Are you ready for the new Current Expected Credit Loss standard?

By Marla Lewis, Audit & Assurance partner, Deloitte & Touche LLP

• The Current Expected Credit Loss (CECL) accounting standard introduced in 2016 for public companies took effect for private companies in 2023.
• The CECL standard uses a forward-looking approach for estimating credit losses.
• Deloitte can advise private companies navigating accounting and documentation requirements for the CECL standard.

In the aftermath of the 2008 financial crisis, regulators realized that generally accepted accounting principles in the United States (US GAAP) rules for calculating bad debts (credit losses) had some sizable shortcomings. The rules at the time required companies such as lending institutions to calculate credit losses using an incurred loss model (ILM) based on probable credit losses. The mortgage meltdown, however, wreaked havoc on the ILM, and many investors that the information provided by the ILM about losses was “too little too late”.

The need for a new credit loss standard

To improve weakness in the ILM, in 2016 the financial accounting standards board (FASB) issued ASU 2016-13, which introduced the new CECL accounting standard. The standard took effect for public companies in 2020, with a stipulation that private companies would follow a few years later. The FASB indeed made the standard effective for most private entities as planned January 1, 2023 with the final implementation of ASC 326. Since then, Deloitte has received a number of questions about the standard from private company clients. What is it? How does it impact private companies? And what can we do to get ready? Here’s a brief overview of the CECL standard and what it does.

What is the CECL standard?

Unlike the backward-looking ILM, the CECL model requires companies to take a forward-looking view of their potential credit losses by estimating credit losses over the life of the asset when the asset first comes onto a company’s balance sheet. Estimated losses are recorded as a contra-asset, and both the initial expected loss and subsequent changes in the expected loss are generally recorded through net income. This method reduces risk by allowing companies, including banks and other lenders, to recognize credit losses earlier than with the previous ILM.

What’s the scope?

CECL applies to financial assets held at amortized cost: loans, debt securities, investments held to maturity, accounts receivable, trade receivables and contract assets that result from revenue transactions, and net investments in leases from the lessor’s perspective for sales type and direct financing leases. Assets measured at fair value are outside the scope of ASC 326.

Forecasts are required

With the CECL standard, it’s no longer enough to consider only previous credit loss data. In fact, the standard requires you to consider forward-looking information. These can include things like unemployment and GDP estimates. This future-focused approach is a significant change from typical accounting practices focused on reporting what happened in the past.