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14.3 Scope of ASC 325-40
Publication date: 31 May 2022
us Loans & investments guide
ASC 325-40 guidance applies to beneficial interests classified as held to maturity, available for sale, or trading. ASC 325-40 includes in its scope for interest income recognition purposes, entities that account for beneficial interests as trading or other accounting models whereby the beneficial interest is measured at fair value with changes in fair value recorded in earnings. The scope of ASC 325-40 begins in ASC 325-40-15-1 through ASC 325-40-15-3.
The guidance in this Subtopic applies to all entities.
The guidance in this Subtopic applies to a transferor’s interests in securitization transactions that are accounted for as sales under Topic 860 and purchased beneficial interests in securitized financial assets.
The guidance in this Subtopic applies to beneficial interests that have all of the following characteristics:
- Are either debt securities under Subtopic 320-10 or required to be accounted for like debt securities under that Subtopic pursuant to paragraph 860-20-35-2.
- Involve securitized financial assets that have contractual cash flows (for example, loans, receivables, debt securities, and guaranteed lease residuals, among other items). Thus, the guidance in this Subtopic does not apply to securitized financial assets that do not involve contractual cash flows (for example, common stock equity securities, among other items). See paragraph 320-10-35-38 for guidance on beneficial interests involving securitized financial assets that do not involve contractual cash flows.
- Do not result in consolidation of the entity issuing the beneficial interest by the holder of the beneficial interests.
- Subparagraph superseded by Accounting Standards Update No. 2016-13.
- Are not beneficial interests in securitized financial assets that have both of the following characteristics:
- Are of high credit quality (for example, guaranteed by the U.S. government, its agencies, or other creditworthy guarantors, and loans or securities sufficiently collateralized to ensure that the possibility of credit loss is remote)
- Cannot contractually be prepaid or otherwise settled in such a way that the holder would not recover substantially all of its recorded investment.
Figure LI 14-1 summarizes how an investor would determine whether a beneficial interest (BI) is within the scope of ASC 325-40.
Figure LI 14-1
ASC 325-40: scoping decision tree
ASC 325-40: scoping decision tree
14.3.1 High credit quality
While ASC 325-40-15-3(e)(1) refers to “high credit quality,” ASC 325-40 does not detail how to evaluate it. In our view, and the view of the SEC, a beneficial interest rated AA or above by S&P (or similarly rated by other rating agencies), or having an equivalent shadow rating, should be considered of high credit quality, and thus (if the other criteria are met) need not be accounted for in accordance with ASC 325-40. An investor would look instead to other relevant guidance such as ASC 310 or ASC 320 when accounting for the investment.
A beneficial interest deemed to be of high credit quality when purchased may not satisfy that condition at a later date (e.g., as a consequence of a rating agency downgrade). In these circumstances, we believe the investor may continue to apply the income recognition and measurement guidance deemed appropriate at the acquisition date. Alternatively, going forward, the investor may treat the beneficial interest as subject to ASC 325-40. In either case, the policy election should be applied consistently.
14.3.2 PCD scope for beneficial interests subject to ASC 325-40
The guidance in ASC 325-40-30-1A related to beneficial interests in securitized financial assets requires the purchased financial asset with credit deterioration (PCD) asset guidance to be applied to certain beneficial interests classified as either held to maturity or available for sale if it meets certain criteria.
An entity shall apply the initial measurement guidance for purchased financial assets with credit deterioration in Subtopic 326-20 to a beneficial interest classified as held-to-maturity and in Subtopic 326-30 to a beneficial interest classified as available for sale, if it meets either of the following conditions:
- There is a significant difference between contractual cash flows and expected cash flows at the date of recognition.
- The beneficial interests meet the definition of purchased financial assets with credit deterioration.
Beneficial interests subject to ASC 325-40 are considered to be PCD if they meet the definition of PCD assets or if they have a significant difference between expected cash flows and “contractual” cash flows as of the acquisition date. At the June 12, 2017 Transition Resource Group meeting (TRG Memo 2: Scope of PCD Assets for Beneficial Interests), the TRG discussed how “contractual cash flows” should be determined for the purposes of applying the PCD guidance. How the term “contractual cash flows” is defined impacts initial and subsequent measurement of beneficial interests that are PCD. Contractual cash flows used for initial measurement determine whether the beneficial interest is accounted for as a PCD asset and the amount of the day 1 allowance if the beneficial interest is a PCD asset. It is also used to determine the accretable yield for beneficial interests that are treated as PCD.
When determining the contractual cash flows of the beneficial interest in the PCD determination, an entity should first look to the stated contractual terms of the asset or the stated contractual terms of the underlying assets if the beneficial interest does not have stated terms (e.g., residual interests). Contractual cash flows should be computed considering expected prepayments at the date of recognition and assuming no credit losses. Under this approach, estimated prepayments would not impact the determination of whether the beneficial interest is considered to be PCD and also limits the day 1 allowance to cash flows not expected to be received solely due to credit losses. Consistent with the beneficial interest model, changes in expected cash flows, whether due to credit, prepayment, or other factors may impact the allowance and/or the accretable yield in subsequent periods.
Question LI 14-1 addresses what is considered a significant difference between contractual and expected cash flows.
Question LI 14-1
What is considered a significant difference between contractual cash flows and expected cash flows at the date of recognition?
What is considered a significant difference between contractual cash flows and expected cash flows at the date of recognition?
PwC response
ASC 326 does not define what is considered a significant difference between contractual and expected cash flows at the date of recognition. Therefore, judgment is required. The FASB has stated that most residual tranches in securitizations (e.g., the subordinated note in a collateralized loan obligation securitization) could be considered to have a significant difference between contractual cash flows and expected cash flows at the date of initial recognition.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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