Recent new guidance and potentially more to come is aiding companies in their long journey to new accounting for credit losses.
The Financial Accounting Standards Board and its Transition Resource Groupare working through questions and determining where standard setting might be in order to help companies that are determining how to develop a more forward-looking approach to recognizing credit losses in financial statements.
Accounting Standards Codification Topic 326 requires companies to develop and implement a “current expected credit losses” approach to determine when and in what amounts to recognize losses arising from credit instruments. Public companies are required to reflect the new CECL standard beginning in 2021, with private companies following a year later.
FASB recently issued a proposed update to accounting standards to indicate its thinking on a few issues, and several more questions have been resolved over the summer through discussion at public meetings. Overall, the financial services industry in particular, which is most heavily affected by the new accounting, is pleased with the direction of technical guidance, says John Gallagher, executive director in advisory services at EY.
“The views expressed by FASB staff show they are supportive of trying to address implementation of CECL in a practical manner,” says Gallagher. “That is welcomed by the industry.”
The board’s latest proposal, for example, seeks to resolve some transition complexity expected by private banks and to shore up some confusion over operating leases. The original standard, issued in Accounting Standards Update No. 2016-13, contained language that seems to suggest operating lease receivables would fall within the scope of accounts receivable subject to the new credit losses standard. FASB proposes to amend the standard to clarify that operating leases should be accounted for under separate rules for lease accounting.
While the amendment is not yet final, it gives a clear indication of where the rule is headed, which gives companies some comfort about how to proceed with their adoption activities, says Gautam Goswami, national assurance partner at BDO USA. “That was a gray area,” he says.
The board has indicated that it plans further amendments to clarify treatment of accrued interest receivable balances as well. The amendments will allow companies to measure the allowance for credit losses on accrued interest receivable balances separately from other components of amortized cost basis of associated financial assets and net investments in leases.
“You can’t just throw your data over the fence and wait for a magic number to come back. The management team has to stay really engaged to understand what decisions are being made by the model, to agree with those decisions and to be able to defend why it was the right decision for their portfolio.”
Mike Lundberg, Partner, RSM
The board also plans to allow companies to make an accounting policy election to present accrued interest receivable balances and related allowance for credit losses separate from the associated financial assets and net investments in leases in the balance sheet, and it plans to provide for a practical expedient for certain disclosure requirements. Additional amendments will focus on accrued interest on nonaccrual loans, transfers of loans and debt securities between categories, and recoveries.
The board’s intended direction on accrued interest is an example of a practical conclusion emerging from FASB, in Gallagher’s view. “Historically, companies have never really combined accrued interest receivable and the principal balance when coming up with their impairment, so it was going to cause a lot of effort in order to look at them together,” he says.
The continued chipping away at technical questions through the standard-setting process enables companies to continue chipping away at implementation. And they’re doing so at varied paces, depending on how critical the standard is to their balance sheet and how soon they are facing an effective date, experts say.
On one end of the spectrum, the largest financial institutions facing the public company effective date are generally working to refine and test their intended models this year so they can run their new processes side by side with their current processes for an entire calendar year before the standard takes effect, says Gallagher.
“Companies are preparing to do parallel runs to make sure what they are running makes sense,” he says. Ideally, that means being ready to run by Jan. 1, 2019, but even a six-month parallel run would be helpful, he says. To meet that kind of time line, “the clock is ticking,” he says. “You are running out of runway.”
Parallel runs enable double checks not only on the accounting itself, but also the internal controls and governance issues, says Jonathan Prejean, managing director in the advisory practice at Deloitte. “You want to run it through your governance process for approval and mockup, and you want to practice that approval process so there’s an understanding of what’s going to be needed and how it’s going to be presented so you can make an informed decision,” he says.
Even for larger financial institutions facing that most aggressive time line, readiness spans a wide spectrum, says Prejean. Some companies are planning parallel runs for the entire calendar year of 2019, some for only part of the year, he says. “For the most part, they are making progress toward that goal of implementation in 2020,” he says.
On the opposite end of the spectrum, smaller banks, especially those that are private, are still trying to determine what they need to do, says Mike Lundberg, a partner and national director of financial institution services at audit firm RSM. “Progress is still slow,” he says. “Community banks are still digesting and formulating a plan.”
Banks on the smaller end of the spectrum generally are finding the job to be more difficult than they expected, says Lundberg. Facing uncertainty about how to address some of the technical requirements or how to source some of the data they may need, some banks are starting to turn to third-party technology vendors, he says.
While it’s a viable resource, that path comes with “challenges of its own,” says Lundberg. Companies are required to own their accounting processes and decisions, not blindly rely on third parties to provide them, he says. “You can’t just throw your data over the fence and wait for a magic number to come back,” he says. “The management team has to stay really engaged to understand what decisions are being made by the model, to agree with those decisions and to be able to defend why it was the right decision for their portfolio.”
James Kendrick, vice president of accounting and capital policy at Independent Community Bankers of America, shares that concern. He’s worried third-party vendors may be selling smaller banks on solutions they can simply plug in and run to achieve compliance, especially in situations where the bank may not even need such a solution. “Banks may get a false sense of security that just because they’re using this solution they’re compliant,” he says. “They still have to understand what it’s doing.”
CECL should also be on the radar at public companies that are not in the financial services sector, says Goswami, although many of them are heavily occupied now with the adoption of the new lease accounting standard, which takes effect Jan. 1, 2019. Although non-financial companies are not as heavily affected as those in financial services, the standard will apply to any company that carries an accounts receivable balance, he says.