FASB Reaches Tentative Decisions on the Classification and Measurement of Financial Assets

Published on: 25 Jan 2011

At today’s Board meeting, the FASB continued its discussions on the classification and measurement portion of its project on accounting for financial instruments. The Board reached tentative decisions on several key issues.

In its discussion on business strategy criteria that should be used to determine the classification and measurement of a financial asset, the Board focused on two potential approaches — a business activity approach and a value realization approach — for financial assets in the amortized cost category:

  • Business activity approach — This approach would be based on the business activities an entity employs in acquiring and managing financial assets. Under this approach, the amortized cost category would include debt instruments that are generated through a lending activity.1
  • Value realization approach — This approach would be based on the manner in which an entity intends to realize the value from the financial assets it holds. Under this approach, the amortized cost category would include financial assets that an entity has both the intent and ability to hold for the collection of contractual cash flows through substantially all of the asset’s effective life.

The Board unanimously favored the business activity approach. This tentative decision represents a change from the Board’s original proposal,2 which referred to business strategy as an approach to collect or pay the related contractual cash flows rather than to sell the financial asset or settle the financial liability with a third party. The Board suggested that the business activity approach is more consistent with how an entity manages its business and would require less implementation guidance. The Board further noted that traded debt securities would not be eligible for amortized cost classification and would be measured at fair value. More specifically, the fair value through net income category would encompass financial assets in an entity’s held-for-trading and held-for-sale activities, and the fair value through other comprehensive income (FV-OCI) category would encompass financial assets in the entity’s investing activities.

The Board did not discuss the second classification criteria in the Board’s original proposal, i.e., the cash flow characteristics test. This will be discussed at a future meeting. In addition, the Board directed the staff to readdress at a future meeting how the proposed new business activity criterion would apply to a group of originated loans of which an entity expects to sell a portion.

The Board also discussed whether to permit the reclassification of financial assets between categories as well as potential tainting implications that may arise as a result of reclassifications. By unanimous vote, the Board tentatively determined that reclassifications should not be permitted between any categories for any financial asset.

Lastly, the Board reaffirmed its support to require changes in fair value that have been recognized in other comprehensive income for a financial asset accounted for at FV-OCI to be recognized in net income (i.e., “recycled”) when such gains or losses are realized from sales or settlements.

 


[1] Some Board members expressed concern that the term “lending activity” implied that only financial institutions would be eligible to account for financial assets at amortized cost. These Board members indicated that the intent of the business activity approach is to include activities of all entities in which an entity provides funds to a borrower or customer and expects to collect contractual cash flows (principal and interest) and manage credit risk. Accordingly, the Board directed the staff to further refine the language of the business activity approach to be consistent with this intent.

[2] Refer to the proposed FASB Accounting Standard Update, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities.

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