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									New rules on
guarantees of debt
FIN No. 45 – Guarantor‟s Accounting
and Disclosure Requirements for
Guarantees, Including Indirect
Guarantees of Indebtedness of Others
(November 2002)

FIN45 Covers guarantee contracts that have
any of the following 4 characteristics
1. Contracts that contingently require the guarantor to
   make payments to the guaranteed party based on an
      Examples:
           Irrevocable standby letter of credit which guarantees payment of
            a specified obligation
            Market value guarantee of asset owned by the guaranteed party
            Guarantee of the market price of common stock of the guaranteed
            Guarantee of the collection of cash flows from assets held by
            special purpose entity
2. Performance standby letter of credit or similar
   arrangements in which guarantor must make payments
   to the guaranteed party in the event of another entity‟s
   failure to perform under a nonfinancial contract
Covers guarantee contracts that have
any of the following 4 characteristics
3. Indemnification agreements that require
   guarantor to make payments to the indemnified
   party (guaranteed party) based on changes in
   an “underlying” such as an adverse judgment in
   a lawsuit, imposition of additional taxes due to
   adverse interpretation of the law
4. Indirect guarantees of the indebtedness of
   others even though the payment to the
   guaranteed party may not be based on an
   underlying asset, liability, etc., of the guaranteed
   The issuance of a guarantee obligates the
    guarantor (issuer) in two respects:
    1. The guarantor undertakes an obligation to stand
      ready to perform over the term of the guarantee if
      the event that the specified triggering events or
      conditions occur
          This is the noncontingent part of the obligation
    2. The guarantor undertakes a contingent obligation to
      make future payments if those triggering events or
      conditions occur
          This is the contingent part of the obligation
           New Disclosure – FIN 45
Key point of FIN 45
   FASB 5 should not be interpreted as
    prohibiting the guarantor from initially
    recognizing a liability for a guarantee even
    though it is not probable that the payments
    will be required under that guarantee.

Measurement of obligation
a. The premium received or receivable – when the
   guarantee is issued in a standalone arm‟s-length
   transaction with an unrelated party
b. When the guarantee is part of a transaction with multiple
   elements, estimate the fair value of the guarantee.
      Consider the premium which would be required by the guarantor
       to issue a standalone guarantee with an unrelated party
      In the absence of observable transactions for identical or similar
       guarantees, use expected present value measurement

Measurement of obligation
c. If a guarantor must recognize a guarantee at inception
   because it is probable and can be estimated (FASB 5),
   the amount to initially recognize is the GREATER of the
   fair value of the guarantee (as measured above) or the
   contingent liability amount required under paragraph 8 of
   Statement 5.
d Not for profit situation: guarantees provided as a
   contribution to an unrelated party (like a loan guarantee
   by a community foundation to a nonprofit entity), the
   guarantee (gift) should be measured at the fair value of
   the guarantee and NOT considered merely a conditional
   promise to give.

The debit side is not prescribed
   Some examples provided in FIN 45 include:
    a. If a premium is received, the debit would be to cash or
    b. If the fair value of the premium is an allocation of the receivable
       or cash received on a transaction that involves other assets,
       liabilities, etc., the allocation to the guarantee will affect the
       calculation of the gain or loss on the transaction.
    c. If the guarantee is associated with the acquisition of a business
       accounted for under the equity method, the guarantee would
       increase the carrying value of the investment.
    d. In an operating lease situation, the guarantee would affect
       prepaid rent.
    e. If no consideration is received, the offsetting entry would be to
Disclosures Required – FIN 45
a. Nature of the guarantee including, the approximate term,
   how the guarantee arose, and the event or circumstance
   that would require the guarantor to perform under the
b. Maximum potential amount of future payments
c. Current carrying amount of the liability
d. Nature of (1) any recourse provisions that would enable
   guarantor to recover from third parties any of the
   amounts paid under the guarantee and (2) any assets
   held either as collateral or by third parties that the
   guarantor would be able to liquidate to recover any of the
   amounts paid.
Disclosures Required – con‟t
e. FOR PRODUCT WARRANTIES. The disclosure of the
   maximum amount of future payments requirement above
   is waived. Instead:
      1. The accounting policy and methodology used to determine its
       liability for product warranties including any deferred revenues
       associated with extended warranties.
      2. A tabular reconciliation of the changes in the guarantor‟s
       aggregate product warranty for the reporting period.
           Beginning balance
           Aggregate reduction for payments made or services provided
           Aggregate increase for new warranties issued during period
           Aggregate changes in the liability related to pre-existing warranties
            (changes in estimate)
           Ending balance
Example from Recent F/S

New rules on
redeemable preferred
SFAS No. 150 – Accounting for
Certain Financial Instruments with
Characteristics of both Liabilities
and Equity (May 2003)
Redeemable financial instruments

 Mandatorily redeemable financial instrument
  shall be classified as liability
 Exceptions
     Redemption       is contingent
       Required only upon liquidation or termination of the
        reporting entity
       Required only if an uncertain future event occurs
             Becomes liability only when the event becomes certain to
                         Certain not
Other redeemable securities
   Classify as liability:
    Obligation to repurchase equity
    Obligations to issue variable number of

Measurement of liability
 Financial instruments that meet these
  requirements are initially measured at fair
 Most are then re-measured at fair value
  and the subsequent changes in fair value
  are recognized in earnings

Reporting on Statements
   Balance sheet required description:
     “Shares subject to mandatory redemption”
     Should be on separate line and not
      commingled with other liabilities
   Income statement transition
     Through  “cumulative effect of a change in
      accounting principle”

   Nature and terms of the financial instruments
    including rights and obligations
     Amount   that would be paid or number of shares that
      would be issued and their fair value “as if settled” at
      reporting date
     How changes in fair value of issuer‟s equity shares
      impact the settlement amount
     Maximum amount issuer could be required to pay
     Maximum number of shares that might have to be
     And several more items (see paragraph 27)

Example financial instrument
   Trust-preferred securities
       A financial institution establishes a trust or other entity that is
        consolidated with the financial institution
       The trust issues mandatorily redeemable preferred stock and
        uses the proceeds to purchase from the financial institution an
        equivalent amount of junior subordinated debt
       The financial institution pays interest to the trust, the trust uses
        the funds to pay the dividends
   Why they exist
       Upon consolidation, the intercompany transaction (payment of
        interest) disappears along with the debt (and the receivable on
        the trust‟s books)

Example financial instrument
   Trust-preferred securities
     Under   the new rules, the financial institution
      will have to report INTEREST EXPENSE and
      DEBT instead of dividends and redeemable
      preferred stock
   FAS 150 Appendix A includes other
    examples to aid implementation of the new

Additional Pension
FAS 132 (revised 2003)
Revised again by FAS 158
New Disclosures for Public Entities

   Percentage of total plan assets by categories
    like equity securities and debt securities
     More  detailed categories are encouraged if it would
      help assess risk and long-term expected rate of return
   Narrative discussion of investment policies and
   Narrative discussion of how the expected rate of
    return was determined
   Accumulated benefit obligation
New Disclosures for Public Entities
   Benefits expected to be paid to retirees in each
    of the next five years and in aggregate thereafter
    (presumably NOT the present value of benefits)
   Estimated employer contribution that will be
    made during next fiscal year
   Weighted averages for assumptions in tabular
     Discount rates, rates of compensation increase,
      expected long-term rate of return, etc.
   Measurement dates used to determine PBO,
   Appendix C provides illustrations that should be
    useful in doing the footnote for the TDT project
    (Spring 2007)
   Illustration 1 is probably your “best bet” but you
    need to get the changes from FAS158
   You MIGHT be able to find “real examples” of
    the new disclosures since the rules were
    effective for fiscal years beginning after 12/15/06

FSP of interest
   Note that FSP158-1 (Feb 21, 2007)
    contains Update of Illustrations,
    Application Guidance
     Don‟t hit „print‟ – 257 pages!
     Fixes examples in FAS87, FAS88 & FAS106
      as related to issuance of FAS158. FAS132R
      was “fixed” in FAS158 so is not included in
      this FSP

More to come on pensions
   November 10, 2005, FASB decided to add a
    comprehensive project to its technical agenda on
    accounting for postretirement benefits including pensions
    and to conduct that project in two phases.
   Phase 1 Completed by issue of FAS 158
       Require that funded or unfunded status be recognized on
        balance sheet (e.g., difference between PBO and Plan Assets
        for pensions)
   Phase 2 (multi-year project in collaboration with IASB)
       Comprehensively consider measurement & display of various
        elements of post-retirement benefits


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