What Are Current Expected Credit Losses (CECL)?

What Are Current Expected Credit Losses (CECL)?

In January 2023, the Financial Accounting Standards Board’s (FASB) new Accounting Standards Update (ASU) No. 2016-13, Topic 326, Financial Instruments – Credit Losses, went into effect for private companies and smaller reporting companies. The new accounting model, current expected credit losses (CECL), has already been implemented by Security and Exchange Commission (SEC) public business entities. The CECL model requires immediate recognition of estimated expected credit losses over the life of all financial instruments that are not accounted for at fair value through net income. Previously, losses were recognized only as they were incurred which delayed recognition of expected losses that might not yet have met the threshold of being probable.

Main Provisions

  • Assets measured at amortized cost, eliminate the probable initial recognition threshold and instead reflect an entities current estimate of all expected credit losses. (CECL Model)
  • Available for sale debt securities losses should be presented as an allowance vs write down.

Objectives of the CECL Model

The goal of CECL is to simplify U.S. generally accepted accounting principles (GAAP) and provide more timely recognition of credit losses. The new guidance aims to accomplish the following objectives:

  • Reduce the amount of credit impairment models that entities use to account for debt instruments. Since financial assets are measured at fair value in every reporting period, no impairment model is needed. The CECL model excludes available-for-sale (AFS) debt securities, meaning that it will continue to be assessed for impairment under ASC 320.
  • Use an expected loss model instead of an incurred loss model. The CECL model does not specify a threshold for recognizing an impairment allowance, unlike the incurred loss models in GAAP. At the end of the reporting period, entities will recognize its estimate of expected credit losses for financial assets. The credit impairment will be identified as an allowance rather than a direct write-down of the amortized cost basis of a financial asset.
  • Require an entity to recognize an allowance of lifetime expected credit losses. Entities can measure and set an allowance for credit losses under CECL. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions and reasonable and supportable forecasts that affect the collectability of the reported amount.
  • Does not require a specific method. Since FASB did not put any restrictions on the methodology used, there are a variety of approaches that can be used. These methodologies include discounted-cash-flow analysis, the average charge-off method, vintage analysis, static pool analysis, the roll-rate method, the probability-of-default method and regression analysis.

In Scope Vs. Out of Scope

CECL is required for assets measured at amortized cost , therefore certain assets are out of CECL’s scope. Here is a list of some of the financial instruments that fall in scope or out of scope with the new model.

In scope:

  • Financing receivables
  • Trade receivables that result from revenue transactions and other income
  • Reinsurance recoverables that result from insurance transactions
  • Off-balance sheet credit exposures not accounted for as insurance
  • Held-to-maturity debt securities
  • Net investments in leases recognized by a lessor

Out of scope:

  • Any financial asset measured at fair value through net income
  • Available-for-sale debt securities
  • Lessor receivables from operating leases
  • Participant loans from defined contribution employee benefit plans
  • Policy loan receivables of an insurance entity
  • Loans and receivables between entities under common control
  • Receivables arising from operating leases accounted for

Policy CECL Disclosure Updates

Entities will need to find an appropriate balance of being thorough and concise on drafting financial statement disclosures since CECL is based more on principles than a checklist. The policy section should address an entity’s summary of significant accounting policies for financial assets within the scope that should include:

  • Nonaccrual policies, including the policies for discontinuing accrual of interest, recording payments received on nonaccrual assets (the cost recovery method, cash basis method, or some combination of those methods) and resuming accrual of interest, if applicable
  • The protocol used to ascertain past-due or delinquency status
  • The policy for recognizing write offs within the allowance of credit losses

If you have any questions on the new accounting model, CECL, contact BSSF today!

Posted In: Audit | Insights

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