US FASB presents new exposure draft of Accounting for Financial Instruments

27 May, 2010: As we have often commented, the standard setters have almost insatiable appetite to write new standards on accounting for financial instruments. Even before the existing standards settle, a new standards comes up. 

Many countries world-over are still trying to learn IAS 39. In the meantime, IASB and FASB put up a joint working group to rewrite IAS 39. They decided to do so in 3 phases. IASB came up with IFRS 9 that rewrites one part of IAS 39 – the question of fair valuation, as that was arguably the most urgent thing to do in view of the crisis. IASB came up with an Exposure Draft for the Phase 2 of IAS 39 re-write – pertaining to impairment accounting. The third phase, hedge accounting, was perhaps thought to be less as urgent and hence, is still pending. 

FASB and IASB were apparently working together – or at least that is what the world thought. But on 26^th May 2010, FASB came up with an Exposure Draft of an Accounting Standard Update, for Financial Instruments. The FASB apparently decided to go alone in the process of replacing the accounting standards on financial instruments – the FASB is seemingly disinclined to go for the phased-rewrite that IASB is going for.  The Summary to the Exposure Draft says: “Ideally, this proposal would have been issued jointly with the IASB and contain converged guidance. …However, each Board has faced different imperatives that have resulted in different approaches for accounting for certain types of financial instruments, resulting in different timetables for the project. ..In addition, the IASB has been replacing its financial instruments requirements in a phased approach, whereas the FASB has been developing this comprehensive proposal.” 

The essence of the new standard is something that this author has been forecasting for quite some time – that currently, accounting standard-setters are tinkering with the rules of accounting with no clear sense of direction, and they are prescribing fair value accounting as the alternative to historical cost accounting, and that eventually, the standards will take a full circle and will provide for historical cost accounting once again, most likely with an added column containing the fair value information. That is to say, the balance sheet of future may be twin columns of historical costs  and fair values, side by side. Accordingly, the Exposure Draft states: “Under this proposal, most financial instruments would be measured at fair value in the statement of financial position each reporting period. … However, for certain other financial instruments for which this represents a change, the proposal acknowledges that amortized cost information also is relevant and would require its presentation along with fair value information”. 

It may be noted that IFRS 9 considerably widened the scope of instruments where entities could choose to do without fair value – unlike the so-called “hold to maturity” instruments under IAS 39 or FAS 115. See Vinod Kothari’s note on IFRS 9 here: http://www.vinodkothari.com/fair_value_accounting.htm In short, entities may, under IFRS 9, choose to treat instruments at amortised cost based on their “business model”. The same business model approach is sought. The FASB Exposure draft also recognizes the same “business strategy approach” by permitting entities to present amortised cost: “Financial instruments for which an entity’s business strategy is to hold for collection or payment(s) of contractual cash flows, the proposed guidance would recognize the utility to financial statement users of both fair value and amortized cost information by requiring a reconciliation from amortized cost to fair value on the face of the statement of position. By continuing to reflect a “business strategy” approach to what is recognized in net income, the proposed model would enable entities to preserve most of the existing aspects of reporting net income and earnings per share.”.. 

While IASB is yet to formulate its proposals on hedge accounting, FASB has gone ahead and opened its mind. The highlight is that the current approach, laying down the intringuing 80:125 rule is going away. The new rules are more qualitative than quantitative.  

However, there are significant differences  between IASB approach and the FASB approach – both in the range of instruments that call for fair valuation, as also valuation of liabilities. It is, therefore, diverging from the idea of convergence.

[Reported by: Vinod Kothari]

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