Understanding the New Current Expected Credit Loss (CECL) Model As It Relates to Trade Accounts Receivable
Lindsay Andrews, CPA
Following the 2008 financial crisis, methods by which entities account for credit losses received critical attention. Regulators believed that methods by which loan loss reserves were recognized under the then current U.S. generally accepted accounting standards (GAAP) were insufficient. The Financial Accounting Standards Board (FASB) responded with the current expected credit loss (CECL) model which incorporates forward-looking information about expected credit losses.
New CECL Model in Relation to Trade Accounts Receivable
All private companies with trade accounts receivable need to follow the CECL standard beginning with December 31, 2023 year-ends. Under the CECL standard, entities are required to estimate and recognize expected credit losses on all financial assets, which include trade receivables. The historical requirements required an allowance to be recognized for trade receivables when losses were probable and able to be reasonably estimated, whereas CECL requires a more forward-looking approach. A company’s allowance for trade accounts receivable won’t necessarily change due to the implementation of CECL, but the methodology and factors that go into the calculation have changed.
The CECL model requires companies to consider various factors in calculating a reserve on trade receivables, including the following:
Review Historical and Current Data
- Gather historical data on trade accounts receivable, including details on past uncollectible accounts, default rates, payment patterns, and any relevant economic indicators.
- Review current accounts receivable aging with contact terms with customers and subsequent collections of year-end receivables.
Develop Reasonable and Supportable Forecasts
- Develop a process for incorporating economic forecasts into estimates of credit loss. Consider qualitative factors that may impact credit losses– including changes in customer behavior, industry trends, and specific customer circumstances.
- Estimate lifetime expected credit losses based on historical data, current conditions, and future economic forecasts. Use statistical models or other methods to determine loss rates. Aging methods may be an appropriate part of your analysis for trade accounts receivable.
Keep Documentation of Analysis and Disclose Appropriately
- Document your methodologies, assumptions, and rationale behind your credit loss estimates.
- Create an internal control process for the frequency of the credit loss review and process for analyzing the allowance for credit losses.
- Ensure that your GAAP financial statements include the required disclosures related to CECL.
Every company has unique circumstances, and it is important to assess your specific situation and determine how the credit loss standard applies to your trade accounts receivable (or other financial assets). If you have any questions on how you need to look at your trade accounts receivable under CECL, please reach out to your Louis Plung advisor or email at [email protected].