Accounting Changes Proposed by the FASB


The Financial Accounting Standards Board (FASB) has issued an exposure draft (ED) that will significantly revise accounting for banking institutions. The revisions could radically change how investors and customers view banking institutions. In summary, the ED includes:

The accounting will be similar for loans and debt securities.

• The balance sheet classification for both loans and debt securities will be similar to today's "trading" and "available for sale" buckets.

All loans and debt securities will be recorded at fair value (FV) on the balance sheet.

• Changes in FV for assets held for trading purposes will continue to be recorded through earnings.
  
• For assets held for long-term investment, an allowance for credit losses will be maintained, with changes affecting earnings. Changes in FV will be recorded to Other Comprehensive Income (OCI). 

• Currently, the FVs for loans held for investment and held-to-maturity debt securities are recorded at amortized cost, with FVs disclosed only in the footnotes to the financial statements.
  
• For those assets held for long-term investment, the balance sheet will detail the amortized cost, the allowance for credit losses, and a FV adjustment to reach an ending balance at FV.
  
• Unfunded loan commitments for most loans will be reported at FV on the balance sheet, with any changes in FV reported in OCI. Currently, most unfunded loan commitments are not reported on the face of the balance sheet, but are disclosed in the footnotes.

• Borrowers are exempt from this requirement.
• Credit card loan commitments are exempt from this requirement.

Allowances for credit losses will apply to both loans and debt securities held for long-term investment and will now be estimated based on "expected losses", as opposed to "incurred losses".

• The "triggers" for recognizing losses that have been subject to much controversy and audit scrutiny will be eliminated.
• Interest income will be based on an effective yield calculated after (not prior to) expected losses.
• Based on the expected losses at the time of acquisition, for practical purposes there may be "Day 1 losses" recorded.

Equity Securities will be marked to market, with changes in FV recorded directly to earnings.

• Equity method accounting will apply for unconsolidated equity investments if the entity has significant influence over the investee and the investment is related to the entity's consolidated business.

One Statement of Comprehensive Income will be required to be presented.*

• A "continuous statement of comprehensive income that would enhance the prominence of the items reported as other comprehensive income" will be required. Both net income and other comprehensive income will be reported, summing to total comprehensive income (TCI).  Thus, the FV adjustments that go through OCI will be included in the new bottom line as part of TCI.
  
• It is expected that TCI will be available at the time of earnings releases along with Net Income, though a TCI per share will not be required to be provided on the Statement of Comprehensive Income.

Financial liabilities will generally be recorded at FV.

• Core deposit liabilities are recorded at their present value, which may reflect a core deposit intangible that approximates the interest rate borrowing advantage inherent to banks from deposits. The amount of this intangible is much more limited than the deposit intangibles now recorded in business combinations.
  
• Other than for derivative liabilities, changes in FV will generally be reported in OCI.
  
• Companies have the option to record their own debt at amortized cost if FVs would create or exacerbate a mismatch with the asset it is funding.

Hedge accounting will be streamlined to allow hedging of specific risks, as opposed to whole instruments.

• Hedging instrument must be "reasonably effective" to offset changes in value or cash flows of the hedged item.
  
• Qualitative analysis of effectiveness is required at inception.
  
• Effectiveness is reassessed only if circumstances indicate the relationship is no longer reasonably effective.
  
• "Shortcut" and "critical terms match" methods are eliminated.
  
• Hedge accounting may be discontinued only if criteria for hedge accounting are no longer met. No arbitrary de-designation.

The effective date for non-public banks with assets under $1 billion is deferred for four years.

• These smaller banks will still be required to disclose fair values of all financial instruments with a FAS 157-based "exit price".

*Note: The statement of comprehensive income is addressed in a separate ED, issued concurrently with the Accounting for Financial Instruments ED. The proposal is issued at this time because of FASB's desire to reflect all fair value changes as a prominent part of a financial institution's performance.

For more information contact:  Michael Gullette (202) 663-4986