ASC 810-30-10 through ASC 810-30-16 provides a measurement alternative to address the potential measurement asymmetry. The measurement alternative permits entities to measure both the financial assets and financial liabilities owned by third parties of the CFE at the same value—using either the fair value of the financial assets or the fair value of the financial liabilities, whichever is more observable. This approach minimizes the parent’s earnings impact resulting from the remeasurement of a consolidated CFE’s financial assets and financial liabilities owned by third parties.
Reporting entities that consolidate a CFE that meets the scope requirements may choose to:
- measure the CFE’s financial assets and financial liabilities in accordance with applicable GAAP,
- measure the CFE’s financial assets and financial liabilities at fair value (through the fair value option), or
- follow the measurement alternative.
Under any of these elections, beneficial interests held by the parent and/or received as compensation for services provided to the CFE will continue to impact the income statement.
However, if a reporting entity elects the measurement alternative, the net gains (losses) reflected in its consolidated earnings will be limited to changes in the fair value of the beneficial interests it holds, as well as compensation for services provided, which is measured under other applicable guidance.
The fundamental premise behind the measurement alternative is that a CFE’s financial assets and financial liabilities are inextricably linked (i.e., the CFE’s financial assets can be used solely to settle its financial liabilities, and the CFE’s financial liabilities can be settled only with its financial assets).
Eligibility
To be eligible for the measurement alternative, a CFE must meet the following two scope requirements:
- All of the CFE’s financial assets and financial liabilities are required to be measured at fair value. If a CFE has financial assets or financial liabilities that are incidental to its operations (e.g., cash and payables due to/from brokers) that are not measured at fair value, the parent would not be prohibited from applying the measurement alternative if the book value of the incidental financial assets and financial liabilities approximates their fair value.
- Changes in the fair value of those financial assets and financial liabilities are reflected in earnings.
CFE’s may also hold nonfinancial assets and liabilities in certain circumstances (for example, assets acquired upon foreclosure). A CFE’s ownership of nonfinancial assets would not prohibit its parent from electing the measurement alternative if the nonfinancial assets will be held temporarily.
The measurement alternative is designed to address the concerns about volatility related to consolidated securitization vehicles and asset-backed entities. However, any entity that consolidates a variable interest entity that meets the definition of a CFE would be eligible for the election.
A CFE’s parent that has guaranteed all or a portion of the CFE’s beneficial interests would not be eligible to elect the measurement alternative because the CFE’s financial liabilities could potentially be settled with assets outside the CFE. Standard representations and warranties by the transferor of the CFE’s collateral would not in and of itself preclude the CFE’s parent from electing the measurement alternative.
Entities may have various economic interests in a CFE; e.g., direct ownership of beneficial interests and rights to compensation for services provided to the CFE. In the application of this measurement alternative, changes in the fair value of direct beneficial ownership interests retained by the entity should be reflected in consolidated earnings. The carrying value of beneficial interests that represent compensation for services, such as management fees or servicing fees, should be calculated under other applicable GAAP.
Calculation
When a reporting entity that elects the measurement alternative determines that the fair value of a CFE’s financial assets is more observable, the CFE’s financial liabilities (that are not eliminated in consolidation) are measured as:
The sum of:
- the fair value of the CFE’s financial assets
- the carrying value of the CFE’s nonfinancial assets
- the carrying value of any incidental financial assets
Less the sum of:
- the fair value of the CFE’s beneficial interests held by the reporting entity, which are not eligible for the measurement alternative
- the reporting entity’s carrying value of the CFE’s beneficial interests held by the reporting entity that represent compensation for services (i.e., management or servicing fees)
When a reporting entity that elects the measurement alternative determines that the fair value of a CFE’s financial liabilities is more observable, the CFE’s financial assets are measured as:
The sum of:
- the fair value of the CFE’s financial liabilities, excluding beneficial interests held by the reporting entity
- the fair value of beneficial interests held by the reporting entity other than beneficial interests received as compensation for services provided to the CFE
- the reporting entity’s carrying value of beneficial interests held by the reporting entity that represent compensation for services (e.g., management fees or servicing fees)
- the carrying value of any incidental financial liabilities
Less:
- the carrying value of the nonfinancial assets held temporarily by the CFE
The result of either calculation should be allocated to individual financial assets (if the liabilities are more observable) or individual liabilities (if the assets are more observable) using a reasonable and consistent methodology.