The Financial Accounting Standards Board (FASB) on Nov. 19, 2018, proposed a package of clarifications and technical corrections covering three of the board’s most significant accounting updates in recent years.
The proposal covers several questions raised by banks and other businesses as they prepare to implement Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, (FASB ASC 326), and ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, (ASC 815). The proposal also attempts to answer questions from ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which public companies started following in 2018.
The FASB characterized the proposal as technical corrections and improvements as opposed to meaningful changes to any of the accounting standards. Comments are due by Dec. 19, 2018.
“Since issuing the financial instruments standards, the FASB staff has been working with stakeholders to obtain feedback and address questions on the guidance,” FASB Chairman Russell Golden said in a statement. “Through these interactions, the FASB identified areas of the guidance that require clarification and correction. The amendments in the proposed ASU would address those areas.”
The proposal offers 11 changes to the credit losses accounting standard.
The clarifications cover how to assess the allowance for credit losses on accrued interest receivable balances and how to account for the allowance when transferring debt securities between measurement categories. It also clarifies that a business should include recoveries when estimating future losses on loans.
In addition, it clarifies how to determine the effective interest rate (EIR) for variable rate loans; how to adjust the EIR for prepayment expectations; and the consideration of costs to sell when foreclosure becomes probable. The proposal also clarifies that reinsurance receivables are within the scope of FASB Accounting Standards Codification (ASC) 326-20, Financial Instruments—Credit Losses—Measured at Amortized Cost. In addition, the FASB proposed correcting a minor reference error in Paragraph FASB ASC 310-40-55-14, Receivables — Troubled Debt Restructurings by Creditors — Implementation Guidance and Illustrations — Example 2: Fair Value Less Cost to Sell Less Than the Seller’s Net Receivable, as well as update a cross-reference in the guidance for equity method losses.
The proposal also clarifies how businesses must disclose line-of-credit arrangements that convert to term loans. It also calls on businesses to consider extension and renewal options when determining the contractual term of a financial asset.
The questions the FASB is attempting to address in the Nov. 19, 2018, proposal are not related to requests from banks, lawmakers and trade groups to either tweak major parts of the standard or delay when companies must comply with it.
The credit losses accounting standard, considered the board’s chief response to the 2008 financial crisis, is expected to cause the biggest change to bank accounting in decades. It upends how banks calculate losses on souring loans and other financial products, requiring them to look to the future and make estimates of expected losses when calculating their loan loss reserves. The new accounting method, which starts going into effect in 2020 for large, publicly traded banks, reverses current generally accepted accounting principles (GAAP), which requires banks to only consider losses when they are “probable,” which in practice has meant long after customers stop making payments.
Because the new credit losses accounting standard will usher in such significant changes, the FASB has been trying to stay abreast of questions from accountants, auditors and regulators on how businesses should interpret the rules and calculate their credit losses. The board convened a special panel called a transition resource group to field questions. Some of the questions in the Nov. 19, 2018, proposal originated from the special panel.
On hedge accounting, the proposal calls for eight updates to the FASB’s August 2017 update to GAAP. The update, which goes into effect in 2019 for public companies, attempts to simplify some aspects of hedge accounting and make the specialized, favorable accounting treatment easier to attain. Businesses largely have welcomed the FASB’s updates to hedge accounting.
The clarifications address: how to handle partial-term fair value hedges of both interest rate risk and foreign exchange risk; the amortization of fair value hedge basis adjustments; disclosure of fair value hedge basis adjustments; and consideration of the hedged contractually specified interest rate under what the accounting guidance calls the hypothetical derivative method. In addition, the FASB plans to make some transition provisions clearer, clarify two narrow application questions for not-for-profit organizations and specify how to apply a “first of” cash flow hedging technique to overall cash flows on a group of variable interest payments.
The classification and measurement accounting standard is considered less of a change for banks and other businesses. It attempts to lay out broad principles for businesses to determine how to classify and measure certain types of assets and liabilities, a move the FASB said was necessary after the financial crisis revealed that financial products had become more complex and existing classification and measurement models had not kept up with them.
The proposal addresses four questions about the accounting standard. It attempts to clarify how to apply ASC 820, Fair Value Measurement, to an alternative measurement technique in the classification and measurement standard. It also clarifies that private companies do not have to disclose the fair value of financial instruments they hold to maturity and measure at amortized cost, and states that health and welfare plans are excluded from the scope of the standard. In addition, the proposal attempts to answer questions about whether equity securities without readily determinable fair values measured in accordance with the measurement alternative should continue to be remeasured at historical exchange rates.
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