CUNA Regulatory Comment Call
July 29, 2003
AICPA Proposal Regarding Allowance for Credit Losses
EXECUTIVE SUMMARY
- The American Institute of Certified Public Accountants’ (AICPA's) Accounting Standards Executive Committee has issued a proposed Statement of Position (SOP), Allowance for Credit Losses. The proposed SOP addresses the recognition and measurement by creditors of the allowance for credit losses related to all loans, as that term is defined in Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (FAS) No. 114, Accounting by Creditors for Impairment of a Loan, with certain exceptions. FAS 114 is available here.
- The proposed SOP would apply to all creditors other than state and local governmental entities and federal governmental entities. In other words, credit unions would be covered under this proposed SOP.
- Under the proposal, the allowance for credit losses reported on a creditor's balance sheet should consist only of (1) a component for individual loan impairment recognized and measured pursuant to FASB Statement No. 114 and (2) one or more components of collective loan impairment recognized pursuant to FASB Statement (FAS) No. 5, Accounting for Contingencies, and measured in accordance with the guidance in the proposed SOP. FAS 5 is available here. If a creditor evaluates or grades an individual loan as part of a credit risk evaluation or grading process, that loan has been "identified for evaluation" within the meaning of paragraph 6 of FASB Statement No. 114.
- The proposal also provides that a creditor should group into pools, based on similar credit risk characteristics, loans other than those that were individually determined to be impaired. Those pools should be evaluated for collective loan impairment and include loans that were individually evaluated and determined to not be impaired and loans that were not individually evaluated. Loans that have been individually evaluated and have been determined to be impaired, regardless of whether an impairment allowance has been recorded, should not be included in those pools.
- CUNA’s Accounting Task Force has determined that there appears to be no significant accounting changes for those credit unions following NCUA’s Interpretive Ruling and Policy Statement (IRPS) on Allowance for Loan and Lease Losses (ALLL) or the FASB Statements of Financial Accounting Standards. The IRPS on ALLL is available here.
- If this proposal were to become final, it would become GAAP (generally accepted accounting principles). As GAAP, it would supercede the IRPS on ALLL for those credit unions with $10 million or more in assets, which are required to follow GAAP in the call reports they file with NCUA.
- Comments on the proposed SOP are due to the AICPA by September 19, 2003. Comments should be sent to: Frederick Gill, Senior Technical Manager, Accounting Standards, File 3480, AICPA, 1211 Avenue of the Americas, New York, NY 10036-8775. Or you may e-mail comments to fgill@aicpa.org. Please feel free to fax your responses by September 5 to CUNA at 202-638-7052; e-mail them to Associate General Counsel Mary Dunn at mdunn@cuna.com or to Senior Regulatory Counsel Catherine Orr at corr@cuna.com; or mail them to Mary and Catherine in c/o CUNA’s Regulatory Advocacy Department, 601 Pennsylvania Avenue, NW, South Building, Suite 600, Washington, DC 20004-2601.
DESCRIPTION OF THE PROPOSAL
The following items are the significant provisions of the proposed SOP.
- The SOP applies to all creditors other than state and local governmental entities and federal governmental
entities. The SOP addresses the recognition, measurement and disclosure by creditors of allowance for credit losses
related to all loans, EXCEPT the following:
- Loans that are measured at fair value (market value) of at the lower cost of fair value;
- Leases accounted for in accordance with FASB Statement (FAS) No. 13, Accounting for Leases;
- Debt securities, as defined in FASB Statement (FAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities;
- Loans, other than purchased or originated credit card receivables, that are:
- Accounts receivable with contractual maturities of one year or less and that arose from the sale by the reporting entity of goods or services, or
- Unconditional promises to give that are assets of not-for-profit organizations and that are due in one year or less
- Amounts intended to provide security for a counterparty to an agreement with the reporting entity (for example, security deposits or retainages on construction; and contracts)
- Loans that are retained interests.
- The allowance for credit losses reported on a creditor's balance sheet should consist only of (1) a component for individual loan impairment recognized and measured pursuant to FASB Statement No. 114 and (2) one or more components of collective loan impairment recognized pursuant to FASB Statement No. 5, Accounting for Contingencies, and measured in accordance with the guidance in the proposed SOP.
- If a creditor evaluates or grades an individual loan as part of a credit risk evaluation or grading process, that loan has been "identified for evaluation" within the meaning of paragraph 6 of FAS No. 114.
- A creditor should group into pools, based on similar credit risk characteristics, loans other than those that were individually determined to be impaired. Those pools should be evaluated for collective loan impairment and include loans that were individually evaluated and determined to not be impaired and loans that were not individually evaluated. Loans that have been individually evaluated and have been determined to be impaired, regardless of whether an impairment allowance has been recorded, should not be included in those pools.
- Creditors should specifically consider relevant observable data in the recognition and measurement of components of collective loan impairment and each component of collective loan impairment should be supported with one or more sets of relevant observable data. Observable data is relevant for a particular creditor if it is representative of the component of collective loan impairment (in other words, if the data provides information about the existence of a factor that has a logical relationship to the probability of incurred credit losses in a pool of loans for that creditor or about how that factor affects the amount of incurred credit losses in the pool for that creditor). Observable data is not relevant if its relationship to impairment of a pool of loans is purely or primarily coincidental. A creditor need not demonstrate a direct mathematical correlation between the observable data and the amount of the element of asset impairment that the component of collective loan impairment is intended to capture – it is sufficient that the observable data be indicative of an increase or a decrease in the element of asset impairment. Creditors should make a reasonable effort to obtain relevant observable data to support their components of collective loan impairment.
- The measurement of a component of collective loan impairment should be directionally consistent with changes in the related observable data from period to period. For example, if the changes in observable data indicates a deterioration in the credit quality of a pool of loans, an increase in the component of collection loan impairment related to that pool of loans (as a percentage of the pool of loans under assessment) would be directionally consistent with the change in the observable data. Conversely, if the change in the observable data indicates an improvement in the credit quality of a pool of loans, a decrease in the component of collective loan impairment related to that pool of loans (as a percentage of the pool of loans under assessment) would be directionally consistent with the change in observable data. Further, creditors should take into account the interaction of components of collective loan impairment over time. For example, in applying this principle to a component established in a previous period to adjust the creditor’s historical charge-off experience component for conditions not reflected in the historical experience, the creditor should take into account the extent to which those conditions are currently reflected in the creditor’s historical charge-off experience component. The extent to which such directional changes should affect the amount of the allowance for credit losses is a matter of significant judgment and expertise.
- Creditors should change the observable data considered only if changes in the environment indicate that other observable data has become more relevant or if new observable data that is more relevant becomes available.
- Components of the allowance for credit losses recognized pursuant to FAS No. 5, that is, components of collective loan impairment, should be measured based on the present value of expected future cash flows. Each component of collective impairment should be estimated based on relevant observable data relating to existing conditions; creditors should not project changes in the observable data that may occur in the future. The estimate of loss in pools of loans should reflect losses that have already been incurred, even if not yet identifiable, and not losses that might be incurred over the remaining life of the loans, even if predictable based on historical experience.
- A creditor should disclose the following information:
- The methodology for determining each significant component of the allowance for credit losses. The disclosure should include sufficient narrative information to enable users of the financial statements to understand critical aspects of the methodology and the breadth and depth of the process.
- The accounting recognition and measurement policies and methods used by the creditor for each significant component
of its allowance for credit losses. The disclosure should include the following:
- A general description of each significant component of the allowance for credit losses;
- For pools of loans, a description of the credit risk evaluation process used (for example, credit risk grading schemes, credit scoring models, industry, collateral, and geography), if applicable, and the similar credit risk characteristics associated with each pool or category of credit risk-graded loans; and
- A description of the observable data that are used in the measurement of the component, and significant changes in the types of observable data for all periods presented.
- For those loans that are subject to a credit risk grading methodology, the recorded investment by credit risk grade.
- For loans that are not subject to a credit risk grading methodology, the recorded investment by payment status.
- The total allowance for credit losses by loan type.
QUESTIONS REGARDING THE PROPOSED SOP
Scope
Issue 1
Is the scope of the proposed SOP readily understandable with respect to the kind of loans and the kinds of
entities to which the proposed SOP would apply?
Yes ______ No ______
Please explain why or why not.
Do you agree with the scope?
Yes ______ No ______
If you do not agree, what changes would you recommend?
Issue 2
The scope of the proposed SOP would exclude loans that are unconditional promises to give that are assets
of not-for-profit organizations and that are due in one year or less. That implies (a) that unconditional
promises to give that are assets of not-for-profit organizations are loans, as that term is defined in
paragraph 4 of FAS No. 114 and (b) that unconditional promises to give that are assets of not-for-profit
organizations and that are due in more than one year are in the scope of the proposed SOP. Do unconditional
promises to give that are assets of not-for-profit organizations meet the definition of loans?
Yes ______ No ______
If not, why not?
Do you believe unconditional promises to give that are assets of not-for-profit organizations and that are
due in more than one year should be included in the scope of the proposed SOP regardless of whether they
meet the definition of loans?
Yes ______ No ______
If not, why not?
Recognition and Measurement
Issue 3a
SOP 03-X, Accounting for Loans or Certain Debt Securities Acquired in a Transfer (which has not yet been
issued), permits investors to aggregate smaller balance homogeneous loans that were acquired in the same
fiscal quarter and that have common risk characteristics, as defined, and thereby use a composite interest
rate and cash flow expectation for the pool for purposes of the recognition, measurement, and disclosure
provisions of that SOP. SOP 03-X requires investors to maintain the integrity of such a pool once it is
assembled. In contrast, this proposed SOP states in paragraph 17 that certain loans should be grouped for
purposes of collective loan impairment evaluation into pools based on similar credit risk characteristics,
as defined in the proposed SOP. The AICPA’s Accounting Standards Executive Committee (AcSEC) chose to use a
different basis for the grouping of loans into pools in the proposed SOP because AcSEC believes the concept
of common risk characteristics, as defined in SOP 03-X, is too restrictive for purposes of collective loan
impairment evaluation. In addition, AcSEC viewed SOP 03-X as a revenue recognition model rather than a loss
recognition model. Is the difference between the guidance in the proposed SOP and the guidance in SOP 03-X
on pools of loans appropriate?
Yes ______ No ______
Please explain why or why not.
What practical difficulties would the application of the guidance in the proposed SOP by an entity that is
also complying with SOP 03-X present?
Would the proposed SOP’s aggregation guidance impose an unjustifiable cost on an entity that is also
complying with SOP 03-X?
Yes ______ No ______
If yes, please explain the costs involved.
Issue 3b
The proposed SOP would apply to loans that are within the scope of SOP 03-X. Concerning recognition
and measurement of any impairment subsequent to acquisition, however, this proposed SOP states that,
although paragraphs 19 and 20 are applicable to loans that are within the scope of 03-X for purposes
of determining whether impairment of multiple loans accounted for as a single asset may have occurred,
the methodology for recognition and measurement of any loss is set forth in SOP 03-X. Other guidance
in the proposed SOP, such as the guidance on loan impairment concepts and components of the allowance
for credit losses and the proposed disclosure requirements, would apply to loans within the scope of
SOP 03-X. in its entirety. Is the applicability of the proposed SOP to loans within the scope of SOP
03-X sufficiently clear?
Yes ______ No ______
If not, how could the applicability be made clearer?
Issue 4
The proposed SOP requires credit unions and other creditors to consider relevant observable data in the
recognition and measurement of components of collective loan impairment and to support each component of
collective loan impairment with one or more sets of observable data. Is the concept of observable data
described in paragraph 19 of the proposed SOP understandable?
Yes ______ No ______
If not, how could the concept be made more understandable?
Do you agree with the proposed SOP’s requirements concerning relevant observable data?
Yes ______ No ______
If not, why not?
Issue 5
The proposed SOP requires in paragraph 25 that creditors consider the directional consistency of
the measurement of a component of collective loan impairment with changes in the relevant observable
data from period to period, taking into account the interaction of components of collective loan
impairment over time. Is that concept understandable?
Yes ______ No ______
If not, how could the concept be made more understandable?
Do you agree with that guidance?
Yes ______ No ______
If not, why not?
Issue 6
The proposed SOP, which is premised on an incurred loss model, provides only limited guidance on the measurement
of impairment in a pool of loans. AcSEC considered several measurement methods and techniques but could identify no
single measurement method or technique that should be required in all situations to capture losses that have been
incurred while excluding from the measurement those future losses that are expected to occur but that have not yet
occurred. AcSEC decided not to prescribe any specific methodology. Should the proposed SOP require a specific
impairment measurement method or technique for pools of loans?
Yes ______ No ______
If so, please describe the method or technique you would propose and your views on why it would produce results that are
in conformity with existing authoritative literature.
Disclosures
Issue 7
Paragraph 28 of the proposed SOP sets forth additional disclosure requirements related to the allowance for credit losses.
Do you believe the volume of disclosures set forth in the proposed SOP is too much, just right or not enough?
Will the proposed disclosures be useful to users of financial statements?
Yes ______ No ______
Please explain.
Will preparers be able to develop the proposed disclosures from existing information?
Yes ______ No ______
If not, would it be unjustifiably costly to obtain the necessary information and why?
Other Comments
Other comments?
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Eric Richard • General Counsel • (202) 508-6742 • erichard@cuna.com Mary Mitchell Dunn • SVP & Associate General Counsel • (202) 508-6736 • mdunn@cuna.com Jeffrey Bloch • Assistant General Counsel • (202) 508-6732 • jbloch@cuna.com Catherine Orr • Senior Regulatory Counsel • (202) 508-6743 • corr@cuna.com |
