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Journal entry — Accounting for financial instruments — FASB makes decisions regarding scope and classification of financial liabilities

Published on: Feb 24, 2010

Today, the FASB held a Board meeting to continue its deliberations on the Accounting for Financial Instruments (AFI) project. The agenda for today’s Board meeting was to discuss (1) which nonconsolidated equity method investments should be accounted for under the equity method or included within the scope of the AFI project, (2) scope exception for certain entities, and (3) classification and measurement of financial liabilities. Discussed below are tentative decisions reached by the Board on the above-mentioned topics:

Equity Method Investments

The Board tentatively agreed that equity method accounting would be required if (1) the investor has significant influence over the investee and (2) the investment is considered related to the investor’s consolidated business. The Board agreed that all other investments would be within the scope of the AFI project and thus measured at fair value with changes in fair value recognized in net income. The Board directed the staff to identify a principle that must be applied when determining whether the criteria for equity method accounting are met.

The Board also agreed (by a narrow margin) to prohibit the fair value election  currently permitted under ASC 825, Financial Instruments, for investments that are required to be accounted for under the equity method, as discussed above. However, for investments accounted for under the equity method, the Board agreed to require fair value disclosures if such investments are publicly traded.

Scope

The Board tentatively agreed to allow a delayed effective date for private entities with less than $1 billion in consolidated total assets. Although the Board has not yet discussed the effective date of the proposed standard, the Board members indicated that the effective date for private entities with less than $1 billion in consolidated total asset would be four years after the effective date of the new standard. However, note that the delayed effective date only relates to loans and core deposit liabilities that require remeasurement under the AFI project. Therefore, private entities (with less than $1 billion in consolidated total assets) will continue to measure all loans and core deposit liabilities under today’s accounting requirements during this period. In reaching this decision, the Board noted cost/benefit concerns for such entities and emphasized that a delayed effective date for such financial items would allow practice and infrastructure to develop for remeasurement of core deposit liabilities.

The Board will discuss as part of the effective date and transition requirement of the AFI project (at a future meeting) whether the delayed effective date for remeasurement of loans and core deposit liabilities is a requirement or an election for such private entities. However, the Board concluded that such private entities will be required to provide fair value disclosures (consistent with an exit price notion) for loans in its notes to the financial statements. The Board directed the staff to consider, as part of the overall AFI project, the accounting for loan commitments.

Classification and Measurement of Financial Liabilities

The Board reaffirmed its previous decisions regarding the classification and measurement of financial liabilities, that is, those measured at fair value (with changes in fair value recorded in earnings or other-comprehensive income) or at amortized cost, if certain criteria are met. The Board reaffirmed that for financial liabilities with principal amounts held for contractual cash flows that contain embedded derivatives that require bifurcation under ASC 815-15, the hybrid instrument must be measured at fair value through earnings. That is, no bifurcation and separate accounting is permitted for the embedded feature and the host contract. However, the Board tentatively agreed to require entities to present on the face of the financial statement significant changes in gains or losses related to own credit risk for financial liabilities that are measured at fair value through earnings or other comprehensive income. The Board also directed the staff to conduct an outreach to preparers to identify how gains and losses related to changes in own credit risk are calculated by entities that have currently elected the fair value option under ASC 825.

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