On January 5, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.

The new guidance is intended to enhance the reporting model for financial instruments to provide financial statement users with more useful information. Companies reporting under FASB standards should begin evaluating the potential financial statement impact now as well as whether early adoption could be advantageous.

Main Provisions

The main provisions address certain aspects related to the recognition, measurement, and disclosure of financial instruments. In particular, they:

• Require a company’s equity investments (except those accounted for under the equity method or that result in consolidation) to be measured at fair value. Any changes in fair value are to be recognized in net income.
• Allow companies to choose to measure equity investments without readily determinable fair values at cost less impairment (if any), plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer.
• Simplify the impairment assessment of equity securities without readily determinable fair values. The ASU now requires a qualitative assessment to identify impairment. When such an impairment exists, an entity is required to measure the investment at fair value.
• Eliminate the requirement for nonpublic business entities to disclose the fair value of financial instruments measured at amortized cost.
• Eliminate the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost on the balance sheet.
• Require public business entities to use an exit price notion when measuring the fair value of financial instruments for disclosure purposes.
• Require an entity to separately present 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 (also commonly referred to as own credit risk) when the entity has elected to measure the liability with the fair value option.
• Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (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.

Impact

While the existing guidance for most classification and measurement decisions for financial instruments will be retained, the amendments in the ASU result in several changes that impact both public and nonpublic business entities.

One of the most significant benefits from the ASU will be the elimination of disclosure requirements related to financial instruments measured at amortized cost. Public business entities won’t be required to disclose the methods and significant assumptions used to estimate the fair value of these financial instruments, and nonpublic entities won’t be required to disclose their fair value. Nonpublic business entities may want to consider adopting this provision early due to the potential cost savings of the reduced disclosure requirement. This applies to any current or future fiscal years for which its financial statements haven’t yet been made available for issuance.

For public business entities, the new standard will require disclosure of fair value using the exit price notion for all financial instruments measured at amortized costs. This new requirement eliminates the option of using other fair value estimation methods that were previously permitted. This will likely require a more rigorous fair value determination process. While this provision will likely increase compliance costs, the changes will increase the comparability of financial statements and provide users of those statements with more relevant information.

Both public and nonpublic business entities with equity securities as investments should carefully examine the amendments in this ASU. For these assets, the ASU supersedes current guidance and no longer requires equity securities with a readily determinable fair value to be classified into categories (that is, trading or available for sale). Rather, all equity securities must now be measured at fair value, with changes in the fair value recognized through net income. Equity investments without readily determinable fair values will require a qualitative assessment for impairment at each reporting period, similar to qualitative assessments for goodwill and other intangible assets. Enhanced disclosures regarding equity securities will also be required.

Effective Dates

The amendments in the ASU are effective for public business entities for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Entities not considered public business entities may elect to adopt the amendments early, as of fiscal years beginning after December 15, 2017.

Additionally, the new guidance permits earlier adoption of certain provisions. All entities may early adopt the instrument-specific credit risk provision for financial statements of fiscal years or interim periods that haven’t yet been issued (for public business entities) or made available for issuance. Entities that aren’t public business entities may also early adopt the provision that eliminates the disclosure of fair value information about financial instruments measured at amortized cost for financial statements that haven’t yet been made available for issuance.

Next Steps

Companies have at least two years before the effective date of the full ASU, at which point they’ll need to apply the amendments with a cumulative-effect adjustment to their balance sheet as of the beginning of the fiscal year of adoption. Portions of the ASU related to equity securities without readily determinable fair values should be applied prospectively to equity investments that exist as of the adoption date.

For now, companies should assess the early adoption provisions. They should also examine how this ASU will impact their financial statements as well as their systems, controls, and processes for the recognition and measurement of financial instruments. This is especially important for nonpublic business entities, since adopting allowable provisions early would permit them to be applied to financial statements as of December 31, 2015, if those statements haven't yet been made available for issuance. As a first step, begin taking inventory of all your company’s assets and liabilities that will be affected so you can begin to determine the overall financial statement impact to your organization.

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For questions about how this new ASU may affect your organization, contact your Moss Adams professional.