by Michelle Leon and Jon Howard, Deloitte &
On November 26, 2019, the FASB issued ASU 2019-11,1 which amends certain aspects of the Board’s new credit losses standard, ASU
2016-132 (codified in ASC 3263).
ASU 2019-11 amends or clarifies the following aspects of the guidance in ASC 326 on
Purchased credit-deteriorated (PCD) financial assets — The ASU
permits entities to record a negative allowance when measuring the
expected credit losses for a PCD financial asset, not to exceed the
total amount of the amortized cost basis previously written off and
expected to be written off.
The Board notes in the ASU’s Basis for Conclusions that negative
allowances should be recognized only to the extent that they offset
expected credit losses. ASC 326-20-30-13A specifies that an entity that
estimates expected credit losses by using a method other than a
discounted cash flow approach is permitted to include expected
recoveries in the allowance for credit losses (“ALL”). However, those
expected recoveries should not include “any amounts that result in an
acceleration of the noncredit discount.” As the Board explains in
paragraph BC10, “[b]ecause a valuation allowance is intended to capture
only losses related to credit, an entity cannot record a negative
allowance for noncredit related amounts because the noncredit amounts
are independent from the valuation allowance.”
Examples from the ASU that illustrate the above concepts
are reproduced in the appendix of
this Heads Up.
Connecting the Dots
In ASU 2019-04,4 the FASB clarified that an entity must include expected
recoveries of amounts previously written off and expected to be
written off in determining the ALL for non-PCD assets.
Accordingly, an entity may be required to include a negative
allowance (or basis recovery) in the ALL for non-PCD assets that
have been written off as long as the negative allowance does not
exceed the aggregate amount of previous or expected write-offs
of the non-PCD asset. ASU 2019-11 allows an entity to apply a
similar approach when determining the ALL for PCD assets but
does not permit the premature recognition (i.e., acceleration)
of interest income (as discussed above).
Transition relief for troubled debt restructurings — Entities may
calculate the effective interest rate for existing troubled debt
restructurings by using prepayment assumptions as of the date they adopt
Disclosure relief for accrued interest receivable (AIR) — ASU
2019-04 provides certain alternatives for the measurement of the ALL on
AIR. Those include (1) measuring an ALL on AIR separately, (2) electing
to provide separate disclosure of the AIR component of amortized cost as
a practical expedient, and (3) making accounting policy elections to
simplify certain aspects of the presentation and measurement of AIR. ASU
2019-11 amends ASC 320 to give entities that elect the separate
measurement or disclosure alternative in (1) or (2) the same AIR
disclosure relief they have under ASU 2019-04 when accounting for
available-for-sale debt securities.
Financial assets secured by collateral maintenance provisions —
ASC 326-20-35-6 gives entities a practical expedient for financial
assets secured by collateral maintenance provisions (e.g., the borrower
is contractually required to adjust the amount of the collateral
securing the financial asset). Under the practical expedient, entities
can measure the expected credit losses of the financial asset as the
difference between the amortized cost basis and the fair value of the
collateral. If the fair value of the collateral equals or exceeds the
amortized cost basis of the financial asset, an expected credit loss of
zero may be appropriate.
ASU 2019-11 clarifies that to use the practical
expedient, entities must reasonably expect the borrower “to continue to
replenish the collateral to meet the requirements of the contract.” In
addition, if entities have elected the practical expedient (i.e., they
reasonably expect the borrower to continue to replenish the collateral
to meet the requirements of the contract) and the fair value of the
collateral is less than the amortized cost of the financial asset, they
should estimate expected credit losses on the portion of the amortized
cost basis that is unsecured (i.e., the amount by which the amortized
cost basis of the financial asset exceeds the fair value of the
collateral). The expected credit loss is limited to the difference
between the amortized cost basis of the financial asset and the fair
value of the collateral.
ASU 2019-11 also makes conforming amendments to ASC 805-20.
For entities that have not yet adopted ASU 2016-13, the amendments in ASU 2019-11 are
effective on the same date as those in ASU 2016-13. For entities that have adopted
ASU 2016-13, the amendments in ASU 2019-11 are effective for fiscal years beginning
after December 15, 2019, and interim periods therein.
Appendix — Implementation Examples
The following examples from the ASU illustrate how, for PCD financial assets,
entities should include in the ALL expected recoveries of amounts previously written
off and expected to be written off:
Example 18: Determining the Negative Allowance for Purchased
Financial Assets With Credit Deterioration With No Change in
326-20-55-86 The following Example illustrates the
application of the guidance in paragraph 326-20-30-13A for
purchased financial assets with credit deterioration. For
purposes of this Example, the acquired portfolio of loans is
assumed to share similar risk characteristics and is
evaluated for credit losses on a collective basis.
326-20-55-87 Bank Q purchases a portfolio of loans
with a par amount of $10 million for $2 million. At
acquisition, Bank Q expects to collect $2.5 million on the
loan portfolio. Bank Q estimates expected credit losses
using a method other than a discounted cash flow method in
accordance with paragraph 326-20-30-4. The acquisition-date
journal entry is as follows.
326-20-55-88 After acquisition, Bank Q determines that
each loan is deemed uncollectible on an individual
unit-of-account basis and, therefore, writes off the loan
portfolio. The following journal entries are recorded.
326-20-55-89 Although deemed uncollectible on an
individual basis, when grouped together, the group of loans
is expected to have some recoveries on an aggregate basis.
Therefore, Bank Q records a negative allowance in accordance
with paragraph 326-20-30-13A. Because Bank Q’s expectation
of credit conditions has not changed since acquisition, the
expected recoveries of $2.5 million must not result in the
acceleration of the noncredit discount that existed
immediately before being written off. Therefore, the
following journal entry is recorded.
Example 19: Determining the Negative Allowance for Purchased
Financial Assets With Credit Deterioration After a Change in
326-20-55-90 Assume the same facts from Example 18.
Bank Q subsequently determines that a change in credit
conditions has occurred and expects to collect an additional
$600,000 (for a total of $3.1 million) on the group of
loans. Because Bank Q’s expectation of credit conditions has
changed and it is determining the amount that it expects to
collect using a method other than a discounted cash flow
method, the expected recoveries of $3.1 million would be
reduced by the noncredit discount of $0.5 million (that has
not been accreted). This would result in Bank Q having an
overall negative allowance of $2.6 million. Therefore, the
following journal entry is recorded.