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Current Expected Credit Loss Accounting [Video]

Current Expected Credit Loss Accounting

The FASB issued an accounting standard update (ASU 2016-13) on current expected credit losses (CECL) on June 16, 2016. Prior to this update, companies reported credit losses only when it was probable a loss had been incurred.

This “incurred loss method” became a problem during the 2008 financial crisis. Banks weren’t recognizing losses fast enough, as GAAP didn’t allow them to consider future developments. Thus, in spite of a bleak economic outlook, loan loss reserves weren’t being adjusted to account for the future expected losses.

Under the new CECL method, companies must incorporate information from forward-looking forecasts to estimate credit losses over the entire contractual life of the asset. In short, banks and other companies must now forecast future economic conditions and record expected credit losses. We are therefore shifting from an incurred-loss model to an expected-loss model, and this is intended to accelerate the recognition of impairments.

Now this accounting rule doesn’t just apply to banks. It applies to companies holding any of the following financial assets:
• Trade receivables
• Lease receivables from a sales-type or direct-financing lease
• Reinsurance receivables
• Receivables related to repurchase agreements
• Loans held for investment
• Held-to-maturity debt securities carried at amortized cost
• Some off balance sheet credit exposures like loan commitments and financial guarantees

Note that the CECL rules do NOT apply to:
• Loans held for sale
• Trading assets
• Financial assets for which the company has elected the fair value option
• Loans or receivables between entities under common control

So let’s talk about the journal entry that a company would record. If a company expects to have a future credit loss, it would:
• Record credit loss expense
• Record a credit loss allowance. The allowance account is a contra asset; you don’t reduce the asset directly

Credit loss expense 500
Allowance for expected credit losses 500

If circumstances later change and the company doesn’t believe it will have a credit loss, the company can simply reverse the entry. In any case, the balance sheet shows the net amount the company expects to collect. In rare cases, recognizing zero credit losses might be appropriate

So, how should a company measure the allowance?

The FASB didn’t mandate a specific method. Companies could use:
• Discounted cash flow methods
• Probability-of-default methods
• Loss-rate methods
• Roll-rate methods
• An aging schedule

It’s up to each company to develop its own estimation model. If a company has financial assets with similar risk characteristics (asset type, term, credit ratings, geography) it can pool those assets and evaluate them on a collective basis, and if the company ultimately finds that a financial asset is uncollectible, it should write the account off:

Allowance for expected credit losses 500
Financial asset 500

Now if you’re wondering about the international accounting rules:
The IASB adopted a similar credit loss model in 2014 (IFRS 9), so companies outside the U.S. also need to estimate future expected credit losses. However, there are differences between the international rules and U.S. rules, so make sure to refer to IFRS 9 if your company follows IFRS

Edspira is the creation of Michael McLaughlin, an award-winning professor who went from teenage homelessness to a PhD. Edspira’s mission is to make a high-quality business education accessible to all people.

SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO THE FINANCIAL STATEMENTS, PLUS:
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• A 44-PAGE GUIDE TO U.S. TAXATION
• A 75-PAGE GUIDE TO FINANCIAL STATEMENT ANALYSIS
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GET CERTIFIED IN FINANCIAL STATEMENT ANALYSIS, IFRS 16, AND ASSET-LIABILITY MANAGEMENT
* https://edspira.thinkific.com

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ABOUT EDSPIRA AND ITS CREATOR
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The Difference between a Top-tier and a Low-tier Business School [Video]

I’ve taught at several different business schools, and I’ve found that both higher-tier and lower-tier business schools teach the same business concepts. You’ll learn about Porter’s Five Forces, the four P’s of marketing, and the financial statements. So if you’re learning the same concepts, why do some people try so hard to get into a top business school? I mean, why does it matter where you go to school? It matters because classroom learning is just one aspect of the business school experience. What you get out of business school is also a function of: • The quality of the school’s alumni network and faculty, as well as your classmates • The helpfulness of the school’s career center • The reputation of the school and its ability to become a recruiting target for top firms — Edspira is the creation of Michael McLaughlin, an award-winning professor who went from teenage homelessness to a PhD. Edspira’s mission is to make a high-quality business education freely available to the world. — SUBSCRIBE FOR A FREE 53-PAGE GUIDE TO THE FINANCIAL STATEMENTS, PLUS: • A 23-PAGE GUIDE TO MANAGERIAL ACCOUNTING • A 44-PAGE GUIDE TO U.S. TAXATION • A 75-PAGE GUIDE TO FINANCIAL STATEMENT ANALYSIS • MANY MORE FREE PDF GUIDES AND SPREADSHEETS * http://eepurl.com/dIaa5z — SUPPORT EDSPIRA ON PATREON *https://www.patreon.com/prof_mclaughlin — GET CERTIFIED IN FINANCIAL STATEMENT ANALYSIS, IFRS 16, AND ASSET-LIABILITY MANAGEMENT * https://edspira.thinkific.com — LISTEN TO THE SCHEME PODCAST * Apple Podcasts: https://podcasts.apple.com/us/podcast/scheme/id1522352725 * Spotify: https://open.spotify.com/show/4WaNTqVFxISHlgcSWNT1kc * Website: https://www.edspira.com/podcast-2/ — GET TAX TIPS ON TIKTOK * https://www.tiktok.com/@prof_mclaughlin — ACCESS INDEX OF VIDEOS * https://www.edspira.com/index — CONNECT WITH EDSPIRA * Facebook: https://www.facebook.com/Edspira * Instagram: https://www.instagram.com/edspiradotcom * LinkedIn: https://www.linkedin.com/company/edspira — CONNECT WITH MICHAEL * Twitter: https://www.twitter.com/Prof_McLaughlin * LinkedIn: https://www.linkedin.com/in/prof-michael-mclaughlin — ABOUT EDSPIRA AND ITS CREATOR * https://www.edspira.com/about/ * https://michaelmclaughlin.com

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