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Nonderivative financial assets, such as loans, may be recorded on the balance sheet based on a number of different models under US GAAP. If they are reported or disclosed at fair value, ASC 820 applies.
Key concepts to consider when applying ASC 820 to nonderivative financial assets include:
  • Unit of account

    The unit of account is generally the individual instrument (e.g., a share of stock).
  • Principal or most advantageous market

    The principal market is the market with the greatest volume of activity for the asset to which the reporting entity has access. In the absence of a principal market, the reporting entity should determine the most advantageous market.
  • Valuation approach

    An income or market valuation approach should be used as appropriate. The cost method is generally not appropriate for financial assets.
  • Market participant assumptions

    The valuation should include market participant, not entity-specific, assumptions. Accordingly, no adjustment for blockage factors is permitted (see FV 4.7.1.1).
  • Bid-ask spread

    The price within the bid-ask spread that is most representative of fair value in the circumstances should be used, but there are certain practical expedients (see FV 4.2.4.3).
  • Transaction costs

    Costs to sell are generally not included in determining fair value.
Other considerations for specific nonderivative assets and liabilities are addressed in the sections that follow.

6.2.1 Loans

Fair value is used in the measurement of loans in various circumstances. The classification of a loan under US GAAP generally depends on whether the loan meets the definition of a debt security under ASC 320 (see LI 3.2.2). In addition, US GAAP provides industry-specific guidance for mortgage banking entities.
A creditor holding loans that are not debt securities will use one of three models to report the loans on its balance sheet:
  • Lower of amortized cost or fair value for loans held for sale
  • Amortized cost less an allowance for credit losses for loans held for investment
  • Fair value for loans for which the fair value option under ASC 825-10 is elected (discussed in FV 5)

A loan held for investment for which the fair value option has not been elected is recorded at amortized cost, and assessed for a credit allowance under the guidance in ASC 326. While the initial measurement of the loan and its basis after an allowance are not fair value measurements, a practical expedient in ASC 326-20-35-5 allows the allowance for a collateral dependent asset to be estimated using the fair value of the underlying collateral less costs to sell, if the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the sale or operation of the collateral. In this case, ASC 820 would apply.

6.2.1.1 Mortgage loans

ASC 948 provides industry-specific guidance for mortgage banking entities.
Mortgage loans held for sale represent a mortgage banker’s “inventory” of products. ASC 948-310-35-1 states that mortgage loans held for sale should be reported at the lower of amortized cost or fair value.
When measuring the fair value of mortgage loans, there are a number of challenges in applying ASC 820-10-35-5 in determining the principal or most advantageous market. The principal market, or, in its absence, the most advantageous market, may be represented by either the loan market or, in some cases, by reference to the securitization markets. If a market exists for the item the reporting entity holds (i.e., the loan), that market should be used as the basis for the valuation.
If a market does not exist for the asset or liability being measured, but a market does exist for the securitized loan, the market for the securitized loan can be used to determine the fair value of the asset or liability, adjusted, as appropriate, for transformation costs and margins (or profit) to reflect the fair value of the asset or liability held by the reporting entity. Thus, a reporting entity may work backwards from the reference market for the securitized loan to derive a fair value for the asset in the state in which it exists at the measurement date. This is not the same as using the value of the securitized loan as a substitute for the value of the loan. Measurement under ASC 820 should focus on the asset or liability that is being valued (i.e., loans) and not on what the asset or liability may become (i.e., securitized loans). Accordingly, the adjustment to the fair value in the market for the securitized loan is a necessary step to arrive at the value of the individual loan.

6.2.1.2 Measuring pools of loans

Financial institutions typically manage their loan assets on a portfolio basis. ASC 820 requires reporting entities to measure fair value using assumptions that market participants would use, assuming they act in their economic best interest. The market participant in the context of mortgage loans typically would be another bank or insurance company that also has a portfolio of similar loans. The market participant purchasing a mortgage loan will act in its economic best interest by considering how the loan will fit into its overall portfolio when determining a price to pay for it. As a result, it is likely that a market participant will value the mortgage loan based on portfolio-level inputs, as opposed to valuing it solely as an individual loan.
However, ASC 820 requires financial institutions to consider the unit of account that is specified in other guidance. For loans held for sale, ASC 948-310-35-3 changes the unit of measurement by specifically allowing aggregation by type of loan to determine fair value. At a minimum, a reporting entity should make separate determinations of fair value for residential and commercial mortgage loans. Either the aggregate or individual loan basis may be used to determine the lower of amortized cost or fair value for each type of loan. The analysis should be consistent with the way the underlying loans are valued and ultimately sold by the reporting entity. The same policy will establish the unit of account to be used in the measurement of fair value under ASC 820.
Because allowances may be calculated at the portfolio level, we believe reporting entities may measure the fair value of loans held for sale using portfolio-level assumptions. This conclusion would also apply to determining the fair value of loans not held for sale. In those situations, market participants are generally banks or insurance companies that have portfolios of similar instruments and generally purchase a single loan because it fits into one of their existing portfolios. While the loans not held for sale are recorded at the individual loan or contract level, allowances may be calculated at the portfolio level.

6.2.1.3 Loan commitments

SAB 109 provides guidance on the measurement of written loan commitments recorded at fair value. SAB 109 expresses the SEC staff’s view that, consistent with the guidance for transfers and servicing in ASC 860-50 and for financial instruments in ASC 825-10, the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are measured at fair value through earnings.

6.2.1.4 Fair value in loan impairment calculations

The measurement framework of ASC 820 applies when fair value is used to determine the carrying amount of held for sale loans. Additionally, allowances for certain loans supported by collateral may use practical expedients to simplify the estimate of credit losses. These practical expedients relate to certain collateral-dependent assets and certain assets with collateral maintenance provisions, and the allowance for impairment in these cases can be measured based on the difference between the fair value of the collateral and the amortized cost basis of the asset (adjusted, in certain cases, for the costs to sell the collateral). The measurement framework of ASC 820 applies when fair value is used to measure the allowance.

6.2.2 Investments in equity and debt securities

Equity interests with readily determinable fair values are carried at fair value with changes in value recorded in earnings. ASC 321 provides a definition of readily determinable fair value. Equity interests without readily determinable fair values are initially measured at cost and subsequently remeasured to fair value if determined to be impaired or upon an observable, orderly transaction of the same or similar security from the same issuer. Outside ASC 321, there are other instances when securities without a readily determinable fair value are carried at fair value.
ASC 320 provides three models for the initial recording and subsequent adjustment of debt securities: trading, available-for-sale, and held to maturity. Debt securities may be recorded at fair value as either trading or available-for-sale. Under certain conditions, ASC 320 also permits a third option, held-to-maturity, under which debt securities may be recorded at amortized cost.
Equity securities recorded at fair value and debt securities treated as either trading or available-for-sale are subject to the measurement and disclosure requirements of ASC 820. Debt securities reported as held-to-maturity and carried at amortized cost are subject to the fair value disclosure requirements of ASC 825 (for financial instruments not measured at fair value) and ASC 820’s disclosure requirements. In those cases, the fair values of held-to-maturity debt securities are required to be measured consistent with the provisions of ASC 820 when preparing the disclosures required by ASC 320 and ASC 825. Fair value disclosures are addressed in FSP 20. For more information on accounting for equity and debt securities, refer to LI 2.3 and LI 3.4, respectively.
For available-for-sale debt securities and equity interests measured using the measurement alternative, fair value may be relevant when recording an impairment. For available for sale debt securities, if a security is expected to be sold or it is more likely than not that a reporting entity will be required to sell the security before it recovers its amortized cost basis, and the fair value of the security is less than the amortized cost basis, the security should be impaired to its current fair value. For equity interests measured using the measurement alternative, the interest must be impaired to fair value if based on a qualitative assessment there are indications that the fair value is less than the carrying value. Upon these events, the measurement requirements of ASC 820 apply.
New guidance
The FASB issued ASU 2020-01 in January 2020 to clarify the interaction among the accounting standards for equity securities, equity method investments, and certain derivatives. The amendments are intended to address issues around (1) accounting for certain equity securities upon the application or discontinuation of the equity method of accounting, and (2) scope considerations for forward contracts and purchased options on certain securities. For public entities, the update was effective for fiscal years beginning after December 15, 2020 and for interim periods therein. All other entities have an effective date for fiscal years beginning after December 15, 2021 and interim periods therein. Early adoption is permitted, including adoption in an interim period.
ASU 2020-01 clarifies that a forward or option to purchase shares that will be accounted for as an equity method investment should be accounted for under ASC 321. A forward or an option with no intrinsic value at acquisition should be measured at fair value at exercise or settlement even if the measurement alternative is elected based on the guidance in ASC 815-10-35-6. While the scope of ASC 815-10-15-141 and ASC 815-10-15-141A does not include options with intrinsic value at acquisition, we generally believe the guidance should also be applied to options with intrinsic value. Subsequent to the adoption of ASU 2020-01, ASC 815-10-15-141A provides guidance on applying ASC 815-10-15-141 to forward contracts and purchased options of equity securities that will be within the scope of ASC 323 upon purchase. See LI 2.3.2.3 for a discussion of options or forwards accounted for under ASC 321. See PwC’s Equity method investments and joint ventures guide for additional information on the application of ASU 2020-01.

6.2.3 Investments in convertible securities

In determining the fair value of an investment in a convertible security, the question arises as to whether the instrument should be evaluated in its current form as convertible debt or using the “if converted” value.
We believe the investor generally should evaluate the security in its current “all-in” form as convertible debt and not use the “if converted” value. It would be highly unusual for the “if converted” value to reflect the price a market participant would pay for the convertible instrument. That is because the holder generally would not exercise the option prior to its expiration, as it would then forfeit the remaining time value. Instead, the holder would sell the entire convertible security to another investor. One exception to this might occur when the conversion option is so deep in-the-money that it behaves as a forward; i.e., when the time value of the option is very small compared to the intrinsic value.

6.2.4 Restricted securities

As noted in FV 4.8, the impact on fair value of a restriction on the sale or use of an asset depends on whether the restriction would be considered by market participants in pricing the asset, which, in turn, depends on the source of the restriction and its connection to the underlying security.
Example 6, Case A, Restriction on the Sale of an Equity Instrument, of ASC 820 (ASC 820-10-55-52) illustrates the impact of a legal restriction on the sale of an equity instrument. It notes that the “restriction is a characteristic of the instrument and, therefore, would be transferred to market participants.” Accordingly, the restriction should be considered in the valuation of the security as, presumably, it would be considered by market participants when determining the fair value of the security. However, if the restriction arises outside of the security, it would not be included in the valuation. This may occur as a result of side agreements or compliance with statutory requirements imposed on the holder of the security that are not a direct attribute of the security.
For a restriction to be considered an attribute of the security, the restriction should be specific to the security, not to the reporting entity holding the security. For example, a reporting entity holding a block of stock in another entity may also hold a board seat on the investee. Through the board seat, the reporting entity obtains material nonpublic information and, as a result, cannot sell the security until such information becomes public. Because the board seat is not a specific attribute of the security held, the restriction should not be considered in the valuation of the security. However, if it is the security itself that provides the right to a board seat, it might be considered in the valuation.
The key factor is whether the security itself carries the legal restriction, or if the restriction exists due to the nature of the business of the reporting entity holding the security, or by any means other than restriction on transfer of the security itself.
The date that the restriction is established is not critical to the analysis. Whether the restriction existed on the date the security was acquired or if the restriction was created subsequent to acquisition, the holder should only consider its impact on the security’s fair value at each reporting date if the restriction is a characteristic of the security and would be considered by market participants in determining the exit price.

6.2.5 Investments held by not-for-profit entities

ASC 958 is the applicable guidance for not-for-profit reporting entities; its requirements for recording the value of investments are similar to ASC 320 and ASC 321. The key difference from ASC 320 and ASC 321 is that all equity securities with readily determinable fair values (as defined by ASC 958) and all debt securities are recorded at fair value on a recurring basis. Unlike ASC 320, there is no option to record certain investments in debt securities at amortized cost. Fair value under ASC 958 is consistent with the definition in ASC 820.

6.2.6 Fund investments using NAV as a practical expedient

The NAV of an open-end fund, whether a registered investment company such as a mutual fund or an alternative investment such as a hedge fund, serves as the basis for subscription and redemption transactions for investors in the entity. If the investment is required to be measured at fair value under ASC 820, and does not have a readily determinable fair value, as discussed in LI 2.3.2, it may qualify for a practical expedient to determine the fair value of investments in certain funds (e.g., hedge funds, private equity funds, real estate funds, venture capital funds, commodity funds, funds of funds) using NAV, without adjustment, in certain defined circumstances. This practical expedient can be applied on an investment-by-investment basis, but should be applied consistently to the entire investment in that entity. Further, it is an accounting policy election and should be applied consistently from period to period, unless a change is preferable.
Using NAV as a practical expedient is permissible in the following circumstances:
  • there is no readily determinable fair value for the investment, and
  • the investment is in an entity that has all of the characteristics of an investment company specified in ASC 946, or
  • if one or more of those criteria are missing, the investment is in an entity for which it is industry practice to issue financial statements using guidance consistent with ASC 946.

6.2.6.1 NAV of investments in structures similar to mutual funds

NAV as a practical expedient is allowed only if there is no readily determinable fair value for the investment. The definition of readily determinable fair value includes a reference to structures that are similar to mutual funds. The ASC Master Glossary does not define the term “mutual fund.” It is a popular name for an investment company, and therefore, in considering if an investment is in a structure similar to a mutual fund, a reporting entity should consider if the structure is similar to an investment company, as defined in ASC 946, Financial Services—Investment Companies.
Mutual funds registered with the SEC under the Investment Company Act of 1940 (the 1940 Act) are a common form of investment company. There are other investment funds that may be structured similar to a registered mutual fund that are not registered under the 1940 Act. Examples of such funds may include (but are not limited to) separate accounts, common collective or commingled trusts, hedge funds, and private equity funds.

6.2.6.2 Published NAV and the basis for current transactions

The readily determinable fair value definition in ASC 321-10-20 requires that to be readily determinable (and therefore ineligible for NAV as a practical expedient), an equity security’s fair value must be based on a fair value per share (unit) that is “published” and is the “basis for current transactions.” However, the literature provides no guidance on what it means for fair value per share (unit) to be published or how to consider whether it is the basis for current transactions. Thus, the evaluation of those terms requires judgment. Reporting entities need to develop definitions that are reasonable under the concepts in the guidance and apply them consistently.
If a fund's NAV is not considered to be published and the basis for current transactions, it does not have a readily determinable fair value. The reporting entity would consider other guidance for equity interests in ASC 325, or choose to elect the fair value option (discussed in FV 5) for the investment.
If the reporting entity is required to report the investment at fair value per ASC 820 for another reason (e.g., it is an investment company), it would need to evaluate whether the NAV qualifies under the guidance for NAV as a practical expedient.
Published
Funds generally report NAV per share (unit). Access to NAV per share information varies. Some information is widely accessible (e.g., NAV of a registered investment company that is published publicly), and would generally be considered published per the definition. However, in other instances, there is limited access to the NAV per share information (e.g., an alternative investment fund in which the NAV is only known to investors in the fund) In this case, the NAV may not be considered published, depending on the reporting entity’s definition.
Basis for current transactions
A published NAV will only be considered fair value (and thus a necessary part of the readily determinable fair value definition) if it is the basis for current transactions. Reporting entities need to determine if they have the ability to redeem at NAV in the near term (i.e., they should consider both the contractual and practical ability to redeem).
Investors typically purchase mutual fund shares from the fund itself (or through a broker for the fund), not in a secondary market such as the NYSE or NASDAQ. In open-end funds, the price that investors pay for the mutual fund shares is the fund's per-share NAV. Open-end mutual fund shares are redeemable; investors sell the shares back to the fund at their approximate NAV, less applicable fees, with normal settlement provisions, which may indicate that NAV is a basis for current transactions.
Some closed-end funds trade on exchanges and may be traded at prices different than NAV, which may indicate that NAV is not the basis for current transactions.
Other fund structures, like limited partnerships or venture capital entities, may have restrictions on how frequently investors can redeem from the fund, which would impact the determination of whether the NAV is the basis for current transactions.

6.2.6.3 Determining whether NAV is calculated consistent with ASC 946

A reporting entity’s management is responsible for the valuation assertions in its financial statements. Determining that a reported NAV is calculated consistent with ASC 946, including the measurement of all or substantially all of the underlying investments of the investee in accordance with ASC 820, requires a reporting entity to independently evaluate the fair value measurement process utilized by the investee fund manager to calculate the NAV. Such an evaluation is a matter of professional judgment and includes determining that the investee fund manager has an effective process and related internal controls in place to estimate the fair value of its investments that are included in the calculation of NAV. The reporting entity should have adequate controls to evaluate the process of the investee fund manager, which may include initial due diligence procedures, ongoing monitoring procedures, and financial reporting controls.
If the measurement of NAV is not calculated consistent with ASC 946, an adjustment to the NAV may be necessary. A reporting entity would need to consider and understand the reasons why the NAV is not based on fair value, whether an NAV that is based on fair value can be obtained from the investee management, and whether the specific data needed to adjust the reporting NAV can be obtained and properly utilized to estimate fair value based on NAV.
Before concluding that the reported NAV is calculated in a manner consistent with the measurement principles of ASC 946, the reporting entity might evaluate the evidence gathered via the initial due diligence and ongoing monitoring of the investee fund. Only after considering all relevant factors can the reporting entity reach a conclusion about whether the reported NAV is calculated in a manner consistent with the measurement principles of ASC 946.

6.2.6.4 Calculating NAV at other than the measurement date

NAV should be calculated as of the reporting entity’s measurement date. If the measurement of NAV is not as of the reporting entity’s measurement date, the reporting entity may either request that the investee fund manager provide a supplemental NAV calculation consistent with the measurement principles of ASC 946 or adjust the most recent measure of NAV to reflect significant events between the measurement dates. That is, the reporting entity may roll forward or roll back the reported NAV for factors that might cause it to differ from the NAV at the measurement date. These factors could include additional investments (capital contributions), distributions received or partial redemptions, and market changes or other economic conditions affecting the value of the investee's portfolio.

6.2.6.5 Calculating NAV is not practical or a sale at other than NAV is probable

It should be probable that the investment will not be sold at an amount other than NAV. If a reporting entity finds that it is not practical to calculate an adjusted NAV, or if it deems that a sale at other than NAV is probable (based on criteria in ASC 820-10-35-62), then the practical expedient is not available. The reporting entity may also elect not to utilize the practical expedient. In those instances, the reporting entity should instead apply the general measurement principles of ASC 820 to estimate fair value.

6.2.7 Collateralized financing entities

A collateralized financing entity, or CFE, is defined in the ASC Master Glossary.

Definition from the ASC Master Glossary

Collateralized Financing Entity: A variable interest entity that holds financial assets, issues beneficial interests, and has no more than nominal equity. The beneficial interests have contractual recourse only to the related assets of the collateralized financing entity and are classified as financial liabilities. A collateralized financing entity may hold nonfinancial assets temporarily as a result of default by the debtor on the underlying debt instruments held as assets by the collateralized financing entity or in an effort to restructure the debt instruments held as assets by the collateralized financing entity. A collateralized financing entity also may hold other financial assets and financial liabilities that are incidental to the operations of the collateralized financing entity and have carrying values that approximate fair value (for example, cash, broker receivables, or broker payables).

Collateralized loan obligations and other securitization vehicles are example of CFE’s.
Consolidators of CFE’s often elect the fair value option for the financial assets and liabilities to avoid accounting mismatches caused by financial asset impairments. Because the fair value of the CFE’s financial assets and financial liabilities are measured independently, the periodic remeasurement can produce net gains (losses) each period not attributable to the beneficial interests held by the primary beneficiary. Although the recourse for a holder of a CFE’s financial liabilities (beneficial interest holder) may be limited to the financial assets within the CFE, and the financial assets of the CFE may only be used to settle its financial liabilities, the methodologies and inputs used to separately fair value the financial assets and financial liabilities may produce different values for each.
The change was driven by concerns expressed by stakeholders that the income statement volatility arising from the different measurements of financial assets and liabilities did not provide decision-useful information, as it did not reflect the actual economic risks to which the reporting entity was exposed.

6.2.7.1 Measurement alternative

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.

6.2.7.2 Subsequent measurement

Upon the initial consolidation of a CFE, gains or losses resulting from the remeasurement of the CFE’s financial assets and third-party financial liabilities should be recognized through earnings and attributed to the parent. This difference may not be allocated to noncontrolling interest or appropriated retained earnings; it should be reflected in the reporting entity's earnings and earnings per share.
If the measurement alternative is elected upon initial consolidation, subsequent remeasurement gains and losses will be limited to the CFE’s economic interests that are held by the reporting entity (parent). This remeasurement includes the change in the fair value of the beneficial interests held by the reporting entity, as well as changes in the reporting entity’s carrying value of beneficial interests received that represent compensation for services provided.
Once a reporting entity adopts the measurement alternative, it is required to consistently apply it for each subsequent reporting period as long as the consolidated CFE continues to meet the necessary conditions to apply it.
If a reporting entity that consolidates a CFE elects the measurement alternative, and that CFE fails to meet the scope requirements to apply the measurement alternative at a later date, application of the measurement alternative must be permanently discontinued and ASC 820 should be applied prospectively to remeasure that CFE’s financial assets and financial liabilities. Any subsequent remeasurement gains or losses related to the CFE’s financial assets and third-party financial liabilities should be included in the reporting entity’s earnings and attributed to the reporting entity.
If a reporting entity that consolidates a CFE elects the measurement alternative and subsequently transfers financial assets into the CFE that are not accounted for at fair value through earnings, it would be prohibited from continuing to apply the measurement alternative in future periods. For example, a primary beneficiary of a consolidated CFE may transfer loans into the CFE that must be accounted for at amortized cost. In that scenario, the CFE would no longer meet the necessary conditions to apply the measurement alternative, thus requiring the primary beneficiary to remeasure both the CFE’s financial assets and financial liabilities that existed prior to the loan transfer at fair value under the fair value option in future periods. Subsequent remeasurement of the CFE’s financial assets at fair value would exclude the transferred loans that disqualified the CFE from continuing to apply the measurement alternative, which must follow an amortized cost model. Even if the financial assets that prevented the CFE from qualifying for the measurement alternative are sold in subsequent periods, the parent may not resume application of the measurement alternative. In other words, the measurement alternative may only be elected on the date a CFE is initially consolidated.
If the measurement alternative is elected, a reporting entity is implicitly electing the fair value option for the CFE’s financial assets and financial liabilities. Because that election is irrevocable, the parent should “continue” application of the fair value option for the CFE’s financial assets and financial liabilities if it is subsequently disqualified from applying the measurement alternative. Separately measuring the individual financial assets and financial liabilities of the CFE could give rise to measurement differences. In that scenario, any remeasurement differences must be attributed to the parent for purposes of calculating earnings per share.
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