ASU No. 2016-13 – Financial Instruments – Credit Losses, will be effective for entities with reporting years beginning after December 15, 2022. This ASU addresses concerns that resulted from the 2008-2009 financial crisis where a delay in the recognition of credit losses causes overstatement of assets in financial reporting. The FASB developed the Current Expected Credit Loss, or “CECL” model as a forward-looking analysis that can be used to estimate expected credit losses. Originally, many people thought this ASU would only apply to financial institutions; however, it applies to the following:
- All financial assets measured at amortized cost basis
- Net investment in leases recognized by a lessor
- Off-balance-sheet credit exposures not accounted for as insurance
- Reinsurance recoverables that result from insurance transactions
This broadens the scope of this standard to cover more entities than just financial institutions.
The CECL model will require entities to estimate credit losses over the contractual life of the financial asset, instead of after an event has occurred like the current GAAP. Currently, the model is an “incurred loss” model which delays credit loss recognition until a loss has actually been incurred. Now the estimate needs to be based on multiple factors including historical loss experience with similar assets, current conditions, and reasonable and supportable forecasts. Some of the common financial assets in the scope of this standard are:
- Cash equivalents
- Loans
- Held to maturity debt securities
- Trade and reinsurance receivables
- Net investment in leases
- Loan commitments
- Financial guarantees
- Sales-type or direct financing leases
Some of the common items excluded from this standard are:
- Loans made to participants by defined contribution employee benefit plans
- Policy loan receivables of an insurance entity
- Promises to give (pledges receivable) for not-for-profits
- Loans and receivables between entities under common control
To learn more about CECL, talk to your Hawkins Ash representative and make sure you are ready for implementation.
