Subsequent declines in the fair value of OREO should be recorded through the use of a valuation allowance. Changes in fair value should be determined on a property-by-property basis; an allowance allocated to one property may not be used to offset losses incurred on another property. In addition, unallocated valuation allowances are not permitted.
Subsequent increases in the fair value of a property may be used to reduce the valuation allowance, but only to an amount that does not exceed the OREO’s foreclosure date cost basis of the property, as illustrated in
ASC 310-20-55-51 through
ASC 310-20-55-53. Refer to
PPE 5 for further discussion on accounting for assets classified as held for sale.
EXAMPLE LI 11-1
Subsequent measurement of OREO classified as held for sale
On December 10, 20X5, Bank Corp received a real estate property in satisfaction of a loan. Bank Corp’s recorded investment in the loan at the time was $160,000. The estimated fair value of the property was $162,000 and estimated costs to sell were $7,000; therefore, the new cost basis of the OREO asset was $155,000.
As of March 31, 20X6, the fair value of the property declined to $160,000 and the estimated cost to sell remained at $7,000, resulting in a value of $153,000. Bank Corp recorded the decline in value by establishing a $2,000 valuation allowance.
As of June 30, 20X6, the fair value of the property increased to $165,000 while estimated costs to sell declined to $5,000.
How should Bank Corp record the increase in the fair value of the property as of June 30, 20X6?
Analysis
The value of the property less costs to sell as of June 30, 20X6 is $160,000 ($165,000 fair value — $5,000 costs to sell). However, Bank Corp can only increase the carrying value of the OREO to the OREO’s foreclosure date cost basis of $155,000. Therefore, Bank Corp can reverse the previously recorded valuation allowance of $2,000, but may not increase the value of the OREO any further.