Fair value option

Fair value option – There are two of them,

  1. the FV option for debt instruments: in case the business model test (hold to collect (Yes/No) or hold and sell (Yes/No) debt instruments) and the Solely payments of principal and interest test (Yes/No) both result in an Yes answer, the valuation is at amortised costs (hold to collect Yes) respective FVOCI (with recycling)  (hold and sell Yes). The entity can use the FV option at initial recognition to designated the fair value through profit or loss valuation to a debt instrument.
  2. the FVOCI option for equity instruments (not held for trading): The entity can use the FVOCI option at initial recognition to designated the fair value through other comprehensive income (no recycling) to a equity instrument (not held for trading).

The fair value through profit or loss option

In addition to the standards that require assets and liabilities to be reported at fair value, US GAAP and IFRS provide reporting entities with an option to measure many financial instruments and other items in the balance sheet at fair value. The fair value option considerably expands the ability of a reporting entity to select the basis of measurement for certain assets and liabilities. In general the FVO is the designation of financial transactions in the balance sheet at fair value through profit or loss.

In accordance with the requirements issued in IFRS 9 (2009), entities are permitted to designate financial assets that would otherwise be measured at amortised cost as measured at fair value through profit or loss if, and only if, such designation eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an ‘accounting mismatch’). Such designation is available at initial recognition and is irrevocable. Fair value option

The fair value through other comprehensive income option

Investments in equity instruments (within the scope of IFRS 9) that are not held for trading can, at initial recognition, be irrevocably designated at fair value through other comprehensive income. Subsequent measurement is off course also at fair value with all gains and losses recognised in other comprehensive income. Changes in fair value are not subsequently recycled to profit and loss!!!! Dividends are recognised in profit or loss. Fair value option

The IASB decided that the same fair value option that is available to financial assets that would otherwise be measured at amortised cost should be available for financial assets that would otherwise be measured at fair value through other comprehensive income. The IASB noted that the rationale set out in paragraph BC4.79 for permitting the fair value option for assets measured at amortised cost is equally applicable for financial assets measured at fair value through other comprehensive income. Fair value option

IFRS Standards with a FV option

The IFRS standards that include a fair value option are: Fair value option

  • IAS 28 Investments in Associates and Joint Ventures permits a venture capital organisation, mutual fund, unit trust, and similar entities, including investment-linked insurance funds, to measure investments in associates and joint ventures at fair value through profit or loss in accordance with IFRS 9 Fair value option
  • IAS 16, Property, Plant and Equipment, which permits a reporting entity to choose either the cost model or the revaluation model as its accounting policy after initial recognition
    IAS 38, Intangible Assets, which permits a reporting entity to choose either the cost model or the revaluation model as its accounting policy after initial recognition when an active market exists for an intangible asset Fair value option
  • IAS 39 1, Financial Instruments: Recognition and Measurement, which permits the FVO for a financial asset or financial liability (or a group of financial assets, financial liabilities, or both) on initial recognition, with changes in fair value recognised in profit or loss if certain criteria are met
  • IFRS 9, Financial Instruments, which permits the FVO for a financial liability in a manner consistent with IAS 39. However, with respect to the FVO for a financial asset, IFRS 9 retains only one of the three conditions in IAS 39, which is that an entity can only designate a financial asset at fair value when it eliminates or reduces an accounting mismatch. IFRS 9 will replace IAS 39 effective for reporting periods beginning on or after January 1, 2018, with early adoption permitted
  • IAS 40, Investment Property, which permits an entity to choose as its accounting policy either the fair value model or the cost model
  • IFRS 3, Business Combinations, which provides the acquirer with the option to measure a non-controlling interest (NCI) in an acquiree at either fair value or the present ownership instruments’ proportionate share in the recognised amounts of the acquiree’s net identifiable assets

Financial assets

At initial recognition an entity may irrevocably designate a financial asset as measured at fair value through profit or loss if doing so eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an ‘accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases (see Designation eliminates …. an accounting mismatch).

Financial liabilities

At initial recognition an entity may, at initial recognition, irrevocably designate a financial liability as measured at fair value through profit or loss when permitted by Fair value option for embedded derivatives, or when doing so results in more relevant information, because either:

  1. it eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as ‘an accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases (see Designation eliminates …. an accounting mismatch); or
  2. a group of financial liabilities or financial assets and financial liabilities is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity’s key management personnel (as defined in IAS 24 Related Party Disclosures), for example, the entity’s board of directors and chief executive officer (see Group managed and performance evaluated on a fair value basis).

Embedded derivatives

If a contract contains one or more embedded derivatives and the host is not an asset within the scope of IFRS 9, an entity may designate the entire hybrid contract as at fair value through profit or loss unless:

  1. the embedded derivative(s) do(es) not significantly modify the cash flows that otherwise would be required by the contract; or
  2. it is clear with little or no analysis when a similar hybrid instrument is first considered that separation of the embedded derivative(s) is prohibited, such as a prepayment option embedded in a loan that permits the holder to prepay the loan for approximately its amortised cost.

Fair value option

Fair value option

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