Posted by Christina K. Bell, CPA
Accounting Standard Update (ASU) 2016-13: Financial Instruments – Credit Losses (Topic 326) – An Overview for Not-for-Profit Organizations
Accounting Standard Update (ASU) 2016-13: Financial Instruments – Credit Losses (Topic 326) was issued in June 2016 and becomes effective for nonprofit entities for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021.
Currently, under generally accepted accounting principles (GAAP), most nonprofit organizations follow the incurred loss methodology, meaning a loss is recognized only after a loss event has occurred or is probable. For example, most nonprofit organizations record an allowance for doubtful accounts in anticipation of future losses, based on experience.
ASU 2016-13 replaces the incurred loss methodology with the current expected credit loss (CECL) model. While this model will greatly impact financial institutions, it will also affect nonprofit organizations.
Under the CECL model, management must also consider current conditions and reasonable and supportable forecasts of future events and circumstances, in addition to experience, to estimate expected credit losses for certain financial assets, including:
- Financing receivables (loans, for example)
- Held-to-maturity debt securities (available-for-sale debt securities guidance has been amended separately and there is no change to the accounting for trading debt securities)
- Receivables that result from revenue transactions (trade receivables)
- Lease receivables recognized by a lessor
Financial assets excluded from the scope of ASU 2016-13 include:
- Promises to give (pledges) of nonprofit entities
- Loans and receivables between entities under common control
- Defined contribution employee benefit plan loans
ASU 2016-13 provides no threshold for recognition of an impairment allowance. Therefore, organizations must also measure expected credit losses on assets that have a low risk of loss. As a result, trade receivables that are either current or not yet due (which may not require an allowance reserve under current GAAP) may have an allowance for expected credit losses under ASU 2016-13.
The CECL model allows management to select the most appropriate method for estimating its expected credit losses based on the nature of their organization’s financial assets. Common methods for estimating expected credit losses include the loss rate method, discounted cash flow method, and probability of default method.
Credit impairment will be recognized as an allowance for credit losses, rather than as a direct write-down of the financial asset.
BLS will continue to monitor this topic and provide more in-depth guidance as the effective date draws nearer.