Background
Under the current guidance in ASC 326-20 (i.e., before the adoption of ASU 2025-05), an organization must estimate probable credit losses over the course of term of an instrument using reasonable and supportable forecasts and historical data adjusted for current circumstances. Existing guidance requires that an entity consider available information relevant to assessing the collectability of cash flows when developing an estimate of expected credit losses.
The historical credit loss experience of financial assets with similar risk characteristics generally provides a basis for an entity’s assessment of expected credit losses. An entity is required to consider adjustments to that information 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. Those adjustments may be qualitative in nature and should reflect changes related to relevant data (such as changes in unemployment rates, property values, commodity values, delinquency, or other factors that are associated with credit losses on the financial assets or in the group of financial assets) during the forecast period. In addition, under ASC 326, an entity is not permitted to consider collections received after the balance sheet date when developing its estimate of expected credit losses.
In their feedback, stakeholders indicated that identifying, analyzing, and documenting macroeconomic data—such as unemployment rates and property values when developing reasonable and supportable forecasts under Subtopic 326-20 can be costly and complex. Moreover, such efforts often immaterially impact the estimated credit losses for short-term assets.
They also highlighted that estimating expected credit losses for current accounts receivable and contract assets that are collected prior to the issuance of financial statements can involve significant effort and documentation, frequently resulting in loss allowances for amounts already received. Stakeholders emphasized that permitting consideration of post–balance sheet collection activity would enhance the decision-usefulness of financial information while meaningfully reducing preparer burden.
In response, the amendments in this Update introduce a practical expedient—available to all entities—and an accounting policy election—available to entities other than public business entities—specific to the application of Subtopic 326-20 to current accounts receivable and current contract assets arising from transactions within the scope of Topic 606.
Key Highlights of Amendment in ASU
The amendment in ASU allows entities with practical expedients and an accounting policy election, as stated below, when estimating expected credit losses:
A. Practical Expedient for forecasting- All Entities
Main Provision
As per existing guidance, the estimation of expected credit losses should reflect available information relevant to assessing the collectability of cash flows. That information should include historical loss information adjusted for:
- Current asset-specific risk characteristics
- Current conditions
- Reasonable and supportable forecasts for future economic conditions
ASU 2025-05 allows all entities to use a practical expedient when estimating expected credit losses on current accounts receivable and current contract assets (those from transactions under ASC 606). The practical expedient allows entities to assume that the economic conditions as of the balance sheet date remain unchanged throughout the remaining life of the asset—eliminating the need for complex forecasting of future economic conditions. Therefore, an entity will not need to develop reasonable and supportable forecasts of future economic conditions.
Application Guidance
- The practical expedient is limited to current accounts receivable and current contract assets arising from transactions accounted for under Topic 606. To determine whether these items are current, entities should apply a one-year threshold, unless their operating cycle exceeds 12 months, in which case the longer cycle applies.
- Entities that elect to apply the practical expedient must do so consistently across all qualifying current receivables and contract assets arising from transactions within the scope of Topic 606
- There is no relaxation on adjustment for current asset-specific risk characteristics and for current conditions.
- For example; the Company that has identified an individual customer that is experiencing financial distress would consider that information in its estimate of expected credit losses even if that information has not yet affected its historical loss experience or current conditions (that is, even if the customer has remained current on existing receivables as of the balance sheet date). Similarly, the Company that has recently expanded its credit policies to offer credit to lower-quality customers would consider that information in its estimate of expected credit losses even if that change has not yet affected its historical loss experience (that is, even if the new, lower credit-quality customers have remained current as of the balance sheet date).
B. Accounting Policy Election- Non Public Business Entities (Non-PBEs)
Main Provision
Entities other than public business entities may elect an accounting policy to incorporate subsequent cash collection activity, occurring after the balance sheet date but before the financial statements are issued (or an alternative cut-off date selected by the entity within that window), when estimating expected credit losses on current accounts receivable and current contract assets.
Application Guidance
- This election is not available to public business entities, as the FASB concluded it would not significantly reduce their costs, given the typically shorter reporting timelines and interim reporting requirements applicable to those entities.
- The accounting policy election may be made only in conjunction with the practical expedient, and if elected, must be applied consistently to all current receivables and contract assets arising from transactions under Topic 606.
- By allowing entities to reflect actual post–balance sheet collections, this approach can lead to more accurate and timely measurement of credit losses, particularly benefiting entities with short collection cycles. For instance, a credit loss allowance for current accounts receivable/current contract assets that have been fully collected as of the date the financial statements are available to be issued shall be recorded as zero.
