FASB proposes major revisions to accounting for credit losses
For the past few years, the Financial Accounting Standards Board (FASB) has been discussing the adoption of the “expected loss model” for the Allowance for Loan and Lease Losses (ALLL). On December 20, 2012, FASB issued a Proposed Accounting Standards Update that finally defines the actual accounting framework and clearly differentiates this proposal from the current accounting standard. The proposal calls for an entity to recognize an allowance for credit losses based on supportable forecasts of contractual cash flows not expected to be collected.
Under the “incurred loss” model presently employed, a loss is not recorded until it is probable that a loss event has occurred. This model has been criticized for a number of reasons but primarily since the loss is recorded too late in the credit cycle.
The FASB’s proposed model eliminates any threshold required to record a credit loss and allows entities to consider a broader information set when establishing their allowance for loan losses. In addition, the model aims to simplify current practice by replacing today’s multiple impairment models with one model that applies to all debt instruments.
WHAT IS THE POTENTIAL IMPACT?
It is very likely that this proposed standard will have a profound impact on financial institutions. Below you will find a few possible impacts of these new standards.
1. ALLL levels may rise as loss measurements would be measured over the life of the loan rather than on only losses that have been incurred as of the balance sheet date.
2. The result of increased ALLL balances would inversely reduce net income levels.
3. The “probable loss” threshold will be removed, and estimates will be based on “possible” estimates.
4. Financial institutions will need to implement revised calculation methodology that will be scrutinized and presumably challenged by your auditors and examiners.
5. Significant changes to required disclosures.
To find out more about what a financial institution should do to prepare, download this free whitepaper “FASB’s CECL Model: How it will impact ALLL.”
