In response to the financial crisis in 2008, the Financial Accounting Standards Board (FASB) took action for revisiting the methodology for recognizing credit losses as the existing approach to estimating credit losses was determining whether such losses met the threshold of being “probable”, regardless of whether or not they were expected. The existing standard led to the possibility for assets to be overstated as current expected credit losses could not be recorded if they did not meet the “probable” threshold. Additionally, a primary focus was placed solely over past events and current conditions when performing the analysis, while the consideration of future events was not a focal point. As a result, the FASB issued a new standard Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (CECL). This article highlights key aspects of the information provided in ASU 2016-13 (Topic 326), including the effective date and information that M&A expects to be utilized in the analysis and presentation of CECL.
The FASB issued CECL in June 2016, taking effect for all nonpublic entities, including not-for-profits and employee benefit plans, for fiscal years beginning after December 15, 2022. With this update, a financial asset (or group of financial assets) measured at amortized cost basis are now required to be presented at the net amount expected to be collected on the financial asset by reducing the amortized cost basis of the financial asset(s) by the allowance for credit losses valuation account.
M&A has evaluated the impact of the new CECL standard and notes that while this update impacts several types of financial assets such as accounts receivable, loans, net investment in leases, off-balance sheet credit exposure, and other financial assets that have the contractual right to receive cash, for our clients this will be most prevalent in regard to the analysis and presentation of Trade Accounts Receivable as well as Student Notes Receivable.
In order to measure the expected credit losses, an analysis must be performed over relevant information related to past events, current conditions, and forecasts that are considered both reasonable and supportable to the future collectability of the financial asset. When considering the collectability of student receivables, M&A’s primary focus will be based on several factors including:
- Overall historical collectability of balances
- Clients will be required to maintain historical loss information on an aggregate basis for financial assets that share similar risk characteristics.
- The impacts of collectability during COVID-19 (decline in frequency or amount of student payments, student balance forgiveness, etc.).
- Student status
- Active students naturally have a higher likelihood of repaying outstanding balances than inactive students. In addition, consideration as to whether these balances are due from students as cash payments or from 3rd-party sources (e.g., Title IV, other Federal and state agencies, external 3rd-parties).
- Inactive student balances which will likely be analyzed in two separate pools: withdrawals and graduates.
- Despite Active students having a higher likelihood of repaying outstanding balances, considering an estimation of the active student population that are not expected to graduate and especially if the balance is a cash payment from a student.
- The existence of third-party institutional loan and or/payment plan servicer resulting in notes receivable that will be analyzed in a separate pool from student trade receivables.
Overall, we do not anticipate significant changes occurring to our current processes, as the method of pooling for assessing collectability by analyzing active versus inactive students as well as trade receivable versus note receivable balances has been in practice by our clients since the adoption of ASC 606 – Revenue Recognition. However, we do encourage all clients to review their allowance calculations and collection practices to ensure your historical patterns and expected future results can support the current allowance reserve.
M&A is currently working through the process of finalizing proposed updates to footnote disclosures related to CECL and clients can expect these updates to appear in audited financial statement reports for both calendar and fiscal years beginning after December 15, 2022.