At their joint meeting last week, the FASB and IASB made several tentative decisions related to their projects on the classification and measurement of financial instruments.¹ The boards made these tentative decisions in light of constituents’ feedback on the overall business model assessment, the hold-to-collect business model, and fair value measurement categories.

Overall Business Model Assessment

In determining the appropriate classification of a financial asset, an entity assesses the asset’s cash flow characteristics and the business model within which it is managed. The boards have previously discussed constituents’ feedback on the cash flow characteristics assessment. At this meeting, the boards discussed the following aspects of the business model assessment:

• The meaning of the term “business model.”
• The level at which the business model should be assessed.
• Factors that an entity should consider in performing the business model assessment.
• Changes in the business model.

The Meaning of the Term “Business Model”

The boards tentatively decided to clarify that the business model assessment refers to the manner in which an entity manages groups of financial assets “in order to generate cash flows and create value for the entity.”² The business model assessment is designed for an entity to classify financial assets in the measurement category that best reflects how the entity manages its activities and risks to generate income, whether that income results from collecting contractual cash flows, selling financial assets to realize changes in fair value, or a combination of both.

The Level at Which the Business Model Should Be Assessed

The boards decided that the business model assessment should be performed at the level at which groups of financial assets are managed together to achieve a common objective, and not at the level of individual financial assets.

Factors That an Entity Should Consider in Performing the Business Model Assessment

The boards explained that the volume and frequency of sales activity are not necessarily determinative in the assessment of the business model. For example, a temporary increase in sales during a particular period may not indicate a change in business model if the entity is able to substantiate its basis for why the fluctuation in sales activity is not indicative of a change in strategy for managing those financial assets.

The IASB tentatively decided to clarify that:

1. Business activities usually reflect the way in which the performance of the business model and underlying financial assets in that business model are evaluated and reported (that is, key performance indicators) as well as the risks that typically affect the performance of the business model and how those risks are managed.

2. An entity should consider all relevant and objective information that is available at the date of the assessment but should not consider every “what if” or worse-case scenario if the entity does not reasonably expect those scenarios to occur.

3. If cash flows are realized in a way that is different from the entity’s expectations at the date the business model assessment was made, it will neither:

a. Result in the restatement of prior-period financial statements; nor

b. Change the classification of the remaining financial assets in the business model, as long as the entity considered all relevant and objective information that was available at the time it made the assessment.

Change in Business Model

The boards tentatively decided to clarify that a change in business model would only occur when an entity has either ceased or commenced an activity that is significant to its operations, which would typically only happen when “the entity has acquired or disposed of a business line.”

Further, the FASB tentatively decided to change “the date on which reclassification is reflected in the financial statements” to converge its guidance on this topic with that in IFRS 9. Specifically, the FASB indicates that “[although it] had earlier proposed the reclassification date as the last day of the reporting period in which the change in business model occurs,” its current tentative decision is that “the reclassification date [will] be the first day of the first reporting period following the change in the business model.”

Hold-to-Collect Business Model

The boards tentatively decided to clarify that insignificant or infrequent sales may not be inconsistent with the hold-to-collect business model. Further, “the guidance on the hold to collect business model should emphasize activities aimed at achieving the business model’s objective.” For example, sales that occur close to maturity and for which the sales proceeds approximate the amount of remaining contractual cash flows to be collected would not be inconsistent with an objective of collecting contractual cash flows. Similarly, sales associated with credit risk management activities that are aimed at minimizing potential credit losses and maximizing collection of contractual cash flows are integral to the hold-to-collect objective. The boards also tentatively decided that sales made to manage credit risk concentration should be assessed in the same way as any other sales made as part of the business model.

Fair Value Measurement Categories

The boards agreed to retain two fair value measurement categories: (1) fair value through other comprehensive income (FVOCI) and (2) fair value through profit or loss (FVPL). Moreover, the boards tentatively decided that financial assets with eligible contractual cash flows should be mandatorily measured at FVOCI if they are managed by both collecting contractual cash flows and selling financial assets.

The boards also tentatively decided that the FVPL category would be the residual category. That is, the business models that result in subsequent measurement at amortized cost and FVOCI would be defined categories.

Further, the boards “tentatively decided to clarify the application guidance for the FVPL measurement category, specifically that:

1. Financial instruments managed and evaluated on a fair value basis or held for trading purposes must be measured at FVPL.
2. For financial assets that are measured at FVPL, the entity makes decisions based on changes in — and with the objective of realizing — the assets’ fair value.”

The IASB tentatively decided to clarify that the activities the entity performs for financial instruments measured at FVPL focus primarily on fair value information. In addition, key management personnel and financial statement users make decisions and assess the entity’s performance on the basis of that information.

The boards also tentatively clarified that an entity achieves its business model objectives for the FVOCI category by both collecting contractual cash flows and selling to realize changes in fair value. That is, both holding to collect and selling are outcomes (rather than the objective itself) that are integral to the performance of a hold-to-collect-and-sell business model Objectives for the hold-to-collect-and-sell business model could include liquidity management, interest rate risk management, yield management, and duration mismatch management. In addition, the IASB tentatively decided to clarify that contractual interest yield, impairment charges, and fair value changes are key performance indicators for financial assets under the hold-to-collect-and-sell business model.

Next Steps

At a future meeting, the boards will discuss certain aspects related to the SPPI³ test that was initially discussed at the September 18, 2013, meeting. In addition, the FASB will consider whether to retain the SPPI test or pursue a different approach. The boards will also consider any other related matters pertaining to this project at a later date. The IASB plans to substantially complete its redeliberations by the end of 2013, while the FASB plans to complete its redeliberations early next year.

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1 In November 2012, the IASB proposed limited amendments to the guidance in IFRS 9, Financial Instruments, on the classification and measurement of financial assets and financial liabilities (see IASB Exposure Draft, Classification and Measurement: Limited Amendments to IFRS 9 — proposed amendments to IFRS 9 (2010)). In February 2013, the FASB issued a proposed ASU, Recognition and Measurement of Financial Assets and Financial Liabilities, containing a comprehensive model for the classification and measurement of financial assets and financial liabilities. The FASB’s intention in issuing this proposal was to converge its guidance on this topic with that in the IASB’s proposed amendments.

2 Quoted content is from the FASB’s Summary of Board Decisions for its November 20, 2013, videoconference meeting with the IASB.

3 Solely payments of principal and interest.