IASB Proposes New Accounting Model for Financial Instruments

The International Accounting Standards Board (IASB) on Thursday published proposals that if implemented would fundamentally shift the way banks and other financial institutions report the value of loans (or portfolios of loans) and other financial instruments carried at amortized cost.

Both International Financial Reporting Standards (IFRS) and U.S. GAAP currently use an incurred loss model for the impairment of financial assets. An incurred loss model assumes that all loans will be repaid until evidence to the contrary (known as a loss or trigger event) is identified. Only at that point is the impaired loan (or portfolio of loans) written down to a lower value.

The global financial crisis has led to criticism of the incurred loss model for presenting an initial, overly optimistic assessment of credit losses, only to be followed by a large adjustment once a trigger event occurs.

Under the new IASB proposals, expected losses would be recognized throughout the life of the loan (or other financial asset measured at amortized cost), and not just after a loss event has been identified. This would avoid the front-loading of interest revenue that occurs today before a loss event is identified and would better reflect the lending decision. A provision against credit losses would be built up over the life of the financial asset. Extensive disclosure requirements would provide investors with an understanding of the loss estimates that an entity judges necessary. For the IASB’s summary of the proposals in the exposure draft, click here.

The IASB, in a press release, said its proposed changes are in response to requests by the Group of 20 (G-20) leaders and others. The G-20 leaders have called on accounting standard setters to make improvements to valuation standards for financial instruments by the end of 2009. The chairmen of both FASB and the IASB have offered assurances that their boards are doing everything possible to improve their respective standards by the end of this year.

Although the IASB and FASB were reportedly unable to reach an agreement on details of this new measurement model at a joint meeting last week, the IASB says it will cooperate closely with FASB with a goal of agreeing to a common approach to the impairment of financial assets.

The exposure draft on the amortized cost measurement and impairment of financial instruments forms the second part of a three-part project to replace the current international standard, IAS 39, Financial Instruments: Recognition and Measurement, with a new standard, to be known as IFRS 9, Financial Instruments. Proposals for the first part of the project, which focused on the classification and measurement of financial instruments, were published in July, with a final standard expected shortly. The third part of the project, which focuses on hedge accounting, is still in development.

Comments on the exposure draft are due June 30. After considering comments received on the exposure draft, the IASB says it plans to issue a standard in 2010 that would become mandatory about three years later with early application permitted.

—Matthew G. Lamoreaux (mlamoreaux@aicpa.org) is a JofA senior editor.