New Accounting Standard Recognizes Losses Earlier

By Eric Woodruff, CPA, CCIFP
Partner, Director of Audit & Assurance Services
Email Eric

The last of the Financial Accounting Standards Board’s “Big Three” Accounting Standard Updates — (ASU) 2016-13, Measurement of Credit Losses on Financial Instruments — is now in effect.

Under generally accepted accounting principles (GAAP), the old standard delayed recognition of credit losses until it was probable they had been incurred. The new standard, commonly referred to as Current Expected Credit Losses (CECL), allows for earlier recognition by incorporating historical loss information, current market conditions and reasonable, supportable economic forecasting in the process of measuring and reporting losses.

The final measurement reflects an organization’s current estimate of all expected credit losses over the contractual life of financial assets.

When measuring the allowance for credit losses (formerly known as the allowance for doubtful accounts), entities should pool assets that share similar risk characteristics, including location, age, term, industry or credit ratings.

In terms of the scope of the CECL standard, it applies to the following financial assets measured at amortized cost:

  • Loans
  • Trade receivables
  • Contract assets (including retainage)
  • Net investments in leases as a lessor
  • Held-to-maturity debt securities

It excludes:

  • Loans and receivables between entities under common control
  • Pledges receivable for nonfarm payroll (conditional and unconditional)
  • Notes receivable for employee benefit plans
  • Operating leases of lessors

The CECL standard is effective for fiscal years beginning after December 15, 2022. Institutions should implement this guidance with a cumulative effect adjustment to retained earnings in the adoption period. In other words, private entities with a calendar year-end initially adopt the standard on January 1, 2023. The cumulative effect adjustment enables entities to increase their allowance for credit losses through an adjustment to equity rather than impacting net income.

Entities should start assessing their asset pools based on risk characteristics, reviewing their historical loss rates and identifying whether an additional allowance for credit losses is necessary at the date of adoption.

If we can assist you further with your business or personal affairs, please email Eric or call us at (317) 608-6699.