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Amortizing premiums to multiple call dates

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Amortizing premiums to multiple call dates The amendments in ASU 2017-08, Premium Amortization on Purchased Callable Debt Securities, change how entities amortize premiums on investments in callable debt securities into interest income. Some have questioned how to apply these amendments to debt securities with multiple call dates, as well as to debt securities with provisions that allow the issuer to call the security after, rather than on, a specific date.

Amortizing a premium to the call date The amendments in ASU 2017-08 revise the guidance on amortizing a premium on a callable debt security under ASC 310-20-35-33, Receivables: Nonrefundable Fees and Other Costs. The amended guidance requires entities to amortize a premium on a debt security to the earliest call date. Under the guidance in ASC 310-20-35-33, a debt security is carried at a premium when its amortized cost exceeds the amount repayable by the issuer at the earliest call date. This guidance applies only to securities with explicit, noncontingent call features that are callable at fixed prices on preset dates and to which the guidance in ASC 310-20-35-26 has not been applied.

If the issuer does not exercise the call option at the earliest call date, the effective yield on the debt security is reset using the contractual payment terms of the debt security.

Example 1 – Single call date Entity A purchases a debt security with a par value of $1,000 for $1,200 on 1/1/X1. The debt security has a 15-year term with interest-only payments until maturity and is callable by the issuer on 12/31/X2 for $1,100.

At the acquisition date, the amortized cost basis of the security ($1,200) exceeds the call price ($1,100) by $100. Pursuant to the guidance in ASU 2017-08, the $100 difference between the amortized cost and the call price (the premium) is amortized into interest income over the period between the acquisition date and the call date.

If the issuer does not exercise the call right, Entity A would reset the effective yield on the debt security by comparing the security’s remaining contractual cash flows to the amortized cost basis at the call date ($1,100).

Securities with multiple call dates Some debt securities have multiple call dates, and the call price may change at each call date. The amortized cost of a debt security with multiple call dates at acquisition might not exceed the call price at the earliest call date, but might exceed the call price at the next immediately following call date.

Based on discussions with the FASB staff, we believe an entity should compare the amortized cost basis of a callable debt security immediately following each call date to the call price at the subsequent call date, to determine if the guidance in ASC 310-20-35-33 should be applied from that point forward.

Example 2 – Multiple call dates Entity A purchases a debt security with a par value of $1,000 for $1,200 on 1/1/X1. The debt security has a 15-year term with interest-only payments until maturity. The debt security is callable by the issuer on 12/31/X1 for $1,300 and on 12/31/X2 for $1,100.

At the acquisition date, the amortized cost basis of the security ($1,200) does not exceed the earliest call price ($1,300), so the guidance in ASC 310-20-35-33 does not apply. The effective yield on the debt security is calculated by comparing the security’s contractual cash flows over its full contractual life, to the amortized cost basis at acquisition ($1,200).

If the issuer does not exercise the call on 12/31/X1, Entity A would then compare the amortized cost basis as of 12/31/X1 to the call price at the next call date ($1,100 at 12/31/X2). Assuming Entity A’s amortized cost basis at 12/31/X1 is $1,180, Entity A would reset the effective yield on the security and would amortize the premium ($80) over the period from 1/1/X2 to the next call date at 12/31/X2.

If the issuer does not exercise the call right at the second call date on 12/31/X2, Entity A would reset the effective yield on the debt security by comparing the remaining contractual cash flows on the debt security to the amortized cost basis at the second call date (that is, $1,100).

Calls exercisable over a period The guidance in ASC 310-20-35-33 applies to a debt security with an explicit, noncontingent call feature that is callable at fixed prices on preset dates. However, some debt securities grant the issuer a call right that can be exercised over a period of time rather than on one specific date.

Based on discussions with the FASB staff, we believe that a debt security with a call provision that can be exercised over a period of time falls within the scope of the guidance in ASC 310-20-35-33, provided that the call provision is explicit and noncontingent, and can be exercised at a fixed price.

Scope of ASC 310-20-35-33 Amortizing premiums to multiple call dates

Contacts:

Graham DyerGraham Dyer
Partner
Accounting Principles Group
T +1 312 602 8107


Rahul GuptaRahul Gupta
Partner
Accounting Principles Group
T +1 312 602 8084


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