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Converged Financial Instruments Standard May Not Happen

January 31, 2014

The odds of the FASB and IASB coming up with a converged method to classify and measure financial instruments have become slimmer, given the FASB’s rejection of the joint model’s underlying premise, which called for basing an instrument’s measurement on the business model of the organization holding it. The U.S. board hasn’t decided the approach it will take, but it directed its research staff to study the issue. None of the options the board is considering will help it align with the guidance being written by the international board.

The FASB on January 29, 2014, further reduced the chances that it will issue a converged standard with the IASB on the model the boards had been developing for measuring financial instruments.

The FASB decided to stray from a key part of the joint model—requiring banks and other businesses to determine how to measure their assets and liabilities by assessing the business model in which they are held—and chart a separate path. The board did not decide what direction to take, but instructed its research staff to develop ideas.

The board wants its staff to analyze whether it should make targeted improvements in existing U.S. GAAP guidance for classification and measurement for loans and securities. After that, the FASB may consider whether it should require the same accounting for loans and securities or keep them separate.

“Regardless of what we do, we should not in any way prohibit banks or restrict institutions from doing good management,” FASB member Harold Schroeder said. “In fact, I want to know about that. I want to know to the degree that they’re selling and they’re transferring.”

The January 29 decision was another step away from the standard-setters’ goal to create a single, global way to promote consistent measurement of increasingly sophisticated financial assets and liabilities. A global standard had been a top priority in the wake of the 2008 financial crisis, but it became an elusive goal as the FASB and IASB wrestled with tough questions from banks, auditors, and analysts.

The IASB released Exposure Draft, (ED) No. 2012-4, Classification and Measurement: Limited Amendments to IFRS 9 (Proposed amendments to IFRS 9-2010), in November 2012. The FASB released Proposed Accounting Standards Update (ASU) No. 2013-220, Financial Instruments—Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities, in February 2013. The proposals, which were mostly converged, were the result of more than three years of work.

The proposals called for financial instruments to be measured in three ways—amortized cost, fair value with changes recorded in net income, and fair value with changes recorded in other comprehensive income. Instruments were assigned to categories based upon their cash-flow characteristics and the business models they serve.

Loans that a lender lists on its balance sheet and holds to collect payments of principal and interest would have been measured at amortized cost, while assets that are traded would be measured at fair value, with changes recorded in net income. Financial products a business may hold onto but could sell later would fall into a third category: fair value with changes recorded in other comprehensive income.

But after weighing feedback from banks, auditors, and investors, the FASB in December had second thoughts.

Banks especially criticized the criteria to qualify for amortized cost accounting. The proposals required that the cash flows consist “solely of payments of principal and interest,” which seemed to close the door on amortized cost measurement for loans that a bank may sell in the future. It also ruled out amortized cost measurement for loans with adjustable rates.

The FASB and IASB in November tried to make the decision process easier by adding more guidance, but the FASB in December said the simplifications didn’t go far enough and the problems lay with complexity in the overall model. (See GAAP’s Measurements for Financial Instruments May Not Match Up with IFRS in the December 23, 2013, edition of Accounting & Compliance Alert.)

The FASB’s research staff is expected to come back to the board in the coming months with potential paths forward.

One of the solutions discussed on January 29 involved taking the current accounting model for debt securities outlined in SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, (FASB ASC 320-10), and using it for loans, including trade receivables.

Several FASB members supported this idea, but they didn’t like other ideas would have been incorporated into this solution. FASB Chairman Russell Golden advocated the strongest for making targeted improvements to U.S. GAAP, but this would result in accounting differences for loans and debt securities.