Important GAAP Updates for Financial Reporting

Financial reporting relies on a standardized framework to ensure that information is clear, consistent, and comparable across different organizations. In the United States, this framework is known as Generally Accepted Accounting Principles (GAAP). The responsibility for establishing and updating GAAP for public companies, private companies, and non-profits falls to the Financial Accounting Standards Board (FASB). The FASB is an independent organization recognized by the U.S. Securities and Exchange Commission (SEC) as the designated accounting standard-setter for public companies.

To communicate changes, the FASB issues Accounting Standards Updates (ASUs). These documents explain how and why GAAP is being amended by updating the FASB Accounting Standards Codification®, which is the single source of authoritative U.S. GAAP. These updates are the mechanism through which financial reporting standards evolve.

Major Changes in Lease Accounting

A change in financial reporting was the implementation of Accounting Standards Codification (ASC) 842, which altered how companies account for leases. The standard increased transparency by requiring companies to recognize most lease arrangements on the balance sheet. Previously, many operating leases were kept off the balance sheet and only mentioned in the footnotes of financial statements, obscuring a company’s true financial obligations.

The new standard introduced two concepts: the right-of-use (ROU) asset and the lease liability. The lease liability represents the present value of future lease payments, while the ROU asset is an intangible asset representing the company’s right to use the leased item. This change ensures that financial statements reflect the economic reality that a lease is a form of financing.

At the start of a lease, a company calculates the lease liability by discounting its future lease payments. The initial value of the ROU asset is then calculated based on this liability. For operating leases, the company recognizes a single, straight-line lease expense. For finance leases, which are economically similar to a purchase, the ROU asset is amortized, and interest expense on the lease liability is recognized separately.

This shift has had a considerable impact on company balance sheets, leading to an increase in reported assets and liabilities for many organizations. Consequently, financial metrics like debt-to-equity and debt-to-assets often increase due to the newly recognized lease liabilities. This can have consequences for companies with loan agreements that contain covenants tied to these metrics.

The income statement is also affected. While the total expense recognized over the life of an operating lease remains the same, the classification of the expense changes. Under the new guidance, operating lease expense is not broken down into interest and amortization, which can increase metrics like Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA).

Updates to Financial Instruments and Credit Losses

A change in accounting for financial instruments arrived with the issuance of ASC 326, which introduced the Current Expected Credit Losses (CECL) model. This standard departed from the previous “incurred loss” methodology, where companies would only recognize a credit loss when it was probable that the loss had already been incurred. This approach was criticized for delaying the recognition of losses.

The CECL model requires entities to estimate the credit losses they expect to incur over the entire contractual life of a financial asset from the moment of its origination. This forward-looking approach mandates that companies incorporate not only past events and current conditions but also reasonable and supportable forecasts about the future. This leads to a more timely recognition of expected losses.

While the CECL standard has the most pronounced impact on banks and other financial institutions, its reach is broad. Any entity holding financial assets such as trade accounts receivable, notes receivable, or held-to-maturity debt securities falls within its scope. Companies must develop a systematic methodology for estimating these expected losses, which can involve pooling assets with similar risk characteristics.

Another update in this area, ASC 848, addressed Reference Rate Reform. This standard was created to ease the accounting burdens associated with the global transition away from the London Interbank Offered Rate (LIBOR). Modifying contracts to replace LIBOR with an alternative rate could have triggered complex accounting consequences under normal GAAP.

This guidance provided optional practical expedients that simplified the accounting for these modifications. If criteria were met, an entity could treat a contract modification due to reference rate reform as a continuation of the existing contract, avoiding the need to remeasure assets and liabilities. The relief provisions for this temporary guidance expired at the end of 2024 as the transition was completed.

Targeted Improvements and Simplification Initiatives

In addition to major overhauls, the FASB issues updates aimed at simplifying specific areas of GAAP, often in response to feedback from stakeholders.

Goodwill for Private Companies

One simplification effort provides an accounting alternative for how private companies handle goodwill. Goodwill is an intangible asset recognized in a business acquisition. Under standard GAAP, goodwill is not amortized but is tested for impairment annually, which can be a complex and costly process.

In response to concerns, the FASB introduced an alternative that allows private companies to amortize goodwill on a straight-line basis over 10 years, or a shorter period if appropriate. Companies electing this alternative must still test goodwill for impairment, but only when a “triggering event” occurs. A triggering event is an adverse change that suggests the fair value of the entity might be below its carrying amount, which reduces the burden of performing an annual test when no such indicators are present.

Government Assistance Disclosures

U.S. GAAP historically lacked specific guidance on how business entities should account for government assistance. The government aid provided during the COVID-19 pandemic highlighted the need for greater transparency. In response, the FASB issued ASC 832, which establishes disclosure requirements for business entities receiving government assistance.

The standard does not dictate how to account for the assistance but mandates what must be disclosed. Companies must provide annual disclosures detailing:

• The nature of the assistance received, including its form and any significant terms and conditions.
• Commitments made by the entity or provisions for recapture.
• The accounting policies used to account for the transactions.
• The line items on the balance sheet and income statement affected, along with the corresponding amounts.

These requirements apply to assistance from all levels of government.

The FASB’s Current Agenda and Emerging Topics

The FASB maintains a public technical agenda that outlines its current projects, providing a window into the future of financial reporting. These projects are often initiated in response to stakeholder feedback and emerging economic trends.

In late 2023, the FASB finalized a project by issuing new guidance on the accounting for certain crypto assets. The previous model treated assets like Bitcoin as indefinite-lived intangible assets recorded at cost. The new standard requires entities to measure these crypto assets at fair value, with changes in value recognized in net income each reporting period. This guidance is effective for fiscal years beginning after December 15, 2024, with early adoption permitted.

Another area of focus is Environmental, Social, and Governance (ESG) matters. The FASB has initiated projects to address the accounting for environmental credits, such as renewable energy certificates and carbon offsets. This project aims to establish clear guidance on the recognition, measurement, presentation, and disclosure of these tradable credits.

Further improvements to disclosure requirements are also a priority. The FASB has been working on projects to enhance the disaggregation of information in financial reports, including improvements to segment reporting and income tax disclosures. The goal of these projects is to provide investors with more detailed information to better understand a company’s performance and global tax obligations.