This section focuses primarily on the impairment of a loan, within the context of the Allowance for Loan and Lease Losses ("ALLL"). The ALLL is a contra asset account used to recognize losses inherent in funded loans intended to be held-for-investment that are probable and can be reasonably estimated as of the financial statement date. The impairment assessment should provide adequate support and documentation for the estimated losses incurred as of the financial statement date (using methods that are consistently employed) in:
loans identified as impaired that are individually assessed and measured for the extent of loss; and
loans and leases in homogenous portfolio segments (i.e., pools of similar loans), typically quantitatively assessed based on historic net loss experience that may be "qualitatively" adjusted for current conditions and for imprecision in the estimation process, as applicable. Adjustments for current conditions should be incremental to the base quantitative loss estimation method(s) applied to the respective portfolio segments (i.e., do not account for the same event or risk twice).
These estimates involve significant management judgment based on observable facts and circumstances, including such aspects as: loan portfolio and external data sufficiency, loan portfolio loss behavior and segmentation, timing of loss events, discovery or identification of the incurred loss, and loss confirmation and ultimate resolution associated with the loans and leases.
Portions of loans that are considered uncollectible, such as when a loss event has occurred and is confirmed, are charged (i.e., written/charged off) against this contra account. Recoveries on previously charged-off amounts are credited to this contra account. A credit loss provision expense (or release) reflected in the income statement and credited (or debited/charged) to the ALLL is based on the periodic ALLL estimate, net of charge-offs and recoveries. Part of the credit loss provision also may be estimated for and credited (or debited/ charged) to support separate liability reserves for estimated credit losses associated with certain off-balance sheet credit exposures such as loan commitments and financial guarantees.
The financial accounting principles, definitions, and criteria that govern the ALLL estimation and disclosure are set forth in an array of authoritative guidance, supplemented in practice by certain regulatory guidance for public issuers and regulated enterprises, some of which is summarized below.
, and ASC 450-20
, Loss Contingencies
, together provide the general principles a creditor should apply to account for impairment in financing receivable portfolios under US GAAP. The impairment guidance for receivables is also applicable to loans whose terms are modified in a troubled debt restructuring (see ASC 310-40
, Receivables, Troubled Debt Restructurings by Creditors
) and those loans that are credit impaired upon acquisition (see ASC 310-30
, Receivables, Loans and Debt Securities Acquired with Deteriorated Credit Quality
). In addition, the FASB staff has addressed various interpretive questions on the interaction of contingencies guidance in ASC 450-20
and receivables guidance in ASC 310-10
, which has been incorporated into ASC 310-10-35
In providing for losses on loans, the overriding concept in GAAP is that impairment for losses should be recognized when, based on all available information, it is probable that a loss has been incurred based on past events and conditions existing at the date of the financial statements. Losses are not to be recognized before it is probable that they have been incurred (referred to as an incurred loss model), even though it may be probable or expected based on past experience that losses will be incurred in the future.
One way to think about incurred loss as of the financial statement date is to consider that loss triggering events occur generally before they are discovered, subsequently confirmed through charge-offs, and ultimately resolved through disposition or workout (and may result in recoveries). This is particularly important for those loans which have not been identified as individually impaired (which are assessed individually) where incurred loss can be estimated collectively in pools based on historical loss experience, adjusted for current conditions. Pools of loans and leases are typically evaluated together when they have similar characteristics, consistent with the ASC 450-20
guidance. Loss events for loans held-for-investment and leases that occur after the reporting date are future losses that cannot be included in the reserve estimate as of the reporting date. Distinguishing between loss events and loss confirmation events occurring after the reporting date requires careful consideration. A loss confirmation event after the reporting date could suggest a loss event occurred prior to the reporting date that should be evaluated as part of the ALLL as of the reporting date. The diagram below may be helpful in illustrating this horizon.
Recognition of a loss is required when (a) information available prior to issuance of the financial statements indicates that it is probable that an asset has been impaired at the date of the financial statements and (b) the amount of the loss can be reasonably estimated (see ASC 450-20-25-2
). If both conditions are met, "…an accrual shall be made even though the particular receivables that are uncollectible may not be identifiable." Those conditions may be considered in relation to individual receivables or in relation to groups of similar types of receivables. However, "double counting" by applying the impairment guidance for Receivables under ASC 310-10
and then applying the guidance for Loss Contingencies under ASC 450-20
to measure the same loss is inappropriate. That is, loans evaluated as impaired under ASC 310-10-35
should be removed from the analysis used to develop and support the ASC 450-20
component of the ALLL.
The basic guidance for recognition of impairment losses for all receivables is addressed in ASC 450-20
, except for those receivables that are deemed impaired and individually assessed following ASC 310-10-35
guidance, and those receivables which have been specifically addressed by other accounting literature, such as debt securities, certain leases, troubled debt restructurings, and acquired impaired loans.
requires that loans identified as impaired be individually assessed and measured for impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent (see ARM 3560.2
). However, because the aforementioned guidance provides only principles of identification, evaluation, and measurement of impairment, some institutions and professionals have looked to other guidance and industry practice when implementing the guidance in ASC 310-10-35
(see ARM 3560.12