest rate. This avoids the complexities of derecognition accounting for instruments like loans and leases, provided the modification is directly related to the replacement of a discontinued reference rate. The relief is elective and can be applied on a contract-by-contract basis.

Another part of the relief pertains to hedge accounting. Companies often use hedging to manage risks, and these arrangements must meet strict criteria under ASC 815 to qualify for favorable accounting treatment. A change in the benchmark rate of a hedged item or the hedging instrument itself could have caused the relationship to fail its effectiveness tests, forcing the termination of hedge accounting. Topic 848 provides expedients that allow companies to preserve these hedging relationships despite changes to critical terms, as long as the changes are a direct result of reference rate reform.

The ASU 2022-06 Deferral and Effective Date

The original guidance in Topic 848 included a sunset provision, setting a deadline after which the accounting reliefs could no longer be applied. This date was initially set for December 31, 2022. However, the UK’s Financial Conduct Authority, LIBOR’s regulator, subsequently announced that the final cessation for the most widely used U.S. dollar LIBOR settings would be delayed until June 30, 2023.

This delay created a problem where contract modifications would occur after the relief expired. To address this, the FASB issued ASU 2022-06. The update defers the sunset date of the relief provided in Topic 848. It officially moved the expiration date from December 31, 2022, to December 31, 2024.

This extension allows companies to apply the optional reliefs through the final LIBOR cessation period. The amendments in ASU 2022-06 were made effective for all entities immediately upon the issuance of the update in December 2022. After December 31, 2024, the temporary relief will no longer be available for new modifications or hedging relationships.