FASB INTERPRETATION ON GUARANTEES

BY MARTIN ROSENBLATT

The FASB has issued FASB interpretation no. 45 on Guarantor's Accounting and Disclosure Requirements for Guarantees.

It provides that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This applies on a prospective basis to guarantees issued or modified after 12/31/02.

It also prescribes the disclosures to be made by a guarantor of its new and pre-existing guarantees, in its interim and annual financial statements. This applies to interim or annual periods ending after 12/15/02.

At the inception of a guarantee, the guarantor shall recognize in its balance sheet a liability for that guarantee:

1. When a guarantee is issued in a standalone arm's-length transaction with an unrelated party, the liability recognized at the inception of the guarantee ordinarily should be the premium received or receivable by the guarantor.

2. When a guarantee is issued as part of a transaction with multiple elements with an unrelated party (such as in conjunction with selling an asset), the liability recognized at the inception of the guarantee should be an estimate of its fair value. i.e. guarantors should consider what premium would be required by the guarantor to issue the same guarantee in a stand-alone arm's length transaction with an unrelated party. In the absence of observable transactions for similar guarantees, expected present value of estimated cash flows will likely provide the best estimate of fair value. Expected present value according to FASB is the sum of the probability-weighted present values in a range of estimated cash flows, all discounted using the same interest rate convention, and not the guarantor's single best estimate of what it will be required to pay under the guarantee [often zero].

These provisions do not apply to guarantees accounted for as derivatives or guarantees issued by insurance and reinsurance companies. There are several other exclusions from the scope--refer to the actual document for more information.

The interpretation does not prescribe a specific account for the guarantor's offsetting entry when it recognizes the liability at the inception of a guarantee, nor does it prescribe the approach for subsequently adjusting the liability over the term of the guarantee as the guarantor is released from risk under the guarantee. a guarantor's release from risk has typically been recognized (a) only upon either expiration or settlement of the guarantee, (b) by a systematic and rational amortization method, or (c) as the fair value of the guarantee changes.

A guarantor shall disclose the following information about each guarantee, or each group of similar guarantees, even if the likelihood of the guarantor's having to make any payments under the guarantee is remote:

a. The nature of the guarantee, including the approximate term of the guarantee, how the guarantee arose, and the events or circumstances that would require the guarantor to perform under the guarantee.

b. The maximum potential amount of future payments (undiscounted) the guarantor could be required to make under the guarantee. That maximum potential amount of future payments shall not be reduced by the effect of any amounts that may possibly be recovered under recourse or collateralization provisions in the guarantee (which are addressed under (d) below). If the terms of the guarantee provide for no limitation to the maximum potential future payments under the guarantee, that fact shall be disclosed. If the guarantor is unable to develop an estimate of the maximum potential amount of future payments under its guarantee, the guarantor shall disclose the reasons why it cannot estimate the maximum potential amount.

c. The current carrying amount of the liability, if any, for the guarantor's obligations under the guarantee (including the amount, if any, recognized under paragraph 8 of Statement 5), regardless of whether the guarantee is freestanding or embedded in another contract.

d. The nature of (1) any recourse provisions that would enable the guarantor to recover from third parties any of the amounts paid under the guarantee and (2) any assets held either as collateral or by third parties that, upon the occurrence of any triggering event or condition under the guarantee, the guarantor can obtain and liquidate to recover all or a portion of the amounts paid under the guarantee. The guarantor shall

indicate, if estimable, the approximate extent to which the proceeds from liquidation of those assets would be expected to cover the maximum potential amount of future payments under the guarantee.