By Linda Cavanaugh, CPA - FAS 159: The Fair Value Option for Financial Assets and Liabilities, including an amendment of FASB Statement No. 115
FAS 159 permits entities to choose to measure, at fair value and on an instrument-by-instrument basis, financial instruments that are not currently reported at fair value. This Statement was effective for fiscal years beginning after November 15, 2007 and is to be applied prospectively. Early adoption was allowed if FAS 157: Fair Value Measurements was also adopted.
Election of the Fair Value Option
Per paragraph 7 of FAS 159, a recognized financial asset or liability, a firm commitment that would otherwise not be recognized at inception and that only involves financial instruments, a written loan commitment, the rights and obligations under an insurance contract or warranty that is not a financial instrument but permit the insurer to settle by paying a third party to provide goods or services, and a host financial instrument resulting from the separation of an embedded non-financial derivative instrument from a non-financial instrument are eligible to be measured at fair value.
However, an investment in a subsidiary or variable interest entity that is required to be consolidated, employers’ and plans’ obligations for pensions, stock awards and other deferred compensation plans, financial assets and liabilities recognized under leases, deposit liabilities or withdrawable on demand of depository institutions and financial liabilities that are classified in shareholder’s equity are scoped out of the fair value option and can not be measured at fair value.
An entity can chose to value any eligible items at fair value on the balance sheet with changes in fair value running through earnings. This election can be made at inception, upon entering into a firm commitment, when the financial instrument ceases to qualify for specialized accounting, when the accounting treatment for an investment in another entity changes or an event requires an eligible item to be measured at fair value but does not require subsequent re-measurement (i.e. a business combination).
The fair value election can be made on an instrument-by-instrument basis except i) if multiple advances are made to one borrower under one contract, the entire balance must be fair valued and not the individual advances; ii) if the option is applied to an equity investment, the entity’s complete interest in the equity investment must be fair valued including any debt; iii) if the option is applied to an insurance or re-insurance contract, all of the claims and obligations under the contract must be fair valued; or iv) if the option is applied to an insurance contract that has integrated or non-integrated contract features, then the entire contract including both the integrated and non-integrated features must be fair valued.
Items valued at fair value can be presented on the balance sheet either as a separate line item or aggregately with similar items with the amount of fair value presented parenthetically (similar to accounts receivable.
For interim and annual balance sheets for each period presented:
1. Management’s reason for electing the fair value option
2. If using the instrument-by-instrument option:
a. a description of similar items and the reasons for the partial election
b. reconciliation between the aggregate number and the fair valued number
3. For each line item that includes an item that has been fair valued:
a. information to enable users to understand how each line item in the balance sheet relates to major categories of assets and liabilities presented in accordance with FAS 157.
b. the aggregate carrying amount of items included in each line item in the balance sheet that are not eligible for the fair value option, if any.
4. The difference between the aggregate fair value and the aggregate unpaid principal balance of:
a. loans and long-term receivables that have contractual principal amounts
b. long-term debt instruments that have contractual
5. For loans held as assets:
a. the aggregate fair value of loans that are 90 days or more past due
b. the aggregate fair value of loans in non-accrual status if interest income is recognized separately from other changes in fair value
c. the difference between the aggregate fair value and the aggregate unpaid principal balance for loans that are 90 days or more past due, in non-accrual status, or both
6. For equity investments:
a. the information required by paragraph 20 of APB OP. 18.
For interim and annual income statements for each period presented:
1. For each line item in the balance sheet:
a. the amounts of gains and losses for fair value changes included in earnings
b. where the gains and losses are reported in the income statement
2. A description of how interest and dividends are measured and where they are reported in the income statement
3. For loans and other receivables held as assets:
a. the estimated amount of gains or losses included in earnings during the period attributable to changes in instrument-specific credit risk
b. how the gains and losses were determined
4. For liabilities with fair values that have been significantly affected during the period by changes in the instrument-specific credit risk:
a. the estimated amount of gains and losses included in earnings that are attributable to changes in instrument-specific credit risk
b. qualitative information about the reasons for the changes
c. how the gains and losses were determined
In annual periods only:
1. The methods and significant assumptions used to estimate the fair value of items for which the fair value option has been elected.
If the election date is chosen because the accounting treatment for an investment in another entity changes or an event requires an eligible item to be measured at fair value but does not require subsequent re-measurement, then an entity should disclose qualitative information about the nature of the event and quantitative information by line item in the balance sheet indicating which line item in the income statement includes the effect on earnings of initially electing the fair value option for that item.
This Statement is a prelude to more items being recognized on the balance sheet at fair value. Part II is going to consider fair value for non-financial instruments.