Revenue, SPACs, and LIBOR pose year-end accounting challenges

By Maria L. Murphy, CPA

As companies and their auditors prepare for this year end, they face some new and complex accounting and reporting issues.

"The challenge is dealing with the complexities of adopting new standards, like revenue recognition, and interpreting and applying existing standards to new transactions," said Lisa Munro, CPA, an audit partner at KPMG who is scheduled to participate in a panel on accounting hot topics at the AICPA & CIMA Conference on Current SEC and PCAOB Developments, which will be held Dec. 6–8 in Washington, D.C.

"In dealing with difficult technical areas and areas of significant judgment, it is important to understand when you need help," said Brandon Coleman, CPA, an audit partner at Deloitte who is moderating the panel. "Talk to advisers and your auditors and find out where others have struggled, or what the significant areas of challenge are from the SEC."

Revenue from contracts with customers

Accounting for revenue under FASB ASC Topic 606, Revenue From Contracts With Customers, is still new for many companies. An emerging issue in this area is revenue recognition for platform companies that host infrastructure in providing services. A platform business model facilitates transactions between consumers and producers by creating and facilitating the way they connect. While these companies started out mostly with online advertising platforms that matched up buyers and sellers, there are many more of them now in many different industries.

"This is a complicated area because there are usually at least three parties involved, and it is not always obvious who the customer is, which is a starting point in applying Topic 606," Munro said. "Without knowing who your customer is, and there can be more than one, it is really hard to work your way through the revenue model to determine the performance obligations, whether you are a principal or agent in the transaction that determines gross versus net treatment, and the pattern of revenue recognition."

She advises that under Topic 606 the contract terms drive the outcome and that even companies in the same industry that on the surface have similar fact patterns can have different accounting outcomes depending on their specific facts and circumstances.

"There is a trend in platform companies pre-clearing their accounting model with the SEC, especially those who are pre-IPO," she said.

Special-purpose acquisition companies (SPACs)

A popular way for private companies to go public is to use a SPAC, which is formed to raise capital in an initial public offering (IPO) and then finds a private company to buy so that the combined company becomes a public company. Although SPACs are not new, there has been a significant trend in the use of them in recent years, and the high volume of these transactions received significant attention from the SEC in 2021.

"SPACs have been in the news quite a bit this year, and SPACs and IPOs have been the most prevalent area of our National Office accounting consultations this year," Coleman said.

"Although GAAP in this area has not changed, there are many challenges in applying it," Munro said. Some of these include how to account for the SPAC itself, determining:

  • Whether the SPAC or the target is the "accounting acquirer";
  • If there is a reverse acquisition or reverse recapitalization;
  • Whether there is a step-up in basis and how to determine fair values; and
  • Whether the operating company is subject to variable interest accounting.

"The number one significant accounting challenge for SPACs this year relates to the complex financial instruments issued and whether they should be classified as equity or liabilities," Coleman said. In a SPAC IPO, investors may get a unit of securities consisting of common shares and warrants to purchase additional shares.

"This area got a lot of recent attention when the SEC took exception to how many companies accounted for these instruments as equity, and there were a significant number of restatements of SPAC financial statements," Munro said. "The devil is in the details in this area because if the instruments are in the scope of [FASB] ASC 718 on stock compensation, you get one answer, but they can also be in the scope of [FASB] ASC 480 or ASC 815 on derivatives."

Coleman agrees. "It is critical to fully understand the provisions of the financial instruments issued to determine whether they can be classified as equity, which companies prefer, or whether they must be considered derivative liabilities and marked to market through the income statement."

After the SPAC transaction, there are additional issues. "If private companies granted employee stock awards in the scope of [FASB] ASC 718 and they are exchanged for the now public company, modification accounting applies," Munro said.

Shares issued to SPAC founders can either be stock compensation or an equity transaction. "A challenging area relates to valuing earnouts post-acquisition," Coleman said. "If the stock price goes up or other performance targets are met, the founders or sponsors of the acquired target get additional shares over time."

Munro said, "In addition to the accounting, SPACs face the challenges shared by all companies going public of implementing internal controls and complying with SEC and SOX requirements. These companies have not been around long and have to move quickly to become a public company and put processes and staff in place."

Reference rate reform

As of Dec. 31, 2021, reference rates such as the London Interbank Offered Rate (LIBOR) will be discontinued and replaced with other reference rates. LIBOR-based contracts will have to be modified for the change in rates, and FASB ASC Topic 848, Reference Rate Reform, addresses contract modifications that will result.

"ASC 848 provides that if contracts are modified only for replacing LIBOR rates with other rates, the GAAP framework for modification accounting (for example, the debt, hedging, and lease standards) are not required to be applied," Coleman said. For example, in the area of hedge accounting, there are exemptions and various documentation elections companies can apply, including a practical expedient for companies to not de-designate and re-designate hedges but instead to assume perfect hedge effectiveness continues.

"Banks have been working on preparing for this change for years and have modified their products in response," he added. "For companies, although there are accounting considerations, it is a critical business initiative, as they need to replace LIBOR and determine how those contracts are impacted by the cessation of LIBOR."

Maria L. Murphy, CPA, is a freelance writer based in North Carolina. To comment on this article or to submit an idea for another article, contact Ken Tysiac, the JofA's editorial director, at Kenneth.Tysiac@aicpa-cima.com.

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