1.3 History of Guidance on Guarantees

In the early 2000s, a high-profile corporate failure highlighted an existing practice in which an entity could issue a guarantee to certain nonconsolidated entities but did not have to recognize the guarantee in its financial statements or provide transparent disclosures regarding the previously issued guarantee. After this corporate failure, the FASB undertook a project to amend certain aspects of the consolidation accounting guidance. In deliberating the project, the FASB concluded that there was sufficient diversity in practice related to the recognition and disclosure of guarantees issued by an entity to warrant a separate standard-setting project on guarantees. The FASB’s conclusion ultimately led to its issuance of Interpretation 45 in November 2002. The guidance in Interpretation 45 (codified in ASC 460) has remained largely unchanged, other than minor revisions made by FASB Staff Positions issued in 2003 through 2005.

As a result of the recognition and disclosure complexity described above, it may be challenging to determine whether an agreement represents a guarantee that is within the scope of ASC 460. The lack of a definition of “guarantee” in the ASC master glossary adds to the complexity of this determination. Because a guarantee may take many forms (e.g., derivative, product warranty, letter of credit) and may be used for various business purposes, it is difficult to provide one succinct definition of this term. Given the detailed nature of ASC 460’s scope guidance and the multiple sections of the Codification that address guarantee contracts, a significant portion of Chapter 5 on guarantees (specifically Section 5.2) is dedicated to providing additional guidance on the scope of ASC 460.

Another challenge with applying the guidance in ASC 460 is that it does not comprehensively address how to subsequently measure guarantees that are recognized in accordance with the standard’s initial recognition and measurement provisions. Many entities will need to apply significant judgment to determine how they are released from risk under the guarantee and, therefore, the period over which the guarantee liability should be released to earnings.

Although much of the guidance in ASC 450 is unrelated to that in ASC 460, both of these Codification topics address the accounting for uncertainties. A guarantor that issues a guarantee is obligated to the guaranteed party in two ways: (1) a noncontingent stand-ready obligation and (2) a contingent obligation. The guidance in ASC 460 on the recognition and measurement of the contingent obligation aspect of a guarantee is described in Sections 5.3.2.2 and 5.4.2. This contingent aspect is accounted for in accordance with the principle outlined in ASC 450, which is described throughout Chapter 2.