Demystifying CECL: A guide for NFPs to managing credit losses

Notes receivable with carried amortized cost? Loans made to officers or employees? Financing leases where you are the lessor? If you have trade and financing receivables (think instruments with accrued interest receivable or a note receivable), or any of the other triggers mentioned above, then you should be prepared for the new standard for reporting current expected credit losses and applying it now.

Considered one of the most significant accounting changes in decades, the new current expected credit loss (CECL) standard affects the way organizations evaluate impairment of financial assets such as loans, receivables and investments in debt securities. All organizations with balances due to them, or that have an off-balance-sheet credit exposure (such as a guarantee) will feel the effects. Depending on the size and nature of the receivables and other financial instruments on the balance sheet, organizations can expect major impacts through both the changes in loss reserve methodology itself, as well as the associated technological, operational and reporting advances required for proper implementation to record allowance for certain trade and financing receivables under Accounting Standard Update (ASU) No. 2016-13: Financial Instruments – Credit Losses.

We’ve written extensively on the subject, but here are the top five things that not-for-profit organizations should know.

1 – Timeline

Not-for-profit (NFP) organizations will be required to adopt CECL for fiscal years beginning after Dec. 15, 2022. This timing reflects an extension in the implement date made by the Financial Accounting Standards Board (FASB) to allow organizations addition time to prepare for the transition following the COVID-19 pandemic. So, what this really means is that you need to be working on your CECL implementation now.

2 – CECL scope

It is important to know what is, and what is not, scoped in under the regulation. Some of the most relevant pieces to note for NFPs are:

What’s in scope

• Trade receivables
• Contract assets that result from revenue transactions or other income
• Student or patient receivables
• Loans receivable
• Notes receivable
• Loans to officers and employees

What’s not in scope

• Promises to give (pledges receivable)
• Investments at fair value (available for sale debt securities, trading securities, equity securities)
• Loans made to participants by defined contribution employee benefit plans
• Loans between entities under common control
• Loans held for sale
• Receivables arising from operating leases only

3 – Forward-looking approach

Different from the current accounting guidance that focuses on historical and current information to assess credit losses, a goal of the CECL standard is to ensure a forward-looking approach to credit loss recognition. It requires organizations to account for foreseeable economic conditions when estimating expected credit loss. Consideration should be given to both internal and external economic data to develop a reasonable and supportable forecast.

4 – Methodologies

Part of your CECL implementation is selecting the methodology by which you will estimate credit losses. Your selection should factor in the characteristics of your organization’s loan portfolio and should be reasonable, systematic and consistently applied. Most NFPs will not require complex methodologies and may consider choosing to use a loss rate or aging method. The methodology used is one of the new required disclosures in the accounting policy footnotes to your financial statements.

5 – Expertise

While CECL is not rocket science, it can be complicated and does require awareness and understanding. Organizations should provide training to staff members responsible for estimating credit losses under the new regulation and ensure they understand the practical implications and necessary changes mandated under CECL. External consultants can also be a valuable resource when transitioning to and implementing your CECL methods.

It is also important to take note of the common elements that should be included in your CECL financial statement disclosures, namely:

1. Accounting policies
2. The nature of financial assets
3. An explanation of the methodologies and models used
4. Disclosures of credit quality
5. Changes in expected credit loss during the reporting period

CECL is a significant change in how many trade and financing receivables are recorded, and organizations need to be ready now.