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9.4 Subsequent measurement of PCD assets
Publication date: 31 May 2022
us Loans & investments guide
The PCD asset accounting model is designed such that in many aspects, the subsequent measurement and presentation of the allowance for credit losses is consistent among similarly classified financial assets (e.g., receivables, loans, HTM securities, AFS debt securities) originated or acquired (but that do not qualify as PCD) by the reporting entity. Refer to LI 7 for further information on subsequent measurement under the CECL model. Refer to LI 8 for further information on subsequent measurement for the AFS model.
When an entity uses a non-DCF method under ASC 326-20, the initial allowance for credit losses for PCD assets should be based on the asset’s unpaid principal balance and not its amortized cost basis. The initial allowance is then added to the asset’s “initial amortized cost basis” (e.g., purchase price). This is required by the guidance in ASC 326-20-30-14 and was needed to avoid a potentially circular calculation in which the allowance is based on the collectibility of the amortized cost basis of an asset, but it also impacts the amortized cost basis through the PCD gross up. When subsequently measuring the allowance, ASC 326-20-35-1 states that the method used to determine the allowance should generally be applied consistently over time. As such, the allowance on a PCD asset should be consistently based on the unpaid principal balance and not the amortized cost basis of the asset when using a non-DCF approach.
Subsequent changes in expected credit losses will follow either the CECL impairment model or the AFS debt security impairment model, whereby subsequent changes in expected credit losses are recognized as an adjustment to the allowance for credit losses recorded in net income (an increase to the allowance if credit losses increase and a release of the allowance if credit losses decrease) and not as an adjustment to investment yield recognition (with the possible exception of instruments subject to ASC 325-40).
Example LI 9-4 addresses the subsequent measurement accounting for PCD loans
EXAMPLE LI 9-4
Accounting for PCD loans after initial recognition
Accounting for PCD loans after initial recognition
Bank Corp purchases a loan with a par value of $100,000 for $83,000. The loan has experienced a more-than-insignificant deterioration in credit quality since origination. Therefore, Bank Corp determines that the loan meets the definition of a PCD asset. At the date of acquisition, Bank Corp calculates an allowance for expected credit losses of $10,000.
At the end of the first reporting period subsequent to Bank Corp’s purchase of the loan, Bank Corp should recalculate the allowance for credit losses in accordance with the CECL model. Assume that as a result of an improving credit position of the borrower, Bank Corp determines the expected credit loss has declined from $10,000 to $7,000.
Bank Corp should account for this decrease in expected credit losses as it would for any other instrument subject to the CECL model. As a result, Bank Corp should decrease its allowance for expected credit losses with an offsetting entry to the income statement.
Dr. Allowance for expected credit losses
|
$3,000
|
|
Cr. Credit loss expense
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$3,000
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Note that the impact of the decrease in the expected credit loss is reported through net income even though the initial credit loss estimate was recognized as an adjustment to the amortized cost basis of the instrument and did not initially impact net income.
9.4.1 PCD beneficial interests subject to ASC 325-40
When expected cash flows of a beneficial interest subject to ASC 325-40 change from previous estimates, a reporting entity should first apply the CECL or AFS debt security impairment model as appropriate, depending on whether the beneficial interest is classified as HTM or AFS, respectively.
See LI 14 for more information on interest income recognition for beneficial interests subject to ASC 325-40 and for guidance on estimating credit losses for those beneficial interests classified as HTM and AFS.
9.4.2 PCD: determination of nonaccrual status
The guidance on determining when a PCD asset should be placed on nonaccrual status is different than for non-PCD assets. In accordance with ASC 310-10-35-53C, the recognition of income on PCD assets is dependent on having a reasonable expectation about the amount expected to be collected over the life of the asset. When an entity can no longer reasonably estimate the amount expected to be collected, it should place the PCD asset on nonaccrual status. However, the ability to place a financial asset on nonaccrual status cannot be used to circumvent recognition of a credit loss.
See LI 14.6.6 for more information on nonaccrual status for beneficial interests subject to ASC 325-40.
9.4.3 PCD: application of the recoveries guidance
The allowance for credit losses on PCD assets should include expected recoveries of amounts previously written off and expected to be written off and should not exceed the aggregate of amounts previously written off and expected to be written off by the entity. In addition, if an entity estimates expected credit losses using a method other than a DCF method pursuant to ASC 326-20, expected recoveries should not include any amounts that result in an acceleration of the noncredit discount. The noncredit discount is the excess of the contractual amount of principal (or par) of the asset over the amortized cost basis of the asset that includes the adjustment to the amortized cost basis recorded at acquisition related to the allowance for credit losses (i.e., the balance sheet gross-up). This provision was included in the guidance to prevent entities from recording "day one gains" by (1) acquiring PCD assets, (2) recording a "balance sheet gross up" increasing the amortized cost basis, (3) recording a write off of those assets, and then (4) recording estimated recoveries on an undiscounted basis.
ASC 326-20-30-13A also clarifies that estimated recoveries and negative allowances may include increases in expected cash flows after acquisition, subject to the guidance discussed above.
It is important to note that the guidance for recoveries and negative allowances is different for PCD assets than non-PCD assets. In addition, negative allowances are not permitted for available-for-sale securities. Companies should consider these differences in establishing and maintaining policies, procedures, and controls related to their allowance estimates. Refer to LI 7.3.6.4 for further guidance related to recoveries on non-PCD assets.
ASC 326-20-30-13 and ASC 326-20-30-13A provides guidance on the allowance for credit losses and expected recoveries for PCD assets.
An entity shall record the allowance for credit losses for purchased financial assets with credit deterioration in accordance with paragraphs 326- 20-30-2 through 30-10, 326-20-30-12, and 326-20-30-13A. An entity shall add the allowance for credit losses at the date of acquisition to the purchase price to determine the initial amortized cost basis for purchased financial assets with credit deterioration. Any noncredit discount or premium resulting from acquiring a pool of purchased financial assets with credit deterioration shall be allocated to each individual asset. At the acquisition date, the initial allowance for credit losses determined on a collective basis shall be allocated to individual assets to appropriately allocate any noncredit discount or premium.
The allowance for credit losses for purchased financial assets with credit deterioration shall include expected recoveries of amounts previously written off and expected to be written off by the entity and shall not exceed the aggregate of amounts previously written off and expected to be written off by the entity.
a. If the entity estimates expected credit losses using a method other than a discounted cash flow method in accordance with paragraph 326-20-30-4, expected recoveries shall not include any amounts that result in an acceleration of the noncredit discount.
b. The entity may include increases in expected cash flows after acquisition.
(See Examples 18 and 19 in paragraphs 326-20-55-86 through 55-90.)
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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