This summer, the Financial Accounting Standards Board (FASB) completed its project on credit losses with the issuance of a new standard that brings one of the most significant changes to financial reporting that financial institutions have seen in decades: The incurred loss model for estimating credit losses will be replaced with a new model, the current expected credit loss (CECL) model. In many cases, the new credit loss calculations are expected to result in an increase in the allowance, and, thus, might have a significant impact on capital requirements. Banks will need sufficient time to prepare and adjust capital planning and capital management strategies.
Banks are educating themselves on the changes, and boards of directors should be aware of the challenges faced by the banks they oversee.
As with any major initiative, a successful transition to the new standard will require the active involvement of the audit committee, the board of directors, and senior management. Given the audit committee’s responsibility for overseeing financial reporting, it has a critical role to play in overseeing implementation.
Recently, speakers from the Securities and Exchange Commission’s (SEC’s) Office of the Chief Accountant have emphasized the role that audit committees should have in implementing new significant accounting standards. In his speeches at Baruch College and the AICPA Bank Conference, Wes Bricker, interim chief accountant, addressed CECL implementation. Likewise, the federal financial institution regulatory agencies have addressed the role of the board in implementing the new credit loss standard. The agencies issued a joint statement on June 17, and in March the Federal Reserve System (Fed) released an article, “New Rules on Accounting for Credit Losses Coming Soon.” The speeches, joint statement, and article highlight tasks that boards of directors and audit committees may consider during transition, including:
- Evaluate management’s implementation plan, including the qualified resources allocated for execution.
- Monitor the progress of the implementation plan, including any concerns raised by the auditors or management that might affect future financial reporting.
- Understand the changes to the accounting policies that are required for implementation.
- Understand management’s transition to any new information systems, modeling methodologies, or processes that might be necessary to capture the data to implement the standard.
- Oversee any changes to internal control over financial reporting in transitioning to the new standard.
- Review impact assessments of the new standards, including impact on financial statements; key performance metrics, including credit loss ratios, that might be disclosed to investors outside the financial statements; regulatory capital; and other aspects of the organization such as compensation arrangements and tax-planning strategies.
- Understand management’s plan to communicate the impact of the new standard on key stakeholders, including the new disclosures required by the standards and disclosures made leading up to the adoption date. Those who file with the SEC will need to disclose information about standards effective in future periods, including the expected impact when adopted.
In evaluating management’s implementation plan, it is important to develop an understanding of management’s timeline for implementing the new standards and to be aware of the effective date. Recognizing that the definition of a public business entity (PBE) under FASB includes many financial service entities, the FASB split the definition to provide additional time for PBEs that are not SEC filers.
- For PBEs that are SEC filers, the standard is effective in fiscal years beginning after Dec. 15, 2019, and interim periods in those fiscal years. For calendar year-end SEC filers, it first applies to the March 31, 2020, interim financial statements.
- For PBEs that are not SEC filers, the standard is effective in fiscal years beginning after Dec. 15, 2020.
- For all other entities, the effective date includes fiscal years beginning after Dec. 15, 2020, and interim periods in fiscal years beginning after Dec. 15, 2021.
- Early adoption is permitted for all entities in fiscal years beginning after Dec. 15, 2018, and interim periods in those fiscal years. That means, any calendar year-end entity may adopt as early as the March 31, 2019, interim financial statements.
While those dates might seem somewhat distant, there really is no time to lose in preparing for the transition.