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CBIZ & MHM Executive Education Series™

Accounting for Impairment under the Credit Loss Impairment Rules Mike Loritz & Christine McAlarney November 30, 2016

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About Us

• Together, CBIZ & MHM are a Top Ten accounting provider • Offices in most major markets • Tax, audit and attest and advisory services • Over 2,900 professionals nationwide

A member of Kreston International A global network of independent

accounting firms

MHM (Mayer Hoffman McCann P.C.) is an independent CPA firm that provides audit, review and attest services, and works closely with CBIZ, a business consulting, tax and financial services provider. CBIZ and MHM are members of Kreston International Limited, a global network of independent accounting firms.

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Before We Get Started…

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CPE Credit

This webinar is eligible for CPE credit. To receive credit, you will need to answer periodic participation markers throughout the webinar. External participants will receive their CPE certificate via email immediately following the webinar.

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Disclaimer

The information in this Executive Education Series course is a brief summary and may not include all

the details relevant to your situation.

Please contact your service provider to further discuss the impact on your business.

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Presenters

Mike has 18 years of experience in public accounting with diversified

financial companies and other service based companies, including

banking, broker/dealer, investment companies, and other diversified

companies ranging from audits of public entities in the Fortune 100 to

small private entities.

He is a member of MHM's Professional Standards Group, providing

accounting knowledge leadership in the areas of derivative financial

instruments, financial instruments, share-based compensation, fair

value, revenue recognition and others.

816.945.5611 • mloritz@cbiz.com

MIKE LORITZ, CPA MHM Shareholder

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Presenters

Located in our Tampa Bay office, Christine has worked extensively in all

aspects of audit, review and compilation engagements, as well as

Securities and Exchange Commission reporting. Her industry experience

includes mortgage service, manufacturing, distribution, software,

biopharmaceutical, insurance, and healthcare.

Christine is a member of MHM's Professional Standards Group where

she spends a dedicated portion of time providing internal consultations

and supporting the Professional Standards Group's thought leadership

and educational activities. Her subject matter expertise is in business

combinations, complex debt and equity arrangements, and financial

instruments.

727.572.1400 • cmcalarney@cbiz.com

CHRISTINE MCALARNEY, CPA MHM Senior Manager

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Overview

Two new primary impairment models

• Current expected credit loss impairment model (ASC Topic 326-20) • Available-for-sale credit loss impairment model (ASC Topic 326-30)

Other changes have impacted the following:

• Troubled debt restructuring (ASC Topic 310-40) • Purchased credit impaired financial assets (ASC Topic 310-30/SOP 03-2

superseded) • Beneficial interest (ASC Topic 325-40)

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Agenda

Overview of the new standard and effective dates

02

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03

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Current expected credit loss (CECL) model

Available-for-sale (AFS) debt securities impairment model

Transition guidance and disclosure requirements

05 Questions

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Overview of the New Standard

Accounting Standards Update 2016-13:

• Issued on June 16, 2016 • Global financial crisis underscored certain concerns

• Addresses perceived concerns regarding the recognition of accounting losses after the identification of expected credit losses

• Credit losses will be recognized using forward-looking information rather than using an incurred loss methodology

• Convergence will not be achieved • FASB – Single measurement lifetime losses at inception except for AFS • IASB – Dual measurement approach

• Amendment affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income.

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Measurement for Credit Losses

Current Model CECL

Incurred Loss Model Losses are not recorded

until they are incurred Implies a “triggering”

event – probable Includes several different

models for instruments Loans receivable Loans with significant credit

deterioration AFS securities Beneficial interests

Expected Loss Model Estimate expected losses

to be incurred throughout the life of the instrument

Should present the net amount expected to be collected

Simplifies the various existing models

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ASU 2016-13 Issuance and Effective Dates

ISSUANCE EFFECTIVE

December 15, 2017 FASB Recognition &

Measurement effective for periods after 12/15/17 for

public business entities.

CECL & AFS Credit Loss Model Effective Dates For Periods Beginning After:

December 15, 2019 – public business entities that are U.S. Securities and Exchange Commission (SEC) filers

December 15, 2020 – For all other entities* December 15, 2018 – Early adoption for all entities

January 2016 FASB issues standard on

Recognition & Measurement (ASU 2016-1).

June 2016 FASB issues standard on measurement of

credit losses (ASU 2016-13).

* Effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021.

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CURRENT EXPECTED CREDIT LOSS MODEL (CECL)

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Measurement for Credit Losses - CECL Model

In Scope Specifically Excluded

Financing receivables Held-to-maturity debt securities Receivables that result in revenue

transactions within the scope of Topic 605

Reinsurance receivables Receivables that relate to

repurchase agreements and securities lending agreements (Topic 860)

Net investments in leases recognized by a lessor

Off-balance-sheet credit exposures not accounted for as insurance

Financial assets measured at fair value through net income

Available-for-sale debt securities Loans made to participants by

defined contribution employee benefit plans

Policy loan receivables of an insurance entity

Promises to give (pledges receivable) of a not-for-profit entity

Loans and receivables between entities under common control

Derivatives Equity instruments and equity

method investments

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Measurement for Credit Losses - CECL Model

Initial Measurement

• Measured at amortized cost basis and presented at the net amount expected to be collected

• Allowance for credit losses (CECL reserve) is a valuation account deducted from the amortized cost basis

• Net income (as a credit loss expense) is recorded to adjust the allowance for credit losses

• CECL allowance for credit losses reflects an entity’s current estimate of all expected credit losses rather than credit losses from past events and current conditions under current GAAP

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Measurement for Credit Losses - CECL Model

Initial Measurement (continued)

• Allowance for credit losses may be determined using various methods • Discounted cash flow method • Loss-rate method • Roll-rate method • Probability-of-default method

• Information entities must consider has broadened to estimate expected credit losses • Entire contractual life of long-dated financial assets • Historical information with current specific risk characteristics • Information relevant to assessing the collectability of cash flows

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Measurement for Credit Losses - CECL Model

Initial Measurement (continued)

• Must measure on a collective (pool) basis when similar risk characteristics exist

• If an instrument does not share similar risk, it must be evaluated individually

• No prohibition against pooling “impaired” instruments if they share a similar risk profile

• Measure the expected risk of credit loss even if that risk is remote

• However, if no risk of loss exists, an ALL is not required to be recorded

• Revert to historical loss information for periods beyond the time frame for which reasonable and supportable forecasts can be developed

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Measurement for Credit Losses - CECL Model

Measurement

Initial entry to record a loan origination: Loan receivable $100 Cash $100 Provision for credit loss $10 Allowance for credit loss $10 The result is a day-one loss of $10 resulting from the loan origination.

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Measurement for Credit Losses - CECL Model

Subsequent Measurement

For each reporting period: • Compare current estimate of expected credit losses with previously

recorded estimate • Evaluate whether a financial asset in a pool continues to exhibit

similar risk characteristics • Entry to record adjustment to allowance for credit losses

Allowance for credit losses $10 Provision for credit losses $10

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Measurement for Credit Losses - CECL Model

Subsequent Measurement

Assume an example in which a loan with an outstanding principle balance of $500, with an allowance of $375 is determined to be uncollectible.

Adjust the allowance & Write-off Credit loss expense 125

Allowance for loan losses 125

Allowance for loan losses 500

Loan receivable 500

Assume a recovery of $50 Cash 50

Credit loss expense 50

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Measurement for Credit Losses - CECL Model

Example 1: Loans Receivables Fact Pattern: Bank C provides loans to consumers purchasing new or used farm equipment throughout the local area. Bank C originates approximately the same amount of loans each year. The four-year amortizing loans it originates are secured by collateral that provides a relatively consistent range of loan-to-collateral-value ratios at origination.

• Equipment will be repossessed if borrower is 90 days past due • Loans are tracked on a calendar year basis (year of origination) each referred to as “vintage” • Bank C needs to calculate estimated credit losses as of 20X9 • Shaded cells represent remaining expected losses • Bank C expects the trend to continue due to current conditions and reasonable and supportable

forecasts.

The following pattern of credit losses has been developed based on historical write-offs:

Answer: Expected credit loss allowance is $1,260 using the Vintage –

Year Basis.

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Measurement for Credit Losses - CECL Model

Example 2: Trade Receivables Fact Pattern: Entity E manufactures and sells products to a broad range of customers, primarily retail stores. Customers typically are provided with payment terms of 90 days. Entity E has tracked historical loss information for its trade receivables and compiled the following historical credit loss percentages.

Entity E believes historical loss information is reasonable base but expects there will be a decrease in the unemployment rate over the next two years. Entity E estimates the loss rate to decrease by approximately 10 percent in each aging bucket.

Illustration of Estimate of Expected Credit Losses:

Past Due Status Gross Accounts Receivable

Base Expected Loss

Credit Loss Rate Expected Credit Loss Estimate

Current $5,984,698 0.3% 0.27% $16,159

1-30 day past due $8,272 8% 7.2% $596

31-60 days past due $2,882 26% 23.4% $674

60+ days past due $1,942 58% 52.2% $1,014

$5,997,794 $18,443

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Measurement for Credit Losses - CECL Model

Troubled Debt Restructuring (TDR)

A troubled debt restructuring may involve receipt of assets in partial satisfaction of a receivable and/or a modification of terms of the remaining receivable.

• No change in the guidance for identifying a TDR • CECL model is used to estimate the impairment • Restructured loan shall not be accounted for as a new loan

Key Changes:

• The allowance for credit losses should include concessions given to the borrower

• Effective interest rate used to discount expected future cash flows should be that of the original loan (not the impaired loan)

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Measurement for Credit Losses - CECL Model

Purchased Financial Assets with Credit Deterioration

• Purchased with more than insignificant credit deterioration (PCD assets)

• Initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense (“grossed up”)

• Subsequent changes in the allowance are reported as a credit loss expense

• Discounts (excluding embedded discount attributable to the acquirer’s assessment of credit losses at acquisition) should be accreted to interest income using the effective interest model

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Measurement for Credit Losses - CECL Model

Purchased Financial Assets with Credit Deterioration

Assume an example in which a loan with an outstanding principal balance of $100 was acquired for $80. Assume no discount was acquired - effective rate is the same as the stated rate. Current GAAP Loans Receivable 80

Cash 80

ASU 2016-13 Loans Receivable 100

ALL 20

Cash 80

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Measurement for Credit Losses - CECL Model

Purchased Financial Assets with Credit Deterioration

Assume an example in which a loan with an outstanding principal balance of $100 was acquired for $70. Assume a discount of $10 was also acquired. Current GAAP Loans Receivable 70

Cash 70

ASU 2016-13 Loans Receivable 100

ALL 20

Cash 70

Loan discount 10

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Measurement for Credit Losses - CECL Model

Beneficial Interests

• The beneficial interest definition did not change from existing GAAP.

• Beneficial interests may be classified as AFS or HTM. The loss model is applied based on the entity’s classification

• AFS – AFS security model • HTM – Debt security model

• The purchased financial assets with credit deterioration model is applied if there is a significant difference in the contractual and expected cash flows at the date of acquisition.

• Includes those that may not meet the definition of PCD (investments in a residual tranche at issuance)

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Measurement for Credit Losses - CECL Model

Off-Balance Sheet Exposures

• An entity must account for expected credit losses in addition to and separately from the fair value of a financial guarantee

• The credit losses for off-balance sheet guarantees/commitments should

represent the expected losses over the contractual period, unless that obligation is unconditionally cancellable by the issuer. Expected losses should consider:

• Likelihood of funding & expected losses on funding • An accrual for credit loss on a financial instrument with off-balance-sheet risk

(including financial guarantees and financial standby letters of credit) shall be a liability that is recorded separate from a valuation account related to a recognized financial instrument.

• Should be presented as a credit loss expense in the income statement

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Measurement for Credit Losses - CECL Model

Off-Balance Sheet Exposures

326-20-55-55 Bank M has a significant credit card portfolio, including funded balances on existing cards and unfunded commitments (available credit) on credit cards. Bank M’s card holder agreements stipulate that the available credit may be unconditionally cancelled at any time. 326-20-55-56 When determining the allowance for credit losses, Bank M estimates the expected credit losses over the remaining lives of the funded credit card loans. • Bank M does not record an allowance for unfunded commitments on the

unfunded credit cards because it has the ability to unconditionally cancel the available lines of credit.

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Measurement for Credit Losses - CECL Model

Business Combinations

805-20-30-4A For acquired financial assets that are not purchased financial assets with credit deterioration, the acquirer shall record the purchased financial assets at the acquisition-date fair value. Additionally, for these financial assets within the scope of Topic 326, an allowance shall be recorded with a corresponding charge to credit loss expense as of the reporting date. 805-20-30-4B For assets accounted for as purchased financial assets with credit deterioration (which includes beneficial interests that meet the criteria in paragraph 325-40-30-1A), an acquirer shall recognize an allowance in accordance with Topic 326 with a corresponding increase to the amortized cost basis of the financial asset(s) as of the acquisition date.

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AFS DEBT SECURITIES

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Measurement for Credit Losses – AFS Impairment Model

In Scope Specifically Excluded

Debt securities classified as available-for-sale securities

Equity securities classified as available-for-sale securities

Trading securities Held-to-maturity securities Equity instruments and equity

method investments Derivatives

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Measurement for Credit Losses – AFS Impairment Model

Accounting for Impairment of AFS Debt Securities

• Impaired if fair value is less than amortized cost basis • Impairment related to credit losses is recorded as allowance for credit

losses • Other than temporary impairment terminology no longer exists • Concepts of length of time impaired and volatility are removed from the

impairment analysis

• Allowance is limited to amount that the fair value is less than the amortized cost basis

• NOTE: The same concept does not apply to HTM securities! • Impairments unrelated to credit losses are recorded through other

comprehensive income, net of applicable taxes

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Measurement for Credit Losses – AFS Impairment Model

Accounting for Impairment of AFS Debt Securities

• Assessed at the individual security level • Cannot aggregate an investment bearing the same CUSIP number if it

was purchased in a separate trade lot • Not appropriate to record a general allowance

• Each reporting date, record an allowance for credit losses that reflects the amount of the impairment related to credit losses (limited by the amount that fair value is less than the amortized cost).

• Changes in the allowance are recorded as credit loss expense (or reversal of credit loss expense).

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Measurement for Credit Losses – AFS Impairment Model

Calculating the Impairment

Present Value of Cash Flows

Expected to be Collected

• A credit loss exists if the present value of cash flows expected to be collected is less than the amortized cost basis of the security.

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Measurement for Credit Losses – AFS Impairment Model

Calculating the Impairment (continued)

• Intent to sell security (decided or more likely than not will be sold) • Write off allowance for credit losses • Write down amortized cost basis to the debt security’s fair value at

the reporting date • Record any impairment in earnings

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Measurement for Credit Losses – AFS Impairment Model

Calculating the Impairment (continued)

Assume a debt security with a par of $100 is acquired and subsequently incurs credit losses of $10. Fair value is $85: 1. Entry to record the acquisition AFS debt security $100

Cash $100

2. Entry to record fair value adjustment and credit losses OCI (AOCI) $ 5

AFS debt security $ 5

Provision for credit losses $ 10

Allowance for credit losses $ 10

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Measurement for Credit Losses – AFS Impairment Model

Purchased AFS Debt Securities with Credit Deterioration

The allowance for credit losses for purchased available-for-sale debt securities with a more-than-insignificant amount of credit deterioration since origination is determined in a similar manner to other available-for-sale debt securities; except for the following:

• Initial allowance for credit losses is added to the purchase price rather than reported as a credit loss expense (“grossed up” to reflect expected loss estimate on Day 1).

• Only subsequent changes in the allowance for credit losses are recorded in credit loss expense (or reversal).

• Discounted cash flow model is required to be used • Interest income should be recognized based on the effective interest

model, excluding the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at acquisition.

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Measurement for Credit Losses – AFS Impairment Model

Calculating the Impairment (continued)

Assume a debt security with a par of $100 is acquired with a credit loss of $10. Security is acquired for $85: 1. Entry to record the acquisition AFS debt security $ 95*

Cash $85

Allowance for credit losses $10

*The $5 discount acquired will be accreted to income over the contractual life of the debt security

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TRANSITION AND DISCLOSURE REQUIREMENTS

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Transition Guidance and Disclosure Requirements

Transition Guidance

Cumulative-effect adjustment to the opening retained earnings in the statement of financial position as of the date of adoption Purchased Financial Assets with Credit Deterioration: Purchased assets previously accounted for under Subtopic 310-30 (PCI) will be classified as PCD at transition To avoid re-amortizing any purchased financial assets with credit deterioration at the adoption date, those assets should be considered purchased assets with credit deterioration at the adoption date, resulting in an adjustment to the amortized cost that reflects the addition of the allowance for credit losses at the date of adoption.

Debt instruments with OTTI: Requires a prospective transition approach

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Transition Guidance and Disclosure Requirements

Disclosure Requirements

• Retains many of the disclosure amendments in ASC 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses, updated to reflect the change from an incurred loss methodology to an expected credit loss methodology

• Disclosures of credit quality indicators in relation to the amortized cost of financing receivables, a current disclosure requirement, are further disaggregated by year of origination (or vintage) • Optional disclosure of entities that are not public.

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? QUESTIONS

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