Interpreting FAS 5
In a webinar on How to Calculate Your FAS 5 Reserves, Sageworks consultants discussed the ambiguous nature of the FAS 5 (ASC 450-20).
From the video:
The topic of the day is our FAS 5s, also known at ASC 450-20. We are talking about one of two major components or guidances under GAAP that contribute to the loan loss reserve. So basically establishing a rainy-day fund for potential losses in a portfolio. With that being said, what we are focusing on is the group of homogenous loans – grouped together with a general reserve – and the underlying accounting items.
It is important when we talk about FAS 5 – or really any other accounting principle or accounting guidance – to note that we understand that anytime we talk about accounting guidance, we don’t mean to speak in definites. This is because there is always room for interpretation.
An example that I use occasionally is that if I ask my four year old, “What is 1+1?,” he will answer that 1+1 equals 2. However, that’s not such an easy question when you ask an accountant because when you ask an accountant, 1+1 in some cases may equal 2, in some cases may equal 3, in some cases may equal 4, depending on your interpretation of how the question was asked. It goes back to the joke, “If you ask an accountant what 1+1 is, the accountant will pull down the window shade and, in a hushed voice, will lean into you and say, ‘Well, what do you want it to be?'”
For a lot of what we talk about today, I use that as a disclaimer. Some people may be taken aback by some of the statements we make and say, “wait a second, that’s not the way that we do it!” In no way are we trying to indict you for doing something incorrectly. We merely have a unique perspective dealing with institutions across the country. We mentioned that we have institutions that are $11 million in size to $20+ billion in size that we work with on a day in, day out basis. We basically are going to present some of the common things that we see and what we believe to be best practices in our experience, both from Sageworks and in prior work experience as well.
For more detailed instructions and information about how to classify loans as either FAS 5 or FAS 114, ways to segment the portfolio into homogenous pools and how to document loss rates and qualitative adjustments, download the whitepaper titled How to Calculate Your FAS 5 Reserves.