Accounting for financial instruments has been deemed the highest priority of both the FASB and IASB because of the role it played in the recent financial crisis. However, it is an extremely complex area without an easy solution making it difficult to predict what may happen and when. All entities that have financial instruments would be affected by the proposed standard. However, the extent of the effect would depend upon the relative significance of financial instruments to an entity’s operations and financial position as well as the entity’s business strategy.
While this initially started out as a convergence project, this has not been achieved. The FASB and the IASB continue to have regular discussions to achieve convergence in most areas, however, in spite of their efforts, there will be some differences between the two standards.
In July 2014, the IASB published the final version of IFRS 9 Financial Instruments. For FASB, the project has been divided into three parts: Classification and Measurement, Impairment and Hedging. On January 5, 2016, the FASB issued the final standard for Classification and Measurement. The Impairment and Hedging standards are still to come.
Of the three standards, the Impairment standard will have the greatest impact on users and therefore will require the most time and resources to implement. The AICPA will develop member benefit resources including an FAQ document, a financial reporting brief and a video highlighting the key changes.
Recognition and Measurement
Download - Financial Reporting Center Brief
On January 5, 2016 the FASB issued its final standard on the recognition and measurement of financial instruments. The new standard:
- Requires public business entities to sue the exit price notion when measuring the fair value of financial instruments for disclosure purposes,
- Requires separate presentation of financial assets and financial liabilities by measurement category and form of financial assets (securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements,
- Requires a reporting organization to present separately in other comprehensive income the portion of the total change in the fair value of a liability result in from a change in the instrument-specific credit risk (entities “own credit”) when the organization has elected to use the fair value option to measure its financial instruments,
- Eliminates the requirement to disclose the fair value of financial instruments measured at amortized costs for organizations that or not public business entities, and
- Eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet.
Public companies will be required to adopt the standard in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For private companies, not-for-profit organizations, and employee benefit plans, the standard becomes effective for fiscal years beginning after December 15, 2018, and for interim periods within fiscal years beginning after December 15, 2019.
The ASU permits early adoption of the own credit provision (referenced above). Additionally, it permits early adoption of the provision that exempts private companies and not-for-profit organizations from having to disclose fair value information about financial instruments measured at amortized cost.
This FASB project addresses issues related to the impairment of financial assets. The objective of this project is to significantly improve the decision usefulness of financial instrument reporting for users of financial statements. The Boards believe that simplification of the accounting requirements for financial instruments should be an outcome of this improvement. The Boards’ goal is to develop a single credit loss model for financial assets that enables more timely recognition of credit losses. On January 31, 2011, the FASB and the IASB proposed a common solution for impairment accounting, Supplementary Document—Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities—Impairment. However, despite, their best efforts the two Boards could not agree on key aspects of the converged model. On December 20, 2012, the FASB issued a separate proposed Accounting Standards Update, Financial Instruments—Credit Losses (Subtopic 825-15). The impairment standard is scheduled to be released by the end of the first quarter of 2016.
The new credit impairment (CECCL) model will apply to most debt instruments, trade recivables, lease receivables, reinsurance recievables, financial guarantee contracts and loan commitments. However, financial instruments measured at fair value, some equity instruments and available for sale debt securities will still be excluded. Under the current incurred loss model, entities would only recognize as an allowance, losses that have already been incurred as of the reporting date. Under the new standard, entities would recognize as an allowance the estimate of contractual cash flows not expected to be collected. This is a fundamental shift.
Under the new standard, in order to measure the amount of impairment, an entity would consider all available relevant information in making the estimate, including historical charge-offs and other past events, current conditions, and reasonable and supportable forecasts and their implications for expected credit losses. However, it still needs to evaluate how conditions that existed during the historical charge-off period differ from its current expectations, and then revise its estimate of expected credit losses. The entity would revert to an unadjusted historical credit loss experience for the period beyond which it can make its reasonable and supportable projections.
Transition and Next Steps
The Board affirmed the transition disclosure requirements included in the proposed Update and discussed the next steps in the preparation of the pending issuance of the final standard in first quarter 2016.
Public business entities that meet the definition of an SEC filer will be required to apply the guidance for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.
Public business entities that do not meet the definition of an SEC filer will be required to apply the guidance for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.
Non-public, not for profit and employee benefit plan entities will be required to apply the guidance for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.
Early application of the guidance will be permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.
FASB’s final phase of the overall financial instrument project to the address the current model for hedge accounting. This project addresses issues related to hedge accounting for financial instruments and non-financial items. The objective of this project is to make targeted improvements to the hedge accounting model based on the feedback received from preparers, auditors, users and other stakeholders. The Board also will consider opportunities to align hedge accounting guidance in GAAP with IFRS 9, Financial Instruments.
The staff is developing a draft proposed Accounting Standards Update based on the tentative decisions reached by the Board. This draft is expected to be released in first quarter 2016.