An expected credit loss is the current estimate of contractual cash flows the entity does not expect to collect over the financial asset's contractual term. The estimate uses relevant historical experience, current conditions, and reasonable and supportable forecasts.
Start with the population and term
Reconcile the covered assets to the gross ledger. Define the contractual term and supported treatment of extensions, renewals, prepayments, and expected recoveries. Group assets only when they share relevant risk characteristics; evaluate an asset separately when it no longer shares those characteristics.
For a $200,000 pool with a supported 1.5 percent expected cash-shortfall rate, the estimated loss is $3,000. The multiplication is easy. The difficult work is showing that the population is complete and that the rate fits its population and term. Historical adjustments must also avoid counting current or forecast information twice.
Separate evidence from outcome
Record source dates, model version, pool assignment, overrides, later collections, forecast horizon, reversion, and approval. Compare the result with prior periods and explain changes. Do not wait for a default to become probable, and do not choose a reserve to smooth earnings.
Boundary and source
Arithmetic cannot validate the method or its judgment inputs. Read ASC 326-20-30-2 for pooled and individual evaluation and ASC 326-20-30-7 for the information used in the estimate.
Put the concept to work
Understand this concept
- Explain the expected contractual cash-flow shortfall, contractual-term boundary, evidence layers, and difference from waiting for probable default.
Analyze this concept
- Evaluate a credit-loss estimate for population scope, method fit, historical basis, current conditions, forecast, reversion, expected recoveries, and model limitations.
Learning resources
Choose a lesson, try an application, or inspect the sources behind this concept.
Build on these ideas
- Accounts receivable — Understand
To understand this concept: Required. The estimate measures collection of a recognized claim.
- Expected credit loss — Understand
To analyze this concept: Required. Evaluation follows the estimate's measurement objective.
Lessons
Worked examples and cases
Practice
Common mistaken ideas
- Mistaken idea: A collateral appraisal equals expected collection
- Mistaken idea: An older receivable is automatically uncollectible
- Mistaken idea: Expected loss waits for a probable default
Show 1 more mistaken ideas
Sources
Standard references
Broader topics
Related concepts
Show 11 more related concepts
- Collateral-dependent financial asset
- Credit-loss expense or benefit
- Creditor accounting for a receivable modification
- Current-conditions, forecast, and reversion adjustment
- Debt security investment
- Loss-rate method
- Pooled and individual credit-loss evaluation
- Price concession and credit-loss boundary
- Purchased financial asset with credit deterioration
- Recourse obligation in a receivable transfer
- Subsequent-collection evidence
Use this idea next
- Collateral-dependent financial asset — Understand
Required level here: understand. Required. Collateral evidence serves a specified expected-loss measurement path.
- Credit-quality indicator — Understand
Required level here: understand. Required. Indicators describe risk evidence relevant to the expected-loss estimate.
- Current-conditions, forecast, and reversion adjustment — Understand
Required level here: understand. Required. The evidence layers update the lifetime loss estimate.
Show 4 more next steps
- Expected credit loss — Analyze
Required level here: understand. Required. Evaluation follows the estimate's measurement objective.
- Loss-rate method — Understand
Required level here: understand. Required. The method serves the expected-loss measurement objective.
- Pooled and individual credit-loss evaluation — Understand
Required level here: understand. Required. Pooling is a design choice within the expected-loss estimate.
- Purchased financial asset with credit deterioration — Understand
Required level here: understand. Required. PCD initial measurement uses a distinct allowance interaction.