Financial Instruments: Recognition and Measurement — Comprehensive Project

Date recorded:

The Board continued their deliberations of Fair Value Measurements (FVM) and debated a number of key issues relating to recognition and measurement.

Reliability of fair value measurement

The Board discussed the question whether all financial instruments and related items can be measured with sufficient reliability at a reasonable cost. The Board indicated that particularly for some unquoted equity instruments and long-term derivatives subjective assumptions might be necessary. However, it decided that no exceptions should be allowed. The question whether costs might outweigh the benefits was not discussed at this meeting.

Unit of account for recognition

The staff paper considered the following possible units of account for recognition purposes:

  • A portion of the individual instrument
  • The individual instrument
  • A linked (synthetic) instrument

The Board decided that the individual instrument should be used as starting point for recognition purposes. It noted that this approach might be overridden by a specific requirement in a Standard, e.g. by allowing the recognition of linked financial instruments.

Initial measurement

The Board discussed whether a financial instrument should be initially measured at:

  • Market exit price
  • Transaction price/market entry price

Some Board members noted that the transaction price/market entry price should not differ from the market exit price on initial recognition. Other Board members argued that there might be a difference depending on the evaluation model used by the entity at initial recognition. Finally, the Board was nearly equally split between market exit price model and entry price model and no final decision was made. However, it was noted that for subsequent measurement the exit price should be applied.

Unit of measurement

The staff paper considered the following possible units of measurement:

  • Individual instrument
  • Portfolio of instruments
    1. Portfolios of identical financial instruments traded in an active market
    2. Portfolios of non-identical financial instruments that share broadly similar risks
    3. Portfolios of non-identical financial instruments with offsetting separately identifiable risks

The Board decided that the individual instruments should be the starting point for measurement purposes but that also portfolio categories a) and b) might be an appropriate unit of measurement.

Reporting of unrealized gains and losses

The Board considered how unrealised gains and losses arising from the remeasurements of financial instruments should be reported. The Board decided not to distinguish between realised and unrealised gains and losses and that all realised and unrealised gains and losses should be reported in profit and loss.

Measurement of guaranteed liabilities

The Board discussed whether a financial guarantee affects the measurement of a guaranteed liability and whether the guarantee should be considered separate from the liability (and hence not affect the fair value of the debtor's liability) or as part of the liability (and hence should be taken into account in measuring the fair value of the debtor's liability). No decision was made but the staff was asked to elaborate this issue further for discussion in a future meeting. Reporting of fair value changes arising from changes in an entity's own credit risk or own share price. No decision was made. The staff was asked to elaborate this issue further for discussion in a future meeting.

Measurement of certain options and embedded options

This issue relates to the question, what expected cash flows should be used in valuing the present contractual rights and obligations of an entity. As an example the Board discussed the option a credit card company writes to the holder of the credit card, under which the holder can either obtain a cash advance or use the card to purchase goods or services.

Two approaches were deliberated:

  • Approach A: The cash flows used assume exercise of the option only in those circumstances in which a securities option would be exercised, that is, when the exercise price of an option to buy an item is less than the market price for the same item
  • Approach B: All expected cash flows a market participant are considered in valuing the option contract, i.e. to use all the possible cash flows arising from the operation of the existing contract
The Board decided that approach B should be applied.

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