Accounting Resources for ASC 326 and IFRS 9

Before we dive into the accounting for impairment of financial assets and the various impairment models under U.S. GAAP, let’s take a step back and consider what types of financial assets we are talking about. The FASB defines a financial asset as “cash, evidence of an ownership interest in an entity, or a contract that conveys to one entity a right to do either of the following: (a) receive cash or another financial instrument from a second entity, (b) exchange other financial instruments on potentially favorable terms with the second entity.” Examples are cash, accounts receivable, loans/notes receivable, investments in equity securities, investments in debt securities, derivatives, and many more!

Impairment is an important consideration for many financial assets such as accounts receivable, loans/notes receivable, certain specific investments in equity securities, and certain investments in debt securities. Not so important for cash, or any financial asset carried at fair value with changes in fair value recorded in the profit or loss (FVPL). Under U.S. GAAP, most equity securities and derivatives are carried at FVPL, making impairment a moot point.

U.S. GAAP has several different impairment models for financial assets as illustrated below. This topic page will focus on impairment of financial assets within the scope of ASC 326. This includes amortized cost instruments, available-for-sale (AFS) debt securities, and purchased credit deteriorated instruments.

This page serves as a guide about accounting for impairment of financial assets. It brings together a compilation of accounting issues, references, and links to various content, including our training courses on impairment.

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Current expected credit losses model

The current expected credit losses model, “CECL” for short, is applied to most financial assets measured at amortized cost under U.S. GAAP. This includes debt securities classified as held-to-maturity (HTM), loans receivable, notes receivable, trade accounts receivable, contract assets under ASC 606, lease receivables, and several others. It does not apply to investments accounted for under the equity method, loans held for sale, receivables between entities under common control, and several others.

Overview of the CECL model

The goal of the CECL model is to present, in the financial statements, the net amount of the asset to be collected, via the use of an allowance for credit losses. Instead of just accounting for losses an entity has incurred, the CECL model requires the consideration of all losses expected during the contractual life of the asset. The resulting allowance for credit losses is adjustable as conditions change. Reassessment is required each reporting period.

The expected loss model requires consideration, over the contractual life of the instrument, of the past (historical data), the present (current conditions), and the future (reasonable and supportable forecasts). ASC 326 does not prescribe a specific methodology to be used to estimate expected credit losses. The approach used may vary across different entities and different financial instrument types at the same entity as long as it is consistently applied. ASC 326 does provide the following qualitative factors to consider:

How to estimate expected credit losses

Entities are not required to search for all possible information, instead, entities need to consider information that is reasonably available without undue cost and effort. For periods beyond which the entity is able to make or obtain reasonable and supportable forecasts, an entity should revert to historical loss information. As noted above, ASC 326 requires the estimation of expected losses over the contractual life of an asset. ASC 326 contains guidance regarding when certain features such as prepayment options, extensions, and renewal options are required to be considered in determining the contractual life of the asset.

The CECL model does not prescribe a unit of account (e.g., an individual asset or a group of financial assets) in the measurement of expected credit losses. However, an entity is required to evaluate financial assets within the scope of the model on a collective (i.e., pool) basis when assets share similar risk characteristics. If a financial asset’s risk characteristics are not similar to the risk characteristics of any of the entity’s other financial assets, the entity would evaluate the financial asset individually.

An allowance for credit losses is recognized as a contra-asset with the offset in the income statement. The allowance needs to be assessed and measured each reporting period and adjusted, as necessary. This means that a previously recorded allowance and corresponding loss should be reversed in the future if circumstances change. It is important to recognize that under ASC 326, there is no threshold for recognition. This means that all probabilities of loss must be considered, no matter how small or remote. While ASC 326 does include one exception, generally there will always be an estimate of expected credit losses for an asset.

Available-for-sale (AFS) debt securities impairment model

As a quick reminder, available-for-sale (AFS) debt securities are accounted for at fair value. Excluding any credit impairment, unrealized holding gains and losses are recorded in other comprehensive income (OCI), net of tax. ASC 326-30 contains a separate impairment model for AFS debt securities.

Entities are required to assess if AFS debt securities are impaired. A security is impaired if the fair value of the investment is less than its amortized cost basis. Impairment is assessed at the individual security level. How the impairment is recorded depends on what factors are causing the impairment. Any amount of impairment resulting from credit losses is recorded as an allowance for credit losses with the offset in the income statement. Any amount of impairment arising from other factors (i.e., not related to credit losses) is recorded in OCI. However, if an entity intends to sell or is more likely than not, will be required to sell the AFS debt security before recovery of its amortized cost basis, any impairment should be recognized through earnings.

While there is no specific prescribed methodology, ASC 326 provides factors to consider when determining if impairment is related to credit losses. Any credit loss allowance recognized for AFS debt securities is subject to reversal in the future if conditions change. Expected cash flows should continue to be monitored and the allowance adjusted accordingly as expectations change.

Purchased credit deteriorated assets

ASC 326 includes specific guidance for purchased credit deteriorated (PCD) assets. It is important to note that this guidance applies to acquired (purchased) assets, and only those that have experienced a more-than-insignificant deterioration in credit quality since origination. It may require significant judgment upon purchase to determine whether assets have experienced a more-than-insignificant deterioration in credit quality since their origination.

The purchase price of a PCD asset will be less than its par value due to the existence of credit deterioration. Therefore, in order to establish a credit loss allowance upon recognition, ASC 326 requires the “gross-up” approach, as follows:

At initial recognition, entities must allocate any associated non-credit premiums or discounts to the assets on an individual basis.

Subsequently, interest income is recognized by applying the effective interest rate to the unamortized principal balance. This approach maintains a constant effective yield throughout the asset’s life. Any subsequent changes to expected cash flows is accounted for via adjustments to the credit loss allowance. The offset of these adjustments is to income.

Does the CECL model apply to non-financial entities?

Yes! ASC 326 applies to all entities with in-scope instruments. Examples include trade receivables, note receivables, contract assets under ASC 606, loans and held-to-maturity (HTM) debt securities (and more). Want to learn more? Download our FAQs: Applying ASC 326 for Non-financial Entities.

Accounting Differences: ASC 326 vs. IFRS 9

Key differences when accounting for impairment of financial assets include:

Online Learning

GAAP Dynamics training courses are designed to help leading accounting firms and multinational companies move beyond the training status quo. Our courses are continually updated and new courses are constantly being added, so check back often! Below are a few of our courses related to impairment of financial assets under both U.S. GAAP and IFRS:

Credit Losses: Introduction to the CECL Model – This CPE-eligible, eLearning course (1.5 CPE) covers the concepts of the current expected credit loss (CECL) model within ASC 326, Financial Instruments – Credit Losses. This course explains the initial recognition accounting, subsequent measurement, and required disclosures in accordance with ASC 326. It includes considerations of forming an estimate of expected credit losses and accounting for purchased credit deteriorated assets.

Investments: Debt Securities – This CPE-eligible eLearning course (1.5 CPE), dives into the accounting for debt securities under ASC 320, Investments. The course begins with the classification of debt securities as trading, available for sale, or held to maturity. Initial recognition and subsequent measurement of debt securities based on their classification in accordance with ASC 320 is discussed. This course also covers assessing impairment and recognizing credit losses on debt securities in accordance with ASC 326.

Financial Instruments: Overview of IFRS 9 – This CPE-eligible, eLearning course (1.0 CPE), provides an overview of accounting for financial instruments under IFRS 9. This course covers classification, measurement, and impairment of financial instruments, hedge accounting, and derecognition accounting for financial assets and liabilities.

Accounting Resources

We have written several blogs related to the impairment of financial assets. Below are some of the blog posts and you can find even more on GAAPology.

Implementing ASC 326: Reversion to Historical Data Under CECL Model
Impairment has been a hot topic recently. So exactly how do you calculate an impairment loss under ASC 326? This post walks you through the guidance.

CECL Conundrums: Credit Card Considerations
Applying the CECL model to credit cards can be complex! This post will provide you with questions to consider when estimating expected credit losses.

CECL: Can There Be Zero Expected Credit Losses Under ASC 326?
The CECL model requires an entity to record lifetime expected credit losses for financial instruments, but can that expectation ever be zero?”

Impairment of AFS Debt Securities under ASC 326
ASC 326’s CECL model does not apply to AFS debt securities; rather, there is a separate impairment model for AFS debt securities.

Methods to Estimate Current Expected Credit Losses
ASC 326 is not prescriptive with a methodology to estimate current expected credit losses. Let’s take a look at some of the common methodologies.