With the credit loss accounting standard update deadline coming up this December, non-financial institutions are now trying to catch up and understand the impact of how the Current Expected Credit Losses or CECL change will affect their profits.
The CECL is mainly focused on how the details of contracts and transactions are assembled.
For example, in trade receivables, there doesn’t appear to be a significant change to the allowance for noncollectable trade receivables. While usually, the Financial Accounting Standards Board (FASB) suggests using the aging schedules to determine an allowance, the CECL is broadening that method as well as others.
All receivables now need to be considered
This means that as soon as a receivable has been recorded, an allowance calculated and designated to it.
This change also reflects the notable transformation by the CECL in the financial services industry where a new loan must receive an allowance from the initiation point. A comparable requirement is set for the trade receivables as well.
Considering the future economic conditions
Another noticeable change that comes with the CECL’s new standard is the requirement that you must consider the future economic conditions when determining an allowance. Not only that, but other future implications could be impactful if not properly considered.
Contracts set up with customers may be initially set up as short term and low risk for CECL but if not structured to consider the contract’s off-balance sheet exposure a company could unintentionally offer credit terms to customers that require attention beyond the short-term receivable.
- Deals with terms to extend the receivable in combination with other purchases.
- Guaranteed delivery of future purchases despite the customer not meeting a threshold with their other receivables.
- Establishing a future purchase well in advance and extending the credit terms for those purchases before recognizing the receivable.
These situations don’t typically fall under the scope of the CECL but with the details of the contracts, they could. As such, the risks of these possible impacts should be considered on a contract-level review.
Stemming from the subsidiary transactions of third parties is the off-balance-sheet exposures that could be causing an impact on the non-financial institutions. The CECL doesn’t directly pertain to intercompany transactions, but it could apply to exposures that exist for those subsidiaries.
The structural and contractual obligations
With non-financial companies, there is much more uncertainty in the corporate line items.
Corporations utilize their time before the implementation date to review the deal structures that they have in place and consider how they will be held accountable. Being prepared before the date arrives is a great way to understand how calculations will be performed.