FASB Proposes Improvements to Accounting for Credit Losses on Financial Assets
The Financial Accounting Standards Board (FASB) has issued for public comment its proposal to improve financial reporting about expected credit losses on loans and other financial assets held by banks, financial institutions, and other public and private organisations.
‘Proposed Accounting Standards Update, Financial Instruments – Credit Losses (Subtopic 825-15)’
, proposes a new accounting model intended to require more timely recognition of credit losses, while also providing additional transparency about credit risk. Stakeholders are asked to review and comment on the proposal by 30 April 2013.
“The global financial crisis highlighted the need for improvements in the accounting for credit losses on loans and other debt instruments held as investments,” said FASB chairman Leslie Seidman. “The FASB’s proposed model would require more timely recognition of expected credit losses and more transparent information about the reasons for any changes in those estimates. We invite comments from stakeholders on both the usefulness of the resulting information and the operationality of the proposed approach.”
The FASB’s proposed model would utilise a single ‘expected credit loss’ measurement objective for the recognition of credit losses, replacing the multiple existing impairment models in US Generally Accepted Accounting Principles (GAAP), which generally require that a loss be ‘incurred’ before it is recognised. Under the proposal, management would be required to estimate the cash flows that it does not expect to collect, using all available information, including historical experience and reasonable and supportable forecasts about the future.
The balance sheet would reflect the current estimate of expected credit losses at the reporting date (the allowance for credit losses) and the income statement would reflect the effects of credit deterioration (or improvement) that has taken place during the period (the provision for bad debt expense).
Both the FASB and the International Accounting Standards Board (IASB) have been developing expected loss models for impairment of loans and other debt instruments. Previously, the boards had agreed on an approach that would track the deterioration of the credit risk of loans and other financial assets in three ‘buckets’ of severity.
However, US preparers, auditors, investors, and regulators expressed concerns about the ability to understand, operate and audit the ‘three-bucket’ credit impairment model, and whether it would reflect an appropriate measure of risk. This led the FASB to revise its approach. However, the FASB model retains several key concepts that have been jointly deliberated and agreed upon with the IASB, including the main concept of expected credit loss and the current recognition of the effects of credit deterioration on collectibility expectations.
The key difference relates to the IASB’s use of a different expected loss approach for assets that have not yet exhibited significant deterioration in credit risk; specifically, full recognition of an allowance for the expected credit loss would be deferred for financial assets for which a loss event is expected to occur beyond 12 months. Under the FASB model, the organisation would not limit its estimate to losses that are expected to occur in a particular time period; rather the organisation would always consider all available information and recognise its current estimate of cash flows not expected to be collected.
The FASB will consider the comments received on its proposal as well as the comments received by the IASB on its proposal, which is expected to be issued in Q113.