Accounting and Auditing Update TRAVIS SMITH, CPA, CGMA

Transcription

1 Accounting and Auditing Update TRAVIS SMITH, CPA, CGMA

2 Moss Adams Presenter Travis Smith, CPA, CGMA Partner National Credit Union Practice Travis has practiced public accounting since 1996 and is a member of the firm s National Credit Union Practice. For over 20 years, he has served hundreds of financial services companies across the United States and is a frequent presenter at conferences. Travis has extensive experience with complex investments, fair value, derivatives, hedging activities, and routinely works with regulators from all agencies. He is a member of the firm s Financial Services Steering Committee and leads the Scottsdale office s Financial Services Group. He is also a member of the Arizona Society of Certified Public Accountants and the American Institute of Certified Public Accountants. Travis earned a BA in accounting from the University of Washington.

3 Disclaimer The material appearing in this presentation is for informational purposes only and should not be construed as advice of any kind, including, without limitation, legal, accounting, or investment advice. This information is not intended to create, and receipt does not constitute, a legal relationship, including, but not limited to, an accountant client relationship. Although this information may have been prepared by professionals, it should not be used as a substitute for professional services. If legal, accounting, investment, or other professional advice is required, the services of a professional should be sought. Content is not all inclusive.

4 Leases ASU No , Leases (Topic 842)

5 Why Change? FASB has said: Lessees Most leases are off balance sheet Disclosures provide only limited information about operating leases Lessors $1.25 trillion Of off balance sheet operating lease commitments for SEC registrants* * Estimate according to the 2005 SEC report on off balance sheet activities Lack of transparency about residual values Consistency with lessee proposal and revenue recognition proposal

6 Right of Use Model Lease: A contract, or part of contract, that conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

7 Does the Contract Contain a Lease? IDENTIFIED ASSETS Explicitly or implicitly identify leased asset Supplier has no practicable ability to substitute and would not economically benefit from substitution RIGHT TO CONTROL Decision making authority to direct the use of the identified asset Ability to obtain substantially all of the economic benefit from the use of the asset

8 Implementation Guidance ASC Flowchart depicting how to determine whether a contract is or contains a lease.

9 FASB s Dual Model Balance Sheet Income Statement Cash Flows Finance Right of use asset Lease liability Amortization expense Interest expense Financing cash flow for principal Operating cash flow for all other Operating Right of use asset Lease liability (not debt) Single lease expense on a straight line basis Operating cash flow for all lease payments Recognition and measurement option for short term leases.

10 Lease Term Classification & Measurement Assess at lease commencement and reassess only upon changes that are in lessee s control Factors to consider: Contract has penalty for failure to renew Asset is critical to operations Entity performed significant integration Below market option Lessee s options to purchase, extend, or terminate the lease when reasonably certain Lessor s options to extend (or not terminate the lease) Assessment of reasonably certain to consider all factors

11 Financial Statement Presentation Operating Lease Finance Lease Gross presentation of ROU assets and lease liabilities for operating and finance leases (comingling prohibited) Single SL lease expense Operating cash flow classification for all payments Front loaded interest and SL amortization expense Financing and operating cash flow classification Operating lease liability isn t debt

12 Footnote Disclosures Quantitative Periodic lease expense, ROU asset amortization, interest costs Short term, variable leases, sublease income, cash and non cash flows Weighted average discount rate for both finance & operating Weighted average remaining lease term for both finance & operating Qualitative Terms and conditions, purchase options and termination penalties Accounting policy elections, areas of significant judgment, assumptions Residual value guarantees Significant judgments & assumptions

13 Effective Dates Non Public

14 How Will the Change Impact An Organization? Policy elections to be made Current capabilities and system resources may not be sufficient to identify and capture all leases to apply new standard Internal and external financial reporting metrics may need to be revised to account for changes in balance sheet and income statement classification Accounting for book tax differences going forward Impact on borrowers and related debt covenants

15 How Will the Change Impact An Organization? Gross up of the balance sheet Impact to regulatory capital ratios Balance sheet geography Increased assets Lower return on assets Earnings Finance lease reduced earnings up front Operating lease no impact

16 Leases Items to consider... Identify project leader and availability of resources within your organization to manage the transition process Evaluate whether controls and processes are properly designed and implemented across all functional areas (IT, legal, procurement, treasury, accounting) including new reassessment processes Consider benefits of lease accounting software solutions to manage lease accounting and reporting vs. traditional spreadsheets Review contracts to ensure all leases and relevant terms have been identified and properly accounted for Communicate expectations both internally and to key external stakeholders Consider regulatory and tax implications Consider change in strategy for lease vs. buy

17 Financial Instruments ASU No , Financial Instruments Overall (Subtopic ): Recognition and Measurement of Financial Assets and Financial Liabilities

18 Financial Instruments Key elements of the new rule include: Eliminates the available for sale classification for equity securities and contains a new requirement to carry those equity securities with readily determinable fair values at fair value through net income (FV NI) Practicability exception from fair value accounting to equity securities that do not have readily determinable fair values Assesses the need for a valuation allowance for a deferred tax asset related to an available for sale debt security Requires an exit price notion for those items disclosed at fair value (rather than entrance value) eliminates practicability exception

19 Financial Instruments Key elements of the new rule include: Record changes in instrument specific credit risk for own financial liabilities measured under the fair value option in other comprehensive income (not through net income) Eliminates disclosure requirements for Non PBEs for financial instruments measured at amortized cost (AKA the FAS 107 table ) Generally, an entity will record a cumulative effect adjustment to beginning retained earnings as of the beginning of the first reporting period in which the guidance is adopted

20 Financial Instruments Effective date: Public entities: annual periods beginning after December 15, 2017, and interim periods therein. All other entities: annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, Non PBEs can early adopt the standard as of the effective date for PBEs. All entities can early adopt a provision that eliminates the fair value disclosures carried at amortized cost and a provision requiring them to recognize the fair value change from own credit provision that eliminates the fair value disclosures for financial instruments not recognized at fair value as of annual or interim periods for financial statements that have not been issued, including 2015.

21 Business Combinations ASU No , Business Combinations (Topic 805): Clarifying the Definition of a Business

22 Business Combinations Amendment adds a screen that will reduce the number of transactions that need to be further evaluated If the screen is not met, the amendment in this update: Require that to be considered a business, a set of assets and activities must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output Remove the evaluation of whether a market participant could replace missing elements Provides a framework to assist entities in evaluating whether both an input and a substantive process are present

23 Business Combinations Effective date: Nonpublic entities: Periods ending after December 15, 2018 Early adoption permitted

24 Intangibles Goodwill and Other ASU No , Intangibles Goodwill and Other (Topic 350): Simplifying the Test of Goodwill Impairment

25 Intangibles Goodwill and Other Eliminates step two from the goodwill impairment test Impairment test is to be performed by comparing the fair value of the reporting unit to its carrying amount (Step 1 only) May result in recording impairment charges sooner than under current GAAP

26 Intangibles Goodwill and Other Effective date: Nonpublic entities: Periods ending after December 15, 2021 Early adoption permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017

27 Receivables Nonrefundable Fees and Other Costs ASU No , Receivables Nonrefundable Fees and Other Costs (Subtopic ): Premium Amortization on Purchased Callable Debt Securities

28 Receivables Nonrefundable Fees and Other Costs Shortens the amortization period for certain callable debt securities held at a premium Premiums will now be amortized to the earliest call date Does not change accounting for securities held at a discount

29 Receivables Nonrefundable Fees and Other Costs Effective date: Nonpublic entities: Periods ending after December 15, 2019 Early adoption permitted

30 Statement of Cash Flows ASU No , Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments ASU No , Statement of Cash Flows (Topic 230): Restricted Cash

31 Statement of Cash Flows (ASU ) Changes to Cash Flow : Debt prepayment or debt extinguishment costs Cash payments should be classified as cash outflows for financing activities. Settlement of zero coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing The issuer should classify the portion of the cash payment attributable to the accreted interest related to the debt discount as cash outflows for operating activities, and the portion of the cash payment attributable to the principal as cash outflows for financing activities. Contingent consideration payments made after a business combination Cash payments not made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability should be separated and classified as cash outflows for financing activities and operating activities. Cash payments up to the amount of the contingent consideration liability recognized at the acquisition date (including measurement period adjustments) should be classified as financing activities; any excess should be classified as operating activities. Cash payments made soon after the acquisition date of a business combination by an acquirer to settle a contingent consideration liability should be classified as cash outflows for investing activities. Proceeds from the settlement of issuance claims Cash proceeds received from the settlement of insurance claims should be classified on the basis of the related insurance coverage (that is, the nature of the loss). For insurance proceeds that are received in a lump sum settlement, an entity should determine the classification on the basis of the nature of each loss included in the settlement.

32 Statement of Cash Flows (ASU ) (Continued) Proceeds from the settlement of Corporate Owned Life Insurance, including Bank Owned Life Insurance policies Cash proceeds received from the settlement of corporate owned life insurance policies should be classified as cash inflows from investing activities. The cash payments for premiums on corporate owned policies may be classified as cash outflows for investing activities, operating activities, or a combination of investing and operating activities. Distributions received from equity method investees When a reporting entity applies the equity method, it should make an accounting policy election to classify distributions received from equity method investees using either of the following approaches: Cumulative earnings approach: Distributions received are considered returns on investment and classified as cash inflows from operating activities, unless the investor s cumulative distributions received less distributions received in prior periods that were determined to be returns of investment exceed cumulative equity in earnings recognized by the investor. When such an excess occurs, the current period distribution up to this excess should be considered a return of investment and classified as cash inflows from investing activities. Nature of the distribution approach: Distributions received should be classified on the basis of the nature of the activity or activities of the investee that generated the distribution as either a return on investment (classified as cash inflows from operating activities) or a return of investment (classified as cash inflows from investing activities) when such information is available to the investor.

33 Statement of Cash Flows (ASU ) (Continued) Beneficial interests in securitization transactions A transferor s beneficial interest obtained in a securitization of financial assets should be disclosed as a noncash activity, and cash receipts from payments on a transferor s beneficial interests in securitized trade receivables should be classified as cash inflows from investing activities. Separately identifiable cash flows and application of the predominance principle The classification of cash receipts and payments that have aspects of more than one class of cash flows should be determined first by applying specific guidance in generally accepted accounting principles (GAAP). In the absence of specific guidance, an entity should determine each separately identifiable source or use within the cash receipts and cash payments on the basis of the nature of the underlying cash flows. An entity should then classify each separately identifiable source or use within the cash receipts and payments on the basis of their nature in financing, investing, or operating activities. In situations in which cash receipts and payments have aspects of more than one class of cash flows and cannot be separated by source or use, the appropriate classification should depend on the activity that is likely to be the predominant source or use of cash flows for the item.

34 Statement of Cash Flows (ASU ) Effective date: Nonpublic entities: Periods ending after December 15, 2018 Early adoption permitted

35 Statement of Cash Flows (ASU ) Cash Flow Issues addressed: Diversity exists in the classification and presentation of changes in restricted cash on the statement of cash flows Entities classify transfers between cash and restricted cash as operating, investing, or financing activities, or as a combination of those activities, in the statement of cash flows. Entities present direct cash receipts into, and direct cash payments made from, a bank account that holds restricted cash as cash inflows and cash outflows, while others disclose those cash flows as noncash investing or financing activities.

36 Statement of Cash Flows (ASU ) Changes to cash flow presentation: The ASU requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning of period and end ofperiod total amounts shown on the statement of cash flows. Disclosure An entity shall disclose information about the nature of restrictions on its cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. When cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents are presented in more than one line item within the statement of financial position, present on the face of the statement of cash flows or disclose in the footnotes the line items and amounts of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents reported within the statement of financial position that totals the total amount of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents at the end of the corresponding period shown in the statement of cash flows. This disclosure may be provided in either a narrative or a tabular format.

37 Statement of Cash Flows (ASU ) Effective date: Nonpublic entities: Periods ending after December 15, 2018 Early adoption permitted The amendments in this Update should be applied using a retrospective transition method to each period presented.

38 Revenue Recognition ASU No , Revenue from Contracts with Customers (Topic 606): Deferral of the Effective ASU No , Revenue from Contracts with Customers (Topic 606)

39 Revenue Recognition Effective date of ASU No , Revenue from Contracts with Customers (Topic 606) Private entities: Effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019

40 Revenue Recognition Transition Effective January 2019 for private entities (early adoption allowed) Option 1: Full Retrospective Follow current guidance in 2018 In 2019, recast 2018 to new guidance (January 1, 2018, cumulative effect adjustment date) Option 2: Modified Retrospective Follow current guidance in 2018 For 2019, present new guidance (January 1, 2019, cumulative effect adjustment date) Comparative disclosure of 2019 new vs. old Cumulative effect adjustment requires evaluation of open/unsatisfied contracts that carry over in 2018 or 2019, respectively, depending on transition approach

41 Revenue Recognition AICPA Task Forces Also evaluating standard Formed 16 industry task forces for application examples of the standard Three banking industry focused: Asset Management Broker Dealers Depository Institutions ng/revenuerecognition/pages/rrtf DepositoryInst.aspx

42 REVENUE RECOGNITION Potential revenue recognition implementation issues identified by the Depository and Lending Institutions Revenue Recognition Task Force

43 Financial Instruments Credit Losses ASU No , Financial Instruments Credit Losses (Topic 326)

44 CECL Effective Dates The FASB decided to defer the originally planned effective dates by one year to the following: 1. For all non PBE entities, including not for profit organizations and employee benefit plans, the forthcoming standard will be effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, Early adoption will be permitted for all entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Scope: Includes financing receivables (Loans) and HTM debt securities, lease receivables, loan commitments, guarantees, and other items; AFS securities guidance was separately amended. 44

45 Measuring Current Expected Credit Losses THE ULTIMATE LOSS DOESN T CHANGE JUST THE TIMING OF RECOGNITION Estimate of contractual amounts that an entity does not expect to collect over the contractual life When determining the contractual life of the asset: Consider expected prepayments Do not consider extensions, renewals, and modifications unless entity reasonably expects to execute a TDR Assets should be pooled when similar risk characteristics exist; otherwise assess individually Management s expectations should consider all relevant internal and external information including: Past events Current conditions Reasonable and supportable forecasts (how far in the future?) Revert to historical loss average experience for future periods beyond which the entity is able to make reasonable and supportable forecasts Can adjust historical losses for borrower specific factors 45

46 Measuring Current Expected Credit Losses (continued ) OTHER ITEMS OF INTEREST The estimate of expected credit losses should be a best estimate but must not be a best case scenario (or worst case) and must always reflect the risk of loss, even when that risk is remote, however: Not required to recognize a loss on a financial asset in which the risk of default is greater than zero yet the amount of loss would be zero In practice, Treasuries and GSE s likely to meet this definition Collateral dependent financial assets practical expedient (fair value less costs to sell) TDRs remain follow CECL guidance Purchase Credit Deteriorated follow gross up accounting model AFS Debt Securities revised accounting model bifurcate credit and interest rate mark; reserve for credit New disclosures (vintage and qualitative discussion) Business combinations: (ASC A) For acquired financial assets that are not purchased financial assets with credit deterioration, the acquirer shall record the purchased financial assets at the acquisition date fair value. Additionally, for these financial assets within the scope of Topic 326, an allowance shall be recorded with a corresponding charge to credit loss expense as of the reporting date. 46

47 Modeling and Implementation Challenges

48 Modeling Options/Strategies Potential models used in forecasting: Historical loss rate approach Discounted cash flow Provision matrices Risk Migration (pooling open vs. closed) Static Pool/Vintage PD/LGD Regression Analysis (18 different models) Combinations of the above Remember: many of these models are designed to analyze the past, in order to assist you in forecasting future expected credit losses; the models themselves don t give you the future losses. 48

49 Needs/Challenges Related to Models Your Data Data fields available, frequency of updating, connectivity of the data, and overall history available Regression requires approximately 30 to 40 data point observations and no gaps in data, no zeros and no $ signs Have you updated data fields along the way (and lost historical info)? Do you have multiple data sets in a single data field? What historical data do you have from your mergers? PD/LGD doesn t really work without collateral values Bad data quality requires more correlation/forecasting Be very careful with using risk ratings in your CECL modeling may be too subjective/qualitative and diverge from your segmentation that will likely be more useful External Data Accuracy, timeliness, availability (national vs. regional vs. local) 49

50 Needs/Challenges Related to Models (continued ) Segmentation Term loans (fixed vs. variable); balloon, interest only, lines of credit, credit cards Further segmentation by credit metrics (DSC/liquidity/past due status); rate tiers; possibly geography? Credit quality indicators are key to segmentation! Calculating Your Historical Losses What is an appropriate period/method? Life of Loan/Prepayments If you want to use a 7 year life for a 10 year term loan, do you think you will be able to arbitrarily assign that shorter life? NO! If you don t have life of loan data, determining a life other than the contractual term will be a challenge. What s the life of a credit card? 1 month or 10 years? How does your renewal process impact the life? Reasonable & Supportable Forecasts What does this look like? Are you going to forecast over the life of the asset, or a shorter period? 50

51 Segmentation Matters Aggregate CRE Base Case Change in Loan Mix; no Change in Loss Rates Loan Historical Expected Loan Historical Expected Balance Loss Rate Losses Balance Loss Rate Losses CRE total 4, % , % C & I 1, % , % Residential % % 2.13 Consumer % % , % , %

52 Segmentation Matters (continued ) More Detailed CRE Base Case Same Change in Loan Mix; no Change in Loss Rates Loan Historical Expected Loan Historical Expected Balance Loss Rate Losses Balance Loss Rate Losses CRE construction % % 2.88 CRE owner occupied 2, % , % CRE non owner occupied 1, % , % 5.50 CRE other % % 1.50 CRE total 4, % , % C & I 1, % , % Residential % % 2.13 Consumer % % , % , % (0.85) 52

53 Calculating Your Historical Losses Calculating Your Historical Losses COMPARING ANNUAL LOSS RATES TO "LIFE OF LOAN" LOSS RATES CHARGE OFF PERCENTAGES Year of Charge Off TOTALS Origination Year % 0.15% 0.21% 0.21% 0.38% 0.66% 1.32% 2.57% 0.00% 0.00% 0.00% 0.31% % 0.24% 0.37% 0.47% 0.50% 0.57% 0.80% 1.29% 0.00% 0.00% 0.40% % 0.18% 0.23% 0.53% 0.83% 1.15% 1.84% 1.00% 0.00% 0.45% % 0.19% 0.34% 0.65% 0.70% 0.72% 0.95% 1.20% 0.42% % 0.13% 0.24% 0.46% 0.79% 1.19% 1.33% 0.35% % 0.14% 0.27% 0.48% 0.99% 1.53% 0.32% % 0.31% 0.66% 0.62% 0.67% 0.36% % 0.24% 0.40% 0.35% 0.24% % 0.28% 0.17% 0.14% % 0.09% 0.04% % 0.03% Life of Loan Loss Rate Concept 0.13% 0.15% 0.15% 0.18% 0.22% 0.27% 0.34% 0.43% 0.46% 0.43% 0.30% 0.32% Annual Loss Rate Concept 53

54 How Are You Going to Calculate Your CECL Allowance? What is Reasonable & Supportable? Forecast Period Historical Losses 2% Losses 1% Time 54

55 Reasonable & Supportable Data Sources FRB Philadelphia State Indices (Leading, Coincident) FOMC Projections (Economic Projections of Federal Reserve Governors & Reserve Bank Presidents) Federal Reserve Economic Data (FRED) Examples of Data Real Estate, Rental and Lease Earnings Total Payroll Employment Employee data by MSA S&P Case Shiller Home Price Indices 55

56 Governance Role of executive management Cross cutting implementation Timing and decision making Internal control Role of the board and supervisory committee 56

57 Next Steps/Takeaways Implementation plan Data (internal and external) Historical loss rates Contractual lives Segmentation Models Model risk management Reasonable & Supportable Forecasting New disclosures Internal Controls related to all of the above! Communication Not only the plan, but a broader understanding of credit risk is needed at origination/purchase Monitoring regulatory and professional developments 57

58 NCUA Supervisory Priorities

59 NCUA Priorities Cybersecurity Assessment Cybersecurity remains a key supervisory focus. NCUA will continue to carefully evaluate credit unions cybersecurity risk management practices. Bank Secrecy Act Compliance NCUA remains vigilant in ensuring the credit union system is not used to launder money or finance criminal or terrorist activity. All federally insured credit unions must perform certain recordkeeping and reporting requirements under the Bank Secrecy Act. Internal Controls and Fraud Prevention Credit unions with limited staff may be more susceptible to insider fraud as a result of inherent challenges maintaining adequate separation of duties. NCUA field staff will continue to evaluate the adequacy of credit union internal controls, as well as overall efforts to prevent and control fraud. Interest Rate and Liquidity Risk On January 1, 2017, NCUA field staff will begin using a revised interest rate risk supervisory tool and new examination procedures to assess interest rate risk management practices in credit unions. Commercial Lending NCUA s revised Part 723, Member Business Loans; Commercial Lending, is effective January 1, NCUA field staff will evaluate a credit union s commercial loan policies and procedures and assess the risk management processes associated with managing a commercial loan portfolio. Credit union officials should be prepared to provide documentation to support management s ability to effectively monitor and manage its commercial loan portfolio. Consumer Compliance Given changes to the Military Lending Act that have gone into effect recently, as well as additional changes that will go into effect in October 2017, NCUA field staff will evaluate credit unions compliance with the Act. 59

60 True/False Questions The new lease accounting standard will affect the Balance Sheet of my Credit Union. The Credit Union can make policy elections that will simplify the adoption of the new lease accounting standard. The FASB issued an accounting standard that eliminated currently required disclosures. CECL will be effective for Credit Unions for fiscal years beginning after December 15, Historical losses are not considered in ASU (CECL). The NCUA recently issued 6 supervisory priorities. 60

61 Questions? TRAVIS SMITH