The long awaited credit loss standard that the Financial Accounting Standards Board released last week is expected to have a wide-ranging impact beyond only banks and financial services firms.

“It’s not just a banking issue, although that’s probably the party that’s going to be impacted the most just because of what’s on their balance sheet,” said Jonathan Howard, senior consultation partner for national office accounting services at Deloitte & Touche LLP. “This is loans, it’s receivables, it’s net investments and leases. It’s basically any financial asset that has contractual cash flows that are recognized at cost on your balance sheet.”

Jonathan Prejean, managing director at Deloitte Advisory, pointed out that captive finance companies, such as Ford Credit, GM Financial and Caterpillar’s Cat Financial unit, will also see an impact from the standard.

FASB and the International Accounting Standards Board have been working to develop a converged standard for financial instruments since the 2008 financial crisis, although they ended up with different approaches to accounting for credit losses and loan impairments (see FASB Releases New Financial Instruments Standard on Accounting for Credit Losses). FASB’s new standard uses a current expected credit loss, or CECL, model, as opposed to the old incurred loss model, while the IASB is using an expected credit loss model.

“Generally speaking when we’re recording losses on assets that aren’t recorded at fair value, we’ve got a couple of triggers,” said Howard. “It’s got to be probable that a loss has already been incurred, so it’s not very forward looking, and you’ve got to have a threshold where you’ve gotten to the point that someone is going to default imminently. Under the current rules, there were a couple of barriers to companies recording losses. Because of that and because of the credit crisis, there was a push for FASB to address that and think about whether the rules needed to be changed. CECL requires you to be more forward looking. What are the lifetime losses you expect to incur on these assets from the get go? That is forward looking and there’s no probability trigger. In theory there are going to be losses on day one when you become involved in assets.”

Another difference between the new credit loss standard and the old one is that it will use a pool concept instead of an individual assessment.

“When things don’t belong in the pool they’re in now, you need to move it to another one because its credit got worse or its credit got better,” said Howard. “You need to think about how to establish those pools, how to get the historical data so you can come up with a reasonable estimate of the losses for that pool on pool-basis data and have a process in place of making sure periodically that items belong in the pool that they’re in, and think about moving them. To the extent you have a lot of assets, it becomes more complicated.”

Smaller banks in particular will need to get up to speed quickly to deal with the new rules. “The larger banks that have been going through a number of stress-testing efforts, where they have to submit stress test results to various regulators, those banks have been involved in a number of modeling exercises, data-gathering exercises and data-cleansing exercises, all of which are going to be important for the standard,” said Prejean. “To the extent they’re able to leverage some of the work they’ve done, it will be incremental. I don’t want to say it will be easy, but they have something they have already started. The smaller banks will have to think about what they have in place, what data they have, what data they can access and how they’re going to do it. It might be a little tougher for them, but I think they can get it done, given the way the FASB has been approaching the standard.”

Plenty of businesses beyond the finance world will see an impact from the new standard. “Cash flow businesses that invest in debt securities are going to have to think about this, and if the debt securities are held to maturity, so they’re carried at amortized cost, they have to apply CECL,” said Howard. “If they’re available for sale, which means they’re marking them to market, but those changes in fair value generally go in Other Comprehensive Income, not through the P&L, well, CECL technically doesn’t apply to them. It is amending the guidance on how you consider credit losses available for securities too. Today you write it down based on the cash flows you don’t think you’re going to collect. You write it down based on the credit loss. You’re not allowed to write it back up because subsequently you think, oh, instead of 80 cents on the dollar, I think I’m going to get 85 cents on the dollar. It’s kind of a one-time writedown today. They’re making it more consistent with this allowance concept where you set up the allowance and if things get worse, increase the allowance that goes to your P&L, and if things are better, decrease the allowance that goes to your P&L. Granted those are minor changes, but they’re even making some minor changes to debt investments accounting. Think about companies that are cash rich and have asset portfolios. They’re going to have to think about this too, so it’s not even just lenders. It’s assets that have contractual cash flows behind them.”

Multinationals will see some special challenges because of the differences in the new standard under U.S. GAAP and International Financial Reporting Standards.

“That’s going to be difficult because there was a point in this process where the FASB and the IASB were working together and were trying to come up with a converged, consistent model,” said Howard. “They kind of broke apart during that process, so the IASB went forward with their model that’s in IFRS 9, which generally speaking when you start with an asset, you’re only looking at loss events over the next 12 months. You’re not doing lifetime losses from the get go. You’re really only looking at lifetime losses on things where you expect to have issues in the next 12 months. It’s only when things deteriorate with credit that now you use something consistent with what FASB has. They have a kind of bucketed approach. And FASB went on their own and said, ‘Nope, we prefer one measurement approach for all of them, lifetime losses.' So if you have multinationals where they prepare financials in U.S. GAAP here and maybe you have a registrant here in the U.S., and that flows up into a global entity that applies IFRS, or vice versa, you can’t just take the same systems and come up with the same numbers. You’re going to have reconciling differences. That is going to add a layer of complexity.”

Deloitte may face such challenges with some of its own multinational clients. “If you’re an SEC registrant, there are rules about reconciling and whether you have to reconcile from U.S. GAAP to IFRS,” said Howard. “If you’re a foreign private issuer, you may have to do some of that. As far as mandatory disclosures, there aren’t any currently in this ASU [accounting standards update] that say, hey, you need to disclose the difference between this and IFRS. I would say that probably will be more driven by what the users are asking for, whether this is formal disclosures or not. If analysts are asking for this stuff on earnings calls, are you going to have to start coming up with that data and disclosing it?”

Prejean advises companies and their accountants to get ready for the new standard while they still have time. “We do have a 2020 implementation date for public filers,” he said. “But they’re going to need to be ready well before that. They’re going to want to have parallel test runs of their new models to make sure the data is flowing correctly, to make sure the model is flowing correctly. Many are assuming they’re going to have questions from regulators with regards to what do we think the impact of CECL is going to be. That’s probably going to be coming sooner than say the third quarter of 2019, so you need to be thinking about that. The other thing I would just point out is that most of the talk has been focused around the models and the data to run the models, but there are other impacts of the standard that companies are going to think about. This is not an accounting-only exercise. They need to think about their planning because they’re going to be forecasting.”

The new standard will require educating a company’s planning and credit functions, along with the board and the investor relations department to be able to handle questions about the differences between the standards. The new standard could also have an impact on compensation. “It depends on that number, how your allowance is used, because it is going to be a significant change,” said Prejean.