FSR insights: Proposed changes to accounting for credit losses in financial assets

December 2012
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FSR insights: Proposed changes to accounting for credit losses in financial assets

At a glance

The Financial Accounting Standards Board is proposing changes to US GAAP in the accounting for impairment of receivables, loans, loan commitments, and debt securities not measured at fair value with changes in fair value reported in net income (FV-NI).

Under current U.S. GAAP, there are several different impairment and interest income recognition models applicable to receivables, loans and debt securities. These models are largely based on an "incurred loss" concept, whereby credit loss reserves are not recorded until losses are "probable."

In recent years, many stakeholders have commented that the "probable" recognition threshold provides for losses that are "too little, too late". In addition, current U.S. GAAP tends to create a pro-cyclical loan loss reserve that results in entities having to build reserves in deteriorating conditions when they are least prepared to do so because of stress on earnings and capital. Finally, others often cite the complexity in applying current impairment guidance. This is largely driven by the different impairment and interest income recognition models that apply to different asset classes of differing credit qualities.

The Financial Accounting Standards Board is proposing significant changes to U.S. GAAP in the accounting for impairment of receivables, loans, loan commitments, and debt securities not measured at fair value with changes in fair value reported in net income (FV-NI). The "current expected credit loss" (CECL) impairment model, as proposed by the FASB, represents a major shift from the "incurred loss model" under current U.S. GAAP.

The proposal would affect all reporting entities, including private and non-profit entities, regardless of size. Entities should take the time to understand the proposal and how it is differs from current U.S. GAAP.

This FSR Insight helps to understand the specific changes proposed and potential ramifications.