Energy companies: Q2 2022 accounting and reporting update
Accounting guidance issued in second quarter 2022
ASU 2022-03, Fair Value Measurements (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sales Restrictions, provides updated guidance on determining the fair value of equity securities when those securities have contractual sales restrictions. The new ASU clarifies that a contractual sales restriction should not be considered when determining the fair value of the equity security. The new guidance also adds additional disclosure requirements for equity securities subject to contractual sales restrictions. The new ASU is effective for public business entities for fiscal years beginning after Dec. 15, 2023. For all other entities, the new guidance is effective for fiscal years beginning after Dec. 15, 2024.
New lease accounting standard effective for 2022
The FASB’s new lease accounting standard, ASC Topic 842, will be effective for calendar year-end entities that have not previously adopted the new guidance for their 2022 annual financial statements. Many entities that have already adopted ASC Topic 842 have indicated the implementation process was more time-consuming than initially anticipated. Given this, entities that have not started working on their implementation efforts should look to get started as soon as possible in order to ensure a successful outcome. Some of the key steps for a successful implementation include:
- Forming an implementation team. If entities have not already formed an implementation team, the first step should be to form one. While the implementation team is for the adoption of a new accounting standard, many organizations have found it necessary to include resources outside of the accounting/finance department on the implementation team. The implementation team should include team members responsible for negotiating and signing leases as well as members of the accounting/finance department. For entities with larger populations of leases, it may be necessary to include a member of the IT department to help assess technology solutions. Part of forming the implementation team should also include assessing resource needs so an entity can determine if it will be able to complete the implementation plan using internal resources, or if it will need to engage external resources to assist with the implementation.
- Creating and maintaining an inventory of leases. Another important step to take early in the implementation process is to create and maintain an inventory of lease contracts. In organizations with few lease agreements and centralized processes for approving leases, this exercise may be relatively straightforward as leases may be maintained in a single location. However, in organizations where approval of leases is decentralized this may take additional work. While accounting departments are aware of the most significant leases, there may be leases that are individually insignificant but, in aggregate, become significant.
- Assessing technology needs. The new lease standard will require all leases (other than certain short-term leases as described below) to be recorded on the balance sheet. Organizations will need to assess how they will track and account for their leases. Options for tracking include use of spreadsheets, standalone lease software, and a lease accounting module for their enterprise resource planning (ERP) system. Each option has its advantages and disadvantages, and entities should evaluate which option best fits their needs based on the complexity of their lease population. Consideration should be given to the number of leases and complexity of the lease arrangements. Entities will also need to determine whether they plan to centralize the process of inputting leases into the chosen technology solution or if they plan to use a decentralized process for inputting leases. Entities should consider the technology solution they plan to employ as early as possible, so they are able to have the solution implemented prior to the end of the year. They will then be able to record the results of the implementation as part of the year-end close process.
- Evaluating accounting policy elections and practical expedients. The new lease standard allows entities to make accounting policy elections in a number of areas. It’s important for entities to determine the accounting policy elections and practical expedients that will be used before entering leases into their technology solution. Some of the areas where entities can make accounting policy elections or elect practical expedients include:
- At transition:
- Hindsight practical expedient — an entity may elect to use hindsight in determining the lease term
- Package of practical expedients:
- An entity need not reassess whether a contract contains a lease
- An entity need not reassess lease classification determinations made under the previous lease standard
- An entity need not reassess initial direct costs of existing leases
- Lessees may elect, by class of asset, not to separate lease and nonlease components. Entities would instead combine lease and nonlease into a single lease component.
- Lessees may elect, by class of asset, to utilize the risk-free rate in place of the incremental borrowing rate (only available to private companies).
- Lessees may elect not to apply the recognition and measurement requirements to leases with a lease term of 12 months or less.
- Lessees may elect to account for leases at a portfolio level if the leases are entered into at or around the same time, and the resulting accounting would not be materially different from accounting for the leases if the election were not made.
- At transition:
- Assessing debt covenant considerations. Entities should also review existing contracts to determine if there may be impacts on covenants. While the impacts on covenants based on overall assets and liabilities are easily understood, some covenants may be based on debt service ratios or outstanding amount of debt. For these ratios, depending on how the covenant is written, payments on leases that are recorded on the balance sheet or the amount of the lease liability may impact these calculations. Affected entities should discuss covenant calculations with their lender prior to the adoption of the new standard if there is uncertainty as to how the new lease standard will impact the calculation. Entities and lenders may elect to amend covenants prior to the implementation of the lease standard to avoid potential covenant compliance issues.
FASB drops project on subsequent accounting for goodwill
In June 2022, the FASB voted unanimously to remove its project on the subsequent accounting for goodwill. This ongoing project had been evaluating whether changes should be made to the subsequent accounting for goodwill, including amortization of goodwill. As the project was dropped from the FASB’s agenda, any tentative decisions made will not become effective.
Sample letter to companies regarding disclosures pertaining to Russia’s invasion of Ukraine and related supply chain issues
In May 2022, staff in the SEC’s Division of Corporation Finance (Corp Fin) posted a sample letter in their article, “Companies Regarding Disclosures Pertaining to Russia’s Invasion of Ukraine and Related Supply Chain Issues.” They noted that companies may have disclosure obligations under the federal securities laws related to the direct or indirect impact that Russia’s invasion of Ukraine and the international response have had or may have on their business. To satisfy these obligations, Corp Fin believes that companies should provide detailed disclosure, to the extent material or otherwise required, regarding:
- Direct or indirect exposure to Russia, Belarus, or Ukraine through their operations, employee base, investments in Russia, Belarus, or Ukraine, securities traded in Russia, sanctions against Russian or Belarusian individuals or entities, or legal or regulatory uncertainty associated with operating in or exiting Russia or Belarus.
- Direct or indirect reliance on goods or services sourced in Russia or Ukraine or, in some cases, in countries supportive of Russia.
- Actual or potential disruptions in the company’s supply chain.
- Business relationships, connections to, or assets in Russia, Belarus, or Ukraine.
The financial statements may also need to reflect and disclose the impairment of assets, changes in inventory valuation, deferred tax asset valuation allowance, disposal or exiting of a business, deconsolidation, changes in exchange rates, and changes in contracts with customers or the ability to collect contract considerations. Corp Fin also notes that since Russia’s invasion of Ukraine, many companies have experienced heightened cybersecurity risks, increased or ongoing supply chain challenges, and volatility related to the trading prices of commodities regardless of whether they have operations in Russia, Belarus, or Ukraine that warrant disclosure.
In addition, Corp Fin states that, “Companies also should consider how these matters affect management’s evaluation of disclosure controls and procedures, management’s assessment of the effectiveness of internal control over financial reporting, and the role of the board of directors in risk oversight of any action or inaction related to Russia’s invasion of Ukraine, including consideration of whether to continue or to halt operations or investments in Russia and/or Belarus.”
We suggest that management and audit committees carefully review this sample letter as it relates to their exposure and business to ensure appropriate disclosures.
SEC proposal on climate-change disclosures
In May 2022, the SEC extended the comment period for proposed rule changes that would require registrants to include certain climate-related disclosures in their registration statements and annual reports. The comment period for the release was originally scheduled to close on May 20, 2022. The new comment period ended on June 17, 2022. This proposal was discussed in the prior quarter’s update.
Digital assets and crypto investments
On May 16, 2022 at a FINRA conference, Chair Gensler made several speeches dealing with investor protections and specifically warned about investing in cryptocurrencies following the significant price declines. On May 17, 2022, in a speech at the 2022 NASAA Spring Meeting & Public Policy Symposium, Chair Gensler stated: “I think there’s a need to bring greater investor protection to these crypto markets,” and “The crypto-related events in recent weeks have highlighted yet again how important it is to protect investors in this highly speculative asset class.”
Accounting and reporting implications of the Russia/Ukraine war
As the impacts of Russia’s invasion of Ukraine are being felt throughout the world, there will also be accounting and financial reporting implications that entities need to consider in addition to the humanitarian considerations.
The impacts from the war in Ukraine have already begun for many entities both directly and indirectly. Some of the areas where entities may be impacted include (not all-inclusive):
- Asset impairment
- Equity method investments
- Discontinued operations
- Exit/disposal costs
For each of the areas above, see “Accounting, financial reporting, and regulatory developments: First quarter 2022” for additional considerations on the financial reporting impacts. In addition to the items discussed above, entities should also consider other financial statement disclosures that may be appropriate. Entities that may be impacted should consider whether disclosure should be included in their risks and uncertainties disclosures or as a subsequent event.
If SEC registrants are considering including non-GAAP financial metrics in their filings as a result of the war in Ukraine, they should consider the SEC’s rules and guidance on including non-GAAP metrics within their Form 10Q or Form 10K.
You may also be interested in our quarterly publication that summarizes accounting, financial reporting, and regulatory matters that may impact both public and private companies. Read that report here. This content is not meant to be all-inclusive.