Codification Improvements to Financial Instruments: Credit Losses Paper Example

The FASB has issued a proposed accounting standards update Topic 326, Financial Instruments-Credit Losses. The proposed update excludes receivables arising from operating leases and calcifies that such should be accounted for in accordance with Topic 842, Leases (Tysiac, 2018). FASB also intended to reduce the complexity involved in transiting to the new standard. The update proposes the fiscal year beginning 15 December 2021, including interim periods, as the effective implementation date for nonpublic business entities (Tysiac, 2018). It will make it easier for entities to transit from the current standard to the new standard since it aligns the implementation dates for annual and interim financial statements (SEC, 2018).

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Although the alignment of the implementation date for annual and interim financial statements is an improvement, I am against the update since it creates more confusion about the accounting for receivables arising from operating leases. Firstly, the update does not address the accounting for operating lease payments versus operating lease receivables. It proposes that losses due from operating leases should be accounted for as per Topic 842 (Tysiac, 2018). Topic 842 provides guidelines for the treatment of operating lease payments and not operating lease receivables (Flood, 2018). It outlines the assessment of the collectability of operating lease payments and the recognition of income thereon. The definition of operating lease payments as provided by ASC 842-10-30-25 does not apply to unpaid receivables resulting from operating leases (Flood, 2018). Therefore, ASC 842 would not be the appropriate guideline for accounting for receivable losses arising from operating leases as direct by the update.

Secondly, the update will lead to a significant change in the way some lessors account for operating leases contrary to the Board's assertions that it will not change the accounting for leases (Leese, 2018). Under the current standards, lessors account for the collectability of operating lease receivables in the same way as trade losses. Lessors assess the collectability of an operating lease receivable and record a bad debt expense and an allowance for uncollectible receivables if the collection of an operating lease receivable is not probable (Leese, 2018). This would not be permitted if they were to be accounted for under ASC 842. Lessors would not be able to record a bad debts expense. ASC 842 requires that lessors should only recognize a loss when the amount collected is less than the amount due (Iasplus.com, 2018). How would a lessor recognize operating lease receivables not expected to be collected when ASC 842 provides that lessors can only recognize losses when the actual amount collected is less than the amount due?

The update does not also clarify whether an operating lease is a financing receivable. Under the proposed amendments, the assessment and recognition of collectability of a receivable will be based on whether it arises out of a lease transaction or a revenue-generating transaction whose accounting guidelines are provided by ASC 842 and ASC 606 respectively (Iasplus.com, 2018). These two types of receivables seem to be consistent with the definition of financing receivable. Thus, if the update is approved without further clarifications, it will increase complexity. Besides, it will not be consistent with FASB's objective of aligning the accounting for leases under ASC 842 with that of ASC 660.

An accounting standards update should simplify the guidelines for accounting for a particular transaction by eliminating the complexities. Besides, it should enhance consistency in the accounting process by providing guidelines that all accountants can easily follow. Based on the above thee issues, I do not consider the update to ASC 326 as appropriate unless the issues are corrected. It does not address effectively some of the issues stakeholders had raised about the 2016 amendment to ASC 326.

Proposed Corrections

If the update was intended to allow lessors account for operating lease receivables in the same manner as operating lease payments, FASB should amend ASC 842-10-30-25 from paragraph 10 to 14 to include that it applies to both operating lease payments and receivables resulting from operating leases. Alternatively, FASB should clarify in the Background Information and Basis for Conclusions of the update that the guideline is also applicable to the assessment of the collectability of operating lease receivables. The two clarifications will make it easier for accountants to apply ASC 842 when accounting for receivables resulting from operating leases.

The second issue is that it would not be possible to recognize uncollectible operating lease receivables due to the limitations of ASC 842-30-25-14. If the board intends the update to allow lessors to evaluate the collectability of operating lease receivables and recognize the allowance for uncollectible receivables, it should clarify that Background Information and Basis for Conclusions. Background Information and Basis for Conclusions are essential sections of standards update since they describe the issues corrected by the update as well as the rationale for conclusions.

Finally, the Board should clarify whether receivables arising from operating leases are financing receivables or not. In the update to ASC 326, FASB notes that stakeholders have asked for that clarification yet it did not include it. Such a clarification will enable the correct classification and accounting for such receivables thereby reducing complexities and improve the quality of financial reporting.

References

Flood, J. (2018). Wiley GAAP 2018: Interpretation and Application of Generally Accepted Accounting Principles. Hobeken, New Jersey: John Wiley & Sons.

Iasplus.com. (2018). FASB proposes narrow-scope amendments to guidance on credit losses. Retrieved from https://www.iasplus.com/en-us/news/2018/08/pasu-credit-losses

Leese, C. (2018). ASC 326 Credit Losses Changes the Accounting for Credit Impairment | GAAP Dynamics. Retrieved from https://www.gaapdynamics.com/insights/blog/2018/05/22/asc-326-credit-losses-changes-the-accounting-for-credit-impairment/

SEC. (2018). SEC.gov | Progress Is Being Made: Continued Focus on Addressing Implementation Matters. Retrieved from https://www.sec.gov/news/speech/teotia-progress-being-made

Tysiac, K. (2018). FASB addresses credit loss standard concerns. Retrieved from https://www.journalofaccountancy.com/news/2018/aug/fasb-addresses-credit-loss-standard-concerns-201819569.html