CECL for Nonprofits

Special thanks to Julien Decosimo, who contributed significantly to this blog.

The Current Expected Credit Loss (CECL) model, established by Accounting Standards Update (ASU) 2016-13, has implications for nonprofits. As a CPA firm dedicated to serving nonprofits, we’ve closely observed the impact of CECL adoption. Let’s jump into the key aspects and considerations.

What is CECL?

CECL changes how organizations recognize credit losses on financial instruments. Unlike the previous incurred loss model, CECL requires immediate recognition of estimated expected credit losses over the entire life of a financial asset. This includes trade receivables, net investments in leases, and certain off-balance sheet credit exposures.

Scope of CECL Guidance

Here’s what falls within the scope of CECL for nonprofits:

In scope:

• Trade receivables: CECL applies to trade receivables.
• Loans receivable: Nonprofits holding loans must consider CECL.
• Programmatic investments: These usually take the form of low-interest or interest-free loans but can be investments in businesses and are scoped into CECL.
• Net investments in sales-type and direct financing leases: These are subject to CECL.
• Reinsurance receivables: CECL covers reinsurance receivables.
• Financial guarantees: Nonprofits providing financial guarantees are impacted.
• Purchased credit deteriorated assets recorded at amortized cost: These assets fall under CECL.
• Contract assets: After the conditional right to consideration has been fulfilled, CECL applies.

Out of scope:

• Contributions receivable: These are specifically excluded from CECL.
• Operating lease receivables, equity method investments, and derivatives: Not covered by CECL.
• Loans and accounts receivable under common control: Loans and receivables between related parties not under common control do not fall within this scope exception.
• Financial assets measured at fair value: A portfolio of equity securities held by an organization would not be subject to CECL.
• Loans to participants of defined contribution benefit plans: CECL is not applicable to loans to participants.

Effective dates

CECL is effective for all nonprofit entities for fiscal years beginning after December 15, 2022. Entities that have not yet adopted CECL should also consider standards that modify or clarify CECL, such as ASU 2019-04, ASU 2019-05, and ASU 2022-022.

Estimating and disclosing expected credit losses

Nonprofits must consider historical data, current economic conditions, and future events when estimating credit losses. In the past, organizations only considered historical data. Additionally, organizations should pool financial instruments into groups with similar characteristics as required by the accounting standard update.

These updates require organizations to disclose information about the credit quality of their loans, including the credit risk, credit quality of their loans, and the allowance for credit losses. They must also disclose the methods and assumptions used to estimate credit losses.

What we are seeing

Many nonprofit organizations are impacted by this accounting standard update as a result of having financial instruments measured at amortized cost, such as loans and trade receivables. To develop an estimate of credit loss in this situation, organizations need their historical loss data as their starting point.

From there, organizations adjust for current economic conditions and future events. Factors to consider when developing this adjustment include the customers environmental factors and any credit concentration such as:

• Legal, regulatory, or technical environment to which the organization is exposed
• Expected or known changes in the geographical market or industry to which the organization is exposed
• Expected or known changes in national, international, local, or regional business and economic conditions

As an example, a nonprofit Section 501(c)(6) trade organization serves members in a particular industry. The nonprofit would be exposed to economic conditions in the industry it serves if it extends credit to its members or provides, for example, programmatic loans to industry participants.

To develop an adjustment factor to the historical loss rates on receivables carried at amortized cost, we can obtain data available about the conditions in the economy or industry. If conditions in the economy or industry are expected to change, and these changes could impact credit quality, this could support a corresponding adjustment in the historical loss rate.

The nonprofit organization would disclose in its financial statements information about the credit quality of its receivables and loans and what factors it considers when developing its estimate for credit loss.

How we can help

CECL requires organizations to use judgment to apply current and forward-looking information to adjust their historical loss estimates and develop financial models. As a result of the ASU, organizations will need to update their processes related to how they estimate credit loss and update their disclosures about credit loss. If you have questions about implementation for your organization, please contact us.