GASB proposes guidance on financial guarantees: the GASB's exposure draft on nonexchange financial guarantee transactions would apply only when a guarantee qualifies as a nonexchange transaction and involves a legally separate third party.

• Author: Gauthier, Stephen J.
• Position: The Accounting Angle - Governmental Accounting Standards Board

In mid-June 2012, the Governmental Accounting Standards Board (GASB) issued an exposure draft (ED) on Accounting and Financial Reporting for Nonexchange Financial Guarantee Transactions. If ultimately approved, the new guidance would take effect for the fiscal period ending June 30, 2014.

BACKGROUND AND SCOPE

It is not uncommon for one government to guarantee the obligations of another. Typically, such guarantees are not associated with exchange transactions and it is considered highly unlikely that the guarantor will ever have to make payments as a result of the guarantee. The GASB's proposed new guidance would apply only to situations where the guarantee:

* Qualifies as a non-exchange transaction; and

* Involves a legally separate third party (including component units).

PROPOSED GUIDANCE FOR GUARANTORS

Normally a contingency does not result in the recognition of a liability prior to the point at which eventual payment is considered to be probable (= likely to occur). In the specific case of guarantees, however, the ED proposes a less demanding criterion for liability recognition. Specifically, a guarantor would need to recognize a liability at the point at which payment is considered to be more likely than not. Thus, for example, a 51 percent likelihood of payment would be enough to trigger the recognition of a liability for a guarantee, even though it normally would not be considered enough to trigger the recognition of a liability for some other type of contingency.

In the process of determining whether payment is more likely than not, the ED would have financial statement preparers take into account qualitative factors, including the following:

* The guaranteed party is in the process of entering into bankruptcy or a financial reorganization;

* There has been a breach in the debt contract; or

* There are indicators of significant financial difficulty.

The ED proposes...