The Financial Accounting Standards Board has issued an ambitious new plan that will dramatically increase the volume and quality of the disclosures creditors will be asked to provide with respect “financing receivables.” The plan takes the form of a rule exposure draft, and according to the proposal creditors will have to disclose their allowance for credit losses associated with the financing receivables. These rules are scheduled to become effective with respect to interim and annual periods ending after December 15, 2009.
The proposed rule is entitled Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. It applies to all financing receivables held by creditors, both public and private, that prepare financial statements in accordance with generally accepted accounting principles.
For the purpose of the draft statement, financing receivables include “loans” defined as a contractual right to receive money either on demand or on fixed or determinable dates, and that are recognized as an asset regardless of whether the receivable was originated by the creditor or acquired by the creditor. The term loan, however, excludes accounts receivable with contractual maturities of one year or less that arise from the sale of goods or services. Further, there is an exception for credit card receivables, as well, and the draft rule also excludes debt securities as defined in FAS No. 115, Accounting for Certain Investments in Debt and Equity Securities.
The proposal contains several other key terms worth noting. For example, a portfolio segment is the level at which a creditor develops and documents a systematic methodology to determine its allowance for credit losses. For disclosure purposes, portfolio segments are disaggregated in the following way: (1) financing receivables within a portfolio segment that are evaluated collectively for impairment, and (2) financing receivables within a portfolio segment that are evaluated individually for such impairment.
Another term defined in the drat rule is, class of financing receivable, described as a level of information that enables users of financial statements to understand the nature and extent of exposure to credit risk arising from financing receivables. Finally, a credit quality indicator is a statistic about the credit quality of a portfolio of financing receivables.
“Undoubtedly, investors and other users of financial statements will applaud this dramatic expansion of the disclosure standards … the effective date, however, strikes us as somewhat “aggressive” and may be delayed for some period.” — Robert Willens
Types of Disclosures
The proposal also suggests a variety of disclosures that affected creditors will be called upon to provide. For instance, a creditor is required to disclose four key pieces of information related to the financing receivable: (1) a description, by portfolio segment, of the accounting policies and methodology used to estimate the allowance for credit losses; (2) a description, once again by portfolio segment, of management’s policy for charging off uncollectible financing receivables; (3) the activity in the total allowance for credit losses by portfolio segment; and (4) the activity in the financing receivables related to the allowance for credit losses by portfolio segment.
Moreover, a creditor will be expected to disclose information by portfolio segment that enables users of its financial statements to assess the fair value of loans at the end of the reporting period.
There is still more work for creditors, in that they must again disclose management’s policy for determining past-due or delinquency status, this time by class of financing receivable. For financing receivables carried at “amortized cost” that are neither past-due nor impaired, creditors will be asked to disclose quantitative and qualitative information about the credit quality of financing receivables. That includes a description of the credit quality indicator and the carrying amount of the financing receivables by credit quality indicator.
For financing receivables carried at a measurement other than amortized cost, that are neither past-due nor impaired, a creditor will have to provide quantitative information about credit quality at the end of the reporting period.
With respect to financing receivables that are past-due, but not impaired, the creditor will be asked to provide an analysis of the age of the carrying amount of the financing receivables at the end of the reporting period. The creditor will also have to disclose the carrying amount — again at the end of the reporting period — of financing receivables which are 90 days or more past-due, but not impaired, for which interest is still accruing. Moreover, disclosures will be required with respect to the carrying amount of financing receivables at the end of the reporting period that are now considered “current,” but have been modified in the current year subsequent to being past-due.
There disclosure list continues. A creditor will be constrained to disclose by class of financing receivable five pieces of information, including: (1) management’s policy for determining which loans the creditor individually assesses for impairment; (2) management’s policy for recognizing interest income on impaired financing receivables; (3) the total carrying amount and the total unpaid principal balance of the impaired financing receivables; (4) the factors that the creditor considered in determining that the financing receivable is impaired; and (5) the average carrying amount of the impaired financing receivables during each period, as well as the related amount of interest income recognized during the time within the period the financing receivables were impaired. If practical, the creditor should also include the amount of interest income recognized using a cash basis method of accounting during the time within the period the financing receivables were impaired.
Finally, a creditor will be required to disclose the policy it follows for placing financing receivables on non-accrual status, and for recording payments it receives on non-accrual financing receivables. It will also be required to disclose the policy it has adopted for resuming the accrual of interest with respect to these receivables. Moreover, a creditor will be asked to disclose the carrying amount of those financing receivables that are on non-accrual status as of each balance sheet date.
Undoubtedly, investors and other users of financial statements will applaud this dramatic expansion of the disclosure standards for financing receivables. The effective date, however, strikes us as somewhat “aggressive” and may be delayed for some period.
On the other hand, management presumably employs all of the information it is being asked to disclose in its internal deliberations regarding the allowance for credit losses. Accordingly, the accounting authorities, if requested to postpone the effective date of this proposal, might reject as disingenuous assertions that the information required to be disclosed is too difficult to compile in such a brief period of time. In any event, we should prepare ourselves for a degree of controversy surrounding this ambitious proposal.
Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com