Adopting CECL: What Private Companies Should Know

Common lessons learned

The extension of CECL adoption for private companies enables private companies to not only adequately prepare for implementation but to understand the full scope of potential roadblocks.

SEC Filers have provided feedback that there were several unexpected challenges including ensuring the completeness of financial assets that fall under the scope of the standard, collecting auditable data, and coordination across departments.

The overhaul of preparing and actively working through CECL involved heavy lifting not just from corporate accounting, but numerous departments across the business. For example, the most time-consuming element of the adoption process involved obtaining, analyzing, and assessing the impact of the data for various risk portfolios. The adoption does not only affect financial stakeholders, and leadership should be prepared to coordinate with risk management, collections, and managers of customer portfolios for data collection and analysis. Communicating the standard to non-accountants and ensuring their buy-in was a critical step in the adoption process. Even sophisticated accounting and finance teams experienced hurdles around data integrity, completeness, and accuracy for data that was previously not audited.

With expert guidance, private companies can learn from those pitfalls to avoid late audit adjustments and unexpected impacts to earnings.

Implementation process and pitfalls

The first step in the implementation process is to identify the population of financial assets in the scope of the guidance. Once this population has been identified, management must determine how best to estimate an expected credit loss. A widely used approach is a historical loss rate methodology, which allows companies to use their own data, adjusted for current market conditions, to develop a loss rate to apply to asset pools.

Using this methodology means that a significant component of implementation is the compilation and analysis of the company’s historical receivables and loss data. As noted above, many public companies underestimated the data required for this exercise prior to adoption and, as a result, found themselves underprepared for implementation. Through the information-gathering process, management teams have realized that historical data was not always organized in a consistent and sufficiently detailed format that was ready for analysis. In many cases, this lack of organization resulted in a significant time commitment to transition the data into a more usable format.

Two common pitfalls public companies experienced during the information gathering and analysis process were a) the inability to readily identify financial assets within the “other” or “miscellaneous” captions on the balance sheet to easily assess the underlying assets and b) the lack of organization of historical receivable balances, including identifiers that associate write-off amounts to a customer or pool of assets in prior periods.

Identification of financial assets and scoping

Identifying in-scope financial assets measured at amortized cost is an integral first step in calculating an expected credit loss, as this provides the population of financial assets impacted by the new guidance.

Management teams have faced difficulty documenting the composition of the “other” financial statement captions (e.g., other assets, other investments) because they are often catch-all captions for one-off transactions and other smaller items, which can become more cumbersome and time-consuming than expected.

The additional time that public companies spent disaggregating and identifying underlying assets often led to less time to perform thorough analyses of whether these assets were in scope of CECL.

Organization of historical receivables and loss data

Another common pitfall for public companies occurred when compiling historical loss information to calculate loss rates for prior periods. To calculate historical loss rates in prior years, assets are first grouped into pools based on common risk characteristics. A loss rate is then calculated for each asset pool. Companies can then apply an average historical rate to the pools of assets that exist at the effective date.

Obtaining historical data, primarily trade receivable and write-off data, by customer, revenue stream, and/or identified asset pool is difficult, especially when it needs to be organized in a consistent and detailed format over each of the periods utilized in the calculation. Since many companies go back three years to develop historical loss rates, this analysis may involve a significant amount of data.

If the underlying detail is not organized consistently by customer or asset pool, a review of customer listings over each of the three years within the period may be required in order to group customers into pools. Matching details within the bad debt expense account to the respective customers may also be required to group this information by pool.

Steps companies should take now

Management at private companies (and smaller reporting companies) need to start their adoption process as soon as possible.

For the financial asset scoping process, these adjustments can be made by creating a detailed schedule to identify the various assets and transaction-related balances that are included in the “other” or “miscellaneous” accounts and compiling the supporting detail in a central location.

For historical activity, management can perform a baseline analysis of current activity, including determining tentative asset pools and grouping customers into those pools. Maintaining this analysis and detailing the bad debt expense transactions in a way that they can be readily mapped to the associated customer will allow the company to begin developing and refining a loss rate by pool of assets. Management will then be able to book the loss rate upon transition, relieving the pressure felt and avoiding surprises related to adoption of the standard as part of year-end results.