Energy Insights - Going Concern Debt Issuance Costs by Weaver

Energy Insights Going Concern

Debt Issuance Costs

Oil and gas companies face new financial reporting guidance for going concern, debt issuance costs THE FINANCIAL ACCOUNTING STANDARDS BOARD (FASB) ISSUED Accounting Standards Updates (ASU) that are now effective for financial reporting applicable to the fiscal year ending December 31, 2016 (for those companies with fiscal years beginning after December 31, 2015). Energy companies, in particular, should consider relating the new standards to their financial reporting. The updates affect how oil and gas companies address and consider going concern disclosure needs and classification of debt issuance costs in financial statements.

Requirements for Going Concern Assessments ASU 2014-15, PRESENTATION OF FINANCIAL STATEMENTS – Going Concern (subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, was issued to enhance the requirements and related footnote disclosures in certain circumstances when substantial doubt about the entity’s ability to continue as a going concern is in question. Under the previous generally accepted accounting principles (GAAP) before the issuance of ASU 2014-15, the continuation of a reporting entity as a going concern is presumed as the basis for preparing financial statements, unless and until the entity’s liquidation becomes imminent. Once the entity’s liquidation becomes imminent, the reporting entity should prepare the financial statements in accordance with Accounting Standards Codification (ASC) Subtopic 2015-30, Liquidation Basis of Accounting. Under the previous GAAP guidance, there is no responsibility for management to evaluate whether or not there is substantial doubt of the entity to continue as a going concern. This evaluation was the responsibility of the auditor of the entity in accordance with U.S. auditing standards. It was used as a basis for considering the disclosure of relevant conditions and events in the financial statements disclosures and whether or not an emphasis of matter paragraph disclosing going concern should be included in the auditor’s opinion. The new Accounting Standards Update requires two significant changes from the prior guidance, which is effective for 2016 financial reporting. First, the update requires management to assess whether various factors or events make it probable that a company will be unable to meet its financial obligations and therefore continue as a going concern.

Energy Insights: Going Concern Debt Issuance Costs This requirement marks a departure from prior GAAP guidance that placed going concern assessment responsibility upon the entity’s auditor. Management must now evaluate and disclose this substantial doubt, if applicable, even if management has plans in place to alleviate the impact of the noted factors or events. Substantial doubt may arise from a company’s financial condition, conditional and unconditional obligations, or insufficient funds to maintain operations. Other factors that need to be evaluated include: • • • • • •

Negative financial trends Defaults on loans or credit denials Labor difficulties Dependence upon success of a particular project Litigation Losses of customers or suppliers

If management initially determined that there is substantial doubt to continue as a going concern, but such doubt is alleviated by management’s plans moving forward, then the auditing standards require that management disclose how substantial doubt was alleviated by such plans. Actions planned to alleviate substantial doubt must also be disclosed stating that they are reasonable and probable in nature. Such actions may include: • • • •

Disposing of assets Borrowing money or restructuring debt Reducing or delaying expenditures Raising additional capital

This has a particular impact on companies in the oil and gas industry moving forward as the commodity market has been depressed the last several years which has impacted the leverage and liquidity of energy companies.

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This has a particular impact on companies in the oil and gas industry moving forward as the commodity market has been depressed

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over the last several years.

The second significant change under the new guidance is that substantial doubt assessments pertain to a one-year period following the issuance date of the financial statements. This look-forward requirement marks another departure from prior GAAP, which specified that the look-forward period ended one year after the balance sheet/ year-end date. ASU 2014-15 is effective for all companies beginning with the annual financial reporting period ending after December 15, 2016 and all interim reporting periods going forward.

Energy Insights: Going Concern Debt Issuance Costs Updated Guidance for Presenting Debt Issuance Costs TO SIMPLIFY PRESENTATION OF DEBT ISSUANCE COSTS, the FASB issued two updates in 2015: ASU 2015-03, Interest – Imputation of Interest (Subtopic 835-30) and ASU 2015-15, Interest – Imputation of Interest (Subtopic 835-30). The above mentioned standards updates pertain to third-party fees, such as fees for legal or printing services, which a company incurs when it issues debt instruments. The updates require that such costs be presented as direct deductions from the debt liability and amortized, rather than presented as a deferred asset as indicated in prior guidance. The new guidance only affects the presentation and classification of the debt issuance costs at the financial statement level. An exception, identified under ASU 2015-15, is revolving credit facilities and lines of credit that contain up-front commitment fees. Through interpretation, such fees are still considered an asset and amortized over the contractual term of the capital agreement, regardless of whether there are any outstanding borrowings on the credit facility. This shift in the way debt issuance costs are presented may impact debt covenant provisions previously established with lenders. Those covenants should be reviewed and revised as necessary to alleviate potential for technical defaults. The updated guidance went into effect exclusively for public companies for fiscal years beginning after December 15, 2015 and interim periods within such fiscal year, and for all other companies for fiscal years beginning after December 15, 2015 and interim periods within fiscal years beginning after December 15, 2016. The updates further align U.S. GAAP practices with International Financial Reporting Standards (IFRS) and require no changes in accounting for such costs.

Plan Now for Compliance IN CONCLUSION, the new accounting guidance could have an impact on a company’s financial reporting process for 2016 and moving forward. The updated going concern guidance shifts responsibility from the auditor to company management to assess whether or not a company might not meet its obligations for reporting. Disclosures are now required if substantial doubt to continue as going concern is present, and additional disclosures are required if management has plans to alleviate any noted substantial doubt. The manner in which debt issuance costs are presented also changed for 2016 financial reporting. Based upon the volatile energy commodity prices over the last several years, and the resulting financial and leverage constraints impacting companies in the industry, companies need to ensure that financial statements issued after the effective dates comply with the new guidance regarding going concerns and debt issuance costs. Proper controls and procedures around financial statement reporting and evaluation of the impact of covenant calculations should be addressed and reviewed with the consideration of the new guidance.

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