Blog: Challenges Faced by Not-for-Profit Organizations in Adopting the New CECL Standard
By: Cristopher Sefransky, CPA, CFE, LSSGB
Our industry is well over a year into implementation of the transitional guidance in Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (FASB ASC Topic 326): Measurement of Credit Losses on Financial Instruments, or “CECL” as it is affectionately known. CECL is an acronym for current expected credit losses, which is the overarching concept of the new guidance. The CECL standard went into effect for all organizations (except certain public business entities for which it was already effective) for fiscal years beginning after December 15, 2022, which means that by now, all calendar year 2023 and most fiscal year 2024 entities will have adopted CECL. The standard introduced a new approach for recognizing credit losses on a variety of financial assets and affects all organizations, including not-for-profit organizations (“NPOs” as referred to herein). While the standard primarily impacted financial institutions, NPOs were also affected, particularly those whose revenue sources include exchange transactions. Transition to the new standard presented various challenges for NPOs that are different from the challenges faced by public and other non-public entities.
The primary challenge NPOs have faced is a general understanding of the standard. The overall objective of the CECL standard was for entities to provide users of the financial statements with useful information in analyzing an organization’s exposure to credit risk along with the measurement of credit losses. The standard called for a potential shift in methodology as well as expanded disclosures. Prior to FASB ASU 2016-13, allowances for credit losses, or doubtful accounts, were calculated primarily using historical experience and bad debt (credit loss) expense was recognized when it was probable that losses have occurred. CECL completely changed that thought process and requires that entities estimate and record all expected credit losses over the life of the financial asset. In addition, while the standard mandates that an estimated loss method be used, it does not specify a certain method. Any model used may have its own advantages for an organization, so it is important that management weigh the costs and benefits of any potential method. Methods should not just take historical experience into account, but also consider current conditions and reasonable and supportable forecasts. Many NPOs, particularly smaller organizations with limited accounting personnel, may lack the financial expertise or resources to fully understand and implement the requirements under the standard.
A hurdle that many NPOs have faced is understanding what CECL applies to with respect to an organization’s receivables. A significant scope exception for NPOs falls under FASB Accounting Standards Codification (“ASC”) Subtopic 326-20-15-3e. This states that promises to give or contributions receivable are scoped out of the CECL standard. Essentially, any receivable that falls under the FASB ASC 958-605 contribution model is not covered by CECL. Contributions are excluded from the scope of FASB ASU 2016-13, however, receivables arising from membership dues, program service fee revenues, tuition, patient service revenue, etc. are included in the scope of the pronouncement.
As the shift in methodology changed from a historical perspective to a probable loss estimate, reliable data to generate those estimates is necessary. Many NPOs operate with limited historical data, lacking comprehensive financial reporting databases, and may not be able to collect and analyze data effectively. While this may create difficulties from a historical look-back prospective, this limitation creates different challenges in preparing projections and estimates.
NPOs typically do not have unlimited resources and operate on tight budgets. Implementation of any new standard, including significant ones like CECL, can require changes within accounting systems, new and strengthened internal controls, training of staff and even board members, and methodology development. All of these require time and financial investment. Smaller NPOs may face challenges in allocating resources without sacrificing their core missions.
One other major impact on NPOs is that for some organizations, adoption of the CECL standard has led to significant changes to their financial statements. Organizations that previously had no allowance for doubtful accounts or a minimal allowance have been mandated to take a closer look, with a different perspective, and at times, this has led to a much higher allowance for credit losses. This has an impact on the net asset balance and can affect how boards, donors, lenders, and any users of the financial statements view the financial health of the organization. NPOs should be able to explain these changes and the implication on the overall picture of the Organization.
Adoption of the standard and transition to the CECL model involves significant consideration by any Organization. Documentation of the methodologies and assumptions, enhanced and updated internal controls, and internal training are all important aspects of the transition. In addition, the standard affects not just the allowance for credit losses calculation, but the financial statement disclosures surrounding the balances. The methodologies used, significant judgements and assumptions, and the impact on the financial statements are just the minimum disclosures to be added to the notes to the financial statements.
While the transition and adoption of the CECL standard may seem like a considerable hurdle, organizations should familiarize themselves with the financial reporting requirements and note that a large amount of NPO receivables surrounding contributions will be scoped out of the standard. Management should consult and continue to consult with their accounting professionals about the financial statement reporting requirements of the new CECL standard. With the new forward looking methodology, estimates can change from year to year. Collaboration with accounting professionals can ease these burdens and mitigate difficulties that any size NPO may face. At HFCO, we have a team of professionals specializing in audits of nonprofit organizations that can help your organization understand and meet your financial statement reporting requirements.
Reach out to Cristopher Sefransky, CPA, CFE, LSSGB, Audit and Assurance Manager, with any questions.