The financial crisis of 2008-2009 erupted across the globe, leaving a wide array of proposed regulations in its wake. Over the past seven years many regulations have been written and implemented while still others are upcoming. In our new blog series we will be discussing one of these new and upcoming regulations: Financial Instruments—Credit Losses (Topic 326), affectionately known as CECL (Current Expected Credit Losses).

Despite a rather innocuous name, CECL may be the most fundamental change ever made to financial institution accounting. Financial institutions will need to ensure CECL compliance to best manage both their loss allowance calculations as well as their capital.

Why the need for change?

After the financial crisis, the FASB reassessed its current impairment model to address concerns regarding the delayed recognition of credit losses attributable to the incurred loss model.

This initiative was originally intended to be a joint effort with the IASB.  However, after many creative attempts at convergence, the FASB adopted a different approach than the IASB – known as the CECL model. The FASB model generally results in immediate recognition of all expected lifetime credit losses upon initial recognition of the financial instrument.

What is CECL?

For the last four decades, U.S. GAAP has applied the incurred loss model for recognizing credit losses on loans, receivables and held-to-maturity debt securities.  Under this model, a loss is not recognized until it is probable that the loss-causing event has already occurred (debit to bad debt expense and credit to the allowance for loan loss).

CECL replaces the current incurred loss model with a forward-looking expected credit loss model that considers a broader range of reasonable and supportable information in estimating credit losses.

The expected loss model will be mandated under both U.S. GAAP and IFRS 9, although there are differences in technical application and effective dates.

What does CECL change?

CECL considers future conditions, representing a shift away from only looking at the past. CECL also requires that  future estimated losses be evaluated and recorded. At its core CECL is about understanding the risk of a loan portfolio, taking into account numerous factors over its life.

At a glance, this change might seem like just an on-top adjustment to the qualitative factors to include the forward-looking information or a tweak to existing stress test models; however, CECL is much more than that.  CECL represents an opportunity to better understand credit risk and to more effectively manage your business. Lending money and collecting principal and interest payments are essentials for banks and various other financial institutions. CECL doesn’t represent a mere twist to an old accounting policy but a fundamental shift in how these companies view and report on – and operate – a significant part of their business.

When is it effective?

The CECL amendments will be rolled out as follows:

  • SEC Filing Institutions
    • Annual Periods – December 15, 2019
    • Interim Periods – December 15, 2019
  • Non-SEC Filing Public Business Entities (PBEs)
    • Annual Periods – December 15, 2020
    • Interim Periods – December 15, 2020
  • All Other Entities and Not-For-Profit Organizations
    • Annual Periods – December 15, 2020
    • Interim Periods – December 15, 2021

CECL is an intentionally broad and undefined regulation – each organization may adopt its own approach to evaluating and estimating losses within the statute.