New FASB standard requires earlier reporting of credit losses

Financial statement preparers will be required to report credit losses on loans and other financial instruments in a more timely fashion under a new standard issued Thursday by the US Financial Accounting Standards Board (FASB).

Financial institutions and other organisations will be required to measure all expected credit losses for financial assets held at the reporting date in accordance with Accounting Standards Update (ASU) No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.

The expected losses will be based on historical experience, current conditions, and reasonable and supportable forecasts. The move from an incurred-loss approach to an expected-loss approach is designed to provide investors with more forward-looking information.

“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 Chairman Russell Golden said in a news release.

Credit losses became a focus of accounting standard-setters after the financial crisis that began in 2007. Many banks and financial institutions experienced heavy losses related to subprime mortgages during the financial crisis, prompting calls for earlier reporting of expected credit losses.

FASB member Hal Schroeder said during an interview that significant frustration with the current model had built up amongst preparers and investors in the years before the financial crisis because the accounting didn’t match the economics.

“This standard is designed to correct for what we see as a misalignment between the economics of lending and the accounting for the economics,” he said.

FASB, IASB diverge

In 2008, FASB began its project to improve the reporting of credit losses on financial instruments, working at first with the International Accounting Standards Board (IASB) in a converged financial instruments project.

Although both boards agreed on the need for reporting of expected credit losses rather than incurred losses, they couldn’t find common ground on a method for measuring credit losses. The IASB issued IFRS 9, Financial Instruments, in 2014 with a different measurement model from FASB’s current expected credit loss model.

FASB’s standard will permit many of the loss estimation techniques applied today, but the inputs to those techniques will change to reflect what FASB deems to be the full amount of expected credit losses. Financial statement preparers will continue to use judgement to determine which loss estimation method is appropriate for their circumstances.

Enhanced disclosures required by the ASU are designed to help financial statement users understand the significant estimates and judgements preparers used in estimating credit losses, as well as the credit quality and underwriting standards of an organisation’s portfolio.

The disclosures will allow investors to monitor the accuracy of the preparers’ estimation, Schroeder said.

“Investors wanted to know, how accurate was your original assessment?” he said. “So what was your original assessment, and how did that change over time? That’s the information that investors are looking for.”

The accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration also is amended in the standard.

Because the standard moves to an expected-loss approach, it is expected to better align the accounting and reporting group with the credit risk group. The timing difference that exists in current US GAAP is expected to diminish, with financial reporting results better reflecting the expected credit losses that result from the underwriting process.

The standard will take effect for US Securities and Exchange Commission (SEC) filers for fiscal years, and interim periods within those fiscal years, beginning after December 15th 2019. For public companies that are not SEC filers, the standard will take effect for fiscal years beginning after December 15th 2020 and interim periods within those fiscal years. For all other organisations, the standard will take effect for fiscal years beginning after December 15th 2020 and for interim periods within fiscal years beginning after December 15th 2021.

Early application for all organisations will be permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15th 2018.

What preparers can do

Schroeder suggested that financial statement preparers take the following steps as they begin to implement the standard:

• Read the standard carefully. “Read it two or three times to make sure you have a full appreciation of the nuances,” he said.
• Assess how your informational needs will change. Considering the enhanced disclosures should be part of this assessment.
• Assess how systems will need to be changed. This step may require a longer lead time. “Any change to informational systems, those tend to take a while to get in the queue to make the changes, to test those changes, run parallel systems, all those things you do when you make systems changes,” he said.
• Refer questions to FASB’s Transition Resource Group. If challenges arise during implementation, preparers can forward questions to the board’s Transition Resource Group. “The quicker we can get those types of questions to the TRG, the quicker we can get people answers so that they can continue with their implementation process,” he said.

More information on the standard and the financial instruments project is available at the American Institute of CPAs Financial Reporting Center website.

—Ken Tysiac (ktysiac@aicpa.org) is a CGMA Magazine editorial director.