Heads Up, Nonprofits: New Credit-Loss Standards are (Finally) Kicking In
After a long delay, new requirements for reporting expected credit losses are now taking effect, and they apply to most not-for-profits that file under GAAP.
What do these new standards mean for you and your NFP? Let’s take a look.
What is ASU 2016-23?
Under accounting standards update (ASU) 2016-23, expected credit losses reported for fiscal and interim periods beginning after December 15th, 2022, will be subject to new standards.
These new standards are based on a current expected credit loss model (CECL), and they make a number of changes to reporting requirements. The biggest is that management must now consider a broader range of information when estimating expected credit losses. While estimates were previously based on historic data, the new standards require management to account for historic data as well as current conditions and “reasonable and supportable” forecasts.
In other words, when estimating expected credit losses, you now have to account for the past, the present and the future.
Why Are the Requirements Changing?
In short, previous guidelines were often criticized for their overreliance on historic data. They required management to lean on past-facing information, including experience with assets with comparable credit-loss risk, to determine expected credit losses. In some cases, this method worked, but it often failed to account for current and future conditions that could affect losses. It relied too heavily on what happened before to predict what happens next.
The Financial Accounting Standards Board (FASB) expects that, by incorporating a greater range of data, estimates made under the new standards will paint a more accurate picture of an organization’s expected credit losses.
Does This Affect Disclosure Requirements?
Yes, the new standards expand existing disclosure requirements.
Under the CECL model, credit impairment is no longer a direct write-down of a financial asset; instead, it’s an allowance for credit losses. And since ASU 2016-23 does not define a threshold for impairment allowance, NFPs must measure expected losses on many assets that were outside the scope of the previous standards. Now, even assets with minimal credit risk must be included in expected losses.
Wait, Doesn’t This Only Affect Finance Businesses?
While the new standards are making their biggest impact on the finance sector, they apply to several financial instruments commonly used by NFPs. That includes trade receivables (such as amounts billed for merchandise or membership dues), lease receivables, various loan commitments and held-to-maturity debt securities, among others.
How Do You Estimate Expected Credit Losses Under the New Guidelines?
In general, the new guidelines leave it up to you to determine how you estimate expected losses. Estimates must take into account relevant information about past events, current conditions and forecasts of future conditions. Beyond that, you can choose your method of measuring expected credit losses, whether it’s a discounted cash-flow, loss-rate, roll-rate or ‘probability of default’ method, or an aging schedule.
There is no ‘best’, one-size-fits-all method. It all comes down to finding the right fit for your organization and the nature of the financial instruments you’re measuring. However, whichever method you choose, the CECL requires that you apply it consistently.
How to Get Prepared
The new ASU is here, and there are a couple of things your NFP can do to get prepared and ensure compliance.
First, take a look at all of your financial assets and decide which ones fall within the new standard’s scope. Remember: The ASU applies to a broader range of assets, so be sure to review those that may not have fallen under previous requirements.
Second, choose your method for estimating expected losses. As we mentioned above, this all comes down to the nature of your NFP and its financial instruments.
Need Some Help? D+L Has You Covered.
At Dugan + Lopatka, we understand that adjusting to new requirements can be a challenge. But with decades of experience working with nonprofits, we can help. Our trusted CPAs can work with you to develop a plan, ensure you’re complying with all applicable standards, and help you feel confident about your organization’s finances. Because when you feel good about your finances, you’re free to focus on what really matters.