The proposed CECL amendments could enable streamlined credit loss measurement and valuable post-balance sheet collection insight for private and non-profit entities.
The Financial Accounting Standards Board (FASB) and Private Company Council (PCC) issued a proposed update to the current expected credit loss standard (CECL). Private companies could elect a practical expedient to assume current conditions as of the balance sheet date to be reasonable and supportable for forecasts used, as well as an accounting policy election where cash collection activity between the balance sheet date and the date of financial statements available for issuance can be considered when calculating historical loss rates.
Overall, the proposed update hopes to ease the go-forward calculations of a private company's CECL loss rate.
Proposed Accounting Standard Update for CECL
On Dec. 3, 2024, the FASB and the PCC issued a proposed update to the current CECL to address challenges in applying the guidance within CECL to current accounts receivable and contract assets. As private companies have expressed the burden of costs and complexity associated with implementations of CECL, the FASB and PCC have published the proposed Accounting Standards Update (ASU) for private entities, which includes the following:
- Practical Expedient: In developing reasonable and supportable forecasts, an entity may elect a practical expedient that assumes that current conditions as of the balance sheet date persist throughout the forecast period.
- Accounting Policy Election:An entity that elects the practical expedient would be eligible to make an accounting policy election to consider collection activity between the balance sheet date and the date the financial statements are available for issuance when estimating expected credit losses.
The proposed Accounting Standards Update (ASU) would require private and certain not-for-profit entities electing the practical expedient and accounting policy election to apply them prospectively and to disclose the adoption.
Riveron Insight
Companies have spent significant time involving both their accounting and FP&A personnel to document forecasts and future macroeconomic conditions within their CECL memos. However, the final loss rates being calculated are primarily based on historical experience with forecasts and future conditions having minimal impact.
For non-financial institutions, typically with only trade receivables in scope of the standard, these forecasts may not materially affect the allowance given the short life of the assets. Companies can simply use conditions that existed on the balance sheet date as their forecast for the entire period, eliminating the need for complex forecasting work.
In addition to the time spent on developing forecasts, companies also have had to ignore meaningful collection activity after the balance sheet date when calculating their loss rates. Consider this example: A company with a Dec. 31, 2024, year-end (Balance Sheet Date) wouldn't finalize its financial statements until April 30, 2025 (Issuance Date). Under current rules, this company cannot include cash collected during those four months when calculating loss rates, despite having this valuable information. However, given the accounting policy election included within the proposed ASU, companies will be able to include this useful data to more accurately estimate future credit losses. Riveron's experts are ready to help clients through gathering and evaluating subsequent cash collections in the allowance for credit losses calculation.
Riveron CECL Experience
In supporting public and private companies through the adoption and maintenance of compliance with CECL, Riveron professionals have experienced the challenges and complexities described above.
Nuances specifically for non-financial institutions include:
- Pooling assets effectively based on common risk characteristics
- Building loss rates with an inconsistent write-off policy
- Data mining through multiple ERPs
- Control environment over the CECL loss rate calculation
Pooling of In-Scope Assets
After identifying assets in scope of CECL—many times only trade receivables and contract assets for non-financial companies—the company is required to pool these assets based on common risk characteristics. These pools can be defined based on common factors like:
- Customer creditworthiness
- Type of contract (short-term/long-term)
- Payment terms (Net 30 vs. Net 90)
- Industry or geography
Most companies can easily identify these attributes across their receivables and contract assets. However, documenting and supporting the pooling conclusions often proves more challenging and complex. Auditors require clear documentation that justifies how you've defined your asset pools. They also expect to see processes and controls for assigning new customers to existing pools. Finally, they'll look for evidence that you regularly reassess customers whose circumstances change. Auditors will also require additional support on risk pool determination whenever the company makes any changes in future periods.
Companies that historically used an aging approach to calculate loss rates may face additional challenges in the pooling of assets. Since these companies have only supported using aging buckets with loss-rate percentages applied to each bucket without looking to specific attributes of each customer, the process of pooling assets based on common risk characteristics can be a time-consuming effort.
Riveron helps clients in this situation by reviewing their full customer base and recommending a new pooling strategy. We also develop robust documentation that stands up to audit scrutiny.
Building Loss Rate with Inconsistent Write-Off Policy
Once the pooling of assets is concluded on and supported, companies without a consistent write-off policy can struggle to identify pertinent loss-rate data. If a customer receivable balance has been reserved for an extended period, determining if and when it should be written off can be challenging. In calculating the CECL loss rate in these situations, the company will need to apply a consistent methodology in considering when a write-off should have occurred, instead of sitting as a reserve indefinitely.
In supporting clients' CECL reserve calculations without a formal write-off policy, Riveron will help apply the write-off methodology described above to historically aged receivables in calculating the expected losses on the receivable population. In one client case, a major fuel, lubricant, and chemical supply company had not established a formal write-off policy. Riveron advised the company to consider customer balances reserved for an extended period with no cash collections as a loss within their CECL reserve and historical loss rate calculations. Once historical loss rates are calculated and supported, Riveron aids our clients in preparing a formal write-off policy to use going forward.
Lastly, the proposed standard would allow accounting for subsequent collections of cash after balance sheet dates and to consider those impacts to historical loss rates, and depending on facts and circumstances, this could have a meaningful impact on the CECL reserve calculation.
Data Mining
Once a consistent write-off policy is established, the next challenge for companies is gathering all pertinent historical loss data. For acquisitive companies especially, pulling together write-off data over multiple years for each of its newly acquired companies can be difficult. For instance, each entity may have different ERP systems with various historical invoices, payment terms, collections, and related policies and procedures.
In our experience, the data mining exercise tends to be the most time-intensive CECL implementation stage. Once a complete and accurate data set is understood and pulled together across a consolidated entity, the loss-rate calculation can come together quickly after deciding on and applying a loss-rate method. The proposed practical expedient discussed above would also ease the effort to develop a reasonable and supportable forecast.
Data mining may be necessary on an ongoing basis during business combinations, changes in risk profiles of current and new customers, and other factors. Given the proposed standard allowing companies to account for subsequent collections after balance sheet dates, companies will also need to ensure clear data showing when accounts receivable balances are cleared to appropriately calculate the updated CECL loss rate.
Control Environment
Throughout CECL implementation and while maintaining compliance, companies not only need to focus on the ending allowance for credit losses balance, but also the controls in place around the loss-rate calculation.
In many cases, the controls needed in a CECL calculation relate to:
- Proper assignment of customer balances to asset pools
- Complete and accurate accounts receivable and contract asset balance data
- Complete and accurate historical write-off data
- Review and approval of loss-rate calculation
To further emphasize the first point above, Riveron and our clients have spent significant time supporting the process of customer pooling. During the implementation of CECL, the current customer base is the primary focus, but companies also need a process for the go-forward pooling of new customers, as well as a regular ongoing reassessment of pooling as customer facts and circumstances change.
While pooling new customers is a major control point, we've also seen cases where existing customers can move from one pool to another based on risk characteristics over time.
In one instance, Riveron advised a large public SaaS company on revamping its CECL reserve policy. The client had a process upon adoption of CECL to risk pool its customer base. However, we guided the company's new approach for risk pool monitoring to evolve and adapt accordingly. For example, the client may originally place a customer into a small business customer risk pool (which typically carries a higher risk of credit losses). Over time, that customer could grow organically, prompting consideration for reclassification to a mid-market category (typically lower risk of credit losses). Moreover, controls can be established to monitor customer changes like these following adoption of the standard and initial risk pooling. In other situations, the same customer might be acquired by a larger public company in the future with a higher credit rating and less risk. That also requires changes to risk pooling through a "go-forward" monitoring process.
In these situations, Riveron recommends that clients conduct annual reviews of customers and their respective pools with clear attributes distinguishing customers within each pool. In instances where a customer changes from one pool to another, asset and loss-rate balances must be adjusted appropriately within pools.
Next Steps
The FASB invited comments on all matters included within the proposed CECL update through Jan. 17. After analyzing comment letters and all other information obtained through the due process activities, the PCC met on March 6 to discuss feedback summary and recommendations to the FASB.
Most respondents supported the proposed standard's goal of addressing challenges related to applying Topic 326, with suggestions of an expanded scope to include similar assets acquired in business combinations and other short-term financial assets. The FASB staff clarified that allowances for expected credit losses on acquired contract assets should be treated consistently with other contract assets post-acquisition.
The staff also suggested maintaining the proposed practical expedient and accounting policy election, linking them to reduce complexity and costs. Based on feedback, the staff recommended two key changes:
- Expanding the scope to include certain assets acquired during business combinations
- Requiring companies to disclose the specific date (after the balance sheet date) up to which they considered cash collections
If the PCC agrees with the proposed staff recommendations, the staff will present a summary of feedback and a PCC decision to the Board. If the Board votes to move forward, the staff will draft a final update.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
