Boards Propose New Accounting Model for ‘Expected’ Loan Losses

Two entities charged with setting accounting standards for financial instruments have ""released a proposal"":http://www.ifrs.org/NR/rdonlyres/9252820E-0861-434D-A2B0-C6EBD70B5F50/0/Snapshot_Impairment_January2011.pdf that would require lenders to account for anticipated losses on loans earlier, in what is being described as a fundamental shift from current practices.
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The ""International Accounting Standards Board"":http://www.ifrs.org (IASB) and the ""U.S. Financial Accounting Standards Board"":http://www.fasb.org (FASB) have published a joint proposal that entails moving to an ‘expected loss model.' Both boards say it would provide a more forward-looking approach to how credit losses are accounted for, which they believe better reflects the economics of lending decisions.

At present, IASB's International Financial Reporting Standards (IFRSs) and FASB's Generally Accepted Accounting Principles (GAAP) account for credit losses

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using an ‘incurred loss model,' which requires evidence of a loss, known as a trigger event, before financial assets can be written down.

""A major complaint in the financial crisis was that when loan losses were recognized, it was a case of ‘too little, too late,'"" said Sir David Tweedie, chairman of the IASB. ""Such a situation highlighted the need for a more-forward looking approach to loan losses to ensure provisions are made much earlier than before.""

The new proposal has been published as a supplement to an exposure draft published by the IASB in November 2009, and a separate FASB exposure draft published in May 2010. These exposure drafts outlined different methods to account for credit impairment. Since then, the boards have worked to align their approach.

""The FASB and IASB have heard the urgent call for an improved, converged approach to impairment of debt instruments,"" said Leslie F. Seidman, chairman of the FASB.

Seidman added, ""We are keenly interested in whether investors think this revised approach provides relevant and timely information about credit losses, and whether reporting entities find the proposed requirements operational.""

The IASB-FASB joint proposal is open for public comment until April 1, 2011, and can be accessed via the ""IASB"":http://www.ifrs.org/Current+Projects/IASB+Projects/Financial+Instruments+A+Replacement+of+IAS+39+Financial+Instruments+Recognitio/Financial+Instruments+Impairment+of+Financial+Assetseplacement+of+IAS+39+Financial+Instruments+Recog/Supplementary+document/Supplementary+document.htm and ""FASB"":http://www.fasb.org/cs/BlobServer?blobcol=urldata&blobtable=MungoBlobs&blobkey=id&blobwhere=1175822044294&blobheader=application%2Fpdf Web sites.