Category Archives: Accounting Topics

Current Expected Credit Loss (CECL) Standard

Summary of the Current Expected Credit Loss (CECL) Standard

On June 16, 2016, the Financial Accounting Standards Board issued Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments.  This has been codified in the Accounting Standards Codification as ASC 326-30.

This new standard replaces the incurred loss model of recognizing loss on loan portfolios.  The incurred loss model requires that it is probable that a loss has been incurred at the balance sheet date and that it can be estimated.  Instead, the expected loss model requires an estimate of the lifetime expected credit loss.  This lifetime expected credit loss is recorded as an allowance.

Major components of ASC 326-30 include:

  • Scope
    • Financing receivables
    • Lease receivables
    • Trade Receivables
    • Held-to maturity debt securities, loan commitments, financial guarantees, standby letters of credit, reinsurance receivables
  • Expected lifetime losses recognized upon recognition of the loan
  • Loss estimation considerations
    • Historical information
    • Current information
    • Supportable forecasts
  • Expected credit losses will be reported in current income through the Allowance for Loan and Lease Losses
    • Purchased financial assets with credit deterioration would be booked at face value with a noncredit discount (if applicable) and an allowance for credit losses.
  • Implementation:
    • Public Business Entity that is an SEC filer – 2020
    • Public Business Entity – 2021
    • Not a Public Business Entity (Private Companies) – 2021


How CECL Differs from FAS 5

FAS 5 has two components for loss recognition; (1) It is probable that an asset has been impaired and (2) The amount of the loss can be reasonably estimated.  This meant that to accrue a loss, something must have happened at or before the date of the financial statements that caused the loss to occur.  Expected future losses beyond those for which something already happened to cause the loss would not be recognized.  This loss estimation is known as an incurred loss model.

Under the incurred loss model, any estimate of loss relates only to those loans that have been impaired as of the balance sheet date.  So, it is an estimate of who has lost their job, who has large medical bills, or who has divorced that makes it probable that the customer is unable or unwilling to pay as of the balance sheet date.  It does not include an estimate of loss for those customers for whom nothing has yet happened to incur a loss.  The other component of the incurred loss model is that the amount of the loss may be reasonably estimated.

Under the CECL model, all expected losses over the life of the loan must be estimated and recognized when booking the loan.  Past events, current conditions and reasonable and supportable expectations about the future must be utilized to quantify the expected credit losses.  The loan assets on the balance sheet will be reduced by the lifetime estimate of losses.  This reduction will be accomplished through current earnings using the allowance for loan and lease losses.

Assume a pool of five year loans with the following incurred loss characteristics:

Incurred Loss2%5%5%2%1%15%


Using the incurred loss model, each year would have a valuation allowance entry that impacted the income statement through provision for loan losses.  The lifetime losses are spread out over a five year period in this example.

Using the CECL model, the total expected credit loss on the portfolio of 15% would be recognized when the loans are booked.  This results in a much greater impact to current income in many cases than the incurred loss model.

Both the incurred loss model and CECL require the use of historical information to support the loss estimate.  However, the incurred loss model has a much smaller “window” of loss to consider.  Accordingly, only loss data related to the period of time when the loss is incurred needs to be considered.  As a practical matter, most companies use 12 months of actual loss data as a starting point, then adjust this amount for any changes in company or overall economic conditions at the balance sheet date.

The CECL model will require that lifetime historical losses be maintained and used as the starting point for loss estimates.  If the company does not maintain lifetime loss information, this is a good place to start the CECL implementation process.

CECL also requires a forecast of future economic conditions and a methodology to use these forecasted conditions as an adjustment to expected lifetime losses.  Most published literature uses expected unemployment rate as an economic indicator to use as an adjustment factor.  Part of the CECL evaluation process will be to determine if there are any economic indicators that have a specific correlation to the loans being evaluated.

Another component of CECL not used in the incurred loss model is the necessity of determining the life of the loan(s).  Since CECL requires an estimate of lifetime losses, the actual lifetime of the loan(s) must be quantified.  CECL requires that prepayments be considered in the estimated lifetime of the loan, but extensions, renewals and modifications should not be considered.

The key differences between CECL and FAS 5 for loan portfolios are:

Expected Credit Loss ModelIncurred Loss Model
Loss RecognitionIt is probable that a loss has been incurred and can be estimatedAll expected losses over the lifetime of the loan portfolio
Adjustments to historical lossOnly adjust for conditions as of the balance sheet dateAdjust for forecasted conditions over the life of the loan portfolio
Life of loan portfolioNot consideredMust be quantified to estimate expected losses over the life of the portfolio
Content of allowanceIncurred losses not yet charged offAll expected losses over the lifetime of the loan portfolio that have not yet charged off


3 Most Common Financial Reporting Errors

Three Most Common Reasons for Restating Financial Statements

reporting errors due to complex rules

2 women looking at complex calculation

I just finished reading an interesting article in the Wall Street Journal on financial reporting.
Did you know that over 650 companies filed financial revisions or restatements last year?
In most cases, it appears that the reasons for the misstatements has more to do with confusion with complex accounting and tax rules than anything else.
I am sure that not many of you are surprised by that conclusion.  Adding rules to rules seems to be the norm these days.
Can you guess what the 3 most common financial reporting errors are?

I am sure almost all of you immediately guessed Tax which is correct; however, surprisingly, tax  is not the most common error.
How many of you guessed the other two?
The first is  Debt and Equity and  the second is Cash Flows.
Accounting for Debt and Equity errors are often due to dealing with complicated hedging and derivatives which
can be difficult to understand.
Cash flow errors can be easy to make- (my least favorite area of accounting!).
Taxes – well need I say more? It seems as though the tax code grows more complex on a daily basis!
Just a few reasons why continuing professional education remains so important. When you have a chance check out our courses on cash flow, hedging and derivatives and our tax section which is rapidly growing.

Computing a Loan Payment & Creating an Amortization Schedule

Computing the Periodic Payment for a Loan

Excel Financial Function

Computing the periodic payment is probably the most used Excel financial function simply because it is something everyone uses.
Let’s walk through an example.
You want to purchase a car and finance $24,000 over 24 months at an interest rate of 4%.   So, the question is –What is the monthly payment?
Here we have a value today (Pv) of $24,000.  We want a monthly payment for 24 months (Nper) at an annual interest rate of 4%.
First, we need to change the annual interest rate to a monthly one by dividing 4% by 12 = .0033333  Let’s reflect this in our worksheet.
Matching the rate to the payment frequency is important.  If you want to compute a monthly payment and have an annual rate, the rate must be divided by 12.  (So many people forget this little fact which is why I am really emphasizing it here.)

Present Value calculation
Click on cell B5, then click on the Fx button at the top left of the formulas tab.
At the top of the window that opens, select the category “Financial, then find and select PMT at the bottom.

Click OPMT-2K.




Fill in the cell references for Rate, Nper and PV as shown below: Rate is B3, Nper is B2 and PV is B1.
Click OK.
The monthly payment is $1,042.20.  Remember, since this was a monthly payment, the annual interest rate was adjusted by dividing it by 12.Also, please note that the answer is negative as it is considered an outflow. Yes- you can tell the programmer was not a CPA 🙂  The easiest way to fix this is to go up to the formula bar and put a negative sign in front of PMT so that it looks like =-PMT(B3,B2,B1)

Let’s  double-check our work by making an amortization schedule.
An amortization schedule starts with the initial loan amount and progresses it forward using the monthly interest rate and computed monthly payment.

Start with the beginning balance of $24,000.  Add interest to this amount at 4% divided by 12 (=B1*.04/12).  Reflect the payment as a negative amount and sum across the row (B4:D4) for the ending balance.


The new beginning balance in B5 should be the result in E4 (the formula in B5 will be =E4).  Copy these down 23 rows (for a total of 23 periods).  The ending balance should be very close to zero, but may not be exactly zero due to rounding (the use of only two decimal points in the payment).

amortization schedule

This proves that the monthly payment for a loan of $24,000 over 24 months is correct and provides us with the interest and remaining balance at the end of each payment period.

Mortgages work identically except that the number of periods is generally longer.


Dupont Model

Dupont Model

The DuPont Model is a methodology that computes Return on Equity by component parts.
Business owners and shareholders are very interested in their level of return.
A method of consulting with business owners and shareholders on ways to boost Return on Equity would be very valuable to the CPA.
The DuPont Model was first used by the DuPont Corporation in the 1920’s. Dupont logoIt breaks down the Return on Equity formula into three basic components; Net Profit Margin, Asset Turnover and Equity Multiplier. This can be used in conjunction with industry averages or competitor information to pinpoint opportunities to improve Return on Equity (ROE).
ROE = Net Profit Margin x Asset Turnover x Equity Multiplier
or ROE = (Net Income / Sales) x (Sales / Total Assets) x (Total Assets / Equity).
Some of the calculations did not show well in the blog so click here to access the PDF file on the Dupont Model.

Using the Altman Z Score to Predict Bankruptcy

Using the Altman Z Score to Predict Bankruptcy

– Guest Post by Joe Helstrom, CPA

Bankruptcy Predication - a foretller




The Altman Z score for bankruptcy prediction was first published by Edward Altman, an Assistant Professor of Finance at New York University, in 1968. He was trying to find financial ratios that could distinguish between a healthy company and one that might be distressed and enter bankruptcy.
To accomplish his goal, he evaluated common financial ratios of approximately 66 companies, all with assets or more than $1M. Approximately half of the firms had a bankruptcy in their past while the other half did not. He then used a statistical technique called Multiple Discriminant Analysis to determine which ratios were most predictive of bankruptcy and the proportion of those ratios to use.
Upon testing, Altman’s model was found to be 80-90% accurate in predicting bankruptcy one year prior to the event. However, it is also inaccurate 15% – 20% of the time in predicting bankruptcy, predicting that a firm will go bankrupt when it doesn’t.
While the accuracy rate is not 100%, it is still very good. It is so good that the Altman model has gained wide acceptance among accountants, auditors and even the courts.
Altman’s original model was designed for publicly traded manufacturing firms with assets of greater than $1 million. However, he has subsequently created two additional models to be used for private manufacturing companies and private non-manufacturing companies.
The Altman models use the following ratios:
 A. Working Capital/Total Assets
B. Retained Earnings/Total Assets

  C. Earnings Before Interest and Taxes/Total Assets
  D. Equity/Total Liabilities
  E. Sales/Total Assets
Note that for public manufacturing companies, Equity is defined as the market value of equity. For non-public manufacturing companies, Equity is simply book equity.
The proportions of each ratio change with each model.
For a public manufacturing company, the Altman Z Score model is (note Equity is market value of equity):
Z Score = 1.2*A + 1.4*B + 3.3*C + 0.6*D + .999*E
• A score of less than 1.81 has a high likelihood of bankruptcy
• A score of 1.81 – 2.99 is in the “Gray” area
• A score of greater than 2.99 is a safe company

For a private non-manufacturer, the Altman Z Score model is:
Z Score = 6.56*A + 3.26*B + 6.72*C + 1.05*D
• A score of less than 1.1 has a high likelihood of bankruptcy
• A score of 1.1 – 2.6 is in the “Gray” area
• A score of greater than 2.6 is a safe company
Note that the private non-manufacturer model does not use Sales/Total Assets.
The original model was developed for manufacturers. The non-manufacturer model was intended to fit service companies. A continuing criticism is that the model does not work for financial institutions.

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