In 2016, FASB issued Accounting Standards Update (ASU) 2016-13, Financial Instruments—Credit Losses, which effectively replaces the “incurred loss” model in U.S. GAAP with a “current expected credit loss” (CECL) model when measuring the impairment of a wide-ranging scope of financial assets.
While this ASU made a “bigger splash” in the financial services industry, it was mostly overlooked by the healthcare industry at the time of issuance. But with the adoption of this ASU due shortly,1 most healthcare organizations are jumping in now and working with their trusted advisors and auditors to adopt.
What makes the CECL impairment model more complex than the current model is that the estimate of expected credit losses considers not only historical information, but also current and future economic conditions and events over the life of the financial instrument that could impact expected losses. Such lifetime expected credit losses require immediate recognition under the CECL impairment model.
CECL will impact all companies that have financial assets in terms of needing to document the adoption and update disclosures. Whether the standard impacts the actual financial statements and amounts recorded will depend on the facts and circumstances of each organization, including the types of financial instruments held and the counterparties to the financial instruments.
So, where should an organization start in its adoption? A good first step is to inventory your financial instruments and then separate by those that are in scope versus those not in scope. Financial instruments within the scope of the CECL impairment model include (but are not limited to):
- Trade receivables
- Contract receivables
- Loan receivables
- Financial guarantees
- Reinsurance recoverables
- Held-to-maturity debt securities
- Loan commitments
- Certain lease receivables
Financial instruments not in scope include:
- Loans made to participants by defined contribution employee benefit plans
- Policy loan receivables of an insurance entity
- Pledges receivable of a nonprofit entity
- Loans and receivables between entities under common control
- Operating lease receivables
Once an organization has properly identified financial instruments and bifurcated between those in scope and not in scope, it can then risk assess the identified in-scope instruments for CECL and document the considerations and conclusions for each for the year ended December 31, 2023 (or thereafter for off year-ends).
To provide insight into the most significant changes under the CECL standard, below is a summary of current GAAP as compared to the CECL standard (not intended to be all-inclusive):
| Current GAAP | New CECL | Considerations/Challenges | |
|---|---|---|---|
| Recognition Requirement | When loss meets probable threshold or when incurred. | Expected lifetime loss required to be assessed even in cases where probability of loss is remote. | Zero loss estimates, even with assets considered current under payment terms, will be rare and must be substantiated by reasonable and supportable data and documentation. |
| Basis of Loss Determination | Consider historical loss rates and current conditions. | Expected future conditions, in addition to what is required under current GAAP. | Availability of data, the relevance and reliability of that data, and the company’s ability to gather and maintain both historical and forecasted data necessary for CECL compliance. |
| Determine Methodology | Methodologies referenced in the standard include: Specific identification, aging percentage, etc. | Generally similar methodologies: Specific identification, aging, discounted cash flow, vintage, etc. | While methodologies may be similar, the inputs necessary and information needed to support these inputs and the overall methodologies could change. Furthermore, companies will need to reassess their accounting policies and procedures to evaluate any potential information gaps from their current estimation method. |
A zero-loss estimate on assets within the scope of CECL will generally be considered rare. In such cases, companies must be able to support the zero-loss estimate with “reasonable and supportable” historical and forecasted data and include proper documentation noting the rationale used in the determination. This is expected to be a significant change for non-financial institution companies that may have never performed an assessment of expected losses on receivables considered to be current under payment terms.
In addition to limited “zero-loss estimates,” all organizations are expected to have additional disclosures in the footnotes to the financial statements about the considerations made and conclusions reached for both the initial adoption and the ongoing evaluation.
Clarifications & Reminders – Cloud-Based Computing Arrangements
By now, all organizations should have adopted ASU 2018-05, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract. However, in many situations, the adoption did not fully apply to organizations on the date of adoption given limited or no such arrangements. In the last two to three years, however, many have had to revisit the guidance for proper application of the standard, including accounting, presentation, and disclosure implications. In particular, some have gotten tripped up in the different presentations of amortization expense between traditional software development implementation costs and similar costs in cloud-based computing arrangements. Accordingly, we wanted to take this opportunity to provide clarifications and reminders to help healthcare organizations avoid common pitfalls.
Some key reminders of the standard include the following:
- It is critical to work with IT leaders in your organization and review arrangements to determine if the arrangement includes a hosting arrangement and if said hosting arrangement comes with a software license.
- If the hosting arrangement includes a license for internal-use software, the software license is accounted for under Accounting Standards Codification (ASC) 350-40. This generally means an intangible asset is recognized for the software license and—to the extent that the payments attributable to the software license are made over time—a liability also is recognized. This guidance is not new with ASU 2018-052 but was sometimes overlooked post-ASU 2018-05.
- If a hosting arrangement does not include a software license, an entity would account for the arrangement as a service contract.
- Implementation costs incurred in a hosting arrangement are fees incurred by the customer to get the hosted service implemented, set up, and ready for use. They may include the cost of software licenses acquired for setup and implementation of a hosting arrangement and software upgrade, enhancement, and customization activities. Other implementation costs include training, creating or installing an interface, reconfiguring existing systems, and reformatting data.
- Costs are capitalized or expensed depending on the nature of the costs and the project stage during which they are incurred, consistent with costs for internal-use software. Costs to develop or obtain internal-use software that cannot be capitalized under ASC 350-40, such as training costs and certain data conversion costs, also cannot be capitalized for hosting arrangements. An entity would expense those costs that are incurred in the preliminary project and post-implementation-operation stages. Costs incurred for setup fees should be accounted for in accordance with guidance in ASC 340 on prepaid assets or other relevant guidance. Costs incurred for integration with on-premise software, coding, and configuration or customization are capitalized as intangible assets. Those costs incurred for data conversion and training are expensed as incurred. Any costs for business process re-engineering would be accounted for in accordance with ASC 720-45, Other Expenses.
Key Reminder:
Implementation costs capitalized should be presented in the same line item in the statement of financial position that a prepayment of the fees for the associated hosting arrangement would be presented.
Entities are required to expense the capitalized implementation costs over the hosting arrangement’s term. The term would include the arrangement’s noncancelable period plus periods covered by:
- An option to extend the arrangement if the customer is reasonably certain to exercise the termination option
- An option to terminate the arrangement if the customer is reasonably certain not to exercise the termination option
- The vendor’s option to extend (or not to terminate) the arrangement
The amortization expense should be presented in the same income statement line item as the hosting arrangement expense; it should not be presented along with depreciation or amortization expense related to property, plant, and equipment and intangible assets. This is because the asset recognized for the implementation costs is recognized only as a result of enhancing the value of the hosting service, which itself is not recognized as an asset. This is a common pitfall of organizations adopting the guidance and—because of its potential impact on EBITDA—is important for many.
Other matters to consider include:
On December 15, 2021, in response to feedback received on the June 2021 Invitation to Comment, Agenda Consultation, FASB Chair Rich Jones added software costs to the research agenda as part of the Accounting for and Disclosure of Intangibles research project.
On June 22, 2022, the board discussed the pre-agenda research, including stakeholder feedback, on the accounting for and disclosure of software costs. The board decided to add a project to its technical agenda to (1) modernize the accounting for software costs and (2) enhance the transparency about an entity’s software costs. The board decided that the scope of the project is the recognition, measurement, presentation, and disclosure of costs to internally develop or acquire software, which encompasses all of the software costs currently subject to the guidance in Subtopics 350-40, Intangibles—Goodwill and Other—Internal-Use Software, and 985-20, Software—Costs of Software to Be Sold, Leased, or Marketed, for all entities.
An exposure draft of new guidance is expected in late 2023 or early 2024 and organizations with significant software development costs are encouraged to monitor the developments and connect frequently with their trusted advisors and auditors.
Clarifications & Reminders – Debt Compliance, Impairments, & Going Concern Considerations
COVID-19 impacted healthcare organizations both on the front lines and in the back office. The industry is still recovering and amid new challenges such as labor shortages, high inflation, cessation of relief funds, and pressures on reimbursement and margin, no organization is immune to at least some implications on accounting and financial reporting.
For example, most have debt covenants to comply with, which typically include both financial, e.g., metric thresholds, and non-financial (delivery of financial statements by a certain date) requirements. Pressures on margin are impacting financial ratios and all organizations are encouraged to include debt covenant compliance projections in their budgets and reforecasts. Also, more organizations than ever are issuing financial statements close to, at, or even after the required due dates as they contemplate staff turnover, significant accounting issues (such as impairments, discussed next) or other matters. Revisiting and recommitting to timelines, processes, and controls may be critical for some with higher-than-usual changes in teams and transactions. See more details on debt covenants in our article, “Accounting Considerations for When Organizations Don’t Meet Debt Covenant Compliance Requirements.”
The number of healthcare organizations triggering impairments also is on the rise with continuing pressures on margins. Recalling the requirements, including the order of evaluation of impairment, is complex and takes significant time and documentation to evaluate.
Lastly, a reminder that management is required to evaluate whether conditions or events exist that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued or available to be issued (look-forward period). Guidance also mandates comprehensive note disclosures when substantial doubt exists, regardless of whether such doubt is ultimately alleviated.
For more information on how Forvis Mazars can help your organization with account matters, please reach out to one of our professionals or visit forvis.com/healthcare.
- 1 The CECL standard is effective for fiscal years beginning after December 15, 2022, e.g., January through December 2023 for smaller reporting companies (as defined by the SEC), and nonpublic companies with December 31 year-ends.
- 2 FASB first addressed cloud computing costs in 2015 when it issued Accounting Standards Update (ASU) 2015-05, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement, which covered hosting arrangements with a software license. ASU 2015-05 amended ASC 350-40 to help entities evaluate whether a hosting arrangement includes an internal-use software license for accounting purposes.