Armanino Blog

Are You Ready for the New Credit Losses Standard?

by Jason Gilbert
July 20, 2018

The new credit losses standard will require banks and other creditors to recognize losses on bad loans earlier than under current U.S. Generally Accepted Accounting Principles (GAAP). It goes into effect for public companies in 2020; private companies have an extra year to implement the changes. However, the American Institute of Certified Public Accountants (AICPA) is requesting that the latter deadline be extended, because some smaller financial institutions and private companies are concerned that the transition will be difficult unless they get more time.

Close-up on credit losses

The Financial Accounting Standards Board (FASB) responded to the 2008 financial crisis by issuing Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. It’s based on a current expected credit loss (CECL) model, which relies on estimates of future losses. By contrast, current GAAP relies on an incurred-loss model to recognize losses.

Specifically, the new credit losses standard requires banks and other businesses to look to the foreseeable future; consider all reasonable and supportable losses that could happen over the life of the loan, trade receivable or security in question; and book losses. Under the CECL model, the estimate isn’t supposed to cover a best-case or worst-case scenario. To record a loss provision, banks should take into account past experiences, future estimates and current trends in the economy, using their best judgment.

The loss provision, or reserve, is a much-watched figure on banks’ balance sheets and income statements. It’s designed to offer insight into how a bank is performing. Investors and bank examiners pay close attention to changes to loss reserves because, when a bank increases its loss provision, it sends a signal that trouble is coming.

More time

The FASB staggered the effective dates for large banks, small banks, and nonpublic organizations and businesses. But the AICPA and the Credit Union National Association (CUNA) say the standard’s effective date is worded in such a way that many smaller organizations will be left with less time to implement the standard than what the FASB intended. These organizations are asking the FASB to amend the standard’s effective date and give community banks and credit unions until January 1, 2022, to implement the changes.

When the FASB proposed the credit losses standard in 2014, community bankers and credit unions were among the harshest critics of the changes, saying they didn’t partake in the riskiest lending practices that led to the 2008 crash. But the FASB maintained that the new accounting rules needed to apply to all financial institutions because banks of all sizes were affected by the crisis. However, the FASB conceded that credit unions and smaller banks needed more time to comply with changes.

The FASB declined to comment on the requests from the AICPA and CUNA, but that’s not unusual. The FASB doesn’t typically respond publicly to individual comment letters.

Ready, set, implement

Banks and other creditors have a lot of changes to implement in the coming years. In addition to the new credit losses standard, they also must tackle new rules on recognizing revenue and leases. This fall, expect the FASB to issue additional guidance to help facilitate the transition to the CECL model for reporting credit losses.

July 20, 2018

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