The current expected credit losses (CECL) journey began with the issuance of an exposure draft in 2010, continued with the issuance of a supplementary document in 2011, and an additional exposure draft in 2012. After much debate and over 3,300 comment letters, the Financial Accounting Standards Board (FASB) released the much-anticipated Accounting Standards Update (ASU) No. 2016-13, Financial Instruments—Credit Losses in June of 2016.

Understanding the New Standards

As you probably know by now, the CECL model requires affected entities to immediately record the full amount of credit losses on financial assets expected, rather than waiting until the losses are deemed probable (as required by the current incurred loss model). ASU 2016-13 further requires companies to present assets measured at amortized cost at the net amount (of an allowance for credit losses) expected to be collected.

The income statement will reflect the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the relevant reporting period. The measurement of expected credit losses is based on relevant information about past events (including historical experience), current conditions, and the “reasonable and supportable” forecasts that affect the collectability of the reported amount.

Much to the dismay of affected entities, a specific technique to estimate credit losses was not prescribed—rather companies will have to exercise judgment to determine which method is appropriate for their circumstances. ASU 2016-13 allows companies to continue to use many of the loss estimation techniques currently employed, including loss rate methods, probability of default methods, discount cash flow methods, and aging schedules. However, the inputs of those techniques will change to reflect the full amount of expected credit losses and the use of reasonable and supportable forecasts.

How These Changes Will Affect You

The new standard also changes the reporting for credit losses on purchased financial assets with credit deterioration since origination. The allowance for credit losses for such assets will be determined in a manner similar to that of other financial assets measured at amortized cost, except that the initial allowance will be added to the purchase price rather than recorded as credit loss expense. Additionally, credit losses on available for sale debt securities will be recorded through an allowance for credit losses, rather than a one-time write-down.

ASU 2016-13 also expands the disclosures of credit quality indicators related to the amortized cost of financing receivables currently required. The disclosures must be disaggregated by their years of origination (or “vintage”). Disaggregation by vintage will be optional for nonpublic institutions.

Companies will apply the changes through a cumulative-effect adjustment to their retained earnings as of the beginning of the first reporting period in which the standard is effective—what’s known as a modified-retrospective approach. The new standard is effective for SEC filers in the first quarter of 2020. It takes effect for Public Benefit Entities (non-SEC filers) in 2021 and privately held institutions in 2022.

Up until this point, many industry observers have anticipated some form of indefinite delay for smaller, less complex institutions or even a possible exemption. While those discussions continue, the prudent path remains for all companies to press forward on CECL implementation without delay.

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Keep up with the latest CECL regulation advancements and stay engaged with CRI as our CECL experts continue to convey timely and relevant information to assist your institution in meeting the challenges and seizing the opportunities ahead.