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FAS 159: The Fair Value Option On February 15, 2007 FAS 159 was released. This Statement permits entities to choose to measure many recognized financial instruments at fair value. While the stated goal of the Statement was to simplify financial reporting and provide a means to reduce income statement volatility, for many community banks the opposite result occurs. See the “Analysis” section at the end of this report for details. Overview The fair value option applies to all entities that elect its provisions. Eligible items include: 1 Recognized financial assets and liabilities except: a. Investment in a subsidiary required to be consolidated. b. Interest in a variable interest entity required to be consolidated. c. Various benefit plans and obligations. d. Financial assets and liabilities recognized as leases. e. Deposit liabilities withdrawable on demand. f. Instruments classified as a component of shareholders equity. 2 Firm commitments involving only financial commitments. 3 Nonfinancial insurance contracts and warranties. 4 Certain host financial instruments separated from embedded nonfinancial derivatives. The fair value option permits all entities to measure eligible items at fair value at specified election dates. Unrealized gains and losses due to fair value changes are reported in earnings at each subsequent reporting date. Upfront costs and fees related to items for which the fair value option is elected shall be recognized in earnings as incurred and not deferred. The fair value option: 1 May be applied instrument by instrument. 2 Is irrevocable. 3 Is applied only to entire instruments and not to only specified risks, specific cash flows or portions of instruments. An entity may decide to elect the fair value option for each eligible item on its election date, or the election may automatically occur according to a preexisting policy for specified types of eligible items. Election dates include the date: 1 The entity first recognizes the eligible item. 2 The entity enters into an eligible firm commitment. 3 Financial assets that have been reported at fair value with unrealized gains and losses included in earnings because of specialized accounting principles cease to qualify for that specialized accounting. 4 That specific accounting treatment for an investment in another entity changes. 5 An event requires an eligible item to be measured at fair value, but does not require fair value measurement at subsequent reporting dates (such as business combinations, consolidations/deconsolidations and certain modifications of debt).
but not all eligible items within a group of similar items: . all eligible financial interests in the same entity must apply fair value. and the fair value option may be elected for some of those loans. 4 If fair value is applied to eligible base insurance contracts. 2 To understand how changes in fair value affect earnings for the period. it shall be applied to all claims and obligations under that contract.692. 2 If fair value option is applied to an investment accounted for under the equity method. but not others. 3 If fair value is applied to eligible insurance contracts. As of each date for which a statement of financial position is presented. The principal disclosure objectives are to facilitate comparison between entities choosing different measurement attributes for similar assets and liabilities and between assets and liabilities in the financial statements of an entity that selects different measurement attributes for similar assets and liabilities. In contrast. TN 38018 901.1378 Instrument-by-instrument application allows the fair value method to be elected for a single eligible item without electing it for other identical items with the following four exceptions: 1 If multiple advances made to one borrower under a line of credit or construction borrowing lose their identity and become part of a larger loan balance. entities shall disclose: 1 Management’s reasons for electing a fair value option for each eligible item or group of similar items. For example. investors may choose to apply the fair value option to only some shares or bonds issued or acquired in a single transaction. To do so. it shall be applied to all concurrently or subsequently issued riders. The disclosure requirements are expected to allow financial statement users: 1 To understand management’s reasons for electing fair value option. a loan syndication arrangement may result in multiple loans to the same borrower by different lenders.echopartners.971. 3 To observe the same information about certain items that would have been disclosed if the fair value option had not been elected. or present two separate line items to display fair value and non-fair-value carrying amounts. A financial instrument that is a single contract.www. may not be separated into parts for purposes of applying the fair value option. the fair value option is available only to the larger balance and not to each advance individually. Each of these loans is a separate instrument. If the fair value option is elected for some. 4 To understand differences between fair values and contractual cash flows for certain items.com 65 Germantown Court Suite 215 Cordova. The fair value option need not be applied to all instruments issued or acquired in a single transaction.5040 800. such as a loan. Presentation and Disclosures Entities shall report assets and liabilities measured at fair value pursuant to this Statement in a manner that separates the reported fair values from the carrying amounts of similar items. the entity shall either present the aggregate of fair value and non-fair-value amounts in the same line item and parenthetically disclose the fair value amount.
4 For loans held as assets for which the fair value option has been elected: a. Loans and long-term receivables. 4 For liabilities with fair values significantly affected during the reporting period by changes in the instrument-specific credit risk: a. b. If the entity’s policy is to recognize interest income separately from other changes in fair value. b. 3 For loans and other receivables held as assets: a. For each period in which an income statement is presented. 2 Information concerning the measurement of interest and dividends from investments for which the fair value option has been elected. Qualitative information about the reason for those changes.1378 a.971. 2 For each line item in the statement of financial position that includes items for which the fair value option has been elected: a.692. Estimated amount of gains and losses attributable to instrument-specific credit risk. Information to help users understand how each line item relates to major categories of assets and liabilities presented in accordance with FAS 157’s disclosure requirements. How the gains and losses attributed to changes in instrument-specific credit risk were determined. Aggregate fair value of loans 90 days or more past due. or both. 3 The difference between the aggregate fair value and the aggregate unpaid principal balance of: a. in nonaccrual status.5040 800. the amount of gains and losses from fair value changes included in earnings during the period. and in which line in the income statement those gains and losses are reported. b. How the gains and losses attributable to instrument-specific credit risk were determined.com 65 Germantown Court Suite 215 Cordova. Estimated amount of gains and losses attributable to instrument-specific credit risk.www. Long-term debt instruments. The aggregate carrying amount in each line item that is not eligible for the fair value election. The difference between the aggregate fair value and the aggregate unpaid principal balance for loans that are 90 days or more past due. the entity shall disclose the methods and significant assumptions used to estimate the fair values of items for which the fair value option has been elected. . The FAS 159 disclosure requirements do not eliminate disclosure requirements included in other GAAP pronouncements. Information useful to understand how the group of similar items relates to individual line items in the statement of financial position. b. entities shall disclose the following about items for which the fair value option has been elected: 1 For each line item in the statement of financial position. the aggregate fair value of nonaccrual status loans. b. TN 38018 901. Annually. b. c.echopartners. A description of the similar items and reasons for the partial election. c.
So if the borrower’s credit quality were to worsen. which most accurately tracks the market value changes of a properly selected hedge. Wondering how these rules apply to you? Call us today for a free analysis and consultation at 1. the news is not all good for community banks. less burdensome alternative to hedge accounting. but must instead include other risks such as credit risk. . reporting and disclosure requirements of FAS 133. What this means is that unlike hedge accounting under FAS 133. Consider these few issues: 1 While hedge accounting may be terminated at any time.com 65 Germantown Court Suite 215 Cordova. the fair value option may only be elected at specific election dates.echopartners. Perhaps the most dangerous aspect of FAS 159 is the restriction on applying fair value to the entire instrument only and not to specified risks. 2007. Transition provisions permit application to eligible items existing at the effective or early adoption date. 2 While hedge accounting may be elected at any time. Recommendation At this time we are not recommending adoption of FAS 159 as an alternative to hedge accounting under FAS 133. including changes due to credit. We’ll help you understand these complex standards and then advise you on the right approach for your financial situation — ultimately helping you maximize your financial potential. the bank still must grapple with designing a robust methodology to allow the calculation and decomposition of fair values. TN 38018 901. 3 In order to implement the fair value option.1378.971. with early adoption possible in certain circumstances. Consult your accountant for further information.5040 800. the bank could be faced with increased income statement volatility even if the selected hedge were accurately tracking interest rate changes.971.www.1378 This Statement is effective for fiscal years beginning after November 15. 4 Electing the fair value option does not free you from complying with the documentation. Analysis While designed to offer a simpler. FASB has instead created another way for the unwary to become ensnared in accounting complexities.800. 5 Hedge accounting may be implemented for a specifically identified portion or percentage of a loan. while the fair value option is only available for the entire asset. While it is true that entities electing FAS 159 fair value option for fixed rate commercial loans would no longer be required to perform effectiveness testing.692. the bank cannot hedge only the risk related to the benchmark interest rate. the fair value option is irrevocable. specific cash flows or portions of the instrument.
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