CECL: The banking standard that is not just for banks

It is billed as the biggest change to bank accounting in decades. But it is not just for banks.

Tucked into the Financial Accounting Standards Board’s (FASB) sweeping new accounting standard that upends how banks account for loan losses are provisions that can apply to all types of businesses.

This may take some non-financial institutions — fresh off the adrenaline rush from implementing the new, separate revenue and leases standards — by surprise.

“If you’re not thinking about this at all, shame on you,” said Bruce Pounder, executive director of an accounting consulting firm.

The FASB has repeatedly said the standard does not just apply to banks, but financial institutions have been getting the majority of the headlines in the lead up to the public company 2020 effective date of the Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. In addition to loans, the new accounting rules apply to debt securities, off-balance sheet guarantees and trade receivables, among other financial assets.

Trade receivables — amounts billed to customers when a business delivers goods or services to them — are where most companies will have to consider the effects of the new accounting standard.

“That bill will say, ‘Here’s what we did, you have 30 days to pay us,’” said Ted Timmermans, vice president and controller at The Williams Companies, Inc. in Tulsa, Oklahoma. “It’s a very foundational, fundamental element of most businesses across America. Most everybody is not going to be immune to this.”

Under outgoing Generally Accepted Accounting Principles (GAAP), the energy company would bill a customer for, say, providing services to move natural gas through a pipeline, and because there was no evidence that the customer was going to miss payments, the company did not have to book a loss or record bad debt expense until the account became delinquent. Under the new standard, called the current expected credit losses model or CECL, that all changes.

The Williams Companies may have to look at past evidence — has the customer typically paid on time? — and also at greater economic characteristics to decide whether to book losses, Timmermans said.

“I don’t expect the measure of it to be very significant or material, but the process of developing the math and the formula for that — that’s going to take time, some historical analysis, and it’ll take judgment,” he said. “These turn pretty quickly, but the reality is they don’t all turn in 30 days and you’ll likely have some history of loss.”

That is the main thing, said Sean Prince, senior manager at an accounting firm; companies have to set up the processes and controls to make the assessment about potential losses, even if they think it will not be a big deal.

“If we’re truly talking a 30-day trade receivable, the impact may be immaterial,” Prince said. “But this is one of the biggest takeaways: You can’t just ignore it.”

The FASB published ASU No. 2016-13 in 2016, and it is considered the board’s signature response to the 2008 financial crisis. It requires businesses to look to the future, make reasonable and supportable estimates, and set aside reserves to cover losses on loans and other types of financial products.

The board developed the standard after the crisis laid bare the flaws with existing GAAP’s so-called incurred loss model. Under outgoing accounting rules, banks and businesses are prohibited from using forward-looking information to calculate losses. Instead, they record them only after losses are “probable,” a threshold that in practice means when a customer stops making payments. In the lead up to the financial crisis, analysts saw dark clouds ahead but bank balance sheets looked healthy. Investors, regulators and bankers themselves pointed to GAAP’s prohibition against using forward-looking information to calculate loan losses and asked the FASB for changes.

The FASB delivered.

Starting in 2020, publicly traded businesses must use estimates about the future, historical experience and broader economic changes, such as spikes in the unemployment rate or signs of slumps in the local real estate market, to determine how to calculate what they will lose on their financial assets. It is expected to result in earlier recognition of losses compared to today.

For banks, this means major changes. Many expect their loan loss reserves to spike. They also expect to have to boost the regulatory capital they hold, which could mean less money to lend to customers.

For operating companies that do not already have significant bad debt reserves, the change will be nowhere near as significant, but it is still going to require effort.

“The quantitative impact may be less for some of these industries, but everybody’s going to have to put in processes to apply it and do an analysis to demonstrate adoption,” said Matt Schell, partner at an accounting firm.

The issue is on the radar of Mortgage Real Estate Investment Trusts (REITs), which provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities, which will have to evaluate their debt securities to accommodate CECL. But equity REITs, companies that own and typically operate income-producing real estate like shopping malls and office buildings, also need to pay attention because they also could have trade receivables.

“REITs still have to evaluate whether or not they’re in scope and then develop accounting policies and internal controls documentation to address the new standard,” said Chris Drula, senior vice president, financial standards at the National Association of Real Estate Investment Trusts. “They still need to do the work.”

In addition to companies with trade receivables, the standard also will affect businesses with financing arms and those that hold debt securities. Off-balance sheet credit exposures, including loan commitments, standby letters of credit and financial guarantees that do not qualify as insurance also will get wrapped in.

“When we go around and talk to different entities, that’s probably the number one thing people forget about because that’s not a financial asset they have on their books,” Schell said of off-balance sheet credit exposures.

FASB members and members of its research staff have repeatedly said in speeches and presentations that CECL is not just a banking standard. Under ASU No. 2016-13, the new accounting affects “loans, debt securities, trade receivables, net investments in leases, off-balance-sheet credit exposures, reinsurance receivables and any other financial assets not excluded from the scope that have the contractual right to receive cash.”

“It really affects an extraordinarily broad array of companies,” Pounder said.

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