Companies with debt or lease agreements, interest rate swaps, or similar contracts that reference the London Interbank Offered Rate (LIBOR) should determine what the effect will be when LIBOR is phased out in 2021 or shortly after. The Financial Accounting Standards Board (FASB) has released a new Accounting Standards Update (ASU) No. 2021-01 to provide guidance and relief for transitioning to alternative reference rates.
ASU 2021-01 is an update to ASU 2020-04, which was issued last spring to simplify how entities will account for contract modifications that result from the discontinuation of LIBOR and other reference rate reform initiatives. ASU 2021-01 focuses on refining accounting relief for modifications made to certain derivatives and hedging contracts, such as interest rate swaps.
LIBOR is determined based on the rate banks state they would charge each other for overnight borrowings and is widely used in debt and lease agreements, interest rate swaps, and similar contracts that reference a variable interest rate. However, rising concern over the ability for banks to manipulate the LIBOR rate has led the market to transition to the Secured Overnight Financing Rate (SOFR), as SOFR is based on observable rates actually charged rather than a stated rate.
Companies must evaluate their variable-rate agreements now to determine whether the agreements contemplate a change in the reference rate, and if so whether the new rate will be SOFR or some other rate. Depending on the terms of particular agreements, the transition may affect both cash flows and accounting results.
What is Your Successor Rate?
To understand what relief is available to you when your affected lease, debt agreement or other contract transitions from LIBOR, you must first determine if the contract stipulates a successor rate. If it does not, it is imperative to proactively contact your lender to inquire about the successor rate and how you can plan to account for the contract modification.
Given the current low interest rates and lenders’ motivation to move away from LIBOR, now is the time to assess your contracts to determine if any are LIBOR-based and begin to pursue an alternative rate. In time, your options could become more limited by legislative mandate or the possibility of getting locked in at the last LIBOR rate or at the bank’s full borrowing costs.
The relief contained in ASU 2021-01 is effective immediately and generally available through the end of 2022. For more information on how to evaluate your contracts and get this conversation started with your banker, please contact Tammy Straus, Partner, at tstraus@grassiadvisors.com or Jaime Rapps, Senior Manager, at jrapps@grassiadvisors.com.
