Not-for-Profits and the Current Expected Credit Loss (CECL) Model
The current expected credit loss (CECL) model under Accounting Standards Update (ASU) 2016-13 was established to simplify US GAAP and provide for more timely recognition of credit losses. Events such as the housing crisis of 2008 and COVID-19 have proven the need for this new model, as the previous model did not allow for a recognition of expected losses unless seen as, probable.
The CECL model now requires the immediate recognition of estimated expected credit losses over the life of a financial instrument. The estimate of expected credit losses considers not only historical information, but also current and future economic conditions and events. This new standard is effective for fiscal years beginning after December 15, 2022. The CECL model should be implemented in a retrospective approach.
What is in scope?
Trade receivables
Loans receivable
Held-to-maturity debt securities
Loan commitments
Receivables from repurchase agreements
Net investments in sales-type and direct financing leases
Reinsurance receivables
Financial guarantees
Purchased credit deteriorated assets recorded at amortized cost
What is out of scope?
Contributions receivable
Operating lease receivables
Investments at fair value with changes in fair value reported through net income (or for non-healthcare NFPs, the change in net assets)
Available-for-sale debt securities Loans receivable that are held for sale
Loans and receivables between entities under common control
Equity method investments
Derivatives
Great news for NFP organizations: CECL specifically excludes contributions (pledges) receivable.
A Realistic Approach
The CECL model focuses on actual cash collected rather than an outstanding (billing) balance. By shifting the focus from what you are owed to what you collect, you are much less likely to be forced into a write-off.
This concept has proven value in the banking industry, as regulators often request to set aside cash to hedge against all expected losses. This was a strategy for preventing banking failures, such as what we've seen over the past few decades.
Its important to determine how much you are really collecting on receivables. You should not only review historical data and statistics, but also consider current and future events. Additionally, be realistic with yourself about whether or not your customers will be able to pay you. Consider determining factors such as their industry, location, and credit score. The U.S. economy might be strong, but businesses could be struggling in certain cities. That said, if your region is struggling, you may consider writing off any outstanding billing in an upfront manner.
Previous Incurred Loss Model
Losses recorded when probable of being incurred
If no indicators of loss, no reserve required
Based primarily on historical experience
Typically applied to past-due amounts for trade receivables
Current CECL Model
No threshold for recognition: All expected credit losses over the life of the instrument are recorded on day 1, leading to more timely identification and recognition of future losses
Allowance for credit losses is required, even if the risk is remote
Based on reasonable and supportable forecasts about total future credit losses, factoring in both historic and current data as well as forecasts of the future
Must be applied to all balances, including those that are still current
CSH has extensive experience helping clients navigate these waters. Below are some frequently asked questions that we are happy to address.
1. If an entity feels that the future is unpredictable and wants to place more weight on historical data, can their analysis rely on historical data only?
No, you must consider past, current, and future conditions to estimate collection.
2. Can the entity implement CECL, consider historical, current, and future conditions, and still estimate zero losses?
Yes, that is possible. For example, if your receivable is guaranteed or backed up by another entity that is in a solid financial position or an insurance policy, you potentially still estimate zero losses.
3. The entity wants to sue the customer or hire a collection agency. If they write off the receivable from their books, does that mean they are now legally unable to collect it?
This is false. Writing off for financial statements is different from forfeiting your legal rights. The CECL model allows you to determine a write off in total of your receivable or per specific transaction.
4. What is the recommended method of the CECL model to calculate allowance for credit losses?
The CECL model does not identify a specific method. The entity should develop an estimate of credit losses based on historical information, current conditions, and reasonable/supportable forecasts. The entity must estimate and recognize an allowance for credit losses for a financial instrument, even when the expected risk of credit loss is remote. The estimate should be for lifetime expected credit losses.
5. I'm a very small not-for-profit. I do not sell any products or give loans. I only receive donations and offer free stuff. Does the CECL model apply to me?
The only way to know is to review all revenue streams and ensure they do not fall in scope. While its true that contributions and gifts do not fall under the CECL model, there are certain areas where many not-for-profits may have to adopt this standard. For example, if you offer any service arrangements or sponsorships in an exchange transaction, such as memberships or special events that require a fee collection, you fall under the scope of the CECL model.
Still Have Questions?
Don't hesitate to connect with experts in Clark Schaefer Hackett's Not-for-Profit Group. Our professionals have decades of experience and would be happy to assist you with implementing the CECL model.
