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Recognition of Credit Losses Updated

June 28, 2016

Financial Accounting Standards Board (FASB)'s Accounting Standards Update (ASU) 2016-13, Financial Instruments-Credit Losses (Topic 326)- Measurement of Credit Losses on Financial Instruments replaces the existing "incurred loss" methodology for recognizing credit losses with the current expected credit losses (CECL) method. The change affects assets amortized at cost and available-for-sale debt securities and it seeks to clarify the methods, process, and systems entities use to measure credit losses. A response to the global financial crises, changes will affect credit losses related to loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures and reinsurance receivable, among other assets that are not accounted for at fair value through net income.

Assets Measured at Amortized Cost

Assets measured at amortized cost will now be presented at the net carrying value of the amount expected to be collected. Entities will report the allowance for expected credit losses by reducing the amortized cost basis by a valuation account referred to as the allowance for loan and lease losses (ALLL). Determining the expected credit loss requires the consideration of past performance, current conditions and reasonable forecasts that support the collectability of the loss. Judgment is also needed to decide the type of information to consider and which estimation method to use for the expected credit loss amount. Information presented will also include the credit losses for recently recognized financial assets as well as expected increases or decreases to losses that have taken place during the reporting period.

Allowance for credit losses for purchased financial assets with credit deterioration (PCD assets) (those with more than insignificant credit deterioration since original issuance) that are measured at amortized costs will also follow that guidance, with one exception: the initial allowance for credit losses will be added to the purchase price rather than reported as a credit loss expense. Only subsequent changes will be measured as credit loss expenses using the CECL or available-for-sale debt security impairment models. Interest income should be recognized based on the asset's effective interest rate and exclude any discount embedded in purchase price that relates to the assessment of credit losses at acquisition.

Available-for-Sale Debt Securities

Credit losses for available-for-sale debt securities should also be measured as an allowance for credit loss in place of the other-than-temporary impairment (OTTI) model. The new standard will limit the allowance for credit losses to the difference between the security's fair value and its amortized cost because the expectation is the security would be sold at fair value, and if the expected credit loss were factored in, the seller would receive a price less than the fair value for the security. Similarly to the assets measured at amortized at cost, assets with more than insignificant credit deterioration would initially account for their credit loss as part of their purchase price and then recognize subsequent credit loss as credit loss expenses.

Effective Dates

Public business entities registered with the U.S. Securities and Exchange Commission (SEC) are required to adopt the standard for fiscal years, and interim periods within, beginning after December 15, 2019. Other public business entities are required to adopt for fiscal years and interim periods within beginning after December 15, 2020. All other entities, such as private companies, not-for-profit entities and employee benefit plans, are required to adopt for fiscal years beginning after December 15, 2020, and interim fiscal years beginning after December 15, 2021. Early adoption is permitted for all entities for fiscal years and interim periods within beginning after December 15, 2018.

For More Information

If you have specific comments, questions or concern about the new credit loss standard, please contact your local MHM professional.


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