CECL disclosures: Postadoption complexities

CECL disclosure requirements aren’t just for banks

The FASB’s new standard on accounting for expected credit losses (codified in ASC 326) adds to US GAAP the CECL impairment model that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes its estimate of expected credit losses as an allowance. The CECL model incorporates forward-looking information and results in earlier loss recognition than incurred loss models do.

While banks and other financial institutions are often viewed as being the most significantly affected by the new CECL standard from a financial reporting and regulatory perspective, ASC 326 applies to all entities. Although many nonbank commercial entities do not engage in significant lending activities, substantially all commercial entities have financial instruments and other assets (e.g., trade receivables, contract assets, certain lease receivables, financial guarantees, loans and loan commitments, and held-to-maturity debt securities) that are subject to the new CECL standard.

The guidance in ASC 326 became effective in the first quarter of 2020 for calendar-year-end public business entities that are SEC filers, excluding smaller reporting companies. Many public business entities have been applying the new CECL standard for almost a year, but the current economic environment is creating new complexities that companies may find challenging to address with their current processes. Entities may want to evaluate CECL postadoption complexities and how they can enhance their policies and processes related to the new standard, especially as year-end approaches.

For an overview of how the new CECL standard affects nonbank entities, see Deloitte’s July 1, 2019, Heads Up.

CECL postadoption complexities: What we’ve learned

After the issuance of Form 10-Q filings for the first quarter of 2020, we analyzed a sample of disclosures by Fortune 100 nonbank entities in connection with the new CECL standard. Not surprisingly, we observed that many nonbank entities either (1) disclosed that the impact of the new CECL standard is immaterial to their financial statements or (2) did not disclose first-quarter adoption of the CECL standard at all.

While many of the disclosure requirements in ASC 326 do not apply to trade receivables with an original maturity of one year or less, all entities with financial instruments that are within the scope of the new CECL standard must provide certain enhanced disclosures. Specifically, ASC 326-20-50-10 requires entities to provide users with information that allows them to understand the following:

• The method and information management used to develop its estimate of expected credit losses. 
• If applicable, the circumstances that caused a change in management’s estimate of credit losses, resulting in either additional credit loss expense (or reversal of an expense) during the period. 

More information about disclosure observations can also be found in that same July 1, 2019, Heads Up.

Models and data

The new CECL standard does not prescribe any single method for determining expected credit losses. Consequently, entities have latitude to develop processes that are appropriate for the credit risk (and financial statement misstatement risk) associated with their specific assets that are within the scope of the new CECL model.

When complying with the new CECL standard, entities generally base expected losses for each aging bucket on historical loss rates adjusted for expected changes in loss rates as a result of current and forecasted economic conditions. These models can present challenges in periods of economic downturn or recovery.

Aging may not reflect current expected credit risk: In an economic downturn or recovery, the number of days a receivable has been outstanding or past due may not be indicative of the expected credit loss associated with the receivable.

A downturn or recovery may affect different entities at different times: The new CECL standard requires entities to determine expected credit losses for each pool of in-scope financial instruments (e.g., receivables). Receivables are pooled to the extent that they exhibit similar risk characteristics. While the current economic conditions are having a negative effect on many industries, these conditions are resulting in accelerated growth in certain industries.

Concessions versus credit losses: Even if an entity concludes that it does not need to change its existing expected credit loss models to address the current or expected economic environment, it may want to consider how the current economic environment is affecting the data used to determine expected credit losses.

Governance and forecasting

In developing forecasts during the current economic downturn, including those used in determining expected credit losses, entities have needed to make quick, judgmental decisions regarding assessments, process design, internal controls, and governance. It is important to ensure that governance committees (i.e., the parties responsible for evaluating and challenging forecasts) are provided with enough information to make informed decisions.

With all the uncertainties related to the current economic downturn, including the timing and pattern of economic recovery, more companies are preparing multiple forecasts with different recovery scenarios and are probability-weighting the likelihood of each outcome.

Continue your CECL learning

For a comprehensive discussion of the new CECL standard, see Deloitte’s A Roadmap to Accounting for Current Expected Credit Losses. If you have questions about the standard or need assistance with interpreting its requirements, contact Deloitte.