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FASB makes changes to PCD accounting under CECL

Abrigo
October 12, 2022
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FASB announces tentative CECL decision

FASB examined CECL accounting problems and decided to amend PCD accounting rules at a recent meeting.

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PCD to PFA

FASB decides on CECL asset classification

On October 12, FASB made a tentative decision to rename the Purchased Credit Deteriorated (PCD) accounting treatment to Purchased Financial Assets (PFA), eliminating the distinction between PCD and non-PCD financial assets in certain purchase transactions and making the purchase decision process less cumbersome.

The CECL standard requires the acquirer of financial assets to determine if there has been any significant deterioration in credit from origination. Originally, assets were classified as purchased with credit deterioration (PCD) or non-PCD. But this requirement proved to be challenging for financial institutions.

One dilemma was the infamous “double count,” which results in a provision expense in the first period post-acquisition to fund the allowance on non-PCD assets that are already at fair value. In addition, the accounting on non-PCD assets also distorts interest income because the credit portion of fair value marks is being accreted into interest income as a non-cash, non-core interest income, creating a need for non-GAAP measures to understand the underlying economics.

FASB topics

Five tentative board decisions

To minimize these accounting problems, the FASB decided that PCD accounting should be expanded to a broader population of acquired assets. Five topics were discussed in this recent meeting, and the following tentative decisions were made:

1. Amending the terminology

Amending the terminology from PCD to Purchased Financial Assets (PFA) provides clarity to financial statement preparers and users, as credit quality is no longer a consideration in the ongoing purchase accounting.

2. Defining the seasoning period

The FASB decided on a principles-based approach to labeling assets that considers the acquirer’s involvement prior to the acquisition with a bright-line period of 90 days.

This approach identifies whether an acquired financial asset is an “in-substance origination” or is “seasoned.” Purchased assets determined not to be seasoned would be accounted for in the same manner as non-PCD assets are today under CECL. The new PFA model would specifically make changes in accounting for seasoned assets.

All assets acquired in a business combination would receive PFA treatment automatically. Financial assets acquired in a business combination would also be presumed seasoned, meaning that all assets in a business combination would have a CECL allowance applied at purchase through the purchase accounting journal entry. Defining a seasoning period means far more assets will be under the seasoned PFA model, and the risk of double counting on non-PCD assets would be reduced significantly.

3. PFA active revolving privileges 

Credit cards, home equity lines of credit, and other revolving arrangements with active borrowing privileges would be included within the scope of the PFA model when acquired through both business combinations and asset acquisitions.

4. Trade accounts receivable

Trade accounts receivable would be included within the scope of the PFA model. As with revolving arrangements, the FASB decided that operational concerns do not outweigh the “bad” accounting that accompanies the double count issue currently present in PCD accounting.

5. Assets not recognized at fair value

Assets not recognized at fair value in a business combination (mainly contract assets and a lessor’s net investment in leases) should be included within the scope of the PFA model. Much like the last two items, the consensus was that it would be preferable to use a single model foa all seasoned assets receiving PFA treatment.

Next steps

FASB's CECL timeline

While it is unlikely that this improvement will be made prior to the final cohort of CECL adopters getting on board with the standard in January 2023, these tentative decisions move the Board one step closer to the elimination of the PCD label. Regardless of the timing of the final decision, purchase accounting will still require significantly more effort than in the past under CECL, because a CECL allowance is calculated either at or immediately after purchase for all purchased assets.

In conclusion, the changes will have a significant positive impact on business combinations but only a minor impact on other asset purchases. The new PFA accounting continues to require a CECL allowance on all assets purchased and will need to be adjusted monthly, like all other financial assets, based on credit risk changes. Financial institutions must have the correct credit risk calculated at purchase to ensure proper accounting.

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About the Author

Abrigo

Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo’s platform centralizes the institution’s data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth. Make Big Things Happen.

Full Bio

About Abrigo

Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

Make Big Things Happen.