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After the CECL transition: Now comes the hard part

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The Financial Accounting Standards Board issued the Current Expected Credit Loss (CECL) accounting standard in 2016. Since then, many questions have been raised about what it requires, particularly by financial services companies that have been preparing to meet the new standard.

In response, FASB created a Transition Resource Group to try to answer these questions and to discuss the challenges CECL poses for firms — from interpretations of the guidance to hurdles anticipated from actually putting the requirements into practice. Underscoring the difficulty firms have faced, FASB in July 2019 extended the implementation date for non-public entities and those public entities defined as Small Reporting Companies (SRC) to Jan. 1, 2023. For non-public entities not listed as an SRC, however, the implementation deadline remained Jan. 1, 2020.

Now, the entities that adopted CECL at the start of this year need to understand that this transition period may actually be the easier part of putting CECL in place. Here’s why.

Many new considerations

Given that the focus has been on the transition to the CECL standard, firms have made accounting policy decisions and redesigned processes without the ability to perform true parallel testing in a real production-like environment. You could run your CECL allowance process against your existing Incurred Loss process, but that does not meet the definition of a true parallel test in a traditional system design lifecycle. This approach can highlight gaps in the process and even control deficiencies but, for most, the first real run of a new process will likely occur at the beginning of this April.

That may put additional pressure on your employees and your vendors, given that many of them are not accustomed to the rigors of an accounting close. Your credit teams may not have been through a process with the controls and structure required by the accounting team (e.g., SOX-compliant controls and documentation). Are they ready for the questions and issues likely to come up during the close?

For CECL processes that require data and information from credit teams, or forecasting information from other teams within the organization, how much of your CECL data will come from groups outside of accounting or finance? How much insight will your credit team require into the final output? Or consider the timing of 2020’s Q2 close, which falls during the Fourth of July holiday for most organizations. It’s not just process owners; everyone involved with CECL at your firm should be prepared for a busy week over the holiday.

This also holds true for vendor relationships, where your vendors may not be accustomed to an accounting close cycle. For them, this will be a new endeavor. As such, your organization may need to establish whether your vendors are staffed and ready for these critical close periods.

Beyond concerns over the process itself, by the time the Q2 and Q3 closes arrive, the explanation of changes is another area that will need addressing. The implementation and transition period of the past few years has been with a rather benign economic environment with little substantial change. As a result, most forecasts that have been utilized showcase only minor changes in the economy. However, if changes in forecasts occur or if the market shifts in 2020, does your process design consider how to explain results to your CFO or your analysts? Will you know where to turn for explanations of why your allowance calculations are changing period-over-period?

These considerations are all examples of what will become important in a CECL environment after transition. It will be vital, with this transitional period for public entities behind us, that companies focus on making sure that ongoing processes and procedures are sound.

Looking back to look ahead

Lessons for CECL can be learned from the FAS-133 derivative accounting standard, where changes took years for businesses to integrate fully, and the business effect was felt for years. In some ways, the effect is still being felt, as you see companies that economically hedge their portfolio while not applying the hedge accounting standards (using fair value instead).

CECL can be viewed in a similar way. As noted, for most organizations CECL will require a significant number of stakeholders to play a role. Also, much of the data required to calculate the reserves under the new process will need to come from different locations and systems within the organization. The effort required to collect this data, and to do so in a controlled manner, can be significant.

So much time has been spent simply getting the information for initial runs and testing that not enough attention has been paid to the reality that this effort will need to be repeated every quarter. Each period will bring change and nuances that will require research and explanation, not only because an auditor may ask but because that information is now required to be disclosed. Allowance disclosures will have roll-forward reporting as well as extensive qualitative requirements to explain results.

Be prepared

All that being said, there are ways for your organization to be prepared. First and foremost, detailed conversations with your internal and external partners must take place, to make known what processes have been established. This may require some education, for example on what an accounting close looks like and what the key controls are and how they work. As mentioned, for many this will be a new way of thinking as the accounting cycle is not something they have been through in this level of detail.

Another way to prepare is by making sure your accounting team has the knowledge and access to review the inputs into the process. This will not only include verifying that they are able to see all of the components of the loss calculation, but that you can explain what those components mean. For some aspects of the CECL calculation this will be straightforward, but for others it may prove difficult. For example, are you using forecast data from an external source? If so, do you know how to get answers to questions and concerns in short order? Some banks have chosen consensus forecasts or published information, but those can be insufficient if there is no one to answer a question in a timely way.

Still another range of questions relates to the models that are being used to calculate CECL reserves. Does the accounting team have any way to validate that the output appears reasonable? For some firms, especially those using models built in-house, there might be consideration given to challenger models within the accounting group. Such challenger models do not need to be as sophisticated as those used in the production CECL estimates; however, having a way to validate what those sophisticated models are outputting will be crucial. Your own accounting team may consider a simpler, vendor-provided solution as a means of validation.

There are many steps you can take to mitigate the issues that a production CECL process will create. Just remember the importance of sound processes and procedures, and that the hard work of your institution’s CECL journey is far from over.

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