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Classification and measurement of financial liabilities — Fair value option for financial liabilities

Date recorded:

The Board continued its re-deliberation of the proposal for classification and measurement of financial liabilities resulting from the ED Fair Value Option for Financial Liabilities.

Application to loan commitments and financial guarantee contracts

The exposure draft proposed that the portion of changes in fair value of a liability attributable to own credit risk would be recognised in other comprehensive income (OCI). One respondent to the exposure draft had suggested the provisions of separately recognising the credit risk component within OCI should not be permitted for loan commitments and financial guarantee contracts as such instruments either meet the definition of a derivative or have economic characteristics similar to derivatives. Additionally, the IASB's exposure draft Insurance Contracts would require that financial guarantees be scoped out of IFRS 9 and brought within the scope of insurance contract accounting which could result in changes in the accounting treatment for such contracts upon the issuance of this standard and then again upon the issuance of the insurance contracts standard, should the two standards not have similar effective dates.

The Board agreed to remove both loan commitments and financial guarantee contracts, for which the fair value option has been elected, from the scope of the guidance recognising credit risk within OCI such that all changes in fair value for these instruments would continue to be recognised in profit and loss.

Presentation of changes in credit risk

The exposure draft also proposed a presentation requirement that the entire change in fair value of the liability be presented within profit and loss offset by the portion attributable to changes in credit risk recognised in OCI (commonly referred as the two-step approach).

Most of the respondents to the comment letter process preferred the one-step approach (presenting simply the net amount of the changes in fair value not attributable to credit risk) rather than the two-step approach. They felt there was little added benefit to this presentation requirement and added additional clutter to the face of the performance statement. Additionally, the IASB's proposal to combine the statement of profit and loss and statement of other comprehensive income into a single performance statement would present the entire fair value change within the same statement.

One of the Board members expressed concern that the Board seems to address presentation requirements individually within each standard rather than in an overall project on presentation.

The staff recommended a one-step presentation approach based on the feedback received and mentioned that the entire change in fair value of the liability will still be disclosed in the footnotes. The Board agreed with the staff recommendation for the one-step presentation approach.

Recycling of amounts from OCI to profit and loss

The exposure draft proposed that the portion of changes in fair value of a liability attributable to credit risk recognised in OCI should not be recycled to profit and loss upon the ultimate settlement and derecognition of the liability.

Many respondents in the comment letter process disagreed with this aspect of the proposal. They acknowledged that if the contractual amount of the liability were paid on settlement then there would be no amount to recycle. However, if the liability were able to be settled at fair value (or any amount other than contractual), then the amounts recognised within OCI should be recycled to profit and loss as OCI represents a temporary holding place and that realised and unrealised gains and losses should be treated differently (the realisation represents a crystallisation of those gains or losses). Other respondents agreed with the proposal in the exposure draft while others noted that a broad principle needed to be addressed around the use of OCI in all circumstances.

The staff recommended the Board require amounts related to changes in credit risk to be recycled from OCI to profit and loss when the liability is settled for an amount other than the contractual amount due and those amounts are realised. This recommendation was based on the fact that the Board's rational for recognising the impact of credit losses within OCI was that presenting the effect of changes in own credit risk within profit and loss does not provide useful information because the entity will generally not be able to realise those amounts. The staff interpreted that in those instances when the gains or losses are realised then they should be recognised in profit and loss. This is different from the conclusion reached within IFRS 9 for equity investments measured at fair value through other comprehensive income where the benefits are related to non-contractual relationships rather than increases in value of the instrument.

The Board was split on their views related to the recycling of the credit risk component of the fair value changes from OCI to profit and loss. Many Board members felt that the settlement of the liability for other than the contractual amount resulted in a realisation event which should be recognised in profit and loss. Other Board members were strongly opposed to permitting recycling of amounts from OCI to profit and loss, describing it as "opening Pandora's box".

The discussion went back and forth focusing on both the specific question at hand of recycling credit risk upon derecognition of the liability as well as a more philosophical discussion around the overall purpose of OCI, the performance statement and whether recycling represents double counting within the performance statement. Multiple Board members expressed their hope that a project to address the conceptual issues of OCI and the performance statements is added to the agenda, either as part of the financial statement presentation project or as a separate project. Another Board member mentioned that if convergence is to ever be achieved, the issue of OCI will have to be addressed as unlike IFRS, U.S. GAAP frequently permits recycling of amounts within OCI to profit and loss upon a realisation event.

The Board ultimately agreed to not permit recycling of amounts within OCI, even when a liability is derecognised at an amount other than the contractual amount.