Is the fair value option applied?

Is the fair value option applied? is part of the decision model for the classification and measurement of financial assets, that started in the IFRS 9 Framework for 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 (IFRS 9 4.1.5). Is the fair value option applied

Accounting mismatch

The notion of an accounting mismatch necessarily involves two propositions. First, an entity has particular assets and liabilities that are measured, or on which gains and losses are recognised, inconsistently; second, there is a perceived economic relationship between those assets and liabilities. Is the fair value option applied

For example, a liability may be considered to be related to an asset when they share a risk that gives rise to opposite changes in fair value that tend to offset, or when the entity considers that the liability funds the asset (IFRS 9 BCZ4.61). Paragraph IFRS 9 B4.1.30 gives examples when these conditions could be met.  For practical purposes, the entity need not enter into all of the assets and liabilities giving rise to the accounting mismatch at exactly the same time (IFRS 9 B4.1.31). Is the fair value option applied

It is possible to designate only some of a number of similar financial assets or similar financial liabilities if doing so achieves a greater reduction in accounting mismatch, but it is not allowed to designate only a component of a financial instrument (e.g. a specified risk) or its proportion (IFRS 9 B4.1.32).

Examples of reduction of measurement or recognition inconsistencies

  1. an entity has contracts within the scope of IFRS 17 (the measurement of which incorporates current information) and financial assets that it considers to be related and that would otherwise be measured at either fair value through other comprehensive income or amortised cost.
  2. an entity has financial assets, financial liabilities or both that share a risk, such as interest rate risk, and that gives rise to opposite changes in fair value that tend to offset each other. However, only some of the instruments would be measured at fair value through profit or loss (for example, those that are derivatives, or are classified as held for trading). It may also be the case that the requirements for hedge accounting are not met because, for example, the requirements for hedge effectiveness in IFRS 9 6.4.1 are not met.
  3. an entity has financial assets, financial liabilities or both that share a risk, such as interest rate risk, that gives rise to opposite changes in fair value that tend to offset each other and none of the financial assets or financial liabilities qualifies for designation as a hedging instrument because they are not measured at fair value through profit or loss. Furthermore, in the absence of hedge accounting there is a significant inconsistency in the recognition of gains and losses. For example, the entity has financed a specified group of loans by issuing traded bonds whose changes in fair value tend to offset each other. If, in addition, the entity regularly buys and sells the bonds but rarely, if ever, buys and sells the loans, reporting both the loans and the bonds at fair value through profit or loss eliminates the inconsistency in the timing of the recognition of the gains and losses that would otherwise result from measuring them both at amortised cost and recognising a gain or loss each time a bond is repurchased.

The question is: Do you want to designate a financial asset as measured at fair value through profit or loss?

Yes / No

See also: The IFRS Foundation

Is the fair value option applied?

Is the fair value option applied