FASB Announces New Methodology for Credit Loss Recognition by Robert Aldir, CPA
Posted on April 20, 2017 by Robert Aldir
The Financial Accounting Standards Board (FASB) recently issued a new standard for financial institutions and other businesses to follow when accounting for credit losses in financial instruments measured at amortized cost, including debt instruments, trade receivables, lease receivables, reinsurance receivables, net investments in leases, financial guarantee contracts and loan commitments. Accounting Standards Update No. 2016-13, Financial Instruments-Credit Losses (Topic 326) will be effective after December 15, 2019, for U.S. Securities and Exchange Commission (SEC) filing public companies and after December 15, 2020, for non-SEC filing public companies. Early application will be permitted for all organizations beginning after December 15, 2018.
Under the newly introduced Current Expected Credit Loss (CECL) model, businesses will no longer rely on an “incurred loss” approach that allows them to delay recognition of credit losses until it is probable that a loss has been incurred. Rather, the CECL model will require entities to recognize as an allowance in current period earnings an estimate of the contractual credit losses they expect to incur over the contractual life of all loans and financial instruments they hold at the reporting date. Making this immediate, forward-looking estimation will further require businesses to consider historical events, current conditions and reasonable forecasts that support the amount they do not expect to collect in the future on loan portfolios and other assets they hold currently. This, in turn, will require enhanced disclosures to provide investors and other users of financial statements with better transparency regarding businesses’ underwriting standards, credit quality, and how they estimate potential losses.
Excluded from the new model are those instruments measured at fair market value and some equity instruments. Similarly, while entities may continue to use existing methods to measure available-for-sale debt securities with unrealized losses, they will no longer be able to recognize those losses as reductions in the amortized cost of the securities.
Transitioning to the new standard for recognizing credit losses will require all reporting entities to assess how they currently account for credit impairments. It will also require changes to businesses’ existing policies, systems and processes to measure credit quality, maintain loss information, forecast future economic conditions and implement new collection estimation techniques. Earlier recognition of allowances for credit losses may result in significant adjustments in credit reserves, for which businesses must begin planning under the guidance of experienced accountants and advisors sooner, rather than later.
The advisors and accountants with Berkowitz Pollack Brant work with individuals and business owners in a broad range of industries and across international borders to develop and implement strategies that meet ever-changing, often complex, financial reporting and disclosure requirements.
About the Author: Robert C. Aldir, CPA, is an associate director of Audit and Attest Services with Berkowitz Pollack Brant, where he provides accounting, auditing and litigation-support counsel to public and privately held companies located throughout the world. He can be reached at the firm’s Miami office at (305) 379-7000 or via email at firstname.lastname@example.org