Update on FASB’s Financial Instruments Projects
The Financial Accounting Standards Board (FASB) has three active financial instruments projects underway that will
have a significant impact on financial institutions:

Classification and Measurement (C&M)

Credit Impairment – Current Expected Credit Losses (CECL)

Hedges
This paper highlights the major impacts of each proposal and where FASB stands in the process. Unfortunately,
FASB and the International Accounting Standards Board (IASB) diverged on several key decisions on all projects;
none of the final standards will be converged. All tentative decisions are subject to change until the issuance of
the final standards. The C&M and CECL final standards are expected in the first quarter 2015 with effective dates
for public companies no earlier than 2016. Private companies would be permitted an additional year for adoption.
Discussions on the hedging project were restarted in September 2014 on the 2010 exposure draft.
Classification & Measurement
FASB backed away from the sweeping overhauls proposed in its 2013 C&M exposure draft, opting instead to make
targeted improvements to current guidance. The good news for financial institutions is that FASB has retained the
separate models in existing U.S. generally accepted accounting principles (GAAP) for determining classification and
measurement of loans and debt securities, as noted in the table below.
U.S. GAAP – Financial Instruments Classifications
Balance sheet category
Instrument
Debt Instrument
Held-to-maturity
Loans
Held-forinvestment
Trading
Held-for-sale
Income statement measurement
Instrument
Debt Instrument &
Loans
Available-forsale
Amortized Cost
FV OCI
FV Net Income
(FV-NI)
Lower of Cost or
FV
What Is Changing?
Equity Securities
FASB decided most equity securities should be measured at fair value through net income (FV-NI). Equity
securities previously classified as available for sale with changes in fair value recognized in other comprehensive
income (FV-OCI) would be measured at FV-NI. FASB approved a practical exception for nonmarketable equity
securities. If elected on an irrevocable basis, entities would record those securities at cost adjusted for impairment
and increases or decreases in observable prices (for orderly transactions for a similar investment of the same
issuer). FASB plans to provide implementation guidance to clarify the terms “orderly transactions” and “similar.”
Equity investments in entities in which the investor has significant influence remain eligible for the equity method
of accounting.
Update on FASB’s Financial Instruments Projects
Current U.S. GAAP balance sheet classifications of equity investments include available for sale, trading and
other – non-marketable. The proposal would eliminate these categories. The Dodd-Frank Act minimum capital
requirements were finalized while FASB redeliberated the financial instruments projects; unfortunately, the
legislation relies on these historic classifications. At the November 12, 2014, board meeting, FASB agreed to
meet with banking regulators as soon as possible to discuss the best way to address the implications of the
proposed classification and measurement standard for financial institutions.
Impairment of Equity Investments
For equity securities where the “cost +” practical expedient has been elected, the proposal would eliminate the
other-than-temporary impairment (OTTI) model; entities would apply a single-step impairment test. An
impairment charge for the difference between the carrying amount and the fair value would be recognized in net
income when an entity determines the fair value of the investment is less than its carrying amount. Impairment
charges would not be reversed for any subsequent recovery in value. Impairment indicators an entity should
consider include:

A significant deterioration in earnings performance, credit rating, asset quality or business prospects of
the investee

A significant adverse change in regulatory, economic or technological environment of the investee

A significant adverse change in general market condition of either the geographic area or the industry in
which the investee operates
On October 22, 2014, FASB tentatively removed equity method investments from project scope, thereby retaining
current U.S. GAAP for assessing impairment of equity method securities. FASB indicated it would study this issue
further as part of its simplification project.
Measurement of Gains & Losses – Equity Securities
Current
Proposed
FV OCI
Cost – Impairment &
observable price
changes
FV Net
Income
FV Net
Income
Lower of
Cost or
FV
Cost
Equity
Method
Equity
Method
Own Credit
For financial liabilities where the fair value option has been elected, any changes in fair value due to changes in an
entity’s specific credit risk or “own” credit should be presented in other comprehensive income (OCI). The current
impact is reporting in net income, and the existing guidance has been widely criticized for causing undue earnings
volatility. An entity can measure the effect of “own” credit using any method that faithfully represents the change
in an instrument’s specific credit risk. The entity must disclose the method chosen and apply it consistently from
period to period.
New Disclosures

Core Deposits – Public business entities would disclose on an annual basis the following, disaggregated by
significant types of core deposit liabilities, e.g., demand deposits and savings accounts:
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Update on FASB’s Financial Instruments Projects
•
•
The core deposit liability balance
The implied weighted-average maturity period
Nonpublic entities are exempt from this disclosure. The proposal defines “core deposit” differently than
the federal banking regulators. The final standard will not define “core deposit”; entities would be
required to qualitatively disclose what management considers core deposits.
FASB affirmed its tentative decisions on disclosures on core deposits at its July 30, 2014, board meeting. Many
community banks have since reached out to FASB to raise various operational implementation concerns. On
November 12, 2014, FASB agreed to conduct more research to address constituent concerns.

Equity Securities – All entities would disclose the carrying amount of equity investments without readily
determinable fair values and any adjustments made to the carrying amount during the reporting period.
An entity would not have to disclose the information it considered in determining the carrying amounts.

Fair Value of Instruments Measured at Amortized Cost – Public business entities would be required to
disclose the fair value of financial assets and liabilities measured at amortized cost, either parenthetically
on the face of the financial statements or in the footnotes. Public entities also would need to disclose the
level of the fair value hierarchy category for such financial instruments. Financial assets measured at
amortized cost should be disaggregated into major categories of those assets. Receivables and payables
due within one year and core deposits would be exempted from this disclosure.

Bifurcated Embedded Derivative – All entities would disclose the carrying amount, measurement
attribute and line item within the balance sheet in which the bifurcated embedded derivatives and related
host contract are presented; this issue may not be part of the final C&M standard but may be re-exposed
for public comment.
No Change to Current U.S. GAAP
Valuation Allowance on Deferred Tax Assets Related to Available-for-Sale Debt Securities
A valuation allowance on deferred tax assets arising from available-for-sale debt securities would be assessed in
combination with an entity’s other deferred tax assets.
Unconditional Fair Value Option
The original exposure draft would have placed limits on the fair value option. However, in April, FASB tentatively
decided to maintain the current unconditional fair value option for financial assets and financial liabilities. Electing
the fair value option is an irrevocable choice. The fair value option is available instrument by instrument, meaning
instruments of the same type or with similar traits could be accounted for differently.
Bifurcating Hybrid Financial Instruments
Accounting rules on bifurcation—splitting a combination instrument into its host contract and its derivative part
for reporting purposes—will remain unchanged. Entities will continue to separately account for any embedded
derivatives in hybrid financial assets if those derivatives are not “clearly and closely related” to the host contract.
The presence of an embedded derivative may not always result in the classification of the entire instrument as
FV-NI, as would have been the case under the whole instrument approach in the exposure draft.
Next Steps
A final standard is expected in the first quarter of 2015. The effective date for public entities is currently proposed
to be no earlier than 2016, with an extra year for nonpublic entities.
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Update on FASB’s Financial Instruments Projects
Credit Impairment – CECL Is Here to Stay
Incurred/Probable
Expected/Lifetime
FASB is proposing a single impairment model for most financial assets, replacing the multiple models available
under current U.S. GAAP. One of the primary objectives of the project is more timely recognition of credit losses.
Despite strong feedback from preparers, FASB is moving ahead with its proposed CECL model. The CECL model
requires an allowance for impairment to be recognized at inception representing the entity’s assessment of
lifetime expected credit losses.
Currently, depending on the nature of the financial asset, a credit loss either must be probable or other than
temporary before recognition. The proposal eliminates a recognition threshold on credit losses. An entity would
recognize a “Day 1” impairment allowance for its current estimate of contractual cash flows not expected to be
collected on financial assets.
The CECL model likely would increase the credit loss allowance, which could affect capital requirements. Under
the new model, the credit deterioration reflected in the income statement will include changes in the estimate of
expected credit losses resulting from any of the following:

Changes in credit risk of assets held by the entity

Changes in historical loss experience for assets like those held at the reporting date

Changes in conditions since the previous reporting date

Changes in reasonable and supportable forecasts about the future
FASB plans to establish a transition resource group (TRG) to help companies with implementation issues. TRG will
solicit, analyze and discuss stakeholder issues arising from implementation of CECL model and share this
information with the FASB, which will consider information from the TRG and determine what action to take on
each issue.
Scope
The CECL model would apply to financial assets measured at amortized cost, including the following:

Debt securities

Loan commitments

Lease receivables

Trade receivables

Reinsurance receivables

Financial guarantee contracts

Programmatic loans of not-for-profit entities
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Update on FASB’s Financial Instruments Projects
Exclusions from scope would include:

Debt securities classified as available-for-sale

Trading securities, since they are measured at fair value

Loans held for sale, since fair value is considered for balance sheet measurement

Loans made to participants by an employee benefit plan

Policy loan receivables of an insurance entity

Promises to give (pledge receivables) of a not-for-profit entity

Related-party loans and receivables between entities under common control
When Is a Loss Recognized?
Current U.S. GAAP
CECL Model
When loss is probable or incurred plus four other
models
No recognition threshold; updated at each reporting
period
How Much of a Loss Is Recognized?
Current U.S. GAAP
Present value of expected future cash flows
discounted at loan’s effective interest rate
CECL Model
Current estimate of cash flows not expected to be
collected discounted at the effective rate
What Information Set Is Used in Determining a Loss?
Current U.S. GAAP
Past events & current conditions
CECL Model
Past events & current conditions
Reasonable & supportable forecasts
Range of Information
FASB is broadening the information an entity is required to consider in developing its credit loss estimate. Under
current GAAP, an entity usually considers past events and current conditions in measuring credit losses. The
proposed amendments would require the loss estimate to include relevant information about past events, current
conditions and reasonable and supportable forecasts that affect the expected collectability of remaining
contractual cash flows. An entity only needs to consider information reasonably available without undue cost and
effort; it can use both internal and external information—including qualitative and quantitative factors—to
estimate expected credit losses. For future periods beyond which an entity is unable to make a reasonable
forecast, entities should revert to unadjusted historical credit loss experience. The entity can revert over the
financial asset’s estimate life on a straight-line basis or in a period or pattern reflecting the entity’s assumptions
about expected credit losses over that period.
Loss Probabilities
The estimate of expected credit losses must incorporate a range of at least two possible outcomes—that a credit
loss results and that no credit loss results even if this risk of loss is remote. Unfortunately, FASB decided the final
standard will not explicitly state which financial assets might warrant a zero expected loss.
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Update on FASB’s Financial Instruments Projects
An entity is prohibited from estimating expected credit losses based solely on the most likely outcome. A variety
of methods could be used, including a loss-rate method, roll-rate method, probability-of-default method and
provision matrix method using loss factors.
Measurement of Expected Credit Losses
Entities would be required to evaluate financial risk on a pooled basis when similar risk characteristics exist.
Entities would be permitted to evaluate financial assets on an individual basis only if there are no shared
characteristics with the entity’s other financial assets. When developing expected losses on an individual basis,
entities could include relevant external information such as credit ratings and credit loss information for assets of
similar credit quality.
Modified OTTI
For available-for-sale (AFS) debt securities, an allowance approach would be used that would permit an entity to
recognize reversals of credit losses. Entities no longer would be required to consider the length of time the fair
value of the AFS debt security has been less than its amortized cost basis when estimating whether a credit loss
exists. In addition, entities no longer would be required to consider recoveries or additional declines in fair value
for AFS debt securities after the balance sheet date.
PCI Financial Assets
Purchased credit-impaired (PCI) assets are acquired individual assets, or acquired groups of financial assets, with
shared risk characteristics that have experienced a significant deterioration in credit quality since origination,
based on the buyer’s assessment. PCI assets would follow the same approach as originated assets for purposes of
credit impairment. Upon acquisition and at each reporting date, an entity would recognize a credit impairment
allowance for its current estimate of the contractual cash flows not expected to be collected. The discount
embedded in the purchase price attributable to expected credit losses would not be recognized as interest income,
as is the current practice. The remaining portion of the discount not attributed to expected credit losses would be
recognized in interest income over the remaining life of the asset using an effective yield method. The noncreditrelated discount or premium would be allocated to each individual asset. The effective yield determined at
acquisition will be held constant; any changes in expected cash flows, i.e., changes in the allowance for loan losses,
will be recorded as gains and losses through the credit loss provision. Balance sheet and income statement
amounts for originated and PCI financial assets still would be presented separately.
TDRs
The proposal would not change the definition or derecognition guidelines for troubled debt restructurings (TDR),
but it would change the impairment recognized on restructuring. Expected credit losses would be recognized on
the expected shortfall in the post-modification contractual cash flows discounted using the new post-modification
effective interest rate. The cost basis of the TDR would be adjusted so the effective interest rate post-modification
is the same as the original effective interest rate, given the new series of contractual cash flows. The basis
adjustment would be calculated as the amortized cost basis before modification less the present value of the
modified contractual cash flows (discounted at the original effective interest rate). FASB will clarify in the final
standard that this can be an increase or decrease in the cost basis. Under current U.S. GAAP, impairment from the
restructuring is recorded as an allowance, rather than a write-off as described above. FASB is considering
permitting a prospective adjustment to the adjusted yield if prepayment speeds are different from expectations.
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Update on FASB’s Financial Instruments Projects
Contractual Term Extensions – TDRs, Loan Commitments
An entity would consider expected prepayments in estimating future contractual cash flows. Only if an entity
reasonably expects to execute a TDR would it consider extensions, renewals or modifications. For a funded
portion of a loan commitment, the expected credit losses would be estimated consistently with other loans, which
would require an entity to consider all expected contractual cash flows over the life of the loan. For the unfunded
portion of a loan commitment, the credit losses would reflect the entire contractual period that an entity is
exposed to credit risk from its present legal obligation to extend credit, unless the issuer may unconditionally
cancel the commitment.
Write-Offs
It was FASB’s intention to retain the existing requirements for write-offs; however, the proposal modified the
language to read “no reasonable expectation of future recovery,” which many found confusing. FASB decided to
revert to the existing language of “uncollectible.”
New Disclosures
The disclosure carries forward some of the requirements of ASU 2010-20, Disclosures about the Credit Quality of
Financing Receivables and the Allowance for Credit Losses, such as those related to quantitative and qualitative
information about credit quality, including the amount of recorded investment by credit quality indicator. The
following items also would be required for financial instruments covered by the CECL model:

Allowance for expected credit losses – For each portfolio segment, a description of the accounting
policies and methodology used to estimate the allowance for expected credit losses would be disclosed,
including inputs, assumptions and a description of any forecasts affecting the estimate. Any policy or
methodology changes from the prior period would be noted, as well as the reasons for significant writeoffs. A quantitative roll-forward of the allowance would be required, including the beginning balance,
current provisions, write-offs, recoveries and ending balance. Separate tables are required for financial
assets measured at amortized cost and FV-OCI. Entities also would disclose the method applied to revert
to historical credit loss experience for periods beyond which the entity is unable to make or obtain
reasonable and supportable forecasts

Reconciliation between fair value and amortized cost – For debt instruments classified at FV-OCI, if not
presented on the balance sheet

Nonaccrual status – For each portfolio segment, an entity would disclose all of the following:
•


The amortized cost of debt instruments on nonaccrual status as of the beginning of the reporting
period and end of the reporting period
• The amount of interest income recognized during the period on nonaccrual debt instruments
• The amortized cost of debt instruments that are 90 days or more past due but not on nonaccrual
status as of the reporting date
• The amortized cost of debt instruments on nonaccrual status for which there are no related
expected credit losses as of the reporting date because the debt instrument is a fully
collateralized collateral-dependent financial asset
PCI financial assets – For any PCI assets purchased in the current period, the purchase price, credit loss
discount, noncredit discount and par value should be disclosed
Collateralized financial assets – For each financial asset class, a description is required for the type of
collateral provided and the extent to which the collateral secures an entity’s financial assets. Any
significant changes in the level of collateralization from the prior period would be disclosed
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Update on FASB’s Financial Instruments Projects
The two disclosures below were included in the exposure draft, but FASB continues to review in light of various
operational issues raised by financial statement preparers:

Roll-forward for certain debt instruments – For debt instruments classified at amortized cost and FV-OCI,
the roll-forward should include beginning amortized cost, originations, purchases, sales, repayments,
write-offs and ending amortized cost.

Past-due status – For each portfolio segment, an entity would provide an aging analysis of the amortized
cost for debt instruments past due as of the reporting date, as well as a description of when an entity
considers a debt instrument to be past due.
As of October 29, 2014, FASB still is deliberating the relevance of the above disclosures to available-for-sale debt
securities.
Next Steps
A final standard is expected in the first quarter of 2015. The effective date for public entities is proposed to be no
earlier than 2016, with an extra year for nonpublic entities. FASB has a few items to deliberate before finalizing
the standard:

Reconsideration of applicability of CECL to debt securities

Operational simplifications to the measurement principle
•
•
•
Elimination of multiple outcomes
Reversion to the mean
Collateral-based practical expedients

Application guidance for credit card receivables

Disclosures

Transition/effective date
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Update on FASB’s Financial Instruments Projects
Hedging Project
FASB’s proposed changes to the general hedge accounting model were intended to better align and integrate the
model with an entity’s risk management strategies and reduce the complexity and burden of hedge accounting.
Overall respondents to the 2010 proposal felt that making it easier to qualify for hedge accounting treatment and
stay qualified would improve comparability. Below are the key changes proposed and the feedback received.
Hedge Effectiveness
Hedge effectiveness is the extent to which changes in the fair value or cash flows of the hedging instrument offset
changes in the fair value or cash flows of the hedged item for the hedged risk. The proposal would simplify the
requirements for assessing the hedge effectiveness and lower the threshold to qualify for hedge accounting.
Entities would have to make at least a qualitative effectiveness assessment at the inception of a hedging
relationship. A reassessment would be required only if changes in circumstances suggest the hedging relationship
may no longer be reasonably effective. This is a significant change from the current requirement for a quarterly
reassessment of effectiveness. Most respondents supported lower the hedge effectiveness threshold from
“highly” to “reasonably” effective, requesting implementation guidance on application of a “reasonably” effective
threshold.
The proposal would eliminate the shortcut and critical-terms-match methods of hedge accounting. These options
were never widely adopted and most respondents favored elimination.
Voluntary Designations of Hedging Relationships
Entities no longer would be permitted to voluntarily discontinue hedge accounting for otherwise qualifying
hedging relationships. Hedge accounting would only be discontinued in one of the following circumstances:

A hedging relationship is no longer reasonably effective

The hedging instrument expires, is sold, terminated or exercised

The hedged item matured, is derecognized or settled
The proposal also would allow hedge accounting to be terminated if the entity enters into a derivative instrument
that offsets the original derivative-hedging instrument and concurrently documents that the offsetting derivative is
expected to fully offset future changes in the cash flows of the original derivative and is intended to effectively
terminate that derivative instrument.
Feedback on this topic was mixed—most preparers opposed but financial statement users supported.
Measuring & Reporting Ineffectiveness in Cash Flow Hedges
Entities would be required to calculate the ineffectiveness of a cash flow hedge by comparing the cumulative
change in fair value of the derivative instrument with the present value of the cumulative change in expected
future cash flows on the hedged transaction. This proposed change would require entities to recognize
ineffectiveness for overhedges and underhedges. Current U.S. GAAP recognizes ineffectiveness only in the case of
an overhedge, when the change in fair value of the derivative exceeds the change in expected cash flow of the
hedged transaction. The proposal suggests an entity could use a “hypothetical” derivative to measure the
cumulative change in expected future cash flows of the hedged transaction. There was limited support for this
proposal, as the concepts were very confusing to most respondents. Further outreach to financial institutions
raised additional implementation issues.
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Update on FASB’s Financial Instruments Projects
Hedging Components of Nonfinancial Items
Under the proposal, an entity could hedge any risk component of a nonfinancial asset or liability, whereas under
current U.S. GAAP foreign currency risk is the only risk component of a nonfinancial asset that can be designated as
a hedge. To be eligible for designation as a hedge item, a risk component must be a separately identifiable
component of the financial or nonfinancial item; changes in the cash flows or fair value of the item attributable to
the changes in that risk component must be reliably measureable. This proposal received broad support.
Disclosures
For interim and annual periods, entities would be required to disclose all of the following for each line item that
includes an adjustment for fair value:

The carrying amount

Cumulative fair value adjustments related to hedging relationships

Cumulative fair value adjustments other than those related to fair value hedge relationships

The carrying amount of the assets or liabilities, excluding any fair value adjustments
Additional disclosures were requested by financial statement users in responses to the exposure draft:

More detail on gross exposure

Details on which risk are managed

Details on how risks are managed (caps, collars, floors)

Sensitivity disclosure (limited information is available in MD&A)

Realized versus unrealized gains and losses in OCI
Next Steps
On November 5, 2014, FASB formally approved the inclusion of the above topics as part of the active hedging
project. Deliberations will continue in 2015. A final standard is unlikely before 2016. Respondents also requested
FASB consider additional benchmark interest rates, specifically the prime rate and a municipal rate, or moving to a
principle-based approach to allow more flexibility as markets evolve.
For more information on how these issues may affect your organization, contact your BKD advisor.
Contributor
Anne Coughlan
Director
317.383.4000
acoughlan@bkd.com
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