In June 2016, the Financial Accounting Standards Board (FASB) introduced a new accounting standard addressing the recognition and measurement of credit losses on financial assets. Known as the current expected credit loss (CECL), the new accounting standard replaces the longstanding incurred-loss model, which delays recognition of loss until it is probable. Companies must now recognize lifetime expected credit losses for a wide range of financial assets and incorporate forecasts in developing estimates of expected credit losses.
While banks and financial institutions will be mostly impacted by the new method, all companies with balances due will be required to implement the new standard. Ultimately, this new way of reporting provides those reviewing or preparing financial statements with more decision-useful information about expected credit losses. If you’re the head of a privately held company or not-for-profit organization wondering if this new standard impacts you, here’s what you need to know:
Who does CECL apply to?
All companies with balances of all applicable assets or an off-balance-sheet credit exposure will be affected by the new standard.
What information should be considered?
The first step is determining which assets are impacted by the new standard:
• Trade receivables
• Loan/notes receivable
• Held-to-maturity debt securities
• Loans to officers and employees
• Receivables resulting from sales-type or direct financing leases
• Financial assets measured at fair value
• Available-for-sale debt securities
• Loans made to participants by defined contribution employee benefit plans
• Loans and receivables between companies under common control
• Promises/pledges/contributions receivable
Additional Considerations for Not-for-Profit Companies
While donor commitments to contribute are excluded from the financial assets impacted by the standard, not-for-profits should review their various revenue streams, outside of contributions, to determine if other related receivables could be impacted. Take for example programmatic loans. Let’s say an organization provides no interest loans to other organizations who advance their philanthropic mission, and management has recorded a credit loss of 10% on such loans, based on historic collection rates. With adoption of the new standard, an additional credit loss is recorded based on factors specific to the organization in which credit is extended, such as the economic environment in which the organization is operating.
Once the company’s assets have been identified, management will need to determine which specific method to use when measuring expected credit loss. While there is no required method, acceptable methods include:
- Discounted cash flow method
- Loss rate
- Roll rate
- Probability of default
- Aging schedule
Once the assets and method of measuring have been identified, the information must be evaluated, in order to ensure the estimation methods are appropriate for the circumstance. Companies must consider the internal and external factors that could impact the estimated credit loss, such as the historical data, the impact of the current environment and prospective economic forecasts over the horizon period, or reasonable and supportable forecasts, like unemployment rates and the current political climate.
When is the standard required to be implemented?
CECL will be required for implementation for years beginning on or after January 1, 2023.
Why is it important to be prepared to implement the new standard?
The purpose of CECL is to improve recognition and measurement of credit losses on financial assets in which credit is extended. While adoption of the new standard is required by U.S. GAAP, most companies are already evaluating potential losses of financial assets. Now those companies must now consider future implications on such estimates. Even if the effect is marginal, you should also expect new disclosures in your financial statements, in regards to adopting the standard. Now is the time to be proactive and develop the right team to spearhead the research, evaluate the underlying factors of the current process, and determine what numbers are needed to calculate the losses.
Where do we go from here?
While the CECL has been on the minds of the banking industry for some time, the standard has broader implications for companies across many industries, including not-for-profits. That means there’s not a one-size-fits-all approach to implementing this new standard. This article is only meant to give readers a birds-eye overview of the topic. Please consult your accounting professionals or one of the experts at Ellin & Tucker for a more personalized approach to evaluating your preparedness and need for CECL.