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 entitled “The Mixed Attribute Model”):
(ASC 825-10-15-5)
(ASC 825-10-15-4)
A credit loss on a financial instrument with off-statement-of-financial-position risk is recorded as a liability rather than being included in a valuation allowance netted against a recognized financial instrument. When settled, the credit loss is deducted from the liability. (ASC 825-10-5-3)
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.
Source: ASC 825-20. See Definition of Terms Appendix for terms relevant to this chapter: Cash Equivalents, Conduit Debt Securities, Fair Value, Financial Asset, Financial Instrument, Financial Liability, Firm Commitment, Nonpublic Entity, and Public Traded Entity
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.
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:
Private equity investments | |
($75 measured at fair value; $50 measured using the equity method) | $125 |
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 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, 20X2 | ||||
(Unclassified for Illustrative Purposes) | ||||
Amounts measured under the company's customary accounting policies at other than fair value | Amounts required to be measured at fair value or whose carrying values approximate fair value | Eligible amounts measured at fair value at management's election | Total | |
Assets | ||||
Cash and cash equivalents | $ 38 | $ 38 | ||
Accounts receivable | $ 97 | 97 | ||
Notes receivable | 400 | $150 | 550 | |
Inventory | 134 | 134 | ||
Investments | ||||
Trading securities | 115 | 115 | ||
Securities available-for-sale | 75 | 75 | ||
Securities held-to-maturity | 32 | 32 | ||
Derivatives | 60 | 60 | ||
Private equity | 50 | 75 | 125 | |
Property and equipment, net | 10 | 10 | ||
Other assets | 20 | 20 | ||
Total assets | $ 743 | $288 | $225 | $1,256 |
Liabilities | ||||
Borrowings under short-term line of credit | $ 128 | $ 128 | ||
Long-term debt | 140 | $ 60 | 200 | |
Accounts payable | $110 | 110 | ||
Accrued liabilities | 130 | 130 | ||
Other liabilities | 555 | 555 | ||
Total liabilities | 953 | 110 | 60 | 1,123 |
Stockholders' equity | ||||
Common stock | 4 | 4 | ||
Additional paid-in capital | 88 | 88 | ||
Retained earnings | 42 | 42 | ||
Accumulated other comprehensive income | (1) | (1) | ||
Total stockholders' equity | 133 | – | – | 133 |
Total liabilities and stockholders' equity | $1,086 | $110 | $ 60 | $1,256 |
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).
18.220.18.186