The new exposure draft on accounting for impaired loans recently issued by the Financial Accounting Standards Board does not ease the concerns of bankers who would be required to make dramatic changes in their balance sheets.
"This is a real sleeper of an issue," said Donna Fisher, manager of accounting for the American Bankers Association. She explained that she doesn't think FASB fully appreciates the difficulties that will be faced by banks and other lenders, despite the efforts of ABA members to explain them to FASB members in March. "This seems to be a very mechanical approach on the part of FASB," she said. "It also implies a level of precision in accounting for loan losses that doesn't exist."
But Brian Smith, executive vice president of the Savings and Community Bankers of America, was more sanguine. "There are not too many surprises here," he said. Smith noted that the audit and accounting guide for thrifts, published by the American Institute for Certified Public Accountants, already required thrifts to account for impaired loans and that the only real change for them would be the interest rate used.
The AICPA audit and accounting guide for banks is silent on the issue, and some banks do not treat loans as impaired as long as the banks believe they will eventually get their principal back.
Among the key issues the exposure draft addresses:
Measurement - A creditor would be required to measure impairment of a loan based on present value of expected future cash flows.
Definition - A loan is impaired when it is probable that a creditor will be unable to collect all amounts due under the loan contract.
Discount rate - Impairment would be measured based on expected future cash flows discounted at the loan's effective interest rate. The effective interest rate is the rate of return implicit in the loan, i.e., the contractual interest rate adjusted for any deferred loan fees or costs, premiums or discounts.
According to the exposure draft, two members of the seven-member FASB disagreed with using the effective interest rate. They argued that a current market rate should be used, that is, a rate that would be charged under current conditions for a new loan with similar terms and expected future cash flows.
Recognition - An impaired loan would become an income-earning asset.
Scope - Large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment would be excluded from the scope of the proposed statement.
Disclosures - Creditors would be required to disclose activity in the allowance for credit losses account, the recorded investment in impaired loans, and the total allowance for credit losses.
The proposed statement would be effective for fiscal years beginning after Dec. 15, 1993. Public hearings are scheduled for Nov. 3, 4 and 9. The deadline for written notice of intent to testify is Sept. 11 and Sept. 30 for written comments.
