Fair Value Measurement
Fair value of liabilities
The Board revisited the issue of how to measure fair value when there is no observable market price for a liability and whether the fair value of the corresponding asset is an input that an entity should consider when measuring the fair value of its liability. The staff had suggested that the liability value might differ from the asset value in some circumstances, including when the asset value includes:
- the effect of transfer restrictions or
- features such as third-party credit enhancements that are not part of the liability.
The Board disagreed with the staff's suggestion. Several Board members disputed the examples put forward by the staff, noting that the fair value measurement guidance that is being developed is explicit that the fair value is being determined for a transaction involving the same asset in the same market. In both cases in which it was alledged that the presumption that the fair value of the asset would not equal the fair value of the liability, the symmetry was not there. In one case, third-party credit enhancements are, by definition, separate from the asset and liability and would not affect the determination of fair value as explained in the proposed guidance. In the case of transfer restrictions, if the restrictions attached to the asset, the argument would not hold (since all market participants would face the same restrictions), and if the restrictions attached to the market participant, they would not be related to the asset and liability and would thus be excluded from the determination of fair value.
The Board noted that the proposed guidance for 'Level 2' measures goes in to considerable depth to explain how to apply the basic principle in the proposed IFRS. There is a presumption that the fair value of an asset will be the same as that of the corresponding liability, unless there are observable conditions related specifically to the transaction. Most differences that are said to exist are usually related to the counterparties not the asset or liability itself. However, the Board agreed that the assertion is a frequent challenge to the 'exit equals entry' presumption and that the Invitation to Comment should identify the issue and challenge respondents to address disprove the Board's analysis.
Day One gains and losses
The Board decided that for the initial measurement of financial instruments that will subsequently be classified as FVPL:
- An entity should apply the IASB's guidance on fair value measurement in determining the fair value of a financial instrument at initial recognition. Thus, fair value at initial recognition equals the transaction price unless one of the factors described elsewhere in the document (related parties, duress, different unit of account, different market) applies.
- If the fair value at initial recognition differs from the transaction price, the entity should recognise the resulting gain or loss as income or expense if, and only if, a specified observability criterion is met.
- If that observability criterion is not met:
- the entity initially measures the financial asset or financial liability at fair value, adjusted to defer the difference between the transaction price and the initial fair value (a deferred gain or loss).
- subsequently, as already required by IAS 39 paragraph AG76A, the entity recognises the deferred gain or loss only to the extent that it arises from a change in a factor (including time) that market participants would consider in setting a price. It is beyond the scope of the project on fair value measurement to reconsider the subsequent accounting for these deferred gains and losses.
The Board then discussed whether it should retain the existing wording in IAS 39 for the observability criterion. The staff noted that this approach would minimise change to existing practice. However, it would result in two different, but overlapping, hierarchies for financial instruments: the 3-level fair value measurement hierarchy and a 2-level hierarchy that determines whether day one gains or losses are deferred (for financial instruments). The staff was concerned that this might cause confusion and complexity.
After a lengthy debate, the Board decided that it should not change the guidance in IAS 39 with respect to 'Day One' gains and losses. In addition, the guidance in IAS 39 AG76-78 would remain as currently. The Board considered that the guidance being proposed in the fair value measurement guidance was address 'how to do' fair value and used different words and thresholds, but should arrive at the same answer.
Liabilities with a demand feature
After some debate, the Board decided that the fair value measurement guidance should provide a scope exemption for liabilities with a demand feature - that is, the current requirements in IAS 39 would be unaffected by the new IFRS. The Board noted that the measurement and financial reporting issues related to such instruments is unresolved at both the IASB and FASB and will be addressed in other IASB financial instrument projects. To address it unilaterally in the IASB's proposed standard would open other thorny issues and it was best left alone for the time being.