Federal Accounting Standards Advisory Board

Technical Amendments to Accounting Standards

For Direct Loans and Loan Guarantees

In Statement of Federal Financial Accounting Standards No. 2

Statement of Federal Financial Accounting Standards No. 19

March 2001

THE FEDERAL ACCOUNTING STANDARDS ADVISORY BOARD

The Federal Accounting Standards Advisory Board (the FASAB or "the Board") was

established by the Secretary of the Treasury, the Director of the Office of Management

and Budget (OMB), and the Comptroller General in October 1990. It is responsible for

promulgating accounting standards for the United States Government.

An accounting standard is typically formulated initially as a proposal after considering

the financial and budgetary information needs of citizens (including the news media,

state and local legislators, analysts from private firms, academe, and elsewhere),

Congress, Federal executives, Federal program managers, and other users of Federal

financial information. The proposed standard is published in an Exposure Draft for

public comment. A public hearing is sometimes held to receive oral comments in

addition to written comments. The Board considers comments and decides whether to

adopt the proposed standard with or without modification. The Board publishes adopted

standards in a Statement of Federal Financial Accounting Standards.

Additional background information is available from the FASAB:

"Memorandum of Understanding among the General Accounting Office, the

Department of the Treasury, and the Office of Management and Budget, on

Federal Government Accounting Standards and a Federal Accounting Standards

Advisory Board," amended on October 1, 1999.

 "Mission Statement of the Federal Accounting Standards Advisory Board."

Federal Accounting Standards Advisory Board

441 G Street, NW, Suite 6814

Washington, DC 20548

Telephone (202) 512-7350

Fax (202) 512-7366

Www.financenet.gov/fasab.htm

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Federal Accounting Standards Advisory Board

Technical Amendments to SFFAS No. 2

March 2001

EXECUTIVE SUMMARY

I. This Statement presents technical amendments to certain portions of

Statement of Federal Financial Accounting Standards No. 2, Accounting

for Direct Loans and Loan Guarantees (SFFAS No. 2), which was issued

in August 1993. These amendments were proposed for public comment

in an Exposure Draft titled Credit Program Reconciliation and Technical

Amendments to Accounting Standards for Direct Loans and Loan

Guarantees in Statements of Federal Financial Accounting Standards No.

2 and No. 18, issued in May 2000. (Hereinafter referred to as the May

2000 ED.)

II. The technical amendments serve the following purposes:

(A) Clarify that the cash flow discount method used in the accounting

standards prescribed in SFFAS No. 2 is consistent with the

method required in the Federal Credit Reform Act of 1990, as

amended in July 1997.

(B) Clarify that the effective interest rate of a cohort of direct loans or

loan guarantees is the interest rate adjusted for the interest rate

re-estimate, as defined in paragraph 9(A), SFFAS No. 18,

Amendments to Accounting Standards for Direct Loans and Loan

Guarantees in SFFAS No. 2. The adjusted interest rate is used

for amortizing subsidy cost allowance, accruing and compounding

interest on the liability for loan guarantees, determining the book

value of modified direct loans and the book value of the liability for

modified loan guarantees, and calculating the present value of

assets acquired through foreclosure.

(C) Clarify the measurement principle for the default costs of direct

loans and loan guarantees. Briefly, the default cost of direct loans

is measured at the present value of projected deviations due to

defaults by the borrowers from payment schedules for principal,

interest, and fee payments in the loan contracts, minus projected

net recoveries. However, the measurement of default costs does

not include prepayments. The default cost of loan guarantees is

measured at the present value of projected claim payments to

lenders required by the guarantee, plus uncollected fees, minus

interest supplements not paid as the result of the default, and

minus projected net recoveries.

III. In the May 2000 ED, the Board proposed that entities display a programby-program reconciliation for major credit programs between the

beginning and ending balances of subsidy cost allowance for direct loans
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and the liability for loan guarantees. The Board decided not to adopt this

proposal based on cost-benefit considerations.

(Continued on next page.)
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TABLE OF CONTENTS

EXECUTIVE SUMMARY.......................................................................................................................................1

INTRODUCTION.....................................................................................................................................................4

TECHNICAL AMENDMENTS TO SFFAS NO. 2 .................................................................................................6

Cash Flow Discount Method ................................................................................................................................6

Effective Interest Rate...........................................................................................................................................6

Measuring Default Costs ......................................................................................................................................7

APPENDIX A: BASIS FOR CONCLUSIONS ........................................................................................................8

Program-by-Program Reconciliation ...................................................................................................................8

Technical Amendments .........................................................................................................................................9

Effective Date......................................................................................................................................................11

APPENDIX B: THE ACCOUNTING STANDARDS IN SFFAS NO. 2................................................................13
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INTRODUCTION

Background and Purposes

1. In this Statement the Board adopts a number of technical amendments to

certain portions of the Statement of Federal Financial Accounting

Standards No. 2, Accounting for Direct Loans and Loan Guarantees

(SFFAS No. 2), which was issued in August 1993. These amendments

were proposed for public comment in an Exposure Draft (ED) issued in

May 2000. The title of that ED is ìCredit Program Reconciliation and

Technical Amendments to Accounting Standards for Direct Loans and

Loan Guarantees in Statements of Federal Financial Accounting

Standards No. 2 and No. 18.î (Hereinafter the ED is referred to as the

May 2000 ED.)

2. The technical amendments serve the following purposes:

(A) Clarify that the cash flow discount method used in the accounting

standards prescribed in SFFAS No. 2 is consistent with the

method required in the Federal Credit Reform Act of 1990, as

amended in July 1997.

(B) Clarify that the effective interest rate of a cohort of direct loans or

loan guarantees is the interest rate adjusted for the interest rate

re-estimate, as defined in paragraph 9(A), SFFAS No. 18,

Amendments to Accounting Standards for Direct Loans and Loan

Guarantees in SFFAS No. 2.

(C) Clarify the measurement principle for the default costs of direct

loans and loan guarantees.

3. The Board received nine responses to the ED. All of the respondents

were in support for the technical amendments, except for two

respondents who commented on the proposed technical amendments

related to the measurement of default costs. Based on the comments,

the Board made a minor modification to the proposed measurement of

default costs for direct loans. This modification is discussed in this

Statementís Appendix A, Basis for Conclusions.

4. In addition to the technical amendments, the Board proposed a standard

in the May 2000 ED, requiring that entities display a program-by-program

reconciliation for major credit programs between the beginning and

ending balances of subsidy cost allowance for direct loans and the liability
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for loan guarantees. The Board decided not to adopt that proposal based

on cost-benefit considerations.

Effective Date

5. The technical amendments adopted in this Statement are effective for

periods beginning after September 30, 2002. Early implementation of the

amendments is encouraged.

(Continued on next page.)
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TECHNICAL AMENDMENTS TO SFFAS NO. 2

Cash Flow Discount Method

6. The amendments in (a) and (b) below are made to clarify that the

accounting standards in SFFAS No. 2 are consistent with the cash flow

discount method required by the amendment enacted in July 1997 to the

Federal Credit Reform Act of 1990. Sec. 502 (5)(E) of the Act, as

amended, provides that ìIn estimating net present values, the discount

rate shall be the average interest rate on marketable Treasury securities

of similar maturity to the cash flows of the direct loan or loan guarantee

for which the estimate is being made.î

(a) In paragraph 24, SFFAS No. 2, the phrase ìwith a similar maturity

termî is changed to ìwith similar maturity to the cash flows.î

(b) In footnotes 3, 4, 6, and 7, SFFAS No. 2, the phrase ìthe

remaining maturityî is replaced with the phrase ìthe remaining

cash flows.î

Effective Interest Rate

7. The following amendments are made to clarify that the effective interest

rate of a cohort of direct loans or loan guarantees is the interest rate

adjusted for the interest rate re-estimate, as defined in paragraph 9(A),

SFFAS No. 18. The adjusted rate should be used for amortizing subsidy

cost allowance, accruing and compounding interest on the liability for loan

guarantees, determining the book value of modified direct loans and the

book value of the liability for modified loan guarantees, and calculating

the present value of assets acquired through foreclosure.

(a) In paragraph 30, SFFAS No. 2, the first sentence is changed to:

ìThe subsidy cost allowance for direct loans is amortized by the

interest method using the interest rate that was used to calculate

the present value of the direct loans when the direct loans were

disbursed, after adjusting for the interest rate re-estimate.î

(b) In paragraph 31, SFFAS No. 2, the first sentence is changed to:
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ìInterest is accrued and compounded on the liability for loan

guarantees at the interest rate that was used to calculate the

present value of the loan guarantee liabilities when the

guaranteed loans were disbursed, after adjusting for the interest

re-estimate.î

(c) In paragraph 46, SFFAS No. 2, the phrase in the parentheses is

changed to ìthe rate that was originally used to calculate the

present value of the direct loans, when the direct loans were

disbursed, after adjusting for the interest rate re-estimate.î

(d) In paragraph 50, SFFAS No. 2, the phrase in the parentheses is

changed to ìthe rate that was originally used to calculate the

present value of the liability, when the guaranteed loans were

disbursed, after adjusting for the interest rate re-estimate.î

(e) In paragraphs 57 and 59, SFFAS No. 2, the words ìadjusted for

the interest rate re-estimateî are added immediately after the

words ìthe original discount rate.î

Measuring Default Costs

8. Paragraph 27 in SFFAS No. 2 is replaced with the following two

paragraphs:

(a) The default cost of direct loans results from projected deviations

by the borrowers from the payment schedules for principal,

interest, and fee payments in the loan contracts. However, the

measurement of default costs does not include prepayments. The

default cost is measured at the present value of projected

payment deviations due to defaults minus projected net

recoveries. Projected net recoveries include the amounts that

would be collected from borrowers at a later date or the proceeds

from the sales of acquired assets minus the costs of foreclosing,

managing, and selling the assets.

(b) The default cost of loan guarantees results from paying lendersí

claims upon default of the guaranteed loans. The default cost of

loan guarantees is measured at the present value of projected

payments to lenders required by the guarantee, plus uncollected

fees, minus interest supplements not paid as the result of the

default, and minus projected net recoveries as defined in

paragraph 8(a).
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APPENDIX A: BASIS FOR CONCLUSIONS

Program-by-Program Reconciliation

9. In the May 2000 ED, the Board proposed a standard requiring that

entities display a program-by-program reconciliation for major credit

programs between the beginning and ending balances of the subsidy cost

allowance for direct loans and the liability for loan guarantees. Nine

respondents to the ED commented on the proposal. Five of them

supported the proposal and the remaining four were opposed to the

proposed standard.

10. Those who supported the proposal believed that the display of a programby-program reconciliation would enhance disclosure for program costs

and performance. One of the respondents said that the program-byprogram reconciliation would reveal actual program performance

information, such as direct loans written off, default claims paid, fees

received, and interest supplements paid. Reporting this kind of

information on a program-by-program basis is not required by the existing

standards. If the data were reported, they could be useful in analyzing a

programís operating results and providing feedback to the programís

budget expectations. Another respondent pointed out that when program

data are aggregated, increases and decreases in program costs would

offset each other. Thus, without a display of program-by-program

reconciliation, entity-wide reconciliation alone would not disclose

variations in program performance.

11. Among those who were opposed to the proposal, the Chief Financial

Officer (CFO) of US Department of Agriculture (USDA) said that the

proposed standard was unnecessary because USDA has reported

subsidy costs by credit areas. The USDA CFO and several other

respondents expressed their concern that the proposed display of

program-by-program reconciliation would make the disclosure too lengthy

and complex and thus reduce its information value to the users of

general-purpose financial reports.

12. After considering the comments, the Board decided not to adopt the

proposed standard. The Board concluded that SFFAS No. 2 and SFFAS

No. 18 already require sufficient program information. Paragraph 32 in
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SFFAS No. 2, as amended by SFFAS No. 18, requires that entities

disclose each programís interest rate re-estimates and technical/default

re-estimates. More extensive disclosure is required in SFFAS No. 18.

Paragraph 11(a) in SFFAS No. 18, for example, requires that entities

provide a description of the characteristics of the programs that they

administer. It also requires disclosure of the amount of direct or

guaranteed loans disbursed for each program during the reporting year

as well as each programís subsidy expense, and subsidy re-estimates.

Paragraph 11(b) requires disclosure of each programís subsidy rates for

direct loans and loan guarantees in the current yearís cohort.

Furthermore, paragraph 11(c) requires that reporting entities disclose,

discuss, and explain events and changes in economic conditions, other

risk factors, legislation, credit policies, and subsidy estimation

methodologies and assumptions, that have had a significant and

measurable effect on subsidy rates, subsidy expense, and subsidy reestimates. The Board believes that in the process of producing the

program-based information required by paragraph 11(c), an entity will

naturally describe important changes in the actual performance of its

credit programs; e.g., default claims paid, loans written off, etc. Thus, the

Board concluded that the program-based disclosure and discussion

required by the existing standards should provide sufficient information

about credit activities at the program level. In addition, although the

incremental cost of producing the program-based reconciliation would be

quite small for most agencies, the Board believes that requiring the

display of program-based reconciliation would add length and complexity

to the financial reports that are already detailed and complex. As a result

of these benefit and cost considerations, the Board concluded that

requiring the display of a program-by-program reconciliation was not

justified.

Technical Amendments

13. The Board adopted three groups of technical amendments to SFFAS No.

2. The first group affects paragraph 24 and footnotes 3, 4, 6, and 7 of

SFFAS No. 2. These amendments clarify that the accounting standards

are consistent with the cash flow discount method required by the Federal

Credit Reform Act of 1990, as amended in July 1997.1

 As required in

Section 502 (5)(E) of the Act, the amended standards require using as

 

 1 Office of Management and Budget (OMB) has implemented the amendment in Circular A-11,

Preparation and Submission of Budget Estimates, July 1999 and in its recent release of a new credit

subsidy calculator.
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the discount rate the average interest rate on Treasury securities of

similar maturity to the cash flows of a direct loan or loan guarantee. None

of the respondents to the ED objected to these amendments.

14. The second group of amendments affects paragraphs 30, 31, 46, 50, 57,

and 59 of SFFAS No. 2. These amendments are related to interest rate

re-estimates. The amendments clarify that the effective interest rate of a

cohort of direct loans and loan guarantees is the interest rate adjusted by

the interest rate re-estimate, as defined in paragraph 9(a), SFFAS No. 18.

The adjusted rate should be used for amortizing subsidy cost allowance,

accruing and compounding interest on the liability for loan guarantees,

determining the book value of modified direct loans and the book value of

the liability for modified loan guarantees, and calculating the present

value of assets acquired through foreclosure. None of the respondents to

the ED objected to these amendments.

15. The third group of amendments, proposed in ED paragraphs 10(A) and

10(B), concerns the measurement of default costs discussed in

paragraph 27, SFFAS No. 2. ED paragraph 10(A) addressed the default

costs of direct loans. The proposed amendment in that paragraph would

include the effect of short-term delinquencies in the ìother costsî

category, rather than the ìdefault costsî category.

16. The USDA CFO and IG objected to the exclusion of short-term

delinquencies from default costs. They said that the Commodity Credit

Corporation (an USDA unit) uses the Inter-Agency Country Risk

Assessment System (ICRAS) to estimate default costs. The ICRAS,

used for lending to foreign countries, includes short-term delinquencies in

measuring default costs. Thus, the proposed amendment would create a

difference from that practice.

17. The Board understands that practices differ among lending institutions in

treating delinquencies. They may or may not regard a payment delay

within a certain time frame as default. The Board is of the view that the

variation would not distort the measurement of credit subsidy costs, if

each practice is followed consistently. In this regard, it is better that the

accounting standard leaves some leeway for the agencies that are

responsible for developing subsidy estimate models and methodologies.

Thus, the Board deleted the words related to ìdelinquenciesî in

paragraph 8(a) of this Statement on default costs of direct loans.
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18. Paragraph 8(b) of this Statement addressed the measurement of default

costs for loan guarantees. The paragraph reads as follows:

The default cost of loan guarantees results from paying lendersí

claims upon default of the guaranteed loans. The default cost of

loan guarantees is measured at the present value of projected

payments to lenders required by the guarantee, plus uncollected

fees, minus interest supplements not paid as the result of the

default, and minus projected net recoveries as defined in

paragraph 10(A).

19. The USDA CFO commented on the requirement for including uncollected

fees and ìinterest supplements not paidî in measuring default costs. The

USDA CFO stated that although those cash flow components are

specified in the OMB credit subsidy calculator, OMB would give agencies

flexibility in implementation with regard to those cash flow components.

The USDA CFO pointed out that realigning those cash flow components

might entail substantial changes in agenciesí credit subsidy models. She

also indicated problems with private lender restrictions and workload

increases. She suggested that agencies be allowed flexibility to

determine whether those cash flow components are to be included in

default costs.

20. The Board believes the amended standard provides a sound

methodology for measuring the default costs for loan guarantees.

Uncollected fees are a direct result of default itself and therefore should

be included in measuring the default costs. The interest supplements not

paid are also a direct result of defaults. When a guaranteed loan is in

default, the government pays the default claim to the lender and stops

paying interest supplement for that loan. Thus, the interest supplements

that are saved due to default should be subtracted from the default costs.

The Board concluded that the categorization of these cash flow

components should be uniform across the government so that they can

be comparable among programs. However, as discussed in the following

paragraph, the Board has decided to delay the implementation of the

technical amendments for one year. This delay should help resolve some

of the problems raised by the USDA CFO.

Effective Date

21. The proposed effective date for the technical amendments was for

periods beginning after September 30, 2001, which means FY 2002. The

Board realized that that the subsidy expenses to be reported for FY 2002
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would be based on the budget submission for that year. However, there

would not be sufficient time to implement the amendments for the FY

2002 budget. Therefore, the Board decided to make the effective date for

periods beginning after September 30, 2002, and the Board encourages

earlier implementation.

Board Approval

23 This Statement was approved by the Board with a vote of eight members

in approval of its issuance. One member submitted a written dissent,

which is available for inspection at the FASAB office.

(Continued on next page.)
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APPENDIX B: THE ACCOUNTING STANDARDS IN SFFAS No. 2

Presented in this Appendix are the standards originally prescribed in SFFAS No. 2. The

paragraphs and their numbers reproduced in this Appendix are the same as those that appear

in SFFAS No. 2, and are presented here for reference purposes only. The shaded words,

paragraphs, and footnotes are those that have been amended by SFFAS No. 182

 or by this

Statement.

Explanation

21. These standards concern the recognition and measurement of direct

loans, the liability associated with loan guarantees, and the cost of direct

loans and loan guarantees. The standards apply to direct loans and loan

guarantees on a group basis, such as a cohort or a risk category of loans

and loan guarantees. Present value accounting does not apply to direct

loans or loan guarantees on an individual basis, except for a direct loan or

loan guarantee that constitutes a cohort or a risk category.

Accounting Standards

Post-1991 Direct Loans

22. Direct loans disbursed and outstanding are recognized as assets at the

present value of their estimated net cash inflows. The difference between

the outstanding principal of the loans and the present value of their net

cash inflows is recognized as a subsidy cost allowance.

Post-1991 Loan Guarantees

23. For guaranteed loans outstanding, the present value of estimated net

cash outflows of the loan guarantees is recognized as a liability.

Disclosure is made of the face value of guaranteed loans outstanding and

the amount guaranteed.

Subsidy Costs of Post-1991 Direct Loans and Loan Guarantees

24. For direct or guaranteed loans disbursed during a fiscal year, a subsidy

expense is recognized. The amount of the subsidy expense equals the

present value of estimated cash outflows over the life of the loans minus

the present value of estimated cash inflows, discounted at the interest

rate of marketable Treasury securities with a similar maturity term

 

2 SFFAS NO. 18 amended paragraph 32 in SFFAS No. 2.
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applicable to the period during which the loans are disbursed (hereinafter

referred to as the applicable Treasury interest rate).

25. For the fiscal year during which new direct or guaranteed loans are

disbursed, the components of the subsidy expense of those new direct

loans and loan guarantees are recognized separately among interest

subsidy costs, default costs, fees and other collections, and other subsidy

costs.

26. The interest subsidy cost of direct loans is the excess of the amount of

the loans disbursed over the present value of the interest and principal

payments required by the loan contracts, discounted at the applicable

Treasury rate. The interest subsidy cost of loan guarantees is the present

value of estimated interest supplement payments.

27. The default cost of direct loans or loan guarantees results from any

anticipated deviation, other than prepayments, by the borrowers from the

payments schedule in the loan contracts. The deviations include

delinquencies and omissions in interest and principal payments. The

default cost is measured at the present value of the projected payment

delinquencies and omissions minus net recoveries. Projected net

recoveries include the amounts that would be collected from the

borrowers at a later date or the proceeds from the sale of acquired assets

minus the costs of foreclosing, managing, and selling those assets.

28. The present value of fees and other collections is recognized as a

deduction from subsidy costs.

29. Other subsidy costs consist of cash flows that are not included in

calculating the interest or default subsidy costs, or in fees and other

collections. They include the effect of prepayments within contract terms.

Subsidy Amortization and Reestimation

30. The subsidy cost allowance for direct loans is amortized by the interest

method using the interest rate that was originally used to calculate the

present value of the direct loans when the direct loans were disbursed.

The amortized amount is recognized as an increase or decrease in

interest income.
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31. Interest is accrued and compounded on the liability of loan guarantees at

the interest rate that was originally used to calculate the present value of

the loan guarantee liabilities when the guaranteed loans were disbursed.

The accrued interest is recognized as interest expense.

32. The subsidy cost allowance for direct loans and the liability for loan

guarantees are reestimated each year as of the date of the financial

statements. Since the allowance or the liability represents the present

value of the net cash outflows of the underlying direct loans or loan

guarantees, the reestimation should take into account all factors that may

have affected the estimate of each component of the cash flows,

including prepayments, defaults, delinquencies, and recoveries. Any

increase or decrease in the subsidy cost allowance or the loan guarantee

liability resulting from the reestimates should be recognized as a subsidy

expense (or a reduction in subsidy expense). Reporting the subsidy cost

allowance of direct loans (or the liability of loan guarantees) and

reestimates by component is not required.

Criteria for Default Cost Estimates

33. The criteria for default cost estimates provided in this and the following

paragraphs apply to both initial estimates and subsequent reestimates.

Default costs are estimated and reestimated for each program on the

basis of separate cohorts and risk categories. The reestimates take into

account the differences in past cash flows between the projected and

realized amounts and changes in other factors that can be used to predict

the future cash flows of each risk category.

34. In estimating default costs, the following risk factors are considered: (1)

loan performance experience; (2) current and forecasted international,

national, or regional economic conditions that may affect the performance

of the loans; (3) financial and other relevant characteristics of borrowers;

(4) the value of collateral to loan balance; (5) changes in recoverable

value of collateral; (6) newly developed events that would affect the loans'

performance; and (7) improvements in methods to reestimate defaults.

35. Each credit program should use a systematic methodology, such as an

econometric model, to project default costs of each risk category. If

individual accounts with significant amounts carry a high weight in risk

exposure, an analysis of the individual accounts is warranted in making

the default cost estimate for that category.
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36. Actual historical experience of the performance of a risk category is a

primary factor upon which an estimation of default cost is based. To

document actual experience, a database should be maintained to provide

historical information on actual payments, prepayments, late payments,

defaults, recoveries, and amounts written off.

Revenues and Expenses

37. Interest accrued on direct loans, including amortized interest, is

recognized as interest income. Interest accrued on the liability of loan

guarantees is recognized as interest expense. Interest due from

Treasury on uninvested funds is recognized as interest income. Interest

accrued on debt to Treasury is recognized as interest expense.

38. Costs for administering credit activities, such as salaries, legal fees, and

office costs, that are incurred for credit policy evaluation, loan and loan

guarantee origination, closing, servicing, monitoring, maintaining

accounting and computer systems, and other credit administrative

purposes, are recognized as administrative expense. Administrative

expenses are not included in calculating the subsidy costs of direct loans

and loan guarantees.

Pre-1992 Direct Loans and Loan Guarantees

39. The losses and liabilities of direct loans obligated and loan guarantees

committed before October 1, 1992, are recognized when it is more likely

than not that the direct loans will not be totally collected or that the loan

guarantees will require a future cash outflow to pay default claims. The

allowance of the uncollectible amounts and the liability of loan guarantees

should be reestimated each year as of the date of the financial

statements. In estimating losses and liabilities, the risk factors discussed

in the previous section should be considered. Disclosure is made of the

face value of guaranteed loans outstanding and the amount guaranteed.

40. Restatement of pre-1992 direct loans and loan guarantees on a present

value basis is permitted but not required.

Modification of Direct Loans and Loan Guarantees

41. The term modification means a federal government action, including new

legislation or administrative action, that directly or indirectly alters the
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estimated subsidy cost and the present value of outstanding direct loans,

or the liability of loan guarantees.

42. Direct modifications are actions that change the subsidy cost by altering

the terms of existing contracts or by selling loan assets. Existing

contracts may be altered through such means as forbearance,

forgiveness, reductions in interest rates, extensions of maturity, and

prepayments without penalty. Such actions are modifications unless they

are considered reestimates, or workouts as defined below, or are

permitted under the terms of existing contracts.

43. Indirect modifications are actions that change the subsidy cost by

legislation that alters the way in which an outstanding portfolio of direct

loans or loan guarantees is administered. Examples include a new

method of debt collection prescribed by law or a statutory restriction on

debt collection.

44. The term modification does not include subsidy cost reestimates, the

routine administrative workouts of troubled loans, and actions that are

permitted within the existing contract terms. Workouts are actions taken

to maximize repayments of existing direct loans or minimize claims under

existing loan guarantees. The expected effects of workouts on cash flows

are included in the original estimate of subsidy costs and subsequent

reestimates.

A. Modification of Direct Loans

45. With respect to a direct or indirect modification of pre-1992 or post-1991

direct loans, the cost of modification is the excess of the pre-modification

value3

 of the loans over their post-modification value4. The amount of the

modification cost is recognized as a modification expense when the loans

are modified.

 

 3 The term "pre-modification value" is the present value of the net cash inflows of direct loans

estimated at the time of modification under pre-modification terms and discounted at the interest rate

applicable to the time when the modification occurs on marketable Treasury securities that have a

comparable maturity to the remaining maturity of the direct loans under pre-modification terms (simply

stated, the pre-modification terms at the current rate).

 4 The term "post-modification value" is the present value of the net cash inflows of direct loans

estimated at the time of modification under post-modification terms and discounted at the interest rate

applicable to the time when the modification occurs on marketable Treasury securities that have a

comparable maturity to the remaining maturity of the direct loans under post-modification terms (simply

stated, the post-modification terms at the current rate).
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March 2001

46. When post-1991 direct loans are modified, their existing book value is

changed to an amount equal to the present value of the loans' net cash

inflows projected under the modified terms from the time of modification

to the loans' maturity and discounted at the original discount rate (the rate

that was originally used to calculate the present value of the direct loans,

when the direct loans were disbursed).

47. When pre-1992 direct loans are directly modified, they are transferred to

a financing account and their book value is changed to an amount equal

to their post-modification value. Any subsequent modification is treated

as a modification of post-1991 loans. When pre-1992 direct loans are

indirectly modified, they are kept in a liquidating account. Their bad debt

allowance is reassessed and adjusted to reflect amounts that would not

be collected due to the modification.

48. The change in book value of both pre-1992 and post-1991 direct loans

resulting from a direct or indirect modification and the cost of modification

will normally differ, due to the use of different discount rates or the use of

different measurement methods. Any difference between the change in

book value and the cost of modification is recognized as a gain or loss.

For post-1991 direct loans, the modification adjustment transfer5

 paid or

received to offset the gain or loss is recognized as a financing source (or

a reduction in financing source).

B. Modification of Loan Guarantees

49. With respect to a direct or indirect modification of pre-1992 or post-1991

loan guarantees, the cost of modification is the excess of the

post-modification liability6

 of the loan guarantees over their

 

 5 OMB instructions provide that if the decrease in book value exceeds the cost of modification, the

reporting entity receives from the Treasury an amount of "modification adjustment transfer" equal to the

excess; and that if the cost of modification exceeds the decrease in book value, the reporting entity pays

to the Treasury an amount of "modification adjustment transfer" to offset the excess. (See OMB Circular

A-11.)

 6 The term "post-modification liability" is the present value of the net cash outflows of the loan

guarantees estimated at the time of modification under the post-modification terms, and discounted at the

interest rate applicable to the time when the modification occurs on marketable Treasury securities that

have a comparable maturity to the remaining maturity of the guaranteed loans under post-modification

terms (simply stated, the post-modification terms at the current rate).
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Technical Amendments to SFFAS No. 2

March 2001

pre-modification liability7. The modification cost is recognized as

modification expense when the loan guarantees are modified.

50. The existing book value of the liability of modified post-1991 loan

guarantees is changed to an amount equal to the present value of net

cash outflows projected under the modified terms from the time of

modification to the loans' maturity, and discounted at the original discount

rate (the rate that was originally used to calculate the present value of the

liability when the guaranteed loans were disbursed).

51. When pre-1992 loan guarantees are directly modified, they are

transferred to a financing account and the existing book value of the

liability of the modified loan guarantees is changed to an amount equal to

their post-modification liability. Any subsequent modification is treated as

a modification of post-1991 loan guarantees. When pre-1992 direct loan

guarantees are indirectly modified, they are kept in a liquidating account.

The liability of those loan guarantees is reassessed and adjusted to

reflect any change in the liability resulting from the modification.

52. The change in the amount of liability of both pre-1992 and post-1991 loan

guarantees resulting from a direct or indirect modification and the cost of

modification will normally differ, due to the use of different discount rates

or the use of different measurement methods. The difference between

the change in liability and the cost of modification is recognized as a gain

or loss. For post-1991 loan guarantees, the modification adjustment

transfer8

 paid or received to offset the gain or loss is recognized as a

financing source (or a reduction in financing source).

C. Sale of Loans

 

 7 The term "pre-modification liability" is the present value of the net cash outflows of loan guarantees

estimated at the time of modification under the pre-modification terms and discounted at the interest rate

applicable to the time when the modification occurs on marketable Treasury securities that have a

comparable maturity to the remaining maturity of the guaranteed loans under pre-modification terms

(simply stated, the pre-modification terms at the current rate).

 8 OMB instructions provide that if the increase in liability exceeds the cost of modification, the reporting

entity receives from the Treasury an amount of "modification adjustment transfer" equal to the excess;

and that if the cost of modification exceeds the increase in liability, the reporting entity pays to the

Treasury an amount of "modification adjustment transfer" to offset the excess. (See OMB Circular A-11.)
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Technical Amendments to SFFAS No. 2

March 2001

53. The sale of post-1991 and pre-1992 direct loans is a direct modification.

The cost of modification is determined on the basis of the pre-modification

value of the loans sold. If the pre-modification value of the loans sold

exceeds the net proceeds from the sale, the excess is the cost of

modification, which is recognized as modification expense.

54. For a loan sale with recourse, potential losses under the recourse or

guarantee obligations are estimated, and the present value of the

estimated losses from the recourse is recognized as subsidy expense

when the sale is made and as a loan guarantee liability.

55. The book value loss (or gain) on a sale of direct loans equals the existing

book value of the loans sold minus the net proceeds from the sale. Since

the book value loss (or gain) and the cost of modification are calculated

on different bases, they will normally differ. Any difference between the

book value loss (or gain) and the cost of modification is recognized as a

gain or loss.9

 For sales of post-1991 direct loans, the modification

adjustment transfer10 paid or received to offset the gain or loss is

recognized as a financing source (or a reduction in financing source).

D. Disclosure

56. Disclosure is made in notes to financial statements to explain the nature

of the modification of direct loans or loan guarantees, the discount rate

used in calculating the modification expense, and the basis for

recognizing a gain or lose related to the modification.

Foreclosure of Post-1991 Direct and Guaranteed Loans

57. When property is transferred from borrowers to a federal credit program,

through foreclosure or other means, in partial or full settlement of post1991 direct loans or as a compensation for losses that the government

sustained under post-1991 loan guarantees, the foreclosed property is

recognized as an asset at the present value of its estimated future net

cash inflows discounted at the original discount rate.

 

 9 If there is a book value gain, the gain to be recognized equals the book value gain plus the cost of

modification.

 10 See footnote No. 7 for an explanation for "modification adjustment transfer".
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Technical Amendments to SFFAS No. 2

March 2001

58. If a legitimate claim exists by a third party or by the borrower to a part of

the recognized value of the foreclosed assets, the estimated amount of

the claim is recognized as a special contra valuation allowance.

59. At a foreclosure of guaranteed loans, a federal guarantor may acquire the

loans involved. The acquired loans are recognized at the present value

of their estimated net cash inflows from selling the loans or from collecting

payments from the borrowers, discounted at the original discount rate.

60. When assets are acquired in full or partial settlement of post-1991 direct

loans or guaranteed loans, the present value of the government's claim

against the borrowers is reduced by the amount settled as a result of the

foreclosure.

Write-off of Direct Loans

61. When post-1991 direct loans are written off, the unpaid principal of the

loans is removed from the gross amount of loans receivable.

Concurrently, the same amount is charged to the allowance for subsidy

costs. Prior to the write-off, the uncollectible amounts should have been

fully provided for in the subsidy cost allowance through the subsidy cost

estimate or reestimates. Therefore, the write-off would have no effect on

expenses.
FASAB Board Members

David Mosso, Chairman

Barry B. Anderson

Philip T. Calder

Donald H. Chapin*

Joseph L. Kull

James M. Patton

Robert N. Reid

 Nelson Toye

 Kenneth J. Winter

 *Term expired in December 2000.

FASAB Staff

Wendy M. Comes, Executive Director

Project Staff:

Richard Mayo

Lucy Lomax

_______________________________________

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