What Your Nonprofit Needs to Know About CECL

Under current U.S. Generally Accepted Accounting Principles (GAAP), most nonprofit organizations follow the incurred loss methodology for financial assets measured at amortized cost, such as trade receivables and loans receivables, which is primarily based on historical losses. In other words, a loss is recognized only after a loss event has occurred or is probable.

The CECL model focuses on anticipated credit losses over the contractual life of the related financial asset by focusing not only on historical results but also on current conditions and reasonably supportable forecasts.

CECL is effective for all entities with fiscal years beginning after December 15, 2022. This standard aims to provide financial statement users with more timely reporting and disclosure of credit losses on financial instruments that are not reported at fair value.

How CECL Impacts Nonprofit Organizations

Under CECL, a credit loss is measured and recorded upon initial recognition of a financial asset recorded at amortized cost. The loss is subsequently reassessed and adjusted at each reporting date, with any changes included in net assets.

Nonprofit financial assets primarily impacted by the CECL model include:

• Receivables from ASC 606 or ASC 610 revenue transactions (trade receivables)
• Receivables from ASC 860 repurchase and securities lending agreements
• Lessor net lease receivables
• Programmatic investments
• Off-balance sheet credit exposures — i.e., guarantees or loan commitments
• Reinsurance receivable

Assets excluded from the CECL model include:

• Financial assets measured at fair value with changes in fair value reported through the change in net assets
• Promises to give
• Loans and receivables between entities under common control
• Operating lease receivables
• Derivatives

Although measurement under CECL starts with using historical information, the model requires management to also consider present conditions and a broader range of supportable forecasted information to estimate credit loss, an increase in scope that requires significant judgment from those involved.

The CECL model also allows an organization to assess accrued interest separately from other financial assets measured at amortized cost. This allows nonprofit organizations that promptly write off uncollectible balances to choose not to assess an allowance for credit losses on accrued interest receivables. Instead, organizations can write off accrued interest receivables by reversing interest income, recognizing credit loss expense, or combining both.

Changes to Programmatic Investments

Many nonprofits provide loans that meet the definition of programmatic investments. These are investments a nonprofit makes primarily to further its tax-exempt objectives rather than to generate income or appreciate assets.

Because the CECL model requires considering both current circumstances and future projections alongside historical data, nonprofits may need to track and analyze programmatic investments more thoroughly than before. This could involve collecting additional information about borrowers, conducting risk assessments, and maintaining comprehensive records to support credit loss estimates.

Credit losses should only include amounts the nonprofit does not anticipate recovering due to credit risks. Any amounts not expected to be collected for reasons unrelated to credit risk, like services provided by employees or meeting performance criteria, should not be included in the determination of credit losses.

Nonprofit organization may also offer programmatic loans with forgiveness terms, meaning that part or all the loan principal will be forgiven at some point in the future. In such agreements, the nonprofit must determine the portion that constitutes a promise to give (under contribution guidance) to determine which portion of the loan is subject to the CECL model. As discussed earlier, promises to give are not within the scope of ASC 326. As a result, CECL will only impact the portion of the loan where payment is expected.

Implementing CECL Within Your Nonprofit

CECL does not require a specific model or method to measure credit losses. However, historical information, current conditions, and reasonable and supportable forecasts should be considered. Guidelines and examples are included within the standard, but the selection of a method is left to each organization’s judgment.

Examples of potential measurement models include:

• Aging Schedule Analysis: Determined using a basis of how long a receivable has been outstanding — i.e., under 30 days or 31-60 days.
• Discounted Cash Flows: Determined by comparing an asset’s amortized cost with the present value of the estimated future principal and interest cash flow.
• Loss Rate Method: Determined by applying an estimated loss rate to the asset’s amortized cost.
• Vintage-Year Basis: Determined using previous loss patterns for pools of assets with similar characteristics.
• Probability of Default: Determined by multiplying probability of default by the loss given default.
• Roll-Rate Method: Determined using historical trends in credit quality indicators — i.e., delinquency or risk ratings.

Next Steps for Nonprofits Navigating CECL

Careful consideration of measurement models and methods will be essential to implementing CECL correctly. By understanding the implications of CECL and taking proactive steps, nonprofits can adapt to the new standard and enhance their financial reporting practices for greater transparency and accountability.

The introduction of CECL marks a significant shift in how nonprofit organizations approach financial reporting. We can help you make sense of the standard and understand what actions must occur post-implementation.