For the Investor
By Marc Siegel, FASB Member
Preparing for the Next Few Quarters
There are several new accounting rules which will be reflected in financial statements in the next few quarters, so now is the time to make sure that you are ready for them.
There are several new accounting rules which will be reflected in financial statements in the next few quarters, so now is the time to make sure that you are ready for them. In fact, with some companies taking advantage of the option to early adopt the new standards, you may be seeing new results ASAP!
Three standards to get to know relate to revenue recognition, defined benefit pension plans, and hedge accounting.
This broad standard is required to be adopted by public businesses beginning next year, though a handful of companies adopted it early, as of July 1, 2017. Broadly speaking, the effect of the new standard on reported results will vary widely across sectors. However, there will be new disclosure requirements for all companies due to the new rules.
In a prior FASB Outlook article, I discussed some other sources to which to refer to learn more about new standards generally. In addition, we also have recently held Q&A webcasts with companies in the following industries to help investors and analysts prepare:
It’s worth making note of these disclosures and comparing and contrasting them between industry peers.Companies that plan to adopt next year will also be fine-tuning their disclosures in the third and fourth quarter about the expected effects of the new rules. It’s worth making note of these disclosures and comparing and contrasting them between industry peers.
Defined Benefit Pension Plans
Another new standard which goes into effect for public companies during calendar year 2018, but could possibly have been adopted in the first quarter of 2017, relates to how a company displays pension cost within their income statement.
Based on longstanding feedback from investors, it has become understood that the diversity in practice in how defined benefit pension components can be recognized results in confusion and non-comparability of operating results between companies.
For example, some companies moved to reflect in their results the mark-to-market changes of their pension assets each year. Others retained the allowable approach to reflect only the expected return on plan assets, while slowly amortizing, among other things, the cumulative difference between actual and expected.
To resolve some of this diversity in terms of reported operating results, the new rule mandates that for companies which report an operating income subtotal on their income statement, only service cost can be included within the line items making up that subtotal. The other components of pension cost would be shown separately, outside of the operating income subtotal.
This new rule should provide more comparability of operating income between companies with respect to their pension activities.
While not addressing the various ways of calculating the actual pension liability or cost, this new rule should provide more comparability of operating income between companies with respect to their pension activities.
In another column in this Outlook issue, we discuss the highlights of the new hedge accounting rules. The feedback from companies has been that the changes will allow them to better reflect their risk management activities in their income statement. Although it is not mandatory to adopt these new rules right away, some companies will take the opportunity to adopt the new rules early.
Current accounting has constraints on the availability of hedge accounting, as some companies do not use hedge accounting for economic hedges to mitigate risks. This is particularly true for certain non-financial industries in which companies may wish to hedge components used in a manufacturing process.
Under the new rules, more risk management activities will qualify for the optional hedge accounting treatment, reducing some of the earnings volatility seen today.
In those cases, under today’s accounting, the derivatives they utilize must be accounted for at fair value, with possibly volatile quarterly fair value changes reflected in earnings. Under the new rules, more risk management activities will qualify for the optional hedge accounting treatment, reducing some of the earnings volatility seen today.
Additionally, the new rules require that to the extent the hedging derivative does not fully mitigate the risks being hedged, that difference will be reflected in the same line item which is being hedged.
For example, if a company is trying to economically hedge components used in a manufacturing process to the extent the hedging instrument is ultimately not perfectly effective, the new rules provide that the impact be reflected in cost of goods sold. Today, hedge ineffectiveness may sometimes be presented as a component of other income, which often does not receive that same level of scrutiny by investors and analysts.
It is important for investors to ask questions of the companies under coverage during the next few quarters regarding these new accounting standards. In that way, they can be ready to understand the new results, or even find out that a particular company has already adopted one of the new standards!