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5.4 Application of the FVO
Publication date: 31 Mar 2022
us Fair value guide
US GAAP provides guidance regarding the application of the fair value option, including accounting for its election, timing, and presentation.
5.4.1 Accounting election
The financial instruments guidance in ASC 825-10 permits reporting entities to apply the FVO on an instrument-by-instrument basis. Therefore, a reporting entity can elect the FVO for certain instruments but not others within a group of similar instruments (e.g., for a portion of identical bonds issued by the same issuer). However, if the FVO is not elected for all eligible instruments within a group of similar instruments, the reporting entity is required to disclose the reasons for its partial election. In addition, the reporting entity must disclose the amounts to which it applied the FVO and the amounts to which it did not apply the FVO within that group.
The fair value option may be elected for a single eligible item without electing it for other identical items with the following four exceptions:
- If multiple advances are made to one borrower pursuant to a single contract (such as a line of credit or construction loan) and the individual advances lose their identity and become part of a larger loan balance, the fair value option shall be applied only to the larger balance and not to each advance individually.
- If the fair value option is applied to an investment that would otherwise be accounted for under the equity method of accounting, it shall be applied to all of the investor’s eligible financial interests in the same entity (equity and debt, including guarantees) that are eligible items.
- If the fair value option is applied to an eligible insurance or reinsurance contract, it shall be applied to all claims and obligations under the contract.
- If the fair value option is elected for an insurance contract (base contract) for which integrated or nonintegrated contract features or coverages (some of which are called riders) are issued either concurrently or subsequently, the fair value option also must be applied to those features or coverages. The fair value option cannot be elected for only the nonintegrated contract features or coverages, even though those features or coverages are accounted for separately under Subtopic 944-30. Paragraph 944-30-35-30 defines a nonintegrated contract feature in an insurance contract. For purposes of applying this Subtopic, neither an integrated contract feature or coverage nor a nonintegrated contract feature or coverage qualifies as a separate instrument.
A single contract that is deemed to be a financial instrument may not be further separated for purposes of electing the FVO. One exception is a loan syndication arrangement that results in multiple loans issued to the same borrower. Under ASC 825-10, each of those loans is considered a separate instrument, and the FVO may be elected for some loans but not others.
In the US, many financial institutions have elected the fair value option for their mortgage loans held in the pipeline awaiting sale or securitization. This election obviates the need to meet the requirements to achieve hedge accounting as it allows for consistent fair value treatment of the loans and the related derivatives used to economically hedge the risks of holding the loans.
Some reporting entities may be precluded from engaging in security trading activities by law or regulation; these restrictions do not preclude election of the FVO.
Question FV 5-1
Does the fair value option, if elected by a reporting entity, have to be applied on an entity-wide basis? For example, is a subsidiary required to elect the fair value option for a particular financial instrument in its separate reporting if the parent company has elected the fair value option for the instrument for consolidated reporting?
Does the fair value option, if elected by a reporting entity, have to be applied on an entity-wide basis? For example, is a subsidiary required to elect the fair value option for a particular financial instrument in its separate reporting if the parent company has elected the fair value option for the instrument for consolidated reporting?
PwC response
No. We believe that a parent and subsidiary may apply a different treatment because the fair value election under ASC 825-10-25 is not based on management’s intent, as is the case with other areas of accounting (such as ASC 820).
The FASB considered requiring the FVO election to be made on an entity-wide basis. However, the FASB rejected this approach because it could limit the number of reporting entities that would elect the FVO. Accordingly, subsidiaries and parent companies may make different elections with respect to a particular financial asset or liability.
5.4.2 Timing
A reporting entity may elect the FVO only in certain circumstances, as described in ASC 825-10-25-4.
An entity may choose to elect the fair value option for an eligible item only on the date that one of the following occurs:
- The entity first recognizes the eligible item.
- The entity enters into an eligible firm commitment.
- Financial assets that have been reported at fair value with unrealized gains and losses included in earnings because of specialized accounting principles, but which subsequently cease to qualify for that specialized accounting. For example, a transfer of assets from a subsidiary subject to the Investment Companies guidance under Subtopic 946-10 to another entity within the consolidated reporting entity not subject to that Subtopic.
- The accounting treatment for an investment in another entity changes because the investment becomes subject to the equity method of accounting.
- An event that requires an eligible item to be measured at fair value at the time of the event but does not require fair value measurement at each reporting date after that, excluding the recognition of impairment under lower-of-cost-or-market accounting or other-than-temporary impairment or accounting for equity securities in accordance with Topic 321.
ASC 825 also discusses when remeasurement should occur. ASC 825-10 requires reporting entities to make a separate decision about whether to elect the FVO for each eligible item as its election date occurs. Entities may also elect the fair value option based on a pre-existing policy for specified types of eligible items. We believe that the level of documentation of such a policy may vary among reporting entities but that such documentation should be sufficiently clear so that it is easily understood which items are subject to the FVO election.
Some of the events that require remeasurement of eligible items at fair value, initial recognition of eligible items, or both, and thereby create an election date for the fair value option as discussed in ASC 825-10-25-4(e) are:
- Business combinations, as defined in ASC 805-10
- Consolidation or deconsolidation of a subsidiary or VIE
- Significant modifications of debt, as defined in ASC 470-50.
Question FV 5-2
Under US GAAP, the FVO may be elected when a previously-recognized financial instrument is subject to a remeasurement (new basis) event. What qualifies as a “remeasurement event”?
Under US GAAP, the FVO may be elected when a previously-recognized financial instrument is subject to a remeasurement (new basis) event. What qualifies as a “remeasurement event”?
PwC response
The ASC Master Glossary defines a remeasurement (new basis) event.
Partial definition from the ASC Master Glossary
A remeasurement event is an event identified in other authoritative accounting literature, other than the recognition of an other-than-temporary impairment, that requires a financial instrument to be remeasured to its fair value at the time of the event but does not require that financial instrument to be reported at fair value continually with the change in fair value recognized in earnings.
For example, business combinations and significant modifications of debt under ASC 470-50 and ASC 310 are remeasurement events. Other examples of remeasurement events include the preparation of liquidation basis financial statements and fresh-start reporting for companies emerging from bankruptcy.
5.4.3 Collateralized financing entities
ASC 810-30 provides a measurement alternative that clarifies how to account for the difference between the fair values of the financial assets and liabilities of consolidated collateralized financing entities that elect the fair value option. Refer to FV 6.2.7.1 for further details.
5.4.4 Other considerations
ASC 825 requires immediate recognition of upfront costs and fees related to items for which the FVO is elected. For example, if the FVO is elected for an insurance contract, a reporting entity should not recognize any deferred acquisition costs related to that contract. Similarly, if the FVO is elected for a loan receivable, the reporting entity should not recognize any deferred loan-origination fees or costs related to that loan.
Immediate recognition of income and expense items that would be deferred absent election of the FVO might significantly change both the recognition pattern and the presentation of income or expense in the income statement. For example, for originated loans that are not measured using the FVO, deferred fees and costs are capitalized as a net basis adjustment and either amortized to interest income or recognized as part of the gain/loss on the sale of the loan. However, if an originated loan is measured using the FVO, the costs and fees are recognized in current earnings in the applicable expense or revenue accounts (e.g., salaries, legal fees, fee revenue).
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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