Clarifications on the Credit Loss Standard

Banks and creditor losses reporting from sourced loans will change with Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Accountants have some lingering questions about updated guidance details, particularly with the implementation deadline looming for most public companies. Therefore, the Financial Accounting Standards Board (FASB) issued narrowly drawn amendments in November 2019 to clarify five issues.

Much-Needed Change

In the wake of the 2007-2008 global financial crisis, the FASB updated credit loss reporting rules. Financial institutions are now required to record completed expected credit losses in their loan portfolios immediately. This expected credit loss model was introduced for the impairment of financial assets measured at amortized cost basis, replacing the probable, incurred loss model for those assets.

ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments — Credit Losses, removes potential implementation hurdles as companies adopt the updated credit loss rules. These changes are effective at the same time as ASU 2016-13.

“After issuing the current expected credit losses standard — also known as CECL — in 2016, the FASB received questions about certain confusing areas of the guidance,” stated FASB Chairman Russell Golden. “The new ASU clarifies these areas of the guidance to ensure all companies and organizations can make a smoother transition to the standard.”

The amendments provide better guidance on how to report expected recoveries. Expected recoveries are amounts a company expects to recover from soured financial assets after the company initially wrote off a portion of or the full asset amount.

Getting Rid of Implementation Hurdles

ASU 2019-11 specifically addresses five primary issues:

1. Expected recoveries for purchased financial assets with credit deterioration. Financial statement preparers asked the FASB whether expected recoveries were permitted on assets that already show credit deterioration at the time of purchase (PCD assets). Under the updated guidance, it clarifies that the allowance for credit losses for PCD assets should include in the allowance for credit losses any expected recoveries of amounts previously written off and expected to be written off by the entity. The estimate shouldn’t exceed the amount aggregate of the amortized cost basis, previously and expected to be written off.

The updated guidance also clarifies that, when a method other than discounted cash flow is used to estimate expected credit losses, expected recoveries should not include any amounts that result in a noncredit discount acceleration. An entity may include expected cash flow increases after acquisition.

2. Transition relief for TDRs. The updated guidance provides an accounting policy election to adjust the effective interest rate on existing troubled debt restructurings (TDRs) using prepayment assumptions on the Topic 326 adoption date. Without this election, the entity must use the prepayment assumptions immediately before the restructuring.
3. Disclosures related to accrued interest receivables. The updated guidance extends the disclosure relief for accrued interest receivable balances to additional relevant disclosures involving amortized cost bases.
4. Financial assets secured by collateral maintenance provisions. For financial assets secured by collateral maintenance provisions, entities may elect to use a practical expedient to measure the expected credit losses estimate. The practical expedient compares the amortized cost basis of a financial asset and the fair value of collateral securing the financial asset as of the reporting date.

The updated guidance clarifies that an entity using the practical expedient should assess whether it reasonably expects the borrower to be able to continually replenish collateral securing the financial asset. An entity may determine there are no expected losses for the secured portion of the amortized cost basis.

5. Outdated reference replacement in the business combinations guidance. The updated guidance makes an amendment to Accounting Standards Codification (ASC) Subtopic 805-20, Business Combinations — Identifiable Assets and Liabilities, and Any Noncontrolling Interest, removing the cross-reference to Subtopic 310-30, Receivables — Loans and Debt Securities Acquired with Deteriorated Credit Quality. Instead, the amendment correctly cross-references the guidance for purchased financial assets with credit deterioration in Subtopic 326-20, Financial Instruments — Credit Losses — Measured at Amortized Cost.

FASB Approves Credit Loss Standard Delay for Certain Entities

The FASB issued updated guidance that changes the updated credit loss standard effective date for smaller reporting companies (SRCs) from 2021 to 2023, and from 2022 to 2023 for private companies and not-for-profits in November 2019. These dates refer to calendar-year-end filers.

The SEC defines SRCs as companies that have either:

• A public float of less than $250 million, or
• Annual revenue of less than $100 million and no public float or a public float of less than $700 million

Calendar-year-end SEC filers (typically larger public companies) that aren’t SRCs must implement the changes by January 1, 2020.

Need Help?

Generally, investor groups welcome the updated credit loss standard changes. However, many financial intuitions argue that the costs outweigh its benefits. In light of these conflicting views, some members of Congress have asked the FASB to defer the standard’s implementation deadline pending further research. To help clarify matters, the FASB has decided to hold its course and issue ASU 2019-11. If you would like more information on implementing the guidance for credit losses, contact Weaver today.

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