ASC 460 Guarantees, provides accounting and disclosure requirements for guarantees. Certain guarantees that are within the scope of ASC 460 also fall under the scope of the current expected credit loss (CECL) model in ASC 326, and thus must be assessed for expected credit losses. Some have questioned whether expected credit losses on guarantees that fall under both ASC 460 and ASC 326 are being accounted for twice.
In this blog post, we look at the accounting for guarantees under ASC 460 that also fall within the scope of CECL and address the concern of ‘double counting’.
ASC 460 Accounting for Guarantees
The issuance of a guarantee obligates the guarantor in two respects. First, the guarantor undertakes an obligation to stand ready to perform over the term of the guarantee in the event that the specified triggering events or conditions occur. This is the non-contingent aspect of the guarantee. Second, the guarantor undertakes a contingent obligation to make future payments if those triggering events or conditions occur. This is the contingent aspect of the guarantee.
For guarantees that are not within the scope of ASC 326-20, there is no separate accounting required for the contingent and noncontingent aspects of the guarantee. Generally, the guarantor would recognize a liability at fair value at inception of the guarantee.
For guarantees that are within the scope of ASC 326-20, the expected credit losses related to the contingent aspect are required to be measured and accounted for in addition to and separately from the fair value of the guarantee (the noncontingent aspect).
ASC 460 Guarantees in the Scope of ASC 326-20
Before we dive into the issue, it is important to note that determining whether a guarantee falls within the scope of ASC 460 can be challenging. There are various scope exceptions, some of which result in a guarantee not being subject to the recognition, measurement, and disclosure requirements, while other types of guarantees result in being scoped out of the recognition and measurement provisions but subject to the disclosures requirements. This is a critical step to determine the appropriate accounting for a guarantee. While we will not go into depth regarding this analysis here in this post, our eLearning on accounting for contingenices and guarantees is a valuable resource for help and further training on guarantee accounting.
That being said, common types of guarantees that are within the scope of ASC 460 include:
- Financial guarantees
- Performance guarantees
- Indemnifications, and
- Indirect guarantees of the indebtedness of others
Not all of these, though, are subject to CECL. Specifically, ASC 326-20, includes in its scope financial guarantees that are not accounted for as either insurance or derivatives. Examples include a financial standby letter of credit or a guarantee related to the nonpayment of a financial obligation.
Since ASC 460 requires separate measurement and accounting for the contingent and noncontingent aspect of a guarantee, questions have arisen as to whether the amount of expected credit losses is being double counted.
After all, wouldn’t expected credit losses be considered when determining the initial premium charged for the guarantee (and thus recorded as part of the fair value of the noncontingent aspect)?
Yes, expected credit losses most likely are considered in the premium charged to compensate the guarantor to accept the credit risk; this premium generally represents the fair value of the noncontingent liability. But the initial recognition of the liability does not impact earnings. In accordance with ASC 460, it is recognized over the life of the guarantee as the guarantor is released from its obligation.
The initial recognition of a liability for the contingent aspect represents the amount that the guarantor expects to pay on the guarantee related to expected credit losses. This does have an initial impact on earnings similar to Day 1 recognition of expected credit losses on other financial assets within the scope of ASC 326-20. The subsequent accounting for the contingent component also follows ASC 326 whereby at each reporting date, expected credit losses are estimated and related adjustments to the liability are made through net income.
In the basis of conclusions of ASC 2016-13, the FASB indicated that this separate accounting “approach is necessary to appropriately present expected credit losses on financial guarantees in accordance with Subtopic 326-20, without affecting fee recognition, similar to unfunded loan commitments.”
If you would like further training on accounting for guarantees or accounting for current expected credit losses, consider taking our eLearning courses, Contingenices and Guarantees, or Credit Losses: Introduction to the CECL Model.
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