The Financial Accounting Standards Board has released a proposal for comment to improve reporting on expected credit losses on loans and other financial assets held as investments by banks, financial institutions and other public and private organizations.

The new accounting model in Proposed Accounting Standards Update, Financial Instruments — Credit Losses 9 (Subtopic 825-15), aims to require more timely recognition of credit losses, as well as additional transparency about credit risk. It would use a single “expected credit loss” measurement for recognizing credit losses, in place of the multiple current models in U.S. GAAP, which generally require that a loss be “incurred” before it is recognized.

“Every period, the entity would be required to estimate the cash flows that they don’t expect to collect, considering both the possibility of loss and the possibility of full collection,” said FASB Chair Leslie Seidman in a press conference. The estimate would be based on all available information, including the current risk status of the loan, the historical experience of similar assets, and reasonable and supportable forecasts about the future.

“Unlike current GAAP, you would not wait for asset deterioration,” Seidman said. “There’s no trigger for recognition of the loss — you would no longer have to wait” for a particular event or observable deterioration. “The information set is no longer limited to things that have already happened. Rather, you’d be required to consider all available information.”

 

The Convergence Angle

Seidman noted that both FASB and the International Accounting Standards Board are now working on “expected-loss” models. The major difference she described between the two models is that “the IASB will limit estimates for loans that have not yet exhibited significant deterioration to losses for the next 12 months, while the FASB would not limit the time period.”

“The IASB has been hearing concerns similar to those heard by the FASB earlier this year,” she added. “They’re going to refine their guidance, rather than fundamentally revisiting the approach. We are looking forward to broad commentary on the two approaches to help us work through the differences.”

“I am very hopeful that now that we have issued our proposal, including a complete articulation of the proposed guidance, examples to show how it would be implemented, and the basis for conclusions, that we will be able to have a more fulsome evaluation of this proposal from stakeholders around the world," she later added in response to a question. "Likewise, once the IASB issues their proposal with their examples and their basis for conclusions, I think we’ll all be in a better position to evaluate which one we think does better reflect the losses that are inherent at any point in time."

"I think that in light of the financial crisis and the decisions that have been identified about both U.S. GAAP and IFRS, what we have tried to do is remove any barriers to timely recognition of losses, and we think our proposal has done that," said Seidman. "The remaining concerns that we have about the IASB’s approach is that in asset classes that have remaining life beyond one year, we are very concerned about an approach which would say, ‘Limit your forward look and available information to just the next 12 months.’ In our experience we have seen data that shows that assets tend to demonstrate their losses early in their life and the losses are not ratable, so any theory that would say we should limit the losses to 12 months so that it’s matched with the income, we think doesn’t hold because that’s not how losses unfold in a loan portfolio or a bond portfolio. We will find out from the comment period whether people agree with what I just said, but that’s the type of information we’re hoping to learn.”

The exposure draft is available on FASB’s Web site; comments are due by April 30, 2013. The board will consider the comments sent in on its proposal, as well as those sent in on the IASB proposal, which has not yet been released.