CECL: Can there be zero expected credit losses under ASC 326?

Not surprisingly, everyone’s attention lately has been on Revenue from Contracts with Customers (ASC 606) and Leases (ASC 842). But what about CECL (ASC 326)? With an effective date of 2020 for public entities and 2022 for non-public entities, it’s not as high on most accountant’s radars, yet. But, as with the other standards, the implementation of this standard will involve a fundamental shift in the accounting process, controls, data gathering and more, so it’s never too early to start thinking about some of the issues associated with implementing this standard! One such issue is whether or not it is possible to have zero expected credit losses under ASC 326 when estimating current expected credit losses (CECL).

Introducing the CECL model under ASC 326

ASU 2016-13, which created ASC Topic 326, Financial Instruments – Credit Losses, establishes accounting for credit impairment for the following:

• Financial assets measured at amortized cost
• Available-for-sale debt securities
• Purchased financial assets with credit deterioration (PCD)

ASC 326 replaces the incurred loss model with an expected credit loss model, referred to as “the Current Expected Credit Loss (CECL) model”. Under this model, credit impairment is recognized as an allowance (a contra-asset) and not as a direct write-down of the amortized cost basis of the financial asset. While this is consistent with the current incurred loss model approach for loans and trade receivables, it represents a difference for other financial assets, such as held-to-maturity debt securities.

Under CECL, there is no threshold for impairment loss recognition. Rather, impairment should reflect a current estimate of all expected credit losses. For an in-depth look at the accounting under ASC 326, check out this eLearning course.

Is is possible to estimate zero expected credit losses under ASC 326

But could there ever be a time when a company could recognize zero expected credit losses? Generally, the answer is no! However, the standard states that no measure of expected credit losses is required for a financial asset or group of financial assets if historical credit loss information, adjusted for current conditions and reasonable and supportable forecasts, results in an expectation of nonpayment of the amortized cost basis of zero.

This is a very high hurdle to meet! Said another way, the historical information supports the fact that there is zero credit loss, the current conditions support the fact that there are zero credit losses, and the forecasts of the foreseeable future support the fact that there are zero credit losses. Past, present, and future…it takes all three!

Examples of financial instrument that might have zero expected credit losses

So, what types of financial instruments could possibly meet the requirements for an entity to recognize zero expected credit losses?

Recently, the AICPA’s Financial Reporting Executive Committee, or FinREC, issued a working draft on how accountants can help apply the guidance to determine whether an instrument might recognize zero expected credit losses. In the working draft, the FinREC provides three examples to illustrate how management could approach an analysis to evaluate whether the expectation of nonpayment is zero:

• A U.S. Treasury security
• A Ginnie Mae (GNMA) mortgage-backed security
• An agency mortgage-backed security

The working draft goes on to provide indicators that the security would have zero loss. Those might include:

• High credit ratings by rating agencies
• Long histories with no credit losses (adjusted for current conditions and reasonable and supportable forecasts)
• Guaranteed (either by a sovereign entity of high credit quality, the “issuing” agency, or an agency of the U.S. government)
• Rates of return (on instruments that are not U.S. Treasuries) are priced above the risk-free rate
• The ultimate “guarantor” (the U.S. government) can print its own currency

But it also includes factors that would indicate that the instrument might have a loss greater than zero. Those include:

• The treasury securities experiencing a downgrade
• The market not pricing the mortgage-backed securities the same as risk free
• Government agencies are subject to government appropriations
• Issues of mortgage-backed securities are not guaranteed that they would be bailed out should there be another event like the financial crisis of 2008

Closing thoughts

So, although this is a high hurdle to overcome, as you can see, it can be overcome. However, it must be well documented by management and consistently reevaluated. But, assuming the criteria like those listed above are met, there just might be circumstances where management could expect zero credit losses on an instrument.

For more information on the estimating expected credit losses under ASC 326, check out this post or our eLearning course, Credit Losses: Introduction to the CECL Model.

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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.