After Years in the Making, CECL Brings Big Changesby
On June 16, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments—Credit Losses (Topic 326):Measurement of Credit Losses on Financial Instruments. This standard is the culmination of nearly a decade of work following the financial crisis and the subsequent debate about the appropriate timing to recognize impairment on financial instruments.
The guidance introduces a new impairment model, which has become known as the CECL (current expected credit losses) model. It represents a significant shift from the current incurred loss model. Under the CECL model, we can generally expect credit losses to be recognized earlier than under the incurred loss model.
This ASU is a very big deal for the financial services industry, whose balance sheets include billions of financial instruments. Companies outside of the financial industry may not have paid a lot of attention to this FASB project, but entities in industries other than financial services will also be affected by this new ASU. Trade receivables, net investments in leases, loans, or held-to-maturity debt securities are only a few types of financial instruments within the scope of the new CECL model.
Under this new approach, entities will have to estimate the credit losses they expect to incur throughout the remaining life of a financial instrument carried at amortized cost and subject to credit losses. In order to do so, entities will have to come up with reasonable forecasts (including anticipated prepayments), which will require a lot of judgment.
For available-for-sale debt securities, entities will no longer have to consider the length of time during which a security was under water. Instead, entities will have to estimate their estimated credit loss, but only if the fair value of the instrument has dipped below its amortized cost.
The credit loss impairment will be recorded through a valuation allowance at the amount by which the fair value exceeds the amortized cost of the security. In addition, entities will be able to reduce their CECL valuation allowance in case of subsequent recoveries. This could also be a big change for certain entities.
The FASB has also modified the accounting for purchased financial assets with credit deterioration since their origination.
Of course, just like with all other standards requiring a lot of judgment, entities will have to increase their disclosures so that financial statement users can understand their rationale.
Anne-Lise Vivier, CPA, is the managing editor of GAAP Reporter, our GAAP Critical Issues Series, and a number of other accounting publications with Thomson Reuters Checkpoint within the Tax & Accounting business of Thomson Reuters. She is...