Upon completion of this chapter, the reader will be able to:
• Identify how a reporting entity measures an obligation under ASC 405-40
• State the obligations to which ASC 405-40 applies
• Describe the obligations to which ASC 460 applies
¶ 703 OVERVIEW
ASC 405-40 provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date.
It does not apply to obligations addressed within other U.S. GAAP.
¶ 704 BACKGROUND
In some instances, several entities may engage in a transaction in which each entity is jointly and severally liable for the joint obligations of the entities; that is, a liability is established that is shared by more than one party. Examples of such obligations include:
• Debt arrangements
• Contractual obligations
• Settled litigation and judicial rulings
Prior to the issuance of ASU 2013-04, now ASC 405-40, U.S. GAAP offered no specific guidance on accounting for such obligations, including the recognition, measurement, and disclosure of such obligations. Consequently, there were variations in practice.
Some entities recorded the entire amount of the obligation under the joint and several liability. This is on the basis of the concept of a liability and based on the premise that the amount recorded should equal the amount that must be satisfied to extinguish a liability under the guidance in ASC 405-20—Liabilities—Extinguishments of Liabilities.
Other entities recorded a portion of the total obligations allocated among all obligors. The allocation method may be based on the amount allocated among the entities, the amount of proceeds received, or the portion of the amount the entity agreed to pay among its co-obligors. This allocation method is based on guidance found in the contingent liabilities rules in ASC 450-20—Contingencies—Loss Contingencies, and ASC 410-30—Asset Retirement and Environmental Obligations—Environmental Obligations.
ASC 410-30 permits an entity to record its estimated portion of the total obligation subject to joint and several liability.
NOTE: International standards also do not offer specific guidance on the accounting and disclosures related to obligations under joint and several liability arrangements. Instead, international standards require an entity to treat that portion of a joint and several liability that is expected to be met by other parties as a contingent liability under International Accounting Standards (IAS) 37, Provi-sions, Contingent Liabilities and Contingent Assets. Although the guidance of IAS 37 applies to contingent liabilities, contingent liabilities are not included within the scope of ASC 405-40. However, the measurement approach in IAS 37 for joint and several liabilities is rather consistent with the measurement approach in ASC 405-40. In effect, ASC 405-40 does not eliminate any existing differences that currently exist between U.S. GAAP and IFRS.
ASC 405-40 requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date, as the sum of two components:
1. The amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors
2. Any additional amount the reporting entity expects to pay on behalf of its co-obligors
NOTE: The FASB Emerging Issues Task Force (EITF) chose not to define the term “expects to pay. Consequently, an entity should weigh all facts and circumstances to determine the amount that an entity expects to pay on behalf of all co-obligors (co-borrowers).
If there is some amount within a range of the additional amount the reporting entity expects to pay that is a better estimate than any other amount within the range, that amount shall be the additional amount included in the measurement of the obligation. If no amount within the range is a better estimate than any other amount, then the minimum amount in the range shall be the additional amount included in the measure-ment of the obligation.
OBSERVATION: Use of the “better estimate within a range or, absent a better estimate, the minimum amount within the range, is consistent with the rules found in ASC 450, related to loss contingencies.
OBSERVATION: ASC 410-30-30—Asset Retirement and Environmental Obli-gations, Environmental Obligations-Initial Measurement, offers a parallel to the accounting for the joint and several obligation situation found in ASC 405-40. In ASC 410-30-30, an entity is required to record an environmental remediation liability based on that entity’s estimate of its allocable share of the joint and several remediation liability. In making that estimate, the entity is required to take certain actions that include assessing the likelihood that other parties will pay their full allocable share of the joint and several remediation liability. In ASC 405-40, the FASB EITF does not require that the co-borrower assessment the “likelihood that other parties will pay. Instead, the company should calculate the amount it “ex-pects to pay, which does not reflect likelihood.
The guidance in the ASC also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations.
Problem with Current Practice
One of the problems with existing practice that led to the issuance of ASC 405-40 was that several co-borrowers involved with each other under a joint and several liability
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MODULE 2 - CHAPTER 7 - Joint and Several Liability Arrangements
arrangement would potentially record duplicate liabilities to account for the same liability obligation.
EXAMPLE: Companies X, Y, and Z are co-borrowers of a loan in the amount of $3 million. Each of the companies receives one-third of the proceeds ($1 million) and each is jointly and severally liable for the entire $3 million. Because each company is potentially liable for $3 million, each company records the entire $3 million liability even though each only receives $1 million. The result is that the entire liability recorded among the three entities is:
Liability Recorded
Company X $3,000,000
Company Y 3,000,000
Company Z 3,000,000
$9,000,000
Because of the fact that each company is jointly and severally liable for the entire $3 million, the companies collectively record total liabilities of $9 million.
There is clearly redundancy.
¶ 705 SCOPE
ASC 405-40 applies to all entities, both public and nonpublic, that have obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date and for which no specific guidance exists. The ASC applies to obligations that have the following two criteria:
1. There must be a joint and several liability arrangement.
2. The total amount under the arrangement must be fixed at the reporting date.
ASC 405-40 does not apply to obligations accounted for under the following ASC topics:
• Asset Retirement and Environmental Obligations, ASC 410
• Contingencies, ASC 450
• Guarantees, ASC 460
• Compensation—Retirement Benefits, ASC 715
• Income Taxes, ASC 740
In order for the total amount of an obligation to be considered fixed at the reporting date, there can be no measurement uncertainty at the reporting date relating to the total amount of the obligation. However, although the obligation must be fixed at the reporting date, the total amount of the obligation may change subsequent to the reporting date because of factors that are unrelated to measurement uncertainty.
EXAMPLE: Company X has a line of credit obligation under a joint and several arrangement with another company. Both X and the other company have joint and several liability under the line of credit. At the reporting date, the amount of the line of credit outstanding is fixed. Although the amount of the line of credit outstanding is fixed at the reporting date, the total amount of the obligation (line of credit) may change in future periods because an additional amount is borrowed under the line of credit, or because the interest rate on the line of credit changes.
The fact that the amount of the obligation might change subsequent to the reporting date does not negate the fact that the obligation is fixed at the reporting date.
ASC 405-40 applies to all joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date, regardless of the relationship among parties involved in the arrangement. A joint and several liability arrangement is not excluded from the scope of the ASC because the parties involved are unrelated or related.
ASC 405-40 does not apply to guarantors of an obligation. A joint and several liability arrangement involving an entity as a guarantor (instead of borrower) of an obligation must follow the guidance of ASC 460, Guarantees, and not ASC 405-40.
OBSERVATION: ASC 405-40 applies only to situations in which the entity is a primary borrower under a joint and several obligation, and not as a guarantor. In situations in which the entity is a guarantor, that obligation is excluded from the scope of ASC 405-40, and, instead, is covered under ASC 460, Guarantees.
Liabilities subject to a measurement uncertainty (e.g., not fixed) are excluded from the scope of the ASC and should continue to be accounted for under the guidance in ASC 450, Contingencies, or other U.S. GAAP.
STUDY QUESTIONS
1. In order for ASC 405-40 to apply to an entity, the total amount under the
arrange-ment must be .
a. Predictable b. Calculable c. Fixed d. Variable 2. ASC 405-40:
a. Does not apply to guarantors of an obligation b. Applies to guarantors as long as ASC 460 is followed
c. Applies to a guarantor only if the guarantor is not the primary obligor d. Does not address whether it applies to guarantors