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Loan impairment subject of FASB proposal.

How creditors should account for impaired loans is prescribed in a proposal issued by the Financial Accounting Standards Board. Comments on the exposure draft are requested by September 30.

The proposal applies to all creditors and loans individually and specifically evaluated for impairment, uncollateralized as well as collateralized (except loans accounted for at fair value or at the lower of either cost or fair value).

The proposal would require measurement of impaired loans at the present value of expected future cash flows by discounting those cash flows at the loans' effective interest rates. The effective interest rate is the contractual interest rate adjusted for any deferred loan fees or costs, premiums or discounts existing at the loan's inception.

The proposal also would amend FASB Statement no. 5, Accounting for Contingencies, to clarify that a creditor should evaluate the collectibility of both the contractual interest and the contractual principal of a receivable when assessing the need to accrue a loss.

FASB Statement no. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings, also would be amended to require a creditor to account for a troubled debt restructuring involving a modification of terms at fair value by the restructuring date.

If adopted, the proposal would be effective for calendar-year 1994 financial statements.

Public hearings on the proposal are scheduled for November 3, 4, and 9 at the FASB's offices in Norwalk, Connecticut.

One copy of the proposal, Accounting by Creditors for Impairment of a Loan, is available free of charge until September 30 from the FASB order department, 401 Merritt 7, P.O. Box 5116, Norwalk, Connecticut 06856-5116.

GAO critical. In a recent report, the General Accounting Office said the FASB proposal "reflects some progress in improving loan loss accounting, but fails to correct the major weaknesses leading to overstated asset values and capital."

The report said that while the FASB proposed to discard the notion that undiscounted cash flows should be used to measure losses from problem loans, "its techniques for developing estimates of such losses do not require consideration of market prices or market interest rates in either computing loss reserves or as a reality check on such reserves."

The GAO report, Depository Institutions: Flexible Accounting Rules Lead to Inflated Financial Reports (GAO/AFMD-92-52), recommended that loan loss measurement rules for nonperforming loans require

* Recognizing losses if they are more likely than not to be incurred.

* Considering current market prices in evaluating nonperforming loans or else documenting a rational and convincing basis for rejecting market prices.

* When active markets do not exist, developing discounted cash flow estimates that reflect marketbased discount rates commensurate with the risk of the cash flows projected.

* When active markets do not exist, developing estimates of fair values using cash flow projections that consider existing market conditions and appropriate periods of time reflecting periods needed to fully lease properties.

The report also expressed concern that the FASB's rules for evaluating loans do not clearly define the terms "probable," "net realized value," "fair value," "active market" and "foreseeable future."'

Moreover, the GAO recommended the use of regulatory accounting principles as a temporary measure to strengthen generally accepted accounting principles.

AICPA responds. American Institute of CPAs President Philip B. Chenok responded to the GAO report in a letter to Senate Banking, Housing and Urban Affairs Chairman Donald W. Riegle, Jr. (DMich.). Chenok said, "We are confident the FASB will consider the GAO's concerns in its deliberations. We share the regulators' belief that accounting rules should be set by the FASB. We do not agree with the GAO's view that as a 'temporary measure,' regulators should exercise their authority under the FDIC Improvement Act to prescribe regulatory accounting principles that are inconsistent with generally accepted accounting principles." (A fuller text of Chenok's letter can be found in Highlights, JofA, Aug. 92, page 4.)
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Publication:Journal of Accountancy
Date:Sep 1, 1992
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