After attending the Public Company Accounting Oversight Board’s (PCAOB) Forum on Auditing in the Small Business Environment, our HORNE Financial Institutions team was reminded of future certainties that require immediate preparations. Regulations are becoming more complex. Regulators are requiring more diligence from publicly traded companies and banks—as well as from their auditors.
During the conference, PCAOB panelists discussed a variety of topics, including professional skepticism, auditing accounting estimates, the somewhat new revenue recognition and lease standards, auditing related party transactions and inspection trends. The conversations raised some great conversations about hard trends and what the future holds for banks and publicly traded companies. Here are a few of the key takeaways from the SEC’s discussion about upcoming accounting standards. Our team is available to answer questions or go deeper on any of the issues.
We recommend you begin analyzing for revenue recognition as soon as possible. Start by reviewing your non-interest income streams, specifically service charges, asset management fees and interchange fees. Most other revenue streams are scoped out of this standard, but you need to ensure you fully understand which are in and which are out. The key will be to gain an understanding of revenue recognition and document your findings for regulators and auditors. The hardest part will be analyzing the contracts and making sure you are properly identifying the performance obligations in the contract (or when the goods or services are promised to your customers).
With revenue recognition, banks need to take special care for your customer base. Consider how the standard will impact the financial statements of your borrowers. Industries that have long-term contracts and contracts with multiple revenue streams (e.g., telecommunications and construction companies) likely will be impacted. Also, consider how the standard will impact your debt covenants or debt service computations. Start having those conversations with customers now to minimize any credit risks.
Be prepared for the new leases standard to impact all financial institutions. Most property, plant and equipment leases will be required to be included on the balance sheet (similar to capital lease treatment of today). This will impact capital ratios and regulatory assessment fees. For example, the average $1B community bank will likely see a 25 basis point reduction in your Tier 1 capital ratio due to implementing this new standard. Consider how to prepare for the impact of a new lease standard in your capital plans.
This will also impact your customer base. How are you documenting your credit risk exposure and the policies and procedures you are putting in place to minimize this impact to your customer's balance sheets? Most, if not all, community banks deal with entities that lease equipment, run shopping centers that generate heavy lease income or lease buildings. Making sure you fully understand any impact now can help you be prepared when the standard becomes effective.
Every CFO in America is probably tired of hearing about CECL. As a practitioner, I can assert that we keep bringing it up because we don't see as much progress as we would like (or need) to see. For public companies, CECL implementation is effective Q1 2020. While that may still seem far away, it’s crucial that you are running simultaneous models for almost a year to make necessary tweaks to your calculations or better understand the impact to your financial statements. Impact estimates range from a 25 basis point reduction in Tier 1 capital (or roughly $1.3MM impact to a $1B community bank) to zero. Your solution likely will fall in between those estimates, but you won’t know until you start looking at the data and analyzing the impact.
Analyzing the data and the credit quality indicators (CQIs) that impact your institution will be a time-consuming and collaborative process that engages several disciplines within your institution, including credit, accounting and IT. It won’t happen overnight, and you may lack the sufficient flextime to get it done in a short runway—so it the sooner your whole team to starts, the better prepared you can be. In addition, the path to CECL will engage data analytics that will provide valuable, actionable insights into your loan portfolio.
Each of these three standards requires one thing in common—time. We agree with the SEC and your regulators. The time to start your preparations is now. By fostering a sense of urgency behind these complex requirements, you will position your institution for success.
Our HORNE Financial Institutions team has developed tools to help your company management and audit committee understand emerging standards and their impact on your institution. We can support your team every step, and ensure you have a plan in place to minimize risk as you pursue compliance.
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