Reclassification of Residential Real Estate - EMERGING ACCOUNTING ISSUES

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Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure



Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure

The Emerging Issues Task Force (EITF) began its operations in 1984 following the recommendation of the Financial Accounting Standards Board’s task force on timely financial reporting guidance and an invitation from FASB for the EITF to comment on those recommendations (Tang et al, 1999). The mission of the EITF is to assist the FASB in improving their financial reporting. The EITF accomplishes this mission through timely identification, discussion, and resolution of issues relating to finance within the framework of the FASB Accounting Standards Codification. The FASB Accounting Standards Codification represents the source of authoritative standards of accounting and reporting to be used by nongovernmental identities, and these standards are different from those issued by the SEC (Shekelle, 2012).

According to Devi (2011), the most important impact of the mission of the EITF on resolving emerging financial accounting issues of the FASB is its promulgation of the implementation guidance within the framework of the Accounting Standards Codification. This has made it possible for the FASB to reduce diversity in practice on a timely basis. Additionally, EITF has made remarkable efforts to minimize the need for the FASB to spend a lot of time, effort, and valuable resources in addressing narrow implementation, application, or any other emerging issues that can be directly analysed within the existing GAAP (Devi, 2011). The fact that the Task Force members are drawn from a cross section of the FASB’s constituencies and that they attend and participate in the Task Force meetings, makes it possible for the EITF to have a first-hand awareness of any FASB’s emerging issues before they are widespread and before the divergent issues become entrenched (Garner et al, 2008).

Normally, if no consensus is reached by the Task Force meeting on any particular emerging issue, it indicates that an action by the FASB is necessary to resolve the issue. However, if the group can reach a consensus, the FASB takes this as an indication that no Board action is necessary (Bhimani, 2006). This becomes an effective means of finding resolutions to emerging financial accounting issues given the fact that the consensus for the FASB to act on the issues are reached after a systematic voting protocol from the Task Force members. A consensus on an EITF issue is usually reached if no more than three of the voting members present at the meeting object to a proposed position on an issue. In addition, the consensus can only be reached after the proposed position on the issue has been exposed for public comment as a consensus-for-exposure that was approved by the Board (Brody et al, 2012). However, the Task Force could improve their effectiveness if they:

  1. Increase the number of voting members who are necessary to reach a consensus on the position on an emerging accounting issue. This could give room for the FASB to apply its procedure in handling the issue and eliminate the controversies surrounding the issue that could emerge from assumptions posed by the majority voting system
  2. The FASB Board members should be allowed to vote on any consensus at the Task Force meeting. This will allow them to have enough pointers regarding the issues that surround all the consensuses that are presented before them to approve.

This paper focuses on the EITF’s issue entitled “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure”. According to this issue, the number of vacant or abandoned residential properties resulting from the weaknesses in the housing market has increased the potential for higher levels of foreclosed other real estate owned (OREO) by banks or similar lenders (creditors). Owing to the extended foreclosure processes, creditors are reviewing and updating their policies on when to reclassify a collateralized mortgage loan to OREO (Bourne et al, 2013).

According to this issue, the two key areas being addressed by the EITF are

Repossession or foreclosure of the real estate property – the Task Force decided that an in substance repossession or foreclosure (that is, a creditor is considered to have recived physical possession of residential real estate property collateralizing a consumer mortgage loan) only takes place when

  1. The creditor obtains legal title to the residential real estate property upon completion of a foreclosure sale or;
  2. The borrower conveys all interest in the residential real estate property to the creditor to satisfy the particular loan through completion of a deed in lieu of foreclosure or through a similar legal statement

The role of the EITF in this situation becomes fundamental in resolving this emerging issue of repossession of real estate property. The creditors are at times considered exploitative if not controlled and as such, the action or decision of this Task Force in requiring the creditors to have a legal title deed before repossession of these properties would serve to protect the current residents of this properties (Tsamenyi, 2009). The EITF also considers the requirements of the borrower before the repossession could take effect and this serves to make the the process open and fair for all the stakeholders in this business. Another key area addressed by EITF in this situation is

Reclassification of a consumer mortgage loan to residential real estate – the Task Force decided that a creditor should not wait until the redemption period has expired to classify a consumer mortgage loan to residential real estate. In relation to this issue, the Task Force concluded that an entity should be considered to have physical possession when it obtains physical title since the creditor has the right to sell the property subject to the borrower’s right of redemption. The borrowers do not normally exercise their redemption rights and as such, these rights are not generally considered substantive. This consensus serves to protect the creditors from faulty borrowers once they have the legal title deeds to these real estate properties (Gal, 2008).

Although the U.S GAAP guidance for recognition of foreclosed real estate are clearly set, the terms in substance a repossession or foreclosure and physical possession are not defined in the accounting literature (Wallace & Cooke, 2000). It emerges that there is diversity in their application for the purposes of reclassifying the loan receivable. Thus, the work of the EITF on tackling the emerging financial accounting issues in this company will primarily be to reduce this diversity in the application of this guidance. The Task Force reached a consensus-for-exposure that this guidance uused by this company should apply to consumer mortgage loans. These loans are normally issued by creditors that are collateralized by the residential real estate property for which the loan was obtained. This consensus are then to be approved by the FASB board members after comments are received from the public.

The Task Force reached a consensus-for-exposure that entities should apply the amendments (as discussed above) in modified retrospective basis to residential consumer mortgage loans and foreclosed residential real estate properties existing at the date of adoption by means of a cumulative effect adjustment as of the beginning of the reporting period for which the guidance is effective. Following these amendments, the Task Force will be able to eliminate the existing diversity as soon as the amendments are practicable. However, in order for EITF to improve the company’s accounting and financial reporting, it should ensure that

  1. Creditors be required to disclose the amount of residential consumer mortgage loans that is secured by residential properties undergoing the process of foreclosure (Brown, 2001).
  2. Also, creditors that obtain physical possession of real estate property collateralizing a residential consumer mortgage should disclose a roll-forward of such foreclosed properties (Choi, 2003).

The recommendations of the EITF on this issue prove for the resolution of any financial accounting issue that may emerge within the company. The amendments will ensure that the process of foreclosure or repossession of real estate property is under specific guidance and that no entity undergoes an unfair dealing as far as the financial accounting issues in this situation are concerned. The need for the creditors to obtain a legal title to the residential real estate property upon completion of a foreclosure sale will serve to protect the creditors in a number of situations including that when another entity in the company emerges with a claim of ownership of the same residential real estate property (Ballou & Knechel, 2002). The Task Force team will be available any time to handle any diversity that may arise regarding the guidance for foreclosure of any real estate.

These recommendations will also benefit the creditors, as the borrowers are required by the Task Force to convey all interests in the real estate property to the creditor that satisfy the particular loan (Finley, 2010). The reliance and confidence in these EITF recommendations are rooted by the fact that the effective date provided by the Task Force allowed time for both public and nonpublic entities to review them and consequently comply. The Task Force gave an entity the option of applying these amendments on a prospective basis and a nonpublic entity is not allowed to apply this issue to interim periods in the year of adoption.

If the accounting profession adopt one global set of accounting standards, there will be significant differential effects on companies, creditors, investors, and other interest groups. This change in accounting standard or the introduction of one set of global standards will result in a substantial redistribution of wealth within the country’s economy (Horvitz, 2001). The roles of the FASB and EITF in this situation will mainly be to determine and gauge the the appropriate method to report an economic transaction. Both FASB and EITF will have to determine the potential economic consequences that the use of the one global set of accounting standards has on the various interest groups and the society at large. The two bodies will be charged with the role of informing the public whether the new standards are capable of providing a better set of information to external users and whether the standards will be able to improve the resource allocation process (Uddin & Tsamenyi, 2010).


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