ABC Company

LeighJay

gaap_part_2.pdf

Home >Business & Finance homework help >Accounting homework help >ABC Company

GAAP Volume 13, Issue 4 February 28, 2013

UPDATE SERVICE GAAP

Summary & Highlights

PRONOUNCEMENT: Proposed Accounting Standards Update (ASU), Financial Instruments—Credit Losses (ASC 825-15) (Part 2)

EFFECTIVE DATE: Entities would be required to apply the proposed guidance by making a cumulative-effect adjustment in the balance sheet as of the beginning of the fi rst reporting period in which the guidance would be effective. The effective date will be established when the fi nal guidance is issued.

The Financial Accounting Standards Board (FASB) issued the proposed Accounting Standards Update (ASU), Financial Instruments—Credit Losses (ASC 825-15), on December 20, 2012. Comments on the proposal, which are due by April 30, 2013, may be submitted in one of the following three ways:

1. Use the electronic feedback form on the FASB’s website at Exposure Documents Open for Comment;

2. Email a letter to [email protected], File Reference No. 2012-260; or 3. Send a letter to “Technical Director, File Reference No. 2012-260, FASB, 401

Merritt 7, PO Box 5116, Norwalk, CT 06856-5116.

This is Part 2 of a two-part series discussing the proposed ASU. In the February 15, 2013 GAAP Update Service, Part 1 covered the following topics:

Overview; Scope; Recognition; Subsequent measurement; Other presentation matters; and Disclosure.

Part 2 discusses the following topics:

Implementation; and Transition.

Analysis and Implementation

Overview

This proposal is a component of the joint project of the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) (the Boards) to revise and improve their respective guidance on account- ing for fi nancial instruments. The project began before the global economic crisis in 2008, which exposed weaknesses in the existing accounting standards. One of those weaknesses is the overstatement of assets due to the delayed recognition of credit losses related to loans and other fi nancial instruments that were not recog- nized until it is probable that a loss will be incurred. The objective of the project on accounting for the impairment of fi nancial assets is to simplify the accounting guidance and to provide guidance that is useful for decision-making. Currently, there are fi ve different models in U.S. generally accepted accounting principles (GAAP) for accounting for the impairment of fi nancial instruments. A model that includes forward-looking information is needed to assess the impairment of fi nan- cial instruments.

To address that issue, among others, the FASB issued the proposed ASU, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities, in May 2010. That document included pro- posed guidance on classifi cation and measurement, credit impairment, and hedge accounting requirements. Under that proposal, an entity would have been required to recognize a credit impairment when it does not expect to collect all contrac- tual amounts due. The IASB also issued a proposal in November 2009. As a result of the Boards’ considerations of the comments on their respective proposals, they decided to develop a model that varies from the original proposal. In January 2011, the Boards issued a Supplementary Document, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities— Impairment, which was a joint proposal that introduced the concept of two different measurement objectives, one for a “good book” of performing loans and another for a “bad book” of loans. Based on comments received on that proposal, the Boards developed a “three-bucket model,” which would have eliminated an initial rec- ognition threshold, and used two different measurement objectives for the credit impairment allowance that would be subject to the extent of credit deterioration or recovery since a fi nancial instrument’s origination or acquisition. After consid- erable discussion with stakeholders who raised many concerns about the three- bucket model, the FASB decided not to proceed with that model and has agreed on the proposed model, which retains certain sound concepts from other models considered during its discussions and avoids concepts that are complex, inoperable, and believed to be problematic.

Proposed ASU

The proposed guidance below would be included as new Subtopic ASC 825-15 in the FASB Accounting Standards Codifi cationTM (ASC) 825, Financial Instruments.

Implementation Guidance

Estimating expected credit losses. Because estimating expected credit losses requires considerable judgment, the techniques used should be practical and rel- evant to the particular circumstances. The methods used to make such estimates may vary based on the type of fi nancial asset and the available relevant informa- tion. The following are examples of judgments and policy elections that an entity could make for the purpose of developing historical statistics that would be used to estimate its expected credit losses that have been updated for current conditions and supportable forecasts of the future:

The defi nition of “default” used to develop statistics based on defaults; The approach used to measure the amount of a “loss” in the development of statistics based on defaults or the rate of loss, including whether it is based on the amount of amortized cost written off under U.S. GAAP; The method used to weigh historical experience (e.g., on a volume-weighted basis or an equal-weighted basis); The method used to adjust loss statistics for recoveries; and The effect of expected prepayments on the allowance for expected credit losses as of the reporting date.

No specifi c approaches or specifi c elections are required. Entities would be per- mitted to develop estimation techniques that would be applied consistently to accurately estimate expected credit losses by using key principles in the proposal. Entities would neither be required to use a probability-weighted discounted cash fl ow model to estimate expected credit losses nor to reconcile the estimation tech- nique used with a probability-weighted discounted cash fl ow model.

Estimating expected credit losses—time value of money. Under the proposal, an estimate of expected credit losses would be required to refl ect the time value of money, explicitly or implicitly. The time value of money is explicitly refl ected in:

A discounted cash fl ow model; or Loss statistics based on a ratio of:

The amount of amortized cost written off because of credit loss; and The amount of the amortized cost basis of the asset, and by applying the loss statistic after it has been updated for current conditions and reasonable and supportable forecasts of the future to the amortized cost balance as of the reporting date to estimate the portion of the recorded basis of the amortized cost not expected to be recovered because of credit loss.

Loss-rate methods, roll-rate methods, probability-of-default methods, and a pro- vision matrix method using loss factors also may be used.

For collateral-dependent fi nancial assets, methods comparing the amortized cost basis of an asset to the collateral’s fair value may be used as a practical expedient. Under that method, if repayment or satisfaction of an asset depends on the sale of

the collateral, the entity would be required to adjust the collateral’s fair value to consider estimated selling costs (on a discounted basis). If, however, repayment or satisfaction of an asset depends only on the operation of the collateral, rather than its sale, selling costs would not be included in estimated expected credit losses.

Estimating expected credit losses—multiple possible outcomes. Under the proposal, an estimate of expected credit losses would always have to consider the possibility that a credit loss will occur and that no credit loss will occur. If a range of at least two outcomes is implicit in the method used, an entity would not have to identify various credit loss scenarios or estimate the weighted probability of expected credit losses.

Because some measurement methods (e.g., the loss-rate method, a roll-rate method, a probability-of-default method, and a provision matrix method using loss factors) use a wide-ranging population of actual historical loss data as an input to estimate credit losses, the requirement is met implicitly provided that the actual loss data include items that eventually resulted in a loss and items that resulted in no loss. An entity also would be able to use the fair value of collateral (less estimated selling costs, if applicable), as a practical expedient, to estimate credit losses for collateral-dependent fi nancial assets because several potential outcomes are considered on a market-weighted basis in the fair value of collateral and may result in zero expected credit losses if the collateral’s fair value is greater than the asset’s amortized cost basis.

Estimating expected credit losses—lease receivables. An entity would be required to recognize an allowance for all expected credit losses on lease receiv- ables recognized by a lessor in accordance with the guidance in ASC 840, Leases. Instead of using the contractual cash fl ows and the effective interest rate, the cash fl ows and discount rate used to measure a lease receivable under ASC 840 would be used to measure expected credit losses on lease receivables that use a discounted cash fl ow method.

Estimating expected credit losses—loan commitments. An entity would be required to recognize all expected credit losses on loan commitments that are mea- sured at fair value and on which qualifying changes in fair value are recognized in net income. To estimate expected credit losses on such loan commitments, an entity would estimate credit losses over the full contractual period that the entity is exposed to credit risk as a result of a present legal obligation to extend credit, unless the issuer can cancel the obligation unconditionally. During the period of exposure, the entity would be required to consider the following in its estimate of expected credit losses:

The likelihood that a loan will be funded (it may be affected by a material adverse change clause); and An estimate of expected credit losses on commitments expected to be funded.

Estimating expected credit losses—the effect of a fair value hedge on the dis- count rate if a discounted cash fl ow model is used. Under the proposal, an entity that uses a discounted cash fl ow model to estimate expected credit losses would be required to use the fi nancial asset’s effective interest rate. If the carrying amount of a recorded investment in a debt instrument has been adjusted under the guid-

ance in ASC 815, Derivatives and Hedging (ASC 815-25-35), for fair value hedge accounting, the effective interest rate would be the discount rate that associates the present value of the debt instrument’s future contractual cash fl ows with the adjusted recorded investment in the debt instrument.

Disclosure—application of the term “portfolio segment.” The following are examples of portfolio segments:

Type of debt instrument; Borrower’s industry sector; and Risk rates.

Disclosure—application of the term “class of fi nancial asset.” A class of fi nan- cial assets would be determined based on both of the following criteria:

Measurement attribute. Classes of fi nancial assets would fi rst be separated based on the model under which they are measured, for example:

Amortized cost; or Fair value with qualifying changes in fair value recognized in other comprehensive income.

Entity assessment. Classes would next be separated to a level that an entity uses when it evaluates and monitors a portfolio’s risk and performance for various types of fi nancial assets. A fi nancial asset’s risk characteristics would be consid- ered in this evaluation.

To determine which level of its internal reporting to use as a basis for fi nancial statement disclosures, an entity would consider the amount of detail users need to understand the underlying risks of its fi nancial assets. Many factors may be consid- ered in deciding whether an entity needs to disaggregate its portfolio further by the following categories:

Categories of users: Commercial loan borrowers; Consumer loan borrowers; or Related party borrowers.

Type of fi nancial asset: Mortgage loans; Credit card loans; Interest-only loans; Corporate debt securities; Trade receivables; or Lease receivables.

Industry sector: Real estate; or Mining.

Type of collateral: Residential property; Commercial property; Government-guaranteed collateral; or Uncollateralized (unsecured) fi nancial assets.

Geographic distribution: Domestic; or International.

Classes of fi nancial assets are usually separated by portfolio segment, which is the starting point for the decision regarding whether to disaggregate further.

Disclosure—application of the term “credit-quality indicator.” The following are examples of credit-quality indicators:

Consumer credit risk scores; Credit rating agency ratings; An entity’s internal credit risk grades; Loan-to-value ratios; Collateral; Collection experience; or Other internal metrics.

Judgment should be used to determine the applicable credit-quality indicator for each fi nancial asset class. An entity should use the most current information as of the balance sheet date for the credit-quality indicator.

Transition and open effective date information. The following is the proposed transition and effective date for the proposed ASU:

1. The proposed guidance would be effective for fi scal years, and interim periods within those years, beginning on a date to be determined by the FASB.

2. The proposed guidance would be applied as a cumulative-effect adjustment to the balance sheet.

3. Early application of the guidance would not be permitted. 4. The following disclosures would be required in the period in which an entity

adopts the proposed guidance: (a) The nature of the change in accounting principle with an explanation of

the newly adopted accounting principle. (b) The method used to apply the change. (c) The effect of the adoption of a new accounting principle on any line item

in the balance sheet, if material, as of the beginning of the fi rst period for which the guidance is effective. The effect on fi nancial statement subtotals need not be presented.

(d) The cumulative effect of a change on retained earnings or other components of equity in the balance sheet as of the beginning of the fi rst period for which the guidance is effective.

5. An entity that issues interim fi nancial statements would be required to provide the disclosures in (4) above in each interim fi nancial statement of the year of change and the annual fi nancial statement of the period of the change.

About the Author

Judith Weiss, CPA, has been attending EITF meetings regularly since 1991. She was a technical manager in the AICPA Accounting Standards Division and a senior manager in the national offi ces of Deloitte & Touche LLP and Grant Thornton LLP. Ms. Weiss is also one of the authors of the GAAP Guide.

LEADING ACCOUNTING INFORMATION AND TOOLS FOR PROFESSIONALS

CCH, a Wolters Kluwer business, offers a suite of accounting information and products featuring in-depth analysis, guidance, and solutions in a full range of media—from guides, practice manuals, and treatises to journals, newsletters, and Internet research libraries. Make CCH your source for accounting guidance with comprehensive, timesaving products, including:

• Accounting Irregularities and Financial Fraud

• CCH Accounting for Income Taxes

• Financial Instruments

• GAAP Financial Statement Disclosures Manual

• GAAP Guide

• Governmental GAAP Guide

• Not-for-Profi t Reporting

• Revenue Recognition Guide

• SEC Disclosures Checklists

To order or for more information on these and other CCH products and services, call 1-800-248-3248 or visit the CCH Online Store at CCHGroup.com.

CCH LEARNING CENTER

CCH’s goal is to provide you with the clearest, most concise, and up-to-date accounting and auditing information to help further your professional development, as well as a convenient method to help you satisfy your continuing professional education requirements. The CCH Learning Center* offers a complete line of self-study courses covering complex and constantly evolving accounting and auditing issues. We are continually adding new courses to the library to help you stay current on all the latest developments. The CCH Learning Center courses are available 24 hours a day, seven days a week. You’ll get immediate exam results and certifi cation. To view our complete accounting and auditing course catalog, go to: http://cch.learningcenter.com.

* CCH is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have fi nal authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be addressed to the National Registry of CPE Sponsors, 150 Fourth Avenue North, Nashville, TN 37219-2417. Telephone: 615-880-4200.

* CCH is registered with the National Association of State Boards of Accountancy as a Quality Assurance Service (QAS) sponsor of continuing professional education. Participating state boards of accountancy have fi nal authority on the acceptance of individual courses for CPE credit. Complaints regarding QAS program sponsors may be addressed to NASBA, 150 Fourth Avenue North, Suite 700, Nashville, TN 37219- 2417. Telephone: 615-880-4200.

A C C O U N T I N G R E S E A R C H M A N A G E R ®

Accounting Research Manager is the most comprehensive, up-to-date, and objec- tive online resource of fi nancial reporting literature. It includes all authoritative and proposed accounting, auditing, and SEC literature, plus independent, expert-written interpretive guidance to assist you with your accounting and auditing research needs: accounting for public and nonpublic companies, auditing for public companies, and auditing for nonpublic companies.

Material is updated on a daily basis by our outstanding team of content experts, so you stay as current as possible. You’ll learn of newly released literature and deliberations of current fi nancial reporting projects as soon as they occur. You’ll be kept up-to-date on the latest FASB, AICPA, SEC, PCAOB, EITF, GASB and IASB authoritative and proposal stage literature.

With Accounting Research Manager, you maximize the effi ciency of your research time while enhancing your results. Learn more about our content, our experts, and how you can request a FREE trial by visiting us at www.accountingresearchmanager.com.

emailed to multiple sites or posted to a listserv without the copyright holder's express written permission.

However, users may print, download, or email articles for individual use.