The accounting profession is digging into the new accounting standard on credit losses and suggesting some implementation approaches with two draft documents circulating for public review and comment.
The American Institute of Certified Public Accountants has formed a task force to explore implementation issues that are arising particularly in the financial services and insurance sectors as they prepare to adopt Accounting Standards Update No. 2016-13. That’s the new standard on reflecting credit losses in financial instruments, which requires companies to follow a “current expected credit losses” model for determining how to reflect debt instrument performance in financial statements.
The new CECL model, codified in Accounting Standards Codification Topic 326, replaces the current “incurred loss model” by telling companies to take a more forward-looking approach to booking loan losses. The idea is to give investors earlier warning when instruments may be headed for trouble. Companies must estimate the potential for losses using a combination of their own historic data and market or industry data, and they must estimate and book possible losses from the inception of a given instrument, even when it is fully performing. Financial institutions, which are most heavily affected by the new standard, are reporting challenges in preparing for the new accounting.
The FASB formed a Transition Resource Group to field questions and concerns as they arose through implementation activities, and it recently determined it will extend the effective date for non-public business entities due to some uncertainty over how to comply with transition provisions. The FASB is expected to issue a proposed amendment to the standard to clarify its intent with respect to transition for those entities.
The AICPA has formed a task force as well to work through questions arising in the profession, and it is developing draft documents for review and public comment to try to build some consensus in terms of how the requirements are being interpreted and observed. The task force has developed nearly 40 issues that are being developed into similar working draft documents, and it has issued two so far for public review and comment.
The first focuses on zero expected credit losses, or where an entity can reasonably estimate and report that it expects no credit loss to occur. The standard does not preclude the possibility that an instrument will perform perfectly, leading to no loss, but it also doesn’t make it easy for entities to assume as much.
“Under CECL, a measure of expected credit losses is required even if the expected risk of credit loss is remote,” the AICPA writes in its working draft. “However, the ASU goes on to state that no measure of expected credit losses is required for a financial asset or group of financial assets if historical credit loss information, adjusted for current conditions and reasonable and supportable forecasts, results in an expectation of nonpayment of the amortized cost basis of zero.”
The working draft presents a series of indicators that entities might consider as it determines whether it can support a zero expected credit loss on a given instrument. “This is a way for us to help folks say here’s what we identified as potential zero credit losses based on our facts and circumstances now, and here’s why, says Jason Brodmerkel, a staff member in the accounting standards group at the AICPA.
The second paper is focused on the reversion method companies would apply under the new standard. The standard says companies can revert to historic loss information under certain circumstances, and that has produced questions on whether that would constitute a change in accounting principle or a change in accounting estimate, for example. The paper explores the relevant guidance and seeks to help entities understand how to consider the questions based on their own facts and circumstances.