Topic 326 Credit Losses became effective for all entities in calendar year 2023 and provides guidance on the measurement of credit losses on in-scope financial instruments. The standard is comprised of three subtopics: (1) ASC 326-10 Overall; (2) ASC 326-20 Financial Instruments—Credit Losses—Measured at Amortized Cost; and (3) ASC 326-30 Financial Instruments—Credit Losses—Available-for-Sale Debt Securities. While Topic 326 is a broad standard that impacts the measurement of credit losses on a wide range of financial instruments, there are a number of instruments to which the standard does not apply, such as financial assets carried at fair value (e.g., election of the fair value option or FVO) and receivables from entities under common control. Further, the scoping section of each subtopic should carefully be considered when identifying financial instruments within the scope thereof.

In this article, we focus on the application of the current and expected credit loss model to selected financial assets carried at amortized cost that are commonly recognized by reporting entities in the affordable housing space.

ASC 326-20 – The Current and Expected Credit Loss (CECL) model

Entities that own and operate real estate used to provide affordable housing encounter some of the same accounting issues that any other real estate operator would (e.g., operating lease receivables). Affordable housing operators, though, may have considerations such as government rental subsidiaries that are unique to the affordable housing space.

Tenant receivables (operating leases)

Operating lease receivables are accounted for by a lessor in accordance with Topic 842 Leases and are not within the scope of Topic 326.  Accordingly, the CECL model (ASC 326-20) is not applied to operating lease receivables. It should be noted that a lessor’s operating lease receivables include both billed but uncollected rents and recognized but unbilled rental income (deferred rents).

Under Topic 842, when an entity assesses collectability as not being probable, the lessor recognizes a cumulative reversal to result in its ending retained earnings balance to reflect the cumulative cash collections of contractual rents. The adjustment, which is recognized as a current-period reduction of lease income, is measured as the difference between (a) the cumulative income recognized for the lease and (b) cumulative lease income from contractual rents collected. Going forward, income should generally be limited to cash rents collected.

A change in an entity’s assessment of the collectability of lease payments should be considered when evaluating the underlying asset (i.e., the rental property) in an operating lease. In an operating lease, the underlying asset remains on the lessor’s books and is evaluated for impairment under Topic 360 Property, Plant, and Equipment.

Subsidies receivable

Subsidies receivable are amounts due directly or indirectly from the Federal government, a state government, and/or other governmental body. Subsidies receivable commonly arise from a lessor’s receipt of tenant-based vouchers and from contractual agreements between a project (i.e., lessor) and a governmental body. These two forms of subsidies receivable are discussed in greater detail below.

The subsidies received in the form of tenant-based vouchers and through contractual agreements between a project and a governmental body are provided as benefits for qualifying tenants. Those subsidies are provided because the lessor (i.e., the resource provider) is not receiving commensurate value (i.e., market rent) for resources provided (i.e., conveyance of the right to control the use of a residential unit). Subsidies are directly or indirectly provided to enable a tenant to cover their lease payment obligations to the lessor in connection with an existing exchange transaction (i.e., the residential lease contract) between the lessor and the tenant. Accordingly, such subsidies receivable recognized by a lessor should be considered part of the lease and should therefore be accounted for in accordance with Topic 842 Leases. In other words, we believe that such subsidies should be incorporated into the measurement of lease payments under Topic 842. To the extent the respective lease is classified as an operating lease, such a subsidy receivable recognized by a lessor should be treated as a tenant receivable under an operating lease and would therefore not be within the scope of Topic 326 (see Tenant receivables (operating leases) above for further discussion).

Tenant-based vouchers

Tenant-based vouchers are a type of rental assistance received by low-income families or individuals under Federal and/or state programs. Tenant-based vouchers are received by the tenant and remitted to the lessor (i.e., the project). Tenants will pay their applicable portion of the lease payment and the tenant-based voucher enables the lessor to receive payment for the remainder of such lease payment directly from the sponsoring government body. Therefore, the lessor recognizes a subsidy receivable and corresponding rental income for amounts received in connection with tenant-based vouchers. As discussed above, we believe that, to the extent the respective lease is classified as an operating lease, such a subsidy receivable recognized by a lessor should be treated as a tenant receivable under an operating lease.

Tenant subsidies under contracts between the project and Federal, state, and/or other governmental body

These types of subsidies are also a type of rental assistance available to low-income families or individuals under Federal and/or state programs. These subsidies are similar to tenant-based vouchers except that a project/lessor receives them directly from a governmental body under a contract between those parties. A lessor will generally recognize a subsidy receivable and corresponding rental income when a subsidy is earned. As discussed above, we believe that, to the extent the respective lease is classified as an operating lease, such a subsidy receivable recognized by a lessor should be treated as a tenant receivable under an operating lease.

Tenant receivables under direct financing and sales-type leases

Net investments in direct financing and sales-type leases, including unpaid rents receivable under such leases, are within the scope of ASC 326-20 unless they are carried at fair value (e.g., appropriate election of the fair value option) or another scope exception applies. See Applying the CECL model below for more information.

Cash equivalents

Cash equivalents measured at amortized cost are within the scope of ASC 326-20. Cash equivalents generally consist of investments such as those in U.S. government treasury bills (T-Bills), commercial paper, and could include longer duration U.S. government securities such as treasury notes (T-Notes) and bonds (T-Bonds) depending on when the reporting entity acquired such investment(s) relative to their maturity.

Other receivables

Receivables carried at amortized costs that have been recognized from income transactions within the scope of Topic 606 Revenue from Contracts with Customers and transactions with non-customers under Topic 610 Other Income are within the scope of ASC 326-20. Examples include, but are not limited to, receivables from: laundry income, other services provided to tenants, and management fee income (collectively, such receivables may be presented as other receivables).

Amounts due from entities under common control

Financial assets carried at their amortized cost representing the unconditional right to receive cash or other assets from an entity under common control are excluded from the scope of Topic 326. This includes loans between, for example, a general partner and an operating entity under common control. This scope exception also applies to loans between entities under common control such as those found in certain tax credit structures as well as intercompany receivables from a sister entity under common control.

Loans and notes receivable from unrelated parties and/or related parties not under common control

Financial assets due from parties that are unrelated or that are related but not under common control and that are carried at amortized cost are generally within the scope of ASC 326-20.

Applying the CECL model

ASC 326-20 does not require the use of specific approaches for developing estimates of credit losses. Please refer to our publication titled Implementing the Current Expected Credit Loss model (ASC 326-20): A roadmap for an overview of ASC 326-20, financial statement disclosure implications, and a roadmap to applying the CECL model.

ASC 326-30 – Credit losses on available-for-sale debt securities

Entities that hold investments in debt securities classified as available-for-sale under Topic 320 Debt Securities are required to assess whether such investments are impaired and, if impaired, whether such impairment is attributable to credit loss. However, entities do not apply the CECL model when measuring credit losses on their investments in available-for-sale debt securities. Under Topic 320, investments in available-for-sale debt securities are carried at fair value with unrealized gains and losses thereon recognized in other comprehensive income. Entities will apply the guidance in ASC 326-30 to determine whether amounts recognized in accumulated other comprehensive income/loss with respect to available-for-sale debt securities represent credit losses and, if so, will immediately reclassify such amounts to current period earnings as a charge. Refer to our article titled Impact of credit losses on Topic 320 available-for-sale debt securities for more information.

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