To answer questions about implementation of the new credit losses standard, the Financial Accounting Standards Board issued a question-and-answer document focusing on a specific approach that some entities are considering.
The questions surround the “weighted average remaining maturity” or WARM method for estimating allowances for credit losses under Accounting Standards Codification Topic 326. The new standard, taking effect Jan. 1, 2020, for public companies, requires entities to adopt a “current expected credit losses” approach to determine how they should reserve for and report loan losses to investors in financial statements.
FASB says some entities, including smaller financial institutions, have asked the staff whether they can use the WARM method for determining their CECL reserves. In its Q&A, FASB yes, it can work, and it explains how. The document emphasizes the original guidance in ASC 326 that tells entities the standard does not prescribe an exact method for determining the CECL allowance, instead directing entities to use an appropriate combination of historic experience, current conditions, and reliable forecasts to establish their models.
WARM relies on an average annual charge-off rate as a basis for estimating expected losses on remaining balances associated with pools of similar credit-based financial instruments. The Q&A says companies are expected to develop a range of approaches, “from simple spreadsheet calculations to complex econometric models,” with the complexity and sophistication of methods reflecting the complexity and sophistication of the risk management processes that the entity normally uses for specific pools of assets. The Q&A continues to provide detailed examples of how the WARM method might work.
As entities prepare to adopt CECL, they have brought questions and concerns to FASB ranging from detailed technical questions to calls for reconsideration of the model and even a delay in the effective date. FASB has long said it expected entities to develop models they believe reflect the way they manage their business, while smaller financial institutions in particular have worried whether auditors would demand more complex modeling.