Board Meeting Handout. Accounting for Financial Instruments: Classification and Measurement. March 12, 2014

Transcription

1 Board Meeting Handout Accounting for Financial Instruments: Classification and Measurement Background March 12, At its January 29, 2014 meeting, the Board tentatively decided no longer to pursue the business model assessment with a cash flow (value) realization focus in the FASB s proposed Accounting Standards Update, Financial Instruments Overall (Subtopic ): Recognition and Measurement of Financial Assets and Financial Liabilities, as clarified by the Board at the joint FASB and IASB meeting on November 20, In addition, the Board decided to discontinue the consideration of the activities-based business model for classification and measurement of financial assets that the Board had developed before beginning joint deliberations with the IASB in January That activities-based business model focused on the business activities that an entity uses in acquiring and managing the financial assets. 2. The Board directed the staff to analyze whether there are any targeted improvements that can be made to the current U.S. GAAP guidance for classification and measurement of loans and debt securities in the following two areas: a. Reclassification between categories b. Sales from the held-to-maturity (HTM) category for debt securities and the heldfor-investment (HFI) category for loans, including the guidance on tainting. Alternatives to Assess the Business Model of Financial Assets 3. Although the staff did not identify any significant improvements that could be made to the respective U.S. GAAP classification and measurement models for loans and debt securities in isolation (specifically, as it relates to reclassifications and sales out of the amortized cost categories), the staff learned about different views on how the guidance may be developed for a single (merged) classification and measurement model for debt securities and loans. In addition, some respondents to the proposed Update noted that the Board should pursue one classification and measurement model for loans and debt The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

2 securities because a merged model, with consistent definitions of each category, would represent a substantial and cost-effective simplification to current U.S. GAAP, while also ensuring that the accounting models for similar instruments would not be based simply on their legal form. 4. Based on the staff s analysis, and feedback received on the proposed Update, the staff has identified the following three alternatives for the Board s consideration. These alternatives are further summarized in Appendix A. a. Alternative A: One model for loans and debt securities with unrestricted reclassification, unrestricted sales out of the HTM category, and enhanced disclosures regarding those reclassifications/sales. The concept of tainting (both the current and future portfolios) due to sales out of the HTM category would not exist. Alternative A also would incorporate a requirement (similar to paragraph in the proposed Update) such that equity investments would be measured at fair value through net income (FV-NI). b. Alternative B: Retain current U.S. GAAP with respect to debt securities and loans. Incorporate a requirement (similar to paragraph in the proposed Update) such that equity investments would be measured at FV-NI. c. Alternative C: One model for loans and debt securities with restrictions (similar to current restrictions for debt securities) on reclassification and sales out of the HTM category. The concept of tainting (both the current and future portfolios) due to sales out of the HTM category would exist, similar to the current U.S. GAAP guidance for debt securities. Alternative C also would incorporate a requirement (similar to paragraph in the proposed Update) such that equity investments would be measured at FV-NI. Question for the Board Which of the three alternatives does the Board prefer for assessing the classification and measurement of financial assets? Page 2 of 4

3 Appendix A Summary of the Alternatives Classification Categories Alternative A Alternative B Alternative C Debt Instruments Debt Securities Debt Instruments 1) Held to Maturity (AC) 1) Held to Maturity (AC) 1) Held to Maturity (AC) 2) Available for Sale (FV-OCI) 2) Available for Sale (FV-OCI) 2) Available for Sale (FV-OCI) 3) Trading (FV-NI) 3) Trading (FV-NI) 3) Trading (FV-NI) Loans 1) Held for investment (AC) 2) Held for sale (LOCOM) Objective of HTM Equity Investments 1) Trading (FV-NI) Positive intent and ability to hold the debt instruments until maturity or payoff Equity Securities 1) Trading (FV-NI) Debt Securities Positive intent and ability to hold the debt securities to maturity Equity Investments 1) Trading (FV-NI) Positive intent and ability to hold the debt instruments until maturity or payoff Objective of AFS Debt instruments not classified as either HTM or trading (residual category) Loans Intent and ability to hold the loan for the foreseeable future or until maturity or payoff Debt Securities Debt securities not classified as either HTM or trading (residual category) Debt instruments not classified as either HTM or trading (residual category) Objective of Trading Debt instruments that are acquired or originated for the purpose of selling them in the foreseeable future Loans Not Applicable. Category not available to loans Debt Securities Debt securities that are acquired or originated for the purpose of selling them in near term Debt instruments that are acquired or originated for the purpose of selling them in the foreseeable future Loans (measured at the lower of cost or fair value) Loans held for sale (for example, those that an entity does not have intent and ability to hold the loan for the foreseeable future or until maturity or payoff)

4 Tainting Alternative A Alternative B Alternative C Debt Securities Specific rules on when it is acceptable to sell debt securities out of the held-to-maturity category would remain. The concept of tainting also would remain for existing portfolio and future acquisitions of debt securities No tainting of either the existing portfolio or future acquisition/origination of debt instruments Specific rules on when it is acceptable to sell debt instruments out of the held-tomaturity category. The concept of tainting would remain for existing portfolio and future acquisition/origination of debt instruments. Reclassification Reclassifications allowed to and from all categories (no explicit prohibition / limitation) Loans No prohibition / limitation on sales out of the held-for-investment category. No tainting concept Debt Securities Reclassifications should be rare. Existing guidance for reclassification remains. Reclassifications should be rare, similar to existing guidance on reclassification for debt securities. Require disclosure of roll-forward reconciling opening balances with ending balances for each of the categories with reclassifications as a separate reconciling item Loans Reclassifications allowed to and from both categories (no explicit prohibition / limitation) Page 4 of 4

5 Board Meeting Handout Accounting for Financial Instruments: Impairment March 12, 2014 PURPOSE OF THIS MEETING 1. The purpose of this meeting is to discuss whether a single impairment model should apply to all financial assets and whether any practicability exceptions or expedients should be provided in light of feedback received on the current expected credit losses (CECL) model in the December 2012 proposed FASB Accounting Standards Update, Financial Instruments Credit Losses (Subtopic ). 2. At this meeting, the staff and Board will discuss the following issues: (a) (b) (c) Issue 1: Whether an impairment model that is different from the CECL model should apply to either (1) financial assets that are in the form of debt securities or (2) financial assets that are measured at fair value with qualifying fair value changes recognized in other comprehensive income (FV-OCI) Issue 2: Whether a practicability exception that would allow an entity not to recognize credit losses should be provided for certain financial assets (such as financial assets for which credit losses are expected to be insignificant) Issue 3: Whether a fair-value-based practical expedient for measuring credit losses should be provided for financial assets that (1) an entity subsequently identifies for sale or (2) it is more likely than not that an entity will be required to sell before recovery of its amortized cost basis. 3. Because of the interrelated nature of Issues 1 and 2, the staff and Board will discuss those issues together. FEEDBACK RECEIVED Users 4. Users had mixed views on the application of the CECL model to debt securities and financial assets measured at FV-OCI. Many users support a single model for credit impairment and stated that the CECL model would be a significant improvement over The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

6 existing other-than-temporary impairment (OTTI) rules for debt securities because current OTTI rules can result in the delayed recognition of credit losses. Other users noted that there is no need to separately recognize credit losses through net income and stated that sufficient transparency is provided by recognizing all changes in fair value (including those related to management s assessment of the changes in credit risk) through other comprehensive income. Finally, some users are satisfied with the information provided by the application of existing OTTI rules. Others 5. The majority of nonuser stakeholders disagree with the approach for financial assets measured at FV-OCI for a number of reasons. Some would prefer to maintain the existing OTTI model for debt securities while others recommended modifying the practicability exception provided in the proposed Update. Others recommended that U.S. treasury securities (and other similar debt instruments) should be excluded from the scope of the proposed guidance. (a) (b) Maintain the existing OTTI model for debt securities: (i) Some nonusers stated that the existing OTTI model is well understood by investors and is applied consistently by preparers. Those stakeholders stated that applying the CECL model would result in less decisionuseful information as compared with the information provided by applying the OTTI model. They noted that the OTTI model was improved in light of the recent financial crisis, resulting in more timely recognition of credit losses for securities. In addition, some of those stakeholders mentioned that having a different impairment model for debt securities is justified because debt securities are managed differently than other debt instruments, such as loans. Stakeholders who supported retaining the existing OTTI guidance recommended, however, that the Board amend the OTTI guidance to allow an entity to immediately recognize improvements in credit quality through net income. Modify the practicability exception in the proposed Update: (i) Some nonusers recommended that the practicability exception be revised to allow an entity that meets either rather than both of the two proposed criteria to elect the practicability exception. 2

7 (c) (ii) Others recommended that the practicability exception should not require an entity to determine whether the fair value of the financial asset is greater than (or equal to) its amortized cost because this is generally more a reflection of other factors such as interest rate risk rather than credit risk. Those stakeholders noted that an entity should be permitted not to recognize credit losses on financial assets measured at FV-OCI if expected credit losses on the individual financial asset are insignificant. Exclude from the scope U.S. treasury securities (and other similar debt instruments): (i) Some nonusers questioned the relevance, faithful representation, and cost-benefit of recognizing credit losses on debt instruments for which credit risk is expected to be low. Stakeholders provided examples of financial assets with low credit risk, including government-backed securities, short-term receivables, reverse repurchase agreements, and margin loans. Those stakeholders recommended that the Board exclude such financial assets from the proposed guidance or develop a practicability exception that is based on qualitative factors. ISSUE 1: SINGLE IMPAIRMENT MODEL 6. Some believe that the CECL model should apply to all financial assets (consistent with the proposed Update). Others believe that an impairment model that is different from the CECL model should apply to some financial assets. Based on feedback received, the Board has the following broad alternatives regarding whether a single impairment model should apply to all financial assets: Alternative A: The CECL model should apply to all financial assets within the scope of the guidance. Alternative B: An impairment model that is different from the CECL model should apply to financial assets that are debt securities. Alternative C: An impairment model that is different from the CECL model should apply to financial assets measured at FV-OCI. 7. Under Alternatives B and C, the Board could retain the existing OTTI guidance in U.S. GAAP or the Board could consider limited amendments to that guidance. 3

8 ISSUE 2: PRACTICABILITY EXCEPTION FOR CERTAIN FINANCIAL ASSETS 8. Based on feedback received, the staff has identified the following alternatives regarding which financial assets should qualify for a practicability exception that provides relief from recognizing credit losses: Alternative 1: Financial assets for which fair value exceeds or is equal to amortized cost Alternative 2: Financial assets for which credit losses are expected to be an insignificant amount Alternative 3: Financial assets for which (a) fair value exceeds or is equal to amortized cost and (b) credit losses are expected to be an insignificant amount Alternative 4: Financial assets for which (a) fair value exceeds or is equal to amortized cost or (b) credit losses are expected to be an insignificant amount Alternative 5: U.S. government-backed securities. 9. The Board could decide to provide a practicability exception for all financial assets within the scope of the guidance or limit the practicability exception to financial assets that are (a) debt securities, (b) measured at FV-OCI, or (c) any combination. Questions for the Board 1. Should the CECL model apply to all financial assets in the scope of the guidance? 2. If no, should a different impairment model apply to (a) debt securities or (b) financial assets measured at FV-OCI? Should a model similar to existing OTTI guidance apply to those financial assets? 3. Should entities be provided with a practicability exception that provides relief from recognizing credit losses on certain financial assets? If so, to which financial assets should that practicability exception apply? ISSUE 3: FINANCIAL ASSETS IDENTIFIED FOR SALE 10. Similar to the guidance for debt securities in current U.S. GAAP, as part of the February 2013 proposed FASB Accounting Standards Update, Financial Instruments Overall (Subtopic ): Recognition and Measurement of Financial Assets and Financial Liabilities, the Board decided that for debt instruments measured 4

9 at amortized cost, when an entity subsequently identifies a debt instrument for sale, impairment should be recognized as the difference between the financial asset s fair value and its net carrying amount. However, the Board did not decide whether that approach should be required for financial assets that are measured at FV-OCI. 11. For this issue, the staff is seeking direction from the Board about whether it would like to discuss this issue as part of redeliberations on the impairment phase rather than the classification and measurement phase of the project. This issue is only relevant for financial assets for which the CECL model would apply. Question for the Board 4. Does the Board wish to discuss at a future meeting whether credit losses recognized should be the entire difference between fair value and amortized cost for financial assets that (a) an entity subsequently identifies for sale or (b) it is more likely than not the entity will be required to sell before recovery of its amortized cost basis? 5

10 Board Meeting Handout Consolidation: Principal versus Agent Analysis March 12, 2014 PURPOSE OF THIS MEETING 1. At the March 12, 2014, Board meeting, the staff will ask the Board how to consider the interests of related parties for the determination of a controlling financial interest in the variable interest entity (VIE) model and in the voting interest entity (VOE) model. Background 2. At the December 11, 2013, Board meeting, the Board agreed that the principal versus agent factors included in the proposed FASB Accounting Standards Update, Consolidation (Topic 810): Principal versus Agent Analysis, should be integrated within the existing guidance in Topic Currently, the VIE section of Subtopic provides guidance on how interests held by a reporting entity s related parties should affect the consolidation analysis. When considering if the reporting entity along with its related parties (as a group) is the primary beneficiary (PB) of the VIE, the reporting entity would treat the variable interests of its related parties as its own interests. However, if a reporting entity concludes that neither it nor one of its related parties meets both the power criterion and potentially significant economics criterion in paragraph A but, as a group, the reporting entity along with its related parties 1 meets both criteria, then the party within the related party group that is most closely associated with the VIE is the PB. That is determined through the related party tie breaker test. 4. The related party tie breaker test is based on an analysis of all relevant facts and circumstances, including the following (from paragraph ): a. The existence of a principal-agency relationship between parties within the related party group 1 For purposes of the Variable Interest Entities Subsections and an explanation of the term related parties, see paragraph The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

11 b. The relationship and significance of the activities of the VIE to the various parties within the related party group c. A party s exposure to the variability associated with the anticipated economic performance of the VIE d. The design of the VIE. 5. Alternatively, the guidance in the proposed Update provides that the decision maker should consider its direct interests held in the VIE along with indirect proportionate interests held by the decision maker through its related parties in the PB 2 determination, prior to considering the related party tie breaker test. 6. Current VOE guidance does not include any prescriptive guidance for how interests held by related parties should be considered in the determination of a controlling financial interest. In light of the Board s January 29, 2014, decision to add a specific criterion for limited partnerships and similar entities in the VIE/VOE scope determination, the staff believes that an evaluation must be made to determine whether interests held by related parties should be considered differently for those entities than for other VOEs. 7. Therefore, at the March 12, 2014, Board meeting, the staff will present the following three questions to the Board: a. Question 1 How should the decision maker s indirect interests in a VIE, held through the decision maker s related parties, be considered in the PB determination? b. Question 2 How should a decision maker be considered in the related party tie breaker test when the decision maker is considered to have an agency role on an individual basis? c. Question 3 For limited partnerships or similar entities that are considered to be VOEs, how should the general partner s (or managing member s) related party interests in the limited partnerships or similar entities be considered in the controlling financial interest determination in Topic 810? 2 At the November 6, 2012, Board meeting, the Board decided that the principal is the PB of a VIE. The proposed Update did not reflect that decision. 2

12 Alternatives for Board Consideration and Staff Recommendations Question 1 How should the decision maker s indirect interests in a VIE, held through the decision maker s related parties, be considered in the primary beneficiary determination? [For Question 1, presume that the decision maker is a single reporting entity that has the power to direct the activities of a VIE that most significantly impact the VIE s economic performance (that is, power is not shared among variable interest holders).] 8. Alternative A Consider the decision maker s indirect interests in the VIE, held through the decision maker s related parties, solely on a proportionate basis. This formulaic approach is consistent with the guidance in the proposed Update. 9. Alternative B Consider the decision maker s indirect interests in the VIE, held through the decision maker s related parties, under a rebuttable presumption that they should be considered on a proportionate basis. However, this presumption may be overcome based upon a qualitative assessment of the nature and substance of the related party relationship rather than solely a formulaic approach as in Alternative A. In some instances, depending on the nature and substance of the relationship, related party interests may be considered directly or not at all. [This alternative is intended to allow for a more substantive evaluation of the related party relationship, which would allow a decision maker to consider those interests directly or not at all depending on the facts/circumstances rather than defaulting only on an indirect/ proportionate basis. For example, if a decision maker and a related party are under common control, the interests held by the related party may need to be evaluated in a direct manner. In other instances, a decision maker may have an equity investment in a related party that invests in the VIE as a trading asset; this may be an example in which the related party interest may not be considered at all.] 10. Alternative C Consider the decision maker s indirect interests in the VIE, held through the decision maker s related parties, only on a direct basis. This is consistent with current guidance in Topic The staff recommends Alternative B. 3

13 Question 1 for the Board Which alternative would the Board like to pursue when considering how the decision maker s indirect interest in a VIE, held through the decision maker s related parties, should be considered in the primary beneficiary determination? 12. If the Board chooses Alternative A or Alternative B for Question 1, the staff believes that the next question for the Board should be as follows: Question 2 How should a decision maker be considered in the related party tie breaker test when the decision maker is considered to have an agency role on an individual basis? [For Question 2, presume that the decision maker is a single reporting entity that has the power to direct the activities of a VIE that most significantly impact the VIE s economic performance (that is, power is not shared among variable interest holders).] 13. Alternative A Once a decision maker is considered to be acting in an agency role after performing the PB determination, it retains that designation when performing the related party tie breaker test. 14. Alternative B Once a decision maker is considered to be acting in an agency role after performing the primary beneficiary determination, it does not retain that designation when performing the related party tie breaker test. 15. Alternative C Once a decision maker is considered to be acting in an agency role after performing the primary beneficiary determination, there should not be a related party tie breaker test performed by any party in the related party group. Because the decision maker is an agent, the related party, as a group, should not be considered the primary beneficiary. However, if the related parties are being used to circumvent the consolidation guidance, the related party tie breaker test must be performed. The decision maker would not retain its agency role in this case. The facts and circumstances and purpose and design of related party relationships must be considered. 4

14 16. The staff is split in its recommendations; some staff members support Alternative A and some staff members support Alternative C. Question 2 for the Board Which alternative would the Board like to pursue related to how a decision maker should be considered in the related party tie breaker test when the decision maker is considered to have an agency role on an individual basis? Question 3 For limited partnerships or similar entities that are considered to be VOEs, how should the general partner s (or managing member s) related party interests in the limited partnerships or similar entities be considered in the controlling financial interest determination in Topic 810? 17. Alternative A Only consider the general partner s related party interests in the limited partnership or similar entity when performing the controlling financial interest determination in instances in which related parties are being used to circumvent the consolidation guidance. The facts and circumstances and purpose and design of related party relationships must be considered. 18. Alternative B Do not consider the general partner s related party interests in the limited partnership or similar entity when performing the controlling financial interest determination. That is consistent with current guidance in Topic 810 for VOEs that are not limited partnerships or similar entities. 19. The staff recommends Alternative A. Question 3 for the Board Which alternative would the Board like to pursue when considering how the general partner s (or managing member s) related party interests in the limited partnership or similar entity should be considered in the controlling financial interest determination in Topic 810? 5

15 Board Meeting Handout Transfers and Servicing: Accounting for Repurchase Agreements March 12, 2014 PURPOSE OF THIS MEETING 1. In January, the staff distributed a preballot and external review draft of the final Accounting Standards Update, Transfers and Servicing (Topic 860): Repurchaseto-Maturity Agreements, Repurchase Financings, and Disclosures. The Board will discuss fatal flaw concerns raised by preparers on the operability of the secured borrowings disclosure as well as feedback received from users and decide whether the Board would like to modify the disclosure. BACKGROUND 2. At the December 18, 2013 Board meeting, the Board decided that for repurchase agreements and securities lending arrangements accounted for as a secured borrowing, an entity would be required to disclose: (a) (b) (c) (d) (e) A disaggregation of the gross obligation arising by class of collateral pledged The fair value of each class of collateral pledged as of the reporting date The remaining weighted-average contractual duration for each class of collateral pledged The remaining contractual maturity of agreements by class of financial assets A qualitative discussion of any obligation arising from a decline in the fair value of the collateral pledged. 3. External review participants noted operational impediments to providing information related to two components of the disclosure: the fair value of each class of collateral pledged as of the reporting date and the weighted-average contractual duration for each class of collateral pledged. The staff prepares Board meeting handouts to facilitate the audience s understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations.

16 ISSUE FOR DISCUSSION ON THE SECURED BORROWINGS DISCLOSURE 4. In light of the feedback received, the following are potential modifications to the disclosure identified by the staff to address the issues raised in the external review process: (a) (b) (c) Remove the component of the disclosure related to reporting the fair value of the collateral pledged as of the reporting date Remove the component of the disclosure related to reporting the remaining contractual maturity of the collateral pledged Remove the requirement to integrate the disaggregation by class of collateral pledged with the requirement to disclose the tenor of the financing agreement, but show the illustration example as integrated 5. To address external review participants request for additional time to set up their systems for compliance, the Board could consider the following alternative: (a) Extend the effective date for the secured borrowings disclosure. Questions 1 and 2: Modifications to Disclosure for Certain Secured Borrowings 1. Does the Board agree with the changes to the disclosure requirement outlined in paragraph 4? 2. Does the Board wish to grant additional time for these disclosures by extending the effective date? Page 2 of 2

17 Board Meeting Handout Not-for-Profit Financial Reporting: Financial Statements March 12, 2014 PURPOSE OF THIS MEETING 1. The purpose of this meeting is for the Board to discuss and consider possible improvements to the ways not-for-profit (NFP) entities provide financial information about liquidity. At the end of the discussion, the staff will seek the Board s tentative decisions on (a) the objective of liquidity information for NFPs and (b) four alternative ways of improving current guidance for providing information about liquidity: (a) (b) (c) (d) Using a classified statement of financial position Displaying assets that are limited to use separately on the face of the statement of financial position Improving existing asset and net asset note disclosures by expanding them to incorporate information about liquidity Adding a note disclosure to focus specifically on the objective of communicating information about a NFP s liquidity. OBJECTIVE OF LIQUIDITY INFORMATION 2. The objective of liquidity information in the financial statements and notes is to communicate information that enables users to assess a NFP s liquidity. Based on its research and outreach, the staff believes that the information communicated to the users should include information about the NFP s assets that are available to meet its near-term cash needs for operations, including debt service. In the staff s view, the other factors that may affect an entity s liquidity include information about whether and how limits placed on a NFP s uses of assets that stem from donor stipulations, contracts with others, regulations and governing board designations may influence liquidity. Without that information, users may not be able to assess liquidity except perhaps for the most simple of entities that have no donors and no restrictive contracting. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 7

18 STAFF RECOMMENDATION 3. The staff recommends that the Board consider the objective of liquidity as follows: (a) (b) To communicate to users information about the NFP s assets that are available to meet its cash needs for operations in the near term and its current obligations To communicate to users information that allows users to assess the liquidity of the NFP and be able to identify and understand the effects of restrictions placed on the NFP s assets, including designations by the NFP s board of directors. 4. The staff believes that these objectives of improving the clarity in the presentation and disclosure guidance for NFPs on liquidity could be accomplished in two ways: (a) (b) Require the disaggregating of assets and liabilities that possess similar characteristics but have different liquidity characteristics because of donor-imposed restrictions, designations of a governing board, or other contractual restrictions. Require disclosure in notes to the financials statements of relevant information about the nature and timing of assets whose use is limited, including whether those limits affect liquidity. Questions Does the Board believe that an objective of providing liquidity information is to communicate to users information about a NFP s assets that are available to meet its cash needs for operations in the near term and its current obligations? Does the Board believe that the liquidity information should communicate to users information that allows the users to assess a NFP s liquidity and be able to identify and understand the effects of restrictions placed on the NFP s assets, including designations by the NFP s board of directors? ALTERNATIVES FOR IMPROVING INFORMATION ABOUT LIQUIDITY 5. As noted in the paragraph 1, the staff will ask the Board to consider four alternative ways of improving information about liquidity. Page 2 of 7

19 Classified Balance Sheet 6. The current alternatives and diverse practices followed by NFPs in the ways they present assets (and to some degree liabilities) on the face of financial statements generally does not facilitate a user s understanding or assessment of a NFP s liquidity, liquidity risk, or financial flexibility. 7. Too often assets are highly aggregated, not well classified, or both. The staff performed outreach with members of the Project Resource Groups, NACUBO, and the AICPA s NFP Expert Panel, among others, to learn whether a classified balance sheet for NFPs would be helpful. Most said that incremental benefits would be gained because classifying assets and liabilities could help NFPs in distinguishing between cash and other assets that are homogeneous by type but have significantly different liquidity characteristics because of the effects of restrictions. This same group stated, however, that requiring a classified balance sheet by itself may not solve the problem unless accompanied by more prescriptive guidance. Research performed by the staff indicated that most NFPs currently do not prepare a classified balance sheet other than health care entities that are required to do so. 8. However, requiring a classified balance sheet for all NFPs would promote comparability across the NFP sector. This also could enhance comparability with health care entities and colleges and universities that are subject to GASB standards. That is, paragraph 97 of GASB Statement No. 34, Basic Financial Statements and Management s Discussion and Analysis for State and Local Governments, requires a classified balance sheet for proprietary funds, which includes governmental entities engaged only in business-type activities. Some stakeholder asked why the Board would require a classified balance sheet for NFPs but not for public and private business entities? Would that requirement fail to meet the FASB s precept of developing standards that are neutral? 9. The staff notes that donor restrictions that impose limits on the use of a NFP s resources are much more pervasive than contractual limits that exist for all entities. Those limits add complexity that comes along with a wide variety of donor restrictions that adds a layer of cloudiness that impedes understanding a NFP s liquidity. The staff generally believes that Page 3 of 7

20 because donor restrictions and board designation of assets are limited creates enough confusion that this requirement might be helpful. 10. The staff notes that FASB s guidance, although in the form of high-level principles, should lead to reporting of cash and other liquid assets without restrictions separately from similar assets that are subject to restrictions that limit the use and liquidity of such assets. However, it seems that practice is falling short. Like those stakeholders who noted that a classified balance sheet by itself may not solve the problem, the staff thinks that requiring a classified balance sheet together with explicit guidance would add discipline and result in more useful disaggregation of relevant information on the face of financial statements. Assets Limited to Use 11. The concept of distinguishing assets limited to use in a NFP s financial statements is not a new concept. Currently, health care entities under Topic 954 are required to distinguish assets that are limited to use in their financial statements either on the face of the financial statements or in the notes. 12. Improvements could be made in the communication of a NFP s liquidity by clarifying the current requirements of U.S. GAAP in ways similar to what has been done for health care entities. That is, by distinguishing between those assets that are and are not restricted by (a) external parties like donors, laws, regulations, and contracts or (b) internal actions like governing board designations for a particular purpose. Those distinctions would enable users to identify and better differentiate between those assets that are liquid and freely available and those that may be otherwise liquid (by nature) but are not freely available for near-term use because of external or internal limits placed on their use. Note Disclosures 13. The purpose of liquidity disclosures in the notes to the financial statements is to convey information about a NFP s ability to meet its current and near-term obligations. That requires information about the liquidity and availability of its underlying assets that generally goes well beyond what can be presented on the face of financial statements. In Page 4 of 7

21 the paragraph 1, the staff presents two alternatives of improving current note disclosures for providing information about liquidity: (a) (b) Improve existing asset and net asset note disclosures by expanding them to incorporate information about liquidity Add a note disclosure to focus specifically on the objective of communicating information about a NFP s liquidity. 14. The staff believes that in developing its liquidity disclosures a NFP should consider the following factors in improving existing asset and net asset note disclosures, among others: (a) (b) (c) (d) (e) The liquidity of assets held The nature and timing on the use of assets The nature, timing, and amount of limitations on the use of assets The effects of donor-imposed restrictions, contractual restrictions, and board designations on the use of particular assets and the ability to fund planned activities The ability to withdraw from projects or activities that are subject to designations or restrictions of funds. 15. The staff believes that the improvements noted above could be made to the current disclosure requirements for liquidity, mainly by expanding NFP-specific disclosures (for example, pledge receivables, endowment investments, and net assets) and requires a separate l disclosure that includes information about the NFPs liquidity 16. Additionally, the staff believes that the liquidity information in notes could be further enhanced by adding a entity specific note disclosure with the following information that would focus specifically on the objective of communicating information about a NFP s liquidity: (a) (b) (c) Discussion about financial statement line items and those amounts that are liquid A NFP s liquidity policy for how the NFP defines liquidity and its liquidity horizon (30, 60, 90 days, or 365 days) A statement about whether management is aware of any liquidity issues or risk. STAFF RECOMMENDATION 17. The staff s recommendations for the improvement to the presentation and disclosure standards for NFPs are as follows: Page 5 of 7

22 (a) (b) (c) (d) Provide a classified statement of financial position Distinguish assets limited as to use from other assets, either on the face of a statement of financial position or in notes Disclose information in the NFP-specific notes (for example, pledge receivable, endowment, and so forth) of the financial statements that articulate with the face of the financial statements about the nature, timing, amount, and the effect of donorimposed restrictions and board designations on liquidity Require in a separate note to the financial statements a discussion of liquidity that would draw on information included in the expanded NFP-specific and general notes. That would include drawing on information unrelated to the financial statements but that might be included, for example, in a contingency note that deals with a concentration risk that affects liquidity. That note could include the following: (i) (ii) (iii) A statement about whether management is aware of any liquidity issues or risk Information on how the board of directors manages a NFP s liquidity through board policy, if present, liquidity reserves, or other means Discussion of past events and existing conditions and circumstances that are known to the NFP that can affect an entity s future liquidity and or cash flows. 18. The staff recommends that the Board consider each of the four potential ways of improving standards for requiring information helpful in assessing a NPF s liquidity, both individually and collectively. Some staff members believe that the classified balance sheet may be most helpful for business-like NFPs but not especially useful for other NFPs. Some think recommendation (b) would be more effective than recommendation (a). They add that recommendation (b) would remove the need for a classified balance sheet. Regardless of whether the Board accepts all four recommendations or some combination of them, the staff believes that educational efforts will be needed to ensure that NFPs adequately distinguish those restrictions or designations that affect liquidity from those that do not. Question Does the Board agree with the four recommendations for improvements to current U.S. GAAP? If not all four, are there specific recommendations that the Board believes would Page 6 of 7

23 significantly improve information about a NFP s liquidity without adding undue costs and, thus, should be required? Page 7 of 7