by Sara Glen, Adrian Mills, and Ana Zelic, Deloitte & Touche LLP

Introduction

The approach used to recognize impairment losses on financial assets, which could potentially result in delayed recognition of such losses, was identified during the financial crisis as a major weakness in current guidance. After years of separately and jointly deliberating various models to remedy that weakness, the FASB and IASB each released their third of three formal proposals on recognizing credit losses on financial assets.¹

The boards received feedback on their proposals in formal comment letters and as a result of outreach performed to gain a better understanding of stakeholders’ perspectives. Outreach activities included conference calls with one or more organizations, face-to-face meetings, industry and other committee meetings, and limited field testing. Respondents comprised users of financial statements, preparers, auditors, standard setters, and other interested parties (including industry organizations and regulators).

Although the boards’ proposals have changed over time, one constant has been the diversity of stakeholder views on them. Disagreement has sometimes been most evident between respondents of disparate type (e.g., between users of financial statements and preparers) or geographic location (i.e., between U.S. and international respondents).² Constituents’ views on the proposals are summarized briefly below. The appendix in the attached Heads Up outlines details of the proposals and compares feedback on the proposals as presented by the staffs at the boards’ July 2013 joint meeting.³

Overview of Feedback

Constituents disagreed with one another on numerous aspects of the models, including the following:

• Immediate recognition of all lifetime expected credit losses — Many U.S. investors and some regulators supported the FASB’s impairment model, which requires up-front recognition of all expected credit losses over the term of the financial asset (rather than only a portion of those expected credit losses in certain circumstances, as the IASB proposes); they maintained that reserve adequacy is imperative. However, U.S. preparers generally raised concerns about recognizing all lifetime expected credit losses immediately. Specifically, they noted that (1) the asset’s net carrying amount would be understated on day 1 and (2) interest income (i.e., compensation for credit risk) would not be matched with the recognition of credit-loss expense.
• Immediate recognition of less-than-lifetime expected credit losses — Unlike proponents of the FASB’s impairment model, investors, preparers, and others outside the United States generally supported the IASB’s approach, which would require entities to immediately recognize only 12 months of expected credit losses in certain circumstances. They disliked the FASB’s approach of recognizing all lifetime expected credit losses on all assets for two reasons. First, they observed that it would be difficult to estimate such losses reliably, especially for assets that are still performing and not considered at risk of not performing. Second, they noted that a model that immediately recognizes lifetime expected credit losses on all assets ignores the idea that pricing of financial assets incorporates some expectation of credit loss.

Aspects of the proposals on which constituents generally agreed include the following:

• Need for convergence — Because of the global impact of the credit crisis, convergence has been a consistent theme of feedback throughout the history of the joint impairment project. Although commenters and constituents have expressed their belief that convergence is important and have encouraged the FASB and IASB to continue working together, their opinions differ on what a converged model should look like. Further, some have stated that the boards should first focus on improving current guidance in a timely fashion.
• Expected credit loss model — Most respondents supported the transition to
  an expected credit loss model. Under that model, entities would estimate credit losses on the basis of historical information, current information, and reasonable and supportable forecasts of expected collectability of cash flows and recognize such losses earlier than they would under the incurred loss model in current guidance. However, because much confusion was expressed about the meaning of “reasonable and supportable forecasts” during the FASB’s outreach activities, the FASB explained the types of information that entities could use to make forecasts and assured stakeholders that forecasts and predictions of economic conditions over the entire life of the asset would not be required.
• Single model — Most respondents agreed that a single impairment model for all financial assets measured at amortized cost or at fair value through other comprehensive income (FV-OCI) would be preferable to the current multiple impairment models, which can vary (e.g., depending on whether the asset is a security). Some respondents favored the current approach for debt securities, and a number stated that more practical expedients should be permitted for such instruments.
• Simpler approach for PCI assets — Most respondents to the FASB’s proposal agreed on the need to simplify the accounting for losses on purchased credit-impaired (PCI) financial assets under current U.S. GAAP, which in some cases requires a different treatment for changes in expectations depending on whether such changes are favorable or unfavorable. Also, most respondents agreed that PCI assets should be presented “gross” on the financial statements.
• Disclosures — Most users agreed with the disclosure requirements proposed by both boards. Most other respondents agreed with the objective of the disclosures, but noted that they might be too detailed, restrictive, and onerous.

Next Steps

The FASB and IASB will most likely begin redeliberations in September of this year. Given the disparate feedback and the general preference by constituents of each board for that board’s own model, it is unclear whether the boards can fully converge their respective standards. Final guidance is not expected until 2014. No effective date has been set, but feedback generally indicated that constituents would need at least two to three years to implement a final standard (i.e., if a standard is finalized in 2014, it should be effective no earlier than 2017).

1 The FASB issued its proposed Accounting Standards Update, Financial Instruments — Credit Losses, on December 20, 2012 (comments were due by April 30, 2013). The IASB issued its exposure draft, ED/2013/3, Financial Instruments: Expected Credit Losses, on March 7, 2013 (comments were due by July 5, 2013). For a discussion of the FASB’s and IASB’s proposals, see Deloitte’s December 21, 2012, and March 12, 2013, Heads Up newsletters, respectively.

2 Types of respondents are specified only when their responses reflected disagreements among them (e.g., users and preparers).

3 See FASB Memorandum No. 232 (which includes the FASB staff’s feedback summary) and IASB Agenda Papers 5 through 5C.