Accounting boards issue a joint proposal on how derivatives and other assets are presented on bank balance sheets.
The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) released a joint proposal last Friday that would change the way banks account for derivatives and also put more derivatives exposure onto their balance sheets.
If implemented the proposal could limit the ability of banks and also corporations to effectively manage risk because it could conceal information on a counterparty’s position.
The rule would be in line with the FASB and IASB’s commitment to convergence and again bring US rules closer to international standards. The joint proposal would limit the practice of netting, which is allowable under US rules but not under International Financial Reporting Standards. In another sign the two boards are closer to convergence (or that the US is moving more toward international standards), FASB last week stepped back from fair-value rules on loans (see related story here).
Future vs. now
In this most recent proposal FASB and IASB seek to standardize the approach to offsetting financial assets and financial liabilities on the company balance sheets. Current accounting rules allow companies to account for credit losses using an “incurred loss model,” where an actual loss must happen before financial assets can be written down. The new proposal would move companies to an “expected-loss model,” which is more forward-looking.
The proposal covers derivatives, repurchase agreements and reverse repurchase agreements, but will likely have the most impact on the reporting of derivatives. And this is where the joint proposal comes into conflict with the International Swaps & Derivatives Association (ISDA). In a statement, the organization said the proposal to “report derivatives on a gross basis rather than a net basis on the balance sheet is counterintuitive, may lead to complexity in practice and can obscure the real position of the entity.” This will be misleading, ISDA argued, “when presenting the leverage, credit risk and liquidity risk position of an institution.”
The accounting boards are seeking comments on the proposal through April 28 and plan to complete the accounting standard later in 2011.