The Financial Accounting Standards Board (FASB) recently proposed a revised credit impairment model that would facilitate more efficient recognition of credit losses, specifically those of assets unaccounted for at fair value through net income.
The most recent Accounting Standards Update, or ASU, proposes guidelines that apply to all entities holding financial assets that are exposed to credit risk. These include loan receivables, lease receivables and account receivables, as well as debt securities and commitments to lend. The changes come after comments for the originally proposed ASU were solicited in December 2012, with redeliberation taking place thereafter based on the comments received. Essentially, the new model would utilize an expected credit-loss measurement approach that replaces existing impairment models.
The impact on individual entities
Financial services clients should mostly be concerned with the changes pertaining to loan receivables and the allowances for loan loss. Per the terms of the most recent proposal, management is now required to estimate the cash flows they do not expect to collect using all available information, including not only historical indicators but also any supported forecasts for upcoming quarters. The FASB has noted that it anticipates expected credit-loss estimates will be measured for similar asset types based on the credit-risk ratings determined by the balance sheet date. This means, theoretically, that some companies will be in a position to leverage their existing internal credit-risk management tools and services as part of the implementation process for the new model.
As things stand, the current expected credit losses (CECL) model still applies to financial assets measured at cost. Under these conditions, an entity should not recognize expected credit losses for a financial asset whose fair value exceeds or equals its amortized cost basis. If that asset’s fair value is less than its amortized cost basis, the CECL model determines credit losses in net income based on the difference between that asset’s fair value and the cost basis.
Other potential future points of interest
During its redeliberation process, the FASB has considered “follow-on issues,” such as whether there will be a need for unit-of-account guidance during the process of measuring expected losses. The topic of how to appropriately recognize credit losses under unusual circumstances has also been discussed. Specifically, the board has sought to determine whether recognized losses should be the entire difference between fair value and amortized cost if it’s likely the entity will be forced to sell an asset prior to recovery, or if it subsequently identifies a financial asset for sale.
Ultimately, ASU guidance will be provided in the interest of clarifying cost-basis adjustments so that entities understand the requirements for restructured financial assets. Then, that entity would need to allocate for each individual asset any non-related discount or premium that results from acquiring a pool of purchased credit-impaired financial assets. When an entity ceases to accrue interest income, it will receive no further guidance.
Financial services clients seeking greater clarity regarding the impact of the changes on loan receivables and related allowances may consult with a LaPorte professional, who can walk them through the pertinent terms of the latest ASU.