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Journal entry — Financial instruments — FASB and IASB tentatively agree to clarify certain aspects of their impairment models

Published on: Sep 20, 2013

At their September 17, 2013, joint meeting, the FASB and IASB tentatively decided to clarify certain elements of their respective impairment models on the basis of comment-letter feedback. The boards further decided to discuss opportunities to converge on this topic at future meetings. 

The FASB tentatively decided to clarify in the final standard that in the estimation of expected credit losses: 

  • An entity should use historical average loss experience for future periods that are beyond periods for which the entity is able to make reasonable and supportable forecasts.
  • All contractual cash flows over the life of the asset should be considered, including reasonably expected prepayments; renewals, extensions, and modifications should not be considered, unless the entity reasonably expects to execute a troubled debt restructuring with a borrower.1
  • The risk of loss, even if remote, should always be reflected; credit loss would not be recognized when the amount of loss would be zero for an asset for which risk of nonpayment would be higher than zero (e.g., for assets that are collateralized).
  • In addition to the discounted cash flow method, an entity would be allowed to use loss-rate methods, probability-of-default methods, or a provision matrix using a loss factor estimation method.

The FASB also decided to include in the final standard implementation guidance on factors related to current conditions and reasonable and supportable forecasts that an entity should consider in adjusting historical loss experience.

The IASB tentatively decided to:

  • Clarify in the final standard that the objective of the impairment model is to recognize lifetime expected credit losses on all financial instruments for which there has been a significant increase in credit risk, whether on an individual or a portfolio basis. In assessing the change in the credit risk for those instruments, entities would not rely solely on delinquency information2 and should consider all reasonable and supportable information, including forward-looking information. The final standard will include an example to illustrate that clarification.
  • Retain the 12-month expected credit loss measurement objective for financial instruments for which there has not been a significant increase in credit risk.
  • Require entities to apply a definition of “default” in accordance with the entity’s credit risk management practices and to consider qualitative factors as part of such application.3 In addition, the Board would include in the standard a rebuttable presumption that assets are considered to have defaulted when they are 90 days past due, unless an entity’s reasonable and supportable information indicates that a different quantitative default criterion would be more appropriate.4

1   The Board believes that an entity would not consider potential future losses that could result from the future renewal, modification, or extensions in estimating expected credit losses because the lender has not yet been exposed to such credit losses.

2    Some respondents to the comment letters expressed concerns that the proposal would require entities to only consider a “30-days past-due” indicator when determining whether there has been a significant increase in an asset’s credit risk and that the significant increase in credit risk thus would not have been captured on a timely basis.

3    An entity’s evaluation of qualitative factors includes consideration of an obligor’s ability to pay future contractual payments in full before it misses a payment (e.g., breach of covenants).

4    The IASB staff paper indicates that some respondents to the comment letters noted that the measurement of expected credit losses (12-month or lifetime expected credit losses) depends on how “default” is defined.

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