ASC 310-10-35: Accounting for Impaired Receivables

Accounting guidance under ASC 310-10-35 provides a framework for the subsequent measurement of receivables, focusing on impairment. The core principle is the “incurred loss” model, which dictates that a loss is recognized only when it is probable that a creditor will be unable to collect all amounts due according to the contractual terms.

This guidance has been replaced by Accounting Standards Update (ASU) 2016-13, which introduced the Current Expected Credit Losses (CECL) model under ASC 326. The CECL standard is now the effective Generally Accepted Accounting Principle (GAAP) for all entities. Understanding the former ASC 310-10-35 guidance is useful for historical financial statement analysis and for understanding the evolution of credit loss accounting.

Identifying Impaired Receivables

The guidance in ASC 310-10-35 applies to a range of financing receivables, most commonly loans, notes receivable, and lease receivables that are measured at amortized cost. It does not apply to receivables measured at fair value or to certain other specialized instruments. “Probable” in this context means the future event or events are likely to occur.

Several events can signal that a receivable’s impairment is probable. These indicators include the debtor filing for bankruptcy, a history of significant payment defaults, or a modification of the debt terms granted to a borrower experiencing financial difficulty. Other signs might involve a notable deterioration in the debtor’s financial condition, a decline in the value of underlying collateral, or adverse changes in the business or economic environment in which the debtor operates.

Receivables can be evaluated for impairment either individually or on a collective basis. Large, individually significant loans are assessed one by one. When a specific loan shows signs of impairment, its specific loss is calculated. Smaller-balance, homogeneous loans, such as credit card balances or certain consumer loans, are grouped based on similar risk characteristics, like loan type or past-due status. Impairment for these pools is then estimated collectively based on historical loss experience for assets with similar traits.

Methods for Measuring Impairment

Once a receivable is identified as impaired, a creditor must measure the amount of the loss. ASC 310-10-35 provides three distinct methods for this calculation. The goal is to determine the difference between the recorded investment in the loan and the amount the creditor expects to recover.

Present Value of Expected Future Cash Flows

One method involves calculating the present value of the cash flows the creditor expects to collect in the future. These estimated cash flows are then discounted at the loan’s original effective interest rate. The impairment loss is the amount by which the loan’s recorded investment exceeds this calculated present value.

Observable Market Price

A creditor may also measure impairment by referring to the observable market price of the impaired loan. This method is practical if an active, observable market for the specific loan or a highly similar loan exists. For many individual commercial or consumer loans, a direct market price is not readily available, making this method less common.

Fair Value of Collateral

When a loan is considered collateral-dependent, impairment is measured based on the fair value of the underlying collateral. To apply this method, a current appraisal of the collateral’s fair value is obtained. This value is then reduced by any estimated costs to sell or liquidate the property. For example, if a loan has a recorded investment of $500,000 and is secured by property with a fair value of $450,000, with estimated selling costs of $25,000, the impairment loss would be $75,000.

Accounting for Impairment Losses

After calculating the impairment amount using one of the prescribed methods, the loss must be formally recorded in the financial statements. The entry involves debiting an expense account and crediting a contra-asset account, which properly reflects the reduction in the receivable’s value without writing it off directly.

The standard journal entry to recognize an impairment loss is a debit to Bad Debt Expense and a credit to the Allowance for Doubtful Accounts. The Bad Debt Expense appears on the income statement, reducing the company’s net income. The Allowance for Doubtful Accounts is a contra-asset account that is presented on the balance sheet as a reduction from the gross amount of receivables. This presentation shows the net carrying value, or the amount the company realistically expects to collect.

If, in a subsequent period, the estimated amount of the impairment loss changes, the allowance account is adjusted accordingly. An increase in the estimated loss would result in an additional debit to Bad Debt Expense and a credit to the allowance. Conversely, if the outlook for collection improves, the entry would be reversed with a debit to the Allowance for Doubtful Accounts and a credit to Bad Debt Expense.

Financial Statement Disclosures

To provide financial statement users with a clear understanding of a company’s exposure to credit losses from impaired loans, ASC 310-10-35 mandates several specific disclosures in the footnotes. These disclosures offer transparency into the company’s portfolio of impaired receivables and its policies for managing them.

Disclosures include the total recorded investment in impaired loans and the corresponding amount of the allowance for credit losses related to those loans. Companies must also disclose their policy for recognizing interest income on impaired loans, including how cash receipts are applied. This is important because interest income recognition on impaired loans often ceases or is applied on a cash basis.

Companies are required to disclose the average recorded investment in impaired loans during the reporting period. For each class of financing receivable, information must be provided about loans individually evaluated for impairment.