Premium Amortization on Callable Debt Securities

By Baker Newman Noyes June 5, 2017

On March 31 2017 the Financial Accounting Standards Board (FASB) adopted a new Accounting Standards Update (ASU), ASU No. 2017-08, to change the rules governing accounting for amortization of premiums for purchased callable debt securities. Under ASU No. 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20) Premium Amortization on Purchased Callable Debt Securities the amortization period for certain callable debt securities held at a premium has been shortened to the earliest call date.

Under current generally accepted accounting principles, a premium is typically amortized as an adjustment of yield to the maturity date when a callable debt security is purchased at a premium, even if the holder is certain the call will be exercised. As a result, upon the exercise of a call on a callable debt security held at a premium, the unamortized premium is recorded as a loss in earnings.

Stakeholders said current accounting results in the recognition of too much interest income before a borrower calls the debt security, followed by the recognition of a loss on the call date. Additionally, there is diversity in practice (1) in the amortization period for premiums of callable debt securities and (2) in how the potential for exercise of a call is factored into current impairment assumptions.

To address these concerns, this new ASU shortens the amortization period for the premium to the earliest call date to more closely align interest income recorded on bonds held at a premium with the economics of the underlying instrument.

The amendments in this ASU do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity.

The ASU takes effect for public business entities for fiscal years and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted, including adoption in an interim period.  If an entity early adopts in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period.

An entity should apply the amendments in this ASU on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principle.

The text of the Update can be found here. Please contact your BNN advisor at 800.244.7444 if you have any questions about how the Update will impact your organization.