Appendix C — Comparison of U.S. GAAP and IFRS Standards | DART

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Appendix A — Comparison of U.S. GAAP and IFRS Accounting Standards

A.1 Receivables Measured at Amortized Cost

Under U.S. GAAP, ASC 310 and ASC 326 are the primary sources of guidance on receivables measured at amortized cost.

Under IFRS® Accounting Standards, IFRS 9 is the primary source of guidance on recognition and measurement, as well as income recognition, of receivables measured at amortized cost.

This section focuses on differences between the accounting for receivables measured at amortized cost under U.S. GAAP and that under IFRS Accounting Standards, specifically discussing the recognition and measurement of (1) credit losses and (2) interest income. Note, however, that it does not address differences in the accounting for investments in debt securities classified as HTM under U.S. GAAP. See Section A.2 for guidance on U.S. GAAP–IFRS differences related to investments in debt securities, including those classified as HTM and AFS.

Subject	U.S. GAAP	IFRS Accounting Standards
Recognition of credit losses	Expected loss approach in which an entity recognizes expected (rather than incurred) credit losses.	Expected loss approach in which an impairment loss on a financial asset accounted for at amortized cost or fair value through other comprehensive income (FVTOCI) is recognized immediately on the basis of expected credit losses.
Measurement of impairment losses	Entities have flexibility in measuring expected credit losses as long as the measurement results in an allowance that: Reflects a risk of loss, even if remote. Reflects losses that are expected over the contractual life of the asset. Takes into account historical loss experience, current conditions, and reasonable and supportable forecasts. The entity must evaluate financial assets on a collective (i.e., pool) basis if they share similar risk characteristics. If an asset’s risk characteristics are not similar to those of any of the entity’s other assets, the entity would evaluate the asset individually.	Depending on the financial asset’s credit risk at inception and changes in credit risk from inception, as well as the applicability of certain practical expedients, the measurement of the impairment loss will differ. The impairment loss would be measured as either (1) the 12-month credit loss or (2) the lifetime expected credit loss. Further, for financial assets that are credit-impaired at the time of recognition, the impairment loss will be based on the cumulative changes in the lifetime expected credit losses since initial recognition.
Interest method — computation of the EIR	The EIR is computed on the basis of the contractual cash flows over the contractual term of the loan, except for (1) certain loans that are part of a group of prepayable loans and (2) purchased loans that are accounted for as PCD loans. Therefore, loan origination fees, direct loan origination costs, premiums, and discounts typically are amortized over the contractual term of the loan.	The EIR is computed on the basis of the estimated cash flows that are expected to be received over the expected life of a loan by considering all of the loan’s contractual terms (e.g., prepayment, call, and similar options), excluding expected credit losses. Therefore, fees, points paid or received, transaction costs, and other premiums or discounts are deferred and amortized as part of the calculation of the EIR over the expected life of the instrument.
Interest method — revisions in estimates	“Retrospective” approach — If estimated payments for certain groups of prepayable loans are revised, an entity may adjust the net investment in the group of loans — on the basis of a recalculation of the effective yield to reflect actual payments to date and anticipated future payments — to the amount that would have existed if the new effective yield had been applied since the loans’ origination/acquisition, with a corresponding charge or credit to interest income.	“Cumulative catch-up” approach — If estimated receipts are revised, the carrying amount is adjusted to the present value of the future estimated cash flows, discounted at the financial asset’s original EIR (or credit-adjusted EIR for purchased or originated credit-impaired financial assets). The resulting adjustment is recognized within profit or loss. This treatment applies not only to groups of prepayable loans but also to all financial assets that are subject to the effective interest method.
Interest recognition on PCD loans	Interest income is recognized on the basis of the purchase price plus the initial allowance accreting to the contractual cash flows by using the effective interest method.	Interest income is calculated on the basis of the gross carrying amount (i.e., the amortized cost before adjusting for any loss allowance), unless the loan (1) is purchased or originated credit-impaired or (2) subsequently became credit-impaired. In those cases, interest revenue is calculated on the basis of amortized cost (i.e., net of the loss allowance).
Nonaccrual of interest	There is no explicit requirement in U.S. GAAP for when an entity should cease the recognition of interest income on a receivable measured at amortized cost. However, the practice of placing financial assets on nonaccrual status is acknowledged by U.S. GAAP.	IFRS Accounting Standards do not permit nonaccrual of interest. However, for assets that have become credit-impaired, interest income is based on the net carrying amount of the credit-impaired financial asset.

A.1.1 Recognition of Credit Losses

Under U.S. GAAP, ASC 326-20 does not specify a threshold for recognizing an impairment allowance. Rather, an entity recognizes its estimate of expected credit losses for financial assets as of the end of the reporting period. Credit impairment is recognized as an allowance — or contra-asset — rather than as a direct write-down of the amortized cost basis of a financial asset.

Under IFRS Accounting Standards, an impairment loss on a financial asset accounted for at amortized cost or FVTOCI is recognized immediately on the basis of expected credit losses.

A.1.2 Measurement of Credit Losses

ASC 326-20 describes the impairment allowance as a “valuation account that is deducted from, or added to, the amortized cost basis of the financial asset(s) to present the net amount expected to be collected on the financial asset.” An entity can use a number of measurement approaches to determine the impairment allowance. Regardless of the measurement method used, an entity’s estimate of expected credit losses should reflect those losses occurring over the contractual life of the financial asset and should incorporate all available relevant information, including details about past events, current conditions, and reasonable and supportable forecasts and their implications for expected credit losses.

ASC 326-20 does not prescribe a unit of account (e.g., an individual asset or a group of financial assets) for measuring expected credit losses. However, an entity is required to evaluate financial assets within the scope of the model on a collective (i.e., pool) basis when assets share similar risk characteristics. If a financial asset’s risk characteristics are not similar to the risk characteristics of any of the entity’s other financial assets, the entity would evaluate the financial asset individually.

For PCD assets, ASC 326-20 requires that an entity’s method for measuring expected credit losses be consistent with its method for measuring expected credit losses for originated and purchased non-credit-deteriorated assets. However, upon acquiring a PCD asset, the entity would recognize its allowance for expected credit losses as an adjustment that increases the cost basis of the asset (the “gross-up” approach). After initial recognition of the PCD asset and its related allowance, the entity would continue to apply the CECL model to the asset — that is, any changes in the entity’s estimate of cash flows that it expects to collect (favorable or unfavorable) would be recognized immediately in the income statement through an adjustment to the allowance for credit losses.

Under IFRS Accounting Standards, IFRS 9’s dual-measurement approach requires an entity to measure the loss allowance for an asset accounted for at amortized cost or FVTOCI (other than one that is purchased or originated credit-impaired) at an amount equal to either (1) the 12-month expected credit losses or (2) lifetime expected credit losses.

The measurement of 12-month expected credit losses, which reflects the expected credit losses arising from default events possible within 12 months of the reporting date, is required if the asset’s credit risk is (1) low as of the reporting date or (2) has not increased significantly since initial recognition. As noted in paragraph B5.5.22 of IFRS 9, the credit risk is considered low if (1) there is “a low risk of default,” (2) “the borrower has a strong capacity to meet its contractual cash flow obligations in the near term,” and (3) “adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its contractual cash flow obligations.” Paragraph B5.5.23 of IFRS 9 suggests that an “investment grade” rating might be an indicator of low credit risk.

Paragraph 5.5.9 of IFRS 9 states that in assessing whether a financial asset’s credit risk has significantly increased, an entity is required to consider “the change in the risk of a default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses” since initial recognition. Paragraph B5.5.17 of IFRS 9 provides a nonexhaustive list of factors that an entity may consider in determining whether there has been a significant increase in credit risk. For financial instruments for which credit risk has significantly increased since initial recognition, the allowance is measured as the lifetime credit losses, which IFRS 9 defines as the “expected credit losses that result from all possible default events over the expected life of a financial instrument,” unless the credit risk is low as of the reporting date. This measurement is also required for certain contract assets and trade receivables that do not contain a significant financing component in accordance with IFRS 15, and it is available as an accounting policy option for certain trade receivables that contain significant financing components in accordance with IFRS 15 and for certain lease receivables (see paragraph 5.5.15 of IFRS 9).

Purchased or originated credit-impaired financial assets (e.g., distressed debt) are treated differently under IFRS 9. As stated in paragraph 5.5.13 of IFRS 9, for these assets, an entity recognizes only “the cumulative changes in lifetime expected credit losses since initial recognition as a loss allowance.” Changes in lifetime expected losses since initial recognition are recognized in profit or loss. Thus, any favorable change in lifetime expected credit losses since initial recognition of a purchased or originated credit-impaired financial asset is recognized as an impairment gain in profit or loss regardless of whether a corresponding impairment loss was recorded for the asset in previous periods.

A.1.3 Interest Method — Computation of the EIR

Under U.S. GAAP on non-PCD loans, the EIR used to recognize interest income on loan receivables generally is computed in accordance with ASC 310-20-35-26 on the basis of the contractual cash flows over the contractual term of the loan. Prepayments of principal are not anticipated. As a result, loan origination fees, direct loan origination costs, premiums, and discounts are typically amortized over the contractual term of the loan. However, ASC 310-20-35-26 indicates that if an entity “holds a large number of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, the entity may consider estimates of future principal prepayments” in calculating the EIR.

Under IFRS 9, an entity recognizes interest income by applying the EIR. IFRS 9 defines the EIR of a financial asset or liability as the “rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset . . . to the gross carrying amount of a financial asset” (emphasis added). Therefore, the effective interest method in IFRS 9, unlike that in ASC 310-20, requires an entity to compute the EIR on the basis of the estimated cash flows over the expected life of the instrument in considering all contractual terms (e.g., prepayment, extension, call, and similar options) but not expected credit losses. As a result, fees, points paid or received, transaction costs, and other premiums or discounts are deferred and amortized as part of the calculation of the EIR over the expected life of the instrument. Further, in its definition of an EIR, IFRS 9 states that in “rare cases when it is not possible to reliably estimate the cash flows or the expected life of a financial instrument [an] entity shall use the contractual cash flows over the full contractual term.”

A.1.4 Interest Method — Revisions in Estimates

Under U.S. GAAP, whether and, if so, how an entity recognizes a change in expected future cash flows of a receivable depends on the instrument’s characteristics and which effective interest method the entity is applying. ASC 310-20-35-26 indicates that in applying the interest method to non-PCD loans, an entity should use the payment terms of the loan contract without considering the anticipated prepayment of principal to shorten the loan term. However, if the entity can reasonably estimate probable prepayments for a large number of similar loans, it may include an estimate of future prepayments in the calculation of the constant effective yield under the interest method. If prepayments are anticipated and considered in the determination of the effective yield, and there is a difference between the anticipated prepayments and the actual prepayments received, the effective yield should be recalculated to reflect actual payments received to date and anticipated future payments. The net investment in the loans should be adjusted to reflect the amount that would have existed if the revised effective yield had been applied since the acquisition or origination of the group of loans, with a corresponding charge or credit to interest income. In other words, under U.S. GAAP, entities may use a “retrospective” approach in accounting for revisions in estimates related to such groups of loans.

Under IFRS Accounting Standards, the original EIR must be used throughout the life of the instrument for financial assets and liabilities, except for certain reclassified financial assets and floating-rate instruments that reset to reflect movements in market interest rates. Upon a change in estimates, IFRS 9 generally requires entities to use a “cumulative catch-up” approach when changes in estimated cash flows occur. Specifically, paragraph B5.4.6 of IFRS 9 states, in part:

If an entity revises its estimates of payments or receipts (excluding modifications in accordance with paragraph 5.4.3 and changes in estimates of expected credit losses), it shall adjust the gross carrying amount of the financial asset . . . to reflect actual and revised estimated contractual cash flows. The entity recalculates the gross carrying amount of the financial asset . . . as the present value of the estimated future contractual cash flows that are discounted at the financial instrument’s original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets). . . . The adjustment is recognised in profit or loss as income or expense.

A.1.5 Interest Recognition on PCD Loans

Regarding an entity’s acquisition of a loan that it determines to be PCD, ASC 326-20 states that in the calculation of the EIR for PFAs with credit deterioration, “the premium or discount at acquisition excludes the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at the date of acquisition.” For PCD loans, ASC 326-20 requires an entity to use the original EIR throughout the life of the loan and to record all subsequent changes to its estimate of expected credit losses — whether unfavorable or favorable — as impairment expense (or a reduction of expense) during the period of change.

Under IFRS Accounting Standards, the application of the effective interest method depends on whether the financial asset is purchased or originated credit-impaired or on whether it became credit-impaired after initial recognition.

When recognizing interest revenue related to purchased or originated credit-impaired financial assets under IFRS 9, an entity applies a credit-adjusted EIR to the amortized cost carrying amount. The calculation of the credit-adjusted EIR is consistent with the calculation of the EIR, except that it takes into account expected credit losses within the expected cash flows.

For a financial asset that is not purchased or originated credit-impaired, paragraph 5.4.1 of IFRS 9 requires an entity to calculate interest revenue as follows:

Gross method — If the financial asset has not become credit-impaired since initial recognition, the entity applies the EIR method to the gross carrying amount. IFRS 9 defines the gross carrying amount as “the amortised cost of a financial asset, before adjusting for any loss allowance.”
Net method — If the financial asset has subsequently become credit-impaired, the entity applies the EIR to the amortized cost balance, which is the gross carrying amount adjusted for any loss allowance.

An entity that uses the net method is required to revert to the gross method if (1) the credit risk of the financial instrument subsequently improves to the extent that the financial asset is no longer credit-impaired and (2) the improvement is objectively related to an event that occurred after the net method was applied (see paragraph 5.4.2 of IFRS 9).

IFRS 9 defines a credit-impaired financial asset as follows:

A financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include[s] observable data about the following events:

significant financial difficulty of the issuer or the borrower;
a breach of contract, such as a default or past due event;
the lender(s) of the borrower, for economic or contractual reasons relating to the borrower’s financial difficulty, having granted to the borrower a concession(s) that the lender(s) would not otherwise consider;
it is becoming probable that the borrower will enter bankruptcy or other financial reorganisation;
the disappearance of an active market for that financial asset because of financial difficulties; or
the purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.

It may not be possible to identify a single discrete event — instead, the combined effect of several events may have caused financial assets to become credit-impaired.

A.1.6 Nonaccrual of Interest

There is no explicit U.S. GAAP requirement for when an entity should cease recognizing interest income on receivables measured at amortized cost. However, an entity is permitted to cease such recognition as an accounting policy. In addition, U.S. financial institutions subject to banking regulations look to regulatory reporting instructions for guidance on placing financial assets on nonaccrual status and follow these regulatory instructions for U.S. GAAP financial reporting purposes.1

Under IFRS 9, an entity is not allowed to cease the accrual of interest. Rather, interest income recognition is determined on the basis of whether the asset is considered to be credit-impaired. That is, if the financial asset has not become credit-impaired since initial recognition, the entity applies the EIR method to the gross carrying amount (“gross method”). If the financial asset has subsequently become credit-impaired, the entity applies the EIR to the amortized cost balance, which is the gross carrying amount adjusted for any loss allowance (“net method”). An entity using the net method should revert to the gross method if (1) the credit risk of the financial instrument subsequently improves to the extent that the financial asset is no longer credit-impaired and (2) the improvement is objectively related to an event that occurred after the net method was applied.

A.2 Investments in Debt Securities

Under U.S. GAAP, ASC 320, ASC 326-20, and ASC 326-30 are the primary sources of guidance on the accounting for investments in debt securities.

Under IFRS Accounting Standards, IFRS 9 is the primary source of guidance on the accounting for financial assets and financial liabilities, including investments in debt securities.

This section focuses on differences between U.S. GAAP and IFRS Accounting Standards in the accounting for investments in debt securities, specifically discussing the recognition and measurement of (1) credit losses and (2) interest income. It does not address differences in the accounting for financial assets measured at amortized cost except for investments in debt securities classified as HTM under U.S. GAAP. See Section A.1 for guidance on differences between U.S. GAAP and IFRS Accounting Standards related to financial assets measured at amortized cost.

Subject	U.S. GAAP	IFRS Accounting Standards
Credit losses — recognition	An entity recognizes and measures expected credit losses on an investment in a debt security classified as HTM by using the same model as it does for loans in accordance with ASC 326-20 (see Section A.1 for more information). An impairment loss on an investment in a debt security classified as AFS is recognized when the security’s fair value is less than its amortized cost. This evaluation must be performed on an individual security level in accordance with ASC 326-30.	An impairment loss on a financial asset accounted for at amortized cost or FVTOCI is recognized immediately on the basis of expected credit losses.
Credit losses — measurement	Under ASC 326-30, the recognition of an impairment loss depends on whether the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss. If the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss, the impairment loss is equal to the difference between the amortized cost basis and fair value. Any change in the impairment loss is recognized through earnings. If neither condition is met, the impairment loss is separated into the credit loss component (through earnings) and all other factors (through OCI). The credit loss component for an impaired AFS debt security is the excess of (1) the security’s amortized cost basis over (2) the present value of the investor’s best estimate of the cash flows expected to be collected from the security.	Under IFRS 9, the measurement of the impairment loss differs depending on the financial asset’s credit risk at inception and changes in credit risk from inception, as well as the applicability of certain practical expedients. The impairment loss is measured as either (1) the 12-month expected credit loss or (2) the lifetime expected credit loss. Further, for financial assets that are credit-impaired at the time of recognition, the impairment loss is based on the cumulative changes in the lifetime expected credit losses since initial recognition.
Credit losses — reversal of recognized losses	Under ASC 326-30, an entity must use an allowance when recognizing expected credit losses on an AFS debt security. Any changes in the allowance for expected credit losses on an AFS debt security would be recognized as an adjustment to the entity’s credit loss expense.	Under IFRS 9, previously recognized expected credit losses are reversed through profit or loss (as an impairment gain) if expected credit losses decrease.
Subsequent measurement — interest method: interest income recognition	The EIR is computed on the basis of contractual cash flows over the contractual term of the loan, with certain exceptions depending on the specific characteristics of a debt security, such as whether the debt security is (1) part of a group of prepayable debt securities, (2) a BI in securitized financial assets, (3) a callable bond purchased at a premium, (4) considered a PCD asset, or (5) prepayable by the issuer and has a stated interest rate that increases over time.	Under IFRS 9, the EIR is computed on the basis of estimated cash flows that the entity expects to receive over the expected life of the financial asset. The method used to calculate interest revenue depends on whether the financial asset (1) is purchased or originated credit-impaired or (2) has subsequently become credit-impaired.
Subsequent measurement — interest method: revisions in estimates (not from a modification)	Whether and, if so, how an entity recognizes a change in expected future cash flows of an investment in a debt security depends on the characteristics of the debt security and the effective interest method applied.	An entity (1) adjusts a change in estimate that is not a result of changes in the market rates of a floating-rate instrument by applying a cumulative “catch-up” method that uses the original EIR as a discount rate and (2) recognizes the change in estimate through earnings.
Subsequent measurement — nonaccrual of interest	There is no explicit requirement for when an entity should cease the recognition of interest income on an investment in a debt security. However, the practice of placing investments in debt securities on nonaccrual status is acknowledged by U.S. GAAP.	IFRS Accounting Standards do not permit nonaccrual of interest. However, for assets that have become credit-impaired, interest income is based on the net carrying amount of the credit-impaired financial asset.
Subsequent measurement — foreign exchange gains and losses on AFS/FVTOCI debt securities	Under ASC 320, the unrealized change in fair value of an investment in a debt security classified as AFS that is attributable to changes in foreign currency rates must be recognized in OCI.	Under IFRS 9, the unrealized change in fair value of a debt instrument accounted for at FVTOCI that is attributable to changes in foreign exchange rates (calculated on the basis of the instrument’s amortized cost) must be recognized in profit or loss.

A.2.1 Expected Credit Losses

A.2.1.1 Recognition

Under U.S. GAAP, expected credit losses on HTM debt securities are accounted for in a manner consistent with loans receivable. See Section A.1 for more information.

For AFS debt securities, ASC 326-30 states that an impairment loss is recognized when the security’s fair value is less than its amortized cost. This evaluation must be performed on an individual security level.

Under IFRS Accounting Standards, an impairment loss on a financial asset accounted for at amortized cost or FVTOCI is recognized immediately on the basis of expected credit losses.

A.2.1.2 Measurement

Under U.S. GAAP, expected credit losses on HTM debt securities are accounted for in a manner consistent with loans receivable. See Section A.1 for more information.

ASC 326-30 states that for AFS debt securities, the recognition of an impairment loss depends on whether the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss.

If the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss, the impairment is equal to the difference between the amortized cost basis and fair value. Changes in the impairment are recognized through earnings. If neither condition is met, the impairment loss is separated into the credit loss component (through earnings) and all other factors (through OCI). Under ASC 326-30-35-6, “[i]f the present value of cash flows expected to be collected is less than the amortized cost basis of the security” when the credit loss component of the total impairment is measured, “a credit loss exists and an allowance for credit losses shall be recorded for the credit loss, limited by the amount that the fair value is less than amortized cost basis.” Therefore, the amount of credit loss for an impaired AFS debt security is the excess of (1) the security’s amortized cost basis over (2) the present value of the investor’s best estimate of the cash flows expected to be collected from the security.

Under IFRS Accounting Standards, IFRS 9 employs a dual-measurement approach that requires an entity to measure the loss allowance for an asset accounted for at amortized cost or FVTOCI (other than one that is purchased or originated credit-impaired) at an amount equal to either (1) the 12-month expected credit losses or (2) lifetime expected credit losses.

The measurement of 12-month expected credit losses, which reflects the expected credit losses arising from default events possible within 12 months of the reporting date, is required if the asset’s credit risk has not increased significantly since initial recognition. Further, an entity is permitted to apply a 12-month expected credit loss measurement if the credit risk, in absolute terms, is low as of the reporting date. As noted in paragraph B5.5.22 of IFRS 9, the credit risk is considered low if (1) there is a “low risk of default,” (2) “the borrower has a strong capacity to meet its contractual cash flow obligations in the near term,” and (3) “adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfill its contractual cash flow obligations.” Paragraph B5.5.23 of IFRS 9 suggests that an “investment grade” rating might be an indicator of low credit risk.

Paragraph 5.5.9 of IFRS 9 states that in assessing whether there has been a significant increase in a financial asset’s credit risk, an entity is required to consider “the change in the risk of a default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses” since initial recognition. Paragraph B5.5.17 of IFRS 9 provides a nonexhaustive list of factors that an entity may consider in determining whether there has been a significant increase in credit risk. For financial instruments for which credit risk has significantly increased since initial recognition, the allowance is measured as full lifetime expected credit losses, which IFRS 9 defines as the “expected credit losses that result from all possible default events over the expected life of a financial instrument,” unless the credit risk is low as of the reporting date.

A.2.1.3 Reversal of Recognized Losses

Under ASC 326-30, an entity must use an allowance when recognizing expected credit losses on an AFS debt security. Any changes in the allowance for expected credit losses on an AFS debt security would be recognized as an adjustment to the entity’s credit loss expense.

Under IFRS Accounting Standards, previously recognized expected credit losses are reversed through profit or loss if the expected credit losses decrease. Paragraph 5.5.8 of IFRS 9 states that an “entity shall recognise in profit or loss, as an impairment gain or loss, the amount of expected credit losses (or reversal) that is required to adjust the loss allowance at the reporting date to the amount that is required to be recognized in accordance with this Standard [IFRS 9].”

A.2.2 Subsequent Measurement

A.2.2.1 Interest Method: Interest Income Recognition and Revisions in Estimates (Not From a Modification)

Under U.S. GAAP, an entity typically recognizes interest income on investments in debt securities accounted for at amortized cost or FVTOCI in accordance with ASC 310-20-35-18 and ASC 310-20-35-26 by applying the effective interest method on the basis of the contractual cash flows of the security. An entity should not anticipate prepayments of principal. However, the following are exceptions to this method of recognizing interest income:

If a debt security is part of a pool of prepayable financial assets and the timing and amount of prepayments are reasonably estimable, an entity is allowed to anticipate future principal prepayments when determining the appropriate EIR to apply to the debt security under ASC 310-20-35-26. If an entity anticipates estimated prepayments when measuring interest income of an investment in a debt security that is part of a pool of prepayable financial assets in accordance with ASC 310-20-35-26, the entity must continually recalculate the appropriate effective yield as prepayment assumptions change. That is, if the estimated future cash flows of a debt security change, the effective yield of the debt security must be recalculated to take into account the new prepayment assumptions. The adjustment to the interest method under ASC 310-20 must be retrospectively applied to the debt security. That is, the amortized cost of the debt security is adjusted to reflect what it would have been if the new effective yield had been used since the acquisition of the debt security, with a corresponding charge or credit to current-period earnings.
If an investment in a debt security meets the definition of a PCD asset, an entity must not recognize as interest income the discount embedded in the purchase price that is attributable to the acquirer’s assessment of expected credit losses as of the acquisition date. The entity must accrete or amortize as interest income the non-credit-related discount or premium of a PFA with credit deterioration in accordance with the existing applicable guidance in ASC 310-20-35 or ASC 325-40-35.
If the investment is a BI in a securitized financial asset, an entity would apply one of the following income recognition models:
- Non-PCD BI not accounted for under ASC 325-40 — Apply the effective interest method on the basis of the contractual cash flows of the security in accordance with ASC 310-20.
- Non-PCD BI accounted for under ASC 325-40 and classified as HTM:
  - Under ASC 325-40 (as amended by ASU 2016-13), entities must initially estimate the timing and amount of all future cash inflows from a BI within the scope of ASC 325-40 by employing assumptions used in the determination of fair value at recognition. The excess of those expected future cash flows over the initial investment is the accretable yield. Entities recognize this excess as interest income over the life of the investment by using the effective interest method.
  - A subsequent adjustment to expected cash flows is recognized as a yield adjustment affecting interest income or, if related to credit, may be recognized through earnings by means of an allowance for credit losses. In other words, a cumulative adverse change in expected cash flows would be recognized as an allowance, and a cumulative favorable change in expected cash flows would be recognized as a prospective yield adjustment.
- Non-PCD BI accounted for under ASC 325-40 and classified as AFS:
  - Under ASC 325-40 (as amended by ASU 2016-13), entities must initially estimate the timing and amount of all future cash inflows from a BI within the scope of ASC 325-40 by employing assumptions used in the determination of fair value at recognition. The excess of those expected future cash flows over the initial investment is the accretable yield. Entities recognize this excess as interest income over the life of the investment by using the effective interest method.
  - A subsequent adjustment to expected cash flows is recognized as a yield adjustment affecting interest income or, if related to credit, may be recognized through earnings by means of an allowance for credit losses. In other words, a cumulative adverse change in expected cash flows would be recognized as an allowance, and a cumulative favorable change in expected cash flows would be recognized as a prospective yield adjustment.
    
    If there has not been an adverse change in the cash flows expected to be collected but the BI’s fair value is significantly below its amortized cost basis, the entity is required to assess whether it intends to sell the BI or it is more likely than not that it will be required to sell the interest before recovery of the entire amortized cost basis. If so, the entity would be required to write down the BI to its fair value in accordance with ASC 326-30-35-10.
- PCD BI classified as HTM:
  - Under the PCD accounting model in ASC 326-20, entities are required to gross up the cost basis of a PCD asset by the estimated credit losses as of the date of acquisition and establish a corresponding allowance for credit losses. The initial allowance is based on the difference between expected cash flows and contractual cash flows (adjusted for prepayments).
  - For PCD assets within the scope of ASC 325-40 that are classified as HTM debt securities, cumulative adverse changes in expected cash flows would be recognized currently as an increase to the allowance for credit losses (in a manner similar to recognition under the normal ASC 325-40 model, as amended by ASU 2016-13). However, favorable changes in expected cash flows would first be recognized as a decrease to the allowance for credit losses (recognized currently in earnings). Favorable changes in expected cash flows would be recognized as a prospective yield adjustment only when the allowance for credit losses is reduced to zero.
- PCD BI classified as AFS:
  - Under the PCD accounting model in ASC 326-20, entities are required to gross up the cost basis of a PCD asset by the estimated credit losses as of the acquisition date and establish a corresponding allowance for credit losses. The initial allowance is based on the difference between expected cash flows and contractual cash flows (adjusted for prepayments).
  - For a PCD asset within the scope of ASC 325-40 that is classified as an AFS debt security, cumulative adverse changes in expected cash flows would be recognized currently as an increase to the allowance for credit losses (in a manner similar to the accounting under the normal ASC 325-40 model, as amended by ASU 2016-13). However, the allowance is limited to the difference between the AFS debt security’s fair value and its amortized cost. Favorable changes in expected cash flows would first be recognized as a decrease to the allowance for credit losses (recognized currently in earnings). Such changes would be recognized as a prospective yield adjustment only when the allowance for credit losses is reduced to zero. A change in expected cash flows that is attributable solely to a change in a variable interest rate on a plain-vanilla debt instrument does not result in a credit loss and would be accounted for as a prospective yield adjustment.
If an investment in a callable bond is purchased at a premium, the premium must be amortized to the first call date in accordance with ASC 310-20-35-33.
If an investment in a debt security is considered a structured note but does not contain an embedded derivative that must be separated under ASC 815, the interest method articulated in ASC 320-10-35-40, which is based on estimated rather than contractual cash flows, must be applied.
If an investment in a debt security to which the interest method in ASC 310-20-35-18(a) applies has a stated interest rate that increases during the term in such a way that “interest accrued under the interest method in early periods would exceed interest at the stated rate . . . , interest income shall not be recognized to the extent that the net investment . . . would increase to an amount greater than the amount at which the borrower could settle the obligation.” Thus, a limit on the accrual of interest income applies to certain investments in debt securities that have a stepped interest rate and contain a borrower prepayment option or issuer call option.

Under IFRS 9, an entity calculates interest revenue on financial assets accounted for at amortized cost or FVTOCI by applying the effective interest method. Appendix A of IFRS 9 defines the EIR of a financial asset or liability as the “rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset . . . to the gross carrying amount of a financial asset” (emphasis added). Therefore, the effective interest method in IFRS 9, unlike that in ASC 310-20, requires an entity to compute the EIR on the basis of the estimated cash flows over the expected life of the instrument by considering all contractual terms (e.g., prepayment, extension, call, and similar options) but not expected credit losses. Under IFRS Accounting Standards, there is no limit on the accrual of interest income for investments in debt securities that have a stepped interest rate and contain a borrower prepayment option or issuer call option. Further, in its definition of an EIR, IFRS 9 states that in rare cases in which it is not possible to reliably estimate the cash flows or the expected life of the financial instrument, an entity should “use the contractual cash flows over the full contractual term.”

The application of the effective interest method depends on whether the financial asset is purchased or originated credit-impaired or on whether it became credit-impaired after initial recognition. When recognizing interest revenue related to purchased or originated credit-impaired financial assets under IFRS 9, an entity applies a credit-adjusted EIR to the amortized cost carrying amount. The calculation of the credit-adjusted interest rate is consistent with that of the EIR, except that the calculation of the credit-adjusted interest rate takes into account expected credit losses within the expected cash flows.

For a financial asset that is not purchased or originated credit-impaired, paragraph 5.4.1 of IFRS 9 requires an entity to calculate interest revenue as follows:

Gross method — If the financial asset has not become credit-impaired since initial recognition, the entity applies the EIR to the gross carrying amount. Appendix A of IFRS 9 defines the gross carrying amount as the “amortised cost of a financial asset, before adjusting for any loss allowance.”
Net method — If the financial asset has subsequently become credit-impaired, the entity applies the EIR to the amortized cost balance, which is the gross carrying amount adjusted for any loss allowance.

Under IFRS Accounting Standards, paragraphs B5.4.5 and B5.4.6 of IFRS 9 provide guidance on when an entity should recalculate the EIR:

For floating-rate instruments that pay a market rate of interest, paragraph B5.4.5 of IFRS 9 specifies that the “periodic re-estimation of cash flows to reflect the movements in the market rates of interest alters the effective interest rate.” However, paragraph B5.4.5 of IFRS 9 further notes that for such floating-rate financial instruments, “re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or the liability” if the asset or liability was initially recognized at an amount that equals the principal receivable.
For other instruments and for revisions of estimates, paragraph B5.4.6 of IFRS 9 usually requires an entity to recalculate the gross carrying amount of the financial asset “as the present value of the estimated future contractual cash flows that are discounted at the financial instrument’s original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets).” The resulting “catch-up” adjustment to the carrying amount of the financial asset is recognized immediately in profit or loss. This catch-up approach of recognizing changes in estimated cash flows differs from both the prospective and retrospective approaches used under U.S. GAAP.

A.2.2.2 Nonaccrual of Interest

Under U.S. GAAP, there is no explicit requirement for when an entity should cease recognizing interest income on investments in debt securities. However, an entity is permitted to cease such recognition as an accounting policy. In addition, while there is no indication in U.S. GAAP on when the accrual of interest should cease, ASC 325-40 requires that an entity use the cost recovery method when it cannot reliably estimate cash flows on a BI within its scope. That is, once the decision is made to put a BI within the scope of ASC 325-40 on nonaccrual status, the cost recovery method should be applied (i.e., all cash receipts are applied to the asset’s amortized cost basis). Other methods of nonaccrual (e.g., recognition of interest income on a cash basis) are not appropriate.

Under IFRS 9, an entity it not allowed to cease the accrual of interest. Rather, interest income recognition is determined on the basis of whether the asset is considered credit-impaired. That is, if the financial asset has not become credit-impaired since initial recognition, the entity applies the EIR method to the gross carrying amount (the “gross method”). If the financial asset has subsequently become credit-impaired, the entity applies the EIR to the amortized cost balance, which is the gross carrying amount adjusted for any loss allowance (“net method”). An entity using the net method should revert to the gross method if (1) the credit risk of the financial instrument subsequently improves to the extent that the financial asset is no longer credit-impaired and (2) the improvement is objectively related to an event that occurred after the net method was applied.

A.2.2.3 Foreign Exchange Gains and Losses on AFS/FVTOCI Debt Securities

Under U.S. GAAP, unrealized changes in the value of an investment in a foreign-currency-denominated security classified as AFS that are attributable to changes in foreign exchange rates are recognized in OCI. ASC 320-10-35-36 states that the entire “change in the fair value of foreign-currency-denominated available-for-sale debt securities, excluding the amount recorded in the allowance for credit losses, shall be reported in other comprehensive income.” An entity must report credit losses on AFS debt securities as credit losses in the income statement.

Under IFRS Accounting Standards, unrealized changes in the value of a foreign-currency-denominated debt instrument accounted for at FVTOCI that are attributable to changes in the foreign exchange rates are recognized in profit or loss. In accordance with paragraphs 5.7.10 and 5.7.11 of IFRS 9, the amount recognized in profit or loss for debt instruments accounted for at FVTOCI is the same as the amount that would be recognized in profit or loss for instruments accounted for at amortized cost. Paragraph B5.7.2A of IFRS 9 further clarifies this guidance:

For the purpose of recognising foreign exchange gains and losses under IAS 21, a financial asset measured at fair value through other comprehensive income in accordance with paragraph 4.1.2A is treated as a monetary item. Accordingly, such a financial asset is treated as an asset measured at amortised cost in the foreign currency. Exchange differences on the amortised cost are recognised in profit or loss and other changes in the carrying amount are recognised in accordance with paragraph 5.7.10.

Note that under IFRS 9, the treatment discussed above does not apply to investments in equity securities that an entity irrevocably elected to account for at FVTOCI. An investment in such securities is accounted for in a manner consistent with the guidance in paragraph B5.7.3 of IFRS 9, which states that “[s]uch an investment is not a monetary item. Accordingly, the gain or loss that is presented in other comprehensive income . . . includes any related foreign exchange component.”

Footnotes

Federal Financial Institutions Examination Council, FFIEC 031 and 041, “Call Report Instructions.”

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.