Chapter 2 — Scope
Chapter 2 — Scope
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:
- Financing receivables
- Held-to-maturity debt securities
- 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
- Subparagraph superseded by Accounting Standards Update No. 2019-04.
- 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.
The CECL model applies to substantially all financial assets that are measured at
amortized cost; other assets not measured at fair value; and certain off-balance-sheet
exposures, excluding insurance and derivatives accounted for under ASC 815-10.
Accordingly, the following are within the scope of the CECL model:
- Receivables accounted for under ASC 310.
- HTM debt securities accounted for under ASC 320.
- Contract assets recognized in accordance with ASC 606.
- Lessors’ net investments in leases recognized in accordance with ASC 842.
- Reinsurance receivables recognized under ASC 944.
- Certain off-balance-sheet exposures.
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.
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 AFS1) or an equity security (accounted for under ASC 321).2 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 share of preferred stock 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
1
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.
2
Provided that the investor does not consolidate the investee under ASC
810 and the investor does not apply ASC 323 to the investment (e.g., as
an investment in in-substance common stock that provides the investor
with significant influence over the investee).
2.2 Scope Exclusions
ASC 326-20
15-3 The
guidance in this Subtopic does not apply to the following
items:
- Financial assets measured at fair value through net income
- Available-for-sale debt securities
- Loans made to participants by defined contribution employee benefit plans
- Policy loan receivables of an insurance entity
- Promises to give (pledges receivable) of a not-for-profit entity
- Loans and receivables between entities under common control.
- Receivables arising from operating leases accounted for in accordance with Topic 842.
ASC 326-20-15-3 lists a number of items that are outside the scope
of the guidance on credit losses. For such items, impairment is recognized and
measured in accordance with other U.S. GAAP. One of these items is an operating
lease receivable (see ASC 326-20-15-3(g)), which is accounted for under ASC 842
rather than ASC 326, as discussed below.
2.2.1 Loans Held for Sale
The CECL model does not apply to held-for-sale (HFS) loans. An
entity is required to measure an HFS loan at the lower of amortized cost or fair
value in accordance with ASC 948. As discussed in Section 4.9, an entity that transfers a
loan from HFS to held for investment (HFI) must reverse any allowance previously
measured on the HFS loan, transfer the loan to the new classification category
(HFI), and establish a new allowance for expected credit losses on the basis of
the measurement guidance in ASC 326.
2.2.2 Loans and Receivables Between Entities Under Common Control
Loans and receivables between entities under common control are
specifically excluded from the scope of the CECL model. At the June 2018 TRG meeting, the FASB staff indicated that this
scope exception applies to all common-control arrangements at all stand-alone
reporting levels (i.e., parent and subsidiaries); however, such application is
not specifically addressed in ASC 326.
2.2.3 Billed Operating Lease Receivables
Operating lease receivables are within the scope of ASC 842 rather than ASC 326.
That is, an entity would apply ASC 842 rather than ASC 326-20 to account for
changes in the collectibility assessment for operating leases. An entity would
recognize such changes as an adjustment to lease income in accordance with ASC
842-30-25-13 rather than recognizing bad-debt expense.
Lessors have questioned the appropriate accounting for operating lease
receivables that are or are expected to become impaired, since such receivables
are outside the scope of the impairment guidance in ASC 326. On the basis of a
technical inquiry with the FASB staff, we understand the following:
- ASC 842-30 requires entities to assess the probability of an individual customer’s (tenant’s) future payment.
- In addition to applying the guidance in ASC 842-30, an entity may elect to use a general or portfolio reserve approach (which is aligned with the application of ASC 450-20).
- If a lessor elects to record a general reserve, the income statement impact may be recorded as a reduction to lease income or as bad-debt expense.
- Consistent application and transparent disclosure of the policy elected are critical.
For more information about assessing and accounting for the collectibility of
operating lease receivables, see Section
9.3.9.2 of Deloitte’s Roadmap Leases.