The London Interbank Offered Rate (LIBOR) is the mainstay interest rate benchmark in financial contracts entered into by organizations worldwide. However, this is expected to change as international capital markets move away from the LIBOR and other interbank offered rates due to rigging scandals that have plagued these types of rates. It is expected that the LIBOR will be phased out by the end of 2021 because it is believed that more observable rates will be less susceptible to manipulation.
In anticipation of this transition, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The ASU was effective upon issuance on March 12, 2020, and can only be applied to contract modifications entered into through December 31, 2022. The ASU applies to all entities that have reference rates in contracts that reference LIBOR or any other discontinued reference rate.
This guidance is fully optional, temporary, and is intended to relieve the burden of reference rate reform in connection with financial reporting. The ASU provides both practical expedients and exceptions for applying existing guidance to contract modifications, fair value hedges, hedging relationships and other transactions that use the sunsetting reference rates. Additionally, the ASU allows an entity to make a one-time election to sell and/or transfer debt securities classified as held-to-maturity that reference a rate affected by reference rate reform and that were classified as held-to-maturity prior to January 1, 2020.
The optional expedients outlined in the guidance for contract modifications are as follows:
- Modifications of contracts within the scopes of Topic 310, Receivables and Topic 470, Debt, should be accounted
for by prospectively adjusting the effective interest rate.
- Modifications of contracts within the scope of Topic 840, Leases, should be accounted for as a continuation of the
existing contract with no reassessments or remeasurements that otherwise would be required under that Topic.
- Modifications of contracts do not require a reassessment under Subtopic 815-15, Derivatives and Hedging-
Embedded Derivatives, of whether an embedded derivative should be accounted for as a separate instrument.
As the markets move toward the use of alternative reference rates, the full scope of ASU 2020-04 will certainly be helpful to organizations involved in the financial reporting process.
If you have questions or would like more information, please contact Jeffrey Carrick at firstname.lastname@example.org or 844.4WINDES (844.494.6337).