5 Considerations for CECL Adoption – Lessons Learned

In June 2016, the FASB issued ASU 2016-13 (Accounting Standards Codification (“ASC”) 326 – Financial Instruments – Credit Losses) (“CECL”), which is effective for smaller reporting companies and private entities for annual and interim periods in fiscal years beginning after December 15, 2022.  The standard applies to any entity that has financial assets such as trade receivables, contract assets, lease receivables, financial guarantees, loans and loan commitments, available-for-sale, and held-to-maturity debt securities. It requires an estimate of lifetime credit losses to be recognized on day one.

Whether your company is a mortgage REIT, a fund that invests in debt products, a manufacturer or a retailer, or a business that holds any of the other assets above, we hope you can learn from these lessons that arose from CECL implementation projects we previously performed.

Lesson 1 – Do not underestimate the effort required to adopt the standard.

The process for developing an appropriate credit loss reserve calculation involves new factors that were not previously required by existing GAAP.  For example, the standard requires that your company pool assets based on similar risk characteristics, which are subject to significant judgment. Also, the standard requires the development of reasonable and supportable forecasts, which will entail, among other things, consideration of macroeconomic indicators that could impact your company’s expectation of potential lifetime losses.  Further, this standard does require additional financial statement disclosures.

Lesson 2 –Choose economic indicators that are most relevant to the financial asset being evaluated for estimated credit loss.  

Companies may be tempted to automatically conclude that their legacy policies and processes to estimate allowances or reserves will suffice in complying with the CECL requirements. While the standard does not prescribe a specific method to estimate expected credit losses, it provides examples of acceptable methods, and companies can leverage their current methodologies to record the allowance for credit losses. Under this new standard, your company must adapt the current methods to estimate expected lifetime credit losses in order to account for changes in current conditions that indicate historical losses may need to be adjusted. This process will entail adjusting historical loss experience for current conditions and identifying a reasonable support forecast of those economic indicators most relevant to estimating the credit loss for each financial asset.

Lesson 3 – Consider the risk factors that give rise to separate risk pools for each financial asset.

CECL requires pooling financial assets with similar risk characteristics for the purpose of estimating expected credit losses, a new requirement under this model. An asset is only measured individually if it does not share similar risk characteristics with other assets, and the basis for such a conclusion must be adequately supported. This standard provides a list of characteristics your company may consider in aggregating assets into pools, which include credit and non-credit factors that may impact the risk of loss. The decision on the factors to be considered in quantifying risk pools should be addressed early in the CECL adoption process.

Lesson 4 – Consider all financial instruments within the scope of CECL.

CECL covers a wide range of financial instruments and other assets, except for assets measured at fair value. These assets include trade receivables, contract assets, lease receivables, financial guarantees, loans and loan commitments, available-for-sale and held-to-maturity debt securities. Accordingly, companies must properly identify the assets in scope and estimate expected credit losses using methods that are appropriate for each type of asset. Your company may have more than one financial asset. Not only is it important to identify all the financial assets, but it also is critical to apply the right model.

Lesson  5 – Consider the adequacy of historical loss data.

Assessment of historical losses is just the starting point for CECL adoption. Under CECL, those historical losses need to be segregated by risk pool to obtain the foundation for the model.  A company’s policy for credit write-offs and related accounting will need to be considered when quantifying historical credit losses by risk pool.  While your company may be diligent in identifying potentially uncollectible amounts and recording an allowance timely under legacy GAAP, processing actual write-offs could have been sporadic and impactful to historic credit loss trends. Therefore, quantifying the actual credit losses may involve a deeper dive into the details of allowances for doubtful accounts under legacy GAAP and analyzing when accounts should have been written off.

How Centri Can Help

As your company embarks on its journey for the adoption of CECL, here are some ways Centri has helped our clients and can help you:

• Serving as the central point of contact for the working group responsible for CECL adoption by ensuring that responsibilities are clearly defined, and critical deadlines are met
• Reviewing your current credit loss policy and procedures to determine changes needed to meet the requirements of the new CECL standard
• Estimating the credit loss using historical loss experience and forecasting based on pools of similar assets as required by the standard
• Preparing a memorandum documenting the adoption impact of CECL, assumptions used, and illustrative financial statement disclosures
• Assisting with maintenance of the model for subsequent accounting periods, as needed

We recognize the complexities this new standard brings and have the expertise to assist you in navigating through the adoption of CECL. Contact us to learn how we can help your company succeed.