The Financial Accounting Standards Board has issued a revised set of proposals for the financial instruments accounting standards it has been working to converge with International Financial Reporting Standards.
FASB issued the latest proposals for the financial instruments standards and asked for public comment on them. The latest standards include a proposal to improve financial reporting by providing a comprehensive measurement framework for classifying and measuring financial instruments.
FASB developed its proposed accounting standards update, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, as part of a broader joint project with the International Accounting Standards Board to improve and converge accounting for financial instruments under U.S. GAAP with IFRS. FASB is asking stakeholders to provide written comments on the proposal by May 15, 2013.
FASB and the IASB have made the financial instruments standards one of their priority convergence projects, but have disagreed over a number of issues, such as the impairment of bank loans and hedging and offsetting activities.
FASB decided to re-expose the proposals it issued in 2010 and incorporated some of the feedback it received in the latest set of updates.
“The proposed accounting standard would measure financial assets based on how a reporting entity would realize value from them as part of distinct business activities, while the measurement of financial liabilities would be consistent with how the entity expects to settle those liabilities,” said FASB chair Leslie F. Seidman in a statement. “This revised proposal is responsive to the feedback the FASB received on our 2010 exposure draft. It simplifies the multitude of classification methods currently in use, and it offers an opportunity for convergence with the IASB’s proposal issued last November.”
The exposure draft also would narrow the availability of the existing fair value option for financial assets and financial liabilities. In those limited cases where the fair value option would be allowed for financial liabilities, changes in the fair value attributable to an organization’s own credit risk would be reported in other comprehensive income, or OCI, rather than net income.
“We encourage stakeholders to review this proposal as well as our companion exposure draft on accounting for credit losses and provide feedback about whether these changes would cost-effectively improve financial reporting,” Seidman added.
Under the proposal, the classification and measurement of a financial asset would be based on the asset’s cash flow characteristics and the entity’s business model for managing the asset, rather than on its legal form, that is, whether the asset is a loan or a security. Based on this assessment, financial assets would be classified into one of three categories:
• Amortized Cost – financial assets comprised solely of payments of principal and interest that are held for the collection of contractual cash flows
• Fair Value through Other Comprehensive Income (OCI) – financial assets comprised solely of payments of principal and interest that are both held for the collection of contractual cash flows and for sale
• Fair Value through Net Income – financial assets that do not qualify for measurement at either amortized cost or fair value through other comprehensive income.
All equity investments (excluding those accounted for under the equity method of accounting) would be measured at fair value with changes in fair value recognized in net income, because such investments do not have payments of principal and interest. The proposal also provides a practicability exception to measurement at fair value for equity investments without readily determinable fair values.
The proposal also would require financial liabilities to generally be carried at cost, unless the reporting organization’s business strategy is to subsequently transact at fair value or the obligation results from a short sale. The proposal would retain the embedded derivative requirements for hybrid financial liabilities.
For financial assets and financial liabilities measured at amortized cost, public companies also would be required to disclose their fair values parenthetically on the face of the balance sheet (except for receivables and payables due in less than a year and demand deposit liabilities). Nonpublic entities would not be required to disclose such fair value information either parenthetically or in the notes.
In May 2010, FASB issued its first exposure draft on financial instruments, which proposed a much greater use of fair value measurement for financial assets and liabilities than exists in current U.S. GAAP. Through its extensive outreach on that proposal, FASB learned that a significant majority of investors, reporting entities, and other stakeholders do not believe that fair value information is of primary relevance for some financial instruments, particularly loans, deposits, and financial liabilities. Based on that feedback, in the proposed update, the board decided to require amortized cost as a measurement attribute for assets held for collection of cash flows, because the value is realized over the holding period of the asset. Assets that might be sold to manage interest rate risk or liquidity risk would not qualify for cost measurement. In addition, the board also decided that financial liabilities would generally be measured at amortized costs unless certain conditions are met.
The proposed accounting for expected credit losses on debt instruments carried at amortized cost or fair value through OCI is addressed in the FASB’s proposed accounting standards update on credit losses, which was issued in December 2012. Stakeholders are encouraged to consider both of these proposals concurrently.
In January 2012, amid open disagreement over their proposals, FASB and the IASB decided to jointly re-deliberate selected aspects of their classification and measurement models in an attempt to reduce differences in several important areas (see FASB Splits with IASB on Impairment Standards). In November 2012, the IASB issued its proposed amendments to IFRS 9 Financial Instruments, which, like the FASB’s proposed update, would require an entity to classify and subsequently measure financial assets based on the results of cash flow characteristics and business model assessments. A brief comparison of the proposals is included in the proposed update.
The FASB exposure draft, including instructions on how to submit written comments, is available at www.fasb.org. A FASB In Focus also is available at FASB’s Web site. A podcast explaining the key features of the proposal will be available on the Web site within the next week.
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