The Financial Accounting Standards Board is proposing to change the accounting rules around how companies would amortize or write down premiums on debt securities that can be redeemed or repurchased before they mature.
FASB is proposing a shorter time period for the amortization to align it with the earliest call date specified in the instrument. Current GAAP says companies should amortize the premium as an adjustment of the yield over the contractual life of the instrument, which leads to longer writedowns.
FASB says it has heard concerns that current GAAP does not include callable debt securities, or those that can be redeemed or repurchased before they mature, even if the holder knows for a fact that the call will be exercised. That leads to a misalignment between the amortization period the company can reasonably expect and the one permitted by GAAP. “As a result, upon the exercise of a call on a callable debt security purchased at a premium, the unamortized premium is recorded as a loss in earnings,” FASB wrote in its summary explaining the new proposal.
FASB says it also has heard companies are handling the accounting in different ways, leading to different results for similar transactions. Companies are not only treating the amortization differently, but they’re also giving different consideration to how the potential exercise of a call is factored into any impairment assessments.
The standard would not affect how companies would account for callable debt securities purchased at a discount. In those cases, the market pricing assumption is that the security will not be called because redeeming it or repurchasing it would result in a loss. "If you're trading at a discount, you generally assume the issuer is not going to call," says Chip Currie, a partner at PwC. "If the issuer was to call the instrument and reissue, the new debt would be at a higher rate, so why would they do that?"
In an alert regarding the new proposal, PwC says certain financial institutions such as retail and commercial banks as well as insurance companies, are likely to be most affected by the change. Currie says the change is fairly straightforward.
Comments on the proposal are due Nov. 28. FASB says it will determine the effective date when it reviews and responds to comments.