Accounting for Financial Instruments: A Comprehensive Update on the Joint Project

Transcription

1 The Dbriefs Financial Reporting series presents: Accounting for Financial Instruments: A Comprehensive Update on the Joint Project Robert Uhl, Partner, Deloitte & Touche LLP Magnus Orrell, Director, Deloitte & Touche LLP Adrian Mills, Partner, Deloitte & Touche LLP William Fellows, Partner, Deloitte & Touche LLP Shahid Shah, Practice Fellow, Financial Accounting Standards Board February 20, 2013

2 Agenda Classification and measurement Impairment Other developments Question and answer

3 Keep in mind This webcast does not provide official Deloitte & Touche LLP interpretive accounting guidance Check with a qualified advisor before taking any action See later slides for information on obtaining written summaries of issues discussed today

4 Learning objective To enhance participants understanding of important developments and decisions made pertaining to the FASB s and IASB s joint projects on the accounting for financial instruments.

5 Poll question #1 Are you a financial statement preparer, user, auditor, or other interested party? Preparer User Auditor Other

6 Standard setting activity 5 5 Classification & Measurement Impairment Hedging 2008 FASB/IASB DP on Reducing Complexity FASB ED 2010 Comprehensive FASB ED on all topics 2011 FASB/IASB SD FASB DP (Invitation to comment on IASB s proposal) 2012 IASB ED FASB ED 2013 FASB ED Discussion Paper (DP) Exposure Document (ED) Supplementary Document (SD)

7 Classification and measurement

8 Scope and scope exceptions 7 Scope includes all financial instruments (as that term is defined in the FASB Accounting Standards Codification Master Glossary) unless explicitly excluded The following financial instruments are examples of those excluded: Derivative instruments within the scope of Topic 815 Leases Financial guarantee contracts Financial instruments within the scope of Topic 944 Insurance (with certain exceptions)

9 Classification and measurement Financial Assets Cash flow characteristics criterion Business model assessment Financial Liabilities Amortized cost Exceptions

10 Financial assets Classification and measurement Financial Assets SPPI SPPI = Solely payments of principal and interest Not SPPI Held to collect: Amortized cost Hold & sell: FV-OCI FV-NI (residual) FV-NI

11 Cash flow characteristics assessment Principle Contractual terms give rise to cash flows that are Solely Payments of Principal and Interest on the principal amount outstanding (SPPI) Principal is the amount transferred by the holder at initial recognition Interest is consideration for the time value of money and credit risk associated with the principal amount outstanding, which may include a premium for liquidity risk Prepayment provisions, extension options, contingent features, and contractual features that modify the economic relationship must be considered

12 Cash flow characteristics assessment Application Assessing the modified economic relationship Leveraged interest rate (e.g., 1.5x LIBOR) Interest rate reset features (e.g., debt instrument paying 3-month LIBOR resets every 1-month) Compare actual cash flows to benchmark cash flows Fails SPPI if variability in cash flows in more than insignificant Beneficial interests Assess the terms of the tranche The underlying pool has at least one instrument that meets SPPI and can also include instruments that reduce cash flow variability The tranche s exposure to credit risk is equal to or lower than the exposure to credit risk in the underlying pool

13 Poll question #2 An entity holds a 5-year bond with an interest rate feature that resets every year to a 5-year rate. Does the instrument meet the cash flow characteristics criterion? Yes No Maybe, more analysis required

14 Business model assessment Objective Amortized Cost Hold assets to collect contractual cash flows FV-OCI Both Holds assets to collect contractual cash flows Sells assets FV-NI (Residual) Assets that do not qualify for amortized cost or FV-OCI Considerations: Assessment based on how the asset is managed together with other financial assets within a distinct business model An entity may have more than one business model

15 Business model assessment Application Amortized cost classification Sales should be very infrequent: Sales (to maximize collection of cash flows) as a result of significant credit deterioration permitted Sales of financial assets that occur close to maturity and proceeds from those sales that approximate the collection of the remaining contractual cash flows permitted FV-OCI classification Examples of strategies consistent with FV-OCI classification Liquidity management Interest rate risk/yield management FV-NI classification Residual classification category Reclassification Prospectively reclassify financial assets only when the business model changes (expected to be very infrequent)

16 Equity investments Marketable equity investments Measured at FV-NI Non-marketable equity investments Measured at FV-NI (practicability exception permitted) Cost less impairment plus upward or downward adjustments from observable price changes New one-step impairment model Equity method investments Generally unchanged, except for held-for-sale investments at FV-NI New one-step impairment model

17 Financial liabilities 16 Financial liabilities generally at amortized cost FV-NI required for: Short sales Financial liabilities that an entity has the ability and means to transact at fair value at inception Nonrecourse financial liabilities Measured at the same basis and amount as the related financial assets

18 Other key provisions Subject Initial Measurement FX Denominated Financial Assets at FV-OCI Deferred Tax Assets Financial Assets Subsequently Identified for Sale Guidance Transaction price - Financial assets and financial liabilities subsequently measured at amortized cost or FV-OCI Fair value Financial assets and financial liabilities subsequently measured at FV-NI Changes in fair value attributable to foreign currency gain or loss recognized in net income Fair-value based method for computing FX gain or loss Valuation allowance on a deferred tax asset related to unrealized losses on a financial instrument classified at FV-OCI is assessed separately from the entity s other deferred tax assets. Classify and measure at amortized cost less credit losses (if fair value is below cost, recognize loss immediately) Gains are recognized only when the sale is complete Presented as a separate line item on the balance sheet Loan Commitments Assessed based on likelihood of exercise Likelihood: not remote; classify commitment based on the classification of the underlying loan consistent with the contractual cash flow criterion and the business model assessment Likelihood: remote; recognize commitment fee over the commitment period

19 Other key provisions Subject Fair Value Option Presentation Disclosures Guidance Four conditional fair value options Group of financial assets and financial liabilities for which an entity (1) manages the net exposure relating to financial assets and financial liabilities and (2) provides information on a net exposure basis A hybrid financial liability provided that neither of the following conditions exists (1) the embedded derivative(s) do not significantly modify the cash flows and (2) It is clear with little or no analysis when a similar hybrid instrument is first considered that separation of the embedded derivative(s) is prohibited A financial asset that meets the contractual cash flow characteristics criterion and is managed within a FV-OCI business model Nonfinancial hybrid liability provided that the hybrid nonfinancial liability contains an embedded derivative subject to bifurcation and separate accounting in accordance with Subtopic Parenthetical presentation on face of balance sheet (public entities only): Fair value for assets and liabilities measured at amortized cost (not applicable to receivables and payables due within one year and core deposit liabilities) Amortized cost for an entity s own debt measured at FV-NI For financial liabilities elected under the fair value option, changes in fair value attributable to changes in the liability s credit risk presented in OCI and recycled to net income upon settlement Detailed disclosure requirements

20 Transition and effective date Transition Cumulative-effect adjustment to the statement of financial position as of the beginning of the first reporting period in which the guidance is effective Early adoption Prohibited, except for separate presentation requirements related to instrument-specific credit risk for hybrid financial liabilities that would qualify and be measured at fair value as if the entity had elected the fair value option Effective date TBD during redeliberations Next steps Consequential amendments to the FASB Codification

21 Classification and measurement Impact on U.S. GAAP Embedded derivatives no longer bifurcated from hybrid financial assets Available-for-sale classification no longer available for equity investments New practicability exception for investments in nonmarketable equity securities (modified cost approach) Equity method investments at FV-NI if they are held for sale Loans held for sale no longer measured at lower of cost or fair value, but at FV-NI Securitization tranches with above average credit risk at FV-NI Foreign-currency gains & losses on FV-OCI assets separately recognized in earnings Fair value option available only when specific eligibility criteria are met Own credit gains & losses on fair value option liabilities recognized in OCI

22 Classification and measurement Remaining differences with IFRS Application guidance for amortized-cost classification differs FV-OCI is optional under the FASB model, but not under IFRSs Methods for computing foreign currency gains and losses on FV- OCI assets differ FASB has a practicability exception from FV-NI for nonmarketable equity investments FASB requires FV-NI for equity method investments held for sale IFRSs have an FV-OCI option for non-trading equity investments Different fair value option criteria Different reclassification dates upon business model change No recycling of own credit gains and losses under IASB model

23 Poll question #3 Does the requirement to present changes in an entity s own credit risk in other comprehensive income apply to derivative liabilities? Yes No Don t know

24 Classification and measurement Practical insights While changes cosmetically seem familiar, implementation may require a significant investment of time and resources Business model assessments & cash flow tests; Application to certain instruments (e.g., equities, securitized beneficial interests and certain loans formerly held for sale) FVO changes Potential capital impacts for regulated institutions Entities will need to institute new processes and systems to appropriately identify and classify instruments and comply with enhanced disclosures on the face of the financial statements

25 Poll question #4 Do you or your client plan to comment on the classification and measurement exposure draft? Yes No Don t know

26 Financial instruments Impairment

27 Impairment Drivers of impairment project Response to global financial crisis Perception that existing incurred loss approach recognizes impairment losses too late Opportunities to simplify existing guidance Different impairment models for different types of financial assets Complexity of some of the existing guidance Opportunities for international convergence

28 Impairment Timeline 2009/2010 FASB and IASB proposed different impairment models January 2011 Boards jointly proposed good-book, bad-book model (issue supplementary document) June 2012 Boards revise supplementary document approach (develop three-bucket approach) August 2012 FASB develops alternative model due to constituent concerns regarding operability, auditability, and understandability of jointly developed three-bucket approach

29 Impairment of financial instruments IASB s three-bucket approach Bucket 1: 12 months expected credit loss allowance* All financial assets are intially categorized in this bucket** Transfer out of Bucket 1 when there has been a significant deterioration in credit quality since initial recognition (except high quality assets) Buckets 2 and 3: Lifetime expected credit loss allowance Evaluation performed on groups of financial assets and individual financial assets * 12-month expected credit losses = Lifetime expected credit losses for financial assets for which a loss event is expected over the next 12 months ** Except for purchased debt instruments with explicit expectation of credit losses at acquisition, and some trade/lease receivables

30 Impairment of financial instruments FASB s alternative - current expected credit loss model Measurement Objective Single measurement method for all financial assets (not limited to 12 months and no transfer notion) Current expected credit losses i.e., current estimate of future contractual cash flows that management does not expect to collect Contemplates all supportable internally and externally available information, including past events, current conditions, and reasonable and supportable forecasts

31 Impairment of financial instruments Other decisions Estimate of expected losses Interest income Recording impairment - Represents a range of possible outcomes - Incorporates the time value of money - Decoupled from credit losses - Troubled debt restructurings: keep original effective interest rate - Income statement reflects credit deterioration / improvement - Record as an allowance, not as a basis adjustment

32 Impairment of financial instruments Purchased credit-impaired assets FASB: Purchased Credit- Impaired (PCI) Assets Financial assets that have experienced a significant deterioration in credit quality since origination The CECL model applies (i.e., one model for all financial assets) Initial allowance equal to amount of contractual cash flow that the entity doesn t expected to collect Interest income excludes the discount embedded in the purchase price attributable to expected credit losses (i.e., the nonaccretable yield) Positive changes in nonaccretable yield are recognized in earnings in the period of change IASB: Purchased Credit- Impaired (PCI) Assets Similar definition Always measured in Bucket 2/3 Initial allowance based on purchase price (not contractual cash flow) Similar interest income

33 Impairment of financial instruments FV-OCI FV-OCI Assets FASB The CECL model applies, but there is a practical expedient Entities need not recognize an allowance if: (1) fair value > carrying amount and (2) expected credit loss is insignificant IASB No similar exception to the basic model

34 Poll question #5 The FASB and IASB s proposed impairment approaches yield the same allowance for purchased credit impaired assets. True False

35 Impairment of financial instruments Nonaccrual principle (FASB only) Applies when the likelihood of collection of a financial asset s principal and interest is not probable If the full recovery of principal is not probable cost recovery method If the full recovery of principal is probable, but the full payment of interest is not cash basis method

36 Impairment of financial instruments Next steps FASB issued ED in December 2012 (Comments due April 30, 2013) IASB to issue proposed amendments to IFRS 9 in Q1/ 2013 Convergence?

37 Impairment Practical insights Simplification of impairment guidance may require enhanced analytics from preparers, particularly smaller institutions Impact on bottom line Lack of convergence between US GAAP and IFRS Changes will require significant judgment and auditors will need to enhance procedures to understand management s basis for their projections

38 Poll question #6 Which impairment model do you prefer? FASB s single, expected loss measurement IASB s dual, expected loss measurement Current GAAP (incurred loss measurement) Some other model

39 Financial instruments Other developments

40 Repurchase agreements Background Effective control An entity that transfers a financial asset (e.g., in a sale), but maintains effective control of the asset must account for the transfer as a secured borrowing For repurchase agreements (repos), control is considered to have been maintained if the following criteria are met: The financial assets to be repurchased are the same or substantially the same as those transferred The agreement is to repurchase them before maturity, at a fixed or determinable price The agreement is entered into contemporaneously with, or in contemplation of, the transfer

41 Repurchase agreements Proposed ASU Seeks to address concerns around the ability to achieve sale accounting for repo-to-maturity agreements Proposed ASU issued on January 15, 2013 Comments due by March 29, 2013 An entity would not be able to achieve sale accounting solely by setting the settlement date of a repo to equal the maturity date of the transferred asset Instead, secured borrowing accounting would be required for repo-to-maturity agreements that otherwise meet the effective control criteria This would apply even if the held-to-maturity repo will be net cash settled

42 Hedge accounting IASB expects to release new hedge accounting requirements in the second quarter of 2013 Expanded ability to designate hedges of nonfinancial risk components (e.g., crude oil component in jet fuel contract) Simplified hedge effectiveness requirements New hedge rebalancing requirements U.S. GAAP FASB hedge accounting project on hold since 2010 EITF Issue 13-A, "Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes" Copyright 2012 Deloitte Development LLC. All rights reserved.

43 Poll question #7 Do you believe that the FASB should take on a comprehensive project to address derecognition? Yes No But minor changes are needed No Fine as is Don t know

44 Question and answer

45 Join us March 19 at 2 PM ET as our Financial Reporting series presents: EITF Roundup: Highlights from the March Meeting

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47 Contact info Bob Uhl Magnus Orrell Adrian Mills William Fellows Shahid Shah wfellows.deloitte.com

48 This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

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