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AICPA Proposes Firmer Allowance Guidance

AUGUST 29, 2003


AICPA Proposes Firmer Allowance Guidance

The American Institute of Certified Public Accountants has proposed a Statement of Position, Allowance for Credit Losses, that may cause community banks to make some changes in how they set their allowance. The AICPA expects the SOP to result in creditors increasing allowance for credit losses in periods of weakening credit quality and decreasing it in periods of improving credit quality.

In issuing the proposal, the AICPA is responding to some who believe that existing guidance permits excessive flexibility. Critics of current practices believe the allowances currently tend to reflect the past credit quality of a loan portfolio rather than current credit quality. Some think allowances are often inappropriately increased in periods of improving credit quality and earnings, and reduced in periods of declining credit quality and earnings. Concerns have been raised about compliance with existing generally accepted accounting principles, adequacy of supporting documentation and the sufficiency of financial statement disclosures on allowances.

The SOP provides guidance on how to determine the allowance for credit losses in accordance with Financial Accounting Standards Board Statement No. 5, Accounting for Contingencies; Statement No. 114, Accounting by Creditors for Impairment of a Loan, and FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss.

The SOP states that the allowance for credit losses sheet should consist only of a component for individual loan impairment recognized and measured pursuant to FAS No. 114 and one or more components of collective loan impairment recognized according to FAS No. 5, and measured according to the SOP's guidance. Individual loans not determined to be impaired should be grouped into pools. Pools should be evaluated for collective loan impairment.

Each component of collective loan impairment must be supported with one or more sets of relevant, observable data. Measurements should be directionally consistent with changes in the observable data from period to period and over time. Observable data considered should change only if changes in the environment indicate that other data has become more relevant.

Components of the allowance for pools of loans (FAS No. 5) should be based on the present value of expected future cash flows, using data about existing conditions. Creditors should not project changes in the data that may occur in the future. The estimate of loss in pools of loans should reflect losses that have already been incurred, even if not yet identifiable, and not losses that might be incurred over the remaining life of the loans, even if predictable based on historical experience.

Comments on the AICPA's proposed SOP are due September 19. The SOP would be effective for fiscal years beginning after December 15, 2003. The proposed SOP is available at www.aicpa.org under the "Exposure Drafts" section. Send comments to fgill@aicpa.org or Frederick Gill, Senior Technical Manager, Accounting Standards, File 3480, AICPA, 1211 Avenue of the Americas, New York, NY 10036-8775. Please send a copy of your comments to ICBA.