Abstract
In its general move toward forward-looking accounting rules, the Financial Accounting Standards Board (FASB) adopted ASU 2016-13, Measurement of Credit Losses on Financial Instruments, to better align the recognition of expected credit losses with changes in credit risk. This edition of Journal of Accounting, Auditing & Finance (JAAF) contains two articles on this topic: the first by former FASB member Hal Schroeder and a second by an editor emeritus of JAAF, Prof. Joshua Ronen. Although these articles were written around the time that the standard became effective for most SEC filers at the beginning of 2020, they are just as relevant today as Current Expected Credit Loss (CECL) remains one of the most important issues on the radar of accounting firms and corporations. 1 All remaining entities not required to adopt ASU 2016-13 in 2020 will be required to do so beginning in 2023. The purpose of these special essays in JAAF is to stimulate research interest in this standard now that panel data over several years is available regarding the application of ASU 2016-13.
Mr. Schroeder, who is currently a visiting scholar at Rutgers University, provides a thorough and detailed discussion of (1) how new FASB standards are formulated and adopted and (2) how this pertains specifically to the CECL standard. His insights will provide accounting researchers with a better idea about the approach of the FASB and the careful procedures that accompany the formulation of new accounting standards. The Editors of JAAF believe that this information will be useful to academic researchers in designing empirical procedures to test the effects of the standards.
Prof. Ronen of New York University is a distinguished scholar who has contributed many novel ideas in terms of accounting theory and application. His point of view is that there is a weakness pertaining to the way the standard is implemented in practice. Specifically, Prof. Ronen argues that the appropriate discount rate that should be applied to calculate the present value of future losses should not be the nominal rate of the loan. His arguments are backed up by a simple numerical example.
Prof. Sarath, the Editor of JAAF at the time these articles were invited, believes that this issue captures a fundamental tension in forward-looking accounting. A standard that tries to measure the expected value of future losses runs squarely into the development of asset pricing models under uncertainty and/or asymmetric information. There are, as of yet, no convincing equilibrium models of asset pricing under real market conditions. 2 For this reason, accounting rules of valuation must rely on heuristics that attempt to convey information about the future in a general way rather than as a precise point estimate. ASU 2016 represents one possible heuristic that is oriented toward conservatism. By discounting the future losses at the nominal rate provided to the debtor, the standard does not conform to the standard discounted cash flow valuation methodology as pointed out by Prof. Ronen. However, it leads to an initial overestimate which will typically reverse as the loan matures. Whether such a policy is favorable to users of financial statements is a very interesting open issue. 3