The Financial Accounting Standard Board (FASB) dealt a blow to the financial services industry during a recent board meeting. On April 3, the FASB rejected a proposal from a group of regional banks related to changes to the credit loss impairment standard.
Financial services groups and other lenders are gearing up for significant changes to accounting for financial instruments and credit losses. The FASB’s Accounting Standards Update (ASU) 2016-13, Financial Instruments – Credit Losses (Topic 326) is effective for fiscal years beginning after Dec. 15, 2019 (generally calendar year 2020 for public business entities) and Dec. 15, 2020 (generally calendar year 2021) for private entities.
FASB’s credit loss impairment changes could have a dramatic impact on financial services organizations because it is likely that these organizations will be recognizing credit losses earlier than they do under current U.S. generally accepted accounting principles (U.S. GAAP). Credit loss impairment in existing U.S. GAAP follows an “incurred loss” impairment model where entities recognize impairment losses when the credit losses are incurred or when a triggering event indicates it is probable a financial instrument will have credit impairment. Changes to the credit loss impairment model in ASU 2016-13 will require entities to record a lifetime expected loss as an allowance, known as the Current Expected Credit Loss (CECL) reserve, when a financial instrument is acquired.
Financial Services Groups Push Back
A group of regional banks submitted a comment letter to the FASB in November 2018 about the impact the measurement of credit loss for financial instruments would have on their sector. The group proposed an alternative to the CECL model where a reporting entity could recognize the credit loss for impaired and non-impaired financial assets differently. For non-impaired financial assets, the reporting entity would record loss expectations within the first year to Provisions for Losses in the income statement. Loss expectations beyond the first year would be recorded to Accumulated Other Comprehensive Income (AOCI). For impaired financial assets, lifetime expected credit losses would be recognized entirely in earnings.
In its letter, the group argued that its proposed changes would align with the matching principle definition of an expense in FASB Concepts Statement No. 6 while still providing financial statement users with additional insight into a financial instrument’s lifetime risk. The letter also suggested that the new credit loss standard creates challenges for forecasting the changes in economic conditions that could affect credit loss impairment and may result in institutions adjusting their estimates to credit loss impairment at the onset of an economic downturn, potentially “exacerbating” the effect of that downturn on financial instruments.
A follow-up letter on the matter was sent in January 2019, where the regional bank group reiterated its points and requested a delay in the roll-out of the new credit loss standard.
Takeaways from the FASB’s Response
The FASB did more than reject an accounting change proposal in its April 3 meeting. When it ruled not to add the regional banks’ accounting change to its technical agenda, the FASB also indicated that the credit loss impairment standard is still on track to roll out as scheduled. Financial institutions and other entities have been asking for a delay in the implementation of the standard.
Moving Forward
Entities that hold or acquire a significant number of financial instruments need to be preparing now for the potential impact of the change to the credit loss impairment model. It does not appear likely that a longer implementation window will be offered. For assistance in assessing how your organization will be affected by the accounting change, please contact us.
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