Stakeholders seeking clarity were behind the latest Accounting Standards Update (ASU) issued by the Financial Accounting Standards Board (FASB). In response to questions raised, the FASB released ASU 2018-03: Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. This ASU was issued to clarify and improve guidance contained in ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10, and is not expected to significantly change financial reporting practices. Currently, an equity security without a readily determinable fair value that also does not qualify for the practical expedient to measure fair value, may be accounted for based on cost, plus any impairments and observable price changes. This process is known as the cost method. Under the amended guidance, an entity that uses the cost method has the option to make an irrevocable election to change its measurement approach to a fair value method allowable under Topic 820, Fair Value Measurement. As a result, all future purchases of identical or similar investments by the same issuer must be measured using an allowable fair value method. This ASU also clarifies the accounting for equity securities measured under the cost alternative. Specifically, the amended guidance states that value should be measured based on the fair value as of the date an observable transaction takes place—not the financial reporting date.
The update also addresses treatment of forward contracts and purchased options accounted for under the cost method. Now, when an observable price change occurs to an underlying equity security associated with a forward contract or purchased option, the entire value of that contract or option must be remeasured. Further clarification is provided for the presentation of certain fair value option liabilities, stating that when the fair value option is elected for a financial liability, the guidance in paragraph 825-10-45-5 should be applied, regardless of whether the fair value option was elected under either Subtopic 815-15, Derivatives and Hedging-Embedded Derivatives, or Subtopic 825-10, Financial Instruments-Overall.
The ASU also addresses fair value option liabilities denominated in a foreign currency. According to the new update, for financial liabilities where the fair value option has been elected, the amount of change in fair value, in relation to the instrument-specific credit risk, should first be measured in the currency of denomination when it is presented separately from the total change in fair value of the financial liability. Both components of the change in the fair value of the liability should then be remeasured into the functional currency of the reporting entity using end-of-period spot rates. Lastly, the amendment simplifies the transition guidance for equity securities without a readily determinable fair value; entities will use a prospective transition approach only for securities they elect to measure using the measurement alternative.
In summary, the issued amendment addresses multiple items brought to FASB’s attention by stakeholders. The update is intended to provide clarification of previously issued guidance and how to apply that guidance’s fair value option. To give entities time to continue with their current adoption plans for the previously issued update 2016-01, FASB has quickly moved to issue this amendment. For private companies, not-for-profit organizations, and employee benefit plans, the amendments have the same effective date and transition requirements as ASU 2016-01. Early adoption is permitted if the entity has adopted ASU 2016-01.
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