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Journal entry — FASB and IASB continue discussing impairment accounting

Published on: Jul 22, 2011

At their meeting on Wednesday, the FASB and IASB (the “boards”) continued discussing their “three bucket” expected loss approach to the impairment of financial assets. Specifically, the boards discussed (1) an approach to how assets should be transferred between buckets and (2) the measurement of expected losses for assets in Bucket 1.

The boards considered three approaches to transferring assets between buckets:

  1. An event-based approach that would result in moving assets out of Bucket 1 on the basis of an assessment of specific events that indicate the existence of credit deterioration.
  2. An absolute credit risk model in which the buckets would align with the credit quality of the assets.
  3. A relative risk model in which the buckets are based on whether credit quality has deteriorated or improved.

The boards ultimately directed the staffs to further develop the relative risk model approach since this approach would most closely align with the overall objective of the “three bucket” expected loss approach, 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). Loans acquired at a discount because of credit losses were outside the scope of the discussion.

The boards also decided on two possible approaches to measuring expected losses for assets in Bucket 1. Previously, the boards tentatively decided that Bucket 1 would be measured by using the initial estimate of credit losses expected over 12 months plus the full amount of changes in expected credit losses. However, constituents raised operational concerns during FASB and IASB outreach efforts indicating that the costs associated with this measurement approach would most likely outweigh the incremental benefit. The boards therefore decided to develop a Bucket 1 measurement calculation that would be operationally simpler. Accordingly, they directed the staffs to further explore approaches in which 12 or 24 months’ worth of expected losses would be used to measure the Bucket 1 allowance. In addition, the boards agreed that 12 months of expected losses should be based on an annual (losses expected to occur within the next 12 months), rather than an annualized, approach (calculating lifetime losses and dividing by remaining years).

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