Major Accounting Changes from FASB ASU 2015

The Financial Accounting Standards Board (FASB) is the organization responsible for establishing the accounting and financial reporting standards followed by U.S. companies. These standards, known as Generally Accepted Accounting Principles (GAAP), provide the foundation for consistent financial reporting. The FASB communicates amendments to its standards through Accounting Standards Updates (ASUs).

In 2015, the FASB issued a series of targeted ASUs as part of its simplification initiative. This initiative was launched to reduce unnecessary costs and complexity in financial reporting while ensuring that the information provided to investors remains useful. The changes issued during this period affected several distinct areas of accounting and were designed to enhance the relevance of financial information.

New Approach to Inventory Measurement

One change from 2015 simplified how certain types of inventory are measured after initial recognition. ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory, altered a long-standing rule for entities using inventory costing methods like first-in, first-out (FIFO) or average cost. The update aimed to reduce complexity by aligning U.S. GAAP more closely with International Financial Reporting Standards (IFRS).

Previously, the governing principle was the lower of cost or market (LCM). Under this model, “market” was a complex value to determine, defined as replacement cost but capped by a ceiling equal to net realizable value (NRV) and floored by NRV less a normal profit margin. This multi-step calculation was often cumbersome for companies to apply.

The new guidance replaces this process with a more direct approach: the lower of cost and net realizable value (LCNRV). Net realizable value is the estimated selling price in the ordinary course of business, less predictable costs of completion, disposal, and transportation. This change eliminates the need to calculate replacement cost or a normal profit margin.

For example, a product has an original cost of $100, an NRV of $95, and a replacement cost of $92. Under the old LCM rule, the “market” value would be the replacement cost of $92, as it falls between the NRV ceiling and floor. Under the new LCNRV rule, the company simply compares the cost of $100 to the NRV of $95 and values the inventory at $95. This update does not apply to inventory measured using the last-in, first-out (LIFO) or retail inventory methods.

Revised Presentation of Debt Issuance Costs

ASU 2015-03 changed how companies present the costs associated with issuing debt. Previously, when a company incurred costs to obtain financing, such as legal fees or underwriting commissions, these were recorded on the balance sheet as a separate asset, often labeled as a deferred charge. This asset was then amortized, or gradually expensed, over the life of the debt.

The new guidance requires that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of the corresponding debt liability. This treatment makes these costs analogous to debt discounts. The change was made to better reflect the economics of the transaction, as these costs effectively reduce the proceeds received from the borrowing.

For example, if a company issues a $1,000,000 bond and incurs $30,000 in issuance costs, the presentation changes. Previously, the balance sheet would show a deferred charge asset of $30,000 and a long-term debt liability of $1,000,000. Under the new rule, the liability section would report the bond at its face value less the issuance costs, for a net carrying amount of $970,000.

While the balance sheet presentation changed, the method for recognizing the expense did not. Companies continue to amortize the debt issuance costs to interest expense over the term of the debt. Costs incurred to establish a revolving line of credit that remains unused can still be presented as an asset.

Updated Classification of Deferred Taxes

ASU 2015-17 addressed the balance sheet classification of deferred taxes, which arise from temporary differences between the book value of assets and liabilities and their tax bases. Previously, U.S. GAAP required companies to separate their deferred tax assets and liabilities into current and noncurrent portions on the balance sheet.

This separation required companies to analyze the underlying assets and liabilities that created the deferred taxes and classify them accordingly. For deferred taxes not tied to a specific asset or liability, companies had to schedule their expected reversal dates to determine the proper classification. This process was costly and provided little useful information to financial statement users.

ASU 2015-17 eliminated this requirement. The new rule mandates that all deferred tax assets and liabilities, along with any related valuation allowance, must be classified as noncurrent on the balance sheet. This change streamlines the preparation of the balance sheet and removes the need for detailed scheduling of temporary difference reversals for classification purposes.

For instance, a company that previously reported a current deferred tax asset of $50,000 and a noncurrent deferred tax liability of $200,000 would now present them differently. If both items are within the same tax jurisdiction, they would be offset, resulting in a single net noncurrent deferred tax liability of $150,000. This change simplifies reporting and better aligns U.S. GAAP with international accounting standards.

Clarifying Cloud Computing Arrangement Costs

In 2015, the FASB addressed the accounting for fees paid in cloud computing arrangements, such as Software as a Service (SaaS). Before ASU 2015-05, a lack of specific guidance led to diversity in practice, with companies unsure whether to treat these arrangements as an acquired software license or a service contract.

The update provides a framework to make this determination. An arrangement contains a software license only if two criteria are met. First, the customer must have the contractual right to take possession of the software at any time during the hosting period without incurring a significant penalty.

Second, it must be feasible for the customer to run the software on its own hardware or to contract with an unrelated third party to host it. If both conditions are satisfied, the arrangement includes a software license. The fee attributable to the license should be capitalized as an intangible asset and amortized over its useful life.

If an arrangement does not meet both criteria, it is accounted for as a service contract, and the fees are expensed as the services are received. Subsequent guidance clarified that certain implementation costs for these service contracts, such as for configuration and testing, can be capitalized as an asset. This asset is then amortized on a straight-line basis over the term of the hosting arrangement.

Refining the Consolidation Analysis

ASU 2015-02, Amendments to the Consolidation Analysis, revised the rules for when a company must consolidate another legal entity into its own financial statements. Consolidation is the process of combining the financial statements of a parent company and its subsidiaries. The update focused on simplifying the analysis for structures known as Variable Interest Entities (VIEs).

A VIE is an entity where control is not based on traditional voting rights but on other contractual arrangements. The ASU simplified the analysis for determining whether an entity is a VIE and which party is its primary beneficiary, the one required to consolidate it. The changes were prompted by concerns that the previous rules were overly complex.

The update introduced several refinements. It eliminated the presumption that all limited partnerships are VIEs, requiring them to undergo the same full analysis as other entities. The guidance also changed how fees paid to a decision-maker, like an asset manager, are considered, making it less likely that these fee arrangements alone will lead to consolidation.

The ASU also clarified how to treat interests held by a company’s related parties when determining who controls a VIE. These changes place more emphasis on the risk of loss and the power to direct activities. Due to the technical nature of these rules, companies with investments in limited partnerships or other complex legal structures should consult with accounting professionals to ensure proper application.