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Basis of Presentation and Significant Accounting Policies (Policies)

12 Months Ended

Mar. 31, 2021

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”). 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

On April 1, 2020, we adopted the following new accounting standards:

Financial Instruments – Credit Losses

We adopted Accounting Standards Update (“ASU”) 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), along with the subsequently issued guidance amending and clarifying various aspects of ASU 2016-13, using the modified retrospective method as required. In accordance with that method, the comparative period’s information continues to be reported under the relevant accounting guidance in effect for that period. Upon adoption of ASU 2016-13, the incurred loss impairment method was replaced with a new impairment model that reflects lifetime expected losses for our finance receivables. The adoption of ASU 2016-13 resulted in a cumulative-effect adjustment to decrease opening retained earnings by approximately $218 million, net of taxes, resulting from a pretax increase to our allowance for credit losses on finance receivables of approximately $292 million. Additionally, we have changed the presentation of accrued interest related to finance receivables in the Consolidated Balance Sheets from Finance receivables, net to Other assets. As of April 1, 2020, we have reclassified accrued interest of $190 million from Finance receivables, net to Other assets. The adoption of this new guidance did not result in a material impact to our available-for-sale debt securities portfolio.

Refer to Note 2 – Investments in Marketable Securities, Note 3 – Finance Receivables, Net, and Note 4 – Allowance for Credit Losses for additional information.

In conjunction with the adoption of ASU 2016-13, we updated our depreciation policy for operating leases so that the useful life of the vehicles incorporates our historical experience on early terminations due to customer defaults. As a result, we changed the presentation for reporting early termination expenses related to customer defaults on investments in operating leases. We now present the effects of operating lease early terminations as part of accumulated depreciation within Investments in operating leases, net in the Consolidated Balance Sheets and Depreciation on operating leases in the Consolidated Statements of Income. The comparative period’s information continues to be reported under the relevant accounting presentation in effect for that period. Refer to Note 5 – Investments in Operating Leases, Net for additional information.

Other Recently Adopted Standards

We adopted ASU 2018-13, Fair Value Measurement (Topic 820), which modifies disclosure requirements related to fair value measurement. The adoption of this guidance did not have a material impact on our consolidated financial statements and related disclosures.

We adopted 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. The adoption of this guidance did not have a material impact on our consolidated financial statements and related disclosures.

We adopted ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments. The adoption of this guidance related to Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments did not have a material impact on our consolidated financial statements and related disclosures. The impact on our consolidated financial statements for Topic 326, Financial Instruments – Credit Losses is discussed above.

We adopted ASU 2018-17, Consolidation (Topic 810), which requires that an indirect interest held through related parties in common control arrangements are to be considered on a proportional basis for determining whether fees paid to decision makers and service providers are variable interests. The adoption of this guidance did not have a material impact on our consolidated financial statements and related disclosures.

Accounting Guidance Issued But Not Yet Adopted

In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting, along with subsequently issued guidance, which provides temporary optional expedients and exceptions for applying generally accepted accounting principles to transactions affected by reference rate reform if certain criteria are met. Entities may apply the provisions of the new standard as of the beginning of the reporting period when the election is made. The provisions of this update are available until December 31, 2022. We plan to adopt this guidance on April 1, 2021. The adoption of this guidance will not have a material impact on our consolidated financial statements and related disclosures.

In October 2020, the FASB issued ASU 2020-08, Codification Improvements to Subtopic 310-20, Receivables-Nonrefundable Fees and Other Costs, which requires an entity to reevaluate the amortization period for investments in AFS callable debt securities held at a premium each reporting period. The premium is amortized to the earliest call date of the debt security. This ASU is effective for us on April 1, 2021. The adoption of this guidance will not have a material impact on our consolidated financial statements and related disclosures.

Cash and Cash Equivalents

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

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 proceeds from certain debt issuances for which the use of the cash is restricted.

Investments in Marketable Securities

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.

We adopted ASU 2016-13 on April 1, 2020, on a modified retrospective basis, as further described in Note 1 – Basis of Presentation and Significant Accounting Policies. Under the new guidance, once it is determined that a credit loss has occurred, an allowance for credit losses is established. Prior to the adoption of this standard, when a decline in fair value of a debt security was determined to be other-than-temporary, an impairment charge for the credit component was recorded in Investment and other income, net and a new cost basis in the investment was established. As of March 31, 2021, management determined that credit losses did not exist for securities in an unrealized loss position. This analysis considered a variety of factors including, but not limited to, performance indicators of the issuer, default rates, industry analyst reports, credit ratings, and other relevant information, which indicated that contractual cash flows are expected to occur.

All equity investments are recorded at fair value with changes in fair value included in Investment and other income, net in 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, Net

Finance receivables, net consists of retail loan and dealer products portfolio segments, and includes deferred origination costs, deferred income, and allowance for credit losses. 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, 2021 and 2020, all finance receivables were classified as held-for-investment.

Revenues associated with retail and dealer financing are recognized 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 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.

Upon adoption of ASU 2016-13, we elected the accounting policy to present accrued interest related to finance receivables within Other assets in the Consolidated Balance Sheets. As of March 31, 2021, accrued interest related to finance receivables is $187 million and is included in Other assets. The comparative period’s information continues to be reported within Finance receivables, net.

Upon adoption of ASU 2016-13, we no longer reverse accrued interest receivables from interest income for our dealer products portfolio when an account is deemed to be uncollectible. For both retail loan and dealer products portfolio segments, accrued interest, deferred income, and deferred origination costs, if any, are written off within Provision 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.

Allowance for Credit Losses

Upon adoption of ASU 2016-13 on April 1, 2020, the incurred loss impairment method was replaced with a new impairment model that reflects lifetime expected losses. 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:

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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, Lexus, and private label 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.

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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.

Management’s estimate of lifetime expected credit losses is based on an evaluation of relevant information about past events, current conditions, and reasonable and supportable forecasts that affect the future collectability of the finance receivables. Management’s evaluation takes into consideration the risks in the retail loan portfolio and dealer products portfolio, past loss experience, delinquency trends, underwriting and collection practices, changes in portfolio composition, economic forecasts and other relevant factors.

Prior to April 1, 2020, and the adoption of ASU 2016-13, allowance for credit losses were reported under the incurred loss impairment method. Comparative period’s information continues to be reported under the relevant accounting guidance in effect for that period in accordance with accounting policies described in Note 5 – Allowance for Credit Losses in our fiscal 2020 Form 10-K.

Methodology Used to Develop the Allowance for Credit Losses

The allowance for credit losses is measured on a collective basis when loans have similar risk characteristics. Loans that do not share similar risk characteristics are evaluated on an individual basis. We generally use a discounted cash flow approach for determining allowance for credit losses for finance receivables modified as a troubled debt restructuring that are granted with interest rate concessions, and a non-discounted cash flow approach for other loans.

We measure expected losses of all components of finance receivables on an amortized cost basis, excluding accrued interest, and including off-balance-sheet lending commitments that are not unconditionally cancellable by TMCC. Estimated expected credit losses for off-balance-sheet lending commitments within our dealer products portfolio are included in Other liabilities in the Consolidated Balance Sheets. We have elected to exclude accrued interest from the measurement of expected credit losses as we apply policies and procedures that result in the timely write-offs of accrued interest.

Note 4 – Allowance for Credit Losses (Continued)

Retail Loan Portfolio Segment

The level of credit risk in our retail loan portfolio segment is influenced by various factors such as economic conditions, the used vehicle market, credit quality, contract structure, and collection strategies and practices. The allowance for credit losses is measured on a collective basis when loans have similar risk characteristics such as loan-to-value ratio, book payment-to-income ratio, FICO score at origination, collateral type, contract term, and other relevant factors. We use statistical models to estimate lifetime expected credit losses of our retail loan portfolio segment by applying probability of default and loss given default to the exposure at default on a loan level basis.

Probability of default models are developed from internal risk scoring models which consider variables such as delinquency status, historical default frequency, and other credit quality indicators such as loan-to-value ratio, book payment-to-income ratio, FICO score at origination, collateral type (new or used, Lexus, Toyota, or private label), and contract term.

Loss given default models forecast the extent of losses given that a default has occurred and considers variables such as collateral, trends in recoveries, historical loss severity, and other contract structure variables. Exposure at default represents the expected outstanding principal balance, including the effects of expected prepayment when applicable.

The lifetime expected credit losses incorporate the probability-weighted forward-looking macroeconomic forecasts for baseline, favorable, and adverse scenarios. The loan lifetime is regarded by management as the reasonable and supportable period. We use macroeconomic forecasts from a third party and update such forecasts quarterly.

On an ongoing basis, we review our models, including macroeconomic factors, the selection of macroeconomic scenarios and their weighting to ensure they reflect the risk of the portfolio.

If management does not believe the models reflect lifetime expected credit losses, a qualitative adjustment is made to reflect management judgment regarding observable changes in recent or expected economic trends and conditions, portfolio composition, and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the allowance for credit losses may be necessary if conditions differ substantially from the assumptions used in making the evaluations.

Investments in Operating Leases, Net

Investments in operating leases, net consists of vehicle lease contracts acquired from dealers, and includes deferred origination fees and costs, deferred income, and accumulated depreciation. Generally, lessees have the ability to extend their lease term in six month increments up to a total of 12 months from the original lease maturity date. A lease can be terminated at any time by satisfying the obligations under the lease contract. Early termination programs may be occasionally offered to eligible lessees. At the end of the lease, the customer has the option to buy the leased vehicle or return the vehicle to the dealer.

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 recognized on a straight-line basis over the term of the lease. We have made an accounting policy election to exclude from the consideration in the contract, and from variable payments not included in the consideration in the contract, sales and other taxes assessed by a governmental authority that are both imposed on and concurrent with a specific lease revenue-producing transaction and collected from customers. Deferred fees and costs include incentive payments made to dealers and acquisition fees collected from customers. Deferred income includes payments received on affiliate sponsored subvention and other incentive programs. Both deferred fees and costs and deferred income are capitalized or deferred and amortized 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.

Vehicle Lease Residual Values

Contractual residual values of vehicle lease contracts are estimated at lease inception by examining external industry data, the anticipated Toyota, Lexus, and private label product pipeline and our own experience. Factors considered in this evaluation include macroeconomic forecasts, new vehicle pricing, new vehicle incentive programs, new vehicle sales, vehicle features and specifications, the mix and level of used vehicle supply, the level of current used vehicle values, and fuel prices. We are exposed to a risk of loss to the extent the customer returns the vehicle and the value of the vehicle is lower than the residual value estimated at inception of the lease or if the number of returned vehicles is higher than anticipated.

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.

We use various channels to sell vehicles returned at lease-end. Upon disposition, the difference between the net book value of the lease and the proceeds received from the disposition of the asset, including any insurance proceeds is recorded as an adjustment to depreciation on operating leases.

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.

Note 5 – Investments in Operating Leases, Net (Continued)

In conjunction with the adoption of ASU 2016-13 on April 1, 2020, we updated our depreciation policy for operating leases so that the useful life of the vehicles incorporates our historical experience on early terminations due to customer defaults. As a result, we changed the presentation for reporting early termination expenses related to customer defaults on investments in operating leases. Previously, we presented the early termination expenses reserve on operating leases as part of the allowance for credit losses which reduced Investments in operating leases, net in the Consolidated Balance Sheets, and as part of Provision for credit losses in the Consolidated Statements of Income. We now consider the effects of operating lease early terminations when determining depreciation estimates, which are included as part of accumulated depreciation within Investments in operating leases, net in the Consolidated Balance Sheets and Depreciation on operating leases in the Consolidated Statements of Income. As of April 1, 2020, the change in presentation increased accumulated depreciation and decreased allowance for credit losses by $90 million. The comparative period’s information continues to be reported under the relevant accounting presentation in effect for that period.

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, 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. We had no hedge accounting derivatives as of March 31, 2021 and 2020, respectively.

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 with the same counterparty on a net basis. Changes in the fair value of our derivative instruments are recorded in 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

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 Master Agreements are 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, 2021, 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 sheet date 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.

Secured Notes and Loans Payable

Our secured notes and loans payable are denominated in U.S. dollars and consist of both fixed and variable rate debt. Secured notes and loans payable are issued using on-balance sheet securitization trusts, as further discussed in Note 8 – Variable Interest Entities. These notes are repayable only from collections on the underlying securitized retail finance receivables and the beneficial interests in investments in operating leases and from related credit enhancements. Some of our secured notes are backed by a revolving pool of finance receivables and cash collateral, with the ability to repay the notes in full after the revolving period ends, after which an amortization period begins.

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 TFSIC and its subsidiaries. Current and deferred federal income taxes are allocated to TMCC as if it were a separate taxpayer. TMCC’s net operating losses and tax credits are utilized when those losses and credits are used by TFSIC and its subsidiaries including TMCC in the consolidated federal income tax return. 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 and credits utilized in the federal and state income tax returns.

Fair Value Measurement

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 and cash equivalents and Restricted cash and cash equivalents

The fair value of cash equivalents and restricted cash equivalents approximates the carrying value and these instruments are classified as Level 1 within 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 as Level 1 within 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 within 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 within 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 as Level 2 within the fair value hierarchy, however, depending on the significance of the unobservable inputs they may also be classified as Level 3.

Fair Value Transfer

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 as Level 2 within 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 as Level 3 within 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. Nonrecurring fair value items as of March 31, 2021 and 2020 were not significant. 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.

Level 3 Fair Value Measurements

The Level 3 financial assets and liabilities recorded at fair value which are subject to recurring and nonrecurring fair value measurement, and the corresponding activity and change in the fair value measurements of these assets and liabilities, were not significant to our Consolidated Balance Sheets as of March 31, 2021 and 2020, or Consolidated Statements of Income for the years ended March 31, 2021 and 2020.

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 as Level 3 within 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 as Level 2 within 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 as Level 2 within 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 as Level 3 within 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 as Level 3 within the fair value hierarchy.

Other liabilities

Our Other liabilities include notes payable to related parties. As these notes are short term in nature, the carrying value is deemed to approximate fair value and they are classified as Level 3 within the fair value hierarchy.

Credit Loss Financial Instrument

In conjunction with the adoption of ASU 2016-13, we have changed the presentation of accrued interest related to finance receivables in the Consolidated Balance Sheet from Finance receivables, net to Other assets; however, TMCC measures the fair value of each class of finance receivables using scheduled principal and interest payments. Therefore, accrued interest has been included in the carrying value of each class of finance receivables in the tables above, along with finance receivables, deferred origination costs, deferred income, and allowance for credit losses.

Revenue Recognition

Voluntary protection 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 voluntary protection contract revenues in Other liabilities on our Consolidated Balance Sheets.

For the years ended March 31, 2021 and 2020, respectively, approximately 83 percent and 84 percent of voluntary protection contract revenues in the Voluntary protection operations segment were accounted for under ASU 2014-09.

The Voluntary protection operations segment defers contractually determined incentives paid to dealers as contract costs for selling voluntary 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 years ended March 31, 2021 and 2020.

Insurance Losses and Loss Adjustment Expenses

Insurance earned premiums

Revenues from providing coverage under various insurance contracts are recognized over the term of the coverage in relation to the timing and level of anticipated claims. Revenues from insurance policies, net of premiums ceded to reinsurers, are earned over the terms of the respective policies in proportion to the estimated loss development. Management relies on historical loss experience as a basis for establishing earnings factors used to recognize revenue over the term of the contract or policy.

Voluntary protection contract expenses and insurance losses

Voluntary protection contract expenses and insurance losses 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 contracts entered into by TMIS are not significant as of March 31, 2021 and 2020. 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 voluntary protection 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 Voluntary protection operations are determined in a manner consistent with the related reinsurance or risk transfer contract. 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 contracts. Covered losses are recorded as a reduction to Voluntary protection contract expenses and insurance losses.