10.2 FASB Activities

The guidance in Subtopic 326-20, Financial Instruments — Credit Losses — Measured at Amortized Cost, and Subtopic 326-30, Financial Instruments — Credit Losses — Available-for-Sale Debt Securities, contains specific guidance on the measurement, presentation, and disclosure of financial assets within the scope of those Subtopics. Because the definition of amortized cost basis in the Codification includes accrued interest, the guidance in Subtopics 326-20 and 326-30 also applies to the accrued interest amounts included as part of the amortized cost of a related financial asset. Applying the guidance in Subtopics 326-20 and 326-30 to accrued interest as part of the amortized cost basis of a related financial asset potentially imposes unintended costs to implement Update 2016-13.

The guidance in paragraph 326-20-35-8 (and by reference in paragraph 326-30-35-13) requires that writeoffs of financial assets within the scope of Subtopics 326-20 and 326-30 be deducted from the allowance for credit losses when the financial assets are deemed uncollectible. Because accrued interest is included in the definition of amortized cost basis, an entity would be required to write off accrued interest amounts through the allowance for credit losses. The application of the writeoff guidance in paragraph 326-20-35-8 (and by reference in paragraph 326-30-35-13) to accrued interest potentially imposes unintended costs to implement Update 2016-13.

The amendments to Subtopic 326-20 allow an entity to:

1. Measure the allowance for credit losses on accrued interest receivable balances separately from other components of the amortized cost basis of associated financial assets.
2. Make an accounting policy election not to measure an allowance for credit losses on accrued interest receivable amounts if an entity writes off the uncollectible accrued interest receivable balance in a timely manner and makes certain disclosures.
3. Make an accounting policy election to write off accrued interest amounts by reversing interest income or recognizing credit loss expense, or a combination of both. The entity also is required to make certain disclosures.
4. Make an accounting policy election to present accrued interest receivable balances and the related allowance for credit losses for those accrued interest receivable balances separately from the associated financial assets on the balance sheet. If the accrued interest receivable balances and the related allowance for credit losses are not presented as a separate line item on the balance sheet, an entity should disclose the amount of accrued interest receivable balances and the related allowance for credit losses and where the balance is presented.
5. Elect a practical expedient to disclose separately the total amount of accrued interest included in the amortized cost basis as a single balance to meet certain disclosure requirements.

Certain amendments in (a) through (e) above are applicable to Subtopic 326-30.

[See Section 4.4.5.1 of this Roadmap.]

Subtopics 310-10, Receivables — Overall, and 948-310, Financial Services — Mortgage Banking — Receivables, provide guidance on how an entity should account for loans with various classifications. While a significant portion of that guidance was superseded by Update 2016-13, stakeholders questioned how to account for the allowance for credit losses or valuation allowance when transferring nonmortgage loans between classifications (that is, not-held-for-sale and held-for-sale classifications) and mortgage loans between classifications (that is, held-for-long-term-investment and held-for-sale classifications).

Subtopic 320-10, Investments — Debt Securities — Overall, provides guidance on how an entity should account for transfers of debt securities between categories. Stakeholders questioned how to account for the allowance for credit losses when transferring debt securities between the available-for-sale category and the held-to-maturity category.

The amendments require that an entity reverse in earnings, any allowance for credit losses or valuation allowance previously measured on a loan or debt security, reclassify and transfer the loan or debt security to the new classification or category, and apply the applicable measurement guidance in accordance with the new classification or category.

[See Section 4.10 of this Roadmap.]

The guidance in paragraph 326-20-35-8 states that recoveries of financial assets and trade receivables previously written off should be recorded when received. Without proper clarification, stakeholders noted that this guidance could be interpreted to prohibit the inclusion of recoveries in the estimation of expected credit losses on financial assets measured at amortized cost basis.

Furthermore, stakeholders questioned how an entity should account for an amount expected to be collected greater than the amortized cost basis.

The amendments clarify that an entity should include recoveries when estimating the allowance for credit losses.

The amendments clarify that expected recoveries of amounts previously written off and expected to be written off should be included in the valuation account and should not exceed the aggregate of amounts previously written off and expected to be written off by the entity. In addition, for collateral-dependent financial assets, the amendments clarify that an allowance for credit losses that is added to the amortized cost basis of the financial asset(s) should not exceed amounts previously written off.

[See Section 4.5.2 of this Roadmap.]

Stakeholders noted that the cross-reference to paragraph 326-20-35-2 in Example 2 in Subtopic 310-40, Receivables — Troubled Debt Restructurings by Creditors, is incorrect. The illustration describes an entity that determines that foreclosure is probable on a collateral-dependent loan. Therefore, stakeholders asked whether the cross-reference should instead link to paragraphs 326-20-35-4 through 35-5, which require that an entity use the fair value of collateral to determine expected credit losses when foreclosure is probable.

The amendment clarifies the illustration by removing the incorrect cross-reference to paragraph 326-20-35-2 and replacing it with the correct cross-reference to paragraphs 326-20-35-4 through 35-5, which require that an entity use the fair value of collateral to determine expected credit losses when foreclosure is probable.

Stakeholders noted that the guidance on equity method losses in paragraphs 323-10-35-24 and 323-10-35-26 was not amended in Update 2016-13. Specifically, the guidance describes the allocation of equity method losses when an investor has other investments, such as loans and debt securities, in the equity method investee. Stakeholders asked whether the guidance should refer an entity to Topic 326 for the subsequent measurement of those loans and debt securities.

The amendment clarifies the equity method losses allocation guidance in paragraphs 323-10-35-24 and 323-10-35-26 by adding cross-references to Subtopics 326-20 and 326-30 for the subsequent measurement of loans and available-for-sale debt securities, respectively.

Stakeholders asked whether reinsurance recoverables measured on a net present value basis in accordance with Topic 944, Financial Services — Insurance, are within the scope of Subtopic 326-20. As written, the scope could be interpreted to exclude those recoverables because they are not measured at amortized cost basis.

The amendment clarifies the Board’s intent to include all reinsurance recoverables within the scope of Topic 944 within the scope of Subtopic 326-20, regardless of the measurement basis of those recoverables.

[See Section 2.1 of this Roadmap.]

Stakeholders asked whether the prohibition of using projections of future interest rate environments in estimating expected future cash flows and determining the effective interest rate to discount expected cash flow for variable-rate financial instruments was consistent with the Board’s intent. As written, an entity that chooses to use a discounted cash flow method to determine expected credit losses on a variable-rate financial instrument is precluded from forecasting changes in the variable rate for the purposes of estimating expected cash flows and determining the effective interest rate with which to discount those cash flows.

Stakeholders also asked if an entity is required to use a prepayment-adjusted effective interest rate if it uses projections of interest rate environments for variable-rate financial instruments in estimating expected cash flows.

The amendments clarify the Board’s intent to provide flexibility in determining the allowance for credit losses by removing the prohibition of using projections of future interest rate environments when using a discounted cash flow method to measure expected credit losses on variable-rate financial instruments.

The amendments clarify that an entity that uses projections or expectations of future interest rate environments in estimating expected cash flows should use the same assumptions in determining the effective interest rate used to discount those expected cash flows.

The amendments also clarify that if an entity uses projections of future interest rate environments when using a discounted cash flow method to measure expected credit losses on variable-rate financial instruments, it also should adjust the effective interest rate to consider the timing (and changes in the timing) of expected cash flows resulting from expected prepayments.

[See Section 4.4.4.2 of this Roadmap.]

Stakeholders asked whether an entity may adjust the effective interest rate used to discount expected cash flows in a discounted cash flow method for the entity’s expectations of prepayments on financial assets. Stakeholders noted that expected prepayments are required to be considered in estimating expected cash flows. However, they noted that without incorporating those expected prepayments into determining the effective interest rate, the discounted cash flow calculation fails to appropriately isolate credit risk in the determination of an allowance for credit losses.

The amendments permit an entity to make an accounting policy election to adjust the effective interest rate used to discount expected future cash flows for expected prepayments on financial assets within the scope of Subtopic 326-20 and on available-for-sale debt securities within the scope of Subtopic 326-30 to appropriately isolate credit risk in determining the allowance for credit losses.

The amendments also clarify that an entity should not adjust the effective interest rate used to discount expected cash flows for subsequent changes in expected prepayments if the financial asset is restructured in a troubled debt restructuring.

[See Section 4.4.4.1 of this Roadmap.]

Stakeholders asked whether an entity is required to consider estimated costs to sell the collateral when using the fair value of [the] collateral to estimate expected credit losses on a financial asset because foreclosure is probable in accordance with paragraph 326-20-35-4. Stakeholders noted that the collateral-dependent financial asset practical expedient in paragraph 326-20-35-5 requires that an entity consider estimated costs to sell if repayment or satisfaction of the asset depends on the sale of the collateral.

Stakeholders also noted that paragraphs 326-20-35-4 through 35-5 require that an entity adjust the fair value of collateral for the estimated costs to sell on a discounted basis if it intends to sell rather than operate the collateral. Stakeholders asked why an entity is required to estimate the costs to sell on a discounted basis if the fair value of collateral should be based on amounts as of the reporting date.

The amendments clarify the guidance in paragraph 326-20-35-4 by specifically requiring that an entity consider the estimated costs to sell if it intends to sell rather than operate the collateral when the entity determines that foreclosure on a financial asset is probable.

Additionally, the amendments clarify the guidance that when an entity adjusts the fair value of collateral for the estimated costs to sell, the estimated costs to sell should be undiscounted if the entity intends to sell rather than operate the collateral.

[See Section 4.4.9.2 of this Roadmap.]

The guidance in paragraph 326-20-30-1 states that expected recoveries of amounts previously written off or expected to be written off should be included in the allowance for credit losses valuation account. Stakeholders questioned whether this guidance applies to purchased financial assets with credit deterioration (PCD assets) measured at amortized cost basis in Subtopic 326-20, Financial Instruments — Credit Losses — Measured at Amortized Cost.

Specifically, stakeholders questioned whether negative allowances were permitted on PCD assets. The phrase negative allowance is used to describe situations for which an entity determines that it will recover the amortized cost basis, or a portion of that basis, after a writeoff and that “basis recovery” is included in the allowance for credit losses through a negative allowance. Those situations often are a result of an entity applying regulatory charge-off policies that are generally based on delinquency status.

The amendments clarify that the allowance for credit losses for PCD assets should include in the allowance for credit losses expected recoveries of amounts previously written off and expected to be written off by the entity and should not exceed the aggregate of amounts of the amortized cost basis previously written off and expected to be written off by an entity.

In addition, the amendments clarify that when a method other than a discounted cash flow method is used to estimate expected credit losses, expected recoveries should not include any amounts that result in an acceleration of the noncredit discount. An entity may include increases in expected cash flows after acquisition.

[See Section 6.3.3.2 of this Roadmap.]

At the June 2017 Credit Losses Transition Resource Group (TRG) meeting, stakeholders noted the operational complexities of calculating a prepayment-adjusted effective interest rate on troubled debt restructurings (TDRs) that exist as of the adoption date by using the prepayment assumptions in effect immediately before the restructuring. They requested transition relief when adjusting the effective interest rate for those arrangements.

The amendments provide transition relief by permitting entities an accounting policy election to adjust the effective interest rate on existing TDRs using prepayment assumptions on the date of adoption of Topic 326 rather than the prepayment assumptions in effect immediately before the restructuring.

[See Section 9.2 of this Roadmap.]

Accounting Standards Update No. 2019-04, Codification Improvements to Topic 326, Financial Instruments — Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, amended the guidance in Subtopics 326-20 and 326-30, Financial Instruments — Credit Losses — Available-for-Sale Debt Securities, to allow an entity to elect a practical expedient to disclose separately the total amount of accrued interest included in the amortized cost basis as a single balance to meet certain disclosure requirements.

Stakeholders noted that an entity would still be required to include accrued interest in other disclosure requirements of its amortized cost basis for financial assets under other Topics. Stakeholders requested that the disclosure relief for accrued interest receivable balances be extended to all relevant disclosures involving amortized cost basis.

The amendments extend the disclosure relief for accrued interest receivable balances to additional relevant disclosures involving the amortized cost basis.

The guidance in paragraph 326-20-35-6 for financial assets secured by collateral maintenance provisions provides a practical expedient to measure the estimate of expected credit losses by comparing the amortized cost basis of a financial asset and the fair value of collateral securing the financial asset as of the reporting date. Stakeholders questioned whether an entity is required to evaluate whether a borrower has the ability to continually replenish collateral securing the financial asset to apply the practical expedient.

Additionally, stakeholders questioned how an entity should determine its estimate of expected credit losses if the fair value of the collateral securing the financial asset is less than its amortized cost basis.

The amendments clarify that an entity should assess whether it reasonably expects the borrower will be able to continually replenish collateral securing the financial asset to apply the practical expedient.

The amendments clarify that an entity applying the practical expedient should estimate expected credit losses for any difference between the amount of the amortized cost basis that is greater than the fair value of the collateral securing the financial asset (that is, the unsecured portion of the amortized cost basis). An entity may determine that the expectation of nonpayment for the amount of the amortized cost basis equal to the fair value of the collateral securing the financial asset is zero.

[See Section 4.4.9.2.1 of this Roadmap.]

Stakeholders noted that paragraph 805-20-50-1 references Subtopic 310-30, Receivables — Loans and Debt Securities Acquired with Deteriorated Credit Quality, which was superseded by the amendments in Update 2016-13.

The amendment to Subtopic 805-20, Business Combinations — Identifiable Assets and Liabilities, and Any Noncontrolling Interest, clarifies the guidance by removing the cross-reference to Subtopic 310-30 in paragraph 805-20-50-1 and replacing it with a cross- reference to the guidance on PCD assets in Subtopic 326-20.

Stakeholders requested clarification on determining the contractual term of a net investment in a lease for the purposes of measuring expected credit losses. Specifically, stakeholders noted that the contractual term of the net investment in a lease determined in accordance with Topic 842, Leases, may not align with the contractual term determined in accordance with Topic 326, Financial Instruments — Credit Losses.

The amendments clarify that the contractual term of a net investment in a lease determined in accordance with Topic 842 should be the contractual term used to measure expected credit losses under Topic 326.

Stakeholders noted that paragraph 860-20-25-13, which relates to a transferor regaining control of certain financial assets after a transfer that was previously accounted for as a sale is inconsistent with the requirements in Topic 326.

Specifically, stakeholders noted that paragraph 860-20-25-13 precludes an entity from recognizing a loan loss allowance for loans that do not meet the definition of a security when they are rerecognized.

The amendments to Subtopic 860- 20, Transfers and Servicing — Sales of Financial Assets, clarify that when an entity regains control of financial assets sold, an allowance for credit losses should be recorded in accordance with Topic 326.