ASC 825-10-25, Financial Instruments: The Fair Value Option
Financial statement presentation and disclosure
Statement of financial position
Example of disclosure ASC 820 and ASC 825-10-25 combined with ASC 825-10-50 disclosures
ASC 825, Financial Instruments, contains two Subtopics:
The following items are eligible for the fair value option (also see the chapter on ASC 820 – the summary table in the section of the entitled “The Mixed Attribute Model”):
(ASC 825-10-15-5)
(ASC 825-10-15-4)
ASC 825-10-25, The Fair Value Option, encourages reporting entities to elect to use fair value to measure eligible assets and liabilities in their financial statements. The objective is to improve financial reporting by mitigating the volatility in reported earnings that is caused by measuring related assets and liabilities differently. Electing entities obtain relief from the onerous and complex documentation requirements that apply to certain hedging transactions under ASC 815. ASC 825-10-25 applies to businesses and not-for-profit organizations and provides management of these entities substantial discretion in electing to measure eligible assets and liabilities at fair value.
Management is given an extraordinary amount of discretion in selecting the assets and/or liabilities for which it chooses to make this election, the fair value option. In general, the election is made on an individual contract or item-by-item basis.
ASU 2013-03, In February 2013, the FASB issued ASU 2013-03, Clarifying the Scope and Applicability of a Particular Disclosure to Nonpublic Entities. In its meetings related to ASU 2011-04, the Board had decided that nonpublic entities would not be required to disclose “the level in which a fair value measurement would be categorized within the fair value hierarchy for assets and liabilities not recognized at fair value but for which disclosure of fair value is required” After issuance of ASU 2011-04, some constituents noticed an inconsistency between what the Board intended and the actual changes to the codification. With ASU 2013-03, the board clarified that it did exempt nonpublic entities of any size from that disclosure in annual and interim financial statements.
Conduit Debt Securities. Certain limited-obligation revenue bonds, certificates of participation, or similar debt instruments issued by a state or local governmental entity for the express purpose of providing financing for a specific third party (the conduit bond obligor) that is not a part of the state or local government's financial reporting entity. Although conduit debt securities bear the name of the governmental entity that issues them, the governmental entity often has no obligation for such debt beyond the resources provided by a lease or loan agreement with the third party on whose behalf the securities are issued. Further, the conduit bond obligor is responsible for any future financial reporting requirements.
Fair Value. The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Financial Asset. Cash, evidence of an ownership interest in an entity, or a contract that conveys to one entity a right to do either of the following:
Financial Instrument. Cash, evidence of an ownership interest in an entity, or a contract that both:
The use of the term financial instrument in this definition is recursive (because the term financial instrument is included in it), though it is not circular. The definition requires a chain of contractual obligations that ends with the delivery of cash or an ownership interest in an entity. Any number of obligations to deliver financial instruments can be links in a chain that qualifies a particular contract as a financial instrument.
Contractual rights and contractual obligations encompass both those that are conditioned on the occurrence of a specified event and those that are not. All contractual rights (contractual obligations) that are financial instruments meet the definition of asset (liability) set forth in FASB Concepts Statement No. 6, Elements of Financial Statements, although some may not be recognized as assets (liabilities) in financial statements—that is, they may be off-balance-sheet—because they fail to meet some other criterion for recognition.
For some financial instruments, the right is held by or the obligation is due from (or the obligation is owed to or by) a group of entities rather than a single entity.
Financial Liability. A contract that imposes on one entity an obligation to do either of the following:
Firm Commitment. An agreement with an unrelated party, binding on both parties and usually legally enforceable, with the following characteristics:
Liability Issued with an Inseparable Third-Party Credit Enhancement. A liability that is issued with a credit enhancement obtained from a third party, such as debt that is issued with a financial guarantee from a third party that guarantees the issuer's payment obligation.
Nonpublic Entity. Any entity that does not meet any of the following conditions:
Publicly Traded Company. See definition in the chapter on ASC 270.
ASC 825-10-25 provides management with substantial flexibility in electing the fair value option (FVO). Once elected, however, the election is irrevocable unless, as discussed later in this section, a new election date occurs. The election can be made for a single eligible item without electing it for other identical items subject to the following limitations:
Other than as provided in 1 and 2 above, management is not required to apply the FVO to all instruments issued or acquired in a single transaction. The lowest level of election, however, is at the single legal contract level. A financial instrument that is, in legal form, a single contract is not permitted to be separated into component parts for the purpose of electing the FVO. For example, an individual bond is the minimum denomination of that type of debt security.
An investor in an equity security of a particular issuer may elect the FVO for its entire investment in that equity security including any fractional shares issued by the investee in connection, for example, with a dividend reinvestment plan.
Management of an acquirer, parent company, or primary beneficiary4 decides whether to elect the FVO with respect to the eligible items of an acquiree, subsidiary, or consolidated variable interest entity. That decision, however, only applies in the consolidated financial statements. FVO choices made by management of an acquiree, subsidiary, or variable interest entity continue to apply in their separate financial statements should they choose to issue them.
Management may elect the FVO for an eligible item in one of two ways.
(ASC 825-10-25-4)
Among the events that require initial fair value measurement or subsequent fair value remeasurements of this kind are
(ASC 825-10-25-5)
ASC 825-10-25 requires the reporting entity to report assets and liabilities for which the FVO was elected in a manner that separates those amounts from carrying amounts of similar assets and liabilities measured using another measurement method. Two alternatives are provided.
The manner in which the first alternative is illustrated in ASC 825-10-25 could potentially confuse or mislead readers.
Private equity investments ($75 at fair value) | $125 |
This caption could easily be misunderstood by the reader to mean that the reporting entity holds private equity investments with an aggregate carrying value of $125 whose fair value has declined to $75 thus implying a $50 unrealized loss. In fact, this caption is intended to convey the fact that the reporting entity holds private equity investments with an aggregate carrying value of $125 and that the $125 is comprised of $75 valued at fair value in accordance with an election of the FVO and $50 using another measurement attribute such as the cost method or equity method.
If using parenthetical disclosure, it would be less misleading if the amount were presented as follows:
This can get cumbersome and is still confusing. It becomes even more unwieldy when considering the fact that reporting entities customarily present two or three years' comparative statements of financial position and that not-for-profit organizations often use tabular formats for their statements of financial position that present separate columns for unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets.
Another source of confusion is the fact that existing GAAP requires certain items (such as derivatives, trading securities, and available-for-sale securities) to be stated at fair value without consideration of the FVO. Therefore, it is conceivable that a single statement of financial position will contain financial instruments that are stated at fair value due to a requirement in GAAP, financial instruments that are stated at fair value due to management's election of the FVO, and financial instruments that are stated using some other attribute such as cost method or equity method, or, as is permitted for investments in certain debt securities, using amortized cost. When this is the case, the reporting entity may wish to use a format such as the one shown in the sample “Consolidated Statement of Financial Position” for the Young Aviation Chopper and Helicopter Works, Inc.
Many variations can be derived from this method of presentation. For example, subtotals are only necessary to be presented for the total column since the notes to the financial statements provide fair value totals by major class. The financial statement preparer may wish to augment this presentation by including a column that subtotals all amounts stated at fair value irrespective of whether they are subject to the FVO election.
Separate sections of assets and liabilities could contain separate line items enumerating the eligible items within each for which the FVO was elected by management.
Young Aviation Chopper and Helicopter Works, Inc.
Consolidated Statement of Financial Position
December 31, 2013
(Unclassified for Illustrative Purposes)
ASC 825-10-25 requires cash receipts and cash payments related to items measured at fair value to be classified in the statement of cash flows according to their nature and purpose. Inexplicably, however, ASC 825-10-25 leaves the provision of ASC 230 unchanged that requires returns on investments (interest and dividends) to be accounted for as operating activities.
Consistent with the approach in ASC 820, ASC 825-10-25 provides financial statement preparers with the principal objectives associated with fair value option disclosures and then sets forth in detail the disclosures FASB deems necessary to meet the objective. The principal objectives are to facilitate comparisons (1) between entities that choose different measurement attributes for similar assets and liabilities, and (2) between assets and liabilities in the financial statements of an entity that elects to use different measurement attributes for similar assets and liabilities. FASB indicates that it expects the disclosures to result in
Although not required by ASC 825-10-25, FASB encourages management to present the disclosures it requires in combination with related fair value disclosures required to be disclosed by parts of the codification (such as ASC 825-10-50 and ASC 820).
The following example does not purport to illustrate all of the disclosure requirements specified within GAAP. Instead, it is presented to illustrate how the financial statement preparer might organize the required tabular disclosures by integrating the ASC 825-10-50 disclosures regarding the fair value of financial instruments with the ASC 820 and ASC 825-10-25 disclosures discussed in this chapter.
Young Aviation Chopper and Helicopter Works, Inc.
Notes to Financial Statements
December 31, 2012
1 Under ASC 805, consolidated variable interest entities are referred to as subsidiaries in the same manner as consolidated voting interest entities.
2 Insurance contracts that require or permit the insurer to settle claims by providing goods or services instead of by paying cash are not, by definition, financial instruments. Similarly, warranties that require or permit the warrantor to settle claims by providing goods and services in lieu of cash do not constitute financial instruments.
3 ASC 944-30-20 defines a nonintegrated contract feature in an insurance contract as a feature in which the benefits provided are not related to or dependent on the provisions of the base contract. For the purposes of applying the FVO election, neither an integrated nor a nonintegrated contract feature or coverage qualifies as a separate instrument.
4 Under ASC 805 a primary beneficiary is referred to as a parent in the same manner as a company that consolidates a voting interest entity.
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