CECL: It’s Not Just About Financial Institutions
- Doug Mims
Since its issuance in June of 2016, much discussion has been had regarding Accounting Standards Update (ASU) 2016-13, Financial Instruments – Credit Losses (ASC 326): Measurement of Credit Losses on Financial Instruments. This new standard guides how an entity should measure credit losses on financial instruments, with most of the conversation focused on the impact on financial institutions.
Given the emphasis on financial assets, including loans and certain debt securities, many in the industry are looking to familiarize themselves with it before it takes effect in 2023.
The guidance in ASC 326 applies to the following:
ASC 326 defines financial assets as cash, evidence of ownership interest in an entity, or a contract that conveys one entity a right to do either of the following:
Based on the aforementioned, trade receivables represent a financial asset that would fall within the scope of ASC 326. Given that CECL applies to trade receivables, estimated lifetime credit losses will need to be recorded at inception, based on historical information, current conditions, and reasonable and supportable forecasts.
While the probability criterion for initial receivable recognition under ASC 606 considers a customer’s ability and intent to repay, likely repayment under ASC 606 does not imply a credit risk-free receivable or remove the requirement to comply with CECL. Concepts such as pooling receivables with common risk characteristics and employing a methodology for calculating estimated credit losses consistent with the guidance in ASU 326 are required with CECL.
Complying with ASC 326 has been challenging for the public companies that adopted CECL in 2020 and will be equally challenging for the private companies set to adopt it in 2023.
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