Attempting to set straight confusion over its proposal for changing the accounting around credit losses, the Financial Accounting Standards Board has published a 16-page questions-and-answers document to clarify the objective of the proposal and the rationale behind the board's approach.

It's not a normal step in the carefully prescribed standard-setting process, but the board found it necessary in this particular case. “We took this step because we were made aware of misconceptions some stakeholders have about the proposal,” says FASB spokesman Chris Klimek. “The FAQ document addresses those issues.”

The FAQ begins with some pointed reminders that FASB writes rules that are meant to enhance investor understanding of financial statements, not establish or influence capital requirements for financial institutions. “The mission of FASB is very different from the mission of banking regulators,” FASB says.

FASB's proposal calls for a more forward-looking approach to recognizing credit losses that requires entities to book what they expect to lose, not just what they've actually lost. Today's focus in accounting rules on incurred losses is often cited as a reason why financial institutions gave no forewarning of pending disaster heading into the financial crisis.

FASB published its proposal in December and is allowing through late April for preparers, auditors, investors and others to provide their feedback. The International Accounting Standards Board, meanwhile, is taking a different approach with its credit loss model. Both boards have said they will review the feedback to both proposals in hopes they can achieve a more common approach.

Controversy is building around an aspect of FASB's approach that would require entities to consider the likelihood of a loss on every instrument and book some measure of expected loss from the very beginning, even when the debt instrument is performing and producing all contractually expected cash flow. FASB's FAQ acknowledges criticism that such an approach leads to excessive front loading of expected credit losses. It offers nearly a dozen conceptual and practical reasons why it wants to adopt its chosen model -- frontloading and all.

The Credit Union National Association recently vocalized its concerns over the proposal after it met with FASB directly, saying the rule as written would have costly, harmful consequences for credit unions. FASB's proposed model would require entities to rely on “speculative forecasting” of asset performance over the lifetime of a given asset, according to a statement by CUNA President and CEO Bill Cheney. He is worried the approach will be complex and costly to implement.

In its FAQ, FASB writes, “a primary weakness identified with the current accounting model is the delayed recognition of credit losses. When an entity holds a portfolio of debt instruments, credit losses are reasonably expected in the portfolio even if the entity is unable to specifically identify the individual financial assets upon which a loss is likely to materialize. The Board believes that entities should accrue for their expectation of loss.” The FAQ continues with additional reasons around the relevance of historical information, the link between taking on a new loan and increasing an entity's risk, investors' demands for transparency, and several others.