When FASB released the CECL ASU in June 2016, the defining theme through the ASU was the flexibility given to preparers with regard to the new expected losses standard. Since this time, there have been many discussions and buckets of ink spilled on the interpretation of the guidance released, but no new ASUs released that actually changed the guidance. While ASU 2018-19 was issued in late 2018, all this really did was make some clarifications and changes around the effective date of the standard for private companies, essentially extending the adoption date for those companies to Q1 2022.
However, the first proposed ASU with substantial changes to the codification has now been proposed as of November 19th, 2018 with a comment period ending on January 18th, 2019. This ASU addressed many of the issues that have been brought up and discussed in the Transition Resource Group (TRG) formed by FASB to look at the implementation of the standard, as well as other issues brought up by stakeholders to FASB. We’re going to spend the next series of blog posts looking at a few of these issues and how they will affect the implementation of the standards for financial institutions. For reference, the proposed ASU can be found on FASB’s website here under the title 11/19/18: Proposed Accounting Standards Update—Codification Improvements—Financial Instruments. The issues are numbered in the update, and we will use the same number scheme to be consistent.
Issue 1A: Accrued Interest
One of the issues that came up at the June 11, 2018 meeting of the TRG was the issue of Accrued Interest. In CECL, the estimate of credit losses is to be based on the amortized cost basis of the asset. This is defined in the glossary of the ASU as:
The amortized cost basis is the amount at which a financing receivable or investment is originated or acquired, adjusted for applicable accrued interest, accretion or amortization of premium, discount, and net deferred fees or costs, collection of cash, writeoffs, foreign exchange, and fair value hedge accounting adjustments.
Issues Preparers of Financial Statements Found in ASU
Preparers of financial statements, particularly of regulated financial institutions, as well as other stakeholders brought up a few main issues with this. The TRG Memo No. 9 covers these in depth, as well as the meeting minutes following that TRG meeting in Memo No. 13. In short, preparers brought up a few issues:
- Preparers pointed out the operational difficultly involved with reporting accrued interest as part of the amortized cost basis of the asset, as it is typically common practice to report that amount as an accrued interest receivable separate and apart from the loan balance itself.
- Currently, the allowance recorded by most institutions does not include any allowance related to accrued interest amounts, as they are generally reversed directly on the income statement and not against the allowance when a loan moves into nonaccrual status, this is done when a loan reaches 90 days past due with very few exceptions.
FASB's Response to Concerns
To address these concerns, FASB made a few updates to the codification. They basically do three things:
- Allow an entity to make an accounting policy election to not measure an allowance on the accrued interest receivable if the entity writes off the accrued interest in a timely manner. This should be consistent with the practice of most regulated financial institutions today and will likely not require any major changes in systems or processes if they make this election.
- Allow an entity to make an accounting policy election (separate from above) to write off accrued interest either by reversing interest income expense or by recognizing credit loss expense. Again, if most regulated financial institutions elect to follow current practice and write accrued interest amounts off on the income statement, this will likely require very little change.
- Allow an entity to elect to disclose the amount of accrued interest receivable separately from the amortized cost balance of the financial assets. As with the other two changes, this will result in very little change to current practice for institutions that make this election.
These should be welcome changes for most community financial institutions, especially for an issue that has largely gone under the radar for many. These updates were targeted to reduce operational costs and burden at those regulated institutions by allowing them to maintain practices very similar to the ones they have today with regard to accrued interest. Our expectation would be that most community financial institutions will avail themselves of all three policy elections outlined here to streamline the adoption process and not make significant changes to systems and processes.