Accounting Pronouncements and Industry Trends
On June 16, 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, “Financial Instruments-Credit Losses”, (Topic 326) (the ASU) requires an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale (AFS) debt securities and provides a simplified accounting model for purchased financial assets with credit deterioration since their origination.
The ASU requires credit unions to measure impairment on their existing loan portfolios based on the current estimate of contractual cash flows not expected to be collected. The estimate of expected credit losses is based on relevant information about past events, including historical loss experience with similar assets, current conditions, and reasonable supportable forecasts that affect the expected collectability of the assets’ remaining contractual cash flows. This new model is called the Current Expected Credit Loss (CECL) model.
CECL requires credit unions to measure expected credit losses on financial assets carried at amortized cost on a collective or pool basis when similar risk characteristics exist. Similar risk characteristics may include one or a combination of credit scores, risk ratings, collateral type, vintage, geographical location, term, or expected credit loss. Although the new accounting standard provides examples of similar risk characteristics, smaller and less complex institutions may conclude that the segmentation practices they have used under the incurred loss methodology are also appropriate under the expected loss methodology.
The transition to the CECL model will bring with it significantly greater data requirements and demand a more complex methodology to accurately account for expected losses under the new requirements. The transition will also require a significant increase in the allowance for loan and lease losses (ALLL) account balance. FASB has allowed for this one-time increase in the ALLL to come directly from undivided earnings, rather than reflected through the provision for loan losses expense account. The increase, or the adjustment to the ALLL, will reduce net worth, however it does spare a negative impact to the income statement. This ASU applies to all financial assets that are not accounted for at fair value and are exposed to potential credit risk.
Credit unions should currently be identifying the model(s) they plan to use, and the data needed to calculate those model(s). Generally, the first step is to establish a CECL committee which should include all relevant parties. Once the model(s) are determined and there is a good understanding of what data is needed, the next step is to see if the systems in use can provide the data needed. The Credit Union may need to employ a third-party vendor for all or a portion of the CECL calculation. A reasonable goal is to be able to run your model(s) in early 2020 if not before.
The implementation date for “private” companies, which includes credit unions, is for fiscal years beginning after December 15, 2022. Early application of the standard is permitted for fiscal years beginning after December 15, 2018. Since all credit union's fiscal year end is December 31st due to regulatory reporting, the first date to implement is January 1, 2023.
On February 25, 2016, the FASB issued ASU No. 2016-2 “Leases” (Topic 842). The ASU is intended to improve financial reporting about leasing transactions and affects all companies and other organizations. The ASU will require organizations that lease assets (referred to as “lessees”) to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases.
While the accounting by the lessor will remain largely unchanged from current GAAP, lessees will need to recognize a right-of-use asset and a lease liability for virtually all of their leases (other than leases that meet the definition of a short-term lease). The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for initial direct costs. For income statement purposes, the FASB retained a dual model, requiring leases to be classified as either operating or finance. Operating leases will result in straight-line expense (similar to current operating leases) while finance leases will result in a front-loaded expense pattern (similar to current capital leases). Classification will be based on criteria that are largely similar to those applied in current lease accounting, but without explicit bright lines.
The effective date for credit unions is for fiscal years beginning after December 15, 2020. Early adoption is permitted. The new standard may be adopted using a modified retrospective transition and provides for certain practical expedients. This approach would require application of the new guidance at the beginning of the earliest comparative period presented. The standard could also be implemented at the beginning of the fiscal year end and shown as a cumulative effect change to retained earnings. Since all credit union's fiscal year end is December 31st due to regulatory reporting, the first date to implement is January 1, 2021.
In January 2016, The FASB issued ASU No. 2016-01 “Financial Instruments – Overall – Recognition and Measurement of Financial Assets and Financial Liabilities”, (Subtopic 825-10). The main objective in developing this Update is enhancing the reporting model for financial instruments to provide users of financial statements with more decision-useful information.
The Update has two areas of interest to credit unions. One is the removal of the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities. The other has a more significant potential impact.
The ASU requires entities to record equity securities at fair value with adjustments to fair value recorded through the income statement. Currently many securities meeting the definition of an equity security are recorded as available-for-sale with fair value adjustments recorded as part of other accumulated comprehensive income. Securities meeting the definition of an equity security include any ownership interest in an entity. Credit unions with investments in mutual funds, stocks, limited partnerships, and trusts could see unacceptable levels of earnings volatility on their income statements. An entity should apply the amendments by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption.
Removing the disclosure of fair value of financial instruments is available for implementation immediately upon issuance of the ASU. The effective date for the accounting for equity securities for credit unions is for fiscal years beginning after December 15, 2018. Credit Union’s may adopt this ASU early with fiscal years beginning after December 15, 2017. Since all credit union's fiscal year end is December 31st due to regulatory reporting, the first date to implement is January 1, 2019.
In March 2017, the FASB issued ASU 2017-08 “Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-10): Premium Amortization on Purchased Callable Debt Securities”. The Board issued this Update to amend the amortization period for certain callable debt securities held at a premium. The Board is shortening the amortization period for the premium to the earliest call date.
The implementation date for “private” companies, which includes credit unions, is for fiscal years beginning after December 15, 2019. Early application of the standard is permitted. Since all credit union's fiscal year end is December 31st due to regulatory reporting, the first date to implement is January 1, 2020. A credit union should apply this update on a modified retrospective basis through a cumulative adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principle.