FinREC and TIC Weigh in on Two of FASB’s Financial Instrument Proposals

July 18, 2013

The Financial Reporting Executive Committee (FinREC) and the PCPS Technical Issues Committee (TIC) of the American Institute of CPAs (AICPA) recently issued two comment letters on FASB’s proposed Accounting Standards Updates (ASUs).  

The first FinREC comment letter was in response to the FASB’s proposed ASU on Financial Instruments, Credit Losses.  FinREC advised the FASB that the credit loss proposal still requires significant work in order for it to be operational and result in an improvement in financial reporting that is representationally faithful.  For example, the proposed credit loss model:

• Lacks a strong enough conceptual basis for sound financial reporting;
• Departs significantly from the incurred loss model;
• Creates two incompatible loss contingency models;
• Double counts expected losses, and
• Creates an increased but unjustifiable accounting and financial reporting burden for smaller financial institutions and nonfinancial services entities.

Therefore, while the current model could be improved, the proposed model falls short of achieving the FASB’s stated objective.  FinREC encouraged the FASB to continue to work closely with the IASB to develop a high quality and converged model.  As a solution, FinREC suggested that the current incurred loss model be retained with improvements, such as lowering the threshold of when credit losses should be recognized from “probable” to “more likely than not,” in order to achieve a more timely recognition of losses.

The PCPS Technical Issues Committee (TIC) issued a separate comment letter.  TIC’s objective is to represent the views of local and regional firms on professional issues in keeping with the public interest.  That letter expressed concern that this model would apply broadly to all entities (public and private), yet stated there is no evidence that its provisions were filtered through the Private Company Decision-Making Framework (PCDMF) or discussed in a public meeting with the Private Company Council (PCC).  It attempts to be a one-size-fits-all solution for an industry-specific financial reporting problem and fails to take into consideration the differential factors between public and private companies.  Like FinREC, TIC believes the incurred-loss model is the most relevant and the most cost-effective impairment model, particularly for nonfinancial, nonpublic entities. 

FinREC's second comment letter was written in response to the proposed ASU on the recognition and measurement of financial instruments.  FinREC acknowledged that there were many positive aspects to the proposal.  For example, FinREC said it is supportive of the notion that there should be one accounting model for all financial instruments.  FinREC also agreed that entities should be required to report fluctuations in instrument-specific credit risk (own credit) in other comprehensive income (OCI) rather than net income for liabilities under the fair value option election.  Likewise, FinREC supported the FASB’s position on changes in fair value of equity securities being recorded through net income.  Finally, FinREC supported the elimination of the tainting provisions for sales from the hold-to-collect category.

However, there were other areas in the proposal that FinREC found problematic.  Concerns FinREC raised include:

• Complexities will be encountered with the solely payments of principal and interest  (SPPI) model;
• Amortized cost sales provisions are too restrictive;
• Hedge accounting of interest rate risk for securities held at amortized cost is precluded while it is permitted for loans carried at amortized cost; 
• Bifurcation and the fair value option (FVO) of financial assets should be allowed to achieve parallel treatment to that permitted for financial liabilities;
• Reclassification provisions are too restrictive and not clear enough;
• Nonrecourse liabilities should have parallel treatment to the related financial assets;
• Parenthetical disclosure on the balance sheet of amortized cost and fair value should instead be required in the footnotes;
• Limiting the availability of the fair value option is not appropriate, and
• Disclosures place an undue financial reporting burden on smaller financial institutions and nonfinancial entities.

Consistent with the recommendation made in the credit impairment letter, FinREC also encouraged the FASB to continue to work with the IASB to achieve convergence or two closely aligned models.  Additionally, FinREC proposed that rather than moving to a new SPPI model, FASB should retain the current clearly and closely related model as most of the issues with this model initially raised upon implementation have been now been resolved.

TIC also issued a comment letter on this proposal.  TIC wrote it believes the new comprehensive recognition and measurement model in the 2013 ED is an improvement over the 2010 ED, which favored fair value as the primary measurement model for financial instruments.  The 2013 proposal provides more opportunities for use of the amortized cost method for some financial assets and most financial liabilities, which TIC prefers.

However, TIC also had some continuing concerns about the scope and complexity of the ED and the lack of guidance pertaining to non-financial, nonpublic entities.  TIC recommended a scope exclusion for short-term trade receivables and payables and related party loans with owners.  If that’s not possible, TIC requested that the standard include examples that address the accounting for factoring short-term receivables and related party loans from/to owners of a business because they are common transactions among nonpublic entities.

TIC called for greater clarity in many specific sections of the guidance, which discusses complex topics in unnecessarily complicated language.  In its letter, TIC emphasized the importance of providing “plain-English” guidance, especially for private entities.  Otherwise, key principles may be misunderstood resulting in misapplication of the final standard.

In preparation for its post-exposure re-deliberations on these EDs, the FASB staff has reached out to TIC for additional feedback on both comment letters.