What’s Behind the FASB/IASB Dispute on ‘Impairment?’

Should Losses Trigger an Immediate Charge or Later Write Down?

The Financial Accounting Standards Board (FASB) is engaged in an interesting discussion with the International Accounting Standards Board (IASB) regarding how quickly bad loans need to be recognized by banks. Here’s the essence of the dispute.

Financial Accounting Standards Board (FASB) is in an interesting controversy with the International Accounting Standards Board (IASB) dealing with Impairment of Financial Instruments.

The essence of the dispute is this: Assume a bank makes 100 business loans, each of $100,000.  They know, on day one, that 2% of the loans (loans from 2 borrowers) will not be paid, which would be $200,000 or 2% of $10 million.  Knowing there will be these expected losses, should the bank on Day 1, when the loans are made:

1. Take an immediate impairment charge of $200,000?
2. Take an impairment charge of $200,000, but spread it ratably over the expected life of the loans?
3. Wait until one or more loans goes bad and write each loan down to net realizable value as it appears to be a bad loan?
4. Determine the Fair Value of the total portfolio at each (quarterly) balance sheet reporting date?

FASB appears to favor option 4.  Lenders favor option 3, which effectively is current Generally Accepted Accounting Principles (GAAP).

A key issue is whether companies should ‘anticipate’ losses before they are specifically incurred.  Companies cannot accrue for future expenses, e.g., airlines can’t accrue for future engine overhauls. 

So if FASB does adopt either the IASB position (unlikely in this writer’s opinion) or chooses to go the Fair Value route, what is the implication for other assets, both property, plant, and equipment (PP&E) and intangibles? 

Right now the impairment mechanism for intangibles only looks to see if there is impairment, and does not determine fair value (FV) at each reporting period.  Similarly, for PP&E, companies do not determine FV, only test on an undiscounted cash flow basis to see if a write-down is necessary.

The ultimate Fair Value implications of this discussion currently underway at FASB have some very real implications for valuation specialists.

Alfred M. King, CMA, is vice chairman of Marshall & Stevens