The two main changes are 1) an exposure draft released last week on a common approach to offsetting financial assets and financial liabilities. This would end a major difference between IFRS and U.S. GAAP. 2) A supplementary document with a new impairment model for financial assets like loans managed in an open portfolio. The proposal would replace the incurred loss model with a more forward-looking expected loss model--a response to complaints in the financial crisis.
The issue with offsetting is that companies can, in some instances, report IFRS balance sheet figures that are 100 percent greater than their U.S. GAAP numbers. This is confusing to the global capital markets and the proposals would eliminate the difference.
U.S. GAAP would only net in more limited circumstances, with note disclosure of other netting arrangements in footnotes.
Offsetting/netting is required when company presents in net amounts on their balance sheet. As it stands now, financial assets and financial liabilities may show up on a balance sheet as one net amount, or as two gross amounts, depending on whether the balance sheet is in IFRS or U.S. GAAP.
The above netting arrangements cause the largest difference between balance sheets using IFRS and U.S. GAAP. Derivative assets and related liabilities are the most common area where this occurs. Balance sheets of financial institutions generally have the largest derivative positions.
The new proposed rules apply only when the right of setoff is enforceable at all times, including in default and bankruptcy, and the ability to exercise this right is unconditional—i.e. offsetting only occurs after a future event. A company must intend to settle net, i.e. with a single payment, or simultaneously. If all of these requirements are met, offsetting is mandatory. This would also change industry conventions.
The Exposure Draft is Offsetting Financial Assets and Financial Liabilities [FASB Proposed Accounting Standards Update, Balance Sheet (Topic 210): Offsetting]. Comments are due April 28.
On Impairment, changes introduce an expected loss model that is more forward-looking in accounting for credit losses, and is said to better reflect the economics of lending decisions. IFRS and U.S. GAAP currently account for credit losses using an incurred loss model, which requires evidence of a loss (known as a trigger event) before loans can be written down.
“The FASB and IASB are seeking comment on the changes, i.e. whether they agree conceptually and whether the changes can be practically applied.
Some advocate that a more forward-looking approach to loan losses would have made loan provisions show up earlier than before, and may have held off or mitigated the credit crisis by giving earlier warnings about the health of financial institutions.
Comments on the document Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities, are due April 1.
If you need a nap, the IASB is hosting a webcast on the impairment of financial assets proposal on Friday, Feb. 4, with sessions timed for Europe and the U.S. Also “FASB in Focus” has overviews on the new rules netting on FASB’s website and another FASB in Focus on the impairment model.
