On the Radar
Current Expected Credit Losses
(CECL)
ASC 326 provides comprehensive guidance on recognizing and measuring credit losses
related to financial assets measured at amortized cost (e.g., held-for-investment
loans and held-to-maturity [HTM] debt securities), net investments in leases,
reinsurance recoverables, certain off-balance-sheet credit exposures (e.g., certain
loan commitments), and available-for-sale (AFS) debt securities. The CECL impairment
model, which is based on expected losses, applies to all of the above except AFS
debt securities, which are subject to a different model. The objectives of the CECL
model are to:
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Increase the consistency of the credit impairment model applied to debt instruments.
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Ensure timely recognition of credit losses through use of an expected loss model that requires an entity to recognize an allowance of lifetime expected credit losses.
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Provide flexibility by not requiring entities to use a specific method in estimating expected credit losses.
Guidance Applies to More Than Just Banks
Although the CECL standard was more relevant
to banks, most nonbanks have financial instruments or other
assets (e.g., trade receivables, contract assets, lease
receivables, financial guarantees, loans and loan
commitments, and HTM debt securities) that are subject to
the CECL model.
Consistent Impairment Models
As noted above, the CECL model is consistently applied to recognize and measure
credit losses related to financial assets measured at amortized cost, net
investments in leases, reinsurance recoverables, and certain off-balance-sheet
credit exposures; the credit impairment model for AFS debt securities is
separate. Assets measured at fair value (e.g., trading securities) or under
lower-of-cost-or-market models (e.g., mortgage loans held for sale) are not
subject to separate credit loss guidance since credit losses are reflected in
the measurement models that apply to such assets.
Expected Losses Versus Incurred Losses
The CECL model does not specify a threshold for recognizing an
impairment allowance. Rather, an entity recognizes its estimate of expected
credit losses for financial assets as of the end of the reporting period. Credit
impairment is recognized as an allowance — or contra-asset — rather than as a
direct write-down of the amortized cost basis of a financial asset.
An entity’s estimate of expected credit losses should reflect
the losses that occur over the contractual life of the financial asset. When
determining the contractual life of a financial asset, an entity is required to
consider expected prepayments either as a separate input in the method used to
estimate expected credit losses or as an amount embedded in the credit loss
experience that it uses to estimate such losses. The entity is not allowed to
consider expected extensions of the contractual life unless extensions are a
contractual right of the borrower.
An entity must consider all available relevant information when
estimating expected credit losses, including details about past events, current
conditions, and reasonable and supportable forecasts, as well as their
implications with respect to expected credit losses. That is, while the entity
can use historical charge-off rates as a starting point for determining expected
credit losses, it has to evaluate how conditions that existed during the
historical charge-off period may differ from its current expectations and,
accordingly, revise its estimate of expected credit losses. However, the entity
is not required to forecast conditions over the contractual life of the asset.
Rather, for the period beyond the period for which the entity can make
reasonable and supportable forecasts, the entity reverts to historical credit
loss experience.
No Prescribed Method
The CECL model reflects management’s expectations regarding the net
amounts expected to be collected on a financial asset. Because entities manage
credit risk differently, they have flexibility when reporting those expectations
under ASC 326. As a result, ASC 326 does not require entities to use a specific
method when measuring their estimate of expected credit losses. Accordingly, an
entity can select from a number of measurement approaches to determine the
allowance for expected credit losses. Some approaches project future principal
and interest cash flows (i.e., a discounted cash flow [DCF] method), while
others project only future principal losses. ASC 326 emphasizes that an entity
should use methods that are “practical and relevant” given the specific facts
and circumstances and that “[t]he method(s) used to estimate expected credit
losses may vary on the basis of the type of financial asset, the entity’s
ability to predict the timing of cash flows, and the information available to
the entity.”
Although the method used to measure expected credit
losses may vary for different types of financial
assets, the method used for a particular financial
asset should be consistently applied to similar
financial assets.
The table below summarizes various measurement approaches that
an entity could use to estimate expected credit losses under ASC 326.
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Measurement Approach
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High-Level Description
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|---|---|
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DCF method
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Expected credit losses are determined by comparing the
asset’s amortized cost with the present value of the
estimated future principal and interest cash flows.
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Loss-rate method
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Expected credit losses are determined by applying an
estimated loss rate to the asset’s amortized cost
basis.
|
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Roll-rate method
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Expected credit losses are determined by using historical
trends in credit quality indicators (e.g., delinquency,
risk ratings).
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Probability-of-default method
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Expected credit losses are determined by multiplying the
probability of default (i.e., the probability the asset
will default within the given time frame) by the loss
given default (the percentage of the asset not expected
to be collected because of default).
|
|
Aging schedule
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Expected credit losses are determined on the basis of how
long a receivable has been outstanding (e.g., under 30
days, 31–60 days). This method is commonly used to
estimate the allowance for bad debts on trade
receivables.
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Ongoing Standard-Setting Developments
The FASB has continued its postimplementation review of ASC 326 and
recently issued the following two ASUs to further refine the application of the CECL
model to certain current receivables and contract assets (ASU 2025-05) and certain purchased loans
(ASU 2025-08):
- ASU 2025-05 — This ASU establishes a practical expedient for current receivables and contract assets arising from ASC 606 transactions. Specifically, the practical expedient allows entities to assume that conditions as of the balance sheet date remain unchanged over the remaining life of such accounts receivable and contract assets, reducing the need for complex macroeconomic forecasting for these short‑term balances. Nonpublic entities that elect the expedient may also choose a policy of considering subsequent cash collections (through issuance of the financial statements) when estimating credit losses on those balances.
- ASU 2025-08 — This ASU expands the CECL “gross‑up approach” beyond purchased credit-deteriorated (PCD) assets to include purchased seasoned loans (PSLs). Generally, PSLs are acquired loans (excluding credit cards) that are not PCD and meet specified criteria (e.g., it is acquired in an ASC 805 business combination, it is obtained more than 90 days after origination by a transferee that did not participate in origination).
In addition to these two ASUs, the FASB solicited feedback on its future
standard-setting agenda as part of its January 2025 invitation to comment (ITC) (comments were due by June 30,
2025). Feedback on ASC 326 was received as part of the ITC. Examples of ASC 326
topics on which stakeholders provided feedback included making additional
simplifications to the guidance and enhancing certain disclosure requirements.
Accordingly, further refinements to ASC 326 may be made as the FASB resolves its
postimplementation review of the standard.
See Deloitte’s Roadmap Current
Expected Credit Losses (CECL) for
comprehensive discussions related to ASU 2016-13,
including the amendments made by the FASB’s recently
issued ASUs 2025-05 and 2025-08.
Contacts
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|
Andrew Pidgeon
Audit &
Assurance
Partner
Deloitte &
Touche LLP
+1 415 783
6426
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For information about Deloitte’s
offerings on CECL for commercial entities, please contact:
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Will Braeutigam
Audit &
Assurance
Partner
Deloitte & Touche LLP
+1 713 982
3436
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