Will the FASB Simplify the Debt Modification Rules for Private Companies?

The Private Company Council (PCC) is the primary advisory body to the Financial Accounting Standards Board (FASB) on private company matters. The PCC advises the FASB on the appropriate accounting treatment for private companies for items under active consideration on the FASB’s technical agenda. The PCC also advises the FASB on possible alternatives within U.S. Generally Accepted Accounting Principles (GAAP) to address the needs of users of private company financial statements.

In April 2021, the PCC discussed debt modifications in the context of providing the FASB with feedback about its new agenda consultation efforts. Here’s a summary of those discussions.

Debt Modification Rules

Based on feedback from private companies and their financial advisors, the PCC told the FASB that the accounting rules for debt modifications are too complex. These rules have bubbled up as a critical area for private companies given the recent financial activity resulting from the COVID-19 pandemic.

The PCC wants the FASB to consider adding a project to its technical agenda to simplify these rules, because they believe that the costs of the current guidance outweigh the benefits. Specifically, the FASB may want to consider whether 1) the 10% threshold for determining whether modification remains appropriate, or 2) a private company accounting alternative may be appropriate because lenders have access to management.

Other Challenges

In addition, the PCC flagged two other reporting areas that are challenging for private companies to apply:

  1. Accounting rules on variable interest entities (VIEs). The FASB’s guidance on this topic, especially the rules for variable interest and primary beneficiaries, is tough to follow even with papers published by Big Four accounting firms. The PCC wants the FASB to do more to refine the implementation rules, including how to determine whether a variable interest exists.
  2. Disclosures on materiality. The PCC wants the FASB to consider taking up a short-cut project to “provide guidance with criteria to assist financial statement preparers with evaluating whether a disclosure is not material to an entity’s financial statements.” If less-relevant disclosures are eliminated, it would help elevate the remaining disclosures.

Other topics the PCC mentioned in context of the FASB’s agenda consultation include:

  • Goodwill,
  • Share-based payments specific to profits interest,
  • Segment reporting, and
  • Financial performance reporting.

The FASB already has projects on its technical agenda on the subsequent accounting of goodwill, segment reporting and financial performance reporting. The PCC is currently working on developing accounting rules for reporting profits interest, a type of share-based payment.

Stay Tuned

Later this summer, the FASB plans to issue an invitation-to-comment in order to get public input about its five-year agenda. The document will include topics the different FASB advisory groups put forth as the most pressing areas in financial reporting.

More Info: FASB Publishes New Narrow-Scope Rule on Call Options

On May 3, the FASB published Accounting Standard Update (ASU) No. 2021-04, Earnings Per Share (Topic 260), Debt — Modifications and Extinguishments (Subtopic 470-50), Compensation-Stock Compensation (Topic 718), and Derivatives and Hedging — Contracts in Entity’s Own Equity (Subtopic 815-40), Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options.

This narrowly tailored standard will make it easier to report about written call options, such as warrants that remain equity classified after a modification or exchange. The guidance is effective for fiscal years after December 15, 2021, but it can be applied earlier.

The rules might be useful to special purpose acquisition companies (SPACs). A SPAC is a shell corporation without performance history or revenue that’s formed for the sole purpose of raising capital through an initial public offering (IPO) to then acquire a target business. SPACs have come under scrutiny from the Securities and Exchange Commission (SEC) over their reporting of warrants.

SPACs frequently issue warrants with common stock in their IPOs. A warrant is a written call option under which the counterparty has the right, but not the obligation, to purchase a specified quantity or amount of common stock from the issuing entity at a specified price.

Historically, many SPACs classified warrants as part of equity. However, the SEC in April, citing U.S. Generally Accepted Accounting Principles (GAAP), said warrants with certain features probably would be more rightly classified as liabilities.