On June 16, 2016, the Financial Accounting Standards (Board) FASB issued ASU 2016-13, Financial Instruments-Credit Losses which is effective for fiscal years beginning after December 15, 2022. This standard introduces the current expected credit loss methodology (CECL) for estimating credit losses and impacts accounting for trade receivables, loan receivables, and debt securities. This blog addresses the changes you should be aware of for trade accounts receivable due within one year, which impacts most organizations.
Before implementation of CECL, organizations could calculate the allowance for doubtful accounts (allowance) based solely on past experience. CECL requires organizations to include forward- looking, or predictive information in calculating the allowance. Reliance on historical percentages is no longer sufficient.
To efficiently adopt CECL complete the following steps:
- Determine which receivables are the result of revenue transactions. Pledges and receivables resulting from contributions are scoped out of the standard and no change should be made to the method used to record allowances related to these transactions because of implementing CECL.
- Disaggregate receivables and consider whether there are government payors for which no allowance for doubtful accounts should be recorded based on government policies or practices. This could include instances such as when the government pays for required services for those with intellectual disabilities. Document the government payment policies and retain support showing there is no previous bad debt. This support could include details of bad debt accounts by payor for prior years.
- Group the remaining receivables into pools with similar risk characteristics (type of transaction, type of member, aging category, and new customers), determine the historical allowance for each pool, and complete the following:
-Determine that the historical allowance approximates bad debt by comparing actual write offs to the allowance for prior year(s).
-For each pool, consider any current information and/ or expectations that may increase or decrease the historical allowance, such as increase in pricing or rates, changes in payment polices, changes in the industry that your organization operates in and similar types of considerations.
-Estimate any necessary increase in the allowance, and retain your calculation as well as supporting documentation.
-Calculate the current year allowance based on the historical allowance as well as expected increases.
There are also changes to the financial statements required when CECL is adopted. You will also need to show the allowance for credit losses separately on the Statement of Financial Position (Balance Sheet) and remove the word “bad debts” from financial statements footnotes and replace it with “credit losses”. In addition, you will need to create a roll forward of the allowance for credit losses including current year write offs and recoveries.
CECL should be adopted using the modified retrospective approach, meaning you will record a cumulative – effect adjustment to the Statement of Financial Position (Balance Sheet) as of the beginning of the first reporting period in which the guidance is effective. There is no requirement to retrospectively adopt for the earliest period presented.
Auditors are required to obtain and test supporting documentation for allowance calculations and will be requesting this information during audits. If tou have any questions regarding CECL please contact a member of your audit team.