In a letter to the US accounting standards-setter, Nigel Sleigh-Johnson, head of the ICAEW Financial Reporting Faculty, warns that there is “a danger that the proposed model could have serious unintended commercial and broader economic consequences, as it could change the incentives of lending and encourage more short-term loans and commitments”.
For the last 10 years, FASB has been working with the International Accounting Standards Board (IASB) on a convergence project with the aim of producing one set of global accounting standards. They are now at the point where they are discussing the most controversial issues – including impairment – and, after a number of attempts to come up with a common approach, they have agreed to disagree.
The proposed model could have serious unintended commercial and broader economic consequences
In December 2012, FASB issued its exposure draft three months ahead of the IASB’s proposals. Both versions respond to the criticisms levelled at the incurred loss model which was blamed by many commentators during the financial crisis for delaying the recognition of impairment losses and for not accurately reflecting credit losses that were expected to occur.
Both sets of proposals produce a more forward-looking impairment model that reflects expected credit losses. However, that is where the similarities between the two sets of proposals end. FASB opts for upfront recognition of lifetime day one losses while the IASB model is designed to recognise credit losses on a more timely basis.
Sleigh-Johnson also suggests that the FASB proposal that recognition of all expected credit losses on the day a loan agreement is signed may not even meet the objectives of financial reporting. “Such an approach does not in our view reflect commercial lending practice and could result in information that is of questionable use to users of financial statements.”
He urged the US regulator to go back to the drawing board to see if it couldn’t come up with an approach that was closer to the IASB’s.
His views were reflected at the Financial Reporting Faculty’s debate on IFRS 9 and impairments yesterday. The FASB proposals might be prudential but they did not reflect economic reality, IASB board member Martin Edelmann thought, while PwC engagement partner Henry Daubeney said that he knew of at least two large US banks that were likely to come out in support of the IASB line because day one recognition put them at “a significant disadvantage”.
The IASB proposals might not be perfect, said Sondra Tarshis, senior manager of accounting developments at HSBC, and chair of the ICAEW financial instruments working party, but they were “good enough” and "an improvement on what we have had before”.
She urged the IASB to carry on without the FASB and to stop seeking perfection. “We have waited for a new approach since 2008. It’s important to get on with the standard, particularly since there are a lot of different models out there,” she said, adding that she didn’t think anyone would come up with “a miraculous bridge” between the two standard setting bodies any time soon.
Sleigh-Johnson agrees. If the IASB proposals are not perfect, he says, they do at least achieve a balance between having a sound conceptual basis and being practical to apply. They are also suitable for all types of businesses, treat performing and non-performing loans differently, incorporate a broad range of credit information and are consistent with the initial recognition of financial assets at fair value.
He adds that they offer a “solution that is both operationally viable and a potential improvement to existing loan loss recognition practice”.