ASC 942: Accounting for Depository and Lending Institutions

Accounting for financial institutions involves specialized rules to address their unique operations. The Financial Accounting Standards Board (FASB) provides this guidance through Accounting Standards Codification (ASC) 942, Financial Services—Depository and Lending. This standard offers a framework for entities whose primary business involves accepting deposits and providing loans. The guidance in ASC 942 is not standalone; it provides incremental, industry-specific instructions, and institutions must also adhere to other applicable accounting standards.

Scope and Applicability

The guidance in ASC 942 applies to commercial banks, savings and loan associations, and credit unions. The standard also extends to bank holding companies, finance companies, and certain branches of foreign banks regulated by U.S. banking agencies.

A specialized accounting standard is necessary because the core operations of these institutions differ from other companies. Their balance sheets are dominated by financial instruments like loans and deposits, which have unique risk and revenue characteristics. ASC 942 provides a consistent method for recognizing and measuring these items, which helps regulators monitor the financial system and allows investors to compare institutions.

Accounting for Loans and Related Fees

The accounting for loans involves specific treatment for the fees and costs associated with their creation. Loan origination fees paid by the borrower are not recognized immediately as income. Similarly, direct loan origination costs, such as those for evaluating the borrower’s financial condition and preparing documents, are not expensed as incurred.

Instead, these fees and costs are netted against each other, and the resulting net amount is deferred. This deferred net fee or cost is then amortized over the life of the loan as an adjustment to its yield using the interest method. This process results in a constant effective yield over the loan’s term. For example, a net deferred fee will increase the interest income recognized each period, while a net deferred cost will decrease it.

The amortization period is the contractual life of the loan. However, if an institution anticipates that a portfolio of similar loans will be paid off earlier than their contractual maturity, it must use a shorter, estimated life to amortize the net deferred fees or costs.

Accounting for Deposit Liabilities

Deposit liabilities are a primary source of funds and are recorded when a deposit is received from a customer, not when the funds have been collected. This means that checks in the process of collection, or “deposit float,” are recorded as both an asset and a liability. Deposit accounts include demand deposits (checking accounts), savings accounts, and time deposits (certificates of deposit).

The interest accrued on these deposits is recognized as an expense. For credit unions, member share accounts are also treated as liabilities. A unique aspect of deposit accounting is that the fair value option cannot be elected for demand deposit liabilities. When estimating the fair value of deposit liabilities for disclosure, an institution is also prohibited from including the value of its relationships with depositors, known as core deposit intangibles.

If a deposit account becomes overdrawn, it is reclassified from a deposit liability to a loan. The overdrawn amount must then be evaluated for collectibility like any other loan in the institution’s portfolio.

Special Considerations for Acquired Assets and Foreclosures

Institutions sometimes acquire assets through foreclosure when a borrower defaults. These assets, known as Other Real Estate Owned (OREO), are reclassified from loans once the institution obtains legal title or physical possession. Upon acquisition, the foreclosed asset is recorded at its fair value less estimated costs to sell, which establishes its new cost basis. Any difference between this new basis and the recorded investment in the loan is charged against the allowance for credit losses.

While held, the asset must be carried at the lower of its cost basis or its fair value less costs to sell. If the fair value declines, the institution must recognize a write-down. Subsequent increases in value can be recognized, but only up to the original cost basis. Costs to maintain the property are expensed, while costs that significantly improve its value can be capitalized.

When the institution sells the OREO, a gain or loss is recognized if the transaction meets the criteria for derecognition. If the sale involves seller financing, the institution must assess if a sale has occurred. If not, payments received may be recorded as a deposit liability until the conditions are met.

Financial Statement Presentation and Disclosures

Under ASC 942, institutions are not required to present a classified balance sheet that separates current and noncurrent items. The balance sheet should present deposits held in other banks as a separate line item. Investments in Federal Home Loan Bank or Federal Reserve Bank stock are also shown separately in other assets.

The notes to the financial statements must provide detailed disclosures. For loans, institutions must disclose significant categories like commercial, real estate, and consumer loans. They must also provide information about their allowance for credit losses, including a reconciliation of its balances, and details on nonaccrual and past-due loans.

For deposit liabilities, disclosures include the amount of time deposits exceeding the FDIC insurance limit and any assets pledged as collateral. For investment securities, disclosures are required by major security type. Public companies must also disclose the fair value of debt securities across four maturity groupings:

• Within one year
• One to five years
• Five to ten years
• After ten years