In response to the 2008 financial crisis, regulators and investors put pressure on the FASB and IASB to develop models that would require financial institutions to recognize losses earlier in the credit cycle. Measuring credit loss on Pools of loans...

1. FASB Project
Current Expected Credit Loss Model (CECL)
Exposure Draft
November 20, 2013
Scott N. Drake, CPA
Member of the Firm
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2. Background
Proposal 2012-260 (Subtopic 825-15) is the
culmination of 5 years of efforts by
Financial Accounting Standards Board
(FASB) to overhaul accounting standards for
recognizing credit losses on financial
instruments.

3. Background (continued)
Current practice (“I incurred loss model”)
allows for loss recognition when losses are
“probable.” In response to the 2008 financial
crisis, regulators and investors put pressure on
the FASB and International Accounting
Standards Board (IASB) to develop models that
would require financial institutions to
recognize losses earlier in the credit cycle.

4. Background (continued)
At their core, the FASB and IASB’s models are similar
in that they both require credit losses to be
recognized earlier than current standards allow, but
they can’t agree on a “converged” approach to do
that. In October 2013, they agreed to further
develop their individual proposals and then compare
notes.
The result will most likely be two different standards.

5. Overview
The FASB’s proposal is a single credit loss
model for ALL financial assets measured at
amortized cost or Fair Value through Other
Comprehensive Income.
The proposal is based on estimating lifetime
credit losses and setting reserves accordingly
regardless of expected credit quality.

6. Overview (Continued)
Proposal differs significantly from current US GAAP in
that it:
• Results in a single approach to credit loss accounting for all
financial assets that are debt instruments
• Removes the existing “Probable” threshold for recognizing credit
losses in US GAAP
• Requires the allowance for expected losses to reflect an estimate
of contractual cash flows not expected to be collected
• Requires estimates to be based on relevant info including
reasonable & supportable forecasts

7. Overview (Continued)
• Results in recognition of an allowance for expected
credit losses for almost every debt instrument
• Changes accounting for purchased credit-impaired
assets by requiring an allowance to be recognized at
acquisition date
Key Point – with the removal of the “probable
threshold,” the proposal would no longer require a
triggering event to be identified before credit losses are
recognized. The concept of credit losses would become
primarily a measurement issue – not a recognition issue.

8. Overview (Continued)
Key Point – Generally the proposal is expected to
result in larger allowances for credit losses than
those under current GAAP. The FASB’s research
staff estimates that loss reserves under the
proposed model would increase 20% to 45%

9. Current Expected Credit Losses
(CECL) require immediate recognition of the
Proposal would
current estimate of credit losses expected over the
remaining life of the underlying financial assets.
Models used to develop the estimate would be
required to incorporate each of the following:
• Relevant information about expected losses
• Time value of money
• At least two outcomes, one of which reflects a possible
credit loss

10. Current Expected Credit Losses
Key Point – The proposal is principles-based in
nature. Applying it in practice would require
judgment and interpretations. While the
measurement of credit losses would change, the
proposal makes clear that many of the
methodologies currently used could continue
although the inputs used in those approaches would
likely need to change.

11. Current Expected Credit Losses
Relevant Information
CECL would include historical loss experience, current
conditions and reasonable and supportable forecasts.
The proposal does not prescribe how current and
forecasted conditions should be incorporated into an
estimate of credit losses but would permit the
following approaches which are consistent with
current practice.

12. Current Expected Credit Losses
• Adjust historical loss rates to reflect current
conditions and reasonable and supportable
forecasts that affect expected cash flows.
• Estimate a “credit risk adjustment” to supplement
the quantitative calculation similar to how entities
currently supplement their quantitative analysis
with a qualitative overlay.

13. Current Expected Credit Losses
Time Value of Money
• Must be reflected either explicitly or implicitly.
• Discounted cash flow approach would be an explicit
application.
• Application of historical loss rates to amortized cost
basis to estimate uncollectible amounts would be
an implicit application.

14. Current Expected Credit Losses
Key Point – Proposal would not require specific
approaches to be used.
Key Point – Proposal does not specify when credit
losses are to be estimated on an individual loan basis
and when they are to be estimated on a pool
basis, thus providing flexibility in the type of
approaches and modeling to be used.

15. Current Expected Credit Losses
Considerations for Loans
ASC 310-10 and ASC 450-20 would be superseded by
the proposal which does not provide any unit of
measure guidance.
Key Point – Entities could continue to follow the
approach currently used for credit loss estimates of
individual loans and portfolios of loans.

16. Current Expected Credit Losses
Measuring Credit Losses on Individual Loans
Discounted cash flow approach currently used by many
entities to measure losses on individual loans would
generally be acceptable under the proposal.
Key Point – Current GAAP requires allowance to be remeasured only when there has been significant changes
in expected cash flows. Proposal would require changes
to the allowance each reporting period regardless of
significance.

17. Current Expected Credit Losses
Measuring Credit Losses on Individual Loans (Continued)
• Collateral dependent loan would be defined as one in which
repayment is expected to be provided “primarily” through
the operation or sale of the collateral “by the lender”
• Current GAAP requires collateral values to be used where
foreclosure is probable. The proposal would permit, not
require the use of collateral in those situations
• Loan’s observable market price would no longer be
permitted to measure credit losses

18. Current Expected Credit Losses
Measuring Credit Losses on Pools of Loans
Proposal changes the approach from measuring
“probable” losses to one that measures expected
losses over a loan’s lifetime.
Key Point – This is most likely the area that would
require significant adjustments to credit loss
estimation models.

19. Current Expected Credit Losses
Measuring Credit Losses on Pools of Loans (Continued)
Approaches based on historical loss rates may satisfy
the requirements of an expected loss model (e.g. time
value of money and at least two possible outcomes) if
the approach incorporates reasonable and supportable
economic forecasts either through adjustments to
individual loss rates or on overlay to calculated
unmodified loss rates.

20. Current Expected Credit Losses
Illustration 1: Estimation based on loss rate approach
Entity A has developed current expected loss rates by
risk rating for five year commercial mortgage loans
based on historical loss data updated for current
conditions and reasonable and supportable forecasts of
collectability of cash flows
Expected loss rates are applied to the amortized cost
basis of the assets

21. Current Expected Credit Losses

22. Current Expected Credit Losses

23. Current Expected Credit Losses
Illustration 2: Estimation using By-Vintage Basis
Entity B provides four year amortizing loans for the
purchase of farm equipment.
Loans are tracked on the basis of calendar year of
origination.
The pattern of credit loss experience is based on the
ratio of amortized cost in each vintage that was written
off to original amortized cost basis reflected as a %

24. Current Expected Credit Losses

25. Current Expected Credit Losses
Effective Date and Transition
Proposal has not been finalized and effective date has
not been set
In fiscal year of adoption the standard would be
applied by a cumulative-effect adjustment to retained
earnings as of the beginning of the first period for
which the guidance is effective

26. Current Expected Credit Losses
Latest Developments
On October 23, 2013 the FASB research staff came up
with a new approach dubbed the “Gross-Up” approach.
It would still require forecasting all foreseeable credit
losses and recognize the credit allowance on the balance
sheet, but the income statement impact would be
amortized over time.
The FASB’s pursuit of this approach would likely result in
further delays in finalizing the proposal.

28. Scott N. Drake, CPA
Member of the Firm
804 Wayne Avenue
Chambersburg, PA 17201
717-263-3910
sdrake@sek.com
www.sek.com