Third Proposed FASB Update on Credit Impairment

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The current FASB proposed amendments would impact all entities that hold financial assets that are not accounted for at fair value through net income and are exposed to potential credit risk.

Since the global economic crisis that began in 2008, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have acknowledged the delay in timely recognition of financial instrument credit losses as a flaw in our current accounting guidance. The current accounting treatment under U.S. GAAP only requires losses to be recognized when incurred and only after a loss event (e.g., default) has occurred or its occurrence is probable. This treatment delays the recognition of losses that may be estimable, ultimately causing an overstatement of assets.

In December 2012, FASB issued a re-exposure draft on “Financial Instruments – Credit Losses” to address the growing concerns of the delayed recognition of credit losses. The current FASB proposed amendments would impact all entities that hold financial assets that are not accounted for at fair value through net income and are exposed to potential credit risk. These financial assets may include:

  • Loans
  • Debt securities
  • Trade receivables
  • Lease receivables
  • Loan commitments
  • Reinsurance receivables
  • Other receivables that represent the contractual right to receive cash.

Under the proposed FASB amendments, entities would be required to create an allowance for expected credit losses, based upon an estimate of credit losses and related credit risks. The estimate would utilize current estimates of contractual cash flows that the entity does not expect to collect. The allowance for credit losses would use relevant information about past events, including historical loss experience with similar assets, current conditions, and reasonable and supportable forecasts that impact the expected collectability of the assets’ remaining contractual cash flows.

The estimated credit loss allowance could be evaluated on a security-by-security basis and/or a pool basis, and would consider both the possibility that a credit loss results and the possibility that no credit loss results. The exposure draft would prohibit an entity from estimating expected credit losses solely on the basis of the most likely outcome.

For financial instruments carried at amortized cost, the balance sheet would reflect the amortized cost less an allowance for credit losses, and the income statement would reflect credit deterioration (or improvement) during the reporting year.

For entities with financial instruments measured at fair value with changes in fair value recognized as other comprehensive income, the balance sheet would continue to reflect the fair value; however, the income statement would credit deterioration (or improvement) experienced during the reporting year. For instruments recognize at fair value, credit losses do not have to be recognized if (1) the fair value of the financial asset is greater than (or equal to) the amortized cost basis and (2) expected credit losses on the financial asset are insignificant.

The purpose of FASB’s proposed guidance is to provide financial statement users with more timely decision-useful information about expected credit losses on financial instruments that are reasonable to estimate at the reporting date. The proposed amendment would also reduce complexity by replacing the various impairment models found in current U.S. GAAP with a consistent measurement model.

The proposal can be viewed at

http://www.fasb.org/cs/BlobServer?blobkey=id&blobwhere=1175825477164&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs. Comments are due by April 30, 2013.

For more information, contact Magali Welch, Partner, 802-383-4831.

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Terri Robinson
Johnson Lambert LLP
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