FASB’s credit losses standard, Topic 326, will require entities to measure all expected credits losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The standard, commonly known as CECL, will be effective for SEC filers in 2020, for non-SEC public business entities in 2021 and for non-public business entities in 2022.
There has been a lot of discussion and chatter across the financial institutions industry regarding the CECL standard, including the following recent noteworthy matters:
Proposed Narrow-Scope CECL ASU
FASB recently issued a proposed Accounting Standards Update that would give entities the irrevocable option to elect the fair value option for measuring certain financial instruments that were previously measured at amortized cost. The purpose of this narrow-scope update is to increase comparability in financial reporting by institutions that otherwise would have reported similar financial instruments using different measurement methodologies, potentially decreasing costs for financial statement preparers while providing more useful information for investors. The comment letter deadline was March 8, 2019.
FASB CECL Roundtable
FASB hosted a roundtable discussion on January 28, 2019 with a variety of stakeholders in attendance, including small to large-sized financial institutions, audit firms, regulatory agencies and investment firms/investor associations. The roundtable meeting’s agenda was to gather feedback on two topics. The first topic addressed a proposal from a consortium of banks to consider an alternative approach to accounting for credit losses under the CECL standard. The proposed alternative approach suggested having the provision relating to credit losses that are estimated to occur within the next 12 months run through current period earnings, while the provision relating to credit losses that are estimated to occur beyond the next 12 months would run through comprehensive income. Feedback from the attendees representing financial institutions stated that the alternative proposal would be overly complex and would lead to increased costs for financial statement preparers and audit-related fees. Investors at the roundtable noted that the additional information provided by the proposal would not be decision-useful and the proposal’s increased reliance on management estimates and judgments could decrease comparability. At an April 3, 2019 board meeting, FASB rejected this proposal that would have required an entity to bifurcate expected credit losses in net income and other comprehensive income.
The second topic discussed at the roundtable meeting was to address a question submitted to the FASB asking whether gross charge-offs and gross recoveries are required to be presented in the disclosures to financial statements under the CECL standard. The banks that posed the question noted having difficulty gathering historical gross charge-off and gross recovery information. The investors at the roundtable reiterated the importance of getting such vintage information to track performance of certain parts of the portfolio over time.
Acceptable CECL Methods
Since the issuance of ASU 2016-13, the FASB has received many questions about the acceptability of certain estimation methods. Specifically, they have received many questions asking whether the weighted-average remaining maturity (WARM) method is an acceptable method to estimate expected credit losses. The standard does not require a specific credit loss method; however, it allows entities to use judgment in determining the relevant information and estimation methods that are appropriate in their circumstances.
The WARM method uses an average annual charge-off rate that provides the historical loss basis for estimating the credit losses for the remaining balances of a loan pool. The average annual charge-off rate is applied to the contractual term and adjusted for estimated prepayments to determine the unadjusted historical charge-off rate for the remaining balance of the loans
FASB noted in its response to questions about the acceptability of the WARM method that the WARM method as described in the previous paragraph may be an acceptable method to estimate expected credit losses under Topic 326. The WARM method considers an estimate of expected credit losses over the remaining life of the financial assets according to FASB’s response.
Opting In to ASU 2016-13
Many organizations are preparing their first quarter Call Report and asking whether or not they should opt in to ASU 2016-13, financial instruments-credit losses rule. The answer to this is most likely no; however, if you have decided to early adopt CECL starting 1Q 2019, you will need to opt in.
The Call Report has been revised to include the reporting changes for ASU 2016-13, which is the new CECL standard. For non-public business entities, this will be reportable for periods after January 1, 2022. Unless you have decided to early adopt the standard in the current year, you should follow the instructions for institutions that have not adopted ASU 2016-13 (CECL).
If you have any questions or would like more information, contact your Eide Bailly professional.
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