Classification and measurement of financial instruments — FASB deliberates several aspects of the proposed guidance

Published on: 16 May 2014

At its May 14, 2014, meeting, the FASB continued redeliberating its February 2013 proposed ASU1 on recognizing and measuring financial assets and financial liabilities. Specifically, the FASB’s summary of board decisions notes that the Board discussed the following items at the meeting:

1.   Scope of equity investments to be classified in the trading category

2.   Available-for-sale classification for certain equity investments

3.   Clarifications to the practicability exception from classifying all equity investments in the trading category

4.   Impairment assessment of equity investments that are not measured at fair value through net income

5.   Evaluation of the valuation allowance on a deferred tax asset related to debt securities classified in the available-for-sale category

6.   Accounting for pools of similar financial assets

7.   Accounting for loan commitments, revolving lines of credit, and commercial letters of credit

8.   Recognition and measurement of foreign currency gains and losses on debt securities classified as available for sale.

Scope of Equity Investments to Be Classified in the Trading Category

The Board deliberated whether to retain the current U.S. GAAP definition of an equity security or affirm the proposal’s revised definition of equity investment in connection with the determination of which financial instruments an entity would classify in the trading category. Although the Board did not make any decisions about this issue, it requested that the staff further research the following:

  1. The “implication[s] of using the word investment instead of security.”
  2. How an entity should classify “certain forward contracts to acquire or dispose of an ownership interest.”

Editor’s Note: The Board directed the staff to further research whether defining the term as an “equity investment” rather than as an "equity security” would affect the accounting for partnership interests. In addition, the Board noted that the current definition of equity security in U.S. GAAP excludes (1) forward contracts to acquire or sell equity securities and (2) whether the accounting for such contracts should be aligned with the proposed accounting for equity securities/investments. As a result, at a future meeting, the Board will decide how an entity should account for a forward contract on equity securities whose fair value is not readily determinable and that do not meet the definition of a derivative under ASC 815.2 

Under current U.S. GAAP, forward contracts that meet the definition of a derivative must be accounted for as derivatives under ASC 815 unless they qualify for a scope exception (e.g., the one for own-equity contracts). ASC 815-10-25-17 indicates that forward contracts to acquire securities (debt or equity) covered by ASC 320 that have all of the characteristics in ASC 815-10-15-1413 should, at inception, be designated as held to maturity, available for sale, or trading.

Available-for-Sale Classification for Certain Equity Investments

The FASB decided not to provide an FV-OCI4 classification category for equity securities; however, the Board “asked the staff to explore whether parameters could be developed to define strategic equity investments that would be eligible for available-for-sale classification.”

Editor’s Note: The Board discussed the FV-OCI classification for equity securities in the context of (1) strategic investments held by entities, (2) equity securities held by insurers, and (3) exchange-traded funds whose underlying investments are in debt securities. Although the Board discussed stakeholders’ feedback on these three topics, the Board only directed the staff to further research whether specific criteria could be established to define a strategic investment that could qualify for the FV-OCI classification.

Clarifications to the Practicability Exception Related to Classifying All Equity Investments in the Trading Category

The FASB decided that it would provide additional implementation guidance clarifying the (1) “level of effort that preparers should exert to identify observable price changes” and (2) “concept of a similar investment of the same issuer.”

Editor’s Note: The February 2013 proposed ASU provides a practicability exception to fair value measurement for equity investments without readily determinable fair values. This practicability exception would permit entities to measure equity investments without readily determinable fair values at cost less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical investment or a similar investment of the same issuer. Under the proposed guidance, for an equity investment that qualifies for and is measured by using the practicability exception, when information about price changes is observable, the entity would be required to adjust the carrying value of the equity investment upward or downward.

Impairment Assessment of Equity Investments That Are Not Measured at Fair Value Through Net Income

Although the Board did not reach a decision on this topic, it asked the staff to further investigate “application of the one-step impairment model to equity method investments and equity investments that qualify for the practicability exception.”

Editor’s Note: In an effort to simplify the impairment model for equity securities and equity method investments, the February 2013 proposed ASU contains a one-step method under which an entity would consider “impairment indicators to determine if it is more likely than not that the fair value of the investment is less than its carrying amount.” Under this model, an entity that determines that the equity security is impaired would recognize an impairment loss equal to the difference between the security’s fair value and carrying amount. In contrast, ASC 320-10-35-30 requires entities to perform a two-step assessment to determine whether an equity security is impaired. That is, under ASC 320-10-35-30, an entity must determine whether impairment is temporary or other than temporary; under the proposed guidance, this assessment would not be required.

Some board members expressed concern that for equity investments in publicly traded entities that are accounted for under the equity method, the proposed one-step model may require an immediate impairment recognition since the fair value of such investments would be readily observable and impairment losses would not be reversible if the stock price later improved. These board members pointed out that an entity that uses the practicability exception to account for such investments would be permitted to adjust the carrying value of the investment both upward and downward on the basis of observable changes in fair value.

Evaluation of the Valuation Allowance on a Deferred Tax Asset Related to Debt Securities Classified in the Available-for-Sale Category

The Board decided that “the assessment of a valuation allowance for a deferred tax asset related to an available-for-sale debt security should be made in combination with the entity’s other deferred tax assets.”

Accounting for Pools of Similar Financial Assets

The Board decided “not to provide guidance on the recognition and measurement of pools of similar financial assets.”

Accounting for Loan Commitments, Revolving Lines of Credit, and Commercial Letters of Credit

The Board decided “to retain current U.S. GAAP on accounting for loan commitments, revolving lines of credit, and commercial letters of credit.”

Recognition and Measurement of Foreign Currency Gains and Losses on Debt Securities Classified as Available for Sale

The Board decided “to retain current U.S. GAAP for recognition and measurement of foreign currency gains and losses on debt securities classified as available for sale.”

Editor’s Note: For foreign-currency-denominated debt securities measured at FV-OCI, the February 2013 proposed ASU would have required entities to separately recognize in net income changes in fair value attributable to foreign currency gains (losses). The FASB staff noted that some stakeholders had expressed concern that measuring changes in fair value attributable solely to foreign currency gains (losses) would require undue effort and impair comparability. Therefore, the Board tentatively decided not to require entities to separately recognize in net income changes in fair value attributable to foreign currency gains (losses).


1 FASB Proposed Accounting Standards Update, Recognition and Measurement of Financial Assets and Financial Liabilities.

2 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”

3 ASC 815-10-15-141 requires that such contracts:

•   Be “entered into to purchase securities that will be accounted for under [ASC] 320.”

•   Only allow for "physical settlement of the contract by delivery of the securities."

•   Not be "a derivative instrument otherwise subject to [ASC 815]."

•   Have "no intrinsic value at acquisition" (for purchased options).

4 Fair value through other comprehensive income.

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