FASB’s Purchased Financial Assets Project Update

On October 2, 2024, FASB began deliberations on its 2023 purchased financial assets proposal, focusing on the scope of assets subject to the gross-up model and related measurement and recognition. FASB reached consensus on loan commitments, contract assets/lease receivables, and trade accounts receivables. Additional meetings are needed to review seasoning criteria and transition. All decisions are subject to change until a final standard is issued, which is not expected before year-end.

Background

Accounting Standards Update (ASU) 2016-13 updated the definition and accounting treatment for purchased credit impaired assets, rechristened them as purchased credit deteriorated (PCD) assets, and updated Accounting Standards Codification (ASC) 805, Business Combinations, to require the recognition of an allowance for credit losses in the period of acquisition for both PCD and non-PCD assets. The determination of PCD versus non-PCD determines how the allowance for credit loss flows through the financial statements. For PCD assets, the gross-up method includes the impact in the day 1 business combination entries with no impact to expense. For non-PCD assets, the impact is reflected outside of business combination entries (day 2) and hits expense (double count of credit). FASB’s decisions on PCD accounting were one of the most debated deliberations of the standard-setting process. FASB received feedback that in determining if acquired financial assets qualify or do not qualify for PCD accounting, treatment remains complex, and the credit discount on non-PCD loans is viewed as double counted upon acquisition.

To address these concerns, FASB issued an exposure draft in June 2023 which had the following provisions:

Expand the population of acquired financial assets subject to ASC 326’s “gross-up” approach currently applied to PCD assets.
Eliminate the day-one credit loss expense.
Eliminate the use of “gross-up” method for available-for-sale (AFS) debt securities.

Feedback was mixed. Investors and some auditors were supportive, but preparers and other auditors raised concerns on the following areas, which FASB has agreed to redeliberate:

Expanded scope was operationally challenging for certain financial assets like credit cards.
Recognition and measurement challenges for some items covered by the expanded scope.
Seasoning criteria; use of qualitative guidance rather than the 90-day rule.
Prospective application with early adoption permitted is preferred, compared to the proposed retrospective application

Scope

The 2023 proposal would have expanded scope to a variety of financial assets, including credit cards, HELOCs, revolving arrangements, lessor’s net investment in sales-type and direct financing leases, and contract assets. Comment letter feedback raised significant operational and cost challenges of applying gross-up accounting for some of these asset classes. Staff presented the board with multiple alternatives for each of the asset classes below. Some items will require additional research as a consensus could not be reached.

PCD Assets
(326-20-30-13)

Allowance added to the purchase price to determine the initial amortized cost basis
Gross-up
No provision expense

Non-PCD Assets/Originated Financial Assets
(326-20-30-15, 805-20-30-4A)

Allowance accounted for in a manner consistent with originated assets
Not permitted to net any purchase discount with the allowance
Provision expense recorded

Credit Cards & Other Revolvers

Stakeholders were concerned about the operational and reporting implications of applying a gross-up approach. Feedback was primarily related to credit cards, but the board discussed similar instruments like consumer and commercial revolvers. Current industry practice indicates entities convert outstanding balances on credit card debt into a term loan and suspends active revolving privileges when a borrower is having financial difficulty. The loan is tracked separately for loan modification disclosures. GAAP currently does not define revolver or active borrowing privileges.

No consensus was reached, and staff was directed to get additional information on consumer revolving loans.

AFS Securities

The 2023 proposal excluded AFS debt securities from the gross-up approach. Stakeholders noted that interest income could be recognized for amounts not expected to be collected when a significant purchase discount is primarily attributable to collectability.

The board was divided between two possible approaches. The first approach would be to include credit-impaired AFS securities and beneficial interests subject to ASC 325-40 within the scope of the gross-up approach by retaining current GAAP in ASC 326-30. The second approach would be to amend the interest income recognition guidance for credit-impaired AFS securities subject to ASC 326-30 to accrete expected cash flow.

Held-to-Maturity (HTM) Debt Securities

Stakeholders wanted additional guidance and clarification for the proposal to be operably for HTM securities.

The board was divided between two possible approaches. The first would include HTM debt securities that are not beneficial interest in the scope of the gross-up approach and reconsider the seasoning criteria, i.e., assume that all purchased HTM securities are seasoned. The second would exclude HTM debt securities from the gross-up approach.

Loan Commitments & Forward Contracts to Purchase Financial Assets

Stakeholders sought additional clarity on how a gross-up approach would be applied to off-balance-sheet credit exposures such as loan commitments, forward contracts to purchase financial assets and agreements to extend credit, and the related acquisition accounting. Staff noted that was currently the diversity in practice today.

FASB reached a consensus to include off-balance-sheet credit exposures within the scope of the gross-up approach and recognize the credit loss in other comprehensive income. This change may require re-exposure; if so, the board may consider spinning this off into a separate project to let the other changes move more quickly to a final standard.

Contracts Assets & Lease Receivables

For contract assets and lease receivables, a fair value measurement exception in ASC 805 requires that an acquirer initially recognize and measure those assets as if originated using the guidance in ASC 842, Leases, and ASC 606, Revenue from Contracts with Customers, respectively. Stakeholders questioned the benefits of applying the gross-up approach to acquired assets initially measured at cost and that additional guidance would be needed to operationalize.

FASB reached consensus to exclude contract assets and lease receivables from scope and clarify that any initial allowance for credit losses be recognized through the income statement.

Trade Account Receivables

Stakeholders question the proposal’s benefits, given the cost of applying the gross-up approach to short-term trade receivables that generally do not have material credit loss allowances.

FASB voted unanimously to exclude trade accounts receivables from scope.

Conclusion

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