The adoption date for CECL or ASC 326, Financial Instruments – Credit Losses, is fast approaching for private companies, as calendar-year companies are required to adopt CECL on January 1, 2023. The guidance, which was issued in 2016 in connection with ASU 2016-13, transitions accounting for credit losses from the incurred credit loss to an expected credit loss methodology. This methodology requires companies to measure expected credit losses over the contractual lives of financial assets by factoring in reasonable and supportable economic forecasts in addition to historical credit loss experience. Credit losses will likely be recognized earlier than under the incurred loss model as the expectation is credit losses will be recorded on “day one”, when financial assets are acquired or originated, rather than when credit losses reach the “probable” trigger. While the focus has largely been on large financial institutions with loans, this standard impacts all companies with credit exposure.
The process of transitioning to ASC 326 will vary by company, but for all, it will require adjustments to accounting policies and disclosures. At a minimum, companies with short-term receivables in-scope of CECL will need to assess their current methodology under the incurred loss method, how it aligns with the new standard and whether modifications to accounting policies and procedures are necessary. Processes, controls and related documentation all need to also be assessed to determine if changes are warranted. To estimate credit losses over the lives of receivables, companies may need to assess historical credit loss data that they had not previously considered.
CECL also provides companies with an opportunity to reassess how they view and segment their receivable portfolios from a credit risk perspective. The risk of credit loss and level of segmentation may differ compared to how organizations previously assessed credit losses under the incurred method. Furthermore, the evaluation of historical data surrounding receivables balances and aging distributions, write-offs and recoveries may be limited in availability. All private companies, not only Financial Services companies, need to understand the changes introduced by CECL, analyze their methodology accordingly and evaluate the sufficiency of their data as promulgated by the new credit loss standard. This is especially true if companies currently have large allowances for bad debts under the incurred method.
As noted in the table above, ASC 326-20 covers amortized cost assets. In addition, ASC 326-30 changes how companies will measure and recognize losses on Available-for-Sale (AFS) Debt Securities. Many companies will need to change their policies, processes, controls and disclosures related to AFS Securities.
Although it may appear daunting, CFGI has created a 5 Phase Approach specifically designed to guide companies from the old method into the new CECL-sanctioned standard. This includes:
- Understand CECL and Data Collection: Identify financial assets in scope, the key changes, and the data that exists for each portfolio and develop the company’s implementation plan. Consider each of the obstacles faced by all members of the cross-functional CECL team as well as any data gaps identified within the preliminary data assessment phase.
- Risk Identification and Technology Implications: Take a deep dive into its data integrity and processes. In this phase, internal controls, supporting documentation and model working groups will need to be developed.
- Management Oversight: For longer-term receivables, we recommend performing at least two parallel modeling cycles before a company fully adopts CECL. Meanwhile, parallel run cycles related to governance, financial reporting, investor communications and external auditor review should also be performed. A critical aspect of the adoption requires documentation around management’s assumptions and decision making. A company may choose to partner with an external professional service provider to help with CECL modeling.
- Financial Reporting: Verify that all financial reporting joins the allowance estimate with data, day-1 entries, disclosures and analytics in a controlled, scalable and repeatable manner.
- AFS Debt Securities Accounting: Prepare the company for post-ASC 326 adoption and its technical accounting implications for policies, processes and disclosures.
Transitioning from the current credit loss standard to the CECL standard is a substantial undertaking — management should evaluate their methodology and processes for estimating expected credit losses to ensure they’re consistent with CECL under ASC 326-20 and ASC 326-30 for AFS Debt Securities.
To learn more about CECL and how to succeed in the new era of credit loss accounting, reach out to the experts on our CECL team.