In brief: FASB and IASB agree on a three-category financial asset classification and measurement approach (No. 2012-10)

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This week, the FASB and IASB (the boards) continued their joint discussions on classification and measurement of financial assets and agreed on a three-category approach for eligible debt investments. The three categories are (1) amortized cost, (2) fair value with changes in fair value recognized in other comprehensive income, and (3) fair value with changes in fair value recognized in net income. This In brief article provides an overview of the three categories, as well as other decisions reached by the boards.

What's new?

This week, the FASB and IASB (the boards) continued their joint discussions on classification and measurement of financial assets and agreed on a three-category approach for eligible debt investments.

The boards had announced in January 2012 that they would work together in an attempt to achieve a more converged solution on this important part of their broader financial instruments project. These joint discussions are nearing completion and the boards have been successful in agreeing on a substantially converged approach for debt investments.

Prior to January, the boards had reached different conclusions on classification and measurement and were at differing stages of finalization. The FASB had completed most redeliberations of its 2010 proposal while the IASB had already issued its final standard (IFRS 9). However, the IASB decided in late 2011 to consider targeted amendments to that standard.

All decisions noted in this In brief are tentative and therefore subject to change, as the boards have not yet concluded their deliberations. A complete summary of the FASB's decisions on the financial instruments project is available on its website at www.fasb.org.

What are the key decisions?

Under their respective approaches, debt investments (e.g., loans and debt securities) would be classified based on an individual instrument's characteristics (as further explained below) and the business strategy for the portfolio. However, before this week's meeting, the IASB had defined two categories whereas the FASB had defined three categories.

This week, the IASB agreed to introduce a third category in which debt investments are measured at fair value with changes in fair value recognized through other comprehensive income. The FASB also agreed on a revised definition for this category. As a result, the categories for debt investments would be broadly defined as follows:

• Amortized cost – consists of debt investments where the primary objective is to hold the assets to collect the contractual cash flows.
• Fair value with changes in fair value recognized in other comprehensive income – consists of debt investments with the primary objective of both holding the assets to collect contractual cash flows and realizing changes in fair value through sale. Interest and impairment would be recognized in net income in a manner consistent with the amortized cost category, and fair value changes would be recycled from other comprehensive income to net income when the asset is sold.
• Fair value with changes in fair value recognized in net income – consists of debt investments that either (1) do not meet the instrument characteristics criterion or (2) meet the instrument characteristics criterion but do not meet one of the other category definitions (i.e., "the residual category").

In addition, the FASB agreed to adopt the IASB requirement for prospective reclassifications between categories when there is a significant change in business strategy, which is expected to be "very infrequent."

In previous meetings, the FASB had also agreed to incorporate the following aspects of the IASB's approach:

• Instrument characteristics criterion. The contractual cash flows of the debt investment must represent solely payments of principal and interest in order to be eligible for the amortized cost or fair value with changes in fair value recognized in other comprehensive income categories.
• Bifurcation of hybrid financial instruments. Separate accounting for financial asset host contracts and embedded derivatives in hybrid financial assets would be prohibited; instead the entire hybrid financial asset would be accounted for as a single instrument. However, hybrid financial liabilities would continue to be bifurcated.

Is convergence achieved?

Most of the areas slated for joint discussion have now been concluded. While the boards have agreed on a substantially converged approach for debt investments, they do not plan on addressing all differences in their respective approaches (e.g., classification and measurement of equity investments that are not under the equity method of accounting).

Who's affected?

The final guidance will likely affect entities across all industries that hold financial instruments.

What's the effective date?

The FASB must still complete its redeliberations before deciding on an effective date. The IASB had previously decided to extend the effective date for IFRS 9 to annual periods beginning on or after January 1, 2015 (see In brief 2011-55).

What's next?

The boards are still expected to discuss some remaining issues including transition and disclosures. The FASB will also separately address a number of other matters in the coming months before issuing an exposure draft later this year. It is unclear at this time whether the new impairment approach will be included in that document or issued as a separate exposure draft.

Questions?

PwC clients who have questions about this In brief should contact their engagement partner. Engagement teams that have questions should contact the Financial Instruments team in the National Professional Services Group (1-973-236-7803).

Authored by:

Greg McGahan
Partner
Phone: 1-973-236-5250
Email: gregory.mcgahan@us.pwc.com

Marie Kling
Partner
Phone: 1-973-236-4460
Email: marie.kling@us.pwc.com

Craig Cooke
Director
Phone: 1-973-236-4705
Email: craig.cooke@us.pwc.com

Elaine O'Keeffe
Senior Manager
Phone: 1-973-236-4160
Email: elaine.okeeffe@us.pwc.com

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