Financial Instruments Future Changes in Standards? Exposure Draft 2010.

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Presentation transcript:

Financial Instruments Future Changes in Standards? Exposure Draft 2010

Financial Instruments NOW Some financial instruments are currently reported at fair value on a routine basis: – Those included in trading and available for sale investment portfolios – Those for which the fair value option has been adopted at acquisition date Most liabilities are carried at amortized cost with fair values disclosed in the notes

What is a Financial Instrument Financial Instrument Cash, evidence of an ownership interest in an entity, or a contract that both: a. Imposes on one entity a contractual obligation either: – 1. To deliver cash or another financial instrument to a second entity – 2. To exchange other financial instruments on potentially unfavorable terms with the second entity. b. Conveys to that second entity a contractual right either: – 1. To receive cash or another financial instrument from the first entity – 2. To exchange other financial instruments on potentially favorable terms with the first entity.

FASB Exposure Draft Under the proposal, almost all financial instruments would be reported at fair value on the balance sheet. This would include many liabilities currently carried at amortized cost – Exception: long-term debt related to long-lived assets like a mortgage on a building In some cases, the gain/loss would be in other comprehensive income rather than net income

Exposure Draft If this ED becomes a standard (as written) – We would be getting rid of the 3-categories of investments we have from SFAS115 (trading, available for sale, and held-to-maturity) – In effect, we could still have HTM but we would have fair value on the balance sheet and the gain/loss would be reported in “other comprehensive income” rather like what we currently do for available-for-sale securities

Amortized Cost is Also Important The FASB doesn’t want to lose valuable information so the proposal calls for reporting BOTH fair value and amortized cost on the face of the balance sheet Complications: – Credit-worthiness affects borrowing rate – a lower credit rating = higher interest rate – Higher interest rate = lower present value (when using level 2 measurements)

Balance Sheet Display – Investment Side *Amortization of discount/premium is charged to credit impairment allowance * ** **To bring carrying value to fair value of the financial instrument

Exposure Draft Proposal includes disclosure of the portion of the gain/loss that is related to the change in credit score separately from the gain/loss related to general changes in interest rates Choice of equity method for investments will be limited to situations where the investee is closely related to the investor’s business strategy. Otherwise, will be reported at fair value