New Developments Summary

Transcription

1 July 10, 2018 NDS New Developments Summary Transition Resource Group for Credit Losses Summary of issues as of June 11, 2018 Summary On June 11, 2018, the Transition Resource Group for Credit Losses (TRG), formed by the FASB to consider issues that arise from implementing the new credit loss standard, met to discuss five issues raised by stakeholders since the group s previous public meeting in June This bulletin summarizes the issues discussed at that meeting. See NDS for a summary of issues previously discussed by the TRG. Contents A. Overview... 1 B. Highlights of issues discussed during the June 11 TRG meeting... 2 Technical inquiries previously answered by the FASB staff...2 Gains and losses on subsequent dispositions of leased assets... 2 Billed operating lease receivables... 3 Issues submitted by stakeholders to the TRG...3 Capitalized interest... 3 Accrued interest... 4 Transfers of certain loans from Held-for-Sale to Held-for-Investment and transfer of creditimpaired debt securities from Available-for-Sale to Held-to-Maturity... 6 Recoveries... 7 Refinancings and loan prepayments... 8 A. Overview The Transition Resource Group for Credit Losses (TRG) was formed by the FASB to help entities implement the new guidance on measuring credit losses on financial instruments in ASU , Measurement of Credit Losses on Financial Instruments. TRG members include financial statement preparers from the banking and insurance industries, auditors, and financial statement users. Representatives from the Securities and Exchange Commission, the Public Company Accounting Oversight Board, the FASB s Private Company Council, and the federal financial institution regulatory agencies are invited to TRG meetings as observers.

2 New Developments Summary 2 Although it does not issue authoritative guidance, the TRG Solicits and discusses stakeholder issues arising from implementing the new credit losses standard Identifies areas where the new guidance may be unclear or could lead to diversity in practice, requiring additional clarification or guidance by the FASB Provides a forum for stakeholders to learn about the new credit losses standard The TRG meets periodically to discuss issues submitted by stakeholders. To submit an issue and to access all meeting dates, materials, and archived webcasts of meetings, visit the TRG homepage on the FASB website. B. Highlights of issues discussed during the June 11 TRG meeting On June 11, 2018, the TRG discussed several technical inquiries addressed by the FASB staff since the 2017 meeting, as well as five issues subsequently submitted by stakeholders. Several observers to the meeting, including SEC Chief Accountant Wesley Bricker, made general comments regarding their views on the implementation of ASU Comments by SEC Chief Accountant As an observer at the June TRG meeting, SEC Chief Accountant Wesley Bricker noted that entities should have a well-controlled, consistently applied methodology to determine the allowance for credit losses. Mr. Bricker also emphasized the importance of providing clear disclosures, both on an ongoing basis and upon transition to the new accounting standard, that would allow financial statement users to understand the accounting policy choices made by the entity, as well as the economic and credit factors impacting changes in the allowance for credit losses. Technical inquiries previously answered by the FASB staff Loans and receivables between entities under common control Loans and receivables between entities under common control are outside the scope of ASC 326, Financial Instruments Credit Losses (hereinafter called the current expected credit losses model, or CECL). The FASB staff clarified that loans and receivables between entities under common control at any reporting level (that is, parent-subsidiary, subsidiary-parent, or subsidiary-subsidiary) are outside the scope of the CECL standard. Gains and losses on subsequent dispositions of leased assets A lessor s net investment in leases recognized in accordance with ASC 842, Leases, is within the scope of CECL. The FASB staff clarified that a lessor should include future gains and losses expected when assets are disposed of after a lessee returns a leased asset to the lessor in its current estimate of expected credit losses on a net investment in a lease receivable.

3 New Developments Summary 3 Billed operating lease receivables CECL includes within its scope all receivables measured at amortized cost, including billed operating lease receivables. However, the guidance in ASC 842 indicates that changes in the collectibility of billed operating lease receivables should be recognized as a current-period adjustment to lease income. The FASB staff clarified that billed operating lease receivables are outside the scope of CECL and that ASC 842 should be applied instead. The FASB staff said that it would consider clarifying this issue by amending the CECL guidance with a technical improvement to the Codification. Issues submitted by stakeholders to the TRG Capitalized interest Under CECL, expected credit losses reflect the estimated amount of the amortized cost basis of financial assets that is not expected to be collected. The estimate is based on an entity s historical loss experience, adjusted for asset-specific risk characteristics, current conditions, and reasonable and supportable forecasts. An entity may estimate expected credit losses by using a discounted cash flow (DCF) approach or a non-dcf approach. ASC states that the following conditions must exist when utilizing a non-dcf approach to estimate expected credit losses: a) The allowance for credit loss should reflect the entity s expected credit losses of the amortized cost basis of the financial assets as of the reporting date. b) A discount should not offset the entity s expected credit losses if it expects to accrete the discount into interest income. Certain stakeholders stated that these two conditions present conflicting guidance. In particular, stakeholders interpreted bullet (b) to mean that a reporting entity must anticipate the timing of expected credit losses when applying a non-dcf approach in order to identify the amount of the discount that it expects to amortize into income so that this amount does not offset expected credit losses. These stakeholders believe that estimates of future credit losses require anticipating the timing of losses, including an estimate of the amount of the discount that would have been amortized into income and the amount of interest that would have been capitalized into the amortized cost basis of the financial asset when the credit loss occurs. According to this interpretation, the allowance for credit losses (ACL) would not change over time as a result of changes in the amortized cost basis of the asset. TRG views The TRG generally agreed that an entity is neither required to predict the timing of credit losses nor the amount of capitalized interest included in the amortized cost basis when the future credit loss occurs. TRG members agreed with the FASB staff s view that the ACL should be estimated based on the amortized cost of financial assets at the reporting date, without considering unearned future interest. Accordingly, the ACL estimated under a non-dcf approach may increase or decrease as a result of increases or decreases in the amortized cost basis. The FASB staff based its view in part on the notion that non-dcf approaches to estimating expected credit losses inherently contemplate the timing of losses because an entity s historical loss amounts, which serve as the basis for an entity s current

4 New Developments Summary 4 estimate of expected credit losses, are the difference between the amount collected on a financial asset and its amortized cost basis at the time of the credit loss. Additionally, the TRG generally agreed with the FASB staff that there is a difference between an unamortized discount and unearned interest that is expected to be earned and capitalized into the amortized cost basis of the financial asset. In the case of a discount, a borrower who prepays a financial asset must repay the par amount of the financial asset (including the discount), whereas in the case of unearned interest, such amounts are not due until earned. Accordingly, reflecting expected capitalized interest in the ACL estimate before this interest is earned would mean that an entity is recognizing an ACL for amounts that are not an asset as of the balance-sheet date. However, some TRG members indicated that it is unclear how to apply the guidance in ASC These TRG members generally saw little distinction between a discount that is expected to be amortized and future interest that is expected to be earned and capitalized. This feedback prompted the FASB staff to consider whether additional guidance is needed. The impact of discounts on estimating the ACL in a non-dcf approach As noted in ASC , a discount should not offset the entity s expectation of credit losses if an entity expects to accrete a discount into interest income. This guidance does not mean that a discount is ignored altogether when estimating the ACL; rather, it means that for financial assets with expected credit losses, some of that expected credit loss relates to the amortized cost basis at the measurement date. For example, assume a lender advances $60 to a borrower at December 31, 20X1, and the borrower agrees to repay the lender $100 in three years. The lender estimates that it will receive $90 in three years based on its historical loss experience, adjusted for current conditions and reasonable and supportable forecasts. It is inappropriate to conclude that there is no credit loss at December 31 because the lender expects to collect more than the current amortized cost basis of the loan. Instead, the lender must associate some of the future expected credit loss with the current amortized cost basis. For instance, the lender may apply its loss rate ($10 / $100 = 10%) to the current amortized cost basis to estimate a current ACL of $6. As the $40 initial discount is accreted to the amortized cost basis of the loan, the ACL will increase accordingly. Other non-dcf approaches may also be acceptable in estimating a current ACL. As noted in the TRG discussion and as illustrated in this example, the use of a non-dcf approach may result in an increasing ACL over the life of a pool of financial assets if the amortized cost basis of the assets increases over time, whether due to the amortization of discounts or the capitalization of interest. Similarly, the use of a DCF approach to estimating the ACL will also result in an increasing ACL over the life of a pool of financial assets due to the time value of money, assuming all other variables are equal. Accrued interest ASU , Financial Instruments Credit Losses, amends the definition of the amortized cost of a financial asset to include accrued interest. Because the ACL reduces the amortized cost basis of financial

5 New Developments Summary 5 assets to the net amount expected to be collected, accrued interest that is not expected to be collected should be included in the ACL. The accounting for credit losses on accrued interest under ASC , Receivables, is currently mixed in practice regarding whether to include accrued interest in the allowance for loan losses, or to exclude accrued interest from the estimate of the allowance for loan losses and account for it through a charge to interest income. Some entities that apply nonaccrual policies (that is, they cease to accrue interest when the collection of full contractual cash flows on a financial asset is no longer probable) do not include accrued interest in their estimate of the allowance for loan losses, but reverse accrued-but-uncollected interest through interest income when they determine the accrued interest is not collectible. Many of these entities also present accrued interest as an asset separately from the underlying financial asset on the balance sheet. Other entities include an estimate of uncollectible accrued interest in the allowance for loan loss and charge off accrued interest against the allowance for loan loss when they determine that accrued interest is not collectible. Certain stakeholders indicated that including accrued interest in the definition of amortized cost creates a potential conflict with existing practices for treating accrued interest under certain nonaccrual policies. They noted that the FASB s express intention was that the guidance in ASU would not impact how interest income is recognized. However, by requiring accrued interest that is determined to be uncollectible to be accounted for solely through the ACL, the manner in which net interest income is recognized by entities would be impacted. Additionally, certain stakeholders indicated that their existing systems did not track accrued interest in a way that could easily link the interest to the underlying financial asset. TRG views The TRG generally agreed with the FASB staff that there is no conceptual basis for removing accrued interest from the definition of amortized cost. Additionally, TRG members generally agreed with the FASB staff s recommendation to provide a practical expedient that would allow an entity to treat accrued interest as a separate financial asset from the underlying financial asset. This practical expedient would allow reporting entities to Estimate the ACL on accrued interest separately from the underlying financial asset Present accrued interest separately from the underlying financial asset on the balance sheet Exclude accrued interest from the vintage disclosures Further, the TRG generally agreed with the FASB staff s view that if an estimate of accrued interest is included in the ACL, then an entity should reverse uncollectible accrued interest against the ACL, whereas if uncollectible accrued interest is reversed against interest income, then an entity should exclude an estimate of uncollectible accrued interest from the ACL. However, some TRG members pointed out that certain entities, notably those with significant credit card receivable balances, currently provide for uncollectible accrued interest in ACL and reverse uncollectible interest against interest income for certain consumer receivables. The FASB staff said that it would investigate the issue further and consider proposing to the Board an amendment of ASC 326 to include the practical expedient outlined above.

6 New Developments Summary 6 Limits to practical relief of the proposed practical expedient Some TRG members questioned whether the proposed practical expedient for treating the accrued interest receivable would provide the intended practical relief. They noted that CECL requires financial assets to be pooled based on similar risk characteristics. Since the risk characteristics of an accrued interest receivable are likely to be linked to the underlying financial asset that gave rise to the accrued interest receivable, entities may be required to link accrued interest with the underlying financial asset for purposes of pooling accrued interest receivables with similar risk characteristics. Transfers of certain loans from Held-for-Sale to Held-for-Investment and transfer of credit-impaired debt securities from Available-for-Sale to Held-to-Maturity Available-for-sale debt securities are measured at fair value, with changes in fair value recognized in other comprehensive income (OCI). Under the guidance in ASU , credit losses on available-forsale securities should be recognized using an ACL, subject to a fair value floor, meaning that the ACL should not reduce the amortized cost basis below the available-for-sale security s fair value. Any changes in fair value unrelated to credit are recognized as an unrealized gain or loss in OCI. Held-for-sale loans are measured at the lower of cost or fair value, subject to a valuation allowance, under current U.S. GAAP and under the revised guidance in ASU The valuation allowance for held-for-sale loans, however, does not distinguish between changes in fair value due to credit and those due to other reasons. Held-to-maturity debt securities and held-for-investment loans are both measured at amortized cost and are therefore within the scope of CECL. Stakeholders asked how CECL should be applied to loans transferred from the held-for-sale classification to the held-for-investment classification, and to debt securities transferred from the available-for-sale classification to the held-to-maturity classification, when the financial assets have previously recognized credit losses. Specifically, stakeholders questioned whether recognizing an expense for lifetime expected credit losses when transferring an asset previously classified as available-for-sale with recognized credit losses would effectively double count the credit losses previously recognized. All stakeholders agreed that the purchased-credit-deteriorated asset model would not apply in these cases because a transfer of a financial asset between measurement categories is not the initial recognition of a financial asset. TRG views The TRG generally agreed with the FASB staff s analysis that when transferring an available-for-sale debt security to a held-to-maturity classification, any associated ACL should be reclassified as ACL on a heldto-maturity security, while any incremental amount needed to reflect lifetime expected credit losses (that is, the amount not previously recognized due to the fair value floor) would be recognized as a credit loss expense. Any unrealized gains or losses in OCI at the transfer date would be amortized to the amortized cost basis of the debt security as an adjustment to yield over the debt security s remaining life.

7 New Developments Summary 7 The TRG also generally agreed with the FASB staff s analysis that when transferring a loan from held-forsale to held-for-investment classification, the associated balance of valuation allowance should be reversed and lifetime expected credit loss should be recognized, as required under the CECL model. The reason why the valuation allowance is reversed (as opposed to reclassifying the allowance similarly to an allowance related to available-for-sale securities) is because the valuation allowance on held-for-sale loans is not specifically related to credit losses. The TRG did not reach general agreement on whether transfers of debt securities between available-forsale and held-for-sale classification, and loans between held-to-maturity and held-for-investment classification, should be presented on a gross or net basis. The TRG further noted that ASU eliminated certain paragraphs in ASC on loans not previously held-for-sale; this guidance now resides only in ASC , Financial Services Mortgage Banking: Receivables. The FASB staff indicated that a technical improvement may be warranted to avoid any confusion, since ASU was not intended to change the accounting for loans classified as held-for-sale. Recoveries Under ASC , when all or a portion of the amortized cost basis of financial assets is deemed uncollectible, an entity should write off these amounts against the ACL. The guidance further states that subsequent recoveries of amounts previously written off should be recorded when received. This guidance on recoveries is consistent with the existing guidance in ASC 310, which considers recoveries to be gain contingencies. Stakeholders questioned whether an entity may consider expected cash flows from financial assets previously written off ( expected recoveries ) when estimating the ACL. Some stakeholders think that it is inappropriate to consider expected recoveries because recoveries inherently relate to amounts that are no longer included in the amortized cost basis of financial assets. On the other hand, other stakeholders noted that the ACL is generally calculated on the basis of a pool of assets and that all expected cash flows from that pool should be included in the estimate of ACL. These stakeholders believe that excluding expected recoveries from the estimate of the ACL would result in financial assets being presented on the balance sheet at an amount other than the net amount expected to be collected, which is the purpose of the ACL under ASC Discussion The TRG generally agreed that entities may include expected recoveries in the estimate of the ACL, but failed to reach agreement about whether including expected recoveries in the ACL should be required. Some TRG members believe that all expected future cash flows associated with a pool of financial assets should be included in the ACL estimate, including recoveries, as long as those expectations are reasonable and supportable. Other TRG members support including expected recoveries when estimating the ACL for a pool of financial assets, but objected to including expected recoveries when estimating the ACL for an individual asset. The TRG also failed to reach general agreement on whether expected recoveries should be included on the balance sheet as a component of the ACL or as a separate asset.

8 New Developments Summary 8 The FASB staff said it will discuss both matters to determine whether a technical improvement is warranted to clarify the Board s intent. Refinancings and loan prepayments CECL requires that entities consider expected prepayments when estimating the ACL. However, the term prepayment is not defined in U.S. GAAP, resulting in mixed practice today regarding whether a refinancing of a financial asset constitutes a prepayment. Some stakeholders inquired whether a modification of a loan that meets the more than minor modification guidance in ASC through should be considered a prepayment for purposes of estimating the ACL. These stakeholders also asked whether a refinancing would not qualify as a prepayment if the refinancing did not meet the more than minor modification guidance in ASC 310. TRG views The TRG generally agreed that (1) the Board did not intend to alter existing interpretations of what constitutes a prepayment, (2) ASC 326 does not provide a specific framework for defining a prepayment, and (3) entities are not required to use the loan modification guidance to determine whether a refinancing is a prepayment, though an entity is not precluded from using that guidance. Defining prepayments Some stakeholders indicated to the FASB staff that they consider all refinancings of many consumer receivables, such as residential mortgages, to be prepayments, regardless of the significance of the modification (except for troubled debt restructurings). These stakeholders believe this policy is appropriate because consumer receivables are often highly standardized, and borrowers can often easily refinance their debt with parties other than the original lender. Accordingly, the lender has the opportunity to eliminate its credit risk and allow the borrower to refinance with a third party. These stakeholders also said that they believe refinancings of many commercial receivables, such as large consumer and industrial loans, rarely qualify as prepayments, regardless of the significance of the modification. These stakeholders think this policy is appropriate because commercial loans are more often bespoke and are therefore difficult to refinance with parties other than the original lender. Accordingly, the lender rarely has the opportunity to eliminate its credit risk, but sees the refinanced loan as a continuation of a single lending relationship. Entities should utilize judgment to determine an appropriate, consistent definition of prepayment for each pool of financial assets if prepayments are expected to have a material impact on their estimate of expected credit losses.

9 New Developments Summary Grant Thornton LLP, U.S. member firm of Grant Thornton International Ltd. All rights reserved. This Grant Thornton LLP bulletin provides information and comments on current accounting issues and developments. It is not a comprehensive analysis of the subject matter covered and is not intended to provide accounting or other advice or guidance with respect to the matters addressed in the bulletin. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this bulletin. For additional information on topics covered in this bulletin, contact your Grant Thornton LLP professional.