July 20th, 2011, By Dana Haugh
Part Four starts off with a little summary on the impairment changes, goes through the lessor accounting model and ends with a brief outline on insurance contracts.
During their discussions, FASB and IASB came up with a “three bucket” expected loss approach for impairment of financial assets. They are as follows:
Bucket 1 holds assets evaluated collectively for impairment that do no meet the criteria of Buckets 2 or 3. They are usually identified as loans suffering from changes in credit loss expectations from macroeconomic events. Bucket 2 holds assets affected by events that indicate a direct relationship to possible future defaults. Unfortunately, though, the specific assets in danger of default haven’t been identified as of yet. Bucket 3 contains assets for which information is available that specifically identifies that credit losses are expected to occur on individual assets.
As far as the lessor accounting models are concerned, IASB and FASB differ slightly. IASB favors a derecognition model for leases whereas FASB supports a derecognition model with partial sales type gains recognized as well as a method similar to the existing operating lease model with a lease receivable booked. Both agreed, however, that the derecognition model should have the following: partial derecognition where sales type profit will be limited to ratio of the present value of rents to fair value of assets; allocating the asset between receivable and residual by present valuing the cash flow using the implicit rate; accreting residual over the lease term by implicit rates; and presenting receivable and residual assets separately on balance sheets. In addition to all these, the Boards revealed that leveraged lease accounting will not be included in the new rules.
Now, onto the lengthy insurance contract modifications. Are you excited?
IASB decided that the residual margin should not be locked at inception. The insurer should be able to adjust residual margin for favorable and unfavorable changes, not limit increases in residual margin, recognize the changes in risk adjustment for profit and loss and make adjustments to the residual margin as needed. FASB is not in favor of unlocking the residual margin after the inception.
Under the allocation method (strictly for IASB), the residual margin should not be negative and the insurers should allocate the residual margin over the coverage period on a systemic basis, consistent with the pattern of transfer services.
Accounting for acquisition costs will aim to ensure that all direct costs that the insurer will incur will be included in the initial measurement of the portfolio.
These include:
-Direct costs of contract acquisition/origination
-Portion off employee’s total compensation and payroll fringe benefits
(underwriting, policy insurance, medical, inspection, sales force, direct response advertising)
Exludes:
Software, equipment maintenance/depreciation, agent and sales staff recruiting/training, administration, rent, occupancy, utilities, advertising, general overhead
FASB also decided that acquisition costs in cash flows of insurance contracts would be limited to costs related to successful acquisition efforts. IASB decided that no distinction should be made between successful acquisition efforts and unsuccessful.
And yes, there’s a Part Five.
All information gathered from FASB and Leasing 101