New CECL Rules Suggest Review of Banking Organizations’ Incentive Compensation Plans
The new Current Expected Credit Losses (CECL) accounting standard was issued by the Financial Accounting Standards Board (FASB) as ASC 326 in June 2016. Application of the standard was postponed, but is now effective for most SEC filers in fiscal years and interim periods beginning after December 15, 2019, and for others, in fiscal years beginning after December 15, 2022. It applies to all institutions holding financial assets, loans, debt securities, trade receivables, and off-balance-sheet credit exposures, among other financial instruments, and will likely change how many organizations/companies account for credit losses.
In our experience so far (some organizations have not begun to consider this issue yet), banking organization clients are adding language to their short- and long-term incentive compensation plans (or reviewing the existing language – many plans already include adequate language), which allows them to insulate executives and employees from the effects of the new accounting standard in determining the attainment of performance metrics.
For example, clients that previously decided to insulate incentive compensation plan payouts from the effects of the incurred loss accounting standards accounting rules, may similarly decide to insulate compensation plans from the impact of CECL. However, we understand that clients intend to review the impact of this decision after the fact, such that, if it might be appropriate to adjust compensation based on loss experience, that adjustment can be made after sufficient experience. Additionally, some clients are implementing a future “look back” process whereby they will assess whether there are in fact losses in these portfolios and, if so, what impact those losses may have had on results to reassess whether to change the policy of “insulating” management from the effects of the accounting change.
-Mike Melbinger, CompensationStandards.com February 12, 2020
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