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CECL is here, and it might have more impact than you think

Jan 23, 2024

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Measurement of Credit Losses on Financial Instruments (CECL). For entities other than large public filers, the CECL standard is now effective for periods beginning after December 15, 2022 (e.g., January 1, 2023, for calendar year-ends).

ASU No. 2016-13 replaces existing financial asset impairment models with two new models — one for financial assets measured at amortized cost, such as receivables and debt securities held to maturity (the CECL model), and one for debt securities classified as available for sale.

The CECL model

The CECL model is discussed in Accounting Standards Codification (ASC) 326-20 and will require entities to estimate expected credit losses over the contractual life of each asset or off-balance sheet credit exposure within the scope of CECL.

The following table shows financial instruments within (and outside) the scope of CECL:

Financial instruments in the scope of CECL

Financial instruments not in the scope of CECL

Financing receivables (loans, notes receivable)

Receivables between entities under common control

Trade receivables

Equity securities

Contract assets (under ASC 606)

Other financial assets measured at fair value through net income (e.g., derivatives)

Debt securities held to maturity

Debt securities available for sale

Lessor’s net investment in sales-type and direct financing leases

Lessor receivables arising from operating leases

Receivables related to repurchase and securities lending agreements

Loans made to participants by defined contribution employee benefit plans

Reinsurance recoverables

Policy loan receivables of an insurance entity

Off-balance-sheet credit exposure not accounted for as insurance or as derivatives

Promises to give (pledges receivable) of a not-for-profit entity

 

Your organization must consider relevant available quantitative and qualitative information about past events, current conditions and reasonable and supportable forecasts. Assets that share similar risk characteristics will be evaluated on a collective (pool) basis. Assets that do not share risk characteristics with other assets will be evaluated individually.

Your organization may use different methodologies (e.g., loss rate, discounted cash flow) to estimate expected credit losses for other assets if the methodology is appropriate for the asset or asset pool and for the size and complexity of the entity.

Management teams should consider which methodologies will be appropriate for different assets as well as significant judgments that will be required when developing reasonable and supportable forecasts of expected credit losses, such as:

  • The process of segregating financial instruments into pools with similar risk characteristics.
  • The method of measuring the historical loss amount for loss-rate statistics.
  • The method of adjusting historical information to reflect current conditions and forecasts.

Considerations for certain financial assets

Here are some of CECL’s impacts your organization will have to consider as they relate to three more common financial assets:

Trade receivables

CECL will likely have a wide-ranging impact on trade receivables since many different entities recognize them. However, the impact can be mitigated because trade receivables turn over relatively quickly.

Some specific considerations related to trade receivables include, but are not limited to, the following:

  • CECL does not require a specific methodology, so most entities can start with their current allowance methodology as a base for their CECL model.
  • Because CECL requires entities to consider reasonable and supportable forecasts in addition to past events and current conditions, entities should evaluate how those forecasts should be reflected in the allowance for credit losses.
  • CECL requires entities to consider credit losses throughout the life of the receivable, so entities will likely need to measure an allowance for credit losses for current trade receivables in addition to trade receivables that are past due.
  • CECL requires entities to consider the risk of loss, even if that risk is remote. In other words, entities should determine whether an allowance for credit losses should be recognized even if credit losses on trade receivables have been minimal or nonexistent.
  • CECL does not change revenue recognition accounting. Adjustments to receivables recognized as implicit price concessions under ASC 606 should not be treated as credit losses under ASC 326-20.

Contract assets

Many different entities recognize contract assets. Entities do not generally incur credit losses on the contract assets themselves but could incur credit losses when the contract assets become trade receivables.

Some specific considerations related to contract assets include, but are not limited to, the following:

  • CECL does not change revenue recognition accounting. Adjustments to contract assets recognized as implicit price concessions under ASC 606 should not be treated as credit losses under ASC 326-20.
  • Since most credit losses related to contract assets are recognized after they become trade receivables, an entity may be able to apply its analysis of credit losses for trade receivables to many contract asset balances net of any adjustments for expected price concessions recognized under ASC 606. Alternatively, entities may use a different methodology to estimate credit losses for contract assets.
  • Although contract assets are presented net of contract liabilities on the statement of financial position, the evaluation of credit losses should be done for all gross contract assets.
  • Entities should consider reasonable and supportable forecasts when evaluating credit losses for contract assets, especially when payment is expected to occur further into the future (e.g., retainage recognized by construction entities).
  • CECL requires entities to consider the risk of credit loss even if that risk is remote. In other words, entities should determine whether an allowance for credit losses should be recognized even if credit losses on contract assets have been minimal or nonexistent.

Held-to-maturity debt securities

Some entities hold debt securities classified as held-to-maturity, which are recognized at amortized cost. Specific considerations related to held-to-maturity debt securities include but are not limited to the following:

  • Entities may presume no credit loss on securities that are explicitly or even implicitly guaranteed by the U.S. government, which include U.S. Treasury securities, securities issued by the Government National Mortgage Association, and many securities issued by U.S. government agencies (e.g., FNMA, FHLMC, etc.).
  • Since there is very little credit loss activity on many other types of debt securities (e.g., municipal obligations, corporate securities, etc.), one option to estimate credit losses on securities is to obtain probability of default and loss given default information from a rating agency and use a probability of default methodology to estimate credit losses. Entities may need to rely on their debt securities servicer or another third-party specialist to obtain this information.

Securities available for sale

Unlike financial assets measured under CECL, your organization should evaluate debt securities classified as available for sale on an individual security basis. The impairment methodology for securities available for sale under ASC 326-30 is similar to the existing other-than-temporary impairment methodology with some key differences:

  • The impairment evaluation no longer considers the length of time fair value has been less than the amortized cost.
  • Entities should not consider changes in fair value after the reporting date.
  • Any credit impairment is recognized as a valuation allowance rather than a direct write-off to the carrying basis.
  • Any allowance for credit losses is limited to the difference between fair value and amortized cost.

Moving forward

In addition to changing the methodology (or methodologies) used to estimate credit losses described above, ASU 2016-13 will also require changes to financial statement presentation and disclosures and changes to the accounting for financial assets acquired with more than insignificant deterioration in credit quality since origination, formerly known as purchased credit impaired assets.

To help ensure that your ASC 326 adoption is successful, your organization can reach out to your accounting advisors.

How Wipfli can help

Wipfli is ready to help you navigate CECL with confidence. We can provide guidance and support at every stage of your CECL compliance, from model validation to reporting. Contact us today to learn more about our experienced and practical approach to your audit and accounting needs.

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Author(s)

Brett D. Schwantes, CPA
Director
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