How is a credit loss recognized for an AFS or HTM debt security?

The recognition of a credit loss for an Available-for-Sale (AFS) or Held-to-Maturity (HTM) debt security follows specific accounting principles, particularly focusing on the future cash flows expected from the investment.

When assessing the credit loss, the appropriate approach is to compare the present value of expected collections from the security to its amortized cost. This involves estimating the cash flows that will be received and then discounting them to their present value. If this present value is less than the amortized cost of the debt security, a credit loss needs to be recognized. This method reflects a more accurate financial position by acknowledging that the investment is impaired based on expected future cash flows.

The other options do not accurately represent how a credit loss is assessed. Adjusting the selling price does not align with how credit losses are recognized, as it disregards the fundamental credit evaluation of future cash flows. Recognizing a credit loss upon the sale of the investment overlooks situations where impairment may occur even if a sale doesn't happen. Reversing previous gains in Other Comprehensive Income (AOCI) is not applicable to credit losses, which are focused on underlying cash flow expectations rather than historical gain adjustments.