FASB Issues Financial Instruments Proposals

The Financial Accounting Standards Board (FASB) this week announced it will issue an exposure draft proposing that more financial instruments (including loans held by banks and held-to-maturity securities) be recognized at fair value on the balance sheet.

The proposals don't line up perfectly with what the IASB proposed earlier in the week, so this is the newest "fasb vs iasb" scenario, and next year should be interesting as to how the two proposals converge. As per an earlier post, IASB proposals focus on whether a financial instrument has "basic loan features" or is managed on a contractual yield basis. Basic loan features meant that the instrument bears market interest and repays original principal only. To put it bluntly FASB likes fair value better than IASB. The FASB proposals will result in more financial instruments at fair value than the IASB proposals.

Changes in fair value would be recognized either in net income for trading instruments or in other comprehensive income (OCI) for non-trading instruments.

Key aspects of the proposal:

• Fair value changes on derivatives, equity securities, and hybrid instruments containing embedded derivatives requiring bifurcation under FAS 133 (i.e., those not clearly and closely related to the host contract) will be recognized in net income.
  
• For all financial instruments, interest and dividends will continue to be recognized in net income.
  
• Credit impairments and realized gains and losses arising from sales or settlement of financial instruments will be recognized in net income.
  
• The classification of financial instruments will be determined at initial recognition with no subsequent reclassification allowed.
  
• One statement of financial performance will be required, with subtotals presented for net income and OCI. However, only earnings per share for net income will be required.
  

While an exposure draft is planned to be released for public comment in the fourth quarter of 2009, it is possible that it will be issued sooner. At future meetings, the FASB plans to discuss related matters to be included in the exposure draft, including measurement of demand deposits, a credit impairment model based on expected losses, whether to allow nonpublic entities to measure certain financial instruments at amortized cost, and the proposed effective date and transition provisions for a final standard.

This proposal represents a significant change to the existing fair value accounting model and substantial debate is expected, including how the FASB's proposal will align with the International Accounting Standards Board's (IASB) recent exposure draft on financial instrument classification and measurement.

(content from PWC)