As they promised, U.S. and international accounting boards have put their heads together to come up with a single approach for how to account for underwater loans or other financial assets that have taken a beating.

The Financial Accounting Standards Board and the International Accounting Standards Board have published a “supplementary document” explaining their agreed concept for how companies should account for “impaired” financial assets, such as loans or other instruments, where the expected cash flows have fallen below values carried on the books. The two boards have followed a long and twisted path to achieve the compromise solution since the accounting for impairment became a focus of the economic crisis that erupted in 2008.

The document is meant to supplement separate proposals the two boards published earlier—the IASB's in November 2009 and FASB's in May 2010 contained in a more comprehensive and controversial proposal for the accounting for financial instruments. The two boards originally offered different approaches to accounting for credit impairments. As the boards worked through comments to their separate proposals and sought the recommendations of an expert advisory panel, they came up with an expected loss model that both boards could swallow.

The IASB's original proposal did not look at the allowance for credit losses separate from the measurement of financial assets, so it did not call for all expected credit losses to be recognized immediately. As such, it proposed requiring entities to estimate expected cash flows over the life of the related financial instrument. FASB, on the other hand, believed the key objective should be to assure that the allowance for loan losses would be sufficient to cover all estimated credit losses for the remaining life of an instrument. So FASB wanted to see companies estimate the cash flows they expected would not be collected over the life of the instrument and recognize an allowance and reflect it through net income immediately.

Through the supplementary document, the boards explain their compromise. The agreed-upon model would require an entity to consider historical data and current economic conditions, along with reasonable and supportable forecasts of future events and conditions, to develop an estimate of expected credit losses. The model reflects FASB's focus on assuring an adequate allowance for credit losses before they occur while also reflecting IASB's focus on assuring a link between the pricing of financial assets and expected credit losses.

FASB Chairman Leslie Seidman said the compromise reflects an understanding of the need for a better accounting approach for impaired debt instruments, but also one that is consistent across U.S. and international rules. “We are keenly interested in whether investors think this revised approach provides relevant and timely information about credit losses and whether reporting entities find the proposed requirements operational,” she said in a statement.

The boards are accepting comments on the supplementary document through April 1.

Topics