AFS debt securities under 326-30 and purchased credit-deteriorated assets

In this lesson you will

Separate the credit and noncredit components of an AFS security decline
Apply the fair value floor on the AFS allowance in 326-30-35-2
Account for an AFS security the entity intends to sell
Measure the initial amortized cost of a PCD asset or purchased seasoned loan using the gross-up approach

AFS debt securities are not CECL

Available-for-sale debt securities are excluded from 326-20 and follow Subtopic 326-30. The model is security by security, triggered by impairment, and limited by fair value.

An investment is impaired if its fair value is less than its amortized cost basis (326-30-35-1). For an impaired AFS security, the entity determines whether the decline results from a credit loss or other factors such as interest rates (326-30-35-2). To test for a credit loss, compare the present value of cash flows expected to be collected with the amortized cost basis (326-30-35-6). Factors include the extent of the decline below amortized cost, adverse conditions for the issuer or industry, rating changes and payment failures.

The fair value floor

The credit loss is recorded through an allowance, but the allowance is limited to the amount by which fair value is below amortized cost (326-30-35-2 and 35-3). The rest of the decline goes to other comprehensive income, net of tax. Changes in the allowance are credit loss expense or reversals in the period.

A general allowance for unidentified impairment across a portfolio of securities is not appropriate. The assessment is at the individual security level (326-30-35-4).

Intent or requirement to sell

If the entity intends to sell the security, or more likely than not will be required to sell it before recovering amortized cost, it writes off any allowance and writes amortized cost down to fair value, with the incremental impairment in earnings (326-30-35-10). The entity looks at cash needs, working capital, and contractual or regulatory obligations to assess whether a sale will be required.

Purchased credit-deteriorated assets

PCD assets are acquired financial assets that, as of acquisition, have experienced a more-than-insignificant deterioration in credit quality since origination. They arise in loan purchases and business combinations.

The accounting uses a gross-up (326-20-30-13). The entity measures the allowance at acquisition using the normal 326-20 principles and adds it to the purchase price to determine the initial amortized cost basis. No credit loss expense is recorded on day one. Any remaining noncredit discount or premium is allocated to each asset and accreted into interest income.

If the entity uses a discounted cash flow method, it discounts expected credit losses at the rate that equates the present value of the purchaser's expected cash flows with the purchase price. With another method, it estimates losses on the unpaid principal balance (326-20-30-14).

Purchased assets without a more-than-insignificant deterioration (and, once ASU 2025-08 applies, that are not purchased seasoned loans) are treated like originated assets: the day-one allowance goes through credit loss expense (326-20-30-15).

After acquisition, changes in the PCD allowance are credit loss expense or reversals, like any other asset.

ASU 2025-08: purchased seasoned loans

ASU 2025-08, issued November 2025, extends the gross-up to purchased seasoned loans. A non-PCD loan is seasoned if it is obtained in a business combination, or if it is obtained in another transfer (or through consolidating a variable interest entity that is not a business) more than 90 days after origination by a transferee that was not involved in the origination (326-20-30-16). Credit cards, debt securities and Topic 606 trade receivables are excluded (326-20-30-19). The amendments apply to all entities for annual periods beginning after December 15, 2026, prospectively to loans acquired on or after adoption, with early adoption permitted. For a calendar-year entity, 2027 acquisitions are the first under the new rule unless it adopts early.

Audit points

For AFS: obtain fair values from an independent pricing source, test the credit loss analysis for securities in an unrealized loss position, and confirm management's intent and ability to hold.
For PCD: test the deterioration threshold and the allocation of the purchase price between allowance and noncredit discount. The AFS credit loss calculator and the debt securities guide walk through the mechanics.

Worked example

An impaired bond and a loan purchase at Northgate Mutual Holdings, Inc.

AFS bond: Northgate Mutual Holdings, Inc. holds a corporate bond classified as AFS with amortized cost of $1,000,000 and fair value of $930,000 at year-end. The issuer was downgraded. The present value of expected cash flows at the bond's effective rate is $960,000. Northgate does not intend to sell and is not more likely than not required to sell.

Credit loss: $1,000,000 - $960,000 = $40,000, within the $70,000 fair value floor. Allowance $40,000 to earnings; remaining $30,000 to OCI before tax. If the present value had been $900,000, the credit loss of $100,000 would be capped at $70,000, with nothing in OCI.

PCD loans: Northgate buys a pool of loans with unpaid principal of $1,000,000 for $850,000. The loans have deteriorated since origination. Using a loss-rate method on unpaid principal, expected credit losses are $90,000.

Amortized cost: $850,000 + $90,000 = $940,000. Allowance $90,000. Noncredit discount $60,000 ($1,000,000 - $940,000), accreted to interest income.

Conclusion: no day-one credit loss expense on the PCD pool; the AFS bond produces $40,000 of credit loss expense.

Self-check

Answer each question before you open the answer.

What limits the allowance on an AFS debt security?
Show answer
The amount by which fair value is below amortized cost basis (326-30-35-2 and 35-3).
An entity decides to sell an impaired AFS security. How is the loss recorded?
Show answer
Any allowance is written off and amortized cost is written down to fair value, with the incremental impairment in earnings (326-30-35-10).
After adopting ASU 2025-08, a bank buys a pool of performing auto loans from an unrelated lender 120 days after origination. The bank had no purchase commitment with the seller, no exposure to the loans within 90 days of origination and no role in underwriting. Is there day-one credit loss expense?
Show answer
No. The loans are not PCD, but they were obtained more than 90 days after origination by a transferee not involved in the origination, so they are purchased seasoned loans and use the gross-up approach (326-20-30-16 and 30-17).
Is there credit loss expense on day one for a PCD asset?
Show answer
No. The initial allowance is added to the purchase price to determine amortized cost (326-20-30-13). Later changes in the allowance go through credit loss expense.

Sources

Back to the syllabus

Standards are paraphrased from the primary sources listed above; read the source before relying on a requirement. This lesson is training material, not professional advice. Report an error