FASB Makes Progress on Classification and Measurement

Published on: 12 Aug 2011

At its August 10 meeting, the FASB made a number of tentative decisions on three aspects of the classification and measurement portion of its project on the accounting for financial instruments: (1) presentation, (2) the equity method of accounting, and (3) an entity’s “own credit” risk.

Presentation

The Board voted to require public entities to:

  • Present fair value parenthetically on the face of the balance sheet for assets and liabilities measured at amortized cost, excluding core deposit liabilities. (Note that short-term receivables and payables would be exempted from this requirement.)
  • Determine these fair value measurements in accordance with ASC 820.1
  • Disclose a present value amount for core deposit liabilities. (Note that the Board requested the staff to further develop this present value measurement attribute and will discuss this issue at a future meeting. See editor’s note below).
  • Exempt short-term receivables and payables from the parenthetical disclosure of fair value on the face of the balance sheet.

The FASB plans to address these presentation and disclosure requirements for nonpublic entities at a future meeting.

The Board also tentatively decided to require all entities (public and nonpublic) to:

  • Separately present financial assets and financial liabilities on the balance sheet by classification and measurement category (an affirmation of a proposal in the FASB’s May 2010 exposure draft (ED)2).
  • Present amortized cost parenthetically on the face of the balance sheet for an entity’s own debt measured at fair value.
  • Present in net income an aggregate amount of realized and unrealized gains or losses for financial assets measured at fair value through net income (FV-NI) and, similarly, for financial liabilities measured at FV-NI.
  • Separately present cumulative credit losses on the face of the balance sheet for financial assets measured at amortized cost.
  • Separately present the following items in net income for financial assets and liabilities measured at amortized cost or for financial assets measured at fair value through other comprehensive income:
    • Current-period interest income (financial assets) and expense (financial liabilities).
    • Credit losses for the current period (financial assets).
    • Realized gains or losses (both financial assets and liabilities).

Editor’s Note: The Board’s tentative decision to require parenthetical presentation of fair value on the basis of an exit price for financial liabilities measured at amortized cost (excluding core deposits), but not to provide a practicability exception, is a change from existing U.S. GAAP. ASC 825-10-50-10(a) (formerly paragraph 10 of Statement 1073) requires an entity to disclose “the fair value of financial instruments for which it is practicable to estimate that value.”

In addition, some entities use an entry price, instead of the exit price in ASC 820, to comply with this current disclosure requirement. The guidance often cited to support this approach is Example 1 from the implementation guidance in ASC 825-10-55-3, which provides a sample disclosure for a hypothetical bank. ASC 825-10-55-3 states, in part, “The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.” In short, this is a description of the transaction price associated with a loan issuance occurring at the time of valuation, or an entry price. When introducing its presentation questions to the Board, the FASB staff noted that some preparers and auditors had operational concerns about presenting loans at fair value on the face of the balance sheet, including that entities may need more time, and may incur additional costs, when moving from an entry price calculation to an exit price calculation. Despite these concerns, the Board tentatively decided that an exit price should be used.

The Board also tentatively decided to require public entities to disclose a present value measure for core deposit liabilities and requested the staff to further develop the related measurement technique. A starting point may be the core deposits liabilities remeasurement approach prescribed in the May 2010 ED. Specifically, paragraph 31 of the ED stated that “[a]n entity shall measure its core deposit liabilities at the present value of the average core deposit amount during the period discounted at the difference between the alternative funds rate and the all-in-cost-to-service rate over the implied maturity of the deposits (the core deposit liabilities remeasurement approach).” Nonetheless, it remains to be seen what present value measure the Board would require public entities to disclose.

Equity Method Accounting

The FASB’s May 2010 ED proposed eliminating the fair value option for equity method investments. However, at its May 26, 2011 meeting, the Board directed the staff to explore alternative criteria under which entities would be required to measure at FV-NI investments otherwise eligible for the equity method of accounting. At yesterday’s meeting, the Board tentatively decided to require entities to measure such investments at FV-NI if they are held for sale when the investment initially becomes eligible for the equity method of accounting. The FASB’s August 10, 2011, Action Alert notes that the following indicators would be determinative that an entity’s investment that qualifies for the equity method of accounting is held for sale:

1. The entity has specifically identified potential exit strategies.

2. The entity has defined the time at which it expects to exit the investment.

In addition, an entity would not be required to determine, upon an investment’s qualification for the equity method of accounting, the specific strategy to exit the investment. The time at which an entity expects to exit the investment may be based on a range of dates, or the occurrence of a contingent event such as the achievement of specific milestones or investment objectives.

An entity would not be required to reassess its determination of whether an investment eligible for the equity method of accounting is held for sale. Thus, it would not have to subsequently measure at fair value existing equity method investments determined not to be held for sale or subsequently apply the equity method of accounting to investments previously determined to be held for sale when first evaluated.

Own Credit

The Board tentatively decided that it would not require separate presentation of changes in the fair value of financial liabilities measured at FV-NI attributable to changes in an entity’s “own credit” risk.

Editor’s Note: As redeliberations of this project continue, the population of liabilities subsequently measured at fair value may change. The Board indicated during yesterday’s meeting that a significant change in this population may lead the Board to revisit this tentative decision.

For information about the Board’s previous tentative decisions on the classification and measurement of financial instruments, see Deloitte’s May 10, 2011, Heads Up newsletter and May 27, June 1, June 13, and June 22, 2011, journal entries.

[1] For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s "Titles of Topics and Subtopics in the FASB Accounting Standards Codification."

[2] FASB Proposed Accounting Standards Update, Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities.

[3] FASB Statement No. 107, Disclosures About Fair Value of Financial Instruments.

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