Overview of Current Expected Credit Losses for Nonprofits
When thinking about the new accounting guidance for credit losses (CECL), most people think of banks and other financial institutions. However, CECL will apply to any entity that holds financial assets, which includes receivables, loans, and even some investments. Many nonprofits will be affected, especially those with exchange-type revenue transactions or large endowments made up of held-to-maturity investments. CECL is effective for non-profits for fiscal years beginning in 2023.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. CECL replaces the current “incurred loss” model with a new “expected loss” model.
Incurred Loss Model
Previously, incurred losses were measured at the reporting date. Impairment was recognized when it was probable that a loss event had occurred. The incurred model used historical loss rates adjusted for current conditions.
Expected Loss Model
Now, expected losses are measured over the contractual life of the asset. There is no recognition threshold for when an impairment amount should be recognized. All probabilities of losses must be considered, no matter how small. The expected loss model uses the past (historical data), present (current conditions), and future (reasonable and supportable forecasts) to estimate losses.
The goal of the CECL model is to present the net amount expected to be collected, via the use of a contra-asset, an allowance for credit losses (“ACL”). Therefore, the ACL is the amount the entity does not expect to collect of the amortized cost of the asset during the asset’s contractual life.
The scope of CECL is broad and includes most financial assets that are not valued at fair value through net income.
The following assets commonly held by non-profits fall within the scope:
- Trade receivables that result from exchange-type revenue transactions, such as:
- Gift shop or merchandise sales
- Tuition income
- Fee income
- Membership dues
- Special event income
- Held-to-maturity debt securities within an investment portfolio
- Notes receivable and other loan commitments
- Lease receivables recognized by a lessor
The following financial assets are excluded from the scope of CECL:
- Promises to give (pledges) of nonprofit organizations
- Loans and other receivables between related entities under common ownership
- Defined contribution employee benefit plan loans
While CECL will not be effective until 2023, it is important for organizations to be proactive in preparing for implementation. At a minimum, non-profit organizations should be taking an inventory of their financial assets to determine which will fall under the scope of CECL. They should begin to think about potential impairment of these assets under the expected loss model.
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.