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CECL: If You Snooze, You May Lose

by Chris Chiriatti and Jonathan Prejean

True or false: Only banks need to comply with the Financial Accounting Standards Board’s (FASB) Current Expected Credit Loss (CECL) model, which goes into effect at the end of 2019 for public companies? False! The new accounting standard will impact companies across industries in different ways. Clues in the business can help financial executives assess just how significant CECL’s impact will be.

The effective date of the FASB’s new CECL standard is quickly approaching.  For calendar year public business entities that meet the definition of Securities and Exchange Commission (SEC) filers, this date is January 1, 2020.  All other public business entities with fiscal years beginning after December 15, 2020 will need to adopt the CECL guidelines by January 1, 2021.[1] While many organizations have been working diligently on their new credit impairment models for some time, confusion remains over what types of organizations the new rules impact.
Banks are the most obvious target of CECL, simply because they are in the business of making loans and extending credit. However, what many executives don’t realize is that the standard applies to any business with receivables – that is, virtually all companies. Financial executives at many nonbanks are, therefore, in less familiar territory with the standard and may not even realize the extent to which CECL will impact their businesses.
So, the question financial executives at nonbanks should be asking themselves is not “will this standard impact my business,” but rather, “how will this standard impact my business?” Does your retail or specialty business issue its own private label credit card? Does your automotive company have its own financing arm? Did the adoption of the new revenue recognition standard result in recording contract assets?” These and other factors can amplify the effect CECL will have on business operations and processes.
The good news, however, is that there are clues that financial executives at nonbanks can examine to help them ascertain the impact CECL will have on their business as well as adequately prepare for the type of implementation that best suits the organization’s needs and goals.
How CECL could impact your business
Spring earnings season will be the first reporting deadline, leaving little time for nonbank organizations that may need to play catch-up. Financial executives who are just getting started should focus their attention toward some common and surprising indicators to assess where and to what extent their businesses will be impacted by CECL:
  • Receivables: Receivables that result from revenue transactions under the FASB’s new revenue recognition standard (more on that here) are subject to the CECL model. Virtually every business has these, but those with longer-term trade receivables of 90 days or more stand to be impacted the most by the new standard, specifically around changes in the impairment losses recognized on such receivables. Financial executives at these firms will need to consider whether a reasonable and supportable (R&S) forecast exists to incorporate into their estimated impairment losses. These losses will need to be estimated on receivables that are not past due or otherwise demonstrate specific credit risk.
  • Contract assets (a.k.a. unbilled receivables): Companies with unbilled receivables may be more exposed to credit losses than those without them, and therefore would see the impact of the CECL rules amplified on their balance sheets. Certain software contracts, in which the ability to invoice may depend on multiple performance obligations being fulfilled, would fall into this category.
  • Credit risk vs. variable consideration: For nonbank entities in highly regulated industries such as health care, identifying credit risk related price concessions could pose additional implementation and operational challenges. For example, when hospitals render services to uninsured patients, the credit risk impacts the revenue initially recognized, but the hospital might also need to record additional reserves once CECL is adopted due to potential differences in how credit risk impacts variable consideration and how expected credit losses are recorded under CECL.
  • Off balance sheet commitments: Off balance sheet arrangements, such as commitments to extend credit and standby letters of credit that are not considered derivatives under ASC 815, are subject to credit risk and tally up CECL’s impact on a business.
  • Some financial guarantees: Any financial guarantees that are not accounted for as insurance or considered derivatives -– such as a guarantee to pay an equity method investee’s debt if the equity method investee does not pay –- are subject to CECL.
  • Certain debt securities: Some nonbanks also hold held-to-maturity (HTM) debt securities, which fall under CECL’s scope as well. Expected credit losses on these securities must be recognized as allowances under CECL and will no longer be distinguished by temporary and other-than-temporary impairment losses currently required under U.S. GAAP.
What can financial executives do to prepare?
For nonbanks who have not yet started implementation or are early in the process, the most important thing to do is get busy -- now. To jump-start the implementation process, financial executives should consider the following steps to help ensure the business is adequately prepared for adoption ahead of the effective date:
  • Identify the financial instruments your business uses that are subject to CECL. This step may be harder for nonbanks, which typically do not use financial instruments as extensively as banks do and may be less accustomed to the nuanced accounting for more complex instruments.
  • Assess the extent and type of impact that CECL will have on such assets. For instance, if a business is expanding into new customer segments, thereby shifting the risk profile for certain assets, this new strategy could impact R&S forecasting in its CECL model.
  • Determine what new processes, data or other information will be needed to build, test and run CECL models. Identify how current processes -– even the way a business tracks its receivables –- may need to change to comply with CECL, including specific resources needed to facilitate these changes. Take, for instance, pooling: will a business need to adjust its current reserve methodology to comply with CECL pooling requirements? This could pose a significant change from an operational perspective.
  • Partner with the necessary cross-functional business teams, such as IT and sales, to fill gaps in the model. Collaboration throughout the business is a consistent leading practice for compliance with any new accounting standard. For CECL, extensive process changes may require partnership with IT, while the gathering of new data inputs to inform the impairment model could warrant collaboration with business functions, such as marketing and sales, that financial executives might deal with infrequently.
As nonbanks work through adoption, it will also be important to address common roadblocks, such as tracking and managing data on receivables and losses as well as generating executive and entity-wide buy-in on implementation. Company structures are often siloed, and while partnering with teams across the business is recommended, some units may lack the capacity, resources or even willingness to aid the finance department as it works toward adoption. Obtaining support from leadership will be instrumental in positioning CECL implementation as a legitimate, pervasive effort that business functions across the organization can support.
What if an organization has been working to adopt the new CECL standard and is already well on its way to compliance? Congratulations are in order, but now it’s time to take it one step further. In this case, businesses should consider thinking about CECL adoption as less of a compliance exercise and more of a strategic opportunity to enhance –- or even revamp –- current processes and operations. Some companies are now leveraging CECL adoption as a value-add for their business, creating more sustainable processes for determining credit exposure that can benefit them in the future.
With little time left before the effective date for public company adoption, now is the time for nonbanks to take an active stance on CECL and not allow it to become a sleeper issue for their organization. Successful CECL compliance starts and ends with financial leaders, so it’s imperative they: 1) gain an understanding of the standard’s unique impact on their company; and 2) work to adjust processes and operations accordingly to adapt to such impacts. The sooner a company leans into adoption, the better positioned it should be in to achieve regulatory success and create additional business value in the process.
Jonathan Prejean is a Deloitte Risk & Financial Advisory managing director with Deloitte & Touche LLP.  Chris Chiriatti is an Audit & Assurance managing director with Deloitte & Touche LLP.
This article contains general information only and Deloitte is not, by means of this article, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services.  This article is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.
Deloitte shall not be responsible for any loss sustained by any person who relies on this article.
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