The new expected Current Expected Credit Loss (CECL) standard isn’t exactly sneaking up on anyone at this point. After all, it’s not like the fine folks at the Financial Accounting Standards Board (FASB) have been quiet about it. And yet, many organizations are still searching for answers and advice, despite a rapidly encroaching deadline and a tidal wave of changes CECL carries with it.

Thankfully, we have your back here at Embark. That’s why we’ve put together a few critical insights to help prepare you for CECL. Think of it as a heads-up of sorts to prevent you from being blindsided by that tidal wave.

CECL Accounting Is a Significant Change

For entities that borrow and lend money, the CECL standard – as spelled out in ASU 2016-13 – is one of the most significant accounting changes to come along in decades. Sure, banks and credit unions are the most obviously impacted organizations, but companies from a wide variety of industries will also feel the effect of this landmark accounting standards update.

In fact, the new credit loss standard impacts any enterprise that accounts for investments and receivables, or is susceptible to credit risk through commitments, guarantees, and other financial instruments carried at amortized costs. Naturally, that includes everything from small businesses to global conglomerates, with plenty in between.

So what does this mean in plain English? The CECL model impacts the following items for an enterprise that falls under its wide-reaching spell:

• Trade receivables resulting from revenue transactions
• Particular lease receivables recognized by a lessor
• Financial guarantee contracts
• Loan commitments
• Reinsurance receivables or recoveries resulting from insurance transactions
• Held-to-maturity debt securities, except ones measured at fair value via net income
  
  

Further, the ASU allows companies to aggregate financial assets according to either a single or combination of risk characteristics. However, if an asset doesn’t share such characteristics with other assets, then you must evaluate it individually.

The CECL Model vs Legacy GAAP

Think of the new credit loss accounting standard as an elimination of the incurred credit impairment loss model you're probably well acquainted with, replacing it with an expected loss approach built with an eye focused on the road ahead. To put a finer point on it, let's look at the key differences between the legacy guidance and the new current expected credit loss model.

Loss Horizon

Current US GAAP standards produce an estimate of incurred losses in the portfolio as of the date of the balance sheet. By contrast, the CECL model requires companies to estimate the lifetime losses of an asset, beginning at the purchase of the asset or origination of the contract, and extending through its entirety, making it more forward-looking in nature.

Loss Recognition

Under existing GAAP, a company delays recognition until it’s probable the loss has been incurred. The CECL model takes a significantly different approach, providing an allowance for losses expected over the contractual life of the asset – even if the probability of loss is remote – which the enterprise recognizes immediately upon origination or acquisition.

Basis for Credit Loss Estimates

Under the existing incurred loss model, management is only allowed to consider historical information when estimating losses on financial assets. Under the CECL model, companies should continue to include historical loss information when determining estimated losses. However, they should also consider current conditions, reasonable and supportable forecasts, as well as the segmentation of similar financial assets.

While this departure from legacy GAAP and vintage analysis makes loss estimation more decision-useful and forward-looking, you’ll want to adequately document these considerations to make sure both stakeholders and auditors are satisfied.  

CECL Effective Dates

Of course, understanding what you're up against is only half the battle. All the know-how in the world does you no good if you don't adopt the new standards and methodology within the proper time frame.

With respect to CECL, the FASB permitted early adoption for all entities for annual periods beginning after December 15, 2018, and interim periods therein. For enterprises that did not elect early adoption, the CECL day one implementation timelines are as follows:

• Public business entities (SEC filers) – Fiscal years beginning after December 15, 2019, including interim periods. In other words, that ship has sailed.
  
  
• Nonpublic entities, smaller reporting companies (SRCs), most emerging growth companies (EGCs) – Fiscal years beginning after December 15, 2022, including interim periods. Please note the FASB has deferred this effective date for nonpublic entities from its original FY 2021 mandate.

Other Considerations

Aside from the details and deadlines we've provided above, we also wanted to point out a few other considerations. Think of these as items to keep in the back of your mind as you prepare for the CECL model.

• The new accounting standard will impact a bank's annual stress test protocol since the scenarios used under CECL differ from the stress testing used by the Federal Reserve.
• The CECL standard may very well affect your internal controls and, in turn, the data used for your financial reporting. 
• Unlike updates to most other accounting principles, CECL isn't relegated to your accounting and finance functions. Therefore, since it impacts your overall risk management procedures, everyone from IT and FP&A to your board should be involved.
• Given the relative complexity of the CECL model, your financial statement preparers must develop disclosures that are transparent enough for a user to understand, but not so much that they become overwhelming.
• ASU 2016-13 provides organizations with several measurement approaches to estimate expected credit losses, specifically, the discounted cash flows, loss-rate, roll-rate, probability-of-default, and aging schedule methods.

Final Thoughts

Obviously, companies within the financial services industry – from community banks to massive Wall Street firms – are squarely within the new standard’s bullseye. Therefore, these organizations are typically looking at a steeper CECL accounting mountain to climb, including areas like allowance for loan and lease losses (ALLL) and others that don’t necessarily apply to other industries.

That said, as previously mentioned, the CECL standard’s potential impact is in no way relegated to financial services, and has everyone from the SEC and Federal Reserve to the OCC (Office of the Comptroller of the Currency) and FDIC closely watching. In fact, the OCC, Federal Reserve, and FDIC even issued an interagency joint statement on the matter, discussing regulatory capital requirements around the CECL standard and how it interacts with the CARES Act.

For all of you non-banks that might be reading this, though, please take solace in the fact that the new guidance is flexible, giving you leeway to chart your own CECL implementation course, so long as your procedures are accurate and practical relative to the facts and circumstances. Likewise, you must always comply with the guiding principles of the rules for the measurement of expected credit losses, particularly when it comes to using reasonable and supportable forecasts.

As for the future, CECL and related measures will probably continue to evolve in some respect so, as is typical with the accounting standards, nothing is set in stone. To that point, the FASB has already issued updated guidance in the form of ASU 2022-02, speaking on the measurement of credit losses on financial instruments. In it, the FASB refines guidance on accounting for troubled debt restructurings (TDRs) and purchased credit-deteriorated assets, also amending the vintage disclose table spelled out in ASU 2016-13.

So, yes, there’s a lot going on around CECL. However, it’s all in an attempt to provide stakeholders with more reliable, insightful, and timely information on expected credit losses, not to throw another arbitrary hurdle into your accounting procedures. So keep your chin up, that rapidly-approaching deadline clearly circled on your calendar, and get to work. In the meantime, Embark is here to step in should you need us. It’s what we do.