KPMG s CFO Financial Forum Webcast

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order to be eligible for CPE credit Polling questions will appear on your media player on top of the slides Send Questions via Ask a

1 KPMG s CFO Financial Forum Webcast FASB Financial Instruments Project Update October 23, 2012 Enrique Tejerina Jill Windrum Administrative CPE regulations require online participants take part in online questions You must respond to a minimum of 4 questions in order to be eligible for CPE credit Polling questions will appear on your media player on top of the slides Send Questions via Ask a Question Button Help Desk: or outside the U.S. at You can print out presentation slides from the Supporting Material icon 1 1

2 Project Background Objective Significantly improve decision-usefulness of financial instrument reporting for users of financial statements Goals Increase convergence with IFRS Develop a comprehensive accounting model addressing: Classification and measurement Impairment Hedge accounting Liquidity and interest rate risk disclosures 2 Polling Question 1 Have you been following the FASB s financial instruments (AFI) project? A. I have not been following the FASB s AFI project B. I actively follow the FASB s AFI project C. I follow the FASB s AFI project, but not closely D. I follow the FASB s AFI project, but not all phases 3 2

3 Classification and Measurement Overview May 2010: FASB issued comprehensive ED on financial instruments Most financial instruments measured at fair value FASB Redeliberations More financial instruments measured at amortized cost than under the ED Financial asset s characteristics and an entity s business model would drive classification and measurement (financial liabilities generally measured at amortized cost) IASB issued IFRS 9, but decided to make limited amendments FASB and IASB decided to reduce key differences between their classification and measurement models Expect separate exposure documents in Q

4 Characteristics Test for Financial Assets Do the contractual terms of the financial asset give rise on specified dates to cash flows that are solely principal and interest? Yes No Apply Business Model Assessment Measure at FV-NI (e.g., derivatives, equity securities) 6 Business Model Assessment for Financial Assets Only applies to assets that pass characteristics test Based on business activities for managing assets rather than intent or ability Assessment at higher level of aggregation (not individual asset level) Not prevented from managing same or similar assets through different business activities 7 4

5 Business Model Assessment for Financial Assets (continued) FV-OCI no longer default category! Amortized Cost Held within a business model whose objective is to hold assets to collect contractual cash flows FASB to include application guidance to address types of business activities and nature of sales Fair Value Other Comprehensive Income (FV-OCI) Held within a business model whose objective is both to hold the financial assets to collect contractual cash flows and to sell the financial assets Fair Value Net Income (FV-NI) Residual category (i.e., financial assets that fail the amortized cost and FV-OCI business model assessment) 8 Business model assessment for financial assets (continued) No (explicit) tainting notion Reclassifications between categories required when business model changes (expected to be infrequent) Reclassifications accounted for prospectively Financial assets measured at amortized cost subsequently identified for sale: measured at amortized cost less impairment 9 5

6 Polling Question 2 Which of the following is a true statement about the FASB s classification and measurement decisions? A. Most financial assets would be measured at fair value B. FV-OCI would be the default category C. Financial assets would be measured at FV-NI if they pass the characteristics test D. Loans held for investment would likely be measured at amortized cost 10 Polling Question 2 Debrief Answer D Loans held for investment would likely be measured at amortized cost under the FASB s model. 11 6

7 Financial Liabilities Financial liabilities generally measured at amortized cost FV-NI would be required for: Short sales Derivatives Financial liabilities for which the entity s business strategy (at acquisition, issuance, or inception) is to subsequently transact at the financial liability s fair value Financial assets used to settle nonrecourse financial liabilities Measure the financial liabilities in accordance with the measurement of the associated financial assets 12 Other Tentative Decisions Reached Bifurcation of hybrid financial assets would be eliminated i Equity securities would be measured at FV-NI (unless equity method or practicability exception applies) Fair value option only available in limited circumstances 13 7

8 Polling Question 3 How would a marketable equity security be measured under the FASB s tentative classification and measurement model? Choice A. FV-OCI Choice B. Cost Choice C. FV-NI Choice D. Amortized cost 14 Polling Question 3 Debrief Answer C A marketable equity security would be measured at FV-NI under the FASB s tentative classification and measurement model. 15 8

Significant Remaining Differences Between FASB and IASB Business Model Assessment

IFRS would allow equity securities not held for trading to be measured at FV-OCI

9 Significant Remaining Differences Between FASB and IASB Business Model Assessment Converged in principle, but likely differences in application Equity Securities IFRS would allow equity securities not held for trading to be measured at FV-OCI IFRS does not have a practicability exception for equity securities measured at fair value Recycling U.S. GAAP requires recycling of unrealized gains and losses in OCI; recycling is not allowed under IFRS for equity instruments held at FV-OCI 16 Impairment 9

10 Overview Issues with current GAAP Complexity in current U.S. GAAP (e.g., multiple impairment models) Too little, too late (e.g., probability threshold) Separate Exposure IASB impairment ED (November 2009) Documents FASB ED (May 2010) Joint deliberations Joint Supplementary Document Began late 2010 Response to criticism of proposed models and strong support for converged solution Impairment of open portfolios of financial assets (good book/bad book) (issued January 2011) Joint deliberations Boards developed a three-bucket approach to impairment August 2012 FASB decides to explore alternative impairment model 18 The Three-Bucket Impairment Model Debt instruments (except PCI financial assets) measured at amortized cost or at FV-OCI would initially be classified in Bucket 1 Bucket 1 Bucket 2 Bucket 3 Definition: Impairment allowance: Financial assets that do not meet the threshold for lifetime expected losses 12 months expected losses There has been both (1) more than insignificant deterioration in credit quality (2) at least reasonably possible cash flows will not be collected Lifetime expected losses There has been both (1) more than insignificant deterioration in credit quality (2) at least reasonably possible cash flows will not tbe collected Lifetime expected losses Assessment basis: Collective or individual Collective Individual Reflects the general pattern of deterioration or improvement of credit quality 19 10

11 Initial U.S. Feedback on Three-Bucket Model U.S. constituents expressed significant concern about whether the three-bucket model is operational, understandable, and auditable Concerns raised Bucket 1 measurement is confusing Unclear when financial assets would meet the transfer notion Users would have difficulty understanding impairment Impairment may not reflect appropriate level of risk Model does not go far enough in simplifying accounting for PCI financial assets 20 FASB s Current Expected Credit Loss Model Based on a single measurement objective No recognition threshold (e.g., probable) Reflects an entity s current estimate of contractual cash flows that it does not expect to collect Based on all relevant information (past events, current conditions, and reasonable and supportable forecasts) Would reflect the time value of money Other acceptable methods of estimating expected credit losses could be used Impairment recognized as a contra-asset (i.e., allowance) Any changes in the allowance (increases and decreases) would be recognized immediately Nonaccrual principle would be retained (cost recovery or cash basis) 21 11

12 Polling Question 4 Which of the following is NOT a true statement about the FASB s CECL model? Choice A. The model would include a nonaccrual principle. Choice B. The model would be based on a single measurement objective. Choice C.The model would include a recognition threshold. Choice D.The model would reflect an entity s current estimate of contractual cash flows that it does not expect to collect. 22 Polling Question 4 Debrief Answer C The FASB s alternative impairment model would not include a threshold to recognize an impairment allowance

13 FASB s Current Expected Credit Loss Model FV-OCI Entities would not need to estimate expected credit losses if both of the following conditions are met: (i) Fair value is greater than amortized cost, and (ii) Expected credit losses are insignificant PCI financial assets Interest income based on expected cash flows at the date of acquisition Expected credit losses at the acquisition date would be recognized as an allowance Credit impairment would follow same approach as originated assets Other in-scope assets Trade and lease receivables Loan commitments not measured at FV-NI, and financial guarantees not remeasured at FV-NI and not accounted for as insurance Model would apply to all modified debt instruments 24 Polling Question 5 Which impairment model do you prefer? A. The three-bucket impairment model B. The good book/bad book approach in the supplementary document C. The FASB s Current Expected Credit Loss model D. The IASB s originally proposed impairment model from November 2009 E. Not sure/none of the above 25 13

14 Next Steps FASB completed discussions on CECL model FASB s CECL model would not result in convergence Both Boards plan to issue exposure drafts in the 4 th Quarter Polling Question 6 Will your organization submit a comment letter on the FASB s impairment model? A. Yes B. No C. Not sure 27 14

15 Questions? Presenter s Contact Details Enrique Tejerina Partner, Department of Professional Practice Phone: etejerina@kpmg.com Jill Windrum Director, Department of Professional Practice Phone: jwindrum@kpmg.com 29 15

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity.

16 The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of fthe particular situation. ti 2012 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. 16

KPMG s CFO Financial Forum Webcast

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