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FASB sticking with plan to revise tricky accounting for purchased financial assets

Despite pushback from some firms, the FASB on Feb. 28, 2024, voted to move ahead with its plan to revise the accounting for purchased financial assets — a tricky area in the current expected credit losses (CECL) standard that the board recently proposed to fix.

The board said that those who would be most impacted by the guidance favor a change that would allow all purchased financial assets (PFA) to follow one approach. Notable is that both investment analysts and accountants want today’s rules changed, according to the discussions.

“While it happens occasionally, it doesn’t happen regularly that we hear from investors and preparers aligned on an issue – and this one clearly meets those criteria,” Chair Richard Jones observed. “I recognize that there are some preparers that are less apt to have been in business combinations and maybe they have more scope issues versus disagreeing with the economics of the outcome of what PFA accounting would do and I understand that and I would separate that and I think that’s something we can deal with in scope,” he said.

The decision relates to Proposed Accounting Standards Update (ASU) No. 2023-ED400, Financial Instruments—Credit Losses (Topic 326) Purchased Financial Assets, which was issued for public comment last year to expand the purchased credit deteriorated (PCD) model to include high-quality loans. This would result in all loans being accounted for the same way under a new term “purchased financial assets” (PFA). If the changes come, the current non-PCD model, which is deemed to be unintuitive and causes banks to double count losses, will be eliminated.

Board votes 6 to 1 for “gross-up approach”

Board members argued that amid the 35 comment letters to the proposal, there is enough support from preparers and users jointly for the changes, stressing that a good case was made for making new rules.

In light of that, the board agreed – by 6 to 1 – that staff should research and analyze the “gross-up approach” that was proposed for all PFAs. The “gross-up approach” requires acquired financial assets to be measured by adding the allowance for credit losses as of the acquisition date to the purchase price to calculate the amortized cost basis. Any remaining noncredit premium or discount is subsequently amortized or accreted to interest income using the interest method.

Jones, Vice Chair James Kroeker, board members Susan Cosper, Marsha Hunt, and Frederick Cannon, were in agreement with pursuing the “gross-up approach” for all PFAs, believing that this would be the best solution to a complex matter that was solvable. Board member Joyce Joseph said she would not object to the majority view but would have preferred to limit the “gross-up approach” to all loans acquired in a business combination. Board member Christine Botosan, who had dissented to the proposal, favored keeping current rules while instead improving the disclosure requirements.

“I’ve struggled with this particular proposal because I fundamentally don’t see a difference in the economics between an originated loan and an acquired loan,” said Botosan. “In both cases, an entity is going to get compensation for bearing credit risk and then they are going to have losses due to that credit risk,” she said, among other remarks.

At a future meeting, FASB staff will provide the board with an analysis and alternatives for several recognition and measurement elements of the “gross-up approach” that should be considered before it is applied more broadly.

Comment letters offered mixed views

As proposed, the rules would require loans that are purchased in a business combination to apply what is currently the PCD model, and renamed “purchased financial assets.” For loans that are purchased as assets there will be a seasoning criteria utilizing a bright line of 90 days or a principle. Those that meet that seasoning criteria will apply what is today known as the PCD model and those that do not meet the seasoning criteria will continue in the origination model under CECL.

The changes are aimed at providing investors with better information as the distinction between PCD and non-PCD assets is not well understood. This would also help accountants as they would no longer be required to qualitatively assess the change in credit quality of acquired financial assets since origination, the board has said in past discussions.

But the dozens of comment letters that came from banks, trade organizations, accounting firms and others, submitted mixed views, including from dissenting accounting chiefs from regulatory bodies who don’t want the CECL standard changed at this stage as companies are still in the process of adopting the rules.

There was no clear consensus, according to a staff analysis to the board.

“Some respondents generally supported the proposal; some the spirit and intent of the update but not the results of the practical application; and some indicated conditional support provided that certain practical expedients or scope exceptions for applying the gross-up approach are included in the final update,” the staff member said. “Some opposed the proposal, questioning the expected benefits relative to the cost borne by preparers, or they conceptually challenged the differentiation of accounting for originated versus acquired loans – and not necessarily specific to what was being introduced by the proposal.”

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