ASU 2019-04: Key Amendments and Clarifications
Understand ASU 2019-04, a set of Codification Improvements from FASB that provides targeted clarifications and technical corrections to existing standards.
The Financial Accounting Standards Board (FASB) issues Accounting Standards Updates (ASUs) to clarify U.S. Generally Accepted Accounting Principles (GAAP). ASU 2019-04 is not a new foundational standard, but a set of “Codification Improvements” meant to address questions from the implementation of several major standards.
This update provides targeted amendments to enhance clarity and promote the consistent application of existing guidance. The changes are incremental improvements rather than wholesale revisions, intended to smooth the application of the underlying standards for entities within their scope.
Clarifications for Credit Losses
A significant portion of ASU 2019-04 is dedicated to refining ASC Topic 326, which introduced the current expected credit loss (CECL) model. The update provides several clarifications:
- It provides an option to measure the allowance for credit losses on accrued interest receivables separately from the amortized cost basis of the financial asset to which it relates, addressing operational difficulties.
- For financial assets transferred between measurement categories, any existing allowance for credit losses should be reversed through earnings. The asset is then recorded in the new category at its amortized cost, and a new allowance is established based on the principles applicable to that new classification.
- An entity’s estimate of its allowance for credit losses should include expected recoveries of amounts it has already charged off. The amount of expected recoveries recognized, however, cannot exceed the total of amounts previously written off and those expected to be written off.
- For purchased financial assets with credit deterioration (PCD assets), it clarifies that while a discounted cash flow (DCF) method is one way to estimate the allowance, it is not the only permissible method, allowing for other reasonable techniques.
- It explicitly brings reinsurance recoverables within the scope of Topic 326, clarifying that an entity must estimate an allowance for expected credit losses on amounts it expects to recover from reinsurance companies.
Amendments for Derivatives and Hedging
ASU 2019-04 introduced amendments to ASC Topic 815, which governs the accounting for derivatives and hedging activities. These changes were designed to resolve specific implementation questions and better align accounting with an entity’s risk management strategies.
One amendment clarifies that an entity is permitted to hedge only a portion of the term of a financial instrument. When hedging the interest rate risk of a debt security for a period shorter than its full term, the change in the hedged item’s fair value can be measured using an assumed term that matches the hedging derivative.
The guidance also expands on what can be designated as a “contractually specified component” for hedging purposes. The amendments provide clearer criteria for identifying a contractually specified interest rate, such as the Secured Overnight Financing Rate (SOFR), within a financial instrument, making it eligible for hedge accounting.
A clarification was provided for entities hedging portfolios of mortgage-backed securities issued and guaranteed by Ginnie Mae. The update allows these entities to apply the “last-of-layer” method, which permits hedging a portion of a portfolio without considering prepayment risk when assessing hedge effectiveness.
Updates for Financial Instruments
The amendments to ASC Topic 825, Financial Instruments, are more narrowly focused, centering on disclosure requirements. The changes provide relief from certain fair value disclosures for financial instruments that are not measured at fair value on the balance sheet.
This clarification addresses a scenario where an entity has financial instruments not carried at fair value, but for which fair value disclosures would typically be required. If these instruments are subject to the fair value option under other guidance, the entity is not required to provide these specific disclosures, reducing the disclosure burden.
Effective Dates and Transition Guidance
The implementation timeline for ASU 2019-04 is staggered, with effective dates varying based on the specific amendment and the type of entity. For the amendments related to credit losses under Topic 326, entities are required to adopt them at the same time they adopt the broader CECL standard.
The amendments concerning derivatives and hedging under Topic 815 generally followed the effective dates of ASU 2017-12. For public business entities, these changes were effective for fiscal years beginning after December 15, 2018, and for all other entities, the effective date was for fiscal years beginning after December 15, 2019.
Transition methods also differ depending on the amendment. For the credit loss clarifications, the transition is tied to the entity’s chosen method for adopting Topic 326. For the hedging amendments, the transition requirements are specific to each change, with some applied prospectively and others requiring a cumulative-effect adjustment to the opening balance of retained earnings.