Remarks at the AICPA National Conference on Banks and Savings Institutions

James Schnurr, Chief Accountant

Sept. 17, 2015

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author’s colleagues upon the staff of the Commission.

Introduction

Thank you for the kind introduction and the invitation to speak with you today. Before I begin, let me remind you that the views expressed today are my own and not necessarily those of the Commission, the individual Commissioners, or other colleagues on the Commission staff.

Today, I would like to share my thoughts and perspectives on some of our office’s key priorities — implementation of the new revenue recognition standard, the upcoming release of the FASB’s[1] new credit impairment standard, and current thinking with respect to IFRS.[2]

Revenue Recognition Implementation

The staff continues to monitor implementation of the new revenue recognition standard to encourage consistent application not only in the U.S., but globally. Today I’d like to offer a few observations from our monitoring activities. I am encouraged that preparers, auditors, and standard-setters are working together to identify, evaluate and resolve issues in a consistent manner across all industries and transaction types. As these groups continue to work together, I encourage them to apply each step outlined in the standard in a practical way that considers the utility of the resulting information to investors and other users of the financial statements, as well as the costs associated with the implementation and ongoing processing of transactions.

Evaluating issues across industries and transaction types under the standard is critical, as an important objective of the standard is to eliminate industry guidance and practices. That being said, I recognize the significant efforts currently underway by various industry groups that seek to ensure that implementation questions are appropriately addressed, and I commend those efforts. Industry groups are a valuable resource, as the individuals making up these groups possess a degree of knowledge and experience that can be beneficial to the process of implementing a new accounting standard. I would like to recognize the industry groups out there that have taken this initiative. I strongly encourage other industry groups that have not yet started this process to do so as soon as possible. I think most people would agree that the level of effort required to ensure all transaction types are appropriately analyzed is significant, and the time necessary to achieve a successful implementation should not be underestimated.

While industry group involvement is important, it is even more important that the issues identified at the industry group level are elevated for broader consideration and any important interpretative questions are resolved so that we maintain consistent application of the revenue recognition principles across all industries. We saw the benefit of this escalation with the recent TRG[3] decisions around credit card fees. This scope issue was raised and appropriately escalated through the process such that the TRG could address the issue on a timely basis. While the decision related to credit card fees is a positive example of timely escalation and should allow banks to move forward with their implementation, I want to remind the banking industry that they will need to evaluate and document their analyses on whether the fees associated with each credit arrangement product represent an integral part of the credit relationship and, if so, that they are outside the scope of the revenue standard.

As the degree of work intensifies at the industry group level, I anticipate that a significant amount of debate may take place with respect to implementation questions, particularly scope related questions. In this regard, our office does not believe it would be appropriate for industry groups to “agree to disagree” or to agree on a specific accounting treatment when there are real concerns as to whether that accounting treatment is consistent with the standard. It would be unfortunate if key questions or issues of disagreement or concern are not appropriately escalated due to concerns that, if escalated, the resolution of the accounting would change an existing practice or result in an accounting treatment that the industry did not prefer. Rather, the time is now to escalate these issues and ensure they are resolved at the appropriate level.

Credit Impairment

I would like to turn now to a topic that continues to be relevant to the banking industry: accounting for credit impairment. Last year, the IASB[4] released its new credit impairment standard, and the FASB is expected to release its credit impairment standard in the near future. I would like to recognize the efforts made by both boards to respond to constituent feedback following the financial crisis. Both models focus on expected losses and allow for the consideration of a broader range of information in determining credit loss estimates, which are viewed by many to be positive changes from today’s standards.

I also want to recognize the current steps being taken by both boards to prepare for implementation of their respective standards. The IASB has created a TRG subsequent to the issuance of their standard, and that group has already held an initial meeting that generated important dialogue around some key issues. The FASB has formed its TRG prior to issuance of a final standard to identify and resolve any remaining key issues prior to issuance of the final ASU.[5] Consistent with the efforts being made with respect to revenue recognition, I believe the creation of these TRGs will prove beneficial to the boards, preparers, auditors, investors and regulators, and I am pleased to see these groups have been formed to assist with the implementation of the credit impairment standards.

While the IASB and FASB standards are not converged in all respects, I believe this is primarily the result of different standard setting processes that address the needs of their respective constituencies. I also believe that it is important to focus on the many key areas of the standards that are converged. Perhaps most significantly, the application of the lifetime expected credit loss measurement is converged in many respects. The proposed FASB standard would require the use of lifetime loss expectations for all loans. While the IASB standard limits the measurement of expected losses on loans with no indication of credit impairment to the next 12 months, lifetime expected credit losses will be recognized for those loans that have experienced a significant increase in credit risk. Under both models, the definition of expected credit losses is an estimate of all contractual cash flows not expected to be collected from a recognized financial asset or group of financial assets. Therefore, while the models are not fully converged, I believe U.S. registrants preparing for the issuance of the FASB’s credit impairment model can learn from the current implementation efforts overseas and leverage some of those thought processes as they begin their implementation process here in the U.S.

As registrants begin their preparations for implementation of the FASB impairment model, I would like to emphasize the importance of focusing on the objective of the standard, which is to reflect the credit risk inherent in the portfolio. It is expected that the methodologies and assumptions used by various constituents to achieve this objective will vary. As organizations implement the standard, I believe it is appropriate for them to evaluate cost/benefit considerations associated with the variety of different alternatives available to them in achieving the objective of the standard. If different methods achieve the objective of the standard, cost considerations could be a factor in selecting the ultimate methodologies to use. This is consistent with the standard’s overall approach to reducing complexity in determining credit loss estimates.

While the methodologies and approaches to achieving the objective of the standard are expected to vary, one thing is clear — coming up with lifetime expected credit loss estimates will require significant levels of management judgment. In an area that requires significant judgment, and for which methodologies used are expected to vary, it is critical for management to take responsibility for the processes and controls used to develop their estimates, including robust documentation of their organization’s key accounting policies. The development, documentation, and application of a systematic methodology used to determine credit loss estimates, as well as policies surrounding the validation of such methodologies have always been, and will continue to be, critical in supporting the allowance for loan losses recorded in the financial statements.

Credit loss provisioning is one area where the mission and priorities of various stakeholders consistently come into play. Therefore, it is important to highlight the tension that may exist between the goals of financial reporting and the desire to satisfy certain prudential regulation objectives. We continue to believe that the goal of financial reporting is to provide investors with credible, transparent, and comparable financial information they can rely on to make sound investment and credit decisions. The decisions made by the FASB and IASB in developing their models were made with these objectives in mind. Prudential regulation, on the other hand, exists to promote safety and soundness objectives. There may be scenarios where a bank’s approach to estimating expected credit losses meets both objectives. However, it is important for preparers to remember that in preparing the financial statements the objective is for management to make its best estimate of the expected loss, which may not reflect the estimate desired for safety and soundness purposes. In those instances, prudential regulators have the mechanisms available to make changes to the regulatory capital regime, similar to how changes in fair value for available for sale securities are currently addressed in the capital regimes.

The allowance for credit losses is just one area where interplay may exist between financial reporting and other regulations. Recently, risk retention rules were issued where entities that sponsor asset-backed securities are required to retain a certain level of the credit risk of the assets collateralizing the securities. In some recent transactions, questions have arisen with respect to majority-owned affiliates being used to hold that required level of credit risk on behalf of the sponsor. In these scenarios, the analysis surrounding the consolidation of such majority-owned affiliate becomes relevant. Our office continues to believe that the GAAP consolidation model should always be the starting point for financial reporting purposes. Along those lines, we do not believe that a bright-line exists related to the level of ownership necessary to consolidate, and instead the consolidation is based on the control principles as outlined in ASC 810.

Another example is the sale of real estate. The guidance in ASC 606 and ASC 610 will replace the prescriptive literature in ASC 360 with a principles-based approach that will require judgment. When determining when a transfer of real estate qualifies for full profit recognition, we believe these sections of the authoritative guidance should be applied. If the transaction meets the requirements, full profit recognition is appropriate for purposes of the financial statements.

Latest thinking on IFRS

Let me turn now to IFRS. Last year, I had just retired after spending 30 years as an audit partner, and I was approached by Chair White to be the Chief Accountant. One topic we discussed was her speech in May 2014 at the Financial Accounting Foundation’s annual dinner.[6] Chair White indicated that she was making IFRS a priority and would be asking me to advise her on any potential next steps if I were to be appointed. Since arriving at the Commission last October, I have spent considerable time with my staff and others researching and discussing IFRS.

As I mentioned publicly in May during a speech at Baruch College,[7] the staff has recently heard from a number of different constituents about IFRS: preparers, investors, auditors, regulators and standard-setters. We heard three key themes through those discussions:

• There is virtually no support to have the SEC mandate IFRS for all registrants.
• There is little support for the SEC to provide an option allowing domestic registrants to prepare their financial statements under IFRS.
• There is continued support for the objective of a single set of high-quality, globally accepted accounting standards.

So, while full scale adoption or an option does not appear to have support, it does not mean we should abandon the underlying objective of a single set of high-quality, globally accepted accounting standards. On the contrary, constituents continue to support that idea. So, the real questions are: what is the path to achieve that objective and how do we get there?

As it relates to the alternative that I mentioned last December[8] that would allow, but not require, domestic issuers to provide supplementary IFRS based information, I continue to discuss the alternative with the Commissioners and am optimistic that I will be able to provide more clarity on the path forward in the next few months.

In my opinion, in the near term, the FASB and IASB should continue to focus on converging the standards. The boards should renew their commitment to cooperate and develop standards that eliminate differences between IFRS and U.S. GAAP[9] whenever it meets the needs of its constituents and improves the quality of financial reporting. I recognize the boards will not always be able to eliminate differences during the standard-setting process, primarily because they serve different constituents that have different needs. However, when differences in standards arise, the boards should monitor the implementation of those standards with the objective of learning from the implementation and re-engaging with each other with the goal of converging to the standard with the highest quality financial reporting outcome.

I believe the boards should apply the lessons learned from the recent revenue recognition standard and realize that even though the words may be the same, to achieve convergence, cooperation is needed after the standard-setting process is complete and during the implementation stage of the standards. Finally, the FAF[10] and IFRS Foundation should be supportive of the underlying objective and provide their respective boards with the support necessary to achieve convergence.

Let me close our IFRS discussion by repeating some comments I made a few months ago.[11] I believe that, for the foreseeable future, continued collaboration is the only realistic path to further the objective of a single set of high-quality, global accounting standards. Accordingly, how the FAF, IFRS Foundation, FASB and IASB decide to interact in the future is critical to the advancement of the objective of a single set of high-quality, globally accepted accounting standards.

Independent standard setter

I now want to emphasize how important an independent standard setting process that is focused on the needs of investors is to the capital markets. The quality of financial information is paramount to the confidence of investors and the formation of capital. While financial reporting may also be relevant to other users, I believe the development of U.S. GAAP must remain focused on the needs of investors.

The Commission has consistently looked to the private sector for leadership in establishing and improving U.S. GAAP. Since the 1970s, the FASB has been that private sector standard setter. Part of the reason a private sector standard setter has been so important is because the work they do is focused on the objective of setting accounting standards that provide neutral, decision-useful information, free from political or other pressures or objectives. I believe the Sarbanes-Oxley Act strengthened that independence, and I believe that this independence has resulted, and continues to result, in better accounting standards.

Independent accounting standard setting is critical to encouraging a financial reporting system that is robust and responsive to the needs of investors. But investors must have confidence in how those standards are set. An open, transparent process, including thoughtfully considering the input and views of those who participate and play a role in our capital markets, is critical to the standard setter in fulfilling their mission of establishing and improving financial accounting and reporting standards. However, in my view, standard-setting that is focused on other objectives, or on the winners or losers that might result from the provision of neutral decision-useful information, would impair the confidence investors have.

As we reflect on the recent issuance of the revenue recognition standard and look forward to the issuance of several other major standards, the standard setting process will again be at the forefront of discussions among a variety of stakeholders. I would like to take this opportunity to reiterate my support for the independent standard-setting process. A credible and independent standard-setting process is in the interest of investors and is critical to the broader capital markets.

Thank you for your kind attention. Enjoy the remainder of the conference.