The FASB and IASB have been working on a joint project on financial instruments. The project includes classification and measurement of financial instruments and impairment of financial assets. However, the boards have not converged on each element, so there are expected to be differences in the final standards.
Key Developments Related to Classification and Measurement
- In February 2013, the FASB proposed updated guidance for the classification and measurement of investments in debt and equity securities. The proposal includes a “mixed measurement” approach that calls for measurement at amortized cost for certain financial assets. Under this proposed guidance, many more financial assets would be measured at fair value with the changes in fair value reported in net income.
- The IASB completed its deliberations on targeted amendments to its classification and measurement standard and issued an exposure draft in November 2012. The IASB also proposed a mixed measurement model.
- Following the comment period, both boards began redeliberations with the goal of achieving a converged solution. However, as a result of significant negative feedback received on the cash flow characteristics test for classifying and measuring financial assets, the FASB unanimously decided in December 2013 to abandon that approach. Instead, they decided to retain the current guidance related to the bifurcation of hybrid financial assets. The IASB, however, continued to move forward with their proposal.
- Equity investments (not accounted for under the equity method) 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. 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).
- The unrestricted fair value option that currently exists in U.S. GAAP will be retained.
- Financial liabilities will generally be recorded at amortized cost with limited exceptions. If the fair value option is elected for a financial liability, adjustments to the value due to changes in instrument-specific credit risk will be recorded in other comprehensive income.
- The requirement to assess hybrid financial instruments for the need to bifurcate embedded derivatives from their host and account for them separately remains. To the extent that an embedded derivative must be bifurcated and accounted for separately, it will be measured at fair value with changes in fair value recognized in net income.
Key Developments Related to Impairment
- In 2012, the FASB and IASB moved in different directions in their approaches to developing a new impairment model for financial assets.
- The FASB opted for a model that requires recognition, at the inception or acquisition of a financial asset, of an allowance 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.
- 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 financial assets measured at fair value with qualifying changes in fair value recognized in other comprehensive income (FV-OCI), the board decided that expected credit losses should be recognized only to the extent the financial asset’s fair value is less than its amortized cost basis.
- 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. For beneficial interests (purchased or retained) for which there is a significant difference between contractual and expected cash flows, the credit allowance should be recognized and measured consistent with the approach for purchased credit-impaired assets under the proposed update.
What's Next for Financial Instruments?
- Classification and measurement: The FASB will continue redeliberations on this project and expects to issue a final standard in the second half of 2014.
- Impairment: The FASB expects to issue a final standard in the second half of 2014.
- The IASB issued IFRS 9, Financial instruments, in July 2014. IFRS 9 introduces a new model on classification and measurement and impairment.
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