6.1 Introduction
ASC 326-20 includes a distinct model related to acquired assets for
which credit has deteriorated since origination as well as for certain BIs in
securitized financial assets. Paragraph BC85 of ASU 2016-13 describes the FASB’s basis for
this distinction:
[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.
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. In addition, the term PCD would be replaced with the term
PFA.1 See Section 9.2.1 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.