The Current Expected Credit Loss Standard and Not-for-Profits
Not-for-profits (NFPs) have experienced an increased number of new accounting standards that are directly impacting their financial statements, footnotes, and the way they account for transactions. As organizations have spent the past few years adopting new standards, many NFPs were looking forward to a break in fiscal years 2023 and 2024. However, the new current expected credit loss (CECL) standard may impact NFPs in ways that weren’t previously considered. When FASB Accounting Standards Update (ASU) 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, was first released, it was believed that the biggest impact would be to financial institutions. While that industry will still see a significant impact, NFPs may also be impacted by this new standard.
What Is the New CECL Standard?
Under current U.S. Generally Accepted Accounting Principles (GAAP), credit losses follow loss contingency guidance and are only booked when they meet a “probable” threshold. With the issuance of FASB Accounting Standards Codification (ASC) Topic 326, the requirement for credit losses to be “probable” was removed. Instead, organizations are now able to measure expected credit losses based on several factors, such as historical information, current conditions, and reasonable and supportable forecasts. These measurements will inherently have management estimates, and any assumptions will need to be documented. This new methodology will create a CECL allowance on assets accounts. The CECL allowance will be calculated by noting historical loss and adjusting for current conditions and reasonable and supportable forecasts. For periods beyond which forecasts can be made, the NFP should revert to historical loss information.
Topic 326 will apply to a variety of transactions. For example, it applies to loan and debt instruments not measured at fair value through net income, financial guarantees and loan commitments, certain lease receivables, and trade receivables from contracts recognized under FASB ASC Topic 606, Revenue from Contracts with Customers. Some examples of transactions that are not included in the scope of this standard are contributions/pledges receivable and most grants receivable if they are following the contribution model for revenue recognition. For NFPs that have earned revenue and the related receivable under Topic 606, this new standard will likely need consideration on those transactions.
Topic 326 does not require any specific methodology. Organizations could use any of the following methods, as noted in Topic 326: discounted cash flow methods, loss-rate methods, roll-rate methods, probability-of-default methods, or methods that use an aging schedule.
Under Topic 326, the method an organization uses to estimate the CECL allowance will likely vary based on the type of asset, the organization’s ability to predict the timing of cash flows, and the information available. Topic 326 also allows transactions that are similar in nature to be pooled together for the CECL allowance analysis. However, if the organization cannot support the homogeneous nature of the assets to be pooled, each transaction should be evaluated separately.
The new CECL standard will be effective for fiscal years beginning after December 15, 2022. As such, adoption will begin with the calendar year end; NFPs for the year ended December 31, 2023.
How Can NFPs Prepare?
NFPs should first consider if the standard applies to them. The NFP should evaluate their revenue streams and balance sheets for any trade receivables recognized under Topic 606 and any loan or debt instruments that are not valued at fair value. They should also consider if any of their lease receivables would also be included in the scope of this new standard. Once the NFP determines the accounts are included in Topic 326, management must then establish a method for determining the CECL allowance related to the receivable. The NFP may consider pooling similar assets before performing the analysis and document how the assets are similar in nature.
Topic 326 does not require a specific methodology to be followed when applying the CECL allowance; however, any forecasts need to be reasonable and supportable. Topic 326 also does not determine what “reasonable” and “supportable” mean. As such, it will be up to the NFP to define these terms within their own policy. This new policy should be discussed with those charged with governance for the NFP, such as the board of directors, so they have a full understanding of the new standard and how it applies to the financial statements.
Finally, the NFP’s policy and methodology should document how the data is accumulated and what the source of the data is. This data is the support for the allowance and will be subject to audit by the NFP’s auditors. This information will also be used in the disclosures for the credit loss allowance. As such, the NFP should have all policies, assumptions, and data well-documented for their adoption of Topic 326.
- While Topic 326 and the new CECL allowance standard will have a significant impact on financial institutions, NFPs should also be prepared to analyze whether there is an impact on their assets.
- As with any new standard, NFPs should determine the scope and materiality of the standard’s impact. If the standard has a material impact, the NFP should develop a policy and methodology for calculating the CECL allowance. The calculation will include management estimates that should be supported and well-documented.
- NFPs should discuss the implementation with key stakeholders for the organization, including those charged with governance and their auditors.