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Accounting guidance for the effects of reference rate reform

FINANCIAL REPORTING INSIGHTS  | 

The Financial Accounting Standards Board (FASB) recently issued Accounting Standards Update (ASU) 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The ASU provides temporary optional guidance intended to ease the burden of reference rate reform on financial reporting. The ASU applies to all entities that have contracts, hedging relationships and other transactions that reference the London Interbank Offered Rate (LIBOR) or another reference rate that is expected to be discontinued. The ASU was effective upon its issuance on March 12, 2020. However, it cannot be applied to contract modifications that occur after December 31, 2022. With certain exceptions, the ASU also cannot be applied to hedging relationships entered into or evaluated after that date.

The guidance provides optional expedients and exceptions for applying existing guidance to contract modifications, hedging relationships and other transactions that are expected to be affected by reference rate reform and meet certain scope guidance. For example, if a debt instrument that references LIBOR is modified to refer to a different reference rate, an entity could elect to account for that modification prospectively by adjusting the effective interest rate. In other words, in this case, it is not required to analyze whether the modification would be accounted for as a debt modification or extinguishment. Similarly, modifications to leases due to reference rate reform could be accounted for as a continuation of the existing contracts with no requirement to reassess previous accounting determinations (e.g., lease classifications). Also, if an expedient is elected, modifying a contract would not require reassessment of the original conclusion about whether a derivative embedded in it requires separate accounting.

In addition, the ASU provides various optional expedients, including the following, for hedging relationships affected by reference rate reform, if certain criteria are met: 

  • An entity can change certain critical terms of the hedging instrument or hedged item or transaction without having to dedesignate the relationship. 
  • For fair value hedging relationships in which the designated interest rate is LIBOR or another rate that is expected to be discontinued, an entity may change the hedged risk to another permitted benchmark rate without dedesignating the relationship.
  • For cash flow hedging relationships in which the designated hedged risk is LIBOR or another rate that is expected to be discontinued, an entity may assert that the occurrence of the hedged forecasted transaction remains probable.
  • Certain qualifying conditions for the shortcut method and other methods that assume perfect effectiveness may be disregarded.

In addition, the ASU permits an entity to make a one-time election to sell, transfer, or both sell and transfer debt securities classified as held to maturity that reference a rate affected by reference rate reform and that were classified as held to maturity before January 1, 2020. 

Our upcoming white paper will provide a more in-depth analysis of this guidance.

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