Standards Update: 11/30/21

November 30, 2021

The Financial Accounting Standards Board (FASB) regularly issues Accounting Standards Updates (ASUs) to make changes to the FASB Codification, the primary source of Accounting Principles Generally Accepted in the United States (GAAP). Below are ASUs that were recently issued.

ASU No. 2021-07, Compensation – Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share
ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers
ASU No. 2021-09, Leases (Topic 842): Discount Rate for Lessees That Are Not Public Business Entities

ASU No. 2021-07, Compensation – Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share

The FASB has issued ASU No. 2021-07, Compensation – Stock Compensation (Topic 718): Determining the Current Price of an Underlying Share to improve an area of financial reporting for nonpublic business entities (private companies) that issue equity-classified share-based awards.

Summary

Many private companies issue share-based awards to employees and non-employees as a form of compensation. When these awards are made, the grant date fair value of the awards must be determined, typically by using an option pricing model. One input into an option pricing model is the fair value of the shares underlying the award (the current price input), which can be costly and complex to estimate as private company shares are not actively traded.

Under ASU No. 2021-07, the fair value of the private company shares underlying the award may be determined using a practical expedient which allows the use of a reasonable application of a reasonable valuation method. It is important to note that this practical expedient lines up with the requirements of U.S. Internal Revenue Code Section 409A, which must be followed for income tax purposes. Upon election of this practical expedient, private companies will no longer need to pay for two separate stock valuations, one for GAAP financial statements and one for tax purposes, in valuing equity-classified share-based awards.

Effective Date and Transition

This practical expedient is available to private companies related to their equity-classified share-based awards granted or modified during fiscal years beginning after Dec. 15, 2021 and interim periods within fiscal years beginning after Dec. 15, 2022. Early application is permitted for financial statements that have not yet been issued or made available for issuance as of Oct. 25, 2021.

ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers

The FASB has issued a final standard that has been much anticipated since it was first proposed in late 2020. ASU No. 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers now states that an acquirer shall account for revenue contracts with customers acquired in a business combination in accordance with the revenue guidance (Topic 606).

Summary

Prior to ASU No. 2021-08, contract assets and contract liabilities acquired in a business combination were recognized at their fair value on the acquisition date.

Under ASU No. 2021-08, the acquirer should account for acquired revenue contracts at the acquisition date as if the acquirer had originated the contracts. In doing so, the acquirer may consider how the acquiree applied Topic 606, meaning that generally, this will result in the acquirer recognizing the contract assets and contract liabilities from acquired revenue contracts in the amounts presented in the acquiree’s financial statements (assuming the acquiree presents statements in accordance with GAAP). The acquirer would need to consider the impact of any errors that may be identified in the acquiree’s accounting as well as changes that may be needed to comply with the acquirer’s accounting policies.

Acquirers and users will benefit from the comparability of consistently applying Topic 606 to both revenue contracts obtained in a business combination and revenue contracts not obtained in a business combination. For revenue contracts obtained in a business combination, the new standard provides certain practical expedients when recognizing and measuring the acquired contract assets and contract liabilities.

It is important to point out that the new standard does not affect the accounting for certain other assets or liabilities that arise from accounting under Topic 606, such as refund liabilities, as refund liabilities do not meet the definition of a contract liability. Also, the amendments do not affect the accounting of customer-related intangible assets and contract-based intangible assets or the need to consider off-market terms.

Effective Date and Transition

ASU No. 2021-08 is effective, on a prospective basis, for public business entities for fiscal years beginning after Dec. 15, 2022, and for all other entities for fiscal years beginning after Dec. 15, 2023, including interim periods within those fiscal years. Early adoption is permitted.

ASU No. 2021-09, Leases (Topic 842): Discount Rate for Lessees That Are Not Public Business Entities

The FASB has issued ASU No. 2021-09, Leases (Topic 842): Discount Rate for Lessees That Are Not Public Business Entities to improve discount rate guidance for lessees that are not public business entities, including all not-for-profit entities and employee benefit plans.

Summary

As the first of two key changes, ASU No. 2021-09 amends Topic 842 by allowing lessees to elect the risk-free rate practical expedient by class of underlying asset rather than for all (or none) of their leases. This change was made to address concerns that lessees would prefer to use an incremental borrowing rate for their more significant leases (such as real estate), which are also less frequent, while preferring to use the risk-free rate for less significant but more frequent leases (such as equipment). Although use of the risk-free rate is simpler to apply, risk-free rates are often lower than a lessee’s incremental borrowing rate, which would result in recognizing lease liabilities and right-of-use assets that are larger than those calculated using the incremental borrowing rate. Lessees looking to balance implementation costs with lease liability size now have the option to apply the risk-free rate practical expedient by class of underlying asset.

The second key change clarifies that when a rate implicit in a lease is readily determinable, lessees must use the implicit rate rather than an alternative (risk-free rate or incremental borrowing rate) even if the practical expedient has been elected.

Effective Date and Transition

ASU No. 2021-09 is effective for those entities who have not yet adopted Topic 842 at the same time that they adopt Topic 842. For those entities who have already adopted Topic 842, ASU No. 2021-09 is effective for fiscal years beginning after Dec. 15, 2021, and early application is permitted.

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