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Divided Board Approves Publication of Classification and Measurement Update

The FASB plans to publish by the end of the year an update to U.S. GAAP that a divided board believes will make targeted improvements to current accounting. The update will become effective for public companies in 2018.

A divided FASB on November 11, 2015, finished years of debate on improving how to classify and measure financial assets and liabilities.

The board approved a plan, to be published by the end of 2015, with a 4-3 vote. FASB members Harold Schroeder, Marc Siegel, and Thomas Linsmeier voted against it.

“We had a real opportunity to do some dramatic improvements to an area that frankly is not well understood to investors,” Schroeder said. “We had some opportunities to improve; we opted to basically keep the status quo.”

A majority of the board, however, said the changes on the whole justified moving forward with the plan. The board agreed that the standard will become effective for public companies for annual periods starting after December 15, 2017. This means a 2018 effective date for calendar-year companies. Private companies would have an extra year to comply with the standard. Private companies also would not have to comply with the quarterly reporting requirements until periods beginning after December 15, 2019.

The project was considered one of the FASB’s primary responses to the financial crisis, when it became clear that financial instruments were becoming more complex – and risky – and existing accounting for them had not kept pace. Current U.S. GAAP requires different measurement techniques depending on the form of the financial asset or liability, with critics saying this leads to economically similar transactions being accounted for in different ways. The lack of consistency leads to confusion and complexity for investors and analysts.

In February 2013, 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, which set out to overhaul the accounting for financial instruments by classifying instruments into three measurement categories. The proposal largely was aligned with the IASB’s proposed amendments to IFRS 9, Financial Instruments .

Under the two proposals, the classification and measurement of an asset would be based on two factors: its cash flows and the business model in which the asset was held, as opposed to its legal form, such as loan or security. Depending on the assessment, the asset would be measured at fair value or amortized cost. Most simple loans, defined as assets comprised solely of payments of principal and interest that are held to collect payments, would be measured at cost.

But the FASB faced significant pushback in the U.S., plus its members said they realized that the proposed changes would not reduce complexity or improve financial reporting. The IASB also said it was unwilling to change its guidance on the classification and measurement of liabilities. By early 2014, the FASB retrenched, saying it wanted to make “targeted improvements” to U.S. GAAP as opposed to a wholesale change.

While the board did not make significant changes to the classification and measurement guidances for investments in loans and debt securities, investments in equity instruments will have to be measured at fair value.

Throughout the discussions, almost all FASB members acknowledged that the expected final update will retain the complexity that bogs down existing accounting standards – several ways to account for financial assets and liabilities, complicated guidance for embedded derivatives, and measurement differences between loans and debt securities with similar characteristics. Furthermore, U.S. GAAP will not match the guidance in IFRS.

FASB members repeated those disappointments on November 11.

“The objective of this project when we put it on, was to reduce complexity and to converge — and we’ve done neither,” Linsmeier said. “The number of models we have for similar instruments exceeds 10 different models. I don’t see that as a reduction of complexity, and we certainly didn’t converge.”

FASB Chairman Russell Golden said he acknowledged that the final outcome was not going to be as dramatic as many envisioned, but it was still good enough to proceed.

“I do think it’s sufficient improvement to move forward,” Golden said.

Businesses will not be able to adopt the entire forthcoming standard ahead of the effective date, but the board agreed that they could adopt two provisions early.

Businesses will be able to stop including the counterintuitive measurement of changes in the value of their “own” credit risk in earnings, instead recording changes in other comprehensive income. During the crisis, struggling companies recorded gains in earnings when the value of their debt dropped because their creditworthiness declined.

In addition, private companies would not have to include fair value disclosures for financial instruments not recognized at fair value.

For in-depth analysis of the FASB’s work on its planned standard for the classification and measurement of financial instruments, please see – – Catalyst: GAAP Critical Issues — Classification and Measurement, also on Checkpoint.

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