The CECL standard may affect the way businesses calculate and report their expected credit losses—and it's going to have an impact on far more businesses than many chief financial officers expect.
CECL has significant implications for the banking industry. But it's a misconception that CECL only affects lenders and banks. Here's the reality: After January 2023, CECL compliance is a requirement for every business that holds financial assets recorded at amortized cost, with certain exceptions.
We have answers to your most important questions about CECL implementation and compliance—and pointers to next-step CECL resources.
What is CECL?
CECL refers to new accounting guidance for credit losses that are expected to occur. This new guidance was set forth by ASU 2016-13 Financial Instruments–Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (Topic 326) and replaces much of the existing accounting guidance under ASC Topics 310 and 450. Prior to adopting Topic 326, companies would recognize losses on financial instruments when it was probable that a loss had been incurred. In contrast, Topic 326 bases loss recognition on expected losses, which results in entities reflecting expected credit losses for the life of the financial asset.
While the fundamental changes to the recognition criteria alone are substantial, the broad scope of the standard adds to its impact. Subtopic 326-20 addresses the accounting for financial assets held at amortized cost basis, such as trade receivables, loans, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables and held-to-maturity debt securities.
When must CECL be implemented?
The new standard, which includes guidance for CECL, came into effect in 2020 for Securities and Exchange Commission filers that are not smaller reporting companies. There were some exceptions made through the CARES Act and some filers received an extension until Jan. 1, 2022. For all others, the standard is effective for periods beginning on or after Dec. 15, 2022 (2023 calendar year-ends), including all interim periods within that fiscal year.
What is the scope of CECL? Does CECL only apply to banks?
The CECL model applies to most financial assets not recorded at fair value. Although it will have a greater impact on the banking industry, most nonbanks have assets subject to the CECL model (e.g., trade receivables, contract assets, lease receivables and held-to-maturity securities).
CECL does not apply to financial assets that are measured at fair value through net income, loans by defined contribution employee benefit plans to participants, policy loans of insurance companies, pledges to nonprofit entities, and loans and receivables between entities under common control.
Why is CECL such a big deal?
The credit losses standard consists of ASC 326-20 (amortized cost assets). Substantially all assets within the scope of ASC 326-20 will require an allowance for expected (rather than incurred) credit losses including:
- Cash equivalents
- Held-to-maturity debt securities (regardless of the relationship between fair value and amortized cost)
- Receivables and contract assets, including those that are current or from pristine customers
- Purchased/acquired financial assets (e.g., loans, receivables, held-to-market securities)
- Financing receivables, loans and net investments in leases
Under ASC 326-30, an available-for-sale debt security will require an allowance for credit losses if its fair value is less than amortized cost and there are indications of credit impairment.
- An organization can no longer rely on post-balance sheet fair value recoveries or brief periods of time in an unrealized loss position to avoid recognizing a loss
- Write-downs to fair value continue to be required if the entity intends to sell the security or if it is more likely than not that it will be required to sell the security
Is there a required CECL methodology?
The standard does not prescribe a specific methodology for calculating an expected lifetime credit loss reserve. However, CECL calculations must include considerations related to historical performance, as well as current and future trends affecting credit defaults and losses. The judgments and estimates used in the forecasting process will need to continue to be refined and updated as actual and forecasted economic conditions change.