FASB proposals on financial instruments, comprehensive income

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26 May 2010

The US Financial Accounting Standards Board (FASB) has issued exposure drafts (EDs) of proposed accounting standards on financial instruments and comprehensive income.

Both relate to joint projects with the IASB. The IASB has already:

and is working on projects on hedge accounting, and statement of comprehensive income(exposure drafts expected shortly).
Overview of the FASB proposals

Financial instruments

  • The accounting would be based on the characteristics of the financial instrument and how assets and liabilities are used in the business. Classification determined at acquisition or issuance; reclassification not permitted.
  • Financial assets that have variable cash flows or that are regularly traded would be accounted for at fair value, with value changes reflected in net income (regardless of business strategy). This would include all derivatives.
  • Also, changes in the fair value of equity securities, certain hybrid instruments, and financial instruments that can be contractually prepaid in such a way that the holder would not recover substantially all of its investment also would be recognised in net income each reporting period (regardless of business strategy).
  • For financial assets that are held for collection of cash:
    • Both amortised cost and fair value measures would be presented in the balance sheet
    • FV changes arising from interest accruals, credit impairments and reversals, and realised gains and losses would be recognised in net income
    • Other FV changes recognised in other comprehensive income
    • The asset side of the balance sheet would show loans receivable as follows:
      Amortised cost XXX
      Allowance for credit losses (XX)
      Residual FV adjustment (XX)
      Fair value XXX
  • Equity could be presented as follows:
    Common stock XXX
    Retained earnings XXX
    Accumulated OCI, excluding fair value changes XXX
    Equity excluding FV changes YYY
    Fair value changes on financial instruments (XX)
    Total comprehensive equity ZZZ
  • The scope of this ED includes investments in equity securities when the investor has significant influence over the investee but the operations of the investee are unrelated to the investor's consolidated operations. This means that such investments would no longer be accounted for by the equity method.
  • Financial liabilities would be accounted for similarly to financial assets, reflecting how financial assets and liabilities are managed together. Bank core deposit liabilities would be remeasured each period using a current value method that reflects the economic benefit that an entity receives from this lower cost, stable funding source; some may qualify for remeasurement through other comprehensive income (OCI). Some financial liabilities that would otherwise be at fair value would be eligible for an 'amortised cost option' to avoid an 'accounting mismatch' between recognised assets and liabilities.
  • Loans and other debt instruments in the held for collection or payment category will be tested for impairment using a single model for estimating credit losses. The proposal would remove the existing 'probable' threshold for recognising impairments on loans, resulting in an 'expected loss' model.
  • Hedge accounting criteria would be simplified:
    • An entity could continue to designate particular risks in financial items as the risks being hedged in a hedging relationship, with only the effects of the hedged risks reflected in net income each reporting period.
    • The 'shortcut method' and the 'critical terms match' method would be eliminated.
    • An entity would no longer be able to discontinue hedge accounting simply by removing a hedging designation. Hedge accounting would be discontinued only if the criteria for hedge accounting are no longer met or the hedging instrument expires, is sold, terminated, or exercised.
  • Effective dates and transition:
    • Currently estimated to be 2013
    • Non-public entities with less than $1 billion in total consolidated assets would be allowed a four year deferral beyond the effective date from certain requirements relating to loans and core deposits.
    • An entity would apply the proposed guidance by means of a cumulative-effect adjustment to the statement of financial position for the reporting period that immediately precedes the effective date. Early adoption would be prohibited.
Comprehensive income
  • FASB proposes to require presentation of total comprehensive income and its components in two parts – net income (referred to as 'profit or loss' in IFRSs) and other comprehensive income (OCI) – in a single, continuous statement of financial performance.
    • Presentation of financial performance in two separate financial statements would be prohibited.
    • Paragraph 220-10-45-10A of the proposal identifies 11 types of gains and losses that are currently reported as items of OCI under US GAAP.
    • An entity that has no items of OCI would not be required to present comprehensive income.
  • The proposal would not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.
  • The proposal would not affect the calculation of earnings per share.
  • If adopted, the proposal would be:
    • Effective at same time as financial instruments changes
    • Applied on a fully retrospective basis to improve comparability between reporting periods. Early adoption would be permitted, because compliance with the proposed amendments is already permitted.

Comment deadline on both EDs is 30 September 2010. FASB plans to hold roundtable meetings on 12 and 21 October 2010 to collect further input.

The EDs may be downloaded without charge from FASB's website. Appendix A of the FASB ED contains a detailed comparison of the FASB proposals and the financial instruments model currently being developed by the IASB.

FASB has also published a briefing document (PDF 1,339k) about the financial instruments proposal, along with a podcast featuring an in-depth audio interview with FASB Chairman Robert Herz about financial instruments. The FASB will also be hosting a live webcast on the financial instruments proposal on 30 June.

Click for FASB news release (PDF 49k).

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