During a conference, SEC Acting Chief Accountant Paul Munter provided some important reporting areas that banks especially should consider when preparing financial statements during uncertain economic times.
Among other uncertainties, companies and consumers have been experiencing the effects of high inflation, increases in interest rates and continued supply chain issues in the past few years because of COVID-19 and the Russian invasion of Ukraine.
“In particular, one of the things that management should be thinking about and having front of mind is the need to provide information about current judgments and estimates that are particularly susceptible to the potential for change in the near term. And it might require some additional disclosure beyond what has historically been provided when entities were operating in a more steady-state economic environment,” Munter said on Sept. 12 at the 2022 AICPA & CIMA Conference on Banks & Savings Institutions in National Harbor, Maryland.
In the current economic environment, it may be especially challenging for financial institutions to apply the FASB’s current expected credit losses (CECL) accounting model. Currently, only larger banks are applying CECL, but about 4,000 smaller banks, including community banks, will have to start applying the expected loss model in 2023.
The FASB’s Topic 326, Financial Instruments—Credit Losses, requires banks and other lenders to look to the future, make reasonable and supportable estimates and calculate potential losses on loans and certain securities as soon as they issue them—or on day 1—and set aside corresponding loss reserves. This is in contrast to the previous incurred loss model when banks essentially wrote down loan losses after borrowers have essentially defaulted on their payments.
“If you think about some of the particular estimates that might be especially challenging in the current environment are things like credit loss estimates as you are trying to make projections over life of loans and what will the economic environment look like as you look out over the projection of future cash flows as you are doing impairment analysis, and things like that. What is an appropriate discount rate to compute discounted cash flows in those computations, all of which can be very susceptible to revisions and estimates in an environment such as the one we are in right now,” Munter said.
Moreover, he said they should think about certain particular disclosures that might be more prominent in the current uncertain business and economic environments, such as going concern uncertainties, subsequent events, discontinued operations and significant judgments in estimates that are susceptible to change in the near-term.
Further, Munter said that it might be important for banks to provide additional information about changes in assumptions and valuation methods, for example, with CECL, fair value measurements or useful life of assets.
He also flagged a FASB topic that most accountants have not looked at recently: Topic 255, Changing Prices. The United States has been experiencing a 40-year high inflation rate in the past year.
“That might be something that has not been high on your radar, but is there inflationary pressures in the marketplace?” Munter said. The codification section, “while not required—the FASB does still have that in place—is something to think about in terms of reporting the effects of inflation.”
In addition, he said that the current environment can also be challenging to auditors. Uncertain times mean that auditors may have to provide new or additional critical audit matters (CAMs). It may also “require a much more robust risk assessment or audit engagements as they think through what are the key risk elements with respect to issuers and a heightened sense of due care and professional skepticism,” Munter said.
SEC CorpFin OCA Expectations
During a separate panel at the conference, Stephanie Sullivan, an associate chief accountant in the SEC’s Division of Corporation Finance’s (CorpFin) Office of the Chief Accountant (OCA), shared the division’s views on what banks should consider disclosing.
Sullivan noted that CorpFin has published a sample letter that covers disclosures on Russia-Ukraine war and supply chain issues in May.
“Really, the overall purpose of kind of the Dear CFO letters when we issue them is really to provide greater transparency into the division’s comment process and disclosure expectations for companies as they prepare their filings,” she said. “The expectation is that companies will be proactive to these letters so that when the staff does review your filing, the kind of disclosures are already there that we would expect to be there. So, it also reduces the fact that you will get a comment [letter] in the future.”
Sullivan said that other interpretive guidance that has been issued in the past few years still continue to apply today.
For example, CorpFin in 2020 issued CF Disclosure Guidance: Topic No. 9 and CF Disclosure Guidance: Topic No. 9A to help companies better disclose the effects of the COVID-19 pandemic. (See SEC Staff Outlines Disclosure Considerations for Public Company Q2 Reporting in the June 25, 2020, edition of Accounting & Compliance Alert.)
“While the pandemic is certainly evolving, there are still lingering impact and there are things that may still need to be disclosed in your filings,” Sullivan told banking conference attendees. “So, some of the disclosure themes in disclosure guidance Topic 9 and 9A may be applicable in the current environment resulting from other factors that are not directly related to the pandemic such as inflation, for example.”
Companies may have made some operational adjustments in response to COVID-19 or resulting macroeconomic effects, and those changes may have become permanent, she said.
There may be increased costs associated with employees returning to office, wage increases, continued supply shortages and liquidity responses to increases in interest rates and oil prices. Companies might also be involved in new supply chain financial arrangements that could impact cash flows.
“We certainly recognize that a lot of disclosures that were made in 2020 and 2021 no longer continue to be relevant, and they should be removed from the filing,” she added. “We expect disclosures to be evolving: things removed and things added.”
In addition, “to the extent that some of the impacts of COVID-19 are similar to other impacts resulting from other external factors again, like inflation, oil prices, Russia…, they should all be sort of separately quantified and talk about the factors actually driving the kind of the actions resulting from some of those factors,” she said.
For in-depth analysis of the FASB’s guidance for credit losses, please see Catalyst: US GAAP—Financial Instruments-Impairment, also on Checkpoint.
This article originally appeared in the September 14, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.
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