BC1. The following summarizes the Board’s considerations in reaching the conclusions in this Update. It includes reasons for accepting certain approaches and rejecting others. Individual Board members gave greater weight to some factors than to others.

BC2. The following paragraphs are organized by issue, mirroring the organization in the amendments to the Codification section.

BC3. On June 16, 2016, the Board issued Update 2016-13, which introduced the expected credit losses model for the measurement of credit losses on financial assets measured at amortized cost basis, replacing the previous incurred loss model. The amendments in that Update added Topic 326 and made several consequential amendments to the Codification. That Update also modified the accounting for available-for-sale (AFS) debt securities, which must be individually assessed for credit losses when fair value is less than the amortized cost basis in accordance with Subtopic 326-30.

BC4. Since the issuance of Update 2016-13, the Board has assisted stakeholders in implementing the amendments in that Update. Through this assistance, the Board has identified certain areas that require clarification and correction.

BC5. The amendments in this Update include items brought to the Board’s attention by stakeholders through their implementation efforts on Update 2016-13. The Board issued a proposed Accounting Standards Update, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, on June 27, 2019, with a 30-day comment period that ended on July 29, 2019. The Board received 19 comment letters on the proposed Update. Overall, respondents broadly supported the Board’s proposed amendments to provide Codification improvements to Topic 326.

BC6. The amendments clarify, correct, and improve the guidance related to the amendments in Update 2016-13. Therefore, the Board does not anticipate that entities will incur significant costs as a result of these amendments. The amendments provide the benefit of improving the consistent application of GAAP by clarifying guidance that already exists within GAAP.

BC7. The amendments in Update 2016-13 require that writeoffs of financial assets, which may be full or partial writeoffs, be deducted from the allowance. The writeoffs should be recorded in the period in which the financial asset or assets are deemed uncollectible. The amendments further state that recoveries of financial assets and trade receivables previously written off should be recorded when received. Stakeholders questioned whether expected recoveries could be included when estimating expected credit losses for non-PCD assets.

BC8. Update 2019-04 amended the guidance in Update 2016-13 to clarify that an entity is required to include expected recoveries of amounts previously written off and expected to be written off in determining the allowance for credit losses and should not exceed the aggregate of amounts previously written off and expected to be written off by the entity. As a result, an entity may be required to include an expected recovery (that is, a negative allowance) in the allowance for credit losses on financial assets that have been written off as long as the amount does not exceed the aggregate amount of previous or expected writeoffs of the financial assets. The phrase negative allowance is used to describe situations in 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.

BC9. As part of the feedback received through the comment letter process of Update 2019-04, several stakeholders suggested that the Board extend the recoveries and expected recoveries decision to PCD assets.

BC10. The Board decided to extend its decision on recoveries and expected recoveries to PCD assets for similar reasons as noted in the basis for conclusions in Update 2019-04. In addition, the Board decided that additional guidance was needed to limit entities from prematurely recognizing (that is, accelerating) interest income when writing off PCD assets. Therefore, the Board added language to 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. The Board also added this clarifying language for the following reasons:

BC11. The Board also considered capping expected recoveries to the purchase price of PCD assets. The purchase price represents the economic exposure on a PCD asset, which is akin to an originated financial asset’s unpaid principal balance. However, the Board concluded that this alternative would create different pre-writeoff and post-writeoff models for PCD assets because the allowance for credit loss is a valuation account that can be recognized in income before a writeoff but would be unable to be recovered after a writeoff.

BC12. The Board acknowledges that certain situations may result in negative allowances being capped at the purchase price of PCD assets. Stakeholders who responded to the proposed Update described situations in which a PCD asset is written off shortly after the acquisition date because individual financial assets within the PCD pool have been deemed uncollectible. A negative allowance is recorded immediately following the writeoff because, when grouped with similar financial assets that also have been written off, the group of financial assets is expected to have recoveries on an aggregate basis.

BC13. The Board concluded that the negative allowance, in this instance, should then represent the purchaser’s original expectation of credit (that is, the purchase price) because credit conditions have not changed following the writeoff. At acquisition of a PCD asset, the purchaser’s original expectation of credit is the purchase price (the maximum economic exposure on the asset), and any incremental amounts expected to be collected would be classified as noncredit discount. Therefore, if the asset is written off immediately after acquisition and the purchaser’s expectation of credit conditions does not change, the negative allowance would be limited to the purchase price.

BC14. Update 2016-13 also amended the impairment guidance for AFS debt securities, including the requirement to present credit losses as an allowance rather than as a write-down to the amortized cost basis of an AFS debt security. Additionally, the amendments in Update 2016-13 prohibit an entity from recording an allowance for credit losses that is below zero. Stakeholders asked that the Board consider permitting an entity to record a negative allowance for AFS debt securities in a manner similar to held-to-maturity debt securities in accordance with paragraph 326-20-30-1.

BC15. As part of the proposed Update, the Board asked stakeholders whether the recognition of a negative allowance (basis recovery) should be extended to AFS debt securities. Generally, stakeholders who provided feedback stated that the Board should extend the decision on negative allowances to AFS debt securities. Stakeholders noted that there was no conceptual difference between debt securities classified as held to maturity, which is permitted to apply a negative allowance, and AFS debt securities.

BC16. The Board decided to retain the guidance in the amendments in Update 2016-13 that prohibits an entity from adjusting an allowance for credit losses to an amount below zero. In its deliberations, the Board considered that the amendments in Update 2016-13 made targeted improvements, rather than significantly amending, the impairment guidance for AFS debt securities. Therefore, the Board decided that a significant amendment to the impairment guidance would be outside the scope of a Codification improvements project. Furthermore, the Board decided that writeoffs of an AFS debt security should occur infrequently upon adopting the amendments in Update 2016-13 because credit losses will be presented as an allowance, rather than as a writeoff under the existing other-than-temporary impairment guidance.

BC17. Additionally, the Board noted that the impairment methodologies for amortized cost basis financial assets and AFS debt securities are not aligned and that amendments to the current expected credit losses methodology may not necessarily warrant similar amendments to the AFS impairment methodology. The Board concluded that its decision to permit a negative allowance on PCD assets within the scope of Subtopic 326-20 does not warrant corresponding amendments to the AFS debt security impairment methodology for those reasons noted above.

BC18. At the June 2017 Credit Losses TRG meeting, stakeholders noted that to adjust the effective interest rate for prepayments upon the adoption of the amendments in Update 2016-13, entities using a discounted cash flow method to estimate expected credit losses on a preexisting TDR would be required to use the prepayment assumptions in effect immediately before the restructuring date.

Stakeholders noted that identifying the restructuring date for each TDR and recreating the appropriate economic assumptions that existed immediately before those dates would be operationally complex and time consuming. Stakeholders requested transition relief that would reduce the operational burden associated with adjusting the effective interest rate on preexisting TDRs upon the adoption of the amendments in Update 2016-13.

BC19. The Board did not intend to introduce significant operational complexities when measuring expected credit losses on preexisting TDRs. Therefore, at its December 13, 2017 meeting, the Board decided to allow an entity, as an accounting policy election, to calculate the prepayment-adjusted effective interest rate on preexisting TDRs using the prepayment assumptions that exist as of the date that the entity adopts the amendments in Update 2016-13, instead of the prepayment-adjusted effective interest rate immediately before the restructuring date.

BC20. Update 2019-04 amended the guidance in Topic 326 to provide a practical expedient that allows an entity to exclude accrued interest receivable balances from the disclosure requirements in paragraphs 326-20-50-4 through 50-22 and 326-30-50-4 through 50-10 for entities presenting accrued interest receivable balances net of allowance for credit losses (if applicable) separately or within another line item in the statement of financial position. Stakeholders asked that disclosure relief for accrued interest receivable balances be extended to all relevant disclosures involving amortized cost basis to be consistent within all related areas of the Codification.

BC21. The amendments in this Update provide entities with relief from including accrued interest receivable balances in amortized cost basis disclosures for certain Topics in the Codification.

BC22. 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. 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 of the financial asset and the entity expects that the borrower will continue to replenish collateral as necessary. If the fair value of the collateral at the reporting date is less than the amortized cost basis of the financial asset, an entity should limit the allowance for credit losses on the financial asset to the difference between the fair value of the collateral at the reporting date and the amortized cost basis of the financial asset.

BC23. Stakeholders questioned whether an entity is required to determine that a borrower will be able to continually replenish collateral in accordance with the contractual terms of the financial asset. The amendments in this Update clarify that an entity should determine that it reasonably expects that the borrower will be able to continually replenish collateral securing the financial asset in order to apply the practical expedient. In making this determination, the Board decided that an entity need not consider remote scenarios or determine that it is probable that the borrower will be able to continually replenish the collateral.

BC24. Additionally, stakeholders questioned in applying the practical expedient how an entity should determine its estimate of expected credit losses when the fair value of the collateral securing the financial asset is less than its amortized cost basis. The amendments in this Update clarify that an entity should estimate expected credit losses in accordance with paragraphs 326-20-30-4 through 30-5 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). However, the allowance for credit losses should be limited to the difference between the amortized cost basis and the fair value of the collateral. 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.

BC25. Issue 5 represents a conforming amendment to the guidance related to amendments in Update 2016-13. The reasons for making this conforming amendment are sufficiently explained in the summary and amendments to the Codification. Therefore, there is no formal basis for conclusions for this issue.

BC26. As part of the feedback received on the proposed Update, some stakeholders asked that the Board delay the implementation of Topic 326 for U.S. Securities and Exchange Commission filers that are required to adopt the amendments in Topic 326 during 2020. Those stakeholders suggested that the amendments in this Update, in particular the Board’s decision on negative allowances for PCD assets, would require additional implementation time. The Board decided to affirm the effective date requirements in the amendments in the proposed Update because the amendments in this Update clarify the Board’s intent that entities should consider recoveries and expected recoveries in determining the allowance for credit losses, which is consistent with the approach used by entities today. That is, entities generally track their net charge-off information and use that information to determine the allowance for loan losses under existing GAAP. Therefore, the Board’s decision to expand the use of recoveries and expected recoveries conforms practice with Topic 326.

BC27. The Board decided that if an entity has not yet adopted the amendments in Update 2016-13, the effective dates and transition requirements for the amendments in this Update should be the same as the effective dates and transition requirements in Update 2016-13. For entities that have adopted the amendments in Update 2016-13, the Board decided that the amendments in this Update should be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Board also decided that an entity that has adopted the amendments in Update 2016-13 is permitted to early adopt this guidance in any interim period within the fiscal years beginning after December 15, 2018.

BC28. For entities that have adopted the amendments in Update 2016-13, the Board decided that the amendments in this Update should be applied on a modified retrospective transition basis by means of a cumulative-effect adjustment to the opening retained earnings in the statement of financial position as of the date that an entity adopted the amendments in Update 2016-13. The Board determined that this transition approach will provide users with comparable information because the measurement of financial assets measured at amortized cost basis will be consistent for the applicable periods.

BC29. The Board also decided that entities that have adopted the amendments in Update 2016-13 should disclose the following in the period in which they adopt the amendments in this Update: