What Investment Funds Need to Know About Current Expected Credit Loss
Current Expected Credit Loss (CECL) Overview
When Accounting Standards Update (ASU) 2016-03, Topic 326, Financial Instruments—Credit Losses, was released in 2016, the scope included available-for-sale (AFS) securities and other investments held at amortized cost. The amendments updated the accounting for these investments by changing the way the fair value adjustment is recorded. Instead of the fair value mark to market being recorded through an unrealized gain (loss) in equity, the fair value adjustment after the effective date should be recorded as an allowance.
Investment Fund Considerations
The ASU didn’t explicitly include a scope exception for entities applying fair value accounting through ASC 946, Financial Services—Investment Companies. However, these entities can arrive at that conclusion if the investment’s mark to market is recorded directly through the income statement, which is a scope exception included in the update. By recording the investment’s fair value adjustment directly through the income statement, it would be considered incorrect to include an allowance on the adjustment, since the loss is recorded in the year it occurs. The value of the investment on the balance sheet should be the value at which the entity could trade the security on the open market. Investment funds aren’t subject to CECL solely because the fund manager holds AFS securities that are scoped into the standard. The investment fund should be evaluated as a separate entity, and the appropriate GAAP should be applied based on each entity’s circumstances.
For example, consider the following related-party structure. A corporate entity holding AFS securities currently records the fair value or mark to market change through accumulated other comprehensive income and determines the AFS securities are within the scope of ASU 2016-03. The corporate entity also acts as a fund manager for which it receives management fees from the fund. The fund holds identical AFS securities as the corporate entity. Although the corporate entity has determined its AFS investments are subject to CECL, the fund should be evaluated as a separate entity subject to ASC 946. The current change in fair market value is recorded directly to the income statement for the fund’s investments; therefore, CECL isn’t applicable to the AFS securities held by the fund.
Entities following ASC 946 accounting will need to evaluate the nature of their investments to determine if ASU 2016-03 is applicable. Furthermore, a scope exception can’t automatically be assumed.
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