Financial Instruments Update

Date recorded:

The objective of this session was to update Board members on recent developments in financial instruments accounting under US GAAP.

At its Monday 16 March 2009 the FASB discussed and decided on two issues:

  • Additional fair value measurement guidance
  • Changes to the impairment model for some financial instruments (securities)

The Board was informed that both issues would be issued as proposed FASB Staff Positions (FSPs) shortly.

Additional fair value measurement guidance

FASB staff introduced the new proposed guidance on additional guidance how to determine fair value. The proposals would introduce a two-step process:

  • 1. Determine whether a market is active or inactive
  • 2. If inactive, assume that quoted prices (including broker prices) are associated with distressed transaction unless:
    • There was a marketing period prior to the measurement date
    • There were multiple bidders for the asset

FASB staff noted that this should increase the use of level-3 fair values (measurement model) under SFAS 157 Fair Value Measurements. One Board member concluded that private equity instrument transactions are always level-3 measurements as there are rarely multiple bidders for the assets.

Other Board members interpreted the proposals as a requirement to ignore information. FASB staff explained that FSP 157-3, issued late in October 2008, was aimed at bringing more measurements into level 3 but did not do so.

It was also noted without more specific background information that the liquidity premiums on certain assets caused concerns - a level-3 measurement would ameliorate those concerns.

One Board member noted that this guidance would contradict the guidance issued in the final document of the IASB's Expert Advisory Panel (EAP), where it is specifically stated that even in inactive markets transaction prices should not be ignored.

Board members were informed that the members of the panel were already asked to provide their input on possible changes to the EAP document.

Another Board member asked how many of the criteria in the proposed FSP for determining whether a market is inactive or not would have to be met to reach this conclusion. FASB staff responded that it would be a result of applying judgement considering all the factors mentioned plus others if necessary (that is, the list of factors is not exhaustive).

Changes to the impairment model for some financial instruments (securities)

The FASB staff continued to present the proposals on impairment of debt and equity securities. The FASB has agreed to expose for comment a model that would change the way other-than-temporary impairments are determined to exist and recognised.

Under the proposed model, the entity would be required to assess whether it intends to sell the security or whether it is more likely than not that it will be required to sell the securities prior to the recovery of the cost basis.

Only credit-related losses would be recognised in profit or loss. The staff explained that as a first step all changes in fair value would be recorded in profit or loss, but the non-credit loss related piece would be transferred into other comprehensive income via a contra account in profit or loss.

Additional credit losses would have to be recorded in profit or loss. Further, if the intent to sell changes or a requirement to sell becomes more likely than not, the OCI portion would have to be recognised in profit or loss.

Many Board members had specific questions about the logic behind this model and how this would be applied in practice. It seemed many Board members were concerned over the discretion preparers would have in determining whether to recognise an impairment loss.

The chairman asked the FASB staff whether this model would impact the long-term project to improve reporting for financial instruments. FASB staff responded that this was not the case, but there was always the possibility that constituents would favour this proposed new model, which would be reflected in their comment letters.

The chairman asked the IASB Board members what the IASB's response to these developments should be. He proposed to issue the FASB proposals as an IASB 'wrap around'. It was agreed that any document would highlight the differences between US GAAP and IFRSs with respect to accounting for impairments.

There was some debate over the form of the document, as the objective is to ask constituents whether the IASB should develop similar guidance. It was agreed to wait until the IASB has seen the FASB proposals and discuss the form of the document in due course - [subsequently scheduled for Thursday 19 March 2009]. Further the Board agreed that any document should be exposed for comment for 30 days.

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