It was a busy 2016 for accounting standards reviewers, and there are a number of changes coming that financial institutions will want to be ready for. This two-part article covers several key issues to help you stay out in front in 2017.
In Part I of this two-part article, we covered several important accounting standards changes to prepare for in 2017. Here are two more:
4. Leases (ASU 2016-02) – The good times continued to roll with the adoption of this accounting standard date in February. This standard is effective for public entities, certain non-profit entities, and certain employee benefit plans with fiscal years beginning after December 15, 2018, and effective for fiscal years beginning after December 15, 2019, for all other entities. Early adoption is permitted for this update. This accounting standard update directly and indirectly affects financial institutions. Leases entered into by all entities, with a term in excess of 12 months, will now have a direct balance sheet effect – with a right-of-use asset and lease liability recognized – with the income statement effect differing based on how the lease is classified (either financing lease or operating lease). Yes, operating leases will now be reflected on the balance sheet. Banks, as mentioned, will be indirectly affected as they now need to better understand how their borrowers are reporting and treating the lease obligations, as a lessor and lessee.
5. Credit Losses (ASU 2016-13) – And the last big thing (so far) that has hit the industry, Current and Expected Credit Losses (CECL). This was adopted in June, however there is plenty of time to implement. Public entities must adopt this update in fiscal years beginning after December 15, 2019, and all other entities in fiscal years beginning after December 15, 2020. Early adoption, beginning in fiscal years after December 15, 2018, is permitted. In the year of adoption, a one-time cumulative effect adjustment will be reported to retained earnings. While banks have always been required to measure expected losses, it has been based on past events and current conditions and not recognized until the loss was probable of occurring. This accounting update now requires entities to forecast losses on all financial assets carried at amortized cost (e.g. loans and held-to-maturity investment securities), from origination forward and eliminates the delayed recognition of potential losses. While there is no ‘prescribed’ methodology for measuring the expected losses, the FASB has indicated current models and systems can used, but enhancements will be necessary which are fully supported. There is time to prepare for this major accounting change – but some important things to remember: a) review your purging practices and retain loan payment/charge-off activity data as it will be necessary in modifying or creating your model and b) don’t build up too much reserve now in anticipation of what will be needed. The general consensus is that the regulatory bodies are expecting an increase in the Allowance for Loan and Lease Losses (ALLL) at adoption of this ASU and you will be criticized for not complying with current GAAP if there isn’t a one-time increase. Rather than build up your ALLL, build up your capital to prepare for adopting CECL. Also an important note – while this is a critical accounting change in the financial institution industry, this affects other industries as well as any entity with loans or trade receivables are within the scope of this ASU. Thus, not only do banks have to prepare for implementing this ASU, they must ensure they understand how their borrowers are adopting this ASU and the effect on financial statements used for underwriting or credit analysis purposes.
2016 has been a year of change, but what year isn’t without that? Change can be worrisome at times (well, a lot of times) but, in the end, change is good when fully embraced. While there is time to adopt these accounting changes, don’t wait. Start reviewing current practices, agreements, policies, and procedures. Make sure your Board of Directors are fully informed of these accounting changes and the effect to the bank (direct and indirect). Educate and involve bank personnel in preparing for these changes as adoption will require a team of heroes.
That’s Not All
These are just a couple of the accounting standards changes you’ll want to take into account when planning for 2017. In case you missed it, Part 1 of this article covers revenue recognition, consolidation and financial instruments. Check it out to get a full picture, and get yourself ready for a great new year!
Read Part One here.