• Discussed at June 2009 IASB Meeting (jump to notes below)
• Discussed at September 2009 IASB Meeting (jump to notes below)
• Discussed at Special 22 September 2009 IASB Meeting (jump to notes below)
• Discussed at Special 29 September 2009 IASB Meeting (jump to notes below)
• Discussed at Special 6 October 2009 IASB Meeting (jump to notes below)
• Discussed at Special 15 October 2009 IASB Meeting (jump to notes below)
• Exposure Draft issued 5 November 2009
  Click for More Information
• 30 June 2010 Deadline for comments on the ED
• November 2009 Expert Advisory Panel formed. Click for Information.
• April 2010 User Questionnaire
• Discussed at July 2010 IASB Meeting (jump to notes below)
• Discussed at Special 3 August 2010 IASB Meeting (jump to notes below)
• Discussed at Special 24 August 2010 IASB Meeting (jump to notes below)
• Discussed at September 2010 IASB Meeting (jump to notes below)
• Discussed at Special 5 October 2010 IASB Meeting (jump to notes below)
• Discussed at October 2010 IASB Meeting (jump to notes below)
• Discussed at Special 10-12 November 2010 IASB Meeting (jump to notes below)
• Discussed at November 2010 IASB Meeting (jump to notes below)
• Discussed at Special 1 December 2010 IASB Meeting (jump to notes below)
• Discussed at Special 8 December 2010 IASB Meeting (jump to notes below)
• Discussed at December 2010 IASB Meeting (jump to notes below)
• Discussed at January 2011 IASB Meeting (jump to notes below)
• Supplement to Exposure Draft issued 31 January 2011
  Click for More Information
• Discussed at February 2011 IASB Meeting (jump to notes below)
• Discussed at March 2011 IASB and IASB-FASB Meetings (jump to notes below)
• Discussed at Special 29 March 2011 IASB Meeting (jump to notes below)
• Discussed at April 2011 IASB Meeting (jump to notes below)
• Discussed at May 2011 IASB Meeting (jump to notes below)
• Discussed at June 2011 IASB Meeting (jump to notes below)
• Discussed at July 2011 IASB Meeting (jump to notes below)
• August 2011: Deloitte survey finds support for impairment proposals (more information)
• Discussed at September 2011 IASB Meeting (jump to notes below)
• Discussed at October 2011 IASB Meeting (jump to notes below)
• Discussed at December 2011 IASB Meeting (jump to notes below)
• Discussed at January 2012 IASB Meeting (jump to notes below)

Timetable

• Click for IASB Project Timetable

IASB Project Insights

• A quick overview of this project is available on our IASB Project Insights page

Discussion at the June 2009 IASB Meeting - Impairment and Provisioning

Wednesday 17 June 2009 – Education Session by Bank of Spain (BdE) Representatives: the BdE Provisioning Model

Two representatives from the Bank of Spain (regulator of Spanish banks) presented the statistical provisioning approach which the BdE requires from entities regulated by them. The representatives explained that, in their opinion, the model incorporates losses incurred due to under-pricing of credit in times of boom in the lending cycle due to market over-optimism. The lending cycle per the model is closely correlated with the economic cycle as a whole.

The model is based on a statistical formula which incorporates an element of collective impairment relating to the point in the lending cycle ('alpha') and incurred losses relating to individual assets ('beta'). The alpha component is a collective assessment and applied to the change in the portfolio of assets at each date of assessment. Thus in times of boom in the lending cycle, the alpha component is high relative to the beta component, whereas this trend is reversed in times of slump as incurred losses relating to the general cycle are in effect transferred to individual assets; the alpha element can be negative, reflecting over-conservative pricing of credit. The representatives explained that they believe the advantage of the model is the early detection of credit losses.

The Bank has around 6 asset classes which it views as homogeneous, for each of which an alpha (effect on asset class of stage of the lending cycle) and beta (historical incurred losses relating to individual assets) are kept. In order to assess the lending cycle, the BdE holds data from the Spanish national credit register dating back to 1988 for each of the asset classes, which equates roughly to 2 full lending cycles. The representatives stressed that this is an incurred loss model as the inputs to the model are derived only from historic experience.

Board members asked questions around various aspects of the model. One member asked what approach the BdE takes for new products where there is little historic data. The representatives replied that this was not an issue that had caused much difficulty in Spanish banking given the relative absence of new products – for example, credit cards represented only around 1% of total lending in Spain. Another member pointed out that, for loans given out during periods of boom, the model effectively results in a large 'day 1'-type loss for lenders. The representatives replied that this was a necessary reflection of credit pricing in these times.

Another member asked whether BdE was aware of how much credit data other central banks held, and thus how practicable a system such as this would be for banks from other countries. The representatives replied that they were aware of some central banks holding extensive credit data; however it was unlikely that many would hold data in sufficient detail going back as far as 1988. Another board member asked whether, if an expected loss model were incorporated within IFRS, the bank would continue to use its model. The representatives replied that, in their opinion, it was possible to use the model to estimate expected losses, however it would be a relatively simple approach. The representatives agreed with board members' views that, were this model adopted more widely, more active involvement would be required from banking supervisors in assessing provisioning than is currently the case given the complex nature of the model and underlying data. The representatives put forward the view that, in times of economic difficulty such as the present time, banks would be less likely to voice the view that an approach such as their model would lead to competitive disadvantage. This had been their experience in Spain.

The chairman thanked the representatives for their presentation.

Friday 19 June 1009 – Description of Possible Alternative Features to the Exposure Draft Model

The Board discussed a proposal put forward by a Board member describing some additional features (variants) of the classification model developed by the Board. Under this variant:

• (a) Financial assets with basic loan features that are managed on a contractual yield basis would be measured at fair value in the balance sheet, unless they meet the definition of loans and receivables in IAS 39.
• (b) Such financial assets would:
  • (i) be measured on an amortised cost basis in profit or loss (including recognition of impairment using the incurred loss provision requirements in IAS 39); with
  • (ii) any difference between that amortised costs measure and the fair value change being recognised in other comprehensive income. There would be no recycling between OCI and profit and loss.

The effect of this proposal was that potentially more financial instruments would be measured at fair value on the balance sheet, but the value change would be allocated between profit and loss and other comprehensive income in the statement of comprehensive income.

Board members discussed this variant for a while, suggesting other possible variations. At least one member thought the variant as 'dead on arrival' and would not support it. Another Board member thought that it was unhelpful to mix the measurement of financial instruments between the statement of financial position and the statement of comprehensive income. If an item was reported on the statement of financial position at fair value, changes in that measure should be reported in profit and loss. A mixed allocation method, such as proposed with the amortised cost component being reported in profit and loss and the 'plug' between that amount and the value change being reported in other comprehensive income was likely to lead to problems and the Board developed other aspects of the revised financial instruments package.

In particular, some Board members were concerned about the consequences of this variant on hedge accounting, especially that the mixed allocation might add rather than reduce complexity in some situations. If hedging is designed to manage what is recognised in profit and loss, allocating some of the exposure being hedged to other comprehensive income would create challenges in hedge accounting, in particular assessing effectiveness.

While not commenting on its merits, the Board agreed that the variant should be discussed in the forthcoming exposure draft's Basis for Conclusions (as will all the alternatives considered in detail by the Board) and that comments should be invited on it.

Discussion at the September 2009 IASB Meeting

The Board was joined by FASB staff and FASB Board members via video link. The Board discussed the responses to the Request for Information published in July and next steps.

The main message from respondents to the Request for Information was that the expected loss approach would pose significant operational challenges (especially in the area of cash flow estimates and complexity of required calculations) and would entail substantial costs and lead time to implement. Views of constituents on other issues were generally mixed. Constituents requested some additional guidance and clarification on specific issues, but on the other hand requested more prescriptive requirements on portfolio assessment of impairment. Moreover, in their view, further simplification of the approach would be desirable in order to make the principles operational.

The FASB members noted that the FASB did not discuss the impairment issue yet, but the range of interpretation of what was meant by expected loss model was wide. Some constituents understand expected loss in Basel II sense or, alternatively, as a possibility to include losses due to worsening of the economic conditions. This difference in opinion and expectations could pose a challenge in the deliberation process.

Several Board members raised the issue of application of the model to trade receivables of non-financial entities. There was a high degree of consensus that these instruments should not be excluded from the model, but additional application guidance for trade receivables should be included to alleviate the concerns raised by the industry.

Some Board members expressed their concerns over timing of the project. Given estimated lead time (2-4 year after publication of the final standard in order to adjust the systems), some Board members preferred a more thorough discussion, perhaps in the form of issuance of DP rather than ED. Other Board members were concerned that the model is not sufficiently developed for issuance of the ED. They were particularly concerned that additional guidance would be developed only after the ED has been published. Nonetheless, other members pointed to the political environment and the clear need for new guidance that was already pledged by the Board. Moreover, they pointed that alternative views were already explored by the Board in June and July and expected loss model was identified as the way forward.

The Board decided to provide a clear objective and emphasise principles that would be reinforced by clear and concise application guidance. It was felt that providing a comprehensive guidance was impossible as it could not provide guidance for all the issues. Some members of the Board expressed their concerns that if insufficient guidance was provided regulators would step in and impose additional requirements.

The Board decided to establish an Expert Advisory Group on Impairment that would assess the need for development of further guidance. FASB will participate in such discussion. The Board also considered the need for further outreach to constituents perhaps in a way of roundtables as part of deliberations on the ED.

The Board reaffirmed its decision to require one single impairment model to all financial instruments measured at amortised cost. Therefore, it did not support any exception for trade receivables, instruments trade in active markets, or individually significant assets.

The Board then considered possible simplifications of calculations required. The Board did not approve the proposed usage of the straight-line method for measurement of expected losses on initial recognition, as opposed to the effective interest rate method. It was felt that the issue was too technical in nature and should be first assessed by the Expert Advisory Group.

The Board also noted that additional discussion on application of the principles on portfolio level should be included in the ED. Some Board members noted that the application guidance should include also guidance on how portfolios should be identified.

Discussion at the Special 22 September 2009 IASB Meeting

Possible issues to be addressed in the exposure draft by application guidance or clarification

The staff explained that the purpose of this discussion was to follow up on issues that came out from responses to the Board's Request for Information on their Expected Cash Flow approach (ECF). The staff's agenda paper sets out recommendations on what issues should be addressed by application guidance and clarification in the ED and also what issues should be explored by the Expert Advisory Panel (EAP) set up to deal with application issues of the ECF.

Board members asked about the role of the EAP and whether their remit would be restricted to the items set out in the agenda paper. The staff explained that the issues to be considered by the EAP had not yet been finalised and the list in the agenda paper was not an exhaustive list. The FASB who were in attendance by video link and other Board members questioned whether and when the output from the EAP would be incorporated in the final standard on impairment.

The staff explained that the EAP will be working alongside the issuance of the ED and their role will be to advise the Board on the type, nature, and extent of application guidance to be included in the final standard. The EAP would also help facilitate field testing of the proposals.

The Board agreed with each of the following staff recommendations:

1. To provide principles based guidance in the ED that focuses on two aspects of portfolios based versus individual estimates: (a) using the approach that provides the best estimate and (b) ensuring that if entities switch between approaches, that does not result in double counting.
2. Regarding estimation of cash flows, that the ED provide concise application guidance on how to source and adjust historical data drawing on existing guidance in IAS 39.AG89 and charging the EAP with analysing the remaining issues related to cash flow estimates that respondents to the RFI raised.
3. To provide application guidance for trade receivables in the ED without illustrative examples.
4. Rather than provide further application guidance in the ED, the EAP should be charged with addressing process driven implementation issues related to the ECF approach.
5. To include in the ED clarifications regarding point-in-time versus through the cycle estimates, expected value versus most probable value and the use of entity specific versus market date and addressing the differences of fair value (to amortised cost based on ECF) in the basis for conclusions.

Transition

In this session the staff presented their paper considering three potential approaches to transition for new impairment rules based on ECF. These three include:

• Option 1: Retrospective application to all financial instruments
• Option 2: Prospective application to only new financial instruments with initial recognition on or after adoption of the ECF approach and grandfathering the old rules for existing financial instruments.
• Option 3: A customised transition approach that combines prospective application for new financial instruments where initial recognition is on or after adoption of the ECF approach with either (a) retrospective application or (b) a change in measurement (involving discounting revised expected cash flows by the original EIR, and recognising the adjustment to opening reserves) for financial instruments recognised before adoption of the new standard.

Board members discussed these options and generally agreed that Options 1 and 2 were not appropriate. Instead Option 3 seemed the most appropriate, however, there were concerns about the retention of the existing EIR for certain financial instruments initially recognised before adoption of the new standard for which full retrospective application was not elected. The concern was that this has the effect of reducing reserves and increasing interest income over the remaining life of the instrument as the original EIR under the existing incurred loss model would be higher than the EIR derived under the ECF approach.

Alternative EIRs that better represented the EIR under the ECF approach were suggested to solve the issue. However, it was acknowledged that such an EIR could be negative unless it was bound by a corridor (eg limit to between the risk free rate and the contractual rate). It was agreed that these alternatives would be considered by the staff as part of developing the customised transition approach further.

Discussion at the Special 29 September 2009 IASB Meeting

Transition and Effective Date

The staff presented two approaches to transition that are in addition to the approaches discussed at the 22 September 2009 Board Meeting:

• Effective interest rate (EIR) collar approach, which would involve determining on transition a new effective interest rate on the basis of the expected cash flows over the remaining life of the financial instrument that would be subject to a floor (the risk free interest rate) and a ceiling/cap (the contractual interest rate).
• EIR margin adjustment approach, whose objective was to determine an adjustment to the EIR under IAS 39 that resulted in an adjusted EIR that approximated the EIR that would have been determined under the expected cash flow approach.

The Board agreed that EIR collar approach would be too complex and challenging to implement. The Board was split between the customised transition approach discussed during the last meeting (that would lead to a reduction of reserves and increasing interest income over the remaining life of the instrument) and EIR margin adjustment approach (that would be more challenging to implement). The Board decided to include both approaches in the invitation to comment in the forthcoming ED.

The Board discussed the proposed effective date of the new standard (1 January 2014). The Board tentatively agreed to propose this date in the ED. The Board decided to propose that full comparative information should be provided. Some Board members noted that such a decision might delay the effective date even further. The Board decided that early application was to be allowed. Nonetheless, some Board members were concerned about comparability of the data across reporting entities given the long lead time until adoption.

Discussion at the Special IASB Meeting 6 October 2009

Guidance for variable interest rates

The Board decided to provide application guidance on variable rate instruments that requires a catch-up adjustment (a mechanism that is used to ensure that the carrying amount of a variable rate instrument unwinds to the remaining expected cash flows by an adjustment to profit or loss, which changes the carrying amount of the instrument).

Presentation and disclosures

The Board discussed in detail the requirements for presentation and disclosure resulting from the change to the expected losses model of impairment. Some Board members expressed their concerns that the proposed disclosures were overly burdensome and would be too complex and costly to implement. On the other hand, the majority of Board members thought that the disclosures were necessary for the decision-usefulness of the financial statements.

The Board decided to require the following disclosures:

1. interest revenue based on contractual cash flows, adjustment for allocation of initial expected losses and changes in expectations of expected losses on the face of statement of comprehensive income
2. reconciliation of the provision account for credit losses by class of financial instruments
3. vintage information of financial assets held at amortised cost
4. loss triangle in table format and qualitative information in case of significant changes in loss estimates
5. disaggregation of the change in expectations of expected losses
6. management's assumptions and methodology in determining expected losses
7. high level 'sensitivity analysis' on key assumptions and effect of using reasonably possible alternatives
8. stress testing information if management performed stress testing for the internal risk management purposes
9. reconciliation of non-performing financial assets held at amortised cost
10. additional disclosures on transition from incurred loss model to expected loss model

The most significant discussion of disclosures focussed on the requirement to provide information on stress testing (#8 above). Some Board members felt that such disclosures are not appropriate as they would reduce comparability (not all entities would perform stress testing) and would not provide useful information (boilerplate disclosures). Other Board members disagreed. They argued that merely disclosing that the entity performed stress testing was potentially useful. Moreover, most of financial intermediaries may be required to perform stress-testing by the regulators.

Some discussion was directed also to the vintage and loss triangle disclosures (#3 and #4 above). Some Board members felt that those disclosures were not cost beneficial, and on an aggregate level as proposed would not provide the intended information. They pointed out that practices in risk management might differ among entities, and thus the quality of the portfolio was very much influenced not only by the date when the financial instruments were originated but also by the type and quality of an entity's risk management practices. Most Board members disagreed. They noted that these data should be available to any institution as they are based on contractual cash flows and are necessary to assess the risk profile of any portfolio for internal risk management purposes.

Interaction with other IFRSs (IAS 28 and IFRS 4)

The Board considered the consequential amendments to IAS 28 and IFRS 4 resulting from the change of the impairment model.

The Board decided to use the impairment indicators in IAS 36 to determine whether additional impairment testing was required for an investment in associate. The Board considered this approach appropriate, as the amount of impairment loss is measured in accordance with IAS 36 under current IAS 28 requirements.

The Board also agreed to retain the existing requirement for reinsurance assets in IFRS 4 as it felt that eliminating the loss event guidance in IAS 39 would not result in a change in accounting policies for entities applying IFRS 4 to reinsurance assets.

Comment period

The Board briefly discussed the expected comment period. The staff re-affirmed the intention to publish the Impairment ED in October. The staff proposed an extended 180-day comment period for the ED so the Expert Advisory Panel would have a sufficient time to finalise its application guidance for re-deliberations. Some Board members proposed an even longer comment period (9 months). The Board agreed that an extended comment period is desirable given the complex nature of the proposal but deferred a final decision on the comment period to a future Board meeting.

Discussion at the Special IASB Meeting 15 October 2009

Drafting of the exposure draft and comment period

The staff introduced the session by summarising tentative decisions made by the Board. The Board authorised the staff to proceed with drafting the exposure draft (ED). On formal vote, one Board member indicated he would dissent from publishing of the ED as he did not agree with the proposed approach.

The Board agreed to extend the comment period of the ED to 8 months to allow sufficient time for the Expert Advisory Panel (EAP) to articulate its recommendations. This timeline would not endanger the agreed timetable to publish final IFRS in December 2010. The Chairman asked if it was more appropriate to have a shorter comment period and to allow the EAP to respond to the comment letters. The staff replied that it would not recommend such alternative as in that case the comment period would coincide with high reporting season. Moreover, staff stressed that extended comment period was also designed to allow constituents who usually do not comment on the Board's proposals to have sufficient time to express their views.

November 2009: IASB proposes to amend IAS 39 on impairment

On 5 November 2009, the IASB issued an exposure draft (ED) proposing to amend IAS 39 Financial Instruments: Recognition and Measurement to modify the way impairment losses are recognised on financial assets measured at amortised cost. This is one of the phases of the IASB's comprehensive project to replace IAS 39.

The existing incurred loss model

Currently, IAS 39 recognises impairment of financial assets using an 'incurred loss model'. An incurred loss model assumes that all loans will be repaid until evidence to the contrary (known as a loss or trigger event) is identified. Only at that point is the impaired loan (or portfolio of loans) written down to a lower value.

IASB's proposed expected loss model

The model proposed in the ED is an 'expected loss model'. Under that model, expected losses are recognised throughout the life of a loan or other financial asset measured at amortised cost, not just after a loss event has been identified. The expected loss model avoids what many see as a mismatch under the incurred loss model – front-loading of interest revenue (which includes an amount to cover the lender's expected loan loss) while the impairment loss is recognised only after a loss event occurs. Proponents of the expected loss model believe it better reflects the lending decision. Under the IASB's proposed expected loss model:

• Initial measurement. An entity determines the amortised cost carrying amount of a financial asset or portfolio of financial assets at initial recognition on the basis of the present value of future expected cash flows in considering expectations about future credit losses.

• Subsequent measurement. Subsequent to initial recognition the entity re-estimates the future expected cash flows and determines the present value. An impairment loss is therefore recognised only if there is an adverse change in expected cash flows, and a reversal of impairment losses is recognised if there is a favourable change in expected cash flows with any adjustment recognised in profit or loss. All measurements are made on the basis of present values, not market values. Extensive disclosure requirements would provide investors with an understanding of the loss estimates that an entity judges necessary.

Amortised cost is calculated based on the effective interest rate (EIR) method as present value of the expected cash flows over the remaining life of the financial instrument discounted at the EIR. Expected cash flows are estimates based on probability-weighted possible outcomes (that is, even if the most likely outcome is full repayment, the likelihood of the debtor not repaying all contractual principal and interest is also factored into the estimate). For a fixed rate financial instrument, the EIR is held constant over the life of the financial asset and does not change as market interest rates change. For a floating-rate financial instrument (such as a financial asset that pays LIBOR plus a fixed credit spread), the EIR is not a single, constant interest rate. Instead the IASB proposes that the EIR be determined by combining the spot interest rate curve for the benchmark interest rate (for example, LIBOR) and a derived initial effective spread. The IASB has published on its Website numerical examples accompanying the ED illustrating application of the mechanics of the EIR.

This expected loss approach will result in earlier loss recognition than the incurred loss model by taking into account future credit losses expected over the life of loans or other financial assets. Under this approach, an allowance for expected future losses is gradually built over the life of a financial asset by deducting a margin for future credit losses from gross interest revenue even if no losses have yet been incurred. This approach is based on the principle on which a lender would price a loan, that is, based on net yield after deducting a margin for expected credit losses.

The ED also proposes comprehensive presentation and disclosure requirements intended to enable users of the financial statements to evaluate the financial effects of interest revenues and expense and the quality of financial assets including credit risk.

Because of significant practical challenges in moving to an expected loss model, the IASB will establish an Expert Advisory Panel comprising experts in credit risk management to advise the board. Deadline for comments on the ED is 30 June 2010. Click for IASB Press Release (PDF 99k).

November 2009: Heads Up on IASB credit loss proposal

Deloitte United States has published a Heads Up Newsletter (PDF 172k) titled IASB Proposes New Approach to Accounting for Credit Losses. The newsletter discusses the IASB's recent exposure draft Financial Instruments: Amortised Cost and Impairment, which proposes a fundamentally new approach to accounting for credit losses to replace the existing 'incurred-loss' model. The proposed approach, which affects the recognition of both net interest revenue and credit impairment, is designed to result in earlier loss recognition by taking into account future credit losses expected over the life of loans or other financial assets (an 'expected-loss' approach).

November 2009: Expert Advisory Panel on Impairment of Financial Instruments Measured at Amortised Cost

In November 2009, when it issued an Exposure Draft on Impairment of Financial Instruments Measured at Amortised Cost, the IASB announced that because of significant practical challenges in moving to an expected loss model, the IASB will establish an Expert Advisory Panel comprising experts in credit risk management to advise the board. Click for list of Advisory Panel Members (PDF 18k).

April 2010: User views sought on impairment of financial assets

On 27 April 2009 the IASB published a questionnaire seeking input from users of financial statements on the proposals in its November 2009 Exposure Draft on recognition and measurement of impairment of financial assets carried at amortised cost. The exposure draft proposes to move from the 'incurred loss' model currently in IAS 39 to an 'expected loss' model (or, more precisely described, an 'expected cash flow' model). The feedback will assist the Board in its deliberations by helping it to better understand the views and preferences of investors and analysts. Two versions of the questionnaire are available:

• The abridged version has 15 questions and is in an easy-to-use survey format.
• The comprehensive version contains detailed examples and asks for comprehensive responses about the proposal.

Discussion at the July 2010 IASB Meeting

Comment Letter Analysis

The staff presented the Board with the analysis of comment letters on the Exposure draft ED/2009/12 Financial Instruments: Amortised Cost and Impairment. The Board did neither discuss the issues in detail nor did it take any decisions during this meeting. The Board will start the process of re-deliberations on one of the following meetings.

Based on the analysis, most constituents supported the move towards expected loss model for impairment. Nonetheless, some concerns were expressed over the possibilities for earnings management. Some Board members noted that a proposed disclosure package should alleviate these concerns. The Board also briefly discussed the concerns expressed over pro-cyclicality of the proposals and noted that accounting should provide a true and fair view of the situation at the year end and thus would reflect the effects of the cycle. In the view of some Board members that would not mean that the proposals are necessarily pro-cyclical.

Some constituents suggested that the wording of the ED is unclear whether the approach requires considering future expectations when estimating expected cash flows. The Board members noted that they do not see much difference between the objectives of the proposed IASB and FASB approaches. Nonetheless, they admitted that neither of the proposals is expressed clearly and thus the final guidance is likely to be in the middle between these proposals.

The constituents raised some concerns over operationality of the proposal and referred to the work of the EAP on Impairment in areas of open portfolios, lack of historical data, EIR calculation and tracking of losses and related requirement on maintaining of data.

Further concerns were expressed over the proposed catch-up adjustment (changes in estimates of expected losses to be recognised immediately in profit or loss), its consistency with the overall model as well operational challenges. The Boards also noted that concerns were expressed over the probability weighted average method for calculating expected losses (similar to concerns over probability weighted methods expressed in other projects, e.g. proposed revisions to IAS 37).

Finally, the staff noted that constituents expressed also concerns over the practical expedients, presentation and disclosure requirement that were perceived onerous and application of the proposals for non-financial institutions and non-interest bearing financial instruments.

Commenting on the due process, many constituents stated their concerns related to the status of the EAP work and the possibility to comment on the final standard arising from the EAP recommendations and Board re-deliberations.

Summary of work of the Expert Advisory Panel (EAP)s

The staff presented the Board with the summary of deliberations of the EAP prepared by the participating Board members and the staff. No decisions were taken at this meeting. The staff noted that the three most important issues for simplifications were:

• Use of estimated lifetime expected loss
• Decoupling of the contractual EIR calculation and expected losses calculation (e.g. by annuity approach or building block approach)
• Application of the guidance to open portfolios through using several possible approaches how to apply the guidance to 'good book' and 'bad book' portfolios.

Discussion at the Special 3 August 2010 IASB Meeting

Discussion on variations of an Expected Loss Approach

The staff presented the Board with a discussion of the variations of an Expected Loss Approach resulting from the received comments as well as output of the Expert Advisory Panel (EAP). The purpose of this session was orientation only. No decisions have been taken.

The staff presented the Board with a work-plan of issues related to variations of an expected loss approach that will be discussed over the following period. The discussion was meant to provide the Board members with overview of issues related to the Expected Loss Approach and its variations as well as interaction among specific features of the project.

The staff noted that constituents overwhelmingly confirmed the Expected Loss (EL) model over any alternative models (e.g. incurred loss as defined in IAS 39 or fair value approach). Also they noted that majority of constituents agreed with the model including Expected losses estimated over the lifetime of the product. The Board agreed with this overall direction.

The staff then continued to explore the need for the recognition threshold of expected losses. The staff noted that any such threshold would be inconsistent with the objective of the measurement method at amortised cost.

The Board then went on to discuss three major features of the expected loss approach: allocation of initial EL estimate, allocation of subsequent changes to EL estimate and the need for a floor for measurement of EL.

The staff provided overview of four different methods of allocation of initial EL estimate, ranging from the spread over the life using integrated calculation of effective interest rate (as proposed in the ED), two variants of such approach based on decoupling, as proposed by the EAP (spread over life using the annuity approach, spread evenly over average life) to allocating all initial EL in the first period. The staff noted that the last method would require a 'full catch-up' for the subsequent changes to EL estimate. The Board will discuss this issue in detail at a future meeting.

On allocation of subsequent changes to EL estimate, several alternatives were presented:

• full catch-up as proposed in the ED,
• 'partial catch-up' taking time-proportionate revised EL to date to the profit or loss, with the remaining spread over the remaining life (either by restating EIR considering the EIR over the life, or by spreading the unrecognised EL evenly over the remaining life), and
• no catch-up that would treat all subsequent changes prospectively.

The Board discussed the concept of 'Good book' and 'Bad book' as the distinction and precise definition may have an impact on the accounting result. The staff noted that 'Bad book' would require a full catch-up whereas 'Good book' could potentially qualify for other treatment. The Board will discuss this issue at a later stage.

The Board also discussed the implications of transfers between the 'Good book' and the 'Bad book'. The Boards asked the staff to provide a numerical example to compare the alternative of transfer of entire or proportionate balance of the allowance from the 'Good book' to the 'Bad book'. One Board member also noted that the definition of bad book would affect the transfer as well as inclusion or non-inclusion of IBNR provision. The staff noted that the definition of IBNR is not consistent (and does not necessarily equal the definition of IBNR losses in IAS 39).

Finally, the Board discussed the floor for measurement of EL, i.e. whether to apply a symmetrical model or an asymmetrical model (that would require floor in the allowance account that would cover all incurred losses). The Board noted that the need for the floor would result from the overall model.

The Board will discuss impairment issue at a following meeting.

Discussion at the Special 24 August 2010 IASB Meeting

User feedback summary

The staff presented the Board with a summary of feedback from outreach with users of financial statements. No decisions have been taken.

The staff noted that most of the feedback from users was consistent with the general feedback received (as discussed at the July Board meeting). In particular, most users supported the move towards an impairment approach based on expected losses but expressed concerns about its complexity and subjectivity. The main difference between the feedback from users and other constituents was the users� focus on disclosure requirements. Users argued that extensive disclosure might help to counterbalance subjective management judgement and provide useful information.

General approach for re-deliberations

The Board discussed the general approach for re-deliberations. The Board agreed that the re-deliberations should focus on open portfolios. The staff noted that any model that is applicable and operational for open portfolios would be applicable and operational for closed portfolios.

The Board also noted that it will deliberate the impairment approach jointly with the FASB once the FASB comment period on the FASB Accounting for Financial Instruments ED ends at the end of September 2010.

Objective and Approach

The Boards discussed the objective of amortised cost measurement. The staff noted that constituents supported the overall objective but some respondents felt that the objective should be modified to address impairment specifically. The staff noted that the Board would need to reconsider a separate objective if it decides to pursue decoupling of credit losses from the effective interest rate calculation. The Board agreed to consider the issue at that point.

The Board considered four alternative impairment approaches:

• Expected loss approach
• Modified incurred loss approach
• Fair value based approach
• Impairment approach based on IAS 36 Impairment of Assets

Based on the strong support of the expected loss approach to impairment, the Board agreed to pursue the expected loss approach.

The Board discussed the modified incurred loss approach based on IBNR provision. Most Board members felt that the modified incurred loss approach would be subjective and the link between specific events and specific outcome might prove to be elusive.

Scope of Expected Loss: Outlook period and conditions

The Board discussed the length of the outlook period and conditions to consider when determining an expected loss. The discussion focused on high-level issues related to the outlook period and did not focus on practical implications of how to measure expected loss or practical expedients that could be used. These topics would be discussed at one of the future Board meetings.

The Board confirmed the decision from the ED that the expected loss approach should be based on lifetime expected losses. Nonetheless, as one Board member noted, estimate of lifetime losses should not mean explicit forecasting but should allow using long term averages as practical expedients. As one Board member noted, the lifetime approach is consistent with other proposed Standards and was also supported by banking supervisors.

The Board then discussed the conditions when calculating expected loss. The FASB in its Accounting for Financial Instruments ED proposed to determine the expected loss based on past and existing conditions whereas the IASB proposed in the ED to consider all reasonable and supportable information and conditions.

One Board member noted that the difference between the IASB and FASB approach was not that large, and both could be adjusted through wording. In his view, the FASB did not intend to �freeze the situation� on current level and the IASB did not intend to allow �pick and choose� the information � e.g. by allowing using future information. He suggested to work with the FASB on a common ground in this area and to base the assessment on the best available information.

One Board member suggested that the information should be limited to the best estimate of conditions that market participants would consider in the assessment, but not market participant view of credit risk. Another Board member suggested that the consensus forecast should be input to the consideration. He noted that in his view the correct conditions and management consideration of future conditions relate to two different issues that would diverge especially when a market has developed a specific opinion on performance of a specific class of assets.

Finally, the Board tentatively agreed that all reasonable and supportable information and conditions should be considered in determination of expected losses. As one Board member noted, even if the IASB rejected the through-the-cycle impairment approach, long term average loss rates would be one of the inputs to calculation of lifetime expected losses. The IASB will discuss the conditions to consider in determining an expected loss together with the FASB to try to come to a converged solution.

Discussion at the September 2010 IASB Meeting

Treatment of initial expected losses (IASB Only)

The Board continued the re-deliberations of the ED Financial Instruments: Amortised Cost and Impairment in the context of the application of the expected loss model on open portfolios.

After a short discussion the Board agreed to finalise an approach that allocates initial expected loss estimates over the life of the portfolio. The Board argued that this approach is consistent with the economics of the contract as the expected loss is reflected in (and covered by) the margin on the instruments. The Board also noted that if an instrument would not be priced at fair value, adjustment would be required as all financial assets are recognised at fair value at inception under IFRS (e.g. adjustment for an interest-free loan). The Board rejected the approach that would require recognition of a day 1 loss.

The Board also agreed to continue with an approach that spreads initial expected loss estimates using a non-integrated effective interest rate (EIR) (i.e. decoupling � separate calculation of contractual EIR and expected losses). The Board noted that the integrated EIR approach would be difficult to implement in practice and the decoupling should facilitate the operational issues raised by constituents (consistently with the EAP conclusions). The staff noted that the method of decoupling will be discussed at a next IASB meeting in October.

The staff also noted that the decoupled approach would not solve all the operational issues related to expected loss model and its application for open portfolios and that treatment of re-estimation of expected loses will be subject of discussion at a later stage in the project.

Finally, the Board discussed the option to use integrated EIR approach if an entity has the data and resources to calculate expected loss through a single integrated approach. After a significant discussion, the Board decided to address this issue after the model is finalised as future decisions (e.g. re-estimation of expected loses) might have consequences on applicability of calculation of integrated EIR.

FASB/IASB Education Session

The IASB staff held an education session with the FASB and FASB staff to update them on the feedback received through the comment letter process and the Expert Advisory Panel (EAP). The information the IASB staff provided to the FASB was the same as that presented to the IASB during the 23 July 2010 Board meeting.

The staff summary of the comment letter feedback highlighted the following themes:

• there was strong support for movement towards an expected loss impairment approach
• the expected cash flow approach in the ED is too difficult to apply operationally
• certain measurement principles (e.g., use of probability weighted averages in the estimate of expected cash flows) are too prescriptive
• there is a lack of consideration for non-financial entities which have primarily non-interest bearing financial instruments
• the presentation and disclosure requirements are too onerous and voluminous
• the materiality consideration of the practical expedients negate the practicality and the expediency
• concern over lack of convergence, and
• desire to re-expose based on revisions to original proposals.

During the staff discussion of the results of the EAP , the staff noted that the three most important issues for simplifications were:

• use of estimated lifetime expected loss
• decoupling of the contractual EIR calculation and expected losses calculation (e.g. by annuity approach or building block approach)
• application of the guidance to open portfolios through using several possible approaches how to apply the guidance to 'good book' and 'bad book' portfolios.

The education session quickly turned its focus to the process for redeliberations taken by the two Boards. Certain FASB Board members were highly critical of the IASB's decision to proceed with redeliberations and decision making, including already reconsidering areas where the Boards had diverging proposals, while the FASB exposure draft on financial instruments (including impairment) remains in the open comment period through 30 September 2010. The FASB Board members mentioned they receive feedback from their constituents that this project is the most critical joint project in which to reach a converged standard and that the IASB making fundamental decisions on the impairment model without input from either the FASB or FASB constituents impedes their ability to reach a converged solution.

The education session then moved to a discussion by the two Boards in which a better understanding of certain differences was identified, such as a fundamental difference exists in the definition of amortised cost under IFRS and U.S. GAAP.

The IASB staff then presented the FASB with the decision tree being utilised in the IASB redeliberation process. In discussing how to proceed going forward, one IASB Board member expressed his feeling that the education session had been fruitful and hoped that such efforts could continue even while the FASB is assessing the feedback it receives through its exposure draft. However, the IASB plans to continue its deliberations without adjusting or delaying their planned timeline.

Discussion at the Special 5 October 2010 IASB Meeting

The Board held an educational session related to decoupling and allocation of subsequent revisions of expected losses and related mechanics of the calculation. As this was an educational session only, no decisions were made.

The Board considered 'decoupled' approaches to allocate expected loss estimates (linear and non-linear as well as based both on discounted and undiscounted amounts).

The Board also considered the mechanics of the catch-up adjustment – both related to partial catch-up (i.e. recognition of changes to estimates of expected losses to the extent that reflects its age) and no catch-up (i.e. recognition of changes to estimates of expected losses only over the current and future periods, with no consideration to the amount of time that has passed in the portfolio).

The Board focused its discussion mainly on the distinction between the good book and the bad book concepts as well as question when to transfer exposures between good book and bad book as well as how much to transfer between good book and bad book. For the Board this issue represented the accounting question when to recognise the full expected losses of the loan as from the discussion it became clear that the Board favours full catch-up for the bad book and partial or no catch-up method for the good book.

Several Board members posed the question how to define the moment when to transfer between the good book and the bad book and suggested a range of criteria, some of them similar to the IAS 39 loss event identification criteria. A few Board members expressed their concerns that additional clarity is needed when the transfer should be recorded as the business practice around bad book and good book is very vague. They argued that the actual management practice within the industry is not necessarily comparable. The staff clarified that the issue of distinguishing between good book and bad book will be subject of the main October Board meeting. Some Board members observed that the transfer between good book and bad book has a very significant effect on reported profit or loss and therefore should be verifiable. They also observed that these transfers created the largest volatility of the profit or loss in the illustrative examples discussed.

Some Board members expressed their concerns about the economic meaning of the reported numbers under the catch-up approaches. They noted that under the proposals in the exposure draft, the balance reported on the balance sheet was the present value of future expected cash flows, but as you move towards a partial or no catch-up model, it is more difficult to interpret what the amount reported in the balance sheet as well as the balance reported in the statement of comprehensive income represents. The Board asked the staff to provide additional analysis on the issue for the following meeting.

Finally, one Board member also asked the staff to consider in its analysis regulatory requirements related to reporting good book and bad book portfolios.

Discussion at the October 2010 IASB Meeting

The Board continued its discussions on the amortised cost and impairment project, specifically with regard to the recognition of subsequent changes in expected losses. At the 5 October 2010 Board meeting, the staff presented the Board with information about two possible alternatives for recognising subsequent changes in expected losses that could be operational in the context of open portfolios (the full catch up method proposed in the ED was criticised as not operational for open portfolios).

The first alternative is the time proportionate (or partial catch-up) approach which allocates a constantly updated estimate of expected losses over the total life of the portfolio with the amount recognised in the current period representing those expected losses that would have been recognised to date had they been included in the initial estimate. The second alternative is the single period allocation (or no catch-up) approach which would spread the subsequent changes in expected losses proportionately over the current and future periods.

During today's meeting, the staff provided information on what the amounts within the statement of financial position and within profit and loss represent under IAS 39, the full catch up approach in the ED, and the partial and no catch up approach alternatives. Amortised cost under the proposal in the ED represents the present value of all future expected cash flows. However, by addressing the operational limitations of the ED proposal, usage of either the partial catch up or the no catch up approach makes understanding the amount recognised in the statement of financial position more difficult (particularly for the no catch up method which also introduces a ceiling/floor concept for the loss allowance).

The Board generally struggled with the no-catch up approach primarily because of the difficulty in explaining what the amount recognised within the statement of financial position represented. The Board reaffirmed their support of the conceptual basis for amortised cost measurement in the ED but acknowledged that to address the operational issues for open portfolios, the partial catch-up approach would be the only alternative that somewhat maintained the principles within the ED.

The topic shifted to scope with one Board member expressing concern as to whether even the partial catch-up method could be applied by non-financial institutions. The staff responded that they are currently developing a model that would be operational for open portfolios (and therefore for closed portfolios as well). The Board could later consider whether the standard would impose further scope limitations to certain financial instruments (e.g., short term trade receivables) or certain types of entities (e.g., nonfinancial entities).

Some Board members raised the question of whether they should be considering two separate models, the partial catch-up approach for open portfolios and the full catch-up model (as proposed in the ED) for closed portfolios or individually significant items (e.g., leveraged buy-out loans). Another Board member mentioned that another alternative would be to retain the fundamental concepts contained within the ED and perhaps permit practical expedients for open portfolios by using a partial catch-up approach.

The Board made no definitive decisions, but did provide the staff with direction by eliminating the no-catch up approach from further consideration and concentrating their efforts between further development of the partial catch-up approach and reconsideration of the full catch-up approach from the exposure draft.

The Boards held an educational session on the feedback the FASB received from constituents regarding the proposed impairment and interest recognition guidance. The Boards also discussed the way forward in the project by examining various models that could be pursued. This was educational session only, no decisions have been made.

The FASB staff noted that the comment letters urged the Boards to work together and to develop a converged impairment model for financial assets. Constituents also strongly supported development of a single model for both loans and securities.

The outreach showed a strong support for elimination of probability threshold for recognition of impairment. Nonetheless most constituents disagreed with limiting the information considered for estimation of credit loss to current events (i.e. no forecasting of future situation) and noted that such limitation would be inconsistent with pricing of the loans. The FASB noted that it received mixed feedback on timing of recognition of credit losses – some constituents supported upfront recognition of credit losses, others supported spreading the losses over the life of the instruments.

Finally, most constituents urged the FASB to simplify the guidance for accounting for purchased assets and retained guidance on income recognition. In general, constituents urged the Board to provide practical expedients and address operational issue in its model.

The FASB noted that the feedback on its proposal received on public roundtables was consistent with the summary of comment letters.

The FASB staff provided an overview of the four significant questions that need to be addressed by the Boards and permutation of impairment models that flow from answers to these questions:

• Information considered for credit loss estimates (no forecasts, forecasts for foreseeable future, forecasts for the remaining life of the instrument)
• Time horizon for the loss estimates (expected loss over the life of the instrument, expected loss over a shorter period)
• Timing of recognition of credit losses (upfront recognition, spread recognition, distinction between the good book and bad book), and,
• Presentation of yield on the face of the performance statement.

The Boards discussed these four issues and their permutations. They noted that presentation of yield would be probably the least controversial issue and can be addressed separately. Some Board members noted that the presentation of yield would be important as decoupling could potentially lead to different objective of amortised cost measurement than effective yield.

The Boards discussed the information that should be considered for loss estimates. The Boards concluded that in practice the options of considering foreseeable future or the life of the instrument would be similar as in practice estimate of losses over the life of the instrument would be based on forecasts over foreseeable future period (as expectations over one to two years out are fairly unreliable).

The Boards then considered the timing of recognition of credit losses and acknowledged that this would be their biggest hurdle in reaching a converged standard. The preliminary views of the Boards diverged on this issue. Each Board leaned to their respective approaches in their exposure drafts with the FASB members gravitating towards upfront recognition of credit losses, whereas the IASB members preferred spreading the losses over the life of the instrument. When defining the objective of the model, the FASB focused on the principal amount not collected, whereas the IASB focussed on the present value of the future cash flows. The FASB noted that the IASB model, despite proposed practical expedients would be very difficult to apply and noted the operation difficulties in distinguishing between the good book and bad book on a portfolio level.

The Boards noted that these issues should be deliberated jointly and asked the staff of both Boards to consider the issues as well as ways forward. The Boards will discuss the way forward as well as good book – bad book distinction at the November joint meeting. The IASB Chairman noted that the Boards should try to develop a common model for the impairment model or in case of divergence in opinions present alternatives that could be submitted to constituents for comments.

Discussion at the Special 10-12 November 2010 IASB Meeting

Information to Consider in Developing the Estimate of Expected Losses

The IASB's exposure draft required the use of expected cash flows which inherently includes the use of future conditions while the FASB's exposure draft explicitly prohibited consideration of future conditions. Both Boards have received feedback on their proposals through the comment letter process. Comments on the FASB's proposal included that the prohibition from consideration of future conditions was too restrictive, inconsistent with credit risk management processes and would limit decision useful information for investors. Comments on the IASB's proposal included that the guidance was too vague and could result in inconsistent application in the development of expected losses.

Both Boards tentatively agreed that as part of the development of the expected loss estimate, an entity should use current information and expectations of future conditions (this reaffirmed the IASB's previous tentative decision made at its 24 August 2010 meeting and changed the FASB's position within its exposure draft). The Board discussed providing additional guidance on the application of the expectations of future conditions such as:

• not providing specific guidance as to the forecasting period,
• the expectation would be based on reasonable and supportable estimates,
• the expectation would be based on currently available information, and
• the expectation would be consistent with the risk management process.

A couple of IASB Board members were hesitant on providing additional proscriptive guidance outside of the parameters mentioned above as they felt that sufficient guidance exists for discounted cash flow estimates and that additional information could raise more questions than it answers. However, the Acting Chair of the FASB mentioned that she agreed that sufficient guidance exists for discounted cash flow estimates for a single loan but additional guidance may be required to apply in the context of an open portfolio.

Period Used to Estimate Expected Losses

Both Boards' exposure drafts proposed that an entity would estimate expected losses over the life of the instrument.

Some comment letter respondents suggested that a shorter period for estimating expected losses as they feel that estimates made outside of a short-term period are much less precise, more subjective and therefore introduce volatility into profit and loss when the changes in estimates are immediately recognised in profit and loss.

However, the staff of both the IASB and FASB believes that in order to faithfully represent the economics of the transaction, the estimates would have to consider the entire life of the instrument rather than a shorter period. Additionally, establishing a threshold for what period constitutes "short-term" would inevitably be arbitrary.

The Acting Chair of the FASB mentioned she supported developing the expected loss estimate over the life of the instrument but questioned whether this decision would impact the period over when those expected losses would be recognised.

The discussion moved to the topic of what the estimate of expected losses should include, the principal amount outstanding or all the expected cash flows (i.e., principal and interest). The IASB Board members tended to support consideration all expected cash flows while the FASB Board members tended to support a principal only view. The staff mentioned that this would have to be discussed at a future meeting and requested the Board to focus on the specific question at hand.

Both Boards tentatively agreed that the expected losses would be developed considering the entire life of the instrument (this reaffirmed the position of both Board's exposure draft as well as the IASB's previous tentative decision made at its 24 August 2010 meeting).

Recognition of Initial Expected Losses

On Wednesday, 10 November, the Boards began the discussion on when and how to recognise the initial expected losses.

The IASB's exposure draft proposed that the initial expected losses would be recognised as part of the effective interest rate of the instrument so that the bad debt allowance is built systematically over the life of the instrument. During subsequent deliberations, the IASB has tentatively agreed to decouple the contractual interest revenue from the expected credit losses but continue recognising initial losses over the life of the instrument.

The FASB's exposure draft proposed that the initial expected losses would be recognised immediately so that the bad debt allowance reflected those losses expected to be incurred in the future.

The Acting Chair of the FASB mentioned a third alternative for consideration that represented a middle ground between the two Boards' proposals. While not formally developed, the model would essentially recognise the expected losses over the expected loss period so that asset classes where losses occur early in the life cycle would be recognised over that period, rather than on day 1 as under the FASB proposal or over the life as under the IASB proposal.

The Boards discussed the pros and cons of the three alternatives under consideration but made no decisions. The discussions on the recognition of initial expected losses will continue throughout the remainder of the week.

On Thursday, 11 November, the IASB and FASB continued their deliberations on impairment recognition for financial instruments focusing on the method over which to recognise initial estimates of expected losses.

The meeting began by both Boards re-emphasising the objectives of their impairment models as contained within their respective exposure drafts. The IASB staff stated that their objective focused on the measurement of amortised cost and providing information about the effective return of an asset including an expectation of credit losses. So while earlier recognition of credit losses as compared to existing IFRS was a part of the objective, it was not the sole objective. The FASB staff stated that their objective focused on the sufficiency of the allowance reserve covering expected credit losses.

The Boards then began a discussion of the respective feedback they have received from financial statement users. The FASB staff mentioned they talked to over 100 different investor groups and that they generally wanted the recorded allowance to cover the expected losses over at least the near future (2-3 years), lessen the procyclical effect of overreserving during downward economic cycles and did not support an integrated effective interest rate for either presentation or recognition purposes. The IASB staff said that based on their user outreach, which included a meeting last week with the Analyst Representative Group, users appreciated having the information necessary to calculate the net interest margin and liked the disclosure packages contained within the IASB exposure draft, in particular the loss triangle information which provided trend information resulting from vintage tracking. One IASB Board member mentioned that the Analyst Representative Group was generally supportive of allocation recognition and that the ITAC representative (FASB standing analyst committee) was the only one of the group that preferred immediate recognition.

The Boards then began discussing the various models to consider including allocation over the life recognition (IASB ED approach), the immediate recognition (FASB ED), the allocation over the expected loss period which was first discussed at Wednesday's meeting and a fourth alternative mentioned by the Acting Chair of the FASB of recognising the losses expected over the near term immediately (e.g., using a three year rolling expected loss approach).

Similar to the discussion on Wednesday, the Boards generally supported their respective models and raised concerns with the model proposed by the other Board.

FASB Board members were primarily concerned that under the IASB model there would not be sufficient reserves provided for at the time the loss is incurred as a result of the allocation over the life of the loan and that it would result in procyclicality during economic downturns. Additionally, they felt the complexity added from an allocation approach was generally unnecessary as for many asset classes the average life of the loan is between 24 and 36 months so that the accounting differences between immediate recognition and allocation of expected losses was not significantly different from an income statement perspective.

IASB Board members were primarily concerned that an immediate recognition approach would not accurately portray the economics of the lending transactions as their model is fundamentally based on the expected credit losses being a component of the lending decision and that those credit losses are a part of the interest revenue recognition of the loan. IASB Board members also expressed concerns with the fourth alternative raised during the meeting of the immediate recognition of the near term forecast as whatever period is used for the forecast would inevitably be arbitrary.

One IASB Board member stated his support for further consideration of the alternative discussed yesterday of recognising the expected losses over the expected loss period when a loss pattern could be established (e.g., early in the loan life for auto loans). He felt that this approach retained some of the positives aspects of each Board's proposals and this could be a way to reach a common solution and he reiterated the importance of reaching convergence on this issue. Two other IASB Board members agreed with this view and at least three FASB Board members seemed open to further consideration of this approach. However, ten of the IASB Board members held firm on the allocation over the lifetime approach.

The two Boards discussed back testing the four models with actual loan data to better understand the results. However, the IASB Board members mentioned their model had already been tested as part of the Expert Advisory Panel discussions earlier this year. The IASB Chairman referred to the IASB continuing with their development of a second exposure draft, anticipating an issuance in January 2011 and providing the FASB model as an alternative view. However, a FASB Board member mentioned they are still very early on in their own redeliberations and questioned the usefulness of exposing the FASB's approach from the exposure draft as an alternative when it is also under reconsideration.

The two Boards decided to reconvene during their scheduled meeting time for tomorrow and further discuss the plan forward.

On Friday, 12 November the IASB and FASB continued their deliberations from Wednesday and Thursday on the impairment recognition for financial instruments.

The acting Chair of the FASB started the meeting my informing the IASB members that the FASB had recently received loan loss trend information from one of the U.S. banking agencies on a confidential basis. However, they had received permission to share the information with the IASB and therefore the FASB proposed to schedule an education session during next week's joint meetings in Norwalk, CT to go through the information provided. Multiple IASB Board members agreed that analysing this information could be a useful exercise, although it was noted that if the information was only for U.S. loans, then the trends may not be the same throughout other jurisdictions of the world. The acting Chair of the FASB emphasised that the purpose of the data was not to attempt to develop or estimate specific loss periods for certain asset classes, but rather to see if the information provided may assist members from either Board into developing a principle over how best to recognise expected losses over the anticipated loss period.

An IASB member proposed another alternative recognition approach for consideration which he felt helped to bridge the gap between the two Board's positions. This model would recognise the loan at the funded amount at issuance, while recognising the expected credit losses immediately as the loan loss allowance but offset by deferred revenue related to the credit spread implicit in the contractual interest rate related to credit risk. The deferred credit risk amount would then be accreted into income as the loan amortises down. This would help to alleviate the FASB concerns over not having an appropriate reserve recognised in the balance sheet while also retaining the IASB income statement recognition approach of recognising the credit risk component as part of the contractual yield of the loan. There was mixed reaction to the idea with some feeling that it helps to achieve both Board's objectives while others feeling that it reintroduces the complexities with the original IASB exposure draft.

The IASB Chairman took an inventory of the various alternatives that had been discussed over the last three days and requested the staffs to prepare brief summaries of each alternative in anticipation of further discussions at next week's joint meetings. The identified alternatives currently under consideration include:

• Alternative 1 – Spread the expected losses over the life of the loan using a partial catch up approach for subsequent changes in estimates of expected losses; a "bad book" approach would also overlay this model for specific loans that have been identified as going bad where the full amount of expected loss would be reserved for immediately (the IASB approach post re-deliberations of their exposure draft)
• Alternative 2 – Alternative 1 with the addition of a "middle book" concept for loans projected to go bad over the near term (an incurred but not reported 'IBNR' approach) which speeds up recognition of the expected losses for those loans
• Alternative 3a – Spread the expected losses over the expected loss pattern (e.g., for 5 year auto loans where most loans go bad within 24 months, expected losses would be spread over the first two years)
• Alternative 3b – Project expected losses over the near term (perhaps 2 to 3 years) and recognise those losses immediately rolling that estimate over from period to period (continually looking out over the near term expected loss period)
• Alternative 4 – Recognise the expected credit losses immediately as the loan loss allowance but offset by deferred revenue related to the credit spread implicit in the contractual interest rate related to credit risk which is accreted into income as the loan amortises down
• Alternative 5 – Bifurcate the portfolio between those loans before or during the anticipated loss period and those loans that have passed through the anticipated loss period; those within the loss period would have a higher loss rate accrued during that period while those loans past the anticipated loss period would have a much lower loss rate accrued, and
• Alternative 6 – Recognise the expected losses immediately upon loan origination so that the loan loss allowance is always sufficiently provided for the anticipate losses (the FASB exposure draft approach).

The FASB staff agreed to prepare summaries for the alternatives under consideration including a basic summary of the approach and what the balance sheet and income statement would represent under each approach as well as potentially including operational considerations.

Discussion at the November 2010 IASB Meeting

The FASB and IASB met in Norwalk to continue its previous week's discussion on credit impairment. The discussion comprised:

• A presentation by Darrin Benhart and Randy Black, Office of the Comptroller of the Currency, on loan loss data
• Aa high-level overview of the impairment models discussed previously.

The meeting was for informational purposes only and accordingly, no decisions were made.

Presentation on Loan Loss Data

To aide in its discussion on credit impairments, the Boards invited Mr. Benhart and Mr. Black to provide some specifics regarding loan loss data compiled from portfolios of different financial institutions in the U.S. Highlights of the credit loss data presented to the Boards are as follows:

• Losses do not occur smoothly throughout the life of a financial asset
• When losses occur, the losses tend to be significant
• Financial assets that have a low internal risk rating (e.g., BBB-rated) typically have a quicker default period.

When asked whether this U.S.-based credit loss data could indicative of data on a global level, Mr. Benhart indicated that similarities may exist but without further testing, no definitive conclusions could be drawn.

High-Level Overview of Impairment Models

The FASB and IASB staffs outlined the various alternative models when recognising credit impairment losses that were briefly discussed by the Boards in the previous week. The models are as follows:

• Alternative 1: Immediate recognition of lifetime expected losses. This alternative would have the following features:
• Amount of credit loss estimate: The amount of the expected credit losses would be the full amount of losses expected by the entity for the portfolio of the loans, regardless of when they occur during the lifetime of the loan portfolio. For open portfolios, the amount of the credit loss would be determined by applying a loss rate to the portfolio balance (which is an undiscounted principal amount) at each reporting date.
• Timing of recognition: An entity would recognise all expected credit losses (and changes in expected credit losses) in the current period.
• Alternative 2: Immediate recognition of losses expected to occur in a shorter emergence period. This alternative would have the following features:
• Amount of credit loss estimate: The amount of the expected credit losses would be the amount of losses expected by the entity for the portfolio of the loans in a shorter emergence period. For example, this shorter emergence period could correspond to the timeframe used for incorporating into the information set expectations about future conditions. If that timeframe is 2-3 years out, then the coverage period could likewise be 2-3 years worth of losses. For open portfolios, the amount of the credit loss would be determined by applying a loss rate to the portfolio balance (which is an undiscounted principal amount) at each reporting date.
• Timing of recognition: An entity would recognise all expected credit losses (and changes in expected credit losses) as determined above in the current period.
• Alternative 3: Recognition of losses expected to occur in a shorter emergence period over the emergence period. This alternative would have the following features:
• Amount of credit loss estimate: The amount under this alternative would be consistent with Alternative 2; that is, the amount of the expected credit losses would be the amount of losses expected by the entity for the portfolio of the loans in a shorter emergence period.
• Timing of recognition: An entity would recognise expected credit losses for the shorter emergence period over that emergence period.
• Alternative 4: Recognition of lifetime expected credit losses using a time-proportionate approach. This alternative would have the following features:
• Amount of credit loss estimate: The credit loss estimate would be the full amount of the losses expected over the life of the portfolio of assets. However, the timing of recognition would depend on whether an asset is in the good book or in the bad book.
• Timing of recognition of credit losses: The expected loss (EL) estimate is made at the end of each period for the assets in the portfolio at that date. If the assets are in the good book, the EL estimate is then allocated over the weighted average life of the portfolio. In an open pool setting, a constantly updated EL estimate is allocated over the total weighted average life of the portfolio. For the bad book, ELs are fully provided for (i.e., when an asset is moved to the bad book, the lifetime ELs are recognised fully in the allowance account, as are the effects of any subsequent changes in EL estimates on the bad book).
• Alternative 5: Time-proportionate approach with notional sub-portfolios to accelerate recognition of expected losses. This alternative would have the following features:
• Amount of credit loss estimate: The amount of the expected credit losses would be the same as in Alternative 4.
• Timing of recognition of credit losses: For assets in the good book the allocation of the expected credit losses would be driven by notional sub- portfolios with different ages. This would accelerate the recognition of some expected losses in particular circumstances which could align the recognition of credit losses more closely with the expected loss rate for the group of assets.
• Alternative 6: Recognition of credit losses using a 'middle' book to accelerate recognition of expected losses. This alternative would have the following features:
• Amount of credit loss estimate: The amount of the expected credit losses would be the same as in Alternative 4.
• Timing of recognition of credit losses: The recognition of the expected credit losses would be similar to that in Alternative 4; however, an additional credit loss estimate would be recognised immediately for assets in the middle book, to provide earlier provisioning of credit losses.
• Alternative 7: Steven Cooper's alternative approach. The model is a combination of a simplified IASB ED approach but with a minimum balance overlay. The approach gives the same information as the IASB ED, including a full catch up. The minimum balance adjustment addresses the problem that the loan loss allowance may not cover actual losses and the concern that upcoming or foreseeable losses are not covered. It combines the IASB 'allocation' and the FASB 'cover upcoming/ foreseeable losses' philosophies.

The Boards made no definitive decisions but did provide the staffs with direction by asking the staffs to further develop Alternative Models 2, 4, and 5. In doing so, the Boards asked the staffs to illustrate the alternative models using a similar fact pattern that applies to a single asset and open and closed portfolios. The Boards are hopeful to redeliberate these models at the next joint meeting in December.

Discussion at the Special 1 December 2010 IASB Meeting

The IASB and FASB discussed four topics related to the amortised cost and impairment project.

Scope – Short-term Trade Receivables

The IASB's exposure draft proposed that trade receivables, without a stated interest rate and a near term maturity so that the effects of discounting would not be material, would be initially recognised at the invoice amount less the initial estimate of undiscounted expected credit losses. That initial estimate of expected credit losses would be recognised as a reduction in revenue rather than bad debt expense. While IAS 18 requires that revenue be measured at the fair value of the consideration to be received, common practice is to recognise revenue based on the full invoice amount and subsequently estimate credit losses based on collection efforts recognised as bad debt expense.

Most comment letter respondents disagreed with the proposal and felt that short-term trade receivables should not be subject to the same recognition model proposed in the exposure draft.

The Board tentatively decided to exclude short-term trade receivables from the scope of the pending re-exposure draft and further consider the issue of credit risk associated with trade receivables in conjunction with the redeliberations of the revenue recognition exposure draft.

Certain Board members had concerns over how to appropriately define or differentiate trade receivables that should be exempt from the pending re-exposure of amortised cost and impairment and those that are financing receivables. The IASB staff proposed the scope out would exclude short-term trade receivables without a stated interest rate and are so short-term so that the effect of discounting for the time value of money would be immaterial. However, under that set of criteria, certain trade receivables in jurisdictions with high inflation levels may remain within the scope of amortised cost and impairment proposals.

Scope – Individual financial instruments

The IASB's redeliberations on the amortised cost and impairment exposure draft have focused exclusively on the application to open portfolios as a result of the operational issues identified by comment letter respondents and the Expert Advisory Panel regarding the application of the proposals in the exposure draft.

The Board has stated publicly their intention to issue a revised exposure draft in January 2011. However, the Board has not discussed application of the revised proposals to either closed portfolios or individual instruments. The IASB staff requested direction from the Board on the intended scope of the revised exposure draft and whether it should solely address application to open portfolios as issues associated with individual instruments have yet to be deliberated based on comments received on the original exposure draft (such as the requirement to use a probability weighted expected outcome approach for an individual instrument). The IASB staff was concerned about including individual instruments within the exposure draft and asking questions to constituents without initially addressing the comments received on the original exposure draft.

Several Board members had concerns with specifically excluding closed portfolios or individual instruments from consideration within the planned revised exposure draft, particularly because of the worry that a third exposure draft could later be required. One Board member suggested an approach of describing the alternative model under consideration by the IASB within the exposure draft and simply asking for views on the approach and whether it addresses the operational issues identified in the original proposal. Several Board members agreed with this approach with another Board member stating that if the revised exposure draft included some context around the information and where the Board was heading it may help to alleviate some of those constituent concerns about not considering the comments from the original exposure draft.

Allocation of Expected Losses

As part of its redeliberations of the proposals in the exposure draft, the IASB has tentatively decided to permit the use of a non-integrated (or decoupled) effective interest rate calculation between contractual cash flows and expected credit losses.

The IASB and FASB are currently considering three methods for recognising expected credit losses. The IASB's original method (and similar to the approach in the exposure draft) was to allocate the expected losses over the life of the portfolio. The Board is also considering an accelerated recognition of expected losses method as well as the FASB's immediate recognition approach.

The IASB staff has continued building the model for expected losses to be allocated over the lifetime as they feel the accelerated methods under consideration would simply be an overlay of this approach. The methods available for allocating expected losses over the life of the portfolio include a straight line approach (either discounted or undiscounted methods are possible) or an annuity approach in which a discounted present value is converted into an annuity stream. Both the discounted straight line approach and the annuity approach would also require the use of a discount rate; therefore, the Board would also need to consider what guidance or requirements should be included in the proposal for determining the appropriate discount rate should the discounted straight line approach or the annuity approach be required or permitted.

The IASB staff analysis of the three alternatives noted that the undiscounted straight line method is more operational and less complex than the annuity approach; however it does not capture the anticipated timing of losses or the time value of money that the annuity approach includes. The discounted straight line method represents some level of compromise between the two alternatives as it incorporates consideration of the time value of money and is less complex than the annuity approach, yet still may operationally challenging for some to implement. If a discount rate were incorporated as part of the allocation method, potential alternatives for determining the appropriate discount rate include such items as the risk free rate, the IAS 39 EIR or the EIR from the exposure draft (although the IASB staff feels that the IAS 39 EIR is too high as it incorporates the expected credit losses).

The Board discussed how to allocate the initial estimates of expected credit losses over the life of the portfolio. The Board was evenly split between those that preferred not specifying any particular methodology and permitting entities to apply any of the three methods described above and those that preferred not permitting an election and simply requiring an undiscounted straight line approach (the most operational of the three approaches.

Those Board members who preferred requiring the undiscounted straight line method had concerns over the diversity created by allowing various alternatives and felt that once you have moved off the original proposal in the exposure draft, each of these alternatives are not perfect answers anyway. Another Board member noted that the differences in the staff examples (provided in the agenda paper) only occur as a result of discounting when the losses occur later in the life of the loans, which contradicts the loan data presented during the previous joint Board meeting which found that for several asset classes losses are typically front loaded. One other Board member proposed a middle ground of requiring the undiscounted straight line approach unless the impact of discounting would be significant in which case a discounted approach would be required.

Because the Board was split on the matter, the Board tentatively agreed that the revised exposure draft will not specify which method could be applied and to ask a question on the matter of whether a specific approach should be required.

Good Book/Bad Book Consideration

The final topic of the meeting was on the incurred loss model being overlaid on top of the expected loss model (often referred to as the good book/bad book approach). Under this approach, the expected losses are allocated over the life of the portfolio unless a loss event has been identified in which case the loan is transferred from the “good book” (the expected loss model) to the “bad book” (the incurred loss model) where the expected losses are immediately recognised in their entirety.

The Board considered whether to require a specific definition for loans that should be transferred to the “bad book” such as 90 days past due (consistent with the current definition of default established by the Basel Committee) or to develop a “bad book” that follows how an entity manages their non-performing loans (rather than requiring arbitrary definitions). It was noted that a certain period of time past due may be appropriate for certain asset classes but not for other asset classes and therefore a one size fits all model may not be appropriate.

All of the Board members agreed not to mandate a brightline definition for items that should be included in the “bad book” (e.g., 90 days past due). However, several Board members had concern with simply providing management with full discretion as to how and when to transfer items between the “good book” and “bad book”. Those Board members wanted more discipline around the criteria for the “bad book”.

The staff agreed to address those Board member concerns through drafting and would bring revised criteria for the transfer criteria back to the Board at a future meeting.

Discussion at the Special 8 December 2010 IASB Meeting

Recognition of credit impairment losses

The IASB and FASB continued their discussions on the recognition of expected credit losses for financial instruments. At the 17 November 2010 joint meeting, the Boards narrowed their consideration from seven potential impairment models to three models.

The staff of the IASB and FASB further developed those three models including modelling these alternatives under the same data set. Variations on two of the models were also added into the analysis prepared by the staff such that in total, five models were discussed during the meeting. At a high level summary, the models discussed included (numbered based on the original seven models under consideration):

Model 2 – Immediate recognition of the amount of the credit losses expected to emerge, and are reliably estimated, over a portion of the expected life of the financial assets, or where feasible, the full expected life of the financial assets.

Model 4 – Recognition of lifetime expected credit losses using a time-proportionate approach for financial assets in a "good book" and full recognition of lifetime expected losses for financial assets transferred to a "bad book".

Model 4' – Recognition of lifetime expected credit losses using a time-proportionate approach for financial assets in a "good book" and full recognition of lifetime expected losses for financial assets transferred to a "bad book". However, the "good book" allowance would have a floor sufficient to at least cover expected losses in the upcoming year.

Model 5A – Recognition of lifetime expected credit losses using a time-proportionate approach for financial assets transferred to a "good book" and full recognition of lifetime expected losses for financial assets in a "bad book". However, the time-proportionate approach is accelerated so the recognition of expected losses using notional sub-portfolios reflects distinct loss patterns over the life of an asset.

Model 5B – Recognition of lifetime expected credit losses using a time-proportionate approach for financial assets transferred to a "good book" and full recognition of lifetime expected losses for financial assets in a "bad book". However, the time-proportionate approach is accelerated so the recognition of expected losses adjusts the expected loss allocation based on the timing of expected losses.

The meeting began with a discussion of Model 2 which is a variation on the proposal in the FASB's exposure draft to immediately recognise all lifetime expected losses (Model 1). Several IASB Board members were confused over the differentiation between Model 1 and Model 2 focusing on the "reliably estimated" component of the Model 2 definition. To attempt to address some of the confusion over the application of Model 2, the FASB staff clarified that Model 2 would forecast losses over a shorter emergence period as their outreach has said that banks can more reliably estimate credit losses over the near term rather than over the entire life of the instrument. Model 1 would likely apply a historical loss rate over the life of the instrument as specific forecasting would be difficult given the long projection period.

One IASB Board member asked how the credit losses would be recognised for a longer term asset (10 year loan) in a steady state environment with a historical loss rate of 3%. The FASB staff and a FASB Board had differing views with the Board member feeling that loss would be fully recognised immediately where the FASB staff felt that only that portion of the expected losses forecast over the near term would be recognised immediately. The FASB Board member clarified that under Model 2 they may not have used the 3% loss rate as forecasting may have resulted in a different assumption.

The IASB staff then began discussions on Models 4, 4', 5A and 5B. Model 4 is an adaption of the IASB integrated effective interest rate model proposed in the exposure draft with changes made to address operational challenges based on recommendations from the Expert Advisory Panel. Models 4', 5A and 5B each attempt to retain the notion in the IASB's exposure draft that credit losses are priced into the interest rate of a financial asset and therefore should be recognised over the life of the instrument as interest revenue is earned. However, these models also address the concerns some have raised over Model 4 that the allowance amount is insufficient when the loss pattern is front loaded for a financial asset class.

The IASB Chairman asked the IASB staff if the intention of Model 4' was to replace Models 5A and 5B. The IASB staff noted that while they were further developing Model 5, it proved operationally challenging. Model 4' attempts to provide a sufficient allowance without adding the additional complexity of Models 5A and 5B. The IASB staff noted that a twelve month expected loss forecast is already required for banks applying Basel II, therefore applying this minimum "floor" reserve should not add any additional operational burden to Model 4. The IASB staff clarified that the allowance reserve under Model 4' would be the allowance as determined under application of the "bad book" in addition to the allowance calculated under the time proportionate approach from Model 4 unless the twelve month expected losses exceeded the allowance under the time proportionate approach, in which case the twelve month expected loss would be used instead.

One IASB Board member questioned the operational complexity associated with Model 5B and supported its attributes. However, a majority of the IASB (10 Board members) expressed support for Model 4'. One IASB Board member summarised the advantages of Model 4' as a compromise between the Expert Advisory Panel recommendations (retaining the basics of the IASB exposure draft) and the Basel Committee's recommendation of wanting a minimum allowance balance. A few IASB Board members did have concerns with the arbitrary twelve month period for the "floor" preferring instead to use language such as "foreseeable future, but not less than twelve months" to permit entities to forward project near term expected losses in excess of twelve months.

The FASB Board members were split in their views on Model 4'. Two FASB Board members stated their continued preference for Models 1 or 2. However, three FASB Board members expressed interest in further exploring Model 4'. The FASB also had concern over the arbitrary twelve month period used for the minimum "floor" allowance. The FASB analogised the concept in Model 4' to the principal within Model 2 for the losses anticipated over a shorter time horizon. The acting Chair of the FASB felt that Model 4' articulated this concept in a more intuitive way and may be consistent with how management currently estimates their credit losses.

While no official votes were taken, the Boards agreed to further develop Model 4' and conduct outreach activities with the expectation to reconvene during next week's scheduled joint Board meetings.

This concluded the special meeting on impairment.

Discussion at the December 2010 IASB Meeting

Results of outreach on model choices from IASB and FASB

The IASB opened the discussion with the results from their outreach to the Basel committee and a number of international banks regarding the "4'" model previously discussed at the 8 December 2010 meeting. Specifically, the IASB staff asked (1) whether the model was "operational", (2) should the expected loss estimate for a specified time period be a bright line 12 months or an amount based on expected losses for the foreseeable future, but no less than 12 months, and (3) is the proposed good book/bad book split operational.

The informal feedback received by the IASB indicated:

The discussion then turned to the results of the FASB outreach on similar queries to US banks. The FASB's response indicated:

The IASB and FASB members then discussed these results and were concerned that there were conflicting views as to not only the choice of the timeframe for the expected loss period but also for the preference of one model over the other. The discussion then went back and forth between all members on each of the responses described above. The Board held the following two votes in order to move the process forward:

Forward looking plan

The ED will include both 2 and 4' models but will indicate a preference to 4'. The Boards indicated that the period for comment will be two months and should include examples of the application of each model.

This concluded the meeting on the financial instruments - impairment project.
 

Confirmation of previous decisions

During the 1 December 2010 IASB-only meeting, the Board provided the staff with tentative direction on how to further develop the impairment model for financial assets measured at amortised cost. However, the Board had not officially voted on those positions.

During this meeting, the Board tentatively agreed with their previous guidance that:

• short-term trade receivables would be excluded from the scope of the forthcoming supplement being exposed for comment,
• the supplement being exposed for comment will primarily focus on application for open portfolios but would not exclude individual instruments or closed portfolios and would specifically ask a question addressing application to these items,
• a straight-line allocation of undiscounted expected losses would be the most operational method, but other more sophisticated approaches (such as straight-line discounted expected losses or an annuity approach) would also be permitted; if using a discounting approach, the discount rate could be between the risk free rate and the effective interest rate as calculated under IAS 39, and
• the determination of transfers from the "good book" to the "bad book" would be based on an entity's internal credit risk management process.

Loan commitments and guarantees

Loan commitments are currently either outside the scope of IAS 39 and therefore accounted for under IAS 37, or for those commitments issued at below market interest rates and within the scope of IAS 39, still subject to impairment under IAS 37. Certain comment letter respondents to the exposure draft Amortised Cost and Impairment requested a similar impairment approach for both loans and loan commitments. The IASB staff asked the Board if they would like to include a question in the forthcoming supplement being exposed for comment regarding loan commitments. As the original exposure draft did not specifically ask a question on this issue, the responses originally received on the topic were fairly limited.

Two Board members asked for clarification on what the rationale for asking the question would be since the Board has not yet addressed the issue and therefore does not have a view. However, the staff and Board were concerned that not seeking input may result in having to separately expose the issue at a later date. The Chairman suggested that the staff add some clarification in the supplement prior to asking the question so respondents have more context in understanding the issue.

Similarly, financial guarantee contracts have been proposed as within the scope of the exposure draft Insurance Contracts. As such, the Board agreed to postpone any decision with respect to credit guarantees while the comments received in the insurance contract exposure draft are being redeliberated.

Presentation and disclosures

As part of the Board's decision to utilise a "decoupled" approach for allocating lifetime expected losses, the Board has also changed its proposed presentation requirement from the exposure draft and will now propose to present interest revenue and impairment expenses in separate line items.

The Board tentatively agreed that impairment disclosures should be provided at least by class of instrument (if not a lower level of detail) and will provide examples of classes of instruments for financial institutions and corporate entities. The Board is also permitting cross referencing when the required disclosures are already incorporated in an entity's disclosures.

Allowance account for credit losses — The Board tentatively agreed on separate reconciliations for the "good book" allowance and the "bad book" allowance. When the "floor" of losses expected to occur over the near term exceed the time proportionate amount, disclosure of the additional provision from use of the "floor" would also be required. Additionally, a reconciliation of the nominal amounts in the "bad book" would be required. These disclosures would be presented in a comparative tabular format by asset class. Additionally, if an entity writes-off assets directly from the "good book" information on those write-offs should be disclosed.

Factors impacting credit losses for the "good book" — The Board tentatively agreed to require tabular disclosures providing five years of information for the "good book" of 1) lifetime expected losses, 2) balance of the outstanding nominal amount, 3) the time proportionate allowance balance, and 4) any additional provision necessary to reach the floor.

Significant gains and losses — The Board tentatively agreed to require quantitative and qualitative information should a specific portfolio or geographic area experience significant gains or losses.

Credit risk management and application to the "good book"/"bad book" — The Board tentatively agreed to require information on the "good book" and "bad book". Those disclosures would include qualitative information about how loans within the "good book" and "bad book" are managed, the criteria for transfers from the "good book" to the "bad book", and if internal credit rating systems are used - information on that system such as comparisons to external ratings, a description of the various grades used, and information on how a "watchlist" is managed if an entity employs the use of a watch list.

Credit risk management and assessment of expected losses — The Board tentatively agreed to require information on the nominal amount and information about expected losses (both lifetime and those expected to occur in the near term) across credit risk rating grades (at a minimum of "good book" and "bad book").

Management judgment and estimate — The Board tentatively agreed to require information on both lifetime expected losses and those expected to occur in the near term including the basis of inputs and estimation technique used, explanations on changes in estimates, and information about when a change in estimation technique occurs.

Comparison of expected losses with actual outcomes — The Board also tentatively agreed that if an entity utilises back testing of its credit loss estimates, then it should disclose quantitative information that compares actual outcomes to previous estimates. However, if an entity does not perform back testing, then a qualitative analysis of the actual outcomes and previous estimates would be required.

While the Board agreed to all of the above disclosure requirements, certain Board members did express various concerns with the proposals. One Board member had concerns with the requirement to provide five years of information for the "good book" allowance feeling the time period requirement was arbitrary and exceeded the comparative period disclosures. That Board member also had concerns with the requirement to provide comparative information of the internal credit risk rating system to external ratings as that may be more available in advanced capital markets but not as available in other jurisdictions. Another Board member praised the disclosure proposals but requested information on when loans have been modified including when loans may have been transferred back from the "bad book" to the "good book" after the modification. The staff responded that IFRS does not have a definition of a troubled debt restructuring as contained within US GAAP, and therefore putting parameters around the disclosure for modifications would be difficult.

The Board also discussed whether to proscribe a particular method for transferring provisions for credit losses from the "good book" to the "bad book". The Board considered:

• a full depletion approach (100% of expected losses would be transferred from the "good book" to the "bad book"),
• a partial depletion approach (an allowance for credit losses reflecting the age of the loan would be transferred from the "good book" to the "bad book" with a provision recognised to meet the needed target allowance), and
• a no depletion approach (no transfer of allowance from the "good book" to the "bad book" and a provision for the full amount of expected losses would be recognised).

The Board agreed to include the partial depletion approach in its proposals (supported by vote of eight Board members).

Finally, based on concerns expressed by comment letter respondents and the Expert Advisory Panel, the Board tentatively agreed not to require a sensitivity analysis of the estimated expected losses.

Next steps

These discussions finalised the Board's decisions for their anticipated supplement to be released for public comment. The Board agreed to the staff request to begin drafting of the supplement. Two Board members expressed their intent to dissent to the proposals in the supplement.

Discussion at the January 2011 IASB Meeting

The IASB and FASB staffs are currently drafting the supplement for exposure and intend to issue the supplement near the end of January. The Boards agreed to a 60 day comment period for exposure. The Boards also held a brief discussion on outreach activities planned during and after the close of the comment period. The IASB staff mentioned that the plan for outreach was still being determined. Multiple FASB Board members expressed their desire that outreach go beyond that of the Expert Advisory Panel and that large and small financial institutions are included. A FASB Board member also reiterated that the outreach needs to be performed as a team between IASB and FASB staff so that both Boards receive consistent messages.

January 2011: IASB publishes supplement to exposure draft on impairment

On 31 January 2011, the IASB and FASB published for public comment joint proposals on the impairment of financial assets, a supplementary document to the November 2009 IASB exposure draft Financial Instruments: Amortised Cost and Impairment. Many respondents to the IASB's original exposure draft agreed with the impairment approach proposed but considered it to be operationally too difficult to apply, especially in the context of open portfolios.

Financial Instruments: Impairment proposes to replace the incurred loss impairment models in IAS 39 and US GAAP with an expected loss impairment model including separate approaches to recognising expected losses for performing assets in a "good book" and for troubled assets in a "bad book". Expected credit losses in the "good book" would be recognised under a time-proportional approach based on the weighted average age and expected life of the assets in the portfolio, but subject to a minimum allowance of at least those credit losses expected to occur in the foreseeable future (a period on not less than twelve months from the reporting date). When assets are transferred from the "good book" to the "bad book" the proposals would require the expected credit loss to be immediately recognised.

The supplement also includes an IASB-only Appendix Z Presentation and Disclosure for public comment, which includes separate proposals on impairment of financial assets specifically addressing scope, presentation and disclosure. These proposals have been deliberated only by the IASB at this time. The FASB may separately deliberate presentation and disclosure requirements related to proposals in the supplementary document.

The supplement has a 60-day comment period with comments due on 1 April 2011. Click for:

• IASB press release (PDF 42k)
• Access to the Supplement to the Exposure Draft (link to IASB's website)
• IASB Snapshot: Supplement to the Exposure Draft Financial Instruments: Amortised Cost and Impairment (PDF 79k)

Discussion at the February 2011 IASB Meeting

Tuesday, 15 February 2011

The IASB's appendix to the joint Supplement of ED/2009/12 included disclosure proposals specifically related to impairment. During the February IASB meeting, the Board discussed the remaining disclosure proposals from ED/2009/12 not addressed in the appendix, specifically the stress testing requirement and disclosures on the credit quality of financial assets and vintage information.

Disclosures – Write-off Policy

ED/2009/12 included a proposal that an entity disclose its write-off policy and a definition for "write-off" that focused on an entity having no reasonable expectation of recovery and ceasing further enforcement activities. The IASB and FASB will be discussing the definition of "write-off" later in the week, but this meeting was to address user comments that they wanted information about assets still subject to recovery efforts after write-off.

The staff proposed expanding the original ED's disclosure requirement to provide information on an entity's write-off policy by incorporating discussion of whether written-off assets are still subject to enforcement activity and disclosing the nominal amount of written-off assets where collection is still being pursued. Additionally, recoveries of written-off amounts would be required to be shown in a separate line item in the reconciliation of changes in the allowance account.

Some Board members mentioned that providing qualitative information on the collection efforts was important to disclose, but that quantitative information should not be required. Ultimately, 10 Board members agreed to require of whether written-off assets are still subject to enforcement activity and disclosing the nominal amount of written-off assets where collection is still being pursued and 14 agreed to require recoveries in a separate line item in the reconciliation of changes in the allowance account.

Disclosures – Stress Testing

ED/2009/12 proposed requiring information on stress testing when an entity performs this analysis for internal risk management purposes. Financial statement preparers and other comment letter respondents had several issues with this disclosure requirement including that it was only required for certain entities, it was difficult to isolate credit risk from other macroeconomic factors in stress test scenarios and the fact that requiring stress tests was the role of regulators rather than accounting standard setters. Financial statement users did support the disclosure requirement but stated it was the least important of the required disclosures.

Only one Board member expressed some level of support for retaining the stress testing disclosure requirement. The Board tentatively agreed to not require stress testing as part of the disclosure requirements.

Disclosures – Credit Quality of Financial Assets

ED/2009/12 included a specific definition for the term "non-performing" assets as assets greater than 90 days past due and required a rollforward of changes in non-performing assets during the period.

The 'bad book' concept in the joint Supplement is based on management's credit risk management process rather than a specific bright-line such as 90 days past due. The Supplement also includes specific disclosure for the 'bad book' similar to those proposed for non-performing assets in ED/2009/12. However, because the 'bad book' concept does not have a specific requirement for transfers to the 'bad book' the staff recommended providing a disclosure for assets greater than 90 days past due for assets in the 'good book' (in case there are assets in this category that management has not identified as being managed through the 'bad book'). This requirement, along with the disclosures for the 'bad book' would provide users with comparable information to that originally proposed in ED/2009/12. The disclosure recommended by the staff would include information on 1) increases from loans becoming greater than 90 days past due during the period, 2) increases from acquisitions of loans already greater than 90 days past due, 3) decreases from recoveries of assets that were greater than 90 days past due but not included in the 'bad book', 4) renegotiations and 5) write-offs.

One Board member questioned the purpose of the staff recommendation and felt there was an inherent inconsistency in that the 'bad book' required disclosures were based on management's credit risk management while the proposed disclosure for 'good book' assets greater than 90 days past due is based on an arbitrary bright-line. Another Board member mentioned her concern with the 90 day bright-line.

One Board questioned the part of the proposal to include assets acquired greater than 90 days past due as he felt that the purchase price would include a significant discount for credit quality and therefore providing disclosure for these assets may be misleading.

The Board tentatively agreed with the recommendation to require disclosure for assets in the 'good book' greater than 90 days past due including information on 1) increases from loans becoming greater than 90 days past due during the period, 2) decreases from recoveries of assets that were greater than 90 days past due but not included in the 'bad book', 3) renegotiations and 4) write-offs. The Board agreed to hold off on any decisions for disclosure of purchased assets until purchased assets were discussed more broadly.

Disclosures – Vintage Information

ED/2009/12 proposed specific disclosure of asset by year of origination and year of maturity. These disclosures were closely tied to the loss triangle disclosures which were replaced in the Supplement with information of backtesting.

Financial statement preparers had significant concerns with both the vintage information and loss triangle disclosures as they stated in open portfolios, credit risk is not managed on a vintage basis and therefore retaining and tracking this information would require systems modifications. Financial statement users were supportive of the disclosure proposals as they stated it helped in their analysis of credit quality for particular vintages and when underwriting standards had relaxed.

The staff noted these disclosures could provide relevant information in certain scenarios, such as mortgage loans, but would not provide meaningful information in other scenarios such as corporate debt or collateralised debt obligations where the underlying collateral pool comprises assets from various vintage periods.

Two of the three Board members representing the financial statement user community supported retaining the vintage disclosure in some form. One supported an approach that would limit the disclosure for vintage information to instances when it would be most useful to investors. The other requested that origination, provision and write-off information be tracked by vintage and questioned why entities would not have this information. The staff clarified that origination and write-off information could be tracked, but the provision was calculated at the portfolio level rather than the asset level and therefore an allocation of the provision to various vintages in the portfolio was not possible. However, the third Board member representing financial statement users acknowledged the difficulty in tracking vintage information for the provision and that providing origination information in isolation was not worth the costs and efforts preparers would incur in proving the information.

Eleven Board members tentatively agreed not to require the vintage information proposed in ED/2009/12.
 

Thursday, 17 February 2011

Definition of the term 'write-off'

The Boards discussed the definition of the term 'write-off'. Each Board's original exposure draft defined 'write-off' and the definitions were largely similar although the IASB's definition included that "the entity has ceased any further enforcement activities". The IASB included that phrase in their definition as they were told by financial statement users that information on amounts that could still be recovered after being written-off was important information. As a result, the IASB's definition of a write-off extended the period when a balance could be written off so that information about potential recoveries continued to be reported in the required disclosures. However, responses to the financial statement user questionnaire on the IASB's original exposure draft noted that users believe a loss should be written off when it is incurred, regardless if the legal means of recovery have not expired.

The Boards tentatively agreed to provide a definition in the defined terms that a write off is "a direct reduction of the amortised cost of a financial asset resulting from uncollectibility". Additionally, the Boards tentatively agreed to include guidance that an asset is considered uncollectible if the entity has no reasonable expectation of recovery and therefore an asset should be written off, partially or fully, in the period in which the entity has no reasonable expectation of recovery.

Discussion at the March 2011 IASB and IASB-FASB Meetings

Thursday, 17 March 2011 (IASB only)

Estimating Expected Credit Losses (education session)

The IASB and FASB staffs held an education session with the IASB in preparation for the Boards' discussion on estimating expected credit losses next week. The Supplement proposes that entities would consider all available, reasonable and supportable information, including consideration of future events, in developing estimates of expected credit losses, but have not yet discussed how to estimate expected credit losses.

The IASB's ED 2009/12 originally proposed that "estimates of cash flow inputs are expected values...estimates of the amounts and timing of cash flows are the probability-weighted possible outcomes." The FASB's proposed ASU did not refer to expected losses but instead focused on cash flows not expected to be collected. Comment letter responses have concerns with the description of expected value as they felt it required consideration of all possible outcomes. Additionally, they felt the use of probability-weighted possible outcomes was not relevant for a single asset as the calculated expected loss would likely be an amount that was not a possible alternative.

The FASB did not provide any specific guidance on the calculation of credit impairment losses but for individual financial assets provided that an entity could not automatically conclude no credit impairment exists and instead must asset the asset together with other financial assets that have similar characteristics (a 'pool overlay') and apply the historical loss rate for the group. Comment letter respondents did not specifically respond to this issue based on the FASB not proving specific guidance on measurement.

The staffs plan to provide the Boards with two alternatives on how to address estimates of expected credit losses.

• Alternative A – Establish an objective that would require estimating expected losses based on the expected value (mean) of possible outcomes for both portfolios and single instruments. The standard would clarify that one way to estimate an expected value would be to identify the possible outcomes, estimate the likelihood of each and calculate their probability-weighted average. However, other appropriate methods could be used as a proxy to a pure expected value calculation, such as use of loss rate methods, probability of defaults (PDs), loss given defaults (LGDs), or exposure at defaults (EADs)
• Alternative B – Estimate expected losses using all available and supportable information to estimate cash flows that are expected to be uncollectible at the date of estimation (i.e., not specify an approach for estimating expected losses) but for single instruments a 'pool overlay' would also be required.

Based on the discussions during the education session, it was apparent that the IASB staff supported Alternative A while the FASB staff supported Alternative B. The FASB staff fielded several questions from the IASB. The FASB concerns with Alternative A seemed to focus on their view that a burden of proof would be created by requiring probability weighted possible outcomes approach. As a result, entities may need to prove that use of the proxy approaches were also representative of a probability-weighted possible outcomes approach. The IASB Chairman acknowledged that the staffs seemed to be generally wanting the same thing but simply talking past each other. The IASB and FASB will discuss the topic jointly during next week's meetings in Norwalk.

Accounting for Purchased Debt Instruments (education session)

The IASB and FASB staff also held an education session with the IASB to discuss the accounting for purchased debt instruments in preparation for next week's joint Board meetings.

IAS 39 currently differentiates loans acquired at a deep discount that reflect incurred credit losses from other acquired loans. Similarly, US GAAP currently has a separate accounting model for loans acquired at a discount due to credit deterioration.

Presentation of Purchased Loans

IFRS 3(R) and ASC 805-10 require loans acquired in a business combination to be initially recognised at fair value. As a result, loans are recognised on a 'net' basis and do not carryover any valuation allowance related to credit quality. Financial statement users have often complained over losing information on the valuation allowance associated with these assets and the lack of comparability to originated loans.

The staffs have developed three possible alternatives for the presentation of purchased loans.

• Alternative 1 – Present the loan balance 'gross' by separately presenting the principal amount, portion of the discount attributable to the allowance as determined by the impairment model in the Supplement, and a separate premium/discount representing the remaining difference between the acquisition price and the original principal amount
• Alternative 2 – Present the loan balance gross with separate presentation of the portion of the purchase discount attributable to the allowance as determined by the impairment model in the Supplement
• Alternative 3 – Present the loan balance at fair value less the allowance as determined by the impairment model in the Supplement.

The FASB staff tend to support alternative 1 or alternative 2 as they feel such an approach would alleviate some of the presentation concerns by aligning originated and purchased loans and feel that expected losses are part of the transaction price and therefore the transaction price should be 'grossed up' to reflect the expected losses as well as the remaining discount. The IASB staff tend to support alternative 3 as they feel such an approach is consistent with the application of the Supplement to originated loans and do not view loss expectations differently for originated and purchased loans. They would prefer that financial statement users are provided comparability information through disclosures rather than presentation.

Effective Interest Rate and Accretion of Discount on Purchased Loans

As part of the discussion on accounting for acquired loans, the Boards will need to consider whether the effective interest rate should equate the acquisition price of the loan to contractual or expected cash flows. The staffs have developed four approaches for the Boards to consider.

• Alternative 1 – Require all purchased loans to accrete a discount based on the contractual cash flows
• Alternative 2 – Require all purchased loans except for those acquired at a deep discount to accrete a discount based on the contractual cash flows. Loans acquired at a deep discount would accrete a discount based on cash flows expected to be collected
• Alternative 3 – Require all purchased loans to accrete a discount based on cash flows expected to be collected
• Alternative 4 – Permit entities to make an accounting policy election in respect to Alternative 1 or 2.

The IASB staff support Alternative 2 as they feel for 'performing loans' the time proportional approach counters a higher effective interest rate based on contractual estimated cash flows, but it is appropriate to differentiate 'problem loans' to prevent inflated EIRs being calculated. The FASB staff support Alternative 3 as it eliminates the differentiation of credit impaired and non-credit impaired purchased loans.

The IASB expressed surprise at the FASB staff's support for Alternative 3 as they analogised it to the integrated effective interest rate approach in ED 2009/12 and referenced the operational challenges that most comment letter respondents had with the proposals.

Changes in Collectability Subsequent to Purchase

The Boards must also consider how subsequent changes in expectations of collectability should be recognised, as either an adjustment to the effective interest rate, an allowance for credit losses or a combined approach.

The staffs have developed two alternatives, but each having a sub-option.

• Alternative 1 – Recognise certain changes in expectations as an adjustment of yield and certain changes as an impairment and adjustment of the allowance for credit losses
• Alternative 1A – All increases in the amount of cash flows expected to be collected, beyond the reversal of existing impairment reserves, since acquisition or the prior period would be recognised through an increased yield. Decreases in the amount of cash flows expected to be collected would be recognised as an impairment expense.
• Alternative 1B – All increases in the amount of cash flows expected to be collected, beyond the reversal of existing impairment reserves, would increase yield, while decreases in the amount of cash flows expected to be collected would decrease the yield to the initial effective rate, with further decreases recognised as an impairment expense
• Alternative 2 – Recognise no changes in expectations as an adjustment of yield. All changes in expectations would be recognised as adjustments of the allowance for credit losses. Under this alternative, the initial effective interest rate is "locked in" to accrete to the amount of cash flows expected to be collected upon acquisition
• Alternative 2A – All changes in expectations are recognised through an allowance for credit losses (or carrying value adjustment) regardless of whether it is established at acquisition or subsequent to acquisition. Increases in cash flows expected to be collected may be recognised as gains even if there has not been previously recognised impairment charges by the acquiring entity
• Alternative 2B – Changes in expectations related to increases in cash flows expected to be collected may be recognised by reversing the allowance for credit losses until it reaches a zero balance, but not beyond that point. After that point, an entity would not recognise increases in cash flows expected to be collected as gains prior to recognising an impairment expense subsequent to acquisition.

The staffs did not discuss this portion of the proposals in detail.

Tuesday, 22 March 2011 (IASB/FASB)

Estimating Expected Credit Losses

The Boards discussed the measure that entities should use when estimating expected credit losses. The two alternatives discussed by the Boards were:

• Alternative A – Expected losses for both single instruments and portfolios should be estimated using expected value as an objective with clarity being provided related to the calculation of the expected value. For example, one way to estimate a pure expected value would be to identify the possible outcomes (or a representative sample of the possible outcomes), estimate the likelihood of each and calculate their probability-weighted average. The final standard should acknowledge that other appropriate methods could be used as a proxy to a pure expected value calculation (e.g., loss rate methods and use of probabilities of default, loss-given default, and exposure at default data)
• Alternative B – Expected losses should be estimated using all available and supportable information to estimate cash flows that are expected to be uncollectible at the date of estimation. Losses are estimated on single instruments and then a pool overlay would also be required.

Certain Board members (primarily IASB Board members) supported Alternative A as they believe that the most important reason for using an expected value is that an expected value estimate is an inherent part of an expected loss model. When considering expected losses based on all the available evidence (including forward-looking information), an entity will inherently consider multiple scenarios and possible outcomes. Some also believe that an objective that is not based on expected value would be inconsistent with the view that the pricing of financial assets includes considerations of expected losses.

Other Board members supported Alternative B as they believe that the objective for measuring credit impairment losses and the allowance for credit losses does not necessarily need to be expressed in the context of a particular statistical methodology. These Board members would rather not be overly prescriptive in how an entity estimates cash flows, rather they prefer that the objective be that an entity would be required to estimate the amount of cash flows that an entity does not expect to collect (also referred to as losses) using the best available and supportable information at the date of estimation (historical, current, and forecasted). Further, they were concerned with the approach in Alternative A that may result in entities having to prove that the use of the proxy approaches described in Alternative A were also representative of probability-weighted approaches.

After a lengthy discussion about the merits of either alternative, the IASB voted 15 to 0 in favour of Alternative A while the FASB voted 4 to 3 in favour of Alternative B. At least one FASB board member indicated that he could support Alternative A depending on the final language in Alternative A. Specifically, if Alternative A was written in such a way that did not overly burden an entity to prove that its use of a proxy approach, as described in Alternative A, is representative of a probability-weighted approach.

Accounting for Purchased Debt Instruments

The Boards discussed the accounting for acquired loans, specifically whether the effective interest rate should equate the acquisition price of the loan to contractual or expected cash flows. In general, it appeared as though the IASB board members favoured the accretion of a discount based on contractual cash flows while the majority of the FASB Board members supported the accretion of the discount based on expected cash flows.

Those Board members who supported the accretion of the discount based on contractual cash flows believe that separate models should not exist for originated and purchased loans. Further, they believed that it was conceptually purer to have a single model for all loans, whether originated or purchased, that achieves an effective interest rate aligned with the credit quality of the asset.

The Board members who supported accretion based on expected cash flows believe that it would be inappropriate to accrete to an amount that an entity does not expect to collect. Further, they believed that permitting the accretion of the discount in these situations to contractual cash flows would artificially inflate yields where an impairment model would not counter this effect.

In summary, the Boards asked the staffs to prepare illustrations of the accretion the discount to contractual and expected cash flows to be discussed at next week's joint Board meeting.

Discussion at the Additional 29 March 2011 IASB Meeting

Purchased debt instruments

The Boards continued their discussions from the 22 March joint meeting in Norwalk on the accounting for purchased debt instruments subject to impairment accounting. The discussion centred on how to recognise interest income for 'good book' purchased loans and whether purchased and originated loans should be treated similarly (e.g., effective interest rate based on contractual cash flows) or whether purchased loans should be treated differently (e.g., effective interest rate based on expected cash flows, including expected credit losses).

During the previous meeting, the IASB was supportive of a single model while the FASB preferred differentiation for purchased loans. The staffs prepared three illustrative examples to assist the Boards in their continued discussion on the topic.

The staffs began by requesting the Boards to limit the initial discussion in the context of loans in the good book. However, the unit of account question between the 'good book' and 'bad book' added significant complexity to the discussion (whether a 'good book' acquired portfolio would need to separate out any 'bad book' loans or whether an entire portfolio of 'bad book' loans would be considered for a separate interest recognition model). The inclusion of the 'floor' allowance in the examples (as a reduction in the purchase price/fair value of the purchased loans for a net carrying amount) also added to the confusion. One of the IASB members suggested that Board members ignore that part of the example and instead focus solely on the income recognition.

The IASB members generally remained consistent with their view from the prior meeting that for 'good book' loans that interest recognition should be the same as for originated loans. However, two IASB members did express support for separate models by using expected cash flows rather than contractual cash.

One of the FASB members strongly supported different interest recognition models for originated and purchased loans as he felt that information on organic growth of a customer relationship (originated loans) was important information for financial statement users and including acquired loan portfolios distorted that information. However, many of the FASB members were swayed by the examples that for 'good book' loans the interest recognition model should be consistent with originated loans.

The Boards also discussed how income should be recognised for 'bad book' loans acquired. In addressing the unit of account question for 'bad book' loans, the staffs responded they would prefer not to dictate the approach but to leave to how an entity manages their loan portfolios in determining whether an entire acquired portfolio would be considered 'bad book' or whether the 'bad book loans would be individually identified loans from a 'good book' acquired portfolio.

Ultimately both Boards tentatively decided that for 'good book' loans interest income would be recognised based on contractual cash flows while for 'bad book' loans interest income would be recognised based on expected cash flows. However, the Boards acknowledged there were other issues that may need to be addressed including non-accrual status of loans, differentiation between 'good book' and 'bad book' acquired loans and potentially needing to revisit based on feedback received on the impairment approach in the Supplementary document.

The FASB Chair also concluded the impairment discussion by recognising they have received requests from certain constituents to provide additional time to submit their comment letters. She encouraged those constituents to still send in their comments when possible, but mentioned that the Boards had received some consistent themes through the comment letters they have received to date and the outreach activities performed and they have decided to proceed with deliberations on those areas.

Discussion at the April 2011 IASB meeting

WEDNESDAY, 13 APRIL 2011

Summary of feedback from outreach meetings and comment letters

The comment period on the joint supplementary document (the "Supplement") closed on 1 April 2011. During the open comment period, the staff and several Board members held outreach meetings with various constituents around the world. During this meeting, the IASB and FASB received a summary of the views received during those outreach meetings as well as an initial summary of the comment letters received by the comment period closing date.

The FASB staff provided a summary of the outreach activities involving financial statement users since the Boards received few user responses through the comment letter process. Users include buy- and sell-side analysts, regulators and investor or analyst industry groups. They believe that the Boards finding a converged impairment model is highly important. They are also supportive of a move towards a single impairment model for all financial instruments. Additionally, users believe it is important that the final impairment model mitigates pro-cyclicality. Users' primary concern with the proposals in the Supplement is the lack of comparability associated with the 'higher of' test of the time-proportionate approach and the foreseeable future period approach, particularly in instances where the recognised allowance may flip from one approach to another from period to period. Users have concerns over the definition of foreseeable future period as they felt there would be a lack of comparability. Similarly, they also generally prefer a standardised market trigger for transfers from the 'good book' to the 'bad book' to increase comparability.

The IASB staff provided a summary of the comment letters received as of the comment period deadline. Respondents generally felt that the 60 day comment period was not sufficient to properly test the proposals and requested that the entire impairment model be separately proposed so that all components can be considered together. Respondents acknowledged that the foreseeable future period allowance would often be higher than the time proportionate allowance. Respondents from the US generally preferred using only the foreseeable future period allowance while international respondents generally preferred using only the time proportionate approach allowance; although there were diverging views in each of those jurisdictions. Many respondents offered alternative variations of the proposals in the Supplement. Respondents also expressed concern that the degree of judgment provided in the Supplement may be overridden by regulators such that while there exists convergence in the standard, the actual application could vary significantly across jurisdictions.

The Board held a discussion based on the summaries provided by the staffs. One IASB Board member noted the conflicting messages received by constituents, noting that a consistent theme was support for convergence but there was not overwhelming support for the converged proposal. Additionally, the Board developed a principles-based impairment model, but there is concern that regulators will override the principles in the standard and impose bright line applications. Another IASB Board member acknowledged the challenge the Boards will face to balance the feedback received from financial institutions and regulators who have very different perspectives. The Board made no decisions during this meeting.
 

THURSDAY, 14 APRIL 2011

Interest Revenue Recognition and Definition of Amortised Cost (IASB and FASB)

Current IFRS and US GAAP define amortised cost in fundamentally different ways. US GAAP currently contains three separate definitions of amortised cost within various literature (FAS 114, FSP FAS 115-2 and SOP 03-3). The FASB’s proposed ASU includes a single definition of amortised cost of:

“A cost based measure of a financial asset or financial liability that adjusts the initial cash inflow or outflow (or the noncash equivalent) for factors such as amortization or other allocations. Amortized cost is calculated as the initial cash outflow or cash inflow (or the noncash equivalent) of a financial asset or financial liability adjusted over time as follows:

a.	Decreased by principal repayments
b.	Increased or decreased by the cumulative accretion or amortization of any original issue discount or premium and cumulative amortization of any transaction fees or costs not recognized in net income in the period of acquisition or incurrence
c.	Increased or decreased by foreign exchange adjustments
d.	Decreased by write-offs of the principal amount.”

IAS 39 currently defines amortised cost as “the amount at which the financial asset or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortisation using the effective interest method of any difference between the initial amount and the maturity amount and minus any reduction (directly or through the use of an allowance account) for impairment or uncollectibility.”

The primary difference between these two approaches is that the approach under IFRS subtracts an allowance for credit losses in calculating amortised cost while US GAAP does not. The feedback both Boards have received is that financial statement users wanted an interest income recognition model that allows them to analyse net interest margin and credit losses separately. As a result, both Boards unanimously agreed that a reduction for a credit impairment allowance would not be included in the calculation of amortised cost for a financial asset.

Discounted vs. Undiscounted Expected Losses

The joint Supplementary Document proposed that entities would be permitted to use either discounted or undiscounted expected losses in calculating the allowance amount under the time-proportional approach. However, the FASB did not participate in the discussions in developing the time-proportional approach so the Boards had not jointly discussed the issue of whether expected losses should be discounted or undiscounted. The staffs noted that the feedback received from comment letter respondents was that the Boards should either permit the use of undiscounted cash flows of expected credit losses due to operational concerns; or if consistency is desired then to require the use of undiscounted cash flows. The staffs also clarified that this discussion related to expected loss estimates of items in both the 'good book’ and the 'bad book’, expect for those items purchased directly into the 'bad book’ which had been discussed separately at the previous joint meeting.

The Boards’ discussions focused around the consideration of two alternatives. The first alternative would measure expected losses as principal only on an undiscounted basis which would require developing guidance for when to place loans on 'non-accrual’ status. The second alternative would measure expected losses as all cash flow shortfalls (both principal and interest) on a discounted basis which would require determination of how to present the unwinding of the discount on the impairment allowance.

The Boards were fairly split on the issue. IASB members generally agreed conceptually that amortised cost is a discounted cash flow measure. FASB members generally had concerns over the operationality of discounting expected credit losses. Additionally, one FASB member representing financial statement users felt it was important that loans in the bad book be placed on a non-accrual status as doing otherwise would distort the interest margin. The IASB members felt it was important that a principle be established based on the use of discounted cash flows and that methods to address operational concerns could be built in. The FASB members expressed concern with developing a requirement in the standard that people would have difficulty in applying in practice. The financial statement user representatives from both Boards agreed that not all financial statement users would have consistent views on the issue.

The Boards finally found some amount of common ground by tentatively deciding the objective of estimating expected credit losses would be a present value calculation; however, the Boards acknowledged that several statistical approaches may approximate that amount. One IASB member gave an example of utilising a loss rate that incorporates a present value component (using the example of a 5% expected loss rate to occur 5 years from today, an entity may use a loss rate of 3.5% or 4% which reflects the present value of those future cash flows that will not be received).

After deciding that the objective of estimating expected credit losses is a present value calculation approach, the Boards then began discussions on how to unwind (accrete) the associated discount. Under current IAS 39, because amortised cost is reduced for the allowance of incurred losses and interest revenue is calculated as the EIR times amortised cost, the discount is unwound through interest income. However, because the IASB has decided to 'decouple’ the presentation of impairment losses from interest revenue and because the Boards decided earlier in this meeting that amortised cost would not be reduced for the allowance for credit losses, the Boards have to determine whether to present the unwinding of the discount through either interest revenue (either in separate line items or on a net basis) or through impairment losses.

The Boards considered three alternatives for unwinding the discount. The first alternative would present the unwinding in the impairment losses line item. The second alternative would present the unwinding as a separate line item below interest revenue to result in a net interest revenue amount. The third alternative would present the unwinding within interest revenue and disclose the components in the notes to the financial statements.

Similar to the discussion on discounting, the Boards generally had different views on the presentation. The FASB members all supported presented the unwinding in the impairment losses line item. The IASB members generally supported presenting the unwinding as a separate line item below interest revenue to result in a net interest revenue amount.

One FASB member expressed significant concerns over the operationality of either the second or third alternatives believing it would require creating closed portfolios for each year of originated loans. The FASB Chair also expressed concern that this decision was inconsistent with the decision just made on discounting as it would require performing a present value calculation rather than using another statistical method such as a loss rate. The IASB finally found enough support (9 votes) to agree with the FASB on presenting the unwinding in the impairment losses line item and providing some level of disclosure around unwinding.

Discussion at the May 2011 IASB Meeting

Plan for the project given constituent feedback

The Boards discussed a plan forward for the impairment project based on the inconsistent feedback received from comment letter respondents and outreach activities to the Board's proposals as contained in the Supplementary Document (the "Supplement").

The staffs proposed four alternatives for the Boards to consider:

Members from both Boards were in general agreement that they needed to make some final decision soon and that it was important that it be a joint decision. However, one IASB member suggested setting a timetable deadline and if resolution was not achieved by that date then the respective Boards should move on individually. One IASB member noted that they were approaching the fourth anniversary of the financial crisis and were yet to resolve one of the major accounting issues associated with the crisis. Another IASB member asked what timeline the staff had in mind for the alternative of developing a new variation of the impairment model; the staff responded that ideally by the end of June they would have agreement on the big picture.

One of the FASB members suggested that a path forward may be to look at the weaknesses identified in the incurred loss model and addressing those, rather than proceeding with an entirely new model. Specifically he mentioned reconsidering the data set of information used in estimating losses and lowering the threshold for recognising an incurred loss. Other members of both Boards had reservations of such an approach and felt that moving to an expected loss model was critical in order to improve financial reporting. Another FASB member suggested that perhaps the Boards could focus first on disclosures and find agreement there by providing users the information they really need to perform their financial statement analysis and then focus on the amounts recognised in the balance sheet and income statement.

The incoming IASB Chair stated that the financial institutions were also critical of the work of the Basel Committee when developing the Basel III regulatory requirements. So just because the financial institutions were critical of the proposals doesn't mean that that proposals in the Supplement may not be the right answer. He suggested that modifying the incurred loss model would not be strong enough. He also referenced the fact that many European financial institutions have sovereign debt securities in their portfolios trading at significant discounts but for which no impairments have yet been recognised. He closed by saying that the Boards had to come to some resolution.

The FASB Chair mentioned that based on the feedback received, there seemed to be agreement on recognition for the bad book and for removing impairment recognition triggers. The concerns focus more on the transfers to the bad book and then the recognition of expected losses in the good book. She suggested the Boards focus on an approach to the good book that is both operational and explainable to investors, as the potential for switching between the time proportionate and the foreseeable future allowance amounts from period to period was concerning for preparers to explain the amounts to investors. An IASB member followed that it was important the Boards develop a model where one approach does not dominate the other as a common comment received was that the foreseeable future period allowance would often times dominate the time proportionate allowance.

The current IASB Chair closed the meeting with the Board agreeing to the alternative in which the impairment subgroup would work expeditiously to develop a variation of the impairment model based on the feedback received. He suggested one approach the group consider of using a building blocks approach in which the allowance would be comprised of:

The Boards generally agreed that such an approach was worth consideration.
 

Discussion at the June 2011 IASB Meeting

Alternate approach developed by the working group

During the May 2011 Board meeting, the IASB and FASB had asked a small working group of staff and Board members to develop a variation of the proposals in the Supplementary Document (SD) considering the feedback received through outreach activities and comment letters. The IASB staff presented the Boards with a high level summary of the approach developed by the working group.

The model developed by the working group would seek to reflect the general pattern of deterioration of the credit quality of loans. Similar to the proposals in the original exposure drafts and the SD, the impairment model would be based on expected credit losses and would develop those expectations of future credit losses based on historical, current and forward looking information that is reasonable and supportable.

The model would divide assets subject to impairment into three categories based on levels of credit deterioration. The first category would be the general portfolio level of assets that do not meet the criteria for either of the second two categories. For this category the working group has developed three possible alternatives for recognising expected credit losses:

• Alternative A – recognise an impairment allowance equal to 12 months' worth of expected losses only based on current loss expectations by using an annual loss rate multiplied by the balance of assets in category 1
• Alternative B – recognise an impairment allowance equal to a time-proportional amount of expected credit losses based on current loss expectations by calculating the lifetime expected credit losses multiplied by the factor of the weighted average age divided by the weighted average life
• Alternative C – recognise an impairment allowance equal to 12 months' worth of expected losses based on initial expectations plus the full amount of any subsequent changes in expected credit losses; this involves two separate calculations, the first is similar to that required under Alternative A and the second is based on the lifetime effect of changes in expectations of future lifetime losses.

The second category would consist of a group of assets that have been impacted by the occurrence of an observable credit event which indicates a possible future default but the specific assets that will default cannot be specifically identified. For the second category, the full lifetime expected credit losses would be recognised as an allowance, but the allowance would be calculated on a portfolio basis.

The third category would consist of assets where information is available that specifically identifies that credit losses have, or are expected to occur for individual assets. Similar to the second category, the third category would recognise the full lifetime expected credit losses as an allowance, but the allowance would be calculated on an individual asset basis.

The IASB staff provided a simple example to illustrate the application of these three categories. Bank Z's entire portfolio consists of loans in Country X that includes mortgage loans in Town ABC and Town XYZ. The national GDP in Country X decreases such that the general level of credit defaults for Bank Z's entire portfolio increases. This change of circumstances would be considered in the amount of expected losses estimated for the first category but would not result in a transfer of loans to the second category where the entire lifetime expected losses would be recognised. However, if housing prices in Town ABC decrease to an level that defaults are expected to increase, all mortgage loans to borrowers in Town ABC would be transferred from category 1 to category 2 and the entire lifetime expected losses would be recognised immediately. This is because the declining house prices have a direct relationship to potential future defaults but it is not clear yet which specific mortgages to borrowers in Town ABC are likely to default. The working group notes the cliff effect resulting from transferring loans from category 1 to category 2 with the recognition of all lifetime expected losses and therefore the working group believes it appropriate to have a notion of an observable event causing loans to be transferred between categories.

The IASB staff also provided the Board with a table that summarises their considerations for each of the approaches which has been replicated below.

The staff mentioned they had reached out to some of the expert advisory panel (EAP) members to solicit views on the three alternatives for category 1. For operational reasons they generally supported Alternative A over Alternative B and then Alternative B over Alternative C. Some EAP members also had issues with the staff's description of Alternative C as being conceptually the best alternative.

The staff also mentioned that they would consider incorporating the guidance around incurred but not reported (IBNR) losses that exists in current IFRS and US GAAP to provide additional guidance around transfers from category 1 to category 2.

The Boards tentatively agreed to allow the staff to further develop an impairment model based on three categories using credit risk or credit deterioration as the distinguishing feature between the categories. They also tentatively agreed that for the assets in category 2 and category 3 the allowance would be recognised as the full lifetime expected loss and that for category 1 the objective of the allowance would be to recognise an impairment allowance equal to 12 months' worth of expected losses based on initial expectations plus the full amount of any subsequent changes in expected credit losses. However, the Boards acknowledged this objective was based on it conceptual merits and that there may be operational difficulty in complying with that objective; therefore they requested the staff consider how best to make the objective operational.

The IASB Chair also mentioned the Boards would like to re-expose a revised impairment model in September, therefore several decisions would need to be made during the month of July in order to give the staff drafting time in August in preparation to issue an exposure draft.

Discussion at July 2011 IASB Meeting

WEDNESDAY, 20 JULY 2011 (IASB-FASB)

Transfers between impairment 'buckets'

During the June 2011 joint Board meetings, the Boards agreed to continue development of an impairment approach for financial assets using three "buckets":

• The first bucket essentially comprises assets that are not in the second or third bucket (generally performing assets with no heightened expectation of future credit events) and would have an allowance amount recognised of less than the lifetime expected losses
• The second bucket would comprise assets that have been affected by the occurrence of observable events or conditions which indicate possible future default and would therefore have an allowance amount recognised of full lifetime expected losses (this category would typically be a portfolio of assets rather than individual assets)
• The third bucket would comprise assets where available information indicates credit losses are expected to, or have, occurred on individual assets and the allowance amount recognised would be the full lifetime expected losses (similar to bucket two).

At the last meeting, the staffs were asked to develop criteria on how and when assets should be transferred from one bucket to the next; the existing criteria in IFRS and US GAAP on current impairment triggers was one method suggested for developing this criteria.

The staffs presented to the Boards an agenda paper which summarised an event based approach (utilising the existing impairment triggers in IFRS and US GAAP) and a credit risk management approach. The credit risk management approach was further broken down into an 'absolute' credit risk model and a 'relative' credit risk model.

Under the event based model approach all assets (whether originated or purchased) would start in bucket one with transfers occurring based on specific events which indicate the existence of credit deterioration or improvement. However, the event based approach would also require differentiation between events that would cause a transfer between buckets and events that would not cause a transfer but would instead change the loss expectations. In considering this approach, the staffs felt it was difficult to identify a principle to differentiate events and changes in circumstances that would require a transfer across categories from those that would only impact the estimate of expected losses.

Under the 'absolute' credit risk model approach, the objective would be to reflect the change in credit quality of assets consistent with an entity's credit risk management practices. As assets are originated or purchased, they would be categorised into one of the three buckets based on its absolute level of credit risk, regardless of whether the asset's pricing appropriately reflects the associated credit risk.

Under the 'relative' credit risk model approach, the objective would be to reflect the credit deterioration or improvement in assets utilising an entity's credit risk management practices. This approach would result in transfers across buckets based on changes in credit loss expectations. As assets are originated or purchased, they would initially start in bucket one and then transfers to buckets two and three would occur based on changes in credit loss expectations. It was noted by the staffs that under this approach, some loans with higher credit risk could be held in bucket one while other loans with lower overall credit risk but for which changes in credit loss expectations have occurred would be held in buckets two or three.

During Board discussions, many Board members were generally supportive of the use of a credit risk model rather than solely an event driven model, although some Board members requested retaining or layering aspects of the event driven model into the credit risk model approach. Many Board members leaned toward the 'relative' credit risk model approach with some having fundamental concerns with the 'absolute' credit risk model approach.

One of the FASB members suggested using a 'more likely than not' threshold of whether the asset continues to perform consistently with the original pricing of the asset to determine whether the asset would be recognised in bucket one or bucket two. When it becomes 'probable' the asset will not perform consistently with the original pricing then the asset would move to bucket three. He also suggested potential disclosures of a roll-forward of asset balances from period to period which would include a migration of the allowance by bucket.

The FASB Chair added that if the event driven approach were incorporated into the credit risk model it was important that the terminology be more clear as use of the term 'events' suggests the model is no longer focused on 'expected' credit losses but rather incurred credit losses. She suggested use of the term 'cues' instead of 'events'.

The Board tentatively decided to proceed with development of a credit risk model using the 'relative' approach but including event indicators as cues for assets transferring between buckets.

'Bucket One' measurement

During the June 2011 joint Board meetings, the Boards tentatively agreed that for assets in 'bucket one' an allowance should be recognised equal to 12 months of expected credit losses based on the initial expectations plus the full amount of any changes in expectations. However, the Boards recognised there may be operational difficulties with such an approach and requested the staffs to further develop this approach ensuring it was operationally feasible and to conduct outreach to identify how to make the approach operational.

The outreach activities performed by the staffs (including EAP members) identified that the recognition approach supported by the Boards was the most operationally challenging of the alternatives considered by the Boards and would require significant systems modifications. Many also commented on the similarities to the original IASB exposure draft which was not considered operational for open portfolios of assets because of the requirement to track initial expectations of credit losses. These constituents also felt that if the migration to bucket two and bucket three occurred earlier than envisioned for transfers to the bad book would have been under the Supplementary Document (SD) proposals then the pressure on the allowance for bucket one would be diminished. As a result, they suggested the calculation for the bucket one allowance be as operationally simplistic as possible as the incremental benefit from a complex calculation methodology would not be justified.

The staffs presented the Boards with four alternative methods for calculating the bucket one allowance balance:

• Method A – 12 months' worth of losses expected to occur on the financial assets, or for the remaining expected life if that is less than 12 months
• Method B – 24 months' worth of losses expected to occur on the financial assets, or for the remaining expected life if that is less than 24 months
• Method C – A simplification of the original approach supported by the Boards by using a 'rolling' loss rate rather than maintaining an original loss rate
• Method D – A simplification of the original approach supported by the Board using remaining lifetime expected losses of assets expected to be transferred to buckets two and buckets three in the next 12 months plus credit deterioration on remaining assets in bucket one.

Based on the feedback provided during the outreach activities, the staffs believe that Method A and Method B are worthy of additional consideration but do not support further pursuing Method C and Method D because of the operational difficulty associated with these approaches. The staffs also wanted to clarify terminology as they felt the terms 'annual loss rate' and 'annualised loss rate' may be being used interchangeably when in fact they are different concepts. An 'annual loss rate' would be those losses expected to occur over the next 12 months while an 'annualied loss rate' would be the lifetime expected losses divided by the lifetime of the assets multiplied by a 12 month period. These two approaches could result in different allowance amounts if assets have loss emergence patterns that are front or back loaded.

One of the IASB members said that he was one of the more vocal supporters of the Boards' previous decision but he has changed his view to supporting either Method A or Method B as the allowance amount for bucket one would not be significantly different and because the Method C and Method D approaches would result in allowance balances that are not comparable across entities. One FASB member questioned how Method D could be described as a simplification of the Board's previous decision as he felt that such a method could not be practically applied. One IASB member said that he could support either Method A or Method B but that if a 12 month loss period was used then he would like to introduce disclosure requirements for assets on a 'watchlist' of being transferred from one bucket to another. One IASB member said he did not support either Method A or Method B because of the resulting day 1 loss that is associated with such an approach. One FASB member expressed concern with Method A as he felt that based on initial research he had performed of US banks over more than the last half century that banks typically have more allowance recorded than 12 months of write-offs, therefore he felt that Method A could result in less allowance being recognised that current US GAAP.

The Boards tentatively agreed to keep the calculation for the bucket one allowance operationally simple and to further consider an approach of using either 12 or 24 months' worth of losses expected to occur on the financial assets, or for the remaining expected life if that is less than 12 or 24 months. The Boards also tentatively agreed to require the use of an annual loss rate (or a 24 month loss rate).

August 2011: Deloitte survey finds support for impairment proposals

Deloitte's Global Financial Service Industry (GFSI) group has published IFRS 9 Impairment Survey 2011, based on the views of 56 major banking groups on the topic of loan impairment. Banks surveyed included seven of the top 10 global banking groups measured by total assets and span banks headquartered in Europe, Middle East & Africa, Asia Pacific and North America.

The survey found there was broad consensus that, even though the details of the new impairment requirements are not yet finalised, the expected loss approach should be the basis for the new impairment model.

Click for IFRS 9 Impairment Survey 2011 – A changing landscape (PDF 1.2MB, August 2011, 28 pages)

Discussion at September 2011 IASB Meeting

Feedback from Impairment Summit and Financial Instruments Working Group

During August 2011 the IASB and FASB staff and certain Board members held an Impairment Summit with credit risk managers from banks across multiple jurisdictions and a meeting of the IASB's Financial Instruments Working Group (FIWG). The purpose of both meetings was to obtain initial feedback on the Board's direction with the three bucket impairment approach.

The preferred approach of the Impairment Summit would align the impairment buckets with the credit quality of financial assets so that each bucket contains assets of similar credit quality regardless of whether the assets were originated or acquired. The participants of the Impairment Summit felt that requiring initial recognition of all financial assets in bucket one would result in a 'tracking issue' having to track the credit migration throughout the life of the loan. However, those participants who originate financial assets of lower credit quality would only support the above approach if the point of transfer between bucket one and bucket two is low enough so that most assets would be categorised in bucket one upon initial recognition.

The FIWG was conceptually opposed to recognition of day 1 lifetime expected losses for assets originated on market terms and that those loans should start in bucket one and move to lower buckets as they deteriorate in credit quality.

Participants of both the Impairment Summit and the FIWG believed that differentiation between buckets should be based on a principle rather than a brightline. Both groups also preferred a 12-month expected loss allowance rather than a 24-month expected loss allowance for assets in bucket one although the FIWG noted that both approaches are arbitrary. Both groups also supported a single impairment model for types of financial instruments.

Originated/Purchased Assets of Lower Credit Quality

The Boards then began a discussion on how to treat originated or purchased assets of lower credit quality on initial recognition. The staff highlighted that the Boards had previously tentatively decided that loans acquired at a discount due to expected credit losses would calculate the effective interest rate considering those credit losses. Therefore, those loans would need to be separately considered for integration into the impairment model being developed, but those assets were not the assets of lower credit quality being discussed today. Additionally, the staff highlighted that the following topic would focus on where to develop boundaries for each of the buckets so this conversation would not focus on where the lines between buckets would be drawn.

During the July 2011 joint Board meetings, the Boards had stated their preference for a 'relative' credit risk approach (basing the bucket classification on the deterioration of credit quality) rather than an 'absolute' credit risk approach (basing the bucket classification on the credit risk existing at a point in time). Under the 'relative' approach, all assets would be categorised in bucket one upon origination or purchase and then would migrate to buckets two or three based on subsequent deterioration in credit quality (or moving back from buckets two or three to bucket one based on subsequent improvements in credit quality). Under the 'absolute' approach, assets would be categorised based on the credit quality existing at a point in time so that all assets of similar credit quality would be classified in the same bucket. However, this approach could also result in assets being originally classified directly into bucket two or three based on the credit quality of the asset.

The staff provided the Boards with a summary of the outreach performed with financial institutions in Europe, Asia, Australia, Africa and North America. The feedback noted that to apply the 'relative' credit risk approach, entities using the Basel II – Advanced Internal Ratings Based (A-IRB) approach would have less operational difficulties than other institutions; however, even those entities had concerns over the manual intensive nature of the process necessary to gather the relevant data. For other entities, the operational concerns of the 'relative' credit risk approach included 1) currently not maintaining ratings history for existing assets, 2) systems do not monitor deterioration of credit quality to the level of detail required, and 3) historical loss expectation data is not always available. The staff highlighted that consistent feedback has indicated that current credit risk management systems are not built to track deterioration in credit quality over the life of the asset, rather they are built to manage assets of similar credit qualities as of a point in time.

Based on the feedback received, the staff asked the Boards for further direction in the development of the impairment model. The three alternatives proposed to the Boards were 1) to continue investigating the operational challenges posed by the 'relative' credit risk approach, 2) move to an 'absolute' credit risk approach and accept full day-1 lifetime losses for assets originated/purchased into bucket two or three, or 3) explore ways to address the day-1 lifetime loss issue for assets originated/purchased into bucket two such as alternative measurements for expected losses of assets within bucket two or providing an option of applying the 'relative' credit risk approach.

The IASB Chair started the discussions by saying that he was surprised that financial institutions did not track credit migration of assets but has been convinced based on the consistent feedback the staff has received that the 'relative' approach would not be feasible. Another IASB member echoed the Chair's comments saying he too has been convinced after initially believing institutions would have access to such data, but that the cost to implement the necessary systems would not justify the incremental benefit to financial reporting. Another IASB member agreed and reminded the Boards that they often refer to how the model would be applied by the largest financial institutions but that they are building a model for all entities including non-financial institutions.

However, a few IASB members were less convinced of the feedback provided by the staff. One Board member mentioned that he thought institutions would be willing to implement the systems if the resulting accounting answer was preferable. Another IASB member mentioned that he had sympathy for the operational concerns the institutions had expressed, but they could not have it both ways, either they invest in making the systems enhancements are they accept the day-1 loss recognition for assets originated/purchased into bucket two. One IASB member also expressed his scepticism that the systems issue could not be more easily overcome.

One of the FASB members asked the staff about the scope of the model being developed and its application to all financial assets subject to impairment as the discussions of this iteration of the impairment model have focused strictly on commercial loans but not retail loans or debt securities. The staff responded that the same base model should be able to be applied to all assets but it may require accommodations based on asset type. That FASB member also mentioned that there had been conceptual differences across jurisdictions in the approach to impairment but that the operational issue seemed to be a cross-jurisdictional issue. The staff confirmed that consistent messages have been received across jurisdictions regarding the operationality of the 'relative' credit risk approach but that the conceptual differences across jurisdictions may still exist for the treatment of assets originated/purchased directly into bucket 2 and the ensuing recognition of day-1 lifetime expected losses. The FASB Chair inquired how their constituents are currently complying with their rollforward disclosure requirements as she envisioned it would have similar tracking issues, but the staff mentioned that was looking at changes from period to period rather than lifetime credit migration.

The Boards seemed to generally support moving off the 'relative' credit risk approach towards the 'absolute' credit risk approach. Their discussion then shifted to discussing the issue of day-1 losses for assets originated/purchased directly into bucket two.

One IASB member mentioned the difficulty he had with the day-1 loss notion for assets originated/acquired on market terms and suggested the Boards consider the measurement of impairment for bucket two assets. One IASB member mentioned that it was hard to have the conversation without first having the discussion on where the bucket boundaries would be set, but his feeling the number of assets being directly originated/purchased into bucket two would be fairly small. He supported an approach that would permit an option for tracking assets using the 'relative' approach if entities were inclined to pursue such a methodology. Another IASB member expressed support for the alternative of investigating other solutions such as an option to apply the 'relative' approach. Another IASB expressed support for addressing the day-1 loss issue by looking at the notion of bucket two.

One IASB member raised the question of what would be included in the Boards went with alternative two (accepting day-1 losses for assets originated/purchased into bucket two). He expressed concern over purchased assets in a business combination that would be originally measured at fair value (with an imputed discount for expected credit losses) but then could be placed into bucket two and then have full lifetime expected credit losses recognised again. One of the FASB members mentioned that they may need to look at interaction with business combination accounting as part of this project to allow for recognition of an impairment allowance as part of purchase accounting. The IASB member expressed his view that the day-1 losses did not reflect the underlying economics and supported recognition of impairment losses through the effective yield (eg the original IASB approach). Another IASB member had a view that the Boards should go back and reconsider whether three buckets are necessary and perhaps look at simply revising IAS 39.

The IASB Chair attempted to move the discussion forward by summarising that the Boards seemed to generally support a move to an 'absolute' credit risk approach but that two issues had been raised that needed to be further explored. The first issue relates to the acquisition of loans that are initially measured at fair value and then placed into one of the impairment buckets where an additional allowance is calculated. The second issue relates to 'markets' where the origination of assets of lower credit quality is the norm rather than an exception and the impact of initially categorising those assets directly into bucket two under the 'absolute' approach. The second issue prompted discussion on the term 'market' and whether that referred to a geographic location or a product line. Some Board members felt it was a geographic issue, while others thought it was a business model issue.

The IASB unanimously supported the IASB Chair's summary and a proposal that the staffs investigate further how to address the two issues identified. The FASB also agreed to have the staffs further investigate these issues, but expressed significant reservations in addressing the issue through permitting an option of the 'relative' credit risk approach for assets of lower credit quality or for recognising less than lifetime expected losses for assets in bucket two.

Principle of Transfers Between Buckets

The Boards then began a discussion on how to develop a principle of when to transfer financial assets between bucket one and bucket two (ie when it becomes necessary to recognise lifetime expected credit losses). The staff highlighted their consideration of three alternatives for the transfer principle: 1) based on the extent of the deterioration in credit quality, 2) based on 'any' deterioration in credit quality, or 3) based on deterioration in credit quality to a particular level. The staff has also considered three alternatives in the development of a transfer principle by utilising 1) external rating definitions and regulatory classifications, 2) credit risk management objectives, and/or 3) indicators.

The staff provided the Boards with the ratings grades and descriptions from two rating agencies. The Boards began a granular discussion of where to draw the line between bucket one and bucket two using the credit rating agency grades and descriptions. Some felt the line should be the investment/non-investment grade differentiator while others had other cut off levels. However, the Boards quickly took a higher level approach discussing how to develop a principle around the rating descriptions. Several Board members felt that by utilising language similar to that used by the descriptions of the credit rating agencies they could develop a workable principle. One IASB member mentioned he wanted to identify bucket two as the point when an entity begins to manage their assets differently.

While the Boards made no formal decisions, they did express support for the staffs to further develop a principle for transfer based on deterioration of credit quality to a particular level by utilising the concepts and definitions of rating classifications along with concepts of regulatory guidance and other credit risk characteristics. The staff will also develop guidance on information to be considered and examples based on real life fact patterns.

Discussion at October 2011 IASB Meeting

The Boards concluded that the staffs should develop (1) an impairment model using a relative credit risk approach, (2) potential triggers, indicators, or thresholds used to transfer assets out of Bucket 1 into Bucket 2, and (3) disclosures to provide transparency around an entity's credit risk management and application of the impairment model. The staffs plan on presenting these items to the Boards at their joint meeting in December.

Background

The objective of the proposed impairment model is to reflect the general pattern of deterioration of the credit quality of debt instruments. To do this, financial assets subject to impairment accounting (such as loans or debt securities measured at amortised cost or fair value through other comprehensive income) would be split into three main buckets. These buckets would determine the amount and timing of credit losses to be recognised on debt instruments reflecting different phases of credit deterioration.

The boards have been debating whether to apply a "relative" or an "absolute" credit risk approach in "bucketing" debt instruments. Under a relative credit risk approach, originated and purchased assets would be initially classified in Bucket 1 even if they are of lower credit quality (e.g., subprime loans) and would be subsequently transferred into Bucket 2 or 3 if a deterioration in credit quality occurs; for loans acquired at a discount due to credit losses, the effective interest rate is calculated taking into account initial credit loss expectations and no allowance is established upon initial recognition. However, feedback from initial outreach efforts indicated operational challenges related to that approach (e.g., entities may be unable to monitor and track deterioration in the credit quality of assets over time because of system limitations and, in certain circumstances, may not maintain historical loss expectation data). Instead of pursuing a relative credit risk approach, therefore, the boards reversed course and tentatively decided at their September 2011 meeting to pursue an "absolute" credit risk approach in which all assets of similar credit quality as of a point in time are included in the same bucket. Under the absolute credit risk approach, assets with lower credit quality may be originated or acquired directly into Buckets 2 or 3.

Relative Credit Risk Approach

The Boards began their discussion on the impairment of financial assets by providing feedback obtained in a meeting with banking regulators and the Institute of International Finance. Preparers were concerned about a model, such as an absolute credit risk approach i The absolute and relative credit risk approaches were discussed at the September 21, 2011 joint board meeting –, that would result in day 1 losses, particularly for entities who participate in higher risk lending. The Boards responded to these preparers that they had decided to change course (as noted above) and pursue an absolute credit risk approach rather than a relative credit risk approach because of concerns expressed by preparers about the operationality of a relative credit risk approach.

Because of (1) the inconsistencies in the feedback received on the absolute and relative credit risk approaches (through previous outreach studies and by way of this meeting) and (2) the Boards' views that the relative credit risk approach was conceptually better than the absolute credit risk approach and that the perceived operational concerns with a relative credit risk approach were not as insurmountable as previously assumed, the Boards directed the staff to develop an impairment principle using a relative credit risk approach. This approach would most closely align with the overall objective of the "three bucket" expected loss model, which is to reflect the general pattern of deterioration of the credit quality of assets. Under this approach, assets would start in Bucket 1 and would be transferred to Bucket 2 and Bucket 3 as credit loss expectations deteriorate (reflecting the uncertainty in the collectibility of cash flows). In addition, the Boards recommended that the principle apply not only to loans but also to debt securities.

The Boards also discussed the principle supporting the Bucket 1 allowance of 12 to 24 months. While some board members believed that the allowance amount represented an incurred-but-not-reported (IBNR) loss amount, others viewed the allowance as an amount that properly adjusted an asset's effective yield. Because of this debate, the Boards highlighted the need to clearly articulate this principle when drafting the Basis for Conclusions for the new impairment standard.

Transferring Out of Bucket 1

The Boards acknowledged that the a new impairment model would address the "too little, too late" criticism raised in the recent financial crisis about the current impairment model in U.S. GAAP and IFRS only if the principle on when to transfer assets out of Bucket 1 was clearly articulated and grounded by a threshold lower than "probable", indicating a deterioration in an asset's credit quality to a particular level. Based on previous Board discussions, this principle would incorporate the concepts and definitions of rating agency classifications along with concepts of regulatory guidance. Further, certain Board members indicated that the principle should also incorporate a notion that an entity should not ignore current market conditions that may indicate that some or all of the contractual cash flows will not be collected.

Disclosures

The Boards acknowledged that a relative credit risk approach to impairment may lead to comparability concerns across financial institutions because the manner in which entities manage credit risk and view assets' credit quality may differ. Accordingly, the Boards instructed the staffs to develop disclosures to provide transparency around an entity's credit risk management. The Boards also recommended that the staffs leverage existing standards when developing such disclosures.

Next Steps

Some Board members expressed a concern that the staffs could not develop an impairment principle based on a relative credit risk approach and related disclosures in time for the next joint meeting in November. Because of this, the Boards agreed to discuss the staffs' proposals at their joint meeting in December.

Discussion at the December 2011 IASB Meeting

WEDNESDAY, 14 DECEMBER 2011

During the October 2011 Board meetings, the Boards asked the staff to develop a principle for the measurement attribute of the credit allowance balance of financial assets included in bucket one and develop a principal and indicators for when it is appropriate to transfer financial assets from bucket one to bucket two. The December meeting was spent discussing a variety of topics in the continued development of the three bucket impairment model.

Principle of transfer from bucket one to bucket two

When recognition of lifetime expected losses is appropriate

The IASB and FASB staffs brought the Boards three alternatives for establishing a principle of transfer with the first two alternatives having multiple variations. The first alternative focuses on the extent of deterioration in credit quality since initial recognition, the second alternative focuses on both the extent of deterioration in credit quality expected at initial recognition and the risk of not collecting the contractual cash flows, and the third alternative focuses on deterioration in credit quality such that management changes its objective in holding the financial asset.

The variations for each of the alternatives were presented as follows:

• Alternative 1A – Recognise lifetime losses when there has been meaningful credit deterioration since initial recognition (but without defining meaningful)
• Alternative 1B – Recognise lifetime losses when the entity no longer expects to receive substantially all of the cash flows expected at initial recognition due to deterioration in credit quality
• Alternative 1C – Recognise lifetime losses when there has been a more than insignificant deterioration in credit quality since initial recognition
• Alternative 1D – Recognise lifetime losses when the entity no longer expects the same credit risk as at initial recognition due to deterioration in credit quality
• Alternative 2A – Recognise lifetime losses when there has been a more than insignificant deterioration in credit quality since initial recognition AND it is at least more likely than not that the contractual cash flows may not be fully recoverable
• Alternative 2B – Recognise lifetime losses when there has been a more than insignificant deterioration in credit quality since initial recognition AND it is at least reasonably possible that the contractual cash flows may not be fully recoverable
• Alternative 2C – Recognise lifetime losses when there has been a more than insignificant deterioration in credit quality since initial recognition AND it is remote that the contractual cash flows may not be fully recoverable.
• Alternative 3 – Recognise lifetime losses based on deterioration in credit quality being such that it changes managements objective for managing the asset (e.g., when the holders credit risk management objective changes from merely monitoring and analysing regular performance updates to actively engaging in managing the credit risk exposure to try to address the issues giving rise to the problems with the asset(s) and to allow appropriate re-calibration of the legal framework of the asset(s) taking into account the borrower(s) financial situation).

The Boards discussions focused on the meanings of the phrases or how the specific terms would be interpreted in practice. Most of the members from each Board tended to favour alternative 2 (particularly 2B) although some also supported Alternative 1B. One particular reason mentioned by Board members for favouring alternative 2 over alternative 1 was concern over the trigger being solely based on credit deterioration, citing the example of a AAA asset being downgraded to A as that movement may be meaningful or more than insignificant while an A credit rating would have relative insignificant concerns over collectability.

One FASB member suggested replacing the language in Alternative 2B from ‘at least reasonably possible that the contractual cash flows may not be fully recoverable’ to ‘other than remotely possible that the contractual cash flows may not be fully recoverable’. Other Board members were generally supportive of the use of ‘other than remote’ as they felt that was a lower threshold than ‘reasonably possible’. One IASB member expressed his support for Alternative 2B because it represented a fairly quick trigger to move items in to bucket two, which he mentioned was his takeaway of the Boards’ desire when they shifted from an absolute to a relative credit risk approach. However, some Board members had concern that the use of ‘other than remote’ could be interpreted to be as low as 5% while the Board tended to prefer a range of around 10% as the trigger to bucket two. One FASB Board member suggested moving the language used in Alternative 1B to the second criteria of Alternative 2B (i.e., ‘substantially all’ instead of ‘reasonably possible’ or ‘other than remote’) as he felt the term ‘substantially all’ was generally interpreted around 10%.

The Boards tentatively decided to proceed with the language proposed in Alternative 2B (e.g., recognise lifetime losses when there has been a more than insignificant deterioration in credit quality since initial recognition AND it is at least reasonably possible that the contractual cash flows may not be fully recoverable). The Boards also asked the staff to develop illustrative examples to highlight that the transfer should occur when the ‘risk of default starts to substantially excellerate’.

Whether the transfer should be based on probability of default or expected loss

The staffs asked the Boards to clarify whether the deterioration in credit quality is 1) the likelihood of not receiving the expected cash flows probability of default (PD) or 2) the expected loss using PD, loss given default (LGD) and exposure at default (EAD).

The staffs recommended that loss given default (LGD) information would factor in to the measurement of lifetime losses but would not factor in to the assessment of the transfer between buckets. Instead, the transfer assessment would consider solely probability of default (PD). The staffs also clarified that collateral would not be considered in the assessment of transferring items between buckets but rather the focus is whether the contractual payments will be collected. The staffs also stated their recommendation was based in part because financial institutions are familiar with tracking PD and therefore such an approach would be more operational.

The Boards were supportive of using PDs as the basis for the trigger of transfers between buckets. However, one IASB member had significant concerns with not also including consideration of LGDs. Several Board members noted that PDs would be impacted by changes in LGDs information. However, the IASB member with the concern referenced certain scenarios where he felt PDs would not reflect increases in LGDs such as a debt restructuring. Other Board members acknowledged they felt PDs should be the primary driver but could understand the concerns being raised and didn’t want the guidance to be so strict that assessment of other information should not be considered.

The Boards tentatively decided that probability of default should be the primary driver in determining when to transfer financial assets between buckets. However the Boards asked the staff to also include language that would not ignore other information indicating the potential for loss (such as LGD information).

Indicators for when the recognition of lifetime expected losses is appropriate

The staffs presented the Boards with potential indicators of when a financial asset may have experienced deterioration in credit quality. Those indicators include changes in: 1) general economic conditions, 2) industry conditions, 3) market indicators of credit risk, 4) re-origination rates, 5) management approach, 6) company performance, 7) company prospects, 8) collateral values, 9) credit quality enhancements/support, 10) loan documentation, 11) expected performance of the borrower and 12) other changes.

One FASB member questioned the inclusion of collateral values given the previous decision that the trigger would primarily be based on PDs. The staff noted that decreases in collateral values (for example a home value less than the outstanding loan balance) could provide incentive for borrowers to walk away from the debt and that incentive is tied to PDs rather than consideration of the recovery from the collateral which would be tied to LGDs.

Both Boards tentatively decided to include the guidance around potential indicators in the impairment proposals.

Bucket one allowance

The staffs asked the Boards to determine the objective of the allowance and its measurement attribute for financial assets in bucket one of the impairment model.

The staffs first asked the Boards to decide on the objective of the bucket one allowance by considering either 1) the approximation of a yield adjustment or 2) capturing expected losses which have not yet materialised (or no meaningful credit deterioration has occurred). No Board members expressed support for a yield adjustment approximation approach. However, the Board had difficulty in determining how to articulate the capturing of expected losses not yet materialised. One IASB member expressed concern with use of the term ‘materialised’. He also questioned whether the expected losses referred to PD (e.g., shortfall in cash flows) or LGD (including recovery of collateral). The staff clarified that the intention was to measure the shortfall in cash flows but that would also include LGD so recovery on collateral would be part of the consideration. The Boards then engaged in a debate over whether the objective of the bucket one allowance is to capture credit deterioration not yet identified or whether it is losses that are inherent in a portfolio based on original pricing and information. However, one IASB member felt that the only way to describe the objective of the bucket one allowance is one of ‘prudence’.

Given the difficulty in deciding on an objective, the Boards decided to focus on the measurement attribute for the bucket one allowance to see if that provided any better basis for determining the objective.

The staffs presented the Boards with three alternatives for the bucket one allowance:

• Shortfalls in cash flows expected to materialise in the next 12 months,
• Shortfalls in cash flows expected to materialise in the next 24 months, or
• Shortfalls in cash flows expected to materialise over an emergence period (the emergence period could be either 1) no established boundaries, 2) a minimum of 12 months and no upper boundary and 3) defining a range of between 12 and 24 months).

One IASB member started the discussion by acknowledging that the trigger for transfers to bucket two (and recognition of lifetime expected losses) that the Boards have established should result in an allowance balance larger than that currently under the incurred loss models in either IAS 39 or US GAAP. Therefore the allowance for bucket one is an additional provision. He noted that concerns that allowance balances in certain jurisdictions may go down as a result of the three bucket model is a result of regulatory overlays to existing impairment requirements and that the Boards cannot guess what regulators in each individual jurisdiction would want for bucket one. Another IASB member agreed that the Boards cannot consider all regulatory requirements around the world. The IASB Chair agreed that the bucket one allowance was an expedient and that it should not be too big nor too complex. A FASB member also agreed that in some jurisdictions reserves may go down simply because of the regulatory overlay aspect.

However, the FASB Chair said she did not believe that the bucket one allowance was a regulatory issue but rather an acknowledgment that there are future losses that exist in performing loans. Several IASB members showed support for use of a 12 month period for the bucket one allowance. One of those stated he could not support use of an emergence period.

One of the IASB members said that he would use the income statement amounts expected to be transferred to bucket two or three in the next twelve months and adjusted for known or other expected factors. The staff responded that their proposed approach would be 12 months of PDs multiplied by the lifetime losses and that may yield a similar approach as to that described by the Board member but this approach was seen as operational by financial institutions. The FASB Chair clarified that the PDs would need to be adjusted for changes in circumstances and for migrations to bucket two.

The Board tentatively decided to require a measurement for the bucket one allowance of shortfalls in cash flows expected to materialise in the next 12 months. The Board also decided the objective of the bucket one allowance would be to recognise 12 months of expected losses.

Pervasive issues

The Boards discussed two pervasive issues that needed to be addressed in order to continue development of the three bucket impairment model. The first issue relates to aggregation of individual financial assets for collective evaluation of credit deterioration. The second issue relates to the purpose and differentiation of bucket three as compared to bucket two.

Grouping of financial assets for impairment evaluation

Providing guidance on the appropriate level of aggregation for evaluating credit impairment is an important consideration for evaluating credit deterioration, particularly in the context of transferring entire portfolios from bucket one to bucket two.

The staffs noted that the existing guidance in US GAAP and IFRS, as well as the proposals in the supplementary document, emphasize ‘shared risk characteristics’ for determining how to aggregate individual financial instruments into groups.

The staffs recommended including the following guidance in the impairment model:

The objective of grouping is to segregate the financial assets into sub-populations of sufficient granularity to evaluate the groups for impairment (that is, to identify whether the recognition of lifetime losses is appropriate for that sub-population as of the assessment date).

An entity may not group financial assets at a more aggregated level if there are shared risk characteristics for a sub-group that would indicate whether recognition of lifetime losses is appropriate.

(a) Shared risk characteristics may include the following: asset type, credit risk ratings, past-due status, collateral type, date of origination, term to maturity, industry, geographical location of the debtor, the value of collateral relative to commitment for non-recourse assets (which may influence likelihood of debtor electing to default), and other relevant factors. Groups shall be created based on shared risk characteristics as of the assessment date (that is, the groupings may change each period).

If a financial asset cannot be included in a group because the entity does not have a group of assets that share the risk characteristics of that asset, or if a financial asset is individually significant, an entity is required to individually evaluate whether the recognition of expected lifetime losses is appropriate for the financial asset.

If a financial asset shares risk characteristics with other assets held by the entity, an entity is permitted to individually evaluate a financial asset within that group or include it in a collective evaluation of a group of financial assets with shared risk characteristics to determine whether the recognition of expected lifetime loss is required.

One of the FASB Board members asked whether the issue of grouping was related to the assessment for transferring buckets or the measurement of expected losses. The staff responded that for today’s purpose the scope was limited to grouping of financial assets for the evaluation of credit deterioration in determining bucket classification but that the staffs would need to come back to the Boards on the grouping for measurement purposes.

The Boards tentatively agreed to include the guidance as recommended by the staff above.

Differentiation between buckets two and buckets three

The Boards also discussed the issue of how bucket three should be differentiated from bucket two given that both buckets share the same measurement attribute (e.g., lifetime expected credit losses). The Boards considered three alternatives for bucket three. The first alternative would use a deterioration principle such that assets that have continued to deteriorate in credit quality beyond those assets in bucket two would then be transferred to bucket three. The point of transfer would be based on either the degree of credit deterioration since initial recognition or once deterioration has reached a particular level. The second alternative would differentiate bucket two and bucket three based on a unit of evaluation such that bucket two would include assets evaluated collectively while bucket three would include only assets evaluated individually. The third alternative would merge buckets two and buckets three since they share a similar measurement attribute.

The FASB members were generally supportive of alternative two while the IASB members were generally split between alternatives two and three although a couple of IASB member expressed support for alternative one. Certain FASB members felt there was important information provided by stratifying assets between buckets two and three while certain IASB members questioned whether any benefit was gained from stratification other than for disclosure purposes. This led to a debate over whether bucket three was a measurement issue or simply a disclosure issue. Certain FASB members felt, in addition to information for disclosure purposes, there could be measurement implications as individual assets are transferred out of bucket two and in to bucket three could result in measurement difference in the PDs and LGDs of those remaining assets in bucket two.

The Boards tentatively decided that bucket three would be differentiated from bucket two in that bucket three would relate to assets evaluated for credit deterioration individually rather than collectively.

THURSDAY, 15 DECEMBER 2011

Application of the three bucket model to debt securities

The Boards' discussions around development of the three bucket approach have to date focused around commercial loans. However, constituents had raised concerns in the supplementary document and during outreach activities over the application to individual debt securities. The Boards took this opportunity to discuss specific application issues associated with debt securities.

The Boards first discussed whether the guidance around grouping of financial assets was appropriate for debt securities. The Boards felt the guidance would work for debt securities and should not change existing practice of evaluating debt securities on an instrument-by-instrument basis.

The Boards then considered whether the list of indicators decided upon during the previous day were sufficient for both loans and debt securities or whether debt securities, given they often had fair values quoted in active markets, required some rebuttable presumption indicating recognition of lifetime expected losses was appropriate when the fair value was less than the cost basis for a predefined term (either percentage decrease or percentage decrease for a period of time).

The staffs noted that when the fair value of the debt security exceeded the cost basis that in most cases an entity could conclude that recognition of lifetime losses was not required. One IASB member questioned when the fair value exceeding the cost basis could result in recognition of lifetime expected losses. The staff responded that, while remote, there could be a possibility of an instrument with a high coupon in a low interest rate environment where the issuer was experiencing credit deterioration such that the instrument would trade at a premium as a result of the yield above market rates even after taking in to account the credit deterioration of the issuer.

One IASB member raised an issue with the 'change in market indicators of credit risk' indicator decided upon the previous day noting the guidance for securities discusses 'the length of time and the extent to which the fair value of the debt security has been less than the amortised cost'. His concern focused on the trigger established by the Boards for movements to bucket two did not include a time based concept and he feared establishments of brightlines in application. The staffs acknowledged his concern and said they would consider how to clarify the indicator so as not to establish brightlines.

One IASB member then asked the staffs whether debt securities in buckets two or three would be eligible to return to bucket one. The staffs responded that their intention was to keep the impairment model the same for loans and debt securities and that since loans could return to bucket one after being moved to bucket two they felt that debt securities should do the same. This raised the issue with other Board members on whether the impairment model should be symmetrical or not. The FASB Chair raised the issue of a restructured debt and how that would be treated when considering whether to move back from bucket three in to bucket one. Several Board members said the Boards should examine how the indicator approaches when applied to improving credit conditions.

The Boards agreed with the staff that the indicators were sufficient to apply to both loans and debt securities and that no rebuttable presumption (e.g. brightline) should be applied for evaluating debt securities for credit deterioration when fair value is less than the cost basis.

The Boards then discussed the application of an expected value approach in estimating expected losses for debt securities. The Boards had previously decided that expected losses should be estimated with the objective of an 'expected value' approach. However, constituents have raised concerns over application of an 'expected value' approach to assets assessed for impairment on an individual basis as it results in an expected loss that is not one of the possible alternatives and does not consider the fair value of the collateral for secured lending arrangements.

During the March 2011 Board meeting, the Boards had agreed that the final standard would clarify that:

"in practice, a concrete estimate of an expected value would not require the use of every single possible outcome. Rather, in the case where there are many possible outcomes, a representative sample of the complete distribution can be used for determining the expected value of the credit loss. In identifying that sample, the entity would need to take into account only the information that is available about the outcomes. It would not have to (and should not) make up anything else."

The staffs asked the Boards whether additional application guidance should be provided for individually evaluated financial assets. The FASB Chair recommended that the existing guidance in US GAAP with respect to consideration of collateral values be carried forward in to the impairment model. She acknowledged this was not an expected value but would simplify the approach in certain instances. One IASB member expressed concern with inserting US guidance in to IFRS but acknowledged that application guidance should be provided and it should be clarified that a most likely outcome approach is not consistent with an expected value. The FASB Chair asked the IASB member if a loss rate approach were utilised which dropped the high and low end possibilities from consideration if that was viewed as an expected value approach. The IASB member said he would view it as a good proxy for an expected value approach. A FASB member said he agreed with the IASB member but thought the Boards should include some practical expedients are proxy approaches to expected values.

The staffs said they would work on developing further guidance around methods that could reasonably be used to achieve the objective of an expected value approach. The Boards suggested the staff look to the decisions made in the revenue recognition and insurance projects regarding expected value approaches.

Application of the three bucket model to loans

As noted above, the Boards' discussions around development of the three bucket approach have to date focused around commercial loans. The Boards took this opportunity to consider the impairment model under development to both commercial and consumer loans. Based on the analysis provided by the staffs, the Boards felt that the model under development should work for both consumer and commercial loans.

The Boards also decided that the impairment model should not include a presumption (e.g., brightline) that meaningful credit deterioration has occurred based on predetermined factors such as number of days delinquent or reaching a particular credit risk rating.

The staffs also raised the issue of whether concentration risk of loans should be captured within an expected value measurement. Concentration risk of loans is a similar concept to a blockage factor for equity securities in that holding a significant amount of loans in a concentrated area, should the underlying collateral need to be seized and sold, the marketing of all properties in the same area would put downward pressure on the sales price. The Boards were of the view that similar to the blockage factor in a fair value measurement, the concentration risk would not impact the measurement of expected losses but is something that could warrant consideration for disclosure purposes.

Discussion at the January 2012 IASB Meeting

The IASB and FASB continued their discussions on the development of the three bucket impairment model. As part of the development of the Supplementary Document (‘SD’) issued in January 2011, the Boards had tentatively decided in March and April 2011 that purchased financial assets where there was no explicit expectation of credit losses would be assessed for impairment under the SD approach (similar for originated financial assets) while purchased financial asset with an explicit expectation of loss (e.g., those purchased at a deep discount due to credit deterioration) would recognise interest income based on expected cash flows rather than contractual cash flows. However, given the significant differences in the impairment model under the three bucket approach and the good book/bad book approach in the SD, the staffs wanted the Boards to revisit their previous decisions on purchased financial assets.

Application of the general impairment model to financial assets with an explicit expectation of losses at acquisition

The Boards considered whether, for purchased financial assets that have been designated for income recognition using expected cash flows, changes in initial expectations should be based on a bucket one measurement (e.g., changes in the next 12 months) or on a bucket two/three measurement (e.g., changes in lifetime expected losses). The result of this decision would determine whether these purchased assets would initially be classified in bucket one or in bucket two or three for future impairment considerations. While initially classifying these loans in buckets two or three could be viewed as inconsistent with the overall three bucket impairment model (which would begin all assets in bucket one with transfers based on deterioration of credit quality), such an approach still follows a deterioration notion as no impairment expense is recognised upon acquisition, rather impairment is only recognised upon changes in initial expectations. Based on this rational, the IASB and FASB tentatively decided that purchased financial assets with an explicit expectation of losses should be initially classified in buckets two or three and recognise an impairment allowance based on the changes in lifetime expected cash flows since acquisition.

Scope

The Boards then discussed the scope for which purchased financial assets it is appropriate to recognise interest income based on an initial expectation of cash flows at the time of acquisition and what level of aggregation should be used in that assessment.

Both existing IFRS and US GAAP include similar concepts for purchased financial assets that have experienced credit deterioration since origination. IAS 39 describes the scope of such instruments as those ‘acquired at a deep discount that reflects incurred credit losses’. US GAAP’s ASC 310-30 applies to financial assets with ‘evidence of deterioration of credit quality since origination acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable’. During the March and April 2011 discussions on purchased financial assets the Boards had used the phrase ‘purchased financial assets where an explicit expectation of losses exists [when analysed at the individual asset level]’.

The discussion began with the IASB Chair asking the staffs if there was a possibility of marrying the two existing scope criteria. The IASB staff noted that the existing scopes in IFRS and US GAAP are based on an incurred loss model and use in an expected loss impairment model may not be as easily transferable as thought.

The IASB Board members, with minor exceptions, were broadly in favour of keeping the scope fairly narrow by using language similar to ‘explicit expectation of losses’ as they believed this would be interpreted similar to the ‘acquired at a deep discount’. They noted the operational concerns of the original IASB ED which required an expected cash flow interest income recognition model and therefore wanted to ensure the population was not too broad to reintroduce those operational concerns. One IASB member did note a preference for ‘fine-tuning’ the existing scope definitions raising a concern over introduction of the term ‘explicit expectation of losses’ and its ultimate interpretation. Another IASB member preferred to make the division at purchased financial assets expressing concern over how to appropriately differentiate ‘deep discounts’ and other discounts. One IASB member mentioned the importance of appropriately defining unit of account and raised concerns over the possibility of creating arbitrage opportunities such that grouping a problem purchased loan with other performing purchased loans in order to bypass the scope.

However, certain FASB members preferred to use similar terminology as to the model for transferring originated assets to bucket two or three. They suggested that purchased assets would recognise interest income based on expected cash flows when there is a more than insignificant deterioration in credit quality since origination and the likelihood of default is such that it is at least reasonably possible that the contractual cash flows may not be recoverable. However, the IASB cautioned that such an approach could lead to scope much broader than intended and subject more financial assets to this income recognition model, reintroducing the operational concerns with the original IASB exposure draft. The FASB Chair noted that she would prefer to get the scope right and then address the accounting separately to see if modifications could address those operational concerns. However the IASB was highly sceptical of such an approach noting they’ve been working for several years in attempting to address those operational challenges and the time proportional approach in the SD was their best effort at addressing those concerns which was rejected by constituents.

The Boards made no decision on scope of purchased assets subject to an income recognition model based on expected cash flows.

Changes in Expectations Subsequent to Acquisition

Under the model for purchased financial assets with credit deterioration, where interest income is recognised on expected cash flows and impairment is based on credit deterioration subsequent to acquisition, the issue of improvements in credit quality must be considered. The Boards considered whether the original effective interest rate (‘EIR’) based on expected cash flows should be ‘unlocked’ and adjusted for improved expectations or whether reversals of impairment charges or gains should be recognised immediately in profit or loss. Under current US GAAP, the EIR is adjusted for favourable changes in expectations while under IFRS, for fixed rate assets the EIR is locked and any changes are recognised as changes in the impairment allowance.

The Boards were generally supportive of an approach where the initial EIR is locked and any favourable changes in expected cash flows is recognised as income in profit or loss. The staff proposals had included recognition as a ‘gain’ but one of the FASB members raised issue with this classification and requested recognition as a contra provision for loan loss rather than a separate revenue item. The FASB members agreed with this modification; the IASB members were originally not supportive preferring recognition as revenue rather than distorting the provision amount. However, for convergence the IASB also tentatively decided that increases in cash flows expected to be collected are recognised immediately in profit and loss as a reduction of the provision but require disclosure of this contra provision amount.

Presentation of Purchased Financial Assets with an Explicit Expectation of Losses

Under IFRS 3(R) and FAS 141(R), purchased financial assets are recognised at their acquired fair value without any carryover of allowance for uncollectibility. FASB constituents in particular have raised the issue of the differing balance sheet presentation methods for originated and acquired financial assets and the issues raised in financial statement analysis (as originated loans have an associated allowance while purchased loans are recognised at fair value with no associated allowance balance).

One IASB member stated his preference for net presentation (e.g., no associated allowance for purchased loans) as in his view it was not relevant to disclose losses incurred by someone else. However, he did note that appropriate disclosure was needed for comparability between originated and purchased assets. Another IASB member emphasised what a difficult issue this was as recognising purchased loans at fair value without a corresponding allowance balance does impact analysis for financial institutions. However, she also mentioned that presenting purchased assets on a gross basis would also impact other analysis so there wasn’t a clear and simple solution. Other IASB members raised the issue of other asset classes that are acquired under business combination accounting and that there are similar implications for property, plant and equipment and other assets that are recognised at fair value without carryover of accumulated depreciation. The IASB unanimously supported requiring net presentation for purchased financial assets. The FASB had slightly different views with several of their Board members stating initial preferences for gross presentation. However, they noted that for convergence they could also support a net presentation if sufficient information were disclosed about the gross amounts. The Boards tentatively decided to require net presentation for purchased financial assets but would develop disclosures as part of the impairment disclosure package to provide transparency on the gross amounts of purchased financial assets.