The CECL Standard requires more than just another update in the calculation of a financial institution’s (FI’s) allowance for credit losses; the new standard also pushes institutions to be more involved in the entire allowance process, especially on the management/executive level. From explanations, justifications and rationales to policies and procedures, the standard requires them all. The FI needs to discuss them, understand them, and document them.
The first point is to discuss all decisions that must be made regarding the CECL process. This includes everything from the definition of default to the justification of which methodology to use for which segment of the data. Although these discussions may be onerous, the CECL standard requires full understanding and completeness of all decisions. Once there is understanding, all decisions must be documented for regulation purposes:
CECL Topic 326-20-50-10: An entity shall provide information that enables a financial statement user to do the following:
- Understand management’s method for developing its allowance for credit losses.
- Understand the information that management used in developing its current estimate of expected credit losses.
- Understand the circumstances that caused changes to the allowance for credit losses, thereby affecting the related credit loss expense (or reversal) reported for the period.
CECL Topic 326-20-50-11: To meet the objectives in paragraph 326-20-50-10, an entity shall disclose all of the following by portfolio segment and major security type:
- A description of how expected loss estimates are developed
- A description of the entity’s accounting policies and methodology to estimate the allowance for credit losses, as well as discussion of the factors that influenced management’s current estimate of expected credit losses, including:
- Past events
- Current conditions
- Reasonable and supportable forecasts about the future
- A discussion of risk characteristics relevant to each portfolio segment
Although these may seem like surprising jumps in requirements for CECL, these are simply more defined requirements than under existing ALLL guidance. Note that some of the general requirements under the existing guidance will remain relevant under CECL, such as:
- “the need for institutions to appropriately support and document their allowance estimates”
- the “…responsibility for developing, maintaining, and documenting a comprehensive, systematic, and consistently applied process for determining the amounts of the ACL and the provision for credit losses.”
- the requirement “…that allowances be well documented, with clear explanations of the supporting analyses and rationale.”
As you can see, documentation is an important component of the CECL standard. While the documentation will, at least initially, require more effort to produce, it will also give the FI opportunity to fully understand the inner workings of their CECL process.
Lastly, advice to avoid some headache—take the time to document throughout the entire process of CECL. As my math professor always said, “the due date is not the do date.”
- FASB Accounting Standards Update, No. 2016-13, Financial Instruments – Credit Losses (Topic 326).
- Frequently Asked Questions on the New Accounting Standard on Financial Instruments – Credit Losses. FIL-20-2019. April 3, 2019.
Samantha Zerger, business analytics consultant with FRG, is skilled in technical writing. Since graduating from the North Carolina State University’s Financial Mathematics Master’s program in 2017 and joining FRG, she has taken on leadership roles in developing project documentation as well as improving internal documentation processes.