The New Accounting Standard on Credit Losses: Doubts Persist

A year after the Financial Accounting Standards Board (FASB) issued Financial Instruments – Credit Losses with new rules requiring upfront recording of estimated expected credit losses on loan instruments, concerns persist about the impact the directives could have on investors, accountants, and financial institutions.

For investors, there is concern that the new standard could give false comfort that the uncertainty of future events can be minimized by the more timely recognition of potential losses. Financial statements can only report on past (or speculate on future) events, not control or mitigate the possibility of future losses.

Current accounting standards for credit losses are based on the idea that a creditor should recognize losses when incurred. With the new standard, financial institutions will recognize expected losses at inception. The new standard thus shifts the focus away from recording what has happened to recording what might happen in the future.

Physicians are bound by their Hippocratic Oath “to do no harm.” Accountants do not take an oath, but are bound by tradition. Recognizing a loss before it is incurred seems to be contrary to that tradition.

Voting against the new standard, FASB Vice Chairman James Kroeker and board member Lawrence Smith issued a jointly worded dissent in which they wrote that they “disagree with the requirements to recognize a credit loss at origination or purchase, at an amount equal to the life time expected credit loss for financial assets.”

These more forward–looking rules could affect financial institutions' earnings significantly. The impact depends on how large their loan reserves are, and when the standard begins to take effect, Bloomberg BNA staff correspondent Steve Burkholder - noted in his article, New Accounting Rule to Accelerate Loan-Loss Recognition.

Implementation of the new standard could be costly and add more burdens for financial institutions with complex disclosure requirements mandated by the new standard. Smaller credit unions are already asking FASB to provide them relief on the amount and complexity of disclosures, Bloomberg BNA staff correspondent Denise Lugo reported in her article, Credit Unions Seek Relief from Credit Loss Disclosures, Rules (subscription required). Credit unions also seek more implementation guidance for reporting losses, the article revealed. 

“The new rules present challenges for credit unions of all sizes, even those in the multi-billion dollar range, as they prepare to implement the guidance,” Credit Union National Association's senior director Luke Martone, told Bloomberg BNA reporter Denise Lugo. “But for smaller ones in particular it can be resource intensive.”

The 2007 – 2008 financial crisis may have been a driving force behind FASB’s issuance of the new standard on credit losses. However, Harold Schroeder, a FASB member, cautioned that the new standard is “not designed to stop the next crisis. It’s not designed to give early warnings.”

In conclusion, the new standard on credit losses will have a major impact on multiple parties. Time will tell if it has the desired effect of providing the public with more accurate and timely information.

For additional insight to the new credit losses standard refer to Bloomberg BNA Special Report Credit Losses: Radical Changes Coming to Credit Loss Accounting; Bloomberg BNA Portfolio 5187 Financial Instruments: Credit Losses; (subscription required).  James F. Green, CPA, the author of both the Special Report and Portfolio was a source of ideas used in this blog.  Take a free trial today.