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Typically, trade receivables are short term in duration as payment is generally expected to be received within one year. For the accounting associated with the initial recognition and presentation of trade receivables and contract assets, refer to PwC’s Revenue from contracts with customers guide.
CECL is the model that must be used to measure impairment on financial assets measured at amortized cost, which includes trade receivables. Therefore, estimates of expected credit losses on trade receivables over their life will be required to be recorded at inception, based on historical information, current conditions, and reasonable and supportable forecasts.
While the probability criterion for initial receivable recognition under ASC 606 considers a customer's ability and intent to repay, probable repayment under ASC 606 does not imply a credit-risk free receivable, nor does consideration of such collectability remove an entity's requirement to apply the CECL model. There will be an expectation of losses when a portfolio of similar receivables is considered on a pooled basis. An entity’s estimate of expected credit losses should include a measure of the expected risk of credit loss even if that risk is remote, regardless of the method applied to estimate credit losses.

7.7.1 Unit of measurement for assessing trade receivable in CECL

As discussed in LI 7.3.2, ASC 326-20-30-2 requires a reporting entity to use a pooled approach to estimate expected credit losses for financial assets with similar risk characteristics. If a financial asset does not share similar risk characteristics with other financial assets held by the reporting entity, the allowance for credit losses should be determined on an individual basis. Similar risk characteristics for trade receivables may include customer credit rating, trade receivable aging category (e.g., 30-90 days past due), industry, geographical location of the customer, product line, and other factors that may influence the likelihood of the customer not being able to pay for the goods or services.

7.7.2 Applying CECL to trade receivables

As discussed in LI 7.3.3, ASC 326-20-30-3 does not require reporting entities to use a specific method to calculate the allowance for credit losses; instead, it allows entities to use various methods, including methods that utilize an aging matrix.
Prior to the adoption of ASU 2016-13, many non-financial services companies used provision matrices for trade receivables in which historical loss percentages are applied to the respective aging categories. Under the CECL model, these companies are required to use a forward-looking methodology that incorporates lifetime expected credit losses. While the provision matrices may still be used under CECL, historical loss data will need to be combined with current conditions and reasonable and supportable forecasts of future losses to determine estimated credit losses. The most visible impact of CECL may be that receivables that are either current or not yet due, which today may not have a reserve, will have an allowance for expected credit losses.
When using a provision matrix under CECL, a reporting entity should segregate customer accounts into pools with similar risk characteristics, such as by product type, industry, and/or geographic region, and delinquency status. Loss rates are then calculated for each pool based on historical experience and adjusted for any changes in current and future economic conditions or differences in the attributes of the current portfolio. The model generally includes assumptions about (1) the migration of receivables from current to loss, and (2) cure rates associated with receivables that go from delinquent to current. The determination of the actual loss rate may be driven by actual writeoff experience as a percentage of the total receivable balance. When using this approach, reporting entities should be aware of modelling anomalies, such as customers that consistently fall in a particular delinquency category (e.g., a customer that consistently pays at 90 days), large writeoff or recovery activity from a particular customer or type of customer, and the method with which a reporting entity pools assets for purposes of the model.

7.7.3 Lifetime expected credit losses on trade receivables

As discussed in LI 7.3.5, once reporting entities adopt the expected credit loss model, determining what data is relevant in estimating expected credit losses will become a critical part of the allowance assessment. Under the CECL model, reporting entities can leverage historical loss data, but CECL also requires forward looking information and forecasts to be considered in determining credit loss estimates.
Most reporting entities have access to historical loss data that they have been using to estimate an allowance for doubtful accounts under the incurred loss model. This data allows reporting entities to estimate the percentage of uncollectible accounts or the amount of bad debt expense, typically as a percentage of accounts receivable, sales, or a combination of these metrics. Reporting entities may aggregate this data and analyze how it trends over time. Reporting entities can utilize historical data to understand and identify factors that resulted in historical credit losses and incorporate those factors into their analysis of future expected credit losses.
Reporting entities may use historical loss data, adjusted for current conditions and reasonable and supportable forecasts in conjunction with an accounts receivable aging matrix, to form a view of the relative size of credit losses to be expected under the CECL impairment model. For example, data may indicate that as a customer moves from the 60- to 90-day delinquency category to the 90- to 120-day delinquency category, the expected credit losses increase. A reporting entity may use this analysis to identify customers on which it will perform further credit analysis, such as customers who have particularly large uncollectable accounts or who have receivables that have been aged for a long period of time. Reporting entities may have also performed an analysis to determine whether there were significant changes in the credit ratings of their customers, as decreases in the credit ratings of customers may indicate a deterioration in credit quality. This analysis will be important in the CECL model, as the results of the analysis may lead a reporting entity to increase its expectation of credit losses.
Understanding the relationship between the reporting entity, the industry, and the customer base is an important starting point in assessing which factors may impact the assessment of expected credit losses. Understanding customer demographics, payment terms offered in the normal course of business to customers, and industry-specific factors that could impact the reporting entity’s receivables is critical to forming the basis of the expected credit loss analysis.
In addition, under an expected loss model, reporting entities are required to consider available external data in their analyses. These external data points include macroeconomic factors, such as economic growth trends. Companies will need to assess the degree of correlation between these data points and the reporting entity’s loss experience and loss forecasts to determine the impact macro (and micro) economic factors have on loss experience. Judgment will be required to determine how historical loss information, as well as the macroeconomic factors that were present when the historical losses took place (as compared to those that may exist today and in the future), should be incorporated into current period credit loss estimates.
Question LI 7-24 addresses what factors an entity should consider unrelated to credit that could impact expected cash flows related to a receivable when calculating the allowance for credit losses.
Question LI 7-24
Should a reporting entity consider factors unrelated to credit that could impact the expected cash flows of a receivable (e.g., product returns, cash discounts, volume rebates, discounts for early payment) when calculating its allowance for credit losses?
PwC response
No. When developing its allowance for credit losses, a reporting entity should ensure that factors unrelated to credit that may impact expectations of cash flows are excluded. Items that impact the amount of cash to be received that are unrelated to expected credit losses should be accounted for using other GAAP (e.g., revenue guidance).

7.7.4 Application of the CECL model to contract assets

ASC 606-10-20 defines a contract asset as an entity’s conditional right to consideration in exchange for goods or services. The conditional right is based on something other than the passage of time, such as future performance. Once the conditional right has been fulfilled and an unconditional right to consideration exists, the contract asset becomes a trade receivable. While contract assets are not financial assets, ASC 606-10-45-3 requires these assets to be evaluated for credit losses under ASC 326-20. Therefore, estimates of expected credit losses on contract assets over their life will be required to be recorded at inception and on an ongoing basis, based on historical information, current conditions, and reasonable and supportable forecasts.
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