FASB Makes Decisions on Impairment

Published on: 15 Jan 2010

The following is a summary of the FASB’s decisions on impairment made during the January 13 meeting.

Credit Impairment Approach

The FASB discussed the recognition and measurement of credit impairments and interest income under its proposed new model for accounting for financial instruments. Under its new model, credit impairments are recognized separately for financial assets that are measured at fair value through other comprehensive income (FV-OCI), including originated and purchased loans, debt securities, beneficial interests, and other financial assets classified in the FV-OCI category.

The Board discussed what information an entity should consider in recognizing and measuring credit impairments. It tentatively decided that an entity should consider all available information relating to past events and existing conditions (such as the current unemployment rate) and their implications for the current and future collectibility of the financial asset(s), but should not consider near-term expected conditions (such as projected changes in unemployment rates).

Several Board members emphasized that an entity should not wait for a trigger event to occur before recognizing a credit impairment loss. They noted that existing conditions and historical statistics may suggest that a credit impairment loss exists for financial assets that are aggregated in a pool on the basis of similar risk characteristics. In that case, an entity may need to recognize an immediate credit impairment loss on new financial assets that are pooled with other financial assets at the end of the reporting period during which the asset was originated or acquired.

The Board also decided that an entity would present purchased financial assets on a “gross basis” in the statement of financial position, i.e., it would separately present an allowance for its expectations of credit losses inherent in the asset at acquisition. This would represent a change in business combination accounting.

Interest Income Model

The Board tentatively decided that an expected cash flow model should be applied in recognizing interest income on both originated and purchased financial assets. Under the expected cash flow model, interest income is calculated by applying the effective interest rate to the amortized cost for the financial asset at the beginning of the period reduced by any related allowance for credit impairments. The staff suggested that the effective interest rate to be used for originated financial assets would equal the contractual rate (absent any discount or premium on the asset). For purchased financial assets for which no credit losses are expected at the date of purchase, the effective interest rate would equal the rate that equates the purchase price to the present value of the contractual cash flows (i.e., the market interest rate). If credit losses are expected at acquisition, the effective interest rate would be the rate that equals the purchase price to the present value of the expected interest and principal cash flows as of the date of purchase (rather than the market interest rate).

Cash Receipts in Excess of Accrued Interest Income

The Board also discussed the accounting for cash receipts in excess of accrued interest income and tentatively decided to propose that entities recognize cash received in excess of the amounts accrued by increasing the allowance for credit losses and not as interest income (e.g., Dr. Cash $1,200, Cr. Interest Receivable $1,080, Cr. Allowance $120). To the extent that the allowance account exceeds the entity’s estimate of expected credit losses, the difference would be recognized in income as a recovery.

Nonperforming Financial Assets and Nonaccrual Status

The FASB considered whether to define the terms “nonperforming financial assets” and “nonaccrual status,” but tentatively agreed not to define those terms. Board members suggested that since interest income is recognized based on amortized cost less any related allowance under its proposed approach, the practice of placing loans on nonaccrual status would no longer apply except if an asset has a negative yield (for example, if the gross cash flows expected to be collected are less than the original principal amount).

Direct Write-Off

The FASB tentatively agreed to define the term write-off as “a [direct] reduction in the carrying amount of a financial asset due to uncollectibility. A financial asset is considered uncollectible if the entity has no reasonable expectations of recovery.”

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