New Measurement Standards for Credit Losses: Planning for the Changes and Impact to Your Organization
Last year, the Financial Accounting Standards Board (FASB) updated its current accounting guidance to change the way financial institutions record credit losses on receivables. ASU-2016-13, Measurement of Credit Losses on Financial Instruments, represents a sweeping change to the way credit losses are measured. For some public entities, the amendments take effect as early as December 15, 2019. For non-public businesses, the amendments impact companies with fiscal years beginning after December 15, 2020.
Businesses are permitted to adopt the new standard for fiscal years beginning after December 15, 2018, so the implementation process can begin immediately. Anticipating the cost and effort involved in developing your company’s new model will allow for a smoother transition process overall.
FASB issued the update after almost four years of deliberations. It is intended to reflect credit loss reporting on a timelier basis, improving financial reporting for investors and other financial statement users and addressing concerns that anticipated losses were not being recognized because they did not meet the “probable” threshold for recognition. The update changes the criteria for recognizing credit losses and requires recognition of expected credit losses over the life of the asset on day one.
The new standard also requires companies to incorporate additional factors into the current model used to evaluate losses. Doing this will undoubtedly require additional time and resources from various departments within the organization, such as finance, underwriting, credit risk, and asset management.
Preparing Your Company for the Change
Companies may use the current model to measure losses under the new guidance. However, the data used to calculate the losses must change to incorporate forecasted information. Companies may incur significant costs in order to obtain the external data needed to develop forecasts of expected credit losses if the data is unavailable internally. The good news is that FASB and stakeholders affected by the update expect ongoing costs to be like those for the current model once the new model is developed and implemented.
While there are still four years until the update is effective for non-public companies, you should start planning now to give yourself plenty of time to implement. CohnReznick recommends the following immediate steps:
- Have discussions with all company stakeholders including board of directors, investors, and staff. Keep them updated throughout the process so they understand the changes and impact the update is expected to have on your company.
- Your finance, underwriting, credit risk, and asset management departments should begin to collaborate and share resources throughout the process – gathering internal and external data and developing a plan for testing the model, implementing the new processes and internal controls, and adjusting as necessary before the effective date.
- Evaluate the data you are currently using to estimate losses, as well as data available while underwriting the loan, to determine what can be used in developing the current expected credit loss (CECL) model and what additional information will need to be obtained. Assess the availability of market data that may be built into forecasts and the need to obtain such data from external sources.
As you get closer to the implementation period, we recommend that you:
- Develop a timeline with target check-in dates to measure and report on progress and allow for enough time to test the model and evaluate results prior to implementation. The model and processes and procedures for estimating losses will evolve and change throughout and even after implementation.
- Complete a review of your infrastructure, including personnel and information technology, to identify available resources, weaknesses, and needs. Additionally, as you assess your existing control structure, consider how you should develop additional internal controls to address risks related to the new process.
- Stay up-to-date on decisions made by FASB Technical Resource Group (TRG), which will be meeting periodically to discuss implementation questions.
To summarize, the FASB accounting update will result in a major change in the way companies measure losses on receivables. Implementation will require both time and resources. There is still adequate time to plan for the change, so be proactive in developing an implementation strategy for the new standard to ease the burden and provide for a seamless transition.