In 2016, the Financial Accounting Standards Board (FASB) introduced a new impairment model, Accounting Standards Update (ASU) No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, commonly known as Current Expected Credit Loss (CECL).
In The ABCs of CECL , we provided a high-level overview of the new standard, including whom it impacts, when it becomes effective and how consultants can help with implementation. In this second of a three-part series, we’re taking a deeper dive into CECL to discuss the industries that will be impacted and review the phases of implementation.
Industries impacted by CECL
The new credit impairment standard will broadly impact financial services companies and non-financial services entities.
In PwC’s in-depth look at current financial reporting issues surrounding CECL, it noted several relevant considerations for non-financial services companies:
- Trade receivables.CECL will become the single model to measure impairment of financial assets measured at amortized cost, including trade receivables. Companies are required to estimate expected credit losses on trade receivables over their contractual life.
- Lease receivables in a sales-type or direct financing lease.Companies with lease receivable balances with property or equipment leased to other companies will need to make projections of collateral value at lease commencement to calculate a CECL reserve.
- Loans and loan commitments.Companies with loans to officers or employees, store credit card arrangements, tax refunds receivable, and insurance settlements receivable should carefully review their balance sheets to determine whether an allowance for credit losses is required.
- Financial guarantees.Companies that issue financial guarantees to other entities must estimate expected credit losses separately from the fair value of the guarantee liability.
- Held-to-maturity debt securities.Companies will need to group financial assets with similar characteristics to estimate and maintain allowances for expected credit losses.
The CECL model’s scope excludes available-for-sale (AFS) debt securities. However, FASB made targeted improvements to the existing impairment model to eliminate the “other than temporary” concept. Under the new standard, credit losses on AFS debt securities are recorded through an allowance rather than writing down the security’s cost basis. The new impairment model requires an estimate of expected credit losses on AFS debt securities when the security’s fair value is below its amortized cost basis and does not permit pooling of securities.
Converting to CECL
In July of this year, FASB voted to extend the effective date for all non-SEC filers to 2023. However, if we’ve learned anything from the recent revenue recognition and lease accounting standards, it’s not to delay implementation. To avoid rushing the project, your organization should begin work 24 to 30 months before implementation.
Here’s what you can do now to ensure a smooth transition to CECL compliance.
Consider organizing an implementation team to deal with the far-reaching impact of CECL, get a clear understanding of the organization’s current state, and develop and implementation timetable.
Because compliance with CECL will require a tremendous amount of data, the team will need to begin preserving loan data, identifying other data that can be recovered quickly and economically, and determine the cost of collecting missing data.
Because CECL requires organizations to grapple with so much data, most organizations will find that Excel is not an acceptable solution and will need to convert to an automated system.
Whether you develop or buy a solution, you need to be able to test different models, make changes in projections, and compare results from different models to your current processes and results.
Preparing for CECL will also involve rewriting and documenting policies, including the methodology and how the model works. Even a good modeling process will have trouble withstanding auditor and regulatory scrutiny if internal controls are not clearly documented.
Testing and parallel run
Testing is one of the most challenging parts of CECL implementation because the only way to truly test a CECL model is to run it and compare the model projections with existing systems. Set up the infrastructure for regular operation, run it concurrently with established systems, and deal with any unexpected differences in factors well in advance of full implementation.
The process to fully implement a system for CECL can be complex, time-consuming and will impact the accounting processes of many organizations. Controllers and CFOs should act now to understand how CECL will affect internal controls, data gathering, systems and financial reporting processes.
Parker + Lynch Consulting is a professional services and consulting firm specializing in providing strategic solutions and project execution services within the CFO organization. Our focus areas include technical accounting, finance transformation, M&A integration, audit and PMO.