American Accounting Association 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.
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 2
Leases: Joint 3
Agenda Background on the Leases Project Scope Accounting Models & Measurement Issues Reducing Cost and Complexity 4
Why a Leases Project? 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 $1.25 trillion of off-balance sheet operating lease commitments for SEC registrants * * Estimate according to the 2005 SEC report on off-balance sheet activities 5
Proposed Right-of-Use Model A lease contract conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration 6
Scope of Leases Proposals That is explicitly or implicitly specified Lease contracts in the scope of proposals involve An identified asset The right to control the use during the lease term Supplier has no practical ability to substitute or would not economically benefit from substituting the asset Decision-making authority over the use of the asset The ability to obtain substantially all benefits from the use of the asset 7
Short-Term Leases Exemption Recognition and Measurement Exemption for Lessees For leases with a term of 12 months or less No longer based on maximum possible term, now aligned with definition of lease term 8
Small-Ticket Leases 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 9
Lessee Model Approaches All leases (more than 12 months) are recognized on the lessee s balance sheet Current U.S. GAAP (IFRS) Capital (Finance) Leases IASB Type A FASB 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. 10
Lessee Accounting Overview Balance Sheet Income Statement Cash Flow Statement Type A Lease asset Lease liability Amortization expense Interest expense Cash paid for principal and interest payments Type B Right-of-use asset Lease liability Single lease expense on a straight-line basis Cash paid for lease payments 11
Lessee Financial Statement Presentation Balance Sheet Cash Flow Statement Present Type A and Type B lease assets and lease liabilities as separate lines 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 Prohibited from presenting Type A and Type B lease assets and lease liabilities within same line Financing activities include payments for the principal portion of Type A lease liabilities IASB: Present lease assets and lease liabilities as separate line items or disclose in the notes IASB: Principal payments included within financing activities and interest payments follow other guidance 12
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 Same lease classification test (Type A vs. Type B) as IASB FASB 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 13
Lessor Accounting Overview Balance Sheet Income Statement Cash Flow Statement Type A Net investment in the lease Interest income and any profit on the lease Cash received for lease payments Type B Continue to recognize underlying asset Lease income, typically on a straight-line basis Cash received for lease payments 14
Lessor Financial Statement Presentation Balance Sheet Cash Flow Statement 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 Classify cash receipts from leases within operating activities Type B: Continue to present the underlying asset in accordance with other Topics 15
Measurement: Lease Term 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 16
Measurement: Lease Term 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 17
Measurement: Variable Lease Payments 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 18
Measurement: Variable Lease Payments 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 19
Measurement: Discount Rate 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 Subsequent Measurement 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 FASB ONLY accounting policy election to use a risk-free rate will be discussed at a future meeting 20
Multi-element Contracts: Separating Lease and Nonlease Components Separating Lease and Nonlease Components Lessee 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 Lessor 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 21
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 22
Lessee Disclosures Short Term Leases Disclosures - Amount of short-term expense recognized - Whether the short-term expense reflects the lessee s shortterm lease commitments - Qualitative disclosures 23
Lessor Disclosures 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 *Separately disclose owned assets subject to Type B leases from owned assets held and used. 24
Reducing Cost and Complexity in Response to Feedback on the 2013 ED 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 25
Future Topics for Board Discussion Lessee Disclosures Definition of a Lease Private Company Specific Issues Leveraged Leases Transition Effective Date, etc. 26
Financial Instruments: Classification & Measurement (FASB) 27
Hold to collect Hold to collect & sell Other business models Overall Debt Investment Model FASB Exposure Draft (substantially converged) Step 1 Are cash flows solely Principal and Interest? Yes Form of instrument not considered (e.g. loan vs. securities) No Step 2 Hold to collect cash flows ONLY? No Hold to collect cash flows AND sell assets Yes Yes No Amortized Cost* FV-OCI FV-NI Trade receivables Loans held for investment Some debt securities Senior securitization tranches Most Liabilities *No tainting Debt securities Potentially some loans Equity securities Certain debt securities Loans held for sale Convertible debt investments Residual securitization interest Certain hybrid assets Derivatives 28
Debt Investment Model - Redeliberations 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. 29
Equity Investments 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) Fair value through net income Default Practicability election Irrevocable election for investments without readily determinable fair values (practicability exception*) *Measures private equity investments based on any observable price changes in orderly transactions for the identical/similar investment of the same issuer 30
Equity Method of Accounting FASB Exposure Draft (Feb 2013) 1 Continues to be based on existence of significant influence 2 But fair value through net income required if held for sale, defined as: 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 3 Assess for impairment under single-step approach for practicability exception 31
Financial Liabilities FASB Exposure Draft (Feb 2013) FASB s proposed model: Amortized cost Required unless Fair value through net income Short sales, Nonrecourse, intend to subsequently transact at FV, and FVO option for hybrid liability 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) 32
Financial Instruments: Impairment (FASB & IASB) 33
Introduction Financial Crisis Advisory Group (FCAG) Formed in 2008 by FASB and IASB Recommendation Explore alternative to incurred loss model Reduce complexity by having a single impairment model Utilize more forward-looking information 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 34
Impairment: Project Objectives Address concerns about delayed recognition of losses under incurred loss approach Reduce complexity by having a single impairment model 35
History of Expected Credit Loss (ECL) Model 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 36
History of Expected Credit Loss (ECL) Model 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 37
The FASB model simply stated 38 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 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 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 Provides enhanced disclosures compared to current GAAP 38
Model applies to 39 Debt instruments (e.g., loans and securities) measured at: Amortized cost FV-OCI Loan commitments Lease receivables Trade receivables Reinsurance receivables 39
AFI Impairment: Model Change Current U.S. GAAP vs. Current Expected Credit Loss (CECL) When a Loss is Recognized US GAAP Today When a loss is probable, or incurred (+ four other models) Proposal (CECL) No recognition threshold, updated at each reporting date How Much of a Loss is Recognized What Information Set is Used in Determining a Loss Present value of expected future cash flows, discounted at loan s effective interest rate Past events & current conditions Current estimate of cash flows not expected to be collected discounted at the effective rate Past events & current conditions Reasonable & supportable expectations about future 40
Similarities in the FASB & IASB Models No initial recognition threshold Expected credit loss models, reflect more forwardlooking information Assets that have experienced significant increase in credit risk since initial recognition (i.e. performing and underperforming assets) recognize lifetime expected credit losses 41
Similarities in the FASB & IASB Models Measurement of expected credit losses 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) Provide enhanced disclosures compared to current GAAP/IFRS 42
Differences in the FASB/IASB Models Measurement approach FASB Model A single measurement approach measure the loss allowance as the estimate of all contractual cash flows not expected to be collected IASB Model 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) Significant deterioration in credit quality (stage 2) or objective evidence of impairment (stage 3) 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 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) 43
Differences in the FASB/IASB Models 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. No threshold, so no need for a significant deterioration criterion On Day 1, recognize an estimate of lifetime cash shortfalls on expected defaults in the next 12 months 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 44
Key Difference Between FASB & IASB Models 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 45
High Level Feedback U.S. Stakeholders 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 46
Project status and next steps 47 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 47
Financial Instruments: Hedging (FASB) 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 48
Insurance Contracts (FASB)
Insurance Different Starting Points FASB Current U.S. GAAP guidance addresses insurance accounting Issued an Exposure Draft June 2013 IASB 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 50
Insurance Project: Scope Change Proposed Scope All entities that issue insurance contracts New Scope Only insurance entities as described in current U.S. GAAP Project Parts Disclosures about short-duration contracts Targeted improvements to the accounting for long-duration contracts 51
Questions? Copies of these slides will be available tomorrow on the FASB homepage at www.fasb.org 52