Financial instruments

The FASB and IASB were working on a joint project on financial instruments which included classification and measurement of financial instruments and impairment of financial assets. However, the boards did not converge and set down different paths. The IASB issued IFRS 9, Financial instruments in July 2014. IFRS 9 introduces a new model for classification and measurement and impairment. The FASB is still deliberating.

  • The FASB proposed updated guidance for the classification and measurement of financial instruments in February 2013. However, as a result of significant negative feedback, the FASB has dramatically changed its proposal. As a result, convergence with the IASB will not be achieved.

  • Equity investments (not accounted for under the equity method) with readily determinable fair values will be measured at fair value, with changes in fair value recognized in net income. However, entities other than investment companies and broker-dealers will be afforded a practicability exception for investments that do not have readily determinable fair values. Under the practicability exception, these entities will be required to perform a qualitative assessment to identify impairment indicators. Such investments would be measured at cost less impairment and adjusted for observable prices.

  • The accounting for debt investments (i.e., loans and debt securities) will remain unchanged subject to the new proposed impairment model (see below).

  • Financial liabilities will generally be recorded at amortized cost unless the fair value option is elected. If the fair value option is elected for a financial liability, adjustments to the value due to changes in an entity’s own credit risk will be recorded in other comprehensive income.

  • Financial assets and financial liabilities will be required to be presented separately, grouped by measurement category and class of financial asset in the statement of financial position or in the accompanying notes to the financial statements.

  • The IASB issued its final guidance on targeted amendments to its classification and measurement standard in July 2014. The IASB’s classification and measurement standard is substantially the same as the FASB model that was proposed in the ASU issued in February 2013.
  • In 2012, the FASB and IASB moved in different directions in their approaches to developing a new impairment model for financial assets.

  • The IASB's approach would classify debt investments into categories that reflect the pattern of credit deterioration over time. Those categories would dictate the model for determining the amount and timing of when credit losses would be recognized in earnings. All assets would initially be recognized in the first category, where a credit loss would be recorded based on the probability of a default in the next twelve months. Once an asset experiences a significant deterioration in credit risk, it would move to a second category, at which point an allowance would be recorded for the full lifetime expected credit losses.

  • The FASB believes that aspects of the IASB's model are difficult to implement and would result in a credit allowance that does not fully capture all expected losses on an asset. For example, prior to experiencing a significant deterioration in credit, the IASB model would only record credit losses for assets expected to default within 12 months of the balance sheet date. The FASB opted for a model that would require recognition of an allowance, at the inception or acquisition of a financial asset, for the full amount of contractual cash flows not expected to be collected. The FASB issued an exposure draft on its model, referred to as the current expected credit loss (CECL) model, in December 2012.

  • Generally, respondents to the IASB model supported the proposed model, but suggested various refinements. The IASB issued its final standard during the third quarter of 2014.

  • With respect to the FASB model, feedback was mixed. Users generally supported the FASB model, as they preferred a model that would require recognition of all credit losses (as opposed to only ‘some’ expected credit losses). Preparers, on the other hand, did not support the FASB’s proposed model, struggling to reconcile the recognition of credit losses at the inception of a lending arrangement with the credit assessment inherent in the pricing of the transaction. Instead, preparers preferred a model that would recognize those losses expected to occur in the ‘foreseeable future’ or some other truncated period.

  • Throughout the fall of 2013, the FASB conducted outreach with both preparers and users, and conducted joint discussions with the IASB. Ultimately, after considering several alternatives, the FASB decided in December 2013 to move forward with the CECL model and refine various aspects, where necessary. That decision eliminates the possibility of convergence between the FASB and IASB in the recognition and measurement of credit losses. The major difference between the IASB and FASB’s models is the credit deterioration trigger in the IASB’s model—that is, the FASB will require recognition of full lifetime expected credit losses upon initial recognition, whereas the IASB would record such losses upon a significant deterioration in credit.

  • Following its decision to move forward with the CECL approach, the FASB has continued to refine that model. Specifically, the board decided that the CECL model should apply to all financial assets measured at amortized cost. For debt securities measured at fair value with qualifying changes in fair value recognized in other comprehensive income (FV-OCI), the board decided that use of an impairment model similar to that in current guidance would be appropriate, with the following proposed changes.

        –  An allowance approach would be used to recognize impairment losses, which would             allow an entity to recognize reversals of credit losses to the extent improvements occur.

        –  Removal of the requirement to consider the length of time that the fair value of an             available for sale debt security has been less than its amortized cost when estimating             whether a credit loss exists.

        –  Removal of the requirement to consider recoveries or additional declines in fair value of             an available for sale debt security.

  • The FASB also decided that for loans subsequently reclassified as held-for-sale and measured at the lower of cost or market, the amortized cost basis on the transfer date would be considered the loan’s cost basis and a valuation allowance should be recorded equal to the amount by which amortized cost exceeds fair value. For debt securities subsequently identified for sale, the full difference between fair value and amortized cost would be the amount of impairment recorded.

  • The FASB clarified the determination of when a write down to an allowance for credit losses should occur, deciding that instruments uncollectible in full or in part would require a write down, which is similar to the existing guidance for loan receivables.

  • The FASB concluded that contractual cash flows, as defined in the proposed standard, would not include forecasts of extension, renewals or modifications unless the entity expects that such forecasts would be related to a troubled debt restructuring. Estimation of prepayments would be allowable under the standard. It was reaffirmed that expected credit losses for unfunded loan commitments should reflect the full contractual period over which the entity is exposed to credit risk, unless unconditionally cancellable by the issuer.

  • The FASB has concluded that disclosure requirements will include a rollforward schedule of the allowance for credit losses for all in-scope financial assets, including available for sale debt securities. This disclosure requirement is similar to what is required in current GAAP for receivables.

  • The board has also tentatively concluded that companies will not be required to disclose a rollforward schedule of amortized cost as tentatively proposed in prior deliberations. Instead, the proposed disclosure will expand the current U.S. GAAP requirement for disclosure of credit quality indicators for receivables to all financial assets within scope, excluding available for sale debt securities and reinsurance receivables. The disclosure will require presentation of the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by year, vintage, or origination. A minimum of two years comparative disclosures will be required, with up to five years permitted.

  • The board affirmed that assets purchased with evidence of more than insignificant credit deterioration since origination would be classified as purchase credit impaired. The accounting for purchase credit impaired assets would require a day one allowance account to be established through a gross up to the balance sheet. This would be a change from today's accounting requirements, which preclude the recognition of a day one allowance account in business combinations. Today’s model requires deteriorations in expectations of cash flows to be recorded as impairments through a valuation allowance. Improvements in expected cash flows are recognized as a reversal to a previously established valuation allowance. If there is no valuation allowance, improvements in expected cash flows are recognized prospectively as effective yield adjustments. The setup of a day one allowance account in the proposed model would allow for improvements in expected cash flows to be recognized immediately through reversal of the allowance with a credit to earnings. 

The quarter close: Directors edition Q3 2015


This quarterly publication is designed to keep directors informed about the latest accounting and financial reporting issues.

IFRS 9 - impairment for banking


PwC Assurance Partners Ryan Leopold and Chris Wood discuss the new financial instruments standard and how it impacts the banking industry.

Financial statement presentation guide - 2014 second edition (updated June 2015)


PwC's popular Financial statement presentation guide addresses U.S. GAAP presentation and disclosure requirements of common balance sheet and income statement accounts.

In brief: Financial and nonfinancial hedges: Significant changes to be exposed


PwC discusses sweeping changes to be proposed to hedge accounting guidance (ASC 815).

In brief: SEC weighs in on treatment of costs related to revolving debt arrangements


SEC staff expresses views on the treatment of debt issuance costs associated with revolving debt arrangements.

PwC comments on the FASB's bifurcated embedded derivatives exposure draft


PwC does not support the proposal due to both conceptual and practical reservations regarding its requirements.

In brief: FASB issues a final standard to simplify the presentation of debt issuance costs


New standard requires debt issuance costs to be presented as a direct deduction from the associated debt liability.

In depth: SEC speech provides guidance: Modification or exchange of preferred stock


We have updated our guidance on a preferred stock modification or exchange.

In depth: Accounting for a debt modification with a change in principal


We have updated our guidance on the accounting for a debt modification when there is a change in principal.

Financing transactions: debt, equity and the instruments in between – 2014 accounting and financial reporting guide (updated March 2015)


This is a roadmap to the accounting for the issuance, modification, and extinguishment of debt and equity instruments.