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FASB and IASB Finally Reach Agreement on Loan Accounting

January 17, 2011

The Financial Accounting Standards Board and the International Accounting Standards Board have agreed at last on a joint approach to how to account for credit losses, a key issue that has been holding up their convergence efforts on financial instruments standards.

Last week, the two boards said they would publish a proposed joint approach on the credit impairment of loans and other financial assets managed in an open portfolio. Before former FASB chairman Bob Herz retired suddenly last fall, the U.S. accounting standard-setting board appeared to be leaning toward accounting for loans on a purely fair value basis, while the IASB favored what it called a “mixed measurement model” blending fair value for some types of loans and amortized cost for others.

With a new chairman and newly expanded board now in place at FASB, it appears that the mixed measurement model seems to be winning out, and that is sure to please many banks that had criticized efforts to account for all loans at fair value.

However, the proposals have not yet been laid out, and the final standards will still depend on what kind of comments the new proposals receive. Ultimately the accounting treatment for credit losses will determine how non-performing loans that are measured under amortized cost should be impaired.

“Both International Financial Reporting Standards and U.S. generally accepted accounting principles currently apply an ‘incurred loss’ approach to loan loss provisions, whereby specific evidence of a loss is required before a loan can be impaired,” the boards said in announcing their impending proposals. “This approach was criticized during the recent financial crisis for preventing entities from accounting for expected losses early enough.”

The IASB and FASB originally published separate proposals on the credit impairment of financial assets, with the intention of listening to the feedback they received from interested parties and ultimately producing a converged set of standards. After holding a series of joint discussions of the responses that each board received on its original proposals, the boards said they will shortly seek views on a common approach that incorporates elements of each of their original models. The boards also intend to conduct extensive outreach with their constituents about how the proposed standards will operate and the usefulness of the resulting information.

“The boards will propose an impairment model based on accounting for expected losses,” said the two boards. “This approach provides a more forward-looking approach to accounting for credit losses. It builds on the work of the Expert Advisory Panel, an external group comprising risk management experts that was set up to consider how to address the operational difficulties of applying an expected loss model.”

They noted that the proposals respond to requests by the G-20 leaders, the Financial Stability Board, the Basel Committee on Banking Supervision, and others who were urging the IASB and FASB to reach a common solution for impairment accounting. Not to mention all the accountants and bankers who have been clamoring for the boards to finally come to an agreement. It’s not yet here, of course, but it seems an answer is getting closer. Hopefully they will have it in place by the end of June, which is the target date they have set for getting the major sticking points resolved in their convergence efforts.

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