Major accounting changes are on the horizon for credit unions across the nation, thanks to recent updates issued by the Financial Accounting Standards Board regarding equity investments, lease commitments and loan losses. Even though the effective dates are still several years out, there are ways credit union leaders can prepare now for these changes.
The highest profile of these FASB updates deals with the CECL, or current expected credit loss, standard. In June 2016, FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which fundamentally alters the manner in which credit unions calculate the allowance for loan and lease losses.
FASB's new CECL guidance changes the current methodology of accounting for credit losses from an incurred loss model to that of a current expected credit loss model. The new measurement of current expected credit losses will be based on historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This guidance is effective for years beginning after Dec. 15, 2020, with early adoption permitted for years beginning after Dec. 15, 2018. Credit union leaders should begin to consider now the impact this will have on their practices, particularly as it relates to these key areas:
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Data collection: Under the new model, there will be a need for significant amounts of accessible, loan-level data. Credit unions can start to plan now for the collection and maintenance of more granular data.
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Longer loss horizon: The new CECL standard uses the lifetime of the credit instrument as the time horizon instead of the next 12-month period typically used under the previous methodology. These forecasted estimates will need to be defensible, which could be particularly challenging for longer-term loans, so credit union leaders should start to consider how they will address this new longer loss horizon.
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This new model transforms the ALLL from simply an accounting function to an institution-wide calculation. Credit unions should consider forming an implementation committee comprised of senior level representation across all departments/functional areas.
FASB also issued guidance in January 2016 related to the accounting for equity investments. ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities changes how credit unions account for equity investments, except those accounted for under the equity method of accounting or those that result in consolidation of the investee. Starting with fiscal years beginning after Dec. 15, 2018, credit unions will be required to measure equity investments at fair value and recognize any changes in fair value in net income. Credit unions are no longer required to disclose the fair value of financial instruments measured at amortized cost, nor are they required to classify equity securities with readily determinable fair values into different categories, like trading or available-for-sale.
This standard will directly affect credit unions that established a managed investment portfolio in accordance with NCUA Regulation Part 701.19 to help offset the cost of employee benefits, including defined benefit plans. Previously, unrealized gains and losses generated from these investments were recognized in other comprehensive income. Now, these amounts must be run through the income statement, which may affect a credit union's bottom line and capital ratio.
Finally, credit unions with lease agreements will be impacted by new guidance issued by FASB in February 2016 regarding the accounting for leases. ASU 2016-02, Leases requires credit unions to recognize right-of-use assets and lease liabilities, initially measured at the present value of the lease payments, on their balance sheets. Both finance leases and operating leases, a distinction retained by the new guidance, must be recorded in the statement of financial condition for all leases with terms longer than 12 months.
This change in lease accounting, effective for fiscal years beginning after Dec. 15, 2019, could have a significant impact on credit unions that lease branch locations or equipment, resulting in an increase in total assets and liabilities, and a negative impact on capital ratio. Credit unions should evaluate their current leases and the effect this new accounting will have on their statement of financial condition, especially those credit unions nearing the well-capitalized or adequately-capitalized thresholds.
Although the effective dates for these new standards are a few years away, there is a clear benefit to planning for their impact now. Credit unions that proactively consider the changes and consequences of these new standards will be better positioned to adapt to the new accounting standards.
Francis J. Donnelly is partner, Audit Services Group at Reinsel Kuntz Lesher LLP. He can be reached at 610-376-1595 or [email protected].
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