ASU 2016-01's Impact and What You Need to Know About the Standard

The past few years have been big years for new accounting standards. Many entities have been diligently working on implementing the revenue recognition standard, the new lease standard and the credit loss standard. Other entities are breathing a sigh of relief that FASB delayed the effective dates of some of these standards for certain entities.

With all the talk generated by these three big standards, one accounting standards update (ASU) that may have flown under the radar for many entities is ASU 2016-01: FINANCIAL INSTRUMENTS—OVERALL (SUBTOPIC 825-10): RECOGNITION AND MEASUREMENT OF FINANCIAL ASSETS AND FINANCIAL LIABILITIES.

What is ASU 2016-01?
ASU 2016-01 eliminates the classification categories of equity investments and their differing treatments (trading, available-for-sale, or held to maturity securities). This includes equity investments in partnerships, LLCs and unincorporated joint ventures.

The ASU also eliminates the concept of cost method investments. Under the ASU, all equity investments, other than those measured using the equity method or those requiring consolidating of the investee, are required to be reflected at fair value on the balance sheet with changes in fair value recognized in net income. Previous guidance required changes in fair value from available for sale and held-to-maturity investments to be “parked” in other comprehensive income until the gains or losses were realized. This change will increase net income volatility due to the performance of a company’s investments.
Specifically, 2016-01 amends ASC Topic 825 in the following ways:

• Requires equity investments (other than those accounted for under the equity method or those that result in consolidation of the investee) to be measured at fair value with the change in fair value recognized in net income. This includes equity investments in partnerships, LLCs, and unincorporated joint ventures.
• The ASU provides some relief for equity investments that do not have readily determinable fair values. These can be measured at cost, plus impairment, plus/minus changes resulting from observable price changes in orderly transactions of an identical or a similar investment of the same issuer. The ASU requires a qualitative impairment assessment of equity investments that do not have readily determinable fair values. If considered impaired, the investment is required to be measured at fair value. Note that investments measured at NAV are not eligible for this treatment.
• Eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities. Requires public business entities to us the exit price notion to measure fair value of financial instruments for disclosure purposes.
• Eliminates the requirement for public business entities to disclose the method and significant assumptions used to estimate fair value for investments measured at amortized cost.
• Requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments.
• Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.
• Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets.

Who does ASU 2016-01 apply to?
The amendments in this ASU affect all entities that hold financial assets or owe financial liabilities.

When is ASU 2016-01 effective?
ASU 2016-01 is effective for public business entities for fiscal years beginning after December 15, 2017. For all other entities, including nonprofits and employee benefit plans, the update is effective for fiscal years beginning after December 31, 2018, which means 2019 calendar year-ends.

How do you implement ASU 2016-01?
An entity may elect to measure investments that do not have readily determinable fair values at cost, minus impairment, plus/minus changes resulting from observable price changes in orderly transactions of an identical or a similar investment of the same issuer. Note that investments measured using the practical expedient of Net Asset Value (NAV) per share are not eligible for this treatment. Entities should be sure to document this election upon implementation or purchase of these securities (the election can be made on an investment-by-investment basis). These investments are required to be qualitatively assessed for impairment at each reporting period. If considered impaired, the investments are required to be adjusted to fair value, an adjustment that is included in net income.

Don’t get caught overlooking the impacts of ASU 2016-01. While the implementation steps aren’t overly complex and likely won’t be time consuming for most entities, financial statement users should be prepared for the volatility and potential impact to net income.