Accounting Standards Update – Accounting for Financial Instruments

March 2016 | Article

Recently, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The objective of this update is to enhance the reporting model for financial instruments to provide more decision-useful information to financial statement users and to help converge Generally Accepted Accounting Principles (GAAP) with international standards. The ASU will affect all entities (including nonprofit entities) that hold financial assets or owe financial liabilities.

Main Provisions of the Update

  1. Require equity investments (except those accounted for under the equity method or those resulting in the consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income (performance indicator). However, an entity may choose to measure equity investments that do not have readily determinable fair value at cost minus impairment, plus or minus any changes resulting from observable price changes in orderly transactions for an identical or similar investment of the same issuer. The unrealized change in fair value recognized during each reporting period for equity investments still held is required to be disclosed.
  2. Eliminate the concept of cost method investments and incorporate these investments into the requirements for equity investments noted in Provision 1 above.
  3. Simplify the impairment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When the qualitative assessment indicates that impairment exists, an entity must measure the investment at fair value.
  4. Eliminate the requirement for nonprofit entities that issue conduit debt or have greater than $100 million in assets to disclose the fair value of financial instruments not measured at fair value.
  5. Eliminate the requirement to disclose the fair value of financial instruments measure at amortized cost for nonpublic business entities. Eliminate the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value disclosed for financial instruments measured at amortized cost on the balance sheet.
  6. Require an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument specific credit risk when the entity has elected the fair value option for recording the liability.
  7. Require separate presentation of financial assets and financial liabilities by measurement category and form of asset on the balance sheet or in the notes to the financial statements.
  8. Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities.

Key Considerations for Health Care Organizations
Provision 1 will likely have the most significant impact on certain health care organizations. Current guidance allows unrealized gains and losses on equity securities classified as “available-for-sale” (investor-owned entities) or “other-than-trading” (nonprofit entities) to be excluded from the performance indicator (net income or revenues in excess of expenses). The amendments in this ASU will require unrealized gains and losses to run through the performance indicator. This change would also eliminate the requirement to disclose the aggregate fair value and unrealized losses of equity securities in an unrealized loss position at year-end. This ASU does not change the classification and recording of income for debt securities. In addition, all nonprofit entities will now be exempt from disclosing the fair value of financial instruments not measured at fair value.

For public entities, the ASU is effective for fiscal years beginning after December 15, 2017. The ASU is effective for all other entities for fiscal years beginning after December 15, 2018. Organizations will be required to adopt this standard through means of a cumulative-effect adjustment to their balance sheets as of the beginning of the period of adoption. As such and, depending on the size of each organization’s investment portfolio, adoption of the standard may have a significant impact on the performance indicator in the year of adoption. Organizations should begin preparing for implementation of this ASU and educate financial statement users on its potential impact. The ASU generally does not allow for early adoption of a majority of the provisions noted above; however, it does allow for early adoption of the provision that exempts private entities and nonprofit entities from the disclosure requirements related to the fair value of financial instruments.

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