FASB’s proposed new accounting guidance on financial instruments out for comment.
The Financial Accounting Standards Board finally has issued its long-awaited Exposure Draft (ED) for the current phase of its financial instruments project. The ED, released months later than originally anticipated, proposes a big step closer to a full fair value approach to financial instruments accounting, including income recognition, but will still leave many balance sheets in limbo by not ushering in a full fair-value era for all balance-sheet components.
One way to look at the proposed guidance, which FASB produced jointly with the IASB, is that it takes all the fair value elements that had been relegated to the footnotes of financial statements and elevates them to the face. Thus, to the extent you already mark everything you can to market, the ED would represent no big change. However, if you still prefer a historical/amortized cost approach you will be looking at substantial impacts. Just remember, you would still have the opportunity to keep presenting this information (and reconciling it to the fair value approach), but this information would be increasingly relegated to the footnotes of your financials.
Fair for the unfair?
Because financial instruments are core to their business, the hardest hit will be banks, although so far they have maintained significant portions of their balance sheets (core loans and deposits) outside the fair value realm. Further changes toward fair value in the areas of measurement and income recognition, impairment, asset classifications and reclassifications will thus further contribute to the pro-cyclicality arguments of critics.
The argument is that by forcing institutions to mark-to-market, accounting rules will exacerbate the impact of losses and declining valuations in bad times as well as inflate the gains and value increases when markets are good. No longer will banks have the luxury of building reserves in up-cycles to smooth out the loss impacts in down-cycles. Many critics also question the timing of pushing forward now, with so many banks still struggling to recover from losses exacerbated by the fair value guidance made effective on the eve of the financial crisis.
And it’s not just the banks that are seeing red. Non-financial corporates would, of course, also have to navigate the new proposed rules and adjust accounting for financial instruments in their investment portfolios, used in hedging, and in funding. Plus, they will potentially have to pay more for bank products, including standby credit lines that will have been made more costly by a requirement to carry them at fair value on top of regulatory capital rules calling for them to be reserved for as if drawn. Stay tuned for a rundown of key items of concern to treasurers that might inspire a review of the ED and comment letters prior to the September 30 deadline (or if you are really worked up, request a field visit by FASB staff to your shop to demonstrate the impact).