Of course, everyone has heard about Accounting Standards Update (ASU) No. 2016-13, Financial Instruments – Credit Losses, more commonly referred to as “CECL.” CECL certainly represents a substantial change and warrants this attention, but it is important that financial institutions don’t lose sight of other ASUs that will take effect over the next two years.
The following is a summary of other accounting standards financial institutions should be prepared for:
ASU No. 2014-09 – Revenue from Contracts with Customers:
ASU No. 2014-09 substantially supersedes all existing revenue recognition standards, replacing them with a principles-based revenue recognition approach for all entities. The standard introduces a five-step process that will be used to determine when and how to recognize revenue:
- Identify the contract(s) with a customer
- Identify the performance obligations (that is, the promises to deliver goods or services) in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
While this standard will have a significant impact on many industries and will likely impact some commercial loan customers, the standard will not impact most of the revenue-generating activities of a typical financial institution.
Key revenue sources such as interest income, mortgage servicing income and most loan fees are specifically outside of the scope of ASU No. 2014-09.
ASU No. 2014-09 is effective for non-public business entities (non-PBEs) for years beginning after Dec. 15, 2018, and should already have been adopted for any PBEs with fiscal years beginning after December 15, 2017.
Financial institutions will still need to analyze other sources of noninterest income, such as gain on sales of other real estate, deposit fees, interchange fees, income from trust and wealth management activities, insurance commissions, etc., and evaluate whether the timing of revenue recognition will be impacted for any contracts.
Most financial institutions have concluded the timing of revenue recognition for deposit service charges and fees should continue to be recognized when assessed since the customer agreements are cancelable at any time. Some institutions have identified changes in the timing of revenue recognition for certain trust or wealth management fees. All institutions will change their accounting policies for recognizing gain on sales of other real estate owned.
ASU No. 2016-01 – Recognition and Measurement of Financial Assets and Financial Liabilities:
ASU No. 2016-01 is a wide-ranging standard with several elements that will impact most financial institutions. The standard introduces new guidance that applies to most equity investments.
Under the standard, equity securities can no longer be classified as available-for-sale securities. Instead, market value fluctuations on equity securities will have to be recognized directly through net income. An entity may elect to value equity investments without a readily determinable fair value at its cost minus impairment (if any) plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer, with any changes recognized through net income.
The standard also eliminates certain disclosure requirements related to financial instruments. Non-PBEs will no longer have to disclose the fair value of financial instruments measured at amortized cost in the financial statements. PBEs will still need to make this disclosure but will no longer be required to disclose the methods and significant assumptions used to determine the fair value of financial instruments measured at amortized cost.
ASU 2016-01 is effective for non-PBEs for years beginning after Dec.15, 2018, and was effective for PBEs with fiscal years beginning after December 15, 2017.
ASU No. 2016-02 – Leases:
Upon adoption of ASU No. 2016-02, a lessee will need to recognize all leases (including operating leases) with a term greater than 12 months on the balance sheet.
Under the standard, for both qualifying operating and finance leases, the lessee will need to record a right-of-use asset and lease obligation liability based on the present value of expected lease payments. The right-of-use asset may be adjusted for initial direct costs, prepayments, and lease incentives and will be amortized over the expected life of the lease. The lease obligation will be reduced for the determined principal component of each lease payment.
The lessee will need to evaluate the expected term of the lease in determining the right-of-use asset and lease obligation. The lease term should include all noncancelable lease periods and periods covered by an option to extend that the lessee is “reasonably certain” to exercise.
A new principles-based approach will be used for evaluating the classification of a lease (operating vs. finance). This will replace the rules-based approach used under current standards (for example, the period of the lease encompasses at least 75% of the useful life of the asset). The new principles-based classification approach is generally consistent with the previous rules.
For call report purposes, the right-of-use asset will be reflected in Schedule RC, “Premises and fixed assets,” and the asset should be risk weighted at 100 percent.
During 2018, ASU No. 2018-11, Leases: Targeted Improvements,was issued to help simplify the adoption of ASU No. 2016-02. ASU No. 2018-11 will allow institutions to apply the new standard at the adoption date by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption rather than requiring entities to reflect the change at the beginning of the earliest period presented in the financial statements.
ASU No. 2016-02 is effective for PBEs for years beginning after December 15, 2018, and for non-PBEs for years beginning after December 15, 2019.
For more information on each of these accounting standards, check out the following articles:
New Revenue Recognition Guidance for Financial Institutions
Accounting Changes Coming for Equity Securities
Understanding the New Lease Guidance