14 February 2013

FASB proposes improvements to recognition and measurement of financial assets and liabilities

The FASB developed Proposed Accounting Standards Update, 'Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities', as part of its broader joint project with the IASB to improve and converge the accounting for financial instruments.

Under the proposal, the classification and measurement of a financial asset would be based on the asset’s cash flow characteristics and the entity’s business model for managing the asset, rather than on its legal form, that is, whether the asset is a loan or a security. Based on this assessment, financial assets would be classified into one of three categories:

• Amortised Cost–financial assets comprised solely of payments of principal and interest that are held for the collection of contractual cash flows
• Fair Value through Other Comprehensive Income (OCI)–financial assets comprised solely of payments of principal and interest that are both held for the collection of contractual cash flows and for sale
• Fair Value through Net Income–financial assets that do not qualify for measurement at either amortised cost or fair value through other comprehensive income.

All equity investments (excluding those accounted for under the equity method of accounting) would be measured at fair value with changes in fair value recognised in net income, because such investments do not have payments of principal and interest. The proposal also provides a practicability exception to measurement at fair value for equity investments without readily determinable fair values.

The proposal would also require financial liabilities to generally be carried at cost, unless the reporting organisation’s business strategy is to subsequently transact at fair value or the obligation results from a short sale. The proposal would retain the embedded derivative requirements for hybrid financial liabilities.

For financial assets and financial liabilities measured at amortised cost, public companies also would be required to disclose their fair values parenthetically on the face of the balance sheet (except for receivables and payables due in less than a year and demand deposit liabilities). Non-public entities would not be required to disclose such fair value information either parenthetically or in the notes.

In May 2010, the FASB issued its first Exposure Draft on financial instruments, which proposed a much greater use of fair value measurement for financial assets and liabilities than exists in current US GAAP. Through its extensive outreach on that proposal, the FASB learned that a significant majority of investors, reporting entities, and other stakeholders do not believe that fair value information is of primary relevance for some financial instruments, particularly loans, deposits, and financial liabilities. Based on that feedback, in the proposed Update, the Board decided to require amortised cost as a measurement attribute for assets held for collection of cash flows, because the value is realised over the holding period of the asset. Assets that might be sold to manage interest rate risk or liquidity risk would not qualify for cost measurement. In addition, the Board also decided that financial liabilities would generally be measured at amortised costs unless certain conditions are met.

The proposed accounting for expected credit losses on debt instruments carried at amortised cost or fair value through OCI is addressed in the FASB’s proposed Accounting Standards Update on credit losses, which was issued in December 2012. Stakeholders are encouraged to consider both of these proposals concurrently.

In January 2012, the FASB and the IASB decided to jointly redeliberate selected aspects of their classification and measurement models in an attempt to reduce differences in several important areas. In November 2012, the IASB issued its proposed amendments to IFRS 9 'Financial Instruments', which, like the FASB’s proposed Update, would require an entity to classify and subsequently measure financial assets based on the results of cash flow characteristics and business model assessments. A brief comparison of the proposals is included in the proposed Update.

Press release

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