Proposals on impairment of financial assets – a promise of greater consistency or the door to diversity?
The IASB and FASB’s ‘supplementary document’ on impairment of financial assets represents a major step towards convergence. The boards’ original exposure drafts could not have been further apart. The IASB started off with an income statement model that built up an expected loss reserve over time, reflecting the way loans are priced; while the FASB exposure draft took a balance sheet approach and proposed that the entire expected credit loss should be booked immediately.
The expected loss approach was welcomed by constituents, but there was a plea for convergence. Preparers said they couldn’t run two impairment calculations; users wanted a consistent answer. There was also a concern about the ‘operationality’ of the IASB model, especially in the context of open portfolios where loans move in and out and only forward-looking credit loss estimates are available.
So the boards needed to find a way to get to a converged, operational solution. They managed to narrow a possible 12 models down to the three proposed in the supplementary document. A compromise approach is presented as the common proposal, and the two alternatives reflect IASB and FASB preferred approaches. Needless to say, the alternatives represent enhanced variations of the respective boards’ original proposals.
The supplementary document focuses on open portfolios, as this is where the key operational issues arise; it proposes a dual model driven by credit characteristics of financial assets. On a ‘bad book’, the entire remaining lifetime expected credit loss is recognised immediately. On a ‘good book’, the proposal combines a simpler version of the time-based IASB approach with a minimum floor of the full amount of loss expected to occur in the ‘foreseeable’ future.
So what are the implications of the joint proposals? Do they mean consistency in reporting impairment of financial assets or diversity in practice?
The first question that comes to mind is the scope. The supplementary document focuses on open portfolios, scopes out short-term receivables and invites views as to whether the common proposal can be applied to closed portfolios, single instruments and off-balance sheet exposures. Does this mean we may end up with multiple impairment models depending on the type of the instrument?
Once you drill down, you next wonder about the application of the ‘good book’ and the ‘bad book’ approach. The distinction is based off the degree of uncertainty about the collectability of financial asset and internal risk management objective. Credit risk management practices differ between entities, so does it seem inconceivable that where one entity recognises a full expected loss, another continues to spread it?
Within the ‘good book’, there is a further potential for diverse application. More sophisticated entities may be able to come up with detailed forecasts for the next two to three years; less sophisticated entities may end up with a 12-month minimum foreseeable future. This will mean a different ‘floor’ for similar items across preparers.
I would be interested to hear your thoughts and opinions about the proposals. Do you favour the common proposal over the alternatives? What is the right scope? Do you feel a single impairment model should apply in all circumstances or multiple models are justified? Do you support the focus on internal risk management and the flexibility or would you rather limit the available choices? Whatever the outcome of the debate, the boards are to be commended for their willingness to listen and their commitment to work together.