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Journal entry — FASB issues guidance in response to EITF consensuses

Published on: Jan 21, 2014

Last week, the FASB issued the following guidance in response to consensuses reached at the EITF’s November 2013 meeting:

Editor's Note: See Deloitte’s November 2013 EITF Snapshot for details about the EITF Issues on which the new ASUs and proposal are based.

Accounting for Investments in Qualified Affordable Housing Projects (EITF Issue 13-B)

ASU 2014-01 amends ASC 323-7404 to (1) simplify the amortization method an entity uses and (2) modify the criteria that must be met before an entity can elect to use ASC 323-740’s measurement and presentation alternative, including the simplified amortization method, for certain investments in qualified affordable housing projects. This alternative permits the entity to present the investment’s performance net of the related tax benefits as part of income tax expense.

Scope and Recognition

An entity can elect to apply the measurement and presentation alternative in ASC 323-740 to an equity investment in a limited liability entity that owns or manages a qualified affordable housing project and passes low-income housing tax credits (LIHTC) through to the investors if the following conditions in ASC 323-740-25-1 are met:

a. It is probable that the tax credits allocable to the investor will be available.

aa. The investor does not have the ability to exercise significant influence over the operating and financial policies of the limited liability entity.

aaa. Substantially all of the projected benefits are from tax credits and other tax benefits (for example, tax benefits generated from the operating losses of the investment).

b. The investor’s projected yield based solely on the cash flows from the tax credits and other tax benefits is positive.

c. The investor is a limited liability investor in the limited liability entity for both legal and tax purposes, and the investor’s liability is limited to its capital investment.

An entity that makes this accounting policy election will be required to apply the measurement and presentation alternative consistently to all of its LIHTC investments that qualify for the alternative. LIHTC investments that are not accounted for under the measurement and presentation alternative should be accounted for under the equity method or cost method in accordance with ASC 970-323.

Editor's Note: These amendments are likely to increase the number of LIHTC investments that would qualify for the measurement and presentation alternative afforded by ASC 323-740.

Other transactions between the investor and the limited liability entity would not preclude an investor from accounting for LIHTC investments by using the measurement and presentation alternative as long as all of the following conditions are met:

a. The reporting entity is in the business of entering into those other transactions (for example, a financial institution that regularly extends loans to other projects).

b. The terms of those other transactions are consistent with the terms of arm’s-length transactions.

c. The reporting entity does not acquire the ability to exercise significant influence over the operating and financial policies of the limited liability entity as a result of those other transactions.

If either of the following events occurs after initial recognition, an entity should reevaluate its eligibility to use this guidance:

a. A change in the nature of the investment (for example, if the investment is no longer in a flow-through entity for tax purposes)

b. A change in the relationship with the limited liability entity that could result in the reporting entity no longer meeting the conditions in paragraphs 323-740-25-1 through 25-1B.

Proportional-Amortization Method

ASU 2014-01 eliminates the requirement under ASC 323-740 to use an effective-yield method and instead simplifies the amortization method by establishing a proportional-amortization method. Under this simplified approach, an entity would amortize the initial investment balance in proportion to the allocation of tax credits and other tax benefits to the investor. The entity would calculate amortization by:

  1. Determining the actual tax credits and other tax benefits allocated to the investor in the current period as a percentage of the total estimated tax credits and other tax benefits that are expected to be received over the life of the investment.
  2. Multiplying the initial investment balance (less any expected residual value) by the percentage determined in (1).

In addition, the ASU provides a practical expedient that would allow an entity to amortize the initial cost of the investment in proportion to only the related tax credits if the entity reasonably expects that doing so would result in amortization that is substantially similar to the amortization that would result from taking into account both the tax credits and other tax benefits.

Subsequent Measurement

The final standard requires an entity (1) to test LIHTC investments accounted for under the measurement and presentation alternative for impairment when it is more likely than not that the carrying amount of investment will not be realized and (2) to measure an impairment loss as the amount by which the carrying amount of the investment exceeds its fair value. Previously recognized impairment losses cannot be reversed.

Presentation and Disclosure

The ASU:

  • Does not prescribe where an entity would present investments accounted for under the measurement and presentation alternative in its statement of financial position.
  • Requires an entity to disclose information about the nature of its LIHTC investments and the effects of these investments, including the related tax credits, in the entity’s statements of financial position and results of operations.

Transition and Effective Date

Entities that applied the effective-yield method to account for LIHTC investments are permitted to continue to do so, but only for investments already accounted for under the effective-yield method. Otherwise, the guidance in this ASU must be applied retrospectively to all periods presented.

ASU 2014-01 is effective for public business entities for annual periods, and interim reporting periods within those annual periods, beginning after December 15, 2014. For entities that are not public business entities, the guidance in this ASU is effective for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. Early adoption is permitted for all entities.

Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure (EITF Issue 13-E)

ASU 2014-04 affects entities that originate consumer mortgage loans that are collateralized by residential real estate. The ASU amends ASC 310 to clarify when an entity is considered to have obtained physical possession (from an in-substance possession or foreclosure) of a residential real estate property collateralizing a mortgage loan. Upon physical possession of such real estate property, an entity is required to reclassify the nonperforming mortgage loan to other real estate owned (OREO). ASU 2014-04 also introduces new disclosure requirements about nonperforming mortgage loans that are in the process of foreclosure.

The amendments to ASC 310-40 require an entity to reclassify nonperforming mortgage loans collateralized by residential real estate as OREO if either (1) the creditor obtains legal title to the residential real estate property or (2) the borrower satisfies the loan by conveying all interest in the real estate property to the creditor through completion of a deed in lieu of foreclosure or through a similar legal agreement. Under ASU 2014-04, a deed in lieu of foreclosure or similar legal agreement is completed when both the borrower and creditor satisfy the agreed-upon terms and conditions. In addition, ASU 2014-04 clarifies that an entity would obtain legal title to real estate property even if the borrower has redemption rights that give the borrower a legal right for a period after foreclosure to reclaim the real estate property by paying certain amounts specified by law.

Editor's Note: The EITF decided that an entity that has obtained legal title to real estate property subject to borrower redemption rights should not wait until the redemption period has expired before reclassifying the nonperforming loan to OREO because:
  • A creditor that has obtained legal title to real estate property generally has the right to eventually sell it.
  • Such redemption rights are rarely exercised because a borrower who defaults on monthly payments is typically unable to pay off the outstanding loan balance before the redemption.

Disclosure Requirements

ASU 2014-04 amends ASC 310-40 to require an entity to disclose at each interim and annual period:

  • The carrying amount of foreclosed residential real estate property held by the creditor as a result of obtaining physical possession in accordance with the final ASU.
  • The recorded investment in consumer mortgage loans collateralized by residential real estate property for which formal foreclosure proceedings are in process according to local requirements of the applicable jurisdiction.
Editor's Note: ASU 2014-04 introduces new disclosure requirements related to nonperforming mortgage loans collateralized by residential real estate property that is in the process of foreclosure. These requirements are similar to those related to mortgage loans collateralized by single-family residential properties (that are in foreclosure) that regulated financial institutions provide in their quarterly call report5 filings.

Transition and Effective Date

ASU 2014-04 is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. For entities that are not public business entities, the guidance in this ASU is effective for annual periods beginning after December 15, 2014, and interim periods within annual periods beginning after December 15, 2015. Early adoption is permitted. Entities have the option of applying the guidance in ASU 2014-04 either (1) prospectively to all foreclosures occurring after the date of adoption or (2) by using a modified retrospective transition approach in which existing mortgage loans and OREO are reassessed under the ASU’s guidance and reclassified on the basis of the carrying value of the real estate on the date of adoption (or, if reclassifying from loans to real estate, on the basis of the lower of the net amount of the loan receivable or the real estate’s fair value less cost to sell on the date of adoption).

Classification of Certain Government-Guaranteed Residential Mortgage Loans Upon Foreclosure (EITF Issue 13-F)

The proposed ASU would amend ASC 310-40 to provide guidance on the classification and measurement of foreclosed government-guaranteed residential mortgage loans. Comments on the proposal are due by April 30, 2014.

Scope and Recognition

The proposed ASU requires a creditor to derecognize the guaranteed residential mortgage loan receivable and establish another receivable from the guarantor if both of the following conditions are met:

a. The loan has a government guarantee that is not separable from the loan before foreclosure entitling the creditor to the full unpaid principal balance of the loan.

b. At the time of foreclosure (as determined [under ASU 2014-04]), the creditor has the intent to make a claim on the guarantee and the ability to recover through the guarantee.

The other receivable from the guarantor would be measured on the basis of the current amount of the loan balance that the creditor expects to collect under the guarantee.

Editor's Note: The EITF decided that real estate collateralizing nonperforming government-guaranteed residential mortgage loans should be measured at the amount of the guarantee because the creditor intends to recover the loan balance by making a claim for cash under the guarantee rather than by selling the real estate property.

The EITF noted that this guidance is likely to predominantly affect mortgage loans that are fully guaranteed by the Federal Housing Administration (FHA) because of the diversity in practice related to creditors’ classification and measurement of foreclosed FHA-guaranteed loans.

Transition and Effective Date

Entities would be required to apply the proposal’s guidance in a manner consistent with the transition approach they choose under ASU 2014-04. Thus, entities would either apply the proposal’s guidance (1) prospectively to all foreclosures on government-guaranteed mortgage loans collateralized by residential real estate occurring after the date of adoption or (2) by using a modified retrospective transition approach. Under the modified retrospective approach, government-guaranteed residential mortgage loans existing as of the adoption date are reassessed (and remeasured) under the proposal’s guidance and reclassified accordingly, with any resulting measurement differences recorded as an adjustment to beginning retained earnings in the period of adoption. Early adoption would be permitted.

____________________

1 EITF Issue No. 13-B, “Accounting for Investments in Qualified Affordable Housing Projects.”

2 EITF Issue No. 13-E, “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans Upon Foreclosure.”

3 EITF Issue No. 13-F, “Classification of Certain Government-Guaranteed Residential Mortgage Loans Upon Foreclosure.”

4 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s "Titles of Topics and Subtopics in the FASB Accounting Standards Codification."

5 Consolidated reports of condition and income.

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