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Financial instruments – Impairment

Date recorded:

Recognition of initial expected losses

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.

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