CECL: Introducing another dimension in accounting for expected credit losses
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  • CECL: Introducing another dimension in accounting for expected credit losses

    By Jeroen Van Doorsselaere, VP Market Management Risk and Finance EMEA

    Published July 22, 2016

    In June, 2016 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 introduces a new impairment model, commonly known as CECL (Current Expected Credit Losses), which represents a shift from the current incurred loss model.

    CECL applies to the U.S. GAAP based countries within the financial sector such as Israel, Japan (limited) and the United States. Financial Institutions in these countries need to adopt a forward looking expected loss rather than an incurred loss model. This raises a number of important questions.

    Why CECL?

    CECL is effectively the reaction to the global financial crisis, where the general criticism on accounting standards was “too little too late”. The FASB and the International Accounting Standards Board (IASB) initially worked together on a joint project to overhaul the current impairment models. Later, the FASB came out with this U.S. GAAP specific solution.

    Who is impacted by CECL?

    While the CECL standards apply to all entities regulated by the FASB, the rollout will be phased. We also need to examine the different financial statements of the underlying organizations to assess whether they are truly impacted by the accounting standard. Given the measurement of the financial instruments, which in general is closely aligned to amortized cost, it’s fair to say the main impact will be on financial institutions or large corporations with so called “shadow banking” activities.

    What are the timelines?

    For public business entities that are SEC filers, the new guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Other public business entities will need to comply for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020. For all other organizations, the new guidance is effective for fiscal years beginning after December 15, 2020, and for interim periods within fiscal years beginning after December 15, 2021.  An early application is permitted for fiscal years beginning after December 15, 2018.

    What is CECL really about?

    The Current Expected Credit Loss Model ensures that provisions will need to be calculated and booked on a portfolio of certain asset classes to protect the firm against expected losses in the future. In addition to historical data, financial institutions need to take into consideration more forward looking information.

    Unlike the current standard, which recognizes an initial threshold at the start of a contract, the current standard will take into account all lifetime expected losses over the entire contractual lifetime of a loan. In addition, this standard will provide more clarification related to the value of assets the moment they are acquired. The value of credit impaired assets will also be comparable to other non- credit impaired assets that are acquired by the financial institutions. The CECL standard will make it possible to use an allowance account for available for sale debt instruments rather than booking on a write off account. This is a clear difference with IFRS 9 where equity investments are excluded from the expected credit loss calculations.

    From a methodological aspect, the FASB, compared to the IASB, pushes more forward looking information. However, as soon as the FASB cannot reliably measure forward looking data, they revert to historical data. Unlike IASB, the FASB is offering additional guidance and practical expedients around how to apply these forward looking elements and also more details around the application of commitments and over collateralized loans.

    It is obvious that the goal of forward looking information is to provide more and better information to investors. It will however be an additional significant burden for the financial institutions to fully comply with the calculation requirements.

    What if the bank needs to report under both IFRS 9 and CECL?

    Financial institutions that are subject to both IFRS 9 and CECL need to be aware that, while both standards will be subject to the guidance published by the Basel Committee for Banking Supervision, there are different and important nuances.

    The FASB does not apply a three stage model like the IASB but instead applies lifetime expected credit losses over the whole portfolio. This means that the difference between individual assessment and collective assessment remains more important under CECL than under IFRS 9.

    IFRS 9 refers to individual contracts and approaches (also due to stage assessment and related dimension requirements) while CECL, given the illustrative examples, appears to indicate that collective approaches are more likely to be followed. Another difference is that IFRS 9 includes stresses based on macro-economic factors, while CECL simply refers to forward looking information and leaves it up for interpretation whether this includes macro-economic factors or not.

    Both CECL and IFRS 9 will change the way financial statements are interpreted and prepared and as such will pose a number of challenges across the financial sector as a whole.

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