Summary of Interpretation No. 45
Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others—an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34
This Interpretation elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. This Interpretation does not prescribe a specific approach for subsequently measuring the guarantor's recognized liability over the term of the related guarantee. This Interpretation also incorporates, without change, the guidance in FASB Interpretation No. 34, Disclosure of Indirect Guarantees of Indebtedness of Others, which is being superseded.
This Interpretation does not apply to certain guarantee contracts: guarantees issued by insurance and reinsurance companies and accounted for under accounting principles for those companies, residual value guarantees provided by lessees in capital leases, contingent rents, vendor rebates, and guarantees whose existence prevents the guarantor from recognizing a sale or the earnings from a sale. Furthermore, the provisions related to recognizing a liability at inception for the fair value of the guarantor's obligation do not apply to the following:
- Product warranties
- Guarantees that are accounted for as derivatives
- Guarantees that represent contingent consideration in a business combination
- Guarantees for which the guarantor's obligations would be reported as an equity item (rather than a liability)
- An original lessee's guarantee of lease payments when that lessee remains secondarily liable in conjunction with being relieved from being the primary obligor (that is, the principal debtor) under a lease restructuring
- Guarantees issued between either parents and their subsidiaries or corporations under common control
- A parent's guarantee of a subsidiary's debt to a third party, and a subsidiary's guarantee of the debt owed to a third party by either its parent or another subsidiary of that parent.
However, the guarantees described in (a)-(g) above are subject to the disclosure requirements of this Interpretation.
Reason for Issuing This Interpretation
The Board has observed that there are differing interpretations about the disclosures required of guarantors under FASB Statement No. 5, Accounting for Contingencies, and about the need for a guarantor to recognize an initial liability for its obligation under a guarantee. Some constituents believe that Statement 5 prohibits the guarantor from initially recognizing a liability for a guarantee issued unless it is probable that payments will be required under that guarantee. This Interpretation clarifies the requirements of Statement 5 relating to the guarantor's accounting for and disclosures of certain guarantees issued.
Differences between This Interpretation and Current Practice
This Interpretation clarifies that a guarantor is required to disclose (a) the nature of the guarantee, including the approximate term of the guarantee, how the guarantee arose, and the events or circumstances that would require the guarantor to perform under the guarantee; (b) the maximum potential amount of future payments under the guarantee; (c) the carrying amount of the liability, if any, for the guarantor's obligations under the guarantee; and (d) the nature and extent of any recourse provisions or available collateral that would enable the guarantor to recover the amounts paid under the guarantee. For product warranties, instead of disclosing the maximum potential amount of future payments under the guarantee, a guarantor is required to disclose its accounting policy and methodology used in determining its liability for product warranties as well as a tabular reconciliation of the changes in the guarantor's product warranty liability for the reporting period. Disclosures under current practice, which generally include only the nature and amount of guarantees, do not provide the same level of useful information as required by this Interpretation.
This Interpretation also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the obligations it has undertaken in issuing the guarantee, including its ongoing obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. The objective of the initial measurement of that liability is the fair value of the guarantee at its inception. The Board believes that, in current practice, many entities may not be recognizing a liability for a guarantee because the recognition requirements in Statement 5 (pertaining to loss contingencies) have not been met at the inception of the guarantee and the premium for the guarantee was not separately identified because it was embedded in purchase or sales agreements, service contracts, joint venture agreements, or other commercial agreements.
How the Changes in This Interpretation Improve Financial Reporting
The recognition of a liability for the obligations undertaken upon issuing a guarantee results in a more representationally faithful depiction of the guarantor's assets and liabilities. When a guarantee is issued without a separately identified premium in conjunction with another transaction, the gain or loss recognized on that other transaction would be misstated if the guarantor fails to recognize a liability for the guarantee. For example, if a seller-guarantor issues to its customer's bank a guarantee of the customer's loan to facilitate the customer's obtaining funds to pay the seller for the assets being purchased, the failure to recognize a liability for the issuance of the guarantee overstates the profit on the sale. In those circumstances, the recognition of the liability for the guarantee results in a more representationally faithful depiction of the seller-guarantor's liabilities and results of operations. The initial recognition and initial measurement requirements in this Interpretation are expected to affect primarily the accounting for multiple-element transactions that include issuance of a guarantee by one party to the other.
The disclosures required by this Interpretation improve the transparency of the financial statement information about the guarantor's obligations and liquidity risks related to guarantees issued.
How the Conclusions in This Interpretation Relate to the Conceptual Framework
FASB Concepts Statement No. 1, Objectives of Financial Reporting by Business Enterprises, states that financial reporting should provide information to help users assess the amounts, timing, and uncertainty of the guarantor's prospective net cash flows. The disclosures about and the initial recognition of guarantees will provide that information. The guarantor's recognition of a liability at the inception of a guarantee for the obligations it has undertaken in issuing the guarantee is consistent with the definition of a liability in FASB Concepts Statement No. 6, Elements of Financial Statements, which states that "responsibilities such as those to . . . honor warranties and guarantees also create liabilities under the definition" (paragraph 196).
The Effective Date of This Interpretation
The initial recognition and initial measurement provisions of this Interpretation are applicable on a prospective basis to guarantees issued or modified after December 31, 2002, irrespective of the guarantor's fiscal year-end. The disclosure requirements in this Interpretation are effective for financial statements of interim or annual periods ending after December 15, 2002. The interpretive guidance incorporated without change from Interpretation 34 continues to be required for financial statements for fiscal years ending after June 15, 1981-the effective date of Interpretation 34.