The Financial Reporting series presents: IASB and FASB. Financial

Transcription

1 The Financial Reporting series presents: IASB and FASB Financial Instruments Project: A Closer Look

2 Agenda Overview Classification and Measurement Impairment Hedge Accounting Next Steps

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 pertaining to: The FASB/IASB project on the accounting for financial i instruments How the classification and me asurement standards for financial instruments are changing under U.S. GAAP and IFRSs Proposed changes to credit impairment requirements Proposed changes to hedge accounting requirements

5 Poll question #1 In which industry are you? Software/Technology Energy Bio-tech/Health Sciences Financial Services Consumer Products Other

6 Overview

7 Overview Drivers of change Accounting complexity Existing financial instruments accounting standards have been criticized for being overly complex (e.g., hedge accounting, classification requ uirements) Global financial crisis The global financial crisis has focused attention on financial instruments accounting (e.g., the extent to which financial instruments should be subject to fair value accounting and how credit losses should be recognized and measured) 1.1

8 Overview Drivers of change (cont.) Convergence The FASB and the IASB are redoubling [their] efforts to improve and converge U.S. GAAP and International Financial Reporting Standards (IFRSs) Declaration by the Leaders of the G-20 Countries, April 2009 We have agreed that accounting standard setters should take action to reduce the complexity of accounting standards for financial instruments; strengthen accounting recognition of loan-loss loss provisions, [and] make significant progress towards a single set of high quality global accounting standards 1.2

9 Overview Scope and impact The project will radically overhaul the existing accounting literature t for financial i instrumen nts Virtually no company will be una affected Assets Cash and deposits Accounts and notes receivable Investments in debt and equity securities Investments in contractually t linked instruments Private equity investments Loan assets 1.3 Liabilities Accounts and notes payable Bonds, mortgages, and other long-term debt Deposit liabilities Derivatives Options Forwards Swaps

10 Overview Timeline IASB Q Added project to active 2008 agenda Q Exposure Draft (ED) Classification & Measurement Q ED Impairment Q IFRS Classification & Measurement of Financial Assets H ED Hedge Accounting H ED Financial Liabilities (TBD) H Comprehensive IFRS FASB Q Added project to active agenda H Comprehensive ED H Comprehensive Standard FASB/IASB Joint Statement, November 2009 Our efforts to improve IFRS and US GAAP for financial instruments and to achieve their convergence have been complica ted by the differing project timetables we established to respond to our respective stakeholder groups and other factors. We are committed to issuing standards by the end of 2010 that represent a comprehensive and improved solution to this complex and contentious area and that provide international comparability. 1.4

11 Poll question # 2 Do you think the IASB and FASB are moving at an appropriate pace on the joint financial instru uments project? The project is moving too quic ckly The project timeline is appropriate The project needs to speed up Don t know

12 Classification and Measurement

13 What is changing? FASB s tentative decisions Measurement and income recognition Impairment Impact on classifications Hybrids Nonmarketable securities Three measurement and income recognition categories: Fair value through earnings Fair value through other comprehensive income (FVTOCI) Amortized cost Impairment only for FVTOCI assets No available-for-sale, held-to-maturity, loans held for sale, or loans held for investment categories No embedded derivatives in financial instruments No cost exemption for nonmarketable equities Reclassifications No reclassifications after initial recognition 2.1

14 FASB s tentative decisions Classification and measurem ent Default category: All financial instruments Option to record: Debt instruments: Business strategy (to hold a debt instrument for collection or payment of contractual cash flows rather than selling or settling) Option to record: Fair value through earnings Portion of the change in fair value through OCI All equities All derivatives Many hybrids Own Debt: Business strategy + measurement attribute mismatch Amortized cost 2.2

15 FASB s tentative decisions Presentation Category Fair value through earnings Face of the Balance Sheet Fair value Amortized cost (only for own debt meas sured at fair value) Note: No requiremen nt to separately present: Amortized cost (except own debt measured at fair value) Adjustments made to amortized cost to arrive at fair value Face of the Income Statement* Realized and unrealized gains and losses (in the aggregate) Note: No requirement to separately present: Interest accruals Credit losses Dividend income (for investments in equity instruments) 2.3 *One statement of financial performance with a total for comprehensive income, including a subtotal for net income.

16 FASB s tentative decisions Presentation (cont.) Category Fair value through OCI (optional for eligible debt instruments) Face of the Balance Sheet Amortized cost Cumulative credit losses Adjustments to arrive at fair value Fair value Face of the Income Statement Interest income Interest expense Credit losses Realized gains and losses Note: Foreign exchange gains or losses not separated (recognized in OCI) 2.4

17 FASB s tentative decisions Presentation (cont.) Category Amortized cost (optional for own debt only) Face of the Balance Sheet Amortized cost only Face of the Income Statement Interest expense Realized gains and losses 2.5

18 Objective and scope of IFRS 9 Applicable to all financial assets which are within the scope of IAS 39 Establish principles for financial reporting for financial assets Not intended as fair value measurem ment guidance but for determination of which instruments should be at fair value Fair Value Exposure Draft (May 2009) 2010 to be finalised as a standard in 2.6

19 What has changed? IFRS 9 Measurement and recognition Impairment Impact on classifications Hybrids Nonquoted securities Reclassifications Three measurement and income recognition categories: Amortized cost Fair value throu gh profit and loss (FVTPL) Fair value through other comprehensive income (FVTOCI) NEW Impairment only for amortized cost assets No available for sale or held to maturity categories No embedded derivatives in financial assets No cost exempt tion for unquoted equities Limited reclassifications 2.7

20 IASB s classification and measurement Overview Objective of entity s business model is to hold financial asset in order to collect contractual cash flows Contractual terms give rise solely to principal and interest on principal Amortized cost (one impairment method) Fair value option (FVO) for accounting mismatch All other instruments: Equities Derivatives Some hybrid contracts Fair value through pro ofit and loss (No impairment) Equities: Fair value through OCI presentation available (No impairment) 2.8

21 IASB s classification and measurement Business model Objective of entity s business model is to hold to collect contractual cash flows Top-down approach by business unit Not an instrument by instrument approach to classification Not based on management s intent No requirement to hold to maturity No tainting rules for assets at amortized cost Reclassifications i Changes in the busi ness model would require reclassification Top-down approach Can have multiple business models within legal entity 2.9

22 IASB s classification and measurement Contractual terms Contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on principal Leverage is not ok Certain prepa ayment options are ok Certain exten nsion options are ok Non-genuine cash flow characteristics are ignored Non-genuine: affects contractual cash flows only on the occurrence of an event that is extremely rare, highly abnormal and very unlikely to occur 2.10

23 IASB s classification and measurement Other comprehensive income alternative Option only for investments in equity instruments not held for trading Instrument by instrument Changes in fair value recognized through OCI except dividend income No recycling Foreign exchange Dividendsid d Foreign Exchange 2.11 Recognized as income per IAS 18 Not recognized if dividend represents return of investment OCI equities are not monetary items per IAS 21 Foreign exchange element is recognized in OCI permanently

24 IASB s classification and measurement Hybrid contracts Hybrid contracts Financial asset host Non-financial host or financial liability host No separation part of classification Existing separation guidance retained 2.12

25 IASB s classification and measurement Securitization tranches The following three conditions must be met to pass cash flow characteristics test 1. Contractual cash flows of principal and interest on principal 2. Look-through to underlying pool of financial instruments 3. Credit risk of tranche must be equal to or less than the credit risk of underlying pool Look-though test underlying pool Underlying pool can contain certain derivatives (e.g., interest rate swap or foreign exchangee swap that reduces cash flow variability or aligns cash flows between pool and tranches) If underlying pool can change then possible changes must also be assessed as part of look-through If cannot assess underlying pool then tranche must be FVTPL 2.13

26 Poll question # 3 Which classification and measurement model do you prefer? FASB s proposed model IASB s new model Prefer existing model Don t know/not applicable

27 Classification and measurement Operational issues Broad implementation that involves multiple stakeholders Some operational simplificationss include: Reduction in and clearer ration nale for classification and measurement categories Elimination of bifurcation requi irements for financial instruments (still retained for financial liabilities under IFRS) Elimination of the tainting rules related to sale of held-tomaturity securities 2.14

28 Classification and measurement Operational issues (cont.) Several other implementation undertakings including: Accounting policies, operating processes and systems changes to identify contractual terms which give rise to solely principal and interest ca ash flows Impacts on economic hedging of risks associated with previously bifurcated embedded derivatives and application of valuation techniques to hybrid financial instruments in their entirety Vl Valuation processes and contr rols for valuations of unquoted equities System, valuation and capital implications from expanded use of fair value (under FASB s proposed approach) Implications of new classification and measurement on capital requirements 2.15

29 Classification and measurement Collection and tracking of data associated with the look- through approach for classification and measurement for investments in securitized tranches IFRS 9 specific operational is ssues Transition issues including: Business model test performed at date of initial application All previous measurement mismatch FVO elections for BOTH assets AND liabilities are revoked at date of initial application FVO (based on measurement mi ismatch) can be elected for all assets AND liabilities at date of initial application (i.e. measurement mismatch must exist at date of initial application) Designation at fair value through other comprehensive income done at date of initial application Retrospective application required 2.16

30 Impairment

31 Impairment The IASB is proposing to replace the existing incurred loss approach with an expected loss approach Exposure Draft (ED) issued in November Comments due June 30, 2010 Applies to financial assets accounted for at amortized cost (i.e., loans, receivables, and investments in debt securities carried at amortized cost) The FASB is still developing its impairment approach To be addressed in the comprehensive ED to be published in Q Applies to financial assets classified as fair value through OCI (i.e., loans, receivables, and inve estments in debt securities that meet the fair value through OCI criteria) The FASB and the IASB have agre eed to consider jointly the comments received on their respective proposals 3.1

32 IASB s impairment approach High level overview Initial recognition: Estimate future credit losses over life of asset Net interest revenue adjusted for margin to reflect initial estimate of future credit losses Allowance for future credit losses built up over time Ongoing adjustments to estimates of future credit losses Asset by asset or groups of similar assets Estimate expected cash flows taking into account expected future credit losses over the life of the asset or assets Probability-weighted possible outcome approach even if most likely outcome is full repayment No upfront loss is recognized - credit loss estimate impacts net interest revenue over time Margin for initially expected credit losses is deducted from gross interest revenue in each period Determined through h application of the Effective Interest Rate (EIR) method Practical expedients permitted if they meet certain criteria The margin for initially expected credit losses that is deducted from gross interest revenue in each period is set aside to gradually build-up an allowance for expected future credit losses Applies even if no actual losses have yet been incurred Does not require objective evidence of impairment or loss events to have occurred In each period, the entity must reassess the asset s expected cash flows, taking into account expected future cash flows Any changes in credit loss expectations both favorable and unfavorable are recognized immediately on a discounted cash flow basis as a gain or loss in earnings. Discount revised expected future cash flows at the asset s effective interest rate 3.2

33 Poll question # 4 What impairment loss approach do you prefer? Expected loss Incurred loss Neither Don t know/not applicable

34 IASB s impairment approach Example Assume the following Initial net carrying amount of a loan is $100, Loan contract promises one contractual payment of $110,000 in exactly one year Lender considers experience with portfolio of loans with similar credit risk conditions adjusted for current conditions Based on above, lender expects to receive on average $107,000 for a group of similar loans and expects to lose $3,000 of the outstanding amo ount The Effective Interest Rate (EIR) in this example would be 7% under the proposed p approa ach versus the 10% contractual rate 3.3 ED EIR 7% Margin for future losses 3% Traditional EIR 10%

35 IASB s impairment approach Example (cont.) Interest revenue accrued throughout the year is $7,000. Entries during the year would be: Dr. Interest receivable $10,000 Cr. Interest revenue $7,000 Cr. Allowance for expected credit losses $3,000 Assuming that there were no changes in the entity s expectation of future credit losses over the year, there are three possible outcomes at maturity: A Credit losses exactly equal expectations - $107,0 000 is collected. No additional profit or loss is recognized B Credit losses are lower than expectations assu me the entire $110, is collected. A gain of $3,000 is recorded at the end of the year C Credit losses are higher than expectations an amount less than $107, is collected. An impairment loss is recognized to reflect the incremental loss 3.4

36 Poll question # 5 Do you believe the IASB s proposed impairment model creates more or less volatility in earning gs? More volatility Less volatility No volatility Don t know/not applicable

37 IASB s impairment approach Practical expedients Practical expedients permitted if overall effect is immaterial Examples include: Measurement of trade receivables at their invoice amount less the initial estimate of undiscounted expected credit losses, if the effect of discounting is immaterial The use of a provision matrix that defines fixed provision rates on the basis of the number of days a receivable is past due (e.g. 3% if less than 90 days, 20% if 90 to 180 days) Use of a method other than adjustment of the effective interest rate to allocate and amortize initially expec cted future credit losses over the life of the financial asset General principles for any practical expedient : Should consider the time value of money unless effects of discounting are immaterial Calculation should reflect all expected future cash flows of the financial instrument (e.g., not just expected losses over a one e-year horizon) Calculation should NOT give rise to a losss upon initial recognition 3.5

38 IASB s impairment approach Presentation Separate presentation of the following line items: Gross interest revenue (calculated using EIR before expected losses ta aken into account) Effect of allocating initially expected credit losses (the margin deducted from EIR) Net interest revenue ( credit cost adjusted d interest t revenue) Gain resulting from change in loss expectations Using Example 1 No actual credit losses $ 10,000 (3,000) $ 7,000 $ 3,

39 IASB s impairment approach Allowance account and write- -off policy Entities are required to use an allowance account to account for credit losses Additional disclosures about financial assets measured at amortized cost, for example Reconciliation of changes in the allowa nce account showing at a minimum i Increases due to margin deducted from gross interest revenue Losses due to unfavorable changes in estimated credit losses Gains due to favorable changes in estimated credit losses Write offs Entity s write off policy must be disclosed 3.7

40 Impairment Comparison of IASB and FAS SB approaches Scope Trigger for impairment Impairment measurement FASB Financial assets accounted for at fair value through other comprehensive income No trigger Based on expected future cash flows; all available information relating to past IASB Financial assets accounted for at amortized cost No trigger Based on expected future cash flows adjustedd for future credit losses expected throughou ut the life of the asset or portfolio (based on probability- weighted possible outcomes) events and existing conditions is considered. An entity would not consider possible future events 3.8

41 Impairment Comparison of IASB and FAS SB approaches (cont.) Initial recognition Interest recognition Ongoing reassessment IASB FASB Recognition of a loss on initial recognition is Not yet deliberated generally precluded d Adjusted to deduct a margin for initially expected Not yet deliberated credit losses Yes. Changes in expected Yes. Changes in expected cash flows result in gains cash flows result in gains or or losses losses 3.9

42 Impairment Operational issues Models and systems to compute expected future cash flows and expected credit losses Individual asset vs. group of asset application considerations Collection and tracking of historical loss data or ratings information Estimation uncertainty and degree of judgment Application issues related to variable rate instruments Incorporation of credit losses in i nitial EIR plus ability to report both gross and net interest revenue Establish processes and data req quirements to update or validate assumptions each period Interplay with Basel II capital requirements The FASB and IASB are establishing a joint Expert Advisory Panel to advise the two Boards on oper rational issues and how those issues might be resolved 3.10

43 Hedge Accounting

44 Hedge accounting The IASB has agreed on the following proposed approach: Fair value hedge accounting would be replaced with a model similar to cash flow hedge accounting Assessment and measuremen nt requirements would be simplified The FASB has not yet discussed hedge accounting The IASB is delaying the public ation of its hedge accounting proposals until the first quarter of 2010, so as to give the two boards the opportunity to develop a common solution. The FASB plans to include hedging in the comprehensive exposure draft it expects to publish in the first quarter of 2010 Hedging Instrument 4.1 Hedged Item

45 Hedge accounting Details of the IASB s propose ed approach The effective portion of fair value hedges (not just cash flow hedges) would be recognized initially in OC CI The carrying amount of the hedgedd item in fair value hedges would not tbe adjusted d For fair value hedges, ineffectiveness resulting from both underhedges and overhedges would be recognized in profit or loss Current approach - example Dr Hedged Fixed-Rate Bond $100 Cr Earnings $100 Dr Earnings $98 Cr Interest Rate Swap $98 Proposed approach - example Dr OCI $100 Cr Interest Rate Swap $98 Cr Earnings $2 4.2

46 Poll question # 6 Do you like the proposed hedging approach for fair value hedges through other comprehe ensive income? Yes No Don t know/not applicable

47 Next Steps

48 IASB/FASB project plan for 2010 Q1 Q2 Q3 Q4 Q FASB will publish a comprehe nsive ED on classification, measurement, impairment, and hedging (comments due end-june 2010), including a request views on the IASB s proposals IASB will publish: a) an Exposure Draft (ED) on hedge accounting (comments due end-june 2010). b) a revised ED, if appropriate, on the classification and measurement of financial liabilities (comments due end-june 2010). c) a request for views on the FASB s comprehensive ED. Q IASB will conduct a post-imple ementation review of early adopters of its classification and measurement requirements for financial assets Q FASB and IASB will consider comments jointly with the objective of agreeing on a model that will enhance [ ] international comparability. Q FASB and IASB will publish their final standards 5.1

49 IFRS 9 Effective date and transition Classification and measurement of financial assets Mandatory application from 1 Jan nuary 2013 Early adoption permitted If date of initial application is before 1 January 2012 then exempt from comparatives Later additions to IFRS 9 need not be early adopted Initial ap plication date Any date Issue date of IFRS 9 1 Jan Jan Jan Additional disclosures required

50 Poll question # 7 Do you believe the SEC should require U.S. issuers to transition to IFRSs at some poin nt in the future? Yes No Don t know/not applicable

51 Questions & Answers

52 Join us December 16, 2009 at 2 PM EST as our Financial Reporting series presents: Quarterly Acc ounting Roundup: An Update of Important Developments

53 Contact information Bob Uhl Magnus Orrell Trevor Farber Sherif Sakr sb.org

54 Other resources Heads Up: IASB Issues IFRS on Classification and Measurement of Financial Assets (November 17, 2009) sur_heads_up pdf UnitedStates/Local%20Assets/Documents/AERS/us_as Heads Up: IASB Proposes New Approach to Accounting for Credit Losses (November 10, 2009) Heads Up: An Update on the FASB s and IASB s Joint Project on Financial Instruments (October 27, 2009) Heads Up: FASB Continues Deliberations on Financial Instruments and Decides on Presentation (August 18, 2009) Heads Up: IASB Issues Exposure Draft and FASB Initiates Deliberations on New Classification and Measurement Requirements for Financial Assets and Financial Liabilities (July 27, 2009) Heads Up: FASB Invites Comments on IASB s Financial Instruments Discussion Paper (April 2, 2008) ng-standards-communications/heads-up- Newsletters/us_assur_Heads_Up_ pdf UnitedStates/Local%20Content/Articles/AERS/Accounti ng-standards-communications/heads-up- Newsletters/us_assur_Heads_Up_102709a.pdf UnitedStates/Local%20Assets/Documents/AERS/us_as sur_heads_up_ pdf ww ww.deloitte.com/assets/dcom- UnitedStates/Local%20Assets/Documents/AERS/us_as sur_heads_up_ pdf ww ww.deloitte.com/assets/dcom- Australia/Local%20Assets/Documents/us_assur_Heads _Up_040208(2).pdf UnitedStates/Local%20Content/Articles/AERS/Accounti

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