The Financial Accounting Standards Board (FASB) recently proposed technical improvements for the soon-to-be effective Accounting Standards Update (ASU) 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 makes targeted, but significant, changes related to classification and measurement of investments in equity securities and presentation of fair value changes in certain financial liabilities. This standard will be effective for public business entities (PBE) in 2018.
The proposed amendments address a number of issues. The changes are not expected to have a significant effect on current accounting practice or create significant administrative costs for most entities. FASB addresses when and how to apply the measurement alternative to equity securities without a readily determinable fair value (RDFV) and presentation when the fair value option (FVO) is elected.
The corrections, if adopted, would have the same effective date as ASU 2016-01; special transition applies to early adopters of the FVO provisions. Comments are due by November 13, 2017, and a final standard is expected before year-end.
Ability to Change Measurement Method When Applying the Measurement Alternative for Equity Securities Without an RDFV
ASU 2016-01 provides a measurement alternative that can be elected for individual equity securities that do not have an RDFV and do not qualify for the net asset value (NAV) practical expedient. Under the measurement alternative, a security would be measured at cost minus impairment, adjusted for observable price changes. Once elected, an entity must continue to apply the measurement alternative until the investment no longer qualifies for the measurement alternative, e.g., if the investment has an RDFV or becomes eligible for the NAV practical expedient.
FASB did not want to preclude the future use of a more precise measurement method as market conditions change; therefore, the proposal would allow an entity to apply a more precise measurement method if it subsequently elects to do so. The proposal clarifies that an entity measuring an equity security using the measurement alternative may change its measurement approach to a fair value method in accordance with Topic 820, Fair Value Measurement, by electing an initial accounting policy that would apply to that security and all other securities of the same type. Any resulting gains or losses on the securities for which that election is made would be recorded in earnings at the time of the election.
Measurement Date to Be Used When Applying the Measurement Alternative for Equity Securities Without an RDFV
The amendments would clarify that the adjustments made under the measurement alternative should aim to reflect the security’s fair value as of the date the observable transaction for a similar security took place. No other adjustments should be made to reflect events or other circumstances through the reporting date.
Measurement of Changes in Fair Value for Forward Contracts & Purchased Options on Equity Securities Without an RDFV for Which the Measurement Alternative Is Applied
The amendments would clarify that the remeasurement of forward contracts and purchased options on equity securities should be performed when observable transactions or impairment occurs on the underlying equity securities. Remeasuring the entire value of forward contracts and purchased options is required when observable transactions occur on the underlying equity securities. An entity must update all valuation inputs, not just the input related to the change in the underlying security’s value.
Transition Guidance for Equity Securities Without an RDFV
ASU 2016-01 requires a prospective transition for equity securities without an RDFV. This proposal clarifies the prospective approach is only meant for instances in which the measurement alternative is actually applied. An entity could choose to measure some equity securities without an RDFV at fair value under Accounting Standards Codification 820, and would then use a modified retrospective transition, with a cumulative adjustment to opening retained earnings.
Fair Value Option
Presentation Requirements for Certain FVO Liabilities
Current guidance requires separate presentation of the portion of the total change in the fair value of a liability attributable to a change in instrument-specific credit risk (ISCR) within other comprehensive income. FASB never intended to amend practice on how ISCR should be measured. The proposal clarifies that when the FVO is elected for a financial liability, the liability should be considered to have ISCR if it is a general obligation of the entity, regardless of whether the FVO was elected under Subtopic 815-15, Derivatives and Hedging—Embedded Derivatives, or Subtopic 825-10, Derivatives and Hedging.
Presentation of FVO Liabilities Denominated in a Foreign Currency
ASU 2016-01 was not intended to amend practice on how ISCR or FVO liabilities should be measured. The proposal updates Topic 825 and Topic 830, Foreign Currency Matters, to clarify that for FVO liabilities, the amount of the change in fair value that relates to ISCR should first be measured in the currency of denomination when presented separately from the total change in the financial liability’s fair value. Then, both components of the change in the liability’s fair value should be remeasured into the functional currency of the reporting entity using end-of-period spot rates.
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