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Journal entry — Impairment of financial instruments — FASB begins deliberations on alternative impairment model

Published on: Aug 24, 2012

At its board meeting this week, the FASB began deliberating an alternative to the “three-bucket” impairment model jointly developed with the IASB.

Editor’s Note: At its August 1, 2012, board meeting, the FASB directed its staff to explore an alternative model to address significant concerns expressed by constituents about the three-bucket approach. See the FASB’s project update and Deloitte’s August 3, 2012, journal entry for additional information.

The Board tentatively decided that:

  • The measurement objective of the alternative model would be expected credit losses (i.e., an entity’s current estimate of contractual cash flows not expected to be collected). Therefore, as of each reporting date, an entity would recognize a credit impairment allowance equal to its current estimate of expected credit losses. Furthermore, the measurement of expected credit losses would (1) be an expected value (i.e., a probability-weighted average of at least two possible outcomes) and not the most likely outcome and (2) incorporate the time value of money.
  • The alternative model would not include a recognition threshold (e.g., probable), and interest income would continue to be “decoupled” from credit losses (i.e., interest income would be based on contractual cash flows).
  • The information to be considered in estimating expected credit losses would include “all supportable internally and externally available information considered relevant in making the forward-looking estimate, including information about past events, current conditions, and reasonable and supportable forecasts and their implications for expected credit losses.”1
  • The alternative model would not prescribe a unit of account (e.g., an individual asset or a group of financial assets) to be used in the measurement of credit impairment.
  • The recognition of impairment for purchased credit-impaired (PCI) financial assets2 would also follow the expected-credit-loss concept. Accordingly, upon acquisition, an entity would recognize an allowance for credit impairment equal to the estimate of the contractual cash flows not expected to be collected (measured in a manner consistent with the guidance on calculating expected credit losses discussed above). In subsequent periods, any changes in the impairment allowance — whether favorable or unfavorable — would be recognized immediately through earnings. Interest income recognition for PCI assets would include a yield adjustment for the noncredit premium or discount to par embedded in the purchase price but would exclude any discount to par embedded in the purchase price attributable to expected credit losses (i.e., the nonaccretable yield).3
  • For financial assets measured at amortized cost, any unrealized loss (i.e., the difference between the fair value and the net carrying amount — that is, amortized cost net of any credit impairment allowance — of the asset) would be recognized through earnings when the entity determines that it intends to sell the financial asset. In contrast, for financial assets measured at fair value through other comprehensive income (FV-OCI), unrealized losses would only be recognized in earnings when the entity sells the financial asset.
  • Credit impairment should be recognized as an allowance — or contra-asset — rather than as a direct write down of the amortized cost basis of a financial asset.
  • For financial assets measured at FV-OCI, reporting entities would be required to disclose within the statement of financial position (i.e., parenthetically) the amortized cost net of the credit impairment allowance. Entities would disclose the information they use to reconcile the amortized cost of such assets with their fair value in the notes to the financial statements.

The tentative decisions reached about the alternative model would apply to all financial assets measured at either amortized cost or FV-OCI. However, the Board noted that its tentative decisions may change after it discusses the following open items:

  • The application of the model to debt securities.
  • Nonaccrual accounting.
  • The application of the alternative model to trade receivables, lease receivables, and off-balance-sheet items.
  • Disclosure requirements.
  • Transition guidance.


[1] See the FASB’s summary of decisions for the August 22, 2012, meeting.

[2] The Board defined PCI financial assets as “acquired individual [financial] assets (or acquired groups of financial assets with shared risk characteristics . . . that have experienced a significant deterioration in credit quality since origination, based on the assessment of the buyer.”

[3] The Board’s summary of decisions states, “One way an entity might practically follow this approach and integrate it into existing systems would be to deem the amortized cost of the PCI asset, at acquisition, to equal the sum of (1) the purchase price and (2) the associated impairment allowance at the date of acquisition. By doing so, the asset could then be accreted from the PCI amortized cost to the contractual cash flows (that is, par) without ever recognizing as interest income the purchase discount attributable to expected credit losses at acquisition.”

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