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May 14, 2018 Article 1 min read
With the new CECL accounting standard approaching, institutions are re-evaluating their methodologies. The more complex choice isn’t always better. Are you selecting the right methodology for your institution?

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With the adoption of the new Financial Instruments — Credit Losses (CECL) accounting standard approaching, many institutions may be selecting methodologies that are unnecessarily complex and, in turn, increasing their risk of error.

There are a handful of methods available that range in complexity — but since the Regulatory Chief Accountants have been indicating an institution that uses Microsoft Excel today can use Microsoft Excel with CECL, it makes sense to apply a less complex methodology. For example, if your institution is currently using a loss rate methodology, by looking back three to five years and calculating an average annual loss rate with additional adjustments for qualitative factors, you can continue to use this method with a few easy-to-add “twists.”

There are lots of traps out there — so select your methodology carefully because your decision can increase your risk and impact long-term consequences.

Ultimately, our advice is to select your methodology carefully as added complexity inherently leads to an increase in potential error. For example, many of the methods for calculating CECL require an accurate determination of when a renewal qualifies as a “new” loan in accordance with the accounting rules. The main trick with this determination is the requirement to consistently identify if the renewed loan has a more than minor difference than the original loan. Furthermore, in assessing the more than minor difference, the accounting standard references a cash flow test of a 10 percent change in expected cash flows — a threshold that’s seemingly tough to meet unless new money is extended. While all public business entities will need to ensure “new” loan determinations are correct for the new vintage disclosures, institutions that aren’t public business entities may be selecting a method that’s unnecessarily adding complexity and risk of error.

There are lots of traps out there — so select your methodology carefully. And remember, you’re more likely to make errors when you’re rushed. Therefore, if you lack comfort with the accuracy and completeness of the data required, start with a less complex methodology with a plan to transition when you’re further down the road.

For additional perspective on the right methodology for your institution or additional information on CECL, give us a call.