Did you know that every year the Financial Accounting Standards Board (“FASB”) issues updates that modify the accounting rules for businesses? If not, your company’s accounting system may not be in compliance with the latest accounting rules of FASB. These accounting rules have been updated over the last several years. Here are five major accounting changes issued by FASB over the last several years that may affect your company:
1. Treatment of Operating Leases
If your company is leasing any assets from another company or you intend on doing so in the future, this change in accounting is relevant to your company. In February 2016, FASB issued an accounting standards update regarding changes to how operating leases are recorded initially and during the lease term. Operating leases were leases that did not need to be recorded on a company’s Balance Sheet and could just be expensed when lease payments were made. However, this accounting standards update states that operating leases will also need to be recorded on the Balance Sheet as an asset & a liability. This will result in an additional liability on your Balance Sheet, which will affect certain financial ratios that banks use to assess your company’s financial health. For companies that are not publicly traded and operate as a for-profit entity, these changes go into effect at the beginning of 2020.
2. Revenue Recognition
In May 2014, FASB issued an accounting rule relating to revenue recognition. This update is relevant for companies whose sales with customers are in the form of a contract to provide products and related services to those products. These changes went into effect at the beginning of 2018 for companies that are not publicly traded and operate on a for-profit basis. An example of this type of sale would include the sale of software that includes periodic updates and maintenance to that software. This accounting standards update states that these types of sales must separately recognize the revenue of the products and related services based upon when the seller’s obligations have been fulfilled. For example, a company selling software and related updates to the software would recognize the revenue relating exclusively to the software sold when the actual software is sold to the customer, while the portion of revenue relating to the software updates would be recognized over the period of the updates. If those software updates were for 5 years, then you would recognize that portion of revenue relating to software updates evenly over a 5-year period. While this rule would not change the overall revenue recognized, it does result in a portion of revenue that would be deferred and not recognized until later periods. This would temporarily decrease revenue until all services that customers are entitled to have been fulfilled.
3. Accounting for Cloud Services & Related Software Services
In April 2015, FASB issued a rule that clarified how companies account for fees paid in an agreement regarding the use of cloud computing services and software, which went into effect in 2016. This rule affects any company that pays for cloud computing services from a third party vendor. The new accounting rule states that if the agreement includes a software license providing access to software, then the value of that software license should be capitalized on the Balance Sheet as an intangible asset, while the portion of the agreement relating to hosting services should be expensed as incurred. This new rule would result in additional balances initially added to the Balance Sheet as an asset and a liability for software licenses, resulting in changes in your company’s financial ratios used by your lenders to evaluate your company’s financial position. In addition, FASB also issued an update to this rule in August 2018 on how to account for the implementation costs of hosting services of a cloud computing agreement, which go into effect in 2021.
4. Employee Compensation of Stock Options
About a decade ago, FASB issued an accounting rules update regarding the accounting treatment of employee compensation of stock options. This affects any company that issues share-based stock payments to their employees. The main goal of this rule is to set up the accounting treatment of stock compensation. The main rule change is that all stock compensation must be expensed as compensation expense and recorded as an increase in the equity of the company. While this rule change will not change the overall value of assets, liabilities, or equity, it does change the presentation of equity on the Balance Sheet by reducing the value of Retained Earnings (overall net income or loss through the life of the company), as well as a corresponding increase in the common stock and additional paid-in capital. The main result of this rule is that it will decrease your company’s earnings per share compared to before this accounting rule.
5. Aligning U.S. GAAP with IFRS
For many years, FASB has been trying to align their accounting rules with the International Financial Reporting Standards (IFRS) that are issued by the International Accounting Standards Board (IASB) . These IASB standards are generally used by most countries around the globe. While both accounting standards are similar in their accounting rules and definitions, FASB rules in the United States tend to have more strict thresholds, while IFRS rules used internationally tend to have more of a principle-based interpretation. As U.S. GAAP and IFRS rules become more aligned, this will make accounting easier for those companies who operate in the United States and in multiple countries around the world.
The Financial Accounting Standards Board (FASB) issues updates to the accounting rules for businesses every year. As a business owner, it is in your best interest to understand these updates, so you can ensure your accounting system stays in compliance with the new rules. Especially, if your business is involved in any of the areas listed above. If your accountants are not keeping up with the changes in the accounting rules, please let us know. We will ensure that your company’s accounting system stays in compliance with the latest updates. Call us today (480) 980-3977.
Paul J. Beckert MBA, CPA
Note: The information contained in this material represents a general overview of accounting and should not be relied upon without an independent, professional analysis of how any of these provisions apply to a specific situation.