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Journal entry — Financial instruments — FASB makes tentative decisions on credit impairment for debt securities and CECL measurements

Published on: Aug 14, 2014

Yesterday, the FASB met to discuss impairment of debt securities and clarifications to the measurement principle in the current expected credit losses (CECL) model. During the meeting, the Board considered feedback obtained from informal workshops with preparers, auditors, and regulators.

Impairment of Debt Securities

The Board tentatively decided that the CECL model would not apply to available-for-sale (AFS) debt securities. Instead, entities would apply a revised other-than-temporary impairment (OTTI) model. (See Deloitte’s June 16, 2014, journal entry for information about the Board’s previous tentative decisions on credit impairment.)

Editor’s Note: This scope modification is limited to AFS securities, which are measured at fair value with changes in fair value reflected in other comprehensive income if there is no OTTI. The Board tentatively decided that this scope modification is warranted because the CECL model would have required an entity to recognize lifetime expected credit losses for AFS securities even though the holding period may not be for the lifetime since an AFS security can be held for collection of cash or sold. The Board further deemed the CECL model appropriate for held-to-maturity securities, since they are measured at amortized cost (like most loans) and sales are not typically permitted (i.e., these securities are held for the collection of cash). In addition, the FASB discussed potential changes to the current OTTI model in U.S. GAAP, including (1) using an allowance approach that would permit the reversal of impairment losses and (2) earlier recognition of impairment losses, which the Board could achieve by removing factors an entity considers in determining whether there is an OTTI, such as the length of time fair value has been less than amortized cost and fair value changes after the balance sheet date in the assessment of whether a credit loss exists.

Clarifications to the Measurement Principle in the CECL Model

The Board discussed the following topics:

  • Replacing the requirement to weight the probability of multiple outcomes in the measurement of expected credit losses — For all financial assets (except AFS debt securities, which are outside the scope of the CECL model in accordance with the Board’s earlier tentative decision), the Board tentatively decided that credit losses would be evaluated on a collective (i.e., pool) basis when similar risk characteristics are shared; otherwise, such assets would be evaluated individually.
  • Individually assessing an impaired financial asset — Pooling such assets on the basis of risk characteristics addresses the recommendation of workshop participants that such assets should be removed from a pool when they become impaired, since the risk characteristics of an impaired asset would not be similar to those of the other assets in the pool. The Board stated that it will consider adding implementation guidance on this topic to the final standard.
  • Expected credit loss allowance permitted to be zero — Previously, the Board tentatively decided that a loss on a financial asset does not need to be recognized when the amount of the loss would be zero, even if the risk of nonpayment is greater than zero. The Board considered whether to explicitly state which financial assets this provision would apply to (e.g., U.S. Treasury securities) but decided against it since doing so could inadvertently limit which types of financial assets could qualify. Rather, the final standard would state the principles that an entity can employ to determine whether the provision applies to a given financial asset.
  • Collateral-based practical expedients — The Board tentatively decided that the final standard would include collateral-based practical expedients for certain financial assets. Under such expedients, the allowance for expected credit losses would be measured as the amortized cost basis of the asset less the collateral’s fair value (adjusted for selling costs, when applicable). Entities would accordingly be allowed to immediately default to the fair value of the collateral for the CECL measurement rather than considering this fair value as only one potential input.
  • Reversion to historical average-loss experience — The Board tentatively decided to provide guidance on how an entity should revert to its historical loss experience for the future periods beyond which the entity is able to make or obtain reasonable and supportable forecasts. The Board tentatively decided to allow an entity to either (1) estimate the appropriate amount of historical average loss applicable to each reporting period over the appropriate reversion period if the entity has justification for the estimate (e.g., more of the loss would be allocated to earlier or later periods) or (2) use a straight-line method over the asset’s remaining life (i.e., the expected credit losses would be allocated evenly over the reversion period).

Next Steps

At future meetings, the FASB will continue redeliberating credit impairment, including scope and disclosures. See Deloitte’s August 8, 2014, Heads Up for more information.

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