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ASC 842 lease accounting standards: Finance and operating leases

11.22.19

Editor’s note: Read this if your organization is an entity with significant lease transactions with terms greater than a year.  

Updated: June 2020

The new Accounting Standards Codification Topic 842 (ASC 842) lease accounting standard is actually not that new. The Financial Accounting Standards Board (FASB) first released the standard in 2016 but, due to a series of delays, it hasn’t been required yet. Even with delays, some organizations have already started to implement ASC 842. They include:

  1. Public business entities
  2. Not-for-profits that have issued or are conduit bond obligors for securities traded, listed, or quoted on an exchange or an over the-counter market

All other entities will start implementing for fiscal years starting after December 15, 2021 and internal periods within fiscal years beginning after December 15, 2022 (January 1 for calendar reporting periods).

Here’s a quick rundown of the lease classifications and how they’ll impact your financial statements.  

Classifying leases

Under the new standards, leases fall into one of two classifications: finance leases and operating leases. This classification makes all the difference in how leases are reported in the financial statements. 

Finance lease

A finance lease essentially treats an asset as if it were purchased by the lessee and financed with funds from the lessor. This prevents companies from hiding financial obligations that are basically liabilities. ASC 842 requires leases to be classified as finance leases if they meet any of the following five criteria:

  1. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
  2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
  3. The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purposes of classifying the lease.
  4. The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments in accordance with paragraph 842-10-30-5(f) equals or exceeds substantially all of the fair value of the underlying asset.
  5. The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

As you can see from the five criteria, finance leases are just purchase arrangements financed over time. ASC 842 is designed to reflect that and improve transparency for investors and other stakeholders.  

Operating lease

Any lease not meeting any of the above criteria is classified as an operating lease. 

No more off-book leases

One of the problems ASC 842 seeks to solve is “off-book” operating leases that show up only as notes on the balance sheet and cloud the debt ratios of companies. Under the new standards, both operating and finance leases will be reported on the balance sheet. The only exceptions are certain leases with terms of 12 months of less. 

Recording finance vs. operating leases

With both operating and finance leases reported on the balance sheet, what’s the difference between the two? The major difference is the way they are recorded on the income statement:

  • Interest and amortization are recorded separately on the income statement for finance leases.
  • Operating leases will report a single line item based on the lease payment. 
  • Principal repayments for finance lease are classified as financing activities.
  • Payments on operating leases are classified as operating activities.

Next Steps 

Make sure you start by implementing for fiscal years starting after December 15, 2021 and internal periods within fiscal years beginning after December 15, 2022. If you have questions about finance or operating leases, or need help with the new standard, please don’t hesitate to contact the team

Download our lease classification infographic for a comparison of finance and operating leases under ASC 842.

Download our Lease Classification Infographic

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Read this if you are a Chief Financial Officer or Controller at a financial institution.

Back in April, we wrote about recently released Accounting Standards Update (ASU) No. 2022-02, Financial Instruments – Credit Losses (Topic 326). Here, we are going to look at the standard in more depth. 

One of the most notable items this ASU addresses, is that it eliminates the often tedious troubled debt restructuring (TDR) accounting and disclosure requirements. Accounting for loan modifications will now be maintained under extant US generally accepted accounting principles, specifically Accounting Standards Codification (ASC) 310-20-35-9 through 35-11. However, rather than eliminate loan modification disclosure requirements altogether, the Financial Accounting Standards Board (FASB) created some new requirements, inspired by voluntary disclosures many financial institutions made during the coronavirus pandemic. 

Rather than disclosing information on TDRs, financial institutions will now be required to disclose information on loan modifications that were in the form of principal forgiveness, an interest rate reduction, an other-than-insignificant payment delay, or a term extension (or a combination thereof) made to debtors experiencing financial difficulty. These disclosures must be made regardless of whether a modification to a debtor experiencing financial difficulty results in a new loan or not. 

ASC 310-10-50-42 through 50-44 establishes these new disclosure requirements, and ASC 310-10-55-12A provides an example of the required disclosures. 

New Loan Modification Disclosure Requirements

Financial institutions have long had internal controls surrounding the determination of TDRs given the impact such restructurings can have on the allowance for credit losses and financial statement disclosures. Banks may find they are able to leverage those controls to satisfy the new modification disclosures, with only minor adjustments. Similar to previous TDR determinations, the above disclosures are only required for modifications to debtors experiencing financial difficulty. Therefore, financial institutions will need to have a process —or defined set of parameters—in place to determine debtor “financial difficulty”, thus triggering the need for modification disclosure. Banks may also find that the specific data gathered for preparation of these new disclosures will change, but should be readily available, with (hopefully) only minor manipulation required.

ASU No. 2022-02 is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years—the same effective date for those who have not yet adopted ASU No. 2016-13, more commonly referred to as CECL (Current Expected Credit Loss). As always, if you have any questions as to how this new ASU may impact your financial institution, please reach out to BerryDunn’s Financial Services team or submit a question via our Ask the Advisor feature.

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New loan modification disclosure requirements: A deeper dive

Read this if your organization offers health insurance through a health insurance exchange.

When the Affordable Care Act (ACA) was passed in 2010, it contained a known gap which made healthcare premiums unaffordable for some families covered under Medicare or employer-sponsored health insurance plans. The gap in the law, commonly referred to as the family glitch, was formalized in 2013 as the result of a Final Rule issued by the IRS. 

The “family glitch” calculates the affordability of an employer-sponsored health insurance plan based on the cost for the employee, not additional family members. An article published in April 2022 on healthinsurance.org estimated that the cost of health insurance for a family covered by an employer-sponsored plan could end up being 25% or more of the household’s income, even if the plan was considered affordable (less than 9.61% of the household’s income) for the employee alone. Almost half of the people impacted by the family glitch are children.

The family glitch was allowed to stand in 2013 partly because of concerns that resolving the issue could push more people off employer-sponsored plans and onto marketplace qualified health plans, ultimately raising the cost of subsidies. Since then, several attempts have been made to fix the issue, which affects around five million Americans. The most recent attempt was an executive order issued by President Biden soon after taking office in January 2021. The Office of Management and Budget has been reviewing regulatory changes proposed by the Treasury Department and IRS, details of which were published in April 2022. 

These regulatory changes would alter the way health insurance exchanges calculate a family’s eligibility for subsidies when the family has access to an employer-sponsored health insurance plan. If the changes go into effect in 2023 as proposed, audits of the 2023 fiscal year will need to account for the new regulations and potentially conduct different testing protocols for different parts of the year. 

Our team is closely following these proposed changes to help ensure our clients are prepared to follow the new regulations. Earlier this week, we attended a public hearing held by the Treasury Department, where representatives of various groups spoke in support of, or in opposition to the proposed regulatory change. Supporters noted that families with plans that offer expensive coverage for dependents would benefit from this change through reduced costs and more coverage options, including provider networks that may more closely align with the family members’ needs. Those in favor of the change anticipate that families with children would see the most benefit. 

Those opposed to the change expressed that due to the way the law is currently written, they do not see the regulatory flexibility for the administration to make this change through administrative action. Additionally, concerns were raised that families covered by multiple health insurance plans could be faced with higher out-of-pocket-costs due to having separate deductibles that must be met on an annual basis. Lastly, not all families that have unaffordable insurance would see financial relief under this proposal. 

The Treasury Department is expected to announce its decision in time for open enrollment for plan year 2023 which is scheduled to begin on November 1, 2022. Our team will continue to monitor the situation closely and provide updates on how the changes may impact our clients. 

For more information

If you have more questions or have a specific question about your situation, please reach out to us. There is more information to consider when evaluating the effects these changes will have on the landscape of healthcare access and affordability, and we’re here to help.

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Fixing the "family glitch": How a proposed change to the ACA will affect healthcare subsidies 

Editor's note: read this if you are a CFO, controller, accountant, or business manager.

We auditors can be annoying, especially when we send multiple follow-up emails after being in the field for consecutive days. Over the years, we have worked with our clients to create best practices you can use to prepare for our arrival on site for year-end work. Time and time again these have proven to reduce follow-up requests and can help you and your organization get back to your day-to-day operations quickly. 

  1. Reconcile early and often to save time.
    Performing reconciliations to the general ledger for an entire year's worth of activity is a very time consuming process. Reconciling accounts on a monthly or quarterly basis will help identify potential variances or issues that need to be investigated; these potential variances and issues could be an underlying problem within the general ledger or control system that, if not addressed early, will require more time and resources at year-end. Accounts with significant activity (cash, accounts receivable, investments, fixed assets, accounts payable and accrued expenses and debt), should be reconciled on a monthly basis. Accounts with less activity (prepaids, other assets, accrued expenses, other liabilities and equity) can be reconciled on a different schedule.
  2. Scan the trial balance to avoid surprises.
    As auditors, one of the first procedures we perform is to scan the trial balance for year-over-year anomalies. This allows us to identify any significant irregularities that require immediate follow up. Does the year-over-year change make sense? Should this account be a debit balance or a credit balance? Are there any accounts with exactly the same balance as the prior year and should they have the same balance? By performing this task and answering these questions prior to year-end fieldwork, you will be able to reduce our follow up by providing explanations ahead of time or by making correcting entries in advance, if necessary. 
  3. Provide support to be proactive.
    On an annual basis, your organization may go through changes that will require you to provide us documented contractual support.  Such events may include new or a refinancing of debt, large fixed asset additions, new construction, renovations, or changes in ownership structure.  Gathering and providing the documentation for these events prior to fieldwork will help reduce auditor inquiries and will allow us to gain an understanding of the details of the transaction in advance of performing substantive audit procedures. 
  4. Utilize the schedule request to stay organized.
    Each member of your team should have a clear understanding of their role in preparing for year-end. Creating columns on the schedule request for responsibility, completion date and reviewer assigned will help maintain organization and help ensure all items are addressed and available prior to arrival of the audit team. 
  5. Be available to maximize efficiency. 
    It is important for key members of the team to be available during the scheduled time of the engagement.  Minimizing commitments outside of the audit engagement during on site fieldwork and having all year-end schedules prepared prior to our arrival will allow us to work more efficiently and effectively and help reduce follow up after fieldwork has been completed. 

Careful consideration and performance of these tasks will help your organization better prepare for the year-end audit engagement, reduce lingering auditor inquiries, and ultimately reduce the time your internal resources spend on the annual audit process. See you soon. 

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Save time and effort—our list of tips to prepare for year-end reporting

Read this if you are a leader in the healthcare industry.

BerryDunn recently held its first annual Healthcare Leadership Summit. Here are some highlights of the topics, presentations, and discussions of the day. 

Healthcare CFO survey results

The day began with an industry update where Connie Ouellette and Lisa Trundy-Whitten had the opportunity to present with Rob Culburt, Managing Director, Healthcare Advisory, The BDO Center for Healthcare Excellence & Innovation. Rob shared highlights from a recent survey of healthcare CFOs by The BDO Center for Healthcare Excellence & Innovation, while Connie and Lisa reflected on the similarities between study results and hospital and senior living clients.

It was no surprise the study found one of the most significant challenges CFOs are facing at both the national and local level is the sustained strain on healthcare systems amid the pandemic, and ongoing supply chain and workforce struggles. Additionally, providers are concerned about the upcoming reporting and regulation requirements. Also top of mind are the Provider Relief Fund (PRF) reporting requirements, as the requirements have been ambiguous and ever changing. There is also concern among survey respondents that a misinterpretation or reporting error could cause providers to have to pay back funding they received from PRF.

The BDO healthcare survey reported that 63% of the providers who responded to the survey are thriving, but 34% are just surviving. Out of those surveyed, 82% expect to be thriving in one year. You can view the full results of the survey here

Recruitment and retention in the current climate

Recruitment and retention of direct care providers are significant challenges within the senior living industry. Providers are facing workforce shortages that are forcing them to temporarily suspend admissions, take beds off line, and, in worst case scenarios close whole units or facilities. Sarah Olson, BerryDunn's Director of Recruiting and Bill Enck, Principal at BerryDunn discussed factors leading to the talent shortage, and shared creative short- and long-term recruitment and retention strategies to try.

Change management

The pandemic has forced many in healthcare to rethink how they operate their facilities. Employees have had to pivot on a moment’s notice, and in general do more with less. However, there are still initiatives that need to be undertaken and projects that must be completed in order for your facility to operate and remain financially viable. How do you manage the change associated with these projects? Can you manage the change without burning out your employees? Dan Vogt, BerryDunn Principal, and Boyd Chappell from Schoolcraft Memorial Hospital provided tips and strategies for managing change fatigue. 

Overall, the Leadership Healthcare Summit proved to be an informative and engaging event, and many new ideas and forward-looking strategies were shared to help enable providers to continue to weather current challenges and pistion themselves for success. For more in-depth information on these topics and others discussed, please visit our Healthcare Leadership Summit resources page

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Top three takeaways from BerryDunn's first annual Healthcare Leadership Summit 

Read this if you are a financial institution.

Choosing a method for estimating lifetime expected losses is a commitment. A commitment that signals, in spite of any other option, you’re certain this method is the right one for you—your segment, portfolio, and institution. While you might be able to support a change in method later, it is much more likely you’ll be living with this decision a good long while. So, how exactly does one know which method is the right one? Let’s take a few minutes to answer some frequently asked questions about selecting methods for CECL.

How many CECL methods are there?

This depends on who you ask. Section 326-20-30-3 of the standard names five (5) categories: discounted cash flow, loss-rate, roll-rate, probability of default, and aging schedule. Some categories, like loss-rate, have several methods. Additionally, some methods seem to be referred to by different names, giving people the impression that there are exponentially more options out there than there really are. With this in mind, I tend to think of two (2) broad categories, and seven (7) unique methods:  

  • Loss-rate methods
    • Snapshot (open pool, static pool, cumulative loss rate)
    • Remaining Life and Weighted Average Remaining Maturity (WARM)
    • Vintage
       
  • Other methods
    • Scaled CECL Allowance for Losses Estimator (SCALE) (option for banks with assets <$1 billion)
    • Discounted Cash Flow (DCF)
    • Probability of default 
    • Migration (roll rate, aging schedule)  

What’s the difference?

The loss-rate methods use actual historical net charge-off information in different ways to derive a loss rate that can then be used to calculate expected losses over the remaining life of a pool. In general, they do this by holding the mix of a group of loans constant (e.g., by year of origination) and then tracking net losses tied to that grouping over time. The “other” methods employ a variety of mathematical techniques and/or credit quality information to estimate expected lifetime losses. For a quick overview of each method and corresponding resources, access our CECL methodologies guide here.

How do I know which to use?

This is the CECL equivalent of the proverbial million-dollar question. Technically, any institution could use any one, or all of these methods. But there are considerations that make some of them a more or less likely fit. For example, if your institution has >$1 billion in assets, SCALE is not even an option for you, and you can cross it off the list. If you are not in a position to afford software, or lack the internal expertise to build a similar model internally, then discounted cash flow and probability of default methods would likely be extremely burdensome in the normal course of business. For that reason, you may need to cross those off your list. If you lack large pools with consistently diverse performance over time, then migration methods will be difficult to support. If you have a relatively stable loan mix, consistent credit culture, and a lot of reliable historical loss data—especially through multiple economic cycles—the loss-rate methods may be a good fit, with or without software. If your portfolio has undergone a lot of changes—products, underwriting standards, merger and acquisition activity—and/or there are significant gaps in key data that cannot be restored, then you might want to re-consider software and one of the “other” methods. 

What are the pros and cons of the various methods?

One pro of the loss-rate and SCALE methods is they have been shown to be manageable without software. Examples of all of these methods have been illustrated using Excel spreadsheets. The use of Excel is also potentially a con, given that more spreadsheets and, maybe more people, are likely going to be involved in computing the Allowance for Credit Losses (ACL). As a result, version control as well as validation of spreadsheet macros, inputs, formulas, math, and risk of accidentally overwriting or deleting values should be addressed. One pro of the discounted cash flow method is that it is a bottom-up approach, meaning each loan’s discounted cash flow (DCF) is computed and then rolled up to the segment level. Because of this, DCF can more easily handle mixed pools, e.g., loans of all vintages, sizes, terms, payment and amortization schedules, etc. A potential con of DCF is that it really requires software, staff trained to use the software appropriately, and an understanding of the vast array of choices, levers, and decisions that come with it.     

Does my choice of method affect my qualitative adjustment options?

How’s this for commitment: maybe. In general, I think it’s safe to say that CECL requires additional thought be given to the nature and degree of adjustments. This is especially true when you look at the combination of potential segmentation changes, new elements of the calculation, and the variety of methods now available. Consider the example of a bank using a loss-rate method and facing a potential economic downturn. If that bank has sufficient history and a relatively stable portfolio mix, credit culture, and geography, then it might elect to use a different time period—say, historical loss-rates observed from the last recession—rather than those more recently computed. In this case, the loss-rate method would already be using a recessionary experience. 

How then, would the bank approach additional qualitative adjustments for changing economic outlooks to ensure it is not layering (or double counting) reserve? Going back to the original “maybe” response, perhaps the answer is less about inherent conflicts between methods and qualitative adjustments. Rather, it’s about understanding that given your chosen method, you may be faced with even more decisions about if, where, and how much adjusting you are doing.

CECL adoption is required. Struggling to adopt isn’t. We can help.

No matter what stage of CECL readiness you are in, we can help you navigate the requirements as efficiently and effectively as possible. For more information, visit the CECL page on our website. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions.

For more tips on documenting your CECL adoption, stay tuned for our next article in the series. You can also follow Susan Weber on LinkedIn.

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Questions to ask when deciding your CECL Method

Read this if you are a financial institution.

As you know by now, ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326), better known as the CECL standard, has already been implemented for some and will soon be implemented for all others (fiscal years beginning after December 15, 2022 to be exact). During your implementation process, the focus has likely been on your loan portfolio, and rightfully so, as CECL overhauls 40+ years of loan loss reserve practices. But, recall that the CECL standard applies to all financial instruments carried at amortized cost. So, it therefore includes held-to-maturity (HTM) debt securities. And, although not carried at amortized cost, the CECL standard also makes targeted enhancements to available-for-sale (AFS) debt securities. As if re-hauling your entire allowance methodology wasn’t enough! Before tearing out your hair because of another CECL-related change, let’s quickly review what is currently required for securities, and then focus on how this will change when you implement CECL.

Current US GAAP

Under current US generally accepted accounting principles (GAAP), direct write-downs on HTM and AFS debt securities are recorded when (1) a security’s fair value has declined below its amortized cost basis and (2) the impairment is deemed other-than-temporary. This assessment must be completed on an individual debt security basis. Providing a general allowance for unidentified impairment in a portfolio of securities is not appropriate. The previous amortized cost basis less the other-than-temporary impairment (OTTI) recognized in earnings becomes the new amortized cost basis and subsequent recoveries of OTTI may not be directly reversed into interest income. Rather, subsequent recoveries of credit losses must be accreted into interest income.

CECL: Held-to-maturity securities

Then comes along CECL  and changes everything. Once the CECL standard is implemented, expected losses on HTM debt securities will be recorded immediately through an allowance for credit loss (ACL) account, rather than as a direct write-down of the security’s cost basis. These securities should be evaluated for risk of loss over the life of the securities. Another key difference from current GAAP is that securities with similar risk characteristics will need to be assessed for credit losses collectively, or on a pool basis, not on an individual basis as currently prescribed. Also, contrary to current GAAP, since expected losses will be recorded through an ACL account, subsequent improvements in cash flow expectations will be immediately recognized through earnings via a reduction in the ACL account. CECL effectively eliminates the direct write-down method, with write-offs only occurring when the security, or a portion thereof, is deemed to be uncollectible. 

In practice, there may be some types of HTM debt securities that your institution believes have no risk of nonpayment and thus risk of loss is zero. An example may be a US Treasury debt security or possibly a debt security guaranteed by a government-sponsored enterprise, such as Ginnie Mae or Freddie Mac. In these instances, it is acceptable to conclude that no allowance on such securities is necessary. However, such determination should be documented and changes to the credit situation of these securities should be closely monitored.

Financial institutions that have already implemented CECL have appreciated its flexibility; however, just like anything else, there are challenges. One of the biggest questions that has risen is related to complexity, specifically from financial statement users in regards to the macroeconomic assumptions used in models. Another common challenge is comparability to competitors’ models and estimates. Each financial institution will likely have a different methodology when recording expected losses on HTM debt securities due to the judgment involved. These concerns are not unique to the ACL on HTM debt securities but are nonetheless concerns that will need to be addressed. A description of the methodology used to estimate the ACL, as well as a discussion of the factors that influenced management’s current estimate of expected losses must be disclosed in the financial statements. Therefore, management should ensure adequate information is provided to address financial statement users’ concerns.  

CECL: Available-for-sale securities

Upon CECL adoption, you are also expected to implement enhancements to existing practices related to AFS debt securities. Recall that AFS debt securities are recorded at fair value through accumulated other comprehensive income (AOCI). This will not change after adoption of the CECL standard. However, the concept of OTTI will no longer exist. Rather, if an AFS debt security’s fair value is lower than its amortized cost basis, any credit related loss will be recorded through an ACL account, rather than as a direct write-down to the security. This ACL account will be limited to the amount by which fair value is below the amortized cost basis of the security. Credit losses will be determined by comparing the present value of cash flows expected to be collected from the security with its amortized cost basis. Non-credit related changes in fair value will continue to be recorded through an investment contra account and other comprehensive income. So, on the balance sheet, AFS debt securities could have an ACL account and an unrealized gain/loss contra account. The financial institution will be responsible for determining if the decline in the value below amortized cost is the result of credit factors or other macroeconomic factors. In practice, the following flowchart may be helpful:

Although changes to debt securities may not be top of mind when working through CECL implementation, ensuring you reserve time to understand and assess the impact of these changes is important. Depending on the significance and composition of your institution’s debt security portfolio, these changes may have a significant impact on your financial institution’s financial statements from CECL adoption forward. For more information, visit the CECL page on our website. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions.

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Don't forget about me! Changes in debt security accounting resulting from CECL 

Read this if you are at a financial institution.

While documentation of your CECL implementation and ongoing practices is essential to a successful outcome, it can sometimes feel like a very tall order when you are building a new methodology from the ground up. It may help to think of your CECL documentation as your methodology blueprint. While others will want to see it, you really need it to ensure that what you are building is well-designed, structurally sound, appropriately supported, and will hold up to subsequent “renovations” (model changes or tweaks). To help you focus on what’s essential, consider these documentation tips:

Getting started

Like any good architect, you need to understand the expectations for your design—what auditors and regulators want to see in your documentation. Two resources that can really help are the AICPA Practice Aid: Allowance for credit losses-audit considerations1, and the Interagency Supervisory Guidance on Model Risk Management2. One way to actively use these guides is to take note of the various section/subject headers and the key points, ideas, and questions highlighted within each, and turn that into your documentation checklist. You’ll also want to think strategically about where to keep the working document, who needs access to it, and how to maintain version control. It is also a good idea to decide up-front how you will reference, catalog, and store the materials (e.g., data files, test results, analyses, committee minutes, presentations, approvals, etc.) that helped you make and capture final decisions. You can download our CECL Documentation checklist now.   

What to watch out for

What’s new under CECL are areas requiring documentation (e.g., broader scope of “financial assets,” prepayments, forecasts, reversion, etc.). But watch out for elements that seem familiar—they may now have a new twist (e.g., segmentation, external data, Q factors, etc.). It’s a good idea to challenge any documentation from the past that you feel could be re-purposed or “rolled into” your CECL documentation. Be prepared also to spend time explaining or customizing vendor-provided documents (e.g., model design and development, data analysis memos, software procedures, etc.). 

While this material can give you a running start, they will not on their own satisfy auditor and regulator expectations. Ultimately, your documentation will need to reflect your own understanding and conclusions: how you considered, challenged, and got comfortable with the vendor’s work; what validations and testing you did over that work, and how you’ve translated this into policies and procedures appropriate for your institution’s operations, workflows, governance, and controls. For more information on making the vendor decision, and for suggestions of vendor selection criteria, read our previous article “CECL Readiness: Vendor or no vendor?” 

Point of view

It is human nature, especially whenever entering new territory, to want to know how others are approaching the task at hand. Related to CECL, networking, joining peer discussion groups, researching what and how those who have already adopted CECL are disclosing, are all great ways to see possibilities, learn, and gain perspective. When it comes to CECL documentation, however, the most important point of view to communicate is that of your institution’s management. Consider the difference in these two documentation approaches: (a) we looked at what others are doing, this is what most of them seem to be doing, so we are too; or (b) this is what we did and why we feel this decision is the best for our portfolio/risk profile; as part of our decision-making process, we did this type of benchmarking and discovered this. Example b is stronger documentation: your point of view is the primary focus, making it clear you reached your own conclusions. 

Other elements for CECL documentation

Documenting your CECL implementation, methodology, and model details is critical, but not the only documentation expected as you transition to CECL. It has been said that CECL is a much more enterprise-wide methodology, meaning that some of the model decisions or inputs may require you use data and assumptions traditionally controlled in other departments and for other purposes. One common example of this is prepayments. Up to this point, prepayment data may have been something between management and a vendor and used for management discussion and planning, but not necessarily validated, tested, or controlled for in the same way as your loss model calculations. Under CECL, this changes specifically because it is now an input into the loss estimate that lands in your financial statements. As a result, prepayments would be subject to, for example, “accuracy and completeness” considerations, among others (for more information on these expectations, refer to our earlier articles on data and segmentation). Prepayments is just one example, but does illustrate how CECL adoption will likely trigger updates to policies, procedures, governance, and controls across multiple areas of the organization.    

One final note: There are some new financial statement disclosures required with CECL adoption. Beyond those, there may be other CECL-related information either you want to share, or your audit/tax firm recommends be disclosed. Consulting with your auditor at least a quarter prior to adoption will help make sure you aren’t scrambling last minute to draft new language or tables.  

Struggling with CECL documentation or other elements of CECL? 

No matter what stage of CECL readiness you are in, we can help you navigate the requirements as efficiently and effectively as possible. For more information, visit the CECL page on our website. If you would like specific answers to questions about your CECL implementation, please visit our Ask the Advisor page to submit your questions.

For more tips on documenting your CECL adoption, stay tuned for our next article in the series. You can also follow Susan Weber on LinkedIn.

1You can find the AICPA Practice Aid here.
2The interagency guidance was released as OCC Bulletin 2011-12, FRB SR 11-7, and as FDIC FIL 22-2017

 

Article
CECL documentation: Your methodology blueprint