Deloitte's Roadmap: Current Expected Credit Losses | DART

Preface

We are pleased to present the 2023 edition of Current Expected Credit Losses. Since the issuance of ASU 2016-13 1 (codified as ASC 326) on June 16, 2016, the FASB has focused on implementation efforts related to the adoption of this ASU. Since issuing the ASU, the FASB has held three transition resource group (TRG) meetings — as well as several public board meetings,2 public roundtables, and credit losses workshops — to discuss implementation questions raised and challenges identified by stakeholders. In response to the feedback received, the FASB has released (as of the date of this publication) nine final ASUs to amend certain aspects of ASC 326. In addition, the Board recently issued a proposed ASU that would amend the scope of assets subject to the model for accounting for purchased credit-deteriorated (PCD) assets (see Section 10.2.4). For a table summarizing substantive changes made to this Roadmap since the release of the previous edition, see Appendix D.

Although calendar-year-end companies have already adopted the guidance in ASC 326, challenging questions remain. We look forward to assisting you with whatever questions you have remaining and hope that you find this Roadmap integral to your success.3

Be sure to check out On the Radar (also available as a stand-alone publication), which briefly summarizes emerging issues and trends related to the accounting and financial reporting topics addressed in the Roadmap.

Footnotes

1

For a list of abbreviations used in this publication, see Appendix C. For the full titles of standards, topics, and regulations used in this publication, see Appendix B.

2

This Roadmap discusses the FASB’s standard setting through August 1, 2023. Stakeholders are encouraged to continue to monitor activity at the FASB, SEC, and other standard setters or regulators for any relevant developments or interpretations that may affect the views expressed in this publication. See Chapter 10 for more information.

3

We encourage you to use this Roadmap as a guide throughout your application of the credit losses standard and to contact us with any questions or suggestions for future improvements. However, the Roadmap is not a substitute for consulting with Deloitte professionals on complex accounting questions and transactions.

On the Radar

The approach used to recognize impairment losses on financial assets has long been identified as a major weakness in current U.S. GAAP, resulting in delayed recognition of such losses and leading to increased scrutiny. Accordingly, the FASB issued ASU 2016-13 to amend its guidance on the impairment of financial instruments. The ASU adds to U.S. GAAP an impairment model known as the current expected credit loss (CECL) model, which is based on expected losses rather than incurred losses. The objectives of the CECL model are to:

Reduce the complexity in U.S. GAAP by decreasing the number of credit impairment models that entities use to account for debt instruments.
Eliminate the barrier to timely recognition of credit losses by using an expected loss model instead of an incurred loss model.
Require an entity to recognize an allowance of lifetime expected credit losses.
Not require a specific method for entities to use in estimating expected credit losses.

Guidance Applies to More Than Just Banks

The new guidance will significantly change the accounting for credit impairment. Although the new CECL standard has a greater impact on banks, most nonbanks have financial instruments or other assets (e.g., trade receivables, contract assets, lease receivables, financial guarantees, loans and loan commitments, and held-to-maturity [HTM] debt securities) that are subject to the CECL model. While banks and other financial institutions (e.g., credit unions and certain asset portfolio companies) have been closely following standard-setting activities related to the new CECL standard, are actively engaged in discussions with the FASB and the TRG, and are far along in the implementation process, many nonbanks may not have started evaluating the effect of the CECL model. Nonbanks that have yet to adopt the guidance should (1) focus on identifying which financial instruments and other assets are subject to the CECL model and (2) evaluate whether they need to make changes to existing credit impairment models to comply with the new standard.

Reduction in Impairment Models

The FASB set out to establish a one-size-fits-all model for measuring expected credit losses on financial assets that have contractual cash flows. Ultimately, however, the FASB determined that the CECL model would not apply to available-for-sale (AFS) debt securities, which will continue to be assessed for impairment under ASC 320.

No impairment model is needed for financial assets measured at fair value (e.g., trading securities or other assets measured at fair value by using the fair value option) because the assets are measured at fair value in every reporting period.

The diagram below depicts the impairment models in current U.S. GAAP that are being replaced by the CECL model.

Although the FASB was not able to develop a single impairment model for all financial assets, it did achieve its objective of reducing the number of impairment models in U.S. GAAP.

Expected Losses Versus Incurred Losses

Unlike the incurred loss models in existing U.S. GAAP, the CECL model does not specify a threshold for recognizing 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 the amortized cost basis of a financial asset.

Estimates Represent Lifetime Losses

An entity’s estimate of expected credit losses should reflect the losses that occur over the contractual life of the financial asset. When determining the contractual life of a financial asset, an entity is required to consider expected prepayments either as a separate input in the method used to estimate expected credit losses or as an amount embedded in the credit loss experience that it uses to estimate such losses. The entity is not allowed to consider expected extensions of the contractual life unless (1) extensions are a contractual right of the borrower or (2) the entity has a reasonable expectation as of the reporting date that it will execute a TDR with the borrower.1

An entity must consider all available relevant information when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts and their implications with respect to expected credit losses. That is, while the entity can use historical charge-off rates as a starting point for determining expected credit losses, it has to evaluate how conditions that existed during the historical charge-off period may differ from its current expectations and accordingly revise its estimate of expected credit losses. However, the entity is not required to forecast conditions over the contractual life of the asset. Rather, for the period beyond the period for which the entity can make reasonable and supportable forecasts, the entity reverts to historical credit loss experience.

No Prescribed Method

The FASB believes that the impairment allowance should reflect management’s expectations regarding the net amounts expected to be collected on a financial asset and that, because entities manage credit risk differently, they should have flexibility when reporting those expectations. As a result, the FASB did not require entities to use a specific method when measuring their estimate of expected credit losses. Accordingly, an entity can select from a number of measurement approaches to determine the allowance for expected credit losses. Some approaches project future principal and interest cash flows (i.e., a discounted cash flow [DCF] method), while others project only future principal losses. ASU 2016-13 emphasizes that an entity should use methods that are “practical and relevant” given the specific facts and circumstances and that “[t]he method(s) used to estimate expected credit losses may vary on the basis of the type of financial asset, the entity’s ability to predict the timing of cash flows, and the information available to the entity.”

Although the method used to measure expected credit losses may vary for different types of financial assets, the method used for a particular financial asset should be consistently applied to similar financial assets.

The table below summarizes various measurement approaches that an entity could use to estimate expected credit losses under ASU 2016-13.

Measurement Approach	High-Level Description
DCF method	Expected credit losses are determined by comparing the asset’s amortized cost with the present value of the estimated future principal and interest cash flows.
Loss-rate method	Expected credit losses are determined by applying an estimated loss rate to the asset’s amortized cost basis.
Roll-rate method	Expected credit losses are determined by using historical trends in credit quality indicators (e.g., delinquency, risk ratings).
Probability-of-default method	Expected credit losses are determined by multiplying the probability of default (i.e., the probability the asset will default within the given time frame) by the loss given default (the percentage of the asset not expected to be collected because of default).
Aging schedule	Expected credit losses are determined on the basis of how long a receivable has been outstanding (e.g., under 30 days, 31–60 days). This method is commonly used to estimate the allowance for bad debts on trade receivables.

Looking Ahead

Although the FASB has issued several ASUs that amend certain aspects of ASU 2016-13, the Board continues to seek feedback on the new guidance. As a result of that feedback, in March 2022, the FASB issued ASU 2022-02, which eliminates the accounting guidance on TDRs for creditors in ASC 310-40 and amends the guidance on “vintage disclosures” to require disclosure of current-period gross write-offs by year of origination. For entities that have already adopted ASU 2016-13, the amendments in ASU 2022-02 are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For entities that have not yet adopted ASU 2016-13, the amendments in ASU 2022-02 are effective upon adoption of ASU 2016-13. Early adoption is permitted in certain circumstances. See Section 10.2.1 for more information.

In addition, on June 27, 2023, the FASB issued a proposed ASU that would broaden the population of financial assets that are within the scope of the gross-up approach currently applied to PCD assets under ASC 326. Accordingly, an asset acquirer would apply the gross-up approach to all financial assets acquired in a business combination in accordance with ASC 805 rather than first determining whether an acquired financial asset is a PCD asset or a non-PCD asset. For financial assets acquired as a result of an asset acquisition or through consolidation of a variable interest entity (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. In addition, the gross-up approach would no longer apply to AFS debt securities. Comments on the proposed ASU are due by August 28, 2023. The Board will determine the effective date, as well as whether to permit early adoption, after considering stakeholder feedback on the proposed ASU.

Footnotes

1

ASU 2022-02, issued in March 2022, eliminates the concept of a TDR from a creditor’s accounting. As a result, an entity that has adopted ASU 2022-02 will no longer be able to extend the contractual term for expected extensions, renewals, and modifications when it reasonably expects, as of the reporting date, that a TDR will be executed with the borrower.

Contacts

Chapter 1 — Overview

1.3 Key Provisions of ASU 2016-13

The table below highlights some of the key provisions of ASU 2016-13 and includes links to sections of this Roadmap that discuss these provisions in more detail.

Topic	Key Provisions of ASU 2016-13
Scope (Chapter 2)	The ASU applies to: Most debt instruments (other than those measured at fair value through net income). Trade receivables and contract assets recognized under ASC 606. Certain lease receivables. Reinsurance receivables from insurance transactions. Financial guarantee contracts. Loan commitments. AFS debt securities are outside the ASU’s scope (see Chapter 7 for discussion of targeted changes made to the impairment model for AFS debt securities).
Recognition threshold (Chapter 3)	None. Impairment is based on expected (rather than probable, incurred) credit losses.
Measurement (Chapter 4)	Entities have flexibility in measuring expected credit losses as long as the measurement results in an allowance that: Reflects a risk of loss, even if remote. Reflects losses that are expected over the contractual life of the asset. Takes into account historical loss experience, current conditions, and reasonable and supportable forecasts. The entity must evaluate financial assets on a collective (i.e., pool) basis if they share similar risk characteristics. If an asset’s risk characteristics are not similar to those of any of the entity’s other assets, the entity would evaluate the asset individually.
Application of the CECL model to off-balance-sheet commitments, trade and lease receivables, and reinsurance receivables (Chapter 5)	The CECL model affects the accounting for assets commonly found at nonbanks and includes guidance that an entity should apply when accounting for such assets.
PCD assets (Chapter 6)	The allowance for PCD assets is the estimate of CECL. Interest income recognition is based on the purchase price plus the initial allowance accreting to the contractual cash flows. The non-credit-related discount or premium that results from acquiring a pool of PCD assets is allocated to each individual financial asset. 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 asset would be replaced with the term PFA.1
AFS debt securities (Chapter 7)	The CECL model does not apply to AFS debt securities. However, the FASB made targeted improvements to existing guidance, including removing the OTTI concept and requiring the use of an allowance limited to the difference between a debt security’s amortized cost and its fair value.

Shortly before issuing ASU 2016-13, the FASB formed a credit losses TRG.2 Although the group does not issue guidance, it provides feedback on potential issues related to the implementation of the CECL model. By analyzing and discussing such issues, the TRG helps the Board determine whether it needs to take action, such as providing clarification or issuing additional guidance.

On the basis of feedback received from the TRG and other stakeholders since the issuance of ASU 2016-13, the Board has thus far issued eight final ASUs (this number does not include ASU 2022-01) in an attempt to (1) clarify the guidance in ASU 2016-13 and (2) provide relief from the costs of implementing the standard. The effective dates of the final ASUs are aligned with that of ASU 2016-13. See Chapter 10 for more information about recent FASB activities.

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.

2

The TRG comprises financial statement preparers, auditors, and users; FASB members also attend the group’s meetings. In addition, representatives from the SEC, PCAOB, Federal Reserve, Office of the Comptroller of the Currency (OCC), FDIC, National Credit Union Administration, and Federal Housing Finance Agency are invited to observe the meetings.

Chapter 2 — Scope

2.2 Scope Exclusions

ASC 326-20

15-3 The guidance in this Subtopic does not apply to the following items:

Financial assets measured at fair value through net income
Available-for-sale debt securities
Loans made to participants by defined contribution employee benefit plans
Policy loan receivables of an insurance entity
Promises to give (pledges receivable) of a not-for-profit entity
Loans and receivables between entities under common control.
Receivables arising from operating leases accounted for in accordance with Topic 842.

ASC 326-20-15-3 lists a number of items that are outside the scope of the credit losses guidance. For such items, impairment is recognized and measured in accordance with other U.S. GAAP. One of these items is an operating lease receivable (see ASC 326-20-15-3(g)), which is accounted for under ASC 842 rather than ASC 326, as discussed below.

Changing Lanes

Billed Operating Lease Receivables

In November 2018, the FASB issued ASU 2018-19 to clarify certain aspects of the CECL model. Specifically, ASU 2018-19 states that operating lease receivables are within the scope of ASC 842 rather than ASC 326. That is, an entity would apply ASC 842 rather than ASC 326-20 to account for changes in the collectibility assessment for operating leases. An entity would recognize such changes as an adjustment to lease income in accordance with ASC 842-30-25-13 rather than recognizing bad-debt expense. We believe that the Board’s clarification that operating lease receivables are within the scope of the collectibility guidance in ASC 842 rather than ASC 326 may have resulted in a change in how some lessors accounted for the collectibility of operating lease receivables upon adopting ASC 842.

Because of that change, lessors that adopted ASC 842 raised questions about the appropriate accounting for operating lease receivables recognized by a lessor that are or are expected to become impaired, since such receivables are outside the scope of the impairment guidance in ASC 326. On the basis of a technical inquiry with the FASB staff, we understand the following:

ASC 842-30 requires entities to assess the probability of an individual customer’s (tenant’s) future payment.
In addition to applying the guidance in ASC 842-30, an entity may elect to use a general or portfolio reserve approach (which is aligned with the legacy application of ASC 450-20).
If a lessor elects to record a general reserve, the income statement impact may be recorded as a reduction to lease income or as bad-debt expense.
Given the expected diversity in practice, consistent application and transparent disclosure of the policy elected are critical.

For more information about assessing and accounting for the collectibility of operating lease receivables, see Deloitte’s July 1, 2019, Financial Reporting Alert.

2.2.1 Loans Held for Sale

The CECL model does not apply to held-for-sale (HFS) loans. An entity is required to measure an HFS loan at the lower of amortized cost or fair value in accordance with ASC 948. As discussed in Section 4.10, an entity that transfers a loan from HFS to held for investment (HFI) must reverse any allowance previously measured on the HFS loan, transfer the loan to the new classification category (HFI), and establish a new allowance for expected credit losses by using the measurement guidance in ASC 326.

2.2.2 Loans and Receivables Between Entities Under Common Control

Loans and receivables between entities under common control are specifically excluded from the scope of the CECL model. At the June 2018 TRG meeting, the FASB staff indicated that this scope exception applies to all common-control arrangements at all stand-alone reporting levels (i.e., parent and subsidiaries); however, such application is not specifically addressed in ASC 326.

Chapter 3 — Recognition and Unit of Account

3.1 Recognition

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 existing 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 will no longer 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 welcome this change given the concerns expressed about the current accounting for credit losses on HTM debt securities (i.e., prospective yield adjustments after a recognized credit loss), the new requirements may present other challenges for preparers. For example, an entity will now be 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 will no longer be allowed to avoid recognizing a credit loss simply because the fair value of the HTM debt security equals or exceeds its amortized cost basis. Accordingly, an entity may need to modify its existing credit risk management and financial reporting systems because the entity will now be required to continually update the underlying cash flows expected at the end of the financial reporting period when measuring its expected credit losses, irrespective of the HTM debt security’s fair value.

In addition, because the CECL model does not have a minimum threshold for recognition of impairment losses, entities will 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.

Footnotes

1

In accordance with ASC 326-20-35-8, an entity would write off the HTM debt security if it is “deemed uncollectible.”

Chapter 4 — Measurement of Expected Credit Losses

4.1 Introduction

For assets measured at amortized cost, the CECL model eliminates the existing recognition thresholds in U.S. GAAP. Under the guidance, the estimate of expected credit losses will be (1) recognized immediately upon either origination or acquisition and (2) adjusted in each subsequent reporting period. Since the primary guidance in ASU 2016-13 is measurement-related, measurement is the most significant aspect of the CECL model. This chapter addresses the following topics:

Contractual life (Section 4.2).
The information an entity needs when estimating credit losses (Section 4.3).
Measurement methods (Section 4.4).
Write-offs and recoveries (Section 4.5).
Credit enhancement features (Section 4.6).
TDRs (Section 4.7).
Considerations related to postacquisition accounting for acquired loans (Section 4.8).
Subsequent events (Section 4.9).
Transfers to other measurement categories (Section 4.10).

Changing Lanes

FASB ASU on Troubled Debt Restructurings and Vintage Disclosures

In March 2022, the FASB issued ASU 2022-02, which completely superseded the accounting guidance on TDRs for creditors in ASC 310-40 and requires entities to evaluate all receivable modifications under ASC 310-20-35-9 through 35-11 to determine whether a modification made to a borrower results in a new loan or a continuation of the existing loan. The ASU also amended other Codification subtopics to remove references to TDRs for creditors.

In addition to the elimination of TDR guidance, an entity that has adopted ASU 2022-02 no longer considers renewals, modifications, and extensions that result from reasonably expected TDRs in calculating the allowance for credit losses in accordance with ASC 326-20. Further, an entity that employs a DCF method to calculate the allowance for credit losses will be required to use a postmodification-derived effective interest rate (EIR) as part of its calculation in accordance with ASC 326-20-30-4.

For entities that had already adopted ASU 2016-13, the amendments in ASU 2022-02 are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For entities that had not yet adopted ASU 2016-13, the amendments in ASU 2022-02 are effective upon adoption of ASU 2016-13. Early adoption is permitted in certain situations, as discussed in Section 10.2.1.8.

We have updated this section of the Roadmap to reflect the amendments made by ASU 2022-02. However, because some entities that already have adopted ASU 2016-13 may not have adopted ASU 2022-02 as of the issuance of the Roadmap, we have included the amendments made by ASU 2022-02 as pending content.

4.4 Measurement Methods and Techniques

ASC 326-20

30-3 The allowance for credit losses may be determined using various methods. For example, an entity may use discounted cash flow methods, loss-rate methods, roll-rate methods, probability-of-default methods, or methods that utilize an aging schedule. An entity is not required to utilize a discounted cash flow method to estimate expected credit losses. Similarly, an entity is not required to reconcile the estimation technique it uses with a discounted cash flow method.

30-4 If an entity estimates expected credit losses using methods that project future principal and interest cash flows (that is, a discounted cash flow method), the entity shall discount expected cash flows at the financial asset’s effective interest rate. When a discounted cash flow method is applied, the allowance for credit losses shall reflect the difference between the amortized cost basis and the present value of the expected cash flows. If the financial asset’s contractual interest rate varies based on subsequent changes in an independent factor, such as an index or rate, for example, the prime rate, the London Interbank Offered Rate (LIBOR), or the U.S. Treasury bill weekly average, that financial asset’s effective interest rate (used to discount expected cash flows as described in this paragraph) shall be calculated based on the factor as it changes over the life of the financial asset. An entity is not required to project changes in the factor for purposes of estimating expected future cash flows. If the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall use the same projections in determining the effective interest rate used to discount those cash flows. In addition, if the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall adjust the effective interest rate used to discount expected cash flows to consider the timing (and changes in the timing) of expected cash flows resulting from expected prepayments in accordance with paragraph 326-20-30-4A. Subtopic 310-20 on receivables — nonrefundable fees and other costs provides guidance on the calculation of interest income for variable rate instruments.

Pending Content (Transition Guidance: ASC 326-10-65-5)

30-4 If an entity estimates expected credit losses using methods that project future principal and interest cash flows (that is, a discounted cash flow method), the entity shall discount expected cash flows at the financial asset’s effective interest rate. When a discounted cash flow method is applied, the allowance for credit losses shall reflect the difference between the amortized cost basis and the present value of the expected cash flows. If a financial asset is modified and is considered to be a continuation of the original asset, an entity shall use the post-modification contractual interest rate to derive the effective interest rate when using a discounted cash flow method. See paragraph 815-25-35-10 for guidance on the treatment of a basis adjustment related to an existing portfolio layer method hedge. If the financial asset’s contractual interest rate varies based on subsequent changes in an independent factor, such as an index or rate, for example, the prime rate, the London Interbank Offered Rate (LIBOR), or the U.S. Treasury bill weekly average, that financial asset’s effective interest rate (used to discount expected cash flows as described in this paragraph) shall be calculated based on the factor as it changes over the life of the financial asset. An entity is not required to project changes in the factor for purposes of estimating expected future cash flows. If the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall use the same projections in determining the effective interest rate used to discount those cash flows. In addition, if the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall adjust the effective interest rate used to discount expected cash flows to consider the timing (and changes in the timing) of expected cash flows resulting from expected prepayments in accordance with paragraph 326-20-30-4A. Subtopic 310-20 on receivables — nonrefundable fees and other costs provides guidance on the calculation of interest income for variable rate instruments.

30-4A As an accounting policy election for each class of financing receivable or major security type, an entity may adjust 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. However, if the asset is restructured in a troubled debt restructuring, the effective interest rate used to discount expected cash flows shall not be adjusted because of subsequent changes in expected timing of cash flows.

Pending Content (Transition Guidance: ASC 326-10-65-5)

30-4A As an accounting policy election for each class of financing receivable or major security type, an entity may adjust 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.

30-5A An entity may make an accounting policy election, at the class of financing receivable or the major security-type level, not to measure an allowance for credit losses for accrued interest receivables if the entity writes off the uncollectible accrued interest receivable balance in a timely manner. This accounting policy election should be considered separately from the accounting policy election in paragraph 326-20-35-8A. An entity may not analogize this guidance to components of amortized cost basis other than accrued interest.

The objectives of ASU 2016-13 are to eliminate the incurred loss approach and the probability threshold for recognition of credit losses. In accordance with ASC 326-20-30-3 (see above), various methods can be used to meet these objectives. In paragraph BC50 of ASU 2016-13, the FASB indicates that its reasoning behind allowing entities to use various methods in estimating credit losses is that “entities manage credit risk differently and should have flexibility to best report their expectations.” The Board also acknowledges that “different methods may result in a range of acceptable outcomes” and do not inherently cause a particular estimate to be unreasonable.

Accordingly, an entity can select from a number of measurement approaches to determine the allowance for expected credit losses. Some approaches project future principal and interest cash flows (i.e., a DCF method), while others project only future principal losses. If an entity chooses to estimate credit losses by using a method other than a DCF method, it has the option of estimating such losses on the asset’s amortized cost basis in the aggregate or by separately measuring the components of the amortized cost basis (e.g., premiums and discounts), as described in ASC 326-20-30-5.

While an entity is not required to change its current method(s) of estimating credit losses upon adopting ASU 2016-13, it should consider, for each type of financial asset, whether it is more appropriate to use a different method to meet the ASU’s objectives. For example, the entity may determine that certain methods are not suitable for measuring expected credit losses on prepayable financial assets (see Section 4.4.5 for discussion of how estimated prepayments may affect the estimate of expected credit losses if a method other than a DCF approach is used). In addition, as required by ASC 326-20-30-10 and discussed in paragraph BC63 of ASU 2016-13, regardless of the method used, an entity’s estimate of expected credit losses should take into account “the expected risk of loss, even if that risk is remote.”

To faithfully estimate the collectibility of financial assets within the scope of ASC 326-20, an entity should use judgment in developing estimation techniques and apply those techniques consistently over time. ASC 326-20-55-7 emphasizes that an entity should use methods that are “practical and relevant” given the specific facts and circumstances and that “[t]he method(s) used to estimate expected credit losses may vary on the basis of the type of financial asset, the entity’s ability to predict the timing of cash flows, and the information available to the entity.”

Regardless of whether an entity changes its current method(s) of estimating credit losses upon adoption of ASU 2016-13, the method(s) used must be disclosed by portfolio segment and major security type in accordance with ASC 326-20-50-11. In changing the estimation technique or assumptions used to calculate expected credit losses after initially adopting ASU 2016-13, an entity should consider whether the change reflects a change in accounting principle3 or a change in accounting estimate4 in accordance with ASC 250. ASC 250 also discusses a change in accounting estimate effected by a change in accounting principle.5 The table below discusses (1) when it is appropriate to effect a change in accounting principle or a change in accounting estimate and (2) how such changes should be accounted for in an entity’s financial statements.

Type of Change	When a Change Is Appropriate	Accounting for the Change
Change in accounting principle	May be made upon the initial adoption of a newly issued Codification update. If it occurs under any other circumstances, it must be justified on the basis that the alternative accounting principle is preferable (see ASC 250-10-45-2). SEC registrants are required to file a preferability letter to effect a change in accounting principle.	Reported “through retrospective application of the new accounting principle to all prior periods, unless it is impracticable to do so” (see ASC 250-10-45-5).
Change in accounting estimate	Generally results from “the continuing process of obtaining additional information and revising estimates” related to the present status and expected future benefits and obligations associated with assets and liabilities (see ASC 250-10-45-18 and the definition of a change in accounting estimate). The objective of measuring an asset or liability in other Codification topics will affect the assessment of when a change in accounting estimate is justified given the particular facts and circumstances.	Should not be accounted for by restating or retrospectively adjusting amounts reported in prior-period financial statements. Rather, such a change should “be accounted for in the period of change if the change affects that period only or in the period of change and future periods if the change affects both” (see ASC 250-10-45-17).
Change in accounting estimate effected by a change in accounting principle	May only be made “if the new accounting principle is justifiable on the basis that it is preferable” (see ASC 250-10-45-19). An SEC registrant is not required to file a preferability letter to make a change in accounting estimate effected by a change in accounting principle (see paragraph 4230.2(c)(4) of the SEC Financial Reporting Manual).	Treated as a change in accounting estimate (see ASC 250-10-45-18).

The determination of the allowance for credit losses on financial assets reflects an accounting estimate. Making such an estimate involves the determination of both the estimation technique (e.g., DCFs, loss-rate method) and the assumptions inherent in that technique. ASC 326-20-55-6 notes that “[e]stimating expected credit losses is highly judgmental” and includes the following nonexhaustive list of judgments that may be involved in such estimation:

The definition of default for default-based statistics
The approach to measuring the historical loss amount for loss-rate statistics, including whether the amount is simply based on the amortized cost amount written off and whether there should be adjustments to historical credit losses (if any) to reflect the entity’s policies for recognizing accrued interest
The approach to determine the appropriate historical period for estimating expected credit loss statistics
The approach to adjusting historical credit loss information to reflect current conditions and reasonable and supportable forecasts that are different from conditions existing in the historical period
The methods of utilizing historical experience
The method of adjusting loss statistics for recoveries
How expected prepayments affect the estimate of expected credit losses
How the entity plans to revert to historical credit loss information for periods beyond which the entity is able to make or obtain reasonable and supportable forecasts of expected credit losses
The assessment of whether a financial asset exhibits risk characteristics similar to other financial assets.

As part of its processes for estimating expected credit losses, an entity will need to continually obtain and evaluate new information to determine how it affects the presentation of the net amounts expected to be collected on financial assets. Such processes could include changing the estimation technique for specific types of financial assets, changing the assumptions inherent in the application of a particular estimation technique, or both.

4.4.1 Changes in Estimation Techniques

ASC 326-20-35-1 and ASC 326-20-55-7 address considerations related to determining the estimation technique used to calculate expected credit losses and state:

35-1 At each reporting date, an entity shall record an allowance for credit losses on financial assets (including purchased financial assets with credit deterioration) within the scope of this Subtopic. An entity shall compare its current estimate of expected credit losses with the estimate of expected credit losses previously recorded. An entity shall report in net income (as a credit loss expense or a reversal of 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). The method applied to initially measure expected credit losses for the assets included in paragraph 326-20-30-14 generally would be applied consistently over time and shall faithfully estimate expected credit losses for financial asset(s). [Emphasis added]

55-7 Because of the subjective nature of the estimate, this Subtopic does not require specific approaches when developing the estimate of expected credit losses. Rather, an entity should use judgment to develop estimation techniques that are applied consistently over time and should faithfully estimate the collectibility of the financial assets by applying the principles in this Subtopic. An entity should utilize estimation techniques that are practical and relevant to the circumstance. The method(s) used to estimate expected credit losses may vary on the basis of the type of financial asset, the entity’s ability to predict the timing of cash flows, and the information available to the entity. [Emphasis added]

An entity may consider changing its estimation technique for a particular type of financial asset for various reasons. For example, in practice, it may be common for a financial asset’s risk characteristics to no longer be similar to those of the original pool of financial assets. In such situations, an entity may need to measure expected credit losses on the asset by using a method different from that used for the original pool. Accordingly, it may be appropriate for the entity to change the estimation technique for the financial asset and, depending on the facts and circumstances, the new estimation technique may be applied to the financial asset individually or to a different pool of financial assets whose risk characteristics are now similar to those of that asset. For instance, an entity may determine that the allowance for credit losses on a credit-deteriorated financial asset (including, but not limited to, a modified financial asset) should be estimated by using a DCF approach or by applying the practical expedient related to collateral-dependent financial assets, but the entity may also determine that the allowance for credit losses on the original pool of financial assets should continue to be estimated by using a loss-rate approach.

If there is no change in risk characteristics, an entity would generally be expected to apply its estimation technique consistently over time. However, when a change in an estimation technique is justified given the particular facts and circumstances, an entity should treat the change as a change in accounting estimate rather than as a change in accounting estimate effected by a change in accounting principle. Although the definition of a change in accounting principle in ASC 250 indicates that “[a] change in the method of applying an accounting principle also is considered a change in accounting principle” (emphasis added), the definition of a change in accounting estimate cites uncollectible receivables as an item for which estimates are necessary. In prior registrant comment letters and informal conversations, the SEC staff has expressed its view that changes in the method of estimating the allowance for credit losses represent changes in accounting estimates. We do not expect a change in this view upon adoption of ASU 2016-13.

4.4.2 Applying Different Measurement Methods to Similar Pools of Assets

An entity can select from a number of measurement approaches to estimate expected credit losses. Some approaches project future principal and interest cash flows (i.e., a DCF method), while others project only future principal losses. An entity is not necessarily required to apply the same measurement approach when measuring expected credit losses related to similar pools of assets. While it is clear that an entity could use different approaches to measure expected credit losses related to individual financial assets that do not share similar risk characteristics, it is less clear whether that same conclusion applies to similar pools of financial assets. As discussed in Chapter 3, an entity must evaluate financial assets on a collective (i.e., pool) basis if they share similar risk characteristics. Once the entity determines a pool of financial assets, it can apply any of the measurement methods discussed in ASC 326-20 to that pool. As a result, an entity could potentially apply a different measurement approach to different pools of similar financial assets.

Example 4-1

A commercial real estate lender has historically provided financing in the northeastern and southeastern United States and has determined its pools of assets for measuring expected credit losses on the basis of internal risk rating (1–5). The internal risk rating takes into account borrower-specific factors such as size, geographical location, historical payment defaults, and loan term (note that the lender does not believe that the borrower-specific factors cause the loans not to share similar risk characteristics). Given the amount of historical information gathered on these commercial pools, the lender uses a DCF method to estimate expected credit losses related to the pools.

In the current year, the lender begins to finance commercial loans in the southwestern United States. As the lender has historically done, it assigns an internal risk rating to the loans issued in the southwestern United States and determines that those loans should be pooled together. However, the lender does not have sufficient information to apply a DCF method to these loans (as noted above, the lender did have such information for the loans issued in the northeastern and southeastern United States). Therefore, on the basis of the guidance in ASC 326-20-55-7, which emphasizes that an entity should use methods that are “practical and relevant” given the specific facts and circumstances and that “[t]he method(s) used to estimate expected credit losses may vary on the basis of . . . the entity’s ability to predict the timing of cash flows, and the information available to the entity,” the lender chooses to apply a loss-rate method to the pool of commercial real estate loans issued in the southwestern United States and continues to apply a DCF method to the pools of commercial real estate loans issued in the northeastern and southeastern United States.

4.4.3 Changes in Assumptions

Changes to the assumptions an entity uses in applying a particular estimation technique are appropriate when the entity is making those changes because it has obtained and evaluated new information that affects its process for faithfully estimating the collectibility of financial assets in accordance with ASC 326. Any such changes, which should be justifiable given the particular facts and circumstances, should be reflected as a change in accounting estimate. Such changes would include the nonexhaustive list of judgments listed in ASC 326-20-55-6.

While changes in the estimation techniques and assumptions used to measure expected credit losses are considered changes in accounting estimates, changes in certain items, which are described in ASC 326 as “significant accounting policies,” could indirectly affect the estimation of credit losses and would need to be reflected as changes in accounting principles. ASC 326-20-50-17 states that an entity’s significant accounting policies would include the following:

Nonaccrual policies, including the policies for discontinuing accrual of interest, recording payments received on nonaccrual assets (including the cost recovery method, cash basis method, or some combination of those methods), and resuming accrual of interest, if applicable
The policy for determining past-due or delinquency status
The policy for recognizing writeoffs within the allowance for credit losses.

In addition, an entity’s change in its interest income recognition practices may reflect a change in accounting principle or a change in accounting estimate effected by a change in accounting principle. Interest income recognition guidance is largely addressed in other Codification topics. However, ASC 326 does address an entity’s treatment of the change in the allowance for credit losses that results from the passage of time when a DCF approach is used to estimate expected credit losses. ASC 326-20-45-3 allows an entity to either (1) report the entire change in present value as credit loss expense or (2) report the change in present value attributable to the passage of time as interest income. The alternative chosen would reflect an accounting policy; thus, any change in the alternative used would be considered a change in accounting principle.

See ASC 250-10-50 for information about the disclosures that must accompany a change in accounting principle or a change in accounting estimate.

4.4.4 Considerations Related to Estimating Credit Losses by Using a DCF Method

4.4.4.1 Effect of Prepayments on an Entity Using a DCF Method

An entity that uses a DCF method to estimate expected credit losses must “discount expected cash flows at the financial asset’s effective interest rate” (emphasis added) in accordance with ASC 326-20-30-4. This paragraph further states that “[w]hen a discounted cash flow method is applied, the allowance for credit losses shall reflect the difference between the amortized cost basis and the present value of the expected cash flows.” ASC 326-20-20 defines the EIR, in part, as “[t]he rate of return implicit in the financial asset, that is, the contractual interest rate adjusted for any net deferred fees or costs, premium, or discount existing at the origination or acquisition of the financial asset.”6

Consequently, ASC 326 is unclear on whether an entity that applies a DCF method to discount the expected cash flows should use the same EIR it applied to recognize interest income in accordance with ASC 310-20. With few exceptions, it is assumed under ASC 310-20 that for interest income recognition purposes, the loan will remain outstanding until its contractual maturity (and that, therefore, expected prepayments are not considered). However, the CECL model requires an entity to consider prepayments when applying the DCF method. As a result, the loan term used for recognizing interest income is inconsistent with that used for estimating expected credit losses.

Further, this inconsistency could result in certain anomalies. For example, when an entity uses a DCF method to estimate expected credit losses for a loan that includes a premium to par, any expected prepayments would accelerate the recognition of premiums that are related solely to the use of a discount rate under which, for CECL model purposes, prepayments are assumed to a set of cash flows for which prepayments are not assumed for interest income recognition purposes. The acceleration of the premium recognition results in an increase to the credit allowance because the amortized cost basis on day 1 would be greater than the present value of the expected cash flows. The opposite is true for a loan that includes a discount to par under which the use of a DCF method that includes expected prepayments would accelerate the recognition of the discount. This acceleration would, in turn, artificially lower the allowance because the amortized cost basis on day 1 would be less than the present value of the expected cash flows.

This issue, among others discussed at the June 2017 TRG meeting, led the FASB to issue ASU 2019-04, under which an entity can make an accounting policy election (at the “class of financing receivable” level) to use a prepayment-adjusted EIR when applying a DCF method under the CECL model, even though the EIR used for interest income recognition is not adjusted for prepayments. The ASU also states that an entity that has elected an accounting policy of adjusting the EIR for prepayments should update the adjusted EIR periodically to match any changes in expected prepayments. Moreover, the ASU clarifies that an entity should not adjust the EIR used to discount expected cash flows for subsequent changes in expected prepayments if the financial asset is restructured in a TDR.7

Changing Lanes

FASB ASU on Troubled Debt Restructurings and Vintage Disclosures

ASU 2022-02 states that an entity that uses a DCF method to calculate the allowance for credit losses will be required to use a postmodification-derived EIR as part of its calculation in accordance with ASC 326-20-30-4.

4.4.4.2 Variable-Rate Instruments

ASU 2016-13 originally stated that if a financial asset’s contractual interest rate varies on the basis of an independent factor, such as an index or rate, “[p]rojections of changes in the factor shall not be made for purposes of determining the effective interest rate or estimating expected future cash flows” (emphasis added). After the ASU was issued, however, stakeholders questioned whether it was inconsistent for the guidance to prohibit entities from projecting changes in the factor that leads to changes in the financial asset’s contractual interest rate while requiring them to consider projections when estimating expected cash flows.

As a result, in ASU 2019-04, the FASB clarifies that an entity is permitted to consider projections of changes in the factor as long as such projections are the same as those used to estimate expected future cash flows. For example, the reasonable and supportable forecast period over which an entity chooses to project the contractual variable interest rate should be consistent for both estimating future cash flows and determining the EIR.

Specifically, ASC 326-20-30-4 states, in part:

If the financial asset’s contractual interest rate varies based on subsequent changes in an independent factor, such as an index or rate, for example, the prime rate, the London Interbank Offered Rate (LIBOR), or the U.S. Treasury bill weekly average, that financial asset’s effective interest rate (used to discount expected cash flows as described in this paragraph) shall be calculated based on the factor as it changes over the life of the financial asset. An entity is not required to project changes in the factor for purposes of estimating expected future cash flows. If the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall use the same projections in determining the effective interest rate used to discount those cash flows. In addition, if the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall adjust the effective interest rate used to discount expected cash flows to consider the timing (and changes in the timing) of expected cash flows resulting from expected prepayments in accordance with paragraph 326-20-30-4A. Subtopic 310-20 on receivables — nonrefundable fees and other costs provides guidance on the calculation of interest income for variable rate instruments.

Connecting the Dots

Measuring Expected Credit Losses When an EIR on a Fixed-Rate Loan Is Lower Than a Current Market Rate

ASU 2019-04 clarifies that an entity is permitted to consider projections of changes in factors that lead to changes in a variable-rate instrument’s contractual interest rate when determining the asset’s EIR. However, when an entity is determining the EIR on a fixed-rate loan, even in situations in which interest rates have increased since the origination of the loan, the entity would not consider the current market rate when discounting the expected future cash flows of the loan. Keep in mind that discounting the future cash flows at a rate lower than the current market rate will result in a lower amount of expected credit losses. An entity should change its estimate of expected credit losses solely on the basis of changes in credit quality (i.e., a change in future cash flows that is attributable to credit). The FASB did not intend the measurement of expected credit losses to reflect changes in interest rates in general or changes specific to a borrower.

However, if the creditor uses a practical expedient in measuring expected credit losses (e.g., fair value of collateral on a collateral-dependent loan), the measurement may reflect changes in interest rates because fair value incorporates current market conditions as of the measurement date.

4.4.5 Estimating Credit Losses by Using Methods Other Than a DCF Method

If an entity chooses to estimate credit losses by using a method other than a DCF method, it has the option of estimating credit losses on the asset’s amortized cost basis in the aggregate or by separately measuring the components of the amortized cost basis (e.g., premiums and discounts), as described in ASC 326-20-30-5. Depending on which of these alternatives the entity chooses, it may be required to adjust its historical loss information. For example, if an entity’s historical loss rate reflects losses of only principal amounts, it may need to adjust that information if it chooses to estimate credit losses on the entire amortized cost basis of an asset to which premiums, discounts, or other basis adjustments apply.

4.4.5.1 Accrued Interest

ASU 2016-13 defines “amortized cost basis” as “the amount at which a financing receivable or investment is originated or acquired, adjusted for applicable accrued interest, accretion or amortization of premium, discount, and net deferred fees or costs, collection of cash, writeoffs, foreign exchange, and fair value hedge accounting adjustments” (emphasis added). The ASU’s inclusion of accrued interest in the definition of amortized cost basis has three significant implications for financial statements with respect to the measurement, presentation, and disclosure of the amortized cost basis and the allowance for credit losses of financial assets:

To measure an allowance for credit losses on the amortized cost basis of a financial asset, entities will be required to include an allowance for the applicable accrued interest of that asset.
Entities will have to present the accrued interest amount in the amortized cost basis of the financial assets in the same line item on the balance sheet.
Entities will be required to include accrued interest in their disclosures about the amortized cost basis by class of financing receivable and vintage in accordance with ASC 326-20-50-5 and 50-6, respectively.

Further, because accrued interest is included in the definition, the reversal of such interest will need to be written off in the same manner as the principal or other components of the amortized cost basis (see Section 4.5 for a discussion of write-offs). ASC 326-20-35-8 states that “[w]riteoffs of financial assets, which may be full or partial writeoffs, shall be deducted from the allowance” (emphasis added). In other words, all components of the amortized cost basis, including the accrued interest, must be written off through the allowance for credit losses.

After the issuance of ASU 2016-13, stakeholders raised concerns that the inclusion of accrued interest in the definition of amortized cost basis could be operationally burdensome because many loan systems are not able to track accrued interest on an individual loan level. Stakeholders have also expressed concerns about the conflict between existing nonaccrual policies, which generally follow regulatory instructions requiring the reversal of accrued interest as a debit to the interest income line item (at least in part), and the write-off guidance in ASC 326-20-35-8. Many stakeholders, primarily financial institutions, indicated that existing nonaccrual policies present a more accurate reflection of the earning potential of a loan and interest income than does the write-off guidance in ASC 326-20-35-8. Those stakeholders further maintained that any change from the existing nonaccrual policies would reduce the consistency and comparability of current-period financial statements, regulatory reports, and important interest-income-based metrics (e.g., net interest margin) with those of prior periods.

ASU 2019-04 addresses these concerns (which were originally discussed at the June 2018 TRG meeting). Specifically, ASU 2019-04 states that an entity would be allowed to:

Measure the allowance for credit losses on accrued interest receivable balances separately from other components of the amortized cost basis of associated financial assets.
Make an accounting policy election not to measure an allowance for credit losses on accrued interest receivable amounts if an entity writes off the uncollectible accrued interest receivable balance in a timely manner and makes certain disclosures.
Make an accounting policy election to write off accrued interest amounts by [either] reversing interest income or recognizing credit loss expense, or a combination of both. The entity also is required to make certain disclosures.
Make an accounting policy election to present accrued interest receivable balances and the related allowance for credit losses for those accrued interest receivable balances separately from the associated financial assets on the balance sheet. If the accrued interest receivable balances and the related allowance for credit losses are not presented as a separate line item on the balance sheet, an entity should disclose the amount of accrued interest receivable balances and the related allowance for credit losses and where the balance is presented.
Elect a practical expedient to disclose separately the total amount of accrued interest included in the amortized cost basis as a single balance to meet certain disclosure requirements.

4.4.5.2 Nonaccrual Loans

ASC 310-20-35-17 states that the amortization of net deferred fees and costs should be discontinued when an entity is not accruing interest on a loan “because of concerns about the realization of loan principal or interest.” The guidance in ASC 310-20-35-17 applies even if an entity has net deferred costs or a premium associated with the loan.

While ASC 310-20 does not explicitly refer to premiums and discounts, if a loan is on nonaccrual status, presumably no interest should be recorded, including the amortization of premiums and discounts. Note, however, that when an entity estimates expected credit losses on a nonaccrual loan, it must consider the entire amortized cost basis of the loan, including unamortized net deferred costs and unamortized premiums (irrespective of whether the entity chooses to measure expected credit losses on the asset’s amortized cost basis in the aggregate or by separately measuring the components of the amortized cost basis, as permitted by ASC 326-20-30-5).

4.4.5.3 Discounting Inputs When a Method Other Than a DCF Method Is Used

An entity that uses a method other than a DCF method (e.g., a probability-of-default or a loss-given-default credit loss method) in estimating credit losses is not allowed to discount only certain inputs; partial discounting is prohibited. If an entity wants to discount the inputs used to measure the allowance for credit losses, it should discount all the inputs used in the measurement. Note that this question was addressed at the November 2018 TRG meeting, and it was determined that ASU 2016-13’s guidance on discounting is clear. As a result, the FASB is not expected to amend the guidance in ASC 326 to reflect the TRG discussion.

In addition, it would not be acceptable for an entity to discount future losses when using a loss-rate method (i.e., amortized cost × expected loss rate). Discounting is allowed only under a DCF approach in which an entity uses the EIR at inception.

4.4.5.4 Consideration of Capitalized Interest When a Method Other Than a DCF Method Is Used

When an entity uses a method other than a DCF method to estimate credit losses, its allowance for credit losses should not take into account future capitalized interest, since such interest is not included in the asset’s amortized cost basis on which the entity is estimating expected credit losses. For a financial asset issued at a discount, the amount due upon default — provided that there are no terms or conditions that only require the repayment of “accreted value” at any point in the asset’s term — would be the par amount and accrued interest to date (which is greater than the asset’s amortized cost basis). For a financial asset issued at par with expected future capitalized interest, the amount due upon default is also the par amount and accrued interest to date, which would equal the amortized cost basis at the time of default (as long as there are no other adjustments to the amortized cost basis). Therefore, an entity would not consider any unearned interest, regardless of the expectation that it will be capitalized in future periods before a default occurs, in the calculation of an allowance for credit losses because the legal amount owed upon default would not include that future expected accrued interest.

To illustrate this point, at its June 2018 meeting, the TRG discussed an example in which an entity issues a student loan for $60,000. The student is not required to make any payments on the loan until after four years (i.e., the loan will be in deferment for four years). However, interest accrues during the deferment period in such a way that at the end of year 4, the student will owe the lender $100,000, comprising a principal amount of $60,000 and interest of $40,000. In this scenario, although the student will owe the lender $100,000 after the deferment period ends, the lender will calculate its expected credit losses during the deferment period by using an amortized cost amount that does not include future capitalized interest (i.e., the principal amount of $60,000).

4.4.6 Effect of Timing on Expected Credit Losses

The timing of defaults and prepayments (e.g., repayment of the financial asset, either partially or entirely, before its stated maturity according to its contractual terms) affects an entity’s calculation of expected credit losses differently depending on the method used:

DCF method — When a DCF method is applied to a pool of financial assets, the time value of money is explicitly incorporated (i.e., both the amount and timing of cash flows matter). For example, the timing of prepayments affects the timing of the recognition of discounts and premiums and the number of interest coupons to be received. These factors could increase or offset credit losses when a DCF method is applied to a pool of assets by using an overall EIR.
Measuring expected credit losses on the separate components of amortized cost (e.g., premiums, discounts) or on the asset’s combined amortized cost basis — Regardless of whether an entity estimates expected credit losses on the separate components of amortized cost or the combined amortized cost basis of the asset, an entity is permitted but not required to consider the timing of when credit losses will occur.8 However, if an entity chooses to consider timing when estimating expected credit losses, the timing will affect the amount of amortized premiums, discounts, deferred fees and costs, etc. In addition, the entity would also need to estimate the acceleration of the amortization of the amounts resulting from prepayments.

4.4.7 Inclusion of Taxes, Insurance, and Other Costs

A lender’s expectations of future losses on payments of tax, insurance premiums, and other “costs” (i.e., payments made by the lender that may not be recovered from borrowers) should not be included in the lender’s day 1 estimate of expected credit losses. Those amounts should only be included in its estimate of expected credit losses when the funds are advanced. Some would argue that because the lender is not obligated to make those payments on the borrower’s behalf, not establishing an allowance for these amounts before such advances is consistent with the treatment of unfunded loan commitments discussed in Section 2.1. Others would argue that even if the lender was effectively compelled to make the advances to protect its collateral, not including estimates of future advances in the expected credit losses is consistent with the treatment of future capitalized interest discussed in Section 4.4.5.4 since those amounts do not represent the amount owed by the borrower on the balance sheet date.

4.4.8 Weighted-Average Remaining Maturity Method

In January 2019, the FASB staff issued a Q&A document that addresses whether and, if so, how the WARM method could be used to estimate expected credit losses. The document states that the “WARM method uses an average annual charge-off rate [that] contains loss content over several vintages and is used as a foundation for estimating the credit loss content for the remaining balances of financial assets in a pool at the balance sheet date. The average annual charge-off rate is applied to the contractual term, further adjusted for estimated prepayments to determine the unadjusted historical charge-off rate for the remaining balance of the financial assets.” The staff indicated that it is acceptable to use the WARM method to estimate an allowance for credit losses, particularly for less complex financial asset pools, and that an entity needs to consider whether qualitative adjustments should be made.

To illustrate how an entity might apply the WARM method, the FASB staff included a number of examples in the Q&A, one of which is reproduced below.

FASB Staff Q&A

Topic 326, No. 1: Whether the Weighted-Average Remaining Maturity Method Is an Acceptable Method to Estimate Expected Credit Losses

Question 3 . . .

Fact Pattern

Estimate the allowance for credit losses as of 12/31/2020
Pool of financial assets of similar risk characteristics
- Amortized cost basis of ~$13.98 million
- 5-year financial assets (contractual term adjusted by prepayments)
Management expects the following in 2021 and 2022:
- Rise in unemployment rates
Management cannot reasonably forecast beyond 2022
Assume 0.25% qualitative adjustment to represent both current conditions and reasonable and supportable forecasts

The example illustrates estimating an allowance for credit losses on a pool of financial assets as of December 31, 2020. The pool has an outstanding balance of approximately $13.98 million as of December 31, 2020 and has financial assets with a contractual life of 5 years. The $13.98 million amortized cost is for a pool of financial assets with similar credit risk characteristics.

Management expects a rise in unemployment rates for 2021 and 2022 and cannot reasonably forecast beyond 2022. The example assumes a 0.25% qualitative adjustment for current conditions and reasonable and supportable forecasts discussed further below. It is important to note that this input will be a significant assumption when estimating expected credit losses under Update 2016-13 because it represents amounts for the current conditions and reasonable and supportable forecast. Moreover, because the example is for illustrative purposes, the staff has not assumed a specific type of financial asset pool given the breadth of products that exist in the market place and the specific facts and circumstances that may exist for a particular entity. Rather, the calculations are meant to depict the mechanics of the model in various ways. Therefore, as noted in the example calculations, an entity will need to determine if adjustments need to be made to historical loss data in accordance with paragraph 326-20-30-8 in addition to the reasonable and supportable forecasts.

Step 1: Calculate Annual Charge-Off Rate

In Table 1 above:

Red bolded number of 0.36% is an average of 5 years of annual charge-off rates.
The historical time period used to determine the average annual charge-off rate is a significant judgment that will need to be properly supported and documented in accordance with paragraph 326-20-30-8. For this example, assume the entity compared historical information for similar financial assets with the current and forecasted direction of the economic environment, and believes that its most recent 5-year period is a reasonable period on which to base its expected credit-loss-rate calculation after considering the underwriting standards and contractual terms for loans that existed over the historical period in comparison with the current pool. Additionally, assume the entity considered whether any adjustments to historical loss information in accordance with paragraph 326-20-30-8 were needed before considering adjustments for current conditions and reasonable and supportable forecasts but determined that none were necessary. It should be noted that this is a simplified example using a generic pool. An entity that estimates the allowance for credit losses using the WARM method (or any method) should determine if its historical loss information needs to be adjusted for changes in underwriting standards, portfolio mix, or asset term within the pool at the reporting date.

Step 2: Estimate the Allowance for Credit Losses

In Table 2 above:

First column titled “Year End” displays subsequent years, until 2025, which represents the time anticipated for the pool to be paid off.
Second column titled “Est. Paydown” represents expected payments in the future periods until the pool is expected to fully pay off. Management will need to estimate the future paydowns, which includes the scheduled payments + prepayments.

Note: Do not include the expected credit losses in this column. Paydowns should include scheduled payments and non-credit related prepayments.

Note: Estimated prepayments are also a significant judgment that will need to be properly supported and documented.
Third column titled “Projected Amort Cost”:
1. Begin with $13.98MM outstanding balance as of the balance sheet date of 12/31/2020.
2. Subtract projected paydowns from the “Est. Paydown” column to estimate future projected amortized cost for each of the remaining years of the pool’s life (for example, $13,980M minus $3,700M equals $10,280M).
Fifth column titled “Allowance for Credit Losses”:
1. Take each of the future years’ projected amortized cost and multiply by the average annual charge-off rate, thereby estimating each of the remaining years’ losses and aggregating to estimate the cumulative losses (for example, in the first year, $13.98MM of amortized cost is multiplied by the average annual charge-off rate of 0.36% for a first year’s credit loss estimate of $50K dollars).
2. For the second year, which is 2022, the $10.28MM representing the ending balance as of 2021 and the beginning balance as of 2022 is multiplied by the average annual charge-off rate of 0.36% to estimate the second year’s credit losses of $37K dollars. This process is repeated for each remaining year.
3. Sum the last column to estimate the total expected credit losses of $126K dollars.
  Note: This is not the full allowance for credit losses because the entity has not yet accounted for current conditions and reasonable and supportable forecasts.
4. Convert $126K of expected losses into a loss rate of 0.90% by dividing $126K by the amortized cost of $13.98MM.
Finally, add 0.25% of qualitative adjustments as an assumption established as part of the fact pattern of the example to estimate the allowance for credit losses rate of 1.15%. The 1.15% is multiplied by $13.98MM to estimate the total allowance for credit losses of $161K dollars.
Note: 0.25% is a significant assumption made by management that will need to be adequately documented and supported. For this example, in accordance with paragraph 326-20-55-4, the entity considered significant factors that could affect the expected collectability of the amortized cost basis of the pool and determined that the primary factor is the unemployment rate. As part of this analysis, assume that the entity observed that the unemployment rate has increased as of the current reporting period date. Based on current conditions and reasonable and supportable forecasts, the entity expects that unemployment rates are expected to increase further over the next one to two years. To adjust the historical loss rate to reflect the effects of those differences in current conditions and forecasted changes, the entity estimates a 25-basis-point increase in credit losses incremental to the 0.9 percent historical lifetime loss rate related to the expected deterioration in unemployment rates. Management estimates that the incremental 25-basis-point increase based on its knowledge of historical loss information during past years in which there were similar trends in unemployment rates. Management is unable to support its estimate of expectations for unemployment rates beyond the reasonable and supportable forecast period. Under this loss-rate method, the incremental credit losses for the current conditions and reasonable and supportable forecast (the 25 basis points) is added to the 0.9 percent rate that serves as the basis for the expected credit loss rate. No further reversion adjustments are needed because the entity has applied a 1.15% loss rate where it has immediately reverted into historical losses that reflect the contractual term in accordance with paragraphs 326-20-30-8 through 30-9. This approach reflects an immediate reversion technique for the loss-rate method. It is important to note that the 25-basis-point increase reflects the entity’s estimate of the incremental losses in years 2021 and 2022 from unemployment and assumes no incremental losses for the remaining years. Further, the reversion technique selected by the entity is a significant assumption that will need to be supported by management and is not a policy election or practical expedient.

Connecting the Dots

Applicability of the WARM Method

The FASB staff indicated that it is acceptable to use the WARM method to estimate expected credit losses. Under that method, entities use qualitative adjustments to alleviate the operational challenges they may face when applying other loss methods. For example, in its response to Question 2 of the Q&A document, the staff suggests that such qualitative adjustments may be used to overcome “situations involving minimal loss history, losses that are sporadic with no predictive patterns, low numbers of loans in each pool, data that is only available for a short historical period, a composition that varies significantly from historical pools of financial assets, or changes in the economic environment.”

However, the FASB staff also cautions preparers that although the WARM method can be used effectively in some situations, certain “challenges will be more significant, and an entity may find that the WARM method is inappropriate for its situation.” Because the WARM method relies heavily on qualitative adjustments for which significant judgment is required, we believe that entities may discover that the costs of applying it outweigh its benefits. As a result, we do not expect many entities to apply the WARM method in practice.

4.4.9 Practical Expedients Related to Measuring Expected Credit Losses

ASC 326 permits entities to use practical expedients to measure expected credit losses for the following two types of financial assets:

Collateral-dependent financial assets — In a manner consistent with its practice under existing U.S. GAAP, an entity is permitted to measure its estimate of expected credit losses for collateral-dependent financial assets as the difference between the financial asset’s amortized cost and the collateral’s fair value (adjusted for selling costs, when applicable).
Financial assets for which the borrower must continually adjust the amount of securing collateral (e.g., certain repurchase agreements and securities-lending arrangements) — An entity is permitted to measure its estimate of expected credit losses on these financial assets as the difference between the amortized cost basis of the asset and the collateral’s fair value.

4.4.9.1 Collateral-Dependent Financial Assets

ASU 2016-13 does not change the U.S. GAAP guidance on determining when a financial asset is a collateral-dependent financial asset. As is consistent with previous U.S. GAAP, a financial asset is considered collateral-dependent if “repayment is expected to be provided substantially through the operation or sale of the collateral.” Furthermore, under ASC 326-20-35-4, and in a manner consistent with previous U.S. GAAP, an entity is required to measure the allowance for credit losses on the basis of the fair value of the collateral when it determines that foreclosure is probable.

However, ASU 2016-13 does change an entity’s ability to measure the allowance for credit losses on a collateral-dependent financial asset when foreclosure is not probable. Under previous U.S. GAAP, an entity could elect, as a practical expedient, to measure the allowance for credit losses on a collateral-dependent financial asset that is impaired on the basis of the collateral’s fair value in any circumstance. By contrast, ASC 326-20-35-5 indicates that if foreclosure is not probable, an entity can elect to use such a practical expedient for collateral-dependent financial assets only “when the borrower is experiencing financial difficulty based on the entity’s assessment as of the reporting date.” The phrase “when the borrower is experiencing financial difficulty” is consistent with the guidance that an entity considers to determine whether a modification of a financial asset (1) reflects a TDR before the adoption of ASU 2022-02 or (2) is subject to the disclosure requirements in ASC 310-10-50-42 through 50-44 (added by ASU 2022-02). Therefore, the guidance in ASC 310-40 (before the adoption of ASU 2022-02) and 310-10-50 (after the adoption of ASU 2022-02) that is used to determine whether a debtor is experiencing financial difficulties is relevant to the determination of an entity’s ability to use the practical expedient for a collateral-dependent financial asset. Before the adoption of ASU 2022-02, ASC 310-40-15-20 indicates that the following indicators9 should be considered in the determination of when a debtor may be experiencing financial difficulties (this list is not all-inclusive):

The debtor is currently in payment default on any of its debt. In addition, a creditor shall evaluate whether it is probable that the debtor would be in payment default on any of its debt in the foreseeable future without the modification. That is, a creditor may conclude that a debtor is experiencing financial difficulties, even though the debtor is not currently in payment default.
The debtor has declared or is in the process of declaring bankruptcy.
There is substantial doubt as to whether the debtor will continue to be a going concern.
The debtor has securities that have been delisted, are in the process of being delisted, or are under threat of being delisted from an exchange.
On the basis of estimates and projections that only encompass the debtor’s current capabilities, the creditor forecasts that the debtor’s entity-specific cash flows will be insufficient to service any of its debt (both interest and principal) in accordance with the contractual terms of the existing agreement for the foreseeable future.
Without the current modification, the debtor cannot obtain funds from sources other than the existing creditors at an effective interest rate equal to the current market interest rate for similar debt for a nontroubled debtor.

In determining when the practical expedient for collateral-dependent financial assets can be applied, an entity should also consider the FASB’s rationale for changing previous U.S. GAAP to limit the application of this expedient. Since the CECL model is built on the foundation that expected credit losses are estimated over the contractual life of a financial asset, the FASB was concerned that allowing an unrestricted practical expedient for collateral-dependent financial assets could enable entities to defer the recognition of credit losses that are expected to occur over the asset’s contractual life as a result of declines in the collateral’s fair value. Consequently, under the guidance, the practical expedient can only be elected if the borrower is experiencing financial difficulties, since only at this point does the collateral’s fair value signify a reasonable expectation of the recoverability of the financial asset. This guidance is consistent with paragraph BC64 of ASU 2016-13, which refers to the acceptability of measuring expected credit losses on the basis of the fair value of the collateral “because fair value reflects the amount expected to be collected.” Before the point at which a debtor is experiencing financial difficulties, the collateral’s fair value would not necessarily reflect the net amount of the financial asset expected to be collected because of an entity’s prolonged exposure to declines in that fair value.

Entities may wish to implement accounting practices under which they perform an objective determination of when a borrower is experiencing financial difficulties (e.g., when a loan is a certain number of days past due or becomes subject to the entity’s nonaccrual policy). The reasonableness of such practices would depend on the specific facts and circumstances, including the financial asset type, and any such objective evidence would need to be supplemented by qualitative considerations since an entity must use judgment and consider its particular facts and circumstances in determining when a borrower is experiencing financial difficulties.

Since ASC 326 does not require entities to use the practical expedient for collateral-dependent financial assets before foreclosure is probable, the principal risk in the application of objective evidence lies in prematurely measuring expected credit losses on the basis of the collateral’s fair value. Rather, to apply this practical expedient when foreclosure is not probable, an entity must appropriately assess all relevant facts and circumstances to determine whether the borrower is experiencing financial difficulties. The entity may consider both quantitative and qualitative indicators in performing this assessment. While the mere fact that a borrower is past due on its payments would generally indicate that it is experiencing financial difficulties, this may not always be the case. For example, a borrower may be past due on a loan because of a payment delay was temporarily caused by a natural disaster or other similar event that did not have a significant bearing on the borrower’s wherewithal to make the contractually required payments on the loan receivable.

Keep in mind that the entity is only allowed to use the practical expedient (when foreclosure is not probable) if the borrower is experiencing financial difficulty. As a result, the entity would be permitted to continue to use the practical expedient only if it concludes that the borrower continues to experience financial difficulty. In other words, the conditions related to using the practical expedient when foreclosure is not probable must be met in every reporting period. To the extent that the entity determines that the borrower is no longer experiencing financial difficulty (or that repayment will no longer be substantially provided through the collateral’s sale or operation), the entity would need to measure expected credit losses by using another appropriate measurement method discussed in ASC 326-20-30-3.

An entity must use judgment in determining whether repayment of a loan is expected to be provided solely by the underlying collateral. On October 24, 2013, the federal financial institution regulatory agencies jointly issued “Interagency Supervisory Guidance Addressing Certain Issues Related to Troubled Debt Restructurings” (the “Interagency Guidance”10), which provides the following additional interpretation of the definition of a collateral-dependent loan:

An impaired loan is collateral dependent if “repayment is expected to be provided solely by the underlying collateral,” which includes repayment from the proceeds from the sale of the collateral, cash flow from the continued operation of the collateral, or both. Whether the underlying collateral is expected to be the sole source of repayment for an impaired loan is a matter requiring judgment as to the availability, reliability, and capacity of sources other than the collateral to repay the debt. Generally, repayment of an impaired loan would be expected to be provided solely by the sale or continued operation of the underlying collateral if cash flows to repay the loan from all other available sources (including guarantors) are expected to be no more than nominal. For example, the existence of a guarantor is one factor to consider when determining whether an impaired loan, including a TDR loan, is collateral dependent. To assess the extent to which a guarantor provides repayment support, the ability and willingness of the guarantor to make more-than-nominal payments on the loan should be evaluated.

The repayment of some impaired loans collateralized by real estate may depend on cash flow generated by the operation of a business or from sources outside the scope of the lender’s security interest in the collateral, such as cash flows from borrower resources other than the collateral. These loans are generally not considered collateral dependent due to the more-than-nominal payments expected to come from these other repayment sources. For such loans, even if a portion of the cash flow for repayment is expected to come from the sale or operation of the collateral (but not solely from the sale or operation of the collateral), the loan would not be considered collateral dependent.

For example, an impaired loan collateralized by an apartment building, shopping mall, or other income-producing property where the anticipated cash flows for loan repayment are expected to be derived solely from the property’s rental income, and there are no other available and reliable repayment sources, would be considered collateral dependent because repayment is expected to be provided only from the continued operation of the collateral. However, an impaired loan secured by the owner-occupied real estate of a business (such as a manufacturer or retail store) where the anticipated cash flows to repay the loan are expected to be derived from the borrower’s ongoing business operations and activities would not be considered collateral dependent because the loan is not expected to be repaid solely from cash flows from the sale or operation of the collateral. Nevertheless, if the borrower’s condition worsens so that any payments from the operation of the business are expected to be nominal and repayment instead is expected to depend solely on the sale or operation of the underlying collateral, the loan would then be considered collateral dependent. [Footnotes omitted]

Under this guidance, a loan would be collateral-dependent if it is a nonrecourse loan and the creditor expects to foreclose on it, because in such circumstances, the creditor may only look to the collateral for satisfaction of the loan. Conversely, if the creditor is unsure whether it will foreclose on the collateral, the loan would not be considered collateral-dependent unless it is expected to be repaid solely through the continued operation of the collateral.11

However, if the loan is collateralized by real estate and the creditor has recourse to the general credit of the borrower or to a guarantor, the assessment is less clear. The creditor would need to (1) consider whether the borrower’s financial ability to satisfy the obligation would include repayment sources other than the collateral and (2) formulate an expectation regarding the borrower’s future actions. If a debtor has no means of repaying the loan other than through operation of the collateral, the creditor should conclude that the loan is collateral-dependent. However, if more-than-nominal payments are expected to come from other repayment sources, the loan would generally not be considered collateral-dependent. A similar assessment should be performed when a source of repayment may come from a guarantor. The ability and willingness of a guarantor to make more-than-nominal payments on a loan would result in a conclusion that the loan is not collateral-dependent.

4.4.9.1.1 Considering Collateral Values in the Measurement of Expected Credit Losses

For collateral-dependent financial assets, ASC 326-20-35-4 requires an entity to measure expected credit losses on the basis of the collateral’s fair value if the entity determines that foreclosure is probable. Further, even if a financial asset does not qualify for the practical expedient for collateral-dependent financial assets, the collateral value is still relevant to the estimate of expected credit losses on the financial asset. ASC 326-20-30-10 states, in part:

Except for the circumstances described in paragraphs 326-20-35-4 through 35-6, an entity shall not expect nonpayment of the amortized cost basis to be zero solely on the basis of the current value of collateral securing the financial asset(s) but, instead, also shall consider the nature of the collateral, potential future changes in collateral values, and historical loss information for financial assets secured with similar collateral.

Accordingly, if the practical expedient for collateral-dependent financial assets in ASC 326-20-35-5 is not applied, an entity should consider, among other factors that may affect expected credit losses on the financial asset (or group of similar financial assets), how the collateral’s fair value may affect the estimation of such losses over the contractual life of the financial asset (or group of financial assets).12 If the practical expedient is not applied, an entity cannot measure the allowance for credit losses solely on the basis of the reporting-date fair value of the collateral or avoid recognizing an allowance for credit losses solely because the reporting-date fair value of the collateral equals or exceeds the amortized cost basis of the financial asset (or group of financial assets).

Nevertheless, the collateral security on a financial asset would be expected to affect an entity’s estimation of expected credit losses. In this regard, as discussed in ASC 326-20-30-10, an entity should consider the nature of the collateral (including the nature of the security and the seniority thereon), potential future changes in the collateral’s fair value, and historical losses (adjusted for current conditions and reasonable and supportable forecasts) for financial assets secured with similar collateral. ASC 326-20-55-15 further indicates that debt-to-value ratios and collateral affect the credit quality indicators that are pertinent to financial assets. Accordingly, the collateral securing a financial asset is likely to have an impact on both the probability of default and the loss-given default on the financial asset.

If the practical expedient for collateral-dependent financial assets is not applied, there could potentially be no allowance for credit losses on financial assets, although such situations are not typical. Paragraph BC63 of ASU 2016-13 states:

The Board decided that an entity should consider the expected risk of loss, even if that risk is remote, and that an entity need not measure an expected credit loss when historical information adjusted for current conditions and reasonable and supportable forecasts results in an expectation that the risk of nonpayment of the amortized cost basis is zero. The Board decided not to explicitly state which financial assets are appropriate to have a zero allowance for expected credit losses. The Board understands that an expectation of zero loss is entirely based on the nature and characteristics of a financial asset, which may change over time. As a result, the Board concluded that a “bright-line” approach would be inappropriate for all facts and circumstances and decided not to provide explicit guidance on what specific assets are appropriate for zero expected credit losses. The Board decided that an entity should determine at the reporting date an estimate of credit loss that best reflects its expectations (or its best estimate of expected credit loss).

For example, it may be appropriate not to recognize an allowance for credit losses on certain secured financial assets in which the loan-to-value ratio is so low that it reduces the expected credit losses to zero. To make such a determination, an entity would need to appropriately consider the relevant facts and circumstances, including, but not limited to, the following:

The remaining contractual term of the financial asset (and, if relevant, the entity’s ability to call the financial asset upon a decline in the collateral’s fair value).
The nature of the collateral.
The nature and terms of the security (including any subordination provided by other interests in the collateral).
Past experience with similar collateralized financial assets.
Current conditions and reasonable and supportable forecasts that may affect the prior historical loss information (e.g., potential reasonable and supportable declines in the fair value of the collateral that have not occurred in the past). An entity is not required to consider extremely remote scenarios but should consider those that are reasonably possible.

However, if an entity is aware of a historical default on a particular asset or an asset with similar risk characteristics, regardless of whether the asset was held by the entity or another entity, it would be difficult for the entity to conclude that it is not required to recognize an allowance for credit losses for that asset or asset class. In addition, an entity should consider that paragraph BC71 of ASU 2016-13 states, in part, that “it would be inappropriate to measure credit losses for financial assets on an individual basis to arrive at a zero expected credit loss when a pool of financial assets with similar risk characteristics exists that would indicate otherwise.”

4.4.9.2 Consideration of Costs to Sell When Foreclosure Is Probable

In estimating expected credit losses, an entity that believes foreclosure is probable should consider the costs to sell the collateral securing the financial asset. ASU 2019-04 amended ASC 326-20-35-4 to clarify that an entity is required to adjust the fair value of the collateral by the estimated costs to sell if it intends to sell rather than operate the collateral when it determines that foreclosure on a financial asset is probable.

4.4.9.2.1 Collateral Maintenance Provisions

ASC 326-20

35-6 For certain financial assets, the borrower may be contractually required to continually adjust the amount of the collateral securing the financial asset(s) as a result of fair value changes in the collateral. In those situations, if an entity reasonably expects the borrower to continue to replenish the collateral to meet the requirements of the contract, an entity may use, as a practical expedient, a method that compares the amortized cost basis with the fair value of collateral at the reporting date to measure the estimate of expected credit losses. An entity may determine that the expectation of nonpayment of the amortized cost basis is zero if the fair value of the collateral is equal to or exceeds the amortized cost basis of the financial asset and the entity reasonably expects the borrower to continue to replenish the collateral as necessary to meet the requirements of the contract. If the fair value of the collateral at the reporting date is less than the amortized cost basis of the financial asset and the entity reasonably expects the borrower to continue to replenish the collateral as necessary to meet the requirements of the contract, the entity shall estimate expected credit losses for the unsecured amount of the amortized cost basis. The allowance for credit losses on the financial asset is limited to the difference between the fair value of the collateral at the reporting date and the amortized cost basis of the financial asset.

In arrangements in which the borrower must continually adjust the collateral securing the asset to reflect changes in the collateral’s fair value (e.g., reverse repurchase arrangements), the entity is permitted to measure its estimate of expected credit losses on these financial assets only on the basis of the unsecured portion of the amortized cost as of the balance sheet date (i.e., the difference between the amortized cost basis of the asset and the collateral’s fair value). In such arrangements, the entity must reasonably expect that the borrower will continue to replenish the collateral as necessary. Under the practical expedient for the collateral maintenance provision, the entity may assume that there will be zero losses on the portion of the asset’s amortized basis that is equal to the fair value of the collateral as of the balance sheet date. If the fair value of the collateral is equal to or greater than the amortized cost of the asset, the expected losses would be zero. If the fair value of the collateral is less than the amortized cost of the asset, the expected losses are limited to the difference between the fair value of the collateral and the amortized cost basis of the asset. Example 7 in ASC 326-20 illustrates application of this practical expedient.

ASC 326-20

Example 7: Estimating Expected Credit Losses — Practical Expedient for Financial Assets With Collateral Maintenance Provisions

55-45 This Example illustrates one way an entity may implement the guidance in paragraph 326-20-35-6 for estimating expected credit losses on financial assets with collateral maintenance provisions.

55-46 Bank H enters into a reverse repurchase agreement with Entity I that is in need of short-term financing. Under the terms of the agreement, Entity I sells securities to Bank H with the expectation that it will repurchase those securities for a certain price on an agreed-upon date. In addition, the agreement contains a provision that requires Entity I to provide security collateral that is valued daily, and the amount of the collateral is adjusted up or down to reflect changes in the fair value of the underlying securities transferred. This collateral maintenance provision is designed to ensure that at any point during the arrangement, the fair value of the collateral continually equals or is greater than the amortized cost basis of the reverse repurchase agreement.

55-47 At the end of the first reporting period after entering into the agreement with Entity I, Bank H evaluates the reverse repurchase agreement’s collateral maintenance provision to determine whether it can use the practical expedient in accordance with paragraph 326-20-35-6 for estimating expected credit losses. Bank H determines that although there is a risk that Entity I may default, Bank H’s expectation of nonpayment of the amortized cost basis on the reverse repurchase agreement is zero because Entity I continually adjusts the amount of collateral such that the fair value of the collateral is always equal to or greater than the amortized cost basis of the reverse repurchase agreement. In addition, Bank H continually monitors that Entity I adheres to the collateral maintenance provision. As a result, Bank H uses the practical expedient in paragraph 326-20-35-6 and does not record expected credit losses at the end of the first reporting period because the fair value of the security collateral is greater than the amortized cost basis of the reverse repurchase agreement. Bank H performs a reassessment of the fair value of collateral in relation to the amortized cost basis each reporting period.

4.4.9.2.2 Frequency of Collateral Replenishment

ASC 326-20-35-6 states, in part, that “[a]n entity may determine that the expectation of nonpayment of the amortized cost basis is zero if the fair value of the collateral is equal to or exceeds the amortized cost basis of the financial asset and the entity reasonably expects the borrower to continue to replenish the collateral.”

The guidance is not clear on how frequently an entity must post additional collateral to meet the condition that it “continually” replenish the collateral. While “continually” may mean that the replenishment must occur on a daily basis, certain arrangements require that collateral be replenished only if a specific minimum threshold is reached (i.e., if the change in the fair value of the collateral is greater than a specified amount). In such arrangements, the requirements to use the practical expedient would never be met, which we believe was not the FASB’s intent. Therefore, we think that an entity should use judgment when evaluating the terms of the arrangement with respect to posting additional collateral. In performing this evaluation, the entity should consider whether there are certain situations in which the posting of additional collateral is either required or prohibited when a specified threshold is reached.

In addition, we believe that the entity should also consider the collateral’s nature as well as how frequently it evaluates the collateral’s adequacy. The adequacy of the collateral’s value should be evaluated continually, even daily. If the evaluation is performed less frequently than daily, we believe that it would be more difficult for the entity to support its use of the practical expedient. Furthermore, the entity should consider the nature of the collateral because the more liquid and observable the collateral’s value is, the easier it is to support the collateral’s adequacy in the arrangement. The less liquid and observable the value of the collateral is (e.g., Level 3 for fair value disclosure purposes), the harder it will be for the entity to demonstrate that it has evaluated the adequacy of the collateral in attempting to qualify to use the practical expedient.

4.4.10 U.S. Treasury Securities and Other Highly Rated Debt Instruments

ASC 326-20

Example 8: Estimating Expected Credit Losses When Potential Default Is Greater Than Zero, but Expected Nonpayment Is Zero

55-48 This Example illustrates one way, but not the only way, an entity may estimate expected credit losses when the expectation of nonpayment is zero. This example is not intended to be only applicable to U.S. Treasury securities.

55-49 Entity J invests in U.S. Treasury securities with the intent to hold them to collect contractual cash flows to maturity. As a result, Entity J classifies its U.S. Treasury securities as held to maturity and measures the securities on an amortized cost basis.

55-50 Although U.S. Treasury securities often receive the highest credit rating by rating agencies at the end of the reporting period, Entity J’s management still believes that there is a possibility of default, even if that risk is remote. However, Entity J considers the guidance in paragraph 326-20-30-10 and concludes that the long history with no credit losses for U.S. Treasury securities (adjusted for current conditions and reasonable and supportable forecasts) indicates an expectation that nonpayment of the amortized cost basis is zero, even if the U.S. government were to technically default. Judgment is required to determine the nature, depth, and extent of the analysis required to evaluate the effect of current conditions and reasonable and supportable forecasts on the historical credit loss information, including qualitative factors. In this circumstance, Entity J notes that U.S. Treasury securities are explicitly fully guaranteed by a sovereign entity that can print its own currency and that the sovereign entity’s currency is routinely held by central banks and other major financial institutions, is used in international commerce, and commonly is viewed as a reserve currency, all of which qualitatively indicate that historical credit loss information should be minimally affected by current conditions and reasonable and supportable forecasts. Therefore, Entity J does not record expected credit losses for its U.S. Treasury securities at the end of the reporting period. The qualitative factors considered by Entity J in this Example are not an all-inclusive list of conditions that must be met in order to apply the guidance in paragraph 326-20-30-10.

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.” On the basis of Example 8 in ASC 326-20-55-48 through 55-50, we believe that the FASB may have contemplated U.S. Treasury securities and other similar financial assets when it decided to allow an entity to recognize zero credit losses on an asset.

Keep in mind, however, that the FASB did not specifically exclude certain financial assets from the scope of the CECL model on the basis of the level of an asset’s credit risk. Rather, Example 8 illustrates that although it may be easy to conclude that the risk of nonpayment is zero on a U.S. Treasury security, the entity should still apply the CECL model to financial assets, even if the risk of loss associated with those assets is low. Consequently, the entity should apply the CECL model consistently to all of its financial assets regardless of the credit risk associated with each asset. That is, the entity should measure expected credit losses by considering all available relevant information, including details about past events, current conditions, and reasonable and supportable forecasts and their implications related to such losses.

Connecting the Dots

Zero Expected Losses

While the FASB did not explicitly exclude specific assets from the CECL model (other than by illustrating that an entity may conclude that the allowance on a U.S. Treasury security could be zero), the AICPA has published guidance indicating that an entity can expect zero losses on U.S. Treasury securities, Government National Mortgage Association (Ginnie Mae) mortgage-backed securities, and agency mortgage-backed securities (Fannie Mae and Freddie Mac). In reaching its conclusion, the AICPA compared indicators that would cause the entity to incur zero losses with indicators that would cause the entity to incur losses greater than zero. While none of the indicators are individually determinative, the comparison illustrated that, in the current economic environment, there was sufficient evidence that the entity could expect zero losses on the financial assets considered.

Footnotes

3

ASC 250-10-20 defines a change in accounting principle as follows:

A change from one generally accepted accounting principle to another generally accepted accounting principle when there are two or more generally accepted accounting principles that apply or when the accounting principle formerly used is no longer generally accepted. A change in the method of applying an accounting principle also is considered a change in accounting principle.

4

ASC 250-10-20 defines a change in accounting estimate as follows:

A change that has the effect of adjusting the carrying amount of an existing asset or liability or altering the subsequent accounting for existing or future assets or liabilities. A change in accounting estimate is a necessary consequence of the assessment, in conjunction with the periodic presentation of financial statements, of the present status and expected future benefits and obligations associated with assets and liabilities. Changes in accounting estimates result from new information. Examples of items for which estimates are necessary are uncollectible receivables, inventory obsolescence, service lives and salvage values of depreciable assets, and warranty obligations.

5

ASC 250-10-20 defines a change in accounting estimate effected by a change in accounting principle as follows:

A change in accounting estimate that is inseparable from the effect of a related change in accounting principle. An example of a change in estimate effected by a change in principle is a change in the method of depreciation, amortization, or depletion for long-lived, nonfinancial assets.

ASC 250-10-45-18 highlights that an entity must often use judgment to differentiate between a change in accounting principle and a change in accounting estimate and discusses certain changes that reflect a change in accounting estimate effected by a change in accounting principle.

6

The EIR is different for PCD assets. ASC 326 states that when determining the EIR “[f]or purchased financial assets with credit deterioration, however, to decouple interest income from credit loss recognition, the premium or discount at acquisition excludes the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at the date of acquisition.”

7

After adoption of ASU 2022-02, this requirement would no longer be relevant because the ASU eliminated the concept of a TDR from a creditor’s accounting.

8

Discussed at the August 29, 2018, FASB meeting.

9

Although ASU 2022-02 eliminates the TDR guidance in ASC 310-40, the guidance in ASC 310-40-15-20 has been moved to ASC 310-10-50-45. As a result, a creditor would now refer to ASC 310-10-50-45 when determining whether a debtor is experiencing financial difficulty.

10

The Interagency Guidance was jointly issued by the Board of Governors of the Federal Reserve System, the FDIC, the National Credit Union Administration, and the OCC.

11

As indicated in the examples in the Interagency Guidance, an entity must use judgment and consider the specific facts and circumstances, including the nature and functionality of the underlying collateral, in determining whether a loan is expected to be repaid solely through continued operation of the collateral. In OCC Supervisory Memorandum No. 2009-7, the OCC indicated that “[r]esidential real estate loan modifications without evidence of a sustained repayment capacity or cash flows from the borrower rely on the underlying collateral as the sole source of repayment and, as such, would likely be deemed collateral-dependent upon modification.”

12

Other factors that can affect an entity’s estimation of expected credit losses may include estimated prepayments on the financial asset (or group of financial assets) and expected repayments that may be received from sources other than the collateral (e.g., general recourse to the borrower or an embedded credit enhancement provided by a third-party guarantor).

4.6 Credit Enhancements

ASC 326-20

30-12 The estimate of expected credit losses shall reflect how credit enhancements (other than those that are freestanding contracts) mitigate expected credit losses on financial assets, including consideration of the financial condition of the guarantor, the willingness of the guarantor to pay, and/or whether any subordinated interests are expected to be capable of absorbing credit losses on any underlying financial assets. However, when estimating expected credit losses, an entity shall not combine a financial asset with a separate freestanding contract that serves to mitigate credit loss. As a result, the estimate of expected credit losses on a financial asset (or group of financial assets) shall not be offset by a freestanding contract (for example, a purchased credit-default swap) that may mitigate expected credit losses on the financial asset (or group of financial assets).

Among other factors that may affect expected credit losses on a financial asset (or group of similar financial assets), an entity should consider whether the asset includes an embedded credit enhancement provided by a third-party guarantor (e.g., private mortgage insurance). In determining whether an enhancement feature is embedded or freestanding, an entity must consider the following definition of a freestanding contract in the ASC master glossary:

A freestanding contract is entered into either:

Separate and apart from any of the entity’s other financial instruments or equity transactions
In conjunction with some other transaction and is legally detachable and separately exercisable.

If the financial asset includes an embedded credit enhancement feature, the entity should consider how the cash flows associated with such a feature should be incorporated into the expectation of cash flows that are recoverable on the financial asset. By contrast, the entity must not consider cash flows associated with a freestanding credit enhancement contract (e.g., credit insurance purchased by the entity, including credit default swaps) even though the objective of obtaining such a contract is the same as if it were embedded in the financial asset (i.e., to mitigate credit exposure). To avoid double counting, an entity is prohibited from considering the effects of a freestanding credit enhancement feature when estimating expected credit losses. For example, the cash flows from a credit default swap that is a credit enhancement of a loan asset should not be included in the measurement of expected credit losses because such a swap would be recognized separately as a derivative financial instrument. Even if the freestanding credit insurance is not accounted for as a derivative, cash flows from freestanding credit insurance should not be considered in the estimation of expected losses on the related “covered” assets.

4.6.1 Freestanding Credit Insurance and Other Credit Risk Mitigation Contracts

Although ASC 326-20 is clear that an entity must not consider cash flows associated with a freestanding credit enhancement contract when estimating its expected credit losses, questions have arisen regarding how an entity must account for these freestanding contracts. ASC 326-20 does not address freestanding contracts that mitigate credit risk on financial assets.

To address these questions, the FASB staff stated, in response to a technical inquiry, that it would be appropriate for an entity that is applying ASU 2016-13 to recognize an insurance recovery asset on a freestanding credit insurance contract at the time expected credit losses are recorded. The staff also noted that there may be other acceptable approaches to recognizing freestanding contracts, including recognition of the insurance recovery asset on an incurred basis. However, the staff clarified that its views on freestanding contracts pertain only to contracts that (1) qualify for the scope exception in ASC 815-10-15-13(c) or (d) related to applying derivative accounting and (2) pass the risk transfer test in ASC 340-30 and ASC 944-20.

Connecting the Dots

Recording the Recovery Asset

We believe that, in accounting for recoveries from freestanding insurance contracts, it is appropriate for entities to analogize to the guidance on indemnification assets in ASC 805. That guidance requires entities to measure an indemnification asset on the same basis as the indemnified item.

An approach in which a recovery asset is recorded at the same time an expected credit loss is recorded in earnings under ASC 326 is generally referred to as the “mirror image approach.” Under the mirror image approach, the expected recovery asset would be measured in a manner consistent with the expected credit loss; accordingly, the accounting for the insured instruments would be “matched” and the economics of the arrangement would be reflected. Further, the credit insurance recovery asset would be estimated by using the same assumptions as the loss estimate on the underlying assets and would result in the recording of equal amounts for the allowance for loan losses and the credit insurance recovery asset (provided that the insurance covered the full amount of the expected credit loss). Therefore, an entity would most likely recognize in earnings a “day one recovery of expected credit losses” on purchased credit insurance.

Keep in mind, however, that ASC 326-20 applies to the insurance recovery asset recognized on a freestanding insurance contract. That is, just as expected credit losses must be measured on a reinsurance receivable, an entity must measure expected credit losses on an insurance recovery asset.

Although the credit insurance recovery asset is measured by using assumptions that are consistent with those used to estimate expected credit losses, the credit insurance recovery asset should not be presented net or offset against the allowance for credit losses related to the insured instruments. Moreover, the amounts recorded in the income statement in connection with the credit insurance recovery asset should not be presented net against the related credit loss expense.

4.8 Considerations Related to Postacquisition Accounting for Acquired Loans

An entity may acquire loans in a business combination or in an asset acquisition. Loans acquired in a business combination are initially recognized at fair value in accordance with ASC 805-20-25-1. Loans acquired in an asset acquisition are initially recognized at the amount paid to the seller plus any fees paid or less any fees received in accordance with ASC 310-20-30-5. Other sections of the Codification may address the initial recognition of loans acquired in exchange for noncash consideration or loans acquired in an asset acquisition that includes other assets acquired or liabilities assumed. ASC 310 requires an investor to initially classify acquired loans as “held for investment” or “held for sale.” For more information about the reclassification of the loans, see Section 4.10.

4.8.1 Postacquisition Accounting for Acquired Loans Receivable Classified as Held for Investment

If the fair value option in ASC 825 is elected as of the acquisition date, the acquired loans are subsequently measured at fair value through earnings. Section 12.4.1 of Deloitte’s Roadmap Fair Value Measurements and Disclosures (Including the Fair Value Option) addresses the separate presentation of interest income when the fair value option has been elected.

If the fair value option in ASC 825 is not elected as of the acquisition date, the investor should recognize the acquired loans at amortized cost and would need to evaluate whether to apply the PCD model to the acquired loans. The PCD model applies to acquired 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. See Chapter 6 for more information about the PCD model, including guidance on the recognition of income and expected credit losses on PCD assets.

If the investor determines that the PCD model does not apply to the acquired loans, the investor should subsequently account for them by applying the following guidance in ASC 310-20 and ASC 326-20 on income recognition and expected credit losses, respectively:

ASC 310-20 addresses specific matters related to the application of the interest method to loans within its scope. Under ASC 310-20, the interest method is used to recognize, as a level-yield adjustment, the difference between the initial recorded investment in the loan and the principal amount of the loan.
ASC 326-20 addresses the measurement of expected credit losses for financial assets measured at amortized cost. Upon acquiring the loan(s), the investor would be required to record an allowance for expected credit losses on acquired assets within the scope of ASC 326 (even if the acquired loans were initially recognized at fair value in a business combination or at the amount paid to the seller if acquired in an asset acquisition).

4.8.2 Postacquisition Accounting for Acquired Loans Receivable Classified as Held for Sale

If the fair value option in ASC 825 is elected as of the acquisition date, the acquired loans are subsequently measured at fair value through earnings. Section 12.4.1 of Deloitte’s Roadmap Fair Value Measurements and Disclosures (Including the Fair Value Option) addresses the separate presentation of interest income when the fair value option has been elected.

If the fair value option in ASC 825 is not elected as of the acquisition date, the investor should subsequently measure loans classified as held for sale at the lower of cost or fair value, as required by ASC 310-10-35-48 for nonmortgage loans held for sale and ASC 948-310-35-1 for mortgage loans held for sale. Purchase discounts on mortgage loans are not amortized as interest income when the loans are classified as held for sale. Similarly, purchase discounts on nonmortgage loans are not amortized as interest income when the loans are classified as held for sale. Rather, recognition of interest income on HFS loans is generally based on the stated coupon rate on the loan receivable.

4.9 Subsequent Events

ASC 855-10

55-1 The following are examples of recognized subsequent events addressed in paragraph 855-10-25-1:

If the events that gave rise to litigation had taken place before the balance sheet date and that litigation is settled after the balance sheet date but before the financial statements are issued or are available to be issued, for an amount different from the liability recorded in the accounts, then the settlement amount should be considered in estimating the amount of liability recognized in the financial statements at the balance sheet date.
Subsequent events affecting the realization of assets, such as inventories, or the settlement of estimated liabilities, should be recognized in the financial statements when those events represent the culmination of conditions that existed over a relatively long period of time.

55-2 The following are examples of nonrecognized subsequent events addressed in paragraph 855-10-25-3:

Sale of a bond or capital stock issued after the balance sheet date but before financial statements are issued or are available to be issued
A business combination that occurs after the balance sheet date but before financial statements are issued or are available to be issued (Topic 805 requires specific disclosures in such cases.)
Settlement of litigation when the event giving rise to the claim took place after the balance sheet date but before financial statements are issued or are available to be issued
Loss of plant or inventories as a result of fire or natural disaster that occurred after the balance sheet date but before financial statements are issued or are available to be issued
Changes in estimated credit losses on receivables arising after the balance sheet date but before financial statements are issued or are available to be issued
Changes in the fair value of assets or liabilities (financial or nonfinancial) or foreign exchange rates after the balance sheet date but before financial statements are issued or are available to be issued
Entering into significant commitments or contingent liabilities, for example, by issuing significant guarantees after the balance sheet date but before financial statements are issued or are available to be issued.

Although ASU 2016-13 did not significantly amend the guidance in ASC 855-10 on subsequent events, it did make conforming amendments to reflect the change from an incurred loss model to the CECL expected loss model. However, given the change to an expected loss model that incorporates forward-looking information, questions have arisen about whether an entity is required to consider certain events that occur or information that arises after the reporting date when estimating its expected credit losses as of the reporting date. While we believe that an entity must exercise significant judgment when evaluating whether information that arises after the balance sheet date should be included in the entity’s estimate of expected credit losses, a recent speech by the SEC staff is informative in this regard and provides a framework for an entity’s evaluation of subsequent events.

Specifically, at the 2018 AICPA Conference on Current SEC and PCAOB Developments, OCA Senior Associate Chief Accountant Kevin Vaughn addressed the staff’s observations about a recent consultation related to a registrant’s evaluation of subsequent events after its adoption of ASU 2016-13. The consultation addressed the following three scenarios in which information (1) is received after the balance sheet date but before the financial statements are issued or available to be issued and (2) significantly differs from that expected by management:

Scenario 1 — An entity receives a loan servicer report that includes loan activity (e.g., delinquencies and prepayments) that occurred on or before the balance sheet date.
Scenario 2 — An entity receives an appraisal report detailing the fair value of loan collateral as of the balance sheet date.
Scenario 3 — The government announces unemployment rates for a period that includes the balance sheet date.

The SEC staff indicated that in the first two scenarios, it would object to the registrant’s exclusion of the information from its process for estimating expected credit losses. The staff noted that in both scenarios, an important consideration “was that this information was loan-specific information about factual conditions that existed at the balance sheet date.” By contrast, because the information in Scenario 3 is used to make projections for periods that extend beyond the balance sheet date and is not loan-specific, the SEC staff would not object if such information is included in, or omitted from, the registrant’s estimation process.

In addition, Mr. Vaughn acknowledged that if other facts and circumstances become known after the balance sheet date, a registrant will need to evaluate whether such information should be incorporated into the estimate of expected credit losses. He shared the following views on how an entity should perform subsequent-event evaluations in estimating expected credit losses:

Category 1 — A registrant receives loan-specific information related to facts that exist on the balance sheet date. The registrant should include such information in its estimation process.
Category 2 — A registrant receives information related to forecasting before it completes its estimation process. The registrant is permitted but not required to include such information in its estimation process (unless the information indicates a material weakness or a deficiency in the registrant’s CECL process, in which case the registrant must include such information).
Category 3 — A registrant receives information related to forecasting after it completes its estimation process. The registrant would not include such information in its process (unless the information indicates a material weakness or a deficiency in the registrant’s CECL process, in which case the registrant must include such information).

4.10 Transfers Between Classification Categories

Financial assets reported at amortized cost are within the scope of ASC 326-20. By contrast, HFS loans and AFS debt securities are not within the scope of the guidance on expected credit losses in ASC 326-20 since (1) HFS loans are reported at the lower of amortized cost basis or fair value as of the balance sheet date and (2) AFS debt securities are reported at fair value as of the balance sheet date. However, upon either (1) the transfer of an HFS loan to an HFI loan or (2) the transfer of an AFS debt security to an HTM debt security, the transferred loan (i.e., HFI loan or HTM debt security) then becomes subject to ASC 326-20.

ASU 2016-13 does not provide guidance on how an entity should apply the CECL model when a loan that is HFS is transferred into an HFI classification (or vice versa) or when a debt security is transferred from AFS to HTM (or vice versa).17 As a result, in ASU 2019-04, the FASB provided guidance on transfers between classification categories. The table below summarizes this guidance.

HFS Loan to HFI Loan	HFI Loan to HFS Loan
On the transfer date, reverse any previous valuation allowance that was recorded in the income statement for the HFS loan. Transfer the loan to HFI at its amortized cost reduced by any previous write-offs (but excluding any valuation allowance). Evaluate the HFI loan for expected credit losses in accordance with ASC 326-20. The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.	On the transfer date, reverse any previous valuation allowance that was recorded in the income statement for the HFI loan. Transfer the loan to HFS at its amortized cost reduced by any previous write-offs (but excluding any valuation allowance). Evaluate the HFS loan for any valuation allowance in accordance with ASC 310-10. The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

HFS Loan to HFI Loan

HFI Loan to HFS Loan

On the transfer date, reverse any previous valuation allowance that was recorded in the income statement for the HFS loan.
Transfer the loan to HFI at its amortized cost reduced by any previous write-offs (but excluding any valuation allowance).
Evaluate the HFI loan for expected credit losses in accordance with ASC 326-20.
The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

On the transfer date, reverse any previous valuation allowance that was recorded in the income statement for the HFI loan.
Transfer the loan to HFS at its amortized cost reduced by any previous write-offs (but excluding any valuation allowance).
Evaluate the HFS loan for any valuation allowance in accordance with ASC 310-10.
The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

HTM Debt Security to AFS Debt Security	AFS Debt Security to HTM Debt Security
On the transfer date, reverse into earnings any allowance for credit losses that was previously recorded. Transfer the debt security to the AFS category at the security’s amortized cost basis reduced by any previous write-offs (but excluding any valuation allowance). Evaluate the AFS debt security for expected credit losses in accordance with ASC 326-30. Report in other comprehensive income (OCI) any unrealized gains or losses on the transfer date. Consider whether the transfer between classification categories affects the entity’s intent and ability to hold HTM debt securities. The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.	On the transfer date, reverse into earnings any allowance for credit losses that was previously recorded. Transfer the debt security to the HTM category at the security’s amortized cost basis reduced by any previous write-offs (but excluding any valuation allowance) plus or minus the amount of the remaining unrealized gains or losses reported in accumulated OCI. Evaluate the HTM debt security for expected credit losses in accordance with ASC 326-20. Continue to report any unrealized gains or losses that exist on the transfer date in a separate component of equity. The gains or losses should be amortized over the remaining life of the security as an adjustment to the security’s yield. The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

HTM Debt Security to AFS Debt Security

AFS Debt Security to HTM Debt Security

On the transfer date, reverse into earnings any allowance for credit losses that was previously recorded.
Transfer the debt security to the AFS category at the security’s amortized cost basis reduced by any previous write-offs (but excluding any valuation allowance).
Evaluate the AFS debt security for expected credit losses in accordance with ASC 326-30.
Report in other comprehensive income (OCI) any unrealized gains or losses on the transfer date.
Consider whether the transfer between classification categories affects the entity’s intent and ability to hold HTM debt securities.
The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

On the transfer date, reverse into earnings any allowance for credit losses that was previously recorded.
Transfer the debt security to the HTM category at the security’s amortized cost basis reduced by any previous write-offs (but excluding any valuation allowance) plus or minus the amount of the remaining unrealized gains or losses reported in accumulated OCI.
Evaluate the HTM debt security for expected credit losses in accordance with ASC 326-20.
Continue to report any unrealized gains or losses that exist on the transfer date in a separate component of equity. The gains or losses should be amortized over the remaining life of the security as an adjustment to the security’s yield.
The income statement effect of the reversal of the previous allowance and the establishment of a new allowance should be recognized in the income statement on a gross basis.

ASC 320-10-35-10 through 35-16 provide guidance on transfers between the classifications of investments in debt and equity securities (i.e., trading, AFS, and HTM). Transfers involving the trading classification are expected to be rare. Transfers out of the HTM classification may call into question the entity’s ability to use that classification for a period. Transfers from AFS to HTM are not restricted, provided that the entity has the positive intent and ability to hold the transferred security to its maturity.

Example 4-3

Transfer From HTM to AFS

Company X has an investment in a bond that is classified as HTM. The bond was acquired for $1,000 with a par value of $1,000. Upon initial recognition of the bond, X recognized an allowance of $70 for credit losses. During the following year, X transfers the bond from HTM to AFS. As of the transfer date, the bond’s amortized cost and fair value are $1,000 and $900, respectively. In addition, as of the transfer date, because the bond is now classified as AFS, X determines, in accordance with ASC 326-30, that $90 of the unrealized loss is related to credit and $10 is related to interest rate changes.

As of the transfer date, X would record the following journal entries:

Example 4-4

Transfer From AFS to HTM

Company Z purchases a security and classifies it as AFS. The security is acquired at its par value of $4,000. Immediately before the transfer date, the security’s fair value is $3,500 and its allowance for credit losses is $300 (accordingly, Z recognizes in OCI an unrealized loss of $200 that is due to non-credit-related factors). Once Z transfers the security from AFS to HTM, it estimates the allowance for credit losses on the security to be $350 in accordance with ASC 326-20.

As of the transfer date, X would record the following journal entries:

Keep in mind that the unrealized loss of $200 as of the transfer date will continue to be recorded in AOCI; however, it should be amortized prospectively over the remaining life of the security from AOCI. The amortization should be performed in a manner consistent with the recognition of a premium or discount (e.g., the effective interest method). In addition, the transfer will create a discount of $200 on the carrying amount of the security that should be amortized prospectively over the remaining life of the security. Typically, this amortization will have no net impact on the reported yield of the security because the amortization of the amount in AOCI and the amortization of the discount will offset each other. Effectively, the amortization of the unrealized loss in AOCI will reduce the debt discount, thereby increasing the carrying amount of the investment.

Footnotes

17

This issue was initially addressed by the TRG at its June 2018 meeting and led to the FASB’s issuance of ASU 2019-04.

Chapter 5 — Application of the CECL Model to Off-Balance-Sheet Commitments, Trade and Lease Receivables, and Reinsurance Receivables

5.3 Lease Receivables

Unlike receivables arising from operating leases (see Section 2.2 for more information), net investments resulting from sales-type or direct financing leases are within the scope of ASC 326 and lessors will therefore need to determine expected credit losses for such instruments. Under ASC 840, a lessor was required to assess the net investment in a lease for impairments by assessing (1) the lease receivable in accordance with ASC 310 and (2) the unguaranteed residual asset in accordance with ASC 360. However, ASC 842 did not carry forward the dual model for assessing impairment of the net investment in the lease.

In the Background Information and Basis for Conclusions of ASU 2016-02, the FASB noted that including two impairment models would be overly complex and that the benefits of the resulting financial statement information would not justify its costs. Moreover, the Board indicated that the net investment in a lease primarily comprises a financial lease receivable (i.e., the unguaranteed residual asset is often insignificant) and therefore should be accounted for as a financial asset under ASC 310. Thus, although the unguaranteed residual asset included in a lessor’s net investment in a lease does not meet the definition of a financial asset, a lessor that adopts ASU 2016-13 will be required to apply the CECL model to the net investment in the lease, including both the lease receivable and the unguaranteed residual asset.

5.3.1 Measuring Expected Credit Losses on a Net Investment in a Lease

ASC 842-30-35-3 provides guidance on how a lessor should determine an impairment related to a net investment in a lease. According to that guidance, when a lessor performs its evaluation, the collateral it considers should include the cash flows that the lessor would expect to derive from the underlying asset after the end of the lease term. Specifically, ASC 842-30-35-3 states:

A lessor shall determine the loss allowance related to the net investment in the lease and shall record any loss allowance in accordance with Subtopic 326-20 on financial instruments measured at amortized cost. When determining the loss allowance for a net investment in the lease, a lessor shall take into consideration the collateral relating to the net investment in the lease. The collateral relating to the net investment in the lease represents the cash flows that the lessor would expect to receive (or derive) from the lease receivable and the unguaranteed residual asset during and following the end of the remaining lease term. [Emphasis added]

The unit of account used when the impairment model is applied from the lessor’s perspective is meant to encompass the amounts related to the entire net investment in the lease, including the residual asset. Therefore, when evaluating the net investment in a sales-type or direct financing lease for impairment, a lessor should use the cash flows it expects to derive from the underlying asset during the remaining lease term as well as those it expects to derive from the underlying asset at the end of the lease term (i.e., cash flows expected to be derived from the residual asset). When determining the cash flows to be derived from the residual asset, the lessor should consider the amounts it would receive for releasing or selling the underlying asset to a third party but should not consider the expected credit risk of the potential future lessee or buyer of the underlying asset (i.e., it would not be appropriate for the lessor to include a credit risk assumption in its analysis since it does not know the identity of the theoretical future lessee or buyer).

5.3.2 Gains and Losses on Subsequent Dispositions of Leased Assets

When measuring expected credit losses on a portfolio of net investment in leases, an entity should consider gains arising from the subsequent disposition of leased assets.

At the June 2018 TRG meeting, the FASB staff stated that “entities should estimate expected cash flows from the subsequent disposition of leased assets (whether those result in expected gains or losses on disposal) when calculating expected credit losses on a portfolio of net investments in leases under the guidance in Subtopic 326-20 if that estimate is reasonable and supportable consistent with the treatment of other inputs to the calculation of expected credit losses.” That is, the FASB staff does not view the pool-level assessment required under ASC 326-20 as precluding the inclusion of “cash flows from the subsequent disposition of leased assets expected to result in gains on disposal from the calculation of expected credit losses.”4

However, we believe that the inclusion of expected gains on the disposal of leased assets should not, by itself, cause an entity’s allowance for expected credit losses to be negative. That is, while an entity should include in its estimate of expected credit losses the cash flows expected upon the disposition of the leased assets, we believe that the amount of cash flows related to gains on the disposal of such assets should be limited to the amount necessary to offset any expected credit losses on the lease payments.

Example 5-5

Lessor’s portfolio of sales-type leases has a net investment balance of $6 million. On the basis of its historical experience and its reasonable and supportable forecasts, Lessor estimates that 4 percent will default. Given the projected net investment balance at the time of the defaults and the estimated proceeds from the disposition of the leased assets, Lessor expects $200,000 of credit losses. In addition, it expects to recover $50,000 from the sale of the assets included in its performing leases (i.e., those that will not default during the lease term). On the basis of the FASB staff’s response at the TRG meeting, Lessor would estimate its expected credit losses as the sum of (1) its expected credit losses resulting from expected defaults plus (2) the gains it expects to recover from the disposition of assets on the leases that do not default. That is, Lessor’s expected credit losses would be $150,000, calculated as the net amount expected to be collected at the pool level.

Footnotes

4

See TRG Memo 7.

5.4 Reinsurance Receivables

A reinsurance transaction is one in which a reinsurer (an assuming entity) assumes all or part of a risk undertaken originally by another insurer (a ceding entity) for consideration. As noted in Chapter 2, ASC 326-20 applies to all reinsurance receivables that result from insurance transactions within the scope of ASC 944 regardless of the underlying measurement basis of the receivables (i.e., measured at amortized cost or on a discounted basis). The CECL model does not have any special provisions or guidance that specifically applies to reinsurance receivables. However, we believe that an entity will need to carefully consider the following when applying the CECL model to reinsurance receivables:

Isolating credit risk — Determining what portion of the collectibility concerns about reinsurance receivables is related to credit risk versus other risks (e.g., dispute risk, legal risk).
Unit of account — ASC 326-20 requires entities to perform a collective assessment if the reinsurance receivables share similar risk characteristics.

5.4.1 Isolating Credit Risk

Before being amended by ASU 2016-13, ASC 944-310-35-4 stated, in part, that “the ceding entity shall assess the collectibility of those [reinsurance] recoverables in accordance with Subtopic 450-20.” Accordingly, under current U.S. GAAP, an entity is not required to consider the reasons why collectibility concerns exist. Rather, ASC 944 requires entities to evaluate such concerns in accordance with ASC 450-20, even if they result from a combination of different risks associated with the asset.

However, ASU 2016-13 amended ASC 944-310-35-4 to state that although “[a]n entity shall measure contingent losses relating to disputed amounts in accordance with Subtopic 450-20 on loss contingencies[,] the ceding entity shall measure expected credit losses relating to reinsurance recoverables in accordance with Subtopic 326-20 on financial instruments measured at amortized cost” (emphasis added). Consequently, under ASU 2016-13, an entity is required to isolate the collectibility concerns that are related only to credit risk and measure the expected credit losses in accordance with ASC 326. The requirement to bifurcate risks to isolate credit risk may be challenging for entities that have reinsurance receivables.

5.4.2 Unit of Account

As described in Chapter 3, the CECL model does not prescribe a unit of account (e.g., an individual asset or a group of financial assets) in the measurement of expected credit losses. However, an entity is required to evaluate financial assets within the scope of the model on a collective (i.e., pool) basis when assets 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 asset individually.

Although entities will be required to use judgment when evaluating the risk characteristics of all financial assets, they will need to pay particular attention to the specific risk characteristics of reinsurance receivables. Example 17 in ASC 326-20 illustrates the evaluation of different types of risks related to reinsurance receivables.

ASC 326-20

Example 17: Identifying Similar Risk Characteristics in Reinsurance Recoverables

55-81 Reinsurance recoverables may comprise a variety of risks that affect collectibility including:

Credit risk of the reinsurer/assuming company
Contractual coverage disputes between the reinsurer/assuming company and the insurer/ceding company including contract administration issues
Other noncontractual, noncoverage issues including reinsurance billing and allocation issues.

55-82 This Subtopic only requires measurement of expected losses related to the credit risk of the reinsurer/assuming company.

55-83 In situations in which similar risk characteristics are not present in the reinsurance recoverables, the ceding insurer should measure expected credit losses on an individual basis. Similar risk characteristics may not exist because any one or a combination of the following factors exists, including, but not limited to:

Customized reinsurance agreements associated with individual risk geographies
Different size and financial conditions of reinsurers that may be either domestic or international
Different attachment points among reinsurance agreements
Different collateral terms of the reinsurance agreements (such as collateral trusts or letters of credit)
The existence of state-sponsored reinsurance programs.

55-84 However, similar risk characteristics may exist for certain reinsurance recoverables because any one or combination of the following exists:

Reinsurance agreements that have standardized terms
Reinsurance agreements that involve similar insured risks and underwriting practices
Reinsurance counterparties that have similar financial characteristics and face similar economic conditions.

55-85 Judgment should be applied by ceding insurers in determining if and when similar risks exist within their reinsurance recoverables.

Chapter 6 — Purchased Credit-Deteriorated Assets

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.

Chapter 7 — Available-for-Sale Debt Securities

7.1 Introduction

The CECL model does not apply to AFS debt securities. Instead, the FASB decided to make targeted improvements to the existing OTTI model in ASC 320 for AFS debt securities to eliminate the concept of “other than temporary” from that model. Although the Board originally sought to develop an expected credit losses model that would apply similarly to loans and debt securities, feedback received from stakeholders throughout the model’s development indicated that an entity manages AFS debt securities differently from how it manages other assets measured at amortized cost (e.g., loans and HTM debt securities). Accordingly, in paragraph BC81 of ASU 2016-13, the Board indicates that “the same credit loss model cannot apply because there are different measurement attributes. The measurement attribute for available-for-sale debt securities necessitates a separate credit loss model because an entity may realize the total value of the securities either through collection of contractual cash flows or through sales of the securities.”

The targeted changes to the existing OTTI model can be summarized as follows (see Section 7.2.3.1 for more information):

The entity must use an allowance approach (as opposed to permanently writing down the security’s cost basis).
The entity must limit the allowance to the amount at which the security’s fair value is less than its amortized cost basis.
The entity may not consider the length of time fair value has been less than amortized cost.
The entity may not consider recoveries in fair value after the balance sheet date when assessing whether a credit loss exists.

These targeted changes do not apply to an AFS debt security if (1) the entity intends to sell the security or (2) it is more likely than not that the entity will be required to sell the security before the recovery of the security’s amortized cost basis. In such cases, the entity would write down the debt security’s amortized cost to its fair value, as required under existing U.S. GAAP. The flowchart below illustrates how an entity identifies and assesses impairment on AFS debt securities.

7.1.1 Generally Consistent With Existing U.S. GAAP

7.2 Identifying an Impairment

7.2.1 Whether Fair Value Is Less Than Amortized Cost

ASC 326-30

35-1 An investment is impaired if the fair value of the investment is less than its amortized cost basis.

35-4 Impairment shall be assessed at the individual security level (referred to as an investment). Individual security level means the level and method of aggregation used by the reporting entity to measure realized and unrealized gains and losses on its debt securities. (For example, debt securities bearing the same Committee on Uniform Security Identification Procedures [CUSIP] number that were purchased in separate trade lots may be aggregated by a reporting entity on an average cost basis if that corresponds to the basis used to measure realized and unrealized gains and losses for the debt securities.) Providing a general allowance for an unidentified impairment in a portfolio of debt securities is not appropriate.

Other than moving guidance from ASC 320-10 to ASC 326-30, ASU 2016-13 did not affect how an entity identifies whether there is an impairment on an AFS debt security. That is, an entity is still required to assess whether the security’s fair value is less than its amortized cost and this evaluation must be performed on an individual security level.

7.2.1.1 Expected Loss Presumption

If the fair value of an AFS debt security is less than its amortized cost, there is not necessarily a presumption that a credit loss must be recognized. For AFS debt securities that an entity does not intend and is not more likely than not required to sell, ASC 326-30 requires the entity to recognize in net income the impairment amount related only to credit and to recognize in OCI the noncredit impairment amount. However, ASU 2016-13 requires an entity to use an allowance approach for AFS debt securities when recognizing credit losses (as opposed to a permanent write-down of the AFS security’s cost basis). ASC 326-30-35-2 states:

For [AFS debt securities], an entity shall determine whether a decline in fair value below the amortized cost basis has resulted from a credit loss or other factors. An entity shall record impairment relating to credit losses through an allowance for credit losses. However, the allowance shall be limited by the amount that the fair value is less than the amortized cost basis. Impairment that has not been recorded through an allowance for credit losses shall be recorded through other comprehensive income, net of applicable taxes. An entity shall consider the guidance in paragraphs 326-30-35-6 and 326-30-55-1 through 55-4 when determining whether a credit loss exists. [Emphasis added]

Entities should consider the following factors (not all-inclusive) when determining whether a credit loss exists (for more information about determining whether a credit loss exists, see Section 7.2.3):

Adverse conditions related to the security, an industry, or a geographic area.
The payment structure of the debt security and the likelihood that the issuer will be able to make payments that increase in the future.
Failure of the issuer to make scheduled payments and all available information relevant to the security’s collectibility.
Changes in the ratings assigned by a rating agency.
Other credit enhancements that affect the security’s expected performance.

The fair value of an AFS security may fall below amortized cost solely because of changes in interest rates or market liquidity, which are considered noncredit events. In that case, the entire unrealized loss will be recognized in OCI unless either (1) the entity intends to sell the security or (2) it is more likely than not that the entity will be required to sell the security. If the entity intends to sell the security or will more likely than not be required to sell it before recovery of its amortized cost basis, the entity must write down the amortized cost basis of the AFS security to its fair value as of the reporting date.

7.2.1.2 Management’s Responsibilities

ASC 326-30-35-4 states that management must perform an evaluation for impairment in each reporting period “at the individual security level.” When performing this assessment, management should employ a systematic and rational method for determining whether (1) an investment is impaired and (2) a credit loss exists or the investment’s amortized cost basis needs to be written down to its current fair value. Management should document all factors it considered in reaching its conclusions about whether an investment is impaired; such documentation would typically include:

The nature of the investment.
The cause or causes of the impairment.
An evaluation of management’s intent to sell any debt securities as of the measurement date (see Section 7.2.2 for more information).
Management’s assessment of whether it is more likely than not that it will be required to sell a particular debt security before the recovery of its amortized cost basis (see Section 7.2.2 for more information).
All information relevant to the collectibility of a debt security that was considered in management’s conclusion about whether a credit loss exists (see Section 7.2.1.1 for more information about the assessment of the collectibility of debt securities).

7.2.1.3 Accrued Interest

ASC 326-30

30-1A If for the purposes of identifying and measuring an impairment the applicable accrued interest is excluded from both the fair value and the amortized cost basis of the available-for-sale debt security, an entity may develop its estimate of expected credit losses by measuring components of the amortized cost basis on a combined basis or by separately measuring the applicable accrued interest component from the other components of amortized cost basis.

30-1B If an entity excludes applicable accrued interest from both the fair value and the amortized cost basis of the available-for-sale debt security, the entity may make an accounting policy election, at the major security-type level, not to measure an allowance for credit losses for accrued interest receivables if it writes off the uncollectible accrued interest receivable balance in a timely manner. An entity that elects the accounting policy in this paragraph shall meet the disclosure requirements in paragraph 326-30-50-3C. This accounting policy election shall be considered separately from the accounting policy election in paragraph 326-30-35-13A. An entity may not analogize this guidance to components of amortized cost basis other than accrued interest.

In addition to its amendments on accrued interest for financial assets measured at amortized cost (see Section 4.4.5.1), ASU 2019-04 amended the guidance on how an entity considers accrued interest when measuring expected credit losses on AFS debt securities. The ASU states that for an AFS debt security, an entity is permitted to (1) evaluate for impairment and measure the allowance for credit losses on accrued interest receivable balances separately from other components of the security’s amortized cost basis and (2) make an accounting policy election not to measure an allowance for credit losses on accrued interest receivable amounts if the entity excludes the accrued interest from both the fair value and amortized cost basis of the security, writes off the uncollectible accrued interest receivable balance in a timely manner, and provides certain disclosures (see Section 8.2.7).

7.2.2 Intent or Requirement to Sell

ASC 326-30

35-10 If an entity intends to sell the debt security (that is, it has decided to sell the security), or more likely than not will be required to sell the security before recovery of its amortized cost basis, any allowance for credit losses shall be written off and the amortized cost basis shall be written down to the debt security’s fair value at the reporting date with any incremental impairment reported in earnings. If an entity does not intend to sell the debt security, the entity shall consider available evidence to assess whether it more likely than not will be required to sell the security before the recovery of its amortized cost basis (for example, whether its cash or working capital requirements or contractual or regulatory obligations indicate that the security will be required to be sold before the forecasted recovery occurs). In assessing whether the entity more likely than not will be required to sell the security before recovery of its amortized cost basis, the entity shall consider the factors in paragraphs 326-30-55-1 through 55-2.

7.2.2.1 Intent to Sell

An investor is required to assess, in each reporting period, whether it intends to sell an impaired AFS debt security. Under ASC 326-30-35-10, if the investor intends to sell the security, it must write down the security’s amortized cost basis to its fair value, write off any existing allowance for credit losses, and recognize in earnings any incremental impairment.

An investor is considered to have the intent to sell an impaired AFS debt security if it has decided to sell that security as of the reporting date. If the entity decided to sell the impaired security in a prior period (and thus recognized an impairment loss in that prior period) but has not sold the security by the end of a subsequent period, it would be required to assess whether it still has the intent to sell the security as of the end of that subsequent period. If the entity continues to have such intent, any further declines in fair value should be recognized as an additional impairment through earnings. If the entity revokes its decision to sell in a subsequent period, thereby asserting that it no longer has the intent to sell the security, it is not permitted to reverse any prior-period impairments recognized in earnings. (See Section 7.2.4 for a discussion of accounting for an AFS debt security after a write-down.)

In assessing whether it has decided to sell an AFS debt security, the entity should consider all available evidence, including the following:

The investor or its agent (e.g., a third party that manages the investor’s securities portfolio) has approved the sale of the security (see Section 7.2.2.1.1).
The investor has directed its agent to sell the security, and this sale is contingent on an event that is expected to occur (see Example 7-1).
The security is part of a group of securities that the investor or its agent has identified as being for sale.
The security or group of securities is being marketed to be sold at a price that does not significantly exceed fair value.
The security is sold shortly after the balance sheet date, and the facts and circumstances suggest that the decision to sell was made before that date. (See Section 7.2.2.2.1 for a more detailed discussion of impaired debt securities sold at a loss after the balance sheet date.)

Example 7-1

Company A holds an AFS debt security with a carrying (par) amount of $100, a fair value of $70, and a remaining maturity of five years. Further, A expects that, if it were to hold the security, it would recover the security’s full carrying amount and does not consider a credit loss to have occurred. On March 31, 20X1, A directs its third-party portfolio manager to sell the security if the value reaches $80.

Although A intends to sell the security, that intention is contingent on a future event (i.e., that the security’s value reaches $80). However, A expects to fully recover the security’s carrying amount by the maturity date. That is, A, expects the security’s value to reach $80 before maturity because of the mere passage of time. Therefore, A would be considered to have the present intent to sell the security and, accordingly, should write the security’s amortized cost basis down to $70 and record an impairment loss of $30 in earnings.

If A has not sold the security by the end of a subsequent period, A would still be considered to have the present intent to sell it. Further declines in value would necessitate further write-downs in the amortized cost basis and would be considered impairment losses unless A revokes its intention to sell or the security’s value is no longer expected to reach $80 as a result of credit losses (however, the security would still be evaluated for an allowance for credit losses on the basis of the current amortized cost basis). If A revokes its decision to sell the security in a subsequent period, thereby asserting that it no longer has the intent to sell, it is not permitted to reverse any prior-period impairments recognized in earnings.

7.2.2.1.1 Considerations Related to a Managed Investment Portfolio When the Manager Has Discretion to Sell

ASC 326-30-35-10 states, in part:

If an entity intends to sell the [AFS] debt security (that is, it has decided to sell the security), or more likely than not will be required to sell the security before recovery of its amortized cost basis, any allowance for credit losses shall be written off and the amortized cost basis shall be written down to the debt security’s fair value at the reporting date with any incremental impairment reported in earnings.

In certain circumstances, an AFS debt security is managed by an independent investment adviser that has discretion to purchase and sell debt securities without management approval. In such cases, management would evaluate whether an investor intends, or is more likely than not required, to sell the security before recovery of its amortized cost basis.

In performing such an evaluation, management should understand whether the investment manager has decided to sell impaired AFS debt securities as of the balance sheet date.1 Further, management should evaluate the facts and circumstances if the third-party manager subsequently sells an impaired AFS debt security after that date. See Section 7.2.2.2.1 for a discussion of impaired AFS debt securities sold after the balance sheet date.

In evaluating whether it is more likely than not that the entity will be required to sell an AFS debt security before recovery of the security’s amortized cost basis (see Section 7.2.2.2), management should consider the facts and circumstances that may affect this assessment. An entity may be required to sell a debt security for legal, regulatory, or operational reasons. For example, the entity may need to sell an AFS debt security because it matures later than the date on which it must be sold to meet a contractual obligation. In such cases, management would need to consider whether it is more likely than not that this required sale will occur before the expected recovery. A history of “voluntary” sales of AFS debt securities in an investment portfolio, including sales to meet tax and other investment objectives, is not relevant in the assessment of the likelihood of required sales from the portfolio in the future, regardless of whether the voluntary sales were based on the actions of management or an independent investment adviser. In addition, the possibility that AFS debt securities could be sold anytime at the discretion of the third-party investment manager is insufficient to support an assertion by management that it is more likely than not that the investor will be required to sell the security before recovery of its amortized cost basis (although this factor should be considered in the evaluation of whether there is an intent to sell AFS debt securities, as discussed above).

Note that the impairment model for AFS debt securities differs from that for HTM debt securities. The entity should separately evaluate AFS debt securities and HTM debt securities if they are managed by the same third-party investment manager.

7.2.2.1.2 Evaluating Impairment of Investments in AFS Auction Rate Securities — Intent to Sell

Auction rate securities (ARSs) are distinct from other, more traditional securities. ARSs generally have long-term stated maturities; issuers are not required to redeem them until 20 to 30 years after issuance. However, from an investor’s perspective, ARSs have certain economic characteristics of short-term investments because of their rate-setting mechanism. The return on these securities is designed to track short-term interest rates through a “Dutch” auction process, which resets the coupon (or dividend) rate.

The auction process gives an investor three options as of each remarketing date: (1) hold its ARS “at market” without participating in the auction process; (2) hold its ARS “at rate,” allowing the investor to participate in the auction process; or (3) tender its ARS, allowing the investor to sell its securities into the auction process provided that the auction does not fail. Existing investors that choose to hold their ARSs “at rate” and potential new investors enter into a “blind” competitive-bid process in which they specify the lowest interest/dividend rate and quantity they are willing to accept. The lowest rate at which all of the securities can be placed (including to investors that choose the “at market” option) becomes the interest/dividend rate for these securities until the next auction date.

A failed auction may occur if the demand for the ARS is insufficient to allow existing investors to liquidate their holdings in the auction process.2 For example, if there is a lack of demand for an ARS issuance and no rate is established in the auction process that would clear the entire issuance, a failed auction would occur and current investors would be forced to continue holding their positions (generally, investors in a failed auction receive a maximum predetermined interest rate from the issuer unless and until sufficient bids are received by the next auction date). In typical ARS issuances, investors cannot require the issuer to redeem the securities resulting from a failed auction.

An investor may sell its ARS into the secondary market. However, when an auction has failed, the secondary market may be inactive or nonexistent and the fair value of the ARS may be less than par. Depending on market conditions and the underlying collateral of the ARS, the discount from par may be significant.

Generally, investments in ARSs are debt securities that should be accounted for under ASC 320. If the ARS is designated as an AFS debt security and its fair value is less than its carrying amount, management should evaluate the security to determine whether the recognition of an impairment loss is required. If, for example, management intends to sell the ARS, an impairment loss would be recognized.

The existence of an auction process for an ARS generally does not affect the evaluation of whether the investor has an intent to sell it. If the investor elects to tender its ARS, the security is typically tendered at its par amount. If this amount is equal to or greater than the investor’s amortized cost basis, the investor would expect to recover its entire amortized cost basis. In such instances, an intent to sell before recovery does not exist because the tendering of the securities is contingent on the investor’s receiving at least its entire amortized cost basis in return. If the investor elects to hold its ARS “at market” or “at rate,” an intent to sell does not exist since the investor would continue to hold the ARS regardless of the outcome of the auction.

If management determines that it does not intend to sell, or that it is not more likely than not that it will be required to sell, the ARS before recovery, the entity must assess whether a “credit loss”3 has occurred (e.g., if an auction fails). See Section 7.2.3 for a discussion of the calculation of credit losses.

7.2.2.2 Assessment of Whether It Is More Likely Than Not That the Entity Will Be Required to Sell

As discussed above, if an entity does not intend to sell an impaired AFS debt security, it will still need to assess whether it is more likely than not that it will be required to sell the security before recovery of the security’s amortized cost basis. Such an evaluation should take into account (1) the factors that might affect whether the entity is required to sell the security and (2) the probability that those factors will occur during the expected recovery period.

Factors that influence whether the entity may be required to sell the impaired AFS debt security include, but are not limited to, the following:

The entity’s cash and working capital requirements:
- The entity’s liquidity position, whether the entity expects that it will have to sell the debt security to meet expected cash requirements (e.g., to repay its existing obligations).
- Whether there have been any adverse changes in the entity’s business or industry that could compel the entity to sell the debt security to meet working capital requirements.
Any contractual or regulatory obligations that may cause the debt security to be sold:
- Whether it is likely that a third party (e.g., a regulator) could force the entity to sell the debt security.
- Whether the entity has contracts that would require it to sell specific debt securities upon the occurrence of certain events.

Once the entity has identified the factors that are relevant to determining whether it will be required to sell an impaired AFS debt security, it must consider the probability that those factors will occur during the anticipated recovery period. In evaluating the existence of a credit loss and estimating the debt security’s recovery period, the entity should consider the guidance in ASC 326-30-55-1:

There are numerous factors to be considered in determining whether a credit loss exists. The length of time a security has been in an unrealized loss position should not be a factor, by itself or in combination with others, that an entity would use to conclude that a credit loss does not exist. The following list is not meant to be all inclusive. All of the following factors should be considered:

The extent to which the fair value is less than the amortized cost basis
Adverse conditions specifically related to the security, an industry, or geographic area; for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, changes in the financial condition of the underlying loan obligors. Examples of those changes include any of the following:
1. Changes in technology
2. The discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security
3. Changes in the quality of the credit enhancement.
The payment structure of the debt security (for example, nontraditional loan terms as described in paragraphs 825-10-55-1 through 55-2) and the likelihood of the issuer being able to make payments that increase in the future
Failure of the issuer of the security to make scheduled interest or principal payments
Any changes to the rating of the security by a rating agency.

A write-down of an AFS debt security’s amortized cost to fair value is required if — in light of all relevant factors and the probability that those factors will occur during the expected recovery period — an entity determines that it is more likely than not that it will be required to sell the impaired security before recovery of the security’s amortized cost basis. Consequently, the entity must recognize any incremental impairment loss (i.e., the difference between the security’s fair value and amortized cost basis, less any existing allowance for credit losses) in earnings.

An entity must use professional judgment in determining the factors to consider and the probability that such factors will occur during the recovery period. In addition, the entity should document its conclusions regarding whether it is more likely than not that it will be required to sell the impaired AFS debt security before recovery. The entity should also be mindful of the information disclosed in its financial statements and MD&A and of how to reconcile that information with its assertion that it is more likely than not that it will be required to sell the impaired AFS debt security before recovery of the security’s amortized cost basis.

7.2.2.2.1 Sale of an Impaired AFS Debt Security at a Loss After the Balance Sheet Date

A sale of an impaired AFS debt security at a loss after the balance sheet date does not necessarily indicate that the security’s amortized cost basis should have been written down to its fair value as of the balance sheet date and that any incremental impairment loss should have been recognized in earnings. Under ASC 326-30, an entity’s objective is to write down an AFS debt security’s amortized cost basis to its fair value, write off any allowance for credit losses, and record any incremental impairment loss in earnings in the period in which the investor (1) decides to sell the security or (2) determines that it is more likely than not that it will be required to sell the security before recovery of the security’s amortized cost basis (the “MLTN assertion”). Accordingly, if an impaired AFS debt security is sold after the balance sheet date, the entity must consider whether those sales are inconsistent with its assertions as of the balance sheet date. In doing so, it should consider (1) when the decision to sell was made or (2) whether the impaired debt security was sold as a result of a requirement to sell the security and when it became more likely than not that it would be required to sell.

To assess whether subsequent sales of impaired AFS debt securities are consistent with the entity’s “lack of intent to sell” assertion as of the balance sheet date, the entity should determine when it decided to sell the impaired security. In performing this assessment, the entity should consider factors that include, but are not limited to, the following:

How soon the entity sold the security after the balance sheet date.
When the process of selling the security started and how long it took to sell the security (e.g., the length of the marketing period). The entity should consider whether the security is actively traded and whether the period between the decision to sell and the actual selling was in line with the customary marketing period for the security.
Whether there were standing orders to sell the security as of the balance sheet date.

Assume that an entity originally asserts as of the balance sheet date that it did not intend to sell the impaired AFS debt security. If the entity then concludes that the decision to sell the security was made after the balance sheet date, the original assertion as of the balance sheet date would be supported. Decisions to sell after the balance sheet date could be made for various reasons, including changing market conditions that affect an entity’s risk appetite and investment strategies.

In determining whether the subsequent sale of the impaired AFS debt security is consistent with its MLTN assertion as of the balance sheet date, an entity must first determine whether the subsequent sale occurred as a result of a requirement to sell (e.g., because of regulatory or contractual obligations or cash flow or working capital requirements). If the subsequent sale is not a result of a requirement to sell, the MLTN assertion as of the balance sheet date would be supported. However, if this subsequent sale resulted from a requirement to sell, the entity should consider whether there has been a change in the factors that it considered as of the balance sheet date, a change in the probability of those factors occurring, or both.

Such an assessment is based, in part, on management’s intent. Accordingly, an entity must exercise professional judgment in performing this evaluation and should prepare documentation that supports its “lack of intent to sell” and the MLTN assertions as of the balance sheet date. The entity should also consider contemporaneously documenting (1) when a decision to sell has been made and (2) a requirement to sell the securities and when it becomes more likely than not that it will need to comply with such a requirement. That said, the threshold for not having the intent to sell is lower than that for having the intent and ability to hold the security until recovery.

7.2.3 Whether a Credit Loss Exists

ASC 326-30

35-2 For individual debt securities classified as available-for-sale securities, an entity shall determine whether a decline in fair value below the amortized cost basis has resulted from a credit loss or other factors. An entity shall record impairment relating to credit losses through an allowance for credit losses. However, the allowance shall be limited by the amount that the fair value is less than the amortized cost basis. Impairment that has not been recorded through an allowance for credit losses shall be recorded through other comprehensive income, net of applicable taxes. An entity shall consider the guidance in paragraphs 326-30-35-6 and 326-30-55-1 through 55-4 when determining whether a credit loss exists.

35-3 At each reporting date, an entity shall record an allowance for credit losses that reflects the amount of the impairment related to credit losses, limited by the amount that fair value is less than the amortized cost basis. Changes in the allowance shall be recorded in the period of the change as credit loss expense (or reversal of credit loss expense).

35-6 In assessing whether a credit loss exists, an entity shall compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis of the security, a credit loss exists and an allowance for credit losses shall be recorded for the credit loss, limited by the amount that the fair value is less than amortized cost basis. Credit losses on an impaired security shall continue to be measured using the present value of expected future cash flows.

35-7 In determining whether a credit loss exists, an entity shall consider the factors in paragraphs 326-30-55-1 through 55-4 and use its best estimate of the present value of cash flows expected to be collected from the debt security. One way of estimating that amount would be to consider the methodology described in paragraphs 326-30-35-8 through 35-10. Briefly, the entity would discount the expected cash flows at the effective interest rate implicit in the security at the date of acquisition.

35-7A As an accounting policy election for each major security type of debt securities classified as available-for-sale securities, an entity may adjust the effective interest rate used to discount expected cash flows to consider the timing (and changes in the timing) of expected cash flows resulting from expected prepayments.

35-8 The estimates of expected future cash flows shall be the entity’s best estimate based on past events, current conditions, and on reasonable and supportable forecasts. Available evidence shall be considered in developing the estimate of expected future cash flows. The weight given to the information used in the assessment shall be commensurate with the extent to which the evidence can be verified objectively. If an entity estimates a range for either the amount or timing of possible cash flows, the likelihood of the possible outcomes shall be considered in determining the best estimate of expected future cash flows.

When an entity has an impaired AFS debt security and (1) the entity does not intend to sell the security and (2) it is not more likely than not that it will be required to sell the security before the recovery of the security’s amortized cost basis, the entity will need to consider whether the decline in fair value is related to a credit loss in accordance with ASC 326-30-35-2. If the entity cannot qualitatively conclude that a credit loss does not exist, it must perform this assessment quantitatively. Specifically, ASC 326-30-35-6 states, in part, that “[i]f the present value of cash flows expected to be collected is less than the amortized cost basis of the security, a credit loss exists and an allowance for credit losses shall be recorded for the credit loss, limited by the amount that the fair value is less than amortized cost basis.”

Therefore, the amount of credit loss for an impaired AFS debt security is the excess of (1) the security’s amortized cost basis over (2) the present value of the investor’s best estimate of the cash flows expected to be collected from the security. In accordance with ASC 326-30-35-8, the investor calculates the present value on the basis of its best estimate of the expected future cash flows by using “past events, current conditions, and . . . reasonable and supportable forecasts.” As indicated in ASC 326-20-30-4, the investor discounts the expected future cash flows “at the financial asset’s effective interest rate.” The ASC master glossary, as amended by ASU 2016-13, defines the EIR as the rate implicit in the security as of the acquisition date (i.e., the contractual interest rate “adjusted for any net deferred fees or costs, premium, or discount existing” as of the acquisition date).

When calculating the present value of the expected future cash flows, an entity should consider the guidance in ASC 326-30-55-2 through 55-4:

55-2 An entity should consider available information relevant to the collectibility of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of cash flows expected to be collected. That information should include all of the following:

The remaining payment terms of the security
Prepayment speeds
The financial condition of the issuer(s)
Expected defaults
The value of any underlying collateral.

55-3 To achieve the objective in paragraph 326-30-55-2, the entity should consider, for example, all of the following to the extent they influence the estimate of expected cash flows on a security:

Industry analyst reports and forecasts
Credit ratings
Other market data that are relevant to the collectibility of the security.

55-4 An entity also should consider how other credit enhancements affect the expected performance of the security, including consideration of the current financial condition of the guarantor of a security (if the guarantee is not a separate contract as discussed in paragraph 326-30-35-5), the willingness of the guarantor to pay, and/or whether any subordinated interests are capable of absorbing estimated losses on the loans underlying the security. The remaining payment terms of the security could be significantly different from the payment terms in prior periods (such as for some securities backed by nontraditional loans; see paragraph 825-10-55-1). Thus, an entity should consider whether a security backed by currently performing loans will continue to perform when required payments increase in the future (including balloon payments). An entity also should consider how the value of any collateral would affect the expected performance of the security. If the fair value of the collateral has declined, an entity should assess the effect of that decline on its ability to collect the balloon payment.

When an investor holds an impaired AFS debt security that it does not intend and will not more likely than not be required to sell before the recovery of the security’s amortized cost basis, the investor must determine whether it expects to recover the entire amortized cost basis (i.e., whether a credit loss exists).

Note that for securities within the scope of ASC 325-40, an investor considers, as of each reporting date, current information and events to determine whether there has been a favorable or adverse change in estimated cash flows compared with previous projections. On the basis of such considerations, the investor may adjust the accretable yield for these securities. This section does not address the requirements of this guidance.

An investor must perform a quantitative analysis when determining the amount of a credit loss, but it does not always need to perform such an analysis to conclude that a credit loss does not exist. That is, in certain circumstances, it may be sufficient for an investor to conclude that a credit loss does not exist by performing a qualitative analysis of whether it expects to recover the entire amortized cost basis of the debt security (i.e., whether a credit loss exists).

ASC 326-30-55-1 lists the following factors (not all-inclusive)4 for entities to consider in determining whether a credit loss exists:

The extent to which the fair value is less than the amortized cost basis
Adverse conditions specifically related to the security, an industry, or geographic area; for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, changes in the financial condition of the underlying loan obligors. Examples of those changes include any of the following:
1. Changes in technology
2. The discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security
3. Changes in the quality of the credit enhancement.
The payment structure of the debt security (for example, nontraditional loan terms as described in paragraphs 825-10-55-1 through 55-2) and the likelihood of the issuer being able to make payments that increase in the future
Failure of the issuer of the security to make scheduled interest or principal payments
Any changes to the rating of the security by a rating agency.

In addition, entities should consider the following factors addressed in ASC 326-30-55-2 through 55-4:

Changes in prepayment speeds.
Expected defaults.
Credit enhancements, including guarantees (and the financial condition of the guarantor) and the “value of any underlying collateral.”
Reports and forecasts by industry analysts.
Sector credit ratings.
The presence of “any subordinated interests [that] are capable of absorbing estimated losses on the loans underlying the security.”
Other relevant market data (e.g., applicable credit default swap spreads of the issuer, relevant market indexes, or changes in market interest rates after the acquisition of the security).

If, after performing a qualitative assessment, an entity is unable to obtain sufficient evidence that a credit loss does not exist for a particular debt security (i.e., that the entity will recover the entire amortized cost basis of the debt security), it will need to perform a detailed quantitative cash flow analysis for that security.

7.2.3.1 Changes to the Existing Impairment Model

While the guidance in ASU 2016-13 will not affect the determination of whether a credit loss exists on an AFS debt security (i.e., the comparison of the present value of cash flows expected to be collected with the security’s amortized cost basis), the ASU made some targeted amendments to the existing impairment model for AFS debt securities, as described in the sections below.

7.2.3.1.1 Use of an Allowance Approach

One of the FASB’s objectives in developing an expected credit losses model for an AFS debt security was to allow entities to recognize such losses on a more timely basis. The Board believed that the existing requirement for entities to recognize an OTTI as a direct write-down to the AFS debt security’s amortized cost basis, among other things, made them reluctant to recognize OTTIs. In other words, in the FASB’s view, since the model did not allow entities to reflect improvements in such a security’s credit quality, it caused delays in the recognition of OTTIs. Consequently, the Board decided to require entities to use an allowance when recognizing expected credit losses on an AFS debt security. This requirement is consistent with the requirement to use an allowance approach for all other financial assets that are within the scope of ASC 326-20. As stated in ASC 326-30-35-3, any changes in the allowance for expected credit losses on an AFS debt security would be recognized as an adjustment to the entity’s credit loss expense.

7.2.3.1.2 Credit Losses Limited by a Fair Value Floor

ASC 326-30-35-3 requires an entity to recognize as an allowance an AFS debt security’s expected credit losses, limited by the difference between the security’s fair value and its amortized cost basis. Paragraph BC83 of ASU 2016-13 states, in part:

[A]n entity could look to limit its credit loss exposure by selling a security if the total fair value loss was less than the credit loss measured for the security. That outcome could occur if a portion of the fair value attributable to non-credit-related factors offset the portion of fair value attributable to credit factors. Given the importance of fair value in the measurement of available-for-sale securities, the Board decided to incorporate a fair value floor in the amended model.

Example 7-2

Entity ABC holds a corporate bond that it classifies as an AFS debt security. On the reporting date, the security’s amortized cost is $1,000 and its fair value is $930. In assessing whether there is a credit loss on the security, ABC compares the present value of cash flows it expects to collect from the security with its amortized cost and determines that a credit loss of $100 is expected. However, in accordance with ASC 326-30-35-3, ABC must recognize only $70 as an allowance for credit losses because the security’s fair value is $930 on the reporting date. In other words, since ABC could limit its exposure to credit losses by selling the security at its fair value on the reporting date ($930), it should only recognize $70 ($1,000 – $930) as its allowance for expected credit losses.

7.2.3.1.3 Information to Consider When Estimating Credit Losses

ASC 326-30-55-1 carries forward much of the guidance in ASC 320-10-35-33F on the factors an entity considers when determining whether a credit loss exists. However, because ASU 2016-13 removes the distinction between whether an impairment is temporary or other than temporary, it also amends that guidance by removing an entity’s ability to consider:

The length of time in which fair value has been less than amortized cost.
Recoveries in the securities’ fair value after the balance sheet date.

Example 7-3

Entity X owns a corporate debt security (that does not have nontraditional terms) with a fair value of $90 and an amortized cost basis of $100. Entity X classifies the security as AFS and does not intend to sell it. Further, X concludes that it is not more likely than not that it will be required to sell the debt security before the recovery of the security’s amortized cost basis. To determine whether it will recover the security’s entire amortized cost basis and whether it has incurred a credit loss on the security, X considers, among other factors, (1) the fact that the corporate issuer was making, and is expected to continue to make, timely payments of principal and interest; (2) the relevant factors in ASC 326-30-55-2 through 55-4; and (3) other relevant market indicators.

On the basis of this qualitative assessment, X obtains sufficient evidence that it expects to recover the entire amortized cost basis of the corporate debt security and therefore concludes that a credit loss does not exist. In this circumstance, X did not need to perform a quantitative analysis to make such an assertion.

Connecting the Dots

Whether Changes in Prepayment Assumptions Alone Cause a Credit Loss in Asset-Backed AFS Debt Securities Outside the Scope of ASC 325-40 and PCD Accounting

Changes in prepayment speeds for the assets underlying an asset-backed security (e.g., a mortgage-backed security) often affect the present value of the cash flows expected to be collected from the security. For example, assume that an entity purchases a pass-through security that gives it the right to a pro rata share of the cash flows from an underlying pool of fixed-rate prepayable mortgage loans. If the security was purchased at a premium to par, the present value of the cash flows expected to be collected from the security will decrease when prepayments on the underlying mortgage loans increase. However, if the security was purchased at a discount to par, the present value of the cash flows expected to be collected will decrease when prepayments on the underlying mortgage loans decrease.

ASC 326-30-55-2 requires an investor to consider prepayment speeds, among other factors, when estimating the cash flows expected to be collected.

For AFS debt securities that are within the scope of ASC 325-40 and those that are PCD assets, entities are explicitly required to perform a discounted expected cash flow analysis in every period because of the expectation that more than an insignificant amount of the contractual cash flows will not be collected. This Connecting the Dots addresses only the accounting for asset-backed AFS debt securities that are not within the scope of ASC 325-40 or PCD accounting and for which prepayments on the assets underlying the asset-backed debt security are made at par, plus accrued and unpaid interest.

On the basis of informal discussions with the FASB staff after the issuance of FSP FAS 115-2 and FAS 124-2 that addressed the superseded OTTI guidance in ASC 320-10, an entity was allowed to choose one of two views, discussed below, as an accounting policy for an asset-backed AFS debt security that is not within the scope of ASC 325-40 or PCD accounting. We do not believe that the targeted changes to the impairment model for AFS debt securities affect this policy choice. The policy choice an entity elects should be consistently applied.

View A — Changes in Prepayment Assumptions Alone Could Cause a Credit Loss

According to this view, prepayment speeds affect the economic return to the investor in an asset-backed AFS debt security that is acquired at a premium or discount; therefore, an entity should recognize a credit loss when changes in prepayment speeds alone cause the present value of the cash flows expected to be collected to be less than the amortized cost basis of an impaired asset-backed AFS debt security. View A is consistent with the guidance in ASC 326-30-35-6 and ASC 326-30-55-2; accordingly, an entity should consider whether changes in prepayment assumptions alone cause the present value of the cash flows expected to be collected to be less than the amortized cost basis of the impaired asset-backed AFS debt security.

View B — Changes in Prepayment Assumptions Alone Would Not Cause a Credit Loss

The guidance in ASC 310-20-35-26 continues to apply to accounting for the impact of prepayments on the amortization or accretion of a discount or premium on an asset-backed AFS debt security. In addition, ASC 326-30-55-2 states, in part, that “[a]n entity should consider available information relevant to the collectibility of the security” (emphasis added). Therefore, according to this view, changes in prepayment assumptions alone do not necessarily affect the “collectibility” of cash flows due on the assets underlying an asset-backed AFS debt security.

An entity that adopts View B should, in the absence of a credit loss that occurs for other reasons, continue to apply its accounting policy election under ASC 310-20-35-26 to account for prepayments on an asset-backed debt security. If the entity determines that there is a credit loss for reasons other than mere changes in prepayment assumptions, it would generally be expected to consider anticipated prepayments in determining the cash flows expected to be collected (to calculate the amount of the credit loss). This treatment is consistent with the guidance in ASC 326-20-30-4 and ASC 326-30-35-7 and 35-8, which requires an entity to consider the amount and timing of cash flows in calculating an impairment loss.

Note that for an entity that adopts View B, there will generally not be an impairment on an agency mortgage-backed security (e.g., one that is guaranteed by Freddie Mac or Fannie Mae) in the absence of an intent to sell the security or a conclusion that it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis. That is, given the guarantee from the agency and the implicit support of the agencies by the U.S. government, there generally will not be a credit loss.

7.2.3.2 Variable-Rate Instruments

As originally issued, ASU 2016-13 stated that if a financial asset’s contractual interest rate varies on the basis of an independent factor, such as an index or rate, “[p]rojections of changes in the factor shall not be made for purposes of determining the effective interest rate or estimating expected future cash flows” (emphasis added). Since the issuance of the ASU, however, stakeholders have questioned whether it was inconsistent to prohibit an entity from projecting changes in the factor that leads to changes in the financial asset’s contractual interest rate while requiring the entity to consider projections when estimating expected cash flows.

As a result, the FASB clarified in ASU 2019-04 that an entity is permitted to consider projections of changes in the factor as long as the projections are the same as those used to estimate expected future cash flows.

Specifically, ASC 326-30-35-11 states:

If the security’s contractual interest rate varies based on subsequent changes in an independent factor, such as an index or rate, for example, the prime rate, the London Interbank Offered Rate (LIBOR), or the U.S. Treasury bill weekly average, that security’s effective interest rate (used to discount expected cash flows as described in paragraph 326-30-35-7) may be calculated based on the factor as it changes over the life of the security or is projected to change over the life of the security, or may be fixed at the rate in effect at the date an entity determines that the security has a credit loss as determined in accordance with paragraphs 326-30-35-1 through 35-2. The entity’s choice shall be applied consistently for all securities whose contractual interest rate varies based on subsequent changes in an independent factor. An entity is not required to project changes in the factor for purposes of estimating expected future cash flows. If the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall use the same projections in determining the effective interest rate used to discount those cash flows. In addition, if the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall adjust the effective interest rate used to discount expected cash flows to consider the timing (and changes in the timing) of expected cash flows resulting from expected prepayments in accordance with paragraph 326-30-35-7A. Subtopic 310-20 on receivables — nonrefundable fees and other costs provides guidance on the calculation of interest income for variable rate instruments.

Note that a change in cash flows due solely to a change in a variable interest rate on a plain-vanilla debt instrument does not result in a credit loss. Therefore, an entity would need to determine whether changes in estimated cash flows on a variable-rate AFS debt security should be considered a credit loss or are caused only by changes in expected contractual interest payments that resulted from changes in interest rates.

7.2.4 Subsequent Measurement

7.2.4.1 Accounting for Debt Securities After an Impairment

ASC 326-30

35-12 An entity shall reassess the credit losses each reporting period when there is an allowance for credit losses. An entity shall record subsequent changes in the allowance for credit losses on available-for-sale debt securities with a corresponding adjustment recorded in the credit loss expense on available-for-sale debt securities. An entity shall not reverse a previously recorded allowance for credit losses to an amount below zero.

35-13 An entity shall recognize writeoffs of available-for-sale debt securities in accordance with paragraph 326-20-35-8.

35-13A If for the purposes of identifying and measuring an impairment the applicable accrued interest is excluded from both the fair value and the amortized cost basis of the available-for-sale debt security, an entity may make an accounting policy election, at the major security-type level, to write off accrued interest receivables by reversing interest income or recognizing credit loss expense, or a combination of both. This accounting policy election shall be considered separately from the accounting policy election in paragraph 326-30-30-1B. An entity that elects this accounting policy shall meet the disclosure requirements in paragraph 326-30-50-3D. An entity may not analogize this guidance to components of amortized cost basis other than accrued interest.

An entity must continually assess its expectation of credit losses on an AFS debt security. If its expectation changes, the entity is required to recognize that change as an adjustment to the allowance for expected credit losses and an adjustment to credit loss expense. However, the allowance for credit losses cannot be reversed to an amount less than zero. In addition, the entity is required to assess whether the AFS debt security has become uncollectible. If so, the entity must apply the guidance in ASC 326-20-35-8 to write off the uncollectible portion of the security and the allowance for expected credit losses. For more information about write-offs, see Section 4.5.1.

7.2.4.2 Accounting for Debt Securities After a Write-Down

ASC 326-30

35-14 Once an individual debt security has been written down in accordance with paragraph 326-30-35-10, the previous amortized cost basis less writeoffs, including non-credit-related impairment reported in earnings, shall become the new amortized cost basis of the investment. That new amortized cost basis shall not be adjusted for subsequent recoveries in fair value.

35-15 For debt securities for which impairments were reported in earnings as a writeoff because of an intent to sell or a more-likely-than-not requirement to sell, the difference between the new amortized cost basis and the cash flows expected to be collected shall be accreted in accordance with existing applicable guidance as interest income. An entity shall continue to estimate the present value of cash flows expected to be collected over the life of the debt security. For debt securities accounted for in accordance with Subtopic 325-40, an entity should look to that Subtopic to account for changes in cash flows expected to be collected. For all other debt securities, if upon subsequent evaluation, there is a significant increase in the cash flows expected to be collected or if actual cash flows are significantly greater than cash flows previously expected, those changes shall be accounted for as a prospective adjustment to the yield. Subsequent increases in the fair value of available-for-sale securities after the write-down shall be included in other comprehensive income. (This Section does not address when a holder of a debt security would place a debt security on nonaccrual status or how to subsequently report income on a nonaccrual debt security.)

As is the case under existing U.S. GAAP, and as discussed in Section 7.2.2, if an entity intends to sell an AFS debt security or it is more likely than not that the entity will be required to sell the security before recovery of the security’s amortized cost basis, the entity must write down the amortized cost basis to its fair value, write off any existing allowance for credit losses, and recognize in earnings any incremental impairment.

After such a write-down, the entity must consider the security’s fair value to be its new amortized cost basis in accordance with ASC 326-30-35-14 and 35-15. Any subsequent decreases in expected cash flows are recognized as additional impairments, while increases in expected cash flows are recognized as a prospective adjustment to the security’s accretable yield.

7.2.5 PCD Considerations Related to AFS Debt Securities

ASC 326-30

30-2 A purchased debt security classified as available-for-sale shall be considered to be a purchased financial asset with credit deterioration when the indicators of a credit loss in paragraph 326-30-55-1 have been met. The allowance for credit losses for purchased financial assets with credit deterioration shall be measured at the individual security level in accordance with paragraphs 326-30-35-3 through 35-10. The amortized cost basis for purchased financial assets with credit deterioration shall be considered to be the purchase price plus any allowance for credit losses. See paragraphs 326-30-55-1 through 55-7 for implementation guidance.

30-3 Estimated credit losses shall be discounted at the rate that equates the present value of the purchaser’s estimate of the security’s future cash flows with the purchase price of the asset.

30-4 An entity shall record the holding gain or loss through other comprehensive income, net of applicable taxes.

35-16 An entity shall measure changes in the allowance for credit losses on a purchased financial asset with credit deterioration in accordance with paragraph 326-30-35-6. The entity shall report changes in the allowance for credit losses in net income as credit loss expense (or reversal of credit loss expense) in each reporting period.

As discussed at the beginning of Chapter 6, upon acquiring a PCD asset, an entity will recognize its allowance for expected credit losses as an adjustment that increases the asset’s amortized cost basis (the “gross-up” approach) rather than as an immediate credit loss expense in the income statement. After initially applying the gross-up approach, the entity will recognize as a credit loss expense (or reversal of credit loss expense) any changes in the allowance. To determine whether an AFS security is a PCD asset, an entity must consider the factors in ASC 326-30-55-1, which are the same factors that an investor uses to identify whether a credit loss exists on an AFS debt security. ASC 326-30-55-1 states:

There are numerous factors to be considered in determining whether a credit loss exists. The length of time a security has been in an unrealized loss position should not be a factor, by itself or in combination with others, that an entity would use to conclude that a credit loss does not exist. The following list is not meant to be all inclusive. All of the following factors should be considered:

The extent to which the fair value is less than the amortized cost basis
Adverse conditions specifically related to the security, an industry, or geographic area; for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, changes in the financial condition of the underlying loan obligors. Examples of those changes include any of the following:
1. Changes in technology
2. The discontinuance of a segment of the business that may affect the future earnings potential of the issuer or underlying loan obligors of the security
3. Changes in the quality of the credit enhancement.
The payment structure of the debt security (for example, nontraditional loan terms as described in paragraphs 825-10-55-1 through 55-2) and the likelihood of the issuer being able to make payments that increase in the future
Failure of the issuer of the security to make scheduled interest or principal payments
Any changes to the rating of the security by a rating agency.

An entity would not use the same criteria for AFS debt securities as it does for HTM debt securities when assessing whether it is required to apply PCD accounting to those securities.

As described above, for an AFS debt security, an entity would consider the factors in ASC 326-30-55-1 to determine whether a credit loss exists on the acquisition date. If so, the investor would use the gross-up approach described in Section 6.3.2 to initially account for the PCD AFS debt security. By contrast, when evaluating whether to apply the PCD model to an HTM debt security, an entity must consider whether there has been a more-than-insignificant deterioration in the security’s credit quality since its origination.

In addition, the unit of account differs depending on whether the entity is evaluating the applicability of the PCD model to an HTM or AFS debt security. While an entity can evaluate the applicability of the PCD model to HTM debt securities on a collective basis if the securities share similar risk characteristics (see Section 6.2.6), it is not permitted to determine whether PCD accounting applies to AFS debt securities on a collective or pool basis. Rather, it must make that determination on the basis of each individual AFS debt security.

Changing Lanes

FASB Proposed ASU on Purchased Financial Assets

On June 27, 2023, the FASB issued a proposed ASU that would broaden the population of financial assets that are within the scope of the gross-up approach currently applied to PCD assets under ASC 326. While the scope of assets subject to the gross-up approach would generally be expanded to include more acquired financial assets, the gross-up approach would no longer apply to AFS debt securities. See Section 10.2.4 for further discussion of the proposed ASU.

7.2.5.1 Differences Between ASC 325-40 and PCD Accounting for BIs Classified as AFS Debt Securities

The sections below summarize how the guidance in ASC 325-40 on non-PCD BIs differs from the PCD models for BIs classified as AFS debt securities.

7.2.5.1.1 Initial Accounting Under ASC 325-40

Under ASC 325-40 (as amended by ASU 2016-13), 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 upon 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.

7.2.5.1.2 Subsequent Accounting Under ASC 325-40

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.

If there has not been an adverse change in the cash flows expected to be collected but the BI’s fair value is significantly below its amortized cost basis, the entity is required to assess whether it intends to sell the BI or it is more likely than not that it will be required to sell the interest before recovery of the entire amortized cost basis. If so, the entity would be required to write down the BI to its fair value in accordance with ASC 326-30-35-10.

7.2.5.1.3 Initial Accounting Under the PCD Model in ASC 326-30

Under the PCD accounting model in ASC 326-30 for AFS debt securities, entities are required to gross up the cost basis of a PCD asset by the estimated credit losses as of the acquisition date 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 6.4.1).

7.2.5.1.4 Subsequent Accounting Under the PCD Model in ASC 326-30

For a PCD asset within the scope of ASC 325-40 that is classified as an AFS debt security, 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 the accounting under the normal ASC 325-40 model, as amended by ASU 2016-13). However, the allowance is limited to the difference between the AFS debt security’s fair value and its amortized cost. If any adverse change in cash flows cannot fully be reflected in the allowance because of the “fair value floor,” prospective yield should be adjusted downward to incorporate the amount of the adverse change in cash flows that was not reflected in the allowance. In that case, prospective interest income should be recognized at the yield implied by the fair value of the beneficial interest. Favorable changes in expected cash flows would first be recognized as a decrease to the allowance for credit losses (recognized currently in earnings). Such changes would be recognized as a prospective yield adjustment only when the allowance for credit losses is reduced to zero. A change in expected cash flows that is attributable solely to a change in a variable interest rate on a plain-vanilla debt instrument does not result in a credit loss and would be accounted for as a prospective yield adjustment.

7.2.6 Accounting for Changes in Foreign Exchange Rates for Foreign-Currency-Denominated AFS Debt Securities

When determining whether an impairment exists on an AFS debt security that is denominated in a foreign currency, an entity compares the security’s fair value (measured in the entity’s functional currency at the current exchange rate) with its amortized cost basis (measured at the historical exchange rate). If the fair value of the security is below its amortized cost, the security is impaired. Before adopting ASU 2016-13, an entity that determines an AFS debt security to be other-than-temporarily impaired would recognize in earnings an impairment loss equal to the entire difference between the security’s fair value and its cost basis.

ASC 326-30-35-10 is consistent with this guidance. Specifically, this paragraph states, in part, that “[i]f an entity intends to sell the debt security (that is, it has decided to sell the security), or more likely than not will be required to sell the security before recovery of its amortized cost basis, any allowance for credit losses shall be written off and the amortized cost basis shall be written down to the debt security’s fair value at the reporting date with any incremental impairment reported in earnings.” Accordingly, under ASU 2016-13, an entity would continue to recognize in earnings the entire change in the fair value of an AFS debt security if (1) it intends to sell the impaired security or (2) it is more likely than not that it will be required to sell the impaired security before recovery.

In addition, ASC 320-10-35-36 (as amended by ASU 2016-13) states, in part, that “[t]he change in the fair value of foreign-currency-denominated available-for-sale debt securities, excluding the amount recorded in the allowance for credit losses, shall be reported in other comprehensive income.” As a result, if the entity does not intend to sell the security or it is not more likely than not that it will be required to sell the security before recovery of its amortized cost basis, the entity would recognize in OCI the change in the security’s fair value related to the changes in foreign exchange rates.

Connecting the Dots

Recognizing Unrealized Losses in Earnings

In light of the amendments made by ASU 2016-13, stakeholders have questioned when unrealized losses related to changes in foreign exchange rates on an AFS debt security should be recognized in earnings and whether the guidance will delay loss recognition. Consequently, at the TRG’s November 2018 meeting, the FASB staff confirmed that unrealized losses related to foreign exchange rates should be reported in OCI and recognized in earnings “(a) at the maturity of the security, (b) upon the sale of the security, (c) when an entity intends to sell, or (d) when an entity is more likely than not required to sell the security before recovery of its amortized cost basis.”5 In addition, the staff said that the concern that the amendments made by ASU 2016-13 will result in delayed loss recognition “is beyond the scope of the Credit Losses TRG because the topic relates to reporting changes in fair value related to foreign exchange rates.”

We acknowledge that there is diversity in how an entity may translate its credit loss expense to reflect changes in the spot rate. For example, an entity may translate its credit loss expense at the end of the reporting period by using the spot rate that existed when the asset was acquired or the spot rate that exists at the end of the current reporting period. We believe that either approach is acceptable.

The example below illustrates the accounting for an impairment of a foreign-currency-denominated AFS debt security after adoption of ASU 2016-13. In this example, the impairment is calculated on the basis of the spot rate that existed as of the date of acquisition of the security.

Example 7-4

Impairment of a Foreign-Currency-Denominated AFS Debt Security

Investor Co, a U.S. registrant whose functional currency is the U.S. dollar, holds an investment in an AFS debt security that is denominated in British pound sterling (£). On December 31, 20X2, Investor Co’s balance sheet date, the fair value of the debt security is £675,000 and its amortized cost is £900,000. Furthermore, the present value of the expected cash flows to be collected is £650,000. Assume that the exchange rates in effect on December 31, 20X2, and the date on which Investor Co acquired the investment are £1 = $1.2 and £1 = $1.5, respectively.

After determining that the security’s fair value is less than its amortized cost, in accordance with ASC 326-30, Investor Co concludes that an impairment loss exists. The table below summarizes the related computation.

Assume that Investor Co reaches the following conclusions:

It does not intend to sell the debt security.
It is not more likely than not that it will be required to sell the debt security before recovery of the security’s amortized cost.

Therefore, Investor Co concludes that the impairment loss should be recognized, limited by the difference between fair value and amortized cost, with changes in foreign exchange rates recognized in OCI. Note that Investor Co will translate its credit loss expense at the end of the reporting period by using the spot rate that existed as of the acquisition date of the security. In such circumstances, Investor Co would record the following journal entry to recognize the impairment loss:

7.2.7 High-Level Comparison of Credit Loss Models for HTM and AFS Debt Securities

The table below compares the credit loss model for HTM securities with that for AFS securities.

	HTM Debt Security (ASC 326-20)	AFS Debt Security (ASC 326-30)
Unit of account	Pool-level, if similar risk characteristics exist; otherwise, at the individual debt security level	Individual debt security level
Measurement of credit losses	The amount needed to reduce the amortized cost basis to reflect the net amount expected to be collected	The excess of the amortized cost basis over the present value of the best estimate of expected future cash flows
Recognition threshold	Recognize a credit loss upon acquisition of the security	Recognize a credit loss when amortized cost exceeds fair value
Recognition of credit loss	Apply an allowance approach	Apply an allowance approach
Write-offs	Write off security when it is deemed uncollectible	Write off security when it is deemed uncollectible

Footnotes

1

It is assumed that an independent investment adviser has discretion to sell debt securities without management approval. To the extent that agreements with independent investment advisers give management discretion to hold or sell at the individual security level, management’s intent will also be relevant. These agreements are often tailored to meet the needs of management as well as any regulatory requirements, and an entity must thoroughly understand the agreements’ terms and conditions to determine whose intent is relevant.

2

This may be the case for more complex ARSs issued by trusts in which the underlying collateral of the trust is made up of asset-backed securities, including securities backed by subprime mortgage loans. Given the complexity of many ARSs and the credit profile and other risks associated with the underlying collateral, the potential exists for a failed auction.

3

ASC 326-30-35-6 states that when “assessing whether a credit loss exists, an entity shall compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.”

4

The factors are not necessarily relevant to every credit loss determination and may be helpful in attributing an impairment to something other than credit losses. Note that one or more of these factors may be more relevant to the analysis than others, and an entity must consider all available information about past events, current conditions, and reasonable and supportable forecasts to conclude that a credit loss related to a debt security does not exist. An entity must evaluate all facts and circumstances associated with the debt security and use significant judgment in performing such an assessment.

5

See TRG Memo 14.

Chapter 8 — Presentation and Disclosure

8.1 Presentation

ASC 320-10

45-9 Subsequent increases or decreases in the fair value of available-for-sale securities that do not result in recognition or reversal of an allowance for credit loss or write-down in accordance with Subtopic 326-30 on measuring credit losses on available-for-sale debt securities shall be included in other comprehensive income pursuant to paragraphs 320-10-35-1(b) and 320-10-45-8.

ASC 326-20

45-1 For financial assets measured at amortized cost within the scope of this Subtopic, an entity shall separately present on the statement of financial position, the allowance for credit losses that is deducted from the asset’s amortized cost basis.

45-2 For off-balance-sheet credit exposures within the scope of this Subtopic, an entity shall present the estimate of expected credit losses on the statement of financial position as a liability. The liability for credit losses for off-balance-sheet financial instruments shall be reduced in the period in which the off-balance-sheet financial instruments expire, result in the recognition of a financial asset, or are otherwise settled. An estimate of expected credit losses on a financial instrument with off-balance-sheet risk shall be recorded separate from the allowance for credit losses related to a recognized financial instrument.

45-5 An entity may make an accounting policy election, at the class of financing receivable or major security-type level, to present separately on the statement of financial position or within another statement of financial position line item the accrued interest receivable balance, net of the allowance for credit losses (if any). An entity that presents the accrued interest receivable balance, net of the allowance for credit losses (if any), within another statement of financial position line item shall apply the disclosure requirements in paragraph 326-20-50-3A.

ASC 326-30

45-1 An entity shall present available-for-sale debt securities on the statement of financial position at fair value. In addition, an entity shall present parenthetically the amortized cost basis and the allowance for credit losses. If for the purposes of identifying and measuring an impairment the applicable accrued interest is excluded from both the fair value and the amortized cost basis of the available-for-sale debt security, an entity may present separately on the statement of financial position or within another statement of financial position line item the accrued interest receivable balance, net of the allowance for credit losses (if any). An entity that presents the accrued interest receivable balance, net of the allowance for credit losses (if any), within another statement of financial position line item shall apply the disclosure requirements in paragraph 326-30-50-3A.

45-2 An entity shall separately present, in the financial statement in which the components of accumulated other comprehensive income are reported, amounts reported therein related to available-for-sale debt securities for which an allowance for credit losses has been recorded.

Like the current presentation requirements in U.S. GAAP, the presentation requirements in ASU 2016-13 vary on the basis of the type of financial asset. For example, in the statement of financial position, an entity’s presentation of loans and other debt instruments measured at amortized cost and their corresponding allowances for expected credit losses would differ from its presentation of AFS debt securities and the corresponding allowances for such losses.

The table below summarizes the presentation requirements of ASU 2016-13.

	Statement of Financial Position
Asset Type	Asset Balance	Allowance for Expected Credit Losses	Income Statement
Financial assets measured at amortized cost, including: Loans. HTM debt securities. Trade and lease receivables.	Presented at amortized cost.	Presented separately from the asset’s amortized cost balance.	Expected credit losses presented as a credit loss expense.
Loan commitments and other off-balance-sheet instruments	N/A, since these are unrecognized financial instruments.	Presented as a liability. Liabilities cannot be included with other allowances for expected credit losses.	Expected credit losses presented as a credit loss expense.1
AFS debt securities	Presented at fair value. Entities must also include the security’s amortized cost parenthetically. Changes in fair value unrelated to credit are presented in OCI.	Presented parenthetically.	Expected credit losses presented as a credit loss expense.

8.1.1 Other Presentation Considerations

8.1.1.1 Changes in the Present Value of Expected Cash Flows

Changes in the present value of expected future cash flows may result from the passage of time or from changes in the timing and amount of the cash flows the entity expects to receive. Like existing U.S. GAAP, ASC 326 allows an entity that uses a DCF approach to present a change in the present value of expected future cash flows as an adjustment to credit loss expense (both favorable and unfavorable) or as interest income (only if the change is related to the passage of time). An entity that chooses to present the change as interest income must, in accordance with ASC 326-20-50-12 and ASC 326-30-50-8, disclose that policy decision as well as the amount recorded in interest income that represents the change in present value attributable to the passage of time.

8.1.1.2 Changes in the Fair Value of the Collateral Securing a Collateral-Dependent Financial Asset

Like existing U.S. GAAP, ASC 326 requires an entity to present changes (both favorable and unfavorable) in the fair value of the collateral securing a collateral-dependent financial asset as an adjustment to credit loss expense.

8.1.1.3 Accrued Interest

ASU 2016-13 defines “amortized cost basis” as “the amount at which a financing receivable or investment is originated or acquired, adjusted for applicable accrued interest, accretion or amortization of premium, discount, and net deferred fees or costs, collection of cash, writeoffs, foreign exchange, and fair value hedge accounting adjustments” (emphasis added). As discussed in Section 4.4.5.1, the ASU’s inclusion of accrued interest in the definition has three significant implications for financial statements with respect to the measurement, presentation, and disclosure of the amortized cost basis and the allowance for credit losses of financial assets:

When measuring an allowance for credit losses on the amortized cost basis of the assets, entities will be required to include an allowance for the accrued interest that applies to those assets.
Entities will have to present the accrued interest amount in the amortized cost basis of the financial assets in the same line item on the balance sheet.
Accrued interest must be included in the disclosures of the amortized cost basis by class of financing receivable and vintage, as required by ASC 326-20-50-5 and 50-6, respectively.

After a discussion of these implications at the June 2018 TRG meeting, the FASB issued ASU 2019-04, which amends the presentation and disclosure requirements of ASC 326 related to accrued interest. Specifically, the ASU states that an entity would be permitted to do the following:

“Make an accounting policy election to present accrued interest receivable balances and the related allowance for credit losses for those accrued interest receivable balances separately from the associated financial assets on the balance sheet. If the accrued interest receivable balances and the related allowance for credit losses [are presented separately from the associated financial assets but] are not presented as a separate line item on the balance sheet, an entity should disclose the amount of accrued interest receivable balances and the related allowance for credit losses and where the balance is presented.”
“Elect a practical expedient to disclose separately the total amount of accrued interest included in the amortized cost basis as a single balance to meet certain disclosure requirements.”
“Make an accounting policy election to write off accrued interest amounts by reversing interest income or recognizing credit loss expense, or a combination of both.”

For more information about the recognition and measurement changes related to accrued interest, see Section 4.4.5.1.

Footnotes

1

In May 2020, the Federal Reserve System, the FDIC, the National Credit Union Administration, and the OCC issued a final interagency policy statement on allowances for credit losses. The proposal on which the final statement was based stated that “[p]rovisions for credit losses on off-balance-sheet credit exposures are included as part of ‘Other noninterest expense’ in Schedule RI — Income Statement in the Call Report and in ‘Credit Loss Expense — Off-Balance-Sheet Credit Exposures’ in the Statement of Income and Expense in NCUA Call Report Form 5300.” However, the final statement eliminates any reference to the income statement category in which amounts needed to adjust the liability for expected credit losses for off-balance-sheet credit exposures should be reported in the agencies’ regulatory reports. See Section 10.3.2 for more information.

8.2 Disclosures

8.2.1 Financial Assets Measured at Amortized Cost

8.2.1.1 Overall Objective and Unit of Account

ASC 326-20

50-2 The disclosure guidance in this Section should enable a user of the financial statements to understand the following:

The credit risk inherent in a portfolio and how management monitors the credit quality of the portfolio
Management’s estimate of expected credit losses
Changes in the estimate of expected credit losses that have taken place during the period.

50-3 For financing receivables, the disclosure guidance in this Subtopic requires an entity to provide information by either portfolio segment or class of financing receivable. Net investment in leases are within the scope of this Subtopic, and the disclosure requirements for financing receivables shall be applied to net investment in leases (including the unguaranteed residual asset). For held-to-maturity debt securities, the disclosure guidance in this Subtopic requires an entity to provide information by major security type. Paragraphs 326-20-55-10 through 55-14 provide implementation guidance about the terms portfolio segment and class of financing receivable. When disclosing information, an entity shall determine, in light of the facts and circumstances, how much detail it must provide to satisfy the disclosure requirements in this Section. An entity must strike a balance between not obscuring important information as a result of too much aggregation and not overburdening financial statements with excessive detail that may not assist a financial statement user in understanding the entity’s financial assets and allowance for credit losses. For example, an entity should not obscure important information by including it with a large amount of insignificant detail. Similarly, an entity should not disclose information that is so aggregated that it obscures important differences between the different types of financial assets and associated risks.

50-3A An entity that makes an accounting policy election to present the accrued interest receivable balance within another statement of financial position line item as described in paragraph 326-20-45-5 shall disclose the amount of accrued interest, net of the allowance for credit losses (if any), and shall disclose in which line item on the statement of financial position that amount is presented.

50-3B As a practical expedient, an entity may exclude the accrued interest receivable balance that is included in the amortized cost basis of financing receivables and held-to-maturity securities for the purposes of the disclosure requirements in paragraphs 326-20-50-4 through 50-22. If an entity applies this practical expedient, it shall disclose the total amount of accrued interest excluded from the disclosed amortized cost basis.

50-3C An entity that makes the accounting policy election in paragraph 326-20-30-5A shall disclose its accounting policy not to measure an allowance for credit losses for accrued interest receivables. The accounting policy shall include information about what time period or periods, at the class of financing receivable or major security-type level, are considered timely.

50-3D An entity that makes the accounting policy election in paragraph 326-20-35-8A shall disclose its accounting policy to write off accrued interest receivables by reversing interest income or recognizing credit loss expense or a combination of both. The entity also shall disclose the amount of accrued interest receivables written off by reversing interest income by portfolio segment or major security type.

ASC Master Glossary

Class of Financing Receivable

A group of financing receivables determined on the basis of both of the following:

Risk characteristics of the financing receivable
An entity’s method for monitoring and assessing credit risk.

See paragraphs 326-20-55-11 through 55-14 and 326-20-50-3.

Financing Receivable

A financing arrangement that has both of the following characteristics:

It represents a contractual right to receive money in either of the following ways
1. On demand
2. On fixed or determinable dates.
It is recognized as an asset in the entity’s statement of financial position.

See paragraphs 310-10-55-13 through 55-15 for more information on the definition of financing receivable, including a list of items that are excluded from the definition (for example, debt securities).

Portfolio Segment

The level at which an entity develops and documents a systematic methodology to determine its allowance for credit losses. See paragraphs 326-20-50-3 and 326-20-55-10.

Connecting the Dots

A Debt Security Is Not a Financing Receivable

A debt security initially seems to meet the definition of a financing receivable because the holder of the debt security (i.e., the investor) (1) has a contractual right to receive money either on demand or on fixed or determinable dates and (2) recognizes the debt security as an asset in its balance sheet. However, ASC 310-10-55-13 through 55-15 provide guidance on what should be considered a financing receivable, and ASC 310-10-55-15 states that debt securities within the scope of ASC 320 do not meet the definition of financing receivables. The distinction between the two terms is important because, although many of the disclosure requirements of ASC 326 apply to both financing receivables and debt securities (e.g., those in ASC 326-20-50-5 and ASC 326-20-50-11 through 50-18), some only apply to financing receivables (e.g., the vintage disclosure requirements in ASC 326-20-50-6). As a result, an entity must carefully consider which disclosure requirements apply to which type of financial asset within the scope of ASC 326-20. For a summary of the disclosure requirements by type of financial asset, see the table in Section 8.2.6.

ASC 326-20

Disclosure — Application of the Term Portfolio Segment

55-10 This implementation guidance addresses the meaning of the term portfolio segment. All of the following are examples of portfolio segments:

Type of financing receivable
Industry sector of the borrower
Risk rating.

Disclosure — Application of the Term Class of Financing Receivable

55-11 This implementation guidance addresses application of the term class of financing receivable. An entity should base its principal determination of class of financing receivable by disaggregating to the level that the entity uses when assessing and monitoring the risk and performance of the portfolio for various types of financing receivables. In its assessment, the entity should consider the risk characteristics of the financing receivables.

55-12 In determining the appropriate level of its internal reporting to use as a basis for disclosure, an entity should consider the level of detail needed by a user to understand the risks inherent in the entity’s financing receivables. An entity could further disaggregate its financing receivables portfolio by considering numerous factors. Examples of factors that the entity should consider include any of the following:

Categorization of borrowers, such as any of the following:
1. Commercial loan borrowers
2. Consumer loan borrowers
3. Related party borrowers.
Type of financing receivable, such as any of the following:
1. Mortgage loans
2. Credit card loans
3. Interest-only loans
4. Finance leases.
Industry sector, such as either of the following:
1. Real estate
2. Mining.
Type of collateral, such as any of the following:
1. Residential property
2. Commercial property
3. Government-guaranteed collateral
4. Uncollateralized (unsecured) financing receivables.
Geographic distribution, including both of the following:
1. Domestic
2. International.

55-13 An entity also may consider factors related to concentrations of credit risk as discussed in Section 825-10-55.

55-14 Classes of financing receivables generally are a disaggregation of a portfolio segment. For determining the appropriate classes of financing receivables that are related to a portfolio segment, the portfolio segment is the starting point with further disaggregation in accordance with the guidance in paragraphs 326-20-55-11 through 55-13. The determination of class for financing receivables that are not related to a portfolio segment (because there is no associated allowance) also should be based on the guidance in those paragraphs.

The purpose of the disclosure requirements in ASC 326-20 is to give financial statement users information about the credit risk inherent in an entity’s financial statements and to explain management’s estimate of expected credit losses and the changes in the allowance for such losses. Many of these disclosure requirements, as well as the unit of account at which the disclosures should be presented, are consistent with the requirements in existing U.S. GAAP. That is, like the requirements of ASC 310-10-50, the disclosure requirements of ASC 326-20 for financing receivables measured at amortized cost are applicable at either the portfolio segment level or by class of financing receivable, depending on the specific disclosure required. In addition, although a net investment in a lease does not meet the definition of a financing receivable, ASC 326-20-50-13 requires a lessor to consider it as such. Further, an entity must provide disclosure information for HTM debt securities by major security type in a manner similar to how it must provide disclosures under ASC 320-10-50. Because the level of disaggregation for financing receivables differs from that for HTM debt securities, an entity would be required to disclose information for financing receivables separately from information about HTM debt securities.

Although ASU 2016-13 does not define “major security type,” ASC 320-10-50-1B states:

Major security types shall be based on the nature and risks of the security. In determining whether disclosure for a particular security type is necessary and whether it is necessary to further separate a particular security type into greater detail, an entity shall consider all of the following:

(Shared) activity or business sector
Vintage
Geographic concentration
Credit quality
Economic characteristic.

Under this guidance, an entity could identify a major security type on the basis of how it manages, monitors, and measures its securities as well as the security’s nature and risks. For example, major security types could comprise debt securities that are segregated by industry type, company size, or investment objective; debt securities issued by the U.S. Treasury and other U.S. government corporations and agencies; and corporate debt securities, residential mortgage-backed securities, collateralized debt obligations, and other debt obligations.

Changing Lanes

FASB ASU on Troubled Debt Restructurings and Vintage Disclosures

In March 2022, the FASB issued ASU 2022-02, which requires new disclosures for receivables whose contractual cash flows have been modified because borrowers are experiencing financial difficulties. Modifications in the contractual cash flows of a receivable are defined as principal forgiveness, interest rate reductions, other-than-insignificant-payment delays, or term extensions under ASC 310-10-50-39. Under the ASU, a term extension excludes covenant waivers and modifications of contingent acceleration clauses. Furthermore, the Board indicated that “collateral substitutions, or the addition of a guarantor, will not be captured in the disclosure enhancements.”2

For receivables whose contractual cash flows have been modified, ASU 2022-02 requires entities to disclose, by class of financing receivable, the types of modifications, the financial effects of those modifications, and the performance of these modified receivables (through a 12-month trailing period after the modification).

The ASU also requires entities to disclose receivables involving (1) a payment default during the current period and (2) modifications to the contractual cash flows within the 12 months before the default. The disclosures must show, by class of financing receivable, the type of contractual change that the modification provided and the defaulted amount.

Under ASU 2022-02, a delay in payment that is considered insignificant does not need to be included in the disclosures stated above; however, if the receivable has been previously restructured, an entity should consider all restructurings within the past 12 months in determining the insignificance of the delay in payment.

Importantly, the enhanced disclosures required by the ASU may differ from an entity’s historical TDR disclosures because the scope of the new disclosure requirements does not depend on whether the entity has provided a concession to a borrower experiencing financial difficulty. Instead, an entity will need to evaluate whether a modification or restructuring with a borrower experiencing financial difficulty results in principal forgiveness, an interest rate reduction, an other-than-insignificant-payment delay, or a term extension. These disclosures are required regardless of whether the refinancing or restructuring is accounted for as a new loan under ASC 310-20-35-9 through 35-11. As a result, an entity may need to update its internal controls and processes to comply with the new requirements.

For more information about the ASU’s effective date and transition requirements, see Section 10.2.1.8.

8.2.2 Credit Quality Information

ASC 326-20

50-4 An entity shall provide information that enables a financial statement user to do both of the following:

Understand how management monitors the credit quality of its financial assets
Assess the quantitative and qualitative risks arising from the credit quality of its financial assets.

50-5 To meet the objectives in paragraph 326-20-50-4, an entity shall provide quantitative and qualitative information by class of financing receivable and major security type about the credit quality of financial assets within the scope of this Subtopic (excluding off-balance-sheet credit exposures and repurchase agreements and securities lending agreements within the scope of Topic 860), including all of the following:

A description of the credit quality indicator(s)
The amortized cost basis, by credit quality indicator
For each credit quality indicator, the date or range of dates in which the information was last updated for that credit quality indicator.

50-6 When disclosing credit quality indicators of financing receivables and net investment in leases (except for reinsurance recoverables and funded or unfunded amounts of line-of-credit arrangements, such as credit cards), an entity shall present the amortized cost basis within each credit quality indicator by year of origination (that is, vintage year). For purchased financing receivables and net investment in leases, an entity shall use the initial date of issuance to determine the year of origination, not the date of acquisition. For origination years before the fifth annual period, an entity may present the amortized cost basis of financing receivables and net investments in leases in the aggregate. For interim-period disclosures, the current year-to-date originations in the current reporting period are considered to be the current-period originations. The requirement to present the amortized cost basis within each credit quality indicator by year of origination is not required for an entity that is not a public business entity.

Pending Content (Transition Guidance: ASC 326-10-65-5)

50-6When disclosing credit quality indicators of financing receivables and net investment in leases (except for reinsurance recoverables and funded or unfunded amounts of line-of-credit arrangements, such as credit cards), a public business entity shall present the amortized cost basis within each credit quality indicator by year of origination (that is, vintage year). For purchased financing receivables and net investment in leases, an entity shall use the initial date of issuance to determine the year of origination, not the date of acquisition. For origination years before the fifth annual period, a public business entity may present the amortized cost basis of financing receivables and net investments in leases in the aggregate. For interim-period disclosures, the current year-to-date originations in the current reporting period are considered to be the current-period originations. A public business entity shall present the gross writeoffs recorded in the current period, on a current year-to-date basis, for financing receivables and net investments in leases by origination year. For origination years before the fifth annual period, a public business entity may present the gross writeoffs in the current period for financing receivables and net investments in leases in the aggregate. The requirement to present the amortized cost basis within each credit quality indicator by year of origination is not required for an entity that is not a public business entity.

50-6A For the purpose of the disclosure requirement in paragraph 326-20-50-6, an entity shall present the amortized cost basis of line-of-credit arrangements that are converted to term loans in a separate column (see Example 15 in paragraph 326-20-55-79). An entity shall disclose in each reporting period, by class of financing receivable, the amount of line-of-credit arrangements that are converted to term loans in each reporting period.

Pending Content (Transition Guidance: ASC 326-10-65-5)

50-6A For the purpose of the disclosure requirement in paragraph 326-20-50-6, a public business entity shall present the amortized cost basis of line-of-credit arrangements that are converted to term loans in a separate column (see Example 15 in paragraph 326-20-55-79). A public business entity shall disclose in each reporting period, by class of financing receivable, the amount of line-of-credit arrangements that are converted to term loans in each reporting period and the total of these financing receivables that were written off in the current reporting period in accordance with paragraph 326-20-50-6.

50-7 Except as provided in paragraph 326-20-50-6A, an entity shall use the guidance in paragraphs 310-20-35-9 through 35-12 when determining whether a modification, extension, or renewal of a financing receivable should be presented as a current-period origination. An entity shall use the guidance in paragraphs 842-10-25-8 through 25-9 when determining whether a lease modification should be presented as a current-period origination.

Pending Content (Transition Guidance: ASC 326-10-65-5)

50-7 Except as provided in paragraph 326-20-50-6A, a public business entity shall use the guidance in paragraphs 310-20-35-9 through 35-11 when determining whether a modification, extension, or renewal of a financing receivable should be presented as a current-period origination. A public business entity shall use the guidance in paragraphs 842-10-25-8 through 25-9 when determining whether a lease modification should be presented as a current-period origination.

50-8 If an entity discloses internal risk ratings, then the entity shall provide qualitative information on how those internal risk ratings relate to the likelihood of loss.

50-9 The requirements to disclose credit quality indicators in paragraphs 326-20-50-4 through 50-5 do not apply to receivables measured at the lower of amortized cost basis or fair value, or trade receivables due in one year or less, except for credit card receivables, that result from revenue transactions within the scope of Topic 605 on revenue recognition or Topic 606 on revenue from contracts with customers.

Disclosure — Application of the Term Credit Quality Indicator

55-15 This implementation guidance addresses application of the term credit quality indicator. Examples of credit quality indicators include all of the following:

Consumer credit risk scores
Credit-rating-agency ratings
An entity’s internal credit risk grades
Debt-to-value ratios
Collateral
Collection experience
Other internal metrics.

55-16 An entity should use judgment in determining the appropriate credit quality indicator for each class of financing receivable and major security type. As of the balance sheet date, the entity should use the most current information it has obtained for each credit quality indicator.

The objective of providing credit quality disclosures is to help financial statement users understand how an entity continually monitors the credit quality of a financial asset and to provide insight into the asset’s inherent credit quality. Many of the requirements in ASC 326-20 to provide credit quality information about an entity’s financing receivables are similar to those in existing U.S. GAAP. For example, ASC 310-10-50-27 through 50-30 require an entity to provide quantitative and qualitative information about the credit quality of its financing receivables.

Although there are similarities between the amendments in ASU 2016-13 and existing U.S. GAAP, the requirement in ASC 326-20-50-6 for a PBE to “present the amortized cost basis within each credit quality indicator by year of origination (that is, vintage year)” is a significant addition. That paragraph also requires entities to provide the amortized cost basis for each of the five years preceding the financial reporting date and to include this information in the aggregate for the period before those five years.

Although it could be onerous for preparers to provide such detailed information, on the basis of feedback provided during the development of the disclosure requirements, the FASB believes that the benefits of providing such information outweigh the costs associated with preparing it. Paragraph BC114 of ASU 2016-13 states, in part:

The Board performed extensive outreach on the disclosure requirements after hosting a roundtable meeting to listen to the perspectives of both preparers and users. Preparers indicated that vintage-year disclosures are more operable than amortized cost basis rollforward disclosures, and users supported the additional information that would be provided by vintage disclosures about credit quality trends. The Board concluded that the vintage disclosure requirements for financing receivables and net investment in leases will allow users to understand the credit quality trends within the portfolio from period to period. In addition, by utilizing information disclosed in other areas in the financial statements and assumptions from public sources, users may be able to derive their own rollforward of the balances and related allowance for credit losses for each origination year. This will provide useful information because it will help users develop estimates of (a) originations by period for each class of financing receivable, (b) an estimate of the initially expected credit losses and subsequent changes to the estimate, and (c) an estimate of the current-period provision that is attributable to originations and changes in expected credit losses on previously originated loans.

Example 15 in ASC 326-20 illustrates how an entity may comply with the vintage disclosure requirements. As noted in Section 8.2.2.3, ASU 2022-02 revised Example 15 to make it more consistent with the requirements in ASC 326-20-50-4 through 50-9. Below is Example 15, as revised by ASU 2022-02.

ASC 326-20

Pending Content (Transition Guidance: ASC 326-10-65-5)

Example 15: Disclosing Credit Quality Indicators of Financing Receivables by Amortized Cost Basis

55-79 The following Example illustrates the presentation of credit quality disclosures for a financial institution with a narrow range of loan products offered to local customers — both consumer and commercial. Depending on the size and complexity of an entity’s portfolio of financing receivables, the entity may present disclosures that are more or less detailed than the following Example. An entity may choose other methods of determining the class of financing receivable and may determine different credit quality indicators that reflect how credit risk is monitored. Some entities may have more than one credit quality indicator for certain classes of financing receivables.

8.2.2.1 Scope of Vintage Disclosure Requirements

ASC 326-20-50-6 indicates that only PBEs are subject to the vintage disclosure requirements. That is, only PBEs must present the amortized cost basis of financing receivables and net investments in leases “by year of origination (that is, vintage year)” for each credit quality indicator. Paragraph BC114 of ASU 2016-13 discusses the FASB’s rationale for requiring only PBEs to provide such disclosures:

This disclosure requirement is applicable to public business entities only because investors in private companies generally have greater access to management to obtain the information they believe is necessary. The Board considered exempting public business entities that are not SEC filers because small community banks may meet the public business entity definition, but the Board concluded that a distinction among public business entities (that is, public business entities that are not SEC filers) is inappropriate. The Board believes the disclosures are relevant for users in all public business entities; however, given cost considerations, the Board decided to allow public business entities that are not SEC filers further transition relief in order to prepare for the disclosure requirements and decided not to require this disclosure for entities that are not public business entities.

However, all entities must comply with the requirement in ASC 326-20-50-5 to disclose credit quality information by class of financing receivable or by major type of security. Such information would include a description of the credit quality indicators and the amortized cost basis by credit quality indicator.

Note that for the initial year of adoption, ASC 326 provides transition guidance on the vintage disclosure requirements in ASC 326-20-50-6. This guidance can be summarized as follows:

PBEs that meet the U.S. GAAP definition of an SEC filer3 must disclose credit quality indicators disaggregated by year of origination for a five-year period.
PBEs that do not meet the U.S. GAAP definition of an SEC filer must disclose credit quality indicators disaggregated by year of origination. However, upon adopting the ASU, those PBEs would only be required to disclose such information for the previous three years and would present an additional year of information until they have provided disclosures for the previous five years.
Other entities are not required to disclose credit quality indicators disaggregated by year of origination.

See Chapter 9 for more information about transition.

8.2.2.2 Vintage Disclosures for Revolving Loans That Are Modified Into Term Loans

Under ASC 326-20-50, entities must disclose credit quality information about their financing receivables and net investments in leases that are measured at amortized cost. That is, ASC 326-20-50-6 requires an entity to present the amortized cost basis within each credit quality indicator by year of origination. However, that paragraph exempts “funded or unfunded amounts of line-of-credit arrangements” (e.g., credit cards) from the requirement because the timing of the underwriting decisions related to those arrangements may not be aligned with the borrower’s use of funds. Instead, entities may aggregate such revolving loan balances and report them in a separate single column, without regard to when the initial underwriting decisions were made.

However, ASC 326-20-50-7 requires an entity to apply the guidance in ASC 310-20 to determine whether a loan that is modified should be considered new. If such a loan is considered a new loan, the entity would report it as a current-year origination in the year of the restructuring to comply with the vintage disclosure requirements in ASC 326-20-50-6.

ASU 2019-04 addresses how an entity should apply the vintage disclosure requirements in ASC 326-20-50-6 to a revolving arrangement that is later converted into a term loan.4 Specifically, this ASU adds ASC 326-20-50-6A, which states, in part, that “an entity shall present the amortized cost basis of line-of-credit arrangements that are converted to term loans in a separate column (see Example 15 in paragraph 326-20-55-79). An entity shall disclose in each reporting period, by class of financing receivable, the amount of line-of-credit arrangements that are converted to term loans in each reporting period.”

8.2.2.3 Gross Write-Offs and Gross Recoveries

Example 15 in ASC 326-20-55-79 illustrates how an entity could comply with the disclosure requirements for credit quality information in ASC 326-20-50-4 through 50-9. The example includes a vintage disclosure table showing an entity’s presentation of amortized cost information by vintage year for gross write-offs and gross recoveries.

An entity needs to provide gross write-offs and gross recoveries by class of financing receivable and by vintage year to comply with the credit quality disclosure requirements in ASC 326-20-50-4 through 50-9.

As the FASB noted at its April 3, 2019, meeting, Example 15 in ASC 326-20-55-79 illustrates only one way in which an entity could comply with the credit quality disclosure requirements in ASC 326-20-50-4 through 50-9. Because the guidance in those paragraphs does not include a requirement to provide gross write-offs and gross recoveries by class of financing receivable and by vintage year, an entity is not required to provide such information to comply with the credit quality disclosure requirements.

Changing Lanes

FASB ASU on Troubled Debt Restructurings and Vintage Disclosures

In March 2022, the FASB issued ASU 2022-02, which amends ASC 326-20-50-6 to require that a PBE’s vintage disclosures include gross write-offs recorded in the current period, on a year-to-date basis, by year of origination. The amendments related to the presentation of gross write-offs in the vintage disclosures should be applied prospectively from the date of adoption. For more information about the ASU’s effective date and transition, see Section 10.2.1.8.

8.2.2.4 Vintage Disclosure Requirements — Trade Receivables and Contract Assets Within the Scope of ASC 605 and ASC 606

ASC 326-20-50-9 states that the “credit quality indicators in paragraphs 326-20-50-4 through 50-5 do not apply to receivables measured at the lower of amortized cost basis or fair value, or trade receivables due in one year or less, except for credit card receivables, that result from revenue transactions within the scope of Topic 605 on revenue recognition or Topic 606 on revenue from contracts with customers.” Thus, while ASC 326-20-50-9 is clear on the applicability of the vintage disclosure requirements and trade receivables due in one year or less, it is less clear with respect to contract assets.

ASC 606 states that an entity should apply the CECL model to contract assets, but the term “contract asset” is not used in ASC 326-20. While ASC 606-10-45-3 clearly notes that contract assets are subject to the measurement guidance in ASC 326 and that a credit loss of a contract asset “shall be measured, presented, and disclosed in accordance with Subtopic 326-20,” questions have arisen about which disclosure requirements apply to such assets. Some believe that ASC 606 indicates that a contract asset is a financial asset measured at amortized cost that is within the scope of ASC 326-20 for subsequent measurement and disclosure purposes, even though this is not explicitly stated in ASC 326-20.5 Others believe that a contract asset does not meet the definition of a financial asset6 measured at amortized cost because the entity does not have the unconditional right to receive cash until the contract asset becomes a trade receivable (i.e., when it has the right to collect the consideration from the customer).

Connecting the Dots

Contract Assets

Contract assets may not be converted to receivables and subsequently collected for more than one year. Consequently, if considered to be within the scope of ASC 326-20, such assets may not qualify for the short-term exception for certain disclosures that is described in ASC 326-20-50-9. On the basis of discussions held with the FASB staff, we believe that contract assets do not meet the definition of a financing receivable and are therefore outside the scope of the vintage disclosure requirements in ASC 326-20-50-4 and 50-5. However, once the contract asset is converted to a trade receivable, the entity would need to include that converted trade receivable in its vintage disclosures if it is not due in one year or less.

8.2.3 Allowance for Credit Losses

ASC 326-20

50-10 An entity shall provide information that enables a financial statement user to do the following:

Understand management’s method for developing its allowance for credit losses
Understand the information that management used in developing its current estimate of expected credit losses
Understand the circumstances that caused changes to the allowance for credit losses, thereby affecting the related credit loss expense (or reversal) reported for the period.

50-11 To meet the objectives in paragraph 326-20-50-10, an entity shall disclose all of the following by portfolio segment and major security type:

A description of how expected loss estimates are developed
A description of the entity’s accounting policies and methodology to estimate the allowance for credit losses, as well as a discussion of the factors that influenced management’s current estimate of expected credit losses, including:
1. Past events
2. Current conditions
3. Reasonable and supportable forecasts about the future.
A discussion of risk characteristics relevant to each portfolio segment
A discussion of the changes in the factors that influenced management’s current estimate of expected credit losses and the reasons for those changes (for example, changes in portfolio composition, underwriting practices, and significant events or conditions that affect the current estimate but were not contemplated or relevant during a previous period)
Identification of changes to the entity’s accounting policies, changes to the methodology from the prior period, its rationale for those changes, and the quantitative effect of those changes
Reasons for significant changes in the amount of writeoffs, if applicable
A discussion of the reversion method applied for periods beyond the reasonable and supportable forecast period
The amount of any significant purchases of financial assets during each reporting period
The amount of any significant sales of financial assets or reclassifications of loans held for sale during each reporting period.

50-12 Paragraph 326-20-45-3 explains that a creditor that measures expected credit losses based on a discounted cash flow method is permitted to report the entire change in present value as credit loss expense (or reversal of credit loss expense) but also may report the change in present value attributable to the passage of time as interest income. Creditors that choose the latter alternative shall disclose the amount recorded to interest income that represents the change in present value attributable to the passage of time.

Rollforward of the Allowance for Credit Losses

50-13 Furthermore, to enable a financial statement user to understand the activity in the allowance for credit losses for each period, an entity shall separately provide by portfolio segment and major security type the quantitative disclosures of the activity in the allowance for credit losses for financial assets within the scope of this Subtopic, including all of the following:

The beginning balance in the allowance for credit losses
Current-period provision for expected credit losses
The initial allowance for credit losses recognized on financial assets accounted for as purchased financial assets with credit deterioration (including beneficial interests that meet the criteria in paragraph 325-40-30-1A), if applicable
Writeoffs charged against the allowance
Recoveries collected
The ending balance in the allowance for credit losses.

Many of the disclosure requirements in ASC 326-20-50-10 through 50-12 that describe an entity’s allowance for credit losses are consistent with those in existing U.S. GAAP. In general, the objective of these requirements is to help financial statement users understand the information and methods that management uses in determining the estimate of expected credit losses. In addition, the disclosures should be presented in sufficient detail for financial statement users to understand the factors or conditions that led to any changes in the allowance for credit losses from the prior period.

The rollforward of the allowance for credit losses is generally the same as that required under ASC 310-10-50-11B, with one notable difference. Because ASC 326 requires an entity to recognize at acquisition an allowance for credit losses on assets deemed to be PCD that is not recognized through a provision for credit losses (i.e., the gross-up approach), the entity must also include the allowance recognized on PCD assets within the rollforward required by ASC 326-20-50-13.

8.2.4 Past-Due and Nonaccrual Status

ASC 326-20

Past Due Status

50-14 To enable a financial statement user to understand the extent of financial assets that are past due, an entity shall provide an aging analysis of the amortized cost basis for financial assets that are past due as of the reporting date, disaggregated by class of financing receivable and major security type. An entity also shall disclose when it considers a financial asset to be past due.

50-15 The requirements to disclose past-due status in paragraph 326-20-50-14 do not apply to receivables measured at the lower of amortized cost basis or fair value, or trade receivables due in one year or less, except for credit card receivables, that result from revenue transactions within the scope of Topic 605 on revenue recognition or Topic 606 on revenue from contracts with customers.

Example 16: Disclosing Past-Due Status

55-80 The following table illustrates certain of the disclosures in paragraph 326-20-50-14 by class of financing receivable.

Nonaccrual Status

50-16 To enable a financial statement user to understand the credit risk and interest income recognized on financial assets on nonaccrual status, an entity shall disclose all of the following, disaggregated by class of financing receivable and major security type:

The amortized cost basis of financial assets on nonaccrual status as of the beginning of the reporting period and the end of the reporting period
The amount of interest income recognized during the period on nonaccrual financial assets
The amortized cost basis of financial assets that are 90 days or more past due, but are not on nonaccrual status as of the reporting date
The amortized cost basis of financial assets on nonaccrual status for which there is no related allowance for credit losses as of the reporting date.

50-17 An entity’s summary of significant accounting policies for financial assets within the scope of this Subtopic shall include all of the following:

Nonaccrual policies, including the policies for discontinuing accrual of interest, recording payments received on nonaccrual assets (including the cost recovery method, cash basis method, or some combination of those methods), and resuming accrual of interest, if applicable
The policy for determining past-due or delinquency status
The policy for recognizing writeoffs within the allowance for credit losses.

50-18 The requirements to disclose nonaccrual status in paragraphs 326-20-50-16 through 50-17 do not apply to receivables measured at lower of amortized cost basis or fair value, or trade receivables due in one year or less, except for credit card receivables, that result from revenue transactions within the scope of Topic 605 on revenue recognition or Topic 606 on revenue from contracts with customers.

For certain loans, existing interest income recognition methods are based on the initial investment, without a deduction for the allowance for credit losses, which may allow certain entities to recognize interest income on principal that is not expected to be collected. However, certain regulatory policies mitigate this risk by requiring an entity to stop accruing interest when it believes that the collection of principal, interest, or both is in doubt. As a result, some entities may have a nonaccrual policy in which they no longer accrue interest in certain circumstances (e.g., when a borrower is in default for a specified period, such as 90 days past due).

ASU 2016-13 did not amend the existing requirements related to placing a loan on nonaccrual status. However, ASC 326-20 requires an entity to provide information about financial assets that are past due or for which the entity is no longer accruing interest (the disclosure requirements do not apply to the assets described in ASC 326-20-50-15 and ASC 326-20-50-18). While these disclosure requirements are generally consistent with those in ASC 310-10-50-5A through 50-8, an entity is now required to provide additional information for financial assets on nonaccrual status under ASC 326. The tables below compare the disclosure requirements for financial assets on nonaccrual status under ASC 310 with those under ASC 326. Requirements added by ASC 326 are in boldface.

ASC 310-10-50-6	ASC 326-20-50-17
Accounting policies related to: Placing an asset on nonaccrual status. Recording payments received for assets on nonaccrual status. Resuming interest accrual. Assessing past-due or delinquency status.	Accounting policies related to: Placing an asset on nonaccrual status. Recording payments for assets on nonaccrual status. Resuming interest accrual. Assessing past-due or delinquency status. Recognizing write-offs within the allowance for credit losses.

ASC 310-10-50-7	ASC 326-20-50-16
As of each balance sheet date, the entity must present: The recorded investment in any financing receivable on nonaccrual status. The recorded investment in any financing receivable that is past due 90 days or more and is still accruing.	As of each balance sheet date, the entity must present: The amortized cost basis of any financial assets on nonaccrual status The amortized cost basis of any financial assets that are past due 90 days or more and are still accruing. The interest income recognized on nonaccrual financial assets during the period. The amortized cost basis of any financial assets on nonaccrual status and for which there is no related credit loss allowance.

ASC 310-10-50-7

ASC 326-20-50-16

As of each balance sheet date, the entity must present:

The recorded investment in any financing receivable on nonaccrual status.
The recorded investment in any financing receivable that is past due 90 days or more and is still accruing.

As of each balance sheet date, the entity must present:

The amortized cost basis of any financial assets on nonaccrual status
The amortized cost basis of any financial assets that are past due 90 days or more and are still accruing.
The interest income recognized on nonaccrual financial assets during the period.
The amortized cost basis of any financial assets on nonaccrual status and for which there is no related credit loss allowance.

8.2.5 Other Disclosures

ASC 326-20

Purchased Financial Assets With Credit Deterioration

50-19 To the extent an entity acquired purchased financial assets with credit deterioration during the current reporting period, an entity shall provide a reconciliation of the difference between the purchase price of the financial assets and the par value of the assets, including:

The purchase price
The allowance for credit losses at the acquisition date based on the acquirer’s assessment
The discount (or premium) attributable to other factors
The par value.

8.2.5.1 PCD Assets

If, during the financial reporting period, an entity acquires a PCD asset (and therefore applies the gross-up approach to that asset), it must disclose a reconciliation between the PCD asset’s purchase price and its par value. Such a reconciliation will enable financial statement users to understand how much of the purchase price discount is related to expected credit losses or other factors (discounts or premiums). The reconciliation should include the items listed in ASC 326-20-50-19(a)–(d) above.

Note that entities are only required to provide this reconciliation in the financial reporting period in which the PCD asset is acquired. It does not need to be disclosed in subsequent periods.

ASC 326-20

Collateral-Dependent Financial Assets

50-20 For a financial asset for which the repayment (on the basis of an entity’s assessment as of the reporting date) is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty, an entity shall describe the type of collateral by class of financing receivable and major security type. The entity also shall qualitatively describe, by class of financing receivable and major security type, the extent to which collateral secures its collateral-dependent financial assets, and significant changes in the extent to which collateral secures its collateral-dependent financial assets, whether because of a general deterioration or some other reason.

8.2.5.2 Collateral-Dependent Financial Assets

Under ASC 326-20-50-20, if an asset is determined to be collateral-dependent and the borrower is experiencing financial difficulty (as described in Section 4.4.9.1), the entity must “describe the type of collateral by class of financing receivable and major security type. The entity also shall qualitatively describe, by class of financing receivable and major security type, the extent to which collateral secures its collateral-dependent financial assets, and significant changes in the extent to which collateral secures its collateral-dependent financial assets, whether because of a general deterioration or some other reason.”

ASC 326-20

Off-Balance-Sheet Credit Exposures

50-21 In addition to disclosures required by other Topics, an entity shall disclose a description of the accounting policies and methodology the entity used to estimate its liability for off-balance-sheet credit exposures and related charges for those credit exposures. Such a description shall identify the factors that influenced management’s judgment (for example, historical losses, existing economic conditions, and reasonable and supportable forecasts) and a discussion of risk elements relevant to particular categories of financial instruments.

50-22 Off-balance-sheet credit exposures refers to credit exposures on off-balance-sheet loan commitments, standby letters of credit, financial guarantees not accounted for as insurance, and other similar instruments, except for instruments within the scope of Topic 815.

8.2.5.3 Off-Balance-Sheet Credit Exposures

In a manner consistent with the disclosure requirements in current U.S. GAAP (ASC 310-10-50-9 and 50-10), an entity must disclose its accounting policy and method for estimating expected credit losses on off-balance-sheet credit exposures. ASC 326-20-50-21 states, in part, that “[s]uch a description shall identify the factors that influenced management’s judgment (for example, historical losses, existing economic conditions, and reasonable and supportable forecasts) and a discussion of risk elements relevant to particular categories of financial instruments.”

8.2.6 Summary of ASC 326-20 Disclosure Requirements by Asset Type

			Financing Receivables	Net Investment in Leases	Off-Balance- Sheet Exposures	HTM Debt Securities
			Disaggregated by Portfolio Segment or Class of Financing Receivable			Disaggregated by Major Security Type
Disclosure Category	ASC Reference	Roadmap Reference	Disclosure Required?
Credit quality information	326-20-50-4 and 50-5 and 326-20-50-8	8.2.2	Yes(a), (b)	Yes	No	Yes
Credit quality information — vintage disclosures	326-20-50-6 and 50-7	8.2.2	Yes(b), (c)	Yes	No	No
Allowance for credit losses	326-20-50-10 through 50-12	8.2.3	Yes	Yes	Yes	Yes
Rollforward of the allowance for credit losses	326-20-50-13	8.2.3	Yes	Yes	Yes	Yes
Past-due status	326-20-50-14	8.2.4	Yes(b)	Yes	Yes	Yes
Nonaccrual status	326-20-50-16 and 50-17	8.2.4	Yes(b)	Yes	Yes	Yes
PCD financial assets	326-20-50-19	8.2.5.1	Yes	Yes	Yes	Yes
Collateral-dependent financial assets	326-20-50-20	8.2.5.2	Yes	Yes	Yes	Yes
Off-balance-sheet exposures	326-20-50-21 and 50-22	8.2.5.3	No	No	Yes	No
(a) This disclosure requirement does not apply to repurchase agreements and securities lending agreements within the scope of ASC 860. (b) As indicated in ASC 326-20-50-9, ASC 326-20-50-15, and ASC 326-20-50-18, these disclosure requirements “do not apply to receivables measured at the lower of amortized cost basis or fair value, or trade receivables due in one year or less, except for credit card receivables, that result from revenue transactions within the scope of Topic 605 on revenue recognition or Topic 606 on revenue from contracts with customers.” (c) On the basis of discussions held with the FASB staff, we believe that contract assets do not meet the definition of a financing receivable and are therefore outside the scope of the vintage disclosure requirements in ASC 326-20-50-4 and 50-5.

8.2.7 AFS Debt Securities

ASC 326-30

General

50-1 For instruments within the scope of this Subtopic, this Section provides the following disclosure guidance related to credit risk and the measurement of credit losses:

Available-for-sale debt securities in unrealized loss positions without an allowance for credit losses
Allowance for credit losses
Purchased financial assets with credit deterioration.

50-2 The disclosure guidance in this Section should enable a user of the financial statements to understand the following:

The credit risk inherent in available-for-sale debt securities
Management’s estimate of credit losses
Changes in the estimate of credit losses that have taken place during the period.

50-3 An entity shall determine, in light of the facts and circumstances, how much detail it must provide to satisfy the disclosure requirements in this Section and how it disaggregates information into major security types. An entity must strike a balance between obscuring important information as a result of too much aggregation and overburdening financial statements with excessive detail that may not assist a financial statement user to understand an entity’s securities and allowance for credit losses. For example, an entity should not obscure important information by including it with a large amount of insignificant detail. Similarly, an entity should not disclose information that is so aggregated that it obscures important differences between the different types of financial assets and associated risks.

50-3A An entity that makes the accounting policy election to present separately the accrued interest receivable balance within another statement of financial position line item as described in paragraph 326-30-45-1 shall disclose the amount of applicable accrued interest, net of the allowance for credit losses (if any), and shall disclose in which line item on the statement of financial position that amount is presented.

50-3B If for the purposes of identifying and measuring an impairment the applicable accrued interest is excluded from both the fair value and the amortized cost basis of the available-for-sale debt security, an entity may, as a practical expedient, exclude the applicable accrued interest that is included in the amortized cost basis for the purposes of the disclosure requirements in paragraphs 326-30-50-4 through 50-10. If an entity elects this practical expedient, it shall disclose the total amount of accrued interest, net of the allowance for credit losses (if any), excluded from the disclosed amortized cost basis.

50-3C An entity that makes the accounting policy election in paragraph 326-30-30-1B shall disclose its accounting policy not to measure an allowance for credit losses for accrued interest receivables. The accounting policy shall include information about what time period or periods, at the major security-type level, are considered timely.

50-3D An entity that makes the accounting policy election in paragraph 326-30-35-13A shall disclose its accounting policy to write off accrued interest receivables by reversing interest income or recognizing credit loss expense or a combination of both. The entity also shall disclose the amount of accrued interest receivables written off by reversing interest income by major security type.

Available-for-Sale Debt Securities in Unrealized Loss Positions Without an Allowance for Credit Losses

50-4 For available-for-sale debt securities, including those that fall within the scope of Subtopic 325-40 on beneficial interests in securitized financial assets, in an unrealized loss position for which an allowance for credit losses has not been recorded, an entity shall disclose all of the following in its interim and annual financial statements:

As of each date for which a statement of financial position is presented, quantitative information, aggregated by category of investment — each major security type that the entity discloses in accordance with this Subtopic — in tabular form:
1. The aggregate related fair value of investments with unrealized losses
2. The aggregate amount of unrealized losses (that is, the amount by which amortized cost basis exceeds fair value).
As of the date of the most recent statement of financial position, additional information (in narrative form) that provides sufficient information to allow a financial statement user to understand the quantitative disclosures and the information that the entity considered (both positive and negative) in reaching the conclusion that an allowance for credit losses is unnecessary. The disclosures required may be aggregated by investment categories, but individually significant unrealized losses generally shall not be aggregated. This disclosure could include all of the following:
1. The nature of the investment(s)
2. The cause(s) of the impairment(s)
3. The number of investment positions that are in an unrealized loss position
4. The severity of the impairment(s)
5. Other evidence considered by the investor in reaching its conclusion that an allowance for credit losses is not necessary, including, for example, any of the following:
  1. Performance indicators of the underlying assets in the security, including any of the following:
    
    01. Default rates
    
    02. Delinquency rates
    
    03. Percentage of nonperforming assets.
  2. Debt-to-collateral-value ratios
  3. Third-party guarantees
  4. Current levels of subordination
  5. Vintage
  6. Geographic concentration
  7. Industry analyst reports
  8. Credit ratings
  9. Volatility of the security’s fair value
  10. Interest rate changes since purchase
  11. Any other information that the investor considers relevant.

50-5 The disclosures in (a)(1) through (a)(2) in paragraph 326-30-50-4 shall be disaggregated by those investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or longer.

50-6 The reference point for determining how long an investment has been in a continuous unrealized loss position is the balance sheet date of the reporting period in which the impairment is identified. For entities that do not prepare interim financial information, the reference point is the annual balance sheet date of the period during which the impairment was identified. The continuous unrealized loss position ceases upon the investor becoming aware of a recovery of fair value up to (or beyond) the amortized cost basis of the investment during the period.

Allowance for Credit Losses

50-7 For interim and annual periods in which an allowance for credit losses of an available-for-sale debt security is recorded, an entity shall disclose by major security type, the methodology and significant inputs used to measure the amount related to credit loss, including its accounting policy for recognizing writeoffs of uncollectible available-for-sale debt securities. Examples of significant inputs include, but are not limited to, all of the following:

Performance indicators of the underlying assets in the security, including all of the following:
1. Default rates
2. Delinquency rates
3. Percentage of nonperforming assets
Debt-to-collateral-value ratios
Third-party guarantees
Current levels of subordination
Vintage
Geographic concentration
Industry analyst reports and forecasts
Credit ratings
Other market data that are relevant to the collectibility of the security.

50-8 Paragraph 326-30-45-3 explains that an entity may report the change in the allowance for credit losses due to changes in time value as credit loss expense (or reversal of credit loss expense) but also may report the change as interest income. An entity that chooses the latter alternative shall disclose the amount recorded to interest income that represents the change in present value attributable to the passage of time.

Rollforward of the Allowance for Credit Losses

50-9 For each interim and annual reporting period presented, an entity shall disclose by major security type, a tabular rollforward of the allowance for credit losses, which shall include, at a minimum, all of the following:

The beginning balance of the allowance for credit losses on available-for-sale debt securities held by the entity at the beginning of the period
Additions to the allowance for credit losses on securities for which credit losses were not previously recorded
Additions to the allowance for credit losses arising from purchases of available-for-sale debt securities accounted for as purchased financial assets with credit deterioration (including beneficial interests that meet the criteria in paragraph 325-40-30-1A)
Reductions for securities sold during the period (realized)
Reductions in the allowance for credit losses because the entity intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis
If the entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, additional increases or decreases to the allowance for credit losses on securities that had an allowance recorded in a previous period
Writeoffs charged against the allowance
Recoveries of amounts previously written off
The ending balance of the allowance for credit losses related to debt securities held by the entity at the end of the period.

Purchased Financial Assets With Credit Deterioration

50-10 To the extent an entity acquired purchased financial assets with credit deterioration during the current reporting period, an entity shall provide a reconciliation of the difference between the purchase price of the assets and the par value of the available-for-sale debt securities, including:

The purchase price
The allowance for credit losses at the acquisition date based on the acquirer’s assessment
The discount (or premium) attributable to other factors
The par value.

Like the disclosure requirements for financial assets measured at amortized cost, the disclosure requirements for AFS debt securities were designed to help financial statement users understand the credit quality of AFS debt securities and how management estimates expected credit losses. As a result, many of the disclosure requirements are similar to those in existing U.S. GAAP (e.g., those in ASC 320-10-50-1 through 50-8B). However, given the change from an OTTI model to an expected credit losses model for AFS debt securities, there are some differences. The table below compares the disclosure requirements for AFS debt securities in existing U.S. GAAP with those in ASC 326. Differences between the disclosure requirements are in boldface.

ASC 320-10-50	ASC 326-30-50
Unit of Account	Unit of Account
An entity is required to provide disclosure information for HTM debt securities by “major security type,” which is based on the nature and risks of the security.	An entity is required to provide disclosure information for HTM debt securities by “major security type,” which is based on the nature and risks of the security.
AFS Debt Securities in an Unrealized Loss Position	AFS Debt Securities in an Unrealized Loss Position Without an Allowance for Credit Losses
As of each date for which a balance sheet is presented, entities must provide, in tabular format and aggregated by category of investment, quantitative information about: The aggregate related fair value of investments with unrealized losses. The aggregate amount of unrealized losses (i.e., the amount by which the amortized cost basis exceeds fair value). Entities must provide sufficient qualitative information “to allow financial statement users to understand the quantitative disclosures and the information that the entity considered (both positive and negative) in reaching the conclusion that the impairment or impairments are not other than temporary.” These disclosures are disaggregated by (1) investments that have been in a continuous unrealized loss position for fewer than 12 months and (2) investments that have been in a continuous unrealized loss position for 12 months or longer. The reference point for determining how long an investment has been in a continuous unrealized loss position is the reporting date of the period in which the impairment is identified. For entities that do not prepare interim financial information, the reference point is the reporting date of the annual period during which the impairment was identified. The unrealized loss position ceases when: The entity recognizes the difference between the amortized cost and fair value of the security as an OTTI. The investor becomes aware of a recovery of fair value that is up to or more than the security’s amortized cost basis.	As of each date for which a balance sheet is presented, entities must provide, in tabular format and aggregated by category of investment, quantitative information about: The aggregate related fair value of investments with unrealized losses. The aggregate amount of unrealized losses (i.e., the amount by which the amortized cost basis exceeds fair value). Entities must provide sufficient qualitative information “to allow a financial statement user to understand the quantitative disclosures and the information that the entity considered (both positive and negative) in reaching the conclusion that an allowance for credit losses is unnecessary” (emphasis added). These disclosures are disaggregated by (1) investments that have been in a continuous unrealized loss position for fewer than 12 months and (2) investments that have been in a continuous unrealized loss position for 12 months or longer. The reference point for determining how long an investment has been in a continuous unrealized loss position is the reporting date of the period in which the impairment is identified. For entities that do not prepare interim financial information, the reference point is the reporting date of the annual period during which the impairment was identified. The unrealized loss position ceases when the investor becomes aware of a recovery of fair value that is up to or more than the security’s amortized cost basis.
Credit Losses Recognized in Earnings	Allowance for Credit Losses
For interim and annual periods in which the entity recognizes an OTTI, it must disclose the method and inputs used to measure the credit loss.	For interim and annual periods in which there is an allowance for credit losses, the entity must disclose the method and inputs used to measure expected credit losses, including its accounting policy for recognizing the write-offs of uncollectible AFS debt securities.
Rollforward of Credit Losses Recognized in Earnings	Rollforward of the Allowance for Credit Losses
For each interim and annual reporting period presented, an entity discloses by major security type a tabular rollforward of the credit losses recognized in earnings as follows: The beginning balance of the credit losses recognized in OCI: Additions related to (1) increases in credit losses for which an OTTI was recognized and (2) credit losses for which an OTTI was not recognized. Decreases related to (1) reductions for securities sold during the period (realized) and (2) reductions attributable to the entity’s intent to sell the security or its belief that it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis. The ending balance of the allowance for credit losses.	For each interim and annual reporting period presented, an entity discloses by major security type a tabular rollforward of the allowance for credit losses as follows: The beginning balance of the allowance for credit losses: Additions related to (1) increases in expected credit losses for situations in which the entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis and (2) the acquisition of AFS debt securities accounted for as PCD assets (including BIs that meet the criteria in ASC 325-40-30-1A). Decreases related to (1) reductions in expected credit losses for situations in which the entity does not intend to sell the security and it is not more likely than not that it will be required to sell the security before recovery of the amortized cost basis, (2) reductions for securities sold during the period (realized), and (3) reductions attributable to the entity’s intent to sell the security or its belief that it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis. Write-offs charged against the allowance. Recoveries of amounts previously written off. The ending balance of the allowance for credit losses.
N/A	PCD Assets
	If, during the financial reporting period, an entity acquires AFS PCD assets, it must disclose a reconciliation between the PCD asset’s purchase price and par value that includes the following: The purchase price. The allowance for credit losses as of the acquisition date. The discount (or premium) attributable to other factors. The par value.

8.2.7.1 Changes in the Present Value of Expected Cash Flows

A change in the present value of expected future cash flows can result from the passage of time, changes in the timing and amount of the cash flows the entity expects to receive, or both. In a manner consistent with the requirements in existing U.S. GAAP, ASC 326-30-45-3 allows an entity to present the change in the present value of expected future cash flows as an adjustment to credit loss expense (both favorable and unfavorable) or as interest income (only if the change is related to the passage of time). In accordance with ASC 326-30-50-8, if the entity chooses to present the change as interest income, it is required to disclose that policy decision as well as “the amount recorded to interest income that represents the change in present value attributable to the passage of time.”

Footnotes

2

See paragraph BC28 of ASU 2022-02.

3

The ASC master glossary defines an SEC filer as follows:

An entity that is required to file or furnish its financial statements with either of the following:

The Securities and Exchange Commission (SEC)
With respect to an entity subject to Section 12(i) of the Securities Exchange Act of 1934, as amended, the appropriate agency under that Section.

Financial statements for other entities that are not otherwise SEC filers whose financial statements are included in a submission by another SEC filer are not included within this definition.

4

This issue was originally discussed at the November 2018 TRG meeting.

5

See ASC 326-20-15-2.

6

The ASC master glossary defines a financial asset as “[c]ash, evidence of an ownership interest in an entity, or a contract that conveys to one entity a right to do either of the following:

Receive cash or another financial instrument from a second entity
Exchange other financial instruments on potentially favorable terms with the second entity.”

Chapter 9 — Effective Date and Transition

Chapter 10 — Stakeholder Activities

10.2 FASB Activities

This Roadmap discusses the FASB’s standard setting through August 1, 2023, including the Board’s proposed ASU on PFAs (issued on June 27, 2023).

10.2.1 Final ASUs

As noted above, the FASB has released various final ASUs to amend and clarify the guidance in ASC 326. These standards, which were largely issued in response to TRG discussions, are discussed throughout this Roadmap, as applicable, and include the following:

ASU 2018-19 on Codification improvements to ASC 326 (Section 10.2.1.1).
ASU 2019-04 on Codification improvements to ASC 326, ASC 815, and ASC 825 (Section 10.2.1.2).
ASU 2019-05 on transition relief related to the fair value option (Section 10.2.1.3).
ASU 2019-10 on effective-date considerations for private companies, not-for-profit organizations, and smaller public companies (Section 10.2.1.4).
ASU 2019-11 on Codification improvements to ASC 326 (Section 10.2.1.5).
ASU 2020-02 on amendments to SEC paragraphs in accordance with SAB 119 (Section 10.2.1.6).
ASU 2020-03 on Codification improvements to the guidance on financial instruments (Section 10.2.1.7).
ASU 2022-02 on TDRs and vintage disclosures (Section 10.2.1.8).

10.2.1.1 ASU 2018-19 on Codification Improvements to ASC 326

In November 2018, the FASB issued ASU 2018-19 to address questions regarding (1) the transition and effective date for non-PBEs and (2) whether billed operating lease receivables are within the scope of ASC 326.

10.2.1.1.1 Transition and Effective Date for Non-PBEs

The effective dates of ASU 2016-13 for financial statement preparers are staggered; however, the ASU is effective for fiscal years beginning after December 15, 2020, for both (1) PBEs that do not meet the U.S. GAAP definition of an SEC filer and (2) non-PBEs. Further, 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).

Consequently, in submissions to the TRG, stakeholders raised concerns that for non-PBEs, the effective date and transition requirements related to ASU 2016-13 would, in essence, eliminate the benefit of receiving an additional year to implement the guidance, which is inconsistent with the FASB’s original intent.

As a result, the Board amended the effective date for non-PBEs to fiscal years beginning after December 15, 2021, including interim periods within those fiscal years.

See Chapter 9 for more information about effective date and transition.

Changing Lanes

Effective Dates Changing Yet Again

In November 2019, the FASB issued ASU 2019-10 on effective-date considerations for private companies, not-for profit organizations, and smaller public companies. For more information, see Section 10.2.1.4.

10.2.1.1.2 Billed Operating Lease Receivables

In light of a stakeholder’s concerns, the TRG discussed at its June 2018 meeting “whether billed operating lease receivables are within the scope of the guidance in Subtopic 326-20.”1

On the basis of the TRG’s recommendations, the FASB amended ASC 326-20 to clarify that operating lease receivables are not within its scope. Accordingly, an entity will assess the collectibility of such receivables in accordance with ASC 842.

For more information about billed operating lease receivables, see Section 2.2.

10.2.1.2 ASU 2019-04 on Codification Improvements to ASC 326, ASC 815, and ASC 825

In April 2019, the FASB issued ASU 2019-04 to make certain technical corrections and amendments to the guidance on financial instruments in ASC 326, ASC 815, and ASC 825. The tables below, reproduced from ASU 2019-04, summarize the amendments that were made to ASC 326.

Area for Improvement	Summary of Amendments
Issue 1A: Accrued Interest
The guidance in Subtopic 326-20, Financial Instruments — Credit Losses — Measured at Amortized Cost, and Subtopic 326-30, Financial Instruments — Credit Losses — Available-for-Sale Debt Securities, contains specific guidance on the measurement, presentation, and disclosure of financial assets within the scope of those Subtopics. Because the definition of amortized cost basis in the Codification includes accrued interest, the guidance in Subtopics 326-20 and 326-30 also applies to the accrued interest amounts included as part of the amortized cost of a related financial asset. Applying the guidance in Subtopics 326-20 and 326-30 to accrued interest as part of the amortized cost basis of a related financial asset potentially imposes unintended costs to implement Update 2016-13. The guidance in paragraph 326-20-35-8 (and by reference in paragraph 326-30-35-13) requires that writeoffs of financial assets within the scope of Subtopics 326-20 and 326-30 be deducted from the allowance for credit losses when the financial assets are deemed uncollectible. Because accrued interest is included in the definition of amortized cost basis, an entity would be required to write off accrued interest amounts through the allowance for credit losses. The application of the writeoff guidance in paragraph 326-20-35-8 (and by reference in paragraph 326-30-35-13) to accrued interest potentially imposes unintended costs to implement Update 2016-13.	The amendments to Subtopic 326-20 allow an entity to: Measure the allowance for credit losses on accrued interest receivable balances separately from other components of the amortized cost basis of associated financial assets. Make an accounting policy election not to measure an allowance for credit losses on accrued interest receivable amounts if an entity writes off the uncollectible accrued interest receivable balance in a timely manner and makes certain disclosures. Make an accounting policy election to write off accrued interest amounts by reversing interest income or recognizing credit loss expense, or a combination of both. The entity also is required to make certain disclosures. Make an accounting policy election to present accrued interest receivable balances and the related allowance for credit losses for those accrued interest receivable balances separately from the associated financial assets on the balance sheet. If the accrued interest receivable balances and the related allowance for credit losses are not presented as a separate line item on the balance sheet, an entity should disclose the amount of accrued interest receivable balances and the related allowance for credit losses and where the balance is presented. Elect a practical expedient to disclose separately the total amount of accrued interest included in the amortized cost basis as a single balance to meet certain disclosure requirements. Certain amendments in (a) through (e) above are applicable to Subtopic 326-30. [See Section 4.4.5.1 of this Roadmap.]
Issue 1B: Transfers Between Classifications or Categories for Loans and Debt Securities
Subtopics 310-10, Receivables — Overall, and 948-310, Financial Services — Mortgage Banking — Receivables, provide guidance on how an entity should account for loans with various classifications. While a significant portion of that guidance was superseded by Update 2016-13, stakeholders questioned how to account for the allowance for credit losses or valuation allowance when transferring nonmortgage loans between classifications (that is, not-held-for-sale and held-for-sale classifications) and mortgage loans between classifications (that is, held-for-long-term-investment and held-for-sale classifications). Subtopic 320-10, Investments — Debt Securities — Overall, provides guidance on how an entity should account for transfers of debt securities between categories. Stakeholders questioned how to account for the allowance for credit losses when transferring debt securities between the available-for-sale category and the held-to-maturity category.	The amendments require that an entity reverse in earnings, any allowance for credit losses or valuation allowance previously measured on a loan or debt security, reclassify and transfer the loan or debt security to the new classification or category, and apply the applicable measurement guidance in accordance with the new classification or category. [See Section 4.10 of this Roadmap.]
Issue 1C: Recoveries
The guidance in paragraph 326-20-35-8 states that recoveries of financial assets and trade receivables previously written off should be recorded when received. Without proper clarification, stakeholders noted that this guidance could be interpreted to prohibit the inclusion of recoveries in the estimation of expected credit losses on financial assets measured at amortized cost basis. Furthermore, stakeholders questioned how an entity should account for an amount expected to be collected greater than the amortized cost basis.	The amendments clarify that an entity should include recoveries when estimating the allowance for credit losses. The amendments clarify that expected recoveries of amounts previously written off and expected to be written off should be included in the valuation account and should not exceed the aggregate of amounts previously written off and expected to be written off by the entity. In addition, for collateral-dependent financial assets, the amendments clarify that an allowance for credit losses that is added to the amortized cost basis of the financial asset(s) should not exceed amounts previously written off. [See Section 4.5.2 of this Roadmap.]
Issue 2A: Conforming Amendment to Subtopic 310-40
Stakeholders noted that the cross-reference to paragraph 326-20-35-2 in Example 2 in Subtopic 310-40, Receivables — Troubled Debt Restructurings by Creditors, is incorrect. The illustration describes an entity that determines that foreclosure is probable on a collateral-dependent loan. Therefore, stakeholders asked whether the cross-reference should instead link to paragraphs 326-20-35-4 through 35-5, which require that an entity use the fair value of collateral to determine expected credit losses when foreclosure is probable.	The amendment clarifies the illustration by removing the incorrect cross-reference to paragraph 326-20-35-2 and replacing it with the correct cross-reference to paragraphs 326-20-35-4 through 35-5, which require that an entity use the fair value of collateral to determine expected credit losses when foreclosure is probable.
Issue 2B: Conforming Amendment to Subtopic 323-10
Stakeholders noted that the guidance on equity method losses in paragraphs 323-10-35-24 and 323-10-35-26 was not amended in Update 2016-13. Specifically, the guidance describes the allocation of equity method losses when an investor has other investments, such as loans and debt securities, in the equity method investee. Stakeholders asked whether the guidance should refer an entity to Topic 326 for the subsequent measurement of those loans and debt securities.	The amendment clarifies the equity method losses allocation guidance in paragraphs 323-10-35-24 and 323-10-35-26 by adding cross-references to Subtopics 326-20 and 326-30 for the subsequent measurement of loans and available-for-sale debt securities, respectively.
Issue 2C: Clarification That Reinsurance Recoverables Are Within the Scope of Subtopic 326-20
Stakeholders asked whether reinsurance recoverables measured on a net present value basis in accordance with Topic 944, Financial Services — Insurance, are within the scope of Subtopic 326-20. As written, the scope could be interpreted to exclude those recoverables because they are not measured at amortized cost basis.	The amendment clarifies the Board’s intent to include all reinsurance recoverables within the scope of Topic 944 within the scope of Subtopic 326-20, regardless of the measurement basis of those recoverables. [See Section 2.1 of this Roadmap.]
Issue 2D: Projections of Interest Rate Environments for Variable-Rate Financial Instruments
Stakeholders asked whether the prohibition of using projections of future interest rate environments in estimating expected future cash flows and determining the effective interest rate to discount expected cash flow for variable-rate financial instruments was consistent with the Board’s intent. As written, an entity that chooses to use a discounted cash flow method to determine expected credit losses on a variable-rate financial instrument is precluded from forecasting changes in the variable rate for the purposes of estimating expected cash flows and determining the effective interest rate with which to discount those cash flows. Stakeholders also asked if an entity is required to use a prepayment-adjusted effective interest rate if it uses projections of interest rate environments for variable-rate financial instruments in estimating expected cash flows.	The amendments clarify the Board’s intent to provide flexibility in determining the allowance for credit losses by removing the prohibition of using projections of future interest rate environments when using a discounted cash flow method to measure expected credit losses on variable-rate financial instruments. The amendments clarify that an entity that uses projections or expectations of future interest rate environments in estimating expected cash flows should use the same assumptions in determining the effective interest rate used to discount those expected cash flows. The amendments also clarify that if an entity uses projections of future interest rate environments when using a discounted cash flow method to measure expected credit losses on variable-rate financial instruments, it also should adjust the effective interest rate to consider the timing (and changes in the timing) of expected cash flows resulting from expected prepayments. [See Section 4.4.4.2 of this Roadmap.]
Issue 2E: Consideration of Prepayments in Determining the Effective Interest Rate
Stakeholders asked whether an entity may adjust the effective interest rate used to discount expected cash flows in a discounted cash flow method for the entity’s expectations of prepayments on financial assets. Stakeholders noted that expected prepayments are required to be considered in estimating expected cash flows. However, they noted that without incorporating those expected prepayments into determining the effective interest rate, the discounted cash flow calculation fails to appropriately isolate credit risk in the determination of an allowance for credit losses.	The amendments permit an entity to make an accounting policy election to adjust the effective interest rate used to discount expected future cash flows for expected prepayments on financial assets within the scope of Subtopic 326-20 and on available-for-sale debt securities within the scope of Subtopic 326-30 to appropriately isolate credit risk in determining the allowance for credit losses. The amendments also clarify that an entity should not adjust the effective interest rate used to discount expected cash flows for subsequent changes in expected prepayments if the financial asset is restructured in a troubled debt restructuring. [See Section 4.4.4.1 of this Roadmap.]
Issue 2F: Consideration of Estimated Costs to Sell When Foreclosure Is Probable
Stakeholders asked whether an entity is required to consider estimated costs to sell the collateral when using the fair value of [the] collateral to estimate expected credit losses on a financial asset because foreclosure is probable in accordance with paragraph 326-20-35-4. Stakeholders noted that the collateral-dependent financial asset practical expedient in paragraph 326-20-35-5 requires that an entity consider estimated costs to sell if repayment or satisfaction of the asset depends on the sale of the collateral. Stakeholders also noted that paragraphs 326-20-35-4 through 35-5 require that an entity adjust the fair value of collateral for the estimated costs to sell on a discounted basis if it intends to sell rather than operate the collateral. Stakeholders asked why an entity is required to estimate the costs to sell on a discounted basis if the fair value of collateral should be based on amounts as of the reporting date.	The amendments clarify the guidance in paragraph 326-20-35-4 by specifically requiring that an entity consider the estimated costs to sell if it intends to sell rather than operate the collateral when the entity determines that foreclosure on a financial asset is probable. Additionally, the amendments clarify the guidance that when an entity adjusts the fair value of collateral for the estimated costs to sell, the estimated costs to sell should be undiscounted if the entity intends to sell rather than operate the collateral. [See Section 4.4.9.2 of this Roadmap.]

Area for Improvement	Summary of Amendments
Issue 5A: Vintage Disclosures — Line-of-Credit Arrangements Converted to Term Loans
Stakeholders asked how an entity should disclose line-of-credit arrangements that convert to term loans within the vintage disclosure table.	The amendments require that an entity present the amortized cost basis of line-of-credit arrangements that are converted to term loans in a separate column as illustrated in Example 15. [See Section 8.2.2.2 of this Roadmap.]
Issue 5B: Contractual Extensions and Renewals
Stakeholders asked whether an entity should consider contractual extension or renewal options in determining the contractual term of a financial asset. Stakeholders stated that the guidance in paragraph 326-20-30-6 appears to preclude an entity from considering those contractual extension or renewal options.	The amendments clarify that an entity should consider extension or renewal options (excluding those that are accounted for as derivatives in accordance with Topic 815) that are included in the original or modified contract at the reporting date and are not unconditionally cancellable by the entity. [See Section 4.2.2 of this Roadmap.]

10.2.1.3 ASU 2019-05 on Transition Relief by Providing the Fair Value Option

In May 2019, the FASB issued ASU 2019-05 to allow entities to irrevocably elect, upon adoption of ASU 2016-13, the fair value option for financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. This election would be made on an instrument-by-instrument basis.

First-time adopters of ASU 2016-13 would elect the fair value option upon adoption, and entities would apply a modified retrospective approach in which the cumulative effect of the election would be recorded in beginning retained earnings in the period of adoption. An entity that has already adopted the amendments in ASU 2016-13 should apply them for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The entity should apply the amendments on a modified retrospective basis by making a cumulative-effect adjustment to the balance of opening retained earnings as of the beginning of the first reporting period in which ASU 2016-13 was adopted. Early adoption will be permitted in any interim period within fiscal years beginning after December 15, 2018, provided that the entity has adopted ASU 2016-13.

For more information, see Chapter 9 on effective date and transition.

10.2.1.4 ASU 2019-10 on Effective-Date Consideration for Private Companies, Not-for-Profit Organizations, and Small Public Companies

In November 2019, the FASB issued ASU 2019-10, which grants private companies, not-for-profit organizations, and certain small public companies additional time to implement the Board’s standards on CECL, leases, and hedging. Specifically, the ASU defers the effective dates for (1) SRCs2 by three years, (2) PBEs that are not SEC filers3 by two years, and (3) non-PBEs by one year.

In summary, the amendments change the effective dates as follows (for more information, see Section 9.1.1):

	PBEs That Are SEC Filers	PBEs That Are Not SEC Filers	All Other Entities
ASU 2016-13	Fiscal years beginning after December 15, 2019, and interim periods therein.	Fiscal years beginning after December 15, 2020, and interim periods therein.	Fiscal years beginning after December 15, 2021, and interim periods therein.

	SEC Filers Excluding SRCs	All Other Entities
ASU 2016-13, as amended by ASU 2019-10	Fiscal years beginning after December 15, 2019, and interim periods therein.	Fiscal years beginning after December 15, 2022, and interim periods therein.

10.2.1.5 ASU 2019-11 on Codification Improvements to ASC 326

In November 2019, the FASB issued ASU 2019-11 to make certain technical corrections and amendments to ASC 326. The table below, reproduced from ASU 2019-11, summarizes these amendments.

Area of Improvement	Summary of Amendments
Issue 1: Expected Recoveries for Purchased Financial Assets With Credit Deterioration
The guidance in paragraph 326-20-30-1 states that expected recoveries of amounts previously written off or expected to be written off should be included in the allowance for credit losses valuation account. Stakeholders questioned whether this guidance applies to purchased financial assets with credit deterioration (PCD assets) measured at amortized cost basis in Subtopic 326-20, Financial Instruments — Credit Losses — Measured at Amortized Cost. Specifically, stakeholders questioned whether negative allowances were permitted on PCD assets. The phrase negative allowance is used to describe situations for which an entity determines that it will recover the amortized cost basis, or a portion of that basis, after a writeoff and that “basis recovery” is included in the allowance for credit losses through a negative allowance. Those situations often are a result of an entity applying regulatory charge-off policies that are generally based on delinquency status.	The amendments clarify that the allowance for credit losses for PCD assets should include in the allowance for credit losses expected recoveries of amounts previously written off and expected to be written off by the entity and should not exceed the aggregate of amounts of the amortized cost basis previously written off and expected to be written off by an entity. In addition, the amendments clarify that when a method other than a discounted cash flow method is used to estimate expected credit losses, expected recoveries should not include any amounts that result in an acceleration of the noncredit discount. An entity may include increases in expected cash flows after acquisition. [See Section 6.3.3.2 of this Roadmap.]
Issue 2: Transition Relief for Troubled Debt Restructurings
At the June 2017 Credit Losses Transition Resource Group (TRG) meeting, stakeholders noted the operational complexities of calculating a prepayment-adjusted effective interest rate on troubled debt restructurings (TDRs) that exist as of the adoption date by using the prepayment assumptions in effect immediately before the restructuring. They requested transition relief when adjusting the effective interest rate for those arrangements.	The amendments provide transition relief by permitting entities an accounting policy election to adjust the effective interest rate on existing TDRs using prepayment assumptions on the date of adoption of Topic 326 rather than the prepayment assumptions in effect immediately before the restructuring. [See Section 9.2 of this Roadmap.]
Issue 3: Disclosures Related to Accrued Interest Receivables
Accounting Standards Update No. 2019-04, Codification Improvements to Topic 326, Financial Instruments — Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, amended the guidance in Subtopics 326-20 and 326-30, Financial Instruments — Credit Losses — Available-for-Sale Debt Securities, to allow an entity to elect a practical expedient to disclose separately the total amount of accrued interest included in the amortized cost basis as a single balance to meet certain disclosure requirements. Stakeholders noted that an entity would still be required to include accrued interest in other disclosure requirements of its amortized cost basis for financial assets under other Topics. Stakeholders requested that the disclosure relief for accrued interest receivable balances be extended to all relevant disclosures involving amortized cost basis.	The amendments extend the disclosure relief for accrued interest receivable balances to additional relevant disclosures involving the amortized cost basis.
Issue 4: Financial Assets Secured by Collateral Maintenance Provisions
The guidance in paragraph 326-20-35-6 for financial assets secured by collateral maintenance provisions provides a practical expedient to measure the estimate of expected credit losses by comparing the amortized cost basis of a financial asset and the fair value of collateral securing the financial asset as of the reporting date. Stakeholders questioned whether an entity is required to evaluate whether a borrower has the ability to continually replenish collateral securing the financial asset to apply the practical expedient. Additionally, stakeholders questioned how an entity should determine its estimate of expected credit losses if the fair value of the collateral securing the financial asset is less than its amortized cost basis.	The amendments clarify that an entity should assess whether it reasonably expects the borrower will be able to continually replenish collateral securing the financial asset to apply the practical expedient. The amendments clarify that an entity applying the practical expedient should estimate expected credit losses for any difference between the amount of the amortized cost basis that is greater than the fair value of the collateral securing the financial asset (that is, the unsecured portion of the amortized cost basis). An entity may determine that the expectation of nonpayment for the amount of the amortized cost basis equal to the fair value of the collateral securing the financial asset is zero. [See Section 4.4.9.2.1 of this Roadmap.]
Issue 5: Conforming Amendment to Subtopic 805-20
Stakeholders noted that paragraph 805-20-50-1 references Subtopic 310-30, Receivables — Loans and Debt Securities Acquired with Deteriorated Credit Quality, which was superseded by the amendments in Update 2016-13.	The amendment to Subtopic 805-20, Business Combinations — Identifiable Assets and Liabilities, and Any Noncontrolling Interest, clarifies the guidance by removing the cross-reference to Subtopic 310-30 in paragraph 805-20-50-1 and replacing it with a cross- reference to the guidance on PCD assets in Subtopic 326-20.

10.2.1.6 ASU 2020-02 on Amendments to SEC Paragraphs in Accordance With SAB 119

In February 2020, the FASB issued ASU 2020-02 to make certain amendments to SEC paragraphs in accordance with SAB 119, which adds the text from SAB Topic 6.M to ASC 326-20-S99-1.

10.2.1.7 ASU 2020-03 on Codification Improvements to Financial Instruments

In March 2020, the FASB issued ASU 2020-03 to address various issues associated with financial instruments. The table below, reproduced, in part, from ASU 2020-03, summarizes the amendments related to ASC 326.

Area of Improvement	Summary of Amendments
Issue 6: Interaction of Topic 842 and Topic 326
Stakeholders requested clarification on determining the contractual term of a net investment in a lease for the purposes of measuring expected credit losses. Specifically, stakeholders noted that the contractual term of the net investment in a lease determined in accordance with Topic 842, Leases, may not align with the contractual term determined in accordance with Topic 326, Financial Instruments — Credit Losses.	The amendments clarify that the contractual term of a net investment in a lease determined in accordance with Topic 842 should be the contractual term used to measure expected credit losses under Topic 326.
Issue 7: Interaction of Topic 326 and Subtopic 860-20
Stakeholders noted that paragraph 860-20-25-13, which relates to a transferor regaining control of certain financial assets after a transfer that was previously accounted for as a sale is inconsistent with the requirements in Topic 326. Specifically, stakeholders noted that paragraph 860-20-25-13 precludes an entity from recognizing a loan loss allowance for loans that do not meet the definition of a security when they are rerecognized.	The amendments to Subtopic 860- 20, Transfers and Servicing — Sales of Financial Assets, clarify that when an entity regains control of financial assets sold, an allowance for credit losses should be recorded in accordance with Topic 326.

10.2.1.8 ASU 2022-02 on TDRs and Vintage Disclosures

In March 2022, the FASB issued ASU 2022-02, which eliminates the accounting guidance on TDRs for creditors in ASC 310-40 and amends the guidance on “vintage disclosures” to require disclosure of current-period gross write-offs by year of origination. The ASU also updates the requirements related to accounting for credit losses under ASC 326 and enhances the disclosure requirements for creditors with respect to loan refinancings and restructurings for borrowers experiencing financial difficulty.

10.2.1.8.1 TDRs by Creditors

ASU 2022-02 supersedes the accounting guidance on TDRs for creditors in ASC 310-40 in its entirety and requires entities to evaluate all receivable modifications under ASC 310-20-35-9 through 35-11 to determine whether a modification made to a borrower results in a new loan or a continuation of the existing loan. The ASU also amends other Codification subtopics to remove references to TDRs for creditors.

In addition to the elimination of TDR guidance, an entity that has adopted ASU 2022-02 no longer considers renewals, modifications, and extensions that result from reasonably expected TDRs in calculating the allowance for credit losses in accordance with ASC 326-20. Further, an entity that employs a DCF method to calculate the allowance for credit losses will be required to use a postmodification-derived EIR as part of its calculation in accordance with ASC 326-20-30-4.

Further, entities are required to provide new disclosures about receivables whose contractual cash flows have been modified because borrowers are experiencing financial difficulties. Modifications to the contractual cash flows of a receivable are defined as principal forgiveness, interest rate reductions, other-than-insignificant-payment delays, or term extensions under ASC 310-10-50-39. For more information about the new modification-related disclosures, see Section 8.2.1.

10.2.1.8.2 Vintage Disclosures — Gross Write-Offs

ASU 2022-02 amends ASC 326-20-50-6 to require public business entities to disclose gross write-offs recorded in the current period, on a year-to-date basis, by year of origination in the vintage disclosures. The amendments to the presentation of gross write-offs in the vintage disclosures should be applied prospectively from the date of adoption. For more information, see Section 8.2.2.3.

10.2.1.8.3 Effective Date and Transition

For entities that have already adopted ASU 2016-13, the amendments in ASU 2022-02 are effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. For entities that have not yet adopted ASU 2016-13, the amendments in ASU 2022-02 are effective upon adoption of ASU 2016-13.

Entities are permitted to early adopt these amendments, including adoption in any interim period, provided that the amendments are adopted as of the beginning of the annual reporting period that includes the interim period of adoption. In addition, entities are permitted to elect to early adopt the amendments to TDR accounting and related disclosure enhancements separately from the amendments to the vintage disclosure requirements.

Entities may elect to apply the updated guidance on TDR recognition and measurement by using a modified retrospective transition method, which would result in a cumulative-effect adjustment to retained earnings, or to adopt the amendments prospectively. If an entity elects to adopt the updated guidance on TDR recognition and measurement prospectively, the guidance should be applied to modifications occurring after the date of adoption. The amendments related to TDR disclosures and vintage disclosures should be adopted prospectively.

10.2.1.9 ASU 2022-01 on Fair Value Hedge Accounting

In March 2022, the FASB issued ASU 2022-01, which clarifies the guidance in ASC 815 on fair value hedge accounting of interest rate risk for portfolios of financial assets. The ASU amends the guidance in ASU 2017-12 that, among other things, established the “last-of-layer” method for making the fair value hedge accounting for these portfolios more accessible. ASU 2022-01 also addresses questions raised by stakeholders about the interaction between the last-of-layer method guidance and ASC 326 or other impairment guidance (for entities that have not yet adopted ASC 326) by explicitly prohibiting entities from considering basis adjustments related to existing portfolio layer method hedges when measuring credit losses on the assets included in the closed portfolio.

For more information about ASU 2022-01, see Deloitte’s March 29, 2022, Heads Up.

10.2.2 FASB Staff Q&A Documents

The FASB staff issued two Q&A documents in January and July 2019:

Topic 326, No. 1: Whether the Weighted-Average Remaining Maturity Method Is an Acceptable Method to Estimate Expected Credit Losses (January 2019) — This Q&A discusses the FASB staff’s views that (1) the WARM method is one of many methods that an entity can use to estimate an allowance for credit losses, particularly on less complex financial asset pools, and (2) an entity needs to consider whether qualitative adjustments should be made. In addition, the Q&A provides examples illustrating how an entity would estimate the allowance for credit losses by using the WARM method. For more information about the WARM method, see Section 4.4.8.
Topic 326, No. 2: Developing an Estimate of Expected Credit Losses on Financial Assets (July 2019) — This Q&A discusses the FASB staff’s views on acceptable approaches for “determining reasonable and supportable forecasts and techniques for reverting to historical loss information when developing an estimate of expected credit losses on financial assets.”

10.2.3 TRG Activity

As discussed in Chapter 1, shortly before issuing ASU 2016-13, the FASB formed a credit losses TRG. Although the TRG does not issue guidance, it provides feedback on potential issues related to the implementation of the CECL model. By analyzing and discussing such issues, the TRG helps the Board determine whether it needs to take action, such as providing clarification or issuing additional guidance. Since the issuance of ASU 2016-13, the TRG has met three times, discussing the following issues:

10.2.3.1 June 2017

Determining the EIR under the CECL model (see Section 4.4.4.1).
The scope of the guidance on PFAs with credit deterioration with respect to BIs accounted for under ASC 325-40 (see Section 6.2).
Applying the transition guidance to pools of PCI assets under ASC 310-30 (see Section 9.2.1).
Accounting for TDRs under the CECL model (see Section 4.7).
Estimating the life of a credit card receivable under the CECL model (see Section 4.2.3).

10.2.3.2 June 2018

Considering capitalized interest by using a method other than a DCF method under the CECL model (see Section 4.4.5.4).
Definition of “amortized cost basis” and the reversal of accrued interest on nonperforming financial assets (see Section 4.4.5.1).
Transfer of loans from HFS to HFI and transfer of credit-impaired debt securities from AFS to HTM (see Section 4.10).
Accounting for recoveries under the CECL model (see Section 4.5.2).
Refinancing and loan prepayments (see Section 4.2.1).

10.2.3.3 November 2018

Contractual term: extensions and measurement inputs (see Section 4.2.2).
Vintage disclosures for revolving loans (see Section 8.2.2.2).
Recoveries (see Section 4.5.2).

10.2.4 Proposed ASU on Purchased Financial Assets

On June 27, 2023, the FASB issued a proposed ASU that would broaden the population of financial assets that are within the scope of the gross-up approach currently applied to PCD assets under ASC 326. Accordingly, an asset acquirer would apply the gross-up approach to all financial assets acquired in a business combination in accordance with ASC 805 rather than first determining whether an acquired financial asset is a PCD asset or a non-PCD asset. 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. In addition, the gross-up approach would no longer apply to AFS debt securities.

Comments on the proposed ASU are due by August 28, 2023. The Board will determine the effective date, as well as whether to permit early adoption, after considering stakeholder feedback on the proposed ASU.

Footnotes

1

See TRG Memo 7.

2

SEC Regulation S-K, Item 10(f)(1), defines an SRC, in part, as:

[A]n issuer that is not an investment company, an asset-backed issuer (as defined in § 229.1101), or a majority-owned subsidiary of a parent that is not a smaller reporting company and that:

(i) Had a public float of less than $250 million; or

(ii) Had annual revenues of less than $100 million and either:

(A) No public float; or

(B) A public float of less than $700 million.

3

The ASC master glossary defines an SEC filer as follows:

An entity that is required to file or furnish its financial statements with either of the following:

a. The Securities and Exchange Commission (SEC)

b. With respect to an entity subject to Section 12(i) of the Securities Exchange Act of 1934, as amended, the appropriate agency under that Section.

Financial statements for other entities that are not otherwise SEC filers whose financial statements are included in a submission by another SEC filer are not included within this definition.

Appendix A — Comparison of U.S. GAAP and IFRS Accounting Standards

A.1 Receivables Measured at Amortized Cost

Under U.S. GAAP, ASC 310 and ASC 326 are the primary sources of guidance on receivables measured at amortized cost.

Under IFRS® Accounting Standards, IFRS 9 is the primary source of guidance on recognition and measurement, as well as income recognition, of receivables measured at amortized cost.

This section focuses on differences between the accounting for receivables measured at amortized cost under U.S. GAAP and that under IFRS Accounting Standards, specifically discussing the recognition and measurement of (1) credit losses and (2) interest income. Note, however, that it does not address differences in the accounting for investments in debt securities classified as HTM under U.S. GAAP. See Section A.2 for guidance on U.S. GAAP–IFRS differences related to investments in debt securities, including those classified as HTM and AFS.

Subject	U.S. GAAP	IFRS Accounting Standards
Recognition of credit losses	Expected loss approach in which an entity recognizes expected (rather than incurred) credit losses.	Expected loss approach in which an impairment loss on a financial asset accounted for at amortized cost or fair value through other comprehensive income (FVTOCI) is recognized immediately on the basis of expected credit losses.
Measurement of impairment losses	Entities have flexibility in measuring expected credit losses as long as the measurement results in an allowance that: Reflects a risk of loss, even if remote. Reflects losses that are expected over the contractual life of the asset. Takes into account historical loss experience, current conditions, and reasonable and supportable forecasts. The entity must evaluate financial assets on a collective (i.e., pool) basis if they share similar risk characteristics. If an asset’s risk characteristics are not similar to those of any of the entity’s other assets, the entity would evaluate the asset individually.	Depending on the financial asset’s credit risk at inception and changes in credit risk from inception, as well as the applicability of certain practical expedients, the measurement of the impairment loss will differ. The impairment loss would be measured as either (1) the 12-month credit loss or (2) the lifetime expected credit loss. Further, for financial assets that are credit-impaired at the time of recognition, the impairment loss will be based on the cumulative changes in the lifetime expected credit losses since initial recognition.
Interest method — computation of the EIR	The EIR is computed on the basis of the contractual cash flows over the contractual term of the loan, except for (1) certain loans that are part of a group of prepayable loans and (2) purchased loans that are accounted for as PCD loans. Therefore, loan origination fees, direct loan origination costs, premiums, and discounts typically are amortized over the contractual term of the loan.	The EIR is computed on the basis of the estimated cash flows that are expected to be received over the expected life of a loan by considering all of the loan’s contractual terms (e.g., prepayment, call, and similar options), excluding expected credit losses. Therefore, fees, points paid or received, transaction costs, and other premiums or discounts are deferred and amortized as part of the calculation of the EIR over the expected life of the instrument.
Interest method — revisions in estimates	“Retrospective” approach — If estimated payments for certain groups of prepayable loans are revised, an entity may adjust the net investment in the group of loans — on the basis of a recalculation of the effective yield to reflect actual payments to date and anticipated future payments — to the amount that would have existed if the new effective yield had been applied since the loans’ origination/acquisition, with a corresponding charge or credit to interest income.	“Cumulative catch-up” approach — If estimated receipts are revised, the carrying amount is adjusted to the present value of the future estimated cash flows, discounted at the financial asset’s original EIR (or credit-adjusted EIR for purchased or originated credit-impaired financial assets). The resulting adjustment is recognized within profit or loss. This treatment applies not only to groups of prepayable loans but also to all financial assets that are subject to the effective interest method.
Interest recognition on PCD loans	Interest income is recognized on the basis of the purchase price plus the initial allowance accreting to the contractual cash flows by using the effective interest method.	Interest income is calculated on the basis of the gross carrying amount (i.e., the amortized cost before adjusting for any loss allowance), unless the loan (1) is purchased or originated credit-impaired or (2) subsequently became credit-impaired. In those cases, interest revenue is calculated on the basis of amortized cost (i.e., net of the loss allowance).
Nonaccrual of interest	There is no explicit requirement in U.S. GAAP for when an entity should cease the recognition of interest income on a receivable measured at amortized cost. However, the practice of placing financial assets on nonaccrual status is acknowledged by U.S. GAAP.	IFRS Accounting Standards do not permit nonaccrual of interest. However, for assets that have become credit-impaired, interest income is based on the net carrying amount of the credit-impaired financial asset.

A.1.1 Recognition of Credit Losses

Under U.S. GAAP, ASC 326-20 does not specify a threshold for recognizing 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 the amortized cost basis of a financial asset.

Under IFRS Accounting Standards, an impairment loss on a financial asset accounted for at amortized cost or FVTOCI is recognized immediately on the basis of expected credit losses.

A.1.2 Measurement of Credit Losses

ASC 326-20 describes the impairment allowance as 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.” An entity can use a number of measurement approaches to determine the impairment allowance. Regardless of the measurement method used, an entity’s estimate of expected credit losses should reflect those losses occurring over the contractual life of the financial asset and should incorporate all available relevant information, including details about past events, current conditions, and reasonable and supportable forecasts and their implications for expected credit losses.

ASC 326-20 does not prescribe a unit of account (e.g., an individual asset or a group of financial assets) for measuring expected credit losses. However, an entity is required to evaluate financial assets within the scope of the model on a collective (i.e., pool) basis when assets share similar risk characteristics. If a financial asset’s risk characteristics are not similar to the risk characteristics of any of the entity’s other financial assets, the entity would evaluate the financial asset individually.

For PCD assets, ASC 326-20 requires that an entity’s method for measuring expected credit losses be consistent with its method for measuring expected credit losses for originated and purchased non-credit-deteriorated assets. However, upon acquiring a PCD asset, the entity would recognize its allowance for expected credit losses as an adjustment that increases the cost basis of the asset (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 entity’s estimate of cash flows that it expects to collect (favorable or unfavorable) would be recognized immediately in the income statement through an adjustment to the allowance for credit losses.

Under IFRS Accounting Standards, IFRS 9’s dual-measurement approach requires an entity to measure the loss allowance for an asset accounted for at amortized cost or FVTOCI (other than one that is purchased or originated credit-impaired) at an amount equal to either (1) the 12-month expected credit losses or (2) lifetime expected credit losses.

The measurement of 12-month expected credit losses, which reflects the expected credit losses arising from default events possible within 12 months of the reporting date, is required if the asset’s credit risk is (1) low as of the reporting date or (2) has not increased significantly since initial recognition. As noted in paragraph B5.5.22 of IFRS 9, the credit risk is considered low if (1) there is “a low risk of default,” (2) “the borrower has a strong capacity to meet its contractual cash flow obligations in the near term,” and (3) “adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its contractual cash flow obligations.” Paragraph B5.5.23 of IFRS 9 suggests that an “investment grade” rating might be an indicator of low credit risk.

Paragraph 5.5.9 of IFRS 9 states that in assessing whether a financial asset’s credit risk has significantly increased, an entity is required to consider “the change in the risk of a default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses” since initial recognition. Paragraph B5.5.17 of IFRS 9 provides a nonexhaustive list of factors that an entity may consider in determining whether there has been a significant increase in credit risk. For financial instruments for which credit risk has significantly increased since initial recognition, the allowance is measured as the lifetime credit losses, which IFRS 9 defines as the “expected credit losses that result from all possible default events over the expected life of a financial instrument,” unless the credit risk is low as of the reporting date. This measurement is also required for certain contract assets and trade receivables that do not contain a significant financing component in accordance with IFRS 15, and it is available as an accounting policy option for certain trade receivables that contain significant financing components in accordance with IFRS 15 and for certain lease receivables (see paragraph 5.5.15 of IFRS 9).

Purchased or originated credit-impaired financial assets (e.g., distressed debt) are treated differently under IFRS 9. As stated in paragraph 5.5.13 of IFRS 9, for these assets, an entity recognizes only “the cumulative changes in lifetime expected credit losses since initial recognition as a loss allowance.” Changes in lifetime expected losses since initial recognition are recognized in profit or loss. Thus, any favorable change in lifetime expected credit losses since initial recognition of a purchased or originated credit-impaired financial asset is recognized as an impairment gain in profit or loss regardless of whether a corresponding impairment loss was recorded for the asset in previous periods.

A.1.3 Interest Method — Computation of the EIR

Under U.S. GAAP on non-PCD loans, the EIR used to recognize interest income on loan receivables generally is computed in accordance with ASC 310-20-35-26 on the basis of the contractual cash flows over the contractual term of the loan. Prepayments of principal are not anticipated. As a result, loan origination fees, direct loan origination costs, premiums, and discounts are typically amortized over the contractual term of the loan. However, ASC 310-20-35-26 indicates that if an entity “holds a large number of similar loans for which prepayments are probable and the timing and amount of prepayments can be reasonably estimated, the entity may consider estimates of future principal prepayments” in calculating the EIR.

Under IFRS 9, an entity recognizes interest income by applying the EIR. IFRS 9 defines the EIR of a financial asset or liability as the “rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset . . . to the gross carrying amount of a financial asset” (emphasis added). Therefore, the effective interest method in IFRS 9, unlike that in ASC 310-20, requires an entity to compute the EIR on the basis of the estimated cash flows over the expected life of the instrument in considering all contractual terms (e.g., prepayment, extension, call, and similar options) but not expected credit losses. As a result, fees, points paid or received, transaction costs, and other premiums or discounts are deferred and amortized as part of the calculation of the EIR over the expected life of the instrument. Further, in its definition of an EIR, IFRS 9 states that in “rare cases when it is not possible to reliably estimate the cash flows or the expected life of a financial instrument [an] entity shall use the contractual cash flows over the full contractual term.”

A.1.4 Interest Method — Revisions in Estimates

Under U.S. GAAP, whether and, if so, how an entity recognizes a change in expected future cash flows of a receivable depends on the instrument’s characteristics and which effective interest method the entity is applying. ASC 310-20-35-26 indicates that in applying the interest method to non-PCD loans, an entity should use the payment terms of the loan contract without considering the anticipated prepayment of principal to shorten the loan term. However, if the entity can reasonably estimate probable prepayments for a large number of similar loans, it may include an estimate of future prepayments in the calculation of the constant effective yield under the interest method. If prepayments are anticipated and considered in the determination of the effective yield, and there is a difference between the anticipated prepayments and the actual prepayments received, the effective yield should be recalculated to reflect actual payments received to date and anticipated future payments. The net investment in the loans should be adjusted to reflect the amount that would have existed if the revised effective yield had been applied since the acquisition or origination of the group of loans, with a corresponding charge or credit to interest income. In other words, under U.S. GAAP, entities may use a “retrospective” approach in accounting for revisions in estimates related to such groups of loans.

Under IFRS Accounting Standards, the original EIR must be used throughout the life of the instrument for financial assets and liabilities, except for certain reclassified financial assets and floating-rate instruments that reset to reflect movements in market interest rates. Upon a change in estimates, IFRS 9 generally requires entities to use a “cumulative catch-up” approach when changes in estimated cash flows occur. Specifically, paragraph B5.4.6 of IFRS 9 states, in part:

If an entity revises its estimates of payments or receipts (excluding modifications in accordance with paragraph 5.4.3 and changes in estimates of expected credit losses), it shall adjust the gross carrying amount of the financial asset . . . to reflect actual and revised estimated contractual cash flows. The entity recalculates the gross carrying amount of the financial asset . . . as the present value of the estimated future contractual cash flows that are discounted at the financial instrument’s original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets). . . . The adjustment is recognised in profit or loss as income or expense.

A.1.5 Interest Recognition on PCD Loans

Regarding an entity’s acquisition of a loan that it determines to be PCD, ASC 326-20 states that in the calculation of the EIR for PFAs with credit deterioration, ”the premium or discount at acquisition excludes the discount embedded in the purchase price that is attributable to the acquirer’s assessment of credit losses at the date of acquisition.” For PCD loans, ASC 326-20 requires an entity to use the original EIR throughout the life of the loan and to record all subsequent changes to its estimate of expected credit losses — whether unfavorable or favorable — as impairment expense (or a reduction of expense) during the period of change.

Under IFRS Accounting Standards, the application of the effective interest method depends on whether the financial asset is purchased or originated credit-impaired or on whether it became credit-impaired after initial recognition.

When recognizing interest revenue related to purchased or originated credit-impaired financial assets under IFRS 9, an entity applies a credit-adjusted EIR to the amortized cost carrying amount. The calculation of the credit-adjusted EIR is consistent with the calculation of the EIR, except that it takes into account expected credit losses within the expected cash flows.

For a financial asset that is not purchased or originated credit-impaired, paragraph 5.4.1 of IFRS 9 requires an entity to calculate interest revenue as follows:

Gross method — If the financial asset has not become credit-impaired since initial recognition, the entity applies the EIR method to the gross carrying amount. IFRS 9 defines the gross carrying amount as “the amortised cost of a financial asset, before adjusting for any loss allowance.”
Net method — If the financial asset has subsequently become credit-impaired, the entity applies the EIR to the amortized cost balance, which is the gross carrying amount adjusted for any loss allowance.

An entity that uses the net method is required to revert to the gross method if (1) the credit risk of the financial instrument subsequently improves to the extent that the financial asset is no longer credit-impaired and (2) the improvement is objectively related to an event that occurred after the net method was applied (see paragraph 5.4.2 of IFRS 9).

IFRS 9 defines a credit-impaired financial asset as follows:

A financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include[s] observable data about the following events:

significant financial difficulty of the issuer or the borrower;
a breach of contract, such as a default or past due event;
the lender(s) of the borrower, for economic or contractual reasons relating to the borrower’s financial difficulty, having granted to the borrower a concession(s) that the lender(s) would not otherwise consider;
it is becoming probable that the borrower will enter bankruptcy or other financial reorganisation;
the disappearance of an active market for that financial asset because of financial difficulties; or
the purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.

It may not be possible to identify a single discrete event — instead, the combined effect of several events may have caused financial assets to become credit-impaired.

A.1.6 Nonaccrual of Interest

There is no explicit U.S. GAAP requirement for when an entity should cease recognizing interest income on receivables measured at amortized cost. However, an entity is permitted to cease such recognition as an accounting policy. In addition, U.S. financial institutions subject to banking regulations look to regulatory reporting instructions for guidance on placing financial assets on nonaccrual status and follow these regulatory instructions for U.S. GAAP financial reporting purposes.1

Under IFRS 9, an entity is not allowed to cease the accrual of interest. Rather, interest income recognition is determined on the basis of whether the asset is considered to be credit-impaired. That is, if the financial asset has not become credit-impaired since initial recognition, the entity applies the EIR method to the gross carrying amount (“gross method”). If the financial asset has subsequently become credit-impaired, the entity applies the EIR to the amortized cost balance, which is the gross carrying amount adjusted for any loss allowance (“net method”). An entity using the net method should revert to the gross method if (1) the credit risk of the financial instrument subsequently improves to the extent that the financial asset is no longer credit-impaired and (2) the improvement is objectively related to an event that occurred after the net method was applied.

A.2 Investments in Debt Securities

Under U.S. GAAP, ASC 320, ASC 326-20, and ASC 326-30 are the primary sources of guidance on the accounting for investments in debt securities.

Under IFRS Accounting Standards, IFRS 9 is the primary source of guidance on the accounting for financial assets and financial liabilities, including investments in debt securities.

This section focuses on differences between U.S. GAAP and IFRS Accounting Standards in the accounting for investments in debt securities, specifically discussing the recognition and measurement of (1) credit losses and (2) interest income. It does not address differences in the accounting for financial assets measured at amortized cost except for investments in debt securities classified as HTM under U.S. GAAP. See Section A.1 for guidance on differences between U.S. GAAP and IFRS Accounting Standards related to financial assets measured at amortized cost.

Subject	U.S. GAAP	IFRS Accounting Standards
Credit losses — recognition	An entity recognizes and measures expected credit losses on an investment in a debt security classified as HTM by using the same model as it does for loans in accordance with ASC 326-20 (see Section A.1 for more information). An impairment loss on an investment in a debt security classified as AFS is recognized when the security’s fair value is less than its amortized cost. This evaluation must be performed on an individual security level in accordance with ASC 326-30.	An impairment loss on a financial asset accounted for at amortized cost or FVTOCI is recognized immediately on the basis of expected credit losses.
Credit losses — measurement	Under ASC 326-30, the recognition of an impairment loss depends on whether the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss. If the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss, the impairment loss is equal to the difference between the amortized cost basis and fair value. Any change in the impairment loss is recognized through earnings. If neither condition is met, the impairment loss is separated into the credit loss component (through earnings) and all other factors (through OCI). The credit loss component for an impaired AFS debt security is the excess of (1) the security’s amortized cost basis over (2) the present value of the investor’s best estimate of the cash flows expected to be collected from the security.	Under IFRS 9, the measurement of the impairment loss will differ depending on the financial asset’s credit risk at inception and changes in credit risk from inception, as well as the applicability of certain practical expedients. The impairment loss is measured as either (1) the 12-month expected credit loss or (2) the lifetime expected credit loss. Further, for financial assets that are credit-impaired at the time of recognition, the impairment loss will be based on the cumulative changes in the lifetime expected credit losses since initial recognition.
Credit losses — reversal of recognized losses	Under ASC 326-30, an entity must use an allowance when recognizing expected credit losses on an AFS debt security. Any changes in the allowance for expected credit losses on an AFS debt security would be recognized as an adjustment to the entity’s credit loss expense.	Under IFRS 9, previously recognized expected credit losses are reversed through profit or loss (as an impairment gain) if expected credit losses decrease.
Subsequent measurement — interest method: interest income recognition	The EIR is computed on the basis of contractual cash flows over the contractual term of the loan, with certain exceptions depending on the specific characteristics of a debt security, such as whether the debt security is (1) part of a group of prepayable debt securities, (2) a BI in securitized financial assets, (3) a callable bond purchased at a premium, (4) considered a PCD asset, or (5) prepayable by the issuer and has a stated interest rate that increases over time.	Under IFRS 9, the EIR is computed on the basis of estimated cash flows that the entity expects to receive over the expected life of the financial asset. The method used to calculate interest revenue depends on whether the financial asset (1) is purchased or originated credit-impaired or (2) has subsequently become credit-impaired.
Subsequent measurement — interest method: revisions in estimates (not from a modification)	Whether and, if so, how an entity recognizes a change in expected future cash flows of an investment in a debt security depends on the characteristics of the debt security and the effective interest method applied.	An entity (1) adjusts a change in estimate that is not a result of changes in the market rates of a floating-rate instrument by applying a cumulative “catch-up” method that uses the original EIR as a discount rate and (2) recognizes the change in estimate through earnings.
Subsequent measurement — nonaccrual of interest	There is no explicit requirement for when an entity should cease the recognition of interest income on an investment in a debt security. However, the practice of placing investments in debt securities on nonaccrual status is acknowledged by U.S. GAAP.	IFRS Accounting Standards do not permit nonaccrual of interest. However, for assets that have become credit-impaired, interest income is based on the net carrying amount of the credit-impaired financial asset.
Subsequent measurement — foreign exchange gains and losses on AFS/FVTOCI debt securities	Under ASC 320, the unrealized change in fair value of an investment in a debt security classified as AFS that is attributable to changes in foreign currency rates must be recognized in OCI.	Under IFRS 9, the unrealized change in fair value of a debt instrument accounted for at FVTOCI that is attributable to changes in foreign exchange rates (calculated on the basis of the instrument’s amortized cost) must be recognized in profit or loss.

A.2.1 Expected Credit Losses

A.2.1.1 Recognition

Under U.S. GAAP, expected credit losses on HTM debt securities are accounted for in a manner consistent with loans receivable. See Section A.1 for more information.

For AFS debt securities, ASC 326-30 states that an impairment loss is recognized when the security’s fair value is less than its amortized cost. This evaluation must be performed on an individual security level.

Under IFRS Accounting Standards, an impairment loss on a financial asset accounted for at amortized cost or FVTOCI is recognized immediately on the basis of expected credit losses.

A.2.1.2 Measurement

Under U.S. GAAP, expected credit losses on HTM debt securities are accounted for in a manner consistent with loans receivable. See Section A.1 for more information.

ASC 326-30 states that for AFS debt securities, the recognition of an impairment loss depends on whether the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss.

If the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis” less any current-period credit loss, the impairment is equal to the difference between the amortized cost basis and fair value. Changes in the impairment are recognized through earnings. If neither condition is met, the impairment loss is separated into the credit loss component (through earnings) and all other factors (through OCI). Under ASC 326-30-35-6, “[i]f the present value of cash flows expected to be collected is less than the amortized cost basis of the security” when the credit loss component of the total impairment is measured, “a credit loss exists and an allowance for credit losses shall be recorded for the credit loss, limited by the amount that the fair value is less than amortized cost basis.” Therefore, the amount of credit loss for an impaired AFS debt security is the excess of (1) the security’s amortized cost basis over (2) the present value of the investor’s best estimate of the cash flows expected to be collected from the security.

Under IFRS Accounting Standards, IFRS 9 employs a dual-measurement approach that requires an entity to measure the loss allowance for an asset accounted for at amortized cost or FVTOCI (other than one that is purchased or originated credit-impaired) at an amount equal to either (1) the 12-month expected credit losses or (2) lifetime expected credit losses.

The measurement of 12-month expected credit losses, which reflects the expected credit losses arising from default events possible within 12 months of the reporting date, is required if the asset’s credit risk has not increased significantly since initial recognition. Further, an entity is permitted to apply a 12-month expected credit loss measurement if the credit risk, in absolute terms, is low as of the reporting date. As noted in paragraph B5.5.22 of IFRS 9, the credit risk is considered low if (1) there is a “low risk of default,” (2) “the borrower has a strong capacity to meet its contractual cash flow obligations in the near term,” and (3) “adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfill its contractual cash flow obligations.” Paragraph B5.5.23 of IFRS 9 suggests that an “investment grade” rating might be an indicator of low credit risk.

Paragraph 5.5.9 of IFRS 9 states that in assessing whether there has been a significant increase in a financial asset’s credit risk, an entity is required to consider “the change in the risk of a default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses” since initial recognition. Paragraph B5.5.17 of IFRS 9 provides a nonexhaustive list of factors that an entity may consider in determining whether there has been a significant increase in credit risk. For financial instruments for which credit risk has significantly increased since initial recognition, the allowance is measured as full lifetime expected credit losses, which IFRS 9 defines as the “expected credit losses that result from all possible default events over the expected life of a financial instrument,” unless the credit risk is low as of the reporting date.

Purchased or originated credit-impaired financial assets (e.g., distressed debt) are treated differently under IFRS 9. As stated in paragraph 5.5.13 of IFRS 9, for these assets, an entity recognizes only “the cumulative changes in lifetime expected credit losses since initial recognition as a loss allowance.” Changes in lifetime expected losses since initial recognition are recognized in profit or loss. Thus, any favorable change in lifetime expected credit losses since initial recognition of a purchased or originated credit-impaired financial asset is recognized as an impairment gain in profit or loss regardless of whether a corresponding impairment loss was recorded for the asset in previous periods.

A.2.1.3 Reversal of Recognized Losses

Under ASC 326-30, an entity must use an allowance when recognizing expected credit losses on an AFS debt security. Any changes in the allowance for expected credit losses on an AFS debt security would be recognized as an adjustment to the entity’s credit loss expense.

Under IFRS Accounting Standards, previously recognized expected credit losses are reversed through profit or loss if the expected credit losses decrease. Paragraph 5.5.8 of IFRS 9 states that an “entity shall recognise in profit or loss, as an impairment gain or loss, the amount of expected credit losses (or reversal) that is required to adjust the loss allowance at the reporting date to the amount that is required to be recognized in accordance with this Standard [IFRS 9].”

A.2.2 Subsequent Measurement

A.2.2.1 Interest Method: Interest Income Recognition and Revisions in Estimates (Not From a Modification)

Under U.S. GAAP, an entity typically recognizes interest income on investments in debt securities accounted for at amortized cost or FVTOCI in accordance with ASC 310-20-35-18 and ASC 310-20-35-26 by applying the effective interest method on the basis of the contractual cash flows of the security. An entity should not anticipate prepayments of principal. However, the following are exceptions to this method of recognizing interest income:

If a debt security is part of a pool of prepayable financial assets and the timing and amount of prepayments are reasonably estimable, an entity is allowed to anticipate future principal prepayments when determining the appropriate EIR to apply to the debt security under ASC 310-20-35-26. If an entity anticipates estimated prepayments when measuring interest income of an investment in a debt security that is part of a pool of prepayable financial assets in accordance with ASC 310-20-35-26, the entity must continually recalculate the appropriate effective yield as prepayment assumptions change. That is, if the estimated future cash flows of a debt security change, the effective yield of the debt security must be recalculated to take into account the new prepayment assumptions. The adjustment to the interest method under ASC 310-20 must be retrospectively applied to the debt security. That is, the amortized cost of the debt security is adjusted to reflect what it would have been if the new effective yield had been used since the acquisition of the debt security, with a corresponding charge or credit to current-period earnings.
If an investment in a debt security meets the definition of a PCD asset, an entity must not recognize as interest income the discount embedded in the purchase price that is attributable to the acquirer’s assessment of expected credit losses as of the acquisition date. The entity must accrete or amortize as interest income the non-credit-related discount or premium of a PFA with credit deterioration in accordance with the existing applicable guidance in ASC 310-20-35 or ASC 325-40-35.
If the investment is a BI in a securitized financial asset, an entity would apply one of the following income recognition models:
- Non-PCD BI not accounted for under ASC 325-40 — Apply the effective interest method on the basis of the contractual cash flows of the security in accordance with ASC 310-20.
- Non-PCD BI accounted for under ASC 325-40 and classified as HTM:
  - Under ASC 325-40 (as amended by ASU 2016-13), 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.
- Non-PCD BI accounted for under ASC 325-40 and classified as AFS:
  - Under ASC 325-40 (as amended by ASU 2016-13), 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.
    
    If there has not been an adverse change in the cash flows expected to be collected but the BI’s fair value is significantly below its amortized cost basis, the entity is required to assess whether it intends to sell the BI or it is more likely than not that it will be required to sell the interest before recovery of the entire amortized cost basis. If so, the entity would be required to write down the BI to its fair value in accordance with ASC 326-30-35-10.
- PCD BI classified as HTM:
  - 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).
  - 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, as amended by ASU 2016-13). 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.
- PCD BI classified as AFS:
  - 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 acquisition date 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).
  - For a PCD asset within the scope of ASC 325-40 that is classified as an AFS debt security, 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 the accounting under the normal ASC 325-40 model, as amended by ASU 2016-13). However, the allowance is limited to the difference between the AFS debt security’s fair value and its amortized cost. Favorable changes in expected cash flows would first be recognized as a decrease to the allowance for credit losses (recognized currently in earnings). Such changes would be recognized as a prospective yield adjustment only when the allowance for credit losses is reduced to zero. A change in expected cash flows that is attributable solely to a change in a variable interest rate on a plain-vanilla debt instrument does not result in a credit loss and would be accounted for as a prospective yield adjustment.
If an investment in a callable bond is purchased at a premium, the premium must be amortized to the first call date in accordance with ASC 310-20-35-33.
If an investment in a debt security is considered a structured note but does not contain an embedded derivative that must be separated under ASC 815, the interest method articulated in ASC 320-10-35-40, which is based on estimated rather than contractual cash flows, must be applied.
If an investment in a debt security to which the interest method in ASC 310-20-35-18(a) applies has a stated interest rate that increases during the term in such a way that “interest accrued under the interest method in early periods would exceed interest at the stated rate . . . , interest income shall not be recognized to the extent that the net investment . . . would increase to an amount greater than the amount at which the borrower could settle the obligation.” Thus, a limit on the accrual of interest income applies to certain investments in debt securities that have a stepped interest rate and contain a borrower prepayment option or issuer call option.

Under IFRS 9, an entity calculates interest revenue on financial assets accounted for at amortized cost or FVTOCI by applying the effective interest method. Appendix A of IFRS 9 defines the EIR of a financial asset or liability as the “rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset . . . to the gross carrying amount of a financial asset” (emphasis added). Therefore, the effective interest method in IFRS 9, unlike that in ASC 310-20, requires an entity to compute the EIR on the basis of the estimated cash flows over the expected life of the instrument by considering all contractual terms (e.g., prepayment, extension, call, and similar options) but not expected credit losses. Under IFRS Accounting Standards, there is no limit on the accrual of interest income for investments in debt securities that have a stepped interest rate and contain a borrower prepayment option or issuer call option. Further, in its definition of an EIR, IFRS 9 states that in rare cases in which it is not possible to reliably estimate the cash flows or the expected life of the financial instrument, an entity should “use the contractual cash flows over the full contractual term.”

The application of the effective interest method depends on whether the financial asset is purchased or originated credit-impaired or on whether it became credit-impaired after initial recognition. When recognizing interest revenue related to purchased or originated credit-impaired financial assets under IFRS 9, an entity applies a credit-adjusted EIR to the amortized cost carrying amount. The calculation of the credit-adjusted interest rate is consistent with that of the EIR, except that the calculation of the credit-adjusted interest rate takes into account expected credit losses within the expected cash flows.

For a financial asset that is not purchased or originated credit-impaired, paragraph 5.4.1 of IFRS 9 requires an entity to calculate interest revenue as follows:

Gross method — If the financial asset has not become credit-impaired since initial recognition, the entity applies the EIR to the gross carrying amount. Appendix A of IFRS 9 defines the gross carrying amount as the “amortised cost of a financial asset, before adjusting for any loss allowance.”
Net method — If the financial asset has subsequently become credit-impaired, the entity applies the EIR to the amortized cost balance, which is the gross carrying amount adjusted for any loss allowance.

An entity that uses the net method is required to revert to the gross method if (1) the credit risk of the financial instrument subsequently improves to the extent that the financial asset is no longer credit-impaired and (2) the improvement is objectively related to an event that occurred after the net method was applied (see paragraph 5.4.2 of IFRS 9).

Under IFRS Accounting Standards, paragraphs B5.4.5 and B5.4.6 of IFRS 9 provide guidance on when an entity should recalculate the EIR:

For floating-rate instruments that pay a market rate of interest, paragraph B5.4.5 of IFRS 9 specifies that the “periodic re-estimation of cash flows to reflect the movements in the market rates of interest alters the effective interest rate.” However, paragraph B5.4.5 of IFRS 9 further notes that for such floating-rate financial instruments, “re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or the liability” if the asset or liability was initially recognized at an amount that equals the principal receivable.
For other instruments and for revisions of estimates, paragraph B5.4.6 of IFRS 9 usually requires an entity to recalculate the gross carrying amount of the financial asset “as the present value of the estimated future contractual cash flows that are discounted at the financial instrument’s original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets).” The resulting “catch-up” adjustment to the carrying amount of the financial asset is recognized immediately in profit or loss. This catch-up approach of recognizing changes in estimated cash flows differs from both the prospective and retrospective approaches used under U.S. GAAP.

A.2.2.2 Nonaccrual of Interest

Under U.S. GAAP, there is no explicit requirement for when an entity should cease recognizing interest income on investments in debt securities. However, an entity is permitted to cease such recognition as an accounting policy. In addition, while there is no indication in U.S. GAAP on when the accrual of interest should cease, ASC 325-40 requires that an entity use the cost recovery method when it cannot reliably estimate cash flows on a BI within its scope. That is, once the decision is made to put a BI within the scope of ASC 325-40 on nonaccrual status, the cost recovery method should be applied (i.e., all cash receipts are applied to the asset’s amortized cost basis). Other methods of nonaccrual (e.g., recognition of interest income on a cash basis) are not appropriate.

Under IFRS 9, an entity it not allowed to cease the accrual of interest. Rather, interest income recognition is determined on the basis of whether the asset is considered credit-impaired. That is, if the financial asset has not become credit-impaired since initial recognition, the entity applies the EIR method to the gross carrying amount (the “gross method”). If the financial asset has subsequently become credit-impaired, the entity applies the EIR to the amortized cost balance, which is the gross carrying amount adjusted for any loss allowance (“net method”). An entity using the net method should revert to the gross method if (1) the credit risk of the financial instrument subsequently improves to the extent that the financial asset is no longer credit-impaired and (2) the improvement is objectively related to an event that occurred after the net method was applied.

A.2.2.3 Foreign Exchange Gains and Losses on AFS/FVTOCI Debt Securities

Under U.S. GAAP, unrealized changes in the value of an investment in a foreign-currency-denominated security classified as AFS that are attributable to changes in foreign exchange rates are recognized in OCI. ASC 320-10-35-36 states that the entire “change in the fair value of foreign-currency-denominated available-for-sale debt securities, excluding the amount recorded in the allowance for credit losses, shall be reported in other comprehensive income.” An entity must report credit losses on AFS debt securities as credit losses in the income statement.

Under IFRS Accounting Standards, unrealized changes in the value of a foreign-currency-denominated debt instrument accounted for at FVTOCI that are attributable to changes in the foreign exchange rates are recognized in profit or loss. In accordance with paragraphs 5.7.10 and 5.7.11 of IFRS 9, the amount recognized in profit or loss for debt instruments accounted for at FVTOCI is the same as the amount that would be recognized in profit or loss for instruments accounted for at amortized cost. Paragraph B5.7.2A of IFRS 9 further clarifies this guidance:

For the purpose of recognising foreign exchange gains and losses under IAS 21, a financial asset measured at fair value through other comprehensive income in accordance with paragraph 4.1.2A is treated as a monetary item. Accordingly, such a financial asset is treated as an asset measured at amortised cost in the foreign currency. Exchange differences on the amortised cost are recognised in profit or loss and other changes in the carrying amount are recognised in accordance with paragraph 5.7.10.

Note that under IFRS 9, the treatment discussed above does not apply to investments in equity securities that an entity irrevocably elected to account for at FVTOCI. An investment in such securities is accounted for in a manner consistent with the guidance in paragraph B5.7.3 of IFRS 9, which states that “[s]uch an investment is not a monetary item. Accordingly, the gain or loss that is presented in other comprehensive income . . . includes any related foreign exchange component.”

Footnotes

1

Federal Financial Institutions Examination Council, FFIEC 031 and 041, “Call Report Instructions.”

Appendix B — Titles of Standards and Other Literature

Appendix C — Abbreviations

Abbreviation	Description
AFS	available for sale
AICPA	American Institute of Certified Public Accountants
ARS	auction rate security
ASC	FASB Accounting Standards Codification
ASU	FASB Accounting Standards Update
BI	beneficial interest
CECL	current expected credit loss
CUSIP	Committee on Uniform Security Identification Procedures
DCF	discounted cash flow
ED	exposure draft
EIR	effective interest rate
FAQ	frequently asked question
FASB	Financial Accounting Standards Board
FCAG	Financial Crisis Advisory Group
FDIC	Federal Deposit Insurance Corporation
FFIEC	Federal Financial Institutions Examination Council
FSP	FASB Staff Position
FVTOCI	fair value through other comprehensive income
GAAP	generally accepted accounting principles
GAAS	generally accepted auditing standard
HFI	held for investment
HFS	held for sale
HTM	held to maturity
IASB	International Accounting Standards Board
IFR	interim final rule
IFRS	International Financial Reporting Standard
LIBOR	London Interbank Offered Rate
MD&A	Management’s Discussion and Analysis
MLTN	more likely than not
OCA	SEC Office of the Chief Accountant
OCC	Office of the Comptroller of the Currency
OCI	other comprehensive income
OTTI	other-than-temporary impairment
PCAOB	Public Company Accounting Oversight Board
PCD	purchased credit-deteriorated
PCI	purchased credit-impaired
PCS	postcontract customer support
PFA	purchased financial asset
Q&A	question and answer
SAB	SEC Staff Accounting Bulletin
SEC	Securities and Exchange Commission
SRC	smaller reporting company
TDR	troubled debt restructuring
TRG	transition resource group
VIE	variable interest entity
WARM	weighted-average remaining maturity

Appendix D — Roadmap Updates for 2023

The table below summarizes the substantive changes made in the 2023 edition of this Roadmap.

Amended Content

Section	Title	Description
On the Radar		Added discussion of the FASB’s proposed ASU (issued in June 2023) on PFAs.
4.2.2	Expected Extensions, Renewals, and Modifications	Added Changing Lanes to explain that the elimination of the concept of TDRs does not change how entities consider loss mitigation activities in calculating the allowance for credit losses.
6.1	Introduction	Revised Changing Lanes to mention the FASB’s recently issued proposed ASU on PFAs.
7.2.5	PCD Considerations Related to AFS Debt Securities	Added Changing Lanes to note that the FASB’s recently issued proposed ASU on PFAs would eliminate the PCD model for AFS debt securities.
7.2.5.1.4	Subsequent Accounting Under the PCD Model in ASC 326-30	Added guidance on prospective yield adjustments for adverse changes in cash flows that are not reflected in the allowance for credit losses as a result of the fair value floor.
10.2.4	Proposed ASU	Renamed section and replaced content with discussion of the FASB’s proposed ASU on PFAs.

	Jonathan Howard Audit & Assurance Partner Deloitte & Touche LLP +1 203 761 3235 jonahoward@deloitte.com		Ashley Carpenter Audit & Assurance Partner Deloitte & Touche LLP +1 203 761 3197 ascarpenter@deloitte.com
	Brandon Coleman Audit & Assurance Partner Deloitte & Touche LLP +1 312 486 0259 brcoleman@deloitte.com		Stephen McKinney Audit & Assurance Managing Director Deloitte & Touche LLP +1 203 761 3579 smckinney@deloitte.com

2008	FCAG recommends that FASB and IASB jointly explore alternatives to the incurred loss model that would use more forward-looking information and would eliminate the delayed recognition of credit losses.
2009	IASB issues exposure draft (ED) on amortized cost and impairment related to financial instruments (November).
2010	FASB issues proposed ASU on accounting for financial instruments and revisions to the accounting for derivative instruments and hedging activities (May).
2011	FASB and IASB jointly issue a supplementary document on accounting for financial instruments and revisions to the accounting for derivative instruments and hedging activities — impairment (January).
2012	FASB decides to no longer pursue a converged standard and issues a proposed ASU on credit losses (ASC 825-15) (December).
2013	IASB issues ED on expected credit losses (March).
2014	IASB issues final guidance by adding to IFRS 9 impairment requirements related to the accounting for an entity’s expected credit losses (July).
2016	FASB issues final credit losses standard, ASU 2016-13, codified as ASC 326 (June).
2018	FASB issues ASU 2018-19, which contains Codification improvements to ASC 326 (November).
2019	FASB issues ASU 2019-04, which contains Codification improvements to ASC 326, ASC 815, and ASC 825 (April). FASB issues ASU 2019-05, which provides targeted transition relief to entities that are adopting ASC 326 (May). FASB issues ASU 2019-10 to change effective dates for new accounting standards (November). FASB issues ASU 2019-11 on additional Codification improvements to ASC 326 (November).
2020	FASB issues ASU 2020-02 to make certain amendments to SEC paragraphs in accordance with SAB 119 (February). FASB issues ASU 2020-03 on additional Codification improvements to financial instruments (March).
2022	FASB issues ASU 2022-01 to clarify hedge accounting guidance (March). FASB issues ASU 2022-02 on (1) TDRs by creditors and (2) vintage disclosures (March).
2023	FASB issues proposed ASU on purchased financial assets (PFAs) (June).