New Impairment Model Proposed

New Impairment Model

The International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) have proposed a revised impairment model for financial assets. If enacted, the new model will affect the valuation of financial assets, such as loan portfolios.

The FASB’s version of this document is titled Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities: Impairment. Comments on this document are due April 1, 2011 while feedback from the original proposals is being considered. The document seeks feedback on alternative approaches to valuing financial assets that have been developed by the FASB and IASB. The final standard establishing the new impairment model is expected this year.

Impairment Model Categories

Proposed is a dual impairment model that places financial assets into two categories with two different approaches to account for impairment losses. Companies would have to change their approach in assessing impairment losses on their financial assets and any resulting losses will likely be recognized earlier than how they have been in the past.

The model would divide the portfolio into two categories, based on the company’s estimate of credit risk. When management believes the uncertainty of a financial asset’s collectability increases to the point when recoverability is questioned, the proposed rules would require the company to recognize the expected credit losses immediately.

Until that point, impairment of the financial asset would be recognized at the portfolio level over the term of the portfolio’s life. The credit loss allowance would be the higher of the credit losses expected to occur in the near term or the expected losses over the life of the portfolio.

The general consensus of investors and the accounting world is that the model to account for impairment losses on financial assets has to change dramatically. During the financial crisis, companies often recognized these losses too late. Timely information about credit losses is a key factor for investors in evaluating a company’s future earnings.

Stay tuned in the coming weeks for more about the status of this new impairment model as it will likely significantly affect the operating results of many companies with financial assets.