U.S. GAAP’s rules for calling something a liability or equity are complex, contradictory and easy to manipulate.
But fixing the guidance will be not be easy.
FASB members on June 14, 2017, agreed that they needed to do something to solve the deep-rooted problem of distinguishing liabilities from equity, but they stopped short of committing to a potential years-long project to overhaul the guidance. Instead, FASB Chairman Russell Golden asked the board’s research staff to come up with short-term problems the FASB could fix quickly, and at the same time keep an eye on larger issues that may need resolution over the long term.
“This holistic approach will take much longer, but in the meantime, we can make targeted changes,” Golden said at the end of the meeting.
Some potential improvements could include requiring new disclosures about complex financial instruments that have characteristics of both equity and liabilities, simplifying how to separate, or “bifurcate” measurement of hybrid instruments, or rearranging certain parts of the Codification of U.S. GAAP so the steps accountants must follow are in a logical sequence.
“We can make the literature easier for preparers to apply, reduce the restatements down to an acceptable level — because we know we will never get them down to zero — and we can satisfy some of the investor concerns that we’ve heard,” said Shayne Kuhaneck, a senior project manager with the FASB staff. “From my perspective as a staff member, that’s a pretty big win.”
The board did not make a formal decision about improving the guidance, which has been a source of frustration to accountants and investors for years. Some FASB members said the board will only solve the problem when it determines the fundamental differences between liabilities and equity.
“Adding another couple of patches to this area doesn’t fix the fact that it’s a patchwork quilt,” Marc Siegel said.
Lawrence Smith said he believed the accounting board could make progress by changing some of the most frequently cited frustrations with the guidance.
“I think we’re getting really hung up with the use of the terms ‘targeted’ versus ‘holistic,’” Smith said. “Depending on how you structure a quote-unquote targeted approach, you can get to fairly holistic changes.”
The FASB has tried several times with limited success since 1986 to fix aspects of Topic 480, Distinguishing Liabilities From Equity. In December an accounting professor on the board’s Financial Accounting Standards Advisory Council, called Topic 480 a “nightmare” to teach to students.
While distinguishing between liabilities and equity may seem relatively straightforward, difficulties crop up when analyzing the terms of securities like redeemable equity instruments, equity-linked or indexed instruments and convertible instruments. The problems companies have distinguishing between liabilities and equity also often are the subject of comment letters from the SEC staff when reviewing regulatory filings and often cause restatements of previous financial reports, the FASB said.
The FASB in August 2016 issued Invitation to Comment, Agenda Consultation, listing accounting for the difference between liabilities and equity as one of four potential projects that the board could add to its standard-setting agenda. The other three topics are intangible assets, pensions and other post-retirement benefits, and performance reporting and cash flows.
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