4.3 Information Set
ASC 326-20
30-7 When
developing an estimate of expected credit losses on financial
asset(s), an entity shall consider available information
relevant to assessing the collectibility of cash flows. This
information may include internal information, external
information, or a combination of both relating to past events,
current conditions, and reasonable and supportable forecasts. An
entity shall consider relevant qualitative and quantitative
factors that relate to the environment in which the entity
operates and are specific to the borrower(s). When financial
assets are evaluated on a collective or individual basis, an
entity is not required to search all possible information that
is not reasonably available without undue cost and effort.
Furthermore, an entity is not required to develop a hypothetical
pool of financial assets. An entity may find that using its
internal information is sufficient in determining
collectibility.
30-8 Historical
credit loss experience of financial assets with similar risk
characteristics generally provides a basis for an entity’s
assessment of expected credit losses. Historical loss
information can be internal or external historical loss
information (or a combination of both). An entity shall consider
adjustments to historical loss information for differences in
current asset specific risk characteristics, such as differences
in underwriting standards, portfolio mix, or asset term within a
pool at the reporting date or when an entity’s historical loss
information is not reflective of the contractual term of the
financial asset or group of financial assets.
30-9 An entity
shall not rely solely on past events to estimate expected credit
losses. When an entity uses historical loss information, it
shall consider the need to adjust historical information to
reflect the extent to which management expects current
conditions and reasonable and supportable forecasts to differ
from the conditions that existed for the period over which
historical information was evaluated. The adjustments to
historical loss information may be qualitative in nature and
should reflect changes related to relevant data (such as changes
in unemployment rates, property values, commodity values,
delinquency, or other factors that are associated with credit
losses on the financial asset or in the group of financial
assets). Some entities may be able to develop reasonable and
supportable forecasts over the contractual term of the financial
asset or a group of financial assets. However, an entity is not
required to develop forecasts over the contractual term of the
financial asset or group of financial assets. Rather, for
periods beyond which the entity is able to make or obtain
reasonable and supportable forecasts of expected credit losses,
an entity shall revert to historical loss information determined
in accordance with paragraph 326-20-30-8 that is reflective of
the contractual term of the financial asset or group of
financial assets. An entity shall not adjust historical loss
information for existing economic conditions or expectations of
future economic conditions for periods that are beyond the
reasonable and supportable period. An entity may revert to
historical loss information at the input level or based on the
entire estimate. An entity may revert to historical loss
information immediately, on a straight-line basis, or using
another rational and systematic basis.
An entity must consider all available relevant information when estimating expected
credit losses, including details about past events, current conditions, and reasonable
and supportable forecasts. That is, while an entity can use historical charge-off rates
as a starting point for determining expected credit losses, it must evaluate how
conditions that existed during the historical charge-off period may differ from its
current expectations and revise its estimate of expected credit losses accordingly.
However, the entity is not required to forecast conditions over the entire contractual
life of the asset. Rather, for the period beyond that for which the entity can make
reasonable and supportable forecasts, the entity should revert to historical credit loss
experience.
4.3.1 Historical Credit Loss Experience
ASC 326-20-30-8 states, in part, that “[h]istorical credit loss
experience of financial assets with similar risk characteristics generally provides
a basis for an entity’s assessment of expected credit losses.” Historical credit
loss experience can be used as a starting point for estimating expected credit
losses and for reversion for periods beyond which management can make reasonable and
supportable forecasts of such losses. In calculating historical credit loss
information, an entity may consider different factors depending on its policies,
asset types, and pooling of assets according to their risk characteristics.
ASC 326-20-30-8 and 30-9 require entities to adjust historical loss
information to reflect differences associated with (1) asset-specific risk
characteristics and (2) current conditions and reasonable and supportable forecasts
of future economic conditions relevant to the financial assets. ASC 326-20-30-9
states, in part, that “[f]or periods beyond which the entity is able to make or
obtain reasonable and supportable forecasts of expected credit losses, an entity
shall revert to historical loss information . . . reflective of the contractual term
of the financial asset or group of financial assets.” Further, ASC 326-20-55-6(c)
indicates that when estimating expected credit losses, an entity must use
significant judgment to decide on “[t]he approach to determine the appropriate
historical period for estimating expected credit loss statistics.”
4.3.1.1 Determining Historical Credit Loss Data
The guidance in ASC 326 on the factors that an entity should
consider in determining the appropriate historical periods to use to calculate
historical credit loss information is limited to the following:
- ASC 326-20-30-8 and 30-9 indicate that the historical loss information should reflect “the contractual term of the financial asset or group of financial assets.”
- ASC 326-20-55-3 states, in part: An entity may use historical periods that represent management’s expectations for future credit losses. An entity also may elect to use other historical loss periods, adjusted for current conditions, and other reasonable and supportable forecasts. When determining historical loss information in estimating expected credit losses, the information about historical credit loss data, after adjustments for current conditions and reasonable and supportable forecasts, should be applied to pools that are defined in a manner that is consistent with the pools for which the historical credit loss experience was observed.
To determine the appropriate historical credit loss data to use in calculating
historical loss information, management must apply professional judgment and
consider the nature of the financial assets and their risk characteristics. In
making this determination, an entity must evaluate the number of, and which,
periods to include in historical credit loss information.
4.3.1.1.1 The Number of Periods to Include in Historical Credit Loss Information
As noted above, ASC 326 only discusses the number of periods of historical
credit loss information in the context of whether such information reflects
“the contractual term of the financial asset or group of financial assets.”
Given that guidance, entities may think that the number of periods of
historical loss information must at least equal the contractual term of the
financial assets for which an allowance for credit losses is being estimated
(e.g., 10 years of historical loss information for financial assets with a
10-year contractual maturity). While such a conclusion may be appropriate,
it does not represent a requirement. Rather, ASC 326 specifies only that the
historical loss information must reflect historical defaults of similar
financial assets during the entire contractual term of those assets. For
example, if an entity is estimating expected credit losses for a group of
financial assets with a contractual maturity of 10 years, it may determine
that five years of historical loss information appropriately reflects the
entire contractual term of the financial assets being evaluated because the
composition of the financial assets within the five-year historical loss
information appropriately includes a mix of financial assets that have been
outstanding (seasoned) for periods commensurate with the remaining
contractual maturities of the financial assets being evaluated.
Since ASC 326 (1) does not specifically require that the number of periods of
historical loss information at least equal the contractual term of the
financial assets being evaluated and (2) does not prohibit an evaluation in
which the number of periods of historical loss information exceeds the
contractual term of those assets, an entity should consider the factors
discussed in the subsections below in determining the number of periods to
use in historical loss information.
4.3.1.1.1.1 Whether the Number of Periods Used Appropriately Represents the Seasoning of the Financial Assets Being Evaluated
Since the evaluation of credit losses is rarely linear, it is important
for historical loss information to appropriately reflect the specific
default patterns expected on the basis of the type of financial asset.
For example, for a group of financial assets with a 10-year contractual
maturity, the historical credit loss information should appropriately
represent the expectations regarding defaults that will occur in each
year of the assets’ contractual life on the basis of their seasoning as
of the balance sheet date.
4.3.1.1.1.2 Whether the Number of Periods Used Appropriately Represents the Asset-Specific Risk Characteristics of the Financial Assets Being Evaluated
ASC 326-20-30-8 requires an entity to adjust “historical loss information
for differences in current asset specific risk characteristics, such as
differences in underwriting standards, portfolio mix, or asset term
within a pool.” However, the differences cited in this paragraph are not
inclusive (i.e., there may be other relevant differences in
asset-specific risk characteristics to consider, such as changes in
prepayment behaviors resulting from changes in the nature of the
financial assets or the environmental conditions that affect
prepayments).
If an entity is relying on internal historical loss information and there
have been recent significant changes in asset-specific risk
characteristics, the entity may find it more appropriate to use a more
recent, shorter period of historical loss information (as opposed to
using a longer period, in which case the adjustment of such loss
information may be more complex).
4.3.1.1.1.3 Whether the Number of Periods Used Appropriately Represents How the Historical Loss Information Is Being Used in the Calculation of Expected Credit Losses
ASC 326-20-30-9 requires an entity to revert to historical loss
information, adjusted solely to reflect differences in asset-specific
risk characteristic, in calculating expected credit losses for periods
beyond which management can make reasonable and supportable forecasts of
expected credit losses. Thus, the remaining contractual life of a group
of financial assets for which an entity is solely reverting to
historical loss information will be shorter than the full contractual
maturity of such assets. Accordingly, entities should consider the need,
for reversion purposes, to use historical loss information that reflects
the seasoning of the financial assets, since the determination of credit
losses is not linear. This seasoning aspect for reversion periods is
likely to differ from the seasoning of the financial assets on the
balance sheet date.
Further, paragraph BC50 of ASU 2016-13 notes that “[s]ome entities may be
able to forecast over the entire estimated life of an asset, while other
entities may forecast over a shorter period.” For entities that are able
to forecast expected losses over the entire estimated life of a group of
financial assets, the seasoning considerations above will be reflected
in the forecasted expected losses rather than in historical loss
information used for reversion.
4.3.1.1.1.4 Whether the Number of Periods Used Appropriately Reflects a Full Economic Cycle
It is generally appropriate for the historical credit loss information to
include a full economic cycle (i.e., peaks and troughs) even if the life
of a particular financial asset is shorter than an economic cycle. The
length of the period that encompasses an economic cycle will depend on
the facts and circumstances.
The determination of whether historical credit loss information should
reflect a full economic cycle will also ultimately depend on the
particular facts and circumstances, including the extent to which an
entity is able to adjust historical loss information on the basis of (1)
reasonable and supportable assumptions of future economic conditions and
(2) the remaining period (if any) for which expected credit losses will
be determined by reverting to historical loss information. For example,
if the remaining period for reversion to historical loss information is
short and the timing of such reversion is in the near term, an entity
could reasonably conclude that historical credit loss information that
reflects the current economic conditions is more relevant than
historical credit loss information over an entire economic cycle. In all
cases, the historical loss information used to make adjustments based on
reasonable and supportable assumptions of future economic conditions
should represent where an entity is within an economic cycle.
4.3.1.1.1.5 The Number of Periods of Relevant Historical Loss Information That Are Available to the Entity
Some entities may have more historical loss data than others and
therefore may include longer periods in the calculation of historical
credit losses. Note that, as discussed below, entities that use longer
periods should not be biased in selecting such data (i.e., by including
periods with more peaks than troughs or vice versa).
For example, one entity may only have historical loss information that
starts 10 years ago and therefore may calculate historical loss
information on this basis. Another entity may, however, have historical
loss information that begins 40 years ago and therefore may use a longer
period. Under ASC 326, two entities may reasonably use different
periods. These differences may be attributable to the size and
sophistication of the entity, how long the entity has existed, and the
availability of relevant external data when sufficient internal data are
unavailable.
4.3.1.1.2 Which Historical Periods to Include in Historical Loss Information
In addition to determining the number of historical periods to use in
calculating historical loss information, management should consider which of
these periods to include. While it often may be reasonable for an entity to
start with the most recent period and work backwards consecutively, such an
approach is not necessarily required or always appropriate. In determining
which historical periods to use, an entity should consider the factors
discussed below.
4.3.1.1.2.1 Whether the Approach Is Objective and Reflects Expected Future Credit Losses
An entity should be objective, not biased, in estimating the allowance
for credit losses. Therefore, it would not be appropriate for an entity
to select historical periods that reflect either an overly aggressive or
an overly conservative level of credit losses (i.e., “cherry-picking”
historical information to achieve a desired accounting result). A biased
selection of historical information (e.g., using long-term historical
loss information that includes more peaks than troughs or vice versa)
would not be consistent with the credit loss measurement objective of
ASC 326.
4.3.1.1.2.2 Whether the Approach Is Consistent With Asset-Specific Risk Characteristics
In a manner consistent with the discussion above, an entity that is
selecting among periods of historical credit loss information should
consider how such information is aligned with the current asset-specific
risk characteristics of the financial assets being evaluated. For
example, if an entity has made changes to its underwriting to be more
consistent with an underwriting approach used in prior periods, it may
be more appropriate for the entity, if all else is held constant, to use
older historical loss information (as opposed to using more recent
historical loss information and applying more complex judgments about
how to adjust such information).
Note that management should use significant judgment in
determining the allowance for credit losses and should include thorough
documentation to support that judgment. While an entity is not
prohibited from changing the composition of historical credit loss data
used in this determination, any changes the entity makes in constructing
historical loss information should be justified by the facts and
circumstances and would reflect a change in accounting estimate. See
Section 4.4 for more
information.
4.3.1.1.3 Effect of Accrued Interest on Historical Loss Information
An entity may have a nonaccrual policy under which it
stops accruing interest if it believes the collection of interest is in
doubt. This is generally the case when a borrower is in default for a
specified period (e.g., 90 days past due). Many entities also reverse
the previously accrued interest if the borrower remains in default for
an extended period (e.g., 180 days). In those cases, historical loss
information would not reflect any or all interest amounts that were not
collected, because the entity had already decided to stop accruing
interest on the asset and also may have reversed any interest that
accrued before determining the ultimate amount of any loss on the
asset.
Questions have arisen about whether historical loss
information should be adjusted (increased) to reflect the amount of
accrued interest that would have been charged off if the entity had not
applied a nonaccrual accounting policy.2 ASC 326-20-55-6(b) states that one of the judgments an entity uses
in estimating credit losses is the following:
The
approach to measuring the historical loss amount for loss-rate
statistics, including whether the amount is simply based on the
amortized cost amount written off and whether
there should be adjustments to historical credit losses (if any)
to reflect the entity’s policies for recognizing accrued
interest. [Emphasis added]
In addition, as discussed in Section 4.4.5.1, ASC 326-20-30-5A states that “[a]n
entity may make an accounting policy election . . . not to measure an
allowance for credit losses for accrued interest receivables if the
entity writes off the uncollectible accrued interest receivable balance
in a timely manner.”
Accordingly, we believe that an entity should adjust
historical loss information if its loss data are not consistent with its
accounting policy election related to whether an allowance is measured
for losses on accrued interest. For example, if the entity does not
elect to measure an allowance for credit losses on accrued interest
receivables as permitted by ASC 326-2-30-5A, it should adjust the
historical loss information to reflect the amount of accrued interest
that would have been charged off if the entity had not applied a
nonaccrual accounting policy.
4.3.2 Adjustments to Historical Loss Data for Differences in Asset-Specific Risk Characteristics
While historical loss data serve as a starting point for estimating
expected credit losses, ASC 326 requires an entity to evaluate whether such data are
relevant to the financial assets for which the estimate is being made. Specifically,
ASC 326-20-30-8 states, in part, that “[a]n entity shall consider adjustments to
historical loss information for differences in current asset specific risk
characteristics, such as differences in underwriting standards, portfolio mix, or
asset term within a pool at the reporting date or when an entity’s historical loss
information is not reflective of the contractual term of the financial asset or
group of financial assets.” For example, it would not be appropriate for an entity
to use historical loss data related to subprime mortgages when estimating expected
credit losses on prime mortgages in the current financial reporting period.
4.3.3 Current Conditions and Reasonable and Supportable Forecasts
As discussed in Section 4.3.1, an entity’s
historical credit loss experience with financial assets whose risk characteristics
are similar generally serves as a basis for the entity’s assessment of expected
credit losses. As discussed in Section 4.3.2,
sometimes an entity needs to adjust historical data for differences in
asset-specific risk characteristics. However, ASC 326-20-30-9 states that an entity
“shall not rely solely on past events to estimate expected credit losses.” Rather,
an entity that uses historical loss information should consider adjusting
information to appropriately reflect management’s current expectation of future
credit losses. Specifically, ASC 326-20-30-9 states that an entity “shall consider
the need to adjust historical information to reflect the extent to which management
expects current conditions and reasonable and supportable forecasts to differ from
the conditions that existed for the period over which historical information was
evaluated.”
Note that the adjustments for current conditions and reasonable and supportable
forecasts differ from (and are incremental to) the adjustments discussed in
Section 4.3.2 that are related to differences between historical
data and asset-specific risk characteristics. For example, an entity may upwardly
adjust historical loss rates to reflect that it now lends money to retail customers
with lower credit scores and is trying to estimate losses on a pool of loans to
those customers. This would be an adjustment for differences in asset-specific risk
characteristics. However, the entity may also adjust the historical loss rates again
to reflect the difference between the current economic conditions and the conditions
related to the period represented by the historical information. For example, if
current unemployment rates are lower than the rates during the period reflected in
the historical data, the loss rates may be adjusted down to reflect current
conditions. An entity may also be required to make further adjustments to reflect
reasonable and supportable forecasts.
While some entities may be able to develop reasonable and supportable forecasts over
the contractual term of a financial asset (or group of financial assets), ASC 326
does not require an entity to develop such forecasts. Furthermore, under ASC
326-20-30-7, the entity’s search for all possible information that may be relevant
to management’s expectations regarding future credit losses does not need to involve
“undue cost or effort.” ASC 326-20-30-7 and ASC 326-20-30-9 state, in part:
30-7 When developing an estimate of
expected credit losses on financial asset(s), an entity shall consider
available information relevant to assessing the collectibility of cash
flows. . . . An entity shall consider relevant qualitative and quantitative
factors that relate to the environment in which the entity operates and are
specific to the borrower(s). When financial assets are evaluated on a
collective or individual basis, an entity is not required to search all
possible information that is not reasonably available without undue cost and
effort. . . .
30-9 [F]or periods beyond which the entity is able to make or obtain
reasonable and supportable forecasts of expected credit losses, an entity
shall revert to historical loss information determined in accordance with
paragraph 326-20-30-8 that is reflective of the contractual term of the
financial asset or group of financial assets. An entity shall not adjust
historical loss information for existing economic conditions or expectations
of future economic conditions for periods that are beyond the reasonable and
supportable period. An entity may revert to historical loss information at
the input level or based on the entire estimate. An entity may revert to
historical loss information immediately, on a straight-line basis, or using
another rational and systematic basis.
It would be rare for an entity to conclude that there is no reasonable and
supportable information about current conditions and expectations for future
economic conditions and therefore for the entity to solely use historical loss
information to measure expected credit losses. Paragraph BC51 of ASU 2016-13 states
that the FASB “expects that an entity should not ignore relevant data when
considering historical experience or when considering qualitative adjustments for
current conditions and reasonable and supportable forecasts.” The Board also
acknowledges that “the adjustment for current conditions and reasonable and
supportable forecasts will be the most subjective aspect of the estimate.” Paragraph
BC53 of ASU 2016-13 further explains that the purpose of the language in ASC
326-20-30-9 on reversion to historical loss information is to “provide additional
guidance on how to measure expected credit losses as an entity moves into periods of
increasing uncertainty and decreasing precision.” This guidance is not intended to
allow an entity to merely default to historical loss information when estimating
expected credit losses.
The determination of how far into the future an entity can reasonably adjust
historical loss information to reflect projected future economic conditions relevant
to the recoverability of a particular type of financial asset will depend on the
particular facts and circumstances, including the types of macroeconomic data that
are predictive of future credit losses, and may be limited to the periods for which
future macroeconomic data may be obtained from external sources. ASC 326-20-30-9
specifically prohibits adjustment to historical loss information “for existing
economic conditions or expectations of future economic conditions for periods that
are beyond the reasonable and supportable period.” However, an entity is not
precluded from projecting future economic conditions for periods beyond which there
is published external information if such projections are reasonably supportable
given the particular facts and circumstances.
4.3.3.1 Use of Macroeconomic Data to Make Reasonable and Supportable Forecasts
The objective of incorporating macroeconomic data into the
modeling of the allowance for credit losses is to use relevant information
about how current and projected economic conditions will affect the level of
future credit losses on financial assets (i.e., how current and future
economic conditions will affect historical loss experience). An entity would
be expected to use such macroeconomic data in estimating expected credit
losses.
ASC 326 does not require an entity to incorporate into its
credit loss estimate a certain number of macroeconomic variables, and it
does not establish a required period into the future for which macroeconomic
variables are considered reasonable and supportable information for the
entity to use in making credit loss estimates (i.e., as compared with
defaulting to historical loss information). However, we believe that, in
estimating credit losses, an entity should use macroeconomic data that
correlate to historical losses (and are periodically revalidated) and should
not ignore macroeconomic data that are relevant to the expectation of future
cash flows.
An entity may use more than one external source of
macroeconomic data, although it is not required to do so. If an entity
evaluates more than one external source of macroeconomic data, it is not
required to apply probability weighting to the information. Rather, it could
consider multiple sources to validate the primary source of information
used. In addition, an entity could use its internal views on key economic
indicators rather than using external sources. However, the entity should
consider whether it is appropriate that its internal views are contrary to
published information.
4.3.3.2 Reasonable and Supportable Forecast Periods
ASC 326 does not require an entity’s forecast period to be
the same for all asset types or for all inputs into the models it uses for
estimating credit losses. On the contrary, ASC 326-20-30-7 states, in part,
that “[w]hen developing an estimate of expected credit losses on financial
asset(s), an entity shall consider available information relevant to
assessing the collectibility of cash flows [as well as] relevant qualitative
and quantitative factors that relate to the environment in which the entity
operates and are specific to the borrower(s).” The effects of changes in
macroeconomic data could differ depending on which of the entity’s assets
are involved, causing an entity to use different reasonable and supportable
forecast periods when estimating expected credit losses. For example, an
entity may consider macroeconomic data related to residential mortgages
differently depending on the location of borrowers or the underlying
collateral securing the loans. As a result, the entity may need to use
different reasonable and supportable forecast periods to reflect the
differences in the macroeconomic data relevant to the particular asset.
Further, in July 2019, the
FASB staff addressed this issue in the following Q&A:
FASB Staff Q&A
Topic 326, No.
2: Developing an Estimate of Expected Credit
Losses on Financial Assets
Questions and
Answers — General Questions About the CECL
Standard
Question
8
May the length of reasonable and
supportable forecast periods vary between different
portfolios, products, pools, and inputs?
Response
Yes. The duration or length of the
reasonable and supportable forecast period is a
judgment that may vary based on the entity’s ability
to estimate economic conditions and expected losses.
The reasonable and supportable forecast may vary
between portfolios, products, pools, and inputs.
However, specific inputs (such as unemployment
rates) should be applied on a consistent basis
between portfolios, products, and pools, to the
extent that the same inputs are relevant across
products and pools. It also is acceptable to have a
single reasonable and supportable period for all of
an entity’s products. An entity is to disclose
information that will enable users to understand
management’s method for developing its expected
credit losses, the information used in developing
its expected credit losses, and the circumstances
that caused changes to the expected credit losses
among other disclosures about the allowance for
credit losses.
In addition to not requiring
that an entity’s forecast period be the same, ASC 326 does not require an
entity to develop (or preclude it from developing) multiple economic
scenarios. The following FASB staff Q&A (released in July 2019)
addresses this issue:
FASB Staff Q&A
Topic 326, No.
2: Developing an Estimate of Expected Credit
Losses on Financial Assets
Questions and
Answers — General Questions About the CECL
Standard
Question
12
When developing a reasonable and
supportable forecast to estimate expected credit
losses, is probability weighting of multiple
economic scenarios required?
Response
No. Topic 326 does not require an
entity to probability weight multiple economic
scenarios when developing an estimate of expected
credit losses. One entity may choose to probability
weight multiple economic scenarios when developing
its estimate of expected credit losses, while
another entity may rely on a single economic
scenario to develop reasonable and supportable
forecasts.
4.3.3.3 Assumptions Used by an Entity
The economic forecasts used to estimate expected credit
losses do not necessarily have to be the same as those used for other
forecasting purposes within the organization (e.g., budgeting, goodwill
impairment testing). ASU 2016-13 notes that various methods for forecasting
expected credit losses are acceptable and does not outline a specific
approach to use. While the information used to forecast expected credit
losses may be consistent with the information used for other forecasting
purposes, it does not need to be the same.
4.3.3.4 Validating the Forecasting Process
Although an entity’s forecasts must be reasonable and
supportable, ASC 326 does not require an entity to substantiate its ability
to accurately predict economic conditions. In other words, when estimating
its expected credit losses, an entity is not required to evaluate in the
current reporting period whether it had “successfully” predicted economic
conditions in prior periods. Paragraph BC50 of ASU 2016-13 states that
“[e]stimates of credit losses may not precisely predict actual future events
and, therefore, subsequent events may not be indicative of the
reasonableness of those estimates.” While paragraph BC50 is addressing the
overall estimate of expected credit losses more broadly, we believe that it
applies equally to reasonable and supportable forecasts about the future.
That is, inherent in any forecast of economic conditions is a level of
uncertainty and lack of precision. As a result, we do not believe that an
entity must evaluate whether existing economic conditions were accurately
predicted in its previous forecasts in earlier reporting periods. However,
paragraph 3.5.21(d) of the AICPA Audit and Accounting Guide on credit losses
states that “significantly missing near-term forecasts may be an indicator
of a deficient forecasting process.”
4.3.4 Reversion to Historical Loss Information
As mentioned previously, some entities may be able to develop reasonable and
supportable forecasts over the contractual term of a financial asset. Those that
cannot do so will need to revert to historical loss experience for the periods
beyond which they can develop reasonable and supportable forecasts. The Board
believes that it would be inappropriate to assign zero as the estimate of credit
losses during the period beyond which an entity could develop a reasonable and
supportable forecast. In paragraph BC53 of ASU 2016-13, the FASB indicates that “an
approach that does not record some expected losses (for example, those that are
expected to occur after some prescribed forecast period) would fail to reflect the
amount that an entity expects to collect, which is the Board’s measurement objective
for financial assets. . . . Therefore, the Board decided to provide additional
guidance on how to measure expected credit losses as an entity moves into periods of
increasing uncertainty and decreasing precision.”
In a manner consistent with its objective not to prescribe or
prohibit specific approaches or assumptions that management uses to develop its
expectations about the future, the FASB has given entities flexibility related to
choosing how to revert to historical loss experience. ASC 326-20-30-9, in part,
states that “[a]n entity may revert to historical loss information at the input
level or based on the entire estimate [and] may revert to [such] information
immediately, on a straight-line basis, or using another rational and systematic
basis.” While such use of reversion is not an accounting policy election, the entity
is required to disclose the reversion method (e.g., the level at which it reverts
and the period over which it chooses to revert) as a significant judgment used by
management when determining the cash flows it expects to collect.
Further, how an entity reverts to historical loss experience could
be affected by whether it has a single reasonable and supportable forecast period
covering all financial assets and inputs used in estimating losses or whether it
uses multiple forecast periods for different financial assets and inputs (see
Section 4.3.3.2 for more information about
determining the reasonable and supportable forecast period). In other words, an
entity may believe that reversion on a straight-line basis is appropriate for
certain assets or inputs but may decide to use a different rational and systematic
reversion method for other assets and inputs if it believes that such a method would
result in a better representation of its expected credit losses in such
circumstances.
It is important to highlight two points regarding an entity’s ability to revert to
historical loss information as discussed in ASC 326-20-30-9. First, the historical
loss information used for reversion must be adjusted (to the extent necessary given
the particular facts and circumstances) for differences in asset-specific risk
characteristics (see Section 4.3.2). Second, such reversion is appropriate (and required)
only for periods beyond which management can reasonably adjust historical loss
information “for current conditions and reasonable and supportable forecasts,” as
discussed in ASC 326-20-30-10. That is, an entity may not default solely to
historical loss information to estimate expected credit losses.
While ASC 326-20-30-9 allows an entity to revert to historical loss
experience on “a straight-line basis, or using another rational and systematic
basis,” it does not require that the reversion occur over the remaining contractual
life of the financial asset. As a result, an entity can choose to revert to
historical loss experience over a period shorter than the asset’s remaining
contractual life if it believes that such reversion would result in a better
estimate of its expected credit losses.
Footnotes
2
Note that such questions are not relevant when
expected credit losses are calculated by using DCFs.