US standard-setter gives more detail on expected credit loss proposal

The US Financial Accounting Standards Board (FASB) is providing additional explanation of a proposal in one of its most challenging projects.

A 16-page FAQ document posted on FASB’s website Monday is designed to educate those interested in the standard the board is developing on expected credit losses in its financial instruments project.

The Proposed Accounting Standards Update (ASU), Financial Instruments—Credit Losses (Subtopic 825-15), was issued December 20th and has a comment period that ends April 30th. Before the Proposed ASU was issued, the project had become controversial because FASB and the International Accounting Standards Board (IASB) had decided on different expected credit loss proposals in the convergence project.

The IASB issued its proposal on March 7th, with a comment period ending July 5th. Although the boards have not ruled out the idea of convergence after the comment periods on their proposals end, some organisations are concerned that the process will not result in a single, global standard.

Comment letters from the Basel Committee on Banking Supervision and the International Banking Federation urge the boards to come to a converged solution. A majority of the 17 comment letters on the FASB site ask for an extension of the FASB comment deadline to allow organisations to comment on both proposals during the same time frame.

The document FASB posted Monday is an attempt to clarify questions FASB has received. It says that:

• The board believes the amortised cost measurement objective described in the proposal is consistent with the way an entity expects to realise cash flows from debt instruments. The objective is to reflect the present value of cash flows the entity expects to collect.
• FASB believes the effective interest rate is the best metric to use for recognising interest income because investors have indicated this to the board.
• The board seeks to faithfully represent expected credit losses and is not aiming for a particular size in the allowance for credit losses.
• Some are concerned that the IASB’s approach would fail to address concerns about delayed recognition of credit losses, at least in the United States, according to FASB.

Because losses on loans are viewed by some as partly responsible for the recent financial crisis, the boards are under pressure to come up with an appropriate and converged solution. The Financial Stability Board in October urged the boards to renew their efforts to converge.

When the IASB released its expected credit loss proposal, IASB Chairman Hans Hoogervorst stated his desire to move swiftly to finalise the project, consistent with the repeated requests of the G20.

Just a few of the comment letters FASB has received expressed opinions on its expected credit loss model, and most of those opinions were unfavourable. The Basel Committee’s letter expresses concerns about whether the standards being developed will result in the early and timely buildup of sufficient levels of credit allowances.

Credit Union of Southern California CFO Peter Putnam wrote that the ED violates the “matching principle” of accrual accounting because it requires expected future loan losses to be recorded immediately. Putnam wrote that requiring revenues to be recorded in the same period as expenses is a cornerstone of accrual accounting.

Anheuser-Busch Employees’ Credit Union CFO Ronald Kampwerth also wrote that the proposal violates the matching principle, and recommended withdrawing the proposal.

When the proposal was released, FASB Chairman Leslie Seidman told reporters that current US GAAP contains barriers to timely recognition. She said the proposal removes those barriers and requires that at any point in time, an entity will have an adequate allowance to absorb the losses that are expected.

“We want to make sure … that the amount on the balance sheet represents the present value of the cash flows that are expected to be collected,” Seidman said in December. “We think that this approach appropriately reflects the risk held by an entity at every reporting period.”

—Ken Tysiac (ktysiac@aicpa.org) is a CGMA Magazine senior editor.