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In this edition of our quarterly accounting and reporting update, we have highlighted the regulatory focus on third-party risk management and common CECL findings identified during model validations and audit procedures.
In addition to the items above, we have provided information about financial reporting and accounting issues – some of which are currently being evaluated by regulatory agencies and not resolved at this time. We have also compiled a list of items for consideration in your financial reporting and disclosures for the second quarter and a summary of recently issued accounting pronouncements (see Appendices for summary of recently issued accounting pronouncements and the related effective dates).
This quarterly update is organized as follows:
CECL Model Validations and Internal Audits
Alek Bevensee, Senior Manager, Alek.Bevenesee@elliottdavis.com
As institutions across the country continue to adjust their current expected credit loss (CECL) models, many are experiencing similar pain points and validation/audit findings. In this article, we discuss common CECL findings that apply to institutions of all shapes and sizes.
Model Construct Findings
Of the findings discussed in this article, these are the most materially impactful. While these findings occur less frequently, institutions should be cognizant of the risks and ensure processes and controls are in place to limit their exposure to issues of model construct.
Qualitative Factors
By far, the most frequent CECL findings we see relate to the anchoring of qualitative factors. Where possible, qualitative factors should be tied to quantifiable data points as changes in those data points directly impact the qualitative adjustment being applied within the model. Additionally, management should establish a scale that stipulates that a change of X% in the underlying data point results in a Y% change in qualitative factor. The level of mathematical complexity required in establishing these scales and the correlation to the qualitative factor adjustment may vary depending on the institution’s risk tolerance, availability of historical data points, the qualitative factor in question and the institution’s size and complexity.
Often, management teams review a wide array of external information relating to one of their qualitative factors, then subjectively determine the risk level (minor, moderate, major, etc.). Where many institutions fall short is in their support of the relationship between the underlying data points and the qualitative factor being applied. Developing an objective scale to connect the changes in data points to the change in qualitative factor adjustment ensures that there will be consistency in how the underlying data points impact the outcome of the qualitative model.
Each institution will have unique perspectives as to which qualitative factors are applicable and which external data points are most relevant to influencing each qualitative factor. Additionally, the relationships between the external data points and qualitative adjustments will vary by institution. Should you have concerns regarding how to identify relevant external data points or how to anchor your qualitative factors to those data points, consult with your model provider, independent model validator, or members of your peer group.
Data Integrity
Data integrity issues occur frequently but vary in nature. One of the most common data-related issues that we see is the completeness and accuracy of historical loan and net charge off information. These issues result in a mismatch between the numerator (historical losses) and denominator (loan balance) when calculating historical loss rates and can cause certain segments’ loss rates to be artificially inflated while others are artificially deflated. These types of issues most frequently stem from the institution’s most ‘unique’ credits. To avoid this issue, we recommend performing segment-level reconciliations to ensure loans and their related losses are properly classified over the entire lookback period. Additionally, we recommend tracing the institution’s unique credits (balances and losses) through time to further ensure proper treatment within the model over the loan’s entire life.
Other common data integrity issues relate to models’ interpretation of loan information fields. The fields with the most common issues include maturity date, modification/renewal date, payment amount, loan mapping code (call, purpose, collateral, etc.) and available credit/total commitment. We recommend for each import file, management tie out a sample of data points between the original import model and what is reflected in the model.
As a general rule, the more import files, the higher the probability of experiencing data integrity issues. Where possible, verify all import files contain the same information fields and are complete and accurate. For example, if you are running a discounted cash flow model and one of seven loan import files does not contain payment amount, the model will have to apply a broad overriding assumption or will produce inaccurate outputs.
Model Documentation Findings
Unfunded Commitments
With the implementation of CECL, many institutions developed new processes for calculating a reserve for unfunded commitments. While specific verbiage and process to derive individual components may vary by institution, the calculation is generally:
[Non-Unconditionally Cancellable Credit Available] X [Funding/Utilization Rate] X [Expected Loss Rate] = [Reserve]
The most challenging of these variables tends to be the utilization rate assumption. We have seen institutions apply broad assumptions (example: 50%) across all segments with little to no mathematical support. We have also seen institutions with models reflecting a 0% funding rate for segments that would inherently have unfunded commitments, such as HELOCs or Construction. If your institution does not have the historical data points to calculate accurate funding rates, we recommend identifying external or peer data points that can be used as a proxy for your institution. Such data points can be found through online funding studies or through your model provider. If your institution has a mix of segments that have calculated funding rates and others that do not, we recommend identifying the segment that is most similar to the segment without a calculated rate and using it as a proxy/override, or as described above, identify external or peer data that can be used in lieu of bank specific information.
Policy Documentation
While policy documents should be developed to reflect the specifics of an institution’s model process, management should consider the following items when designing their policy:
Internal Controls
Similar to the policy discussion above, the institution should identify internal controls to fit the risks related to the CECL model and processes. Consider the following items when developing internal control:
Be sure to think about the level of precision within the controls to ensure controls are designed and implemented effectively. CECL models are inherently complex and there are many steps involved in updating them each quarter. Therefore, there are countless opportunities for system, mathematical, and human errors. Being aware of common pitfalls and developing a strong internal control framework are the best defenses against model errors and material misstatements.
Third-Party Relationship Risk Management
Bob Balzano, Senior Manager, Bob.Balzano@elliottdavis.com
SUMMARY
On June 6, 2023, the federal banking agencies, including the Board of Governors of the Federal Reserve System (Federal Reserve), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC) released final interagency guidance covering risk management of third-party relationships. The interagency guidance replaces each of the federal banking agencies’ existing guidance on this subject, and it responds to the continued and growing prevalence of relationships between banking organizations and third parties, including both traditional service providers and fintechs. The interagency guidance provides a framework to be used in all phases of the risk management life cycle of third-party relationships. Similar to existing OCC guidance, the phases of the third-party risk relationship cycle are: planning, due diligence and third-party selection, contract negotiation, ongoing monitoring, and termination. In addition, the same three governance principles discussed within existing OCC guidance are incorporated into the interagency guidance, which includes: oversight and accountability, documentation and reporting, and independent review.
PLANNING
Prior to partnering with third parties, banking organizations should consider whether the organization’s strategic goals, objectives, and risk appetite align with a given third party’s offered products and services. The risks involved and level of reliance on the third-party relationship should dictate the level and detail of planning activities performed, and involvement of senior management and the board of directors (or designated committee). Common considerations would include: the criticality of the third party’s services as it relates to ongoing operations, impact to existing processes and systems, degree of customer-facing activities, handling of confidential customer information, compliance with relevant laws and regulations, among others.
DUE DILIGENCE AND THIRD PARTY SELECTION
Similar to planning activities, the degree of due diligence performed prior to entering into a contract with a third party should be commensurate with the level of risk and complexity of the third-party relationship. To that end, more extensive due diligence may be necessary when the third-party relationship is higher risk or involves critical activities.
The due diligence process should unveil whether a third-party relationship is likely to post significant new risks to the banking organization and how said risks may be mitigated. Due diligence activities can be time consuming and costly for banking organizations. As such, banking organizations may desire to outsource due diligence procedures and/or collaborate with other banking organizations, among other options to alleviate constraints on internal resources. However, itis critical to understand that banking organizations, particularly the board of directors and senior management, are not absolved of their responsibility to make decisions on behalf of the banking organization or for ensuring effective risk management processes are in place.
CONTRACT NEGOTIATION
Banking organizations should ensure contracts with third parties clearly define the rights and responsibilities of all parties involved. In the event third parties prohibit or restrict changes to a standard contract, banking organizations should gain an understanding of the resulting implications. Alternative service providers may need to be considered if risks to the banking organization cannot be mitigated or if the banking organization’s needs will not be met. Senior management should involve the Board of Directors (or committee thereof) and/or legal counsel during contract negotiations, depending upon the circumstances.
ONGOING MONITORING
As with performing initial due diligence over a third-party relationship, the extent of ongoing monitoring performed should be commensurate with the level of risk and complexity of the third-party relationship. Throughout the life of the third-party relationship, banking organizations should evaluate the overall relationship effectiveness, degree and type of risks involved, and significant changes that may have occurred within the third party. Examples of significant changes could include material audit findings, deterioration in financial condition, security breaches, data loss, service or system interruptions, or compliance lapses. Qualified and sufficient staffing should be tasked with performing ongoing monitoring of third-party relationships. Significant issues should be escalated to senior management, or, if warranted, the board of directors or committee thereof. Banking organizations should also conduct regular testing of internal controls over their third-party risk management activities.
TERMINATION
Banking organizations should consider prior to contract termination the risks associated with transitioning service providers, impact to operations, retention and destruction of sensitive or confidential information, among others.
SUPERVISORY REVIEWS OF THIRD-PARTY RELATIONSHIPS
Considering the finalized interagency guidance, it appears likely that examiners will increase their focus on reviewing third-party risk management. Furthermore, examiners may use their authority to subject a banking organization’s third parties to examination, if warranted. All applicable laws and regulations remain the responsibility of the banking organization, such as those related to consumer protection, BSA/AML, OFAC, and others. Management teams should compare the current third-party risk management practices in place at their organization to the finalized interagency guidance in order to identify potential gaps or changes that may be necessary.
INTERNAL CONTROL CONSIDERATIONS
Third-party risk management is not just a regulatory concern but also impacts an entity’s internal controls over financial reporting. All five of the internal control components within the Committee of Sponsoring Organizations (COSO) framework may be impacted by the use of a third-party. For example, within the risk assessment internal control component, entities specify their objectives as well as identify and analyze risks. Many of the same principles in the COSO framework are applied throughout the third-party risk management life cycle. Aside from entity-level internal controls, banking organizations may have more specific key controls in place to address risks to financial reporting, such as:
The following section includes Accounting Standards Updates (ASUs) that were issued or proposed by the Financial Accounting Standards Board (FASB) during the second quarter and other FASB related topics. A complete list of all ASUs issued or effective in 2023 is included in Appendix A.
FASB Improves the Accounting for Investments in Tax Credit Structures
In March, the FASB issued a narrow accounting standard that enables tax credit programs beyond low-income housing tax credit (LIHTC) investments to qualify for using the proportional amortization method, a simple model that allows the initial cost of the investment to be spread out in proportion to the tax credits and other tax benefits allocated to an investor. Prior to the change, the proportional method was limited to LIHTC investments. Investments in other tax credit structures had to use the equity method, which was complex and did not fairly represent the economic characteristics or profitability of such investments. Specifically, the LIHTC program is designed to encourage investment of private capital for use in the construction and rehabilitation of low-income housing projects, but other federal tax credit programs have similar objectives including: New Markets Tax Credit (NMTC), which is intended to attract financing for the development of projects that will bring economic expansion to specifically designated areas; Historic Rehabilitation Tax Credit (HTC), which aims to encourage the restoration of designated historic sites; and Renewable Energy Tax Credit (RETC), which award either production-based or investment-based tax credits from the creation of energy through renewable projects.
The new guidance, ASU 2023-02, Investments—Equity Method and Joint Ventures (Topic 323), Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method (a consensus of the Emerging Issues Task Force), is intended to provide investors and other allocators of capital with a better understanding of the returns from investments that are made primarily for the purpose of receiving income tax credits and other income tax benefits.
The ASU also requires specific disclosures for all investments that generate income tax credits and other income tax benefits from a tax credit program for which the entity has elected to apply the proportional amortization method (including investments within that elected program that do not meet the conditions to apply the proportional amortization method). Businesses must also disclose information in annual and interim reporting periods that enable investors to understand the following information about its investments that generate income tax credits and other income tax benefits from a tax credit program:
The new provisions come at a time when more entities that are starting to make tax equity investments to meet environmental, social and governance (ESG)-related objectives and for certain regulated entities to meet their Community Reinvestment Act goals.
Effective Dates
The amendments in ASU 2023-02 are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years for public companies. For all other entities, it is effective for fiscal years beginning after December 15, 2024, including interim periods within those fiscal years. Early adoption is permitted. The guidance must be applied either on a modified retrospective or a retrospective basis except for LIHTC investments not accounted for using the proportional amortization method.
FASB Proposes Update to Purchased Financial Assets Accounting Under CECL
On June 27, 2023, the FASB issued a proposed ASU to change the accounting treatment of acquired financial assets that are within the scope of ASC 326 (or CECL). The proposal impacts financial institutions that have acquired other institutions or are planning for future deals. The proposal will eliminate the differences in accounting treatment for purchased credit deteriorated (PCD) assets and non-PCD asset. Instead, all financial assets acquired in a business combination would be classified as purchased financial assets (PFA) and accounted for in the same way. The amendments in the proposed ASU will address the comparability and complexity concerns expressed by stakeholders by eliminating the credit deterioration criterion that currently limits the use of the gross-up approach to PCD assets. The goal is to eliminate the “double count” issue that currently exists for non-PCD assets under CECL by allowing institutions to reclassify non-PCD related Day 1 discount into the Day 2 allowance (which is the current treatment for PCD assets). Comments on the proposal are due by August 28, 2023.
Proposed ASU Related to Profits Interests Awards
In May 2023, the FASB issued a proposed ASU that is intended to improve generally accepted accounting principles by adding illustrative guidance to help entities determine whether profits interest and similar awards should be accounted for as a share-based payment arrangement within the scope of ASC 718, Compensation—Stock Compensation.
Certain entities, typically private companies, provide employees and other service providers with profits interest and similar awards to align compensation with the company’s operating performance and provide those holders with the opportunity to participate in future profits and/or equity appreciation of the company. The Private Company Council (PCC) and other stakeholders have highlighted existing diversity in practice in accounting for these awards as a share-based payment arrangement under ASC 718 or similar to a cash bonus or profit-sharing arrangement (ASC 710, Compensation—General, or other Topics). As certain public business entities also may be required to account for profits interest awards, the PCC recommended that the Board add a project that would provide illustrative guidance for all reporting entities that account for profits interest and similar awards.
Proposed ASU on Accounting for Crypto Assets
In March 2023, the FASB published a proposed ASU intended to improve the accounting for and disclosure of certain crypto assets. During the FASB’s recent agenda consultation process, stakeholders from all professional backgrounds identified digital assets as a top priority area for the Board to address. The FASB heard feedback that the accounting for crypto assets as indefinite-lived intangible assets, which is a cost-less-impairment model, does not provide investors with decision-useful information or reflect the underlying economics of those assets.
The amendments in this proposed ASU would improve the accounting for certain crypto assets by requiring an entity to measure those crypto assets at fair value each reporting period with changes in fair value recognized in net income. The proposed amendments also would improve the information provided to investors about an entity’s crypto asset holdings by requiring disclosure about significant holdings, restrictions, and changes in those holdings.
The amendments in this proposed ASU would apply to all entities holding crypto assets that meet all the following criteria:
FASB to Decide Late July Whether to Develop Suite of Accounting Rules on Government Grants
The FASB has tentatively scheduled a meeting for late July to determine whether to develop a suite of accounting rules on government grants for business entities. The topic surfaced during the board’s agenda consultation process a year ago after businesses received massive amounts of COVID-19-related government assistance. Currently, no explicit guidance exists under U.S. GAAP for government assistance received by companies, and thus diversity in practice has developed, making it difficult for users of financial statements to compare reports when making investment decisions. Some companies, for example, apply contributions guidance under Accounting Standards Codification (ASC) 958-605, Not-for-Profit Entities—Revenue Recognition, while others apply either International Accounting Standard (IAS) 20, Accounting for and Disclosure of Government Assistance, ASC 470, Debt, or ASC 450, Contingencies.
Last year, FASB staff issued an Invitation-to-Comment (ITC), Accounting for Government Grants by Business Entities: Potential Incorporation of IAS 20, Accounting for Government Grants and Disclosure of Government Assistance, into Generally Accepted Accounting Principles, to solicit public comment about whether or not it is feasible to use IAS 20 as a basis for developing guidance in GAAP on recognition, measurement and presentation with whatever modifications and additional guidance that may be appropriate. The IASB developed IAS 20 in 2001. The standard defines a government grant as a transfer of resources in return for past or future compliance with certain conditions relating to the operating activities of a company. It gives companies an option to measure non-monetary government grants either at fair value or at nominal value.
Also last year, the FASB added a research project after hearing during the board’s agenda consultation that accounting for government grants was a fairly high priority for many of the board’s stakeholders. The research agenda is a pre-step to determine whether a topic meets the board’s bar for setting standards. Not all topics on the research agenda make it to the technical rulemaking agenda.
FASB to Decide Late July Whether to Develop Suite of Accounting Rules on Government Grants
The FASB has tentatively scheduled a meeting for late July to determine whether to develop a suite of accounting rules on government grants for business entities. The topic surfaced during the board’s agenda consultation process a year ago after businesses received massive amounts of COVID-19-related government assistance. Currently, no explicit guidance exists under U.S. GAAP for government assistance received by companies, and thus diversity in practice has developed, making it difficult for users of financial statements to compare reports when making investment decisions. Some companies, for example, apply contributions guidance under Accounting Standards Codification (ASC) 958-605, Not-for-Profit Entities—Revenue Recognition, while others apply either International Accounting Standard (IAS) 20, Accounting for and Disclosure of Government Assistance, ASC 470, Debt, or ASC 450, Contingencies.
Last year, FASB staff issued an Invitation-to-Comment (ITC), Accounting for Government Grants by Business Entities: Potential Incorporation of IAS 20, Accounting for Government Grants and Disclosure of Government Assistance, into Generally Accepted Accounting Principles, to solicit public comment about whether or not it is feasible to use IAS 20 as a basis for developing guidance in GAAP on recognition, measurement and presentation with whatever modifications and additional guidance that may be appropriate. The IASB developed IAS 20 in 2001. The standard defines a government grant as a transfer of resources in return for past or future compliance with certain conditions relating to the operating activities of a company. It gives companies an option to measure non-monetary government grants either at fair value or at nominal value.
Also last year, the FASB added a research project after hearing during the board’s agenda consultation that accounting for government grants was a fairly high priority for many of the board’s stakeholders. The research agenda is a pre-step to determine whether a topic meets the board’s bar for setting standards. Not all topics on the research agenda make it to the technical rulemaking agenda.
FASB Won’t Tackle ESG Issues Beyond Targeted Accounting Issues
On June 1, 2023, FASB Chair Richard Jones reiterated to a conference that the board will not dive into environmental, social, and governance (ESG) reporting except in targeted accounting areas that clearly need to be addressed. He also provided insights about the board’s current ESG projects—both of which have not been discussed by the board to date this year.
Last year, the FASB added narrow ESG projects to its technical and research agenda but has not discussed them yet this year. The board will continue to stay the course of its mission on financial accounting and reporting but has also seen that there are some transactions and trends that appear that would benefit from the board looking at the accounting, Jones told the SEC and Financial Reporting Institute Conference. Currently, the board has a project on its technical agenda related to ESG-related credits and environmental credits and is researching whether to add another project related to ESG-linked instruments that meet the definition of a derivative. The issue on ESG credits and environmental credits met the FASB’s agenda criteria as it deals with both compliance and voluntary programs. On the research project, the board heard about the emergence of all ESG-linked financial instruments, i.e., borrowings that may lead a company to finance restraints depending on whether or not it is on environmental emissions.
FASB Publishes Conceptual Framework Chapter to Describe the Concept of a Reporting Entity
In June 2023, the FASB published a new chapter on the reporting entity in its Conceptual Framework, which aligns with the premise that the objective of general-purpose financial reporting is to provide financial information that is useful to existing and potential investors, lenders and others in making decisions about allocating capital. The guidance was issued as Statement of Financial Accounting Concepts (CON) 8, Conceptual Framework for Financial Reporting Chapter 2, The Reporting Entity, to introduce a description of a reporting entity in the framework focused on the notion of a circumscribed area of economic activities. Previously a reporting entity was not defined in the framework, which reduced its cohesiveness and effectiveness as a standard-setting tool.
The new chapter describes a reporting entity as “a circumscribed area of economic activities that can be represented by general purpose financial reports that are useful to existing and potential investors, lenders, and other resource providers in making decisions about providing resources to the entity.” Features of a reporting entity are that “economic activities have been conducted,” those “economic activities can be distinguished from those of other entities,” and the financial information in general purpose financial reporting “faithfully represents the economic activities conducted within the circumscribed area and is useful in making decisions about providing resources to the reporting entity.”
Chapter 2 also addresses how the board will approach 1) consolidated financial statements, including in parent-subsidiary relationships; 2) parent-only financial statements; 3) a portion of a larger entity, such as a subsidiary, branch, or division; and 4) combined financial statements, i.e. two or more entities that are under common control or common management, including circumstances in which a parent-subsidiary relationship does not exist.
The conceptual framework is a document of Chapters 1-8, which provide the foundational concepts that the FASB uses to determine the way items like assets, liabilities, revenues, and expenses get recorded in financial statements—and how. It is used by the board as a foundation to build accounting standards and related disclosures so that they are cohesive and comprehensive. The framework itself is not GAAP.
In 2021, the FASB added two chapters: Chapter 4, Elements of Financial Statements, and Chapter 7, Presentation. With the issuance of Chapter 2, only two more chapters are left for the framework to be complete – and the board is near doing so. In May, the board voted to finalize a proposed Chapter 5: Recognition and Derecognition, and also started discussions toward developing a proposal on Chapter 6, Measurement.
FASB Studying Whether to Revise the Statement of Cash Flows
The FASB plans to decide in the future whether to revise the statement of cash flows. The board has been researching two parallel paths related to that issue. The FASB has consistently heard from some investors in the past that they appreciate the information they typically get from entities that use the indirect method, while other investors have wanted the board to get rid of that method and adopt the direct method.
Last year, the board discussed staff research to improve ASC 230, Statement of Cash Flows; disaggregation of certain cash flow line items (specifically working capital and amortization/depreciation); and developing certain supplementary direct cash flow method disclosures. No decisions were made.
CFPB Finalizes Small Business Lending Data Collection Rule
On March 30, 2023, the CFPB published its final rule implementing Section 1071 of the Dodd-Frank Act. The rule will require financial institutions to collect and report data (such as loan recipient’s race, ethnicity, gender, geographic information and credit pricing) for their small business lending activities. The purpose of the rule is to facilitate fair lending laws with respect to women-owned, minority-owned and small business. Small businesses is defined as an entity with gross revenue under $5 million in its last fiscal year.
The rule is effective 90 days after its publication in the Federal Register, with tiered compliance as follows:
The CFPB concurrently issued policy guidance addressing enforcement and supervisory practices relating to the final rule and focus on ensuring institutions comply with the rule’s prohibition on discouraging small business applicants from providing responsive data. The CFPB intends to pay particular attention to financial institutions’ response rates for data requested from applicants compared the response rates of institutions of a similar size, type, and geographic reach.
On May 12, 2023, the CFPB release the small entity compliance guide for the small business lending rule. The guide includes sample forms and resources for filers.
OCC Establishes Office of Financial Technology
On March 30, 2023, the OCC announced the establishment of the Office of Financial Technology and appointed Prashant Bhardwaj to lead the office as Deputy Comptroller and Chief Financial Technology Officer, effective April 10, 2023. The Office of Financial Technology is an expansion of the OCC’s Office of Innovation with the purpose to strengthen the agency’s expertise and ability to adopt to the rapid pace of technological changes in the banking industry. The Office of Financial Technology will “enhance the OCC’s expertise on matters regarding digital assets, fintech partnerships, and other changing technologies and business models within and that affect OCC-supervised banks.”
OCC Issues Semiannual Interest Rate Risk Report
The OCC released its spring 2023 edition of the Interest Rate Statistics Report on April 12, 2023. The report includes interest rate risk (IRR) data gathered during examinations of OCC-supervised midsize and community banks and federal savings associations. IRR data, including exposures, risk limits, and non-maturity deposit assumptions, is compiled into statistics for different populations of banks to establish the range of exposures and risk across mid-size and community banks.
PCAOB Releases Staff Priorities for 2023 Inspections
The PCAOB released a new PCAOB staff report, Spotlight: Staff Priorities for 2023 Inspections, on April 17, 2023. Erica Y. Williams, PCAOB Chair, noted the increase in deficiencies in 2021 inspection reports and the increase in comment forms in 2022 inspections “revealed a troubling trend in audit quality, which we are tackling head-on in 2023.” The 2023 inspection plan takes into account the business risks that were important for auditors to consider when planning and performing audit procedures. The complete list of inspection priorities for 2023 includes:
PCAOB Staff Issues Spotlight on Professional Competency and Skepticism
On April 25, 2023, the PCAOB issued Spotlight: Professional Competence and Skepticism are Essential to Quality Audits. The guidance reminds auditors of the importance of performing work with due professional care and professional skepticism especially in circumstances where changes in economic conditions or other factors affect the company. The publication highlights five areas or aspects of an audit: client acceptance or continuance; audit planning; identifying and assessing risks of material misstatement; performing work with due professional care; and evaluating the results of the audit.
OCC, FDIC Issue Guidance on Overdraft Protection Programs
On April 26, 2023, the OCC and FDIC separately released, respectively, a bulletin and a financial institution letter addressing consumer compliance risks associated with bank overdraft programs. The guidance focuses on certain practices that may result in increased risk exposure related to assessing overdraft fees on a transaction that was authorized against a positive balance but settled against a negative balance, often referred to as “authorize positive settle negative” (APSN). Both agencies noted that charging APSN fees presents a heightened risk of violating prohibitions on unfair or misleading acts or practices under the Federal Trade Commission Act and Consumer Financial Protection Act of 2010. The OCC’s bulletin includes practices that may help banks for managing overdraft protection program risks. The FDIC financial institution letter acknowledges third parties often play a significant role in overdraft programs. The FDIC emphasizes the importance that institutions ensure overdraft programs provided by third parties are compliant with all applicable laws and regulations.
FDIC Releases Report Detailing Supervision of Recent Bank Failures
On April 28, 2023, the Board of Governors of the Federal Reserve and the FDIC each released reports which evaluated the respective agency’s supervision history and analysis of the underlying causes of the two March 2023 bank failures.
The Federal Reserve’s report focuses on the March 10, 2023, failure of Silicon Valley Bank (SVB) and the related shortcomings, both in its own supervision and of bank management. The Federal Reserve’s Vice Chair of Supervision stated “SVB failed because of a textbook case of mismanagement by the bank. Its senior leadership failed to manage basic interest rate and liquidity risk. Its board of directors failed to oversee senior leadership and hold them accountable. And Federal Reserve supervisors failed to take forceful enough action, as detailed in the report.” The Federal Reserve’s report also points out how supervisors at the Federal Reserve did not fully understand the extent of SVB’s vulnerabilities as it grew in complexity and size.
The FDIC’s report analyzes the March 12, 2023, failure of Signature Bank of New York (Signature Bank). Simliar to the Federal Reserve’s report on SVB, the FDIC report notes “the root cause of Signature Bank’s failure was poor management. Signature Bank’s board of directors and management pursued rapid, unrestrained growth without developing and maintaining adequate risk management practices and controls appropriate for the size, complexity and risk profile of the institution.” The FDIC report highlights the fact the FDIC could have escalated supervisory actions sooner and examination work products could have been timelier and communication with Signature Bank’s board and management could have been more effective. The FDIC also points its own difficulties in having adequate headcount and expertise in the supervision and examination teams indicating resource challenges, with vacancies on the examination team and the adequacy of skill sets of the supervisory team.
FDIC Issues Report on Options for Deposit Insurance Reform
On May 1, 2023, the FDIC published the Options for Deposit Insurance Reform report which was prompted by the March 2023 bank failures. The report outlines three potential options for reforms in the nation’s deposit insurance system:
The report includes advantages and disadvantages of each option, along with policy tools that may be used to mitigate unintended consequences created by deposit insurance.
PCAOB Enhances Transparency of Inspection Reports
On May 2, 2023, the PCAOB announced it has enhanced its inspection reports with a new section on auditor independence and made improvements to increase the reports’ transparency. The enhancements to the report include more information related to fraud procedures and the identification of the risks of material misstatements. In addition, reports will provide more commentary in Part I.A for certain situations (such as first year audits of the issuer and whether the firm identified significant risks for areas in which PCAOB inspection staff reported deficiencies). The new reports will also include graphs for annually inspected firms to show firm and engagement partner tenure. The changes will appear in PCAOB inspections reports effective immediately.
FDIC Proposes Special Assessment to Replenish Deposit Insurance Fund
On May 11, 2023, the FDIC issued a proposed rule that would impose special assessments to recover the loss to the Deposit Insurance Fund (DIF or Fund) arising from the March 2023 closure of Silicon Valley Bank and Signature Bank. The FDIC estimates the total cost to protect the uninsured depositors of the Silicon Valley Bank and Signature Bank failures was $15.8 billion. In order to cover this cost, the FDIC will apply a “special assessment” fee of 0.125% to uninsured deposits of lenders in excess of $5 billion, based on the amount of uninsured deposits a bank held as of December 31, 2022. Institutions with uninsured deposits below $5 billion will pay nothing under the proposal, and those with uninsured deposits in excess of $5 billion will be assessed on their uninsured deposits above that threshold. The FDIC is proposing an effective date of January 1, 2024, with special assessments collected beginning with the first quarterly assessment period of 2024 (i.e., January 1 through March 31, 2024, with an invoice payment date of June 28, 2024).
FDIC Releases 2023 First Quarter Banking Profile
The FDIC issued its Quarterly Banking Profile: First Quarter 2023 which provides a comprehensive summary of financial results for FDIC-insured institutions. The reporting, which includes financial data from 4,672 commercial banks and savings institutions, highlighted net income increased 16.9% from fourth quarter 2022. FDIC Chairman Martin Gruenberg commented on the first quarter results which included a caution related to the impact of the March 2023 bank failures nothing although “the banking industry has proved resilient” and “asset quality metrics remained favorable and the industry remains well capitalized,” the first quarter results “do not fully reflect the stress that began in early March.” Other analysis highlights include the net interest margin declined by 7 basis points to 3.31%; unrealized losses on securities still remain elevated but declined for the second consecutive quarter, total deposits declined by 2.5% from prior quarter, and community bank net income decreased by 4.5% from fourth quarter 2022.
OCC Issues Semiannual Risk Perspective
The OCC released its Spring 2023 Semiannual Risk Perspective which addresses key issues facing banks, focusing on those that pose threats to the safety and soundness of banks and compliance with applicable laws and regulations. The OCC reports banks’ financial condition is strong in spite of the increased volatility due to a liquidity crisis in the first quarter 2023. The OCC has engaged with its banks to ensure they are appropriately managing their risks in response to the recent market stress during spring 2023. The risk perspective presents data in four main areas: the operating environment, bank performance, trends in key risks, and supervisory action. Highlights from the report include:
The Fed Reports: Financial Stability Report and Supervision and Regulation Report
The Federal Reserve Board issued its Financial Stability Report – May 2023 which includes its current assessment of the stability of the U.S. financial system with the goes to promote public understanding by increasing transparency around, and creating accountability for, the Federal Reserve's views on this topic. In addition, the Federal Reserve published a semiannual Supervision and Regulation report to inform the public and provide transparency about its supervisory and regulatory policies and actions as well as current banking conditions.
The financial stability report focuses on the conditions affecting the stability of the U.S. financial system by analyzing vulnerabilities related to valuation pressures, borrowing by businesses and households, financial-sector leverage, and funding risks. The report also discusses hot topics such as persistent inflation and tighter monetary policy, banking-sector stress, commercial and residential real estate and geopolitical tensions.
The supervision and regulation report notes the banking system is sound and resilient, with strong capital and liquidity while also acknowledging the recent stress from the March 2023 bank failures indicating the need to for banks to be vigilant in assessing and responding to risks. The report highlights threes areas of focus: banking system conditions, regulatory developments, and supervisory developments. The Federal Reserve supervisors are “redoubling their efforts to assess banks’ preparedness for emerging credit, liquidity, and interest rate risks.”
SEC Adopts Amendments to Share Repurchase Disclosures
In early May 2023, the SEC voted 3 to 2 to issue rules in Release No. 34-97424, Share Repurchase Disclosure Modernization, expanding disclosure requirements for share repurchases. Under the rules, issuers will need to make either quarterly or semi-annual tabular disclosures on their daily buyback data. That tabular disclosure will need to include the total number of shares purchased; average price per share; and total number of shares purchased on the open market, as well as other information. Among other requirements, issuers will also need to present a check-box that indicates whether certain officers or directors bought or sold shares subject to the buyback plan within a window of four business days before or after a buyback announcement. For registrants with December 31, 2023 fiscal year-end, the rule will apply to the Form 10-K for fiscal year ending December 31, 2023. The SEC issued a Fact Sheet summarizing the key provisions of the final rules.
SEC Delays Climate Change Disclosure Rulemaking
The Securities and Exchange Commission (SEC) has delayed its climate change disclosure rulemaking. Now, the agency will consider finalizing its March 2022 proposal in the fall this year, according to an updated rulemaking agenda. The climate change disclosure rule has been one of the most closely watched and one of the most consequential projects that the SEC has undertaken during Chair Gary Gensler’s tenure, in part because it will test the boundaries of the securities laws and the commission’s authority. If adopted, it will represent a significant change for public companies. Many large companies already provide voluntary sustainability reports. But the proposal, in Release No. 33-11042, The Enhancement and Standardization of Climate-Related Disclosures for Investors, has extensive standardized and prescriptive requirements: disclosures inside and outside the financial statements; greenhouse gas emissions disclosures; attestation of disclosures, among others.
Even though the SEC is planning to finalize climate rules around October as reflected in the most current agenda, that is just a best estimate. It can happen before or after October. But it is likely that the vote will not happen in the summer, given the tremendous amount of lobbying either for or against. About 15,000 comment letters have been submitted, with 5,000 of them unique letters. This rulemaking has been especially controversial as many critics—mainly business organizations, conservatives, and even SEC Commissioner Hester Peirce—questioned whether the agency even had the authority to prescribe extensive rules that they view are intended to manage the economy and businesses. The U.S. Chamber of Commerce—while not officially saying it will sue the SEC when the rules are finalized—has been threatening a lawsuit privately.
House GOP Bill Would Add Sixth SEC Commissioner and Oust Chair
House Republican Representative, Warren Davidson, on June 12, 2023, introduced legislation that would add a sixth SEC commissioner, eliminate the chair position, and place the agency’s daily operations under a newly created executive director role. Davidson described the bill as a “corrective action” to remove SEC Chair Gary Gensler, whose agenda on crypto, climate and other areas is deeply unpopular with Republican lawmakers. Joining Davidson as cosponsor was Representative Tom Emmer. Both are members of the House Financial Services Committee and are two of Gensler’s loudest critics. Davidson had signaled plans to introduce the legislation during Gensler’s April appearance before the panel.
The bill would place the commissioners under staggered six-year terms, compared to the current five years. Davidson, in a news release, argued that Gensler’s “concerning level of discretion” today makes the other commissioners’ positions effectively redundant, and argued that the new structure would ensure that a single party never controls more than half of the commission.
House Democrats Seek to Ban Open-Market Stock Buybacks
In May 2023, Representative Jesus Garcia reintroduced legislation that would ban public companies from buying back their own stock on the open market. Garcia introduced H.R. 3694, the Reward Work Act, alongside more than two dozen other House Democrats. The measure would bar issuers from purchasing their own equity securities on a national securities exchange – instead requiring them to turn to tender offers – and would scrap the SEC’s Rule 10b-18, which provides companies seeking to buy back stock with a safe harbor from liability for market manipulation, subject to certain conditions. The bill would also require publicly listed companies to allow their employees to choose at least one-third of the board of directors through a one-employee-one-vote process. The bill represents a broader effort by Democrats and financial reform groups to crack down on corporate share repurchases. It comes weeks after the SEC voted 3 to 2 to issue rules in Release No. 34-97424, Share Repurchase Disclosure Modernization, expanding disclosure requirements for share repurchases which is described above.
The following selected projects are outstanding as of June 30, 2023.
Projects on Environmental Credits, Consolidation, and KPIs
In May 2022, the FASB added a project to its technical agenda on the recognition, measurement, presentation and disclosure of environmental credits that are legally enforceable and tradeable, following a review of the staff’s initial research on accounting for environmental credits, including feedback that there is diversity in practice in this area. The project will address the accounting by participants in compliance and voluntary programs, as well as by creators of environmental credits. In addition, the FASB added a project on consolidation for business entities to its research agenda after removing its project on consolidation reorganization and targeted improvements from the technical agenda. The new project will explore whether a single consolidation model could be developed for business entities. In response to feedback received on the FASB’s Invitation to Comment, Agenda Consultation, the FASB also added a project on financial key performance indicators to the research agenda to explore standardizing the definitions of financial key performance indicators.
EITF Agenda Items
The Emerging Issues Task Force (EIFT) held an educational meeting on June 15, 2023, to discuss Issue No. 23-A, “Induced Conversions of Convertible Debt Instruments.” The meeting was educational in nature and no decisions were made. The Task Force identified areas that require additional staff research to be discussed at a future meeting.
The next EITF meeting is scheduled for September 14, 2023.
PCC Activities
The Private Company Council (PCC) met on Tuesday, April 25, 2023. Below is a summary of topics addressed by the PCC at the meeting:
Selected Implementation Dates (FASB/EITF/PCC)
The illustrative disclosures below are presented in plain English. Please review each disclosure for its applicability to your organization and the need for disclosure in your organization’s financial statements.
{Please give careful consideration to appropriateness of italicized text.}
ASU 2016-13 ― Applicable to entities that hold financial assets and net investment in leases that are not accounted for at fair value through net income:
In June 2016, the FASB issued guidance to change the accounting for credit losses and modify the impairment model for certain debt securities. The guidance requires a financial asset (including trade receivables) measured at amortized cost basis to be presented at the net amount expected to be collected. Thus, the income statement will reflect the measurement of credit losses for newly-recognized financial assets as well as the expected increases or decreases of expected credit losses that have taken place during the period. The amendments will be effective for the Company for [fiscal years beginning after December 15, 2022 including interim periods within those fiscal years.-all other entities] [The Company is currently in the process of evaluating the impact of adoption of this guidance on the financial statements] [The Company adopted the guidance on January 1, 2023 (include impact of addition on the financial statements).
ASU 2018-12 ― Applicable to insurance entities that issue long-duration contracts:
In August 2018, the FASB amended the Financial Services—Insurance Topic of the Accounting Standards Codification to make targeted improvements to the existing recognition, measurement, presentation, and disclosure requirements for long-duration contracts issued by an insurance entity. The amendments will be effective for the Company for [fiscal years beginning after December 15, 2021, and interim periods within those fiscal years.-public business entities that meet the definition of an SEC filer, excluding entities eligible to be SRCs as defined by the SEC] [for fiscal years beginning after December 15, 2023, and interim periods within fiscal year beginning after December 15, 2024.-all other entities] The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2018-19 ― Applicable to entities that hold financial assets and net investment in leases that are not accounted for at fair value through net income:
In November 2018, the FASB issued guidance to amend the Financial Instruments—Credit Losses topic of the Accounting Standards Codification. The guidance aligns the implementation date of the topic for annual financial statements of nonpublic companies with the implementation date for their interim financial statements. The guidance also clarifies that receivables arising from operating leases are not within the scope of the topic, but rather, should be accounted for in accordance with the leases topic. The amendments will be effective for the Company for [reporting periods beginning after December 15, 2019, including interim periods within those fiscal years.-SEC filers] [reporting periods beginning after December 15, 2020, including interim periods within those fiscal years.-public business entities that are not SEC filers] [fiscal years beginning after December 15, 2021, including interim periods within those fiscal years.-all other entities] Early adoption is permitted for all organizations for periods beginning after December 15, 2018. The Company is currently in the process of evaluating the impact of adoption of this guidance on the financial statements.
ASU 2019-09 ― Applicable to insurance entities that issue long-duration contracts:
In November 2019, the FASB issued guidance to defer the effective date of ASU 2018-12, Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long-Duration Contracts. The new effective date will be [for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years.-public business entities that meet the definition of an SEC filer, excluding entities eligible to be SRCs as defined by the SEC] [for fiscal years beginning after December 15, 2023, and interim periods within fiscal year beginning after December 15, 2024.-all other entities] The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2019-10 ― Applicable to all entities:
In November 2019, the FASB issued guidance to defer the effective dates for private companies, not-for-profit organizations, and certain smaller reporting companies applying standards on current expected credit losses (CECL), leases, hedging. The new effective dates will be CECL: [fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.-public business entities that meet the definition of an SEC filer, excluding entities eligible to be SRCs as defined by the SEC] [fiscal years beginning after December 15, 2022 including interim periods within those fiscal years.-all other entities]; Hedging: [fiscal years beginning after December 15, 2020 and interim periods within fiscal years beginning after December 15, 2021.-entities other than public business entities]; Leases: [fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021.-all entities other than public business entities; not-for-profit entities that have issued or are conduit bond obligors for securities that are traded, listed, or quoted on an exchange or an over-the-counter market; and employee benefit plans that file or furnish financial statements with or to the SEC] The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2019-11 ― Applicable to all entities:
In November 2019, the FASB issued guidance that addresses issues raised by stakeholders during the implementation of ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments affect a variety of Topics in the Accounting Standards Codification. [For entities that have adopted the amendments in ASU 2016-13, the amendments are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years] [For entities that have not yet adopted the amendments in ASU 2016-13, the amendments are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years-public business entities that meet the definition of an SEC filer, excluding entities eligible to be SRCs as defined by the SEC] [fiscal years beginning after December 15, 2022 including interim periods within those fiscal years-all other entities]. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2020-04 ― Applicable to all entities:
In March 2020, the FASB issued guidance to provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The amendments are effective as of March 12, 2020 through December 31, 2022. In December 2022, FASB issued ASU 2022-06 to defer the sunset date of ASC 848, Reference Rate Reform from December 31, 2022 to December 31, 2024. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2020-06 ― Applicable to all entities:
In August 2020, the FASB issued guidance to improve financial reporting associated with accounting for convertible instruments and contracts in an entity’s own equity. The amendments are effective for [fiscal years beginning after December 15, 2021, including interim periods within those fiscal years – public business entities that meet the definition of a SEC filer, excluding entities eligible to be smaller reporting companies as defined by the SEC] [fiscal years beginning after December 15, 2023, including interim periods within those fiscal years – all other entities]. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2020-11 ― Applicable to insurance entities that issue long-duration contracts:
In November 2020, the FASB issued guidance to defer the effective dates for insurance entities which have not yet applied the long duration contracts guidance by one year. The new effective dates will be [fiscal years beginning after December 15, 2022, and interim periods within those fiscal years.-public business entities that meet the definition of an SEC filer, excluding entities eligible to be SRCs as defined by the SEC] [for fiscal years beginning after December 15, 2024, and interim periods within fiscal year beginning after December 15, 2025.-all other entities] The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2021-08 ― Applicable to all entities that enter into a business combination
In October 2021, the FASB amended the Business Combinations topic in the Accounting Standards Codification to require entities to apply guidance in the Revenue topic to recognize and measure contract assets and contract liabilities acquired in a business combination. The amendments are effective for [fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. - public business entities] [fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. - all other entities] The amendments are applied prospectively to business combinations occurring on or after the effective date of the amendments. Early adoption of the amendments is permitted, including adoption in an interim period. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2022-01 ― Applicable to entities that elect to apply the portfolio layer method of hedge accounting
In March 2022, the FASB issued amendments which are intended to better align hedge accounting with an organization’s risk management strategies. The amendments are effective for [fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. - public business entities] [fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. - all other entities]. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2022-01 ― Applicable to entities that elect to apply the portfolio layer method of hedge accounting
In March 2022, the FASB issued amendments which are intended to better align hedge accounting with an organization’s risk management strategies. The amendments are effective for [fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. - public business entities] [fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. - all other entities]. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2022-03 ― Applicable to all entities:
In June 2022, the FASB issued amendments to clarify the guidance on the fair value measurement of an equity security that is subject to a contractual sale restriction and require specific disclosures related to such an equity security. The amendments are effective for [fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. - public business entities] [fiscal years beginning after December 15, 2024 including interim periods within those fiscal years. - all other entities]. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2022-04 ― Applicable to all entities that use supplier finance programs in connection with the purchase of goods and services:
In September 2022, the FASB issued amendments to enhance the transparency about the use of supplier finance programs for investors and other allocators of capital. The amendments are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, except for the amendment on roll-forward information, which is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2022-06 ― Applicable to all entities that have contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform:
In December 2022, the FASB issued amendments to defer the sunset date of the Reference Rate Reform Topic of the Accounting Standards Codification from December 31, 2022, to December 31, 2024, because the current relief in Reference Rate Reform Topic may not cover a period of time during which a significant number of modifications may take place. The amendments were effective upon issuance. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2023-01 ― Practical expedient: Applicable to all entities other than public business entities, not-for-profit conduit bond obligors, and employee benefit plans that file or furnish financial statements with or to the SEC; Leasehold improvements: Applicable to all lessees:
In March 2023, the FASB amended the Leases topic in the Accounting Standards Codification to provide a practical expedient for private companies and not-for-profit entities that are not conduit bond obligors to use the
written terms and conditions of a common control arrangement to determine whether a lease exists and, if so, the classification of and accounting for that lease. The amendments also change the guidance for public and private companies to require that leasehold improvements be amortized over the useful life of those improvements to the common control group regardless of the lease term. The amendments are effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect these amendments to have a material effect on its financial statements.
ASU 2023-02 – Applicable to all entities that hold (1) tax equity investments that meet the conditions for and elect to account for them using the proportional amortization method or (2) an investment in a LIHTC structure through a limited liability entity that is not accounted for using the proportional amortization method and to which certain LIHTC-specific guidance removed from Subtopic 323-740 has been applied:
In March 2023, the FASB issued amendments to allow reporting entities to consistently account for equity investments made primarily for the purpose of receiving income tax credits and other income tax benefits. The amendments are effective for [fiscal years beginning after December 15, 2023, including interim periods within those fiscal years.-public business entities] [fiscal years beginning after December 15, 2024, including interim periods within those fiscal years..-all other entities] Early adoption is permitted for all entities in any interim period. The Company does not expect these amendments to have a material effect on its financial statements.
Applicable to all:
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
NOTE: The disclosures in the previous appendix are not intended to be all inclusive. All pronouncements issued during the period should be evaluated to determine whether they are applicable to your Company. Through June 30, 2023, the FASB has issued the following Accounting Standard Updates during the year.
