Oops, Forgot About CECL

You remembered, right? There’s been all the hubbub over Current Expected Credit Losses, otherwise known as CECL. I’m sure you’ve heard of it, meant to do something, but things got busy, procrastination set in and for whatever reason you’re not ready.

The time for procrastinating is over and, if you’re not ready, there’s some work to be done.

The CECL accounting mandate was made by the Financial Accounting Standards Board (FASB) approximately six years ago. All financial institutions, banks, finance companies, or any company that makes loans and publishes financial statements using Generally Accepted Accounting Principles (GAAP) must prepare their financial statements taking CECL into account. Publicly held companies have been following the CECL guidance since January 2020. Privately held companies affected were granted an extension for complying until December 15, 2022.

Here we are now in January and that date has passed. If you haven’t changed how you’re reporting, you are out of compliance, and your internal accounting staff and/or your CPA firm need to bring your financial reporting current to CECL standards.

The basic change with CECL is that, unless a “market value” approach is elected, the lifetime losses associated with every month’s loan originations must be estimated based on historical loss information of the company and modified as needed by other factors, such as the overall economic conditions in your community. The lifetime loss provision is required to be recorded with each month’s financial presentation. The analysis to produce a defensible projection for each month requires an experienced professional to prepare the reporting. If your company does not have that skill on board, your CPA firm or a few fintech companies can prepare the analysis for you.

What effect does this have on your financial statements presented to interested parties such as your company’s lenders – banks, credit unions and investors? The most important and unfortunate effect of CECL is that your monthly loss provision will increase, which reduces net income on the income statement and reduces equity on the balance sheet! The result will be amplified if your portfolio is growing at a rapid pace. But if your portfolio is level or declining, you will not have any major effect following the first adjustment to loss recognition. Keep in mind that CECL only influences your GAAP financial statements, not cash flow or income taxes as actual cash losses are used for your federal tax return, not GAAP losses. It’s a bit confusing, but all explainable by your CPA.

An added requirement is to make a one-time adjustment to cause your previous loss reserve account to reflect the effects of CECL prior to the Dec. 15 conversion date. This adjustment doesn’t require more analysis as past performance is already complete to begin reporting CECL adjusted loss information going forward.

So, what to do?

If you choose not to take the steps necessary to prepare your financial statements using CECL, you will be receiving complaints from your lending bank or other lines of credit provider. The best approach is to embrace the mandate and catch up on incorporating CECL requirements as quickly as possible into your accounting process.

You should note, if presenting CPA prepared audited financial statements or CPA prepared Compilation Financial Statements to your lender, the CPA firm will not give any form of opinion or explanation as the preparation of the financial statements will not follow (GAAP).

Good news, there are options that will save you all this trouble. You just need to present your portfolio’s value at its market value. That is, engage a specialist CPA firm or fintech company to analyze your loan portfolio to calculate the market value of the loan portfolio, rather than the simple sum of the principal values. The market value is what a purchaser of your loan portfolio would be willing to pay for it. The market value is calculated by reducing the principal for expected losses over the life of the loan portfolio plus or minus any premium the market is willing to pay or discount the market would require to purchase loan portfolios of this type. If you have a professionally prepared market value analysis, then no CECL preparation is necessary.

Please feel free to reach out to me for further information or suggestions on how to ensure your dealership is addressing CECL requirements.

Read the original article published by NIADA‘s UCD Magazine here.


Start Making More With AgoraCapital

Get access to unlimited, low-cost capital to use any way you want. See if AgoraCapital would benefit your business.

Leading-edge analytics gives you leading-edge power

Sign up for a free account and gain access to our state-of-the-art auto loan portfolio analytics tools.