Current expected credit loss (CECL)

Definition

Current expected credit loss (CECL) is a financial accounting standard that requires organizations to estimate and recognize the expected credit losses on financial instruments over their entire life. This model emphasizes the need for more timely recognition of credit losses and relies on forward-looking information to improve the accuracy of loss estimations, which ultimately enhances financial reporting and risk management practices.

5 Must Know Facts For Your Next Test

1. CECL applies to a variety of financial instruments, including loans, trade receivables, and debt securities, making it essential for many businesses.
2. Under CECL, organizations must consider historical data, current conditions, and reasonable forecasts when estimating expected credit losses.
3. The standard aims to provide a more proactive approach to recognizing credit losses as opposed to the previous incurred loss model.
4. CECL was introduced by the Financial Accounting Standards Board (FASB) and became effective for public companies starting in 2020.
5. Entities are required to disclose their methodology for estimating expected credit losses, which enhances transparency for investors and stakeholders.

Review Questions

• How does the CECL model differ from the previous incurred loss model in recognizing credit losses?
  • The CECL model differs from the previous incurred loss model by requiring organizations to recognize expected credit losses based on future projections rather than waiting until a loss has been incurred. This proactive approach allows for more timely recognition of potential losses and provides a clearer picture of an entity's financial health. By factoring in historical data, current conditions, and forecasts, CECL enhances the accuracy of loss estimations compared to its predecessor.
• What are the key components that organizations must consider when estimating expected credit losses under CECL?
  • Organizations must consider several key components when estimating expected credit losses under CECL. These include historical loss experience, current economic conditions, and reasonable forecasts about future market trends. Additionally, they need to evaluate factors such as borrower creditworthiness, collateral values, and any changes in payment behavior. This comprehensive approach ensures that estimates reflect both past performance and future risks.
• Evaluate the impact of CECL on financial reporting and risk management practices in organizations.
  • The introduction of CECL significantly impacts financial reporting and risk management practices by promoting a more forward-looking approach to estimating credit losses. Organizations must enhance their data analytics capabilities to incorporate various risk factors into their models, which leads to improved decision-making regarding lending and investments. Additionally, CECL increases transparency in financial statements by requiring detailed disclosures about the methodologies used for estimating expected credit losses. This shift helps stakeholders better understand an organization's risk profile and potential vulnerabilities.

Related terms

Allowance for Credit Losses: A reserve established by an entity to account for potential future credit losses on its financial assets.

Loss Given Default (LGD): The percentage of an asset that is lost when a borrower defaults, which is an important factor in calculating expected credit losses.

Risk Management: The process of identifying, assessing, and controlling threats to an organization's capital and earnings, which includes managing credit risk.