Dramatic Change Coming for Credit Loss Allowance
During June 2016, the Financial Accounting Standards Board (FASB) issued a new reserve for credit loss new standard which will impact how financial institutions and other organizations (including Buy-Here-Pay-Here (BHPH) dealers and Related Finance Companies (RFC's) record and compute their reserve for credit losses on installment contracts receivable on their financial statements. The new pronouncement is in fiscal years beginning after December 15, 2019 for certain public companies and for certain non-public business entities until fiscal years beginning after December 15, 2021.
The new model replaced the probable and incurred criteria under the previous guidelines and replaces them with a lifetime expected credit loss concept. Therefore, the new model will record loss reserves to include losses covering the remaining life of the contracts.
The bottom line impact for BHPH operators is that their reserves for credit losses recorded on their financial statements could substantially increase, resulting in a lower the net worth of the company on its' financial statements. Therefore, it would be prudent for a BHPH operator to consider:
1) Engaging an industry experienced CPA or other professional to consult with the company regarding the new reserve methodology. The company could calculate and compare their existing calculation methods to the amount determined by the new reserve methodology. This will enable the BHPH operator to have an understanding of the computation as well as the estimated impact it will have on the entity's financial statements once the standard is effective.
2) Proactively reviewing existing loan covenants and other relevant agreements and determine what the impact of the change will be as if it were currently made. This will allow the operator time to plan and communicate as considered necessary in the circumstances with their financial institutions (who likely are aware of the new pronouncement as it impacts their own financial statements) as with other users of the financial statements.
In a nutshell, we recommend that the BHPH operator determine the ramifications of the new pronouncement “sooner than later” to ensure there are no significant surprises to the company or other parties once the new standard is effective.READ MORE about this topic from the BHPH Report.