Steven Brice
Steven Brice

Accounting for Financial Instruments

Will the different approaches taken by the FASB and the IASB meet at the end?

August 23, 2010
by Steven Brice

The future of accounting for financial instruments is set for significant changes. But rather than tackle the issue collectively, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) have headed in different directions.

The IASB and FASB have been working more closely together in the past year or so and many of the recent proposals, such as leasing and revenue recognition, are the direct result of the Board’s combined efforts. There are however fundamental differences in the approaches for accounting for financial instruments. This is unfortunate since this is the high priority area as a result of the financial crisis and the focus of the G20 urgings for convergence.

The Differences

These differences have arisen as a result of the different timetables for the project established by the two Boards as well as differences in attitudes and priorities. The IASB has divided its project into pieces which will ultimately be put together into a new financial instrument standard, which will be labelled International Financial Reporting Standards (IFRS) 9 and will replace IAS 39.

FASB issued a single exposure draft (ED) in May 2010 that addresses recognition and measurement, impairment and hedge accounting as well as the scope of the standard, an area not yet considered by the IASB. These differences have resulted in different proposed approaches to accounting for certain types of financial instruments.

The IASB approach is based on a mixed measurement model. Financial assets are measured at amortised cost where that is considered to provide the most useful information, that is where the objective of the entity’s business model is to hold the asset to collect contractual cash-flows and its contractual cash flows are solely payments of interest and principal. The approach to most financial liabilities is unchanged with most non-trading liabilities remaining at amortised cost. Where the fair value option is used, the current proposal is that the fair value movements relating to own credit will be included in Other Comprehensive Income (OCI) rather than net income.

The FASB approach is more firmly based on fair value with almost all financial instruments, liabilities as well as assets, being measured at fair value in the balance sheet. Core deposit liabilities are measured at present value based on the average balance discounted at the difference between the cost of alternative funding and the cost of servicing the core deposits.

FASB acknowledges that amortized cost information is also relevant. Therefore both fair value and amortised cost information is provided in the primary financial statements for financial instruments that are being held for the collection or payment of contractual cash flows. Net profit includes interest and impairment charges on an amortised cost basis with the remaining fair value movements included in OCI. Nevertheless, there are differences in the treatment of more complex and hybrid instruments, with the FASB retaining the concept of embedded derivatives, as well as differences in the recognition of impairment which would mean that net profit calculated under the two approaches may not be comparable.

Comments Requested

Comments are requested by FASB on its ED by September 30, 2010. The IASB has requested that its constituents provide feedback on these proposals. This will not only help the IASB when it considers how to reconcile differences between the IFRS requirements and U.S. Generally Accepted Accounting Principles (U.S. GAAP) but also ensure that FASB can consider feedback from the international community for this part of the global convergence project. As a result, there is some possibility that IFRS 9 or other parts of the IASB project that are still being developed could be changed to reduce the number of differences with the FASB approach.

EU Endorsement Process

Another area of uncertainty is the European Union (EU) endorsement process. Since IFRS 9 will replace the existing financial instrument standard, under EU law it cannot be used by companies in the EU until it is endorsed by the European Commission. The Commission has decided to wait for the entire standard to be completed before starting the endorsement process. It is not clear at this stage when the endorsement process will commence or its outcome. Since the other projects would also change or replace existing requirements, they too would require endorsement.

The financial instrument standard issued to date, IFRS 9, requires adoption by European companies by 2013. It remains to be seen whether all the pieces of the complete standard will be issued sufficiently in advance of this date to allow for an orderly transition or whether there will be some slippage in the adoption date. The completely revised financial instrument standard will represent significant change, particularly in the measurement of many financial instruments with more financial assets potentially being at fair value and with more forward looking impairment calculations for those assets remaining at amortised cost.

The pieces which will collectively comprise IFRS 9 are incorporated into the table below. The approach contrasts dramatically from the approach taken by the FASB which issued a single exposure draft in May 2010.

    Exposure draft Standard
Financial instruments Classification and measurement: financial assets May 2010 (comments due July 16,  2010) Q2 2011

Classification and measurement: financial liabilities

ED Fair value option for financial liabilities — presentation in OCI for fair value gains and losses relating to own credit for fair value option financial liabilities
November 2009 (comments due June 30, 2010)  

Impairment methodology  

ED Amortized cost and impairment of financial assets expected cash-flow approach to determining effective interest and impairment
  Hedge accounting fundamental reconsideration of the hedge accounting requirements Q3 2010  
  Asset and liability offset address differences on balance sheet netting of derivatives and other financial instruments between IFRS and US GAAP Q4 2010  
Financial instruments with the characteristics of equity Amendments to IAS 32 address practical issues with application Q1 2011 Q4 2011
Fair value measurement Single source of guidance on fair value measurement    
  Limited exposure draft on disclosure of measurement uncertainty June 2010 (comments due September 7, 2010) Q1 2011


These revisions to the IFRS standards form part of a complete set of new and revised standards that are to be issued by the IASB over the next few years. The question that then remains is if different approaches are taken by the IASB and the FASB, will they eventually (after publication of all of the IASB pieces) come together to form a consistent view. On such a significant area such as financial instruments, if consistency isn’t achieved, then the golden chalice of convergence seems further away than ever.

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Steven Brice is a technical partner in the financial reporting advisory group for Mazars UK and provides his views on international convergence of GAAP and whether progress is really being made in light of recent developments. For U.S. IFRS, you can contact Remi Forgeas, CPA, who is an audit and assurance partner.

* The views expressed in this article are the author’s own and do not necessarily reflect the views of the AICPA or AICPA CPA Insider™.