The FASB has issued narrowly drawn amendments to clarify five issues that accountants have flagged under its credit loss accounting standard, rules that change the way banks report losses from soured loans.
In its Nov. 26 meeting, the board issued Accounting Standards Update (ASU) No. 2019-11, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, to remove potential implementation hurdles as companies adopt ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.
The rules take effect Jan. 1, 2020, for large public companies with a calendar year-end reporting cycle.
“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,” FASB Chairman Russell Golden said in a statement. “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, which is what a company expects to recover from soured financial assets after it has initially written off a portion or the full amount of the asset.
Financial statement preparers had asked the board whether expected recoveries were permitted on assets that had already shown credit deterioration at the time of purchase (PCD assets). The rules clarify that companies are permitted to record expected recoveries on PCD assets.
“FASB clarified that recoveries should be part of your lost estimation,” said Greg Norwood, Deloitte’s CECL implementation leader for financial institutions. “So not just how much you lost on the loan when you charged it off, but how much did you collect after you’ve liquidated, collateral etcetera.”
The amendments do not change the CECL rules at a micro level, but they do take away from implementation hurdles that companies were seeing as they went through the rules, Norwood said.
Another notable change includes the simplification of disclosure rules for items such as accrued interest receivable, the text of the standard states.
“That was presenting a challenge relative to just pulling the numbers together for disclosure,” Norwood said. “But from an industry perspective, there’s nothing in here people weren’t expecting.”
Issues addressed in the rule
- Expected recoveries for purchased financial assets with credit deterioration: Clarifies that the allowance for credit losses for PCD assets should include in the allowance for credit losses expected recoveries of any amounts previously written off and/or expected to be written off by the entity; it should not exceed the aggregate of amounts of the amortized cost basis previously written off and/or expected to be written off by an entity. In addition, it clarifies that when a method other than a discounted cash flow method is used to estimate expected credit losses, expected recoveries should not include any amounts that result in an acceleration of the noncredit discount. An entity may include increases in expected cash flows after acquisition.
- Transition relief for troubled debt restructurings (TDRs): Provides transition relief by permitting entities an accounting policy election to adjust the effective interest rate on existing TDRs using prepayment assumptions on the date of adoption of Topic 326 rather than the prepayment assumptions in effect immediately before the restructuring.
- Disclosures related to accrued interest receivables: Extends the disclosure relief for accrued interest receivable balances to additional relevant disclosures involving amortized cost basis.
- Financial assets secured by collateral maintenance provisions: Clarifies that an entity should assess whether it reasonably expects the borrower will be able to continually replenish collateral securing the financial asset to apply the practical expedient. An entity applying the practical expedient should estimate expected credit losses for any difference between the amount of the amortized cost basis that is greater than the fair value of the collateral securing the financial asset (that is, the unsecured portion of the amortized cost basis). An entity may determine that the expectation of nonpayment for the amount of the amortized cost basis equal to the fair value of the collateral securing the financial asset is zero.
- Conforming amendment to Subtopic 805-20: The amendment to Subtopic 805-20, Business Combinations-Identifiable Assets and Liabilities, and Any Noncontrolling Interest, clarifies the guidance by removing the cross-reference to Subtopic 310-30 in paragraph 805-20-50-1 and replacing it with a cross-reference to the guidance on PCD assets in Subtopic 326-20.
To see how these changes could impact you, reach out to a professional on the KraftCPAs’ financial institutions industry team.