FASB Issues Q&A on Estimating Credit Loss Reserves
FASB issued a question-and-answer (Q&A) document that addresses particular issues related to the weighted average remaining maturity (WARM) method for estimating the allowance for credit losses. The estimation of the allowance for credit losses is required in the Accounting Standards Update No. 2016-13 titled "Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments."
In the Q&A document, FASB staff agrees that the WARM method is one of many methods that could be used to estimate an allowance for credit losses for less complex financial asset pools. The staff also provides examples of how it could be used. The WARM method uses an average annual charge-off rate. Like other loss rate methods that can be used to estimate expected credit losses, consideration of reasonable and supportable forecasts when applying the WARM method can be accomplished in other ways, as illustrated later in this Q&A (See Question #5).
The credit losses standard issued in 2016 requires organizations to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts with the objective of presenting an entity’s estimate of the net amount expected to be collected on the financial assets. The standard does not require a specific credit loss method; however, it allows organizations to use judgment in determining the relevant information and estimation methods that are appropriate in their circumstances. Some stakeholders, including small financial institutions, asked the staff whether it would be acceptable to use the WARM method to estimate expected credit losses. The WARM method uses an average annual charge-off rate as a foundation for estimating the credit losses for the remaining balances (that is, losses occurring through the end of the contractual term) of financial assets in a pool at the balance sheet date.
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Keywords: Americas, US, Banking, Accounting, IFRS 9, Credit Losses Standard, Q&A, WARM Method, FASB
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