5.4 Subsequent Measurement
ASC 460 does not provide specific guidance on how to account for the guarantees after
issuance. Rather, if an entity does not elect the fair value option for the
guarantee, the entity would apply an overarching principle in the guidance under
which it would release the initial liability to income (by a credit to earnings) as
the guarantor is released from risk under the guarantee; the remaining contingent
aspect should be accounted for in accordance with ASC 450-20.
ASC 460-10
35-1
This Subsection does not describe in detail how the
guarantor’s liability for its obligations under the
guarantee would be measured after its initial recognition.
The liability that the guarantor initially recognized under
paragraph 460-10-25-4 would typically be reduced (by a
credit to earnings) as the guarantor is released from risk
under the guarantee.
35-2
Depending on the nature of the guarantee, the guarantor’s
release from risk has typically been recognized over the
term of the guarantee using one of the following three
methods:
- Only upon either expiration or settlement of the guarantee
- By a systematic and rational amortization method
- As the fair value of the guarantee changes.
Although those three methods are currently being used in
practice for subsequent accounting, this Subsection does not
provide comprehensive guidance regarding the circumstances
in which each of those methods would be appropriate. A
guarantor is not free to choose any of the three methods in
deciding how the liability for its obligations under the
guarantee is measured subsequent to the initial recognition
of that liability. A guarantor shall not use fair value in
subsequently accounting for the liability for its
obligations under a previously issued guarantee unless the
use of that method can be justified under generally accepted
accounting principles (GAAP). For example, fair value is
used to subsequently measure guarantees accounted for as
derivative instruments under Topic 815.
35-3 Paragraph
superseded by Accounting Standards Update No. 2016-13.
35-4 The discussion in
paragraph 460-10-35-2 about how a guarantor typically
reduces the liability that it initially recognized does not
encompass the recognition and subsequent adjustment of the
contingent liability related to the contingent loss for the
guarantee. The contingent aspect of the guarantee shall be
accounted for in accordance with Subtopic 450-20 unless the
guarantee is accounted for as a derivative instrument under
Topic 815 or the guarantee is within the scope of Subtopic
326-20 on financial instruments measured at amortized cost.
For guarantees within the scope of Subtopic 326-20, the
expected credit losses (the contingent aspect) of the
guarantee shall be accounted for in accordance with that
Subtopic in addition to and separately from the fair value
of the guarantee liability (the noncontingent aspect)
accounted for in accordance with paragraph 460-10-30-5.
5.4.1 Subsequent Accounting for Noncontingent Aspect of Guarantee
An entity cannot freely choose to elect one of the three methods in ASC
460-10-35-2 to subsequently account for the liability recognized upon issuance
of a guarantee. Instead, a guarantor should choose the method that is
appropriate given the particular facts and circumstances related to each
individual guarantee. Irrespective of the method it chooses, the entity should
document and consistently apply the method for similar guarantees throughout the
term of each guarantee. Often, a systematic and rational amortization method is
appropriate. At the 2003 AICPA Conference on Current SEC Developments, the SEC
staff stated the following:
So what do we believe the appropriate “day two” accounting for the
obligation to stand ready would be? . . . It would seem a systematic and
rational amortization method would most likely be the appropriate
accounting.
Examples 5-9, 5-22, and 5-27 illustrate how an entity might account for the guarantee
liability in periods after initial measurement.
For some guarantees, an entity is required or permitted to use fair value as the
subsequent-measurement attribute:
- Subsequent measurement at fair value is required for a guarantee that meets the definition of a derivative and is within the scope of ASC 815-10.
- For a guarantee that meets the definition of a financial instrument or that is otherwise within the scope of the guidance in ASC 825-10 on the fair value option, an entity is permitted to elect fair value as the subsequent-measurement attribute. However, an entity cannot justify fair value as the subsequent-measurement attribute solely on the basis of ASC 460-10-35-2, which indicates that for some guarantees, the release from risk changes as the fair value of the guarantee changes. ASC 460-10-35-2 specifies that a “guarantor shall not use fair value in subsequently accounting for the liability for its obligations under a previously issued guarantee unless the use of that method can be justified under [GAAP].” Therefore, a fair value election is appropriate only if it conforms to the guidance in ASC 825-10. See Chapter 12 of Deloitte’s Roadmap Fair Value Measurements and Disclosures (Including the Fair Value Option) for additional discussion of the eligibility and application of the fair value option.
5.4.2 Subsequent Accounting for the Contingent Aspect of a Guarantee
The discussion in ASC 460-10-35-2 about how a guarantor
typically reduces the liability that it initially recognized does not encompass
the recognition and subsequent adjustment of the liability related to the
contingent loss on the guarantee. The subsequent measurement of the contingent
liability, if any, is measured in accordance with ASC 450-20 unless the
guarantee is subsequently measured at fair value through earnings (or is within
the scope of ASC 326-20). The ASC 450-20 liability is subsequently measured on
the basis of facts and circumstances specific to the contingency, and the
related loss is recognized in earnings.
5.4.2.1 Subsequent Accounting for Guarantees Within the Scope of ASC 326-20
The contingent aspect of a
guarantee that is within the scope of ASC 326-20 is accounted for separately
from the initial recognized liability in accordance with the expected credit
loss model.
Example 5-27
Guarantee Within the Scope of ASC
326-20
Assume the same facts as in
Example 5-24. Further assume that the
guaranteed loan has a term of three years and that
A’s systematic and rational method for subsequent
measurement of the initial obligation is to amortize
the liability over the life of the loan, given that
H makes monthly payments of principal and interest.
Company A’s expected credit losses as of the end
date of each reporting period are as follows:
- End of year 1 — $3 million.
- End of year 2 — $1 million.
- End of year 3 — $0 million.
Company A will record the following
subsequent-accounting entries:
End of year
1
End of year
2
End of year
3
In this example, since no amount was
ultimately paid on the guarantee, the expected loss
reverts to zero as of the end of the term of the
guarantee.
5.4.2.2 Subsequent Accounting for Guarantees Not Within Scope of ASC 326-20
Neither ASC 460-10 nor ASC 450-20 provides explicit guidance
on the interaction between those subtopics after initial recognition.
Accordingly, entities should establish a systematic and rational method that
is supportable for the subsequent accounting. In establishing that method,
entities may look to analogous guidance, such as ASC 605-20-25-6, ASC
606-10, ASC 942-825-50-2, and ASC 944. Irrespective of the method it
chooses, the entity should document and consistently apply the method for
similar guarantees throughout the term of each guarantee. Further, the
entity should consider the nature of its operations and the specific terms
of the guarantee to ensure that the method is appropriate on the basis of
the facts and circumstances of the guarantee. Two possible methods of
determining the amount of an ASC 450-20 liability to record are discussed
below.
5.4.2.2.1 Method 1 — Incremental Recognition of the ASC 450-20 Contingent Liability
After the initial recognition, an entity would record a separate ASC
450-20 liability only when the entire estimated ASC 450-20 amount
exceeds the unamortized ASC 460 liability. The ASC 450-20 liability
equals the excess of the entire estimated probable obligation over (1)
the unamortized ASC 460 liability or (2) the expected unamortized ASC
460 liability at the time of the expected payment. In subsequent
periods, the ASC 450-20 liability may need to be adjusted so that it
continues to equal the excess of the entire estimated probable
obligation over the unamortized ASC 460 liability.
5.4.2.2.2 Method 2 — Gross Recognition of the ASC 450-20 Liability
Under this method, after the initial recognition and measurement of the
guarantee, an entity would record a separate ASC 450-20 liability for
the entire amount of the estimated probable obligation. The entity would
continue to amortize the ASC 460 liability in accordance with its
established policy until it is released from its obligation to stand
ready. This approach is similar to the approach required for guarantees
within the scope of ASC 326-20 although the contingent loss is measured
in accordance with ASC 450-20 rather than under the expected credit loss
model.
Note that this guidance does not apply to guarantees that meet the
definition of a derivative or are otherwise recognized at fair value. If
a guarantee meets the definition of a derivative or is otherwise
subsequently accounted for at fair value, both the stand-ready
obligation and contingent obligation of the guarantee should be treated
as a single unit of account, with subsequent changes in fair value of
the guarantee recorded in earnings for the period in which the changes
occur.
The example below
illustrates the two different methods discussed above.
Example 5-28
Contingent
Liability — Incremental Versus Gross
Recognition
Entity B is seeking to borrow $20 million for a
term of five years from Bank C; however, C will
not issue such proceeds to B without a third-party
guarantee. On January 1, 20X1, B pays Entity A $1
million as a separately identified premium in
exchange for A’s issuance to C of a guarantee
stating that, in the event of B’s default, A will
step in and make all remaining scheduled payments.
Also, on January 1, 20X1, C loans Entity B $20
million. The loan calls for equal monthly payments
of principal and interest during the five-year
term.
Upon initial recognition of the guarantee
obligation, A applies ASC 460-10-30-2(a) and
recognizes the $1 million cash received with a
corresponding guarantee liability.
As of each reporting period through September 30,
20X3, A assesses the probability of B’s default
(i.e., the event that would require A to make some
or all of B’s remaining payments to C) and
concludes that it is not probable that B will
default. However, during the fourth quarter of
20X3, a severe decrease in demand for B’s main
product occurred, as a result of which A concluded
that it is probable that it will be required to
pay C for B’s payments due in 20X4 and 20X5.
Entity B can make the contractually required
payments through December 31, 20X3. Assume that
the total amount of the remaining payments after
December 31, 20X3, is $10 million.
The two examples below illustrate how A’s
accounting would differ depending on which method
is applied to the subsequent accounting for the
contingent aspect of the guarantee.
Subsequent
Entries:
December
31, 20X1
No entry is required for the ASC
450 contingent liability because a loss is not
probable.
December
31, 20X2
No entry is required for the ASC
450 contingent liability because a loss is not
probable.
December
31, 20X3
Incremental
Recognition
Gross Recognition
Note that after these two
entries, there remains $400,000 of the guarantee
liability for the unamortized portion of the
stand-ready obligation. It would be acceptable for
that amount to also be recognized immediately into
income since the full amount of the guarantee has
been recognized as a contingent liability.