2.1 Overview

ASC 326-20

15-2 The guidance in this Subtopic applies to the following items:

Financial assets measured at amortized cost basis, including the following:
1. Financing receivables
2. Held-to-maturity debt securities
3. Receivables that result from revenue transactions within the scope of Topic 605 on revenue recognition, Topic 606 on revenue from contracts with customers, and Topic 610 on other income
4. Subparagraph superseded by Accounting Standards Update No. 2019-04.
5. Receivables that relate to repurchase agreements and securities lending agreements within the scope of Topic 860.
Net investments in leases recognized by a lessor in accordance with Topic 842 on leases.
Off-balance-sheet credit exposures not accounted for as insurance. Off-balance-sheet credit exposure refers to credit exposures on off-balance-sheet loan commitments, standby letters of credit, financial guarantees not accounted for as insurance, and other similar instruments, except for instruments within the scope of Topic 815 on derivatives and hedging.
Reinsurance recoverables that result from insurance transactions within the scope of Topic 944 on insurance.

One of the FASB’s objectives related to developing a new impairment model was to reduce the complexity of U.S. GAAP by decreasing the number of credit impairment models that entities use to account for debt instruments. Accordingly, the FASB set out to establish a one-size-fits-all model for measuring expected credit losses on financial assets that have contractual cash flows.1 Ultimately, however, the FASB determined that the CECL model would not apply to AFS debt securities, which continue to be assessed for impairment under ASC 320. (As discussed in Chapter 7, the FASB moved the impairment model for AFS debt securities from ASC 320 to ASC 326-30 and made limited amendments to this model.)

The diagram below depicts the impairment models in U.S. GAAP that were replaced by the CECL model.

Under ASC 325-40, as amended by ASU 2016-13, an entity’s measurement of a credit loss allowance for purchased or retained BIs depends on whether the BIs are classified as HTM debt securities or AFS debt securities. (No impairment model is needed for BIs classified as trading securities because they are measured at fair value, with changes recognized in earnings.) An entity would measure the credit loss allowance on a BI classified as an HTM debt security or an AFS debt security in accordance with ASC 326-20 or ASC 326-30, respectively.

Changing Lanes

HTM Debt Securities No Longer Accounted for Under OTTI Guidance

The CECL model applies to HTM debt securities. As with the measurement objective associated with other financial instruments measured at amortized cost (e.g., loans), the FASB believes that an entity invests in an HTM debt security solely to collect contractual cash flows. As a result, an entity would be required to apply the CECL model to its HTM debt securities in a manner consistent with how it would measure expected credit losses on its other debt instruments (e.g., loan and trade receivables). Therefore, under the guidance in ASU 2016-13, an entity no longer applies an OTTI model to an HTM debt security when evaluating whether it needs to recognize a credit impairment. An entity that currently has an investment portfolio containing both HTM and AFS debt securities is now required to measure expected credit losses on each type of security by using different expected credit loss models. See Chapter 4 for more information about the measurement of expected credit losses.

2.1.1 Unfunded Loan Commitments

Off-balance-sheet arrangements, such as commitments to extend credit, are subject to credit risk and are therefore within the scope of the CECL model. However, ASC 326-20-30-11 states that an entity is required to measure expected credit losses on commitments “in which the entity is exposed to credit risk via a present contractual obligation to extend credit, unless that obligation is unconditionally cancellable by the issuer” (emphasis added). As a result, if the entity has the unconditional ability to cancel the unfunded portion of a loan commitment, it would not be permitted to estimate expected credit losses for that portion, even if it has historically never exercised its cancellation right. For more information about the measurement of expected credit losses on loan commitments, see Chapter 5.

Changing Lanes

Reinsurance Receivables Are Within the Scope of the CECL Model

Although ASC 326-20 states that the CECL model applies to reinsurance recoverables measured at amortized cost, the FASB clarified in ASU 2019-04 that all reinsurance recoverables are within the scope of the model, regardless of the asset’s underlying measurement basis. That is, an entity will need to apply the CECL model to reinsurance recoverables measured on a discounted basis as well as to those measured at amortized cost. See Chapter 10 for more information about recent FASB decisions and activities.

2.1.2 Forward Commitments to Purchase Loans

We believe that a forward commitment to purchase loans from a third party is within the scope of ASC 326-20 because it exposes the purchaser to the credit risk associated with the underlying loans to be purchased if it is neither (1) unconditionally cancelable by the purchaser nor (2) accounted for as a derivative under ASC 815. That is, once the entity enters into the noncancelable commitment to purchase the loans, it becomes exposed to the credit risk associated with issuing the loans.

2.1.3 Guarantees Between Entities Under Common Control

ASC 326-20-15-3 specifically excludes loans and receivables between entities under common control from the scope of ASC 326-20. However, there is no specific scope exception related to off-balance-sheet credit exposure, including financial guarantees, between entities under common control. A guarantee between common-control entities that exposes the guarantor to the credit risk of a third-party entity is, in substance, the same as direct exposure of the guarantor to the third-party credit risk. Therefore, we believe that guarantee arrangements between common-control entities that are related to third-party credit exposure are within the scope of ASC 326-20. See Chapter 5 for more information about accounting for guarantees within the scope of ASC 326-20.

2.1.4 Guarantees of Lease Payments

In certain lease arrangements, lease payments that are payable to a lessor may be guaranteed by a third party. In a manner consistent with other financial guarantees that are not accounted for as insurance or under ASC 815, the guarantor must determine its credit exposure related to its guarantee of those lease payments. Keep in mind that although operating lease receivables are outside the scope of ASC 326-20, financial guarantees of operating lease payments are within the scope of ASC 326-20 in accordance with ASC 326-20-15-2.

While a financial guarantee can exist in any lease arrangement, a guarantee of lease payments often arises in sublease transactions in which the original lessee (i.e., lessee/intermediate lessor) may guarantee the sublessee’s payment to the original lessor. If the nature of a sublease arrangement is such that the lessee/intermediate lessor is relieved of its primary obligation under the head lease, the transaction would be considered a termination of the head lease under ASC 842. As a result, the lessee/intermediate lessor would derecognize the ROU asset and lease liability arising from the head lease. (See Chapter 12 of Deloitte’s Roadmap Leases for more information about accounting for sublease arrangements.) If the lessee/intermediate lessor in a sublease arrangement with an unrelated third party remains secondarily liable under the head lease, it is a guarantor in accordance with ASC 405-20-40-2.

In this situation, the lessee/intermediate lessor is exposed to the nonperformance (i.e., credit risk) of the unrelated third party. The lessee/intermediate lessor would measure and recognize the contingent obligation (i.e., the expected credit losses) separately from the noncontingent obligation (i.e., the stand-ready obligation) of the guarantee. See Chapter 5 for more information about accounting for guarantees within the scope of ASC 326-20.

2.1.5 Refundable Lease Security Deposits

Certain leasing arrangements may include a security deposit that must be paid to the owner of the leased asset at or before lease commencement. The security deposit is generally provided to support the lessee’s intent and commitment to lease the underlying asset (i.e., upon receipt of a security deposit, the lessor typically stops marketing the asset for lease). Security deposits can be either nonrefundable or refundable depending on the terms of the contract. (See Chapter 6 of Deloitte’s Roadmap Leases for more information about accounting for nonrefundable and refundable security deposits.)

The lessee recognizes a receivable due from the lessor for a refundable security deposit because the lessee is entitled to receive the cash back from the lessor at the end of the lease agreement (provided that it complies with its obligations under the agreement). That is, the refundable security deposit represents a contractual right for the lessee to receive money on fixed or determinable dates and is recognized as an asset in the lessee’s statement of financial position.

Therefore, we generally believe that refundable lease security deposits meet the definition of a financing receivable in the ASC master glossary and are within the scope of ASC 326-20.

2.1.6 Indemnification Assets

ASC 805-20

25-27 The seller in a business combination may contractually indemnify the acquirer for the outcome of a contingency or uncertainty related to all or part of a specific asset or liability. For example, the seller may indemnify the acquirer against losses above a specified amount on a liability arising from a particular contingency; in other words, the seller will guarantee that the acquirer’s liability will not exceed a specified amount. As a result, the acquirer obtains an indemnification asset. The acquirer shall recognize an indemnification asset at the same time that it recognizes the indemnified item, measured on the same basis as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts. Therefore, if the indemnification relates to an asset or a liability that is recognized at the acquisition date and measured at its acquisition-date fair value, the acquirer shall recognize the indemnification asset at the acquisition date measured at its acquisition-date fair value.

25-28 In some circumstances, the indemnification may relate to an asset or a liability that is an exception to the recognition or measurement principles. For example, an indemnification may relate to a contingency that is not recognized at the acquisition date because it does not satisfy the criteria for recognition in paragraphs 805-20-25-18A through 25-19 at that date. In those circumstances, the indemnification asset shall be recognized and measured using assumptions consistent with those used to measure the indemnified item, subject to management’s assessment of the collectibility of the indemnification asset and any contractual limitations on the indemnified amount.

35-4 At each subsequent reporting date, the acquirer shall measure an indemnification asset that was recognized in accordance with paragraphs 805-20-25-27 through 25-28 at the acquisition date on the same basis as the indemnified liability or asset, subject to any contractual limitations on its amount, except as noted in paragraph 805-20-35-4B, and, for an indemnification asset that is not subsequently measured at its fair value, management’s assessment of the collectibility of the indemnification asset.

Indemnification assets are often recognized as part of business combinations in accordance with ASC 805. For example, a seller in a business combination may contractually indemnify the acquirer for uncertainties related to specific assets or liabilities, such as those associated with lawsuits and uncertain tax positions. This type of indemnification represents an asset obtained in the business combination. ASC 805 indicates that an entity must record a valuation allowance for uncollectible amounts related to an indemnification asset recognized as part of a business combination but does not specify what guidance the entity should apply to measure or recognize the valuation allowance.

2.1.6.1 Indemnification Assets Recognized in a Business Combination

Questions have arisen about whether the CECL model applies to indemnification assets recognized in a business combination. We believe that if the indemnified item is a financial asset measured at amortized cost, the associated indemnification asset is within the scope of ASC 326-20 because ASC 805 requires that indemnification assets be “measured on the same basis as the indemnified item, subject to the need for a valuation allowance for uncollectible amounts.”

However, we believe that there are two acceptable approaches for reflecting collectibility in the recognition and measurement of indemnification assets if the indemnified item is not a financial asset measured at amortized cost:

Approach 1 — In accordance with ASC 805-20-25-28, recognize and measure the indemnification asset by “using assumptions consistent with those used to measure the indemnified item, subject to management’s assessment of the collectibility of the indemnification asset.” That is, the measurement of the indemnification asset takes collectibility into account; therefore, a separate allowance for uncollectible amounts is unnecessary. This approach is consistent with the guidance in ASC 805-20-25-28 and ASC 805-20-35-4.
Approach 2 — Measure an allowance for uncollectible amounts associated with the indemnification asset in accordance with ASC 326-20 by analogy. Although indemnification assets are not explicitly included in (or excluded from) the scope of ASC 326-20, an indemnification asset could be viewed as analogous to a reinsurance receivable, which is within the scope of ASC 326-20.

Whichever of these two approaches an entity chooses should be applied consistently.

Example 2-1

Entity X has asbestos liabilities related to business activities of a former subsidiary that has been spun off (Spinnee Y). The asbestos liabilities are measured in accordance with ASC 450. At the time of the spin-off, Y indemnifies X for a portion of the amounts paid by X in connection with the asbestos liabilities. That is, each year Y will reimburse X for 75 percent of the amounts paid by X.

Entity X applies the guidance in ASC 805-20-25-28 by analogy and recognizes an indemnification asset at the time of the spin-off in an amount equal to 75 percent of the recognized asbestos liability. After the spin-off, X remeasures the indemnification asset by analogy to the guidance in ASC 805-20-35-4. That is, each period, X remeasures the indemnification asset to an amount equal to 75 percent of the then current asbestos liability. The following is a summary of how X would reflect collectibility related to the indemnification asset under each of the two approaches described above:

Approach 1 — The indemnification asset recorded by X is measured by using assumptions consistent with those used to measure the indemnified item (i.e., the asbestos liability) under ASC 450, which is subject to management’s assessment of the collectibility of the indemnification asset. Therefore, X is not required to record a separate allowance for uncollectible amounts because assumptions related to collectibility are already incorporated into the measurement of the indemnification asset.
Approach 2 — Entity X should assess collectibility and measure an allowance for uncollectible amounts related to the indemnification asset in accordance with ASC 326-20. The indemnification asset is analogous to a reinsurance receivable, which is within the scope of ASC 326-20, and X is not explicitly prohibited from applying the guidance in ASC 326-20 to measure the allowance for uncollectible amounts related to the indemnification asset.

We believe that either approach above is acceptable given the facts and circumstances. Entity X should choose an approach and apply it consistently to other indemnification assets.

2.1.7 Cash Equivalents

The ASC master glossary defines cash equivalents, in part, as follows:

Cash equivalents are short-term, highly liquid investments that have both of the following characteristics:

Readily convertible to known amounts of cash
So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.

Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations). We believe that cash equivalents that are financial assets recorded at amortized cost (e.g., Treasury bills) are within the scope of ASC 326-20.

2.1.8 Preferred Stock

ASC 326 does not explicitly discuss whether preferred stock is within or outside its scope. The applicability of ASC 326 to preferred stock will depend on whether it meets the definition of a debt security (classified as either HTM or AFS3) or an equity security (accounted for under ASC 321). Because the legal form of the preferred stock is not always determinative, the entity should consider whether certain features in the instrument suggest that it is, in substance, a debt security. ASC 320-10-20 defines a debt security, in part, as follows:

Any security representing a creditor relationship with an entity. The term debt security also includes all of the following:

Preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor.

Therefore, we believe that a preferred stock instrument that meets the definition of a debt security is within the scope of ASC 326-20 (if it is classified as HTM) and ASC 326-30 (if it is classified as AFS).

Perpetual preferred securities that have no maturity date and do not provide for redemption are not within the scope of ASC 326-20. Preferred securities that are not redeemable by the issuing entity either mandatorily or at the option of the investor do not meet the definition of a debt security. Equity-classified instruments are subsequently measured at fair value through net income under ASC 321 and, accordingly, are outside the scope of the CECL model in accordance with ASC 326-20-15-3.

Footnotes

No impairment model is needed for financial assets measured at fair value (e.g., trading securities or other assets measured at fair value by using the fair value option) because the assets are measured at fair value in every reporting period.

Debt securities can also be classified as trading securities under ASC 320. Trading securities are subsequently measured at fair value in the statement of financial position. Unrealized holding gains and losses for trading securities are included in earnings in accordance with ASC 320. Financial assets measured at fair value through net income are explicitly excluded from the scope of ASC 326.

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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.