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Amortized cost of the loan
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$1,000,000 |
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Fair value of the collateral
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600,000 |
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Estimated costs to sell
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(80,000) |
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520,000 |
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Impairment
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$480,000 |
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For certain financial assets, the borrower may be contractually required to continually adjust the amount of the collateral securing the financial asset(s) as a result of fair value changes in the collateral. In those situations, if an entity reasonably expects the borrower to continue to replenish the collateral to meet the requirements of the contract, an entity may use, as a practical expedient, a method that compares the amortized cost basis with the fair value of collateral at the reporting date to measure the estimate of expected credit losses. An entity may determine that the expectation of nonpayment of the amortized cost basis is zero if the fair value of the collateral is equal to or exceeds the amortized cost basis of the financial asset and the entity reasonably expects the borrower to continue to replenish the collateral as necessary to meet the requirements of the contract. If the fair value of the collateral at the reporting date is less than the amortized cost basis of the financial asset and the entity reasonably expects the borrower to continue to replenish the collateral as necessary to meet the requirements of the contract, the entity shall estimate expected credit losses for the unsecured amount of the amortized cost basis. The allowance for credit losses on the financial asset is limited to the difference between the fair value of the collateral at the reporting date and the amortized cost basis of the financial asset.
An asset or liability that has been designated as being hedged and accounted for pursuant to this Section remains subject to the applicable requirements in generally accepted accounting principles (GAAP) for assessing impairment or credit losses for that type of asset or for recognizing an increased obligation for that type of liability. Those impairment or credit loss requirements shall be applied after hedge accounting has been applied for the period and the carrying amount of the hedged asset or liability has been adjusted pursuant to paragraph 815-25-35-1(b). A portfolio layer method basis adjustment that is maintained on a closed portfolio basis for an existing hedge in accordance with paragraph 815-25-35-1(c) shall not be considered when assessing the individual assets or individual beneficial interest included in the closed portfolio for impairment or credit losses or when assessing a portfolio of assets for impairment or credit losses. An entity may not apply this guidance by analogy to other components of amortized cost basis. Because the hedging instrument is recognized separately as an asset or liability, its fair value or expected cash flows shall not be considered in applying those impairment or credit loss requirements to the hedged asset or liability.
Scenario |
Application |
At the reporting date, the fair value of the collateral is equal to or greater than the amortized cost basis (excluding any fair value hedge accounting adjustments from active portfolio layer method hedges).
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Assuming the asset qualified for the collateral maintenance practical expedient, since the fair value of the collateral at the reporting date is equal to or greater than the amortized cost basis (excluding any fair value hedge accounting adjustments from active portfolio layer method hedges), the allowance is $0 as long as the creditor is able to demonstrate a reasonable expectation that the borrower is able to continually replenish the collateral.
Unlike what would usually be required in applying the CECL model, the creditor does not need to consider the possibility of the collateral falling in value after the reporting date. Under the expedient, a creditor is allowed to only consider the reporting period fair value of the collateral. As a result, credit losses are capped at the difference between the amortized cost basis (excluding any fair value hedge accounting adjustments from active portfolio layer method hedges) and the current fair value of the collateral.
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At the reporting date, the fair value of the collateral is $98, and the amortized cost basis (excluding any fair value hedge accounting adjustments from active portfolio layer method hedges) is $100.
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Assuming the asset qualifies for the collateral maintenance practical expedient (including the demonstration that the creditor has a reasonable expectation that the borrower is able to continually replenish the collateral), the financial asset should be evaluated as two separate components:
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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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