Current Expected Credit Losses (CECL)
You may not be aware, but the accounting standard ASC 326 – Current Expected Credit Losses (CECL) is now applicable for all entities.
Top ten things you need to know:
What is CECL?
CECL requires entities to estimate and account for expected credit losses for financial assets over the entirety of the asset’s life versus recognizing loss when the loss meets the probable threshold or when incurred which was typical under pervious GAAP.
When is CECL effective?
For private companies, CECL has an effective date for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Therefore, the effective date for calendar year private companies is January 1, 2023, unless early adopted.
Practical Tip: If your entity has interim reporting for 2023, CECL applies to these interim periods.
What is required?
The standard requires entities to estimate expected credit losses for all financial assets, including loans, debt securities, and other financial instruments, using relevant historical information, current conditions, and reasonable and supportable forecasts of future events.
What should you consider?
Adoption of this standard impacts accounting policy, disclosure, possibly accounting (not always), and procedures performed for audits, reviews, and possibly preparation and compilation engagements.
Who is impacted by the standard?
It is expected that banks and financial institutions are most affected by CECL, but all entities with balances due (receivables), offer loans, extend credit, or that otherwise has a credit exposure are impacted by the new accounting guidance. While entities that are not financial institutions typically have short-term receivables, the concepts apply to all assets that are within the scope of CECL.
Why was the standard issued?
The FASB issued CECL to allow for more accurate and timely recognition of loss reserves enabling investors and other stakeholders to make better informed decisions concerning credit quality of an entity’s financial assets.
Do entities need to look to future expectations when considering credit quality?
The simple answer is yes. Entities need to look to available data, relevance and reliability of this data and the company’s ability to consider both historical and forecasted losses.
When considering credit losses, what methodologies change?
Methodologies to determine credit losses typically consider aging, specific identification, discounted cash flows, past experience and future consideration. Under CECL, entities likely need to reconsider these inputs and reassess their accounting policy to identify potential information gaps in their current estimation methods.
What is scoped out of the standard?
- Financial assets measured at fair value through net income
- Available-for-sale (AFS) debt securities
- Loans to participants by defined contribution employee benefit plans
- Policy loan receivables of an insurance entity
- Promises to give (pledges receivable) of a not-for-profit entity
- Receivables arising from operating leases
- Loans and receivables between entities under common control
Do contract assets fall within the scope of the standard?
ASC 606-10-20 defines a contract asset as an entity’s conditional right to consideration in exchange for goods or services. The conditional right is based on something other than the passage of time, such as future performance. Once the conditional right has been fulfilled and an unconditional right to consideration exists, the contract asset becomes a trade receivable. While contract assets are not financial assets, recovery of these assets are subject to credit risk. Therefore, ASC 606-10-45-3 requires contract assets to be evaluated for credit losses under ASC 326-20. This change impacts industries such as construction who report contract assets.
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Michael A. (Mike) Westervelt is a principal with CLA with over 25 years of experience and a past Chair of the AICPA’s PCPS Technical Issues Committee (“TIC”). Mike is a National Assurance Principal and Construction Industry Assurance Leader. Mike specializes in thought leadership, ethics, independence, financial reporting, client service and accounting consulting for U.S. and international clients. He has managed relationships nationally and internationally for entities in the construction, manufacturing, hospitality, commercial service and healthcare industries. Mike is also a member of the AICPA’s Accounting and Review Service Committee (ARSC) and volunteers as a mentor for American Corporate Partners (ACP). Mike graduated from Iona College with a Bachelor of Arts in Accounting. He is a Certified Public Accountant licensed by the states of North Carolina and New York. Mike lives in Charlotte, NC and enjoys spending time with his family and an avid member of F3 who’s credo is “Leave no man behind, but no man where you find him.”
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