How Will CECL Impact Nonprofit Financial Reporting?
Over the past few years, nonprofit organizations have experienced many financial reporting changes due to the effect of new accounting standard updates (ASUs). Beginning with the new nonprofit financial reporting model a few years ago, then the impact of the new revenue recognition standard, to finally implementing the new lease standard, many nonprofit organizations have experienced major changes to their financial statements. The news of yet another ASU to implement doesn’t provide the relief many nonprofit organizations want; however, while this new ASU will impact some nonprofit organizations, and all organizations should assess its applicability, it isn’t anticipated to be as far-reaching as some of the more recent pronouncements.
ASU 2016-13, Financial Instruments – Credit Losses (Topic 326) (CECL) requires organizations to immediately recognize all expected credit losses on the reporting date for financial assets as an allowance (contra-asset) account rather than a direct write-down of the asset. There are a number of methods for how to make this estimate, but, ultimately, they are all based on the combination of historical experience, current conditions, and reasonable forecasts. While CECL has the biggest impact on financial institutions, nonprofit organizations with certain financial assets will also be impacted by the new ASU. CECL became effective for nonpublic organizations with fiscal years beginning after December 15, 2022. Some of the more common financial assets within the scope of CECL for nonprofit organizations include trade receivables, loans/notes receivable (not including loans/notes receivable from related party entities), held-to-maturity debt instruments, and financing receivables such as program-related investments.
It is important to note that for nonprofit organizations, promises to give (pledges receivable) are not covered under the ASU.
Many nonprofit organizations are accustomed to the incurred loss method, such as when an allowance for doubtful accounts is recorded in anticipation of probable future losses based on historical data. Under CECL, organizations are required to estimate credit losses over the entire term of the asset, starting from the initial recognition date of the asset. The initial estimate and any subsequent change in the estimate is recorded as a credit loss expense on the statement of activities. The credit loss expense is estimated by evaluating three components of the financial asset:
- Historical Loss Information: Management uses historical loss experience of other financial assets with similar characteristics to establish a baseline for the estimate.
- Current Conditions: Management evaluates how the conditions that existed historically compare to current market conditions, using both qualitative and quantitative factors.
- Reasonable and Supportive Forecasts: Management discloses the rationale used to establish the estimate and provides evidence which supports the reliability and accuracy of management’s forecast.
As organizations begin to close their books, management should take the time to review the organization’s statement of financial position and determine if any of its financial assets fall under the scope of CECL. If CECL is found to be applicable, management will need to record an allowance for credit losses based on the three components listed above.
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