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 InstrumentFinancial InstrumentCash, 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