Credit Impaired vs. Purchased Credit Deteriorated Assets

Both IFRS 9 and ASC 326 provide specific guidance for financial assets that have suffered credit deterioration since their origination. When examining credit impaired vs. purchased credit assets, it’s important to understand that under U.S. GAAP, these assets are referred to as purchased credit deteriorated (PCD) assets and under IFRS, they are referred to as purchased or originated credit-impaired (POCI) assets. These terms feel similar, but these impaired assets are accounted for differently depending on which accounting reporting framework you are applying! In today’s post, we will look at the guidance specific to POCI and PCD assets and highlight the differences in accounting treatment.

If you want to learn more or refresh your knowledge regarding the impairment guidance for assets that are not impaired at initial recognition/origination under IFRS 9 or ASC 326, refer to our Impairment of Financial Assets accounting topic page.

What are PCD and POCI assets?

Before we cover the accounting treatment, it is important that we understand the definition of POCI and PCD assets; even though the concept is similar, there is a difference in definition.

Purchased or originated credit-impaired (POCI) assets definition

IFRS 9 defines POCI as “purchased or originated financial asset(s) that are credit-impaired on initial recognition” and indicates that “a financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred.” Examples of events that have a detrimental impact on the estimated future cash flows can include:

• Significant financial difficulty of the issuer or borrower
• A default or past-due event that is a breach of contract terms
• A concession granted by the lender due to the borrower’s financial difficulty that the lender would not consider for other borrowers
• Probable borrower’s bankruptcy/financial reorganization
• Purchase of an asset at a very deep discount that reflects the incurred credit losses

Purchased credit deteriorated (PCD) assets definition

ASC 326 defines PCD as: “acquired individual financial assets (or acquired groups of financial assets with similar risk characteristics) that, as of the date of acquisition, have experienced a more-than-insignificant deterioration in credit quality since origination, as determined by an acquirer’s assessment.”

Definition differences and judgement

Both POCI and PCD assets have significant credit quality issues, but another key distinction to note is that IFRS 9 allows for these assets to be credit-impaired at the time of origination, whereas U.S. GAAP does not include assets the entity originated with credit impairment (rather these instruments could be classified as PCD subsequent to origination). Under both standards, judgement is involved in determining if assets are credit impaired. IFRS 9 provides examples of events that may result in detrimental cash flow impacts and explains that combined events may result in an asset being classified as credit impaired. U.S. GAAP does not define what a “more-than-insignificant deterioration in credit quality”. Differences in the definition and the application of judgement could lead to differences in instruments to which the credit impaired guidance is applied.

Accounting for POCI and PCD assets

The FASB and IASB have different accounting models for POCI and PCD assets.

Initial recognition

Under IFRS 9, no allowance is recorded when a POCI asset is initially recognized.

Under ASC 326, an initial allowance is required to be estimated and recorded and it is added to the purchase price rather than being reported as a credit loss expense. 

To illustrate the difference in initial recognition between IFRS and U.S. GAAP, take a look at a simplified example. An entity pays $10 million for a loan that has a par value of $13 million. The difference in the par value and purchase price is comprised of estimated credit losses of $3 million. 

Under IFRS 9, the POCI loan would be recorded as follows:

Dr.    POCI Loan       $10,000,000

            Cr. Cash                                 $10,000,000

Whereas, under ASC 326, an allowance is required to be recognized at the time of initial recognition, so the entry would be: 

Dr.    PCD Loans        $13,000,000

            Cr. Cash                                 $10,000,000

            Cr. Loss Allowance               $3,000,000  

Under both IFRS 9 and ASC 326, there is no impact to the income statement at the time of initial recognition.

Subsequent measurement

Under IFRS 9, at each subsequent reporting date, the cumulative changes in lifetime expected credit losses since initial recognition, discounted at the credit-impaired effective interest rate is recognized as a loss allowance. The amount of any change in lifetime expected credit losses is recognized as an impairment gain or loss. Favorable changes in lifetime expected credit losses are not limited to the reversal of previously recognized impairment losses.

Under ASC 326, at each subsequent reporting date, both favorable and unfavorable changes in the allowance for credit losses (that was established at initial recognition) are recorded as a credit loss expense. 

There is also a difference in the accounting for interest recognition. Under IFRS 9, the credit-adjusted effective interest rate is applied to the amortized cost, whereas, under ASC 326, generally, the effective interest rate is applied to the gross carrying amount (excludes the allowance for credit losses).

Final thoughts

Whether you are trying to account for financial assets under IFRS or U.S. GAAP, we’ve got resources to help:

• Impairment of Financial Assets Accounting Topic Page
• Financial Instruments: Overview of IFRS 9
• Financial Instruments: Classification and Measurement under IFRS 9
• Financial Instruments: Impairment under IFRS 9
• Credit Losses: Introduction to the CECL Model
• Investments: Debt Securities
• Banking: Loans

As always, don’t hesitate to reach out to us with any questions you have!

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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.