FASB/IASB Update – Part II

Tom Linsmeier

FASB Member

August 3, 2014

The views expressed in this presentation are those of the

presenters. Official positions of the FASB/IASB are reached

only after extensive due process and deliberations.

American Accounting Association

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Agenda

Leasing: Joint

Financial instruments - Classification and measurement: IASB - Classification and measurement: FASB - Impairment: FASB & IASB - Hedging: FASB - Hedging and macrohedging: IASB

Insurance: IASB

Insurance: FASB

Leases: Joint

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Agenda

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Background on the Leases Project

Scope

Accounting Models & Measurement Issues

Reducing Cost and Complexity

Lessee - Most lease assets and

liabilities are off-balance sheet

- Limited information about operating leases

Lessor - Lack of transparency about

residual values

- Consistency with lessee proposal and revenue recognition proposal

Why a Leases Project?

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* Estimate according to the 2005 SEC report on off-balance sheet activities

$1.25

trillion of off-balance sheet

operating lease

commitments for SEC

registrants*

Proposed Right-of-Use Model

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A lease contract conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration

Lease contracts in the scope of proposals

involve

An identified asset

That is explicitly or implicitly specified

Supplier has no practical ability to substitute or

would not economically benefit from substituting

the asset

The right to control the use during the lease

term

Decision-making authority over the use of

the asset

The ability to obtain substantially all benefits from the use of the asset

Scope of Leases Proposals

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Short-Term Leases Exemption

For leases with a term of 12 months or

less

No longer based on maximum possible term, now aligned with definition of

lease term

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Recognition and Measurement Exemption for Lessees

Small-Ticket Leases

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Decided to permit the leases guidance to be applied at a portfolio level

IASB ONLY: to provide an explicit recognition and measurement exemption for leases of small assets

Further Outreach: to be performed on the effects of a recognition and measurement exemption for leases of small assets

Lessee Model Approaches

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Current U.S.

GAAP (IFRS) IASB FASB

Capital (Finance)

Leases Type A Type A

Operating Leases Type A Type B

All leases are the

same.

Not all leases are the same.

Classification is based on

existing U.S. GAAP/IFRS.

All leases (more than 12 months) are recognized on the

lessee’s balance sheet

Lessee Accounting Overview

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Type

A

Type

B

Lease asset

Lease liability

Amortization expense

Interest expense

Cash paid for principal and

interest payments

Right-of-use asset

Lease liability

Single lease expense on a straight-line basis

Cash paid for lease payments

Income

Statement

Cash Flow

Statement Balance Sheet

Lessee Financial Statement Presentation

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Present Type A and Type B lease assets and lease liabilities as separate lines items or disclose in the notes

Prohibited from presenting Type A and Type B lease assets and lease liabilities within same line

IASB: Present lease assets and lease liabilities as separate line items or disclose in the notes

Operating activities include payments from Type B leases and the interest portion of the lease liability from Type A leases

Financing activities include payments for the principal portion of Type A lease liabilities

IASB: Principal payments included within financing activities and interest payments follow other guidance

Balance Sheet Cash Flow Statement

Lessor Model Approaches

IASB A lessor should determine lease classification (Type A vs. Type B)

based on the concept underlying existing U.S. GAAP and IFRS lessor

accounting

FASB

Same lease classification test (Type A vs. Type B) as IASB

A lessor will not recognize upfront profit for Type A leases that do not

transfer control of the underlying asset to the lessee

This aligns with what constitutes a sale in the recently issued revenue

recognition guidance

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Lessor Accounting Overview

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Type

A

Type

B

Net investment in

the lease

Interest income and any profit on the lease

Cash received for lease payments

Continue to recognize

underlying asset

Lease income, typically on a straight-line basis

Cash received for lease payments

Balance Sheet Income

Statement

Cash Flow

Statement

Lessor Financial Statement Presentation

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Type A: Present the net investment in the lease (which includes, the lease receivable, the unguaranteed residual value of the underlying asset, and any deferred selling profit (FASB-only)) separately on the balance sheet or disclose them separately in the notes

Type B: Continue to present the underlying asset in accordance with other Topics

Classify cash receipts from leases within operating activities

Balance Sheet Cash Flow Statement

Measurement: Lease Term

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Initial Measurement

• Consider all relevant factors that create an economic incentive to

exercise a renewal option

• Include the renewal option in the lease term if it is reasonably

certain that the lessee will exercise the renewal option

• Reasonably certain is substantially the same as reasonably assured

*Purchase options are accounted for in the same way as term options

Measurement: Lease Term

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Subsequent Measurement

• A lessee will reassess the lease term only upon the occurrence of

a significant event or a significant change in circumstances that is

within the control of the lessee

• A lessor is not required to reassess the lease term

*Purchase options are accounted for in the same way as term options

Measurement: Variable Lease Payments

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Initial Measurement

• Only include variable lease payments that are linked to an index

or rate in the measurement of the ROU asset and the lease

liability (Consistent with the 2013 ED)

*In-Substance Fixed Payments will remain within lease payments, consistent

with the 2013 ED, and will be further clarified

Measurement: Variable Lease Payments

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Subsequent Measurement

• A lessee will reassess variable lease payments only when the

lessee re-measures the lease liability for other reasons (e.g., a

change in lease term)

• IASB – also when there is a change in contractual cash flows

• A lessor is not required to reassess

Measurement: Discount Rate

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Clarify “value” as the value of the right-of-use asset within the definition of the lessee’s incremental borrowing rate

Describe the rate the lessor charges the lessee as the rate implicit in the lease (consistent with existing lessor guidance)

Include initial direct costs of the lessor in the determination of the rate implicit in the lease

• A lessee will reassess only when lease payments are re-measured for other reasons (e.g., change in the lease term)

• A lessor is not required to reassess

Subsequent Measurement

FASB ONLY accounting policy election to use a risk-free rate will be discussed at a future meeting

Multi-element Contracts: Separating Lease and Nonlease Components

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• A lease of an asset in a contract for the lease

of multiple assets is a separate lease

component if it is distinct. That is:

− The lessee can benefit from use of the

asset on its own or with readily available

resources; and

− The leased asset is neither highly

dependent upon, nor highly interrelated

with, other underlying assets in the

contract.

• Lessors will always separate lease

components from nonlease components

Lessor

Separating Lease and Nonlease Components

• A lease of an asset in a contract for the lease

of multiple assets is a separate lease

component if it is distinct (same criteria as for

lessors in box to right)

• Always separate lease components from

nonlease components unless applying the

accounting policy election below

• Accounting Policy Election – to not separate,

and account for lease and nonlease as a

single lease component

Lessee

Multi-element Contracts: Allocating Consideration to Components Lessors will allocate the consideration in the contract to lease and

nonlease components in accordance with the guidance on

allocating the transaction price in the new revenue recognition

standard

Lessees will allocate the consideration in the contract to lease and

nonlease components on a relative standalone price basis

- Use observable standalone prices, if available

- Estimate standalone prices otherwise

Activities or costs of the lessor that do not transfer a good or

service to the lessee are not components; and therefore, do not

receive a separate allocation of consideration in the contract

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Disclosures

- Amount of short-term expense recognized

- Whether the short-term expense reflects the lessee’s short-

term lease commitments

- Qualitative disclosures

Lessee Disclosures – Short Term Leases

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Qualitative

• Nature of leases

• Significant changes in components of net investment in Type A leases

Quantitative

• Table of lease income

• Maturity analysis of undiscounted cash flows that comprise the lease receivable

• Maturity analysis of undiscounted future lease payments for Type B leases

Judgments

and Risks

• Residual value risk mitigation

• Significant assumptions and judgments made in application

Lessor Disclosures

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*Separately disclose owned assets subject to Type B leases from owned assets held and

used.

Lessor Model

• Maintaining current model with only minor updates • Eliminated Receivable and Residual Approach

• Reduced lessor disclosures

Lessee Model

• FASB – classification line is the same as current accounting

• IASB – single model

Short-term leases

• Aligned definition with the definition of lease term

Reassessment

• No reassessment for lessor

• Limited reassessment for lessees

Reducing Cost and Complexity in Response to Feedback on the 2013 ED

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Future Topics for Board Discussion

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Lessee Disclosures

Definition of a Lease

Private Company Specific Issues

Leveraged Leases

Transition

Effective Date, etc.

Financial Instruments: Classification

& Measurement (FASB)

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Overall Debt Investment Model FASB Exposure Draft (substantially converged)

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Hold to collect cash

flows AND sell assets

Hold to collect

cash flows

ONLY?

Are cash flows

solely Principal

and Interest?

Amortized Cost*

Trade receivables

Loans held for investment

Some debt securities

Senior securitization tranches

FV-OCI

Debt securities

Potentially some loans

FV-NI

Equity securities

Certain debt securities

Loans held for sale

Convertible debt investments

Residual securitization

interest

Certain hybrid assets

Form of instrument not considered

(e.g. loan vs. securities)

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Step 1

Step 2

Yes

Yes

No

Yes No

No

Derivatives *No tainting

Most Liabilities

Debt Investment Model - Redeliberations

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The Board decided not to continue to pursue the

SPPI model to assess the contractual cash flows of

financial assets. The Board also decided to retain

current bifurcation requirements and not apply any

other new cash flow model. (Current U.S. GAAP)

Similarly, the Board decided not to continue to pursue the

business model assessment from the proposed Update. The

Board decided to retain the separate models for classifying

loans and securities that exist in current U.S. GAAP.

Fair value through net income

Default

Practicability election

Irrevocable election for investments without readily

determinable fair values (practicability exception*)

Equity Investments

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The Board decided that equity investments must be classified as FV-NI (other

than those accounted for under equity method or the practicability exception

noted below)

*Measures private equity investments based on any observable price changes in

orderly transactions for the identical/similar investment of the same issuer

• Specifically identified exit strategy

- Exact method of exit does not need to be determined

• Time when expect to exit, which could be

- Specific date

- Range of dates

- Depend on specific facts and circumstances e.g. particular milestones

- Depend on investment objective

Continues to be based on existence of significant influence 1

But fair value through net income required if held for sale, defined as: 2

Assess for impairment under single-step approach for practicability exception 3

Equity Method of Accounting FASB Exposure Draft (Feb 2013)

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Retains bifurcation of hybrid instruments

If elect fair value option for hybrid liability, changes due to own credit go to OCI

For non-recourse debt that can only be settled with certain assets, measurement of debt follows

measurement of assets (FASB only)

Financial Liabilities FASB Exposure Draft (Feb 2013)

FASB’s proposed model:

Short sales,

Nonrecourse, intend to

subsequently transact at

FV, and FVO option for

hybrid liability

Fair value through

net income

Required unless…

Amortized

cost

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Financial Instruments: Impairment (FASB & IASB)

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Recommendation Explore alternative to ‘incurred loss model’

Reduce complexity by having a single impairment model

Utilize more forward-looking information

Introduction

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Current Response Proposals/final guidance that result in more timely recognition of credit losses

• FASB model – proposes recognizing all (lifetime) expected credit losses

• IASB model – requires recognizing some (12 months) expected credit losses until

significant deterioration threshold is met, then recognizes lifetime expected credit

losses

Financial Crisis Advisory Group (FCAG)

Formed in 2008 by FASB and IASB

Impairment: Project Objectives

Address concerns about

delayed recognition of losses

under incurred loss approach

Reduce complexity by having a

single impairment model

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IASB’s 2009 ED

Expected (life of loan) cash flow model

Recognize impairment over time (as interest income is recognized)

Conceptual appeal (to some) of reflecting the economics of lending

Major concerns with operational issues

FASB’s 2010 ED

Measure ECL based all available information relating to past events and

existing conditions but not consider potential future events

Interest income recognized by multiplying effective rate times net carrying

amount of asset

2011 “joint supplemental document” (SD)

Introduces good book/bad book concepts

History of Expected Credit Loss (ECL) Model

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Both boards begin developing “three-bucket” approach

FASB conducts outreach on model developed

July 2012 – FASB tells IASB it has significant concerns about operationality of 3

bucket model based on significant feedback from US constituents (preparers,

auditors, and users)

– Constituents question understandability, operability, auditability and workability

December 2012 FASB Issues Proposed Accounting Standards Update

Full lifetime ECL with initial and subsequent changes in credit loss expectations recognized in earnings

March 2013 IASB Exposure Draft and July 2014 Final Standard (IFRS 9)

12-month ECL until “significant” increase in credit risk and then lifetime ECL

History of Expected Credit Loss (ECL) Model

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The FASB model – simply stated Single measurement objective expected credit loss model reflecting more forward-looking information

Basic estimation objective is consistent from period to period – no need to define a “transfer notion” that prescribes that a different measurement objective for different assets in a period

• Includes changes in the estimate of expected credit losses resulting from, but not limited to

• Changes in credit risk of assets held by entity

• Changes in conditions since previous reporting date

• Changes in reasonable & supportable forecasts about the future

At each reporting date, an organization recognizes a credit impairment allowance for its current estimate of the expected credit losses on financial assets held at the reporting date

Provides enhanced disclosures compared to current GAAP

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Model applies to…

Debt instruments (e.g., loans and securities) measured at:

• Amortized cost

• FV-OCI

Loan commitments

Lease receivables Trade receivables

Reinsurance receivables

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Current U.S. GAAP vs. “Current Expected Credit Loss” (CECL)

AFI Impairment: Model Change

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US GAAP Today Proposal (CECL)

When a Loss is Recognized

When a loss is “probable,” or

“incurred” (+ four other models)

No recognition threshold, updated

at each reporting date

How Much of a Loss is

Recognized

Present value of expected future

cash flows, discounted at loan’s

effective interest rate

Current estimate of cash flows not

expected to be collected

discounted at the effective rate

What Information Set

is Used in Determining

a Loss

Past events & current conditions Past events & current conditions

Reasonable & supportable

expectations about future

No initial recognition threshold

Expected credit loss models, reflect more forward-looking information

Assets that have experienced significant increase in credit risk since initial recognition (i.e. performing and underperforming assets) recognize lifetime expected credit losses

Similarities in the FASB & IASB Models

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• Reflects management’s expectation based on past events, current conditions, and reasonable and supportable forecasts

• Reflect the risk of loss (i.e., the possibility that a loss will occur) as opposed to reflecting the most likely outcome (statistical mode)

Measurement of expected credit losses

Provide enhanced disclosures compared to current GAAP/IFRS

Similarities in the FASB & IASB Models

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FASB Model IASB Model

Measurement

approach

A single measurement approach –

measure the loss allowance as the

estimate of all contractual cash flows

not expected to be collected

Dual measurement approach- distinguishes

between instruments that have not (stage 1)

and have (stages 2 and 3) experienced a

significant increase in credit risk

Initial recognition,

deterioration that is

not significant, or

low credit risk

(stage 1)

In all stages, loss allowance equals

lifetime expected credit losses for

assets measured at amortized cost

In all stages, the recognized amount of

the full CECL allowance on FV-OCI

assets is limited to the difference

between fair value and amortized cost

Loss allowance measured as 12-month

expected credit losses

Significant

deterioration in

credit quality (stage

2) or objective

evidence of

impairment (stage 3)

Loss allowance measured as lifetime

expected credit loss

Accounting for

interest revenue on

non-performing

assets

The Board tentatively decided not to

address the accrual (or nonaccrual) of

interest in this guidance

Interest revenue calculated by applying

effective interest rate to the gross carrying

amount (stages 1 & 2) and to the net carrying

amount (stage 3)

Differences in the FASB/IASB Models

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FASB - Model IASB - Model

On Day 1, recognize an estimate of full

expected credit loss for assets measured at

amortized cost. Recognition of expected credit

losses on FV-OCI assets is limited to the

difference between fair value and amortized

cost, which on day 1 is zero.

On Day 1, recognize an estimate of lifetime

cash shortfalls on expected defaults in the

next 12 months

No threshold, so no need for a “significant

deterioration” criterion

Remainder of full expected credit loss

recognized when threshold is reached: Threshold is “significant deterioration” (e.g.,

deteriorates from Investment Grade to Non-

Investment Grade)

Estimates updated each period Changes flow through current period provision

Applicable “stages” and resulting estimates

updated each period Changes flow through current period provision

Differences in the FASB/IASB Models

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For assets that have not experienced a significant

increase in credit risk (i.e., performing assets)

FASB’s allowance = the entity’s estimate of credit losses

expected over the lifetime of those assets

IASB’s allowance = the entity’s estimate of lifetime credit

losses on defaults expected over the next 12 months

Key Difference Between FASB & IASB Models

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Strong (3-1 margin) user support for FASB proposal

Preparers generally do not support recognition of full

life time losses on day 1

- Concern with projecting losses beyond a reasonably

foreseeable time period

- Concern that CECL does not reflect economics of lending

High Level Feedback—U.S. Stakeholders

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Project status and next steps

The FASB continues redeliberations of the December 2012 proposed Update based on feedback received, including:

- Reconsideration of applicability of CECL to debt securities

- Operational simplifications to the measurement principle

Elimination of multiple outcomes

Reversion to the mean

Collateral-based practical expedients

Whether to allow contractual term extensions

Definition of writeoff

- Application guidance for credit card receivables

- Disclosures

- Transition / Effective Date

A final Accounting Standards Update is expect at the end of 2014

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Financial Instruments: Hedging (FASB)

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• FASB currently undertaking pre-agenda research to decide scope and

objectives of hedging project

• Project currently being viewed as part of the FASB’s simplification

initiative

Insurance Contracts (FASB)

Insurance – Different Starting Points

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Current U.S. GAAP guidance addresses insurance

accounting

Issued an Exposure Draft June 2013

Current standard (IFRS 4, Insurance Contracts) lacks

specific accounting guidance for insurance contracts

Issued an Exposure Draft July 2010

Issued a Revised Exposure Draft June 2013

FASB

IASB

Insurance Project: Scope Change

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• All entities that issue insurance contracts Proposed

Scope

• Only insurance entities as described in current U.S. GAAP

New Scope

• Disclosures about short-duration contracts

• Targeted improvements to the accounting for long-duration contracts

Project Parts

Questions?

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Copies of these slides will be available tomorrow

on the FASB homepage at www.fasb.org