As we all know, the IASB and the FASB have issued new guidance for impairment accounting. Both IFRS 9 and ASC 326 provide specific guidance for instruments that have already suffered credit deterioration since their origination. 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.
We covered overviews of the impairment guidance for both IFRS 9 and ASC 326 in previous blog posts. If you need a refresher, you can review those posts:
- Impairments of Financial Instruments are Changing Under IFRS 9
- ASC 326 Credit Losses Changes The Accounting for Credit Impairment.
In today’s post, we will look at the guidance specific to POCI and PCD assets and highlight the differences in accounting treatment.
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.
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.”
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.”
This difference in definition could lead to differences in instruments to which the credit-impaired guidance is applied.
Accounting for POCI vs PCD assets
The FASB and IASB have different accounting models for POCI and PCD assets. U.S. GAAP has simplified the accounting from the pre-ASC 326 guidance (we have a blog post, ASC 326: Accounting for Purchased Assets with Credit Deterioration, if you want to read more about just the U.S. GAAP changes).
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 the following example.
Under IFRS 9, the POCI loan would be recorded as follows:
Dr. POCI Loans $10,000,000
Cr. Cash $10,000,000
Whereas, under ASC 326, an allowance is required to be recognized, so the entry would be:
Dr. PCD Loans $13,000,000
Cr. Cash $10,000,000
Cr. Loss Allowance $ 3,000,000
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 are recorded as a credit loss expense.
There is also a difference in the accounting for interest recognition. Under IFRS 9, the credit-adjusted EIR is applied to the amortized cost, whereas, under ASC 325, generally, the effective interest rate is applied to the gross carrying amount.
Using the same example from above, you can see the difference in the pattern of interest recognition illustrated below, where under IFRS the amortized cost is accreted to the expected cash flows and under U.S. GAAP, the grossed-up asset is accreted to the contractual cash flows.
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