On January 5, 2016, the FASB issued ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01 included a requirement for companies that have elected the fair value option for a financial liability to record changes in fair value due to instrument-specific credit risk, in OCI. This will be a significant change from current accounting guidance which requires the entire change in fair value to be recorded in earnings. Currently, the change in fair value attributable to instrument-specific credit is only disclosed in the footnotes.
Often, companies with significant debt instruments will not elect the fair value option because the fair value adjustments may cause greater earnings volatility. If some of the change in fair value will be recorded in OCI, rather than earnings, companies might reconsider whether to elect the fair value option for their financial instruments going forward.
The ASU does not change the following:
- It doesn’t change the Company’s ability to elect the fair value option for a financial liability. Under current U.S GAAP, the fair value election allows a Company to irrevocably elect to measure a financial liability at fair value and recognize the entire change in fair value in net income. This election is generally made upon initial recognition of the financial instrument, or when there is a remeasurement event.
- It doesn’t alter current accounting guidance for other financial liabilities, such as derivative liabilities, which require the change in the fair value to be recorded in net income.
ASU 2016-01 also contains other important amendments including a requirement for investments in equity securities to be measured at fair value through net income (subject to certain exceptions) and the elimination of certain financial disclosures for financial instruments measured at amortized cost on the balance sheet.
Effective Dates of the ASU
Public Companies: Effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.
All other organizations: Effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019.
Early Adoption: Certain portions of ASC 2016-01, including the provision related to changes in fair value due to credit risk, may be adopted early. Early application is permitted as of the beginning of the fiscal year of adoption and should be applied by recording a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption.