FASB Issues Improvements for Credit Losses Standard

December 2019


Summary

The FASB issued ASU 2019-11[1] (“Update”) to clarify its new credit impairment guidance in ASC 326[2] based on implementation issues raised by stakeholders. The new ASU is available here and the effective dates align with those for Topic 326.[3]
 

Background

In 2016, the FASB issued ASC 326 requiring application of the current expected credit loss (“CECL”) methodology for the measurement of credit losses on financial assets measured at amortized cost. The CECL methodology replaces the previous incurred loss methodology. It also modifies the accounting for available-for-sale debt securities, which must be individually assessed for credit losses when fair value is less than the amortized cost basis.

Since issuing the standard, the FASB has identified certain areas that need clarification. The FASB also established the Transition Resource Group (TRG) for Credit Losses early in 2016 to solicit, analyze, and discuss implementation issues that could arise when organizations implement ASU 2016-13.

 

Main Provisions

The amendment clarifies five issues, four of which are summarized below. Issue 5 has been excluded as it simply corrects cross-references.

What was the issue?

Summary of Improvements

Issue 1: Expected Recoveries for Purchased Financial Assets with Credit Deterioration (PCD)
 
Under ASC 326, the allowance for credit losses is required to include estimates for expected recoveries. Stakeholders questions whether negative allowances were permitted on PCD assets. A negative allowance relates to situations when an entity determines it will recover all or a portion of the amortized cost basis of an asset previously written off. These situations typically occur because of applying regulatory charge off policies based on delinquency.
 

 
 
 
Expected recoveries are to be included in the allowance for credit losses for these financial assets. However, the expected recoveries should not exceed the total amortized cost basis that is expected to be, or already has been, written off.
 
If a valuation method other than a discounted cash flow method is used to determine the expected credit losses, the calculation of expected recoveries should not accelerate the recognition of any noncredit discount.

Issue 2: Troubled Debt Restructurings Transition
 
Stakeholders in the process of adopting ASC 326 noted significant operational challenges associated with calculating the prepayment-adjusted effective interest rate for troubled debt restructuring transactions that exist as of the adoption date utilizing the prepayment assumptions that were in effect immediately prior to the restructuring event.

 
 
An entity can make an accounting policy election to adjust the effective interest rate for existing troubled debt restructurings based on the prepayment assumptions applicable on the adoption date of ASC 326 instead of the prepayment assumptions applicable immediately prior to the restructuring event.

Issue 3: Disclosures for accrued interest receivables
 
To meet certain disclosure requirements under ASC 326, a previous codification improvement[4] allowed for a practical expedient to separately disclose the total accrued interest included in the amortized cost basis. However, this practical expedient did not nullify the requirements to include accrued interest receivable in disclosures of amortized cost basis under other Topics.

 
 
 
The amendment extends the practical expedient to all additional relevant disclosures involving amortized cost basis.

Issue 4: Financial assets backed by Collateral Maintenance Provisions
 
Stakeholders questioned whether an entity was required to evaluate the ability of the borrower to continue to replenish the collateral associated with the financial asset when applying the practical expedient, where an entity may determine that the expectation of nonpayment of the amortized cost basis is zero if the borrower continually replenishes the collateral securing the financial asset such that the fair value of the collateral is equal to or exceeds the amortized cost basis.
 
They also questioned how to determine the CECL reserve if the fair value of the collateral is less than the amortized cost.

 
 
 
The amendments clarify that an entity should consider the borrower’s ability to continue to replenish the collateral associated with the financial assets.
 
The amendments also clarify that when applying this practical expedient, expected credit losses should be estimated when the amortized cost basis of the financial asset exceeds the fair value of its associated collateral. The allowance would be limited to the difference between the fair value of the collateral and the amortized cost of the associated asset (that is, the unsecured portion of the amortized cost basis).

 

Effective Dates and Transition

For entities that have not adopted ASC 326, the transition requirements and effective dates for this Update are the same as those applicable for ASC 326, as amended by ASU 2019-10.
 
For entities that have adopted ASC 326, the amendments in this Update are effective in fiscal years beginning after December 15, 2019, including interim periods therein. Early adoption is permitted but no earlier than an entity’s adoption date of ASC 326. The amendments should be applied on a modified-retrospective basis through a cumulative-effect adjustment to opening retained earnings as of the date an entity adopted ASC 326.
 
 

Contacts


[1] Codification Improvements to Topic 326, Financial Instruments—Credit Losses
[2] Accounting Standards Update No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments
[3]    The effective dates in Topic 326 were recently amended by ASU 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842) – Effective Dates
[4] 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