CECL: Importance & Tips for Adopting Accounting Standard 326
Many companies are unaware of the recent changes to accounting for credit losses outlined by CECL or accounting standard 326.
CECL isn’t just for banks or financial institutions — it applies to many organizations. And with audit season just around the corner, it is vital to understand and prepare to adopt this regulation to avoid audit delays and setbacks.
As experts in helping organizations effectively navigate risk and compliance, we’ve outlined some essential information regarding CECL and some quick yet effective implementation steps.
Important things to know about CECL, Accounting Standard 326:
- What CECL is and who it applies to
- How CECL differs from the traditional accounting model
- When CECL went into effect for private companies
- How CECL affects audit preparation
- How to calculate CECL
- Tips for streamlining CECL or Accounting Standard 326 adoption
What is CECL, and who does it apply to?
CECL stands for Current Expected Credit Losses and is an accounting standard that changes the way financial institutions (e.g. banks) account for credit losses.
While CECL was originally written for financial institutions, it applies to all companies that have financial assets and net investments that are not accounted for at fair value (e.g. loans, debt securities, trade receivables, and net investments in leases).
CECL can also be referred to as accounting standard ASC 326 and was created in response to the 2008 economic crisis to help establish more transparency and accuracy of financial reporting in banking.
Failure to comply can lead to financial misstatements, restatements, and regulatory inquiries and fines.
How does CECL differ from the traditional accounting model?
Whereas traditional accounting models recognize credit loss when the loss incurred, CECL requires institutions to consider expected losses over time.
This means that organizations must integrate a more forward-looking approach to successfully estimate potential credit losses and ensure this information is properly reflected in financial statements.
When did CECL go into effect for private companies?
CECL went into effect for private companies on January 1, 2023.
How does CECL affect audit preparation?
CECL introduces complexity to the accounting function, as an additional level of management judgement will be needed to estimate expected loss than for probable or incurred loss. And of course, there is always the need to inform auditors of changes to financial statements and ensure everything is properly documented ahead of their review.
Auditors will also need to validate the models the organization used to calculate CECL, which may involve a series of independent testing.
In sum, auditors will need to adapt their processes and procedures to address the challenges of accounting standard 326. As such, it is essential to focus on proper documentation and collaboration to streamline the auditing process and get ahead of potential issues before they arise.
How to calculate CECL
CECL does not require any specific method, and oftentimes, different methods may need to be used for different assets – as there is no one-size-fits-all calculation method for CECL.
Options for CECL calculation include but are not limited to: loss rate, roll-rate, vintage analysis, discounted cash flow, and/or probability of default or loss.
Tips for streamlining CECL or Accounting Standard 326 adoption
- Understand the principles and requirements of the CECL accounting standard as they relate to your organization.
- Assess your historical financial data to ensure accuracy and segment this data based on asset type, risk rating, and other items that may impact credit risk.
- Develop models for forecasting expected credit losses (e.g. probability of default, loss rate, etc.) while taking into account any economic conditions that may impact or cause credit losses.
- Ensure all staff are properly trained in the new accounting standard.
- Conduct rigorous testing of the CECL model to ensure it is free of errors and inconsistencies.
- Consider hiring a consultant to ensure the CECL implementation follows best practices and is in line with regulatory requirements.
Final Thoughts on CECL, Accounting Standard 326
To successfully implement CECL, it is essential to conduct an assessment of your current resources and capabilities to ensure the required documentation and processes can be created – and be audit-ready.
As such, it can often be more beneficial in terms of cost, time, and outcome to turn to a trusted partner for support.
Bridgepoint Consulting has a team of experts ready to help you with:
- Assessing and compiling historical financial data.
- Documenting, calculating, and testing CECL methods and processes.
- Supporting your organization through an audit and juggling auditor requests.
- Conducting risk assessments to identify and mitigate issues before they arise.
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