In the summer of 2016, the Financial Accounting Standards Board (FASB) issued an update to the codification to require companies to further consider the risk of loss associated with their various financial assets. While this initially seemed to impact banks and financial institutions, the update revealed trade receivables to be a susceptible account, meaning that most companies, regardless of industry, will need to consider how this update impacts their financial statements! The best way to prepare? Read this blog to find out!

Background

In June 2016, the FASB issued Accounting Standards Update 2016-13, Financial Instruments — Credit Losses, which created FASB Accounting Standards Codification (ASC) Topic 326 (ASC 326). ASC 326 is effective for non-public business entities for periods beginning on or after December 15, 2022, and will be applicable to financial statements for the year ending December 31, 2023.

How ASC 326 Might Impact You

Although the standard was written primarily with bank and financial institutions in mind, ASC 326 also requires companies to measure expected credit losses for financial assets measured at amortized cost, including trade receivables. It is therefore expected to impact most companies across a broad range of industries.

Change in Terminology

The allowance for doubtful accounts previously used to reserve for uncollectible receivables is now replaced with an allowance for current expected credit losses, otherwise known as CECL.

Current Expected Credit Loss (CECL) Model

The new CECL model requires management to consider additional information when developing a forward-looking estimate and recording an allowance for expected credit losses over the life of the asset. This additional information could include the following:

  • Pooling Similar Risks: When pooling assets with similar risk characteristics for evaluation, considering the various aging categories for accounts receivable.
  • Historical experience: Previous losses should typically be incorporated into the estimate but may require adjustments for current business conditions.
  • External Data: Current macroeconomic and industry-specific factors that may impact collectability.
  • Credit Quality Indicators: Credit ratings of customers and other indicators of deterioration in credit quality such as bankruptcy filings.
  • Product returns, cash discounts, volume rebates, discounts for early payment, etc.: Because these items are not related to credit, they should be excluded when developing the allowance for credit losses.

Principle-Based Standard

Although the FASB has provided implementation guidance and factors to consider when estimating credit losses, it does not specify an exact methodology for companies to apply when developing the estimate for credit losses.

The standard indicates that "the allowance for credit losses may be determined using various methods." Therefore, no change may be required to your current method for estimating your allowance; however, the emphasis on forward-looking information may prompt additional inquiries into the approach and significant assumptions used in determining the allowance for credit losses.

Increased Disclosures

The adoption of ASC 326 will require additional financial statement disclosures related to the adoption of the new account standard and the allowance for credit losses.

How We Can Help You

While ASC 326 introduces changes in estimates, modifies terminology, and increases financial reporting and disclosure requirements, its adoption may not necessarily result in significant changes for entities with historically low allowances for doubtful accounts. However, there will likely be heightened scrutiny of management estimates associated with the allowance for credit losses in order to comply with the new standard.

At Delap we are committed to assisting you in navigating this change seamlessly. If you have additional questions or need further clarification on the new accounting standard or its impact on your company, please reach out to us.

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