New credit loss model hits captives

The Financial Accounting Standards Board (FASB) has issued an Accounting Standards Update (ASU) designed to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations, in a move which is likely to have a significant impact on captive finance companies.

For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. The largest impact will be on lenders and the allowance for loan and lease losses (ALLL).

“The new standard addresses concerns from a wide range of our stakeholders—including financial statement preparers and users—that the existing incurred loss approach provides insufficient information about an organization’s expected credit losses,” stated FASB chair Russell Golden. (pictured above)

“The new guidance aligns the accounting with the economics of lending by requiring banks and other lending institutions to immediately record the full amount of credit losses that are expected in their loan portfolios, providing investors with better information about those losses on a more timely basis,” Golden added.

The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates.

FASB board member Hal Schroeder confirmed in an interview with Accounting Today, that the new rules will apply to any entity that holds loans and debt securities at amortized cost.

“That could be a bank, or it could a finance company embedded within a industrial company like Caterpillar, Boeing or Ford,” said Schroeder. “They all have finance operations. Or it could be a tech company that has cash and it’s holding a pool of debt securities.”

The regulator says many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. Organizations will continue to use judgment to determine which loss estimation method is appropriate for their circumstances.

The ASU on credit losses will take effect for US Securities and Exchange Commission (SEC) filers for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019.

For public companies that are not SEC filers, the ASU on credit losses will take effect for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other organizations, the ASU on credit losses will take effect for fiscal years beginning after December 15, 2020, and for interim periods within fiscal years beginning after December 15, 2021.