In 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13 Financial Instruments—Credit Losses, which effectively replaces the “incurred loss” model with a “current expected credit loss” (CECL) model when measuring impairment of a wide-ranging scope of financial assets. Additionally, on March 31, 2022, the FASB issued ASU 2022-02, which eliminates the accounting guidance on Troubled Debt Restructurings (TDRs) for creditors in ASC 310-40 and amends the guidance on “vintage disclosures” to require disclosure of current-period gross write-offs by year of origination.
What makes the CECL impairment model more complex than the current model is that the estimate of expected credit losses considers not only historical information, but also current and future economic conditions and events over the life of the financial instrument that could impact expected losses. Such lifetime expected credit losses require immediate recognition under the CECL impairment model.
What Companies Are Impacted?
The CECL standard applies to all entities that have financial instruments and net investments in leases that aren’t accounted for at fair value through net income. Specifically, CECL will impact virtually all companies that have financial assets, such as trade receivables, or off-balance sheet credit exposures, such as financial guarantees. Companies in almost every industry are expected to be impacted by the CECL impairment model.
What Financial Instruments Are in Scope?
Financial instruments within the scope of the CECL impairment model include (but are not limited to):
- Trade receivables
- Contract receivables
- Loan receivables
- Financial guarantees
- Reinsurance recoverables
- Held-to-maturity debt securities
- Loan commitments
- Lease receivables
Companies should carefully review their financial assets and off-balance sheet credit exposures in order to take stock of the potential impact of implementing the CECL impairment model.
What’s Really Changing?
To provide insight into the most significant changes under the CECL standard, below is a summary of current GAAP as compared to the CECL standard (not intended to be all-inclusive):
| Current GAAP | CECL (ASC 326) | Considerations/Challenges | |
|---|---|---|---|
| Recognition Requirement | When loss meets probable threshold or when incurred. | Expected lifetime loss required to be assessed even in cases where probability of loss is remote. | Zero loss estimates, even with assets considered current under payment terms, will be rare and must be substantiated by reasonable and supportable data and documentation. |
| Basis of Loss Determination | Consider historical loss rates and current conditions. | Expected future conditions, in addition to what is required under current GAAP. | Availability of data, the relevance and reliability of that data, and the company’s ability to gather and maintain both historical and forecasted data necessary for CECL compliance. |
| Determine Methodology | Methodologies referenced in the standard include: Specific identification, aging percentage, etc. | Generally similar methodologies: Specific identification, aging, discounted cash flow, vintage, etc. | While methodologies may be similar, the inputs necessary and information needed to support these inputs and the overall methodologies could change. Furthermore, companies will need to reassess their accounting policies and procedures to evaluate any potential information gaps from their current estimation method. |
A zero-loss estimate on assets within the scope of CECL will generally be considered rare. In such cases, companies must be able to support the zero-loss estimate with “reasonable and supportable” historical and forecasted data and include proper documentation noting the rationale used in the determination. This is expected to be a significant change for non-financial institution companies who may have never performed an assessment of expected losses on receivables considered to be current under payment terms.
How Can CECL Impact an Acquisition?
From everything between initial due diligence and process integration after the acquisition, the CECL impairment model may have a significant impact on business combinations going forward, therefore companies should carefully assess potential impacts of the CECL impairment model. For example, throughout the due diligence process, companies should evaluate the potential impact on the acquiree’s financial position and results of operations and how any CECL adjustments would impact the overall deal, such as quality of earnings, a purchase price based on certain financial metrics, or net working capital adjustments. If the acquisition is a carve-out, spin-off, or divestiture of a segment or portion of a business, there could be complexities in isolating the appropriate data and allocating the CECL allowance to those portions of the business. Additionally, cross-border acquisitions could be impacted by any accounting practices differing between U.S. GAAP and the International Financial Reporting Standards (IFRS).
CECL Effective Dates
The CECL standard is effective for fiscal years beginning after December 15, 2022 e.g., January 2023 for smaller reporting companies (as defined by the Securities and Exchange Commission (SEC)) and nonpublic companies. For SEC filers that are not smaller reporting companies, the standard was effective for fiscal years beginning after December 15, 2019, e.g., January 2020.
FORVIS Advisory Services — CECL Implementation Assistance
To assist you in the implementation of the CECL standard, advisory professionals at FORVIS can assist in designing and executing an efficient and effective strategy. Specifically, FORVIS can:
- Discuss accounting considerations tailored to your company and industry,
- Provide assistance in developing a model strategy,
- Document your company’s model and applicable accounting policies,
- Provide model validation and perform calculations, and
- Assist in the development of governance of and internal controls surrounding the CECL standard.
We are honored to serve as your trusted advisors and are available to provide guidance throughout your CECL implementation process. For more information, reach out to your FORVIS professional or use the Contact Us form below.