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Planned Credit Losses Standard on Track for Publication in Early 2016

The FASB’s much-watched credit losses standard is expected to be published early next year, not at the end of 2015 as planned. The standard, which will force banks and other businesses to consider future losses on loans and other financial products when estimating loan loss reserves, is considered the FASB’s most important response to the 2008 financial crisis.

The FASB expects to publish in early 2016 the accounting standard considered the board’s chief response to the 2008 financial crisis.

The new schedule for the much-watched credit losses standard is a delay from the board’s previous estimate of publishing it by the end of 2015.Work on the planned standard has dragged on for a decade. The FASB began the project as a joint effort with the IASB in 2005. After the 2008 financial crisis, the project gained urgency as it became clear that many financial companies delayed writing down bad loans and other assets.

The FASB plans to meet on November 11, 2015, to review the questions that cropped up during what the board calls a “fatal flaw” or last-minute review of the draft standard. While the board received hundreds of comments during the confidential external review of the document, none of the issues raised were major, FASB member Harold Schroeder said on October 9, 2015, at a meeting with the AICPA’s Auditing Standards Board’s Audit Issues Task Force.

The FASB also held a closed-door meeting on September 30 with the document’s reviewers. The reviewers plan to meet publicly after the standard is published to field questions and brainstorm solutions on how to implement the new standard, Schroeder said.

FASB member Lawrence Smith, who also spoke to the AICPA task force, said representatives from the SEC, PCAOB, banking regulators, and the Big Four audit firms who attended the meeting said they believed the forthcoming standard was workable and auditable, even if the prescribed accounting treatment would not necessarily result in consistent answers across all businesses.

“I was curious if people were comfortable with that, because if they were not comfortable with that, that’s a nonstarter,” Smith said. “And the PCAOB was there, the SEC was there, and the banking regulators were there, all the Big Four were… and no one objected to it.”

The forthcoming credit losses standard is a reaction to years of complaints by investors, analysts, and regulators that current U.S. GAAP does not do a good enough job of requiring banks to estimate potential losses. This was a major issue in the 2008 financial crisis when banks suffered deep losses, but their balance sheets remained healthy until long after the mortgage business had fallen into a deep recession.

Based on changes the FASB released in draft form in late 2012 in Proposed Accounting Standard Update (ASU) No. 2012-260,Financial Instruments—Credit Losses (Subtopic 825-15), banks and other businesses must look to the foreseeable future, consider all losses that could happen to a loan, security, trade receivable, or security in question and book losses.The estimate is not supposed to cover a best-case or worst-case scenario.

The standard is expected to push banks to boost their loan loss reserves to cover potential losses.While the standard is not limited to banks, they are expected to be its chief user.

Schroeder said when he explained the forthcoming standard to people, he boiled it down to a few sentences: “You know what you’ve lent out.What do you think you’re going to collect back?What’s the difference? Book it.In a nutshell that’s by and large what the standard says.”

Under the model Schroeder described, banks are supposed to take into account past experiences, future estimates, and current trends in the economy, and use their best judgment to set aside reserves to cover losses. The loss provision they report in their financial statements should give investors, regulators, and creditors a sense of the bank’s performance and soundness.

Investors and lenders give particular weight to the quarterly fluctuations in the loss provision. When a bank increases reserves, it is sending a message that it has bad loans on its books, and it needs the higher provision to cover the losses it expects to incur.

Under the FASB’s standard-in-progress, reserves are expected to be large from the date a loan is originated or a security is purchased, not because a lender believes the individual loan will default but because some loans or securities in a portfolio will default or lose value.

Critics of the standard also say they are concerned about how a company’s financial reporting staff can justify the reported reserves to external auditors when there is so much judgment involved. Two banks with similar business models could come to different conclusions about loans with similar characteristics.

“We recognize they will come to different answers,” Schroeder said. “I don’t personally think accounting standards are designed to always come to exactly the same outcome, particularly in estimate-type of situations. Maybe it’s because I come from an investor background, and two investors are never going to come to exact same conclusion with the same facts and circumstances.”

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