In March 2017, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2017-08, ”Receivables — Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” While not as broad in scope as some of the other pending guidance issued by the FASB, the amendments in this ASU are important and will impact financial institutions as well as businesses in other industries that hold callable debt securities in their investment portfolios.
As a result of this newly issued guidance, the accounting yield on individual callable debt securities purchased at a premium will more effectively parallel the front-end yield analysis conducted by businesses and their investment advisors, which has traditionally centered on the yield-to-call rather than the yield-to-maturity for these types of securities. Rather than deferring the expense recognition associated with unamortized premiums when a particular security is called, ASU 2017-08 modifies the existing guidance which, in most situations, requires premiums on debt securities to be amortized to maturity. Under the new guidance, premiums for all qualifying callable debt securities may be amortized to the earliest call date and instruments with multiple call dates are also addressed. Qualifying securities include those which are callable at fixed prices on preset dates and have explicit, noncontingent call features. Discounts on all purchased callable debt securities will continue to be accreted to maturity.
While these changes will not significantly impact the evaluation of a debt security at the time of purchase or change an entity’s cumulative operating results over the life cycle of a security, the FASB has taken sensible steps to converge the accounting for these callable debt securities with their market pricing evaluations and certain ideologies present in other areas of U.S. Generally Accepted Accounting Principles (U.S. GAAP). Prior to the adoption of this ASU, business entities have been afforded a narrow exception in estimating prepayments under current U.S. GAAP. This exception allowed entities to estimate prepayments only when holding a large number of similar instruments. Practical changes brought about by this ASU will modify the current standards to allow a significantly greater number of business entities to assume prepayments in the determination of their accounting yields as well as effectively eliminate concerns over the recordation of too much interest income prior to a security’s call date and the practice of deferring a loss associated with the recognition of an unamortized premium on the call date. In summary, the update will allow for greater synchronization of accounting records and the underlying features of certain investments purchased at a premium.
Public business entities operating on a calendar year are required to adopt the provisions of ASU 2017-08 for interim and annual reporting periods beginning with the first calendar quarter of 2019. All other entities operating on a calendar year are required to apply the guidance to annual periods beginning in 2020 and interim periods beginning with the first calendar quarter of 2021. Early adoption is permitted for all entities, including adoption within an interim period. Upon transition, entities should apply the guidance on a modified retrospective basis, with a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption and provide the disclosures required for a change in accounting principle.
Please contact a member of the YHB Community Banking team for questions you may have in regard to the implementation of this update or the impact of its early adoption.
About the Author
Brandon is an audit leader for the bank team. He regularly prepares audit and accounting updates for the team. Brandon has worked exclusively for the bank team since graduating from Virginia Tech performing external audits, internal audits, bank tax services and SOX consulting.