SOP Proposed on Accounting for Discounts Related to Credit Quality

The Accounting Standards Executive Committee recently issued a proposed SOP, Accounting for Discounts Related to Credit Quality, which presents accounting for purchase discounts on certain loans and securities. Comments on the exposure draft are due by April 29, 1999.

The SOP applies to all enterprises acquiring loans and all loans acquired by completion of a transfer, for which, at acquisition, it is probable that the investor will be unable to collect contractual payments receivable, with certain exceptions.

The proposal addresses accounting for differences between contractual and expected future cash flows from an investor's initial investment in certain loans and debt securities acquired in a transfer when such differences are attributable, at least in part, to credit quality. The SOP states that:

* Any excess of contractual cash flow over expected future cash flow is not recognized as an adjustment of yield, loss accrual, or valuation allowance.

* Investors must recognize the excess of the loan's expected future cash flow over the investor's initial investment in the loan as interest income over the life of the loan, which is defined as accretable yield.

* Investors are prohibited from displaying accretable yield and nonaccretable difference in the balance sheet.

* Investors must disclose certain information about loans within the scope of the SOP separately for those loans accounted for as debt securities and loans that are not accounted for as debt securities, in addition to disclosures required by FASB Statements 5, 114, 115, and 118.