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Hidden Complexities: 7 Key Considerations for CECL Compliance

As the impact of CECL begins to emerge, financial services firms have dominated headlines. Companies outside of this realm have taken varied approaches, and many have concluded that CECL will not have a significant impact on their reserving levels. Many non-financial institutions perceive the costs necessary to purchase a vendor model producing CECL results outweigh the benefits.

Development of in-house CECL models is a logical choice for these entities. As discussed in our prior post “CECL Considerations for Non-Financial Services: Still On the Hook,” any model-based approach must enable a robust analysis, and companies electing to develop in house must document the rationale regarding the historical loss experience and forecast assumptions. CECL will require greater coordination for those entities with decentralized functions, such as conglomerates with multiple operating companies, and often proves a more challenging implementation than anticipated.

During our work developing and implementing CECL compliance programs for non-financial institutions, we have found several key considerations:

7 Key Considerations for CECL Compliance

1. Compile a financial instrument checklist detailing in-scope financial statement line items (FSLI) and other financial assets (OFA) and    distribute to subsidiaries.
  • This is a good starting point for companies to identify potential in-scope financial assets such as trade receivables, contract assets (ASC 606), off-balance sheet exposures, loans to employees (not 401(k)), or sales-type or direct finance leases for lessors.
  • Bear in mind that in-scope financials assets identified may impact disclosures for CECL.

 

2. Draft a standard implementation memo and CECL model templates to ensure that there is consistency across decentralized functions.
  • Companies should determine the most appropriate CECL model and ensure that a consistent approach is applied. Popular options include the aging method, loss rate method, or a combination of both.
  • Model templates should incorporate approaches to pooling, historical loss rate calculation, qualitative adjustments and the final CECL calculation.
  • An effective approach requires project management, training, and communication throughout the implementation.

 

3. Determine receivable pooling based on similar risk characteristics.
  • Customer risk profiles may be determined through review of customer aging, customer type, geographic location or history of payments.

 

4. Calculate the historical loss rate and ensure adequate documentation.
  • Define the data collection process and ensure that the historical period is appropriate and indicative of the customer’s usual payment terms. For example, shorter historical aging periods are appropriate for short-term receivables where customers usually pay within ninety days.
  • Assess the historical loss data through a write-off review, including evaluating reliability of the data and whether it is an accurate reflection of past loss or credit write offs.

 

5. Document that current conditions and reasonable and supportable forecasts have been incorporated into the calculation.
  • Management must identify the key economic driver of losses on financial assets (if any) and adjust the historical loss rate for any future expectations relating to it. For example: For customers situated in geographical locations that pose a “higher risk,” companies could apply an adjustment to their CECL calculation to reflect the potential negative impact on collectability of customer balances.
  • For short-term receivables, entities may conclude qualitative adjustments are not necessary as economic factors are unlikely to impact the collectability of balances due to their short duration. All conclusions should be documented and supported with evidence of adequate research.
  • Entities can leverage the IMF World Economic Outlook as a starting point for economic outlooks and research. The IMF is an excellent source for interest rates, GDP growth, unemployment rates, etc. in key significant regions for the entity.

 

6. Other in-scope financial assets.
  • Contract assets (ASC 606) should be included in the CECL calculation. Entities with contract assets may often adopt the same approach as trade receivables because the customer base and historical loss would be similar.
  • Loans to employees, including those arising from 401(k) loans, are often overlooked but should be considered because they do pose credit risk to the entity.

 

7. Incorporate implementation and on-going controls over the CECL implementation.
  • Identify any additional controls needed over trade receivables or other in-scope financial assets.
  • Refine existing controls.
  • Hold discussions with the internal and/or external auditors to identify any gaps within the updated controls.

Developing a systematic approach and project management plan is key to a successful CECL implementation, especially for companies with numerous subsidiaries. Although CECL may not drive large reserve changes for companies whose primary exposure to CECL is trade receivables, they should ensure that processes and assumptions are documented appropriately and supported by adequate sources, whether internal or external.

As a reminder, if you are a non-SEC filer (even if you are a public business entity), or a smaller reporting company that is an SEC filer, FASB has proposed to delay implementation until January 1, 2023. However, preparation during this time period will ultimately make the CECL implementation process smoother.

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