By Anne Rosivach
The Financial Accounting Standards Board (FASB) expects to issue an Exposure Draft (ED) of an Accounting Standards Update (ASU) that proposes a single measurement model for measuring credit losses, possibly by the end of 2012. The ED of the Current Expected Credit Loss (CECL) model will be published separately from an International Accounting Standards Board (IASB) ED, also expected to be issued soon, that is based on a "three-bucket approach" to credit impairment.
The FASB presented a webcast on November 9 that provided a high-level overview of the draft model. The majority of attendees at the webcast, which is archived on FASB's website, were employees of public and private organizations.
Both the FASB and the IASB had previously agreed on the three-bucket approach, but consistent feedback from US stakeholders raised significant concerns about the operability, auditability, and understandability of that model. The FASB decided that it was inefficient to issue an ED with known problems, and during the summer of 2012, the FASB re-deliberated the issues raised. The FASB proposed a new model, the CECL, that would address the concerns of stakeholders but which would build on important concepts agreed on by both boards.
Presenters Lawrence W. Smith, FASB member, and Steven M. Kane, FASB practice fellow, stated that the views expressed were their own and not necessarily the views of the FASB.
Following the financial crisis of 2008, the FASB and the IASB were asked to develop a usable model that would utilize forward-looking information and better reflect the economics of lending. During the webcast, Smith and Kane reviewed key concepts in an earlier IASB exposure draft and a joint Supplementary Document as well as the three-bucket approach that the IASB continues to support.
The concerns about the three-bucket approach, expressed by US stakeholders in 2012, were (1) the complexity that would arise from using two significantly different measurement objectives over the life of an asset and (2) the difficulty in switching from one time period to another.
Results of CECL
Smith summarized the results of the CECL model for investors and preparers.
- Balance sheet reflects management's current estimate of expected credit losses at the reporting date.
- Allowance can be easily understood since it is based on a single measurement objective.
- Income statement reflects changes in expected credit losses during the period.
- No "cliff effect" resulting from a change in measurement objective for the credit impairment allowance.
- Interest income measured using a decoupled approach; however, accrual ceases when collection is not probable.
- Consistent with investor's suggestions following the May 2010 ED.
- A model that leverages existing internal credit risk management tools and systems; however, the inputs to the measure will change.
- A consistent measurement approach throughout the portfolio with no barriers to recognition.
- An approach for Purchased Credit Impaired (PCI) assets that is (1) less complex and costly to implement and (2) easier to explain to investors.
CECL Measurement Concepts
The CECL model requires that management re-estimate credit losses for every reporting period on the balance sheet; favorable and unfavorable changes are reported in earnings on the income statement.
The new approach will replace the five existing impairment models for debt instruments in current US GAAP with a model that uses a single "expected credit loss" measurement objective for the allowance for credit loss. The CECL model is not limited to any time period.
Management will estimate the credit loss based on information about:
- Past events.
- Current conditions.
- Reasonable and supportable forecasts about the future.
Expected credit losses reflect management's current estimate of the contractual cash flows that the entity does not expect to collect:
- The estimate should reflect the time value of money.
- The CECL reflects that a loss occurs and that it does not occur.
- Allowance would never reflect the most likely outcome.
These concepts are consistent with joint FASB/IASB decisions.
Kane reviewed a loss rate approach over a period of five years for a group of portfolios for a National Bank.
Smith suggested other methods that could be used. The proposed ASU would not specify a method for estimating the loss.
Speakers gave specific guidance for Purchased Credit Impaired (PCI) Assets, Debt Securities and Financial Assets Measured at Fair Value-Other Comprehensive Income (FV-OCI), and a nonaccrual principle.
- Purchased Credit Impaired (PCI) Assets: Follow same approach to estimating expected credit losses as originated and non-PCI assets.
- Debt Securities and Financial Assets Measured at FV-OCI: Do not have to reflect credit losses when the fair value of the financial asset is greater than the amortized cost basis or when expected credit losses on the financial asset are insignificant.
- Nonaccrual principle: If it is not probable that substantially all principal or interest will be received, cease the accrual of interest income.
Kane reviewed the debt instruments that are within the scope of the CECL. He analyzed the disclosures that will be required.
Smith stated that FASB's current plan is to discuss the CECL model with the IASB. The FASB will probably publish an ASU ED of the CECL before the end of 2012. The IASB will expose its model for comment when it has completed re-deliberation. Both organizations will analyze the comments received on both models, and "I fully expect that we will re-deliberate the comments together", Smith said.
The draft of the CECL model may be viewed in FASB Technical Plan and Project Updates.