The intense corporate focus on the Financial Accounting Standards Board’s revenue recognition rules has prompted FASB to try to clarify how companies should account for sales of nonfinancial assets — assets not part of their regular dealings with customers.
Following up on problems it unearthed in its 2014 revenue recognition standard, FASB issued a proposed accounting standards update (ASU) earlier this month on how “Gains and Losses from the Derecognition of Nonfinancial Assets” should be reported.
Before the revenue recognition rules, there was no general guidance on how companies should account for how to take a sale of nonfinancial assets off their books. In issuing the sweeping, controversial revenue recognition standard, FASB sought to clarify, along with much else, what to do about derecognition of financial assets.
As a result of the issuance of the revenue recognition standard, which goes into effect for public companies with interim reporting periods beginning after December 15, 2017, “there’s suddenly so much attention put on sales of things, whether it’s a revenue transaction or not,” says Charles Mulford, a Georgia Tech University accounting professor. (For nonpublic organizations, it will apply for interim reporting periods within annual reporting periods beginning after December 15, 2019.)
“I think the light that has been shone on disposals of assets has moved preparers of financial statements to ask for more guidance on how to account for this stuff,” he adds.
In conjunction with the revenue recognition standard, FASB issued amendments in order “to align the guidance related to the transfer of nonfinancial assets with the guidance for revenue transactions with customers by requiring entities to apply the principles of the new Revenue Standard to their accounting for sales of nonfinancial assets,” according to a PwC issue brief. But the amendments failed to spell out certain key terms mentioned in the original standard amendments.
Through a “transition resource group” FASB set up to help preparers handle problems in implementing the rules, the board found out that corporate executives and auditors were confused by the omissions. To Mulford, the problem was that the regulation relies too much on broad principles and is skimpy on the details. “It’s clear that the principles-based approach to accounting standards setting can only take you so far. You need more guidance, and I think [the proposed ASU] is an example of that,” he says.
Although the two basic terms, “derecognition” and “nonfinancial assets” seem clear enough, accounting and finance folks found some of the other terminology in the original revenue recognition rules foggy. On the surface, what “derecognition” means is fairly obvious. If, for instance, a company owns a piece of land, it’s on the company’s financial statements as an asset. If the company sells the piece of land, it can then take the asset off its books and recognize the transaction as a gain or a loss. The act of taking the asset off the books is defined as derecognition.
If the asset that’s sold isn’t something the company would sell in the course of its ordinary business dealings, it’s a “nonfinancial asset.” For example, a technology company engaged in selling off its office furniture would likely report a sale of nonfinancial assets. (On the other hand, if an office furniture company sells its office furniture inventory, it would probably book the sale as normal revenue.)
Beyond those two basic definitions, however, certain terms were ill-defined, corporate executives and auditors felt. Most of the difficulty the proposed ASU is seeking to allay stems from two ambiguous phrases mentioned in amendments to the revenue recognition rule: so-called “in substance nonfinancial assets; and “partial sales” of such assets.
“Stakeholders have informed the Board that there is not a uniform view on what constitutes an in substance nonfinancial asset because the term is not currently defined. As such, some stakeholders are uncertain about what types of transactions should be within the scope of the nonfinancial asset guidance,” according to the proposed update, which intends to clarify the scope of that guidance.
FASB’s proposed solution is to define an in substance nonfinancial asset as an asset held in one of two situations. One situation is that the asset is part of a contract in which practically all the fair value of the assets promised to a customer “is concentrated in nonfinancial assets.”
The second defining characteristic of an in substance nonfinancial asset is that it can be owned by a “consolidated subsidiary in which substantially all of the fair value of the assets in the subsidiary is concentrated in nonfinancial assets.”
Another sticking point was how to account for “partial sales of nonfinancial assets.” Such deals “are common in the real estate industry and typically include transactions in which the seller retains an equity interest in the entity that owns the asset or has an equity interest in the buyer,” according to the proposed ASU.
Explains Mulford: “For example, I sell you real estate, but as a part of the transaction I hold an equity interest in you. I haven’t really sold the whole thing. What do I do then?”
Another question regarding partial sales is how should a company account for a situation in which it buys a noncontrolling interest in an entity that holds nonfinancial assets as part of its core business. “How do I account for that?” the accounting professor asked.
Unlike sales that occur as part of a company’s regular course of business, the proceeds of a sale of a nonfinancial asset “will not be presented as topline revenue because it does not meet the definition of a customer transaction,” according to Kristin Bauer, partner, national office accounting services, Deloitte & Touche. Instead, it would be presented under income from continuing operations, she said.
The sale of a nonfinancial asset “gives rise to a P&L or income statement effect to the extent there’s a difference between the carrying amount of the thing that was sold and the consideration in the arrangement,” Bauer added.
Public comments for the proposed ASU must be submitted to FASB by August 5.