Financial reporting briefs What you need to know about this quarter’s accounting, financial reporting and other developments

September 2021

In this issue:

Accounting update ....................... 2 Regulatory developments ............. 4 Other considerations .................... 6 Reference library ......................... 7

2 | Financial reporting briefs September 2021

Accounting update New lessor classification guidance for leases with variable payments The Financial Accounting Standards Board (FASB or Board) amended Accounting Standards Codification (ASC) 842 to require lessors to classify leases as operating leases if they have variable lease payments that do not depend on an index or rate and would have selling losses at lease commencement if they were classified as sales-type or direct financing leases. The amendments address concerns raised during the FASB’s post-implementation review that recognizing an immediate loss for these leases, as would otherwise be required under ASC 842, does not appropriately represent the underlying economics at lease commencement. Entities primarily affected are in the energy industry and those with leases that involve consumable goods.

For lessors that had adopted ASC 842 as of 19 July 2021, when the amendments were issued, the amendments can be applied either retrospectively or prospectively and are effective for annual periods beginning after 15 December 2021 and interim periods either within those annual periods or within the following year’s annual period, depending on when they were required to adopt ASC 842. Early adoption is permitted.

Entities that had not adopted ASC 842 as of 19 July 2021 are required to apply the amendments when they adopt ASC 842 and follow the transition requirements in ASC 842.

Proposal would provide discount rate relief for nonpublic lessees The FASB directed the staff to draft a final Accounting Standards Update amending ASC 842 to allow a lessee that is not a public business entity to elect to use a risk-free rate as its discount rate by class of underlying asset, rather than for all leases as currently required. A lessee would have to disclose the class or classes of underlying assets for which it elected the risk-free rate.

Lessees would also be required to use the rate implicit in the lease when it is readily determinable (rather than a risk-free rate or incremental borrowing rate), even if they make the risk-free rate election. However, we do not expect this proposed amendment to affect most lease arrangements because the rate implicit in the lease is often not readily determinable.

Entities that have not adopted ASC 842 as of the issuance date of any final amendments would be required to apply the amendments when they adopt ASC 842 and follow the transition requirements in ASC 842.

For entities that have already adopted ASC 842, the amendments would be effective for annual periods beginning after 15 December 2021 and interim periods beginning the following year and would be applied on a modified retrospective basis. Early adoption would be permitted.

FASB seeks feedback on standard-setting priorities The FASB staff issued an Invitation to Comment (ITC) to solicit broad stakeholder feedback about the Board’s future standard-setting priorities. The ITC summarizes input received during the initial agenda consultation outreach, which generally centered on the following topics: (1) disaggregation of financial reporting information; (2) emerging areas in financial reporting, such as accounting for digital assets and transactions related to environmental, social and governance (ESG) matters, the definition of a derivative, reporting of financial key performance indicators, and a business entity’s recognition and measurement of government grants; (3) reduction of unnecessary complexity in current GAAP; and (4) improvement to FASB processes. The FASB will use the feedback received on the ITC to make sure it allocates the appropriate resources to achievable standard-setting projects that improve financial accounting and reporting standards and address topics that are a high priority for its stakeholders.

FASB post-implementation reviews The FASB is currently performing post-implementation reviews of its standards on revenue recognition, leases and credit losses. As part of this review process, the FASB conducts stakeholder outreach and other research to monitor the implementation of major new standards and obtain an understanding of whether the reporting required by the standard provides enough value to users of the financial statements to justify the cost of having companies produce the information. The Board also uses the post-implementation review process to identify and address any areas for improvement in a timely manner.

Welcome to the September 2021 Financial reporting briefs. This edition highlights the latest developments in financial reporting and alerts you to some important considerations for 2021.

Interested in learning more about the new lessor classification guidance for leases with variable payments? We’ve got it covered in our Accounting update section. In our Regulatory developments section, we provide updates on SEC developments.

Need more information? Check out our Reference library, where we list our recent publications on the topics discussed here and provide links to them.

Accounting update

3 | Financial reporting briefs September 2021

FASB adds project on accounting for acquired financial assets to agenda The FASB added a project to its technical agenda to address the accounting for acquired financial assets under the new standard on credit losses. The Board will consider (1) expanding the scope of the purchased credit deteriorated (PCD) accounting model to include all loans acquired in a business combination and (2) modifying the presentation of expected credit losses for acquired financial assets that meet the definition of PCD.

Reminders on accounting for cryptocurrencies Because US GAAP does not address a holder’s accounting for cryptocurrencies, the accounting must be determined based on the nature of the asset, the type of investor and how the asset is held.

Cryptocurrencies generally meet the definition of indefinite-lived intangible assets, and owners generally should account for these assets at historical cost less impairment in accordance with ASC 350, Intangibles — Goodwill and Other. However, investment companies in the scope of ASC 946, Financial Services — Investment Companies, should account for their cryptocurrency investments as “other investments” and subsequently measure them at fair value through earnings.

Entities that invest in cryptocurrencies need to have controls in place to safeguard the private key that provides access to the cryptocurrencies. They also need to maintain complete and accurate books and records related to their cryptocurrency activities.

Proposal would clarify guidance on equity securities subject to contractual sale restrictions The FASB proposed clarifying that a contractual restriction on the sale of an equity security would not be considered part of the unit of account of the equity security and, therefore, would not be considered when measuring fair value. The proposal would apply to all entities that have investments in equity securities measured at fair value that are subject to contractual sale restrictions.

The proposal would also add the definition of restricted security to the Master Glossary to distinguish equity securities subject to a regulatory sale restriction from those subject to a contractual sale restriction. The guidance would be applied prospectively, with special transition provisions for entities that qualify as investment companies under ASC 946.

4 | Financial reporting briefs September 2021

Regulatory developments SEC releases its annual regulatory agenda The Securities and Exchange Commission (SEC) released its annual regulatory agenda highlighting the priorities of new Chair Gary Gensler among the short- and long-term regulatory actions it plans to take. Key SEC rulemaking areas include disclosures about climate change and other ESG matters, such as board diversity and human capital, and cybersecurity risk governance.

The SEC further plans to propose rules related to special purpose acquisition company mergers and address unfinished rulemaking mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, including finalizing pay versus performance rules and reproposing rules requiring exchanges to mandate the clawback of certain incentive-based compensation upon a financial statement restatement.

The SEC also intends to reconsider and further evaluate proxy rulemaking and several other recently amended rules, including those involving the disclosure of payments by resource extraction issuers and shareholder proposals.

SEC approves new Nasdaq listing rules on board diversity The SEC approved rules proposed by the Nasdaq Stock Market LLC requiring all listed companies to meet certain minimum diversity targets or disclose why they aren’t doing so.

Most Nasdaq-listed companies will be required to have, or explain why they do not have, at least two diverse board members, including one director who self-identifies as female and one director who self-identifies as either an underrepresented minority or lesbian, gay, bisexual, transgender, queer or other (LGBTQ+). Companies with five or fewer board members need to have one diverse board member to meet the target. Underrepresented minorities are defined as individuals who self-identify as one or more of the following groups: Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or two or more races or ethnicities.

All listed companies must also provide statistical information about the diversity of their boards by the later of 6 August 2022 or the filing date of their proxy statement or information statement for their annual shareholders meeting (or the date they file their Form 10-K or Form 20-F if they do not file a proxy or information statement) in 2022.

Under the rule’s transition provision, all listed companies must have one diverse director (or explain why they don’t) by the later of 6 August 2023 or the date they file their proxy statement or their information statement for their annual shareholders meeting (or the date they file their Form 10-K or Form 20-F if they do not file a proxy or information statement) in 2023.

Companies with six or more board members must have two diverse directors (or explain why they don’t) no later than 6 August 2025 if they are listed on the Nasdaq Global Select or Nasdaq Global Market tiers or 6 August 2026 if they are listed on the Nasdaq Capital Market tier.

Trends in SEC staff comments The top three most frequent comment areas in our recent analysis of SEC staff comment letters for the year ended 30 June 2021 were non-GAAP financial measures, management’s discussion and analysis (MD&A) and segment reporting. The staff issued a number of comments related to disclosures about the COVID-19 pandemic that focused on the specificity of a company’s disclosures of risk factors and the effects of the pandemic in MD&A, fair value measurements, non-GAAP financial measures and other company-specific financial statement matters.

We found that the volume of SEC staff comment letters on annual reports declined 20% from the previous year, continuing the downward trend of recent years. The SEC staff continued to use its risk-based approach, which involves concentrating on larger issuers and reviewing their filings more frequently. We believe this approach has contributed to an overall improvement in disclosure, which has allowed the staff to issue fewer comments over time.

Regulatory developments

5 | Financial reporting briefs September 2021

The SEC staff recently has started issuing comments to companies relating to the SEC’s 2010 guidance on climate-related disclosures as part of its increased focus on disclosures related to ESG matters.1

Our SEC comments and trends publication addresses several topics the staff issued comments on. It also includes tips for navigating the comment letter process.

SEC names Jones Director of Division of Corporation Finance Renee Jones was named Director of the SEC’s Division of Corporation Finance (DCF). Ms. Jones previously was a professor of law and associate dean for academic affairs at Boston College Law School, where she taught courses in corporations, securities regulation, startup company governance and financial regulation. She also represented private and public companies on corporate and securities matters at Hill & Barlow. She is a member of the American Law Institute and served as the cochair of the Securities Law Committee of the Boston Bar Association.

John Coates, who had served as the Acting Director of the DCF since February 2021, was named SEC General Counsel.

SEC names Grewal Director of Enforcement Gurbir Grewal was named Director of the SEC’s Division of Enforcement. Mr. Grewal previously was the Attorney General for the State of New Jersey since January 2018. He also served as the Bergen County Prosecutor and as an Assistant US Attorney in the Criminal Division of the US Attorney’s Offices for the District of New Jersey and the Eastern District of New York.

PCAOB members Jurata and Zietsman say they intend to resign Public Company Accounting Oversight Board (PCAOB) members Rebekah Goshorn Jurata and Megan Zietsman issued a joint public statement saying they intend to resign from the PCAOB on the earlier of 1 October 2021 or the date new PCAOB members are appointed by the SEC. The statement followed the SEC’s removal of former Chairman William Duhnke from the PCAOB and the SEC’s announcement seeking candidates to fill all five PCAOB board positions.

New AICPA guidance on use of specialists, external pricing information The Auditing Standards Board of the American Institute of Certified Public Accountants (AICPA) issued a new Statement on Auditing Standards (SAS) to provide guidance on auditing estimates when management used the work of a specialist in developing the accounting estimate. The SAS provides enhanced guidance on evaluating the work of management’s specialist and using the work of an auditor’s specialist. The SAS also provides guidance on the use of pricing information from pricing services when evaluating management’s estimates related to the fair value of financial instruments. The SAS, which generally aligns with the PCAOB’s standards, is effective for audits of financial statements for periods ending on or after 15 December 2023.

1 See Gibson, Dunn & Crutcher LLP’s “SEC Staff Scrutiny of Climate Change Disclosures Has Arrived: What to

Expect and How to Respond,” 20 September 2021.

6 | Financial reporting briefs September 2021

Other considerations Inventory controls and other ICFR reminders Companies may need to reassess their plans for physical inventory counts, given the continued uncertainty related to the COVID-19 pandemic and new variants of the virus. Over the past year, many companies applied different strategies to make the necessary adjustments to the physical inventory count process, including altering the timing of counts, designing and executing a statistical sampling strategy, modifying their existing counting procedures, and identifying and evaluating other transaction-level or monitoring controls to validate the existence of inventory.

Depending on the process a company uses, management may need to expend a fair amount of additional effort to modify controls and procedures to validate the existence of inventory. After considering other counting procedures and transaction-level or monitoring controls, management will need to evaluate whether the body of evidence obtained reduces the risk of material misstatement related to the existence of the company’s inventory to an acceptable level.

It is also important to make sure that disclosure controls are operating effectively. SEC registrants need to consider whether they have made any material changes to the design of their internal control over financial reporting (ICFR) that would need to be disclosed in Form 10-Q or Form 10-K. Management should consider whether any new or modified controls to validate the existence of inventory warrant additional disclosures.

Summary of open comment periods Items are FASB proposals unless otherwise noted.

Proposal Comment period ends

Proposed Accounting Standards Update —Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions

14 November 2021

7 | Financial reporting briefs September 2021

Reference library To the Point • FASB amends lessor classification guidance to prevent selling losses on

leases with variable payments (3 August 2021)

• FASB proposes allowing nonpublic lessees to make the risk-free rate election by class of underlying asset (17 June 2021)

Technical Line • Accounting for the effects of natural disasters (updated 14 July 2021)

• Accounting for DrillCo arrangements (updated 1 July 2021)

Financial reporting developments • Lease accounting: Accounting Standards Codification 842, Leases

(updated 16 September 2021)

• Issuer’s accounting for debt and equity financings (before the adoption of ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity) (updated 16 September 2021)

• Foreign currency matters (updated 15 September 2021)

• Issuer’s accounting for debt and equity financings (after the adoption of ASU 2020-06, Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity) (15 September 2021)

• Impairment or disposal of long-lived assets (updated 31 August 2021)

• Transfers and servicing of financial assets (updated 25 August 2021)

• Derivatives and hedging (before the adoption of ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities) (updated 11 August 2021)

• Earnings per share (updated 9 August 2021)

• Fair value measurement (updated 28 July 2021)

• Derivatives and hedging (after the adoption of ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities) (updated 21 July 2021)

• Intangibles — goodwill and other (updated 14 July 2021)

• Consolidation: determination of a controlling financial interest and accounting for changes in ownership interests (updated 30 June 2021)

• Business combinations (updated 30 June 2021)

• Real estate project costs (updated 30 June 2021)

• Credit impairment for short-term receivables under ASC 326 (updated 24 June 2021)

• Exit or disposal cost obligations (updated 18 June 2021)

• Postretirement benefits (updated 17 June 2021)

• Statement of cash flows (updated 16 June 2021)

• Income taxes (updated 16 June 2021)

Comment letters • ASB proposal on three interrelated standards to address quality

management (31 August 2021)

• FASB’s proposal to allow a nonpublic lessee to make the risk-free rate election by class of underlying asset (15 July 2021)

• FASB’s proposed amendments to expand the last-of-layer method for fair value hedges (1 July 2021)

• ASB proposal on inquiries of the predecessor auditor regarding fraud and noncompliance with laws and regulations (30 June 2021)

• Response to SEC’s request for input on climate change and ESG disclosures (11 June 2021)

Other • SEC Reporting Update: highlights of trends in 2021 SEC comment letters

(21 September 2021)

• Effective date matrix as of 1 September 2021 (8 September 2021)

• Master limited partnership accounting and reporting guide (16 August 2021)

• Quarterly Tax Developments — June 2021 (2 July 2021)

• SEC in Focus — July 2021 (1 July 2021)

• Guide to preparing carve-out financial statements (24 June 2021)

On-demand webcasts • 2021 outlook for international tax reform

• Accounting for income taxes: a quarterly perspective

• Domestic tax quarterly webcast series: a focus on state tax matters

• How the workforce has evolved post-pandemic

• How the workforce has evolved post-pandemic — session 2

• LIBOR transition readiness within corporate treasury

• Privacy protection: why information governance is highly important now

• Regulator update — special purpose acquisition companies (SPACs)

• Tax in the time of COVID-19: update on legislative, economic, regulatory and IRS developments

• Telework and other employer challenges in 2021 and beyond

• Think ESG: the role of finance and the board in enhanced corporate reporting

• What audit committees need to know for Q2 2021

• What boards can do to support a future-ready strategy

• What you need to know for Q2 2021 financial reporting

Upcoming webcasts • What audit committees need to know for Q3 2021 (23 September 2021)

• US Indirect Tax Controversy: current audit trends and outlook, including ways to manage your state tax posture (29 September 2021)

• Will you chart a course on eMobility or be left behind? (14 October 2021)

Click on any of the EY publications below, all of which are available free of charge on AccountingLink at www.ey.com/en_us/assurance/accountinglink.

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