FASB and IFRS Standards Setting for 2021

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Introduction

FASB and IFRS are institutions that formulate financial reporting standards and frameworks. The FASB is recognized by many other similar US bodies and is the primary regulator that creates and annually optimizes financial reporting standards for US companies. IFRS is an international regulatory body that develops and updates reporting standards globally. This paper aims to summarize the plans of both organizations for the current year regarding the setting of new standards and updates to the current ones.

FASB

The FASB was founded on July 1, 1973, when it replaced a similar previous body, the Accounting Principles Board (APB) of the American Institute of Certified Public Accountants (AICPA). The FASB is a privately held, not-for-profit organization whose primary function is to develop and improve Generally Accepted Accounting Principles (GAAP). GAAP principles apply throughout the United States. The FASB has been given the role of setting accounting standards for public companies in the United States, as the Securities and Exchange Commission (SEC) decided. In 2002, the Norwalk Agreement or Memorandum of Understanding (MoU) was adopted according to which FASB standards must be compatible with international IASB standards. The Norwalk Agreement includes plans to merge the FASB and IASB into a single set of standards (Kenton & Khartit, 2020). However, the US has not yet entirely subordinated itself to the IASB and strictly follows the FASB standards. In contrast, the IASB standards play an advisory role in terms of concept development.

Notably, in 2008 the Financial Crisis Advisory Group (FCAG) was established. This international group has coordinated efforts to develop global financial reporting standards in light of the 2007-2010 crises. According to a 2009 FCAG report, it was found that the FASB and SEC were under pressure from politicians and mortgage banks. Politicians and banks have demanded changes in accounting standards to keep banks safe from the effects of their toxic mortgages. Since this information was released to the public by FCAG, FASB received support and attention from the public. It was also suggested that politicians should not influence financial reporting standards (Kenton & Khartit, 2020). Therefore, FCAG acted as an independent body verifying the safety of the conditions for the FASB.

New Standards by FASB in 2021

FASB creates new and changes existing standards in more than ten directions. The list includes topics such as Distinguishing Liabilities from Equity, Reference Rate Reform, Insurance Long-Duration Contracts, Revenue Recognition, Leases, Credit Losses, Non-for-Profit financial Reporting, Hedge Accounting, Tax Cuts and Jobs Act, and other standards (“Implementing new standards,” 2021). These are essential areas of financial reporting, and optimization and monitoring of compliance with reporting standards are critical for the full and quality functioning of the US financial system.

Distinguishing Liabilities from Equity Updates

The new FASB regarding Distinguishing Liabilities from Equity affects commercial entities, SEC applicants, excluding smaller reporting companies. This standard comes into effect on December 15, 2021, as well as from December 15, 2023, for all other enterprises; early application permitted from December 15, 2020 (“Distinguishing liabilities from equity,” 2021). This distinction will allow smaller reporting companies and other organizations to have ample time to study the amendments. Therefore, organizations will have to take over guidance from the beginning of the fiscal year. This Update includes amendments to Accounting Standards Update No. 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities and Equity (Topic 480); Derivatives and Hedging (Topic 815): (PART I) Accounting for Certain Financial Instruments With Down Round Features.

Specifically, amendments in the Update include a reduction in the number of accounting models for convertible preferred shares and convertible debt instruments to increase disclosure transparency. The Update also removes three conditions required to exclude derivatives from the scope when accountants deal with equity contracts. Finally, the Update improves the consistency of the calculation for the diluted earnings-per-share calculation.

Reference Rate Reform Update

This Update was released in April 2020 but could be implemented by businesses until December 31, 2022. The Update is temporary additional guidance to accommodate the base rate reform. The Reference Rate Reform update is directed and applicable to companies that reference the London Interbank Offered Rate (LIBOR) or a similar reference rate as the Update cancels those rates (“Reference rate reform,” 2021). According to the Update, accountants will be able to use new but optional tricks. In particular, the existing accounting analysis will be simplified when changes are made to contracts. Further, the Update simplifies the assessment of hedging effectiveness. It allows the one-time choice “a one-time election to sell or transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform” (“Reference rate reform,” 2021, par. 6). Notably, the FASB provides clarifications on all new standards and updates, so accountants and board directors can use the form on the named Technical inquiry System.

In other words, the Reference Rate Reform (Topic 848) provides temporary non-mandatory exemptions and exemptions applicable to contract modifications and hedging relationships. A condition for granting benefits is compliance with criteria that refer to LIBOR or another reference rate. In particular, these exemptions apply to “derivatives affected by the transition to discounting” (“Media advisory,” 2021, par. 4). The existing guidance on derivatives will be adapted to facilitate the transition to discounting.

The presented Update will also allow a change in the systematic and rational method that accountants use to recognize profit components outside of the assessment of hedge effectiveness. Then, a change in the assigned benchmark interest rate will be allowed concerning “another acceptable benchmark interest rate within the framework of the fair value hedging relationship” (“Media advisory,” 2021, par. 8). The Update also allows the reduced method to hedge the fair value until the end of the hedging relationship. Finally, the Update makes it easier to measure hedge effectiveness; additional funds are also provided for cash flow hedging relationships.

Leases Updates

The following important Update introduced by the FASB the day before concerns leases and related financial reporting. The Update is ready for adoption for most companies after December 15, 2021, and December 15, 2022. Non-profits could also accept it from December 15, 2019 (“Leases,” 2021). The principles of the new standard will affect organizations that provide services for the lease of assets. These companies will have to “recognize in the balance sheet assets and liabilities for rights and liabilities” that arise from such a lease (“Leases,” 2021, par. 1). According to the Update, a lessee must recognize assets and liabilities under leases if the lease term of the assets exceeds 12 months.

Whether a lessee provides a finance lease or an operating lease will impact the recognition, measurement, and presentation of the costs and cash flows that the lessee generates due to the provision of those services. This classification is made following GAAP standards like steel financial activities. It is noteworthy that the main difference from the previous standards will be the recognition in the balance sheet of two types of leases – both finance and operating leases; previously, only capital leases were recognized.

According to the Update, accountants will also be required to provide additional information on the amounts presented in the financial statements. This information will need to be disclosed for investors to better understand the company’s activities and make informed decisions (“Leases,” 2021, par. 5). Other users of financial statements will also be able to understand better the amount, timing, and uncertainty of the cash flows associated with leases. Additional descriptions and disclosures include qualitative and quantitative requirements.

In general, the changes are also aimed at harmonizing the accounting of landlords and tenants, creating a more unified accounting model. This Update also takes into account the updated guidance on revenue recognition introduced in 2014. The new guidance will affect public and private companies and non-profit organizations. Leasing to gain access to assets allows obtaining financing and reducing the risks associated with full ownership of an investment. The Update applies to companies that lease assets, including real estate, aircraft, ships, manufacturing, and construction equipment.

Other Updates Accepted in 2021

FASB emphasizes that some critical updates were released in 2021 and presents a list of them. In particular, it is noted that the 2021-04 Update covered such topics as Earnings per Share (Topic 260), Debt – Modifications and Redemptions (Subtopic 470-50), Equity Compensation (Topic 718), as well as Derivatives and Hedging and Contracts in the organization’s equity capital (Subtopic 815-40) (“Accounting standards updates issued,” 2021, par. 3). This Update took effect in May 2021 and affected all companies. The amendments to this Update apply to fiscal years after December 15, 2021, with early adoption permitted. As in most such cases, interim periods of those financial years are also included in presenting financial statements.

Then, Update 2021-03 addresses Intangible Assets (Topic 350) and alternative accounting for triggering event valuation. The Update became effective in March 2021 and is also applicable on a forward-looking basis for fiscal years after December 15, 2019. Early application is permitted from March 30, 2021; however, retroactive application of the amendments to interim financial statements issued in the year of adoption is prohibited. Early application is feasible for interim and annual financial statements not issued or unavailable before March 30, 2021. The Update also introduces a one-time application of the alternative “prospectively after the effective date without preference assessment” (“Accounting standards updates issued,” 2021, par. 4). Therefore, the Update provides companies with flexibility in financial reporting concerning intangible assets and goodwill.

The next major Update to accounting standards, released in 2021, is Update 2021-02, concerning Franchisors and Revenue from Buyer Contracts (subtopic 952-606). The Update went into effect in January 2021; it affected all organizations that are willing to use the modified flashback or full flashback option for periods after December 15, 2019, and interim periods after December 15, 2020 (“Accounting standards updates issued,” 2021). If companies have not yet applied Section 606, they must indicate the existing transitional provisions and the effective date and apply the Update retrospectively until the date when Section 606 was adopted. Finally, the last major Update adopted in 2021 is Update 2021-01 on the Reference Rate Reform (Topic 848). The Update took effect in January 2021, and the amendments were to be applied immediately to all companies.

About IFRS

IFRS are International Financial Reporting Standards, which are necessary to create common rules for presenting financial statements around the world. As a result of the existence of IFRS, companies must prepare their financial statements in a way that is consistent, transparent, and comparable across 166 jurisdictions in countries that have agreed to follow these standards. These are Turkey, Singapore, South Africa, Kenya, the Philippines, Chile, Russia, and the Persian Gulf countries, Pakistan, Malaysia, Australia, Hong Kong, India, the EU, Brazil, and South Korea. The United States is not obliged to comply with IFRS standards since the main body that regulates the methods of presenting financial statements is GAAP, which is based on FASB standards.

However, companies doing business in the United States are guided by the IFRS standards and concepts as part of the FASB and IFRS compliance agreement, which is still pending. The International Accounting Standards Board (IASB) issues new IFRSs and updates to old standards to streamline financial reporting. The IASB decides on innovations and changes. They form the standard for how companies manage and report their accounts. IFRS also defines events that have financial implications, such as types of transactions and other cases. In general, IFRS, as an international organization, creates a common language for accounting. Clear and unbreakable standards are needed to control financial reporting, which must be consistent across companies and countries, regardless of the volume of financial transactions or the type of business.

IFRS differs from FASB critically, as IFRS is standards-based and used worldwide, and FASB is rules-based and adopted only in the USA. GAAP and IFRS are considered more static, while IFRS is more responsive to a changing economic environment by adopting a dynamic approach to shaping new standards and creating updates. Despite the widespread adoption of IFRS, they have not yet been officially adopted in the United States. The transition to IFRS is under revision by the Securities and Exchange Commission; still, the date of the transition remains unknown, as well as its likelihood.

Even though IFRS is not a mandatory standard in the United States, it is imperative because IFRS standards enable companies worldwide to cooperate and trust each other, checking and comparing financial statements. Therefore, IFRS’s activities aim to create an atmosphere of trust and transparency in global markets and between companies that participate in the stock market. It is vital to comply with IFRS standards if a company wants to inspire confidence among potential investors since international investors can analyze financial statements maintained following international standards.

New Standards by IFRS in 2021

Since January 2021, IFRS has considered several significant changes to financial reporting standards. Notably, IFRS publishes IASB Updates, a compilation of preliminary IASB decisions taken during monthly public meetings. These decisions are preliminary and are usually approved by a vote using the procedure set out in the IFRS Foundation’s Due Process Handbook. In 2021, IFRS held eight meetings, which addressed COVID-19-related rent concessions, Dynamic Risk Management, Financial Instruments with Characteristics of Equity, and other topics.

IFRS also separately presents a selection of IFRS for SMEs Updates, IFRIC Updates, Investor Update, Monthly Update, and Translation Updates. IFRIC Update introduces summarized decisions of the IFRS Interpretations Committee; IFRS for SMEs Updates includes comprehensive standards update news relevant for SMEs; Investor Updates describe how the standards will impact the investors. Finally, Monthly Updates present the monthly news summary of the IFRS activities, news, and decisions.

IASB Updates on COVID-19-Related Rent Concessions

Supplementary IASB Update COVID-19-related rent concession is a topic that was explicitly discussed twice in 2021 during the public meetings – in February and in March. The mentioned updates are to be implemented by companies after June 30, 2021. Notably, according to the decisions taken earlier, tenants were granted lease concessions connected with the COVID-19 pandemic. The concession forms included deferred payments and deferred lease payments for a given period with subsequent repayment in subsequent periods.

Following discussions, the IASB made some changes to the previous requirements for assessing the conformity of rental benefits as modified by the IASB. According to the amendment to IFRS16 Leases, the IASB has granted lessees an exemption in the form of an optional exemption from the valuation and determination of the lease concession related to COVID-19 as a modification of the lease agreement (“Supplementary IASB update,” 2021). The Board then decided to begin the voting process on the amendment to IFRS16Leases without re-disclosure. Twelve members agreed to accept the amendment without re-disclosure, and two members said they did not agree with the amendment. As a result of this amendment adopted on March 31, 2021, businesses will account for the concession as variable rent. In March 2021, the IASB extended the exemption from June 30, 2021, to June 30, 2022. Therefore, reduced lease payments can be paid on leased items until June 30, 2022, taking into account the concession as a variable lease.

June 2021 IFRS for SMEs Update

In June, several important topics were discussed at the IFRS public meetings. In particular, the agenda included a note from Jenny Carter, a member of the SME Implementation Group (SMEIG), an update to the recommendations to members of the Emerging Economies Group (EEG), and an update on the second comprehensive review of the IFRS for SMEs (“June 2021 IFRS for SMEs,” 2021). Online resources for SMEs and feedback on recent meetings with SME preparers were also discussed. It was the main news regarding the work of SMEs within the framework of IFRS standards.

The note by Jenny Carter, a member of SMEIG, is of particular interest. It discussed the specifics of the alignment of UK financial reporting standards under IFRS, which could be a valuable experience for the US. Jenny Carter is Director of Accounting and Reporting Policy at FRC in the UK. In particular, Jimmy Carter noted that one of the main aspects of his responsibility is to ensure the relevance of national standards. FRS 102, the Financial Reporting Standard used in the UK and Ireland, was developed based on IFRS for SMEs and is the country’s primary accounting standard, suggesting some consistency between national and international standards.

Jenny Carter discussed the approach to aligning other standards with IFRS as part of a discussion on whether certain individual IFRSs should be reflected in IFRS for SMEs. Jenny Carter noted that, according to the majority of SMEIG members, the IFRS for SMEs should be further developed into the full version of the IFRS standards (“June 2021 IFRS for SMEs,” 2021). Then, SMEIG members suggested considering the benefits and costs of IFRS for SMEs with the new IFRS standard. It was also recommended that the necessary amendments to IFRS for SMEs be developed, how the two standards should be harmonized, and whether it is worth doing. At the same time, it was pointed out in the discussion that when agreeing on standards, it is necessary to consider the principles of relevance, simplicity, and presentation reliability. As a result, SMEIG recommendations were developed, and the Board of Directors has tentatively adopted these recommendations.

IASB Update May 2021

A public meeting of the IASB was held in May 2021. At this meeting, among other issues, preliminary decisions were made to update the standards for Financial Instruments with Characteristics of Equity (Agenda Paper 5) (“IASB Update May 2021,” 2021). Other topics considered Goodwill and Impairment (Agenda Paper 18), Primary Financial Statements (Agenda Paper 21), Second Comprehensive Review of the IFRS for SMEs Standard (Agenda Paper 30), Disclosure Initiative – Subsidiaries that are SMEs (Agenda Paper 31), IFRS 17 Insurance Contracts (Agenda Paper 2), and Maintenance and consistent application (Agenda Paper 12).

Concerning Financial Instruments with Characteristics of Equity (Agenda Paper 5), the Board discussed clarifying two new types of liquidation priority information. A tentative decision was made to require entities to classify in the notes their claims, which are financial instruments. This classification should reflect the difference in the priority and nature of financial instruments, including and distinguishing between secured and unsecured financial instruments, subordinated and non-subordinated financial instruments, and financial instruments issued or due to the parent and issued or due to subsidiaries. In addition, the meeting required companies to disclose information on all financial liabilities and equity instruments under IAS 32 Financial Instruments: Presentation.

Then, the Board also decided to oblige companies to disclose liquidation priority conditions for specific financial instruments. In particular, it was decided to require entities to disclose conditions that indicate priority in liquidation and conditions that may lead to a change in priority in liquidation. Organizations should also note if a particular type of financial instrument has more than one level of contractual subordination (“IASB Update May 2021,” 2021). Companies are also required to provide descriptive information if they are aware of the uncertainties in applying laws that may affect the prioritization of liquidation. Finally, companies should describe the details of guarantees or intra-group arrangements that may affect priority in liquidation. Reporting and disclosures apply to all financial instruments for handling equity or debt capital. Financial instruments include compound instruments, but the Update does not apply to individual derivatives.

IASB Update June 2021

The latest IASB public meeting was held in June and the topics of Equity Method: Identifying the principles in IAS 28 Investments in Associates and Joint Ventures (Agenda Paper 13), Goodwill and Impairment (Agenda Paper 18), and Primary Financial Statements (Agenda Paper 21) were discussed. Regarding the first topic, the Board discussed the principles of IAS 28 Investments in Associates and Joint Ventures and the possibility of developing other regulations in case the company applies the equity method in situations where the existing principles do not apply (“IASB Update June 2021,” 2021). The second topic was discussed as part of the revision of the goal and scope; it was decided to leave the project’s goal unchanged. In particular, the project explores if companies can provide more helpful information about acquisitions made at a reasonable cost.

Conclusion

Thus, the decisions and plans of FASB and IFRS were summarized for the current year regarding the setting of new standards and updates to the current ones. FASB introduced some critical updates in 2021 regarding Distinguishing Liabilities from Equity, Reference Rate Reform, Leases, and others. IFRS also presented plans to introduce various updates to International Financial Reporting Standards. In particular, changes were presented regarding COVID-19-related Rent Concessions, Financial Instruments with Characteristics of Equity, Goodwill and Impairment, and other issues.