When must a credit loss be recognized for AFS or HTM debt securities?

A credit loss for Available-for-Sale (AFS) or Held-to-Maturity (HTM) debt securities must be recognized when it is probable that the amount due will not be collected. This recognition is based on the assessment of the credit quality of the issuer and any significant financial difficulties that may impact their ability to make scheduled payments of principal and interest.

Accounting standards require that entities assess their investments for impairment whenever events or changes in circumstances indicate that it is probable that an investor will not collect all amounts due according to the contractual terms of the security. This approach allows for timely recognition of credit losses, aligning with the principle of conservatism in financial reporting, which emphasizes the importance of recognizing potential losses as soon as they are anticipated.

In contrast, recognizing losses only upon sale, considering a security to be impaired, or reacting solely to market price decreases does not accurately reflect the economic reality of the investment’s credit quality and may lead to delayed loss recognition. Thus, the correct context for recognizing credit losses follows the assessment of collectability, ensuring that financial statements provide a truthful view of an entity's financial position.