By: Jennie K. Scott, Audit and Assurance Services Assistant Senior Associate
The Accounting Standards Board’s latest update, ASU No. 2016-13 provides users with a new loss reserve model to determine and recognize expected credit losses, described as the Current Expected Credit Loss (CECL) model. The FASB has created this standard hoping to address concerns that the currently utilized incurred loss approach (ASC 310 and ASC 450-20) does not provide enough information surrounding an organization’s true expected credit losses.
The hope of the FASB is that this new guidance will better align the economic and accounting considerations behind the lending/crediting process. The new model will require a lender to immediately recognize credit losses equal to the amount of loss anticipated over the life of the financial asset, rather than recognizing the loss in the period that it occurs or is most probable. This new type of reporting will, in turn, provide investors with a generally more clear, timely picture of the potential losses on these assets.
It is important to recognize that many organizations will be affected by this new guidance, not just financial institutions. In general, an organization that has trade receivables on its balance sheet should be taking into consideration the upcoming implementation of CECL.
As a quick example of the changes that CECL will bring, let’s discuss Accounts Receivable. It is fair to assume that many organizations are currently using an ‘aging approach’ to segregate and determine risks of loss on accounts receivable. Under CECL, the aging approach may be a reasonable starting point, but it will likely be necessary to also develop ‘pools’ of receivables. For example, the creation of a geographic pool could split receivables up by region within the already existing aging buckets. After segregating the receivables into pools, organizations will then need to determine historical loss rates for each pool. These historical loss rates will need to be based on anticipated losses over the remaining life of the receivables that make up each individual pool.
This model goes into effect for SEC filers with fiscal years beginning after December 15, 2019, for other Public Business Entities with fiscal years beginning after December 15, 2020, and for all other entities as of December 15, 2021. Early adoption of the model is permitted beginning in 2019.
As with most FASB updates, the earlier an organization starts to plan for the implementation of the CECL model, the better. While there are some exceptions and alternatives to this update, organizations should start to identify, gather and analyze relevant information sooner rather than later. It is highly likely that effected organizations will also need to consider shifting internal accounting policies, processes and controls in response to the new CECL model.
Reach out to H&M today for more information on this topic. We would be happy to assist you.