The Financial Accounting Standards Board has proposed updating its guidance for accounting for credit losses using the current expected credit loss model, or CECL, and asked for comments on the potential changes.
In an exposure draft issued Nov. 19, the FASB said that stakeholders had helped it identify areas that require clarification and correction in ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments, as well as in the two other ASUs it issued over the last several years that are related to financial instruments (ASU 2016-01: Financial Instruments—Overall and ASU 2017-12, Derivatives and Hedging).
Several of the proposed CECL changes arose from recent meetings of the Transition Resource Group, including a Nov. 1 meeting that covered disclosing lines-of-credit that are converted to term loans and determining the contractual term of a financial asset with extension or renewal options.
Amendments in its proposed CECL update would apply to all reporting entities. Some entities may have already adopted the new methodology by the time these latest proposals are finalized, the FASB acknowledged, saying it will need to set an effective date and transition requirements for the proposed amendments for those entities. For all others, however, effective dates and transition requirements of CECL would remain unchanged. The board said it would accept comments on the proposals through Dec. 19.
Here are some of the changes proposed, as outlined in the exposure draft issued:
Accrued interest: The first area relates to accrued interest and was a topic at the June 11 transition resource group meeting. There were concerns about current guidance related to some unintended implementation costs because of the requirement that writeoffs of assets measured at amortized cost be deducted from the allowance for credit losses when the financial assets are deemed uncollectible.
Because accrued interest is included in the definition of amortized cost basis, an entity would have to write off accrued interest amounts through the allowance, so the board proposed several options. Among them:
• Measuring the allowance for credit losses on accrued interest receivables balances separately from other components of the amortized cost basis of associated financial assets and net investments in leases and
• Allowing an accounting policy election not to measure an allowance for credit losses on accrued interest if the entity reverses or writes off uncollectible accrued interest amounts in a timely manner.
Recoveries: FASB proposes clarifying that an entity should include recoveries when estimating the allowance for credit losses, and its draft explains how to account for an amount expected to be collected greater than the amortized cost basis. Recoverable amounts included in the valuation account should not exceed the aggregate of amounts previously written off and expected to be written off.
Reinsurance recoveries: The proposal clarifies the FASB’s intent to include all reinsurance recoverables – even those measured on a net present value basis – within the scope of the guidance, regardless of the measurement basis of the recoverables.
Projections of interest-rate environments for variable-rate instruments: The proposal would remove the prohibition on using projections of future interest-rate environments when using a discounted cash flow method to measure expected credit losses on variable-rate financial instruments. The proposed amendments instead clarify that the same projections or expectations of future interest-rate environments should be used in both estimating expected cash flows and in determining the effective interest rate used to discount those expected cash flows.
Prepayments’ role in determining effective interest rate: An entity would be allowed, under the proposed amendment, to make an accounting policy election to adjust the effective interest rate used to discount expected future cash flows for expected prepayments. However, effective interest rates used to discount expected cash flows shouldn’t be adjusted for subsequent changes in expected prepayments if the financial asset is restructured in a troubled debt restructuring.
When to consider selling costs on probable foreclosures: The proposal is intended to clarify that an entity must consider estimated costs to sell if it intends to sell rather than operate the collateral when foreclosure is deemed probable.
Vintage disclosures—Line-of-credit arrangements converted to term loans: The proposed amendments would require disclosing the amortized cost basis of line-of-credit arrangements that are converted to term loans by origination year when an additional credit decision was made by the entity after the original credit decision. An entity isn’t required to disclose by origination year the amounts of line-of-credit arrangements that are converted to term loans if no additional credit decision was made by the lender or if they were converted to term loans because of a troubled debt restructuring. Instead, an entity should disclose these line-of-credit arrangements in a separate column within the vintage disclosure, according to the FASB’s exposure draft.
Contractual extensions and renewals: The proposal is intended to clarify that an entity should (with some exceptions) consider extension or renewal options in determining the contractual term of a financial asset if they are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the entity.
As previously discussed at its Nov. 7 meeting, the FASB will issue a separate exposure draft on codification improvements to the CECL standard that will include its proposed amendments to vintage disclosures of gross writeoffs and gross recoveries. The board at that meeting agreed to clarify that “gross writeoffs and gross recoveries should be presented by vintage year and class of financing receivable within the credit quality information vintage disclosure” offered by entities, according to meeting minutes. However, board members wanted to provide more time for feedback that would have been improbable had they included it in the current exposure draft.
The latest proposed changes to CECL also don’t include any mention of a potential extension of the CECL effective date – something that 45 larger banks have requested through their public policy and advocacy group, The Bank Policy Institute, in an Oct. 17 letter to the Financial Stability Oversight Council. The banks asked the FSOC, a panel of regulators, to evaluate “systemic and economic risks posed by CECL” and to engage with the FASB and regulators to seek a delay.