3.2 Unit of Account
ASC 326-20
30-2 An entity
shall measure expected credit losses of financial assets on
a collective (pool) basis when similar risk
characteristic(s) exist (as described in paragraph
326-20-55-5). If an entity determines that a financial asset
does not share risk characteristics with its other financial
assets, the entity shall evaluate the financial asset for
expected credit losses on an individual basis. If a
financial asset is evaluated on an individual basis, an
entity also should not include it in a collective
evaluation. That is, financial assets should not be included
in both collective assessments and individual
assessments.
35-2 An entity
shall evaluate whether a financial asset in a pool continues
to exhibit similar risk characteristics with other financial
assets in the pool. For example, there may be changes in
credit risk, borrower circumstances, recognition of
writeoffs, or cash collections that have been fully applied
to principal on the basis of nonaccrual practices that may
require a reevaluation to determine if the asset has
migrated to have similar risk characteristics with assets in
another pool, or if the credit loss measurement of the asset
should be performed individually because the asset no longer
has similar risk characteristics.
55-5 In
evaluating financial assets on a collective (pool) basis, an
entity should aggregate financial assets on the basis of
similar risk characteristics, which may include any one or a
combination of the following (the following list is not
intended to be all inclusive):
- Internal or external (third-party) credit score or credit ratings
- Risk ratings or classification
- Financial asset type
- Collateral type
- Size
- Effective interest rate
- Term
- Geographical location
- Industry of the borrower
- Vintage
- Historical or expected credit loss patterns
- Reasonable and supportable forecast periods.
An entity must evaluate financial assets within the scope of the model on a
collective (i.e., pool) basis if they share similar risk characteristics. If a
financial asset’s risk characteristics are not similar to those of any of the
entity’s other financial assets, the entity would evaluate that financial asset
individually.
Connecting the Dots
Unit of Account
While ASC 326-20-55-5 identifies risk characteristics that an entity could
consider when segmenting its portfolio of financial assets, ASC 326 does not
discuss how the entity should choose such characteristics. We believe that
an entity should consider risk characteristics that reflect how the entity
manages credit risk. If the risk characteristics are chosen in this manner,
the risk of loss among the assets in the pool is likely to be similar.
Accordingly, in such cases, the historical loss information that management
uses to estimate expected credit losses is likely to be more relevant,
resulting in a better estimate of such losses in the current reporting
period.
In paragraph BC49 of ASU 2016-13, the FASB addresses its rationale for requiring
collective evaluation of assets with similar risk characteristics and observes that
“financial institutions manage many financial assets on a collective basis, wherein
new financial assets are originated, existing financial assets are paid down, and
some financial assets may be purchased and some financial assets may be sold. In
addition, many users analyze financial asset portfolios of financial institutions on
a collective basis.” Furthermore, paragraph BC69 of ASU 2016-13 states, in part:
The Board concluded that financial assets generally are priced assuming an
estimated likelihood of credit losses on similar assets, although an entity
initially expects to collect all of the contractual cash flows on each
individual asset. Similarly, while an entity might not currently expect a loss
on an individual asset, it ordinarily would expect some level of losses in a
group of assets with similar risk characteristics. Therefore, an estimate of
expected credit losses should reflect a collective assessment if similar risk
characteristics exist for assets measured at amortized cost.
3.2.1 Removing a Financial Asset From a Pool of Financial Assets
An entity generally must remove specific financial assets from
larger pools when there is evidence of credit deterioration related to those
assets. If a deteriorated financial asset meets the definition of a
collateral-dependent asset (see Section 4.4.9.1), the financial asset
should be removed from the pool because the calculation of losses for this asset
will differ from the calculation used for the other assets. Similarly, a
financial asset should be removed from a pool of financial assets if it has
deteriorated and therefore no longer shares risk characteristics with the rest
of the assets in the pool. Even when the estimated credit losses for the pool
incorporate a certain level of defaults and the level of individual financial
assets within that pool defaults as expected, the financial asset with
deteriorated credit quality must be removed from the pool because its risk
characteristics are no longer similar to those of the remaining pool assets. If
the asset’s risk characteristics become similar to those of other financial
assets, the asset should be placed into a pool with those assets.
Changing Lanes
Unit of Account for HTM Debt
Securities
ASC 326 requires an entity to collectively measure
expected credit losses on financial assets that share similar risk
characteristics, including HTM debt securities. This requirement
represents a significant change from existing U.S. GAAP, under which an
entity must evaluate the credit impairment of debt securities
individually. As a result, an entity may need to change its existing
impairment assessments and systems related to measuring HTM debt
securities for expected credit losses. See Section 7.2.7 for a comparison
between the credit loss model for HTM debt securities and that for AFS
debt securities.