The International Accounting Standards Board has proposed new standards for measuring the impairment of financial instruments and assets using amortized cost, taking a different tack than the U.S. Financial Accounting Standards Board.
The IASB issued an exposure draft on the new proposals for public comment on Thursday. The proposals form the second part of a three-part project to replace IAS 39, Financial Instruments: Recognition and Measurement, with a new standard, to be known as IFRS 9, Financial Instruments.
Both International Financial Reporting Standards and U.S. GAAP currently use an incurred-loss model for the impairment of financial assets. An incurred-loss model assumes that all loans will be repaid until evidence to the contrary (known as a loss or trigger event) is identified. Only at that point is the impaired loan (or portfolio of loans) written down to a lower value.
The global financial crisis has led to criticism of the incurred-loss model for presenting an initially overly optimistic assessment of no credit losses, only to be followed by a large adjustment once a trigger event occurs.
Under the proposals, expected losses are recognized throughout the life of a loan or other financial asset measured at amortized cost, and not just after a loss event has been identified. This would avoid the front-loading of interest revenue that occurs today before a loss event is identified and would better reflect the lending decision. Under the proposals, a provision against credit losses would be built up over the life of the financial asset. Extensive disclosure requirements would provide investors with an understanding of the loss estimates that an entity judges necessary.
An expert advisory panel is being established to advise the board on the practical implications of the change, and the IASB is providing an eight-month comment period to allow companies adequate time to provide feedback on what such a change would mean within their organizations.
Although moving to a single impairment model significantly reduces complexity, the challenges of applying an expected-loss approach should not be underestimated, said IASB Chairman Sir David Tweedie in a statement. For this reason the IASB will tread carefully and seek input from a broad range of interests before deciding how to proceed.
The IASB plans to cooperate closely with FASB so they can eventually agree on a common approach to the impairment of financial assets. The two boards have recommitted to their memorandum of understanding on converging IFRS with U.S. GAAP. They plan to intensify their efforts by meeting monthly from now on, including a meeting by video conference later this month, with the goal of converging accounting standards by June 2011.
Our successful joint meeting with the IASB in late October demonstrated that improvements in financial reporting and convergence are very much on track, said FASB Chairman Robert Herz in a statement. We will continue our dual objectives of working toward global convergence while addressing reporting issues of critical importance to U.S. investors and financial markets.
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