In June 2016, the U.S. Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13"). The ASU’s main objective is to provide financial statement users with more decision-useful information regarding expected credit losses on financial instruments at each reporting date. The FASB began its project on financial instrument reporting with the International Accounting Standards Board (“IASB”); however, although the FASB and the IASB agreed that there was a need for a different credit loss model, the FASB’s expected credit loss model (discussed below) differs from the measurement model provided by the IASB’s IFRS 9, “Financial Instruments”. The primary difference between the two models relates to the timing of expected loss recognition.
ASU 2013-16 Main Provisions
Current Expected Credit Loss Model
Under existing U.S. GAAP, an “incurred loss” model is used to recognize credit losses; this methodology delays credit loss recognition until it’s probable that a loss had been incurred. ASU 2016-13 replaces this with a “current expected credit loss” (CECL) model. The move from an incurred loss approach to an expected loss approach is to provide access to more timely information about an entity’s credit losses. Amendments in ASU 2016-13 include:
- Require financial assets measured at amortized cost to be presented at the net amount to be collected
- Expected credit loss is recorded as an allowance for credit loss, adjusted for management’s current estimate at each reporting date
- Credit losses will be estimated over the remaining contractual term of the instrument (considering the effect of estimated prepayments)
- Income statement reflects the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the period
- Measurement of expected credit losses is to be based on available and relevant information related to:
- past events, including historical experience
- current conditions
- reasonable and supportable forecasts that affect the collectability of the reported amount
Financial assets that are not measured at fair value are within the scope of the new ASU, including the following:
- Financing receivables (such as loans receivable)
- Receivables from revenue transactions (including accounts receivable from customers)
- Held-to-maturity debt securities
- Receivables from repurchase agreements
- Reinsurance receivables
- Off balance sheet credit exposures not accounted for as insurance
- Net investments in leases recognized by a lessor
The following are excluded from the scope of the new standard:
- Loans and receivables between entities under common control
- Participant loans/defined contribution employee benefit plans
- Policy loan receivables of an insurance entity
- Pledge receivables of not-for-profit entities
Available-for-Sale Debt Securities
ASU 2016-13 also amends the credit loss measurement guidance for available-for-sale debt securities. The new ASU will require credit losses to be recorded through an allowance for credit losses rather than a direct write-down. Entities will be able to record subsequent changes in the credit loss estimate through current period net income.
The allowance for credit losses relating to available-for-sale debt securities is limited to the amount by which fair value is below amortized cost.
Other ASU 2016-13 Changes
ASU 2016-13 also made amendments to the accounting guidance in the following areas:
- Purchased Credit-Deteriorated Financial Assets
- Beneficial Interests in Securitized Financial Assets
ASU 2016-13 provides for enhanced disclosures to assist financial statement users to understand management’s estimates and judgments used. This includes new disclosures relating to the disaggregation of credit quality indicators by year of origination (or “vintage”); this disclosure will be optional for entities that are not public business entities.
For public business entities that are SEC filers, the ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.
For all other public business entities, the ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years.
For all other entities, the ASU is effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021.
Early adoption of ASU 2016-13 is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.
If You Have Further Questions
Please consult us for additional information and/or to discuss the impact ASU 2016-13 may have on your Company’s future accounting and financial reporting.