Credit Loss Standard: The New CECL Model

December 1 2017

A new accounting standard on credit losses goes into effect in 2020 for public companies and 2021 for private ones. It will result in earlier recognition of losses and expand the range of information considered in determining expected credit losses. Here’s how the new methodology differs from existing practice.

Existing model

Under existing U.S. Generally Accepted Accounting Principles (GAAP), financial institutions must apply an “incurred loss” model when recognizing credit losses on financial assets measured at amortized cost. This model delays recognition until a loss is “probable” (or likely) to be incurred, based on past events and current conditions.

The Financial Accounting Standards Board (FASB) found that, leading up to the global financial crisis, financial statement users made independent estimates of expected credit losses using forward-looking information and then devalued financial institutions before the institutions were permitted to recognize the losses. This practice made it clear that the requirements under GAAP weren’t meeting the needs of financial statement users.

New-and-improved model

Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326), introduces a new “current expected credit loss” (CECL) model. The CECL model requires financial institutions to immediately record the full amount of expected credit losses in their loan portfolios based on forward-looking information, rather than waiting until the losses are deemed probable based on what’s already happened. The FASB expects this change to result in more timely and relevant information.

The measurement of expected credit losses will be based on relevant information about past events (including historical experience), current conditions, and the “reasonable and supportable” forecasts that affect the collectibility of the reported amount.

Specifically, an allowance for credit losses will be deducted from the amortized cost of the financial asset to present its net carrying value on the balance sheet. The income statement will reflect the measurement of credit losses for newly recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the relevant reporting period.

Companies will be allowed to continue using many of the loss estimation techniques currently employed, including loss rate methods, probability of default methods, discount cash flow methods and aging schedules. But the inputs of those techniques will change to reflect the full amount of expected credit losses and the use of reasonable and supportable forecasts.

We can help

The updated guidance doesn’t prescribe a specific technique to estimate credit losses — rather, companies can exercise judgment to determine which method is appropriate. Contact us at (818) 789 1179 if you need help finding the optimal method for identifying and quantifying credit losses, along with complying with the expanded disclosure requirements.

© 2017

 

Close-Up On Cutoffs For Reporting Revenues And Expenses

November 30 2017

Under U.S. Generally Accepted Accounting Principles (GAAP), there are strict rules on when to recognize revenues and expenses. Here’s important information about end of period accounting “cutoffs” as companies start to adopt the new revenue recognition standard.

Cutoff games

How closely does your company follow the cutoff rules? The end of the period serves as a “cutoff” for recognizing revenue and expenses. However, some companies may be tempted to play timing games to lower taxes or boost financial results.

To illustrate, let’s suppose a calendar-year, accrual-basis car dealer allows a customer to take home a minivan for a weekend test drive on December 29, 2017. The sales manager has verbally negotiated a deal with the customer, but the customer still needs to crunch the numbers with his spouse. The customer plans to return on January 2 to close the deal — or return the vehicle. Should the sale be reported in 2017 or 2018?

Alternatively, consider a calendar-year, accrual-basis retailer that pays January’s rent on December 29, 2017. Rent is due on the first day of the month. Can the store deduct the extra month’s rent from this year’s taxable income?

As tempting as it might be to inflate revenue to impress stakeholders or defer profits to lower your tax bill, the cutoff for a calendar-year business is December 31. So in both examples, the transaction should be reported in 2018.

Audit alert

The rules regarding cutoffs are changing for some companies. Under Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, revenue should be recognized “to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services.” In some cases, the new standard could cause revenue to be reported sooner or later than under the existing rules. The updated standard goes into effect in 2018 for public companies and 2019 for private companies.

The new guidance requires management to make judgment calls about identifying performance obligations (promises) in contracts, allocating transaction prices to these promises and estimating variable consideration. These judgments could be susceptible to management bias or manipulation.

In turn, the risk of misstatement and the need for expanded disclosures will bring increased attention to revenue recognition practices. So, expect your auditors to ask more questions about cutoff policies and to perform additional audit procedures to test compliance with GAAP. For instance, they’ll likely review a larger sample of customer contracts and invoices to ensure you’re accurately applying the cutoff rules.

Got questions?

Timing is critical in financial reporting. Contact us at (818) 789 1179 if you need help understanding the rules on when to record revenue or expenses. We can help you comply with the rules and minimize audit adjustments next audit season.

© 2017

 

Can I Pay Bonuses In 2018 But Deduct Them In 2017?

November 28 2017

Please contact us by phone at (818) 789 1179 if you would like more information.