The Financial Accounting Standards Board (FASB) completed its project on the classification and measurement of financial instruments with the release of Accounting Standards Update (ASU) 2016-01, Financial Instruments- Overall (Topic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities. The project began as one of the significant convergence projects with the International Accounting Standards Board (IASB), however, differences between the two Boards has resulted in accounting standards for financial instruments that are not converged in many respects.
The project included two previous exposure drafts issued in 2010 and 2013. The finalized ASU, however, differs in many significant respects from the changes proposed in each of those exposure drafts, largely due to the feedback received from constituents. The scope of the classification and measurement project ultimately became narrower in focus. It provides only targeted improvements to various aspects of the measurement and classification of financial instruments, primarily equity instruments.
The final ASU also provides disclosure relief for both public and non-public entities. Guidance for the classification and measurement of debt securities and loans receivable remains unchanged.
Fair Value Measurement – Equity Instruments
Entities currently must classify equity securities with readily determinable fair values into one of two categories, trading or available-for-sale. Equity instruments without readily determinable fair values are recorded at cost.
ASU 2016-01 requires all equity instruments, excluding those accounted for under the equity method and certain other exclusions such as the Federal Reserve and Federal Home Loan Bank Stock, to be recorded at fair value with changes in fair value included in net income. This eliminates the option to account for equity securities as available-for-sale with changes in fair value recorded in other comprehensive income.
Equity instruments such as partnership interests, limited liability interests and other non-marketable instruments are included within the scope of ASU 2016-01. However, entities can elect to measure equity instruments that do not have readily determinable fair values at cost minus impairment, factoring in changes from observable price changes that stem from orderly transactions of the same or substantially similar instruments from the same issuer. This practicability exception differs from the cost method due to the requirement to remeasure the instrument if subsequent transactions of the same issuer indicate the fair value has changed. As described below, changes to the impairment evaluation will also impact the accounting for these instruments. The practicability exception does not apply to investments measured at the Net Asset Value (NAV). Enhanced disclosures will also be required to provide financial statement users with additional information about the equity instruments.
Instruments measured using the practicability exception must be reassessed each reporting period to determine if each instrument remains qualified for the exception. If the instrument no longer qualifies, it must be measured at fair value, with changes recorded through income.
The ASU requires entities to assess impairment for those equity instruments measured using the practicability exception during each reporting period. The assessment is qualitative in nature, and should an entity determine that impairment exists, the entity must remeasure the instrument at fair value and recognize the difference between the carrying amount and fair value as a component of net income. This differs from the current impairment analysis in that the concept of other than temporary is eliminated from the analysis. Should an entity determine the instrument's fair value is below the carrying amount, an evaluation of the facts and circumstances (including amount of impairment, expected recovery, etc.) is not permitted. Rather, the carrying amount of the instrument should be written down to its fair value.
Disclosure Requirements - Instruments Measured at Amortized Cost
All public and many non-public entities are currently required to provide disclosures regarding the fair value of financial instruments recorded at amortized cost in their financial statements. ASU 2016-01 eliminates many of these disclosure requirements for both public and non-public entities. The requirements for non-public entities are eliminated in their entirety, as these entities will no longer be required to disclose the fair value for instruments that are measured at amortized cost.
Public business entities will be required to disclose the fair value of such instruments, however, they will no longer be required to disclose the significant assumptions used to estimate fair value for instruments measured at amortized cost. The ASU also clarifies that the exit price notion in ASC Topic 820, Fair Value Measurement should be used to measure fair value.
Fair Value Option
Original deliberations included the elimination of the fair value option, however, ASU 2016-01 retains the fair value option for financial assets and liabilities in its current state. The ASU does require a change in the classification of unrealized gains and losses related to an entity's own creditworthiness.
Currently, when a liability is recorded at fair value under the fair value option, a change in the instrument's fair value due to a change in the creditworthiness of the reporting entity is reported in net income. Often, this results in unrealized gains during periods in which the reporting entity is experiencing financial difficulties. Users of financial statements have found that the presentation does not provide useful decision-making information. As a result, the ASU addresses this concern by excluding from net income unrealized gains and losses attributable to the reporting entity's creditworthiness. Rather, entities will present separately in other comprehensive income the total change in fair value of a liability that results from a change in an instrument's specific credit risk when the entity has elected the fair value option to measure that liability. The requirement does not apply to financial liabilities that are required to be measured at fair value, such as derivative financial instruments.
Presentation of Financial Assets and Liabilities
The ASU provides additional clarification regarding the presentation of financial assets and liabilities by requiring an entity to separate assets and liabilities by measurement category and by form of financial asset (securities, loans, receivables, etc.) on the balance sheets or the notes thereto. The presentation is designed to provide more clarity about the types of financial assets and liabilities that a reporting entity holds.
Deferred Taxes - Valuation Allowance
Diversity currently exists with respect to the valuation of deferred tax assets associated with available-for-sale securities. The ASU clarifies that the evaluation should be performed in conjunction with an entity's other tax-deferred assets rather than as a separate deferred tax asset. This eliminates the ability to consider the ability and intent to hold the securities to maturity as a tax planning strategy. The change may result in additional valuation allowances required by reporting entities.
Implementing the Changes
Public business entities will be required to implement the amendments from the ASU for fiscal years and interim periods beginning after December 15, 2017 (calendar year 2018). All other entities, including not-for-profits and employee benefit plans subject to Topics 960 through 965, must adopt for annual periods beginning after December 15, 2018 (calendar year 2019) and interim periods beginning after December 15, 2019 (calendar year 2020). Non-public entities may also adopt the amendments on the same effective date as public business entities.
All entities may early adopt the provisions requiring changes in fair value related to instrument specific credit risk to be recorded as a component of other comprehensive income. Non-public entities may also adopt the provisions eliminating the requirement to disclose the fair value of financial instruments measured at amortized cost for any period in which the financial statements have not been issued.
For More Information
If you have any specific comments, questions or concerns about how the amendments to current guidance will affect your organization, please contact Mike Loritz of the MHM Professional Standards Group. Mike can be reached at 816.945.5611 or email@example.com.
Published on January 19, 2016