Navigating the New CECL (ASC 326) Standard

November 21, 2023 - Accounting standard ASC 326 (also known as CECL) is meant to increase balance sheet transparency and requires entities to recognize estimated credit losses expected to occur over the remaining life of many financial assets. It is important for entities to understand how the new standard may affect them and how to get in compliance. 

In June 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-13 Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, commonly referred to as CECL. While, FASB had delayed effective dates for the CECL standard since its creation, it is now effective for private companies with fiscal years beginning after December 15, 2022.

The new guidance significantly impacts banks and other financial institutions, but it does apply to other entities that have the following assets:

• Trade Accounts Receivable
• Contract Assets
• Notes/Loans Receivable
• Held-to-Maturity Debt Securities
• Cash Equivalents
• Sales-type of Direct Financing Lease Receivables

What is the purpose of the new CECL model?

The CECL model aims to provide financial statement users with more insightful information about expected credit losses in financial reporting. Under current Generally Accepted Accounting Principals in the United States of America (US GAAP) entities utilize the incurred loss model, which delays the recognition of credit losses until they become probable, that is typically, recorded after the asset is established. The CECL model, on the other hand, requires entities to account for losses when losses are expected, that is typically, when the asset is initially recorded.

What does it mean for my company?

Under the CECL model companies are required to estimate expected credit losses. The model requires that a company base its estimates on historical loss experience with similar assets and current conditions which exists in the current US GAAP model. The CECL model adds a new wrinkle and requires the use of reasonable and supportable forward-looking information that impacts the expected collectability of the reported amount of the financial assets.

The CECL model also requires an evaluation on a collective (pooling) basis of assets with similar risk characteristics (e.g., type, size, term, geographic area, age, etc.). Current US GAAP does not prohibit pooling, but it does not explicitly require it either. Pooling can be based on any one or combination of risk characteristics. The model does not require a specific methodology to measure an allowance for expected credit losses and an entity may use aging schedule analysis, discounted cash flows, loss-rate method, probability of default method, rate-roll method, or regression analysis.

Are there any exceptions to using the CECL model?

Under the CECL model there are notable exceptions as follows:

• Loans and receivables between entities under common control as well as loans and receivables to the controlling shareholders
• Pledges receivable for not-for-profit entities.
• Loans receivable from participants on an employee benefit plan

When is the new CECL model effective?

The Standard is effective for fiscal years beginning on or after December 15, 2022. For calendar year financial reporting entities that would be an effective date of January 1, 2023.

Is there a prescribed transition method?

The CECL model allows for a modified retrospective approach that allows for a cumulative effect adjustment to the opening balance of retained earnings as of the date of adoption.

What do I do next?

Start with determining appropriate risk pools of your financial assets on the adoption date. Then examine historical loss rates, current economic information, and determine the use of reasonable and supportable forward-looking information to determine if the allowance for credit losses is appropriate at the adoption date.

Example:

ABC Company, a supplier of various proprietary inks used in the printing industry, is implementing CECL and in doing so is performing a look back at historic loss rates based on its aging pools of Trade AR as of the date of adoption. Trade AR is the only financial asset that falls under the guidance provided in the new standard. The Company looked at existing loss ratios, considering historic and current information, and then applied various forward-looking information that is reasonable and supportable in determining expected credit losses under the CECL model as follows:

ABC Company under the standard would record a cumulative effect adjustment to the opening balance of retained earnings on the adoption date as follows:

What if I have further questions? 

Adopting new accounting standards and changing long time processes are not always easy or desirable activities for a company. If you need assistance, we recommend you work with your trusted accounting advisor to help you implement and get in compliance with the new standard.  If you have further questions, you can contact a Redpath advisor here, and someone will reach out to discuss your specific situation and unique needs.