Question

Wang Corporation purchased $220,000 of Hales Inc. 8% bonds at par in 2020 with the intent and ability to hold the bonds until the bonds mature in 2025, so Wang classifies its investment as held-to-maturity. Unfortunately, a combination of problems at Hales and in the debt market caused the fair value of the Hales investment to decline to $180,000 during 2021. Wang applies the CECL model to account for its investment and calculates that, of the $40,000 drop in fair value, $14,000 of it relates to credit losses for amounts not expected to be collected, and the $26,000 remainder relates to noncredit losses. Wang’s accounting for this impairment will reduce before-tax net income for 2021 by:

Multiple Choice

• $0.

• $40,000.

• $26,000.

• $14,000.

Answer 1

Here Wang applied CECL model to account.

CECL means Current Expected Credit Loss. In CECL model we the main objective is the credit risk should be transparent for the person who go through the financial statements or the person who is willing to invest in the organisation. The main intension of CECL method is to give proper information of credit risk to the person who is willing to invest. This method came into force effective january, 2020.

In the given problem $40000 drop in the face value of investments out of which $14000 related to credit loss and $26000 related to non credit loss. In CECL as the name it self indicates we will clearly disclose credit loss which is $14000

In this case CECL reduces the before tax net income by $14000