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Planned Financial Instruments Standard Moves Ahead Despite Dissent

The FASB’s long-running effort to improve the classification and measurement of financial assets and liabilities is coming to an end. But the final result may not yield much change from current U.S. GAAP. A divided board agreed to move the project forward, but many board members expressed disappointment with the outcome of the project.

A divided FASB on January 14, 2014, gave its staff permission to wrap up a project that was undertaken to help analysts, regulators, and investors get a clearer picture about the increasingly complex and risky financial instruments banks and other financial institutions hold on their books.

Even though four of the seven board members agreed to let the drafting of a new accounting standard proceed, almost every member expressed reservations about some part of the project or said it fell short of what the standard-setter originally intended when it started tackling how best to classify and measure financial instruments.

FASB member Lawrence Smith, who voted in favor of the project proceeding, criticized the standard-setting process itself.

“Once we issue this document… we need to do some internal inspection to see what happened,” Smith said. “Because it was a fairly ugly journey, quite frankly.”

The FASB in February 2013 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. It was considered the centerpiece of the FASB’s effort to converge with the IASB on accounting for products that came under increased scrutiny in the wake of the 2008 financial crisis.

After intense criticism from banks and auditors that the joint model was too complex to work, the FASB had a change of heart. The U.S. board announced later in 2013 that would make targeted improvements to U.S. GAAP instead of the sweeping changes that would be required to produce a converged international standard.

The FASB decided that all investments in equity securities, except those that qualify to be accounted for under the equity method, would be measured at fair value with changes recognized in net income. In addition, a business could measure an investment in an equity security without a readily determinable fair value at cost minus impairment.

Broker-dealers in securities subject to guidance in Topic 940, Brokers and Dealers, and investment companies subject to Topic 945, Investment Companies, would measure their securities according to their existing requirements in U.S. GAAP.

The FASB also decided that when a business uses fair value to measure a financial liability, it must present separately in other comprehensive income the portion of the value change caused by its own credit risk. The change responds to a complaint that banks can book gains for accounting purposes when the value of their debt declines despite the continued weakness in their business operations.

FASB Chairman Russell Golden said he disagreed with the decision to measure equity instruments at fair value because the costs didn’t justify the benefits, but he saw the changes to “own credit” as an improvement.

“The improvements of where you present remeasurement of your own debt is a substantial improvement and substantial benefit at little cost,” Golden said. “So in the package of decisions I would be supportive of moving forward and, as a whole, conclude the benefits that come from all of the decisions justify the costs.”

FASB members Marc Siegel, Thomas Linsmeier, and Harold Schroeder disagreed.

“This was a once-in-a-generation opportunity to really take a look at financial instrument accounting, as a whole,” Siegel said. “By sustaining current GAAP, we’re actually retaining costs that are in the system, particularly around keeping the focus around sales of assets that are held to maturity.”

Linsmeier said he would “vehemently” dissent from the publication of the final standard.

“We started this journey as saying how we account for financial instruments was too complex and that we wanted to have an objective to converge to help the world understand risk of these financial instruments. And we did neither in that regard,” Linsmeier said. “What we’ve got left for financial instruments… is 13 different measures for financial assets and liabilities inherent within this model, and that’s not including differences related to impairment.”

Schroeder said he backed the FASB and IASB’s original model when they first started working on it, but then the standard-setters started “chipping away at it.”

“And then I became very disenchanted,” Schroeder said.

The decision to largely stick with U.S. GAAP, however, pleases most banks, which were alarmed by the complexity of the FASB’s 2013 proposal.

The decision to require investments in equity securities to be measured at fair value also would not affect too many banks, said Michael Gullette, a vice president with the American Bankers Association. Insurance companies are more likely to have equity securities available for sale, he said.

Ultimately, most banks won’t see many changes in accounting, he said.

“That’s why they expressed they were disappointed,” Gullette said, referring to the dissenting board members.

“I think there was lot of lot of work for not a huge amount of change,” Gullette said.

Core deposit disclosure rules dropped from standard

In addition to giving its research staff permission to start drafting the final standard, the FASB on January 14 also decided not to require banks to disclose extra information about their deposits — a reversal of a November decision.

In November, some board members expressed concerns that there is no set, legal definition of a core deposit. Bank regulators generally interpret the term as including checking accounts, saving accounts, money market accounts, certificates of deposit, and some other types of accounts. The term is generally applied to deposits stemming from the bank’s main, stable customer base as opposed to short-term customers who open accounts for a special promotion or advertising campaign.

Commercial banks, which rely more heavily on core deposits to fund operations, are generally considered to have more reliable access to cash and other liquid assets than investment banks, which rely on the overnight markets that make use of purchases and loans of short-term instruments

The FASB wanted to require a breakdown of different types of deposit accounts and total balances as well as the weighted-average life of the core deposit liabilities based on the bank’s experience. Banks also would have had to give a description of what its management considers its core deposits.

“Is it going to be an absolutely perfect, precise number? No,” Linsmeier said. “But it gives far greater insight into the core risk of that institution than if we don’t give it.”

Linsmeier, Schroeder, and Siegel voted in favor of keeping the disclosure rules, but they were outnumbered.

Those in favor of removing the disclosures said they would be hard to compile, given the murkiness about how to define a core deposit. FASB Vice Chairman James Kroeker said some of the information was better placed in the Management’s Discussion & Analysis section of the financial statement, which is covered by SEC rules.

“I don’t think just because information is relevant it goes in a GAAP financial statement,” Kroeker said.

The board also voted to require new disclosures about for some derivatives that will be part of a separate proposal it plans to release in mid-February.

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