FASB, IASB Make Progress on Netting, Leasing and Impairment Standards
The Financial Accounting Standards Board and the International Accounting Standards Board issued common disclosure requirements Friday to help investors better understand the impact of offsetting, or netting, on a company’s financial position.
The two boards have been holding a three-day joint meeting this week in an effort to make more progress on some of the thornier issues in their priority convergence projects. In addition to their agreement on offsetting disclosures, they have made tentative decisions in the areas of leasing and the impairment of financial instruments such as bank loans.
The boards noted that the eligibility criteria for offsetting will still be different in International Financial Reporting Standards and U.S. GAAP, so the disclosures aim to “bridge the gap” to help investors understand the differences under the two sets of standards. Earlier this month, FASB chair Leslie Seidman and IASB chairman Hans Hoogervorst announced at an AICPA conference that they would like to change their approach to harmonizing accounting standards once they finish with their four major convergence projects of financial instruments, revenue recognition, leasing and insurance contracts (see FASB Pushes for 'Modified Incorporation' of IFRS). Under the new model, FASB would endorse IFRS one standard at a time into U.S. GAAP rather than trying to work together to arrive at a converged solution.
Offsetting, also known as netting, is the presentation of assets and liabilities as a single net amount in the statement of financial position (balance sheet). Unlike IFRS, U.S. GAAP gives companies the option of presenting net in their balance sheets derivatives that are subject to a legally enforceable netting arrangement with the same party where rights of set-off are only available in the event of default or bankruptcy. The two boards were unable to arrive at a converged solution so under the new proposal they would require disclosures of the differences.
To address these differences between IFRS and US GAAP, in January 2011 the IASB and the FASB issued an exposure draft that proposed new criteria for netting that were narrower than the current conditions currently in U.S. GAAP. However, in response to feedback from their respective stakeholders, the boards decided to retain their existing offsetting models and instead issue new disclosure requirements to allow investors to better compare financial statements prepared in accordance with IFRS or U.S. GAAP.
“The expanded disclosures are responsive to the feedback we received from investors, who wanted to understand both the gross and the net amounts for items offset in accordance with legally enforceable netting arrangements,” said FASB chair Leslie F. Seidman in a statement. “We are also requiring expanded information about the collateral pledged and held in these arrangements.”
The common disclosure requirements also improve transparency in the reporting of how companies mitigate credit risk, including disclosure of related collateral pledged or received. Further information is included in a project summary and feedback statement, also issued Friday.
“These disclosures will help investors to bridge differences in the offsetting reporting requirements of IFRS and U.S. GAAP, while the additional requirements will also provide better information on how companies mitigate credit risk related to offsetting,” said IASB chairman Hans Hoogervorst. “That said, using disclosures to bridge differences in offsetting requirements was plan ‘B’ for both boards.”
Companies and other entities are required to apply the amendments for annual reporting periods beginning on or after Jan. 1, 2013, and interim periods within those annual periods. The required disclosures should be provided retrospectively.
The IASB separately said Friday that it has clarified its requirements for offsetting financial instruments by issuing Offsetting Financial Assets and Financial Liabilities (Amendments to IAS 32). The amendments address inconsistencies in current practice when applying the offsetting criteria in IAS 32 Financial Instruments: Presentation.
The amendments clarify the meaning of ‘currently has a legally enforceable right of set-off’; and that some gross settlement systems may be considered equivalent to net settlement. The amendments are effective for annual periods beginning on or after Jan. 1, 2014 and are required to be applied retrospectively. The IASB also separately issued Disclosures—Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7) on Friday.
In addition to their progress on netting, the two boards also arrived at some tentative decisions Wednesday on their leasing project. The two boards discussed the accounting treatment for leases that are cancellable by both the lessee and lessor with minimal termination payments or include renewal options that must be agreed to by both the lessee and the lessor.
According to a summary of board decisions, they tentatively decided that the lease proposals should be applied only to periods for which enforceable rights and obligations arise. Thus, the cancellable leases would meet the definition of short-term leases if the initial noncancellable period, together with any notice period, is less than one year. In reaching that decision, the boards also tentatively decided not to change their previous decisions on the definitions of short-term leases and lease term.
The two boards, however, were not able to resolve all of their differences with respect to revenue recognition for lessors with leases of investment property.
The IASB tentatively decided that, for leases of investment property, a lessor should recognize rental income on a straight-line basis or another systematic basis if that basis is more representative of the pattern in which rentals are earned from the investment property. FASB, however, has tentatively decided that, for leases of investment property, a lessor that is not an investment property entity or investment company should recognize rental income on a straight-line basis or another systematic basis if that basis is more representative of the pattern in which rentals are earned from the investment property.
Both boards, though, seem to be in agreement on a related point, and have tentatively decided that a lessor with leases of investment property not within the scope of the receivable and residual approach should recognize only the underlying investment property on its statement of financial position (as well as any accrued or prepaid rental income).
The two boards also discussed the disclosure requirements for lessors with leases of investment property not within the scope of the receivable and residual approach. They tentatively decided to require disclosure of a maturity analysis of the undiscounted future noncancellable lease payments. The maturity analysis would show, at a minimum, the undiscounted cash flows to be received in each of the first five years after the reporting date and a total of the amounts in the years thereafter. That maturity analysis would be separate from the maturity analysis of the payments related to the right to receive lease payments under the receivable and residual approach. Lessors would also need to disclose both the minimum contractual lease income and variable lease payment income within the table of lease income; and the cost and carrying amount of property on lease or held for leasing by major classes of property according to nature or function, and the amount of accumulated depreciation in total.
The two boards also made progress on their financial instruments project and the crucial area of impairment. They discussed the “three-bucket” impairment model being developed, specifically the measurement of the allowance balance in Bucket 1, the transfer principle out of Bucket 1 (that is, when a financial asset would qualify for recognition of lifetime expected losses), and the application of the model to loans and publicly traded debt instruments, such as debt securities.
The boards decided that the objective and measurement in Bucket 1 would be to capture the losses on financial assets expected in the next 12 months. The losses being measured would not just be the cash shortfalls over the next 12 months; instead they would be the lifetime expected losses on the portion of financial assets on which a loss event is expected over the next twelve months. The losses expected to occur in the next 12 months would be determined using all reasonable and supportable information, including forward-looking data, which would reflect updated estimates as expectations change.
The boards had previously decided that financial assets would move out of Bucket 1 based on their deterioration in credit quality, and that lifetime expected losses would be recognized for financial assets in Bucket 2 and Bucket 3. At this week’s meeting, the boards decided that recognition of lifetime losses would be appropriate (that is, financial assets would move out of Bucket 1) when there has been a more than insignificant deterioration in credit quality since the initial recognition and the likelihood of default is such that it is at least reasonably possible that the contractual cash flows may not be recoverable.
The boards have asked the staff to develop examples to illustrate that the “reasonably possible” criterion differs from how it may currently be interpreted in GAAP (particularly in the U.S.), and primarily refers to when the likelihood of cash shortfalls begins to increase at an accelerated rate as an asset deteriorates.
Regarding the recognition of lifetime expected losses, the boards also decided that the assessment of whether recognition of lifetime expected credit losses is required should be based on the likelihood of not collecting all the cash flows as opposed to incorporating the “loss given default” in the assessment.
In addition, the two boards decided to include within the model indicators (including those presented at the meeting) for when the recognition of lifetime expected losses may be appropriate.
Separately, the IASB issued amendments Friday to IFRS 9 Financial Instruments that defer the mandatory effective date from Jan. 1, 2013 to Jan. 1, 2015. The deferral will make it possible for all phases of the project to have the same mandatory effective date.
The amendments also provide relief from the requirement to restate comparative financial statements for the effect of applying IFRS 9. The relief was originally only available to companies that chose to apply IFRS 9 prior to 2012. Instead, additional transition disclosures will be required to help investors understand the effect that the initial application of IFRS 9 has on the classification and measurement of financial instruments.
Early application of IFRS 9 is still permitted.