CECL: The Fight Continues
FASB Chairman Russel Golden ran into a bipartisan buzz saw last month when he appeared before the House Financial Services subcommittee to answer lawmaker concerns over his board’s new credit loss rules known as the Current Expected Credit Loss (CECL).
The standard, published in mid-2016, became effective this year for large public companies. Smaller public companies and private companies have until 2023 to adopt the changes.
CECL replaces the GAAP impairment model known as Allowance for Loan and Lease Losses (ALLL) which was based on incurred losses, and where loans are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms.
Under the CECL standard, banks and other financial entities are required to forecast into the future to predict losses over the life of a loan.
Banks and banking industry trade groups have been fighting to stop or delay the standard which they argue will force them to needlessly hold more capital and pull back on lending in a crisis, when borrowers most need the funds. They also have complained that many in their industry lack the macroeconomic and financial forecasts, historical macro data and tools required to simulate the range of credit loss scenarios required by CECL. Additionally, they note that such forecasts of future macro conditions are notoriously unreliable.
At the hearing, Subcommittee Chairman, California Democrat Brad Sherman, a CPA by profession, reiterated his frequent criticisms of CECL questioning the FASB’s basis for defending the standard.
In answer to a question from the ranking member, Republican Bill Huizenga, whether “it would be prudent to impose a moratorium” on the implementation of CECL until Congress has a better understanding of the negative impacts on consumer credit and other areas, Golden rejected a delay stating that FASB believes CECL should be implemented, and that the standard will improve the information available to the capital markets.
Perhaps the most heated exchange came from Republican Blaine Luetkemeyer, who contended: not only has FASB not conducted a full cost-benefit analysis of the new standard, but community banks and credit unions would now have to struggle with the cost of implementation. Golden responded that the board had given small banks and credit unions an additional year to comply, during which time implementation could be monitored at the big public banks.
Although the focus has centered on how CECL affects banks and those in the financial services industry, the CECL also affects companies that hold financial instruments.
What Is Goodwill?
That was the first question the FASB asked last year when it solicited comments on potential changes to the process of calculating the value of “goodwill.”
It’s a growing question. Citing figures from data provider Calcbench, the Wall Street Journal reports that “the recent wave of deal making has created a pile of goodwill.” For all public companies trading on U.S. markets, goodwill exceeds $5.5 trillion. “S&P 500 companies had $3.5 trillion worth of goodwill on their books at the end of September — up 67% from 2013 which represented 9% of total S&P 500 assets and 42% of total equity.”
As a simple definition, goodwill is an intangible asset that most commonly occurs in an acquisition where an acquiring company purchases a target company for more than the target’s book value. That extra goodwill value is recorded on the acquiring company’s balance sheet as an intangible (non-current) asset.
Companies are required to evaluate the value of goodwill on their financial statements yearly and record any impairments.
The problem presents when an acquiring company that has overvalued goodwill must adjust down the goodwill value on their books. Recognizing such a goodwill impairment initiates a negative cascade: it decreases the goodwill account on the balance sheet, which results in a loss on the income statement, which reduces net income, which lowers the earnings per share, which may negatively affect the stock price. Even worse, if the acquiring company one day faces insolvency, all goodwill value disappears, leaving less residual equity for shareholders.
It is this risk to investors and shareholders — coupled with the compliance cost to companies — that has prompted the FASB to consider changing the way goodwill impairment is calculated.
Interestingly, the FASB is considering eliminating impairment tests and returning to an older calculation method known as “goodwill amortization.” Using this method, goodwill value was gradually and predictably reduced each year for up to 40 years. Goodwill was no longer amortized with the enactment of U.S. GAAP (FAS 141) issued in June 2001.
While many companies complain that the existing test method is costly and subjective, critics complain that the old amortization method would allow companies to mask problems and deprive investors of important information.
Another option that the FASB might consider involves combining an amortization approach along with a requirement for impairment testing during the first few years after an acquisition.
The FASB said it will discuss all comments later this year before moving forward.
Fixing Accounting Errors: Restatement or Revision?
The volume of financial statement restatements has plummeted over the past decade. This would be great news were it not tempered by data showing that companies have increasingly corrected accounting mistakes through revisions. Revisions offer an informal correction process that can “avoid the fanfare of a full restatement with the requisite press releases and SEC filings,” according to a Bloomberg story published in Audit Analytics.
Since 2014, “roughly three-fourths of all corrections were reported as a revision,” according to data compiled by Audit Analytics.
Industry leaders say that the “steady flow of revisions” is a sign that auditors are doing what they’re supposed to under the 2002 Sarbanes-Oxley Act, “catching mistakes before they balloon into market-moving problems”.
Others are not so sure. Michael Shaub, accounting professor at the Mays Business School at Texas A&M University, is among those who worry about the volume of revisions to correct misstatements. He questions whether auditors are being skeptical enough. “I’m concerned when you’re allowing clients to handle things through little Rs,” Shaub said of revisions. One study found that almost half of revisions had an arguably material impact on a company that may have warranted restatement.
Overall, restatements and revisions represent a tiny fraction of the total number of audited financial statements.
OTCQX Companies May Benefit from Proposed ESOP Fairness Act
New legislation has just been introduced in both the U.S. House of Representatives (H.R.5851) and the U.S. Senate (S.3270) that would make it easier for small businesses to offer employee stock ownership plans (ESOPs).
The legislation called the ESOP Fairness Act has bipartisan support. If enacted, it would amend the Internal Revenue Code of 1986 to allow certain qualified over-the-counter securities to be treated as readily traded on an established securities market for the purpose of diversification requirements for employee stock ownership plans.
ESOPs provide a streamlined pathway for employees to take an ownership interest in their companies. The ESOP Fairness Act would put hundreds of qualified U.S.-based companies and community banks on par with exchange listed companies, allowing them to fully access the benefits of public company ESOPs.
“ESOP reform remains an important area where legislators can effect positive change to improve public markets for small U.S. companies and make employee equity ownership more inclusive. Modernizing existing ESOP law to include an updated definition of an ‘established securities market’ will allow companies traded on the OTCQX Market to further invest in their long-term growth,” said Dan Zinn, General Counsel for OTC Market Group, a proponent of the legislation.
“When employees have a stake in the success of their workplace, everyone benefits. The ESOP Fairness Act will create opportunities for businesses and their employees alike to invest in each other’s success and growth, resulting in empowered workers, increased workplace longevity, and strong employee retirement benefits,” said Representative Brian Higgins, a sponsor of the House bill.
The legislation is particularly timely in the IT sector where thousands of Baby Boomer owners are mulling potential retirement, business transitions and exits, according to information technology and services provider ChannelE2E.
2020 State Business Tax Climate
How does your state rank when it comes to tax climate? The Tax Foundation’s State Business Tax Climate Index has the answer. The index offers a breakdown of the various taxes collected by each state, historical changes, as well as prospective changes some states are considering.
The Index is designed to show how well states structure their tax systems and provides a road map for improvement. All states are ranked. The top ten best and ten bottom worst states are highlighted. Click here: Index.
Money Can’t Buy Happiness?
It’s said that money can’t buy happiness. It may, however, provide the next best thing: financial satisfaction.
According to the AICPA’s Q4 2019 Personal Financial Satisfaction Index, Personal Financial Satisfaction hit an all-time high in the fourth quarter of 2019. It was an increase from the previous quarter and up significantly from its record lows a decade ago. Major factors attributable to the rise included “a surging stock market.” At the same time, the Pain Index fell, due mainly to declines in underemployment.
If You Can’t Buy Happiness, Maybe You Can Finance It
For the 22nd straight quarter Americans increased their borrowing, reaching an all-time high exceeding $14 Trillion for the first time, according to the Federal Reserve Bank of New York, reports Bloomberg.
- Total U.S. household debt rose by $601 billion in the fourth quarter from a year earlier, or 1.4%, surpassing $14 trillion for the first time.
- Overall household debt is now 26.8% above the second-quarter 2013 trough.
- Total debt for people ages 18 to 29 rose to a record $1.04 trillion.
- Student debt increased to $1.51 trillion from $1.46 trillion at the end of 2018.
- More than $100 billion in student debt is held by those age 60 and over.
- Credit card debt rose to a record $930 billion.
- Credit card delinquencies rose to 8.36% an 18-month high.
- Auto loans rose to $1.33 trillion.
- Almost 5% of auto loans are 90 days or more delinquent — the highest percentage since the third quarter of 2011.
Election year politics
“Those that travel the high road of humility in Washington D.C. are not bothered by heavy traffic.”
Former U.S. Senator – Alan Simpson
“Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies.”
Comedian – Groucho Marx
“Politics is show business for ugly people.”
Political consultant – Bill Miller.
“It’s not the people who vote that counts, it’s the people who count the votes.”
Former Premier of the Soviet Union – Joseph Stalin