Ann: Response to ASX Query - Half Year Accounts, page-45

"Both CCP and PNC attempt to negotiate fixed repayment schedules with debtors. In so far as this is achieved, there is a case for revaluing those PDPs by capitalising the agreed income streams, and keeping each time slot separate – e.g., this coming 12 months, the next 12 months, et cetera. Apart from informing Management of what cash flows it can expect, this information assists borrowing at a low rate, or selling the repayment streams, if that makes sense."

That is effectively what both amortised cost and fair value recognition achieve. Forecasts of future cash receipts on a time bound basis (month, quarter, year etc) and discount those expected cash receipts. Those expectations should be unbiased and probability weighted, take into account time vale of money and be reasonable and supportable (e.g. statistically sound say using actuarial techniques).

I noted in PNC's latest annual report an interesting comment: " Similarly, if expectations of future cash flows were to subsequently increase, a gain would be recognised, up to the original amortised cost, calculated by discounting these incremental cash flows at the original effective interest rate. " This would imply PNC believe amortised cost may be capped at the amortised value using the original profile from acquisition (based on original liquidation profile and EIR). That would be a reason not to move to amortised cost if one believed that. However I would reject that assumption as amortised cost for credit-impaired receivables can rise to a value higher than this value under amortised cost and indeed if the embedded lifetime ECL (expected credit loss) was to reduce to a small value due to a debtor now paying etc then the cap would be the outstanding principal and interest (originated SPPIs). This is supported by Big-4 literature and have included an extract from EY thought leadership on financial instruments ():

Illustration 3-1 — Calculation of credit-adjusted effective interest rate and recognition of loss allowance for purchased credit-impaired financial asset On 1 January 2009, Company D issued a bond that required it to pay an annual coupon of CU800 in arrears and to repay the principal of CU10,000 on 31 December 2018. By 2014, Company D was in significant financial difficulties and was unable to pay the coupon due on 31 December 2014. On 1 January 2015, Company V estimates that the holder could expect to receive a single payment of CU4,000 at the end of 2016. It acquires the bond at an arm’s length price of CU3,000. Company V determines that the debt instrument is credit-impaired on initial recognition, because of evidence of significant financial difficulty of Company D and because the debt instrument was purchased at a deep discount. It can be shown that using the contractual cash flows (including the CU800 overdue) gives rise to an EIR of 70.1% (the net present value of CU800 now and annually thereafter until 2018 and CU10,000 receivable at the end of 2018 is CU3,000 when discounted at 70.1%). However, because the bond is credit-impaired, V should calculate the EIR using the estimated cash flows on the instrument. In this case, the EIR is 15.5% (the net present value of CU4,000 receivable in two years is CU3,000 when discounted at 15.5%). All things being equal, interest income of CU464 (CU3,000 × 15.5%) would be recognised on the instrument during 2015 and its carrying amount at the end of the year would be CU3,464 (CU3,000 + CU464). However, if at the end of the year, based on reasonable and supportable evidence, the cash flow expected to be received on the instrument had increased to, say, CU4,250 (still to be received at the end of 2016), an adjustment would be made to the asset’s amortised cost. Accordingly, its carrying amount would be increased to CU3,681 (CU4,250 discounted over one year at 15.5%) and an impairment gain of CU217 would be recognised in profit or loss.

As the example clearly shows the "impairment gain" recognised would increase the value of the asset above its original amortised cost.

If the example employed fair value as an approach the underlying cash flows used in the dcf (it's level 3 and they'd most likely use the income approach which is dcf) would be the same, the discount rate would reflect current market assessments of time value of money and the risks inherent in the asset (but not already taken into account in the underlying cash flows). Given the risk is already taken into account mostly in the cash flows (they are much less than the contractual SPPIs) then the credit risk effects in the discount rate would be muted.

The above is what I've gone through several times on here and CLH thread in the past, but providing a big-4 firm's thought leadership rather than my own probably adds more credence.

We should dispel the myth that amortised cost means "depreciating/amortising" the original purchase price such that a set and forget amortisation profile is used without adjustment and highlight that adjustments can be both up or down (at least in the case of financial assets that were credit-impaired at acquisition) - and yes up above the original acquisition value or amortised cost using original cash flow profiling at acquisition date....

DYOR