This article was written by Chad Scott, Consulting Manager.
On June 27, 2023, the FASB released an exposure draft, Proposed Accounting Standards Update–Financial Instruments–Credit Losses (Topic 326): Purchased Financial Assets, with a comment deadline of August 28, 2023. If finalized, entities would adopt utilizing a modified retrospective application to the beginning of the fiscal year that ASU 2016-13 was adopted and applicable to all entities subject to ASU 2016-13 (including public business entities/SEC filers).
Under current guidance, there are two models for loans purchased in a business combination or an asset acquisition. These methods and current treatments are described below. The two acquisition accounting approaches outlined below create unnecessary complexity and reduce comparability. More specifically, the accounting treatment of non-PCD assets has been described by stakeholders as unintuitive because a loss is recorded upon the acquisition, whereas no loss is recorded upon the acquisition of PCD assets.
Purchased Credit Deteriorated (PCD) Assets Current Treatment
PCD assets have experienced a “more-than-insignificant” deterioration in credit quality since origination based on an assessment by the acquirer as of the acquisition date. This assessment is highly subjective, as Topic 326 does not define the threshold “more-than-insignificant”; however, the FASB clarified as part of ASU 2016-13 that its intent was a broad population of financial assets beyond only nonaccrual loans or other impaired assets should be considered for PCD asset treatment.
Under the PCD model, an Allowance for Credit Losses (ACL) is recorded, with the offsetting debit being an addition to the assets amortized cost balance. The initial balance of PCD is equal to the purchase price plus the ACL; consequently, this accounting treatment is referred to as the “gross-up approach”.
When differences between the amortized cost and the par value exist, the balance is accreted or amortized to interest income. However, the balance recorded for the initial ACL or the “gross-up balance” is excluded from interest income.
Non-PCD Assets Current Treatment
For non-PCD assets, the initial amortized cost balance equals the purchase price. An initial ACL and credit loss expense is recorded for these assets during the period acquired. Any purchase premium or discount is subsequently amortized or accreted to interest income.
Proposed Changes to Current Accounting Treatment
Financial assets acquired through a business combination will no longer require determination of whether an acquired financial asset is a PCD or non-PCD asset upon acquisition and would be known as purchased financial assets. The “gross-up” approach would be used for all financial assets that are acquired during a business combination.
Financial assets recognized through an asset acquisition or the consolidation of a VIE that is not a business need to meet the following criteria to be considered a purchased financial asset:
- The financial asset was acquired more than 90 days after its origination date and the acquirer did not have involvement with the origination of the asset.
Additionally, when assessing a group of financial assets, substantially all of the assets must have been acquired more than 90 days after origination to conclude on whether a group of financial assets should be accounted for as purchased financial assets or originated financial assets.
How does this impact the financial institutions we serve?
During a business combination, the accounting is simplified as all financial assets will be accounted for using the “gross-up” approach.
Regarding asset acquisitions, institutions will be required to determine whether purchased loans or loan pools qualify as originated loans or acquired financial assets based upon whether the origination date was within 90 days of the acquisition date.
If you have any questions or are interested in learning more about this topic, we’re here to help. Please do not hesitate to reach out to our trusted experts today. You can read the update in it’s entirety here.