Accounting Standard Updates

GAAP Navigates CECL, Statutory Sails Smooth

ASU 2016-13 – Financial Instruments—Credit Losses (Topic 326)

The NAIC rejected ASU 2016-13 and related subsequent ASUs in various SSAPs for statutory accounting. While this was anticipated for statutory financial reporters, those with a holding company and agencies that prepare GAAP financial statements must understand the implementation requirements of ASU 2016-13.

This post summarizes changes introduced by ASU 2016-13 and includes a list of suggested estimation methods, joint accounts subject to CECL, and a sample policy adoption note for financial reporting reference.

Shift from Incurred Loss to CECL Model. ASU 2016-13 introduced significant changes in the accounting for credit losses on financial instruments measured at amortized cost. The main highlight of this standard is the transition from the incurred loss model (legacy GAAP) to the current expected credit loss model (CECL). The incurred loss model recognizes credit losses when it is probable that a loss has been incurred. However, under the CECL model, entities are required to estimate expected credit losses over the life of a financial instrument, even if a loss event has not yet occurred.

Measurement. Like the legacy GAAP incurred loss model, entities must still use historical data and consider current economic conditions when developing credit losses. Furthermore, the CECL model emphasizes incorporating forward-looking information and requires reasonable and supportable forecasts in estimating credit losses.

Estimation Methods. The guidance provides flexibility in choosing estimation methods, requiring consistency with the entity’s historical experience and reflecting an assessment of future economic conditions. Entities can leverage the same estimation methods used under previous guidance and incorporate the suggested methods below, as applicable, to align with the CECL model’s emphasis on reasonable and supportable forecasts.

Accounts Impacted. CECL applies to all financial instruments measured at amortized costs. In addition, ASU 2016-13 introduced the revised impairment model for available-for-sale debt securities. Below are common accounts impacted by ASU 2016-13:

**Entities have the option to make an accounting policy election to exclude accrued interest receivable from the measurement of the allowance for credit losses. This is acceptable if it is separately presented on the balance sheet and any uncollectible balances are written off promptly.

***Available-for-sale debt securities are not subject to CECL but rather must be evaluated using the revised impairment model.

Transition. The update should be applied using a modified retrospective transition approach that would require a cumulative effect adjustment to the opening retained earnings as of the date of adoption.

Disclosures. With updates, invariably, there are enhanced disclosures. The standard introduces disclosure requirements to improve transparency and provide stakeholders with more information on credit quality, risk management, and estimation methodologies. While specific disclosure needs may vary based on an entity’s characteristics and industry, here is a general list of disclosure requirements:

  • Balance sheet: Present allowance for credit losses for each financial instrument for which an allowance was calculated.
  • Shareholder’s Equity: Present the cumulative effect adjustment made to the opening retained earnings at adoption.
  • Quantitative and qualitative information about the credit quality of financial instruments:
    • Description of accounting policies: Provide a detailed explanation of the accounting policy for credit losses, including factors and methodologies used.
    • Methodologies and Assumptions: Outline the specific methods and assumptions in estimating credit losses.
    • Credit Quality Indicators: Disclose key credit quality indicators used by management in assessing credit risk, such as historical loss experience, borrower creditworthiness, and changes in economic conditions.
    • Credit Risk Monitoring: Describe how the entity monitors credit risk, including the tools, models, and metrics utilized to assess and manage credit exposure.
  • Rollforward of the allowance: The rollforward should include the beginning balance in the allowance, cumulative effect adjustment (at the year of adoption), current period provision, write-offs charged against the allowance, recoveries collected, and the ending balance in the allowance.
  • Policy Election: Disclose policy election made to exclude accrued interest and explain how and when these balances are written off. Present the accrued interest receivable separately on the balance sheet.

Below is a sample adoption note that can be included as part of an entity’s significant accounting policies disclosure footnote.

Related topics:
ASU 2016-13 – Financial Instruments-Credit Losses: Accounting for Premium Receivable
ASU 2016-13 – Financial Instruments-Credit Losses: Accounting for Reinsurance Recoverable
ASU 2016-13 – Financial Instruments-Credit Losses: Accounting for Available-for-Sale Debt Securities