12.2 Scope

12.2.1 General

ASC 825-10

Instruments

15-4 All entities may elect the fair value option for any of the following eligible items:

A recognized financial asset and financial liability, except any listed in the following paragraph
A firm commitment that would otherwise not be recognized at inception and that involves only financial instruments (for example, a forward purchase contract for a loan that is not readily convertible to cash — that commitment involves only financial instruments — a loan and cash — and would not otherwise be recognized because it is not a derivative instrument)
A written loan commitment
The rights and obligations under an insurance contract that has both of the following characteristics:
1. The insurance contract is not a financial instrument (because it requires or permits the insurer to provide goods or services rather than a cash settlement).
2. The insurance contract’s terms permit the insurer to settle by paying a third party to provide those goods or services.
The rights and obligations under a warranty that has both of the following characteristics:
1. The warranty is not a financial instrument (because it requires or permits the warrantor to provide goods or services rather than a cash settlement).
2. The warranty’s terms permit the warrantor to settle by paying a third party to provide those goods or services.
A host financial instrument resulting from the separation of an embedded nonfinancial derivative from a nonfinancial hybrid instrument under paragraph 815-15-25-1, subject to the scope exceptions in the following paragraph (for example, an instrument in which the value of the bifurcated embedded derivative is payable in cash, services, or merchandise but the debt host is payable only in cash).

12.2.1.1 Financial Asset or Financial Liability

Generally, all entities may elect the FVO for all financial assets or financial liabilities. However, there are certain exceptions, as discussed in Section 12.2.2.

12.2.1.1.1 Equity Method Investees That Hold Nonfinancial Assets and Nonfinancial Liabilities

An equity method investment meets the definition of a financial asset. An investor is not required to “look through” the investment to the investee’s assets and liabilities to determine eligibility for the FVO. The FVO is available for equity method investments regardless of the nature of the investee’s assets and liabilities. However, certain nonconsolidated equity investments subject to the equity method may be ineligible for the FVO under ASC 825 because of a significant future-services component, as discussed in Section 12.2.2.6.

12.2.1.2 Written Loan Commitment

An entity should consider the definition of a “loan commitment” in the ASC master glossary when determining whether an item represents a written loan commitment for which the FVO may be elected. Only the writer of a loan commitment can elect the FVO. The FVO is not available to the holder of the loan commitment.

12.2.1.3 Warranty Contracts

An entity should consider the definition of a “warranty” in the ASC master glossary when determining whether an item represents a warranty contract for which the FVO may be elected.

12.2.1.4 Host Financial Instrument

12.2.1.4.1 Hybrid Financial Instrument

A host financial instrument that is recognized separately because an embedded financial derivative in the hybrid financial instrument has been separated under ASC 815-15 is not eligible for the FVO. However, the entire hybrid financial instrument is eligible for the FVO provided that none of the exceptions in ASC 825-10-15-5 apply to the instrument.

12.2.1.4.2 Hybrid Nonfinancial Instrument

A host financial instrument that is recognized separately because an embedded nonfinancial derivative in the hybrid nonfinancial hybrid instrument has been separated under ASC 815-15 is eligible for the FVO under ASC 825-10-15-4(f) provided that none of the exceptions in ASC 825-10-15-5 apply to the instrument. Such eligibility depends on both (1) the bifurcation and separate accounting for the embedded derivative instrument under ASC 815-15 and (2) the determination that what remains after such bifurcation is a financial instrument (i.e., the host contract is a financial instrument). Thus, the FVO is not available for an embedded derivative that is subject to an exception in ASC 815 (i.e., an embedded feature that is not separately accounted for under ASC 815-15).

It is important for an entity to identify the features of the separated embedded derivative and the remaining host contract. If the appropriately identified embedded derivative contains all of the nonfinancial features of the hybrid nonfinancial instrument and the host contract is receivable or payable only in cash, the host contract would be considered a financial asset or liability. If the identified features of the host contract contain any nonfinancial items (e.g., delivery of commodities, services), the host contract is not a financial instrument and the entity may not elect to apply the FVO under ASC 825-10-15-4. An entity must use judgment in determining the features of the embedded derivative and host contract.

12.2.1.4.3 Examples

Example 12-1

Prepaid Forward Commodity Contract — Embedded Derivative Is Not Bifurcated

Entity A enters into a prepaid contract to sell a commodity. The contract must be physically settled, and the commodity is not readily convertible to cash. The contract is a hybrid nonfinancial instrument that does not meet the definition of a derivative instrument in its entirety.

Entity A may not elect the FVO for the contract because (1) the hybrid instrument is not a financial instrument (since the contract must be physically settled by delivering a nonfinancial asset) and (2) the embedded commodity is not separated from the host debt contract under ASC 815-15. If the commodity had met the definition of a derivative and been bifurcated from the host contract, A would have been able to apply the FVO to the host financial instrument. See Example 12-2 for a scenario in which the embedded derivative is bifurcated from the host contract.

Example 12-2

Prepaid Forward Commodity Contract — Embedded Derivative Is Bifurcated

Entity B enters into a prepaid contract to sell a commodity. Under the contract, B receives $1 million from the counterparty at inception of the contract and will deliver a fixed quantity of the commodity every month for the next 60 months. The contract must be physically settled, and the commodity is readily convertible to cash. The contract is a hybrid nonfinancial instrument that does not meet the definition of a derivative instrument in its entirety.

Entity B determines that the embedded derivative is bifurcated as a commodity forward in which B receives a fixed dollar amount and delivers the fixed quantity of the commodity every month. Entity B will separately account for the bifurcated derivative at fair value in accordance with ASC 815-15-25-1. Entity B identifies the host contract as a payable in which it received $1 million at inception in return for future deliveries of the commodity to the counterparty. Because the identified host contract is a financial asset, B may elect to apply the FVO under ASC 825-10-15-4 to the host contract upon initial recognition (or on another eligible election date).

Example 12-3

Prepaid Services Contract — Embedded Derivative Is Bifurcated

Entity C enters into a contract to buy a fixed dollar amount of services from Entity D every month for 60 months. Entity C will pay an amount each month for six months that comprises a fixed dollar amount multiplied by an index linked to a foreign currency, Y, which is not the functional currency of either party and whose economic characteristics and risks are not clearly and closely related to either party’s services. Entity C identifies the embedded derivative as a net-cash-settled foreign-currency derivative and the host contract as a contract for services. The embedded derivative will be accounted for at fair value in accordance with ASC 815-15-25-1. Because the host contract is not a financial instrument, C may not elect to account for it at fair value under ASC 825-10-15-4.

12.2.2 Exceptions

ASC 825-10

Instruments

15-5 No entity may elect the fair value option for any of the following financial assets and financial liabilities:

An investment in a subsidiary that the entity is required to consolidate.
An interest in a variable interest entity (VIE) that the entity is required to consolidate.
Employers’ and plans’ obligations (or assets representing net overfunded positions) for pension benefits, other postretirement benefits (including health care and life insurance benefits), postemployment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements, as defined in Topics 420; 710; 712; 715; 718; and 960.
Financial assets and financial liabilities recognized under leases as defined in Subtopic 842-10. (This exception does not apply to a guarantee of a third-party lease obligation or a contingent obligation arising from a cancelled lease.)
Deposit liabilities, withdrawable on demand, of banks, savings and loan associations, credit unions, and other similar depository institutions.
Financial instruments that are, in whole or in part, classified by the issuer as a component of shareholders’ equity (including temporary equity) (for example, a convertible debt instrument within the scope of the Cash Conversion Subsections of Subtopic 470-20 or a convertible debt security with a noncontingent beneficial conversion feature).

Pending Content (Transition Guidance: ASC 815-40-65-1)

15-5 No entity may elect the fair value option for any of the following financial assets and financial liabilities:

An investment in a subsidiary that the entity is required to consolidate.
An interest in a variable interest entity (VIE) that the entity is required to consolidate.
Employers’ and plans’ obligations (or assets representing net overfunded positions) for pension benefits, other postretirement benefits (including health care and life insurance benefits), postemployment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements, as defined in Topics 420; 710; 712; 715; 718; and 960.
Financial assets and financial liabilities recognized under leases as defined in Subtopic 842-10. (This exception does not apply to a guarantee of a third-party lease obligation or a contingent obligation arising from a cancelled lease.)
Deposit liabilities, withdrawable on demand, of banks, savings and loan associations, credit unions, and other similar depository institutions.
Financial instruments that are, in whole or in part, classified by the issuer as a component of shareholders’ equity (including temporary equity).

12.2.2.1 Consolidated Entities

An entity cannot elect the FVO to avoid consolidating another entity under the voting or VIE consolidation model in ASC 810. In the Background Information and Basis for Conclusions of Statement 159, the FASB noted that an “interest in an entity (principally an investment in a subsidiary or a primary beneficiary’s variable interest in a variable interest entity) that would otherwise be consolidated” would be outside the scope of the FVO because the FVO “should not be used to make significant changes to consolidation practices.” While an entity cannot elect the FVO for the entire consolidated entity, it is permitted to elect the FVO for underlying financial assets and financial liabilities held by the consolidated entity that are eligible items.

12.2.2.2 Employers’ and Plans’ Obligations

As noted in ASC 825-10-15-5(c), entities may not elect the FVO for “[e]mployers’ and plans’ obligations (or assets representing net overfunded positions) for pension benefits, other postretirement benefits (including health care and life insurance benefits), postemployment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements.” Rather, these items must be recognized in accordance with the relevant guidance in ASC 420, ASC 710, ASC 712, ASC 715, ASC 718, or ASC 960.

12.2.2.3 Financial Assets and Financial Liabilities Related to Leases

Financial assets and financial liabilities associated with lease accounting are not eligible for the FVO. Rather, they must be accounted for under ASC 842. However, the FVO may be elected for a guarantee of a third-party lease obligation or a contingent obligation arising from a canceled lease.

12.2.2.4 Deposit Liabilities

Under ASC 825-10-15-5(e), “[d]eposit liabilities, withdrawable on demand, of banks, savings and loan associations, credit unions, and other similar depository institutions” are not eligible for the FVO. Rather, they must be accounted for under ASC 942-405.

12.2.2.5 Financial Instruments Classified in Equity

ASC 825-10-15-5(f) excludes “[f]inancial instruments that are, in whole or in part, classified by the [entity] as a component of shareholders’ equity (including temporary equity)” from the scope of the FVO. Such financial instruments include the following:

Common stock.
Equity-classified derivatives indexed to an entity’s common stock.
Convertible preferred stock.
Redeemable preferred stock (not mandatorily redeemable).
Convertible debt within the scope of the cash conversion subsections of ASC 470-20.
Convertible debt with a beneficial conversion feature that is recognized in equity.
Convertible debt with a previously bifurcated conversion option that was reclassified to equity.
Convertible debt issued at a substantial premium that is recognized in equity.
Convertible debt with a modified conversion feature that is recognized in equity.
Noncontrolling interest (e.g., common stock, preferred stock, or equity-classified derivatives issued by a consolidated subsidiary).

The above financial instruments would be measured at fair value through earnings only in the unusual circumstance in which the guidance in ASC 815-15-35-2 was applicable (see Section 12.2.3.2.3 for further discussion). The two examples below illustrate how an entity would consider beneficial conversion features in determining whether convertible debt instruments qualify for the FVO.

Example 12-4

Convertible Debt Instrument — No Beneficial Conversion Feature

Entity D has issued a debt instrument that is convertible by the holder into shares of D’s common stock. Before considering whether to elect the FVO for this convertible debt instrument, D must determine whether the instrument would be classified, in whole or in part, within stockholders’ equity. In this example, assume the following:

There is no beneficial conversion feature under ASC 470-20 that must be recognized as of the issuance date of the convertible debt instrument.
There is no cash conversion feature within the scope of ASC 470-20.

Since no part of the convertible debt instrument is classified in stockholders’ equity at issuance, D is permitted to elect the FVO for the instrument. ASC 825 does not preclude an entity from electing the FVO for a convertible debt instrument if the conversion option, on a freestanding basis, would have been classified in stockholders’ equity, provided that there is no component of the convertible debt instrument that must be separately classified in stockholders’ equity.

Connecting the Dots

A convertible debt instrument may contain an embedded conversion feature that is beneficial (i.e., “in-the-money”) upon issuance. If that beneficial conversion feature is separately recognized in equity, the FVO is not available. However, if that embedded conversion feature would need to be bifurcated under ASC 815-15, no beneficial conversion feature would be recognized in equity upon issuance (i.e., the beneficial element would constitute a component of the liability that would be recognized for the embedded conversion option); therefore, the FVO could be elected for the entire convertible debt instrument. That is, in accordance with ASC 815-15 and ASC 825, if a convertible debt instrument contains an embedded derivative that must be bifurcated, the entity can avoid such bifurcation by electing to apply a fair value measurement to the convertible debt instrument in its entirety. If the entity decides to bifurcate the embedded derivative in lieu of electing the FVO, the entity cannot apply the FVO to the bifurcated host contract because ASC 825-10-25-11 prohibits an entity from separating a financial instrument that is legally a single contract into parts to apply the FVO. (Because the convertible debt instrument is a financial instrument, ASC 825-10-15-4(f), which permits an entity to elect the FVO for a host financial instrument that remains after an embedded nonfinancial derivative instrument is bifurcated from a nonfinancial hybrid instrument, does not apply.)

Example 12-5

Convertible Debt Instrument — Contingent Beneficial Conversion Feature

Entity E issues a convertible debt instrument that contains a contingent beneficial conversion feature. Because a contingent beneficial conversion feature is not separately recognized within stockholders’ equity upon issuance, a convertible debt instrument with a contingent beneficial conversion feature is eligible for the FVO provided that no other exceptions in ASC 825-10-15-5 are applicable. Thus, E can elect the FVO for the convertible debt instrument.

If, after election of the FVO, the contingency is triggered, the instrument would continue to be subject to fair value measurement, because the FVO (1) may be elected only one time, (2) is irrevocable, and (3) is applied to the entire instrument. In this situation, ASC 825 effectively overrides the guidance on contingent beneficial conversion features in ASC 470-20 once the FVO has been elected.

12.2.2.6 Significant Future-Services Component

Nonconsolidated equity investments that are subject to the equity method of accounting meet the definition of a financial asset because they represent an ownership interest. However, in addition to providing the holder with an equity-like return, such instruments may compensate the investor for significant future services. An example of such a financial instrument is a general partnership interest in which the GP has significant management responsibilities (such as managing the partnership’s assets) and is entitled to a return that includes compensation for those future services (e.g., that is disproportionate to the capital invested). Another example is a venture in which (1) an investor will provide future services to the venture and (2) the return from the venture is greater than it would be if the venture paid an unrelated third party for those services.

Because service contracts are not eligible for the FVO under ASC 825, financial instruments with significant service components are also not eligible for the FVO. An entity that applied the FVO to these types of instruments would recognize a day 1 gain (i.e., profit at inception) that represents, in part, compensation for future services. As a result, revenue would be recognized before the performance of related services. This conclusion is consistent with that reached in informal discussions with the SEC and FASB staffs.

An entity should consider all relevant circumstances and exercise judgment when determining whether a financial instrument includes a significant future-services component, particularly when the component is not explicitly stated in the contract terms or the investee’s articles of incorporation. The investor’s obligation to provide services may be established in a contract different from that of the equity ownership interest, or the service contract may contain only a portion of the economic compensation, with the remainder intended to be an element of the “equity instrument.” Entities should consider the substance of the arrangement and whether the financial instrument and the contract for services are interdependent or inseparable.

The following are some indicators that a significant component of an equity investment consists of compensation for the investor’s future services:

The fair value of the investment includes a return that is disproportionately greater than the return to other passive investors, and the services that the investor provides to the investee affect the future payout under the provision.
The fair value of the interest at inception is greater than the investor’s investment, and the investor is expected to provide services to the investee that are beyond those ordinarily expected of an investor acting solely as a nonmanagement owner.

Because ASC 825-10-25-2 requires an entity to apply the FVO to an entire instrument unless the instrument must be bifurcated under other U.S. GAAP, there is no opportunity for the entity to separate the element for future services and elect the FVO for the portion of the instrument that is purely financial.

Example 12-6

General Partnership Interest

Manager A, the only GP of Partnership X, has invested a nominal amount, 1 percent of the total capital, for its general partnership interest. This interest entitles A to 5 percent of X’s net income. Manager A does not provide any services to X other than some insignificant administrative tasks; X’s assets are managed by an unrelated third party. Manager A receives a disproportionately higher return than the limited partners (LPs) because of its unlimited liability as GP for the partnership’s obligations. Manager A estimates the fair value of its general partnership interest to be equal to the amount invested at inception. The general partnership interest does not appear to include significant future services and therefore is eligible for the FVO under ASC 825.

Example 12-7

General Partnership Interest and Limited Partnership Interest

Manager B, the GP of Partnership Y, has invested a nominal amount, 1 percent of the total capital, for its general partnership interest. This interest entitles B to 10 percent of Y’s net income and provides significant additional compensation if Y’s operating margin reaches certain thresholds. Manager B estimates that the fair value of the general partnership interest is greater than the amount invested at inception. Manager B also manages Y’s assets through a separate services contract and receives a servicing fee. In addition, there are certain restrictions on the sale of the general partnership interest during the term of the services contract. Moreover, B holds a limited partnership interest in Y that can be transferred independently of the general partnership interest. Manager B invested the same amount as other LPs for its limited partnership interest and receives the same return on its interest as the other LPs. Manager B estimates that the fair value of the limited partnership interest is equal to the amount invested for this instrument. In this example, B could not elect to measure the general partnership interest at fair value under the FVO in ASC 825 because this interest appears to include compensation for significant future services. However, B could elect to measure its limited partnership interest at fair value under the FVO in ASC 825 because this interest does not appear to include significant future services.

Example 12-8

Securitization Entity

Bank C transfers financial assets to a securitization trust in a transfer that is accounted for as a sale. Bank C provides servicing of the financial assets (e.g., collection) for the trust. The servicing contract is initially measured at fair value under ASC 860. (Note that C may elect to subsequently measure a class of servicing assets or servicing liabilities at fair value in accordance with ASC 860-50.) Bank C holds the residual beneficial interest issued by the trust and determines that the fair value of its residual interest is greater than the allocated cost of this retained interest. Bank C also determines that the residual interest meets the definition of a debt security under ASC 320. Bank C could classify its residual interest as a trading security under ASC 320 and measure it at fair value, with changes in fair value recognized in earnings. Because C may classify the security as trading under ASC 320, it would not elect to measure the security at fair value under ASC 825.

12.2.2.6.1 Investments in Affordable Housing Projects

Section 42 of the Internal Revenue Code allows for affordable housing credits. ASC 323-740-05-3 describes these tax credits as follows:

The following discussion refers to and describes a provision within the Revenue Reconciliation Act of 1993; however, it shall not be considered a definitive interpretation of any provision of the Act for any purpose. The Revenue Reconciliation Act of 1993, enacted in August 1993, retroactively extended and made permanent the affordable housing credit. Investors in entities that manage or invest in qualified affordable housing projects receive tax benefits in the form of tax deductions from operating losses and tax credits. The tax credits are allowable on the tax return each year over a 10-year period as a result of renting a sufficient number of units to qualifying tenants and are subject to restrictions on gross rentals paid by those tenants. These credits are subject to recapture over a 15-year period starting with the first year tax credits are earned. Corporate investors generally purchase an interest in a limited liability entity that manages or invests in the qualified affordable housing projects.

An entity that has an ownership interest in an affordable housing entity may elect the FVO for this interest provided that all of the following conditions are met:

The investment is not consolidated (e.g., it is otherwise subject to the equity method of accounting).
The ownership interest is a financial asset. Although the FVO is not permitted for current or deferred income tax assets and liabilities because they are not contractual, the amount of tax credits to be received by the investor in a qualified affordable housing project is generally known as part of the partnership/investment agreement. Therefore, the tax benefits are conveyed to the investor through a contractual arrangement and an equity ownership interest meets the definition of a financial asset.
The election of the FVO will not cause income recognition of tax credits before they are earned. Recognition in income of any benefit of the tax credits to be received over the term of the investment would preclude an entity from being eligible to elect the FVO for such an interest. Such preclusion is similar to the prohibition on electing the FVO for an equity investment that contains a significant component related to future services.

While the above discussion focuses on investments in affordable housing projects, the same concepts may be applied to investments in other tax-credit equity structures.

12.2.3 Interaction of ASC 825 With Other Codification Topics

12.2.3.1 General

ASC 825-10

Interaction With Other Topics

15-6 The Fair Value Option Subsections:

Do not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value
Do not establish requirements for recognizing and measuring dividend income, interest income, or interest expense
Do not eliminate disclosure requirements included in other Subtopics, including requirements for disclosures about fair value measurements included in Topic 820.

ASC 825-10-15-6 states that the FVO guidance in ASC 825 does not (1) affect any existing U.S. GAAP under which certain assets or liabilities must be recognized at fair value or (2) eliminate disclosure requirements of other Codification topics. However, incremental disclosures are required for items accounted for at fair value by using the FVO. See Section 12.5 for further discussion.

ASC 825-10-15-6 also indicates that ASC 825 does not address the recognition or measurement of dividend income, interest income, or expense on items recognized at fair value under the FVO. For further discussion of the recognition of interest on an interest-bearing financial instrument for which the FVO is elected, see Section 12.4.1.1.1.

12.2.3.2 Hybrid Instruments That Are Not Separated Under ASC 815-15

12.2.3.2.1 General

ASC 815-15

Fair Value Election for Hybrid Financial Instruments

25-4 An entity that initially recognizes a hybrid financial instrument that under paragraph 815-15-25-1 would be required to be separated into a host contract and a derivative instrument may irrevocably elect to initially and subsequently measure that hybrid financial instrument in its entirety at fair value (with changes in fair value recognized in earnings and, if paragraph 825-10-45-5 is applicable, other comprehensive income). A financial instrument shall be evaluated to determine that it has an embedded derivative requiring bifurcation before the instrument can become a candidate for the fair value election.

25-5 The fair value election shall be supported by concurrent documentation or a preexisting documented policy for automatic election. That recognized hybrid financial instrument could be an asset or a liability and it could be acquired or issued by the entity. The fair value election is also available when a previously recognized financial instrument is subject to a remeasurement event (new basis event) and the separate recognition of an embedded derivative. The fair value election may be made instrument by instrument. For purposes of this paragraph, a remeasurement event (new basis event) is an event identified in generally accepted accounting principles, other than the recording of a credit loss under Topic 326, or measurement of an impairment loss through earnings under Topic 321 on equity investments, that requires a financial instrument to be remeasured to its fair value at the time of the event but does not require that instrument to be reported at fair value on a continuous basis with the change in fair value recognized in earnings. Examples of remeasurement events are business combinations and significant modifications of debt as defined in Subtopic 470-50.

25-6 The fair value election shall not be applied to the hybrid instruments described in paragraph 825-10-50-8.

Hybrid Instruments That Are Not Separated

30-1 An entity shall measure both of the following initially at fair value:

A hybrid financial instrument that under paragraph 815-15-25-1 would be required to be separated into a host contract and a derivative instrument that an entity irrevocably elects to initially and subsequently measure in its entirety at fair value (with changes in fair value recognized in earnings)
An entire hybrid instrument if an entity cannot reliably identify and measure the embedded derivative that paragraph 815-15-25-1 requires be separated from the host contract.

Fair Value Election

35-1 If an entity irrevocably elected to initially and subsequently measure a hybrid financial instrument in its entirety at fair value, changes in fair value for that hybrid financial instrument shall be recognized in earnings. Paragraph 815-20-25-71(a)(3) states that the entire contract shall not be designated as a hedging instrument pursuant to Subtopic 815-20.

Inability to Reliably Identify and Measure Embedded Derivative

35-2 If an entity cannot reliably identify and measure the embedded derivative that paragraph 815-15-25-1 requires be separated from the host contract, the entire contract shall be measured subsequently at fair value with gain or loss recognized in earnings. Paragraph 815-20-25-71(a)(4) states that the entire contract shall not be designated as a hedging instrument pursuant to Subtopic 815-20.

Under ASC 815-15-25-1, an entity may be required to bifurcate and separately account for an embedded derivative contained within a hybrid instrument. In lieu of such separation, ASC 815-15-25-4 allows an entity to account for the entire hybrid instrument at fair value, provided that the instrument is a financial asset or financial liability, with changes recognized in earnings and, if applicable, OCI. Further, ASC 815-15-30-1(b) and ASC 815-15-35-2 address the accounting in the unusual circumstance in which an entity is unable to reliably identify and separately measure the embedded derivative in a hybrid instrument that must be accounted for separately as a derivative instrument.

12.2.3.2.2 Fair Value Election

The fair value election in ASC 815-15 originated from the guidance in FASB Statement 155, which was issued before FASB Statement 159 (the pre-Codification FVO guidance now contained in ASC 825). The fair value election in ASC 815-15 can be made on an instrument-by-instrument basis, or an entity can elect this option for all qualifying hybrid financial instruments on some other basis, such as an entity-wide policy decision or a type-of-instrument basis. In all scenarios, the fair value election under ASC 815-15 must be supported with appropriate concurrent documentation that eliminates any question regarding whether the entity elected to apply fair value measurement to a particular instrument.

For the following reasons, the fair value election in ASC 815-15 applies to a narrower population (scope) of items than the FVO in ASC 825:

The fair value election in ASC 815-15 applies only to hybrid financial instruments for which bifurcation of an embedded derivative would otherwise be required. An entity that elects the FVO in ASC 825 is not required to determine that an embedded derivative would need to be accounted for separately under ASC 815-15.
ASC 815-15-25-6 prohibits the fair value election for any hybrid instrument that is discussed in ASC 825-10-50-8, which describes 15 items for which public business entities are not required to provide fair value disclosures. The scope of ASC 825-10-50-8 is more restrictive than the scope of the FVO in ASC 825-10-15-4 and 15-5.

Like ASC 825, ASC 815-15 allows the fair value election for an eligible item only upon (1) initial recognition or (2) the occurrence of a subsequent remeasurement event (i.e., a subsequent remeasurement of the entire instrument at fair value under other U.S. GAAP). Therefore, under both ASC 815-15 and ASC 825, an entity is prohibited from making the fair value election upon determining that an embedded derivative that was previously not bifurcated under ASC 815-15 subsequently must be bifurcated (e.g., a hybrid financial instrument containing an embedded derivative that meets the net settlement condition in ASC 815-10-15-83(c) after initial recognition).

There are no situations for which an entity could make the fair value election for a hybrid instrument under ASC 815-15 but would be prohibited from electing the FVO for the same instrument under ASC 825. In addition, regardless of whether the entity uses ASC 815-15 or ASC 825 in applying fair value accounting, the hybrid financial instrument cannot be designated as a hedging instrument under ASC 815-20. Furthermore, the documentation and disclosure requirements related to the fair value election in ASC 815-15 are the same as those related to the FVO in ASC 825.2

Connecting the Dots

Since the fair value election under ASC 815-15 applies to a narrower population of items than the FVO under ASC 825, entities can effectively disregard the fair value election guidance in ASC 815-15-25-4. While ASC 815-15 requires an entity to first determine that a hybrid financial instrument contains an embedded derivative for which bifurcation would otherwise be required under ASC 815-15, entities can bypass this assessment because — regardless of whether such bifurcation is required — the hybrid financial instruments that are eligible for the fair value election in ASC 815-15 are also eligible for the FVO in ASC 825 (and the FVO in ASC 825 can be elected regardless of whether an entity has identified an embedded derivative for which bifurcation would otherwise be required). Furthermore, the disclosure requirements applicable to a hybrid financial instrument for which the fair value election is made under ASC 815-15 are consistent with the disclosure requirements of ASC 825. Regardless of whether an FVO election is made under ASC 815-15 or ASC 825, it is subject to the applicable incremental disclosure requirements for (1) derivatives in ASC 815 and (2) items for which the FVO has been elected in ASC 825. We believe that the guidance on fair value elections in ASC 815-15 (which was derived from FASB Statement 155) was retained in U.S. GAAP because that guidance was available (and may have been used) before the effective date of FASB Statement 159 (codified in ASC 825). Thus, entities may still have hybrid financial instruments that are being recognized at fair value in their entirety in accordance with ASC 815-15 because those instruments were issued before the effective date of the FVO guidance in ASC 825.

12.2.3.2.3 Inability to Reliably Identify and Measure Embedded Derivatives

The fair value election in ASC 815-15 is available only for hybrid financial instruments with an embedded derivative for which bifurcation would otherwise be required. (As discussed in Section 12.2.3.2.2, hybrid financial instruments that would qualify for the fair value election in ASC 815-15 would also qualify for the FVO in ASC 825, regardless of whether an entity has identified an embedded derivative for which bifurcation would otherwise be required.) However, there may be hybrid nonfinancial instruments that are not eligible for the fair value election in ASC 815-15 or the FVO in ASC 825 and for which the entity cannot reliably identify and measure the embedded derivative that must be bifurcated under ASC 815-15. ASC 815-15-30-1(b) and ASC 815-15-35-2 states that, in these circumstances, an entity should measure the entire hybrid instrument at fair value. The resulting accounting is the same as it would be if the entity had made the fair value election in ASC 815-15 or elected the FVO in ASC 825. Note that under no circumstance can such an instrument be designated as a hedging instrument under ASC 815-20.

Connecting the Dots

The provision of ASC 815-15-30-1(b) and ASC 815-15-35-2 that requires fair value accounting for a hybrid instrument for which the entity cannot reliably identify and measure the embedded derivative that the entity would otherwise be required to bifurcate is necessary because, for example, fair value accounting for a hybrid nonfinancial instrument under the fair value election in ASC 815-15 or the FVO in ASC 825 would be prohibited. In practice, however, this provision is rarely applied.

12.2.3.3 Other Codification Topics

Other Codification topics may give entities the option of measuring assets or liabilities at fair value through earnings. Such assets or liabilities include, but are not necessarily limited to, the following:

Investments in debt securities that are classified as trading under ASC 320.
Investments in equity securities without readily determinable fair values under ASC 321.
Investments in life settlement contracts that are accounted for by using the fair value method under ASC 325-30.
Classes of servicing assets or servicing liabilities that are accounted for by using the fair value measurement method in ASC 860-50.

An entity that elects fair value accounting for such assets or liabilities under a Codification topic other than ASC 825 only needs to comply with the disclosure requirements of that topic and is not subject to ASC 825’s FVO disclosure requirements. See further discussion in Section 12.5.1.

12.2.3.4 NFP Entities

ASC 825-10

Application by Not-for-Profit Entities

15-7 Not-for-profit entities (NFPs) shall apply the provisions of the Fair Value Option Subsections with the following modifications:

References to an income statement shall be replaced with references to a statement of activities, statement of changes in net assets, or statement of operations.
References to earnings shall be replaced with references to changes in net assets, except as indicated in (c).
Paragraph 954-825-45-1 explains that health care entities subject to Topic 954 shall report unrealized gains and losses on items for which the fair value option has been elected within the performance indicator or as a part of discontinued operations, as appropriate. Unlike other NFPs, health care entities subject to that Topic present performance indicators analogous to income from continuing operations. Consistent with the provisions of Subtopic 958-10, NFPs may present such gains and losses either within or outside of other intermediate measures of operations unless such gains or losses are part of discontinued operations. This includes intermediate measures of operations presented by NFPs other than health care entities and any additional intermediate measures of operations presented within the performance indicator by not-for-profit health care entities.
The disclosure requirements in paragraph 825-10-50-30 shall apply not only with respect to the effect on performance indicators or other intermediate measures of operations, if presented, but also with respect to the effect on the change in each of the net asset classes (without donor restrictions or with donor restrictions), as applicable.

ASC 825-10-15-7 explains the FVO presentation requirements for NFP entities, including health care entities, which do not present an income statement. ASC 825-10-15-7 also clarifies the disclosure requirements that apply to NFP entities that have elected the FVO. See Section 12.5 for further discussion of the FVO disclosure requirements.

Footnotes

ASC 815-15-25-5 states that “[t]he fair value election shall be supported by concurrent documentation or a preexisting documented policy for automatic election” (emphasis added). The term “concurrent documentation” is analogous to the term “contemporaneous documentation,” as used in the hedge accounting requirements of ASC 815. Therefore, the fair value election for hybrid financial instruments under ASC 815-15 must be documented at the time a hybrid financial instrument is acquired or issued or when a previously recognized hybrid financial instrument is subject to a remeasurement (new basis) event. If the documentation does not exist at that time, the FVO may not be elected. We believe that entities applying the guidance in ASC 815-15 on the fair value election would also be subject to the requirements related to the FVO in ASC 825.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.