March 6, 2013 - Responding to criticisms that the current allowance model does not adequately estimate losses until it is too late, the Financial Accounting Standards Board (FASB) issued a new version of an exposure draft outlining a new “Current Expected Credit Losses” (CECL) model with its Accounting Standards Update (ASU) Financial Instruments – Credit Losses (Subtopic 825-15). What has changed with this model?
The nine main points of the proposed guidance that are most likely to impact financial institutions and their ALLL reserves are:
1) Requires that forward-looking information and forecasts now be considered in the estimation of credit losses. Current U.S. GAAP allows for present and past events but not future forecasts.
2) Removes the “probable” threshold for recognizing losses.
3) Incorporates Debt Securities under the same model rather than under the current “Other Than Temporary Impairment” (OTTI) model. Instead of a direct write-down, Debt Securities would be recognized through an allowance, which can be reversed if cash flow expectations improve.
4) Now allows for a Day One Allowance for Purchased Credit Impaired Assets.
5) Necessitates that methods must reflect time value of money explicitly or implicitly.
6) Modifies the definition of “collateral-dependent” in certain ways.
7) Defines nonaccrual, cost-recovery and cash-basis methods, which were not previously clearly defined in GAAP.
8) Leaves the ASU 2010-20 essentially unchanged, other than requiring some additional disclosures.
9) Likely requires an institution to record a cumulative effect adjustment as of the beginning of the first period in which guidance is effective.
To see the complete listing of changes, it is recommended to read the proposal in its entirety.
Download the full whitepaper for more information on how FASB’s CECL Model will impact your ALLL.
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