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Basis of Presentation and Significant Accounting Policies (Policies)

12 Months Ended

Mar. 31, 2019

Basis of Presentation and Principles of Consolidation

Our accounting and financial reporting policies conform to accounting principles generally accepted in the United States of America (“U.S. GAAP”). Certain prior period amounts have been reclassified to conform to current period presentation. Related party transactions presented in the Consolidated Financial Statements are disclosed in Note 12 – Related Party Transactions.

The consolidated financial statements include the accounts of TMCC, its wholly-owned subsidiaries and all variable interest entities (“VIE”) of which we are the primary beneficiary. All intercompany transactions and balances have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Because of inherent uncertainty involved in making estimates, actual results could differ from those estimates and assumptions. The accounting estimates that are most important to our business are the accumulated depreciation related to our investments in operating leases and the allowance for credit losses.

Recently Adopted Accounting Guidance

Revenue Recognition

We adopted Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), using the modified retrospective approach and applied it to active agreements at the time of adoption. As such, the comparative information in this Form 10-K has not been restated and continues to be reported under the accounting standards in effect for those periods. The majority of our total consolidated revenues are outside the scope of the standard; however, the majority of revenue reported by our insurance operations segment falls within the scope of ASU 2014-09. Upon adoption, fees collected for administering certain vehicle and payment protection products are now recognized using the same measure as the related product revenue and certain dealer incentives are now capitalized and amortized over the contract term instead of expensed as incurred.

While the adoption of ASU 2014-09 has changed the timing of recognition of certain revenues and expenses, the total revenue and expense recognized over the contract term will not change as a result of adopting the standard. We do not expect the adoption to be significant to our net income on an ongoing basis.

The cumulative effect of the changes made to our Consolidated Balance Sheet as of April 1, 2018 for the adoption of ASU-2014-09 was as follows:

	March 31,		Adjustments related			April 1,
	2018		to adoption			2018
Assets:
Other assets	$	1,614	$	73		$	1,687

Liabilities and shareholder's equity:
Deferred income taxes	$	5,326	$	(36	)	$	5,290
Other liabilities		3,987		219			4,206
Retained earnings		11,992		(110	)		11,882

The impact on our Consolidated Balance Sheet for the adoption of ASU-2014-09 was as follows:

	March 31, 2019
			Effect of			Balances without
	As reported		adoption			adoption
Assets:
Other assets	$	1,981	$	(72	)	$	1,909

Liabilities and shareholder's equity:
Deferred income taxes	$	5,452	$	38		$	5,490
Other liabilities		4,564		(225	)		4,339
Retained earnings		12,658		115			12,773

For the year ended March 31, 2019, the effect on our Consolidated Statement of Income from the adoption of ASU 2014-09 was a decrease of $5 million in net income.

Note 1 – Basis of Presentation and Significant Accounting Policies (Continued)

Recognition and Measurement

We adopted ASU 2016-01, Financial Instruments – Recognition and Measurement of Financial Assets (“ASU 2016-01”), which requires entities to measure equity investments at fair value and recognize any changes in fair value in net income. On April 1, 2018, we recognized the cumulative effect of adoption by recording a reduction to our opening retained earnings of approximately $12 million, net of tax.

Other Recently Adopted Standards

We adopted ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, which is intended to reduce diversity in practice in the classification of certain cash receipts and cash payments in the statement of cash flows. The adoption of this guidance did not have an impact on our consolidated financial statements and related disclosures.

We adopted ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which clarifies how restricted cash and cash equivalents should be classified and presented on the statement of cash flows. This guidance was intended to reduce diversity in practice in the classification of restricted cash and cash equivalents on the statement of cash flows. Effective April 1, 2018, we no longer report the change in restricted cash and cash equivalents in the operating and investing sections in our Consolidated Statements of Cash Flows. Restricted cash and cash equivalents are now included in the beginning and end of the period cash and cash equivalents on the Consolidated Statements of Cash Flows. These changes have been applied using a retrospective transition method to each period presented.

We early adopted ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cut and Jobs Act of 2017 (“TCJA”). The adoption of this guidance did not have a material impact on our consolidated financial statements and related disclosures.

New Accounting Guidance

Accounting Guidance Issued But Not Yet Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-02, Leases (Topic 842), which introduces a lessee model that brings most leases on the balance sheet and aligns many of the underlying principles of the new lessor model with those in the new revenue recognition standard. The FASB also subsequently issued guidance amending and clarifying various aspects of the new leases guidance. The new leasing standard represents a wholesale change to lease accounting for lessees and requires additional disclosures regarding leasing arrangements. We will adopt this ASU using the optional transition method and it will not have a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Upon adoption of the guidance on April 1, 2019, we expect to recognize right-of-use assets and lease liabilities (at their present value) of approximately $120 million in our Consolidated Balance Sheet.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This guidance introduces a new impairment model based on expected losses rather than incurred losses for certain types of financial instruments. It also modifies the impairment model for available-for-sale debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The FASB also subsequently issued guidance amending and clarifying aspects of the new impairment model. This ASU is effective for us on April 1, 2020. We are in the process of developing, refining and testing the models and procedures that will be used to calculate the credit loss reserves in accordance with this new accounting guidance. We expect this new guidance will result in an increase in our allowance for credit losses with a cumulative-effect adjustment to our opening retained earnings in the period of adoption. The magnitude of the increase in our allowance for credit losses is under evaluation. We are currently evaluating the other potential impacts of this guidance on our consolidated financial statements and related disclosures.

In March 2017, the FASB issued ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs, which requires certain premiums on callable debt securities to be amortized to the earliest call date. This ASU is effective for us on April 1, 2019. The adoption of this guidance will not have a material impact on our consolidated financial statements and related disclosures.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815), which makes targeted improvements to accounting for hedging activities. This guidance eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires, for qualifying hedges, the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. The guidance provides new alternatives for applying hedge accounting and measuring the hedged item in fair value hedges of interest rate risk. The guidance also modifies certain disclosure requirements. This ASU is effective for us on April 1, 2019. The adoption of this guidance will not have an impact on our consolidated financial statements and related disclosures as we no longer have hedge accounting derivatives as of September 30, 2018.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), which modifies disclosure requirements related to fair value measurement. This ASU is effective for us on April 1, 2020. We are currently evaluating the potential impacts of this guidance on our disclosures.

Note 1 – Basis of Presentation and Significant Accounting Policies (Continued)

In August 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software, which aligns the accounting for costs incurred to implement a cloud computing arrangement that is a service arrangement with the guidance on capitalizing costs associated with developing or obtaining internal-use software. This ASU is effective for us on April 1, 2020. We are currently evaluating the potential impacts of this guidance on our consolidated financial statements and related disclosures.

In October 2018, the FASB issued ASU 2018-17, Consolidation (Topic 810), which requires indirect interests held through related parties in common control arrangements to be considered on a proportional basis for determining whether fees paid to decision makers and service providers are variable interests. This ASU is effective for us on April 1, 2021. We are currently evaluating the potential impacts of this guidance on our consolidated financial statements and related disclosures.

In April 2019, the FASB issued ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. The applicable provisions of this ASU are effective for us on April 1, 2020. We are currently evaluating the potential impacts of this guidance on our consolidated financial statements and related disclosures.

Cash and Cash Equivalents

Cash and cash equivalents represent highly liquid investments with maturities of three months or less from the date of acquisition and may include money market instruments, commercial paper, certificates of deposit, U.S. government and agency obligations, or similar instruments.

Restricted Cash and Cash Equivalents

Restricted cash and cash equivalents include customer collections on securitized receivables to be distributed to investors as payments on the related secured notes and loans payable, which are primarily related to securitization trusts. Restricted cash equivalents may also contain amounts unrelated to financing activities which are restricted as to use and proceeds from certain debt issuances for which the use of the cash is restricted.

Investments in Marketable Securities

Investments in marketable securities consist of debt securities and equity investments.

Debt securities are designated as available-for-sale (“AFS”) and are recorded at fair value with unrealized gains or losses included in accumulated other comprehensive income (“AOCI”), net of applicable taxes. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. We conduct periodic reviews of AFS debt securities to determine whether the loss is deemed to be other-than-temporary.

If an other-than-temporary impairment (“OTTI”) loss is deemed to exist, we first determine whether we have the intent to sell the debt security or if it is more likely than not that we will be required to sell the debt security before recovery of its amortized cost basis. If so, the cost basis of the security is written down to fair value and the loss is reflected in Investment and other income, net in our Consolidated Statements of Income. If we do not have the intent to sell nor is it more likely than not that we will be required to sell, the credit loss component of the OTTI losses is recognized in Investment and other income, net in our Consolidated Statements of Income, while the remainder of the loss is recognized in AOCI. The credit loss component is identified as the portion of the amortized cost of the security not expected to be collected over the remaining term as projected using a cash flow analysis for debt securities.

Prior to April 1, 2018, our equity investments were also considered AFS. However, beginning on April 1, 2018, all equity investments are recorded at fair value with changes in fair value included in Investment and other income, net within our Consolidated Statements of Income. Realized gains and losses from sales of equity investments are determined using the first in first out method and are included in Investment and other income, net within our Consolidated Statements of Income.

Finance Receivables

Finance receivables, net consist of the retail loan and the dealer products portfolio segments, which includes accrued interest and deferred fees and costs, net of the allowance for credit losses and deferred income. Finance receivables, net also includes securitized retail receivables, which represent retail receivables that have been sold for legal purposes to securitization trusts but continue to be included in our consolidated financial statements, as discussed further in Note 8 – Variable Interest Entities. Cash flows from these securitized retail receivables are available only for the repayment of debt issued by these trusts and other obligations arising from the securitization transactions. They are not available for payment of our other obligations or to satisfy claims of our other creditors.

Finance receivables are classified as held-for-investment if the Company has the intent and ability to hold the receivables for the foreseeable future or until maturity or payoff. As of March 31, 2019 and 2018, all finance receivables were classified as held-for-investment.

Revenues associated with retail and dealer financing are recognized so as to approximate a constant effective yield over the contract term. Incremental direct fees and costs incurred in connection with the acquisition of retail contracts and dealer financing receivables, including incentive and rate participation payments made to dealers, are capitalized and amortized so as to approximate a constant effective yield over the term of the related contracts. Payments received on subvention and other consumer incentives are deferred and recognized to approximate a constant effective yield over the term of the related contracts.

The accrual of revenue is discontinued at the time a retail receivable is determined to be uncollectible. These finance receivables may be restored to accrual status when future payments are reasonably assured. For retail loan finance receivables in non-accrual status, subsequent financing revenue is recognized only to the extent a payment is received. Payments are applied first to outstanding interest and then to the unpaid principal balance.

Impaired receivables in the dealer products portfolio segment are placed on nonaccrual status if full payment of principal or interest is in doubt, or when principal or interest is 90 days or more past due. Interest accrued, but not collected at the date a dealer financing receivable is placed on nonaccrual status, is reversed against interest income. In addition, the amortization of net deferred fees is suspended. Interest income on nonaccrual dealer financing receivables is recognized only to the extent it is received in cash. Dealer financing receivables are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured. Finance receivables in the dealer products portfolio segment are charged off against the allowance for credit losses when the loss has been realized.

Investments in Operating Leases

Investments in operating leases, net consist of leases, net of deferred fees and costs, deferred income, accumulated depreciation and the allowance for credit losses. Securitized investments in operating leases represent beneficial interests in a pool of certain vehicle leases that have been sold for legal purposes to securitization trusts but continue to be included in our consolidated financial statements as discussed further in Note 8 – Variable Interest Entities. Cash flows from these securitized investments in operating leases are available only for the repayment of debt issued by these trusts and other obligations arising from the securitization transactions. They are not available for payment of our other obligations or to satisfy claims of our other creditors.

Operating lease revenues are recorded net of sales tax collected from customers and recognized on a straight-line basis over the term of the lease. Deferred fees and costs, including incentive payments made to dealers and acquisition fees collected from customers, are capitalized or deferred and amortized on a straight-line basis over the contract term. Payments received on affiliate sponsored subvention and other incentive programs are deferred and recognized on a straight-line basis over the contract term. The accrual of revenue on investments in operating leases is discontinued at the time an account is determined to be uncollectible and subsequent revenue is recognized only to the extent a payment is received. Operating leases may be restored to accrual status when future payments are reasonably assured.

Residual values of lease contracts are estimated at lease inception by examining external industry data, the anticipated Toyota and Lexus product pipeline and our own experience. Factors considered in this evaluation include, but are not limited to, economic forecasts, new vehicle pricing, new vehicle incentive programs, new vehicle sales, competitor actions and behavior, vehicle features and specifications, the mix and level of used vehicle supply, the level of current used vehicle values, buying and leasing behavior trends, and fuel prices. We use various channels to sell vehicles returned at lease-end.

We evaluate our investment in operating leases portfolio for potential impairment when we determine a triggering event has occurred. When a triggering event has occurred, we perform a test of recoverability by comparing the expected undiscounted future cash flows (including expected residual values) over the remaining lease terms to the carrying value of the asset group. If the test of recoverability identifies a possible impairment, the asset group’s fair value is measured in accordance with the fair value measurement framework. An impairment charge would be recognized for the amount by which the carrying value of the asset group exceeds its estimated fair value and would be recorded in our Consolidated Statements of Income. As of March 31, 2019 and 2018, there was no impairment in our investment in operating leases portfolio.

Depreciation on Operating Leases

Depreciation on operating leases is recognized using the straight-line method over the lease term. The depreciable basis is the original acquisition cost of the vehicle less the estimated residual value of the vehicle at the end of the lease term. On a quarterly basis, we review the estimated end-of-term market values and return rates of leased vehicles to assess the appropriateness of the carrying values at lease-end. Factors affecting the estimated end-of-term market value are similar to those considered in the evaluation of residual values at lease inception discussed above. Adjustments to depreciation expense to reflect revised estimates of expected market values at lease termination and revised return rates are recorded prospectively on a straight-line basis over the remaining lease term.

Allowance for Credit Losses

We maintain an allowance for credit losses to cover probable and estimable losses incurred on our finance receivables and investments in operating leases resulting from the failure of customers or dealers to make contractual payments. Management evaluates the allowance at least quarterly, considering a variety of factors and assumptions to determine whether the allowance is considered adequate to cover probable and estimable losses incurred as of the balance sheet date.

Management develops and documents the allowance for credit losses on finance receivables based on two portfolio segments. The determination of portfolio segments is based primarily on the qualitative consideration of the nature of our business operations and the characteristics of the underlying finance receivables, as follows:

•

Retail Loan Portfolio Segment – The retail loan portfolio segment consists of retail contracts acquired from dealers in the U.S. and Puerto Rico. Under a retail contract, we are granted a security interest in the underlying collateral which consists primarily of Toyota and Lexus vehicles. Based on the common risk characteristics associated with the finance receivables, the retail loan portfolio segment is considered a single class of finance receivable.

•

Dealer Products Portfolio Segment – The dealer products portfolio segment consists of wholesale financing, working capital loans, revolving lines of credit and real estate loans to dealers in the U.S. and Puerto Rico. Wholesale financing is primarily collateralized by new or used vehicle inventory with the outstanding balance fluctuating based on the level of inventory. Working capital loans and revolving lines of credit are granted for working capital purposes and are secured by dealership assets. Real estate loans are collateralized by the underlying real estate, are underwritten primarily on a loan-to-value basis and are typically for a fixed term. Based on the risk characteristics associated with the underlying finance receivables, the dealer products portfolio segment consists of three classes of finance receivables: wholesale, working capital (including revolving lines of credit), and real estate.

We also separately develop and document the allowance for credit losses for investments in operating leases. Investments in operating leases are not within the scope of accounting guidance governing the disclosure of portfolio segments.

Methodology Used to Develop the Allowance for Credit Losses

Retail Loan Portfolio Segment and Investments in Operating Leases

The level of credit risk in our retail loan portfolio segment and our investments in operating leases is influenced primarily by two factors: default frequency and loss severity, which in turn are influenced by various factors such as economic conditions, the used vehicle market, purchase quality mix, contract term length, and collection strategies and practices.

We evaluate the retail loan portfolio segment and investments in operating leases using methodologies that include roll rate, credit risk grade/tier, and vintage analysis. We review and analyze external factors, including changes in economic conditions, actual or perceived quality, safety and reliability of Toyota and Lexus vehicles, unemployment levels, the used vehicle market, and consumer behavior. In addition, internal factors, such as purchase quality mix and operational changes are also considered in the analyses.

We utilize a loss emergence period assumption in developing our allowance for credit losses. This assumption represents the average length of time between when a loss event first occurs and when the account is charged off. We apply judgment in estimating the loss emergence period using available credit information and trends.

Note 5 – Allowance for Credit Losses (Continued)

Dealer Products Portfolio Segment

The level of credit risk in our dealer products portfolio segment is influenced primarily by the financial strength of dealers within our portfolio, dealer concentration, collateral quality, and other economic factors. The financial strength of dealers within our portfolio is influenced by, among other factors, general economic conditions, the overall demand for new and used vehicles and the financial condition of automotive manufacturers.

We evaluate the dealer portfolio by aggregating dealer financing receivables into loan-risk pools, which are determined based on the risk characteristics of the loan (e.g. secured by vehicles, real estate or dealership assets). We analyze the loan-risk pools using internally developed risk ratings for each dealer. We also utilize a loss emergence period assumption in developing our allowance for credit losses. The loss emergence period represents the time period between the date at which the loss event is estimated to have occurred and the ultimate realization of that loss through charge-off. In addition, field operations management and our special assets group are consulted each quarter to determine if any specific dealer loan is considered impaired. If impaired loans are identified, specific reserves are established, as appropriate, and the loan is removed from the loan-risk pool for separate monitoring.

Accounting for the Allowance for Credit Losses and Impaired Receivables

The majority of the allowance for credit losses covers estimated losses on the retail loan portfolio segment and investments in operating leases which are collectively evaluated for impairment. The remainder of the allowance for credit losses covers the estimated losses on the dealer products portfolio segment. Within the dealer products portfolio segment, we establish specific reserves to cover the estimated losses on individual impaired loans (including loans modified in a troubled debt restructuring). The specific reserves are assessed based on discounted cash flows, the loan’s observable market price, or the fair value of the underlying collateral if the loan is collateral dependent.

Increases to the allowance for credit losses are accompanied by corresponding charges to the Provision for credit losses on our Consolidated Statements of Income. The uncollectible portion of finance receivables and investments in operating leases is charged to the allowance for credit losses at the earlier of when an account is deemed to be uncollectible or when an account is greater than 120 days past due. In the event we repossess the collateral, the receivable is charged-off and we record the collateral at its estimated fair value less costs to sell and report it in Other assets in our Consolidated Balance Sheets. Recoveries of finance receivables and investments in operating leases previously charged off as uncollectible are credited to the allowance for credit losses.

Derivative Instruments

Our liabilities consist mainly of fixed and variable rate debt, denominated in U.S. dollars and various other currencies, which we issue in the global capital markets, while our assets consist primarily of U.S. dollar denominated, fixed rate receivables. We enter into interest rate swaps, interest rate floors, and foreign currency swaps to economically hedge the interest rate and foreign currency risks that result from the different characteristics of our assets and liabilities. Our use of derivative transactions is intended to reduce long-term fluctuations in the fair value of assets and liabilities caused by market movements. All of our derivative activities are authorized and monitored by our management and our Asset-Liability Committee, which provides a framework for financial controls and governance to manage market risk.

We categorize derivatives as those designated for hedge accounting (“hedge accounting derivatives”) and those that are not designated for hedge accounting (“non-hedge accounting derivatives”). At the inception of a derivative contract, we may elect to designate a derivative as a hedge accounting derivative if certain criteria are met. As of September 30, 2018, we no longer have any hedge accounting derivatives.

All derivative instruments are recorded on the balance sheet at fair value, taking into consideration the effects of legally enforceable master netting agreements that allow us to net settle asset and liability positions and offset cash collateral held with the same counterparty on a net basis. Changes in the fair value of our derivative instruments are recognized as a component of Interest expense in our Consolidated Statements of Income. The derivative instruments are included as a component of Other assets or Other liabilities in our Consolidated Balance Sheets.

Offsetting of Derivatives

The accounting guidance permits the net presentation on our Consolidated Balance Sheets of derivative receivables and derivative payables with the same counterparty and the related cash collateral when a legally enforceable master netting agreement exists. When we meet this condition, we elect to present such balances on a net basis.

Our International Swaps and Derivatives Association (“ISDA”) Master Agreements are also our master netting agreements which permit multiple transactions to be cancelled and settled with a single net balance paid to either party. The master netting agreements also contain reciprocal collateral agreements which require the transfer of cash collateral to the party in a net asset position across all transactions. Our collateral agreements with substantially all our counterparties include a zero threshold, full collateralization arrangement. Although we have daily valuation and collateral exchange arrangements with all of our counterparties, due to the time required to move collateral, there may be a delay of up to one day between the exchange of collateral and the valuation of our derivatives. We would not be required to post additional collateral to the counterparties with whom we were in a net liability position at March 31, 2019, if our credit ratings were to decline, since we fully collateralize without regard to credit ratings with these counterparties. In addition, as our collateral agreements include legal right of offset provisions, collateral amounts are netted against derivative assets or derivative liabilities, the net amount of which is included in Other assets or Other liabilities in our Consolidated Balance Sheets.

Debt Issuance Costs

Debt issuance costs are deferred and amortized to interest expense on an effective yield basis over the contractual term of the debt.

Foreign Currency Transactions

Upon issuance of fixed rate debt, we generally elect to enter into pay-float swaps to convert fixed rate payments on debt to floating rate payments. Certain unsecured notes and loans payable are denominated in various foreign currencies. The debt is translated into U.S. dollars using the applicable exchange rate at the transaction date and retranslated at each balance data using the exchange rate in effect at that date. Concurrent with the issuance of these foreign currency unsecured notes and loans payable, we enter into currency swaps in the same notional amount to convert non-U.S. currency payments to U.S. dollar denominated payments. Gains and losses related to foreign currency transactions are included in Interest expense in our Consolidated Statements of Income.

Variable Interest Entities

A VIE is an entity that either (i) has insufficient equity to permit the entity to finance its activities without additional subordinated financial support or (ii) has equity investors who lack the characteristics of a controlling financial interest. The primary beneficiary of a VIE is the party with both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb the losses or the right to receive benefits that could potentially be significant to the VIE.

To assess whether we have the power to direct the activities of a VIE that most significantly impact its economic performance, we consider all the facts and circumstances including our role in establishing the VIE and our ongoing rights and responsibilities. This assessment includes identifying the activities that most significantly impact the VIE’s economic performance and identifying which party, if any, has power over those activities. In general, the party that makes the most significant decisions affecting the VIE is determined to have the power to direct the activities of the VIE. To assess whether we have the obligation to absorb the losses or the right to receive benefits that could potentially be significant to the VIE, we consider all of our economic interests, including debt and equity interests, servicing rights and fee arrangements, and any other variable interests in the VIE. If we determine that we are the party with the power to make the most significant decisions affecting the VIE, and we have an obligation to absorb the losses or the right to receive benefits that could potentially be significant to the VIE, then we consolidate the VIE.

We perform ongoing reassessments, usually quarterly, of whether we are the primary beneficiary of a VIE. The reassessment process considers whether we have acquired or divested the power to direct the most significant activities of the VIE through changes in governing documents or other circumstances. We also reconsider whether entities previously determined not to be VIEs have become VIEs, based on new events, and therefore could be subject to the VIE consolidation framework.

Income Taxes

We use the liability method of accounting for income taxes under which deferred tax assets and liabilities are adjusted to reflect changes in tax rates and laws in the period such changes are enacted resulting in adjustments to the current fiscal year’s provision for income taxes.

TMCC files a consolidated federal income tax return with its subsidiaries and TFSIC. TMCC files either separate or consolidated/combined state income tax returns with TMNA, TFSIC, or subsidiaries of TMCC. State income tax expense is generally recognized as if TMCC and its subsidiaries filed their tax returns on a stand-alone basis. In those states where TMCC and its subsidiaries join in the filing of consolidated or combined income tax returns, TMCC and its subsidiaries are allocated their share of the total income tax expense based on combined allocation/apportionment factors and separate company income or loss. Based on the federal and state tax sharing agreements, TFSIC and TMCC and its subsidiaries pay for their share of the income tax expense and are reimbursed for the benefit of any of their tax losses utilized in the federal and state income tax returns.

Fair Value Measurements

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In order to determine fair value of our assets and liabilities, we use quoted prices for identical or similar instruments, otherwise we utilize valuation models with observable or calculated inputs. The use of observable quotes for identical or similar instruments and the use of unobservable inputs is reflected in the fair value hierarchy assessment disclosed in the tables within this Note as Level 1, 2 and 3 defined below. The availability of observable inputs can vary based upon the financial instrument and other factors, such as instrument type, market liquidity and other specific characteristics particular to the financial instrument. To the extent that a valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires additional judgment by management. We use prices and inputs that are current as of the measurement date, including during periods of market disruption. In periods of market disruption, the availability of prices and inputs may be reduced for certain financial instruments. This condition could result in a financial instrument being reclassified from Level 1 to Level 2 or from Level 2 to Level 3.

Level 1: Quoted (unadjusted) prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.

Level 2: Quoted prices in active markets for similar assets and liabilities, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability.

Level 3: Unobservable inputs that are supported by little or no market activity and may require significant judgment in order to determine the fair value of the assets and liabilities.

Valuation Adjustments

We may make valuation adjustments to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, our own creditworthiness, as well as constraints due to market illiquidity or unobservable parameters.

Recurring Fair Value Measurements

Cash Equivalents and Restricted Cash Equivalents

The fair value of cash equivalents and restricted cash equivalents approximates the carrying value and these instruments are classified in Level 1 of the fair value hierarchy.

Investments in Marketable Securities

We estimate the value of our AFS debt securities using observed transaction prices, independent third-party pricing valuation vendors, and internal valuation models.

We may hold investments in actively traded open-end and private placement equity investments. Where the equity investments produce a daily net asset value that is quoted in an active market, we use this value to determine the fair value of the equity investment and classify the investment in Level 1 of the fair value hierarchy. The fair value of equity investments that produce a daily net asset value that is not quoted in an active market is estimated using the net asset value per share (or its equivalent) as practical expedient and are excluded from leveling in the fair value hierarchy.

In addition, we may hold individual securities where valuation methodologies and inputs to valuation models depend on the security type, thus they may be classified differently in the leveling hierarchy. Where possible, quoted prices in active markets for identical or similar securities are used to determine the fair value of the investment securities; those securities are classified as Level 1 or 2, respectively. Where quoted prices in active markets are not available, we use various valuation models for each asset class that are consistent with what market participants use. The inputs and assumptions to the models are derived from market observable sources including: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, benchmark securities, bids, offers, and other market-related data. These investments are generally classified in Level 2 of the fair value hierarchy, however depending on the significance of the unobservable inputs they may also be classified as Level 3.

Note 13 – Fair Value Measurements (Continued)

Derivatives

We estimate the fair value of our derivatives using industry standard valuation models that require observable market inputs, including market prices, interest rates, foreign exchange rates, volatilities, counterparty credit risk, our own non-performance risk and the contractual terms of the derivative instruments. We consider counterparty credit risk and our own non-performance risk through credit valuation adjustments.

For derivatives that trade in liquid markets, model inputs can generally be verified and do not require significant management judgment. These derivative instruments are classified in Level 2 of the fair value hierarchy.

Certain other derivative transactions trade in less liquid markets with limited pricing information. For such derivatives, key inputs to the valuation process include quotes from counterparties and other market data used to corroborate and adjust values where appropriate. Other market data includes values obtained from a market participant that serves as a third party valuation vendor. These derivative instruments are classified in Level 3 of the fair value hierarchy.

Nonrecurring Fair Value Measurements

Nonrecurring fair value measurements include Level 3 net finance receivables that are not measured at fair value on a recurring basis, but are subject to fair value adjustments utilizing the fair value of the underlying collateral when there is evidence of impairment. We did not have any significant nonrecurring fair value items as of March 31, 2019 and 2018.

Impaired Dealer Finance Receivables

For finance receivables within the dealer products portfolio segment for which there is evidence of impairment, we may measure impairment based on discounted cash flows, the loan’s observable market price or the fair value of the underlying collateral if the loan is collateral-dependent. If the loan is collateral-dependent, the fair values of impaired finance receivables are reported at fair value on a nonrecurring basis. The methods used to estimate the fair value of the underlying collateral depends on the specific class of finance receivable. For finance receivables within the wholesale class of finance receivables, the collateral value is generally based on wholesale market value or liquidation value for new and used vehicles. For finance receivables within the real estate class of finance receivables, the collateral value is generally based on appraisals. For finance receivables within the working capital class of finance receivables, the collateral value is generally based on the expected liquidation value of the underlying dealership assets. Adjustments may be performed in circumstances where market comparables are not specific to the attributes of the specific collateral or appraisal information may not be reflective of current market conditions due to the passage of time and the occurrence of market events since receipt of the information. As these valuations utilize unobservable inputs, our impaired finance receivables are classified in Level 3 of the fair value hierarchy.

Impaired Retail Receivables

Retail finance receivables greater than 120 days past due are measured at fair value based on the fair value of the underlying collateral less costs to sell. The fair value of collateral is based on the current average selling prices for like vehicles at wholesale used vehicle auctions.

Note 13 – Fair Value Measurements (Continued)

Financial Instruments Not Carried at Fair Value

Finance Receivables

Our finance receivables consist of retail loans and dealer financing loans, which are comprised of wholesale, real estate and working capital financing. Retail finance receivables are primarily valued using a securitization model that incorporates expected cash flows. Cash flows expected to be collected are estimated using contractual principal and interest payments adjusted for specific factors, such as prepayments, extensions, default rates, loss severity, credit scores, and collateral type. The securitization model utilizes quoted secondary market rates if available, or estimated market rates that incorporate management's best estimate of investor assumptions about the portfolio. The dealer financing portfolio is valued using a discounted cash flow model. Discount rates are derived based on market rates for equivalent portfolio bond ratings. As these valuations utilize unobservable inputs, our finance receivables are classified in Level 3 of the fair value hierarchy.

Unsecured Notes and Loans Payable

The fair value of commercial paper is assumed to approximate the carrying value due to its short duration and generally negligible credit risk. We validate this assumption by recalculating the fair value of our commercial paper using quoted market rates. Commercial paper is classified in Level 2 of the fair value hierarchy.

Other unsecured notes and loans payable are primarily valued using current market rates and credit spreads for debt with similar maturities. Our valuation models utilize observable inputs such as standard industry curves; therefore, we classify these unsecured notes and loans payables in Level 2 of the fair value hierarchy. When observable inputs are not available for all assumptions, we estimate the fair value using internal assumptions such as volatility and expected credit losses. As these valuations utilize unobservable inputs, we classify these unsecured notes and loans payable in Level 3 of the fair value hierarchy.

Secured Notes and Loans Payable

Fair value is estimated based on current market rates and credit spreads for debt with similar maturities. We also use internal assumptions, including prepayment speeds and expected credit losses on the underlying securitized assets, to estimate the timing of cash flows to be paid on these instruments. As these valuations utilize unobservable inputs, our secured notes and loans payables are classified in Level 3 of the fair value hierarchy.

Revenue Recognition

Insurance Contract Revenues

We receive the contractually determined dealer cost at the inception of the contract. Revenue is then deferred and recognized over the term of the contract according to earnings factors established by management that are based upon historical loss experience. Contracts sold range in term from 3 to 120 months and are typically cancellable at any time. The effect of subsequent cancellations is recorded as an offset to unearned contract revenues in Other liabilities on our Consolidated Balance Sheets.

For the year ended March 31, 2019, approximately 84 percent of Insurance earned premiums and contract revenues in the Insurance operations segment were accounted for under ASU 2014-09.

The Insurance operations segment defers contractually determined incentives paid to dealers as contract costs for selling vehicle and payment protection products. These costs are recorded in Other assets on our Consolidated Balance Sheets and are amortized to Operating and administrative expenses on the Consolidated Statements of Income using a methodology consistent with the recognition of revenue. The amount of capitalized dealer incentives and the related amortization was not significant to our consolidated financial statements as of and for the year ended March 31, 2019.

We had $2.2 billion of unearned insurance premiums and contract revenues within the scope of the revenue recognition guidance included in Other liabilities as of April 1, 2018 and March 31, 2019. We recognized $652 million of the unearned amount in Insurance earned premiums and contract revenues in our Consolidated Statements of Income during fiscal 2019. We expect to recognize as revenue approximately $673 million in fiscal 2020, and $1.6 billion thereafter.

Insurance Losses and Loss Adjustment Expenses

Insurance losses and loss adjustment expenses include amounts paid and accrued for loss events that are known and have been recorded as claims, estimates of losses incurred but not reported based on actuarial estimates and historical loss development patterns, and loss adjustment expenses that are expected to be incurred in connection with settling and paying these claims.

Accruals for unpaid losses, losses incurred but not reported, and loss adjustment expenses are included in Other liabilities in our Consolidated Balance Sheets. These accruals arising from contractual agreements entered into by TMIS are not significant as of March 31, 2019 and 2018. Estimated liabilities are reviewed regularly, and we recognize any adjustments in the periods in which they are determined. If anticipated losses, loss adjustment expenses, and unamortized acquisition and maintenance costs exceed the recorded unearned premium, a premium deficiency is recognized by first charging any unamortized acquisition costs to expense and then by recording a liability for any excess deficiency.

Risk Transfer

Our insurance operations transfer certain risks to protect us against the impact of unpredictable high severity losses. The amounts recoverable from reinsurers and other companies that assume liabilities relating to our Insurance operations are determined in a manner consistent with the related reinsurance or risk transfer agreement. Amounts recoverable from reinsurers and other companies on unpaid losses are recorded as a receivable but are not collectible until the losses are paid. Revenues related to risks transferred are recognized on the same basis as the related revenues from the underlying agreements. Covered losses are recorded as a reduction to Insurance losses and loss adjustment expenses.