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The Current Expected Credit Loss Model is Here… Now What?

HamiltonYou know the feeling you get when you are excitedly looking forward to something? It just can’t come soon enough. For instance, you enter Broadway’s mega-popular Hamilton -- the musical lottery -- every morning and anxiously await the email saying that you won. Even if the chances are only 909 to 1. 

The financial institution community has been anticipating the release of the Financial Accounting Standards Board’s credit losses standard. We have been following the process since the beginning. We reviewed drafts and submitted comments along the way. We participated in focus groups and met with the FASB to discuss the community banks’ concerns. The final standard is here. Now what?

Last month, the FASB issued Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326). The release of this new standard marks the end of accounting for credit losses using an incurred model. Institutions should not only consider all factors that have been incurred as of the reporting date, but also should estimate losses over the life of the loan. If an institution cannot estimate credit losses to the end of the loan’s life, taking into consideration any anticipated prepayments, it must estimate as far as it can and then revert back to the mean for the remaining years. This process sounds simple enough to implement, right?

Large banks and credit unions may have the necessary resources to build new models. However, this may not be the case for small community banks and most credit unions. This population will require education in order to get the accounting right. This subset of financial institutions will need to consider the methodologies available carefully, as well as how their existing allowance strategies would convert to lifetime expected credit losses under the Current Expected Credit Loss (CECL) model. They will want to consider whether the institution will build upon their existing model or acquire new modelling tools from external vendors. In a subsequent blog post, I will discuss various methodologies that institutions can use when implementing the new standard.

The AICPA is here to help. In this video, I provide an overview of the new standard and highlight some of the resources that will be made available. Visit the AICPA’s Financial Instruments webpage for up-to-date information on the new standard. Additionally, the AICPA is hosting a webcast providing an overview of credit losses on financial instruments on July 28 at 2:00 p.m. ET.  

   

Salome Tinker, AICPA Senior Technical Manager - Accounting Standards Team, American Institute of CPAs.

Hamilton image courtesy of Shutterstock

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