Impairment of AFS Debt Securities under ASC 326
Impairment of AFS Debt Securities under ASC 326

Impairment of AFS Debt Securities under ASC 326

Accounting Standards Update (ASU) No. 2016-13, Financial Instruments – Credit Losses, issued in June 2016 changes the accounting for impairment for financial assets and certain other instruments. For an overview of the new impairment guidance, which is codified in ASC Topic 326 (ASC 326), take a look at our previous blog post, ASC 326 Credit Losses Changes the Accounting for Credit Impairment.

Once ASC 326 is adopted or becomes effective, an entity will need to apply different impairment models for impairment of held-to-maturity (HTM) debt securities and available-for-sale (AFS) debt securities. HTM debt securities will fall under the Current Expected Credit Loss (CECL) model while AFS debt securities is carved out from the CECL model and has its own impairment model.

According to the FASB, the reason behind two separate models is as follows:

…the same credit loss model cannot apply because there are different measurement attributes. The measurement attribute for available-for-sale debt securities necessitates a separate credit loss model because an entity may realize the total value of the securities either through the collection of contractual cash flows or through sales of the securities. Furthermore, the unit of account for these assets is defined as an individual security, which means collective evaluation is not an acceptable approach for determining credit losses. Lastly, the amount of credit losses that will be realized for these assets is limited to the amount that fair value is less than amortized cost because an entity can sell its investment at fair value to avoid the realization of credit losses.

  -Excerpt form ASU 2016-13 para. BC81

In this post, we take a closer look at the impairment model for AFS debt securities under ASC 326.

Impairment of AFS Debt Securities under ASC 326

Under ASC 326, AFS debt securities are required to be assessed at the individual debt security level. A security is impaired when its fair value declines below its amortized cost basis. However, just because impairment is present, doesn’t necessarily result in recognition of a credit loss.

The unrealized loss needs further evaluation to determine whether impairment loss recognition is needed and if so, whether it is recorded as a direct write-down of the AFS debt security’s amortized cost basis or recorded as an allowance for credit losses.

An impairment loss is recognized in earnings through a direct write down of the AFS debt security to its fair value if the entity intends to sell the security or if it is more likely than not that they will be required to sell the debt security before recovery of the amortized cost basis.

An impairment is recognized in earnings through an allowance for credit losses, a contra asset account, for any portion of the unrealized loss that is a result of a credit loss. Any portion of the unrealized loss that relates to other factors (i.e. other than credit) is recognized in other comprehensive income.

Here is a basic illustration of the model:

As we can see, key aspects of the previous OTTI model under ASC 320 are retained under the ASC 326 model with targeted amendments made. Some additional differences to note are as follows:

  • Under ASC 326, for credit impairment on AFS debt securities that is recognized as an allowance, any subsequent improvements in credit losses are recognized as a reduction in the allowance and credit loss expense (in other words, this initial write-down can be reversed!). This represents a key difference from impairment recognition of AFS debt securities under the current other-than-temporary impairment (OTTI) model in ASC 320. Under the OTTI model, credit losses were recognized as a reduction to the cost basis of the investment with recovery of an impairment loss recognized prospectively over time as interest income (no immediate reversals of impairment allowed!).
  • The “other-than-temporary” concept has been eliminated. Use of the length of time a security has been in an unrealized loss position as a factor in determining whether a credit loss exists or not is no longer permissible. Therefore, any declines in fair value below cost may be subject to impairment recognition, even if the decline is a recent trend and expected to be temporary.
  • Credit losses are limited to the difference between a security’s amortized cost basis and fair value. This establishes a floor with regards to the ultimate write-down as a result of impairment, irrespective of the extent of credit losses identified.

Disclaimer  

This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.

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Comments (2)

  1. Alexander Baah-Bofah:
    Nov 07, 2019 at 06:01 PM

    I believe the chat deals with more of Held-to-maturity debt securities rather than AFS. AFS is marked to FMV on the financial statements, not amortized cost.
    With AFS, there is already an intention of selling it unlike HTM securities. However, when AFS is permanently impaired, the amount of impairment should be recorded in the Income statement as a loss and the loss should reduce the FMV on the balance sheet.
    Consequently, the impairment takes into account any prior year unrealized gains or losses already recorded in OCI. So even though the impairment might have been discovered in the current year, we take the FMV less the Original Cost to arrive at the impairment loss.
    The impairment loss in then reported in the Income statement/earnings under GAAP.
    The last paragraph is not GAAP i believe. It is IFRS. GAAP uses the direct write-off.

  2. Christine Leese:
    Nov 08, 2019 at 11:22 AM

    The chart depicts the ASC 326-30 impairment model for available-for-sale securities. Agreed that AFS debt securities are reported at fair value with unrealized gains and losses reported in OCI. But, if at the balance sheet date, the debt security’s fair value is below amortized cost, and the entity has not decided to sell the security and more likely than not it will not be required to sell before recovery, then it must be determined whether the decline in fair value below the amortized cost basis is due to credit-related factors or other non-credit related factors. The portion related to non-credit factors is recognized in OCI (net of applicable taxes). The portion related to credit-factors is recorded as an allowance (with a corresponding adjustment to earnings). This allowance for credit losses is limited to the amount that the security's amortized cost exceeds its fair value.

    However, if the entity intends to sell an impaired AFS debt security (meaning it has decided to sell it) or more likely than not will be required to sell the security before recovering its amortized cost basis, then yes, the entire impairment amount is recognized in earnings with the corresponding adjustment to the security’s amortized cost basis.


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