In this episode of GAAP Chats, we’ll provide you with an update on some topics and issues we’ve been discussing in recent podcasts including Credit Suisse, Coinbase, held-to-maturity debt securities, and Buy Now Pay Later companies. We’ll also discuss some of the latest developments in U.S. GAAP by looking at two Exposure Drafts issued by the FASB related to income tax disclosures and accounting for crypto assets. We’ll also look at a new ASU related to common control lease arrangements.

The following content is NOT a full transcript of episode 13 of GAAP Chats. To hear the episode in it's entirety, please click here.

Mike: Welcome to GAAP Chats, the podcast dedicated to all things accounting, brought to you by GAAP Dynamics. I’m your host, Mike Walworth and with me, as always, is my faithful partner, Chris Brundrett. We hope you’ll join us on our journey today as we share our passion for accounting and help change the way you train.

Mike: Well, Chris, we’ve made it to our 13th episode!

Chris: Hope nothing bad happens!

Mike: I always liked the number 13. In fact, it was my football number in high school. That said, a lot of people don’t like the number. Have you noticed that the 13th floor is usually not included in the elevator banks for large buildings?

Chris: It’s weird how different cultures have different superstitions. I don’t suppose the number 13 is bad in all cultures.

Mike: Definitely. Like in China, the number 4 is considered a “bad” number because in Mandarin it sounds a lot like the word “death.” 

[Lots of fun stories from around the world from Chris & Mike...you'll have to listen in to hear more!]

Chris: I’m ready to talk about the latest in U.S. GAAP!

Mike: In due time, my friend. First, I wanted to provide our listeners with an update on some of the issues that we’ve been discussing on recent episodes. And I’ll kind of go in reverse order, starting with the most recent.

• HTM Debt Securities

Last week we discussed the accounting for held-to-maturity debt securities. We’ll that took me down a rabbit hole which ended with me reviewing the latest Form 10-K’s for the top 25 banks in the U.S. And do you know what I found? Many of them substantially increased the proportion of their investments classified as held-to-maturity! I wrote a blog on it that was published one day BEFORE a similar article (with a lot less data) was published by the Wall Street Journal. I even had a reported from Bloomberg email saying how much she liked the post.

• Silicon Valley Bank and Credit Suisse

And the week before that, you and Bob were talking about Silicon Valley Bank and Credit Suisse. Well, since that episode, banking regulators in the U.S. and Switzerland forced the sale of both banks to First Citizens and UBS, respectively. Let’s just say the deal terms were less than ideal for the shareholders of SVB and Credit Suisse!

• Coinbase

Three weeks ago Bob and I discussed the SEC enforcement action against Kraken, forcing Kraken to pay $30 million and close their crypto asset staking-as-a-service program. In that episode we talked about how the Coinbase CEO had sort of a “bring it on” attitude to the SEC. Well, he f’d around and, guess what, they found out! Last week, the SEC issued a Wells Notice indicating that they intended to recommend an enforcement action against the company. Coinbase’s share promptly fell 15%. Like we said in the podcast, best not mess with the SEC!

• Buy Now, Pay Later

And finally, back in February we did a podcast episode about the buy now, pay later phenomenon and the companies operating in this market. We talked about how the market is booming by anyone’s measure and that some big players were eyeing this market. Well, on March 28th, Apple formally announced its Apple Pay Later product to allow Apple Pay users to split purchases into four payments with zero interest and no fees. Sorry Affirm, Afterpay and Klarna, there’s a new competitor…and it just happens to be the largest company in the world! Good luck with that!! In more troubling news, an article by Marketwatch said that in the first two months of 2023, the share of online grocery orders made using buy now, pay later grew by 40% compared with the same period a year ago. Is this a sign of trouble in the economy? I think so! Hang on baby Jesus, it’s about to get bumpy.

Chris: Now, can we talk about the latest developments in U.S. GAAP.

Mike: Let’s do it! You know I never really liked talking about Exposure Drafts in our training materials because who knows what will happen. There’s so many rules that CPAs need to remember, no sense filling their brain with stuff that isn’t even effective yet! That said, this podcast provides the perfect medium to discuss Exposure Drafts.

Chris: I agree. I’ll take the first one. So this one is an exposure draft, as Mike mentioned. You know, it's out for  comment. It was issued March 15th, so just a few weeks ago, and it's out for comment comment deadlines May 30th. So hey, if you want to comment on this, by all means do so. But anyway, what's this one all about? It's actually about disclosure, right? So no changes to the actual mechanics of ASC 740. We're talking about disclosures which, you know, the whole idea is to provide more transparency to the readers of the financial statements about the income tax situation for a company.

Mike: I always thought those tax disclosures, I mean, they're pretty good. So what what's changed?

Chris: A couple of things. So the first area where they're proposing change is the rate reconciliation. Now, the rate reconciliation has been around for a long time. And if you recall, the rate reconciliation is only a requirement for public business entities.  Non public entities don't have to do a rate reconciliation. They disclose certain things. But, the rate reconciliation required by public business or for public business entities, that's not changing. So, what I'm about to talk about is still only for public business entities. But if you look in the standard, it's only like one little paragraph about the rate reconciliation, okay? And it talks about  that you're reconciling right to the stat from the effective tax rate to the statutory rate. You can do it in dollars or percentages or both. And it says that you have to disclose in the reconciliation significant items. Reconciling items doesn't define what significant is.

So that's the current GAAP. It's pretty short and sweet. And so basically what they're doing here is they're going to require more specifics about this rate reconciliation. So first of all, the first major change is the rate reconciliation will have to be done in both percentages and reporting currency, right? A lot of companies are already doing both, but that will be a requirement. In addition, they're going to require certain specific categories regardless of the amount. Now, these are categories that most companies are doing anyway, but it's now required state and local income tax, foreign tax effects and effects from enactment of new tax laws, effective cross border tax laws, tax credits, valuation allowance, non-taxable or non-deductible items and changes in unrecognized tax benefits.

Now, those are all seperate items. They're very commonly disclosed now because they're usually significant, but they're now required regardless. In addition to that, separate disclosure is going to be required for other reconciling items in which the reconciling item is equal to or greater than 5% of the amount computed by multiplying the income or loss from continuing operations before tax by the applicable statutory federal income tax. 

Mike: So no more big "other" line item, right?

Chris: This was always required by Reg SX. It wasn't in the FASB literature, but since this disclosure only applies to public companies, public companies are following SEC recs. Reg SX always had this 5% rule in there. They're now just bringing it to the fold. 

Mike: Is this now going to be both public and private, or is it still only public?

Chris: Just public. They didn't make a change there. So, three main areas:

1. Dollars and percentages
2. Specific line items have to be disclosed
3. The 5% rule, which was always in Reg SX, they're now just folding it into the literature. 

Mike: So just so our learners understand, what we're talking about here is, you know, companies' statutory tax rate at 35%. Then you see Apple only paid taxes amounting to maybe 10%. And so this rate reconcilliation helps you figure out why Apple only paid a 10% rate. This rate reconcilliation is what I want to hand Bernie Sanders when he starts complaining about companies and how they they always get the tax break. Well, this helps explain it. I know you and I love the rate reconcilliation because it kind of helps at the end of a tax audit, doesn't it? 

Chris: Yes it does. It's a really good sort of sanity check when you're doing your audit to make sure you can see all this stuff reconciled and there's no major other items. It's kind of a good I mean it's a good sanity check on it. So it's a really good audit procedure. Looking at that, that's pretty important. And by the way, you dated yourself, Mike. You were using 35%. It's actually 21%.

Mike: Oh, that's right. The Trump Tax cuts.

Chris: All right, so back to it. So that was one. The second one applies to all entities, public and non-public. It's the specific disclosure about income taxes paid. So, the year to date amount of income taxes paid disaggregated by federal, state and foreign taxes, that's on an interim and an annual basis. The amount of taxes paid by individual jurisdictions in which the tax paid is equal to or greater than 5% of total income taxes paid. So, just breaking it down by significant jurisdictions is really what that's getting down to. Then a couple of other things, and I'm not getting into all the details, I'm just kind of trying to highlight the bigger changes in here. Additional disclosures would be required for both public and non-public entities for income or loss from continuing operations before income tax expense disaggregated between domestic and foreign and then income tax expense or benefit from continuing ops disaggregated by federal, state and foreign.  So, those are some other additions. Now for the good news. These proposed amendments are actually going to eliminate a disclosure, and it's one that companies hate. 

Mike: Is it uncertain tax positions? 

Chris: Yes, that's it! They're proposing to eliminate that requirement for entities to disclose the nature and estimate of the range of reasonably possible changes in unrecognized tax benefit balances in the next 12 months. 

For example, let's say this, you have a liability on your books related to an uncertain tax position. Because of the accounting literature, it's on your books. If the statute of limitations is going to expire within the next 12 months, technically you are supposed to disclose it. Like, hey, I have this situation. I have this uncertain tax position. I have this liability on my books and the statute of limitations is going to expire. I'm going to reverse that if it does in the next 12 months. It's like an open letter,  come audit me kind of thing. Companies hate this disclosure for that reason. Because they can be disclosing some stuff that you might not want to call out. Also, it's a pain in the neck to do, and it's somewhat hypothetical.  So they're looking to to to get rid of that. I think it's probably a good thing.

Mike: Have they given any indication when the effective date might be, or are they not there yet?

Chris: No, they're not there yet. We'll see what happens when the comment period comes back. But, if you're interested in more, check out the exposure draft. In the exposure draft they ask questions, and they want you to comment on certain things. So, it's kind of an interesting one. I think overall good stuff. You know, nothing crazy here. So, next one up, Mike. You're going to talk about crypto.

Mike: Finally, some clarity on the accounting for crypto assets! And just to remind that there is essentially NO U.S. GAAP standards that specifically address crypto assets. Most companies CURRENTLY account for crypto assets as intangible assets with indefinite lives. As such, crypto assets currently are accounted for at cost, although ASC 350 requires indefinite-lived intangible assets to be measured for impairment at least annually, or more frequently if there are indications of impairment. This results in crypto assets being written down, but, since you cannot reverse impairment under U.S. GAAP, subsequent recoveries are not captured, at least until the position is sold, at which point any gains or losses would obviously be realized.

I said most companies, because if the entity holding the crypto asset is subject to specialized industry-specific guidance, like investment companies, then they should follow that guidance. For example, if an investment company held crypto assets, ASC Topic 946 would require that investment company to report the crypto asset at fair value, with changes in fair value reported in net income. 

Well, this is all about to change. The FASB issued an Exposure Draft on March 23, 2023, that requires entities that hold in-scope crypto assets:

• Measure at fair value in accordance with ASC Topic 820, with changes in fair value immediately reported in current period net income
• Expense transaction costs, unless industry-specific U.S. GAAP requires a different treatment
• Present separately in the balance sheet apart from other assets
• Provide enhanced disclosure in the footnotes to the financial statements

The proposed ASU only relates to “in-scope crypto assets,” which would include the “biggies” like Bitcoin and ether, but also many other lesser-known and smaller digital assets. That said, what’s out-of-scope of the proposed ASU are non-fungible tokens, or NFTs, and wrapped tokens, digital assets that represent other digital assets on a non-native blockchain. Also out of scope are those digital assets subject to other, existing U.S. GAAP. An example would be stablecoins which meet the definition of a financial asset. Finally, crypto assets held by their issuer or creator (or related parties) would not be in the scope of the proposed ASU.

Currently, the proposed ASU does not have an effective date. The comment deadline for the Exposure Draft is June 6, 2023.

Mike: Now we do have a new ASU this year. It deals with common control lease arrangements and related leasehold improvements. Chris, why don’t you briefly take us through this one.

Chris: And this is the first ASU of the year. I think there's been one other, but it's very specific. Maybe we'll talk about it sometime. But anyway, this is the the first one of the year so, 2023-01, and it deals with common control leasing arrangements. I'll go through this one pretty quickly because it just sounds boring, but, you know, it could be important to some people out there. Just a heads up ahead of time, in case I forget, this is effective really for 2024 for calendar year end companies. So, fiscal years beginning on or after December 15th, 2023.

There's a couple of issues here. First of all, before this ASU becomes effective, ASC 842 requires entities to determine whether a related party arrangement between entities under common control is a lease. What that means is they have to apply all of the guidance in ASC 842 on determining whether or not it's a lease. Those of you that understand or have taken our trainings on 842 or are familiar with it, there's kind of a lot going on to determine whether a contract is a lease, or maybe a portion of a contract is a lease. There's more than just the written terms. And you've got to look at a lot of different things to meeting that definition of a lease. If it is a lease, it has to be accounted for as a lease, obviously. That's the current ASC 842. Common control leasing transactions are no different than any other lease with a third party. That is basically what they're saying. That has been observed as a bit of a problem. It's often difficult to apply ASC 842 to try and determine the enforceable terms and condition of a common control arrangement, because this is between two related parties. They are under common control. So how do you know what exactly those enforceable terms and conditions are? 

Mike: Just to be clear, common control, that'd be like a parent has sub A and B, and both enter into a lease together. 

Chris: Right. It just gets kind of muddy when you're trying to look at applying the definition of a lease under ASC 842. What they're doing for private companies, there's a practical expedient out there that basically says as long as you're not a bond obligor, they can use the written terms and conditions of this common control arrangement to determine whether a lease exists and if so, the classification of the lease. They can look at the written terms and conditions of the agreement between the two parties versus having to apply the full-on definition of a lease under ASC 842. It can be applied on an arrangement by arrangement basis. One note: if there are no written terms and conditions, then you can't do this practical expedient. You got to do the full blown ASC 842 definition of a lease. So, that's important to to note as well. You know, the whole idea of this is to reduce costs associated with implementing ASC 842 for private entities. Also to just to kind of go back to ASC 840 accounting, right? This is kind of what we had in the past. So anyway, that's that's the first issue. The second issue is dealing with leasehold improvements. It's tied in. Generally, as you guys may remember, ASC 842 requires that leasehold improvements be amortized over a period that is either the shorter of the remaining lease term, or the useful life of the leasehold improvements. That makes sense, right? However, in a common control leasing arrangement that doesn't make economic sense.

Mike: Because you're always going to have the leasehold improvements?

Chris: Yes! Think about it. It's my building. Sub A and Sub B have a lease arrangement, right? Let's say Sub B is the lessee. They make leasehold improvements to the lease. So, at the end of the lease, it's still the collective entity's asset, even though the lease is gone. You see what I mean?

Mike: Yeah. It doesn't make sense to it. Might as well do it over the useful life, is what I would say.

Chris: Exactly. That's what this is all about. Again, this is tied into the first issue, right? So really, if you have a common control leasing arrangement,  then you would amortize the leasehold improvements over their useful life rather than the shorter of the term of the lease or the useful life. Now, that applies as long as it's truly a common control leasing arrangement. If you have a situation where the lessor is under common control but they're actually in a sub lease with another entity, so they're the lessee and the lessor, the ultimate leased asset is outside the company, then this doesn't apply. 

Mike: That was a very good explanation, Chris. I appreciated that. So, is the leasehold improvement thing. Is that only for private entities as well, or is that for everyone?

Chris: That's everyone. That's a good clarification. The first one when we're talking about the practical expedient for the definition of a lease, that's only nonpublic entities. So, that is entities that are not public business entities, not for profit, conduit bond obligors, or employee benefit plans that file with the SEC. Then the second issue with the leasehold improvements, that's for everybody. That's all entities that are party to a common control lease.

Mike: Well, awesome. That's a pretty good episode, I think.

Chris: Yes, I agree. We covered a lot of ground here. I'll take us out. That’s all for this episode of GAAP Chats, your source for all things accounting.  Notes and resources from today’s episode are linked in the description and as always you can find us online at GAAPDynamics.com, and @gaapdynamics across social media. It’s never too late to become a GAAPologist! Head over to our website and subscribe to our blog so that you’re the first to know what’s new with GAAP Dynamics.