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GAAP’s Status Quo for Loans and Securities Outlasts Attempt to Change It

March 13, 2014

The FASB is prepared to keep intact U.S. GAAP for determining how to categorize and measure loans and debt securities. The board’s decision was spurred by an earlier move to abandon years of work with the IASB to develop a converged, global plan to promote the consistent measurement of financial instruments.

The FASB on March 12, 2014, continued to retreat from its February 2013 proposal to overhaul the classification and measurement of financial instruments and decided to retain existing, separate accounting treatment for loans and debt securities.

If the board finalizes its decision, loans would continue to be considered either held for investment and measured at amortized cost, or held for sale and measured at either cost or fair value, whichever is lower.

Debt securities would be categorized as either trading, available for sale, or held to maturity. Securities for trade would be measured at fair value with changes recorded in net income, those for sale would be measured at fair value with changes in other comprehensive income, and those held to maturity would be measured at amortized cost.

The FASB’s 2013 proposal, released via Proposed Accounting Standards Update (ASU) No. 2013-220, Financial Instruments—Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities, would have eliminated the separate pieces of guidance and instead required banks and other financial businesses to consider the cash flows of the financial product plus the business model in which it is held to determine whether to measure it at amortized cost or fair value.

Many businesses, auditors, and investors told the FASB that a single method made sense because it would simplify current U.S. GAAP and ensure consistent accounting for similar financial instruments that would not be based on the instruments’ legal form. Many more critics, however, said the costs would outweigh the benefits, FASB project manager Rahul Gupta told the board.

A majority of the FASB agreed with this assessment but said they wanted more disclosures to give investors and analysts a better idea about these transactions. The FASB also agreed that equity investments would be measured at fair value with changes recorded in net income. Board members would like to finalize the rules for the extra disclosure requirements by the end of the year.

FASB member Marc Siegel characterized it as the only option after several years of debate and two rounds of proposals that received harsh feedback from the public.

“When in our 2010 ED [proposal] we said fair value is the benchmark for all assets, we heard, ‘Well, we don’t sell loans frequently, so therefore we don’t want fair value’,” Siegel said. “When we said cost with restrictions, we heard, ‘Well we sell frequently.’ It just feels like we’ve been through that.”

Keeping current U.S. GAAP but requiring added disclosures about sales would represent an improvement, he said. He described requiring new disclosures as “critical” to adding transparency to current accounting.

“At least you start to get a sense of what the sales volumes are,” he said. “I’m not sure we’re going to get disaggregation and the granularity enough to fully understand that. But that’s what I’m sort of hanging my hat on.”

The March 12 decision was spurred by the FASB’s December move to abandon years of work with the IASB to develop a converged, global plan to promote the consistent measurement of financial instruments. The project had taken on heightened significance after the 2008 financial crisis, when it was revealed that financial products had become more complex, but the accounting had not kept pace with the changes.

The IASB released its proposal in November 2012 via Exposure Draft (ED) No. 2012-4, Classification and Measurement: Limited Amendments to IFRS 9 (Proposed amendments to IFRS 9-2010), and the FASB released its proposal in February 2013. The boards were on track to produce a largely converged, joint accounting standard but the FASB—and U.S. banks—raised concerns about complexity and said the new model would not work.

In January, the FASB asked its research staff to analyze whether it should make targeted improvements to existing U.S. GAAP for the classification and measurement of loans and securities. One of the solutions discussed in January 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.

The board also wanted to know whether it could improve current U.S. GAAP for reclassification between categories for loans and debt securities and fine-tune the accounting for sales from the held-to-maturity category for debt securities and the held-for-investment category for loans.

The FASB research staff said it didn’t identify significant improvements that could be made, but it offered the board three choices.

The first would have created one model for loans and debt securities, with unrestricted reclassification and unrestricted sales out of the category of assets that are considered “held to maturity.” This option would have required more disclosures about reclassifications out of the measurement category. It also would have required that equity investments be measured at fair value through net income.

Only FASB member Harold Schroeder supported this alternative, saying it would give accountants flexibility, but it would also give investors important information via footnote disclosures.

The choice “is a blanket option to put anything you want at cost and anything you want at fair value,” FASB Chairman Russell Golden said. “I might as well say, ‘You can do whatever you want.'”

After that, the board had to choose between keeping current U.S. GAAP, with some tweaks, or requiring one model for loans and debt securities, with restrictions on reclassifications and sales out of the held-to-maturity category.

No board member said the third option—which called for restrictions on reclassifications and sales—would be practical, and FASB members concluded that their only remaining choice was to continue with existing U.S. GAAP.

“Part and parcel with my support of [the option] would be greater transparency around any sales of loans and reclassifcations of loans to held-for-sale so you could really see volume of sales,” FASB member Lawrence Smith said.

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