Current Expected Credit Losses (CECL) for Non-Financial Institutions
The last of the Big Three accounting standards changes – the Current Expected Credit Losses (CECL) is now in effect for non-financial institutions. And as with revenue recognition and lease accounting, that means big changes are on the horizon.
First, some background on the CECL
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which affects all entities that hold financial assets measured at amortized cost and available-for-sale debt securities.
It’s already in effect for financial institutions, and now for most non-public entities.
This guidance could significantly impact banks, financial institutions, and entities with substantial long-term financial instruments such as investments in leases or mortgage receivables. However, it’s applicable to all entities that hold financial assets, including trade receivables. So, if your organization has accounts receivable or loan receivables, you’re likely going to feel the impact.
Bridging the GAAP
In current U.S. GAAP, a loss isn’t recognized until it’s probable that it has been incurred. The new guidance was issued in response to the global financial crisis in 2008 in order to accelerate losses based on the amount currently expected, rather than meeting the probable threshold. The new standard requires entities to measure all expected credit losses held at the reporting date based on historical experience.
The allowance for credit losses is calculated using historical loss information as a starting point and is adjusted for current economic conditions and reasonable and supportable forecasts. Entities will need to pool assets that share similar risk characteristics when measuring the allowance for credit losses, which may include location, age, term, industry, or credit ratings.
Prior to this ASU, trade receivables that are either current or not yet due generally do not have a reserve. Those receivables may now have an allowance for expected credit losses under the CECL model.
What’s in and out of scope
Loans and receivables between entities under common control including controlling shareholders are not included in the scope of the CECL model. However, loans to officers or other employees are in scope. Also excluded from the CECL model are pledge receivables of not-for-profit entities and loans made to participants in employee benefit plans.
There are expanded disclosures required by the new guidance. These disclosures include a description of how expected loss estimates are developed, accounting policies and allowance methodology, and reasons for significant write-offs, among others.
What to do next
The ASU is effective for fiscal years beginning after December 15, 2022. The guidance should be implemented with a cumulative effect adjustment to beginning retained earnings in the adoption period. This means that private entities with a calendar year-end initially adopt the standard on January 1, 2023. The cumulative effect adjustment provides entities with an opportunity to increase their allowance for credit losses through an adjustment to equity rather than impacting net income.
Entities should begin determining their pools based on risk characteristics, reviewing their historical loss rates, and determining if an additional allowance for credit losses is necessary at the date of adoption.
If you have questions or would like to learn more about the CECL and how it may affect your organization, join us for our Credit Where Credit Is Due: Accounting for Credit Losses virtual event on Monday, October 30th. If you’re interested in resources related to lease accounting, download our Lease Accounting Toolkit, packed with resources to help ensure compliance, or watch as our top assurance thought leaders unpack lease accounting. If you’d like to have a conversation with one of our CECL professionals, contact us and we’ll make it happen. We’re here to help.