The Financial Accounting Standards Board (FASB) issued a new Accounting Standard Update in early 2017 (ASU 2017-05) to clarify guidance on Accounting Standard Codification (ASC) Subtopic 610-20 - Gains and Losses from the Derecognition of Nonfinancial Assets. All public entities should apply the amendments in ASU 2017-05 to annual reporting periods beginning after Dec. 15, 2017, including interim periods within that reporting period; early adoption is permitted for annual reporting periods beginning after Dec. 15, 2016. Private entities should apply the amendments to annual reporting periods beginning after Dec.15, 2018, and interim periods (within annual reporting periods) beginning after Dec. 15, 2019; early adoption is permitted for annual reporting periods beginning after Dec. 15, 2016, and interim reporting periods beginning the year subsequent to the annual reporting period in which the guidance was first applied.
The new guidance clarifies that ASC 610-20 applies to derecognition (the removal of an asset or liability, or a portion thereof, from an entity's balance sheet) of nonfinancial assets and 'in substance nonfinancial assets' unless other specific guidance applies. FASB also goes on to define an 'in substance nonfinancial asset', in part, as : "a financial asset promised to a counterparty in a contract if substantially all of the fair value of the assets (recognized and unrecognized) that are promised to the counterparty in the contract is concentrated in nonfinancial assets." If substantially all of the fair value of a group of assets comes from nonfinancial assets, then all of the financial assets included in the group promised to the counterparty are considered in substance nonfinancial assets within the scope of Subtopic 610-20.
The scope of Subtopic 610-20 has also been updated to cover the transfers of nonfinancial assets to another entity in exchange for a non-controlling ownership interest in that entity. Consequently, the specific guidance on such partial exchanges provided by ASC 845, Nonmonetary Transactions, no longer applies to these situations.
In addition, the scope of Subtopic 610-20 has been expanded upon to eliminate specific guidance related to real estate sales in ASC Subtopic 360-20, Real Estate Sales. Sales and partial sales of real estate assets will now be subject to the same derecognition model as all other nonfinancial assets.
Effects on the engagement
Currently, GAAP requires an entity to derecognize a subsidiary unless it is considered 'in substance real estate' (e.g., an equity interest in an entity whose sole asset is one individual property). In many cases, income-producing real estate is also considered in substance real estate, and is derecognized in accordance with industry-specific guidance rather than the guidance of Subtopic 610-20. Once the amendments in this update are effective, all entities are required to account for derecognition of a business or nonprofit activity (except those related to conveyances of oil and gas mineral rights or contracts with customers) in accordance with ASC 810, Consolidation. Entities will no longer be required to consider whether the activity is also in substance real estate (or an in substance nonfinancial asset).
Another change brought on by the update relates to the 'partial sale' of nonfinancial assets (including in substance real estate). Under previous guidance, when an entity transferred its controlling interest in a nonfinancial asset into a noncontrolling ownership interest, the entity would measure the retained interest at 'carryover basis' (when the transferor's basis in the property 'carries over' to the transferee; also referred to as 'transferred basis'). The amendments in this update now require an entity to initially measure a retained noncontrolling interest in a nonfinancial asset at fair value, consistent with how a retained noncontrolling interest in a business is measured. Additionally, if an entity transfers ownership interests in a consolidated subsidiary (that is within the scope of ASC 610-20) and continues to have a controlling financial interest in that subsidiary, the amendments require the entity to account for the transaction as an equity transaction. This is consistent with how changes in ownership interests in a consolidated subsidiary are recorded when a parent retains a controlling financial interest in the business.
Overall, ASU 2017-05 is supposed to simplify the application of GAAP, and improve consistency. The new guidance is expected to make an impact on all industries, with the biggest impact relating to the real estate sector. This is due to the elimination of the specific sales model for real estate, and the requirement to recognize a full gain upon partial sales of real estate. Furthermore, with FASB's recently updated definition of a business, more transactions will likely be treated as dispositions of nonfinancial assets (rather than dispositions of a business), likely expanding the number of transactions subject to the new guidance.
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