A new accounting standard from the Financial Accounting Standards Board (FASB) appears on its face to apply only to financial institutions. But it could affect nonprofits that adhere to Generally Accepted Accounting Principles (GAAP). Among other things, Accounting Standards Update (ASU) No. 2016-13, Financial Instruments — Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, requires earlier reporting of credit losses on receivables, loans and other financial assets. It also expands the range of information considered in determining expected credit losses. The standard takes effect in 2023, so it’s smart to review the details as soon as possible.

Current rule

Under the existing “incurred loss” standard, organizations recognize a credit loss only after a loss event has occurred or is probable. Before that point is reached, nonprofits record an allowance based on historical events. For example, based on previous experience, you might record an allowance for doubtful receivables in anticipation of future losses on them.

Critics have complained that this largely backward-looking model restricts an organization’s ability to record expected credit losses that don’t yet meet the “probable” threshold. In response, the FASB launched a project to better align the financial reporting on credit losses with the need of financial statement users for forward-looking information.

New requirements

After considering various models for reporting expected credit losses, the FASB settled on the “current expected credit loss” (CECL) model. This model measures and reports expected losses over the contractual life of the asset — generally starting at the initial recognition of the asset. The measurement of expected credit losses will be based on relevant information not just about past events, including historical experience and current conditions, but also the “reasonable and supportable” forecasts that affect collectability of the reported amount.

Several types of assets often held by nonprofits fall under the new ASU. They include:

  • Trade receivables (generally, amounts billed for goods or services, such as merchandise, tuition, fees, membership dues and special event income),
  • Held-to-maturity debt securities in an investment portfolio,
  • Notes receivable and other loan commitments, and
  • Lease receivables.

The ASU excludes promises to give, loans and receivables between entities under common control, and defined contribution employee benefit plan loans.

Some specifics

The ASU doesn’t prescribe a method for estimating specific credit losses. Rather, it allows nonprofits to exercise judgment to determine which method is appropriate for their circumstances, including the nature of their financial assets. It also permits organizations to continue to use many of the loss estimation techniques currently employed, including loss rate methods, probability of default methods, discount cash flow methods and aging schedules. But the inputs used with those techniques will change to incorporate the full amount of expected credit losses and the use of reasonable and supportable forecasts.

In addition, under CECL, credit impairment is recognized as an allowance for credit losses, not as a direct write-down of the financial asset. The ASU doesn’t establish a threshold for recognizing an impairment allowance, though, so organizations also must measure expected losses on assets with a low risk of loss. That means trade receivables that are current or not yet due will have an allowance. Under the current rule, such receivables might not require an allowance.

Act now

The new FASB standard will take effect for most nonprofits in 2023, although early application is permitted. To begin preparing for implementation of the CECL model, your nonprofit will need to review all of your financial assets to identify those within the standard’s scope and determine the method you’ll use to estimate expected losses.