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Institutions often purchase loans, debt securities, and other instruments after their origination. Usually, these instruments are purchased at amounts other than the amount contractually due from the borrower, as changes in interest rates and/or the credit quality of the borrower may have taken place since origination.
When institutions purchase financial assets that have experienced an increase in credit risk since their origination, the purchase is often at an amount below par, therefore offering the potential of higher returns in exchange for a higher credit risk profile. These assets can be purchased individually, as part of a portfolio acquisition, or through mergers and acquisitions of other institutions. Given the unique nature of these financial assets and their risk/reward profile, the guidance used to account for the purchase of these instruments differs significantly in some respects, from the accounting guidance used to account for purchases of assets that have not experienced a more-than-insignificant credit deterioration.
ASC 326 includes separate guidance on the initial recognition and measurement of purchased financial assets that have experienced a more-than-insignificant credit deterioration since origination (purchased financial assets with credit deterioration, or PCD assets). The “general” CECL model, which applies to certain financial assets that are not considered PCD, requires an initial estimate of expected credit losses to be recognized through current earnings. Non-PCD AFS debt securities will typically not have an allowance recorded at acquisition. In contrast, the PCD guidance requires the initial estimate of expected credit losses to be recognized through an adjustment to the amortized cost basis of the financial asset (i.e., a balance sheet gross up) with no impact to earnings.
Subsequent to initial recognition, a reporting entity would apply the same interest income and impairment model (e.g., CECL or AFS debt security impairment model) to these PCD assets as it would to non-PCD assets.
This chapter discusses the accounting for PCD assets (except for beneficial interests subject to ASC 325-40). See LI 4 and LI 7 for information on the accounting for purchased assets accounted for under an amortized cost basis without credit deterioration (i.e. non-PCD assets) and LI 3 and LI 8 for the accounting for AFS debt securities without credit deterioration.
See LI 14 for information on the accounting for beneficial interests subject to ASC 325-40 (for both PCD and non-PCD assets).
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