With a new standard expected before the end of the year to change the way financial institutions account for credit impairments, the Securities and Exchange Commission will be watching for strong processes and controls around critical judgments.
SEC Chief Accountant James Schnurr told accountants at a national banking conference to prepare themselves to deal with differences between U.S. and international standards on credit impairments, learn what they can from international implementation, and take responsibility for developing robust processes and controls around the many judgments that will be required. “The development, documentation, and application of a systematic methodology used to determine credit loss estimates, as well as policies surrounding the validation of such methodologies have always been, and will continue to be, critical in supporting the allowance for loan losses recorded in the financial statements,” he said, according to his prepared remarks.
The Financial Accounting Standards Board is expected to finalize its new standard on the accounting for loan losses in the fourth quarter. FASB’s planned standard has some similarities to a loan loss standard introduced last year under International Financial Reporting Standards, but with a key difference. FASB’s standard will require entities to estimate the lifetime expected loss for loans and reflect it in financial statements at inception. The IFRS standard limits the measurement of expected losses where there is no indication of credit impairment to 12 months, with lifetime expected losses only recognized where loans have exhibited a significant increase in credit risk.
“Under both models, the definition of expected credit losses is an estimate of all contractual cash flows not expected to be collected from a recognized financial asset or group of financial assets,” Schnurr said. “Therefore, while the models are not fully converged, I believe U.S. registrants preparing for the issuance of the FASB’s credit impairment model can learn from the current implementation efforts overseas and leverage some of those thought processes as they begin their implementation process here in the U.S."
The SEC’s top accountant also warned financial institutions to remember that compliance with the accounting standard to provide transparency to investors should not be confused with concerns that might be raised by other banking regulators, who are more focused on capital adequacy. “In preparing the financial statements the objective is for management to make its best estimate of the expected loss, which may not reflect the estimate desired for safety and soundness purposes,” he said. “In those instances, prudential regulators have the mechanisms available to make changes to the regulatory capital regime, similar to how changes in fair value for available for sale securities are currently addressed in the capital regimes.”
Schnurr also confirmed earlier remarks that the SEC’s interest in pursuing greater use of IFRS in the United States is waning. “There is virtually no support to have the SEC mandate IFRS for all registrants, he said. “There is little support for the SEC to provide an option allowing domestic registrants to prepare their financial statements under IFRS.”
The only consensus the SEC has identified is an interest in moving toward a single set of globally accepted standards, leaving the SEC to explore how to achieve that desired objective. As such, Schnurr batted the ball back to the FASB and the International Accounting Standards Board. “In the near term, the FASB and IASB should continue to focus on converging the standards,” he said. “The boards should renew their commitment to cooperate and develop standards that eliminate differences between IFRS and U.S. GAAP whenever it meets the needs of its constituents and improves the quality of financial reporting.”