After years in the works, the Financial Accounting Standards Board (FASB) issued its final guidance on a new current expected credit loss (CECL) model, starting the clock for banks, credit unions, other entities and their preparers to implement the new requirements over the next few years.
“The CECL model will be the new GAAP-supported standard for U.S. banks, credit unions and lenders to account and plan for credit losses,” said Brian Hamilton, chairman of Sageworks. While the proposal is “non-prescriptive,” meaning that no specific methodologies will be required by the standard, it includes several changes, including forward-looking requirements, which will involve considering all expected, future credit losses, he noted.
Many industry experts agree that institutions will need to alter their methodology or adopt one that is more robust. “It will play a central role in determining the allowance for credit losses, which is one of the most significant estimates in an institution’s financial statements and regulatory reports,” Hamilton said.
Visit ALLL.com for CECL resources and more information especially geared toward financial institutions. For a quick list of resources, access the CECL Prep Kit, a toolkit that aggregates industry resources to help prepare for the accounting change.
• Requires the measurement of all expected credit losses for financial assets held at the reporting date to be based on historical experience, current conditions and “reasonable and supportable” forecasts that incorporate forward-looking information.
• Requires enhanced disclosures on the significant estimates and judgments used to estimate credit losses, as well as on the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements.
• Amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.
“The new guidance aligns the accounting with the economics of lending by requiring banks and other lending institutions to immediately record the full amount of credit losses that are expected in their loan portfolios, providing investors with better information about those losses on a more timely basis,” FASB Chair Russell G. Golden said in the release.
Other benefits identified by the FASB on the new approach include increased transparency about the extent of expected credit losses and consistency in measurement between assets.
Costs associated with applying the new ASU include personnel costs to change processes and controls, costs to educate stakeholders about new reporting requirements and costs to obtain incremental data related to the expected credit loss method, according to the FASB.
American Bankers Association President and CEO Rob Nichols in a news release called the new accounting standard “the biggest change in the history of bank accounting.” He added, “While we continue to have strong concerns with the costs related to CECL’s life of loan loss concept, we are committed to working with both regulators and auditors to ensure banks of all sizes can meet the implementation challenges of the new standard.”
The Independent Community Bankers of America (ICBA) said it was pleased with the consideration given to community banks’ views in the review process. But the National Association of Federal Credit Unions expressed disappointment that an updated draft wasn’t issued for public comment before the FASB finalized the standard. “Credit unions still have reservations with the standard due to its impact on their operations and their ability to serve members,” said NAFCU President and CEO Dan Berger in a news release.
FASB member Hal Schroeder in an interview with Accounting Today noted that non-financial companies could also be affected: “Keep in mind the scope of this standard is all financial assets that are accounted for at amortized cost,” he said. “The other way to say it is all financial assets that are accounted for, other than those at fair value, through net income.” In addition to banks, other entities that could be affected, Schroeder said, could include “a finance company embedded within an industrial company like Caterpillar, Boeing or Ford. They all have finance operations. Or it could be a tech company that has cash and it’s holding a pool of debt securities.”
The FASB said that under the new standard, many of the loss estimation techniques applied today will still be permitted, but it noted inputs will change to reflect the full amount of expected credit losses. Organizations will continue to exercise judgment in determining which loss estimation method is appropriate for their circumstances, the board added.
SEC filers must begin using the new standard for fiscal year and interim periods that begin after Dec. 15, 2019. For non-SEC filing public companies, the standard will be effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. It is effective for all other organizations for fiscal years starting after Dec. 15, 2020, and for interim periods a year later. Early adoption is permitted for everyone after Dec. 15, 2018.