Financial Instruments
Future Changes in Standards?
Exposure Draft 2010
Financial Instruments NOW
• Some financial instruments are currently
reported at fair value on a routine basis:
– Those included in trading and available for sale
investment portfolios
– Those for which the fair value option has been
adopted at acquisition date
• Most liabilities are carried at amortized cost
with fair values disclosed in the notes
What is a Financial Instrument
Financial Instrument
Cash, evidence of an ownership interest in an entity, or a
contract that both:
• a. Imposes on one entity a contractual obligation either:
– 1. To deliver cash or another financial instrument to a second
entity
– 2. To exchange other financial instruments on potentially
unfavorable terms with the second entity.
• b. Conveys to that second entity a contractual right either:
– 1. To receive cash or another financial instrument from the first
entity
– 2. To exchange other financial instruments on potentially
favorable terms with the first entity.
FASB Exposure Draft
• Under the proposal, almost all financial
instruments would be reported at fair value on
the balance sheet.
• This would include many liabilities currently
carried at amortized cost
– Exception: long-term debt related to long-lived assets
like a mortgage on a building
• In some cases, the gain/loss would be in other
comprehensive income rather than net income
Exposure Draft
• If this ED becomes a standard (as written)
– We would be getting rid of the 3-categories of
investments we have from SFAS115 (trading,
available for sale, and held-to-maturity)
– In effect, we could still have HTM but we would
have fair value on the balance sheet and the
gain/loss would be reported in “other
comprehensive income” rather like what we
currently do for available-for-sale securities
Amortized Cost is Also Important
• The FASB doesn’t want to lose valuable
information so the proposal calls for reporting
BOTH fair value and amortized cost on the
face of the balance sheet
• Complications:
– Credit-worthiness affects borrowing rate
– a lower credit rating = higher interest rate
– Higher interest rate = lower present value (when
using level 2 measurements)
Balance Sheet Display –
Investment Side
*
**
*Amortization of discount/premium is
charged to credit impairment allowance
**To bring carrying value to fair value of the
financial instrument
Exposure Draft
• Proposal includes disclosure of the portion of
the gain/loss that is related to the change in
credit score separately from the gain/loss
related to general changes in interest rates
• Choice of equity method for investments will
be limited to situations where the investee is
closely related to the investor’s business
strategy. Otherwise, will be reported at fair
value