FASB and IASB clarify expected credit loss estimate attributes

FASB and the International Accounting Standards Board (IASB) on Wednesday clarified the attributes of an expected credit loss estimate as part of an ongoing joint convergence project on accounting for financial instruments.

With the clarification, the boards addressed concerns about the use of the term “expected value,” according to a summary of board decisions posted on FASB’s website.

According to the clarification, an estimate of expected credit losses should reflect:

• All reasonable and supportable information considered relevant in making the forward-looking estimate.
• A range of possible outcomes and the likelihood and reasonableness of those outcomes. An estimate of the most likely outcome is not sufficient.
• The time value of money.

Information that is reasonably available without undue cost and effort should be considered in estimating expected credit losses, the boards clarified. They also clarified that the so-called “Bucket 1” measurement approach would be explained as “expected losses for those financial assets on which a loss event is expected in the next 12 months.”

In addition, in the Bucket 1 approach:

• Expected losses are all cash shortfalls expected over the lifetime (the full loss content) associated with the likelihood of a loss event in the next 12 months.
• A detailed estimate for periods far in the future is not required for estimating lifetime losses. The degree of detail necessary in forecasting loss estimates decreases as the forecast period increases.
• Various approaches can be used to estimate the expected losses, including approaches that do not include an explicit “12-month probability of a loss event” as an input.

The boards also tentatively agreed that an expected credit loss model should be applied to trade receivables that don’t have a significant financing component under the definitions in the boards’ Proposed Accounting Standards Update on revenue recognition. They also tentatively agreed that a provision matrix can be used as a practical expedient.

The accounting-for-financial-instruments effort is one of three remaining Memorandum of Understanding projects under which FASB and the IASB are attempting to reach convergence. Revenue recognition and leases are the others. The boards also have a joint project on insurance.

On Tuesday, the boards reached tentative decisions affecting the business model assessment for classifying financial assets, and bifurcation of financial assets and financial liabilities.

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.