FASB Issues Narrow-Scope Improvements to Standards on Financial Instruments
Joseph Jalbert, Audit Principal
Perhaps a consequence of the significance of recent accounting guidance coming from the FASB (ever hear of CECL?), it seems to be the new normal that stakeholders raise questions and concerns which prompt the FASB to redeliberate and issue clarifying guidance. One of the FASB’s recent updates, Accounting Standards Update (ASU) 2019-04, is no exception to this. The standard, issued separately in order to increase stakeholders’ awareness, aims to clarify and, in some instances, correct guidance contained within three previously-issued standards related to credit losses, hedging, and recognition and measurement of financial instruments. We’ll delve into each of these separately and look at some of the more significant changes that could impact your institution.
The amendments allow institutions to measure the allowance for credit losses on accrued interest receivable balances separately from other components of the amortized cost basis. Alternatively, institutions can make an accounting policy election not to measure an allowance for credit losses on accrued interest receivable balances if the institution writes off uncollectible accrued interest receivable in a timely manner (similar to what many institutions do today). Institutions are also permitted to make certain elections with respect to where accrued interest receivable balances and the related allowance for credit losses are presented and disclosed. Disclosure regarding the accounting policies elected is required.
The standard clarifies that institutions should include recoveries of amounts previously written off and expected to be written off when estimating the allowance for credit losses. The standard also notes that such recoveries should not exceed the aggregate of amounts previously written off and expected to be written off. It goes without saying, but institutions will need to be able to support their estimates of expected recoveries included in the allowance for credit losses.
Under the new standard, institutions are permitted to make an accounting policy election to adjust the effective interest rate used to discount expected future cash flows for expected prepayments in order to appropriately isolate credit risk when determining the allowance for credit losses. The new standard also clarifies that institutions should not adjust the effective interest rate used to discount expected cash flows for changes in expected prepayments resulting from a troubled debt restructuring.
Projections of interest rate environments
The standard clarifies that if a discounted cash flow method is selected to measure expected credit losses on variable-rate instruments, institutions are permitted to incorporate projections of future interest rate environments. The standard also clarifies that if such an approach is employed, an institution should also incorporate the projections of future interest rates when determining the effective interest rate used to discount expected cash flows.
Contractual extensions and renewals
The amendments clarify that an institution should consider extension or renewal options that are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the institution.
Partial-term fair value hedges
The new standard clarifies that an institution may measure the change in fair value of a hedged item using an assumed term only for changes attributable to interest rate risk. The new standard also clarifies that more than one partial-term fair value hedging relationship related to a single financial instrument can be outstanding at the same time.
Amortization of fair value hedge basis adjustments
The amendments clarify that an institution may elect (but is not required) to amortize a fair value hedge basis adjustment before the fair value hedging relationship is discontinued. If such an election is made, the basis adjustment should be fully amortized before the hedged item’s assumed maturity date.
The standard clarifies that transition adjustments to amend the measurement methodology of the hedged item in a fair value hedge of interest rate risk should be made as of the date of initial application of ASU 2017-12 rather than the date of adoption. The standard also clarifies the following:
- An institution may rebalance its fair value hedging relationships of interest rate risk when it modifies the measurement methodology used for the hedged item from total contractual coupon cash flows to the benchmark rate component of the contractual coupon cash flows. The guidance permits a number of methods to achieve this.
- An institution may transition from a quantitative method of hedge effectiveness assessment to a method that compares the hedging relationship’s critical terms without dedesignating the existing hedging relationship.
- An institution may reclassify a debt security from held-to-maturity to available-for-sale without calling into question the classification of the institution’s other held-to-maturity securities. A reclassified security is not required to be designated in a last-of-layer hedging relationship and may be sold at any time after reclassification.
Fair value disclosures
The standard clarifies that only public business entities are required to disclose the fair value of financial instruments not measured at fair value on the balance sheet.
Measurement alternative for equity securities
The standard requires an institution to remeasure equity securities without a readily determinable fair value accounted for under the measurement alternative at fair value under Topic 820 when an orderly transaction is identified for an identical or similar investment of the same issuer. Institutions should also adhere to the disclosure requirements in Topic 820 for a nonrecurring fair value measurement.
The amendments outlined above related to credit losses and hedging are effective when those standards become effective, unless those standards have already been adopted. For institutions that have already adopted the new credit losses standard, these amendments become effective in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and should be applied on a modified retrospective basis. For institutions that have already adopted the hedging standard, the amendments become effective as of the beginning of the institution’s next annual reporting period and should be applied retrospectively as of the date ASU 2017-12 was adopted (if already adopted) or prospectively when the amendments are adopted, with some exceptions. Early adoption is permitted for amendments to the credit losses and hedging standards.
The amendments related to the recognition and measurement of financial instruments are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and must be applied on a modified-retrospective basis. An exception to this is for the amendments related to equity securities without readily determinable fair values for which an institution selects the measurement alternative, which should be applied prospectively. Early adoption is permitted for institutions that have already adopted the standard.
Although the amendments in ASU 2019-04 are generally narrow in scope, institutions need to be aware of these changes and incorporate them into their current or planned processes depending on whether the related standards have already been adopted. We expect that additional clarifying guidance on these and other topics will be forthcoming, so be on the lookout for further updates in future newsletters - we’ll be sure to keep you up-to-date.
If you would like to discuss these matters further, contact Joseph Jalbert or your BNN advisor at 800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.