All public companies will soon face new requirements to provide investors a better picture of their pending cash obligations and available funds to meet them, with banks facing even more requirements to explain their risks.

The Financial Accounting Standards Board has proposed a new accounting standard that will require companies to present additional tables in the footnotes to explain liquidity risks and mandate that banks disclose their risks from potential fluctuations in interest rates. FASB initially sought to expose such risks with a May 2010 proposal to require all financial assets and financial liabilities to be measured at fair value, but it abandoned the idea after determining that no measurement approach—fair value or historical cost—would adequately convey risks related to liquidity problems or changes in interest rates.

That prompted the board to look at other ways to give investors the information they have demanded since the financial crisis to gain a better understanding of where companies may get into trouble due to liquidity problems or changes in interest rates, FASB said in its proposal. The board also heard demands for more information on risks tied to credit issues, and in 2010 it issued ASU 2010-20 to answer those concerns, calling for new disclosures about the credit quality of financing receivables and the allowance for credit losses.

The new proposal would require all public companies to produce two new tables in the footnotes of their financial statements: one to explain expected cash flow obligations and another to explain the available liquid funds to settle those obligations, says Chris Smith, a partner with audit firm BDO USA. “The tables are trying to achieve a one-stop-shop view of an entity's obligations and the available resources to meet those obligations,” he says. For public companies, most of the information already exists in different disclosures throughout the financial statements, but the new standard would create a snapshot view, he says.

FASB's proposed rule also will require all companies to provide any quantitative or narrative discussion necessary to explain its liquidity risks. Companies would need to address significant changes to the timing or amounts of financial assets and liabilities from one reporting period to the next, significant changes to available funds, reasons for the changes, and any action to address liquidity risks. Depending on the type of company, the narrative portion of the requirement could lead to significant new content in the financial statements, says Faye Miller, director of the national professional standards group at McGladrey & Pullen. “I could see that it might add only a page for a fairly small, uncomplicated entity, but it could add several pages for a larger, more complex entity,” she says.

Still Some Questions

For financial institutions, the liquidity-risk disclosure will need to include additional information about the carrying amounts of classes of financial assets and financial liabilities according to their expected maturities, including off-balance-sheet obligations or commitments. As written, the proposal is likely to raise questions with preparers on a couple of points, says Miller. Companies are accustomed to reporting their contractual cash obligations in management discussion and analysis, but the proposal calls for companies to disclose their “expected” cash obligations. “There's a lack of clarity as to what would be captured as a cash flow obligation,” she says.

“Companies need to familiarize themselves with what's in the proposal, assure they have systems in place, know where judgments will come in, and consider commenting where they think they need implementation guidance.”

—Mark Bolton,

Director,

Deloitte & Touche

Companies might also have questions about what constitutes the available liquid funds they will be required to disclose, says Mark Bolton, a director with Deloitte & Touche. “A lot of questions may arise in practice as to what a high-quality liquid asset is,” he says. “That's one of the areas where people will need to be careful and make sure they have processes in place for coming up with those numbers.”

Bolton says some companies will have a lot more work to do than others to comply with the new disclosures once they are effective. “It could require more information than they have, and they will have to assess if they have the systems in place to meet the disclosure requirements,” he says. “The standard seems straightforward, but that doesn't mean there won't be a lot of judgment involved.”

Another important consideration is the auditor's role, says Jamie Mayer, managing director in the accounting principles group at Grant Thornton. There may be significant management assumptions that go into the disclosures, and it will be up to auditors to assess those assumptions. “It will probably be similar to the work that goes into fair-value measurements,” he says.

Peter Bible, a partner with audit firm EisnerAmper, says he doesn't expect the requirement to be too onerous for public companies broadly. “They generally have systems in place to pull this information together,” he says. “What's new for them is the audit involvement in these disclosures. Right now there is no auditing involved at all.”

LIQUIDITY DISCLOSURES

The excerpt below is from Deloitte's Heads Up newsletter regarding FASB's proposed disclosure requirements for financial institutions:

Financial institutions must provide a tabular liquidity gap maturity analysis that

discloses carrying amounts of the various classes of financial assets and financial liabilities

(including leases and insurance contracts) categorized into specified time intervals by

the expected maturities of these instruments (see Table 1 in Appendix B). The liquidity

gap maturity analysis is intended to help users understand an entity's liquidity position

by showing how the expected timing of its cash inflows from financial assets compares

to the expected timing of its financial liability cash outflows. Regarding “expected

maturities,” ASC 825-10-50-23E states, in part:

“The term expected maturity relates to the expected settlement of the instrument resulting

from contractual terms (for example, call dates, put dates, maturity dates, and prepayment

expectations), rather than the entity's expected timing of the sale or transfer of the

instrument.”

Entities would not allocate financial instruments classified as FV-NI (except derivatives) or

equity securities classified as fair value through other comprehensive income into specific

time intervals. Instead, they would disclose the instruments' total carrying amount. In

addition, entities would be required to disclose off-balance-sheet commitments and

obligations (e.g., loan commitments, operating lease commitments, and lines of credit).

Editor's Note: There may be differences in how entities determine the expected

maturity classifications for financial assets and financial liabilities that have stated

contractual maturities but incorporate other contractual characteristics (e.g.,

prepayments on certain home loans, or early termination rights on a lease contract).

To address these potential differences, the proposal requires an entity to describe,

in the narrative that accompanies the liquidity gap maturity analysis, the significant

assumptions used in determining the expected maturity of a financial asset or liability

if the expected maturity differs significantly from the contractual maturity. Examples

of these assumptions may include (but are not limited to) prepayment rates affecting

loan cash flows, and run-off rates for demand deposits. The illustration in ASC 825-10-

55-5A lists other contractual features that may be relevant to the determination of

expected maturities.

Source: Deloitte.

Bible questions, however, whether the new disclosures will add meaningful new insight to financial statements. “I think we have a fairly good mechanism for addressing liquidity already,” he says. “You can see sources and uses of cash in the cash flow statement.”

Beyond liquidity risk for all companies, the new standard also calls for financial institutions to explain where they have risks related to changes in interest rates. Financial institutions will need to show carrying amounts of classes of financial assets and financial liabilities based on their time intervals and their contractual repricing. They will also need to produce tables showing the effects if interest rates move up or down and a qualitative discussion of interest rate risk that explains the tables to investors.

Another important point to the proposal, says Bolton, is the definition of a financial institution for purposes of determining who would be required to make which disclosures and the requirement for companies to make the assessment according to each reportable segment in the business. The definition is slightly different in the proposal compared with other definitions of financial institutions or banks, and it could lead to questions about what segments might be scoped into the standard. “I think it's fair to say there may be some questions about the definition of a financial institution,” he says. “Companies need to familiarize themselves with what's in the proposal, assure they have systems in place, know where judgments will come in, and consider commenting where they think they need implementation guidance.”

FASB is accepting comments on the proposal through Sept. 25, and it plans to set an effective date after seeing feedback. “It's evident in their deliberations on this that they would like this to come into effect as soon as feasible,” says Miller.

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