FASB addresses breakage recognition, derivative contract novations

By Ken Tysiac

FASB issued financial reporting standards Thursday that address recognition of breakage for prepaid stored-value products and the effects of derivative contract novations on existing hedge accounting relationships.

Both standards are the result of projects undertaken by FASB’s Emerging Issues Task Force.

Accounting Standards Update (ASU) No. 2016-04, Liabilities—Extinguishment of Liabilities (Subtopic 405-20) Recognition of Breakage for Certain Prepaid Stored-Value Products, addresses liabilities related to prepaid stored-value products (such as gift cards and traveler’s checks).

The standard addresses inconsistencies in practice related to the methodology used to recognize the portion of the dollar value of the prepaid stored-value products that are not redeemed, known as breakage.

Although the new revenue recognition standard, Topic 606, includes authoritative breakage guidance, financial liabilities are excluded from the scope of Topic 606.

Prepaid stored-value products within the scope of ASU No. 2016-04 are financial liabilities. The amendments in the standard provide a narrow-scope exception to the guidance in Subtopic 405-20 to require that breakage for those liabilities be accounted for under the breakage guidance in the new revenue recognition standard, Topic 606.

Public business entities, certain not-for-profits, and certain employee benefit plans are required to apply the new guidance in financial statements issued during fiscal years beginning after Dec. 15, 2017, and interim periods within those fiscal years.

All other entities are required to apply the new rules for financial statements issued for fiscal years beginning after Dec. 15, 2018, and interim periods within fiscal years beginning after Dec. 15, 2019. Early adoption is permitted, including early adoption during an interim period.

Derivative contract novations

ASU No. 2016-05, Derivatives and Hedging (Topic 815), Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships, addresses the topic of novations, a term that refers to replacing one of the parties to a derivative instrument with a new party.

The derivative instrument that is the subject of a novation may be a hedging instrument. The standard states that a change in the counterparty to a derivative instrument that has been designated as a hedging instrument under Topic 815 does not result in a requirement to de-designate that hedging relationship and discontinue the application of hedge accounting, as long as all other hedge accounting criteria continue to be met.

ASU No. 2016-05 takes effect for public business entities for fiscal years beginning after Dec. 15, 2016, and interim periods within those fiscal years. All other entities are required to apply the new rules for fiscal years beginning after Dec. 15, 2017, and interim periods within fiscal years beginning after Dec. 15, 2018. Early adoption is permitted, including early adoption in an interim period.

An entity can apply the amendments in ASU No. 2016-05 on either a prospective basis or a modified retrospective basis.

Ken Tysiac (ktysiac@aicpa.org) is a JofA editorial director.

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