Earlier this month, the FASB directed its staff to explore a revised impairment model for financial instruments. At its August 22 meeting, the board made some key decisions about the revised model. The board is considering a model that incorporates the concept of expected losses, but applies that concept to all financial assets and uses a single measurement approach. This In brief article provides an overview of the key decisions made at the board meeting.
Earlier this month, the FASB (the “board”) directed its staff to explore a revised impairment model for financial instruments. At its August 22 meeting, the board made some key decisions about the revised model.
Over the past several months, the FASB and IASB have jointly deliberated a “three bucket” impairment model for financial assets. After considering constituent feedback, the board concluded that aspects of the “three bucket” impairment model are difficult to understand and present operational challenges that cannot be addressed through implementation guidance.
As a result, the board decided not to move forward with an exposure draft on the “three bucket” approach. Instead, the board is considering a model that incorporates the concept of expected losses, but applies that concept to all financial assets and uses a single measurement approach.
The board reached the following tentative decisions about key aspects of the revised impairment model.
Estimating expected losses
The model will focus on the recognition of all expected losses, which will be defined as “the estimate of contractual cash flows not expected to be collected.” The board decided not to establish a threshold that should be met before an entity recognizes a credit impairment. This decision will result in a change to current practice under which entities recognize all incurred losses for which it is probable that one or more future events will occur confirming the loss.
When estimating expected losses, an entity will be required to consider a range of potential outcomes. The information used to develop the estimate will include: (1) a current assessment of credit risk and (2) an estimate of expected credit losses. The estimate of expected credit losses will be based on all relevant internal and external information, including past events, current conditions, and reasonable and supportable forecasts.
Time value of money
The model will incorporate the time value of money into the measurement of expected credit losses. The FASB plans to issue guidance to communicate appropriate methods to accomplish this objective
Purchased credit impaired assets
Purchased credit impaired (PCI) assets will be defined as “acquired assets or acquired groups of assets with shared risk characteristics that have experienced significant credit deterioration since origination based on an assessment by the buyer.” For PCI assets, entities will be required to establish an initial impairment allowance based on the level of expected losses. The impairment allowance will be updated each period with changes recognized in income immediately. The remaining non-credit purchase discount or premium will be accreted over the life of the asset.
The FASB’s tentative decisions do not result in convergence with the IASB’s model. The IASB has not publicly discussed the recent FASB decisions and whether these decisions will affect its current plan to issue an exposure draft in the fourth quarter of 2012.
Over the next several weeks, the FASB will continue to discuss the application of the model to debt securities and assets recorded at fair value with changes in fair value recognized through other comprehensive income. In addition, the board expects to further discuss non-accrual loans, trade receivables, transition, and disclosure requirements.
The FASB’s goal is to complete all significant discussions about the model by the end of September. The FASB plans to share its revised model with the IASB at that time.
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).
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