IASB Assures Obama and G-20 on Fair Value Accounting Reforms

Ahead of the G-20 Pittsburgh summit, the oversight body of the IASB has assured the G-20 that the reform of the international standard for fair value accounting in proceeding along the lines of principles outlined by the Basel Committee. Complimentary reform of loan loss provisioning is also on target. In a letter to President Barack Obama, host of the G-20, Gerrit Zalm, chair of the IASB oversight committee, stressed the urgency in completing the first component of the comprehensive revision of IAS 39, the IASB’s financial instrument standard, by year end. In this work, the IASB is guided by principles of transparency and the avoidance of undue complexity enunciated by Basel and recently endorsed by the G-20 Finance Ministers, including Treasury Secretary Tim Geithner. In addition, Basel urges that the standards reflect the need for earlier recognition of loan losses.

The IASB has proposed significant changes to its fair value accounting standard that would essentially require all financial instruments that do not have basic loan features to be measured at fair value. The proposal would also eliminate the requirement to identify and account for embedded derivatives separately. The IASB’s proposed approach would reduce the complexity that results from the many categories and related impairment methods in the current standard.

The draft proposes two primary measurement categories for financial instruments: amortized cost and fair value. A financial asset or financial liability would be measured at amortized cost if the instrument has loan features and is managed on a contractual yield basis. All other financial assets or would be measured at fair value. Therefore, the draft proposes that all investments in equity instruments, as well as derivatives on those equity instruments, should be measured at fair value.

Mr. Zalm noted that the proposals are consistent with the view of the Basel Committee, that cost-based accounting is appropriate for some categories of financial instruments. In order to provide transparency and reflect economic reality, the IASB’s emphasis has been to define in a balanced and transparent way the appropriate criteria for classifying instruments to be measured at cost and fair value, he noted, and not to increase or decrease arbitrarily the use of fair value. Whether there is a decrease or an increase of fair value will depend on a particular institution’s business model and holdings. Importantly, Chairman Zalm emphasized that the IASB is not proposing that the loan book of banks will be held at fair value.

Similarly, the IASB is improving the accounting for loan-loss provisions, another area cited by the G-20. The IASB is working closely with regulators, financial institutions, and investors to develop more forward-looking measures, such as an expected loss model
rather than the incurred loss model currently in place in IFRS and US GAAP. The IASB has already issued a discussion document on provisions and will release a final proposal in the fourth quarter.

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