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Bramwell’s Lunch Beat: No Convergence for Accounting Rules on Financial Instruments

Jul 24th 2014
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Tax accounting to be simplified for money-market funds
The US Securities and Exchange Commission (SEC) voted 3-2 on Wednesday for sweeping changes to institutional money-market funds, Emily Chasan, senior editor of the Wall Street Journal’s CFO Journal, reported.

The SEC’s final rules require money funds that cater to large institutional and corporate investors to give up their longstanding $1 fixed share price. After a two-year transition period, the funds will float in value like other mutual funds. However, the SEC said it has worked with other government agencies, such as the IRS, to reduce the accounting impact, Chasan wrote.

Guidance from tax authorities will eliminate “significant costs,’’ SEC Chair Mary Jo White said, and let investors in institutional prime money-market funds use a simpler accounting method to determine tax gains and losses on the fund, according to the article.

Without guidance, investors in the funds would have to track individual transactions for tax reporting, which corporate treasurers have complained would impose an unbearable compliance cost.

[In response to the SEC’s rules, the IRS on Wednesday afternoon released Revenue Procedure 2014-45, which describes the circumstances in which the agency will not treat a redemption of shares in a money market fund as part of a wash sale. The US Treasury Department also released guidance yesterday.]

IASB gives non-US banks a loan-accounting overhaul
Michael Rapoport of the Wall Street Journalreported that European banks and other banks outside the United States will have to record losses on bad loans more quickly and set aside more reserves for loan losses under an overhaul of finance accounting rules that the London-based International Accounting Standards Board (IASB) finalized on Thursday.

Under the new standard – IFRS 9, Financial Instruments – beginning in 2018, non-US banks will be required to immediately book only those losses based on the probability that a loan will default in the next 12 months. If the loan’s quality gets significantly worse, other losses would be recorded in the future. That is expected to speed up the booking of losses and require greater loan-loss reserves.

Currently, banks don’t record losses until they have actually happened, but many observers believe that method led banks to be too slow in taking losses during the financial crisis, Rapoport wrote.

He noted that the new rules, which have been in the works for years, could create a conundrum for the banking industry: Because the IASB and the Financial Accounting Standards Board (FASB) haven't been able to agree on the same accounting approach for writing off bad loans, it could become more difficult to compare US banks and those outside the United States.

The FASB has proposed that US banks switch from the incurred-loss model that both sides use now to the expected-loss approach, too. But the two disagree on just how rapidly banks should book their loan losses. The FASB proposal would require all losses expected over the lifetime of a loan to be booked up front.

What’s being said about the new IASB rules on financial instruments
IASB Chairman Hans Hoogervorst said: “The reforms introduced by IFRS 9 are much needed improvements to the reporting of financial instruments and are consistent with requests from the G20, the Financial Stability Board, and others for a forward-looking approach to loan-loss provisioning.

“The new standard will enhance investor confidence in banks’ balance sheets and the financial system as a whole.”

Nigel Sleigh-Johnson, PhD, head of the financial reporting faculty at the Institute of Chartered Accountants in England and Wales (ICAEW), said: “The new loan-loss requirements will provide earlier indications of potential losses on loans made by banks and other financial institutions, and that is a major and long overdue step forward. However, those who think that provisions made in the run-up to the global financial crisis were ‘too little, too late’ should not see the change as a panacea. Even an expected loss model won’t result in provisions being made for unexpected losses.

“All companies holding financial assets such as loans and bonds, trade debtors, and lease receivables will have to consider the new requirements. There will be considerable costs involved in meeting the new requirements for some, involving at one end of the scale the re-building of information systems and processes.

“While almost everybody has agreed that moving to a more forward-looking model would provide more useful information, it’s been very difficult to agree on the precise details of the new accounting model. It is regrettable that the IASB and the FASB have been unable to agree on all aspects of their models, but ultimately it is more important that we finally have a standard in place that will provide global investors with more timely information about increases in credit risk and expected credit losses.”

Iain Coke, head of the ICAEW’s financial services faculty, said: “We expect the new model will increase the loan-loss provisions on banks’ balance sheets by about 50 percent on average, although this will vary substantially between institutions. It will reduce profits in the year of implementation, but it may not have a major impact on the income statement in future years. That doesn’t mean banks got it wrong before – it only means banks will measure provisions differently.

“Increasing the accounting provisions will also reduce regulatory capital. Regulators have adjusted the reported accounting numbers since before the financial crisis to take account of some expected losses. However, the new standard will go further still in providing for expected losses. Banks will need to consider the impact of the new standard on their regulatory capital, taking into account the results of regulators’ stress-testing and asset quality review exercises.

“It is important to remember that this accounting change will not change the cash flows of underlying loans. However, when combined with tougher regulatory capital requirements, it may force banks to hold more capital for the same risks. This may make banks safer but may also make them more costly to run.”

Anne-Lise Vivier, accounting publications managing editor for the Tax & Accounting business of Thomson Reuters, said: "Accounting for financial instruments was highly criticized during the financial crisis. The delayed recognition of impairment losses and, in particular, credit losses on loans, was highlighted as one of the aggravating factors of the financial meltdown and a major weakness of the existing accounting standard for financial instruments.

"The IASB and the FASB have both been working for nearly a decade on a new model for the accounting and reporting of financial instruments. On July 24, 2014, the IASB issued its final installment of this accounting reform and published a full version of its revised IFRS 9, Financial Instruments.

"Among the main changes introduced by this standard, the new expected-loss model for impairment is probably the most significant, but the changes sweep through all aspects of accounting for financial instruments:

  • Classification and measurement: Financial assets will have to be recogized based on the business model in which they are managed and the nature of their cash flow.
  • Measurement: The expected-loss model for impairment is a major change in the standard (as compared to the current incurred-loss model), and should result in losses being recognized in a more timely manner. This may also result in losses being recognized as soon as the financial instrument is initially recognized. In addition, the standard eliminates the income statement volatility introduced by the current standard regarding a company's own credit fluctuations.
  • Disclosures: Enhanced disclosures should provide more insights into an entity's expected credit losses and credit risk.
  • Hedge accounting: The revised IFRS 9 links the accounting for hedged transactions to an entity's risk management policies.

"Despite years of joint efforts, the FASB and the IASB could not reach convergence on their financial instruments project."

GAO: Too early to draw Obamacare fraud conclusions
Mackenzie Weinger of Politicoreported that during a hearing of the House Ways and Means Oversight subcommittee on Wednesday, a congressional investigator told lawmakers that it is too early to draw conclusions about fraud in the Obamacare marketplaces.

A report released yesterday by the US Government Accountability Office (GAO) found that 11 out of 12 fake applicants were able to obtain subsidized health insurance. Republicans jumped on the report as proof that the healthcare law invites fraud, but GAO investigator Seto Bagdoyan said the sample is too small and investigators “can’t draw any conclusions” until their work is complete.

The investigation is ongoing, Bagdoyan said, and the “intent of this sample was not to project in any way” based on this initial stage of work, but instead to identify areas of potential focus for future work, Weinger wrote. He also said the investigative and audit work done so far, although too narrow and small to draw any conclusions, has yielded “a number of questions that are fundamental about the effectiveness of controls” in the verification process.

Bagdoyan said the investigation is continuing and further results could come in several months.

IRS chief says agency no longer probing missing emails
IRS Commissioner John Koskinen told lawmakers on Wednesday that the agency has effectively halted its investigation of Lois Lerner’s missing emails to avoid interfering with an inspector general’s investigation, Josh Hicks of the Washington Postreported.

The IRS chief’s testimony, at his third hearing this month before the House Oversight and Government Reform Committee, came a day after House Republicans said the hard drive of Lerner, a former IRS official, was less damaged than the agency let on and that backup tapes containing her missing emails may still be available.

According to the testimony released on Tuesday, IRS Deputy Associate Chief Counsel Thomas Kane told congressional investigators that the agency is no longer certain whether it recycled all of the backup tapes containing Lerner’s emails.

Koskinen said on Wednesday that he has not examined how Kane determined some tapes might still exist. “I agreed with [the inspector general's office] that they would do the investigation, we wouldn’t do anything to interfere with that – I wouldn’t, and none of our people would, talk to anybody about it,” he said, according to the article.

Republicans expressed skepticism and frustration with Koskinen on Wednesday.

“People cite ongoing IG investigations when it suits them not to cooperate, and they don’t cite competing IG investigations when it doesn’t suit them,” said Representative Trey Gowdy (R-SC), according to the article.

Senate to vote on ending the gas tax
Keith Laing of The Hillreported on Wednesday that the Senate will hold a vote this week on a proposal that would eliminate most of the gas taxes that are paid by drivers in the United States.

A proposal to begin phasing out the gas tax, which has been dubbed the Transportation Empowerment Act, is being pushed by staunchly conservative lawmakers who advocate major changes to federal infrastructure funding, Laing wrote. The proposal to end the taxes will be voted on as an amendment to a short-term extension of highway funding, which is set to run out in August.

The concept, commonly referred to by transportation observers as “devolution,” calls for lowering the gas tax that currently pays for most federal transportation projects from 18.4 cents per gallon to 3.7 cents in five years. During the same time period, the bill would transfer authority over federal highways and transit programs to states and replace current congressional appropriations with block grants, according to the article.

Senator Mike Lee (R-UT), who is the primary sponsor of the gas tax reduction proposal, said on Tuesday that it would give states more control over transportation funding that they collect via their own fuel levies.

“Under this new system, Americans would no longer have to send significant gas-tax revenue to Washington, where politicians, bureaucrats, and lobbyists take their cut before sending it back with strings attached,” Lee said in a statement. “Instead, states and cities could plan, finance, and build smarter and more affordable projects.”

Hatch: Outsourcing tax loophole is ‘total B-S’
The Hill also reported on Wednesday that Senator Orrin Hatch (R-UT), the top Republican on the Senate Finance Committee, said Democrats’ claims that there is a tax loophole for US businesses that ship jobs overseas are false.

“It’s total B-S,” Hatch said on the Senate floor yesterday, according to an article by The Hill’s Ramsey Cox. “It’s amazing to me what people will do for political advantage – it’s shameless.”

Earlier Wednesday, the Senate voted 93-7 to procedurally advance S. 2569, the Bring Jobs Home Act, which would end tax breaks for companies that send jobs overseas. Hatch said supporters of the bill are making false claims because there is no “special treatment” for companies moving outside the United States.

US companies currently can deduct from their corporate taxes some expenses of moving facilities overseas, Cox wrote. But Hatch said the same tax credit is also available for those companies moving from one state to another.

Internet sales tax bill dealt a blow, Wyden cheers
According to an article by Niels Lesniewski of Roll Call, Senate Majority Leader Harry Reid (D-NV) is quietly stepping back from his intention to bundle an Internet tax moratorium with a more contentious proposal to allow states to collect online sales taxes – at least for now.

Reid had said on July 16, “I think it’s fair to say the two are going to be together.” The move, backed by Senate Majority Whip Dick Durbin (D-IL), would have constituted a run around Senate Finance Committee Chairman Ron Wyden (D-OR), who opposes the legislation known as the Marketplace Fairness Act.

But Roll Call’s Alan K. Ota reported that as of Tuesday, the plan had changed. Senior Democratic aides confirmed on Tuesday that Reid planned to move in September on the short-term extension of the soon-to-expire Internet access tax moratorium. “It will extend the Internet Tax Freedom Act until early 2015. We are focusing on what we can get done,” said one aide, according to the article.

Wyden praised the apparent move, saying it “reflects a growing awareness that as written, the two bills contradict each other.”

Quick Links:

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  • A tale of two tax cases: Halbig and King (Tax Litigation Survey)
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