Business Models Matter (for Accounting, That Is)

With the first in a trio of rules on financial instruments, the IASB requires companies to evaluate their business model before abandoning fair-value accounting.

Changes to the controversial rules surrounding the accounting treatment of financial instruments — rules that were skewered during several rancorous debates among politicians, bankers, and accounting experts during the past year — are one step closer to being finalized.

On Thursday the International Accounting Standards Board issued IFRS 9, a revised set of rules dealing with the classification and measurement of financial assets, such as loans, as well as debt and equity securities. Similar rules related to financial liabilities will be addressed separately.

The new rules are the first installment of a three-part rewrite of the standard known as IAS 39, which has long been criticized for being too complex and therefore not useful to financial-statement users. The old standard was one of the accounting rules at the heart of the fair-value controversy that bubbled up as the global economy started its decline in late 2007. Critics of fair-value accounting, including bankers and some heads of European countries, lambasted the rules for exacerbating the crisis. Their main contention was that requiring financial institutions to mark subprime loans to market caused massive book losses for the institutions that held the loans.

A proposal addressing impairment of financial instruments, which is the second part of the IASB project, was released by the board for public comment earlier this month. The third part, revised rules for hedge accounting, is still in development.

The U.S. Financial Accounting Standards Board is working on its version of classification and measurement rules for financial assets, and is expected to issue an exposure draft for public comment by year-end or early 2010. FASB declined to comment on what changes to current rules the exposure draft might contain, but in a recent statement issued jointly by FASB and the IASB, the boards reaffirmed their commitment to the convergence effort, which is their plan to develop similar accounting principles and a single set of global standards.

In the statement, the boards acknowledged that the financial-instruments project has been “complicated by differing project timetables [established] to respond to our respective stakeholder groups and other factors.” As a result, the board members agreed to pursue slightly different timetables on the first phase since a significant amount of work had already been completed, and then better align their rulemaking processes for parts two and three.

The financial-instruments project will be completed by the end of 2010, and the standards will be considered “converged,” say the boards. Converged standards have identical underlying principles, although some rule details may differ between the IASB and FASB versions. Those details are expected to be worked out through subsequent application guidance.

The IASB’s overarching intent was to reduce the complexity inherent in IAS 39. To do that, IFRS 9 uses a single approach to determine whether a financial asset is measured at amortized cost or fair value, rather than following the many different rules contained in IAS 39. The approach is based on two main criteria: a company’s business model and the contractual cash-flow characteristics of the financial asset, both of which a company must satisfy before adopting the amortized-cost treatment.

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