On November 5, the International Accounting Standards Board issued an exposure draft on the amortized cost measurement and impairment of financial instruments. The exposure draft proposes an expected loss model for recognizing impairments on financial assets recorded at amortized cost.
As noted in the IASB press release, currently, both U.S. GAAP and IFRS use an incurred loss model for recording impairments on financial assets. Under an incurred loss model, impairments are recognized only after a loss or trigger event is identified. An expected loss model would recognize loss estimates throughout the life of a loan (or portfolios of loans) and other financial assets recorded at amortized cost.
A column in the Financial Times, Beware the ripple effect of accounting losses, warned that the expected loss model would accelerate losses at the beginning of a down cycle and, consequently, still have a pro-cyclical effect. However, the Financial Crisis Advisory Group (FCAG), a group of senior leaders with broad experience in international financial markets, supports exploring alternatives to the incurred loss model, including the expected loss model and a fair value model. The Basel Committee on Banking Supervision released a statement earlier this year calling for accounting changes, including the need for earlier recognition of loan losses to ensure robust provisions.
The FCAG in their July report to the FASB and IASB expressed concern about the risk of earnings management and said the Boards should take care to develop an approach that would not foster earnings management, which would decrease transparency.
Do you believe that a move to an expected loss model and the proposals introduced in the exposure draft would be a move in the right direction? Let us know what you think.