Chapter 3 — Recognition and Unit of Account | DART – Deloitte Accounting Research Tool

ASC 326-20

30-1 The allowance for credit losses is 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. Expected recoveries of amounts previously written off and expected to be written off shall be included in the valuation account and shall not exceed the aggregate of amounts previously written off and expected to be written off by an entity. At the reporting date, an entity shall record an allowance for credit losses on financial assets within the scope of this Subtopic. An entity shall report in net income (as a credit loss expense) the amount necessary to adjust the allowance for credit losses for management’s current estimate of expected credit losses on financial asset(s).

Unlike the incurred loss models in U.S. GAAP, the CECL model does not specify a threshold for the recognition of an impairment allowance. Rather, an entity will recognize its estimate of expected credit losses for financial assets as of the end of the reporting period. Credit impairment will be recognized as an allowance — or contra-asset — rather than as a direct write-down of a financial asset’s amortized cost basis.

Financial assets within the scope of the CECL model are generally measured at amortized cost. Such assets, including loans and HTM debt securities, are recorded at their amortized cost basis because an entity expects to realize the total value of the financial asset by collecting this basis. Consequently, in paragraph BC48 of ASU 2016-13, the Board reasons that for assets measured at amortized cost, “an entity should not wait for an event of default or other actual shortfall of cash flows to conclude that a credit impairment exists.” Accordingly, the Board believes that “[r]emoving the probable threshold would result in a more timely measurement of expected credit losses because losses can be expected before they are probable (as that term is used in Topic 450) of occurring (or have occurred).”

Changing Lanes

Allowance Approach Used for HTM Debt Securities

Because the CECL model requires the use of an allowance approach for all financial assets measured at amortized cost, an entity does not adjust the cost basis of an HTM debt security to reflect an expected credit loss.1 Paragraph BC75 of ASU 2016-13 explains the Board’s rationale for this decision:

[S]takeholders expressed concerns that the requirement to adjust the amortized cost basis of a security when an entity recorded an other-than-temporary impairment distorted yields because those amounts are recognized as interest income in future periods. As a result, the Board decided that expected credit losses should be recorded through an allowance for credit losses for all financial assets that are held for the collection of contractual cash flows and the allowance (as opposed to the yield) should be adjusted if credit loss expectations subsequently improve. This decision was supported by both preparers and users. Preparers often cited the complexity of continually adjusting the yield on those securities on a prospective basis.

Although preparers may have welcomed this change given the concerns expressed about the accounting for credit losses related to HTM debt securities (i.e., prospective yield adjustments after a recognized credit loss) before the adoption of the CECL guidance, the CECL requirements may present other challenges for preparers. For example, an entity is now required to recognize expected credit losses upon initial recognition of an HTM debt security without regard to the security’s fair value. That is, the entity is no longer allowed to avoid recognizing a credit loss simply because the fair value of the HTM debt security equals or exceeds its amortized cost basis. In addition, because the CECL model does not have a minimum threshold for recognition of impairment losses, entities need to measure expected credit losses on assets for which there is a low risk of loss (e.g., investment-grade HTM debt securities). However, ASC 326-20-30-10 states, in part, that “an entity is not required to measure expected credit losses on a financial asset . . . in which historical credit loss information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that nonpayment of the [financial asset’s] amortized cost basis is zero.” While the FASB may have been thinking of U.S. Treasury securities and certain highly rated debt securities when it decided to allow an entity to recognize zero credit losses on an asset, ASC 326 does not indicate that this is the case. Regardless, challenges will most likely be associated with measuring expected credit losses on financial assets whose risk of loss is low. For more information about the measurement of expected credit losses on U.S. Treasury securities and other highly rated debt instruments, see Section 4.4.10.