Historically, entities recognized a credit loss when it was probable to occur under U.S. GAAP. Now, ASU 2016-13 has removed the “probable” threshold. The current expected credit loss (CECL) model in effect for private companies for the years beginning after December 15, 2022, requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates.
Entities are required to immediately recognize the full amount of credit losses expected. The new guidance in effect does not prescribe a specific method that must be used; rather, entities can continue to use judgment as long as three factors are considered: 1) historical experience, 2) current conditions and 3) reasonable and supportable forecasts.
In addition, CECL must be applied to assets measured at amortized cost and available-for-sale debt securities. Affected financial instruments include receivables that result from revenue transactions that fall within the scope of Topics 605, 606 or 610, including short-term and long-term trade receivables, which is an issue impactful to many of our clients.
Historical experience can be based on both internal and external information. For trade receivables, a company may have tracked and compiled historical credit loss percentages. Below is an example using an aging schedule, adapted from ASU 2016-13:
| Aging Bucket | Historical Loss Estimate |
|---|---|
| Current | 0.3% |
| 1-30 Days Past Due | 8.0% |
| 31-60 Days Past Due | 26.0% |
| 61-90 Days Past Due | 58.0% |
| More than 90 Days Past Due | 82.0% |
If the composition of trade receivables is the same as when the historical information was compiled, those historical loss estimates can continue to be used as a reasonable basis (or starting point) to determine expected credit losses. Prior to CECL, the company may have used the historical loss estimates alone to determine the allowance for doubtful accounts.
Under CECL, the company must now consider how current conditions compare with historical experience to better estimate future expected credit losses. In the example adapted from the ASU, the company has determined that economic conditions have improved since they compiled the historical information.
In their assessment of current conditions, the company has considered reasonable and supportable forecasted information. Specifically, as outlined in the example in the ASU, unemployment has decreased in the current year, and the company expects unemployment will further decrease over the next year. The company could have made this assessment using published economic reports and considering their own industry environment, geographic location, as well as general economic future forecasts.
This may be one of the more challenging aspects of the new standard, as it applies to trade receivables for private companies. However, the ASU requires disclosures of the factors that influenced management’s estimate of expected credit losses, including a discussion of the reasonable and supportable forecasts used. This allows transparency to the financial statement users, who may not necessarily agree with the forecasts chosen.
In the example adapted from the ASU, the company adjusts the historical loss rates to reflect the effects of the differences between current conditions and forecasted changes. This results in decreases of the loss rate in each aging bucket.
| Past-Due Status | Amortized Cost Basis | Historical Credit Loss Rate | Historical Credit Loss Estimate | Adjusted Credit Loss Rate | Adjusted Credit Loss Estimate |
|---|---|---|---|---|---|
| Current | $5,984,698 | 0.3% | $17,954 | 0.27% | $16,159 |
| 1-30 Days Past Due | 8,272 | 8.0% | 662 | 7.2% | 596 |
| 31-60 Days Past Due | 2,882 | 26.0% | 749 | 23.4% | 674 |
| 61-90 Days Past Due | 842 | 58.0% | 488 | 52.5% | 440 |
| More than 90 Days Past Due | 1,100 | 82.0% | 902 | 73.8% | 821 |
| $5,997,794 | $20,755 | $18,681 |
For short-term trade receivables, applying the CECL model is not expected to make a significant change to the estimate of the allowance for doubtful accounts. However, it is expected that a company would report an estimate for credit losses even if the risk of loss is remote. It would be a rare set of facts and circumstances under which no credit allowance loss is necessary, such as if a company has one revenue stream entirely from one government entity and prior experience indicates the risk of loss is nonexistent.
In addition, at each reporting date, companies must record an adjustment to achieve the appropriate allowance for credit losses through net income as either credit loss expense or a reversal of credit loss expense. Assets determined to be uncollectible should be written off from the credit allowance, and any recoveries should be recorded once the collection is received.
The ASU also requires expanded disclosures related to items including credit quality, allowances, policies, past-due status and nonaccrual status.
In light of ASU 2016-13, review how you are calculating your allowance for trade receivables now, and determine what changes are needed to apply the CECL model. In addition, you will need to consider how the ASU effects your other assets measured at amortized cost and available-for-sale debt securities.
Contact Marie Brilmyer at mbrilmyer@cohencpa.com or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.