CECL Accounting: Implementation & Challenges
What is current expected credit loss (CECL) and why is it important? Ultimately, while it’s been beneficial to financial statements, has been a challenge for accounting teams to implement. Below we’ll break it down to help you better understand this accounting standards update as you apply it to your financial reporting.
What Is CECL Accounting?
CECL is a new accounting standard released in June of 2016 by the FASB to help estimate allowances for expected credit losses as opposed to using the old model around incurred accounting losses. It replaces the Allowance for Loan and Lease Losses (ALLL) accounting standard. The CECL effective date for most SEC filers was after Dec. 15, 2019. For SRC and private companies, it went into effect after Dec. 15, 2022.
Instead of focusing on what’s incurred during a defined reporting period, CECL focuses on estimated losses. CECL applies to any businesses whose financial statements must adhere to the Generally Accepted Accounting Principles (GAAP). It’s currently being applied to several types of financial instruments and assets like trade receivables, contract assets, lease receivables, financial guarantees, and loan/loan contingencies.
What’s The Purpose Of CECL Adoption In Financial Reporting?
The goal behind the changes in ASU 2016-13 was to create a ‘one-size-fits-all’ model for assessing a business’ expected credit losses on any assets that have a cash flow stipulated by a contract. (Although it doesn’t apply to available-for-sale debt securities, which are continuing to be accounted for under ASC 320.)
The weak point of using the ALLL methodology and incurred accounting is that the losses were only being recognized on the financial reporting once deemed ‘probable.’ This made it challenging to estimate them. Many criticized this method, feeling it wasn’t reactive enough to give a warning of potential credit deterioration. Or simply put, it was too backward looking.
CECL shifts the focus to expected loss and gives a more proactive outlook. It allows for:
- Recognition of loss sooner
- Increased transparency around disclosures
- Improved alignment between risk management and accounting teams
How Is It Calculated?
Below we’ll break the new methodology down into simple steps. For more detailed information, we recommend visiting the FASB’s resource center for CECL.
1. Define Scope
You’ll need to start by figuring out what instruments should be subjected to CECL. Typically that could include:
- Held-to-maturity debt securities
- Lease receivables
- Off-balance sheet credit exposures
- Trade receivables
- Contract assets
2. Collect The Right Data
Next, you’ll need to have the right information to build out an accurate calculation. We recommend gathering relevant economic factors, historical credit loss data, and any other pertinent information about your financial instruments.
3. Segment Your Portfolio
After collecting what you’ll need, it’s important to put financial instruments into similar groups or segments based on their shared credit risk characteristics. Each grouping needs to have a similar risk profile to obtain as accurate an estimate of expected credit losses as possible.
4. Determine Your Expected Credit Losses (ECL)
Once you’ve gathered all your information, you’re now ready to calculate what your Expected Credit Losses are. You’ll need to do this for each segment you have identified to obtain an idea of expected losses over the life of those financial instruments. You can determine this with the following calculation:
5. Include Disclosures
CECL disclosure requirements are an important factor of this new methodology. You’ll need to provide transparent disclosures about the assumptions, methodologies, and data used in the calculation of expected credit losses.
Challenges Of Implementing The CECL Model
Some common challenges can arise from adapting CECL. Hear from our Partner and Technical Accounting Practice Leader about the 5 common pitfalls the Centri team has seen businesses face in implementing CECL.
Best Practices For Implementing CECL
To start, you’ll want to make sure you have robust data governance. Collecting and sharing the right data is key in starting to use the CECL accounting standard.
On the flip side, you’ll also need to plan out robust management reviews and internal controls. This is where establishing strong collaboration between your finance and risk management teams is a must.
Beyond that, there is no one-size-fits-all advice. The specifics of your company and its structure will come into play to determine how to implement it.
That’s where having an experienced partner is invaluable. Our team has the expertise from past projects to share what we’ve learned helping other businesses adopt CECL. Plus, as the future of CECL continues to evolve, we can guide your business and act as an extension of your team to help you implement it with confidence.
Need more guidance in implementing CECL? Learn how our technical accounting experts can help.
About Centri Business Consulting, LLC
Centri Business Consulting provides the highest quality advisory consulting services to its clients by being reliable and responsive to their needs. Centri provides companies with the expertise they need to meet their reporting demands. Centri specializes in financial reporting, internal controls, technical accounting research, valuation, mergers & acquisitions, and tax, CFO and HR advisory services for companies of various sizes and industries. From complex technical accounting transactions to monthly financial reporting, our professionals can offer any organization the specialized expertise and multilayered skillsets to ensure the project is completed timely and accurately.
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