The Codification contains several Topics on the various forms of investments:
ASC 325 contains four subtopics:
ASC 325-40 “applies to a transferor's interests in securitization transactions that are accounted for as sales under Topic 860 and purchased beneficial interests in securitized financial assets.” (ASC 325-40-15-2)
According to ASC 325-15-40-3, the guidance applies to beneficial interests that have all of the following characteristics:
(ASC 325-40-15-3)
Note that a beneficial interest in securitized financial assets that is in equity form may meet the definition of a debt security. These beneficial interests would be with in the scope of this topic and ASC 320 because ASC 320 requires them to be accounted for as debt securities:
(ASC 325-40-15-5)
ASC 325-40 does not apply to hybrid beneficial interests measured at fair value pursuant to paragraphs 815-15-25-4 through 25-6 for which the transferor does not report interest income as a separate item in its income statements. (ASC 325-40-15-9)
ASC 325-30 provides guidance on investments in insurance contracts. A life settlement contract is an agreement executed between a third-party investor and the owner of a life insurance policy where (1) the investor does not have an insurable interest in the life of the insured, (2) the investor pays an amount in excess of this policy's cash surrender value to the policy owner, and (3) upon the death of the insured, the face value of the policy is paid to the investor. These investments may be facilitated by a broker or transacted directly between the investor and the policy owner.
ASC 325-40 provides guidance on another type of investment. When a reporting entity sells a portion of an asset that it owns, the portion retained becomes an asset separate from the portion sold and separate from the assets obtained in exchange. This is the situation when financial assets such as loans are securitized with certain interests being retained (e.g., a defined portion of the contractual cash flows). Management of the reporting entity must allocate the previous carrying amount of the assets sold based on the relative fair values of each component at the date of sale. In most cases, the initial carrying amount (i.e., the allocated cost) of the retained interest will be different from the fair value of the instrument. Furthermore, cash flows from those instruments may be delayed depending on the contractual provisions of the entire structure (for example, cash may be retained in a trust to fund a cash collateral account). The issue is addressed by ASC 325-40.
Source: ASC 325 Glossaries.
See Appendix A, Definitions of Terms, for other terms related to this Topic: Debt security, Probable, Publicly traded company.
Beneficial Interests. Rights to receive all or portions of specified cash inflows received by a trust or other entity, including, but not limited to, all of the following:
Cash Surrender Value. The amount of cash that may be realized by the owner of a life insurance contract or annuity contract upon discontinuance and surrender of the contract before its maturity. The cash surrender value may be different from the policy account balance due to outstanding loans (including accrued interest) and surrender charges. (Note: The use of this glossary term is not consistent among legal contracts. When determining the applicability of this term, the economic substance of the item shall be taken into consideration.)
Certificates. An insurance entity issues to each individual in a group contract a certificate of insurance for each person insured under the group contract. The certificate is merely a summary of the rights, duties, and benefits available under a group policy. If there is any conflict between the certificate and a group policy, the group policy is the controlling document. (Note: The use of this glossary term is not consistent among legal contracts. When determining the applicability of this term, the economic substance of the item shall be taken into consideration.)
Claims Stabilization Reserve. The claims stabilization reserve is established through deductions from the policy account balance through the cost of insurance charge and is sometimes held in a general account (that is, an account that is intermingled with the insurance entity's assets) as opposed to a legally segregated account (sometimes referred to as a separate account). The amounts are accumulated in this account until a death benefit is paid. The death benefit represents a combination of the policy account balance and the claims stabilization reserve based on the contractual terms. The cost of insurance is recalculated periodically based on actual experience of the insured class. Annually, the claims stabilization reserve is reviewed and an experience credit may be issued back to the policyholder if the experience has been favorable. The balance in the claims stabilization reserve will be reviewed annually and to the extent the balance is greater than the forecasted or expected amount, an experience refund would get credited to the entity's policy account balance. An entity's claims stabilization reserve will generally be realized through the collection of death benefits or an experience refund that gets credited to the policyholder's policy account balance or upon surrender of the group policy. A claims stabilization reserve is included in a policy as a mechanism for the policyholder and the insurance entity to share in the mortality risk, which in this case is the risk that the deaths will occur sooner than originally expected. Absent a claims stabilization reserve, the policyholder's net cost of insurance would typically be higher than in a policy without a claims stabilization reserve. The claims stabilization reserve is sometimes referred to as a mortality reserve or a mortality retention reserve. (Note: The use of this glossary term is not consistent among legal contracts. When determining the applicability of this term, the economic substance of the item shall be taken into consideration.)
Deferred Acquisition Costs Tax. Section 848 of the Internal Revenue Code requires insurance entities to capitalize certain policy acquisition costs and defer deducting them in determining the insurer's tax liability. These costs are known as the deferred acquisition costs tax and are based on a percentage of the premium received as specified by the Internal Revenue Code. The initial deferred acquisition costs tax is deducted from a policyholder's policy account balance when the premium is paid. The deferred acquisition costs tax is credited back to the policyholder's policy account balance as the tax deduction is recognized in the insurer's tax return. (Note: The use of this glossary term is not consistent among legal contracts. When determining the applicability of this term, the economic substance of the item shall be taken into consideration.)
Insurance Policy. The legal agreement between the policyholder and the insurance entity that states the terms of the arrangement. The term insurance policy includes all riders, attachments, side agreements, and other related documents that are either directly or indirectly part of the contractual arrangement. (Note: The use of this glossary term is not consistent among legal contracts. When determining the applicability of this term, the economic substance of the item shall be taken into consideration.)
Life Settlement Contract. A life settlement contract is a contract between the owner of a life insurance policy (the policy owner) and a third-party investor (investor), and has all of the following characteristics:
Policy Account Balance. At any point in time, this is the amount held by the insurance entity on behalf of the policyholder. This balance may be held in a general account, a separate account (a legally segregated account), or a combination of both on the insurance entity's balance sheet. This account includes premiums received from the policyholder, plus any credited income, less any relevant charges (acquisition costs, cost of insurance, and so forth). (Note: The use of this glossary term is not consistent among legal contracts. When determining the applicability of this term, the economic substance of the item shall be taken into consideration.)
Surrender Charge. A contractual fee imposed by the insurance entity when a policyholder surrenders the insurance policy that typically decreases over the life of the policy. The surrender charge represents a recovery of costs incurred by the insurance entity in originating the policy. It may or may not be explicitly called a surrender charge and can be embedded in other agreements besides the insurance contract. (Note: The use of this glossary term is not consistent among legal contracts. When determining the applicability of this term, the economic substance of the item shall be taken into consideration.)
An entity may hold stock in entities other than subsidiaries. The entity should account for these investments by one of three methods—
The cost method is generally followed for most investments
For investments using the cost method, the investor recognizes, initially at cost, investments in stock of investees as assets on the statement of financial position.
Dividends are the vehicle for an investor to recognize earnings from an investment under the cost method. From the date of the investment entities recognize dividends received from an investee in one of two ways:
The value of the investment in stock accounted for under the cost method may lose its value because of a series of operating losses or other factors. If the impairment is considered other than temporary, investors should look to ASC 320-10-35-17 through 35-35. Those paragraphs discuss the methodology for determining impairment and evaluating whether the impairment is other than temporary and, therefore, must be recognized.
The level of ownership in stock of an investee may change. An investor may lose the ability to influence policy or gain the ability to influence policy. These circumstances call for a change to or from the equity method of accounting. In those cases, preparers should look to ASC 323-10-35 for guidance.
ASC 325-20 provides guidance on Accounting for a Cost Method Investment in Affordable Housing Projects with Allocated Tax Credits. Disclosures required by ASC 325 may be found in the disclosure checklist included with this volume.
For guidance on the use of the cost method by real estate investment trusts with related service corporations, see Topic 974. (ASC 325-20-60)
For a life settlement contract, ASC 325-30 requires the investor to elect to account for these investments using either the “investment method” or the “fair value method.” This irrevocable election is made in one of two ways:
The investor recognizes the initial investment at the transaction price plus all initial direct external costs. Continuing costs (payments of policy premiums and direct external costs, if any) necessary to keep the policy in force are capitalized. Gain recognition is deferred until the death of the insured. At that time the investor recognizes in net income (or other applicable performance indicator) the difference between the carrying amount of the investment and the policy proceeds.
The investor is required to test the investment for impairment upon the availability of new or updated information that indicates that, upon the death of the insured, the expected proceeds from the insurance policy may not be sufficient for the investor to recover the carrying amount of the investment plus anticipated gross future premiums (undiscounted for the time value of money) and capitalizable external direct costs, if any. Indicators to be considered include, but are not limited to:
As a result of performing an impairment test, if the undiscounted expected cash inflows (the expected proceeds from the policy) are less than the carrying amount of the investment plus the undiscounted anticipated gross future premiums and capitalizable external direct costs, an impairment loss is recognized. The loss is recorded by reducing the carrying value of the investment to its fair value. The fair value computation is to employ current interest rates. Note that a change in interest rates would not by itself require an impairment test.
The initial investment is recorded at the transaction price. Each subsequent reporting period, the investor remeasures the investment at fair value and recognizes changes in fair value in current period net income (or other relevant performance indicators for reporting entities that do not report net income). Cash outflows for policy premiums and inflows for policy proceeds are to be included in the same financial statement line item as the changes in fair value are reported.
On the face of its statement of financial position, the investor is required to differentiate between investments remeasured at fair value and those accounted for using the investment method. This may be accomplished by either:
Investment income attributable to fair value remeasurements is presented on the face of the income statement separately from investment income attributable to contracts accounted for using the investment method. This may be accomplished by either:
Cash inflows and outflows attributable to investments in life settlement contracts are to be classified based on the nature and purpose for which the contracts were acquired.
In addition to other applicable GAAP disclosures, the investor is to disclose the policy it follows to account for life settlement contracts, including the classification in the cash flow statement of cash inflows and outflows associated with these contracts.
For life settlement contracts accounted for under the investment method, the investor is required to disclose the following information based on the remaining life expectancy of the insured individuals:
For life settlement contracts accounted for under the fair value method, the investor is required to disclose the following information based on the remaining life expectancy of the insured individuals:
This subtopic provides that the holder of the beneficial interest is to recognize the excess of all cash flows anticipated at the acquisition transaction date over the initial investment (ASC 325-40-30-2) as interest income using the effective yield method. (ASC 325-40-35-1) The holder is required to update the estimate of cash flows over the life of the beneficial interest. If the estimated cash flows change (but there was still an excess over the carrying amount), the adjustment is accounted for prospectively as a change in estimate with the amount of the periodic accretion adjusted over the remaining life of the beneficial interest. If the fair value of the beneficial interest declines below its carrying amount, the reporting entity should determine if the decline is other than temporary and apply the impairment guidance in ASC 320-10-35-18. If it is not practicable for a holder/transferor to estimate the fair value of the beneficial interest at the securitization date, interest income is recognized using the cash basis rather than the effective yield method.
If, based on current information and events that the reporting entity anticipates a market participant would use in determining the current fair value of the beneficial interest, there is a change in estimated cash flows, the amount of accretable yield is recalculated. If the change in estimated cash flows is adverse, an other-than-temporary impairment would be considered to have occurred.
OTTI evaluations. The objective of the analysis as to whether an impairment is other-than-temporary is to determine whether it is probable that the holder will realize some portion of the unrealized loss on an impaired security. Under U.S. GAAP, a holder may ultimately realize an unrealized loss on the impaired security because, for example:
It is inappropriate for management to automatically conclude that, because all of the scheduled payments to date have been received, a security has not incurred an OTTI. Conversely, it is also inappropriate for management to automatically conclude that every decline in fair value of a security represents OTTI. The longer and/or the more severe the decline in fair value, the more persuasive the evidence that would be needed to overcome the premise that it is probable that the holder will not collect all of the contractual or estimated cash flows from the security. (ASC 325-40-35-10A)
Further analysis and the exercise of judgment are required to assess whether a decline in fair value indicates that it is probable that the holder will not collect all of the contractual or estimated cash flows from the security.
In performing the assessment of OTTI and developing estimates of future cash flows, the holder should look to the guidance in ASC 320-10-35-33G through 35-33I and consider all information available that is relevant to collectibility, including information about past events, current conditions, and forecasts that are reasonable and supportable. ASC 320-10-35 provides that this information should generally include:
(ASC 320-10-35-33G through 35-33I)
Some or all of the securitized loans that comprise many beneficial interests may be structured with payment streams that are not level over the life of the loan. Thus, the remaining payments expected to be received from the security could differ significantly from those received in prior periods. These so-called “nontraditional” loans may have features such as:
In achieving this objective, the holder considers information such as:
The existence of these or other features necessitates consideration by the holder of whether a security backed by loans that are currently performing will continue to perform when the contractual provisions of those loans require increasing payments on the part of the borrowers. In addition, the holder is to consider how the value of any collateral would affect the expected performance of the security. Naturally, if the fair value of the collateral has declined, the holder must assess the effect of the decline on the ability of the borrower to make the balloon payment since the decline in value may preclude the borrower from obtaining sufficient funds from a potential refinancing of the debt.
Timing of recognition of an OTTI. If management of the entity both holds an available-for-sale beneficial interest whose fair value is less than its amortized cost basis and does not expect the fair value to recover prior to an expected sale shortly after the date of the statement of financial position, a write-down for other-than-temporary impairment is recognized as a charge to net income in the period in which the decision to sell the beneficial interest is made. (ASC 325-40-35-13)
3.142.12.207