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MEMO
Memo No.
Issue Date
Meeting Date(s)
18
February 15, 2019
TRG Meeting November 1, 2018
Contact(s)
Jay Shah
Project Manager
Ext. 340
Damon Romano
Practice Fellow
Ext. 334
Chris Cryderman
Practice Fellow
Ext. 467
Darien Williams
Postgraduate Technical Assistant
Ext. 462
Doug Jepsen
Postgraduate Technical Assistant
Ext. 388
Shayne Kuhaneck
Assistant Director
Ext. 386
Project
Transition Resource Group for Credit Losses
Project Stage
Post-Issuance
Issue(s)
November 2018 Meeting – Summary of Issues Discussed and Next Steps
Memo Purpose
1. The fourth public meeting of the Transition Resource Group for Credit Losses (TRG) was held on November 1, 2018. The purpose of the meeting was for the TRG members to inform the FASB about potential issues with implementing Accounting Standards Update No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, to help the Board determine what, if any, action may be needed to address those issues.
2. The purpose of this memo is to provide a summary of (a) the issues discussed at the November 1, 2018 meeting, (b) the views expressed at the meeting by the TRG members and observers, and (c) the completed and planned next steps, if any, for each of those issues.
Background
3. The following topics were discussed at the November 1, 2018 meeting:
(a) Topic 1: Cover Memo
(i) Recent Technical Inquiry
(ii) Discounting Inputs When Using a Method Other Than a DCF
(iii) Accounting for Changes in Foreign Exchange Rates for Foreign-Currency-Denominated Available-for-Sale Debt Securities
(iv) Beneficial Interests Classified as Trading.
(b) Topic 2: Contractual Term: Extensions and Measurement Inputs
(c) Topic 3: Vintage Disclosures for Revolving Loans
(d) Topic 4: Recoveries.
4. The staff’s memos for each of these topics were made public to all stakeholders before the TRG meeting and are available on the FASB’s website. A direct link to the staff memos also is included within each topic below. This summary should be read in conjunction with those staff memos, which contain a more detailed description of the issues, stakeholders’ views, and the staff’s analysis.
5. A recording of the November 1, 2018 TRG webcast is available on the FASB’s website.
Topic 1: Cover Memo (Memo 14)
Recent Technical Inquiry
Issue Summary and Staff’s Initial Views
6. Before the TRG meeting on November 1, 2018, a stakeholder submitted a technical inquiry about the amendments in Update 2016-13 regarding the credit quality information disclosure requirements in paragraphs 326-20-50-4 through 50-9 and the illustration of those disclosure requirements in Example 15 (paragraph 326-20-55-79). Specifically, stakeholders asked whether gross writeoffs and gross recoveries by origination year and class of financing receivable or major security type are required to be included in the credit quality disclosure, as portrayed in Example 15. The stakeholder noted that the disclosure of that information is not required by the guidance contained within paragraphs 326-20-50-4 through 50-9.
7. The staff informed the TRG members of its interpretation regarding this inquiry that the Board intended to require the disclosure of gross writeoffs and gross recoveries by origination year for each class of financing receivable or major security type, as portrayed in Example 15. Specifically, the staff supported the belief that the Board intended to provide financial statements users with insight into management’s estimate of the allowance for credit losses and how the individual components of the allowance are changing each period. The staff stated that omitting the information needed to track management estimates would significantly decrease the confirmatory value of the financial information provided in the credit quality information disclosures.
Views Expressed at the TRG Meeting
8. TRG members had mixed views on requiring the disclosure of gross writeoffs and gross recoveries by origination year and for each class of financing receivable or major security type. Those supporting the disclosure requirement noted that the information is critical to users’ understanding of management’s estimates of expected credit losses over time. One TRG member that is a user noted that the credit quality disclosures, specifically disclosures in paragraphs 326-20-50-5 through 50-6, become significantly less decision useful without the gross writeoffs and gross recoveries by origination year because a user will be unable to determine the cause of the change in the amortized cost basis of any particular origination year (that is, whether the loans in that origination year were paid down or charged off).
9. Many preparers on the TRG noted that the disclosure requirement would be operationally burdensome because the information on gross writeoffs and gross recoveries by origination year is not readily available in their financial reporting systems. Those TRG members stated that their current implementation plans do not include obtaining that data or the information may exist in a loan system, but that system has not been integrated with the financial reporting system. As a result, those TRG members noted that significant implementation costs would be incurred to obtain the information needed for these disclosure requirements. In addition, TRG members noted that if the Board were to require that entities disclose gross writeoff and gross recovery information, additional time to prepare those disclosures may be needed because certain entities have not considered providing this type of information.
10. Another financial institution preparer stated that writeoff and recovery information is more closely related with the allowance for credit losses rather than the credit quality disclosures of amortized cost basis and questioned the location of the disclosure in the vintage table rather than in the disclosure about the allowance for credit losses. He noted that the challenges associated with a rollforward of amortized cost basis are similar to the challenges in obtaining information on gross writeoffs and gross recoveries. Finally, that preparer noted that a large portion of the writeoff and recovery activity would be associated with the retail loan portfolio that, based upon the terms of the loan portfolio, would generally be shown in the revolving loans column in the vintage table; therefore, the data would not be broken out by origination year.
11. Another financial statement preparer noted that disclosing gross recoveries will be operationally difficult and that many recoveries will fall into the prior column in the vintage disclosure because they happen years after an entity originates and writes off the loan balance. This preparer asked the Board to consider any practical expedients in this area. Financial statement preparers noted that information on recoveries will be more of a burden to obtain than information on writeoffs because of the time frame over which recoveries on those written off balances typically occur. Those preparers noted that the operational difficulty will vary by portfolio because recoveries on some portfolios are recorded directly to the general ledger and recoveries on other portfolios are recorded in the in the loan processing system. Finally, those preparers noted that a manual process of collecting that data would be required, thereby increasing the operational burden of implementing the standard.
12. One TRG member asked about the incremental value of disclosing this information by vintage year compared with the disclosure of those amounts in the rollforward of the allowance for credit losses that already is required by portfolio segment. The user on the TRG stated that economic situations and underwriting criteria change by vintage. For users to project the allowance for credit losses on a go-forward basis, the timing of the writeoff and recovery events is very important and can be gleaned from the vintage disclosures. The financial statement preparer responded that the vintage information is not perfect and questioned the level of precision that can truly be provided and whether the benefits will justify the operational costs to preparers. The preparer noted that information from other disclosures, such as the rollforward of the allowance for credit losses, could be used to inform a user’s analysis and that vintage information is not absolutely critical.
13. One TRG member asked the group whether the disclosure requirement for gross writeoffs and gross recoveries should apply to all entities in various industries. For example, the TRG member questioned how useful the disclosure requirement would be for users of the financial statements of a retailer versus users of the financial statements of a financial institution.
14. Overall, all TRG members and observers stated that the disclosure requirement would need to be clarified through a Codification Improvement because the guidance as written currently does not require disclosure of gross writeoffs and gross recoveries by origination year for each class of financing receivable or major security type. Instead, those TRG members stated that Example 15 in paragraph 326-20-50-79, which includes gross writeoffs and gross recoveries by origination year, only depicts one way in which entities may meet the credit quality disclosure requirements in paragraphs 326-20-50-4 through 50-9 rather than prescribing a requirement to disclose particular information. Therefore, without proper clarification, entities would not be required to disclose gross writeoff and gross recovery amounts. Some TRG members stated that requiring gross writeoffs and gross recoveries without an amendment to the disclosure requirements could be interpreted to require all aspects of Example 15 (and other examples) to be requirements rather than allowing entities to use judgement in providing relevant information to users.
Next Steps
15. The staff brought this issue to the Board for a potential Codification Improvement at the November 7, 2018 Board meeting (minutes linked here). At that meeting, the Board decided to clarify that gross writeoffs and gross recoveries should be presented by origination (vintage) year for each class of financing receivable within the credit quality information vintage disclosure described in paragraph 326-20-50-6.The Board directed the staff to incorporate the proposed amendments to the vintage disclosure regarding gross writeoffs and gross recoveries in a separate proposed Accounting Standards Update, Codification Improvements—Financial instruments—Credit Losses (Vintage Disclosures: Gross Writeoffs and Gross Recoveries), for vote by a written ballot with a 60-day comment period.
16. However, after further consideration and recognition that the staff was going to conduct outreach with financial institutions of all sizes as well as nonfinancial institutions and users in early 2019, the Board decided to instruct the staff at the December 19, 2018 meeting to conduct further outreach on the requirement to include gross writeoffs and gross recoveries when disclosing credit quality information as required in paragraph 326-20-50-6. This outreach took place in early 2019 with various stakeholders and was discussed at a public roundtable in early 2019 as well.
Other TRG Submissions
Discounting Inputs When Using a Method Other Than a Discounted Cash Flow
Issue Summary and Staff’s Initial Views
17. Before the November 1, 2018 TRG meeting, stakeholders asked through a TRG submission whether discounting certain cash flows in estimating credit losses would be permitted when an entity uses a method other than a discounted cash flow (DCF) method, such as a probability-of-default method. In addition, those stakeholders questioned whether an entity is permitted to discount certain cash flows to a date other than the reporting date. Those stakeholders noted that using inputs and other data that may be readily available for regulatory reporting purposes would reduce the cost and effort needed to comply with Update 2016-13 by more closely aligning accounting and regulatory reporting. Although those stakeholders acknowledged that many other adjustments must be made between regulatory requirements and GAAP, they believe that minimizing the number of adjustments to loss data would ease the burden of adopting Update 2016-13.
18. At the November 1, 2018 TRG meeting, the staff supported the view that if an entity were to discount expected cash flows used to measure the allowance for credit losses, the effect of discounting would have to be measured as of the reporting date, not an arbitrary default date. In addition, the staff supported the belief that if an entity chooses to discount the expected cash flows used to measure the allowance for credit losses, the entity should discount all the expected cash flows used in the measurement.
View Expressed at the TRG Meeting
19. Most TRG members agreed that partially discounting cash flows to a date other than the reporting date should not be permitted, even if this methodology is used for regulatory reporting purposes. Many of the TRG members noted that it would be difficult to support partial discounting on a conceptual basis. Some preparers noted that allowing partial discounting would ease the cost and operational burden of adopting Update 2016-13 because their loss-given-default data in their reporting systems already includes partial discounting. Also, a representative from a credit union noted that, where possible, it would be preferred to align the accounting and regulatory guidance.
20. In response, a TRG observer noted that financial reporting and regulatory capital reporting rules differ in many respects, and that an entity’s model for determining the allowance for credit losses for financial reporting purposes should adhere to the requirements of the accounting standard rather than attempting to align with regulatory capital reporting. That is, aligning CECL with the regulatory capital rules should not be the Board’s goal.
21. Much of the discussion at the TRG meeting also centered on how much flexibility the Board intended to provide with respect to the method of estimating expected credit losses. Some TRG members interpreted paragraphs 326-20-30-4 through 30-5 to provide entities with the choice of using either a DCF method or a method that does not employ any use of discounting. Other stakeholders interpreted those paragraphs to allow for either a DCF method or other methods, which may or may not employ discounting of certain, but not all, expected cash flows. Generally speaking, auditors supported the interpretation that the discounting of cash flows can be applied only in a DCF method, while preparers supported the interpretation that provides the ability to employ discounting in a method other than a DCF method.
22. TRG members noted that entities are considering different combinations of discounting and not discounting certain cash flows or inputs to the determination of the allowance for credit losses to simplify the process or to manufacture a higher or lower allowance. A TRG member noted that guidance on the appropriateness of those practices would help alleviate any confusion in practice.
23. One TRG member noted that the guidance in the meeting materials about being able to fully discount all inputs in a non-DCF approach was concerning. This TRG member was concerned that the meeting materials would be introducing an alternative method for discounting that is outside the guidance in paragraph 326-20-30-4, by which an entity is required to discount all expected cash flows and compare the present value to the amortized cost basis in determining the allowance for credit losses. The staff clarified in the meeting that the intent of the TRG meeting materials in Memo No. 14, “Cover Memo,” were not intended to create an alternative model for determining the allowance for credit losses. Rather, the staff clarified that if an entity chooses to discount one expected cash flow, it must then discount all expected cash flows to the reporting date and compare that amount to the amortized cost basis in determining the allowance for credit losses.
24. A financial statement preparer noted that the Basel III rules that require discounting of recoveries from the receipt date back to the default date are intended to reflect the economics of the transaction. That is, because recoveries can occur relatively far out into the future, it does not make sense economically to consider those recoveries in the allowance determination at undiscounted amounts.
25. Another financial statement preparer stated that there is not any conceptual basis for discounting selected cash flows. The preparer noted that the time value of money applies to both positive and adverse cash flows the same. However, this financial statement preparer stated that this issue can be handled in practice between auditors and preparers when an entity can determine the allowance for credit losses in alternate ways that achieve the same result.
26. Another financial statement preparer stated that the guidance in Update 2016-13 makes a distinction between a DCF method and other methods. He stated that it was intentional not to name the “other methods” as non-discounted methods because many people noted that discounting was inherent in those other approaches. This financial statement preparer noted that the Board intended to provide flexibility in determining the allowance for credit losses when using a method other than DCF methods. The preparer questioned how granularly the Board intended to prescribe guidance around these methods and whether it would be against the Board’s intent to decide one way or another. That is, this financial statement preparer stated that some methods other than DCF methods may or may not include discounting and that it was not the Board’s intent to prescribe guidance at that level of granularity.
27. A financial statement preparer noted that discounting the expected recovery cash flows to the default date has conceptual merit because all expected cash flows would be undiscounted as of the default date. This financial statement preparer re-emphasized the potential magnitude of the time value of money within an expected recovery cash flow that may occur multiple years after the default date. He also was concerned about the wording in the meeting materials opening up practices under which one would discount all the inputs into a loss-given-default method, which could result in counterintuitive results.
28. A TRG member noted that recoveries from the fair value of the collateral would often be calculated using a discounted cash flow approach and that member noted that entities would be averse to language that would preclude that method of determining the fair value of the collateral.
29. Also, TRG members and observers had mixed views on whether additional clarification in the guidance is needed on this topic. Some TRG members and observers noted that determining the appropriateness of specific methods, assumptions, and inputs would be best addressed in practice as preparers and auditors evaluate an entity’s unique facts and circumstances. Some stakeholders requested that the Board provide additional clarification in the guidance that auditors can use as a guiding principle when determining the appropriateness of a specific entity’s credit loss estimation method.
30. One TRG observer noted that existing practices regarding procedural discipline and the role of controls embedded in regulatory guidance is an important safeguard against potential bias or manipulation within the determination of the allowance for credit losses. That observer also noted that the required disclosures regarding an entity’s methods, assumptions, and approaches will provide users with sufficient information to determine how an entity is applying the new credit losses standard. Finally, this observer noted that the standard should not be too rigid such that it precludes operational approaches in developing management’s best estimate of expected credit losses.
31. The staff agreed with that observer and continues to believe that entities should apply an approach with appropriate assumptions to present the net amount expected to be collected on the balance sheet.
Completed and Next Steps
32. The staff brought this issue to the Board for discussion at the November 7, 2018 Board meeting (minutes linked here). At that meeting, the Board decided that no further clarifications in the guidance were needed with respect to the role of discounting when using a method other than a discounted cash flow method. Furthermore, the staff continues to support the view that if an entity were to discount expected cash flows used to measure the allowance for credit losses, the effect of discounting would have to be measured as of the reporting date.
33. The staff plans no further work on this issue.
Accounting for Changes in Foreign Exchange Rates for Foreign-Currency-Denominated Available for-Sale Debt Securities
Issue Summary and Staff’s Initial Views
34. Before the November 1, 2018 TRG meeting, stakeholders asked through a TRG submission when unrealized losses related to changes in foreign exchange rates from an investment in a foreign-currency-denominated available-for-sale (AFS) debt security should be recognized in earnings. Those stakeholders noted that the consequential amendments in Update 2016-13 to Subtopic 320- 10 amended and superseded the guidance related to the accounting for fair value changes of foreign-currency-denominated AFS debt securities.
35. At the November 1, 2018 TRG meeting, the staff supported the view that the guidance is clear that unrealized losses related to changes in foreign exchange rates from an investment in a foreign-currency-denominated AFS debt security reported in other comprehensive income are recognized in earnings (a) at the maturity of the security, (b) upon the sale of the security, (c) when an entity intends to sell, or (d) when an entity is more likely than not required to sell the security before recovery of its amortized cost basis. The staff understands stakeholders’ concerns but believes that this topic is beyond the scope of the TRG because the topic relates to the accounting for changes in fair value related to foreign exchange rates.
Views Expressed at the TRG Meeting
36. Overall, TRG members and observers agreed with the staff’s analysis that the issue is outside the scope of the TRG. However, many TRG members expressed concern that unrealized foreign exchange losses in accumulated other comprehensive income (AOCI) would not be recognized in earnings in a timely manner. Therefore, many TRG members suggested that an agenda request should be submitted on this issue.
37. Some TRG members stated that entities should be required to consider the foreign exchange risk under the contingent loss guidance in Topic 450. Specifically, one TRG member stated that the insurance industry may look to Topic 450 to account for foreign exchange losses on debt securities and recognize those losses in earnings. However, other TRG members stated that entities need clarification on whether the application of Topic 450 to foreign-currency-denominated AFS debt securities is required for risks other than credit risk. Those TRG members noted that applying Topic 450 would add another assessment for AFS debt securities for entities and may be operationally burdensome. In addition, a TRG member asked the staff to clarify whether prepayment risk would be considered in a Topic 450 assessment.
38. TRG members raised questions about the mechanics of the foreign exchange translation and how that translation will affect the assessment of credit losses on a foreign-currency-denominated AFS debt security. Many TRG members asked the staff to clarify the order or sequence in which the guidance in various Topics would apply in accounting for foreign-currency-denominated AFS debt securities.
Next Steps
39. The staff plans no further work on this issue.
Beneficial Interests Classified as Trading
Issue Summary and Staff’s Initial Views
40. Before the November 1, 2018 TRG meeting, stakeholders asked in a TRG submission whether an entity should maintain an allowance for credit losses for a beneficial interest within the scope of Subtopic 325-40 that is classified as trading. Update 2016-13 amended the subsequent measurement guidance for beneficial interests within the scope of Subtopic 325-40 and requires entities to account for credit losses on beneficial interest classified as held-to-maturity (HTM) and AFS in accordance with Topic 326. Subtopic 325-40 also was amended to include subsequent measurement guidance on determining the accretable yield for HTM and AFS beneficial interests, which may be affected if the HTM or AFS beneficial interest recorded an allowance for credit losses.
41. At the November 1, 2018 TRG meeting, the staff supported the view that the guidance in paragraph 325-40-15-7 clearly includes beneficial interests classified as trading within the scope of Subtopic 325-40 for interest income recognition. The staff also believes that the scope of Subtopic 326-20 clearly excludes financial assets measured at fair value through net income. Therefore, the staff believes that the guidance is clear that an entity is not required to maintain an allowance for credit losses for beneficial interests classified as trading.
42. The staff noted that Update 2016-13 does not include specific guidance for determining the subsequent measurement of the accretable yield for beneficial interests classified as trading similar to the guidance for HTM and AFS beneficial interests. However, the staff believes that the guidance on recognition of interest income for beneficial interests within the scope of Subtopic 325-40 classified as trading is beyond the scope of the TRG. The staff believes that entities will need to apply reasonable judgment in determining the amount of accretable yield for beneficial interests classified as trading.
43. During outreach before the November 2018 TRG meeting, certain outreach participants provided an alternative view that beneficial interests classified as trading should be excluded from the scope of Subtopic 325-40. The staff believes that this alternative is beyond the scope of the TRG and would require standard setting by the Board. The staff believes that supporters of this view should submit an agenda request if they believe that the issue warrants additional consideration.
Views Expressed at the TRG Meeting
44. Overall, the TRG members agreed with the staff’s analysis and views presented. TRG members believe that the scope of Subtopic 325-40 and Subtopic 326-20 was clear as written in the guidance. One TRG member noted that different amounts of interest income would be recognized on beneficial interests based on how a beneficial interest is classified. That TRG member noted that the issue is a part of a larger accounting issue, which is the interest income recognition on financial assets measured at fair value. The TRG member agreed with the staff and acknowledged that those issues are outside of the purview of the TRG.
Next Steps
45. The staff plans no further work on this issue.
Topic 2: Contractual Term: Extensions and Measurement Inputs (Memo 15)
46. Before the November 1, 2018 TRG meeting, stakeholders submitted two TRG submissions concerning the contractual term of financial assets. The first TRG submission asks whether certain contractual extension options should be considered in determining the contract term of the financial assets. The second TRG submission asks whether future economic and other information from periods beyond the contractual maturity may be considered in determining the estimate of expected credit losses.
Issue 1: Evaluating Contractual Extensions
Issue Summary and Staff’s Initial Views
47. Although paragraph 326-20-30-6 states in part that “…an entity shall not extend the contractual term for expected extensions, renewals, and modifications…,” stakeholders believe that considering extensions when determining the contractual term in certain situations would more closely align with the Board’s overall intent for Update 2016-13. The submission asks if stakeholders should consider extension options when determining the contractual term in the following four fact patterns:
(a) Scenario A: The financial instrument does not have explicit extension options; however, the lender may have a past practice of renewing or extending the term of the loan.
(b) Scenario B: The financial instrument contains a contractual extension option that provides the borrower with a unilateral right to extend the term of the lending arrangement.
(c) Scenario C: The financial instrument contains a contractual extension option that provides the borrower with a conditional right to extend the term of the lending arrangement. The conditional right may or may not be within the control of the borrower.
(d) Scenario D: The financial instrument contains a contractual extension option that provides the lender with the right to extend the life of the lending relationship.
48. At the November 1, 2018 TRG meeting, the staff supported the view that noncontractual extensions (Scenario A) would not be permitted to be considered in determining the contractual term of the financial asset based on the guidance in paragraph 326-20-30-6. Specifically, the use of the phrase contractual term was intended to include conditions limited to the current legal terms of the contractual arrangement between the borrower and lender, not potential extensions negotiated after the initial underwriting.
49. The staff also supported the view that extension options for which the lender has the option to extend the contract (Scenario D) do not represent a present obligation to extend credit. Because the lender is not obligated to extend credit to the borrower, the lender can choose to avoid such credit exposure by not extending the contractual term. Therefore, the staff believes that extension options held by the lender would not be considered when determining the contractual term.
50. The staff supported the view that extension options providing the borrower with the unilateral right to extend the loan (Scenario B) represent a present obligation to extend credit, in accordance with the terms of the contract. The staff notes that the contractual nature of the extension and the borrower’s complete control over the exercise of the extension indicate that the lender has a present legal obligation to extend credit to the borrower. Therefore, the staff believes that extension options able to be unilaterally exercised by the borrower would be considered when determining the contractual term.
51. The staff did not support a view with regards to Scenario C but, rather, asked TRG members questions to solicit feedback on whether an entity should consider contractual extension options that provide the borrower with a conditional right to extend the term of the lending arrangement, under which the conditional right may or may not be within the control of the borrower.
Views Expressed at the TRG Meeting
52. Overall, the majority of the TRG members and observers agreed with the staff’s analysis that an entity should not consider extensions such as those in Scenarios A and D. Additionally, the majority of the TRG members and observers stated that an entity should consider the contractual extension options that are within the control of the borrower, such as those in Scenarios B and C. Some TRG members noted the operational challenges with Scenario C to acquiring the data and performing a probability analysis of (a) whether the contingent event will occur and (b) whether the borrower will exercise those options. The preparers on the TRG suggested an alternative method to consider both Scenarios B and C. Under that alternative method, an entity would be required to consider contractual extension options in the contractual term without performing either probability assessment. Instead, an entity would assume that all of the contractual extension options would be exercised in determining the contractual term of financial assets as if the borrower meets the pre-specified conditions as of the reporting date. An entity would then consider prepayments to determine if that contractual term should be shortened because of expected prepayments. Those preparers referred to this method as an “on/off” switch to considering contractual extension options that would provide a more operable method that depicts a lender’s exposure to credit risk. Some TRG members also noted that contractual extensions not in the control of the borrower (for example, market-based options, such as the results of the S&P 500 index) should not be considered in determining the contractual term of the financial asset.
Completed and Next Steps
53. The staff brought this issue to the Board for a potential Codification Improvement at the November 7, 2018 Board meeting (minutes linked here). At that meeting, the Board decided that an entity should be required to evaluate extension or renewal options (excluding those that are accounted for as derivatives in Topic 815, Derivatives and Hedging) that are included in the original or modified contract and are not unconditionally cancellable by the entity in determining the contractual term of a financial asset(s). The Board directed the staff to incorporate the proposed amendments on contractual extensions in proposed Accounting Standards Update, Codification Improvements— Financial Instruments, with a 30-day comment period.
54. On November 19, 2018, the Board issued the proposed Accounting Standards Update on Codification Improvements to financial instruments. At the December 19, 2018 Board meeting, the comment letter period was revised to end on January 18, 2019. The staff expects to bring issues for redeliberations to the Board in an upcoming meeting in the first quarter of 2019.
Issue 2: Measurement Inputs for Short-Term Arrangements
Issue Summary and Staff’s Initial Views
55. Stakeholders asked through the second TRG submission whether entities should consider forecasted economic and other information beyond the contractual term of a loan when estimating credit losses. The submission provided an example in which some stakeholders stated that forecasting beyond the contractual term would be appropriate. The details of this example can be found in paragraphs 27 through 30 of Memo 15, linked here.
56. At the November 1, 2018 TRG meeting, the staff noted that it expects entities to use judgment when interpreting the guidance and that an entity should consider the facts and circumstances present when measuring the allowance for credit losses. While conducting outreach with stakeholders, it became evident that stakeholders were asking for guidance on what types of inputs could be used by entities when measuring the allowance for short-term lending arrangements. Therefore, the staff believes that providing an interpretation on Issue 2 is fundamentally different from providing an interpretation on Issue 1. Instead, the staff supported the belief that entities should consider available.
Views Expressed at the TRG Meeting
57. The TRG members and observers generally agreed that an entity should consider all relevant information in determining the risk of credit losses expected over the contractual term of the financial asset. TRG members and observers generally agreed that this information may include information beyond the contractual term that would be relevant to an entity’s expectation of credit losses over the contractual term. That is, an entity should use relevant information that is reasonable and supportable information from beyond the measurement date to inform an entity about the risk of credit loss inherent on the balance sheet on the measurement date.
58. TRG members noted that the scope of this issue is broader than the fact pattern presented in Memo 15. One TRG member noted that this issue would relate to any lending arrangement in which the lender is expecting to provide the borrower with refinancing.
59. TRG members and observers had mixed views on whether the Codification needs additional clarification. Specifically, some TRG members and observers requested clarifications or examples that clearly distinguish between determining the contractual term (as discussed in paragraphs 47 through 54 of this memo) and the ability to use information beyond the contractual term (as discussed in paragraphs 55 through 61 of this memo). However, other TRG members noted that the guidance in paragraph 326-20-30-7 is clear that an entity should use available, relevant information to estimate expected credit losses and that paragraph 326-20-30-7 does not limit that relevant information to the contractual term of the financial asset(s).
60. The staff believes that the guidance is clear that an entity should consider available information relevant to assessing the collectibility of cash flows. The staff believes that information may include projections of economic conditions beyond the contractual term that are relevant to assessing the collectibility of the contractual cash flows over the contractual term. The staff believes this information could be relevant in other fact patterns beyond the narrow fact pattern presented in Memo 15 and that the scope of this issue is broader than that narrow fact pattern.
Completed and Next Steps
61. The staff plans no further work on this issue.
Topic 3: Vintage Disclosures for Revolving Loans (Memo 16)
Issue Summary
62. Before the November 1, 2018 TRG meeting, stakeholders asked through a TRG submission how to properly present loans initially established as line-of-credit (revolving) arrangements that later are converted to term loans in the vintage disclosure requirements in paragraph 326-20-50-6. Certain revolving loans are converted into a fixed-term loan, and stakeholders recommended numerous ways to present this information within the vintage disclosure tables.
63. At the November 1, 2018 TRG meeting, the staff presented the following alternative views with respect to the disclosure of line-of-credit arrangements that are converted to term loans in the vintage disclosure:
(a) View A: The loans always should be included in the revolving loan totals, even after conversion to a term loan.
(b) View B: The loans should be presented in the vintage year that corresponds with the start date of the term loan (the conversion date).
(c) View C: The loans should be presented in the vintage year that corresponds with the origination date of the original revolving credit arrangement.
(d) View D: Lenders should make and disclose a policy election by class of receivable and apply one of View A, B, or C.
(e) View E—Alternative View Raised During Outreach: Term loans should be presented in the vintage year that corresponds with the lender’s most recent credit decision.
64. In addition, the staff presented a View F in which an entity would be required to disclose amounts of revolving loans that have been converted to term loans in a separate column in the vintage disclosure table
65. The staff dismissed View A because this view would not provide users with decision-useful information. Leaving term loans in the revolver column would be misleading and for an entity to disclose information that would be useful, the entity would have to disclose the amount of the term loans in each of the rows disclosed in the vintage table. With respect to the other alternatives presented, the staff believes that there are strong arguments for each and asked the TRG members which view would be the most beneficial for financial statement users, while balancing any operational concerns.
Views Expressed at the TRG Meeting
66. The TRG members and observers agreed with the staff’s analysis that View A would be inappropriate. The majority of TRG members and observers expressed support for Views E and F. Those supporting View E noted the conceptual merit of requiring an entity to disclose amounts of revolvers converted to term loans in the origination year corresponding with the most recent credit decision because that disclosure would provide investors with the most useful information. However, some TRG members had concerns about amounts of certain longer duration loans, such as home equity lines-of-credits or HELOCs, that automatically convert to term loans. Those loans would be presented in the “prior” column in the vintage disclosure table, which would not provide adequate insight into those amounts.
67. Supporters of View F noted that adding a column for amounts of revolvers converted to term loans provides an operational approach for disclosing those transactions.
68. Based on the feedback at the meeting, the staff suggested another alternative that would combine both Views E and F. That is, an entity would be required to disclose conversions from revolver to term that include a credit decision within the origination year that corresponds with the lender’s most recent credit decision (View E). However, for those conversions from revolver to term that do not include the lender’s credit decision, the lender would disclose those amounts of revolvers converted to term loans in a separate column on the vintage disclosure table (View F). The staff’s suggested alternative was generally agreed to by the TRG members and observers as an appropriate disclosure for those amounts, while also providing an operational way for preparers to disclose that information. TRG members also noted that an entity would be required to determine whether the conversions that include a credit decision should be accounted for as a new loan under the loan modification guidance in paragraphs 310-20-35-9 through 35-12 or whether the conversion should be accounted for as a troubled debt restructuring.
Completed and Next Steps
69. The staff brought this issue to the Board for a potential Codification Improvement at the November 7, 2018 Board meeting (minutes linked here). At that meeting, the Board decided that an entity should be required to disclose amounts of line-of-credit arrangements that are converted to term loans in the vintage disclosure column that corresponds to the year in which an additional credit decision after an entity made the original credit decision. The Board also decided than an entity should not be required to disclose amounts of line-of-credit arrangements that are converted to term loans by origination year if no additional credit decision after the original credit decision was made by the lender or that are converted to term loans because of a troubled debt restructuring. Instead, the Board decided that an entity should disclose those line-of-credit arrangements in a separate column within the vintage disclosure. The Board directed the staff to incorporate the proposed amendments on vintage disclosures for revolving loans in the proposed Accounting Standards Update on Codification Improvements to financial instruments with a 30-day comment period.
70. On November 19, 2018, the Board issued the proposed Accounting Standards Update on Codification Improvements to financial instruments. At the December 19, 2018 Board meeting, the comment letter period was revised to end on January 18, 2019. The staff expects to bring issues for redeliberations to the Board in an upcoming meeting in the first quarter of 2019.
Topic 4: Recoveries (Memo 17)
Issue 1: Recoveries
Issue Summary and Staff’s Initial Views
71. Before the TRG meeting on June 11, 2018, stakeholders informed the staff that there was diversity in views on whether future expected cash flows (expected recoveries) from a financial asset that had been written off, or may be written off in the future, should be included in the calculation of expected credit losses under Update 2016-13. At that meeting, the staff supported the view that the Board’s intent is clear that expected recoveries should be estimated and included in the calculation of the allowance if the information used to measure expected recoveries is determined to be in accordance with guidance in paragraphs 326-20-30-7 through 30-9, which is consistent with the treatment of other inputs or assumptions used in the measurement of expected credit losses.
72. After the June 2018 TRG meeting, the staff received numerous questions from stakeholders asking for clarification on what was meant by recoveries. Specifically, stakeholders asked the staff if the Board was going to clarify (a) what types of recoveries could be included when measuring the allowance and (b) if entities could record a negative allowance when applying the collateral dependent guidance in paragraphs 326-20-35-4 through 35-5.
73. At the June 2018 TRG meeting, the staff clarified that entities should be required to consider recoveries when estimating the allowance for credit losses. If an entity expects to record a charge off or has previously charged off a financial asset, the staff stated that allowing entities to record a recovery would be in line with the intent of the guidance that requires entities to report the net amount expected to be collected with regards to financial assets within the scope of Subtopic 326-20. After initial outreach on the subject of recoveries, the staff believed that, at a minimum, recoveries should be included when measuring the allowance for credit losses, but those recoveries should be limited to amounts received from the borrower. The staff asked stakeholders what types of recoveries should be included when measuring the allowance and nearly all stakeholders supported allowing all types of recoveries in the measurement of the allowance, including (a) cash from the borrower (principal and interest payments), (b) collateral (such as, homes or vehicles), and (c) the sale proceeds of a financial asset to a third party (such as, the sale of defaulted credit card balances to a debt collector), subject to the exclusions of freestanding instruments and sales of performing financial assets. Those stakeholders also noted that entities should not consider freestanding contracts as recoveries.
74. The staff had numerous follow-up questions for stakeholders; most importantly, the staff asked stakeholders what changes should be made to Update 2016-13 to clarify that all types of recoveries should be included in the measurement of the allowance. Stakeholders generally maintained that the guidance is clear as written and that no additional changes need to be made to Update 2016-13, other than deleting the language in paragraph 326-20-35-8 that states “[r]ecoveries of financial assets and trade receivables previously written off shall be recorded when received.”
75. In considering the feedback received, the staff identified two alternatives that could be considered in deciding whether the Board’s tentative decision on recoveries should be expanded. The alternatives below would be incremental to deleting the language in paragraph 326-20-35-8 (as referenced in paragraph 14 of Memo No. 17, “Recoveries”):
(a) Alternative 1: Allow for All Types of Recoveries to Be Considered Except Sales of Performing Financial Assets—Most stakeholders noted that the guidance is already clear that all types of recoveries can be included when measuring the allowance for credit losses. This alternative would require some limited standard setting. This alternative would have to amend the guidance to limit recoveries to those amounts expected to be received only on nonperforming financial assets.
(b) Alternative 2: Allow for All Types of Recoveries to Be Considered—Under this alternative, an entity would be able to consider all forms of recoveries when measuring the allowance for credit losses. Because stakeholders noted that the guidance is already clear that all types of recoveries can be included when measuring the allowance for credit losses, no further amendments are recommended for Update 2016-13.
Views Expressed at the TRG Meeting
76. Overall, many TRG members stated that the guidance is clear as written (outside of minor changes mentioned in the staff’s analysis) and that stakeholders should continue to leverage current practices and historical data regarding recoveries to use as an input for the expected credit losses calculation. Observers and certain TRG members stated that they preferred that the Board prescribe more guidance about which recoveries should be considered in determining the allowance for credit losses, including additional examples in the Implementation Guidance. In response to observers and those TRG members who suggested that the Board amend the guidance in Update 2016-13 to clarify which recoveries should be considered when measuring the allowance, some TRG members stated that providing additional guidance on the scope of recoveries would be inconsistent with the intent of the guidance to provide flexibility and scalability in the allowance determination.
Completed and Next Steps
77. The staff brought this issue to the Board for a potential Codification improvement at the November 7, 2018 Board meeting (minutes linked here). At that meeting, the Board decided to affirm its prior decision from the August 29, 2018 meeting that an entity should be required to include recoveries in determining the allowance for credit losses. The Board also decided to reverse its decision from the August 29, 2018 meeting that limited recoveries to amounts from the borrower in the allowance for credit losses. The Board directed the staff to incorporate the proposed amendments on recoveries in proposed Accounting Standards Update on Codification Improvements to financial instruments with a 30-day comment period.
78. On November 19, 2018, the Board issued proposed Accounting Standards Update on Codification Improvements to financial instruments. At the December 19, 2018 Board meeting, the comment letter period was revised to end on January 18, 2019. The staff expects to bring issues for redeliberations to the Board in an upcoming meeting in the first quarter of 2019.
Issue 2: Negative Allowance
Issue Summary and Initial Staff Views
79. At the June 2018 TRG meeting, the staff clarified that an entity could record a negative allowance when measuring expected credit losses. After the TRG meeting, stakeholders highlighted the guidance for collateral-dependent financial assets in paragraphs 326-20-35-4 through 35-5 and asked whether an entity could have a negative allowance when it measures the allowance for credit losses using the fair value of the underlying collateral. Stakeholders noted that when a borrower experiences financial difficultly and an entity elects to apply the practical expedient guidance for collateral-dependent financial assets, the fair value of the underlying collateral may increase in a subsequent period. Therefore, if the entity had to previously write down the financial asset, those stakeholders noted that entities should be able to reverse that writedown by recording a negative allowance as long as the negative allowance does not exceed amounts previously charged off.
80. At the November 1, 2018 TRG meeting, the staff supported the view that entities should be permitted to record a negative allowance, which would be consistent with the nature of a valuation account and the intent of the guidance in Update 2016-13. That is, entities should be permitted to increase or decrease a valuation account so that the net amount expected to be collected is reported on the balance sheet when measuring a financial asset. The staff believes that entities may record a negative allowance subject to a cap. The staff believes that the cap would preclude an entity from recording a negative allowance that exceeds the aggregate amount of previous or expected writeoffs of the financial asset.
Views Expressed at the TRG Meeting
81. All TRG members and observers stated that an entity should be permitted to record a negative allowance when measuring the expected credit losses for financial asset(s) as long as the negative allowance does not exceed the aggregate amount of previous or expected writeoffs of the financial asset(s). Those TRG members and observers asked for clarification in the guidance to allow an entity to record such a negative allowance when using the fair value of collateral to determine the allowance for credit losses in accordance with paragraphs 326-20-35-4 through 35-5 and when measuring the allowance for credit losses in accordance with paragraphs 326-20-30-1 through 30-5.
82. Two TRG members and an observer maintained that a negative allowance arising from an asset previously written off should be presented as a separate asset from the amortized cost basis or the allowance for credit losses. Those TRG members and an observer noted that certain financial ratios, such as the coverage ratio, may be skewed if the negative allowance amount is left to offset the allowance for credit losses balance. Other TRG members and observers suggested that an entity could provide clarity to its investors about negative allowances through robust disclosures. In addition, TRG members noted that the financial ratios that would be affected by permitting negative allowances are imperfect currently and that negative allowances would not dilute the usefulness of that financial information significantly. Finally, TRG members noted that the operational complexity of dissecting and tracking the amount of expected recoveries related to previously written off financial assets would be overly costly and burdensome for information that would not provide users with much benefits.
Completed and Next Steps
83. The staff brought this issue to the Board for a potential Codification improvement at the November 7, 2018 Board meeting (minutes linked here). At that meeting, the Board decided that an entity should be permitted to record a negative allowance on financial assets as long as the negative allowance does not exceed the aggregate amount of previous or expected writeoffs of the financial asset(s). For financial assets within the scope of the collateral-dependent guidance (see paragraphs 326-20-35-4 through 35-5), the Board decided that an entity should be permitted to record a negative allowance for the increase in fair value as long as the allowance for credit losses that is added to the amortized cost basis of the financial asset(s) does not exceed amounts previously written off. The Board directed the staff to incorporate the proposed amendments on negative allowance in a proposed Accounting Standards Update on Codification Improvements to financial instruments with a 30-day comment period.
84. On November 19, 2018, the Board issued the proposed Accounting Standards Update on Codification Improvements to financial instruments. At the December 19, 2018 Board meeting, the comment letter period was revised to end on January 18, 2019. The staff expects to bring issues for redeliberations to the Board in an upcoming meeting in the first quarter of 2019.
1 The amendments in Update 2016-13 require certain beneficial interests to apply the model for purchased financial assets with credit deterioration (PCD). Beneficial interests classified as trading do not apply the PCD accounting guidance. The discussion in the remainder of this memo exclude purchase financial assets with credit deterioration.
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