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What is CECL?

CECL, or Current Expected Credit Losses, refers to the Financial Accounting Standard Board’s (FASB) Accounting Standards Codification (ASC) 326. It made many headlines in 2020 as it significantly increased reserves at banks and finance companies heading into the COVID-19 pandemic.

In simple terms, CECL requires all companies, including private companies, to identify financial assets measured at amortized cost (accounts or notes receivable, loans, net investments in sales-type or direct finance leases, held-to-maturity securities, etc) as well as available-for-sale debt securities. Companies then must estimate all expected losses due to credit risk in financial assets for the contractual life of those assets and record the lifetime estimate as an allowance.

CECL is crucial because it changes how companies account for credit losses and the need for more accurate and timely recognition of credit losses in financial reporting. Furthermore, it provides a more realistic reflection of a company’s financial health in the face of potential credit risks.

Am I Required to Adopt CECL?

CECL is effective for all companies, public and privately held. Private companies are required to adopt it for years beginning after December 15, 2022, meaning they will account for credit risk under CECL for the first time in their 2023 financial statements. For calendar year-end companies, this means calculating an opening adjustment to retained earnings as of January 1, 2023, and year-end estimates of the allowance required as of December 31, 2023, with changes in the estimates of lifetime losses reflected through earnings. While financial services companies like lenders are most significantly affected, all companies with receivables or financial assets are affected.

What Changed?

CECL essentially re-wrote the book on allowance for credit losses from legacy GAAP, with some significant changes:

  • There is no longer a “when loss is incurred” recognition threshold. Lifetime expected credit losses are estimated for nearly every asset in nearly every case, even if losses aren’t “probable.” Even assets with zero historical losses must be estimated for future loss under CECL. Depending on the asset and your business, this estimate may be more or less complex.
  • Assets with similar characteristics must be pooled and evaluated collectively.
  • Current economic conditions continue to be evaluated, but entities must consider their expectations of future economic conditions in estimating expected losses.
  • Estimates of expected losses now must be calculated over the contractual term of the asset, meaning that long-lived assets may have more complex estimates.

Several other details exist for specific asset types and circumstances within this long and complex standard, so please discuss them with your CPA.

What Should You Do If You Are Working on Your 2023 Financial Statements?

If you haven’t already evaluated CECL for your company, begin today. To understand how much CECL affects your financial statements, you should:

  • Identify all financial assets that are in scope or potentially in scope for CECL
  • Identify all the components of the asset’s amortized cost
  • Determine which characteristics should be used for pooling
  • Identify data sources for details of assets, including any collateral and reliable historical loss information
  • Determine which economic variables are relevant and obtain reputable economic forecast data
  • Develop a reasonable and supportable estimate of lifetime losses for each pool of financial assets
  • Apply financial reporting and disclosure requirements for the effects of adoption changes during the year. Also, disclose additional information about the allowance and the key assumptions and collateral as required by CECL.

While there’s flexibility in how companies apply the standard and the approach can be customized to your entity’s facts and circumstances, it is important to have a thorough, supported, and documented approach to implementing this important accounting standard.

How Can Calvetti Ferguson Help?

Our risk advisory practice can help you navigate the complexities of CECL and develop tailored solutions to ease adoption for your company. By sharing expertise and lessons learned from public company adopters, we draw on our experience as auditors, helping you get it right the first time.

We can assist you with any or all of the steps above, from scoping to estimating the allowance and updating your financial statements and disclosures.

If you’re a Calvetti Ferguson audit client, please get in touch with your audit partner for information and guidance, FAQs, and informational meetings where we can share industry best practices.

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