In addition to financial institutions, non-financial services entities also have exposure to Current Expected Credit Loss (CECL) through trade accounts receivable, loans receivable, off balance sheet credit, and more.
The well-defined CECL accounting standards for banks, credit unions, and other banking companies must be understood and complied with for non-financial institutions that may not even know their financial guarantees and financial assets are under the scope of CECL.
Every operating entity should assess its financial reporting and accounting capacity in light of CECL's credit impairment model.
What Is CECL?
The CECL accounting standard originated in 2016 from the Financial Accounting Standards Board (FASB). Between 2019 and 2022, most SEC filers fell under CECL guidance, with the standard going into effect for most other institutions by 2023.
CECL is considered one of the largest changes to financial institution accounting in decades, replacing the previous impairment model (also known as incurred loss model) with a more forward-looking credit loss model in light of the financial crisis of 2008-2009. Instead of relying on incurred losses, the new standard is centered on expected losses across the life of a loan. The accounting standards update forces institutions to estimate credit losses over the contract term of the financial instrument.
The objective is to have a more accurate and timely recording of credit losses now and in the future without relying solely on incurred losses, which don't reflect the reality that future cash flows might not be collected in times of economic stress.
In-Scope Financial Assets Under CECL
The CECL model is inclusive of a wide range of financial assets, including but not limited to:
- Receivables from loans and notes.
- Receivables from trade and contract assets resulting from revenue transactions.
- Receivables from time-sharing or direct financing leases.
- Loan commitments.
- Mature debt securities.
More information from the Federal Reserve can be found here.
Out-of-Scope Financial Assets Under CECL
Loans and receivables between companies under common control do not fall under the CECL model. This is due to the FASB's view that loans of this kind (even if they result in loan loss) occur between related parties and may be considered capital contributions and not a traditional loan to be repaid.
Financial assets measured at fair value -- including through net income, loans from defined contribution employee benefit plans, etc. -- also are not counted as expected loss under CECL.
Other types of assets not specifically addressed by the CECL standard may be in or out of scope based on a number of conditions and definitions, so it's best to partner with an advisory services firm to ensure proper accounting, disclosure, and compliance.
Key Considerations for Non-Financial Institutions
Non-financial services entities may find themselves on the hook for CECL if they have assets held at amortized cost-like accounts and notes receivable, such as lessors with a sales-type or direct finance-type lease, or entities with off balance sheet credit exposures.
Most have concluded that CECL will not have a significant impact on their reserving levels, which is likely true, but not enough. You must perform the analysis and document your rationale and position with proper substantiation - such as historical loss experience.
We'll walk through some key considerations for non-financial entities, as well as what may prove to be a challenge.
What Needs to Happen for Non-Financial Institutions to Ensure CECL Compliance?
1. Review your balance sheet and financial statement notes to identify potentially in-scope financial assets. Some considerations would be:
You will likely have to go a few levels below your balance sheet to look more deeply into other assets, etc.
Are you the lessor in any sales-type or direct finance leases?
2. Document financial assets in scope including rationale for in or out of scope.
3. Determine reasonable approach to producing a CECL estimate based on your portfolios and your data. Some modeling considerations are:
- A variant of a historical loss rate model provides a good starting point, but you still must document how you determined your historical loss rate.
- Another approach may be to use your accounts receivable aging schedules. A close look at what data you have available and the analytic reports you use will help assess your credit exposures as these schedules and analyses will provide guidance in how to calculate your expected credit loss under CECL.
4. Document your selected modeling approach and how reasonable forward-looking and supportable forecasts are incorporated. Categorizations may be based on asset lifetime, such as:
- Short-term trade receivables may not require much research.
- Longer-term in-scope assets will require more judgment documentation.
5. Evaluate and potentially draft disclosures for CECL. However, if most in-scope assets are short-term trade receivables, you likely won’t need to prepare any of the other credit quality disclosures due to the short-term nature of those receivables.
What Makes Some of the Non-Financial Services CECL Assessments More Challenging Than Others?
1. A conglomerate with multiple entities:
- It’s hard to share the message, provide training and ensure consistency in judgments across a decentralized organization.
- CECL does not require the same approach to calculating the expected credit loss across entities or portfolios, but if they are similar, then the key judgments and approach should share some consistency. The various entities may have different data that they capture, which could easily be housed in various systems. A one-size-fits-all approach may not work across a conglomerate of entities.
2. Communication among impacted groups:
- The implementation of CECL and coordination between credit risk, underwriting and operations is challenging. These groups are not accustomed to sharing information and reporting externally on information provided by risk management. In order to implement, they must understand one another and work cooperatively together.
3. Less industry discussion and coordination:
- Making it a challenge to figure out how your peer groups will incorporate CECL, there historically has been less discussion regarding its application to non-financial services entities than there has been for financial services.
For expert support in implementing CECL, contact CrossCountry Consulting today.
Editor's note: Updated March 2022