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Financial instruments — Classification and measurement

Summary

The FASB is currently finalizing amendments to its guidance on the classification and measurement of financial instruments. The Board is no longer pursuing a converged approach but rather has decided to retain existing requirements related to (1) the classification and measurement categories for financial instruments other than equity investments, (2) the method for classifying financial instruments, (3) bifurcation of embedded derivatives in hybrid financial assets, and (4) accounting for equity method investments (including impairment of such investments). However, the amendments include significant changes pertaining to (1) classification and measurement of investments in equity securities, (2) recognition of certain fair value changes in financial liabilities measured at fair value, and (3) disclosure requirements.

See Deloitte’s February 2, 2015, Heads Up for more information.

Classification and measurement of equity investments

Under the FASB’s tentative approach, entities will be required to carry all investments in equity securities that do not qualify for the equity method or a practicability exception at fair value through net income (FVTNI). For investments in equity securities without a readily determinable fair value that do not qualify for the net asset value (NAV) practical expedient in ASC 820-10-35-59, an entity would be permitted to elect the practicability exception to fair value measurement, under which the investment would be measured at cost, less impairment, plus or minus observable price changes (in orderly transactions) of an identical or similar investment of the same issuer. This exception would not be available to reporting entities that are investment companies or broker-dealers in securities.

Impairment assessment of equity investments that are measured by using the practicability exception

In an effort to simplify the impairment model for equity securities for which an entity has elected the practicability exception, the FASB has tentatively decided to eliminate the requirement to assess whether an impairment of such an investment is other than temporary. In each reporting period, an entity would qualitatively consider the following indicators (from paragraph 825-10-35-18 of the proposed ASU) to determine whether the investment is impaired:

  1. A significant deterioration in the earnings performance, credit rating, asset quality, or business prospects of the investee
  2. A significant adverse change in the regulatory, economic, or technological environment of the investee
  3. A significant adverse change in the general market condition of either the geographic area or the industry in which the investee operates
  4. A bona fide offer to purchase, an offer by the investee to sell, or a completed auction process for the same or similar investment for an amount less than the cost of that investment
  5. Factors that raise significant concerns about the investee’s ability to continue as a going concern, such as negative cash flows from operations, working capital deficiencies, or noncompliance with statutory capital requirements or debt covenants.

If the entity determines that the equity security is impaired on the basis of an assessment of the above indicators, it would recognize an impairment loss equal to the difference between the security’s fair value and carrying amount. In contrast, the existing guidance in ASC 320-10-35-30 requires entities to perform a two-step assessment under which an entity first determines whether an equity security is impaired and then evaluates whether any impairment is other than temporary.

Presentation of fair value changes attributable to instrument-specific credit risk for fair value option liabilities

The FASB has tentatively decided to introduce a new requirement related to the presentation of fair value changes of financial liabilities for which the fair value option has been elected. Under this tentative decision, an entity would be required to separately recognize in other comprehensive income the portion of the total fair value change attributable to instrument-specific credit risk. For derivative liabilities, however, any changes in fair value attributable to instrument-specific credit risk would continue to be presented in net income.

Under the FASB’s tentative approach, an entity would measure the portion of the change in fair value attributable to instrument-specific credit risk as the excess of total change in fair value over the change in fair value “resulting from a change in a base market risk, such as a risk-free interest rate . . . . Alternatively, an entity may use another method that it considers to more faithfully represent the portion of the total change in fair value resulting from a change in instrument- specific credit risk.” In either case, the entity would be required to disclose the method it “used to determine the gains and losses attributable to instrument-specific credit risk and [to] apply the method consistently from period to period.”1

Valuation allowance on a deferred tax asset related to an AFS debt security

The proposed guidance would clarify that an entity is required to “make the assessment of a valuation allowance for a deferred tax asset related to an available-for-sale debt security in combination with the entity’s other deferred tax assets.”

Next steps

The FASB plans to issue an ASU on the classification and measurement of financial instruments during the second quarter of 2015. The effective date of the new guidance will be determined at a future FASB meeting.

FASB project information

For further information, see the project update page on the FASB's Web site.

Contacts

Magnus Orrell
Director, Deloitte & Touche LLP
+1.203.761.3402

Shahid Shah
Partner, Deloitte & Touche LLP
+1.203.563.2749

           

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1 Quoted text is from a handout for the April 23, 2014, FASB meeting.

 

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