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Financial instruments – Impairment

Date recorded:

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

 

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
  • 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

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.

Related Topics

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