KPMG s CFO Financial Forum Webcast

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KPMG s CFO Financial Forum Webcast FASB Proposes Changes to Classification

Joe Santucci Luba Liberman Administrative CPE regulations require online

4 questions in order to be eligible for CPE credit Polling questions will

Question Button Help Desk: 1-877-398-1471 or outside the U.S.

1 KPMG s CFO Financial Forum Webcast FASB Proposes Changes to Classification and Measurement of Financial Instruments February 27, 2013 Enrique Tejerina Joe Santucci Luba Liberman 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 2 1

2 Agenda Classification and Measurement Project Overview Initial Measurement Measurement Categories Cash Flow Characteristics of Financial Assets Business Model Assessment for Financial Assets Fair Value Option Guidance for Specific Types of Financial Instruments Presentation Disclosures Effective Date and Transition Significant Differences Between FASB and IASB Proposed Models 3 Polling Question 1 Please indicate your industry A. Banking and Finance B. Insurance C. Consumer Markets D. Energy and Natural Resources E. Communications and Media F. Other 4 2

3 Classification and Measurement Project Overview May 2010: FASB issued comprehensive ED on financial instruments IASB issued IFRS 9, but decided d to make limited it amendments FASB and IASB decided to reduce key differences between their classification and measurement models IASB ED on limited amendments to IFRS 9 issued Q (comments due March 28, 2013) FASB issued proposed ASU, Financial Instruments Overall, Recognition and Measurement of Financial Assets and Liabilities (comments due May 15, 2013) 5 Polling Question 2 Does your organization plan to comment on the FASB s proposed classification and measurement model? A. Yes B. No C. Not sure 6 3

4 Initial Measurement Initial measurement would depend on the subsequent measurement of a financial instrument Financial instruments subsequently measured at FV-NI would be initially measured at FV Financial instruments subsequently measured at FV-OCI or amortized cost would be initially measured at transaction price In certain circumstances, an entity would evaluate whether consideration given or received includes an element other than the financial instrument 7 Measurement Categories Financial assets (based on both their cash flow characteristics and the business model) Amortized cost FV-OCI FV-NI Financial liabilities Amortized cost FV-NI (required for short sales or when the entity s business strategy is to subsequently transact at fair value) Fair value option, with changes attributable to instrument-specific credit risk recognized in OCI and other changes recognized in net income When, by contract, an entire nonrecourse financial liability is required to be settled with only cash flows from related financial assets, an entity would measure the financial liability consistently with the measurement of the related financial assets. 8 4

5 Knowledge Check 1 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. Short sales would be measured at FV-NI 9 Knowledge Check 1 Debrief Answer D Short sales would be measured at FV-NI. 10 5

6 Cash Flows Characteristics of Financial Assets Do the contractual terms of the financial asset give rise on specified dates to cash flows that are solely principal p and interest? (SPPI test) Yes No Apply Business Model Assessment Measure at FV-NI (e.g., equity instruments) * may include a premium for liquidity risk 11 Cash Flow Characteristics of Financial Assets (continued) Modified Economic Relationship Contingent Cash Flows Prepayment and Extension Options Beneficial Interests 12 6

7 Cash Flow Characteristics of Financial Assets (continued) Equity instruments Convertible bonds Inverse floaters Examples of assets that Constant t maturity bonds may fail the SPPI test Debt instruments indexed to the debtor s net income or an equity index Debt instruments with embedded derivatives Examples of assets that may pass SPPI test Plain vanilla variable interest debt instruments Plain vanilla fixed rate debt instruments Zero coupon bonds Inflation-linked bonds Interest-rate capped variable rate bonds Collateralized full recourse loans 13 Knowledge Check 2 True or False: An entity would be required to measure financial assets that do not meet the SPPI test at FV-NI. A. True B. False 14 7

8 Knowledge Check 2 Debrief Answer: A (True). An entity would be required to measure financial assets that do not meet the SPPI test at FV-NI. 15 Business Model Assessment for Financial Assets Only applies to financial assets that pass SPPI test Assessment performed at initial recognition by key management Based on business activities for managing assets rather than intent or ability Evidenced by the way the business is managed and its performance evaluated by key management Assessment at higher level of aggregation (not individual asset level) 16 8

Business Model Assessment for Financial Assets (continued) Amortized Cost FV-OCI FV-NI Held and managed within a business model whose objective is to hold assets to collect contractual cash flows

not meet the SPPI test as well as those that are held for sale) 17 Business Model Assessment for Financial Assets (continued) Types of sales that could be consistent with the objective of the

9 Business Model Assessment for Financial Assets (continued) Amortized Cost FV-OCI FV-NI Held and managed within a business model whose objective is to hold assets to collect contractual cash flows Held within a business model whose objective is both to hold the assets to collect contractual cash flows and to sell the assets Residual category (i.e., all other assets and includes assets that do not meet the SPPI test as well as those that are held for sale) 17 Business Model Assessment for Financial Assets (continued) Types of sales that could be consistent with the objective of the conditions for amortized cost classification: cat Sales due to significant deterioration in the issuer s creditworthiness Sales for other than managing issuer credit risk that are very infrequent Sales that result from events other than significant deterioration in the issuer s creditworthiness that are isolated, nonrecurring, unusual for the entity, and result from events that could not have been reasonably anticipated Types of sales that could be consistent with the objective of the conditions for FV-OCI classification: Sales for managing credit exposure due to concentration of credit risk Sales for managing exposure to interest rate risk Sales for maintaining certain yield profile Sales for liquidity management Sales that occur close to the maturity of the assets for proceeds that approximate the collection of the remaining cash flows 18 9

10 Business Model Assessment for Financial Assets (continued) No explicit tainting notion Sales out of the amortized cost category and related disclosures Reclassifications between categories required when business model changes (expected to occur very infrequently) Reclassifications accounted for prospectively Reclassifications on the last day of the reporting period in which the change occurs 19 Fair Value Option Irrevocable fair value option at initial recognition only available for: Certain hybrid financial and nonfinancial liabilities Financial assets that would otherwise be measured at FV- OCI OR Group of financial assets and liabilities managed on a fair value basis and internally reported on a net exposure basis Changes in fair value attributable to instrument-specific credit risk presented separately in OCI for financial liabilities at FV-NI 20 10

11 Knowledge Check 3 How would an entity account for the reclassification of financial assets if the business model within which the assets are held and managed changes? A. Prospectively B. Retrospectively 21 Knowledge Check 3 Debrief Answer: A. An entity would be required to prospectively reclassify financial assets if the business model within which the assets are held and managed changes

12 Guidance for Specific Types of Financial Instruments Hybrid Financial Instruments Loan Commitments, Revolving Lines of Credit, and Commercial Letters of Credit Nonrecourse Financial Liabilities 23 Guidance for Specific Types of Financial Instruments (continued) Equity investments - generally measured at FV-NI unless the investment qualifies for the equity method of accounting or results in consolidation Practicability exception for equity investments without readily determinable fair values (not available for investment companies and broker-dealers) Equity method investments Retain the significant influence criterion in current U.S. GAAP Require FV NI if the investment is held for sale at initial recognition Practicability exception available for equity investments that would qualify for the equity method of accounting but are held for sale Impairment analysis 24 12

13 Presentation Instrument Presentation on the Statement of Financial Position Financial assets and liabilities Financial assets and liabilities measured at amortized cost (except for receivables or payables due in less than one year and demand deposit liabilities) Financial assets at amortized cost that have been identified for sale Financial assets and liabilities measured at FV-NI Own debt instruments at FV-NI Separately, grouped by classification and measurement category Parenthetical fair value information (required for public entities only) Separate line item with parenthetical information of either fair value or amortized cost, as applicable Fair value information Parenthetical amortized cost information Equity method investments held for sale Separate line item 25 Presentation Instrument Financial instruments measured at amortized cost and FV-OCI Financial instruments measured at FV- NI Financial liabilities measured at FV-NI Presentation on the Statement of Comprehensive Income Separately within net income: Interest income or expense Changes in expected credit losses Realized gains and losses FX gains and losses (for financial instruments measured at FV-OCI only) Separate the total change in the FV of the instrument into: A change in the price of the instrument in the currency in which it is denominated FX transaction gain or loss (separately present in net income) Separately, at a minimum, one aggregate amount for realized and unrealized gains or losses Separately the portion of the total change in the FV of liability due to change in the instrument-specific credit risk 26 13

14 Disclosures Quantitative and qualitative information about sales out of amortized cost ASC 820 disclosures would Other disclosures, including apply to financial information about equity instruments measured at instruments without readily amortized cost (applies to determinable fair values public entities only) and nonrecourse liabilities Reclassification due to a change in business model Public entities would disclose information about core deposit liabilities Amount of change in FV due to instrument-specific credit risk for liabilities measured at FV-NI, including how gains/losses were determined Effective Date and Transition FASB will decide on an effective date after considering constituent feedback Early adoption, with one exception, would not be permitted Allow early adoption of presentation requirement in other comprehensive income of the changes in fair value due to changes in instrumentspecific credit risk for financial liabilities designated under fair value option Cumulative-effect adjustment to the statement of financial position as of the beginning of the first reporting period Transition disclosures 28 14

15 Knowledge Check 4 How would the FASB s proposed classification and measurement model be applied? A. Retrospectively B. Prospectively C. Through a cumulative-effect adjustment 29 Knowledge Check 4 Debrief Answer: C. The FASB s proposed classification and measurement model would be applied through a cumulative-effect adjustment to beginning retained earnings (or other components of equity)

Significant Differences Between FASB and IASB Proposed Models

differences in application Equity Securities IFRS would allow equity

not have a practicability exception for equity securities measured

OCI would be required for all financial assets measured at FV-OCI;

16 Significant Differences Between FASB and IASB Proposed Models 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 Recycling of unrealized gains and losses in OCI would be required for all financial assets measured at FV-OCI; recycling is not allowed under IFRS for equity instruments held at FV- OCI 31 Questions? 16

17 Presenters Contact Details Enrique Tejerina Partner, Department of Professional Practice Phone: Joe Santucci Partner, Department of Professional Practice Phone: Luba Liberman Senior Manager, Department of Professional Practice Phone: 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 the particular situation 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. Printed in the U.S.A. NDPPS The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International. 17

KPMG s CFO Financial Forum Webcast

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