Question

What is a recent accounting rule change, and how does it affect financial statements as well as the effects on ratios? How would an investor who was not aware of this accounting rule be influenced by the financial statements .

Answer 1

The Financial Accounting Standards Board (FASB) has released four major updates to U.S. Generally Accepted Accounting Principles (GAAP). Four major policy updates have been identified an outlined in the 2018 GAAP Financial Reporting Taxonomy and 2018 SEC Reporting Taxonomy. They are the:-

1).Non-profit Standard:

Applies to a wide variety of organizations, including charities, educational institution foundations, and cultural, religious and trade-related nonprofits. Most notably, the updated standard will reduce the number of net asset classes from three to two: 1) net assets with donor restrictions, and 2) net assets without donor restrictions.

2).Revenue Recognition Standard:

It is expected to have a big impact on entities such as construction contractors, software companies, media companies, telecommunications providers, manufacturers, distributors and asset managers with other industries such as banking, insurance and healthcare moderately affected. This standard primarily affects the timing of revenue recognition.

3).Lease Standard:

Under current practice, many lease obligations (typically for real estate, vehicles or equipment) have no balance sheet impact as they are accounted for as operating leases with their payments included in an entity’s income statement as rent expense and disclosed in the notes.

For all leases with terms of more than 12 months, the revised standard requires right-to-use assets to be added to the assets section of the balance sheet and the present value of the related lease obligations to be included as liabilities. These changes could make lessees appear significantly more leveraged and cause unprepared entities to violate their loan covenants.

Under the updated guidance, some long-term leasing arrangements, such as service contracts and contracts with third party manufacturers, may be difficult for entities to identify and assess who’s in control. The new standard will require management to make subjective judgments about these complex transactions.

4).Credit Loss Standard:

It applies primarily to banks, credit unions and other companies that provide financing to customers. Beyond traditional loans, the revised standard will affect such assets as debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures and reinsurance receivables.

Existing GAAP requires companies to report the amortized cost of credit losses using an “incurred loss” model. That model delays recognition until it’s “probable” that the financial institution has incurred a loss.

Effects:-

Impact is largely contingent on organizational specifics and the nature of a business organization. Retroactively modifying your accounting systems and collecting data can be cumbersome. They must employ far more resources than management teams anticipated.