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AFS debt securities are required to be individually evaluated for impairment in accordance with ASC 326-30-35-4 and ASC 326-30-35-5. A security is considered impaired if the fair value of the security is less than its amortized cost basis (e excluding fair value hedge accounting adjustments from active portfolio layer method hedges).

ASC 326-30-35-1

An investment is impaired if the fair value of the investment is less than its amortized cost basis.

ASC 326-30-35-1A

An entity shall not consider a basis adjustment related to an existing portfolio layer method hedge designated in accordance with paragraph 815-20-25-12A when measuring impairment of the individual investments or individual beneficial interest included in a closed portfolio hedged using the portfolio layer method

ASC 326-30-35-4

Impairment shall be assessed at the individual security level (referred to as an investment). The impairment assessment of the individual securities or individual beneficial interest in a closed portfolio hedged using the portfolio layer method shall not consider the basis adjustment related to an existing portfolio layer method hedge. Individual security level means the level and method of aggregation used by the reporting entity to measure realized and unrealized gains and losses on its debt securities. (For example, debt securities bearing the same Committee on Uniform Security Identification Procedures [CUSIP] number that were purchased in separate trade lots may be aggregated by a reporting entity on an average cost basis if that corresponds to the basis used to measure realized and unrealized gains and losses for the debt securities.) Providing a general allowance for an unidentified impairment in a portfolio of debt securities is not appropriate.

ASC 326-30-35-5

An entity shall not combine separate contracts (a debt security and a guarantee or other credit enhancement) for purposes of determining whether a debt security is impaired or can contractually be prepaid or otherwise settled in such a way that the entity would not recover substantially all of its cost.

If the reporting entity concludes that it does not intend to sell an impaired security and it is not more likely than not required to sell an impaired security before recovery of its amortized cost basis (except for fair value hedge accounting adjustments from active portfolio layer method hedges), an entity should record the portion of the impairment related to credit losses (if any) in an allowance for credit losses with an offsetting entry to net income. Any portion of the impairment not related to credit losses is recorded through other comprehensive income (OCI) (unless other GAAP such as hedge accounting would dictate other treatment). The amount of the allowance for credit losses is limited to the amount fair value is less than the amortized cost basis.
If the security is impaired and the entity intends to sell or will more likely than not be required to sell the security before recovering its amortized cost basis (except for fair value hedge accounting adjustments from active portfolio layer method hedges), an entity should first writeoff any previously recognized allowance for credit losses with an offsetting entry to the security’s amortized cost basis. If the allowance has been fully written off and fair value is less than amortized cost basis, an entity should directly write down the amortized cost basis of the asset to its fair value with an entry to net income. See Example LI 8-1 in LI 8.2.5, Example LI 8-2 in LI 8.2.6, and Example LI 8-3 in LI 8.2.7. If an unrealized holding loss was deferred in OCI, additional consideration is needed.
Figure LI 8-2 provides an overview of the AFS debt security impairment model.
Figure LI 8-2
Analysis of impairment of an AFS debt security
Note: Figure LI 8-2 assumes the securities are not designated as hedged items in a portfolio layer method hedge. See LI 8.1.1.

8.2.1 Guarantees and other credit enhancements

If a guarantee is a freestanding financial instrument (i.e., distinct legal contract and not a component of the originated or purchased debt security), it should be accounted for separately and cannot be considered in the credit loss analysis performed on the security. The Codification Master Glossary provides information on the definition of a freestanding financial instrument.

Definition from ASC Master Glossary

Freestanding Financial Instrument: A financial instrument that meets either of the following conditions:
a. It is entered into separately and apart from any of the entity’s other financial instruments or equity transactions.
b. It is entered into in conjunction with some other transaction and is legally detachable and separately exercisable.

Additionally, ASC 326-30-35-5 provides information on the accounting for debt securities and guarantees and other credit enhancements.

ASC 326-30-35-5

An entity shall not combine separate contracts (a debt security and a guarantee or other credit enhancement) for purposes of determining whether a debt security is impaired or can contractually be prepaid or otherwise settled in such a way that the entity would not recover substantially all of its cost.

A guarantee or other credit enhancement that is not required to be accounted for as a bifurcated derivative under the guidance in ASC 815 and that is contractually part of the purchased debt security should be considered when determining whether a credit loss exists. For example, a guarantee of principal and interest payments by a third-party guarantor included in the terms of a purchased debt security may create a single legal instrument (i.e., a guaranteed security). In that case, the guaranteed security itself is the unit of account, rather than accounting for the security and guarantee separately.

8.2.2 Determine if an AFS debt security is impaired

An investment in an AFS debt security is considered impaired if the fair value of the security is less than its amortized cost (excluding fair value hedge accounting adjustments from active portfolio layer method hedges). If the fair value of the security is higher than its amortized cost basis, the security is not considered impaired.
Question LI 8-1
If an AFS debt security’s fair value exceeds its amortized cost basis, but the security has experienced an adverse change in cash flows due to credit-related factors, should an impairment be recorded?
PwC response
No. While a credit loss may exist in a security whose fair value exceeds its amortized cost basis (excluding fair value hedge accounting adjustments from active portfolio layer method hedges), no impairment is recognized. For example, the credit on a fixed-rate bond may have deteriorated (resulting in a decrease in the fair value of the security), but there may also have been a decline in market interest rates since the security was issued (resulting in an increase in the fair value of the security) that could offset the impact of the credit deterioration. Such a security is not considered impaired, as the entity would be able to recover the amortized cost basis of the security by selling it at fair value. Therefore, no impairment would be recognized.

8.2.3 Assess if the entity may sell an impaired AFS debt security

If the AFS debt security is impaired, the reporting entity should determine whether it has decided to sell the security, or will more likely than not be required to sell the security before recovery of its amortized cost basis (excluding fair value hedge accounting adjustments from active portfolio layer method hedges).

8.2.3.1 AFS debt security: intent to sell

ASC 326-30-35-10 states that a reporting entity has the intent to sell when it has decided to sell a security, but it does not provide guidance for determining when such a decision is considered to have been made.

ASC 326-30-35-10

If an entity intends to sell the debt security (that is, it has decided to sell the security), or more likely than not will be required to sell the security before recovery of its amortized cost basis, any allowance for credit losses shall be written off and the amortized cost basis shall be written down to the debt security’s fair value at the reporting date with any incremental impairment reported in earnings. If an entity does not intend to sell the debt security, the entity shall consider available evidence to assess whether it more likely than not will be required to sell the security before the recovery of its amortized cost basis (for example, whether its cash or working capital requirements or contractual or regulatory obligations indicate that the security will be required to be sold before the forecasted recovery occurs). In assessing whether the entity more likely than not will be required to sell the security before recovery of its amortized cost basis, the entity shall consider the factors in paragraphs 326-30-55-1 through 55-2.

A decision to sell that is contingent on the occurrence of a future event may not be evidence of a present intent to sell. The following indicators, though not all-inclusive, may help determine the point at which a reporting entity has the intent to sell a security:
  • A person with the appropriate authority approves the sale of the security subject only to terms that are usual and customary for sales of such securities
  • The security is being actively marketed for sale at a price that is reasonable in relation to its current fair value

In general, for marketable securities, we expect a relatively short period of time (measured in days) between a reporting entity’s assertion about its decision to sell and an actual sale.
If it is determined that a reporting entity intends to sell the impaired security, then it should record the entire impairment loss in net income as a direct write-down to the amortized cost basis of the security. The write-down amount should equal the difference between the fair value and amortized cost (excluding fair value hedge accounting adjustments from active portfolio layer method hedges), which includes amounts due to both credit and noncredit related factors.
If a reporting entity does not have the intent to sell the impaired security, it should assess whether it will more likely than not be required to sell the security before recovery of its amortized cost basis.

8.2.3.2 AFS debt security: more likely than not required to sell

As discussed in ASC 326-30-35-10, once a reporting entity concludes that it does not have the intent to sell an impaired security, it must assess whether it will more likely than not be required to sell the security before recovery of its amortized cost basis (except for fair value hedge accounting adjustments from active portfolio layer method hedges).

Excerpt from ASC 326-30-35-10

If an entity does not intend to sell the debt security, the entity shall consider available evidence to assess whether it more likely than not will be required to sell the security before the recovery of its amortized cost basis (for example, whether its cash or working capital requirements or contractual or regulatory obligations indicate that the security will be required to be sold before the forecasted recovery occurs).

To determine whether it is more likely than not that it will be required to sell an impaired security before recovery of its amortized cost basis, a reporting entity should assess two factors:
  • The conditions or events that might require the reporting entity to sell the security
  • The likelihood of such conditions or events occurring

In general, only sales that involve a level of legal, regulatory, or operational compulsion should be considered “required” sales, consistent with the guidance in ASC 326-30-35-10. Once the reporting entity has considered available evidence of conditions or events that may require the sale of an impaired security are identified, a reporting entity should determine whether it is more likely than not that these conditions or events will occur. If it is, a reporting entity should assess whether the security would be sold if the events or conditions occur. The potential sale of an impaired debt security, even if considered more likely than not, may not result in a credit loss if that sale is not required before the recovery of the security’s amortized cost basis. Other indicators should be considered to determine whether a reporting entity is more likely than not required to sell an impaired security before recovery of the amortized cost basis. In determining whether a reporting entity will recover the amortized cost basis before it is required to sell the security, a reporting entity should not project changes in market prices that would increase the fair value as of the estimated sales date. Instead, the analysis of whether the amortized cost basis will be recovered should be based solely on the passage of time (i.e., if the asset’s amortized cost basis amortizes to an amount that is equal to or less than its current fair value before a sale could be required, the asset is not impaired).
If it is determined that a reporting entity will more likely than not be required to sell an impaired security before the recovery of the amortized cost basis (excluding fair value hedge accounting adjustments from active portfolio layer method hedges), then the reporting entity should record the entire impairment loss in net income as a direct write-down of the amortized cost basis. The write-down amount would equal the difference between the fair value and amortized cost basis (excluding fair value hedge accounting adjustments from active portfolio layer method hedges) of the security, which would include both credit and noncredit related factors.
Question LI 8-2
Assume a reporting entity either has the intent to sell an impaired AFS debt security or will more likely than not be required to sell an AFS debt security prior to recovery of its amortized cost basis. Should the reporting entity record two separate impairment amounts – one for credit impairment and another for non-credit impairment?
PwC response
No. If the debt security is impaired (i.e., fair value is less than amortized cost excluding fair value hedge accounting adjustments from active portfolio layer method hedges) and the reporting entity either intends to sell the impaired debt security, or it is more likely than not that the reporting entity will be required to sell the impaired debt security before recovery of its amortized cost basis, the impairment amount should be equal to the difference between the debt security’s fair value and its amortized cost (excluding fair value hedge accounting adjustments from active portfolio layer method hedges). Therefore, the credit and noncredit loss components would already be included in the impairment loss and therefore should not be separately calculated and presented in the financial statements.

Question LI 8-3
A reporting entity sells an AFS debt security shortly after it has asserted that it does not intend to sell the security. Does the sale invalidate the reporting entity’s assertion regarding its intent not to sell?
PwC response
It depends. If an AFS debt security’s fair value is below its amortized cost basis, a reporting entity should have a basis for asserting its intention not to sell and that it is more likely than not it would not be required to sell the security at the reporting date. Subsequent sales of such AFS debt securities may call into question the validity of the reporting entity’s previous assertion unless there has been a change in facts and circumstances. The entity should document the rationale for why its original assertion changed in the subsequent period.

Question LI 8-4
If an AFS debt security is impaired and managed by a third-party investment adviser that has discretion to purchase and sell debt securities without management approval, is management required to assert whether there is an intent to sell the security, or if the entity will more likely than not be required to sell the security, before recovery of the security’s amortized cost basis?
PwC response
Yes. Management must evaluate whether there is an intent to sell the security, or more likely than not the entity will be required to sell the security, even when assets are managed by a third-party investment adviser. A third-party investment adviser typically acts as an agent for the entity and performs functions that the entity itself would legally perform. Although the contractual agreement may provide the third-party investment adviser with discretion regarding which assets to buy and sell, this discretion is typically defined within the parameters of a given investment strategy that is approved by the entity. Effectively, the third-party investment adviser is not dissimilar to the entity’s internal function, which must comply with internal investment guidelines.
In this situation, management should still be able to assert that it does not intend to sell the security, and that it is not more likely than not that the entity will be required to sell the security simply because the securities are managed by a third-party investment adviser, through discussions with and instructions to the third-party investment adviser.

8.2.4 Assess impairment for credit or non-credit related factors

When an AFS debt security is impaired at the reporting date, and the reporting entity does not meet the guidance for intending to sell or more likely than not being required to sell the security before the amortized cost basis (excluding fair value hedge accounting adjustments from active portfolio layer method hedges) is recovered, the reporting entity should determine whether the impairment is related to credit or noncredit factors, as discussed in ASC 326-30-35-7.

ASC 326-30-35-7

In determining whether a credit loss exists, an entity shall consider the factors in paragraphs 326-30-55-1 through 55-4 and use its best estimate of the present value of cash flows expected to be collected from the debt security. One way of estimating that amount would be to consider the methodology described in paragraphs 326-30-35-8 through 35-10. Briefly, the entity would discount the expected cash flows at the effective interest rate implicit in the security at the date of acquisition.

ASC 326-30-55-1 through ASC 326-30-55-4 discusses some of the many factors to be considered when determining whether a credit loss exists, including:
  • the extent to which fair value is less than the amortized cost basis,
  • adverse conditions specifically related to the security, an industry, or geographic area (for example, changes in the financial condition of the issuer of the security, or in the case of an asset-backed debt security, changes in the financial condition of the underlying loan obligors),
  • changes in the quality of the security’s credit enhancement,
  • the payment structure of the security,
  • changes in the security’s rating,
  • failure of the issuer to make scheduled principal or interest payments on the security,
  • remaining payment terms of the security,
  • prepayment speeds,
  • the issuer’s financial condition, and
  • the value of any underlying collateral.

The length of time the security has been in an unrealized loss position should not be considered when determining if a credit loss exists.
To determine the amount of impairment related to credit, a reporting entity should compare the present value of the cash flows expected to be collected on the AFS debt security with the security’s amortized cost basis (except for fair value hedge accounting adjustments from active portfolio layer method hedges). If the present value of cash flows expected to be collected is less than the security’s amortized cost basis, a credit-related impairment exists, and the difference should be recorded as an allowance for credit losses through net income. After the allowance for credit losses is recorded, any remaining difference between the security’s fair value and amortized cost basis is considered to be non-credit-related impairment and should be recorded in OCI (assuming the security is not designated in a fair value hedging relationship). The amount of total impairment recognized is limited to the excess of the amortized cost basis over the fair value of the AFS debt security (i.e., the model contains a “fair value floor”).
Question LI 8-5
Can an entity perform a qualitative assessment to determine if a credit loss on an AFS debt security is required under ASC 326-30?
PwC response
In many instances, yes. An entity may not need to calculate the present value of cash flows to assess whether a credit loss exists. Based on an assessment of qualitative factors (including those noted in ASC 326-30-55-1), an entity may determine that a qualitative analysis is sufficient to support its conclusion that the present value of expected cash flows equals or exceeds the security’s amortized cost basis (i.e., that it expects to receive all of the contractual cash flows from a security). For example, it may be evident that the fair value is below the amortized cost of the security solely due to changes in market interest rates. In this scenario, an entity could conclude that a credit loss does not exist without performing a quantitative assessment.
If the qualitative assessment suggests a credit loss may exist, the entity would be required to perform a quantitative present value of cash flows analysis to measure any credit loss to confirm whether a credit loss exists. The factors (or “screens,” as commonly referred to in practice) used as a basis for an entity’s qualitative assessment under ASC 326-30 may differ from those used under previous GAAP.
When a qualitative process concludes there is no credit related impairment, an entity should be able to support that a quantitative analysis would have resulted in the same conclusion. It is important that an entity document and refresh the basis for its conclusions. We expect there to be scenarios when a quantitative assessment, performed because a qualitative analysis suggests there may be a credit loss, will indicate there is no credit loss.
Generally, the more the amortized cost basis of the security (except for fair value hedge accounting adjustments from active portfolio layer method hedges) exceeds its fair value, the more challenging it will be to justify using only a qualitative assessment. In addition, other specific factors, like significant adverse conditions, may also indicate that a quantitative assessment is required.

8.2.4.1 Calculating the present value of expected cash flows

The first step in determining whether there is an impairment related to credit on an AFS debt security is to compare the present value of the cash flows expected to be collected with the security’s amortized cost basis (excluding fair value hedge accounting adjustments from active portfolio layer method hedges). If the present value of cash flows expected to be collected is less than the security’s amortized cost basis, a credit-related impairment exists, and the difference between the present value of the expected cash flows and the amortized cost basis should be recorded as an allowance for credit losses through net income. After the allowance for credit losses is recorded, any remaining difference between the security’s fair value and amortized cost basis is considered to be non-credit-related impairment and should be recorded in OCI (assuming the security is not designated in a fair value hedging relationship). The amount of impairment recognized is limited to the fair value floor (the difference between the amortized cost basis and fair value). The mechanics of the calculation used to calculate the present value of the expected cash flows on an AFS debt security will depend on whether the entity uses a single best estimate approach or a probability weighted approach. When using a single best estimate of cash flows, the reporting entity should discount its estimate of expected cash flows using the security’s effective interest rate. In contrast, the probability-weighted approach considers various scenarios, some of which result in credit losses, and considers the probability of each of those scenarios occurring. When using a probability-weighted approach for a fixed rate AFS debt security, the discount rate should be the effective interest rate excluding the credit risk impact captured in probability weighting multiple discounted cash flow scenarios. Under the probability-weighted approach, we expect the discount rate to be between the effective interest rate and the risk-free rate at acquisition.
ASC 326-30 does not prescribe a specific method to determine the best estimate of the expected cash flows for AFS debt securities. A reporting entity’s estimate should be based on all available evidence, including past events, current conditions, and reasonable and supportable forecasts. ASC 326-30-55-2 provides guidance for determining the estimate of expected future cash flows.

ASC 326-30-55-2

An entity should consider available information relevant to the collectibility of the security, including information about past events, current conditions, and reasonable and supportable forecasts, when developing the estimate of cash flows expected to be collected. That information should include all of the following:
  1. The remaining payment terms of the security
  2. Prepayment speeds
  3. The financial condition of the issuer(s)
  4. Expected defaults
  5. The value of any underlying collateral.

A reporting entity’s method of estimating the expected cash flows should be consistent with the FASB’s intent that such cash flows “represent the cash flows that an entity is likely to collect after a careful assessment of available information.” The decision to use either a single best estimate or a probability-weighted methodology to measure the present value of cash flows expected to be collected is an accounting policy election by similar transaction type. Methodologies that implicitly or explicitly recognize changes in cash flows that are not due to credit would generally not be appropriate (e.g., cash flow changes due to foreign currency volatility).
An entity should consider whether the assumptions underlying its economic forecasts are consistent with its other economic forecasts when appropriate, especially when different sources are used for different assumptions.
Calculating AFS debt securities’ effective interest rate
AFS debt securities accounted for under ASC 326-30 are required to use a discounted cash flow (DCF) method to measure credit impairment. When using a DCF method, an entity should discount expected cash flows at the financial asset’s effective interest rate. Per ASC 326-30-35-7, the effective interest rate implicit in the financial asset at the date of acquisition should be used.
When an entity uses an unadjusted effective interest rate (i.e., the effective interest rate used for interest income recognition purposes) to discount expected cash flows on fixed and/or floating rate AFS debt securities, that discount rate will generally not include expectations of prepayments. However, in estimating credit losses under ASC 326-30, an entity is required to consider the impact of prepayments in its expected cash flows on these securities. ASC 326-30-35-7A allows an accounting policy election to adjust the effective interest rate used to discount expected cash flows for the consideration of timing (and changes in timing) of expected prepayments of an AFS debt security within the scope of ASC 326-30. This election should be made by major security type.

ASC 326-30-35-7

In determining whether a credit loss exists, an entity shall consider the factors in paragraphs 326-30-55-1 through 55-4 and use its best estimate of the present value of cash flows expected to be collected from the debt security. One way of estimating that amount would be to consider the methodology described in paragraphs 326-30-35-8 through 35-10. Briefly, the entity would discount the expected cash flows at the effective interest rate implicit in the security at the date of acquisition.

ASC 326-30-35-7A

As an accounting policy election for each major security type of debt securities classified as available-for-sale securities, an entity may adjust the effective interest rate used to discount expected cash flows to consider the timing (and changes in the timing) of expected cash flows resulting from expected prepayments.

Entities need to calculate expected cash flows, including future interest (or coupon) payments, in order to determine the effective interest rate. In regard to variable rate AFS debt securities, a company can elect whether to use projections of future interest rate environments to estimate future interest payments used in the calculation of these expected cash flows or they can elect to estimate future interest payments using the current rate. ASC 326-30-35-11 further requires variable rate AFS debt securities to use the same expected cash flows for the purposes of determining both the effective interest rate and the allowance for credit losses. If an entity does elect to project future interest rate environments when using a DCF to estimate credit losses for variable rate securities, it is required to adjust the effective interest rate used in discounting cash flows to consider the timing (and changes in timing) of expected cash flows resulting from prepayments.

ASC 326-30-35-11

If the security’s contractual interest rate varies based on subsequent changes in an independent factor, such as an index or rate, for example, the prime rate, the London Interbank Offered Rate (LIBOR), or the U.S. Treasury bill weekly average, that security’s effective interest rate (used to discount expected cash flows as described in paragraph 326-30-35-7) may be calculated based on the factor as it changes over the life of the security or is projected to change over the life of the security, or may be fixed at the rate in effect at the date an entity determines that the security has a credit loss as determined in accordance with paragraphs 326-30-35-1 through 35-2. The entity’s choice shall be applied consistently for all securities whose contractual interest rate varies based on subsequent changes in an independent factor. An entity is not required to project changes in the factor for purposes of estimating expected future cash flows. If the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall use the same projections in determining the effective interest rate used to discount those cash flows. In addition, if the entity projects changes in the factor for the purposes of estimating expected future cash flows, it shall adjust the effective interest rate used to discount expected cash flows to consider the timing (and changes in the timing) of expected cash flows resulting from expected prepayments in accordance with paragraph 326-30-35-7A. Subtopic 310-20 on receivables—nonrefundable fees and other costs provides guidance on the calculation of interest income for variable rate instruments.

The elections within ASC 326-30-35-7A and ASC 326-30-35-11 are only applicable to adjusting the effective interest rate for the purposes of estimating credit losses. Interest income is required to be recognized using an effective interest rate in accordance with other GAAP (for example ASC 310-20, which was not amended by ASC 326-30).
Consistent with the guidance in ASC 815-25-35-10 through ASC 815-25-35-12, ASC 326-30-35-1A, and ASC 326-30-35-4, we believe that the effective interest rate used in a DCF approach should not consider the impact of basis adjustments relating to active portfolio layer method hedging relationships.

8.2.4.2 Fair value/present value of expected cash flow assumptions

When estimating the present value of cash flows expected to be collected under ASC 326-30, a reporting entity should consider all relevant facts and circumstances, including the market’s view of the likelihood and amount of future cash flows. However, the inputs and assumptions are not required to be the same as those used to measure fair value under ASC 820 and exclusive reliance does not need to be placed on market participant assumptions of future cash flows. As the differences between management’s assumptions and market participant assumptions increase, though, the level of analysis and objective evidence needed to support the differences also increase.

8.2.5 Initial measurement of an AFS debt security’s allowance

This section discusses the initial measurement of credit losses for AFS debt securities that are not purchased credit deteriorated (PCD). The initial measurement of the allowance for credit losses for non-PCD AFS debt securities will typically be subsequent to origination or purchase since the securities are generally recognized at fair value. Refer to LI 9 for further information on the initial measurement of the allowance for credit losses for PCD AFS debt securities.
If the present value of expected cash flows is greater than the amortized cost basis (except for fair value hedge accounting adjustments from active portfolio layer method hedges) of an AFS debt security, the impairment is noncredit related. In this case, no allowance for credit losses would be recorded in net income; instead, the decline in fair value would be recorded in OCI.
If the present value of expected cash flows is less than the amortized cost basis of an AFS debt security, then an allowance for credit losses for this difference should be recorded in net income. The amount of allowance for credit losses recorded is limited to the difference between the fair value and amortized cost.
The following example illustrates the initial measurement and recognition of an impairment on an AFS debt security.
EXAMPLE LI 8-1
Initial recognition of impairment on an AFS debt security
On January 1, 20X0, Investor Corp pays $1,000 for a debt security with the following terms.
Par amount
$1,000 paid at maturity
Coupon rate
4.5% paid annually
Maturity date
December 31, 20X4
The AFS security is not designated as a hedged item in a fair value hedging relationship.
On December 31, 20X0, the fair value of the security is $700 and there has been a decline in expected cash flows. Investor Corp determines that it does not intend to sell the security and it is not more likely than not that it will be required to sell the security.
Year
Contractual cash flows
Cash flows expected at 12/31/X0
Decrease in expected cash flows
20X1
45
45
20X2
45
45
20X3
45
45
20X4
$1,045
$905
$140
Total cash flows
$1,180
$1,040
$140
Present value of cash flows
$1,000
$883
$117

How should Investor Corp assess whether an impairment exists as of December 31, 20X0? If the security is impaired, how should Investor Corp record the impairment?
Analysis
The security is impaired at December 31, 20X0 because the fair value ($700) is below the amortized cost basis of the security ($1,000).
Investor Corp should determine whether the loss is related to credit or noncredit factors. Since the present value of expected cash flows to be collected ($883) is less than the amortized cost basis of the security ($1,000), a credit loss exists.
Investor Corp would separate the total impairment of $300 ($1,000 amortized cost basis – $700 fair value) into the following components:
  • The credit loss or amount representing the decrease in cash flows expected to be collected of $117
  • The noncredit component related to all other factors of $183 (calculated as the remaining impairment after deducting the credit-related loss)

After the impairment (credit and noncredit), the debt security’s amortized cost basis will still be $1,000 and the security will be carried at its fair value of $700 as shown in the following table.
Amortized cost basis on December 31, 20X0
$1,000
Allowance for credit losses
(117)
Net value on December 31, 20X0
883
Unrealized loss
(183)
Fair value on December 31, 20X0
$700

Investor Corp would record the following entry to recognize the impairment of the debt security (tax effects are ignored for illustration purposes).
Dr. Provision expense
$117
Dr. OCI – AFS unrealized loss
$183
Cr. Allowance for credit losses
$117
Cr. AFS security fair value
$183

8.2.6 Subsequent measurement of an AFS debt security’s allowance

At each subsequent reporting period, a reporting entity should assess whether there has been a change in the expected cash flows of the asset. If there is a decrease in expected cash flows, the allowance for credit losses may need to increase. If there is an increase in expected cash flows, some portion or all of the allowance for credit losses may need to be reversed. A reversal of the allowance for credit losses should not exceed the allowance amount initially recognized. The reporting entity should determine its allowance for credit losses in subsequent periods by comparing the security’s present value of cash flows to its amortized cost basis, similar to initial measurement.
Example LI 8-2 demonstrates the subsequent measurement of impairment on an AFS debt security.
EXAMPLE LI 8-2
Subsequent recognition of impairment on an AFS debt security
On January 1, 20X0, Investor Corp pays $1,000 for a debt security with the following terms.
Par amount
$1,000 paid at maturity
Coupon rate
4.5% paid annually
Maturity date
December 31, 20X4

Investor Corp classifies the security as available for sale. The AFS security is not designated as a hedged item in a fair value hedging relationship.
On December 31, 20X0, the fair value of the debt security is $700. Investor Corp determines that it does not intend to sell the security and it is not more likely than not that it will be required to sell the security. The present value of expected cash flows to be collected is $883 and the amortized cost basis of the security is $1,000 (a credit loss exists). As a result, Investor Corp, records an allowance for credit losses of $117 and an unrealized loss in AOCI of $183.
On December 31, 20X1, the fair value of the debt security remains at $700. Investor Corp determines that it does not intend to sell the security and it is not more likely than not that it will be required to sell the security.
At December 31, 20X1, Investor Corp re-estimates the expected cash flows of the security. The expected cash flows improve as shown in the following table. To calculate the present value, the cash flows are discounted at 4.5%, the original effective interest rate on the security.
Year
Contractual cash flows
Cash flows expected at 12/31/X1
Decrease in expected cash flows
20X2
45
45
20X3
45
45
20X4
$1,045
$935
$110
Total cash flows
$1,135
$1,025
$110
Present value of cash flows
$1,000
$904
$96

How should Investor Corp measure and recognize the impairment on the debt security as of December 31, 20X1?
Analysis
The security is impaired at December 31, 20X1 because the fair value ($700) is below the amortized cost basis of the security ($1,000).
Since the present value of expected cash flows to be collected ($904) is less than the amortized cost basis of the security ($1,000), a credit loss exists.
Investor Corp would then separate the total impairment of $300 ($1,000 amortized cost basis – $700 fair value) into the following components:
  • The credit loss or present value of the cash flows not expected to be collected of $96
  • The noncredit component related to all other factors of $204 (calculated as the remaining impairment after deducting the expected credit loss)

Investor Corp would adjust the allowance for credit losses by $21, to reduce it from $117 to $96 and then increase the amount allocated to noncredit impairment in OCI by the same amount.
After the recognition of the impairment (credit and noncredit), the debt security’s amortized cost basis will still be $1,000 and the security will be carried at its fair value of $700 as shown in the following table.
Amortized cost basis on December 31, 20X1
$1,000
Allowance for credit losses at January 1, 20X1
(117)
Adjustment to allowance
21
Net value on December 31, 20X1
$904
Unrealized loss in OCI at January 1, 20X1
(183)
Adjustment to OCI
(21)
Fair value on December 31, 20X1
$700

Investor Corp would record the following entry to recognize the reversal of the allowance for credit losses in net income and to recognize the additional noncredit impairment loss in OCI.
Dr. Allowance for credit losses
$21
Dr. OCI – AFS unrealized loss
$21
Cr. Provision expense
$21
Cr. AFS security fair value
$21

8.2.6.1 Subsequent measurement of foreign-currency AFS debt security

Changes in the fair value of foreign currency-denominated AFS debt securities that are related to changes in foreign exchange rates should be recorded in AOCI, as these changes are considered non-credit related. As a result, the allowance for credit losses on a foreign currency-denominated AFS security will not change if there has been no change in expected cash flows. Per the November 1, 2018 TRG meeting (TRG Memo 14: Cover Memo and TRG Memo 18: Summary of Issues Discussed and Next Steps), unrealized losses related to changes in foreign exchange rates on foreign currency-denominated AFS debt securities should be released from AOCI into earnings at the earliest of the following:
  • Maturity of the security
  • Sale of the security
  • When the entity intends to sell the security
  • When the entity is more-likely-than-not required to sell the security before recovery of its amortized cost basis

We believe the allowance for credit losses on foreign-denominated AFS debt securities should be measured by calculating the expected cash flows at the historical exchange rate (i.e., the date the security was acquired) and comparing the present value of those cash flows to the security’s amortized cost basis (measured at the historical exchange rate).

8.2.7 Writeoffs and recoveries of an AFS debt security allowance

Reporting entities should consider whether estimated credit losses recognized in the allowance for credit losses have become uncollectible. When such a scenario occurs, the allowance on the uncollectible portion should be charged off with an offsetting entry to the carrying value of the security.

ASC 326-30-35-12

An entity shall reassess the credit losses each reporting period when there is an allowance for credit losses. An entity shall record subsequent changes in the allowance for credit losses on available-for-sale debt securities with a corresponding adjustment recorded in the credit loss expense on available-for-sale debt securities. An entity shall not reverse a previously recorded allowance for credit losses to an amount below zero.

ASC 326-30-35-13

An entity shall recognize writeoffs of available-for-sale debt securities in accordance with paragraph 326-20-35-8.

ASC 326-20-35-8

Writeoffs of financial assets, which may be full or partial writeoffs, shall be deducted from the allowance. The writeoffs shall be recorded in the period in which the financial asset(s) are deemed uncollectible.

Example LI 8-3 illustrates the recognition of a writeoff and subsequent recovery of an AFS debt security.
EXAMPLE LI 8-3
Recognition of a writeoff and subsequent recovery on an AFS debt security
On January 1, 20X0, Investor Corp pays $1,000 for a debt security with the following terms.
Par amount
$1,000 paid at maturity
Coupon rate
4.5% paid annually
Maturity date
December 31, 20X4

Investor Corp classifies the security as available for sale.
On December 31, 20X1, the fair value of the debt security was $700. Investor Corp determines that it does not intend to sell the security and it is not more likely than not that it will be required to sell the security. As a result, Investor Corp records an allowance for credit losses of $96 and an unrealized loss in AOCI of $204. On March 31, 20X2, the issuer of the debt security files for bankruptcy. Investor Corp determines that the full amount on the security is uncollectible (i.e., the fair value of the security is $0).
On April 1, 20X3, Investor Corp receives a partial payment from the issuer of $500.
How should Investor Corp measure and recognize the impairment on the debt security as of March 31, 20X2? How should Investor Corp record the partial recovery on April 1, 20X3?
Analysis
To recognize the impairment on the debt security as of March 31, 20X2, Investor Corp would first measure the full credit loss and then writeoff the entire amortized cost by recording the following journal entry.
Dr. Allowance for credit losses
$96
Dr. Provision expense
$904
Dr. AFS security – unrealized loss
$204
Cr. OCI
$204
Cr. AFS security – Amortized cost basis
$1,000

ASC 326-30 permits a recovery of a financial asset previously written off to be recognized when consideration is received if the allowance is already reduced to zero. In this example, the allowance was reduced to zero as of March 31, 20X2, so the April 1, 20X3 recovery is recognized when received. To record the partial recovery on April 1, 20X3, Investor Corp would recognize the payment against provision expense by recording the following entry.
Dr. Cash
$500
Cr. Provision expense
$500

8.2.8 Accrued interest on AFS debt securities

ASC 326-30 defines an asset’s amortized cost basis to include accrued interest.

ASC 326-30-20

The amortized cost basis is the amount at which a financing receivable or investment is originated or acquired, adjusted for applicable accrued interest, accretion, or amortization of premium, discount, and net deferred fees or costs, collection of cash, writeoffs, foreign exchange, and fair value hedge accounting adjustments.

For entities that have accounting policies to exclude accrued interest from both the fair value and the amortized cost basis of an AFS debt security for purposes of identifying and measuring impairment, ASC 326-30 provides the following additional guidance:
  • A reporting entity can elect to develop expected credit losses on its accrued interest receivable balances separate from other components of the amortized cost basis.
  • A reporting entity can make an accounting policy election to not measure an allowance for credit losses on accrued interest if an entity writes off the uncollectible accrued interest receivable balance in a timely manner. This accounting policy election should be made at the major security-type level and should be disclosed, including the time period they consider timely. This guidance should not be applied by analogy to other components of the amortized cost basis.
  • ASC 326-30 does not define what is considered a “timely manner.” This could differ between entities, portfolios, and industry practices. We believe that writing off accrued interest amounts once such amounts are greater than 90 days past due may be consistent with current practice for some securities in certain industries following guidance issued by, for example, the US banking regulators. Entities should apply judgment and consider the specific facts and circumstances of their portfolio when determining what time period is considered timely.
  • A reporting entity can make an accounting policy election to write off accrued interest by reversing interest income or recognize the write off as a credit loss expense (or a combination of both). This accounting policy election should be made at the major security-type level. This election cannot be applied by analogy to other components of the amortized cost basis. This accounting policy is required to be disclosed and any reversal of interest income should be disclosed by major security type.

If any of the elections are made with regard to AFS debt securities, accrued interest must also be excluded from measuring impairment.
See LI 12 for information regarding the presentation and disclosure requirements related to these elections.
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