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Credit losses: A new scope

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If you have put off reviewing the Financial Accounting Standards Board’s (FASB) new Credit Loss standard since its effective date is “in a galaxy far, far away,” you are not alone.

This is the largest accounting standard change affecting depository institutions (and other industries) within the last 40 years, so it can be intimidating for management to get started. Plus, the amount of flexibility and professional judgement allowed within the standard itself has caused confusion and fear, making it hard even to begin.

Do not give into your fear. “Fear is the path to the Dark Side.” Instead, read below to digest the new standard piecemeal, and to understand what it does and doesn’t say. Then you will have the tools needed to take the steps to implement it. 

*Cue the Star Wars theme song*

How did we even get here?

The “Current Expected” Credit Loss Standard (CECL) was developed by the FASB in direct response to the financial crisis. The goal was to address weaknesses in the application of the current Credit Loss Standard. The most important weakness identified was a delay in recognition of credit losses by management for losses they wanted to take upfront but couldn’t. This was because the current standard requires a high-level threshold in order to book a loss (known as “probable”). The new standard eliminates this threshold and allows for more forward-looking information to be considered when developing a best estimate. Ultimately, the standard allows for an increase in management’s professional judgement when considering a wide-variety of factors.

To help you implement the new standard, we have created a new Current Expected Credit Loss webpage containing up-to-date information and resources. Check the page often as it will be updated as more materials become available.

What’s changing?  

The new CECL model applies to financial assets at amortized cost, including loans, reinsurance and trade receivables, held-to-maturity (HTM) debt securities, impairment model for available-for-sale debt securities, net investment in leases, and certain off-balance sheet credit exposures, such as loan commitments.

When do I need to implement?  

For public business entities that are U.S. Securities and Exchange Commission (SEC) filers, the ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Thus, for a calendar-year company, it would be effective January 1, 2020.

For public business entities that are not SEC filers, the standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020.

For all other organizations, the standard is effective for fiscal years beginning after December 15, 2020, and for interim periods within fiscal years beginning after December 15, 2021.

Not really so far, far away.

What's my first assignment?

Your first assignment takes patience and is not for the faint of heart.

You must actually sit down and read the standard. As Yoda once said, “Do or do not, there is no try.”

I know, I know. Your first response is most likely, “I don't have time to read a 285-page standard.” I have good news for you. You don't have to read the entire standard. I recommend focusing on about 50-65 specific pages to help hone in on the key points in the standard.

Here’s a suggestion for how to read the standard:

  1. Read the Summary: This will help you familiarize yourself with the standard a bit further. (6 pages)
  2. Background and Basis for Conclusions: This will explain the “Why” behind the decisions that were made. (13 pages)
  3. Topical Guidance: This will explain the “What” that is involved (Scope, Glossary, Measurement, Presentation and Disclosure). (22 pages)
  4. Implementation Guidance & Illustrations: This will explain “How” to implement. (25 pages)

Even if you plan to outsource...

Even if you plan to outsource to a third party provider, I highly recommend you take the time to read the standard. Here are three reasons why:

  1. The standard requires a significant level of management’s professional judgement. Even though you plan to outsource, you must still understand the fundamentals in this significant management estimate.
  2. Outside parties might misinterpret the standard by trying to sell you on over-complicated techniques that are incorrect and potentially costly and unnecessary. (You don’t want to be that Stormtrooper. Or any, really.) There are key nuances within the standard itself that allow for flexibility and require appropriate judgments that management needs to consider.
  3. Outside parties could use inappropriate risk factors, portfolio segments, reversion techniques, and so forth that do not correctly align with the risks associated with your portfolio. Remember, no one knows your portfolio better than you do.

I’ve completed my detailed review of the standard. What’s next?

Once you have reviewed the standard in detail, the next step is to share that knowledge with your board members and management. In my next blog post, I will include details on techniques to make sure you cover.

 Until then, rest up. There is much more training to be had!

Jason Brodmerkel, Senior Technical Manager- Accounting Standards, Association of International Certified Professional

BB8 courtesy of Crystal Eye Studio/Shutterstock.

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