6.1 Introduction
Since the beginning of its credit losses project, the FASB has sought to
develop a model in which an entity would recognize in net income, in each reporting
period (including upon initial recognition), a credit loss expense that arises from an
allowance for expected credit losses that reflects management’s current estimate of such
losses for both originated and purchased assets. However, as discussed in paragraph BC85
of ASU 2016-13,
the Board questioned whether the same model should be applied to all originated and
purchased assets:
[R]ecognizing interest revenue on the basis of contractual cash
flows for all purchased assets could result in situations in which an entity
accretes to an amount that it does not expect to collect, which would result in
artificially inflated yields. For this reason, the Board concluded that when
recognizing interest income on certain assets, it is inappropriate to accrete
from the purchase price to the contractual cash flows. Specifically, when a
purchased asset has deteriorated more than insignificantly since origination, it
is more decision useful to exclude the credit discount from the amount accreted
to interest income. As a result, the discount embedded in the purchase price
that is attributable to credit losses at the date of acquisition of a purchased
financial asset with credit deterioration should not be recognized as interest
income.
On the basis of that logic, the Board developed an alternative credit loss and interest
income recognition model for acquired assets for which a certain level of credit
deterioration has occurred since origination. The alternative model applies to PCD
assets (see discussion below of what constitutes a PCD asset). An entity’s method for
measuring expected credit losses on PCD assets should be consistent with its method for
measuring such losses on originated and purchased non-credit-deteriorated assets. Upon
acquiring a PCD asset, the entity would recognize its allowance for expected credit
losses as an adjustment that increases the asset’s cost basis (the “gross-up” approach).
After initial recognition of the PCD asset and its related allowance, the entity would
continue to apply the CECL model to the asset — that is, any changes in the estimate of
cash flows that the entity expects to collect (favorable or unfavorable) would be
recognized immediately as credit loss expense in the income statement. Interest income
recognition would be based on the purchase price plus the initial allowance accreting to
the contractual cash flows.
Changing Lanes
FASB Proposed ASU on Purchased Financial Assets
On June 27, 2023, the FASB issued a proposed ASU that would expand the model
for PCD assets to include all financial assets acquired in (1) a business
combination, (2) an asset acquisition, or (3) the consolidation of a VIE that is
not a business. The term PCD would be replaced with the term PFA.1
See Section
10.2.4 for more information.
Footnotes
1
AFS debt securities would be excluded from the PFA
model. In addition, for financial assets acquired as a result of an
asset acquisition or through consolidation of a VIE that is not a
business, the asset acquirer would apply the gross-up approach to
seasoned assets, which are acquired assets unless the asset is deemed
akin to an in-substance origination. A seasoned asset is an asset (1)
that is acquired more than 90 days after origination and (2) for which
the asset acquirer was not involved with the origination.