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Investments in debt securities (after adoption of IFRS 9 and ASU 2016-01): Key differences between U.S. GAAP and IFRSs

IFRS 9, Financial Instruments, which was issued in November 2009 and most recently amended in July 2014, is effective for annual periods beginning on or after January 1, 2018, although entities can elect to apply it earlier. IFRS 9 supersedes IAS 39, Financial Instruments: Recognition and Measurement.

In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, which amends the guidance in U.S. GAAP on the classification and measurement of financial instruments. For public business entities (PBEs), the ASU is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2017. For all other entities, it is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019.

Further, in June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments, which significantly amends the guidance in U.S. GAAP on the measurement of credit losses on financial instruments. For PBEs that meet the U.S. GAAP definition of an SEC filer, ASU 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For PBEs that do not meet the U.S. GAAP definition of an SEC filer, the ASU is effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. In addition, entities are permitted to early adopt the new guidance for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years.

In March 2017, the FASB issued ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities, which shortens the amortization period for premiums on investments in purchased callable debt securities to the first call date. For PBEs, the ASU is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2018. For all other entities, it is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted.

In this comparison, it is assumed that an entity is applying IFRS 9 and ASU 2016-01 but has not yet adopted ASU 2016-13 or ASU 2017-08.

For key differences between U.S. GAAP and IFRSs in the accounting for investments in debt and equity securities before adoption of IFRS 9 and ASU 2016-01, click here.

Under U.S. GAAP, ASC 320 is the primary source of guidance on the accounting for investments in debt securities.

Under IFRSs, IFRS 9 is the primary source of guidance on the recognition and measurement of financial assets and financial liabilities, including investments in debt securities.

This comparison focuses specifically on differences between U.S. GAAP and IFRSs in the accounting for investments in debt securities. It does not discuss the accounting for loan receivables, investments in equity instruments, and equity method investments. Further, this comparison does not discuss the election of the fair value option. For comparisons addressing these and other financial instruments and transactions within the scope of IFRS 9, click here.

The table below summarizes the key differences between U.S. GAAP and IFRSs in the accounting for investments in debt securities. It is followed by a detailed explanation of each difference.1

Subject U.S. GAAP IFRSs
Scope — applicability to financial instruments that are not in security form ASC 320 applies only to investments in debt instruments that are securities. Investments in debt instruments that are not securities are outside its scope. IFRS 9 applies to financial assets and financial liabilities. Accordingly, the scope includes investments in financial assets that are not in security form, such as loan receivables and trade receivables.
Initial recognition — trade-date versus settlement-date accounting ASC 320 does not provide guidance on whether a debt security should be initially recognized on a trade-date or settlement-date basis. An entity’s accounting often depends on the industry in which the entity operates. An entity may elect as an accounting policy to apply trade-date or settlement-date accounting to each financial asset classification group defined in IFRS 9. However, trade-date or settlement-date accounting must be applied consistently to all financial assets in the same classification category.
Initial recognition — accounting for changes in value between the trade date and settlement date ASC 320 does not provide guidance on accounting for a change in value of a debt security between its trade date and settlement date. IFRS 9 requires an entity that elects to apply settlement-date accounting to account for changes in fair value between the trade date and settlement date in a manner consistent with the entity’s accounting for the related asset.
Classification categories — instruments accounted for at amortized cost Under ASC 320, an investment in a debt security classified as held to maturity (HTM) is accounted for at amortized cost. A debt security is classified as HTM if the entity has the “positive intent and ability” to hold it to maturity. Under IFRS 9, the amortized cost classification applies to a financial asset (1) that is within a business model for which the objective is to hold and collect the contractual cash flows of the instrument and (2) for which the contractual cash flows are solely payments of principal and interest (SPPI).
Classification categories — instruments accounted for at fair value through other comprehensive income (FVTOCI) Under ASC 320, an investment in a debt security classified as available for sale (AFS) is accounted for at fair value with certain changes in fair value recognized in OCI. A debt security is classified as AFS if it does not qualify for classification as a trading security or HTM security. Under IFRS 9, the FVTOCI classification applies to a financial asset (1) that is within a business model for which the objective is to both collect the contractual cash flows and sell financial assets and (2) for which the contractual cash flows are SPPI.
Classification categories — instruments accounted for at fair value through net income (FVTNI) or fair value through profit or loss (FVTPL) Under ASC 320, trading securities are accounted for at FVTNI. A debt security is classified as a trading security if it is bought and held principally to sell in the near term. However, the absence of an intent to sell in the near term would not preclude a debt security from qualifying as a trading security. Under IFRS 9, a financial asset is accounted for at FVTPL if (1) its contractual cash flows are not SPPI or (2) it is not held as part of a business model for which the objective is to manage assets to (a) collect contractual cash flows or (b) both collect contractual cash flows and sell financial assets.
Classification categories — subsequent reclassifications ASC 320 requires an entity to reassess the classification of its investments in debt securities as of each reporting date. An entity reclassifies its HTM debt securities if it (1) no longer has the ability to hold HTM-classified securities to maturity, (2) sells or transfers one or more HTM securities before maturity for reasons that materially contradict the entity’s stated intent to hold those securities until maturity, or (3) has a pattern of such sales. Reclassifications of investments in trading securities should be rare. IFRS 9 requires reclassification of financial assets only upon a change in the business model for managing those financial assets.
Subsequent measurement — interest method: interest income recognition The effective interest rate is computed on the basis of contractual cash flows over the contractual term of the loan, with certain exceptions depending on the specific characteristics of a debt security, such as whether the debt security (1) is part of a group of prepayable debt securities, (2) is a beneficial interest in securitized financial assets, (3) has been other-than-temporarily impaired, or (4) is prepayable by the issuer and has a stated interest rate that increases over time. Under IFRS 9, the effective interest rate is computed on the basis of estimated cash flows that the entity expects to receive over the expected life of the financial asset. The method used to calculate interest revenue depends on whether the financial asset (1) is purchased or originated credit-impaired or (2) has subsequently become credit-impaired.
Subsequent measurement — interest method: revisions in estimates (not from a modification) Whether and how an entity recognizes a change in expected future cash flows of an investment in a debt security depends on the characteristics of the debt security and the effective interest method applied. An entity (1) adjusts a change in estimate that is not a result of changes in the market rates of a floating-rate instrument by applying a cumulative “catch-up” method that uses the original effective interest rate as a discount rate and (2) recognizes the change in estimate through earnings.
Subsequent measurement — foreign exchange gains and losses on AFS/FVTOCI debt securities Under ASC 320, the unrealized change in fair value of an investment in a debt security classified as AFS that is attributable to changes in foreign currency rates must be recognized in OCI. Under IFRS 9, the unrealized change in fair value of a debt instrument accounted for at FVTOCI that is attributable to changes in foreign exchange rates (calculated on the basis of the instrument’s amortized cost) must be recognized in profit or loss.
Impairment — recognition of impairment loss “Incurred-loss” approach — An impairment loss on an investment in a debt security classified as AFS or HTM is recognized only if the investment is considered other-than-temporarily impaired. “Expected-loss” approach — An impairment loss on a financial asset accounted for at amortized cost or FVTOCI is recognized immediately on the basis of expected credit losses.
Impairment — measurement of impairment loss

Under ASC 320, the recognition of an other-than-temporary impairment (OTTI) loss depends on whether the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss.”

If the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss,” the impairment loss, equal to the difference between the amortized cost basis and fair value, is recognized through earnings.

If neither condition is met, the impairment loss is separated into the credit loss component (through earnings) and all other factors (through OCI).

Under IFRS 9, the measurement of the impairment loss will differ depending on the financial asset’s credit risk at inception and changes in credit risk from inception, as well as the applicability of certain practical expedients. The impairment loss is measured as either (1) the 12-month expected credit loss or (2) the lifetime expected credit loss. Further, for financial assets that are credit-impaired at the time of recognition, the impairment loss will be based on the cumulative changes in the lifetime expected credit losses since initial recognition.
Impairment — reversal of recognized impairment losses Under ASC 320, once an OTTI is recognized, subsequent recoveries in fair value of that security are not recognized in earnings. Under IFRS 9, previously recognized expected credit losses are reversed through profit or loss (as an impairment gain) if expected credit losses decrease.

Scope

Applicability to Financial Instruments That Are Not in Security Form

Under U.S. GAAP, ASC 320 applies only to investments in debt securities. Investments in debt instruments that are not in security form are outside the scope of ASC 320. ASC 320-10-20 defines a debt security as “[a]ny security representing a creditor relationship with an entity.” Further, ASC 320-10-20 defines a security as follows:

A share, participation, or other interest in property or in an entity of the issuer or an obligation of the issuer that has all of the following characteristics:
a. It is either represented by an instrument issued in bearer or registered form or, if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer.
b. It is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.
c. It either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations.

IFRS 9 applies to financial assets and financial liabilities regardless of whether they are in security form. Thus, more types of instruments are within the scope of IFRS 9 than within that of ASC 320.

Initial Recognition

Trade-Date Versus Settlement-Date Accounting

Under U.S. GAAP, ASC 320 does not provide guidance on whether the acquisition of a debt security that qualifies as a regular-way trade should be recognized on a trade-date or settlement-date basis. Whether a particular entity applies trade-date or settlement-date accounting often depends on the industry in which the entity operates. For example, broker-dealers subject to ASC 940-320-25-1 must account for all regular-way securities transactions on a trade-date basis. In addition, the following accounting guidance indicates that trade-date accounting is required for regular-way security trades:

  • ASC 942-325-25-2, Financial Services — Depository and Lending: Investments — Other.
  • ASC 946-320-25-1, Financial Services — Investment Companies: Investments — Debt and Equity Securities.
  • ASC 960-325-25-1, Plan Accounting — Defined Benefit Pension Plans: Investments — Other.
  • ASC 962-325-25-1, Plan Accounting — Defined Contribution Pension Plans: Investments — Other.

Further, ASC 815-10-15-141 and ASC 815-10-35-5 provide special guidance on purchases of nonderivative securities that will be accounted for under ASC 320 if the purchase contract (1) is either a purchased option contract with no intrinsic value at acquisition or a forward contract, (2) requires physical settlement by delivery of the security, and (3) is not a derivative instrument within the scope of ASC 815. Such purchase contracts are accounted for in accordance with ASC 815-10-35-5, which distinguishes the accounting treatment by initial classification category and whether the purchase contract is an option or a forward. Generally, if the purchase contract is a forward, the purchase is recognized on the settlement date, and if the purchase contract is an option, the purchase is recognized on the exercise date.

Under IFRSs, IFRS 9 indicates that for a regular-way purchase or sale, an entity may elect as an accounting policy to apply trade-date or settlement-date accounting to each category of financial assets. Specifically, paragraph B3.1.3 of IFRS 9 states, in part:

A regular way purchase or sale of financial assets is recognised using either trade date accounting or settlement date accounting . . . . An entity shall apply the same method consistently for all purchases and sales of financial assets that are classified in the same way in accordance with [IFRS 9]. For this purpose assets that are mandatorily measured at [FVTPL] form a separate classification from assets designated as measured at [FVTPL].

For example, under IFRSs, an entity may elect to recognize financial assets that are accounted for at amortized cost on a settlement-date basis but elect to recognize financial assets that are mandatorily accounted for at FVTPL on a trade-date basis.

Accounting for Changes in Value Between the Trade Date and Settlement Date

Under U.S. GAAP, as discussed above, ASC 320 does not provide guidance on whether an entity should follow trade-date or settlement-date accounting when recognizing the acquisition of a security, although certain other Codification topics require trade-date or settlement-date accounting. ASC 320 also does not provide guidance on accounting for the change in value of a security between its trade date and settlement date if the security is initially recognized on a settlement-date basis.

However, for purchases of nonderivative securities that qualify under ASC 815-10-15-141, as discussed above, ASC 815-10-25-17 and ASC 815-10-35-5 require an entity to account for changes in the fair value of such forward contracts and purchase options in a manner similar to how the underlying debt security will be accounted for once the contract is settled.

Under IFRSs, IFRS 9 allows a policy choice for the application of trade-date or settlement-date accounting for regular-way purchases or sales by classification category of the related financial assets. An entity that elects to initially recognize a financial asset on its settlement date must still account for changes in value between the trade date and settlement date in accordance with how the entity will account for the financial asset once it is acquired. Specifically, paragraph B3.1.6 of IFRS 9 states, in part:

When settlement date accounting is applied an entity accounts for any change in the fair value of the asset to be received during the period between the trade date and the settlement date in the same way as it accounts for the acquired asset. In other words, the change in value is not recognised for assets measured at amortised cost; it is recognised in profit or loss for assets classified as financial assets measured at [FVTPL]; and it is recognised in [OCI] for financial assets measured at [FVTOCI].

Classification Categories

Under U.S. GAAP, ASC 320 prescribes the following classification categories for investments in debt securities: (1) HTM securities accounted for at amortized cost, (2) AFS securities accounted for at FVTOCI, and (3) trading securities accounted for at FVTNI. The determination of which classification category is applicable depends, in part, on management’s intent and ability to hold the securities and is made on an instrument-by-instrument basis. Further, ASC 825-10 permits the election of a fair value option under which the instrument would be accounted for at FVTNI.

Under IFRSs, IFRS 9 prescribes the following classification categories for financial assets other than equity investments: (1) amortized cost, (2) FVTOCI, and (3) FVTPL. The classification is determined on the basis of the business model under which the financial assets are held as well as the financial asset’s contractual cash flow characteristics. Further, IFRS 9 permits the election of the fair vale option under which the instrument would be accounted for at FVTPL, in limited circumstances.

This comparison does not address differences between U.S. GAAP and IFRSs regarding fair value option guidance (click here).

Instruments Accounted for at Amortized Cost

Under U.S. GAAP, investments in HTM securities are accounted for at amortized cost. ASC 320-10-25-1(c) allows an entity to classify investments in debt securities “as [HTM] only if the reporting entity has the positive intent and ability to hold those securities to maturity.” However, an entity is not permitted to classify an investment in a debt security as HTM if it “[c]an contractually be prepaid or otherwise settled in such a way that the holder of the security would not recover substantially all of its recorded investment” in the debt security, as noted in ASC 320-10-25-5(a).

Under IFRSs, paragraph 4.1.2 of IFRS 9 requires an entity to measure a financial asset at amortized cost if:

a. [T]he financial asset is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows and
b. [T]he contractual terms of the financial asset give rise on specified dates to cash flows that are [SPPI] on the principal amount outstanding.

Paragraph 4.1.3(b) of IFRS 9 states, in part, that “interest consists of consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs, as well as a profit margin.”

Instruments Accounted for at Fair Value Through Other Comprehensive Income

Under U.S. GAAP, investments in AFS debt securities are accounted for at fair value with certain changes in fair value recognized in OCI. ASC 320 requires an entity to classify an investment in a debt security as AFS if the debt security does not otherwise qualify for classification as a trading security or HTM security (unless the entity elects the fair value option in ASC 825-10 for the investment).

Under IFRSs, paragraph 4.1.2A of IFRS 9 requires an entity to measure a financial asset at fair value with certain changes in fair value recognized in OCI if:

a. [T]he financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets and
b. [T]he contractual terms of the financial asset give rise on specified dates to cash flows that are [SPPI] on the principal amount outstanding.

Unlike the AFS category under U.S. GAAP, the FVTOCI category is not a “residual” category under IFRSs.

Instruments Accounted for at Fair Value Through Net Income or Fair Value Through Profit or Loss

Under U.S. GAAP, trading securities are accounted for at fair value with changes in fair value recognized in net income. A debt security is classified as trading if it is bought and held principally to sell in the near term. ASC 320-10-20 states that “[t]rading generally [involves] active and frequent buying and selling . . . with the objective of generating profits on short-term differences in price.” However, ASC 320-10-25-1(a) clarifies that an entity is not precluded from classifying a debt security as trading “simply because the entity does not intend to sell it in the near term.”

Under IFRSs, IFRS 9 requires entities to account for financial assets at FVTPL if they do not qualify for measurement at amortized cost or FVTOCI. Accordingly, a financial asset is accounted for at FVTPL if the asset’s contractual cash flows are not SPPI or, as stated in paragraph B4.1.5 of IFRS 9, the financial asset is “not held within a business model whose objective is to hold assets to collect contractual cash flows or within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets.” For example, paragraph B4.1.6 of IFRS 9 notes that this would apply to a “portfolio of financial assets that is managed and whose performance is evaluated on a fair value basis . . . . For such [a portfolio], the collection of contractual cash flows is only incidental to achieving the business model’s objective.”

Subsequent Reclassifications

Under U.S. GAAP, ASC 320 requires an entity to reassess the classification of its investments in debt securities at each reporting date.

For investments in debt securities initially classified as HTM, if an entity no longer has the ability to hold its securities to maturity, it should reclassify its HTM securities. In addition, sales and transfers of HTM debt securities before maturity may call into question management’s intent to hold its remaining HTM securities until maturity. In accordance with ASC 320-10-35-9, the reclassification of all remaining HTM debt securities to the AFS classification is required if a sale or transfer “[r]epresents a material contradiction [of] the entity’s stated intent to hold those securities [until] maturity or when a pattern of sales [or transfers] has occurred.” However, certain sales or transfers of HTM securities may not call into question management’s intent to hold other securities to maturity if they occur under the conditions noted in ASC 320-10-25-6, ASC 320-10-25-9, or ASC 320-10-25-14. Examples of such conditions include (1) a significant deterioration in the creditworthiness of the counterparty; (2) a major business combination or disposition that necessitates the sale or transfer of HTM securities; and (3) events that are isolated, nonrecurring, and unusual for the reporting entity, and that could not have been reasonably anticipated.

As for investments in debt securities initially classified as trading securities, ASC 320-10-35-12 further states that “given the nature of a trading security, transfers into or from the trading category . . . should be rare” (emphasis added).

Under IFRSs, paragraph 4.4.1 of IFRS 9 states, in part, that “[w]hen, and only when, an entity changes its business model for managing financial assets it shall reclassify all affected financial assets.” Further, paragraph B4.4.1 of IFRS 9 states that “such changes are expected to be very infrequent,” adding that “[s]uch changes are determined by the entity’s senior management as a result of external or internal changes and must be significant to the entity’s operations and demonstrable to external parties.”

For financial assets classified as measured at amortized cost, paragraph B4.1.3 of IFRS 9 clarifies that “[a]lthough the objective of an entity’s business model may be to hold financial assets in order to collect contractual cash flows, the entity need not hold all of those instruments until maturity. Thus an entity’s business model can be to hold financial assets to collect contractual cash flows even when sales of financial assets occur or are expected to occur in the future.”

Subsequent Measurement

Interest Method: Interest Income Recognition

Under U.S. GAAP, an entity typically recognizes interest income on investments in debt securities accounted for at amortized cost or FVTOCI in accordance with ASC 310-20-35-18 and ASC 310-20-35-262 by applying the effective interest method on the basis of the contractual cash flows of the security. An entity should not anticipate prepayments of principal. However, the following are exceptions to this method of recognizing interest income:

  • If a debt security is part of a pool of prepayable financial assets and the timing and amount of prepayments are reasonably estimable, an entity is allowed to anticipate future principal prepayments when determining the appropriate effective interest rate to apply to the debt security under ASC 310-20-35-26.
  • If an investment in a debt security is purchased with evidence of credit deterioration, the interest method articulated in ASC 310-30-35-8 and 35-9, which is based on expected rather than contractual cash flows, must be applied.
  • If an investment in a debt security is a beneficial interest in securitized financial assets that (1) is not of high credit quality or (2) can be contractually prepaid or otherwise settled in such a way that the holder would not recover substantially all of its investment, the interest method articulated in ASC 325-40-35-4, which is based on estimated rather than contractual cash flows, must be applied.
  • If an investment in a debt security is considered other-than-temporarily impaired after acquisition, the interest method articulated in ASC 320-10-35-35, which is based on estimated rather than contractual cash flows, must be applied.
  • If an investment in a debt security is considered a structured note3 but does not contain an embedded derivative that must be separated under ASC 815, the interest method articulated in ASC 320-10-35-40, which is based on estimated rather than contractual cash flows, must be applied.
  • If an investment in a debt security to which the interest method in ASC 310-20-35-18(a) applies has a stated interest rate that increases during the term such that “interest accrued under the interest method in early periods would exceed interest at the stated rate . . . , interest income shall not be recognized to the extent that the net investment . . . would increase to an amount greater than the amount at which the borrower could settle the obligation.” Thus, a limit on the accrual of interest income applies to certain investments in debt securities that have a stepped interest rate and contain a borrower prepayment option or issuer call option.

Under IFRS 9, an entity calculates interest revenue on financial assets accounted for at amortized cost or FVTOCI by applying the effective interest method. Appendix A of IFRS 9 defines the effective interest rate of a financial asset or liability as the “rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial asset . . . to the gross carrying amount of a financial asset” (emphasis added). Therefore, the effective interest method in IFRS 9, unlike that in ASC 310-20, requires an entity to compute the effective interest rate on the basis of the estimated cash flows over the expected life of the instrument by considering all contractual terms (e.g., prepayment, extension, call, and similar options) but not expected credit losses. Under IFRSs, there is no limit on the accrual of interest income for investments in debt securities that have a stepped interest rate and contain a borrower prepayment option or issuer call option. Further, in its definition of an effective interest rate, IFRS 9 states that in rare cases in which it is not possible to reliably estimate the cash flows or the expected life of the financial instrument, an entity should “use the contractual cash flows over the full contractual term.”

The application of the effective interest method depends on whether the financial asset is purchased or originated credit-impaired or on whether it became credit-impaired after initial recognition. When recognizing interest revenue related to purchased or originated credit-impaired financial assets under IFRS 9, an entity applies a credit-adjusted effective interest rate to the amortized cost carrying amount. The calculation of the credit-adjusted interest rate is consistent with that of the effective interest rate, except that the calculation of the credit-adjusted interest rate takes into account expected credit losses within the expected cash flows.

For a financial asset that is not purchased or originated credit-impaired, paragraph 5.4.1 of IFRS 9 requires an entity to calculate interest revenue as follows:

  • Gross method — If the financial asset has not become credit-impaired since initial recognition, the entity applies the effective interest rate to the gross carrying amount. Appendix A of IFRS 9 defines the gross carrying amount as the “amortised cost of a financial asset, before adjusting for any loss allowance.”
  • Net method — If the financial asset has subsequently become credit-impaired, the entity applies the effective interest rate to the amortized cost balance, which is the gross carrying amount adjusted for any loss allowance.

An entity that uses the net method is required to revert to the gross method if (1) the credit risk of the financial instrument subsequently improves to the extent that the financial asset is no longer credit-impaired and (2) the improvement is objectively related to an event that occurred after the net method was applied (see paragraph 5.4.2 of IFRS 9).

Interest Method: Revisions in Estimates (Not From a Modification)

Under U.S. GAAP, interest income on investments in debt securities accounted for at amortized cost is typically recognized by applying the effective interest method on the basis of the contractual cash flows of the security, as discussed above. Under ASC 310-20-35-18(c), if the stated interest rate varies on the basis of future changes in an independent factor (e.g., LIBOR), the effective interest rate used to amortize fees and costs is “based either on the factor . . . that is in effect at the inception of the loan or on the factor as it changes over the life of the loan.” For investments in debt securities for which recognition of interest income is based on estimated rather than contractual cash flows, there are several methods for recognizing changes in estimated cash flows, depending on the type of the security:

  • If an entity anticipates estimated prepayments when measuring interest income of an investment in a debt security that is part of a pool of prepayable financial assets in accordance with ASC 310-20-35-26, the entity must continually recalculate the appropriate effective yield as prepayment assumptions change. That is, if the estimated future cash flows of a debt security change, the effective yield of the debt security must be recalculated to take into account the new prepayment assumptions. The adjustment to the interest method under ASC 310-20 must be retrospectively applied to the debt security. That is, the amortized cost of the debt security is adjusted to reflect what it would have been had the new effective yield been used since the acquisition of the debt security with a corresponding charge or credit to current-period earnings.
  • If an investment in a debt security is within the scope of ASC 310-30 because there is evidence of credit deterioration, an entity must prospectively recalculate the amount of accretable yield for the debt security if it is probable that there is a significant increase in cash flows previously expected to be collected or if actual cash flows are significantly greater than cash flows previously expected.
  • If an investment in a debt security is a beneficial interest in securitized financial assets that is within the scope of ASC 325-40, an entity must prospectively recalculate the amount of accretable yield of the debt security whenever it is probable that there is a favorable or adverse change in estimated cash flows from the cash flows previously projected.
  • If an investment in a debt security is within the scope of ASC 320-10-35 because it is other-than-temporarily impaired, an entity must prospectively recalculate the amount of accretable yield as if the debt security had been purchased on the measurement date of the OTTI, in a manner consistent with the method described in ASC 310-30.
  • If an investment in a debt security is a structured note within the scope of ASC 320-10-35-38, an entity must retrospectively recalculate the amount of accretable yield for the debt security on the basis of the current estimated future cash flows as of the reporting date. However, if the recalculated effective yield is negative, a zero percent effective yield is used instead.

Under IFRSs, paragraphs B5.4.5 and B5.4.6 of IFRS 9 provide guidance on when an entity should recalculate the effective interest rate.

  • For floating-rate instruments that pay a market-rate of interest, paragraph B5.4.5 specifies that the “periodic re-estimation of cash flows to reflect the movements in the market rates of interest alters the effective interest rate.” However, paragraph B5.4.5 further notes that for such floating-rate financial instruments, “re-estimating the future interest payments normally has no significant effect on the carrying amount of the asset or the liability” if the asset or liability was initially recognized at an amount that equals the principal receivable.
  • For other instruments and for revisions of estimates, paragraph B5.4.6 usually requires an entity to recalculate the gross carrying amount of the financial asset “as the present value of the estimated future contractual cash flows that are discounted at the financial instrument’s original effective interest rate (or credit-adjusted effective interest rate for purchased or originated credit-impaired financial assets).” The resulting “catch-up” adjustment to the carrying amount of the financial asset is recognized immediately in profit or loss. This catch-up approach of recognizing changes in estimated cash flows is different from both the prospective and retrospective approaches used under U.S. GAAP.

Foreign Exchange Gains and Losses on AFS/FVTOCI Debt Securities

Under U.S. GAAP, unrealized changes in the value of an investment in a foreign-currency-denominated security classified as AFS that are attributable to changes in foreign exchange rates are recognized in OCI. ASC 320-10-35-36 states that the “entire change in the fair value of foreign-currency-denominated [AFS] debt securities shall be reported in other comprehensive income.” However, impairment losses are recognized in net income when the impairment is determined to be other than temporary. Such losses may include foreign exchange gains or losses.

Under IFRSs, unrealized changes in the value of a foreign-currency-denominated debt instrument accounted for at FVTOCI that are attributable to changes in the foreign exchange rates are recognized in profit or loss. In accordance with paragraphs 5.7.10 and 5.7.11 of IFRS 9, the amount recognized in profit or loss for debt instruments accounted for at FVTOCI is the same as the amount that would be recognized in profit or loss for instruments accounted for at amortized cost. Paragraph B5.7.2A of IFRS 9 further clarifies that:

For the purpose of recognising foreign exchange gains and losses under IAS 21 [The Effects of Changes in Foreign Currency Rates], a financial asset measured at [FVTOCI] in accordance with paragraph 4.1.2A is treated as a monetary item. Accordingly, such a financial asset is treated as an asset measured at amortised cost in the foreign currency. Exchange differences on the amortised cost are recognised in profit or loss and other changes in the carrying amount are recognised in accordance with paragraph 5.7.10.

Note that under IFRS 9, the treatment discussed above does not apply to investments in equity securities for which an irrevocable election to account for these instruments at FVTOCI was made. An investment in such securities is accounted for in a manner consistent with the guidance in paragraph B5.7.3 of IFRS 9, which states that “[s]uch an investment is not a monetary item. Accordingly, the gain or loss that is presented in [OCI] includes any related foreign exchange component.”

Impairment

Recognition of Impairment Loss

Under U.S. GAAP, ASC 320-10-35-18 indicates that an entity recognizes an impairment loss on an AFS or HTM debt security if “a decline in fair value below the amortized cost basis is other than temporary,” which is akin to when the loss has been incurred. An impaired debt security is considered other-than-temporarily impaired if the entity (1) intends to sell the security or (2) has determined that it is more likely than not that it would be required to sell the security before the recovery of its amortized cost. Further, if the entity has determined that (1) it does not intend to sell the security and (2) it is not more likely than not required to sell the security, an OTTI is still considered to have occurred if recovery of the entire amount of the amortized cost basis of the security is not expected (i.e., a credit loss has occurred).

Unlike U.S. GAAP, IFRSs do not include the concept of OTTI. Under IFRSs, an impairment loss on a financial asset accounted for at amortized cost or FVTOCI is recognized immediately on the basis of expected credit losses.

Measurement of Impairment Loss

Under U.S. GAAP, ASC 320 specifies that the amount of OTTI loss recognized in earnings on an investment in a debt security classified as HTM or AFS depends on whether the entity “intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss,” as noted in ASC 320-10-35-34A.

In accordance with ASC 320-10-35-34B, if the entity “intends to sell the [debt] security or more likely than not will be required to sell the [debt] security before recovery of its amortized cost basis less any current-period credit loss,” an impairment loss equal to the difference between the security’s amortized cost basis and fair value must be recognized in earnings.

As noted in ASC 320-10-35-34C, if the entity “does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss,” the OTTI loss is separated into two components: the amount representing the credit loss (recognized in earnings) and the amount related to all other factors (recognized in OCI). The entity measures the credit loss by comparing the debt security’s amortized cost basis with the entity’s best estimate of the present value of cash flows expected to be collected from the debt security. The remaining difference between the security’s amortized cost basis and fair value is recognized in OCI.

Under IFRSs, IFRS 9 employs a dual-measurement approach that requires an entity to measure the loss allowance for an asset accounted for at amortized or FVTOCI (other than one that is purchased or originated credit-impaired) at an amount equal to either (1) the 12-month expected credit losses or (2) lifetime expected credit losses.

The 12-month expected credit losses measurement, which reflects the expected credit losses arising from default events possible within 12 months of the reporting date, is required if the asset’s credit risk has not increased significantly since initial recognition. Further, an entity is permitted to apply a 12-month expected credit loss measurement if the credit risk, in absolute terms, is low as of the reporting date. As noted in paragraph B5.5.22 of IFRS 9, the credit risk is considered low if (1) there is a “low risk of default,” (2) “the borrower has a strong capacity to meet its contractual cash flow obligations in the near term,” and (3) “adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfill its contractual cash flow obligations.” Paragraph B5.5.23 of IFRS 9 suggests that an “investment grade” rating might be an indicator of low credit risk.

Paragraph 5.5.9 of IFRS 9 states that in assessing whether there has been a significant increase in a financial asset’s credit risk, an entity is required to consider “the change in the risk of a default occurring over the expected life of the financial instrument instead of the change in the amount of expected credit losses” since initial recognition. Paragraph B5.5.17 of IFRS 9 provides a nonexhaustive list of factors that an entity may consider in determining whether there has been a significant increase in credit risk. For financial instruments for which credit risk has significantly increased since initial recognition, the allowance is measured as full lifetime expected credit losses, which IFRS 9 defines as the “expected credit losses that result from all possible default events over the expected life of a financial instrument,” unless the credit risk is low as of the reporting date.

Purchased or originated credit-impaired financial assets (e.g., distressed debt) are treated differently under IFRS 9. As stated in paragraph 5.5.13 of IFRS 9, for these assets, an entity recognizes only “the cumulative changes in lifetime expected credit losses since initial recognition as a loss allowance.” Changes in lifetime expected losses since initial recognition are recognized in profit or loss. Thus, any favorable change in lifetime expected credit losses since initial recognition of a purchased or originated credit-impaired financial asset is recognized as an impairment gain in profit or loss regardless of whether a corresponding impairment loss was recorded for the asset in previous periods.

Reversal of Recognized Impairment Losses

Under U.S. GAAP, ASC 320-10-35-34E states that once an OTTI is recognized on an investment, the “previous amortized cost basis less the [OTTI] recognized in earnings shall become the new amortized cost basis of the investment.” The guidance further states that the “new amortized cost basis shall not be adjusted for subsequent recoveries in fair value.”

After the OTTI is recognized, significant increases in expected (or actual) cash flows are accounted for through an adjustment to the accretable yield on a prospective basis in accordance with ASC 310-10. (Also see ASC 320-10-35-35.) For AFS securities, subsequent changes in fair value that are not further OTTIs are recognized in OCI.

Under IFRSs, previously recognized expected credit losses are reversed through profit or loss if the expected credit losses decrease. Paragraph 5.5.8 of IFRS 9 states that an “entity shall recognise in profit or loss, as an impairment gain or loss, the amount of expected credit losses (or reversal) that is required to adjust the loss allowance at the reporting date to the amount that is required to be recognized in accordance with [IFRS 9].”

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1 Differences are based on comparison of authoritative literature under U.S. GAAP and IFRSs and do not necessarily include interpretations of such literature.

2 The guidance of ASC 310-20 applies to investments in certain debt securities within the scope of ASC 320-10, unless such securities are marked to market in accordance with ASC 310-20-15-4.

3 ASC 320-10-20 defines a structured note as a “debt instrument whose cash flows are linked to the movement in one or more indexes, interest rates, foreign exchange rates, commodities prices, prepayment rates, or other market variables. . . . Contractual cash flows for principal, interest, or both [from structured notes] can vary in amount and timing throughout the life of the note based on nontraditional indexes or nontraditional uses of traditional interest rates or indexes.” However, certain embedded derivatives in structured notes must be separated from their host contracts and accounted for in accordance with ASC 815.

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