The FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which addresses the impairment of beneficial interests and is effective beginning in 2020. The discussion in this section considers the accounting standards in effect prior to the adoption of ASU 2016-13. For information on the impairment of beneficial interests after the adoption of this standard, see LI 14.

The following decision tree summarizes the steps to determine whether an other than temporary impairment should be recognized under ASC 325-40.

View image

Determining whether an other-than-temporary impairment should be recognized on a beneficial interest subject to ASC 325-40 may involve numerous judgments. An investor must consider not only the prescriptive impairment rules in ASC 325-40-35, but also certain provisions of the impairment guidance in ASC 320-10-35 applicable to debt securities more generally.

In either case, the trigger for a potential impairment charge is a determination that, at the reporting (evaluation) date, the reference amount of the beneficial interest exceeds its fair value. The fair value of the beneficial interest should be based on the price that would be received to sell the asset in an orderly transaction between market participants at the measurement date (i.e., based on market participant assumptions about current information and events) consistent with the guidance in ASC 820.

If the fair value of the beneficial interest is less than its reference amount and the beneficial interest is reported at amortized cost or as available for sale, the investor should first assess whether it has the intent and ability to hold the investment until its amortized cost can be recovered. Consistent with the guidance in ASC 320-10-35, if the investor either intends to sell the security or it is more likely than not that the investor will be required to sell the security before recovery of its amortized cost basis, an-other-than-temporary impairment is considered to have occurred. Accordingly, the beneficial interest should be written down to its current fair value, with a corresponding charge to earnings. Any amounts attributable to the beneficial interest that were previously included in OCI should also be reclassified into earnings.

If either of these conditions exist, whether the beneficial interest has experienced an adverse change in cash flows is irrelevant; an-other-than-temporary impairment (with a corresponding charge to earnings) must be recorded.

If a reporting entity concludes that, based on its ability and intent to hold the beneficial interest, it does not need to record an other-than-temporary impairment charge based on the guidance in ASC 320, it should then consider the other-than-temporary impairment guidance specific to ASC 325-40.

ASC 325-40-35-4 states that a beneficial interest should be considered to have experienced an-other-than-temporary impairment if both of the following conditions are satisfied:

Examples 1 through 4 illustrate how an investor should assess whether a beneficial interest has undergone an adverse change in cash flows.

If these two conditions are present, the beneficial interest is considered to have suffered an-other-than-temporary impairment, and the investor should write down the beneficial interest to its current fair value, as discussed in ASC 325-40-35-4(b). The guidance in ASC 320-10-35 should be used to determine how to allocate the impairment between OCI and earnings.

The reference in ASC 325-40-35-4(b) to the impairment of securities guidance in ASC 320 can lead to confusion regarding the apportionment of the impairment between earnings and OCI. In many cases, investors may look to ASC 320-10-35-34D, which states that when apportioning the charge arising from an other-than-temporary impairment, the amount representing the credit loss should be recognized in earnings while the amount related to all other factors should be recognized in OCI.

This could lead to the conclusion that only the credit loss associated with the beneficial interest should be recognized in earnings. However, for beneficial interests subject to ASC 325-40, the guidance in ASC 320-10-35-33E effectively “re-routes” the investor back to ASC 325-40-35-4 through ASC 325-40-35-9 to determine whether there has been a decrease in cash flows expected to be collected. The guidance in ASC 325-40-35-5 requires consideration of both the timing and amount of the cash flows expected to be collected. Therefore, a beneficial interest subject to ASC 325-40 could have impairment charges recognized in earnings related not only to credit losses, but also to changes in expected prepayments.

If an entity intends to sell a depreciated beneficial interest (or it is more likely than not that the entity will be required to sell the interest before recovery of its amortized cost basis less any current period credit loss) the required write-down to fair value should be charged entirely to earnings. No portion of the loss may be allocated to OCI in these circumstances.

Consistent with the general debt security guidance in ASC 320-10-35-34E, after recording an other-than-temporary impairment for a held-to-maturity or available-for-sale security, a holder of a beneficial interest may not recognize a recovery in the fair value of the beneficial interest by crediting earnings directly. Rather, a subsequent increase in fair value may be indicative of a favorable change in estimated future cash flows, triggering an increase in accretable yield recognized prospectively. To the extent that an other-than temporary impairment has been recognized in OCI, the related amount would be expected to be removed from OCI in subsequent reporting periods – as the fair value of the beneficial interest would likely “pull to par” (or approach its reference amount) as the maturity date of the beneficial interest nears (or as principal payments are received).

The following examples illustrate how a holder of a beneficial interest should evaluate whether a change in cash flows expected to be collected should be considered adverse (unfavorable) or not adverse (favorable) based on applying the guidance in ASC 325-40-35-4(a).

At the end of 20X1, Transferor Corp updates its cash flow estimates as shown in the following table. The updated estimate considers both the amounts expected to be collected in future periods and the timing of their receipt. Transferor Corp uses a discount rate of 15% in its evaluation, as this was the internal rate of return (accretable yield) used to recognize interest income on the beneficial interest during 20X1.

Has an adverse or favorable change occurred in the expected cash flows?

The revised estimate indicates that there has been an unfavorable change in gross cash flows expected to be received. However, an offsetting favorable change in the timing of anticipated receipts is also projected. As a result, the NPV of the revised cash flow estimate ($73.21) is slightly greater than the original estimate ($72.50). Therefore, a favorable increase in cash flows has occurred, and the change (increase) in yield should be recognized prospectively.

At the end of period 20X1, Transferor Corp updates its cash flow estimates as shown in the following table. The updated estimate considers both the amounts expected to be collected in future periods and the timing of their receipt. Transferor Corp uses a discount rate of 15% in its evaluation, as this was the internal rate of return (accretable yield) used to recognize interest income on the beneficial interest during 20X1.

Has an adverse or favorable change occurred in the expected cash flows?

The timing and amounts of cash flows expected to be received subsequent to period 20X1 remains unchanged from the original estimate. However, cash received in period 20X1 was $5 less than anticipated. As a result, the NPV of the revised cash flow estimate ($69.51) is less than the original estimate ($73.86), an adverse change. If the fair value of the beneficial interest is greater than or equal to its reference amount, the change (decrease) in yield would be recognized prospectively. However, if the fair value of the beneficial interest is less than its reference amount, an other-than-temporary impairment would be recognized.

At the end of period 20X1, Transferor Corp updates its cash flow estimates as shown in the following table. The updated estimate considers both the amounts expected to be collected in future periods and the timing of their receipt. Transferor Corp uses a discount rate of 15% in its evaluation, as this was the internal rate of return (accretable yield) used to recognize interest income on the beneficial interest during 20X1.

Has an adverse or favorable change occurred in the expected cash flows?

Similar to Example 2, the timing and amounts of cash flows expected to be received subsequent to period 20X1 remains unchanged from the original estimate. However, cash received in period 20X1 was $5 more than anticipated. As a result, the NPV of the revised cash flow estimate ($78.21) is greater than the original estimate ($73.86). The change (increase) in yield would be recognized prospectively. Although the timing and amounts of the remaining expected cash inflows are unchanged from the original estimate, the beneficial interest’s effective yield will be higher going forward, stemming from the fact that the reference amount of the interest at the beginning of 20X2 is $5 less than what was anticipated based on the original estimate.

At the end of period 20X1, Transferor Corp updates its cash flow estimates as shown in the following table. The updated estimate considers both the amounts expected to be collected in future periods and the timing of their receipt. Transferor Corp uses a discount rate of 15% in its evaluation, as this was the internal rate of return (accretable yield) used to recognize interest income on the beneficial interest during 20X1.

Has an adverse or favorable change occurred in the expected cash flows?

The gross amount of cash flows expected to be received remains unchanged from the original estimate. However, the revised estimate indicates that there has been extension in the timing of the projected receipts. As a result, the NPV of the revised cash flow estimate ($64.32) is less than the original estimate ($67.12), an adverse change. If the fair value of the beneficial interest is greater than or equal to its reference amount, the change (decrease) in yield would be recognized prospectively. However, if the fair value of the beneficial interest is less than its reference amount, an other-than-temporary impairment would be recognized.