FASB Racing Through Impairment Revisions

The Financial Accounting Standards Board’s high-speed effort to rewrite the accounting rules for impaired assets will take the shape of four quick projects, modifying three existing rules and calling for more disclosures via a fourth new rule.

FASB is racing to complete the revisions in time to be effective for year-end 2008 financial reporting, but isn’t entirely sure the revisions will help thaw the frozen credit markets. Even FASB Chairman Robert Herz, speaking at a Board meeting last week, voiced reservations about the planned new guidance.

Herz

“I think all this impairment stuff is voodoo,” he said. “I see a lot of utility for understanding what’s happened to particular instruments, market values, cash flows currently and projected. I don’t see a lot of value to some of these calculations that get done now under any of the impairment models … For those who believe impairment is an important element of the accounting model, I invite them to try to persuade me.”

FASB’s impairment projects stem partly from study due out in January by the Securities and Exchange Commission, expected to say that fair-value accounting rules are not a prime culprit in the financial crisis; rather, the problem is inconsistent application of rules regarding how to report impaired financial instruments. That conclusion is pressuring FASB to clarify rules for reporting such impaired assets, even when Herz and others aren’t sure any new rules will actually help.

Herz said FASB is acting largely based on what it heard in roundtables it conducted with the International Accounting Standards Board in Tokyo, London, and New York, as well as roundtables held by the SEC, to hear views about fair-value accounting’s role in the credit crisis.

The SEC’s study was required as part of the Wall Street bailout Congress passed in October. It will not arrive until the first week of January, but Herz said the Commission has come to believe accounting rules should have a single trigger to declare an asset “impaired.”

Linsmeier

Board member Tom Linsmeier bluntly said FASB is revising its impairment rules because the SEC told it to do so. “We’re talking about this because, as many of you know, [SEC Chairman Christopher] Cox said we should look at this,” he said. “The SEC views this as an important area for us to be looking at in terms of impairment guidance.”

“… For those who believe impairment is an important element of the accounting model, I invite them to try to persuade me.”

— Robert Herz,

Chairman,

FASB

Linsmeier was referring to Emerging Issues Task Force Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets.” One of FASB’s four impairment projects is to square EITF 99-20 with Financial Accounting Standard No. 115, Accounting for Certain Investments in Debt and Equity Securities—even though an informal telephone poll by FASB staff found that half of the respondents wanted the change, and half preferred FASB leave the two rules alone.

“I don’t understand why we would necessarily address impairment in this isolated sense,” Linsmeier said. “The users are unanimous in saying they want additional disclosures to help them understand risk and uncertainties and judgments in fair value, yet we’re not going to do an emergency project related to that call … I’m greatly concerned that the reason we’re getting pressure to do this is because the preparer community does not want to recognize losses. They’re going to find the weakest point in the impairment model and criticize inconsistencies to make a change to not recognize losses. I’m quite conflicted on this decision.”

Linsmeier and other board members ultimately agreed to proceed with a revision to EITF 99-20, but with plans to look for clues in comment letters that would suggest the current guidance is genuinely skewing the economics. “I remain skeptical, but I'm willing to [propose it for public comment] because some users say this might be beneficial,” Linsmeier said.

Other Moves

Next, FASB plans to call for new or enhanced disclosures about impairments related to the most toxic instruments locking down credit markets today: debt securities classified as available for sale or held to maturity, loans, and long-term receivables. FASB wants to require companies to provide the pro forma effect on pretax net income as if those instruments were carried at fair value and measured based on the incurred loss, to provide data regarding how those instruments would look in the financial statements if reported at current market values.

BOARD DECISIONS

The Financial Accounting Standards Board met recently to discuss accounting for financial instruments:

Short-Term Project 1—Practice Issues with EITF Issue 99-20

The Board decided to address practice issues with EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” by making the impairment guidance in it consistent with FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities. That is, as in Statement 115, a decline in fair value below the amortized cost basis that is other than temporary would be recognized as a realized loss through earnings.

The Board noted that this change simplifies U.S. GAAP. However, the Board acknowledges that differences continue to exist between U.S. GAAP and IFRS with regard to the accounting for financial instruments and that a comprehensive project to address the complexity in reporting for financial instruments will address those differences.

Effective Date, Transition, and Comment Period

The Board decided that the guidance should be effective as of the last day of all interim and annual reporting periods ending after December 15, 2008 and applied prospectively. In the first fiscal year that this FSP is applied, information related to quarterly interim periods that began on or before September 15, 2008 may be omitted. The Board also decided that the comment period for the exposure document should end on December 30, 2008. The Board expects to issue a proposed FSP on or around December 19, 2008, to allow for a comment period of approximately 10 days.

Short-Term Project 2—Disclosures of Certain Financial Instruments

The Board agreed to require enhanced disclosures about the impairment of:

1. Debt securities classified as available-for-sale

2. Debt securities classified as held-to-maturity

3. Loans

4. Long-term receivables.

The Board decided that for those instruments within the scope of this project, an entity should disclose:

1. The pro forma effects on pretax net income as if the instruments were (a) carried at fair value and (b) measured based on the incurred loss

2. The amount of the instruments reported in the statement of financial position and the amounts that would have been reported had they been measured:

At fair value

On a historical cost basis using an incurred loss method of measuring impairment

3. Qualitative disclosures including the valuation methodologies and factors resulting in the differences among the three measures of the instruments’ value.

The IASB is undertaking a similar project. The two Boards share a goal of requiring similar disclosures that would help investors when comparing financial statements of entities holding financial instruments within the scope of the proposed guidance.

Effective Date, Transition, and Comment Period

The Board decided that an entity should provide the disclosures in financial statements for fiscal years ending after December 15, 2008, and for quarterly interim periods within those fiscal years. In the first fiscal year that this FSP is applied, the disclosures may omit information related to quarterly interim periods that began on or before September 15, 2008. The Board decided that disclosures are required only for the current reporting period. The Board further decided that the comment period for the exposure document should end on January 15, 2009. The Board expects to issue a proposed FSP on or around December 23, 2008, to allow for a comment period of approximately 20 days.

Source

Financial Accounting Standards Board (Dec. 15, 2008).

The Board also wants investors to see the difference between the amounts reported in the statement of financial position and the amounts that would have been reported if they had been measured at fair value or historical cost using an incurred loss method of measuring impairment. And FASB plans to call for qualitative disclosures, such as a description of the valuation methods and the factors that would result in the differences among the various measures of an instrument’s value.

Third, the Board plans to examine whether an entity should be permitted to report a gain on an impaired security that later recovers its value. Currently, U.S. Generally Accepted Accounting Principles forbid companies from reversing an other-than-temporary impairment, but international accounting standards allow it. Board members have pondered whether that prohibition in U.S. GAAP contributes to the heartburn over recording an impairment in the first place.

Finally, FASB plans to amend FAS 133, Accounting for Derivative Instruments and Hedging Activities, to clarify a scope exception related to embedded credit derivatives, to assure it isn’t fouling the impairment process.

FASB plans short comment periods and quick turnarounds on the four impairment-related and disclosure initiatives, with hopes it can be achieved in time to take effect for 2008 financial reports.

Meanwhile, the Board also decided separately to abandon its planned revisions to FAS 133, which sought to simplify the infamously complex world of derivative accounting. FASB said it will focus on the bigger-picture assessment of complex financial instruments in tandem with IASB instead.

Okochi

Not everyone is happy with the sudden change in course. Jiro Okochi, CEO of derivatives software provider Reval, said ending the amendment project for FAS 133 suggests that preparers at least will be spared implementing a rule change destined to change again as the United States moves toward international accounting rules. “Thanks, FASB, for wasting everyone’s time,” Okochi said tartly.

Board member Leslie Seidman, however, said for all FASB’s fussing over specific pieces of accounting literature, the path out of the current lockdown in credit markets is simply more information.

“It seems to me the only way to remedy this situation is for servicers and sponsors of these deals to provide full, timely disclosure of the composition and performance of the pools, including information collections, collateral values, defaults, foreclosures, modifications, et cetera,” she said. “It would significantly reduce the uncertainty about the quality of theses securities and provide better information for all market participants, not just the servicers, to estimate fair value in the absence of trades. I don’t think this is an issue for general purposes of financial reporting. Rather, I think it is a market regulation issue.”