FASB Requires Earlier Reporting of Credit Losses: A New Financial Instruments Standard Is Designed to Align Accounting with the Economics of Lending
[ILLUSTRATION OMITTED] Financial statement preparers will be required to report credit losses on loans and other financial instruments in a more timely fashion under a new standard FASB issued in June. Financial institutions and other organizations will be required to measure all expected credit losses for financial assets held at the reporting date in accordance with Accounting Standards Update (ASU) No. 2016-13, Financial Instruments--Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The expected losses will be based on historical experience, current conditions, and reasonable and supportable forecasts. The move from an incurred-loss approach to an expected-loss approach is designed to provide investors with more forward-looking information. "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," FASB Chairman Russell Golden said in a news release. Credit losses became a focus of accounting standard setters after the financial crisis that began in 2007. Many banks and financial institutions experienced heavy losses related to subprime mortgages during the financial crisis, prompting calls for earlier reporting of expected credit losses. FASB member Hal Schroeder said during an interview that significant frustration with the current model had built up among preparers and investors in the years before the financial crisis because the accounting didn't match the economics. "This standard is designed to correct for what we see as a misalignment between the economics of lending and the accounting for the economics," he said. FASB AND IASB DIVERGE In 2008, FASB began its project to improve the reporting of credit losses on financial instruments, working at first with the International Accounting Standards Board (IASB) in a converged financial instruments project. Although both boards agreed on the need for reporting of expected credit losses rather than incurred losses, they couldn't find common ground on a method for measuring credit losses. The IASB issued IFRS 9, Financial Instruments, in 2014 with a different measurement model from FASB's current expected credit loss model. FASB's standard will permit many of the loss estimation techniques applied today, but the inputs to those techniques will change to reflect what FASB deems to be the full amount of expected credit losses. Financial statement preparers will continue to use judgment to determine which loss estimation method is appropriate for their circumstances. Enhanced disclosures required by the ASU are designed to help financial statement users understand the significant estimates and judgments preparers used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio. …