Consistent with the adoption of other major accounting standards, regulators will be watching closely for increasingly detailed disclosures to investors about the expected effects of moving to a new method for recognizing credit losses.
Wesley Bricker, chief accountant at the Securities and Exchange Commission, told bankers at a recent conference that disclosures explaining transition to the new “current expected credit losses,” or CECL model for reflecting performance in credit-based financial instruments, will need to be specific enough to help investors understand the change that is coming. “Nobody likes surprises,” he said.
All public companies, but financial institutions in particular, will see changes to their balance sheets as they adopt Accounting Standards Codification Topic 326 to adopt a more forward-looking approach to recognizing signs of trouble in their loan portfolios or accounts payable balances. The standard takes effect on Jan. 1, 2020, for public companies, a year after companies complete their adoption of new lease accounting requirements.
Leading up to the adoption of major new accounting standards, the SEC staff has reminded companies early and often to be sure they give investors plenty of fair warning about what is going to change, as required under SEC Staff Accounting Bulletin No. 74. “Transition disclosures enable investors to understand the anticipated effects of the new standard,” Bricker said.
Companies that report under International Financial Reporting Standards have already adopted a similar but not identical standard for recognizing loan losses under IFRS 9. Their reporting has informed the thinking at the SEC about what companies should consider disclosing, said Bricker, who suggested some specific concepts for companies to keep in mind.
Forewarning disclosures under SAB 74 should contain “easy-to-understand explanation of new terms and key concepts,” Bricker said, along with “specific descriptions of the methodology and significant judgments made by management.” Companies should even consider tabular presentation of the economic assumptions they are relying on as they arrive at their loan loss provisions, as well as quantified effects of moving from the current incurred loss approach to the new expected loss approach, he said. In fact, those effects should be disaggregated, or presented separately, for each lending portfolio, Bricker said.
Audit committees need to be engaged as well, said Bricker, overseeing the implementation plans, the status of progress, and any changes that are necessary to internal control over financial reporting as a result of the transition. “The audit committee plays a vital role in overseeing a company’s financial reporting, including implementation of new accounting standards,” he said.
With respect to the ongoing work to adopt the new standard, Bricker reminded companies to be sure they keep good books and records, establish sufficient internal controls, and document their methodology for determining loan losses each reporting period.