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ASC 405 Liabilities
Perspective and Issues
Technical Alert
ASU 2016-04
In March 2016, the FASB issued ASU 2016-04, Recognition of Breakage for Certain Prepaid Stored-Value Products. The ASU is a consensus of the EITF.
Guidance
ASC 2016-04 was created to align the guidance in ASC 405-20 for financial liabilities with the guidance for nonfinancial liabilities in ASU 2014-09, Revenue Recognition, and codified in ASC 606. To do so, the guidance in ASU 2016-04 creates an exception to the requirements of ASC 405-20. It requires issuers to derecognize financial liabilities related to breakage amounts in either of the following two ways:
- If the entity expects to have a related breakage amount, derecognize the liability:
- in amounts proportionate to the pattern of rights expected to be exercised by the holder of the product
- to the extent that a significant reversal of the breakage amount will not subsequently occur, or
- If the entity does not expect to be entitled to a breakage amount, the entity derecognizes the liability when the likelihood of the exercise of rights becomes remote.
(ASC 405-20-40-4)
Entities must reassess their breakage estimates each reporting period. Changes in estimates are accounted for as a change in accounting estimate under the guidance in ASC 250-10-45-17 through 45-20.
Implementation
The guidance in ASU 2016-04 is effective concurrent with ASU 2014-09. For more on breakage and the effective dates of ASU 2014-09, see the chapter on ASC 606.
Subtopics
ASC 405, Liabilities, consists of four subtopics:
- ASC 405-10, Overall, which merely points to other areas of the Codification that contain guidance on liabilities
- ASC 405-20, Extinguishments of Liabilities, which provides guidance on when an entity should consider a liability settled
- ASC 405-30, Insurance-Related Assessments, which provides guidance on items such as assessments for state guaranty funds and workers' compensation second-injury funds
- ASC 405-40, Obligations Resulting from Joint and Several Liabilities, which provides guidance on arrangements where the total amount of the obligation is fixed at the reporting date.
Scope and Scope Exceptions
ASC 405
ASC 405 guidance applies to all entities with the covered transactions.
ASC 405-20
ASC 405-20 applies to extinguishments of both financial and nonfinancial liabilities unless addressed by another topic. (ASC 405-20-15-2)
ASC 405-30
ASC 405-30 applies to entities:
- Subject to guaranty-forward assessments
- Subject to other insurance-related assessments.
(ASC 405-30-15-1)
The guidance also applies to assessments mandated by statue or regulatory authority related directly or indirectly to underwriting activities, such as self-insurance. (ASC 405-30-30-15-2)
ASC 405-30 does not apply to the following:
- Amounts payable or paid as a result of reinsurance contracts or arrangements that are in substance reinsurance, including assumed reinsurance activities and certain involuntary pools that are covered by Topic 944.
- Assessments of depository institutions related to bank insurance and similar funds.
- The annual fee imposed on health insurers by the Patient Protection and Affordable Care Act as amended by the Health Care and Education Reconciliation Act (the Acts). The accounting for the Acts' fee is addressed in Subtopic 720-50.
(ASC 405-30-15-3)
ASC 405-30 also does not apply to assessments related to income taxes and premium taxes.
ASC 405-40
ASC 405-40 applies to all entities and obligations such as debt arrangements, other contractual obligations, and settled litigation and judicial rulings. The guidance does not apply to obligations accounted for under the following topics:
- ASC 410, Asset Retirement and Environmental Obligations
- ASC 450, Contingencies
- ASC 460, Guarantees
- ASC 715, Compensation––Retirement Benefits
- ASC 740, Income Taxes.
(ASC 405-40-15-1)
To be within the scope of this subtopic, the total amount of the entity's and its co-obligors' obligation must be fixed at the reporting date. However, the amount the entity expects to pay on behalf of its co-obligors may be uncertain. (ASC 405-40-15-2)
Overview
ASC 405 provides accounting and reporting guidance related to short-term liabilities and certain guidance that may apply broadly to any liability.
The FASB has declared, as a long-term goal, that all financial liabilities should be recognized in the statement of financial position at fair value, rather than at amounts based on their historical cost. The proper calculation of fair value is described in detail in the chapter on ASC 820, Fair Value Measurements and Disclosures. Under ASC 825, Financial Instruments, an entity has the option to record certain of its current liabilities that meet the definition of “financial liabilities” at their respective fair values, with changes in fair value recognized each period in net income. Liabilities that require the entity to provide goods or services to settle the obligation, instead of cash settlement, are not financial liabilities and thus are not eligible for the fair value measurement election permitted by ASC 825. This option is addressed in detail in the chapter on ASC 825.
Although measurement of liabilities is generally straightforward, some liabilities are difficult to measure because of uncertainties. Uncertainties regarding subsequent events, whether an obligation exists, how much of an entity's assets will be needed to settle the obligation, and when the settlement will take place can impact whether, when, and for how much an obligation will be recognized in the financial statements.
Most entities continue to measure their current liabilities at their settlement value, which is the amount of cash (or its equivalent amount of other assets) that will be paid to the creditor to liquidate the obligation during the current operating cycle. Accounts payable, dividends payable, salaries payable, and other current obligations are measured at settlement value because they require the entity to pay a determinable amount of cash within a relatively short period of time. If a current liability is near its payment date, there will be only an insignificant risk of changes in fair value because of changes in market conditions or the entity's credit standing, and settlement value and fair value will be essentially the same.
Other current liabilities are measured at the proceeds received when the obligation arose. Liabilities that are measured in this manner generally require the entity to discharge the obligation by providing goods or services rather than by paying cash. Deposits payable, or rents paid in advance on the statement of financial position of a lessor, are examples of current liabilities measured by reference to proceeds received.
Definitions of Terms
Source: ASC 405, Glossaries. Also see Appendix, Definitions of Terms, for Conduit Debt Security, Nonpublic Entity, and Reinsurance.
In-force Policies. Policies effective before a specified date that have not yet expired or been cancelled.
Incurred Losses. Losses paid or unpaid for which the entity has become liable during a period.
Involuntary Pools. A residual market mechanism for insureds who cannot obtain insurance in the voluntary market.
Life, Annuity, and Health Insurance Entities. An entity that may issue annuity, endowment, and accident and health insurance contracts as well as life insurance contracts. Life and health insurance entities may be either stock or mutual entities.
Obligated to Write. A circumstance in which an entity has no discretion to cancel a policy because of legal obligation under state statute, contract terms, or regulatory practice and is required to offer or issue insurance policies for a period in the future.
Premium Tax Offsets. Offsets against premium taxes levied on insurance entities by states.
Premiums Written. The premiums on all policies an entity has issued in a period.
Property and Casualty Insurance Entity. An entity that issues insurance contracts providing protection against either of the following:
- Damage to or loss of property caused by various perils, such as fire and theft
- Legal liability resulting from injuries to other persons or damage to their property.
Property and liability insurance entities may be either stock or mutual entities.
Concepts, Rules, and Examples
ASC 405-10, Overall
ASC 405-10 contains no guidance. Its purpose is to point to guidance in other areas of the Codification. ASC 410-10-02 points to the following Codification topics which contain guidance on accounting and reporting on liabilities:
- Asset Retirement and Environmental Obligations––ASC 410
- Exit or Disposal Cost Obligations and Contract Liabilities (added by ASU 2014-09)––ASC 420
- Deferred Revenue and Contract Liabilities––ASC 430
- Commitments––ASC 440
- Contingencies––ASC 450
- Guarantees––ASC 460
- Debt––ASC 470
- Distinguishing Liabilities from Equity––Topic 480.
ASC 405-20, Extinguishments of Liabilities
Note: See the Technical Alert section at the beginning of this chapter for important information on an ASU that updates this subtopic.
Unless addressed by other guidance, the entity recognizes extinguishment of a liability when:
- The debtor pays the creditor
- The debtor is legally given relief from the liability.
(ASC 405-20-40-1)
If the entity becomes a guarantor on the debt, the entity applies the guidance in ASC 460. (ASC 405-20-40-1)
ASC 405-30, Insurance—Related Assessments
Entities that self-insure, as well as insurance entities, are subject to assessments related to insurance activities. However, note that the annual fee imposed on health insurers by the Patient Protection and Affordable Care Act is not considered an insurance-related assessment. The accounting for that fee falls under the guidance in ASC 720-50.
ASC 405-40, Obligations Resulting from Joint and Several Liabilities
ASC 405-40 requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of the guidance is fixed at the reporting date as the sum of:
- The amount the reporting entity agreed to pay on the basis of its arrangement among its obligors, and
- Any additional amount the entity expects to pay on behalf of its co-obligors.
The corresponding entry depends on the particular facts and circumstances.