Accounting For The Next Financial Crisis

by. Henry Meier

As I pointed out in a previous blog post, even though my father was able to get five kids through college and give himself the flexibility to play the occasional weekday game of tennis by starting his own accounting firm, it became painfully obvious at a very young age that his older son would not be following in his footsteps.  So, it is with that caveat that I am here to tell you that one of the most troubling issues on the regulatory horizon for credit unions has to do with changes proposed by the Financial Accounting Standards Board (FASB) which would make financial institutions anticipate and more quickly reflect investment losses on their balance sheets.

Under existing accounting standards, financial institutions must generally reflect investment losses on their balance sheets once they are incurred.  Under FASB proposal, 2012-260, this standard would be changed so that financial institutions would have to account for expected financial losses.  The distinction is between reflecting a loss that is going to happen and one that may happen given current economic conditions.

The rationale behind the change is a sound one as applied to financial institutions whose balance sheets are confusing to even the most sophisticated investors.  The intent behind the shift is to put investors in a better position to react to changes in a corporation’s financial condition before trouble strikes.  For example, in an analysis of the failure of small community banks and recent testimony before Congress, the GAO pointed out that existing accounting standards did not adequately capture the fact that community banks were aggressively moving into the commercial real estate market.  It opined that “loan loss allowances were not adequate to absorb the wave of credit losses that occurred when the financial crisis began, in part because current accounting standards for loan loss provisions require banks to estimate loan losses using an incurred loss model” as opposed to one that forces banks to more quickly recognize likely investment losses.

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