Chapter 6 — Purchased Credit-Deteriorated Assets

6.2 PCD Model

6.2.1 Scope of the PCD Model

The ASC master glossary defines PCD assets as follows:

Acquired individual financial assets (or acquired groups of financial assets with similar risk characteristics) that as of the date of acquisition have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by an acquirer’s assessment.

PCD assets can be either loans or debt securities. If they are debt securities, they may be classified as either HTM or AFS. ASC 326 does not specify either the cause of “more-than-insignificant deterioration” or the factors an entity should consider when assessing whether the deterioration in the credit quality of an asset (or a group of assets) has been more than insignificant since origination. Paragraph BC90 of ASU 2016-13 notes that the FASB did not want to identify which assets would meet the definition of a PCD asset:

Some stakeholders requested clarification on which purchased financial assets should be recognized through a gross-up approach. The Board discussed the definition of purchased assets with credit deterioration and did not intend for the gross-up approach to be limited to nonaccrual loans or other assets that may have been considered to be an “impaired” asset before the issuance of the amendments in this Update. The Board was concerned that stakeholders would misinterpret the guidance and apply the guidance to the same scope of assets as Subtopic 310-30. As a result, the Board clarified that a gross-up approach should be applied to purchased financial assets with a more-than-insignificant amount of credit deterioration since origination. This change in wording was recommended by user stakeholders. In addition, the Board concluded that this will expand the population of purchased financial assets that are eligible to be considered purchased financial assets with credit deterioration.

Although ASC 326 does not discuss what constitutes a more-than-insignificant deterioration in credit quality since origination, it does provide an example illustrating one way in which an entity may evaluate the credit quality of purchased financial assets.

ASC 326-20

Example 11: Identifying Purchased Financial Assets With Credit Deterioration

55-57 This Example illustrates factors that may be considered when assessing whether the purchased financial assets have more than an insignificant deterioration in credit quality since origination.

55-58 Entity N purchases a portfolio of financial assets subsequently measured at amortized cost basis with varying levels of credit quality. When determining which assets should be considered to be in the scope of the guidance for purchased financial assets with credit deterioration, Entity N considers the factors in paragraph 326-20-55-4 that are relevant for determining collectibility.

55-59 Entity N assesses what is more-than-insignificant credit deterioration since origination and considers the purchased assets with the following characteristics to be consistent with the factors that affect collectibility in paragraph 326-20-55-4. Entity N records the allowance for credit losses in accordance with paragraph 326-20-30-13 for the following assets:

Financial assets that are delinquent as of the acquisition date
Financial assets that have been downgraded since origination
Financial assets that have been placed on nonaccrual status
Financial assets for which, after origination, credit spreads have widened beyond the threshold specified in its policy.

55-60 Judgment is required when determining whether purchased financial assets should be recorded as purchased financial assets with credit deterioration. Entity N’s considerations represent only a few of the possible considerations. There may be other acceptable considerations and policies applied by an entity to identify purchased financial assets with credit deterioration.

Example 11 in ASC 326-20 illustrates that an entity could use the factors in ASC 326-20-55-4 to evaluate whether the deterioration of an asset’s credit quality has been more than insignificant. ASC 326-20-55-4 states, in part:

Examples of factors an entity may consider include any of the following, depending on the nature of the asset (not all of these may be relevant to every situation, and other factors not on the list may be relevant):

The borrower’s financial condition, credit rating, credit score, asset quality, or business prospects
The borrower’s ability to make scheduled interest or principal payments
The remaining payment terms of the financial asset(s)
The remaining time to maturity and the timing and extent of prepayments on the financial asset(s)
The nature and volume of the entity’s financial asset(s)
The volume and severity of past due financial asset(s) and the volume and severity of adversely classified or rated financial asset(s)
The value of underlying collateral on financial assets in which the collateral-dependent practical expedient has not been utilized
The entity’s lending policies and procedures, including changes in lending strategies, underwriting standards, collection, writeoff, and recovery practices, as well as knowledge of the borrower’s operations or the borrower’s standing in the community
The quality of the entity’s credit review system
The experience, ability, and depth of the entity’s management, lending staff, and other relevant staff
The environmental factors of a borrower and the areas in which the entity’s credit is concentrated, such as:
1. Regulatory, legal, or technological environment to which the entity has exposure
2. Changes and expected changes in the general market condition of either the geographical area or the industry to which the entity has exposure
3. Changes and expected changes in international, national, regional, and local economic and business conditions and developments in which the entity operates, including the condition and expected condition of various market segments.

These factors are provided in the context of how an entity might adjust historical loss information on the basis of certain conditions and characteristics that affect the asset’s collectibility. While the existence of these factors may signify that collectibility concerns are associated with a particular asset (or group of assets), it may not indicate that the asset (or group of assets) should be considered PCD because an entity can only conclude that an asset is PCD if the deterioration of its credit quality has been more than insignificant since origination.

Connecting the Dots

Considerations Related to AFS Debt Securities Under the PCD Model

The PCD model applies to an AFS debt security that meets the definition of a PCD asset. To determine whether this definition is met, an entity must consider the factors in ASC 326-30-55-1, which are the same factors that an investor uses to identify whether there is a credit loss on an AFS debt security. In addition, the subsequent-accounting guidance in ASC 326-30 on AFS debt securities that are considered PCD assets slightly differs from the PCD model for assets measured at amortized cost (e.g., loans and HTM debt securities). See Section 7.2.5 for further discussion of the accounting for AFS debt securities that are considered PCD assets.

6.2.1.1 Application of PCD Model to BIs

The PCD model sometimes applies to BIs in securitized financial assets. The PCD model applies to assets that meet the definition of PCD assets as well as to certain BIs in debt securities that do not necessarily meet that definition (see Connecting the Dots below). ASC 325-40-30-1A states:

An entity shall apply the initial measurement guidance for purchased financial assets with credit deterioration in Subtopic 326-20 to a beneficial interest classified as held-to-maturity and in Subtopic 326-30 to a beneficial interest classified as available for sale, if it meets either of the following conditions:

There is a significant difference between contractual cash flows and expected cash flows at the date of recognition.
The beneficial interests meet the definition of purchased financial assets with credit deterioration.

For more information about BIs accounted for under ASC 325-40, see Section 6.2.4.

Connecting the Dots

PCD Model May Apply to a BI That Does Not Meet the Definition of a PCD Asset

Under ASC 325-40-30-1A (quoted above), an entity may need to account for a BI under the respective PCD model in ASC 326-20 or ASC 326-30, even if the BI does not meet the definition of a PCD asset. For example, the entity may be required to apply the PCD model to certain BIs in new securitizations (i.e., securitizations for which there is no deterioration in credit quality because they are new) since there may be a significant difference between contractual cash flows and expected cash flows on the recognition date.

6.2.1.2 Application of PCD Model to Assets Acquired in a Business Combination

Assets acquired in a business combination are subject to evaluation under the PCD model. The PCD model applies to any acquired asset whose deterioration in credit quality has been more than insignificant since origination. Paragraph BC88 of ASU 2016-13 states that “the Board concluded that there is no inherent difference between assets acquired in a business combination and those that are purchased outside a business combination.”

An entity will still have to evaluate whether the individual financial assets (or groups of financial assets with similar risk characteristics) acquired in a business combination meet the definition of a PCD asset before applying the PCD model.

Note that while it may generally be relatively simple to determine whether the PCD model applies to acquired assets in a business combination, an entity may be required to perform an additional step if those acquired assets were previously written off by the seller. We believe that, in those instances, the acquirer would first need to evaluate whether it still has a contractual right to the cash flows of the asset at the time of acquisition and therefore has an asset to recognize. We believe that if the acquirer determines that it has a contractual right to the cash flows of a financial asset that was previously written off, it would then apply the PCD model to the acquired assets as of the acquisition date.

6.2.1.3 Partially Funded Lines of Credit That Are PCD

Upon initially acquiring a partially drawn line of credit, an acquirer should account for the funded portion (that is considered to be PCD and noncancelable by the acquirer) in a manner similar to how it would account for any other PCD asset, as described in ASC 326-20-30-13. The accounting for the unfunded portion of the line of credit would be the same as that prescribed in ASC 326-20-30-11 for all unfunded loan commitments. That is, a liability for the expected credit losses should be recognized for the unfunded portion of the line of credit for which subsequent adjustments as of each reporting date are reported in net income as credit loss expense. In addition, adjustments to the allowance for expected credit losses on the funded portion of the line of credit are also reported in net income as credit loss expense.

As the entity continues to draw down on the line of credit, the acquirer would revise its estimate for credit losses recognized on the unfunded portion of the line of credit (i.e., potentially reducing its liability for off-balance-sheet credit exposure) while adjusting the allowance for expected credit losses on the funded loan amount (to reflect the newly funded amount).

6.2.1.4 Whether Pushdown Accounting Results in Applying PCD Accounting at the Subsidiary Level

Under ASC 805-50-30-10, if an acquiree elects to apply pushdown accounting, the carrying amounts of its assets and liabilities in its separate financial statements are adjusted to reflect the amounts recognized in the acquirer’s consolidated financial statements as of the date on which control was obtained. As a result, if the acquirer applies (or would have applied) PCD accounting at the consolidated level to assets acquired and the acquiree elects to apply pushdown accounting, the acquiree would need to adjust its assets to reflect the application of PCD accounting in its separate, stand-alone financial statements. Note that an acquiree that elects pushdown accounting must apply it in its entirety; the acquiree cannot pick and choose which assets or liabilities to recognize in its separate financial statements.

6.2.1.5 Accounting for a Net Investment in a Lease by Using the PCD Model

A lessor should consider a decline in the fair value of the residual asset in an acquired net investment in a sales-type or direct financing lease when evaluating whether the net investment in the lease meets the definition of a PCD asset. The unit of account used when the impairment model is applied from the lessor’s perspective is meant to encompass amounts related to the entire net investment in the lease, which would include the residual asset. Therefore, we believe that when evaluating whether the deterioration in the credit quality of an acquired net investment in a sales-type or direct financing lease has been more than insignificant since origination, the lessor should consider declines in the (1) lessee’s credit quality that are related to lease payments and (2) fair value of the underlying residual asset.

6.2.2 Unit of Account for PCD Assets

The unit of account used in the PCD model depends on the type of financial asset to which the entity is applying the PCD model. An entity is allowed to evaluate the applicability of the PCD model to loans, HTM debt securities, and other assets measured at amortized cost on a collective basis if they share similar risk characteristics (see Section 3.2). However, the entity is not permitted to determine whether PCD accounting applies to AFS debt securities on a collective or pool basis; instead, it must make that determination on the basis of each individual AFS debt security. For more information about the PCD assessment for AFS debt securities, see Section 7.2.5.

Connecting the Dots

Maintaining Integrity of Pools

The general principles in ASC 326-20 that address the unit of account apply similarly to all assets measured at amortized cost. That is, 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. For more information about when to remove a financial asset from a pool of financial assets, including PCD assets, see Section 3.2.1.

Before adopting ASU 2016-13, entities were required to account for certain acquired financial assets under the PCI model in ASC 310-30. The previous guidance in ASC 310-30-40-1 (superseded by ASU 2016-13) indicated that “once a pool of [PCI] loans is assembled, the integrity of the pool shall be maintained” and that a loan could only be removed if it met certain conditions. However, this guidance allowed an entity to continue to apply ASC 310-30 to pools of PCI assets if it elected to maintain those pools under ASC 326. An entity’s approach to maintaining its existing pools should be determined on a pool-by-pool basis. As a result, while ASC 326-20 does not require an entity to maintain the integrity of a pool of PCD assets, an entity would be required to do so if it elected to maintain its pools of PCI assets upon adopting ASU 2016-13.

6.2.3 Recognition and Measurement Under the PCD Model

6.2.3.1 Overview

ASC 326-20

30-13 An entity shall record the allowance for credit losses for purchased financial assets with credit deterioration in accordance with paragraphs 326-20-30-2 through 30-10, 326-20-30-12, and 326-20-30-13A. An entity shall add the allowance for credit losses at the date of acquisition to the purchase price to determine the initial amortized cost basis for purchased financial assets with credit deterioration. Any noncredit discount or premium resulting from acquiring a pool of purchased financial assets with credit deterioration shall be allocated to each individual asset. At the acquisition date, the initial allowance for credit losses determined on a collective basis shall be allocated to individual assets to appropriately allocate any noncredit discount or premium.

Pending Content (Transition Guidance: ASC 326-10-65-7)

30-13 An entity shall record the allowance for credit losses for purchased financial assets with credit deterioration and purchased seasoned loans in accordance with paragraphs 326-20-30-2 through 30-10, 326-20-30-12, and 326-20-30-14. Additionally, expected recoveries of amounts previously written off and expected to be written off shall be included in determining the allowance for credit losses in accordance with paragraph 326-20-30-1 for purchased seasoned loans and paragraph 326-20-30-13A for purchased financial assets with credit deterioration. An entity shall add the allowance for credit losses at the date of acquisition to the purchase price to determine the initial amortized cost basis for purchased financial assets with credit deterioration and purchased seasoned loans. Any noncredit discount or premium resulting from acquiring a pool of purchased financial assets with credit deterioration or purchased seasoned loans shall be allocated to each individual asset. At the acquisition date, the initial allowance for credit losses determined on a collective basis shall be allocated to individual assets to appropriately allocate any noncredit discount or premium.

30-13A The allowance for credit losses for purchased financial assets with credit deterioration shall include expected recoveries of amounts previously written off and expected to be written off by the entity and shall not exceed the aggregate of amounts previously written off and expected to be written off by the entity.

If the entity estimates expected credit losses using a method other than a discounted cash flow method in accordance with paragraph 326-20-30-4, expected recoveries shall not include any amounts that result in an acceleration of the noncredit discount.
The entity may include increases in expected cash flows after acquisition.

(See Examples 18 and 19 in paragraphs 326-20-55-86 through 55-90.)

30-14 If an entity estimates expected credit losses using a discounted cash flow method, the entity shall discount expected credit losses at the rate that equates the present value of the purchaser’s estimate of the asset’s future cash flows with the purchase price of the asset. If an entity estimates expected credit losses using a method other than a discounted cash flow method, the entity shall estimate expected credit losses on the basis of the unpaid principal balance (face value) of the financial asset(s). See paragraphs 326-20-55-66 through 55-78 for implementation guidance and examples.

Pending Content (Transition Guidance: ASC 326-10-65-7)

30-14 If an entity estimates expected credit losses using a discounted cash flow method for purchased financial assets with credit deterioration and purchased seasoned loans, the entity shall discount expected credit losses at the rate that equates the present value of the purchaser’s estimate of the asset’s future cash flows with the purchase price of the asset. If an entity estimates expected credit losses using a method other than a discounted cash flow method, the entity shall estimate expected credit losses on the basis of the unpaid principal balance (face value) of the financial asset(s), unless the entity elects the accounting policy election in paragraph 326-20-35-1A for purchased seasoned loans. See paragraphs 326-20-55-66 through 55-78 for implementation guidance and examples.

30-15 An entity shall account for purchased financial assets that do not have a more-than-insignificant deterioration in credit quality since origination in a manner consistent with originated financial assets in accordance with paragraphs 326-20-30-1 through 30-10 and 326-20-30-12. An entity shall not apply the guidance in paragraphs 326-20-30-13 through 30-14 for purchased financial assets that do not have a more-than-insignificant deterioration in credit quality since origination.

Pending Content (Transition Guidance: ASC 326-10-65-7)

30-15 An entity shall account for purchased financial assets that do not have a more-than-insignificant deterioration in credit quality since origination or are not purchased seasoned loans in a manner consistent with originated financial assets in accordance with paragraphs 326-20-30-1 through 30-10 and 326-20-30-12.

As previously stated, an entity’s initial recognition of expected credit losses for PCD assets differs from that for non-PCD 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. 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, it would immediately recognize in the income statement any changes in its estimate of the cash flows it expects to collect (favorable or unfavorable). Consequently, any subsequent changes to the entity’s estimate of expected credit losses — whether unfavorable or favorable — would be recorded as credit loss expense (or a reduction of expense) during the period of change. Interest income recognition would be based on the purchase price plus the initial allowance accreting to the contractual cash flows.

6.2.3.2 Initial Recognition

A key difference between the PCD model and the “general” credit loss model lies in how an entity recognizes expected credit losses on a PCD asset when it is acquired. As described in ASC 326-20-30-1, for financial assets not considered to be PCD, “[a]n 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)” (emphasis added).

For an asset that meets the definition of a PCD asset, an entity should apply the gross-up approach when initially recognizing expected credit losses upon acquisition. That is, upon acquiring the PCD asset, the entity would recognize such losses as an adjustment to the asset’s cost basis. Because the entity applies the gross-up approach to recognize expected credit losses on PCD assets, it does not recognize in net income the initial expected credit losses on those assets.

Example 12 in ASC 326-20 illustrates how an entity would apply the PCD model, specifically the gross-up approach to recognizing expected credit losses as an adjustment to the amortized cost basis of the acquired assets.

ASC 326-20

Example 12: Recognizing Purchased Financial Assets With Credit Deterioration

55-61 This Example illustrates application of the guidance to an individual purchased financial asset with credit deterioration.

55-62 Under paragraphs 326-20-30-13 and 310-10-35-53B, for purchased financial assets with credit deterioration, the discount embedded in the purchase price that is attributable to expected credit losses should not be recognized as interest income and also should not be reported as a credit loss expense upon acquisition.

55-63 Bank O records purchased financial assets with credit deterioration in its existing systems by recognizing the amortized cost basis of the asset, at acquisition, as equal to the sum of the purchase price and the associated allowance for credit loss at the date of acquisition. The difference between amortized cost basis and the par amount of the debt is recognized as a noncredit discount or premium. By doing so, the credit-related discount is not accreted to interest income after the acquisition date.

55-64 Assume that Bank O pays $750,000 for a financial asset with a par amount of $1 million. The instrument is measured at amortized cost basis. At the time of purchase, the allowance for credit losses on the unpaid principal balance is estimated to be $175,000. At the purchase date, the statement of financial position would reflect an amortized cost basis for the financial asset of $925,000 (that is, the amount paid plus the allowance for credit loss) and an associated allowance for credit losses of $175,000. The difference between par of $1 million and the amortized cost of $925,000 is a non-credit-related discount. The acquisition-date journal entry is as follows:

55-65 Subsequently, the $75,000 noncredit discount would be accreted into interest income over the life of the financial asset consistent with other Topics. The $175,000 allowance for credit losses should be updated in subsequent periods consistent with the guidance in Section 326-20-35, with changes in the allowance for credit losses on the unpaid principal balance reported immediately in the statement of financial performance as a credit loss expense.

6.2.3.3 Initial and Subsequent Measurement

ASC 326-20-30-14 permits an entity to use various methods to estimate expected credit losses for PCD assets. This guidance is similar to that for non-PCD assets in ASC 326-20-30-3 (see Section 4.4 for more information). ASC 326-20-30-14 (as amended by ASU 2025-08) states, in part:

If an entity estimates expected credit losses using a discounted cash flow method for purchased financial assets with credit deterioration and purchased seasoned loans, the entity shall discount expected credit losses at the rate that equates the present value of the purchaser’s estimate of the asset’s future cash flows with the purchase price of the asset. If an entity estimates expected credit losses using a method other than a discounted cash flow method, the entity shall estimate expected credit losses on the basis of the unpaid principal balance (face value) of the financial asset(s), unless the entity elects the accounting policy election in paragraph 326-20-35-1A for purchased seasoned loans.

Although there are similarities between the methods an entity uses to estimate expected credit losses for PCD assets and those for non-PCD assets, there are also two distinct differences:

Application of the DCF method:
- Non-PCD assets — ASC 326-20-30-4 requires an entity to discount expected credit losses by using the asset’s EIR (i.e., the rate of return implicit in the financial asset).
- PCD assets — ASC 326-20-30-14 requires an entity to discount expected credit losses by using a “rate that equates the present value of the purchaser’s estimate of the asset’s future cash flows with the purchase price of the asset.” For an illustration of how an entity would apply the DCF method to estimate expected credit losses on PCD assets, see Example 14 in ASC 326-20-55-72 through 55-78.
Application of a method other than the DCF method (e.g., a loss-rate method):
- Non-PCD assets — ASC 326-20-30-5 requires an entity to estimate expected credit losses on the basis of an asset’s amortized cost.
- PCD assets — ASC 326-20-30-14 requires an entity to estimate expected credit losses “on the basis of [the asset’s] unpaid principal balance.” For an illustration of how an entity would apply a loss-rate method to estimate expected credit losses on PCD assets, see Example 13 in ASC 326-20-55-66 through 55-71.

Paragraphs BC92 and BC93 of ASU 2016-13 provide the FASB’s rationale for the differences between the measurement guidance for PCD assets and that for non-PCD assets:

BC92. For purchased financial assets with credit deterioration, the Board decided to include additional guidance on how to determine the amortized cost basis and effective interest rate due to circularity concerns. Stakeholders noted that there could be a circularity issue because the amortized cost basis of the purchased asset with credit deterioration should include the allowance for credit losses, which may not be measured until one knows the amortized cost basis. Similarity, a circularity concern was expressed on determining the effective interest rate when measuring expected credit losses using a discounted cash flow approach. Again, the effective interest rate could not be determined for the amortized cost basis of the asset if one did not know the effective interest rate to discount the expected credit loss.

BC93. After receiving feedback from stakeholders on how best to operationalize the accounting for purchased financial assets with credit deterioration, the Board decided that when using a method to estimate expected credit losses that does not project future interest and principal cash flows (for example, a loss rate approach), the allowance for credit losses should be based on the unpaid principal balance (or par) amount of the asset. When using a discounted cash flow approach to estimate expected credit losses, the expected credit losses should be discounted at the rate that equates the present value of estimated future cash flows with the purchase price of the financial asset. The Board concluded that this guidance, which stakeholders did not object to, eliminates circularity concerns and maintains the flexibility to use various approaches to measure credit risk.

After initial recognition of the PCD asset and its related allowance, an entity would continue to apply the CECL model to the asset — that is, any changes to the estimate of cash flows that the entity expects to collect (favorable or unfavorable) would be recognized immediately in the income statement (such recognition differs from how the original estimate of expected credit losses was recognized under the gross-up approach).

6.2.3.4 Expected Recoveries

ASC 326-20

Pending Content (Transition Guidance: ASC 326-10-65-7)

If the entity estimates expected credit losses using a method other than a discounted cash flow method in accordance with paragraph 326-20-30-4, expected recoveries shall not include any amounts that result in an acceleration of the noncredit discount.
The entity may include increases in expected cash flows after acquisition.

(See Examples 18 and 19 in paragraphs 326-20-55-86 through 55-90.)

Under ASC 326-20-30-13A, in the measurement of expected credit losses on a PCD asset, the allowance for credit losses includes “expected recoveries of amounts previously written off and expected to be written off by the entity.” Further, the expected recoveries should not “exceed the aggregate” of such amounts.

When measuring expected credit losses on a PCD asset by using an approach other than a DCF method, an entity may include increases in expected cash flows after acquisition and amounts written off or expected to be written off. However, an entity is prohibited from accelerating the recognition of the asset’s noncredit discount. Accordingly:

Entities should include expected recoveries within the allowance for expected credit losses and should not directly write up the related assets.
Because an entity recognizes expected recoveries as an adjustment to the allowance for expected credit losses, the allowance may have a negative balance in situations in which a full or partial write-off has occurred.
Unlike the guidance on recoveries that applies to non-PCD financial assets (see Section 4.5.2), the guidance on expected recoveries is not limited to that on the aggregate of amounts previously written off and amounts that are expected to be written off by the entity.

When an approach other than a DCF method is applied to a PCD asset, an entity could determine its negative allowance for a previously written-off PCD asset by performing the following two steps:

Subtracting the noncredit discount that existed just before write-off from the total recoveries expected to be received.
Applying subsequent cash recoveries to the negative allowance until the negative allowance is reduced to zero. Any additional collections would be recognized as income.

We believe that the application of these two steps achieves the FASB’s objective of not allowing entities to accelerate the recognition of the noncredit discount when writing off a PCD asset because the noncredit discount is immediately deducted from any expected recoveries. Once the noncredit discount is deducted, any increases in expected recoveries would have the effect of increasing the negative allowance and reducing the credit loss provision.

We acknowledge that there could be other acceptable methods of applying the guidance in ASC 326-20-30-13A(a) that prohibits an entity from prematurely recognizing the noncredit discount.

6.2.4 Considerations Related to BIs

Under ASC 325-40, an entity should measure an allowance for expected credit losses for a purchased or retained BI in a manner consistent with how it measures an allowance for expected credit losses for PCD assets if the BI is (1) within the scope of ASC 325-40, (2) classified as AFS or HTM, and (3) meets the definition of a PCD asset or there is a significant difference between the contractual cash flows and expected cash flows of the BI.

Therefore, if a BI is within the scope of the PCD asset model, at initial recognition, the BI holder would present an allowance for expected credit losses equal to the estimate of expected credit losses and add that allowance to the purchase price to determine the initial amortized cost basis of the BI. Any subsequent changes to the entity’s estimate of expected credit losses — whether unfavorable or favorable — would be recorded as a credit loss expense (or the reduction of an expense) during the period of change. In addition, the entity must accrete changes in expected cash flows attributable to factors other than credit into interest income over the asset’s life. Changes in cash flows due to prepayments are considered credit-related and are therefore reflected as a change to the entity’s estimate of expected credit losses.

Under the CECL model, an entity must determine the contractual cash flows of BIs in securitized transactions. However, the BIs in certain structures may not have easily determinable contractual cash flows (e.g., when a BI holder receives only residual cash flows of a securitization structure). Further, ASC 326 does not define the term “contractual cash flows.” In these situations, the entity may need to use a proxy for the contractual cash flows of the BI (e.g., the gross contractual cash flows of the underlying debt instrument).

6.2.4.1 Prepayment Expectations in BIs

An entity should not assume that there will be no prepayments when determining the contractual cash flows of BIs in securitized transactions. As discussed at the June 2017 TRG meeting, while ASC 325-40-30-1A uses the term “contractual cash flows,” it would be reasonable for entities to determine such cash flows on the basis of the expected prepayments of the assets underlying the securitization on the acquisition date. However, in determining contractual cash flows, entities should assume that there will be no defaults. The rationale for allowing an expected level of prepayments but no expected level of defaults was to prevent expected prepayments alone from causing a BI to be accounted for under the PCD model.

6.2.4.2 Accounting for BIs Classified as HTM Debt Securities — Comparison Between PCD and Non-PCD Guidance

The paragraphs below discuss how the guidance in ASC 325-40 on non-PCD BIs classified as HTM debt securities differs from the PCD model for BIs classified as HTM debt securities in ASC 326-20-30-13 through 30-15.

6.2.4.2.1 Initial and Subsequent Accounting Under ASC 325-40

Under ASC 325-40, entities must initially estimate the timing and amount of all future cash inflows from a BI within the scope of ASC 325-40 by employing assumptions used in the determination of fair value at recognition. The excess of those expected future cash flows over the initial investment is the accretable yield. Entities recognize this excess as interest income over the life of the investment by using the effective interest method.

A subsequent adjustment to expected cash flows is recognized as a yield adjustment affecting interest income or, if related to credit, may be recognized through earnings by means of an allowance for credit losses. In other words, a cumulative adverse change in expected cash flows would be recognized as an allowance, and a cumulative favorable change in expected cash flows would be recognized as a prospective yield adjustment.

Connecting the Dots

Amendments Related to Accounting for Beneficial Interests

ASU 2025-12 (released in December 2025) makes minor enhancements to various Codification topics, one of which is the calculation of the reference amounts for beneficial interests. Specifically, the ASU revises ASC 325-40-25-1 to explain that, “[u]nder the effective yield method, the current yield is applied to the amount determined as the initial investment (or initial amortized cost basis for beneficial interests that apply the accounting for purchased financial assets with credit deterioration) minus cash received to date minus writeoff of amortized cost basis plus the yield accreted to date.” This amendment is intended to clarify how interest income is recognized under the effective interest method over the life of the beneficial interest.

6.2.4.2.2 Initial and Subsequent Accounting Under the PCD Model in ASC 326-20

Under the PCD accounting model in ASC 326-20, entities are required to gross up the cost basis of a PCD asset by the estimated credit losses as of the date of acquisition and establish a corresponding allowance for credit losses. The initial allowance is based on the difference between expected cash flows and contractual cash flows (adjusted for prepayments as discussed in Section 6.2.4.1).

For PCD assets within the scope of ASC 325-40 that are classified as HTM debt securities, cumulative adverse changes in expected cash flows would be recognized currently as an increase to the allowance for credit losses (in a manner similar to recognition under the normal ASC 325-40 model).

However, favorable changes in expected cash flows would first be recognized as a decrease to the allowance for credit losses (recognized currently in earnings). Favorable changes in expected cash flows would be recognized as a prospective yield adjustment only when the allowance for credit losses is reduced to zero.

6.2.4.3 Requirement for Using a DCF Approach to Measure Credit Losses on BIs

An entity is permitted to use various measurement methods to estimate expected credit losses on assets within the scope of ASC 326 (see Section 4.4). However, the entity would not have the same flexibility when measuring expected credit losses on BIs in securitization transactions.

ASC 325-40-35-7 requires an entity to use a DCF approach to measure expected credit losses on a BI in a securitization transaction within the scope of ASC 325-40. The requirement to use a DCF approach may result in differences between how an entity measures expected credit losses on HTM debt securities that are BIs within the scope of ASC 325-40 and how it measures such losses on other HTM debt securities. In other words, the entity may choose to use a loss-rate approach when measuring expected credit losses on an HTM debt security that is not a BI within the scope of ASC 325-40 but may be required to use a DCF approach when measuring expected credit losses on an HTM debt security that is a BI in a securitization transaction within the scope of ASC 325-40.

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