Wednesday, January 26, 2011

Fair Value vs. Amortized Cost for Financial Instruments: FASB Moves Toward Business Strategy Criterion, Permitting Loans To Be Held At Amort. Cost

At yesterday's (Jan. 25) Financial Accounting Standards Board meeting, the board tentatively decided to use a 'business strategy' criterion for the classification and measurement of financial instruments at fair value vs. amortized cost. Significantly, this represents a change in the board's earlier proposal to carry loans at fair value. Separately, as previously reported, FASB and the IASB recently announced they would work toward bringing their differing proposals on accounting for credit losses closer together.

Yesterday's decision by FASB on valuation of financial instruments can be thought of in simple terms as falling into 3 'buckets:'

  1. Trading activities, Held for Sale: Fair Value, with all changes in fair value recognized in net income. (FV-NI)
  2. Investments - i.e. investing with a focus on managing risk exposures and maximizing total return: Fair value measurement with qualifying changes in fair value recognized in other comprehensive income. (FV-OCI)
  3. Loans, Customer Financing (managing asset for collection of contractual cash flows through lending/customer financing activity): Amortized Cost.

As reported by BNA's Steve Burkholder today in FASB Shifts to Cost Treatment of Loans,
Away From Proposed Fair Valuation
(subscription required):

The preliminary decision on what FASB's chairwoman, Leslie Seidman, and board
colleagues called “plain vanilla” debt instruments held for contractual collection of payments, as well as receivables, was applauded by the American Bankers Association. Security analysts interviewed by BNA after the meeting were
less happy.

Reclassifications, 'Tainting'
On the question of reclassifications among the above categories, and regarding 'tainting' of remaining assets in a category for which the intent regarding certain assets had changed (e.g. if certain long-term investements were sold for short-term liquidity purposes), FASB decided:

  • reclassifications between categories of financial assets would not be permitted, and

  • subsequent sales would not “taint” an entity’s financial assets classified at amortized cost.

Additional details regarding decisions reached at yesterday's FASB board meeting can be found in FASB's Summary of Board Decisions.

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