Did Banks Exploit ASU 2016-13 Transition Guidance to Manage their Earnings and Capital Ratios?

• In Event: Earnings Management and Professional Judgment

Abstract

In the aftermath of the financial crisis in 2007-2010, the FASB issued new accounting guidance for credit loss estimation in ASU 2016-13 that expands the loan types requiring allowances and also increases the time horizon for loss estimation. Both changes are expected to increase required allowances for loan losses at adoption. The FASB’s transition guidance allows banks to record the “income effects” from initial adoption as direct adjustments to retained earnings, thus, bypassing the income statement. Furthermore, bank regulators have adopted special rules allowing banks to spread the initial retained earnings adjustments over three to five years when calculating capital ratios. Together, these special features of the ASU 2016-13 adoption context create both opportunities and incentives for banks to delay the recording of provision accruals in the 4th quarter of 2019 and instead record them as initial allowance adoption adjustments in the first quarter of 2020. We perform several tests to determine whether banks actually engaged in such provision-shifting. The results of the tests are directionally consistent with the provision-shifting hypothesis and several tests are statistically significant.

Authors

• Allison Kristina Beck, University of Tampa

• Paul Beck, University of Southern Mississippi