Guidance for Independent Schools on FASB’s New CECL Model

The long-awaited Current Expected Credit Losses (CECL) Standard, Accounting Standards Update 2016-13 – Financial Instruments-Credit Losses (Topic 326) is effective for nonpublic businesses and not-for-profit entities for fiscal years beginning after December 15, 2022. This means CECL is in effect during fiscal year 2024 for independent schools with June 30 year ends. AAFCPAs advises that independent schools not delay and begin their preparations now.

The most significant change.

The most significant change you will notice from current accounting guidance is a move from the incurred to the expected loss model. Under the new CECL model, an organization will recognize the estimated expected loss across the lifetime of the receivable at the origination date and as subsequently adjusted at the end of each reporting period.

Two factors that make CECL different from the legacy incurred-loss model are:

• Expected Losses Versus Incurred Losses. CECL requires entities estimate expected future credit losses based on information about past events, current conditions, and reasonable and supportable forecasts of future conditions.
• Estimates Represent Lifetime Losses. Expected credit losses across the contractual life of a financial asset must be recorded at origination rather than waiting until a loss event has happened.

Organizations should evaluate expected losses on receivables on a collective (pool) basis where similar risk characteristics exist, e.g., loan product type. For assets that do not fall into a collective group with similar risk characteristics, the organization will evaluate the asset on an individual basis.

The main criteria used to estimate expected losses include: 1.) current conditions, 2.) reasonable and supportable forecasts, and 3.) historical credit loss experience. Note that organizations shall consider adjustments to historical loss information for differences in current asset specific characteristics and shall consider both qualitative and quantitative factors in the assessment.

Under CECL guidance, there is no specific method to measure losses but rather what most closely aligns with management’s expectations of expected credit losses. Some relevant and cited methods for consideration include the aging schedule along with the discounted cash flow, loss rate, roll-rate, and probability of default methods.

Who is subject to the CECL Standard?

Many companies will find they are subject to the new CECL requirements because the standard applies to a number of commonly held financial assets including:

• Financing receivables, i.e., loans, trade accounts receivable, notes receivable, credit cards, lease receivable arising from sales-type, or direct financing leases.
• Receivables that result from revenue transactions within the scope of Topic 606 on revenue from contracts with customers and Topic 610 on other income, i.e., contract assets.
• Receivables from Topic 860 repurchase and securities lending agreements.
• Net investments in leases recognized by lessor (Topic 842).
• Off-balance-sheet credit exposures (guarantees, loan commitments).
• Reinsurance recoverable (Topic 944).
• Programmatic loans.

Other financial assets excluded from the scope of the CECL model include promises to give (pledges receivable), loans and receivables between entities under common control, loans issued under defined contribution employee benefit plans, and receivables arising from operating leases under Topic 842.

FAQs for Independent Schools

Q: The only financing receivables we have is tuition receivable. Does this fall under the scope of the new CECL requirements?

A:  Yes, tuition receivables fall under the scope of the new CECL requirements.

Q: We have calculated an allowance on our tuition receivable in previous years. How will the adoption of CECL impact our FY24 calculation?

A: Independent schools may continue to determine their allowance using their existing methodologies such as aging schedules or a loss-rate method. However, due to CECL, the inputs into that methodology, the factors considered, and additional qualitative adjustments will likely change as the principles of what constitutes a credit loss have changed significantly.

Q: Historically, we have never had an allowance on our tuition receivable. What should we do?

A: An independent school should develop an estimate of credit losses based on historical information, current conditions, and reasonable and supportable forecasts. The standard requires that a school estimate lifetime expected credit losses using internally generated data and reasonably accessible external data such as write-offs of student receivables. Installment plans and other tuition payment arrangements should be considered in the calculation. This data must be adjusted, as necessary, to reflect the extent to which management expects current conditions and reasonable and supportable forecasts to differ from the conditions that existed for the period over which historical information was evaluated. An independent school can look at current trends in the industry related to the collectability of tuition receivables, such as the unemployment or inflation rate.

Q: Will financial statement disclosures and accounting policies change with the adoption of CECL?

A: Yes, there will be a change in management’s policy and methodology for developing the estimate of the allowance for credit losses.

This standard is complex and careful analysis is necessary to determine whether the entity’s assets are within scope. If you have questions, please contact Aaron Diamond, CPA, Director, Assurance at 774.512.4182 or adiamond@nullaafcpa.com—or your AAFCPAs Partner.