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Changes are coming to banks that invest or hold equity investments.

Impacts of financial decisions

Impact of New FASB Financial Instruments Guidance on Banks

  • 1/18/2016

This year may prove to be a busy one in terms of new accounting guidance, with several pronouncements that may impact banks expected to be issued by the Financial Accounting Standards Board (FASB) during 2016.

ASU 2016-01 will be effective for public business entities for fiscal periods beginning after December 31, 2017, and all other entities for fiscal periods beginning after December 31, 2018.

On January 5, 2016, Accounting Standards Update (ASU) 2016-01, Financial Instruments — Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities was issued.

Initially, this update may appear to only affect banks that invest in and hold marketable equity investments. However, there is a beneficial provision that will allow certain non-public business entities to elect to eliminate a previously required financial statement footnote.

Changes to accounting for equity investments

Equity investments are defined in ASU 2016-01 as:

  • Any security representing ownership interest in an entity, such as common, preferred, or other capital stock
  • A right to acquire an ownership interest in an entity at a fixed or determinable price, such as warrants, rights, forward purchase contracts, or call options
  • A right to dispose of an ownership interest in an entity at a fixed or determinable price, such as put options and forward sales contracts

Equity investments have historically been classified and accounted for as either “available-for-sale” or “trading” (with the exception of those accounted for under the equity method), since these investments lack a maturity date that would allow for them to be classified as “held-to-maturity.”

ASU 2016-01 will eliminate the “available-for-sale” or “trading” classifications, requiring equity investments to be measured at fair value on the balance sheet with changes in fair value recognized in net income.

There are a few exceptions for this accounting treatment:

  • Investments accounted for using the equity method, or that result in the consolidation of the investee, remains unchanged.
  • An entity may choose to account for equity investments that do not have a readily determinable fair value at cost less any impairment, plus or minus any observable changes in price resulting from transactions for similar or identical investments of the same issuer. Examples of this include Federal Home Loan Bank (FHLB) or Federal Reserve Bank (FRB) stock.

ASU 2016-01 simplifies the impairment assessment for equity investments without readily determinable fair values by requiring a two-step assessment, similar to the impairment assessment for good will. Step one is a qualitative assessment. If step one indicates potential impairment, then the entity is required to measure the investment at fair value.

ASU 2016-01 will be effective for public business entities for fiscal periods beginning after December 31, 2017, and all other entities for fiscal periods beginning after December 31, 2018.

Financial statement presentation changes

ASU 2016-01 will require the separate presentation of financial assets and financial liabilities by measurement category and form of financial assets (i.e., securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements.

In addition, this update will require an entity to present separately in other comprehensive income (Loss) the portion of the total change in fair value of a liability resulting from a change in the instrument specific credit risk when the entity has elected to measure the liability at fair value under the fair value option for financial instruments.

There are also a few additional presentation changes that will depend upon whether your entity is a public business entity.

Entities that are not public business entities

ASU 2016-01 will eliminate the requirement for entities that are not public business entities to disclose the fair value of financial instruments reported at amortized cost on the balance sheet as seen in the table below. Given how rarely financial institutions are able to shorten their financial statement footnotes as a result of the issuance of a new accounting standard (almost like seeing a leprechaun ride a unicorn under a blue moon these days), we should all probably take a moment to appreciate this change.

The disclosure requirement related to fair value of financial instruments was included in ASC 825-10-50. Prior to ASU 2016-01, this disclosure was required for all entities unless they met all of the following criteria:

  • The entity is a nonpublic entity
  • The entity’s total assets are less than $100 million as of the balance sheet date.
  • The entity has no instrument accounted for as a derivative, other than commitments, related to the origination of mortgage loans held for sale during the reporting period.
Typical Example of the Disclosure That Will Be Eliminated by ASU 2016-01
  2015   2014  
  Carrying Amount Fair Value Carrying Amount Fair Value
Financial Assets $ - $ - $ - $ -
Cash and cash equivalents - - - -
Interest-bearing deposits in banks - - - -
Securities held-to-maturity - - - -
Federal home loan bank stock, at cost - - - -
Accrued interest receivable - - - -
Financial Liabilities - - - -
Deposits - - - -
Federal funds purchased and repurchase agreements - - - -
Federal home loan bank advances - - - -
Notes payable - - - -
Subordinated debentures - - - -
Accrued interest payable - - - -

Please note that in addition to this table, the descriptions of the methods and assumptions used to estimate fair value for financial instruments reported at amortized cost on the balance sheet for entities that are not public business entities would also be eliminated. For those financial institutions that present comparative financial statements, the adoption of this provision to eliminate the above disclosure would apply to both fiscal years presented.

Public business entities

ASU 2016-01 will eliminate the requirement to disclose the methods and assumptions used to estimate fair value for financial instruments reported at amortized cost on the balance sheet.

ASU 2016-01 will also require public business entities to use the exit price notion when measuring fair value for disclosure purposes. A key point to note is the requirement to use exit pricing may significantly alter the cost to develop fair values for disclosure purposes.

For example, financial institutions currently estimate fair values for portfolio loans reported at amortized cost on the balance sheet by examining the average rates per the terms of these loans, and comparing that average rate to the current rates offered by the institution to develop an estimated fair value of those loans. Utilizing the exit price notion will require financial institutions to estimate fair value of these loans based on the price that would be received to sell these loans in an orderly transaction between market participants at the measurement date. Developing fair value estimates using the exit price notion potentially could require some institutions to seek the help of a valuation specialist, particularly smaller institutions that do not have the information or capability to develop this type of an estimate in-house.

Banking considerations for this year

Early adoption is permitted for the following provisions:

  • For institutions that are not public business entities, the elimination of the previously required disclosure related to fair value of financial instruments (ASC 825-10-50), including the methods and assumptions used to estimate the fair value of financial instruments reported at amortized cost on the balance sheet.
  • Separately present in other comprehensive income (loss) the portion of the total change in fair value of a liability resulting from a change in the instrument specific credit risk, when the entity has elected to measure the liability at fair value under the fair value option for financial instruments.

All of the other guidance included in ASU 2016-01 may NOT be early adopted prior to the effective dates listed above.

How we can help

It is highly recommended that you examine the criteria in ASU 2013-12 to determine if your institution would fall in the definition of a public business entity, and therefore be subject to the presentation requirement for the use of exit pricing.

If your institution is eligible and interested in eliminating the disclosure listed above, this option is available for your current fiscal year, assuming your current fiscal year financial statements have not been issued.

As you probably know, this standard is part of a larger recognition and measurement FASB project that is intended as a response to weaknesses identified during the recent financial crisis, in the hopes of providing users of financial statements with more decision-useful information related to financial instruments. Our experienced professionals can help your institution respond to the changes and prepare your bank for the first of many FASB changes coming in 2016.