9.2 Transition Approach
ASC 326-10
65-1 The following represents the
transition and effective date information related to
Accounting Standards Updates No. 2016-13 . . .
c. An entity shall apply the pending content that
links to this paragraph by means of a
cumulative-effect adjustment to the opening retained
earnings as of the beginning of the first reporting
period in which the pending content that links to
this paragraph is effective.
d. An entity shall apply prospectively the pending
content that links to this paragraph for purchased
financial assets with credit deterioration to
financial assets for which Subtopic 310-30 was
previously applied. The prospective application will
result in an adjustment to the amortized cost basis
of the financial asset to reflect the addition of
the allowance for credit losses at the date of
adoption. An entity shall not reassess whether
recognized financial assets meet the criteria of a
purchased financial asset with credit deterioration
as of the date of adoption. An entity may elect to
maintain pools of loans accounted for under Subtopic
310-30 at adoption. An entity shall not reassess
whether modifications to individual acquired
financial assets accounted for in pools are troubled
debt restructurings as of the date of adoption. The
noncredit discount or premium, after the adjustment
for the allowance for credit losses, shall be
accreted to interest income using the interest
method based on the effective interest rate
determined after the adjustment for credit losses at
the adoption date. The same transition requirements
should be applied to beneficial interests for which
Subtopic 310-30 was applied previously or for which
there is a significant difference between the
contractual cash flows and expected cash flows at
the date of recognition.
e. An entity shall apply prospectively the pending
content that links to this paragraph to debt
securities for which an other-than-temporary
impairment had been recognized before the date of
adoption, such that the amortized cost basis
(including previous write-downs) of the debt
security is unchanged. In addition, the effective
interest rate on a security will remain unchanged as
a result of the adoption of the pending content that
links to this paragraph. Amounts previously
recognized in accumulated other comprehensive income
as of the adoption date that relate to improvements
in cash flows will continue to be accreted to
interest income over the remaining life of the debt
security on a level-yield basis. Recoveries of
amounts previously written off relating to
improvements in cash flows after the date of
adoption shall be recorded to income in the period
received. . . .
j. An entity that adjusts the effective interest
rate used to discount expected cash flows to
consider the timing (and changes in timing) of
expected cash flows resulting from expected
prepayments in accordance with paragraphs
326-20-30-4 through 30-4A for troubled debt
restructurings that exist as of the date of adoption
may, as an accounting policy election, calculate the
prepayment-adjusted effective interest rate using
the original contractual rate and the prepayment
assumptions as of the date of adoption.
For most debt instruments, entities must record a cumulative-effect adjustment to the
statement of financial position as of the beginning of the first reporting period in
which the guidance is effective (modified retrospective approach). However, ASU
2016-13 provides the following instrument-specific transition guidance:
-
Other-than-temporarily impaired debt securities — An entity must prospectively apply (1) the CECL model to HTM debt securities and (2) the changes to the impairment model for AFS debt securities. As a result, previous write-downs of a debt security’s amortized cost basis would not be reversed; rather, only cumulative unfavorable changes in the estimate of expected cash flows of the debt security occurring on or after the ASU’s effective date would be reflected as an allowance for credit losses. Upon adopting the guidance, an entity would continue to accrete into interest income any amounts previously recognized in OCI before the effective date that are related to improvements in expected cash flows. In addition, an entity would recognize in the period in which they are received recoveries of amounts that were previously written off before adoption of the guidance. An entity would recognize such write-offs in a manner consistent with how it would recognize recoveries on amounts written off after adopting the guidance (see Section 4.5.2).
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PCD assets — An entity is required to apply the changes to PCD assets prospectively. That is, the change in the definition of a PCD asset applies only to assets acquired on or after the ASU’s effective date. For debt instruments accounted for under ASC 310-30, an entity would apply the gross-up approach as of the transition date (i.e., establish an allowance for expected credit losses and make a corresponding adjustment to the debt instrument’s cost basis).In addition, an entity would immediately recognize any postadoption changes to the estimate of cash flows that it expects to collect (favorable or unfavorable) in the income statement as credit loss expense (or as a reduction of expense). Accordingly, the yield on a PCD asset as of the date of adoption would be “locked” and would not be affected by subsequent changes in the entity’s estimate of expected credit losses.
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Certain BIs within the scope of ASC 325-40 — ASC 326-10-65-1 states that entities holding “beneficial interests for which Subtopic 310-30 was applied previously or for which there is a significant difference between the contractual cash flows and expected cash flows at the date of recognition” would apply the same transition requirements as those that apply to PCD assets.
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TDRs for which the EIRs are adjusted for prepayments — ASU 2019-11 amended ASU 2016-13 to allow entities to calculate the prepayment-adjusted EIR on preexisting TDRs by using the prepayment assumptions that exist as of the date on which an entity adopts ASU 2016-13, instead of the prepayment-adjusted EIR immediately before the restructuring date.3
9.2.1 Applying the Transition Guidance to Pools of PCI Assets Under ASC 310-30
ASC 326-10-65-1(d) allows entities to “elect to maintain pools
of loans accounted for under Subtopic 310-30 at adoption.” Under current U.S.
GAAP, entities are permitted to (1) pool PCI assets acquired in the same fiscal
quarter that have similar risk characteristics and (2) use a composite interest
rate to estimate the cash flows expected to be collected by the pool. In
addition, under ASC 310-30-40-1 (which was superseded by ASU 2016-13), pools of
loans must be maintained, and loans may be removed from a pool only in limited
circumstances (e.g., sale of a loan, receipt of assets in satisfaction of a
loan, a loan write-off).
If a TDR occurs on a loan accounted for in a pool, entities
still apply ASC 310-30 to the pool and do not apply TDR accounting to the
individual loan. Under ASC 326-20-30-2 (added by ASU 2016-13), entities are
required to reevaluate the characteristics of the assets in the pool and remove
assets that no longer have similar characteristics. In other words, if an asset
that was considered to be a PCI asset at transition no longer has
characteristics that are similar to those of the rest of the assets in the pool,
that asset should be removed and placed in a different pool containing loans
with similar risk characteristics.
At its June 2017 meeting, the TRG noted that while the transition
guidance permits entities to elect to maintain pools of loans accounted for
under ASC 310-30, ASU 2016-13 is unclear on the extent to which entities can
continue to apply the guidance in ASC 310-30 to these pools. However, TRG
members generally agreed that entities have the choice of maintaining their
existing pools accounted for under ASC 310-30 either at adoption only or on an
ongoing basis after adoption. Note that if an entity elects to maintain pools of
loans accounted for under ASC 310-30, it would continue to estimate its expected
credit losses by using a DCF approach, as it did when applying ASC 310-30 before
the adoption of ASU 2016-13.
Furthermore, the FASB staff noted in TRG Memo 6 that an entity’s
approach to maintaining its existing pools should be determined on a
pool-by-pool basis. The staff also stated:
[A]s part of
complying with the disclosure requirements in paragraphs 326-20-50-10
through 50-11, any entity that [maintains its existing pools on an ongoing
basis] should evaluate the need for disclosure of their election to maintain
pools and any additional qualitative or quantitative information that may be
necessary for a financial statement user to understand the size and nature
of former Subtopic 310-30 pools. Additionally, an entity would need to
consider disclosure of the accounting policies that are in place for these
pools that are different from other assets held by the entity.
9.2.2 Transition for PCD AFS Debt Securities
Questions have arisen regarding how an entity should apply the
transition provisions of ASU 2016-13 to an AFS debt security with an unrealized
gain that was previously accounted for in accordance with ASC 310-30. ASC
326-10-65-1(d) provides transition guidance related to PFAs with credit
deterioration and states:
An entity shall apply
prospectively the pending content that links to this paragraph for purchased
financial assets with credit deterioration to financial assets for which
Subtopic 310-30 was previously applied. The prospective application will
result in an adjustment to the amortized cost basis of the financial asset
to reflect the addition of the allowance for credit losses at the date of
adoption. An entity shall not reassess whether recognized financial assets
meet the criteria of a purchased financial asset with credit deterioration
as of the date of adoption. An entity may elect to maintain pools of loans
accounted for under Subtopic 310-30 at adoption. An entity shall not
reassess whether modifications to individual acquired financial assets
accounted for in pools are troubled debt restructurings as of the date of
adoption. The noncredit discount or premium, after the adjustment for the
allowance for credit losses, shall be accreted to interest income using the
interest method based on the effective interest rate determined after the
adjustment for credit losses at the adoption date. The same transition
requirements should be applied to beneficial interests for which Subtopic
310-30 was applied previously or for which there is a significant difference
between the contractual cash flows and expected cash flows at the date of
recognition.
Example 9-3
Entity ABC purchases a debt security
with a par/UPB of $1,000 and a fair value of $600
(before the adoption of ASU 2016-13). Entity ABC
classifies the debt security as AFS in accordance with
ASC 320. The discount on the security is partially due
to a deterioration in credit since its issuance and
therefore is within the scope of ASC 310-30. At the time
of purchase, the credit portion of the discount is $150
and the noncredit discount (also known as the
“accretable yield”) is $250. Market interest rates have
dropped since the debt security was acquired by ABC, but
the expected cash flows are unchanged. As a result,
immediately before the adoption of ASU 2016-13, the
amortized cost basis has increased to $675 through
accretion but the fair value is $700.
In this scenario, ABC might conclude that it should increase the amortized cost
basis by $150, with an offsetting credit of $150 as an allowance for credit
losses. However, ASC 326-30 governs the accounting for credit losses for AFS
debt securities. Under ASC 326-30-35-1, “[a]n investment is impaired if the fair
value of the investment is less than its amortized cost basis.” In addition,
under ASC 326-30-35-2, if an investment in an AFS debt security is impaired, the
allowance for credit losses is “limited by the amount that the fair value is
less than the amortized cost basis.” If ABC were to gross up the debt security
in such a way that the amortized cost basis is now $825 ($675 + $150), but the
fair value is $700, ABC would be limited to having an allowance for credit
losses of $125 ($825 – $700).
On the basis of discussions with the FASB staff, we understand
that it would be appropriate for an entity to apply the guidance in ASC
326-30-35-1 in determining whether an allowance for credit losses is required
upon the adoption of ASU 2016-13. In other words, if an AFS debt security has a
fair value that is greater than its amortized cost as of the date of adoption,
that AFS debt security is not impaired. Accordingly, the entity would not adjust
the amortized cost basis of the AFS debt security upon adopting ASU 2016-13 and
would not establish an allowance for credit losses. With respect to the entity
in this example, the AFS debt security would continue to have an amortized cost
basis of $675 and no allowance for credit losses. In addition, the noncredit
discount would remain at $175 ($250 at inception minus $75 of accretion before
adoption).
If a PCD AFS debt security has an unrealized loss as of the date
of adoption, the amortized cost basis of the security should be adjusted for the
allowance for credit losses required by ASC 326-30 at transition (the full
“gross up” model).
9.2.3 Transition Relief by Providing the Fair Value Option
ASC 326-10
65-1 The following represents
the transition and effective date information related to
Accounting Standards Updates No. 2016-13 . . .
i. An entity may irrevocably elect the fair
value option in accordance with Subtopic 825-10
for financial instruments within the scope of
Subtopic 326-20, except for those financial assets
in paragraph 326-20-15-2(a)(2), that also are
eligible items in Subtopic 825-10.
In May 2019, the FASB issued ASU 2019-05 to allow companies to irrevocably elect,
upon adopting ASU 2016-13, the fair value option for financial instruments that
were previously recorded at amortized cost and are within the scope of ASC
326-20 if the instruments are eligible for the fair value option under ASC
825-10. The entity would make this election on an instrument-by-instrument
basis. For the effective date of ASU 2019-05, see Section 9.1.
9.2.4 Transition for Financial Guarantees Within the Scope of ASC 326-20
As discussed in Chapter 5,
for guarantees within the scope of ASC 326-20, the guarantor is required to
recognize (1) the fair value of the obligation related to the noncontingent
portion of the guarantee and (2) an estimate of expected credit losses in
accordance with ASC 326-20 on the contingent obligation related to the
guarantee.
Before the adoption of ASU 2016-13, a guarantor was not required to bifurcate and
separately account for the contingent and noncontingent aspects of a financial
guarantee under ASC 460. Rather, the guarantor was required to initially
recognize the guarantee liability at the greater of the following:
- The noncontingent liability stand-ready obligation of the guarantee measured at fair value in accordance with ASC 460-10-30-2.
- The contingent liability measured in accordance with ASC 450-20-30.
ASC 460 distinguishes between the noncontingent “stand ready” obligation
associated with a guarantee (accounted for under ASC 460) and the contingent
obligation associated with a guarantee (accounted for under ASC 450-20). The ASC
460 liability, established at the inception of a guarantee, generally represents
unearned income related to the noncontingent liability (premium charged for
standing ready) and, as noted in ASC 460-10-35-1 and 35-2, is typically reduced
by a credit to earnings because the guarantor is released from risk under the
guarantee. ASC 450-20, on the other hand, provides guidance on establishing a
liability for a loss contingency, which represents an estimate of an entity’s
probable future obligation related to an incurred loss. The ASC 450-20 liability
is subsequently measured on the basis of facts and circumstances specific to the
contingency, and the related loss is recorded apart from the credit to earnings
recognized under ASC 460.
Neither ASC 460 nor ASC 450-20 provides explicit guidance on the
interaction between ASC 460 and ASC 450-20 after initial recognition.
Accordingly, entities generally established a systematic and rational method
with a reasonable basis for supporting subsequent accounting. The following is a
discussion of two different methods that entities have applied in practice to
determine the amount of an ASC 450-20 liability to record:
- Method 1: Incremental recognition of the ASC 450-20 contingent liability — After initial recognition, an entity would record a separate ASC 450-20 liability only when the entire estimated ASC 450-20 amount exceeds the unamortized ASC 460 liability. The ASC 450-20 liability equals the excess of the entire estimated probable obligation over (1) the unamortized ASC 460 liability or (2) the expected unamortized ASC 460 liability at the time of the expected payment. In subsequent periods, the ASC 450-20 liability may need to be adjusted so that it continues to equal the excess of the entire estimated probable obligation over the unamortized ASC 460 liability.
- Method 2: Gross recognition of the ASC 450-20 contingent liability — Under this method, after the initial recognition and measurement of the guarantee, an entity would record a separate ASC 450-20 liability for the entire amount of the estimated probable obligation. The entity would continue to amortize the ASC 460 liability in accordance with its established policy until the entity is released from its obligation to stand ready.
ASU 2016-13 amended ASC 460-10-35-4 to require an entity to
account for a guarantee that is within the scope of ASC 326-20 in a manner
consistent with Method 2 discussed above (i.e., the contingent and noncontingent
liabilities are recognized on a gross basis), although the measurement of that
contingent liability should be calculated in accordance with ASC 326-20.
Accordingly, the transition adjustments that an entity adopting ASU 2016-13 is
required to make in connection with the contingent liability of a guarantee
within the scope of ASC 326-20 will depend on the following factors:
- Whether a contingent liability was recognized before the adoption of ASU 2016-13.
- If a contingent liability was recognized before the adoption of ASU 2016-13, whether it was measured by using Method 1 or Method 2 above.
- Whether the contingent liability must now be measured on the basis of CECL in accordance with ASC 326-20 instead of by using the best estimate required under ASC 450-20.
Example 9-4
Transition
Adjustments Upon Adoption of ASU 2016-13
Scenario 1 —
Guarantor Recognized the Noncontingent Obligation
in Accordance With ASC 460 Before Adoption of ASU
2016-13
Entity X is a guarantor of debt incurred
by Entity Y. The guarantee arrangement stipulates that X
must guarantee payment of 100 percent of Y’s debt
obligations borrowed from a third-party debtor for a
specified time frame. Entity X is not an insurance
entity, and the guarantee is not within the scope of ASC
815.
On January 1, 20X9, Y borrows $1 million
from a third-party debtor for which X is obligated to
guarantee repayment under the guarantee arrangement. The
debt matures in five years, and X’s guarantee
arrangement covers the entire debt term. Entity X
receives an up-front cash premium payment of $25,000 for
the guarantee, and the cash premium is considered to be
at arm’s length. Entity X measures and recognizes the
fair value of its stand-ready obligation (i.e., the
noncontingent obligation) to guarantee Y’s repayment
under the debt arrangement to be $25,000 on the basis of
the arm’s-length premium it received. That is, the cash
premium that X received was greater than the contingent
liability amount that needed to be recognized at the
inception of the guarantee in accordance with ASC
450-20-30.
Entity X’s subsequent-measurement
accounting policy for the guarantee liability is to
amortize the obligation on a straight-line basis over
the life of the guarantee, which is equal to the term of
the debt (i.e., five years). As of December 31, 20X9,
the unamortized guarantee obligation is $20,000.
Upon adoption of ASU 2016-13 on January
1, 20Y0, X determines that this guarantee is within the
scope of ASC 326-20 and measures the contingent
obligation to be $50,000 in accordance with the guidance
in ASC 326-20. The table below summarizes the facts in
Scenario 1.
On January 1, 20Y0, X would record the
following journal entry related to the contingent
obligation associated with the guarantee:
Journal Entry:
January 1, 20Y0
Note: The contingent obligation is
measured and recognized in accordance with ASC
326-20 upon adoption of ASU 2016-13. The
noncontingent obligation that was recorded before
the adoption of ASU 2016-13 is not adjusted upon
adoption of ASU 2016-13.
Scenario 2 —
Guarantor Recognized Both a Noncontingent and
Contingent Obligation in Accordance With ASC 460
and ASC 450-20 Before Adoption of ASU
2016-13
Assume the same facts as in Scenario 1
above, except that X recorded a contingent obligation
amount after the inception of the guarantee under ASC
450-20 in accordance with ASC 460-10-35-4 (i.e., gross
recognition of the ASC 450-20 liability). That is, after
the initial recognition and measurement of the
guarantee, X separately recorded an ASC 450-20 liability
for the entire amount of the estimated contingent
obligation and recognized the establishment of that
liability in earnings.
The unamortized noncontingent obligation
as of December 31, 20X9, is $20,000, and the contingent
obligation recognized under ASC 450-20 is $30,000. Upon
adopting ASU 2016-13 on January 1, 20Y0, X determines
that this guarantee is within the scope of ASC 326-20
and measures the contingent obligation to be $50,000 in
accordance with the guidance in ASC 326-20. The table
below summarizes the facts in Scenario 2.
On January 1, 20Y0, X would record the
following journal entry related to the contingent
obligation associated with the guarantee.
Journal Entry:
January 1, 20Y0
Note: The contingent obligation is
remeasured and recognized in accordance with ASC
326-20 upon adoption of ASU 2016-13. The
noncontingent obligation that was recorded before
the adoption of ASU 2016-13 is not adjusted upon
adoption of ASU 2016-13.
9.2.5 Transition Disclosures
ASC 326-10
65-1 The following represents
the transition and effective date information related to
Accounting Standards Updates No. 2016-13 . . .
f. An entity shall disclose the following in
the period that the entity adopts the pending
content that links to this paragraph:
1. The nature of the
change in accounting principle, including an
explanation of the newly adopted accounting
principle.
2. The method of applying
the change.
3. The effect of the
adoption on any line item in the statement of
financial position, if material, as of the
beginning of the first period for which the
pending content that links to this paragraph is
effective. Presentation of the effect on financial
statement subtotals is not required.
4. The cumulative effect
of the change on retained earnings or other
components of equity in the statement of financial
position as of the beginning of the first period
for which the pending content that links to this
paragraph is effective.
g. An entity that issues interim financial
statements shall provide the disclosures in (f) in
each interim financial statement of the year of
change and the annual financial statement of the
period of the change.
h. In the year of initial application of the
pending content that links to this paragraph, a
public business entity that is not within the
scope of paragraph 326-10-65-1(a)(1) may phase-in
the disclosure of credit quality indicators by
year of origination by only presenting the three
most recent origination years (including the first
year of adoption). In each subsequent fiscal year,
the then-current origination year will be added in
the periods after adoption until a total of five
origination years are presented. Origination years
before those that are presented separately shall
be disclosed in the aggregate. For example, the
phase-in approach would work as follows assuming a
calendar year-end entity:
1. For the first annual
reporting period ended December 31, 2X23, after
the effective date of January 1, 2X23, an entity
would disclose the end of period amortized cost
basis of the current period originations within
2X23, as well as the two origination years of 2X22
and 2X21. The December 31, 2X23 end of period
amortized cost balances for all prior originations
would be presented separately in the
aggregate.
2. For the second annual
reporting period ended December 31, 2X24, after
the effective date of January 1, 2X23, an entity
would disclose the end of period amortized cost
basis of the current period originations within
2X24, as well as the three origination years of
2X23, 2X22, and 2X21. The December 31, 2X24 ending
amortized cost basis would be presented in the
aggregate for all origination periods before the
four years that are presented separately.
3. For the third annual
reporting period ended December 31, 2X25, after
the effective date of January 1, 2X23, an entity
would disclose the end-of-period amortized cost
basis of the current-period originations within
2X25, as well as the four origination years of
2X24, 2X23, 2X22, and 2X21. The December 31, 2X25
ending amortized cost basis would be presented in
aggregate for all origination periods before the
five years that are presented separately.
4. For interim-period
disclosures within the years discussed above, the
current year-to-date originations should be
disclosed as the originations in the interim
reporting period. . . .
As discussed in Section
8.2.2.1, only PBEs are required to provide the vintage
disclosures in ASC 326-20-50-6. That is, only PBEs are required to present the
amortized cost basis “by year of origination (that is, vintage year)” for each
credit quality indicator. However, the FASB decided to provide transition relief
to PBEs that are not within the scope of ASC 326-10-65-1(a) to make it less
burdensome for such entities to adopt these vintage disclosure requirements.
Specifically, ASC 326-10-65-1(h) requires PBEs that are not within the scope of
ASC 326-10-65-1(a) to only (1) disclose credit quality indicators disaggregated
for the previous three years and (2) add another year of information until they
have provided disclosures for the previous five years.
Footnotes
3
Note that once an entity adopts ASU 2022-02, ASU
2019-11’s transition relief for TDRs will no longer be relevant.