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Fair Value Measurement Option May Remain in U.S. GAAP

April 7, 2014

The FASB continued to move away from the largely converged classification and measurement proposal it issued in February 2013, voting to keep intact the fair value measurement option in U.S. GAAP for certain types of financial instruments. Current U.S. GAAP allows wider use of the fair value option for financial assets and liabilities than the 2013 proposal.

The FASB on April 4, 2014, rejected a part of its February 2013 classification and measurement proposal that would have narrowed down the types of financial assets and liabilities a business could choose to measure at fair value.

Instead, a 5-2 majority of the board voted to keep current U.S. GAAP’s so-called fair value option, which allows more financial instruments to be measured at fair value.

The tentative decision keeps intact the part of Subtopic 825-10 Financial Instruments, formerly SFAS No. 159, that enshrines the fair value option for many financial instruments. The FASB released SFAS No. 159 in 2007, saying it would improve financial reporting by allowing businesses the opportunity to reduce artificial swings in reported earnings caused by measuring related assets and liabilities differently. It also would reduce the need for companies to comply with complex hedge accounting provisions, the FASB said at the time.

A majority of FASB members and the FASB’s research staff said those reasons were still valid and practice should not change.

“In addition, the staff is not aware of the fair value option in U.S. GAAP being a source of significant practice issues,” FASB fellow Nicholas Milone said.

The FASB’s move is a further retreat from the major changes proposed in Proposed Accounting Standards Update (ASU) No. 2013-220, Financial Instruments—Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities, which was released in February 2013 and called for an overhaul in the way businesses recognize and measure their financial instruments.

The FASB’s proposal was largely aligned with the IASB’s November 2012 Exposure Draft (ED) No. 2012-4, Classification and Measurement: Limited Amendments to IFRS 9 (Proposed amendments to IFRS 9-2010), but discussions between the boards broke down late in 2013 when the FASB said the joint model was too complex to represent an improvement over existing U.S. GAAP. (See GAAP’s Measurements for Financial Instruments May not Match Up with IFRS in the December 23, 2013, edition of Accounting & Compliance Alert. )

The FASB instead has been focusing on narrower changes to current accounting rather than a wholesale revamp of U.S. GAAP.

The FASB’s original classification and measurement proposal eliminated the unconditional fair value option in U.S. GAAP. It narrowed down the instruments allowed to take the fair value option to groups of assets and liabilities whose net exposure is managed on a fair value basis and whose information is reported to management on a net exposure basis; hybrid financial instruments that contain an embedded derivative; financial assets that may be held to collect payments or may also be sold; and nonfinancial hybrid liabilities that contain an embedded derivative.

Many investors and analysts applauded the reduction of instruments that could take the option to be measured at fair value—and some supported eliminating the option entirely, Milone told the board. Reducing or eliminating the option would enhance their ability to compare businesses more easily, he said. But businesses said they wanted to retain the option.

“The staff acknowledges that the unrestricted fair value option has the potential to impair comparability between entities, particularly in cases where two entities use the option differently,” Milone said.

The joint FASB and IASB classification and measurement project was once the crux of the standard-setters’ overhaul of accounting for financial instruments.

The boards had sought to create a single, global way to promote consistent measurement of increasingly sophisticated financial assets and liabilities. A global standard had been a top priority in the wake of the 2008 financial crisis, but it became an elusive goal as the FASB and IASB wrestled with tough questions from banks, auditors, and analysts.

The proposals called for financial instruments to be measured in three ways—amortized cost, fair value with changes recorded in net income, and fair value with changes recorded in other comprehensive income. Instruments were assigned to categories based upon their cash-flow characteristics and the business models they serve. Loans that a lender lists on its balance sheet and holds to collect payments of principal and interest would have been measured at amortized cost, while assets that are traded would be measured at fair value, with changes recorded in net income. Financial products a business may hold onto but could sell later would fall into a third category: fair value with changes recorded in other comprehensive income.

After weighing feedback from banks, auditors, and investors, the FASB in December had second thoughts and has since focused on smaller, targeted improvements to U.S. GAAP.

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