ASC 326 Financial Instruments - Credit Losses: Expected Credit Losses Transaction Explained with Journal Entries

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The ASC 326 standard, introduced by the Financial Accounting Standards Board (FASB), has significantly impacted the accounting for credit losses on financial instruments. One critical aspect of ASC 326 is the concept of expected credit losses, which requires organizations to estimate and recognize lifetime credit losses on financial assets. In this article, we will provide an overview of expected credit losses transactions under ASC 326 and illustrate how journal entries can be used to account for them.

 

Expected Credit Losses under ASC 326

ASC 326 introduces the Current Expected Credit Losses (CECL) model, which requires organizations to recognize credit losses on financial assets based on the expected lifetime credit losses. This model marks a shift from the previous incurred loss model, which only recognized credit losses when they became probable. Under the CECL model, organizations must consider historical information, current conditions, and reasonable supportable forecasts when estimating expected credit losses.
 

Journal Entries for Expected Credit Losses Transactions

To illustrate the concept of expected credit losses and the accounting treatment under ASC 326, let's consider a simplified example involving a bank that has a $1,000,000 loan portfolio. The bank estimates the lifetime expected credit losses for the portfolio to be 5%.
 

1. Calculate the allowance for credit losses

First, the bank must calculate the allowance for credit losses based on the estimated lifetime expected credit losses:
 

Allowance for Credit Losses: $1,000,000 x 5% = $50,000
 

2. Journal entries for expected credit losses

Now, let's create journal entries to account for the expected credit losses:
 

a) Record the initial allowance for credit losses:

Debit: Provision for Credit Losses - $50,000

Credit: Allowance for Credit Losses - $50,000
 

b) Record the charge-off of actual credit losses:

Debit: Allowance for Credit Losses - $X

Credit: Loan Receivable - $X
 

c) Record the recovery of previously charged-off credit losses:

Debit: Loan Receivable - $Y

Credit: Allowance for Credit Losses - $Y
 

d) Adjust the allowance for credit losses for changes in estimates:

If the bank revises its estimate of expected credit losses, it should adjust the allowance for credit losses accordingly. For instance, if the new estimate of expected credit losses is 6%:
 

New Allowance for Credit Losses: $1,000,000 x 6% = $60,000

Adjustment: $60,000 - $50,000 = $10,000
 

Debit: Provision for Credit Losses - $10,000

Credit: Allowance for Credit Losses - $10,000

 

The ASC 326 standard has introduced new requirements for estimating and recognizing expected credit losses on financial instruments, requiring organizations to adopt a more forward-looking approach. By understanding the concept of expected credit losses and properly accounting for them through journal entries, organizations can ensure accurate financial reporting and maintain compliance with ASC 326. As businesses continue to adapt to the new financial instruments landscape, it is essential to invest in the right tools and resources, such as advanced accounting software, to streamline the process and ensure ongoing compliance.