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Timing for Loan Write-Offs Won’t Change From Existing GAAP

The FASB agreed that lenders will continue to write off bad loans in the periods they determine the loans are uncollectible. The decision led the board to scrap wording from its December 2012 proposal on writing down bad financial assets. Comment letters said the proposed wording ran counter to bank regulations and existing industry practices.

The FASB at its September 3, 2014, meeting decided to keep the existing wording in U.S. GAAP that requires a lender to write off a bad loan in the period in which it determines the loan is uncollectible.

The decision led the board to scrap wording from its December 2012, Proposed Accounting Standards Update (ASU) No. 2012-260,¬†Financial Instruments — Credit Losses (Subtopic 825-15).¬†After board members reviewed the comment letters in response to the proposal and met with lenders and auditors, they realized that the proposal’s wording that called for recognition of a write-down once a lender “determines that it has no reasonable expectation of future recovery” would conflict with bank regulations and existing industry practices. Lenders and their auditors told board members that they were concerned that the wording change would delay recognition of the losses, which was something the board never intended.

Some comments complained that the proposal would result in differences between a company’s financial statements and its tax reporting. That led board member Harold Schroeder to wonder what problem the proposed guidance was designed to address.

“We don’t have a problem, so let’s not try to fix something that doesn’t exist,” Schroeder said. Similarly, FASB Chairman Russell Golden recommended that in this project and in others, “when we are not seeking a change, we should strive to not write new words to try to get us to the same outcome we had before. That causes cost. That causes confusion.”

The FASB agreed that when it publishes the final amendments, the update will explain that partial write-offs are permissible as they are done in existing industry practice or allowed by bank regulations.

In addition, the FASB decided that the write-off principle should be applied to debt securities classified as available for sale, which is used for assets the owner intends to only sell in response to a change in strategy or the markets.

Board members affirmed a previous decision that estimates of the projected cash flows on a financial instrument should include early payments, which are common with mortgages. The board also agreed that the cash flow projections should be adjusted for loan extensions and modifications when there’s a reasonable expectation that a lender will have to adjust the loan to keep the borrower afloat.

Vice Chairman James Kroecker said he worried that an old saying, “a rolling loan gathers no loss,” would gain currency if the cash flow projections don’t reflect the adjustments to the loan’s terms. Board member Lawrence Smith said he shared that concern.

Similarly, board member Thomas Linsmeier said that allowing the items to be considered in the absence of such an expectation would be contrary to the FASB’s accounting model, which he described as limiting asset recognition to present rights. “The concept that has to be here is ‘we do not recognize assets in the balance sheet as future rights to anything,'” he said.

For the funded portion of loan commitments, the FASB decided that expected credit losses should be estimated in the same manner as for other loans, which will mean that all contractual cash flows over a loan’s expected life should be considered in its value. The FASB said the same approach should apply to prepayments, but not expected extensions or modifications.

The board’s decision concerning funded loan commitments reflected its view that there was no difference between a funded portion of a loan commitment and a loan. “The funded portion of a loan commitment is a loan,” FASB member Marc Siegel said. Other board members agreed.

The board also affirmed a previous decision that expected credit losses for unfunded loan commitments should reflect the full contractual period the lender is legally obligated to extend the loan.

That decision was made despite concerns on the part of some members that the use of the term “contractual period” or a similar term would cause confusion. Linsmeier was particularly exercised about the issue and said the language should lead preparers to focus on expected cash flows instead of the loan’s term. But the board was reassured by a staff member that the language already did that.

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