Bank regulators apparently are getting peppered with questions about how new accounting requirements for credit losses intersect with various rules and requirements for financial institutions, prompting a year-end Q&A to assure both institutions and examiners are on the same page.
The “frequently asked questions” guidance is focused on Accounting Standards Update No. 2016-13, issued by the Financial Accounting Standards Board in mid-2016 to require companies to follow a new, more forward-looking formula for estimating allowances for credit losses. Four agencies, including the Federal Reserve and the Federal Deposit Insurance Corporation, jointly issued the FAQs.
The FAQs summarize the new accounting requirements, which apply to all financial instruments carried at amortized cost, including loans held for investment purposes, net investment in leases, and debt securities that are held to maturity. For companies outside the financial services sector, the rules also apply to trade receivables and other off-balance-sheet credit exposures that are not accounted for as insurance, including loan commitments, standby letters of credit, and financial guarantees.
The “current expected credit loss” methodology that will be adopted under the new accounting standard will require entities to reflect in financial statements not just losses that have occurred, but those that could occur or will occur in future reporting periods based on some estimation and application of historical data. That's a big change from the way banks have reflected such allowances historically. Smaller financial institutions in particular objected to the new requirements, anticipating auditors and banking regulators would demand complex, costly modeling to arrive at the new loan loss allowances.
The FAQs say the CECL model is scalable to institutions of all sizes, so smaller banks and community institutions will not be expected to adopt complex modeling approaches to comply with the new accounting. The guidance also says institutions will not be required to hire third-party service providers to help estimate credit losses under the new model.
“CECL allows institutions to apply judgment in developing estimation methods that are appropriate and practical for their circumstances,” the guidance says. “The agencies expect supervised institutions to make good faith efforts to implement the new accounting standard in a sound and reasonable manner.”
For public companies, the new standard takes effect in 2020. FASB allowed plenty of lead time because of other bigger accounting changes taking effect for all public companies sooner, like revenue recognition, leases, and the recognition and measurement of financial instruments other than credit instruments.
The new guidance from banking regulators says the agencies will assess implementation of the accounting standard after it takes effect and consider whether additional supervisory guidance is in order to further steer practices for the sound application of the standard.