12.3 Recognition

12.3.1 Overall Guidance

ASC 825-10

Overall Guidance

25-1 This Subtopic permits all entities to choose, at specified election dates, to measure eligible items at fair value (the fair value option).

25-2 The decision about whether to elect the fair value option:

Shall be applied instrument by instrument, except as discussed in paragraph 825-10-25-7
Shall be irrevocable (unless a new election date occurs, as discussed in paragraph 825-10-25-4)
Shall be applied only to an entire instrument and not to only specified risks, specific cash flows, or portions of that instrument.

An entity may decide whether to elect the fair value option for each eligible item on its election date. Alternatively, an entity may elect the fair value option according to a preexisting policy for specified types of eligible items.

25-3 Upfront costs and fees related to items for which the fair value option is elected shall be recognized in earnings as incurred and not deferred.

12.3.1.1 Election of the FVO

An entity is permitted to elect the FVO for eligible financial assets and financial liabilities (see Section 12.2.1) on the election dates discussed in Section 12.3.2. ASC 825 provides little guidance on the documentation an entity is required to maintain to support its election of the FVO but indicates that the decision to elect the FVO should be made as of the election date for each eligible item. An entity also may establish an automatic election policy for certain eligible items. For example, an entity may document in a written policy that it will elect the FVO for all single-family mortgages that it originates. In deciding to permit entities to elect the FVO, the Board noted that maintaining evidence of compliance with the election requirements of ASC 825 is a matter of internal control. Although ASC 825 leaves room for discretion regarding documentation, an entity that does not have a well-developed preexisting policy for election should document evidence of the election concurrently with the recognition or remeasurement of eligible items.

12.3.1.1.1 Application on an Instrument-by-Instrument Basis

In the absence of specific exceptions addressed in ASC 825-10-25-7, an entity can elect the FVO on an instrument-by-instrument basis. This election is made on the basis of the unit of account for eligible instruments under other applicable U.S. GAAP. Thus, entities may elect the FVO for a single eligible item without electing the FVO for other identical items. Entities also have the flexibility to establish an automatic election policy for certain eligible items of an identical or similar nature. Section 12.3.1.1.1.1 includes additional discussion of the unit of account with respect to FVO elections, including exceptions to the general ability to elect the FVO on an instrument-by-instrument basis.

The FVO election approach applied will affect the nature and extent of documentation related to FVO elections. For example, if an entity makes an FVO election decision each time it initially recognizes an eligible item within a group of identical or similar eligible items, the entity would need to concurrently document the FVO elections more frequently than an entity that has a policy of always electing the FVO for such an item. Further, this documentation would need to be sufficiently clear on the items for which the FVO has been elected. An entity that does not apply the FVO to all eligible items within a group of similar eligible items would also be required to provide additional disclosures (see Section 12.5.3).

In all scenarios, an entity must support its FVO election under ASC 825 with appropriate concurrent documentation that eliminates any question regarding whether the entity elected to apply fair value measurement to a particular instrument.

12.3.1.1.1.1 Unit of Account

ASC 825-10

Unit of Accounting

25-7 The fair value option may be elected for a single eligible item without electing it for other identical items with the following four exceptions:

If multiple advances are made to one borrower pursuant to a single contract (such as a line of credit or a construction loan) and the individual advances lose their identity and become part of a larger loan balance, the fair value option shall be applied only to the larger balance and not to each advance individually.
If the fair value option is applied to an investment that would otherwise be accounted for under the equity method of accounting, it shall be applied to all of the investor’s financial interests in the same entity (equity and debt, including guarantees) that are eligible items.
If the fair value option is applied to an eligible insurance or reinsurance contract, it shall be applied to all claims and obligations under the contract.
If the fair value option is elected for an insurance contract (base contract) for which integrated or nonintegrated contract features or coverages (some of which are called riders) are issued either concurrently or subsequently, the fair value option also must be applied to those features or coverages. The fair value option cannot be elected for only the nonintegrated contract features or coverages, even though those features or coverages are accounted for separately under Subtopic 944-30. Paragraph 944-30-35-30 defines a nonintegrated contract feature in an insurance contract. For purposes of applying this Subtopic, neither an integrated contract feature or coverage nor a nonintegrated contract feature or coverage qualifies as a separate instrument.

25-10 The fair value option need not be applied to all instruments issued or acquired in a single transaction (except as required by paragraph 825-10-25-7(a) through (b)). For example, investors in shares of stock and registered bonds might apply the fair value option to only some of the shares or bonds issued or acquired in a single transaction. For this purpose, an individual bond is considered to be the minimum denomination of that debt security.

25-11 A financial instrument that is legally a single contract may not be separated into parts for purposes of applying the fair value option. In contrast, a loan syndication arrangement may result in multiple loans to the same borrower by different lenders. Each of those loans is a separate instrument, and the fair value option may be elected for some of those loans but not others.

25-12 An investor in an equity security may elect the fair value option for its entire investment in that equity security, including any fractional shares issued by the investee (for example, fractional shares that are acquired in a dividend reinvestment program).

25-13 For the issuer of a liability issued with an inseparable third-party credit enhancement (for example, debt that is issued with a contractual third-party guarantee), the unit of accounting for the liability measured or disclosed at fair value does not include the third-party credit enhancement. This paragraph does not apply to the holder of the issuer’s credit-enhanced liability or to any of the following financial instruments or transactions:

A credit enhancement granted to the issuer of the liability (for example, deposit insurance provided by a government or government agency)
A credit enhancement provided between reporting entities within a consolidated or combined group (for example, between a parent and its subsidiary or between entities under common control).

An entity can generally elect the FVO for a single eligible item without electing it for other identical items (with four exceptions addressed in ASC 825-10-25-7, which are discussed below). Note that the determination of what constitutes a “single eligible item” is made on the basis of the unit of account under U.S. GAAP. The unit of account is generally determined under other applicable Codification topics; however, ASC 825 does contain the following unit-of-account guidance that applies to application of the FVO:

The FVO may be applied to a “host financial instrument resulting from the separation of an embedded nonfinancial derivative from a nonfinancial hybrid instrument” (ASC 825-10-15-4(f)).
An “individual bond is considered . . . the minimum denomination of [a] debt security” (ASC 825-10-25-10).3
A “financial instrument that is legally a single contract may not be separated” into its component parts when the FVO is applied (ASC 825-10-25-11).
The unit of account for a liability issued with an inseparable third-party credit enhancement “does not include the third-party credit enhancement” (ASC 825-10-25-13).

Connecting the Dots

In applying ASC 825-10-25-11, which states, in part, that “[a] financial instrument that is legally a single contract may not be separated into parts for purposes of applying the fair value option,” an entity must consider the definition of the term “freestanding financial instrument” in the ASC master glossary. For example, a debt instrument with a $1 million principal amount and a warrant on 100,000 shares of common stock may be entered into with a single investor and documented in the same contract. If the warrant is legally detachable and separately exercisable, the debt instrument and warrant would individually represent freestanding financial instruments (i.e., the debt instrument would be considered an individual contract under ASC 825-10-25-11). The entity could therefore apply the FVO to its liability related to the $1 million debt instrument provided that none of the FVO exceptions in ASC 825-10-15-5 are applicable. The warrant would be separately evaluated as a liability or equity instrument under other applicable U.S. GAAP (e.g., ASC 480, ASC 815, and ASC 815-40). The entity could not, however, apply the FVO to only $500,000 of the $1 million principal amount of debt, because the entire principal amount represents a single unit of account and ASC 825-10-25-11 prohibits the election of the FVO for only a portion of the amount of an individual bond. If, however, the entity had entered into the aforementioned contract with 10 different investors, it could individually make the FVO election for the $1 million principal amount of the debt component of each of the 10 different contracts (e.g., it could elect the FVO for the $1 million debt component related to five investors and not elect the FVO for the $1 million debt component for the other five investors).

ASC 825-10-25-7 describes the following four situations in which it is not appropriate to elect the FVO for only a single eligible item without electing the FVO for other identical items:

Multiple advances to a single borrower — “If multiple advances are made to one borrower pursuant to a single contract (such as a line of credit or a construction loan) and the individual advances lose their identity and become part of a larger loan balance, the [FVO] shall be applied only to the larger balance and not to each advance individually.” See Example 12-9 for a related illustration.
Equity method investments — If the FVO “is applied to an investment that would otherwise be accounted for” by using the equity method, the FVO must be applied to all of the investor’s financial interests in the investee that are eligible for the FVO (e.g., equity, debt, guarantees). Note that this requirement is one-directional. That is, if an entity has not elected the FVO for an equity method investment, it could still elect the FVO for a financial guarantee issued on the investee’s debt.
Insurance or reinsurance contracts — If the FVO “is applied to an eligible insurance or reinsurance contract,” it must be applied to all “claims and obligations under the contract.”
Insurance contracts with integrated or nonintegrated contract features or coverages — If the FVO “is elected for an insurance contract (base contract) for which integrated or nonintegrated contract features or coverages (some of which are called riders) are issued either concurrently or subsequently, the [FVO] also must be applied to those features or coverages. The [FVO] cannot be elected for only the nonintegrated contract features or coverages, even though those features or coverages are accounted for separately under Subtopic 944-30.”

Example 12-9

Electing the FVO for Portions of a Financial Instrument That Includes Multiple Lendings to the Same Borrower

Entity F has a $5 million line-of-credit agreement with Bank A. On March 1, 20X7, F draws $500,000 on its line of credit and chooses not to elect the FVO. On April 1, 20X7, F draws another $1 million. Because the $1 million is added to the $500,000 and becomes part of the larger balance, the FVO may not be elected for the $1 million. When F chose not to elect the FVO for the $500,000, it also chose not to elect the FVO for any subsequent draws on that line of credit. Under ASC 825-10-25-4, that election is irrevocable unless a new election date occurs.

12.3.1.1.1.2 Debt Guaranteed by a Governmental Entity

The guidance in ASC 825-10-25-13 on inseparable third-party credit enhancements does not specifically apply to a guarantee provided by a government entity, but it may inform the borrower’s accounting. We believe that there are two acceptable views regarding the impact of government-provided guarantees on a loan payable (or other debt obligation) for which the FVO is elected (or for which fair value amounts are disclosed). These two views are premised on the notion that if the government entity makes a payment on an obligation, the borrower is required to reimburse the government entity that made the guarantee payment.

The two views are as follows:

View A: Exclude the guarantee in measuring or disclosing the debt’s fair value — This view is premised on an analogy to the guidance in ASC 825-10-25-13 on inseparable third-party credit enhancements. This analogy is made because the guarantee represents an arrangement that is consistent with third-party credit enhancements. If the occurrence of a triggering event requires the government entity to make unpaid principal and interest payments to holders of the obligation, the government entity effectively becomes a creditor to the issuer. The issuer’s debt obligation continues with the government entity, and the issuer is required to reimburse the government entity for insured payments made on its behalf. Therefore, from the issuer’s perspective, the debt issued is not considered to be guaranteed and is treated as a unit of account that is separate from the guarantee (i.e., under the contractual obligation, the issuer is not released from its debt obligation; rather, the issuer’s obligation in connection with the debt liability is transferred to the government entity that provided the guarantee if the guarantee is triggered).

This view is appropriate because when the guidance in ASC 825-10-25-13 was developed, the scope exception in ASC 825-10-25-13(a) was created with a focus on government guarantees that are inherent in all instruments of a specific type, usually as a result of statutory requirements. The background materials for EITF Issue 08-5 (which is codified in ASC 825-10-25-13) listed deposit insurance as an example of a guarantee that meets this criterion. Deposits held at U.S. depository institutions are required by law to be insured by the FDIC. In addition, rather than simply paying out the guarantee if the depository institution fails, the FDIC may take other actions to ensure that depositors are paid. Unlike liabilities that are insured or guaranteed under statutory rules that cover all such liabilities, debt issued with a government-provided guarantee is guaranteed under a contractual arrangement with a government entity that is specific to the debt instrument.
View B: Include the guarantee in measuring or disclosing the debt’s fair value — The debt issued with the government-provided guarantee is outside the scope of ASC 825-10-25-13 since the guarantee is issued by a government entity. Thus, in accordance with ASC 820-10-35-16B and 35-16BB, the borrower would determine the fair value of the loan on the basis of the fair value as determined by an investor that holds the identical item as an asset. However, the issuing entity must still analyze the economic substance of the guarantee to determine how to apply the guidance in ASC 820 when determining the debt’s fair value.

Borrowers that elect the FVO in ASC 825-10 and apply View B will most likely not recognize an “inception gain” on the debt obligation. However, borrowers that apply View A may find that when the guarantee is ignored, the debt’s initial fair value is less than the proceeds received. This may suggest that an “inception gain” should be recognized. However, any “inception gain” that may exist as a result of initially recognizing a loan liability at fair value could potentially result from an element of the lending transaction that is akin to a government grant. Therefore, it may be viewed as inappropriate to recognize any such amount in earnings immediately. Accordingly, entities that elect the FVO under ASC 825-10 and apply View A should exercise caution in determining the appropriate accounting and disclosure regarding any “inception gain.” Consultation with an entity’s accounting advisers is therefore encouraged.

Entities should consider disclosing their accounting policy in accordance with ASC 235. Entities should also consider the disclosures required under ASC 820 and ASC 825-10 for liabilities that are measured or disclosed at fair value. See Chapter 11 and Section 12.5 for more information.

Note that the guidance on inseparable credit enhancements discussed above applies only to the debtor. Investors in debt obligations that are entitled to an inseparable government-provided guarantee would always consider the guarantee in their accounting for the investment in the loan regardless of whether that investment is accounted for at amortized cost or at fair value. Investors would not separately account for any benefit received in the form of credit support as a result of an inseparable government guarantee (i.e., the guarantee would be considered embedded in the investment).

12.3.1.1.2 Application on an Irrevocable Basis

Once an entity makes an FVO election for an eligible item, fair value accounting is required and may not be revoked unless a new election date occurs under ASC 825-10-25-4. See Section 12.3.2 for discussion of election dates.

12.3.1.1.3 Application to an Entire Instrument

ASC 825-10-25-2(c) requires entities to apply the FVO “to an entire instrument and not to only specified risks, specific cash flows, or portions of that instrument.” There is one exception to this requirement. Specifically, as noted in ASC 825-10-15-4(f), the FVO may be applied to a “host financial instrument resulting from the separation of an embedded nonfinancial derivative from a nonfinancial hybrid instrument” (see Section 12.2.1.4 for more information). See Section 12.3.1.1.1.1 for more information about the unit of account.

12.3.1.1.3.1 Accrued Interest on an Interest-Bearing Financial Instrument

An entity cannot separately elect the FVO for accrued interest (receivable or payable) on an interest-bearing financial asset or financial liability. Similarly, an entity cannot elect the FVO for an interest-bearing financial asset or financial liability and exclude the accrued interest component from such election. (Accrued interest simply represents one or more future interest cash flows of an interest-bearing financial asset or financial liability that have already been earned.) Rather, in accordance with ASC 825-10-25-2(c), an entity must either (1) elect the FVO for an interest-bearing financial asset or financial liability that includes any accrued interest or (2) not elect the FVO for any component of an interest-bearing financial asset or financial liability.

Certain Codification topics permit entities to defer and amortize up-front costs over the life of an interest-bearing financial asset or financial liability. However, if an entity elects the FVO, any such up-front costs and fees related to the asset or liability that the entity incurs must be recognized in earnings as incurred and not deferred. See Section 12.3.1.2 for more information.

12.3.1.2 Up-Front Costs

ASC 825-10-25-3 requires that up-front costs and fees related to items for which the FVO is elected be recognized in earnings as incurred and not deferred. This requirement is consistent with ASC 820-10-35-9B, which indicates that transaction costs are not part of a fair value measurement. Thus, loan origination fees and costs will be recognized in earnings as incurred and not capitalized under ASC 310-20. Similarly, acquisition costs will not be capitalized when the FVO is elected for an insurance contract.

As a result of the requirement to expense (or recognize in income), rather than defer, incremental direct costs or origination fees or costs associated with the origination or acquisition of an interest-bearing financial instrument that is accounted for at fair value by using the FVO, the reported amounts of interest expense or interest income (if separately reported) will differ from those that are reported when the same asset or liability is accounted for at amortized cost. See Section 12.4.1.1.1.2 for further discussion of the measurement of interest income or expense related to an interest-bearing financial instrument for which the FVO is elected.

12.3.2 Election Dates

12.3.2.1 General

ASC 825-10

Election Dates

25-4 An entity may choose to elect the fair value option for an eligible item only on the date that one of the following occurs:

The entity first recognizes the eligible item.
The entity enters into an eligible firm commitment.
Financial assets that have been reported at fair value with unrealized gains and losses included in earnings because of specialized accounting principles cease to qualify for that specialized accounting (for example, a transfer of assets from a subsidiary subject to Subtopic 946-10 to another entity within the consolidated reporting entity not subject to that Subtopic).
The accounting treatment for an investment in another entity changes because the investment becomes subject to the equity method of accounting. . . .
An event that requires an eligible item to be measured at fair value at the time of the event but does not require fair value measurement at each reporting date after that, excluding the recognition of impairment under lower-of-cost-or-market accounting or accounting for securities in accordance with either Topic 321 on investments — equity securities or Topic 326 on measurement of credit losses.

25-5 Some of the events that require remeasurement of eligible items at fair value, initial recognition of eligible items, or both, and thereby create an election date for the fair value option as discussed in paragraph 825-10-25-4(e) are:

Business combinations, as defined in Subtopic 805-10
Consolidation or deconsolidation of a subsidiary or VIE
Significant modifications of debt, as defined in Subtopic 470-50.

In accordance with ASC 825-10-25-4, an entity can elect the FVO only upon (1) the initial recognition of an eligible item or the date an entity enters into a firm commitment or (2) the occurrence of a qualifying event. Those qualifying events are specified in the items in ASC 825-10-25-4(c)–(e) and include the following:

Fair value accounting ceases under specialized accounting guidance.
An equity investment becomes subject to the equity method.
An event occurs that “requires an eligible item to be measured at fair value at the time of the event but does not require fair value measurement at each reporting date after that, excluding the recognition of impairment” on financial assets not accounted for at fair value. (ASC 820-10-20 defines these events as “remeasurement events.”)

Upon the occurrence of any of these qualifying events, an entity has, in addition to the ability to elect the FVO, the option to cease applying the FVO to an eligible item to which it was previously applied. See Section 12.3.2.2 for interpretive guidance on these election dates. See Section 12.5.4 for discussion of the incremental disclosures an entity is required to provide when electing the FVO upon the occurrence of the qualifying events in ASC 825-10-25-4(d) and (e).

In addition, the transition provisions of certain ASUs may allow for a one-time FVO election. For example, ASU 2019-05 allows entities to elect the FVO in lieu of applying the guidance in ASC 326 on expected credit losses.

Connecting the Dots

As discussed in Section 12.2.3.3, other Codification topics may give entities the option of measuring an asset or liability at fair value through earnings. An entity should consult such other U.S. GAAP to determine whether it may elect fair value accounting after initial recognition of the related item. For example, ASC 321, as amended by ASU 2018-03, allows an entity that is measuring an equity security without a readily determinable fair value, and that is using the measurement alternative, to change its measurement approach to a fair value method in accordance with ASC 820. This election would be irrevocable and would apply to that security and all identical or similar investments of the same issuer. Once an entity makes this election, the entity should measure all future purchases of identical or similar investments of the same issuer by using a fair value method in accordance with ASC 820.

12.3.2.2 Interpretive Guidance

12.3.2.2.1 Entity Enters Into an Eligible Firm Commitment

ASC 825-10-25-4(b) allows an entity to elect the FVO on the date it “enters into an eligible firm commitment.” We believe that this date is that on which the definition of a firm commitment is met. This date could not occur before the date on which the commitment is binding on both parties and is legally enforceable.

12.3.2.2.2 Fair Value Accounting Under Specialized Accounting Guidance Ceases

Under ASC 825-10-25-4(c), an entity can elect the FVO when “[f]inancial assets that have been reported at fair value with unrealized gains and losses included in earnings because of specialized accounting principles cease to qualify for that specialized accounting.” This new election date may be relevant when an entity ceases to be an investment company under ASC 946, which can occur for a number of reasons.

12.3.2.2.3 Matters Related to Equity Method Accounting

12.3.2.2.3.1 Investment Becomes Subject to Equity Method of Accounting

Under ASC 825-10-25-4(d), if an entity’s investment in another entity “becomes subject to the equity method of accounting,” the entity may elect the FVO for its investment in lieu of applying the equity method. An investment could become subject to the equity method for various reasons, including (1) an acquisition of an additional interest in an investee that causes the investor to obtain significant influence over the investee; (2) a change in an investee’s governing provisions in such a way that an investor obtains significant influence over the investee; (3) an investee’s repurchase of its outstanding equity shares, resulting in an increase in an investor’s ownership percentage in the investee in such a way that the investor obtains significant influence over the investee; or (4) an investor’s loss of control, but retention of significant influence, over an investee.4 If an investor elects the FVO when its investment becomes subject to the equity method of accounting, the investor must elect the FVO for all other interests in the investee that are eligible items in accordance with ASC 825-10-25-7(b). For this purpose, we believe that other preexisting interests in the investee that would not otherwise become subject to the equity method of accounting are not eligible items unless they are subject to another remeasurement event as of the date on which the entity becomes subject to the equity method of accounting.

12.3.2.2.3.2 Investment Is No Longer Subject to Equity Method of Accounting

The FVO election dates listed in ASC 825-10-25-4 do not include the date on which an investor loses significant influence over an investee (through either a decline in the investor’s holding of voting stock or other changes in circumstances that cause an investor to lose its ability to influence an investee’s policies). Thus, if an investor concludes that it would no longer be subject to the equity method of accounting for an investee, it does not have a new election date for the FVO under ASC 825. The table below describes how an investor would account for the retained investment if it determines that it loses significant influence and therefore is no longer subject to the equity method of accounting.

Table 12-2

Accounting While Having Significant Influence	Accounting for Retained Investment After Losing Significant Influence
Equity method of accounting	The investor should account for the equity investment in accordance with ASC 321. If the investment has a readily determinable fair value, it must be recognized at fair value, with changes in fair value reported in earnings. If the investment does not have a readily determinable fair value, the investor can either account for the equity investment at fair value, with changes in fair value reported in earnings, or elect the measurement alternative in ASC 321-10-35-2. When the measurement alternative is elected, the investor should account for observable price changes that necessitate its discontinuation of the equity method immediately before discontinuing the application of equity method accounting under ASC 323. When there is not a new FVO election, if the investor applies ASC 321 to account for the investment at fair value, with changes in fair value recognized in earnings, the result will be the same as it would when the FVO is applied.
FVO was elected	The investor must continue to apply the FVO to any retained investment that was previously accounted for at fair value by using the FVO, because the loss of significant influence does not warrant a new election date.

Accounting While Having Significant Influence

Accounting for Retained Investment After Losing Significant Influence

Equity method of accounting

The investor should account for the equity investment in accordance with ASC 321. If the investment has a readily determinable fair value, it must be recognized at fair value, with changes in fair value reported in earnings. If the investment does not have a readily determinable fair value, the investor can either account for the equity investment at fair value, with changes in fair value reported in earnings, or elect the measurement alternative in ASC 321-10-35-2. When the measurement alternative is elected, the investor should account for observable price changes that necessitate its discontinuation of the equity method immediately before discontinuing the application of equity method accounting under ASC 323.

When there is not a new FVO election, if the investor applies ASC 321 to account for the investment at fair value, with changes in fair value recognized in earnings, the result will be the same as it would when the FVO is applied.

FVO was elected

The investor must continue to apply the FVO to any retained investment that was previously accounted for at fair value by using the FVO, because the loss of significant influence does not warrant a new election date.

12.3.2.2.4 Remeasurement Events

12.3.2.2.4.1 General

ASC Master Glossary

Remeasurement Event

A remeasurement (new basis) event is an event identified in other authoritative accounting literature, other than the measurement of an impairment under Topic 321 or credit loss under Topic 326, that requires a financial instrument to be remeasured to its fair value at the time of the event but does not require that financial instrument to be reported at fair value continually with the change in fair value recognized in earnings. Examples of remeasurement events are business combinations and significant modifications of debt as discussed in paragraph 470-50-40-6.

In accordance with ASC 825-10-25-4(e), an entity may make a new FVO election upon the occurrence of a remeasurement event. Thus, upon a remeasurement event, an entity can elect the FVO for, or cease applying it to, an eligible item. ASC 825-10-25-5 lists examples of remeasurement events. See below for further discussion of certain types of remeasurement events.

12.3.2.2.4.2 Initial Consolidation of a Subsidiary or VIE

The initial consolidation of a subsidiary or VIE represents a remeasurement event only for eligible financial assets or financial liabilities that are initially recognized at fair value. For example, under ASC 810-10-30-1 and ASC 810-10-30-3, assets and liabilities recognized upon initial consolidation of a VIE may not be measured at fair value (i.e., the amounts are recognized on the basis of their historical carrying amounts). In these situations, a remeasurement event allowing for a new FVO election does not exist. Further, we believe that, in initial consolidation transactions among entities under common control, it would not be appropriate for the receiving entity to elect to cease applying the FVO to elected items of the transferring entity, since common-control transactions do not meet the definition of a remeasurement event in ASC 825-10-20.

12.3.2.2.4.3 Debtors’ and Creditors’ Considerations When a Loan Is Refinanced or Modified

The determination of whether an entity’s refinancing or modification of a loan (in situations other than a troubled debt restructuring) qualifies under ASC 825-10-25-4(e) as a remeasurement event for the borrower or creditor depends on the facts and circumstances. Paragraph A15 of the Basis for Conclusions of FASB Statement 159 states:

When a contract is modified (or a rider added to it) after it has been initially recognized, the question arises as to whether that modification would permit election of the fair value option for the related asset or liability. The Board decided that the availability of the fair value option should be based on whether, under GAAP, the modification is accounted for as the continuation of the original contract or as the termination of the original contract and the origination of a new contract. If the modification is considered the origination of a new contract, the fair value option could be elected on the date of its initial recognition. Otherwise, the entity’s previous decision about electing the fair value option for the original contract would govern the accounting for the continuation of that original contract.

12.3.2.2.4.3.1 Debtor’s Evaluation

ASC 470-50

Modifications and Exchanges

40-10 From the debtor’s perspective, an exchange of debt instruments between or a modification of a debt instrument by a debtor and a creditor in a nontroubled debt situation is deemed to have been accomplished with debt instruments that are substantially different if the present value of the cash flows under the terms of the new debt instrument is at least 10 percent different from the present value of the remaining cash flows under the terms of the original instrument. If the terms of a debt instrument are changed or modified and the cash flow effect on a present value basis is less than 10 percent, the debt instruments are not considered to be substantially different, except in the following two circumstances:

A modification or an exchange affects the terms of an embedded conversion option, from which the change in the fair value of the embedded conversion option (calculated as the difference between the fair value of the embedded conversion option immediately before and after the modification or exchange) is at least 10 percent of the carrying amount of the original debt instrument immediately before the modification or exchange.
A modification or an exchange of debt instruments adds a substantive conversion option or eliminates a conversion option that was substantive at the date of the modification or exchange. (For purposes of evaluating whether an embedded conversion option was substantive on the date it was added to or eliminated from a debt instrument, see paragraphs 470-20-40-7 through 40-9.)

ASC 470-50 indicates that a modification of an existing debt instrument or an exchange of debt instruments is an extinguishment of the original debt instrument if (1) the modification or exchange is not a troubled debt restructuring and (2) the new debt instrument is substantially different from the existing debt instrument.5 If a debt instrument has been refinanced or modified in such a way that it is substantially different from the original instrument, a remeasurement under ASC 825 has occurred and the FVO could be elected (or no longer applied if it was previously elected).

If the modification represents a troubled debt restructuring, the debt instrument is not considered a new instrument and, therefore, a new election date for the FVO is not available.

12.3.2.2.4.3.2 Creditor’s Evaluation

ASC 310-20

Loan Refinancing or Restructuring

35-9 If the terms of the new loan resulting from a loan refinancing or restructuring, are at least as favorable to the lender as the terms for comparable loans to other customers with similar collection risks who are not refinancing or restructuring a loan with the lender, the refinanced loan shall be accounted for as a new loan. This condition would be met if the new loan's effective yield is at least equal to the effective yield for such loans and modifications of the original debt instrument are more than minor. Any unamortized net fees or costs and any prepayment penalties from the original loan shall be recognized in interest income when the new loan is granted. The effective yield comparison considers the level of nominal interest rate, commitment and origination fees, and direct loan origination costs and would also consider comparison of other factors where appropriate, such as compensating balance arrangements.

35-10 If the refinancing or restructuring does not meet the condition set forth in paragraph 310-20-35-9 or if only minor modifications are made to the original loan contract, the unamortized net fees or costs from the original loan and any prepayment penalties shall be carried forward as a part of the net investment in the new loan. In this case, the investment in the new loan shall consist of the remaining net investment in the original loan, any additional funds advanced to the borrower, any fees received, and direct loan origination costs associated with the refinancing or restructuring.

ASC 310-20 addresses when an entity should consider a refinancing or restructuring of a loan receivable to represent a “new loan” for accounting purposes. (This guidance is used in determining how to recognize unamortized net fees or costs and any prepayment penalties from the original loan.) An entity should apply this guidance in determining whether a refinancing or restructuring of a loan receivable represents a remeasurement event under ASC 825-10-25-4(e). If the two criteria in ASC 310-20-35-9 are met in a refinancing or modification of a loan receivable, a remeasurement event under ASC 825 has occurred and the FVO can be elected (or no longer applied if it was previously elected).6 Otherwise, as stated in ASC 310-20-35-10, the refinanced or restructured loan receivable is not considered a new loan and a remeasurement event under ASC 825 therefore has not occurred.

12.3.3 Differences Between FVO Election for Investors and That for Investees

12.3.3.1 Consolidated and Separate Financial Statements

ASC 825-10

Consolidation

25-6 An acquirer, parent, or primary beneficiary decides whether to apply the fair value option to eligible items of an acquiree, subsidiary, or consolidated VIE, but that decision applies only in the consolidated financial statements. Fair value option choices made by an acquired entity, subsidiary, or VIE continue to apply in separate financial statements of those entities if they issue separate financial statements.

Upon a business combination or consolidation of a VIE, the acquirer, parent, or primary beneficiary may elect whether to apply the FVO in its consolidated financial statements provided that the initial consolidation of the acquiree, subsidiary, or consolidated VIE represents a remeasurement event (see Section 12.3.2.2.4.2 for more information). However, for the separate financial statements, the acquired entity, subsidiary, or VIE cannot make or change any FVO election unless pushdown accounting under ASC 805 is applied as of the date of the change-of-control event. Thus, a parent and a subsidiary may have different accounting bases for an eligible asset or liability of the subsidiary (i.e., the FVO has been elected in the consolidated financial statements but not in the separate financial statements of the subsidiary).

ASC 825-10-25-6 only specifically addresses the FVO election as of the date of a change-of-control event (e.g., when an acquirer obtains control of an acquiree in a business combination). Thus, questions have arisen regarding whether the FVO can be elected in the consolidated financial statements upon a subsidiary’s initial recognition of an eligible item if the subsidiary does not elect the FVO in its separate financial statements. Although an FVO election for the consolidated financial statements is generally consistent with that for a subsidiary’s separate financial statements, we believe that it is acceptable for the FVO election to be made in the consolidated financial statements without being made in the subsidiary’s separate financial statements. Similarly, we believe that it is generally acceptable for a subsidiary to elect the FVO for an eligible item even if that same election is not made in the parent’s consolidated financial statements. (However, such situations are not expected to be common.) These potential differences between the FVO election in the consolidated financial statements and that in the subsidiary’s separate financial statements may arise when the FVO is not elected on the basis of management’s intent.

12.3.3.2 Equity Method Investees

As discussed in Section 12.2.1.1.1, an investor can apply the FVO to an equity method investee without needing to “look through” to the investee’s assets and liabilities to determine whether they are financial in nature. However, when the equity method of accounting is applied to an investee, an investor may not, in determining equity method earnings and losses, (1) elect the FVO for otherwise eligible financial assets and financial liabilities of the investee (e.g., elect the FVO at the investee level and therefore adjust the reported results of the investee) or (2) “unwind” the investee’s FVO elections (e.g., adjust the reported results of the investee to exclude mark-to-market adjustments to the investee’s financial assets or financial liabilities for which the investee elected the FVO).

Footnotes

An entity may elect the FVO for one eligible debt instrument (such as an individual loan or an individual bond) and not elect the FVO for a separate but identical debt instrument, provided that the debt instrument reflects a separate and distinct contract (i.e., the debt instrument has a different counterparty or is legally detachable and separately transferable). For instance, the FVO may be applied to only some of the individual bonds issued or acquired in a single transaction even though the terms of each bond are identical. If a group of lenders jointly fund a loan to a single borrower and each lender loans a specific amount to the borrower and has the right to demand repayment from the borrower, the loan from each lender is considered separate and distinct from the loans from other lenders even if each of the loans forms part of the same overall loan syndication agreement. Thus, ASC 825-10-25-11 permits election of the FVO for each loan in a loan syndication arrangement in which the loans are made to the same borrower by different lenders.

This would also represent a remeasurement event under ASC 825-10-25-4(e).

ASC 470-50 provides guidance on calculating the present value of cash flows for the 10 percent test.

ASC 310-20-35-11 provides guidance on how a creditor should evaluate whether a modification of the terms of a debt instrument as a result of a refinancing or restructuring (other than a troubled debt restructuring) is “more than minor” under ASC 310-20-35-9.

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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.