In April 2015, the Financial Accounting Standards Board issued Accounting Standards Update 2015-03 for the stated purpose of simplifying the presentation of debt issuance costs. Updates to standards often bring about questions – how will this impact my business? How quickly can I get up-to-date?
To help you get acquainted with the recent update, we sat down with Michael Cohen, Friedman LLP partner, to discuss big questions on businesses’ minds and their answers.
To provide some background, when a company issues debt, it will often incur legal, accounting, placement fees or other costs, which are collectively referred to as debt issuance costs. Previous accounting guidance required those costs to be reported in the balance sheet as an asset. Those costs will now be shown as a reduction of the carrying value of the associated debt. Let’s get started.
Q – If the previous requirement was that debt issuance costs be shown on the balance sheet as a separate asset, that sounds pretty simple. How does this pronouncement simplify that?
A – The answer is really two-fold. First, International Financial Reporting Standards (IFRS) require that transaction costs be deducted from the carrying value of the financial liability and not recorded as separate assets, so this pronouncement conforms US GAAP with IFRS. Second, debt discounts or premiums, which ordinarily result when proceeds of a debt issuance are either less than (in the case of a discount) or more than (in the case of a premium) the face amount of the debt, are already combined with the carrying value of the debt. So the perception was that accounting for debt issuance costs differently from debt discounts or premiums was inconsistent and created unnecessary complexity.
Q – How much additional burden is this going to add to my accounting and financial reporting team?
A – Virtually none. The pronouncement is really just a change in presentation. The method of amortization of the balance will remain the same. It’s just that now, the amortization expense will be reported as interest expense and the remaining balance that was reported as an asset will be aggregated and reported as part of the debt value.
Q – I don’t like it. It doesn’t make sense that my reported debt balance is less than the amount that I actually owe.
A – That’s not really a question, but you are correct. There are a few people that disagree with this pronouncement. Although the FASB adopted the pronouncement with a unanimous vote of the seven members, nine of the ten members of the Private Company Council supported alternatives. Furthermore, in June 2015 the SEC said they would not object to continued asset classification for revolving debt arrangements.
Q – So when does this pronouncement become effective?
A – Public entities are required to apply the guidance for fiscal years beginning after December 15, 2015, and for interim periods within those years. Earlier adoption is permitted, and retroactive application will be required upon adoption. In addition, companies will be required to provide applicable disclosures for a change in accounting principle upon adoption.