- The Financial Accounting Standards Board is proposing to tweak standards that govern how companies report purchased financial assets such as equities, loans and debt securities — a response to requests for simpler guidance from investors, according to a FASB release.
Under current generally accepted accounting principles, there are effectively two models for reporting such assets depending on whether the assets are deemed healthy or deteriorated. With the new proposal, there would be one “gross up” accounting model used under which there would be no credit loss recorded on acquisition, according to the FASB, which is inviting comments on the plan through August 28.
“This will impact any company with purchased financial assets. But its largest application will be for banks and financial institutions,” Jack Castonguay, an accounting professor at Hofstra University in New York, wrote in an emailed response to questions from CFO Dive. The existing current expected credit losses standard was issued in 2016 as the FASB sought to foster timelier reporting of losses after concerns about delays in recognizing deteriorated asset values rose out of the financial crisis in 2008, according to the FASB’s webpage.
FASB’s CECL standard was viewed as a consequential accounting change for certain financial companies, CFO Dive previously reported. Previously, banks set aside their reserves on an incurred-loss basis. The reserves were only for loans showing signs of trouble and typically only for 12-month periods. But under the then-new system, some said that banks would end up making less credit available, and at a higher cost, because of the increased volatility the change introduced in their reserve calculations.
FASB’s latest proposed tweak to the standard aims to “curb complaints that accounting rules counterintuitively make banks report more losses when they buy performing loans versus loans that show signs of deteriorated credit quality,” according to a June 27 Bloomberg Law report.
KPMG Audit Partner Mark Northan said the proposal is a significant change for business combinations and asset acquisitions because “the allowance for credit losses (aka the allowance for doubtful accounts) will no longer be established via credit loss expense (a “Day-1 loss”) at acquisition. Instead, the initial measurement of the allowance for loan losses will have the effect of reducing the recognition of interest income in subsequent reporting periods.”
The extent of the impact of the change will vary in part on the level of asset acquisitions or business combinations they enter into and the related allowance for credit losses that is initially recognized, he wrote in an emailed response to questions.