The Current Expected Credit Loss standard (CECL) comes into effect for SEC filers (except Small Reporting Companies)1 on January 1, 2020 and for private companies on January 1, 2023. Affected companies have had several years to prepare for the standard, but less attention has been paid to the significant impact this new accounting methodology will have on mergers and acquisitions, including its influence on transaction pricing and other valuation factors. Many acquirers are now beginning to awaken to the impact of CECL as adoption approaches.
Knowing and anticipating CECL’s future financial impact on a target's enterprise value, balance sheet, and accounting for the transaction is necessary for deal modeling and structuring. According to KPMG’s 2019 CECL Survey, respondents who expect CECL to increase their credit reserve believe it will result in a 29% increase to the allowance, on average. Potential earnings and valuation impacts include: 1) a one-time charge to earnings upon implementation to increase the allowance, 2) a reduction in capital as a result of the higher allowance, which could impact covenant compliance and regulatory capital requirements, and 3) increased earnings volatility due to unexpected changes in macroeconomic variables or changes in expected cash flows from Purchased Credit Deteriorated (PCD) assets.
The potential implications outlined above will affect all stages of transactions, and it is important for acquirers to assess the impact both on the target company’s financials and valuation, and on purchase accounting. Acquirers will also need to understand the status of the target’s CECL readiness and adoption process. While public companies are in final stretches of adoptions, major challenges still exist around process, data, controls, and modeling choices. If an acquisition target is not prepared for CECL, acquirers should consider future required expenditures for people, advisors, and/or systems to assess the impact of CECL and adopt the related accounting guidance.
Furthermore, while private companies will not be required to adopt CECL until 2023, an IPO or sale to a public company may require an accelerated adoption of CECL. Thus, PE owned lenders should be prepared for CECL such that a deal will not fall through due to accounting compliance. Acquirers and sellers must prepare now to adequately understand CECL’s requirements and be ready to make well-informed acquisition decisions going forward.
Further KPMG insights on CECL’s impact on M&A: M&A must move to address CECL’s imminent impact
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New KPMG article calls for swift action by dealmakers in meeting requirements of CECL accounting methodology taking effect Jan 1.