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Expected Credit Losses – Background and Overview

ECL stands for “expected credit loss,” which refers to the estimated amount of money a company expects to lose due to credit defaults or other credit-related losses. The incurred loss model is the traditional approach to calculating ECL under US GAAP, which requires companies to recognize losses only when they are incurred.

The expected loss model requires companies to recognize anticipated losses over the entire asset life, even if no loss event has occurred. It also takes a forward-looking approach to calculate ECL, which requires companies to consider all possible future scenarios that could lead to credit losses and estimate the likelihood and magnitude of those losses. Accordingly, companies should consider obtaining assistance from accounting advisors to implement the expected loss model.

Implementing Expected Credit Losses (ECL) has become increasingly important for financial institutions due to its impact on financial reporting and risk management. Auditors have a crucial role in ensuring the accuracy and reliability of ECL estimates, particularly in selecting appropriate methodologies and assumptions.

The key components of the ECL, such as the definition of default, probability of default, and loss gave default, must be carefully considered to reflect the credit risk of financial instruments accurately. Implementing ECL requires a comprehensive and disciplined approach, and auditors must meet stakeholders’ expectations to ensure confidence in financial reporting.