The Financial Accounting Standards Board issued Interpretation No. 45 to improve disclosure requirements for guarantees.
The interpretation is entitled, "Guarantor's Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others." Its key provisions:
- The interpretation clarifies that companies must recognize liabilities for the obligations they assume under guarantees at the time they make the guarantees. Previously, liabilities were not recognized until it became likely the company would have to honor its guarantee.
- It also adds disclosure requirements that may help investors avoid surprises like the one associated with the sudden revelations of executive loans at Adelphia Communications Corporation.
FASB Senior Project Manager Robert C. Wilkins explains, "The interpretation should significantly improve the reporting of guarantees that are issued in conjunction with other transactions."
Critics say the changes overcompensate for damage done in a few cases. "I'm all for better disclosure, but this rule is an overreaction," said Robert Willens, an accounting specialist with Lehman Brothers. "They're making companies record a liability even though they have merely guaranteed someone else's liability. That's pretty radical. Normally, you don't record a liability until you incur one." ("FASB Issues Rules To Improve Companies' Loan Disclosure," Wall Street Journal, November 25, 2002).
But the criticism is muted by the fact that the rule changes are applied judiciously, not across-the-board. For example, they don't apply to product warranties, guarantees accounted for as derivatives, or certain other types of guarantee contracts, such as those issued by insurance companies.
The interpretation may be obtained via FASB's Web site or by contacting the FASB's Order Department at 800-748-0659.