November 30, 2023Share:
Accounting Standards Update (ASU) 2016-13, also known as the Current Expected Credit Loss (CECL) standard, represents a fundamental shift in the accounting for credit losses for financial instruments. While this ASU mainly impacts financial institutions (i.e.: banks, credit unions, etc.), any entity that holds a financial asset subject to credit losses should be informed of the changes made by this standard. Examples of financial assets subject to credit losses include trade/accounts, note, loan, lease, or other receivables. In this blog post, we will delve into the key aspects of ASU 2016-13 and its implications for financial reporting.
- Effective Date – ASU 2016-13 is effective for all non-public entities for years beginning after December 15, 2022. Meaning, it impacts calendar year-end companies as of January 1, 2023. The applicability and impact of ASU 2016-13 is made on an entity-by-entity basis.
- Current Expected Credit Loss Model – One of the main provisions of ASU 2016-13 is the shift from recognizing credit losses based on incurred losses to expected losses over the life of the financial instrument. This requires entities to consider historical information, current conditions, and reasonable and supportable forecasts to estimate expected credit losses in a more forward-looking and dynamic manner.
- Disclosures – ASU 2016-13 requires enhanced financial statement disclosures related to credit quality indicators, credit risk management practices, and significant changes in the allowance for credit losses. These disclosures aim to provide users of financial statements with more useful information regarding an entity’s credit risk exposure and the impact of the new standard on the financial statements, if any.
All of the provisions above aim to improve financial transparency and equip entities with better tools for assessing and managing credit risk. These goals do not come without challenges, however. We have identified 3 of the top challenges facing entities tasked with implementing ASU 2016-13.
- Data – Implementing ASU 2016-13 requires access to data, and lots of it. Types of data to consider include historical performance data, projected performance data, industry-specific data, and economic forecasting data.
- Modeling – The CECL approach involves complex modeling, and entities may face challenges in developing and validating models that accurately reflect their credit risk profiles. Topics to consider when developing a model include data quality, economic conditions, risk characteristics, historical performance, projected future performance, and industry impacts.
- Economic Forecasting – The reliance on predicted economic performance introduces an element of uncertainty. Entities must carefully consider the reasonableness and supportability of their economic forecasts.
Implementing new accounting standards can be overwhelming, but we are here to help. If you have any questions regarding ASU 2016-13, please give us a call.