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The coronavirus epidemic could complicate how U.S. companies comply with a new accounting standard on expected future losses. The rule, known as Current Expected Credit Losses, or CECL, went into effect for large U.S. public companies in December. To comply with it, companies are required to forecast expected future losses as soon as loans are issued.
They are expected to use economic indicators for forecasting. But the novel coronavirus, which has shaken global financial markets, is making it difficult for companies to make predictions about credit risk. "I don't think the Centers for Disease Control and Prevention or anyone else has the ability yet to forecast the future evolution of the virus with much confidence," said Stephen Ryan, an accounting professor at New York University.
Finance executives continue to evaluate how the epidemic affects their companies' ability to collect receivables. If a company raises its forecast for credit losses, its reserves set aside to cover estimated losses could go up, resulting in lower profitability, all other things being equal, accounting experts said. Before CECL, companies didn't have to recognize losses until they had evidence the losses had been incurred.
The incurred-loss model, by definition, had no future component. "Even if they knew the economy was going to worsen in the future, they were not allowed to consider that in determining future reserves," said Maria Mazilu, a senior accounting analyst at Moody's Investors Service.
The Financial Accounting Standards Board, which sets U.S. accounting standards, has said it changed the rule to provide investors with more transparency about the loan-issuing process and to more closely align companies' accounting with true risk.
All public and private companies will ultimately have to adopt the standard. FASB last year delayed the rule's effective start date for small public companies and all private and nonprofit companies until after Dec. 15, 2022. Financial institutions—among the most affected, given their large loan reserves—have likely begun to consider macroeconomic indicators such as gross domestic product growth, unemployment rate and housing prices in making projections for expected future credit losses, Ms. Mazilu said.
The standard gives companies greater discretion in its application than the incurred-loss model, potentially creating volatility in company earnings— a concern of bankers and lawmakers that criticized the rule. It could be a while before speculation on the economic impact of the coronavirus epidemic becomes substantial enough for a forecast that meets the standard's requirements, said Brad Bird, a national technical partner at accounting firm BDO USA LLP.
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