Knowledge and Insights

WHAT IS CECL?

Current Expected Credit Loss (CECL) is an accounting standard introduced in 2016 by the Financial Accounting Standards Board (FASB) with the objective of improving the accuracy and timeliness of financial reporting for financial institutions.  However, the standard has far-reaching implications beyond the banking sector. Nonprofit organizations, despite the unique funding mechanisms and structure, are also significantly impacted by this standard. Let’s explore the impact of CECL on nonprofit organizations and the challenges they may face in adapting to the new requirements.

UNDERSTANDING CECL

CECL is a forward-looking accounting model that replaces the previous incurred loss approach with an expected credit loss model. Under the incurred loss model, nonprofits only recognized credit losses when they were probable. CECL requires organizations to recognize expected credit losses over the life of the financial asset, taking into account historical data, current market conditions, and reasonable forecasts of future events. The standard removes the concept of “probable” and requires recognition of credit losses when such losses are “expected.” In other words, financial assets measured at amortized cost are presented at the net amount expected to be collected.

CECL APPLICATIONS & EXCLUSIONS

CECL applies to financial assets measured at amortized cost, including trade, loans and notes receivables. The CECL model does not apply to financial assets measured at fair value through net income, loans made to participants by defined contribution employee benefit plans, or promises to give (pledges receivable) of a not-for-profit entity, amongst other additional exclusions. Further, as some related-party loans may be viewed as a capital contribution rather than a loan to be repaid, these loans and receivables between entities under common control are excluded from the CECL model.

SUGGESTIONS FOR CECL IMPLEMENTATION

Organizations must thoroughly understand the CECL requirements and the scope. Further, it’s important to evaluate the availability and integrity of the data necessary for CECL compliance. This includes gathering historical credit loss data, analyzing current market conditions, and identifying other factors that could impact the financial assets. This data will form the foundation for estimating expected credit losses.

Documentation will become critical in implementation of the standard as nonprofits will be required to identify and document the most critical assumptions that may impact the final results. Nonprofits will need to develop an estimation methodology and support CECL estimates with documentation. There are several approaches available to nonprofits to estimate the loss amount. The most common and familiar to nonprofits will be the aging schedule methodology, where receivables are grouped into aging categories, based upon how long the receivable has been outstanding. Historical write-offs of each aging category and forward-looking information can be used to develop an estimate of future losses for each current aging category. Finally, it’s important for nonprofits to develop policies, procedures, and internal controls over CECL estimates.

CONCLUSION

The implementation of CECL has a significant impact on nonprofit organizations, introducing challenges related to financial reporting, data analysis, forecasting, and donor relations. Organizations need to be proactive in addressing these challenges by embracing technology, seeking expert advice, and educating their stakeholders about the implications of CECL.

To learn more about CECL and how it impacts your organization, please contact me at [email protected].

OUR TEAM IS HERE TO HELP

For over 40 years, Mercadien’s Nonprofit and Human Services Group has provided comprehensive support to nonprofits in NJ and surrounding areas through our specialized services in accounting, auditing, and strategic consulting. We understand the unique needs of nonprofits and offer customized solutions that are tailored to your organization. Contact us today to learn more about how we help nonprofits like yours.

DISCLAIMER: This advisory resource is for general information purposes only. It does not constitute business or tax advice and may not be used and relied upon as a substitute for business or tax advice regarding a specific issue or problem. Advice should be obtained from a qualified accountant, tax practitioner or attorney licensed to practice in the jurisdiction where that advice is sought.