FASB ED Accounting For Financial Instruments

Proposed Accounting Standards Update
Issued: May 26, 2010

Comments Due: September 30, 2010
Accounting for Financial Instruments and

Revisions to the Accounting for Derivative
Instruments and Hedging Activities
Financial Instruments (Topic 825) and

Derivatives and Hedging (Topic 815)
This Exposure Draft of a proposed Accounting Standards Update of Topic 825

and Topic 815 is issued by the Board for public comment.
Written comments should be addressed to:
Technical Director
File Reference No. 1810-100
The FASB Accounting Standards Codification™ is the source of authoritative
generally accepted accounting principles (GAAP) recognized by the FASB to
be applied by nongovernmental entities. An Accounting Standards Update is
not authoritative; rather, it is a document that communicates how the
Accounting Standards Codification is being amended. It also provides other
information to help a user of GAAP understand how and why GAAP is
changing and when the changes will be effective.
Notice to Recipients of This Exposure Draft of a Proposed Accounting

Standards Update
The Board invites individuals and organizations to send written comments on all
matters in this Exposure Draft of a proposed Accounting Standards Update.
Responses from those wishing to comment on the Exposure Draft must be
received in writing by September 30, 2010. Interested parties should submit their
comments by email to [email protected], File Reference No. 1810-100. Those
without email should send their comments to “Technical Director, File Reference
No. 1810-100, FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT 06856-5116.” Do
not send responses by fax.
All comments received constitute part of the FASB’s public file. The FASB will
make all comments publicly available by posting them to its website and by
making them available in its public reference room in Norwalk, Connecticut.
An electronic copy of this Exposure Draft is available on the FASB’s website until
the FASB issues a final Accounting Standards Update.
Copyright © 2010 by Financial Accounting Foundation. All rights reserved.

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Financial Accounting Standards Board

of the Financial Accounting Foundation
401 Merritt 7, PO Box 5116, Norwalk, Connecticut 06856-5116
Proposed Accounting Standards Update
Accounting for Financial Instruments and Revisions

to the Accounting for Derivative Instruments and
Hedging Activities
Financial Instruments (Topic 825) and Derivatives and

Hedging (Topic 815)
May 26, 2010
Comment Deadline: September 30, 2010
CONTENTS
Page
Numbers
Summary .........................................................................................................1–21
Proposed Guidance.......................................................................................23–65
Proposed Implementation Guidance ...........................................................66–109
Background Information, Basis for Conclusions, and Alternative Views....110–180
Appendix A: Comparison of the FASB’s and the IASB’s
Proposed Models for Financial Instruments ............................................181–194
Appendix B: Possible Methods for Measuring Changes in
an Entity’s Credit Standing ......................................................................195–200
Appendix C: Summary of Proposed Amendments to the
FASB Accounting Standards CodificationTM .............................................201–214
Summary
Why Is the FASB Issuing This Proposed Accounting

Standards Update (Update)?
Before the global economic crisis, both the Financial Accounting Standards
Board (FASB) and the International Accounting Standards Board (IASB) had
begun a joint project to revise and improve their respective standards on
accounting for financial instruments. The global economic crisis further
highlighted the ongoing concern that the existing accounting model for financial
instruments with its inherent gaps and inconsistencies is inadequate for today’s
complex economic environment. In the aftermath of the global economic crisis,
effective financial reporting has become the subject of worldwide attention, with a
focus on the urgent need for improved accounting standards in a number of
areas, including financial instruments. As a result, to support well-functioning
global capital markets many investors, preparers, and even high-level governing
bodies urged as a top priority the development of a single converged financial
reporting model for financial instruments that provides investors with the most
useful, transparent, and relevant information about an entity’s exposure to
financial instruments.
The main objective in developing this proposal is to provide financial statement
users with a more timely and representative depiction of an entity’s involvement
in financial instruments, while reducing the complexity in accounting for those
instruments. Currently, a high threshold for recognition of credit impairments
impedes timely recognition of losses, while complex hedging requirements
produce reported results that lack transparency and consistency. Furthermore,
existing U.S. generally accepted accounting principles (GAAP) permit different
accounting treatments for similar financial instruments. For example, under
existing U.S. GAAP, debt instruments may be measured at amortized cost (for
example, loans held for investment or held-to-maturity debt securities), at lower
of cost or fair value (for example, loans held for sale), or at fair value (for
example, trading securities). This proposal simplifies and improves financial
reporting for financial instruments by developing a consistent, comprehensive
framework for classifying financial instruments, removes the threshold for
recognizing credit impairments, and makes changes to the requirements to
qualify for hedge accounting, the result of which should be more consistent and
transparent reporting for hedging activities.
Strong opinions about the relative benefits and detriments of amortized cost and
fair value have sparked widespread commentary. This proposal would require (1)
presentation of both amortized cost and fair value on an entity’s statement of
financial position for most financial instruments held for collection or payment of
contractual cash flows and (2) the inclusion of both amortized cost and fair value
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information for these instruments in determining net income and comprehensive
income. In addition, this proposal would require that financial instruments held for
sale or settlement (primarily derivatives and trading financial instruments) be
recognized and measured at fair value with all changes in fair value recognized
in net income.
Ideally, this proposal would have been issued jointly with the IASB and contain
converged guidance. The goal remains for both Boards to issue comprehensive
improvements to this complex area that will foster international comparability of
financial information about financial instruments. However, each Board has faced
different imperatives that have resulted in different approaches for accounting for
certain types of financial instruments, resulting in different timetables for the
project. The FASB’s main objective is to develop accounting standards that
represent an improvement to U.S. financial reporting. What may be considered
an improvement in jurisdictions with less developed financial reporting systems
applying International Financial Reporting Standards (IFRS) may not be
considered an improvement in the United States. In addition, the IASB has been
replacing its financial instruments requirements in a phased approach, whereas
the FASB has been developing this comprehensive proposal. Those differing
factors and timetables have contributed to the Boards’ reaching differing
conclusions on a number of important technical issues.
Following the issuance of this proposal, the FASB and the IASB have jointly
committed to continue attempting to reduce differences in the accounting for
financial instruments under U.S. GAAP and IFRS. The strategy calls for both
Boards to consider together the comment letters and other feedback received in
an effort to try to reconcile differences in views in ways that foster convergence
while meeting project objectives.
Who Would Be Affected by the Proposed Guidance?

All entities that have financial instruments would be affected by the proposed
requirements. However, the extent of the effect would depend upon the relative
significance of financial instruments to an entity’s operations and financial
position as well as the entity’s business strategy. For example, traditional
banking-type institutions that currently measure a large number of financial
assets at amortized cost would be affected to a greater extent than brokers and
dealers in securities and investment companies that currently measure most
financial assets at fair value. Insurance companies would be affected to varying
degrees depending on their asset mix with companies that invest more heavily in
equity securities being the most affected. The effect would likely be less
significant for many commercial and industrial entities and for many not-for-profit
entities. As noted below, the Board is proposing providing nonpublic entities with
less than $1 billion in total assets with an additional 4 years to implement the new
requirements relating to loans, loan commitments, and core deposit liabilities that
meet certain criteria. In addition, some specific types of financial instruments,
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such as pension obligations and leases, would be exempt from the proposed
guidance. Also, short-term receivables and payables would continue to be
measured at amortized cost (plus or minus fair value hedging adjustments).
What Are the Main Aspects of the Proposed Guidance?

The proposed guidance focuses on providing the most useful, transparent, and
relevant information to investors about the financial assets and financial liabilities
of an entity. Financial statements have traditionally focused on providing
information about how an entity manages its business to provide information to
help present and potential investors and creditors and other users in assessing
the amounts, timing, and uncertainty of future cash flows. For financial
instruments, in addition to obtaining information about how an entity manages its
business, information about the risks inherent in the instruments also is important
for assessing the amounts, timing, and uncertainty of future cash flows.
Under this proposal, most financial instruments would be measured at fair value
in the statement of financial position each reporting period. For some financial
instruments, this represents no change. However, for certain other financial
instruments for which this represents a change, the proposal acknowledges that
amortized cost information also is relevant and would require its presentation
along with fair value information.
For derivatives and financial instruments for which an entity’s strategy is trading
the instruments, fair value would continue to be required, with all changes in fair
value recognized in net income each reporting period. Changes in the fair value
of equity securities, certain hybrid instruments, and financial instruments that can
be contractually prepaid in such a way that the holder would not recover
substantially all of its investment also would be recognized in net income each
reporting period regardless of an entity’s business strategy with respect to those
financial instruments. The Board believes that this better reflects the risks
presented by volatility associated with those financial instruments.
Financial instruments for which an entity’s business strategy is to hold for
collection or payment(s) of contractual cash flows, the proposed guidance would
recognize the utility to financial statement users of both fair value and amortized
cost information by requiring a reconciliation from amortized cost to fair value on
the face of the statement of position. By continuing to reflect a “business
strategy” approach to what is recognized in net income, the proposed model
would enable entities to preserve most of the existing aspects of reporting net
income and earnings per share. Financial instruments for which an entity’s
business strategy is to hold for the collection or payment(s) of the contractual
cash flows, net income would remain relatively unchanged because only
changes arising from interest accruals, credit impairments, and realized gains
and losses would be recognized in net income each reporting period. With the
exception of certain liabilities that qualify for the amortized cost option, all other
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changes in fair value from these instruments would be recognized in other
comprehensive income each reporting period.
A consistent measurement model for all financial instruments should improve
both comparability across entities and consistency in how an entity accounts for
different financial instruments. Many have said that there should be symmetry
between the accounting for financial assets and the financial liabilities funding
those assets. This may be particularly relevant for financial institutions as
financial liabilities are incurred in order to support related financial asset activity.
Asset-liability management is core to the business strategy and analysis of
financial institutions. Changes in market variables affect valuations of both
financial assets and financial liabilities. Accordingly, like financial assets in the
proposed model, many financial liabilities of financial institutions would be
measured at fair value (with amortized cost also being presented for certain
financial liabilities). In addition, core deposit liabilities would be remeasured each
period using a current value method that reflects the economic benefit that an
entity receives from this lower cost, stable funding source. Thus, under the
proposed model for a financial institution, the effects of changes in market
interest rates would be transparent on core deposit and other financial liabilities
and the financial assets that they fund.
By presenting both fair value and amortized cost information on the face of
financial statements for instruments that are being held for collection or
payment(s) of contractual cash flows, investors can more easily incorporate
either or both in their analyses of an entity. Fair value would provide users with
the best available information about the market’s assessment of an entity’s
expectation of its future net cash flows, discounted to reflect both current interest
rates and the market’s assessment of the risk that the cash flows will not occur.
Amortized cost would provide users with information about the instrument’s
contractual cash flows. Additionally, the Board believes the proposal would
improve the timeliness of fair value information because the Board believes that
fair value information would likely be available for public entities at the same time
as other material financial information, rather than only being disclosed later in
the notes to the financial statements included in regulatory filings. The proposed
guidance also would continue to provide, if so desired, prudential regulators with
the information necessary to compute regulatory capital using either fair value or
amortized cost amounts.
The proposed guidance would remove the existing “probable” threshold for
recognizing impairments on loans and proposes a common approach to
providing for credit losses on loans and debt instruments. Interest income would
be recognized after considering cash flows that are not expected to be collected.
This should better reflect a financial instrument’s interest yield.
By replacing highly complex, quantitative-based hedging requirements with more
qualitative-based assessments that would make it easier to qualify for hedge
accounting, the economic effects of hedging should be reported more
4
consistently over multiple reporting periods. An entity could continue to designate
particular risks in financial items as the risks being hedged in a hedging
relationship, with only the effects of the hedged risks reflected in net income each
reporting period. In addition, eliminating the shortcut method and the critical
terms match method would result in a more consistent model for assessing
hedge effectiveness. Hedge accounting would be discontinued only if the criteria
for hedge accounting are no longer met or the hedging instrument expires, is
sold, terminated, or exercised. Eliminating the ability to discontinue hedge
accounting simply by removing a hedging designation would contribute to both
increased comparability and transparency.
How Do the Proposed Provisions Compare with IFRS?

Both the proposed guidance and IFRS apply more than one measurement
attribute to financial instruments.
Under the proposed guidance, the measurement attribute for most financial
assets would be fair value. When specific eligibility criteria are met primarily
relating to whether the financial asset is being held for collection of contractual
cash flows, amortized cost also would be presented with qualifying changes in
fair value recognized in other comprehensive income rather than net income.
Under IFRS 9, Financial Instruments, when similar eligibility criteria are met,
financial assets are measured at amortized cost and fair value information is
disclosed in the notes to the financial statements. The qualifying criteria under
both the proposed guidance and IFRS 9 are based on the entity’s business
strategy (held for collection or payment of cash flows) with respect to the financial
instrument and the cash flow characteristics of the instrument.
This proposed guidance is based on the view that both amortized cost and fair
value information convey important information to users of financial statements
about financial instruments that an entity intends to hold for collection or
payment(s) of contractual cash flows. For financial assets, IFRS 9 is based on
the view that either fair value or amortized cost provides more relevant and
useful information about the amounts, timing, and uncertainty of the entity’s
future cash flows based on the cash flow characteristics of the financial asset
and the reporting entity’s business strategy for its financial assets.
The difference in the classification categories would result in measuring loans at
fair value under the proposed guidance (with amortized cost also being
presented), and measuring most loans at amortized cost under IFRS 9 if the
qualifying criteria are met (with fair value information disclosed in the notes to the
financial statements). Under the proposed guidance, all investments in debt and
equity securities would be measured at fair value. Under IFRS 9, investments in
debt instruments, including those traded in active markets with quoted market
prices, may be measured at amortized cost (with fair value information disclosed
in the notes to the financial statements) if they meet the qualifying criteria; other
5
debt instruments would be measured at fair value. IFRS 9 provides an election to
recognize changes in fair value in other comprehensive income only for equity
instruments that are not held for trading purposes; other equity instruments would
be measured at fair value.
Under the proposed guidance, financial liabilities would be measured at fair
value, amortized cost (based on eligibility criteria), or a remeasurement amount
specifically applicable to core deposit liabilities. Financial liabilities are not in the
scope of IFRS 9. However, the IASB tentatively has decided to retain existing
guidance for financial liabilities except for financial liabilities measured at fair
value under the fair value option. IFRS currently measures most financial
liabilities (including core deposit liabilities) at amortized cost if they are not held
for trading. The proposed guidance would provide an amortized cost option for
qualifying financial liabilities, while IFRS provides a fair value option for qualifying
financial liabilities. The proposed guidance would require hybrid financial
instruments that would otherwise have been required to be bifurcated under
Subtopic 815-15 on embedded derivatives to be classified and measured at fair
value in their entirety, while IFRS requires bifurcation of hybrid financial liability
instruments in certain situations with the derivative instrument measured at fair
value and the host contract measured at amortized cost.
Overall, because of these measurement differences, more financial instruments
would be measured at fair value on the statement of financial position under the
proposed guidance than those measured in accordance with IFRS. This
difference also would result in a difference in reported stockholders’ equity. The
measurement differences in financial assets primarily would result in differences
in the amount of comprehensive income reported with limited differences in
reported net income for most entities. However, differences in reported net
income may be significant for certain entities because IFRS will continue to
require bifurcation of certain hybrid financial liabilities and the proposed guidance
would require such liabilities to be measured at fair value with changes in fair
value recognized in net income in their entirety.
With regard to impairment of financial assets, the IASB also has issued an
Exposure Draft that proposes a different approach to providing for credit losses
and to accruing interest income. The Boards have established and are receiving
input and advice from an Expert Advisory Panel comprising representatives from
major financial institutions and other companies, audit firms, and securities and
prudential regulators from around the world. The Expert Advisory Panel is
providing operational input on both the FASB’s and IASB’s approaches that
should assist in the Boards’ efforts to develop a common approach to impairment
of financial assets and accrual of interest income.
The IASB tentatively decided to retain the classification and measurement
guidance in IAS 39, Financial Instruments: Recognition and Measurement, for
financial liabilities. However, the IASB also tentatively decided to amend the fair
value option for financial liabilities and issued an Exposure Draft, Fair Value
6
Option for Financial Liabilities (Exposure Draft on fair value option), on May 11,
2010. The IASB expects to issue a proposal on hedge accounting in the near
term.
See the comparison of the FASB’s and the IASB’s proposed models for financial
instruments in Appendix A for more information.
When Would the Proposed Amendments Be Effective?

The Board will establish the effective date of the requirements when it issues the
final amendments. Whatever that date, nonpublic entities with less than $1 billion
in total consolidated assets would be granted an additional 4 years to measure
its loans and loan commitments at fair value and remeasure its core deposit
liabilities that qualify for changes in fair value to be recognized in other
comprehensive income. The Board believes that such a deferral would allow
these entities to develop and refine the capabilities and processes necessary for
valuing loans, loan commitments, and core deposit liabilities before being
required to recognize these amounts on the face of its financial statements. It
also would enable the Board to perform a post-implementation review of the new
financial instruments’ requirements two or three years after the initial effective
date but before the requirements become effective for all entities. In the interim,
loans, loan commitments, and core deposit liabilities subject to the deferral would
continue to be measured in the financial statements under existing U.S. GAAP.
Also during the interim, the fair value of loans would be disclosed in the notes to
the financial statements.
An entity would apply the proposed guidance by means of a cumulative-effect
adjustment to the statement of financial position for the reporting period that
immediately precedes the effective date. Early adoption would be prohibited.
Questions for Respondents

The Board invites individuals and organizations to comment on all matters in this
proposed Update, particularly on the issues and questions below. Comments are
requested from those who agree with the proposed guidance as well as from
those who disagree. Comments are most helpful if they identify and clearly
explain the issue or question to which they relate. Those who disagree with the
proposed guidance are asked to describe their suggested alternatives, supported
by specific reasoning. For questions requesting comments on operationality,
assume an effective date of no earlier than January 1, 2013.
7
Scope
Questions for All Respondents

Question 1: Do you agree with the scope of financial instruments included in this
proposed Update? If not, which other financial instruments do you believe should
be excluded or which financial instruments should be included that are proposed
to be excluded? Why?
Question 2: The proposed guidance would require loan commitments, other
than loan commitments related to a revolving line of credit issued under a credit
card arrangement, to be measured at fair value. Do you agree that loan
commitments related to a revolving line of credit issued under a credit card
arrangement should be excluded from the scope of this proposed Update? If not,
why?
Question 3: The proposed guidance would require deposit-type and investment
contracts of insurance and other entities to be measured at fair value. Do you
agree that deposit-type and investment contracts should be included in the
scope? If not, why?
Question 4: The proposed guidance would require an entity to not only
determine if they have significant influence over the investee as described
currently in Topic 323 on accounting for equity method investments and joint
ventures but also to determine if the operations of the investee are related to the
entity’s consolidated business to qualify for the equity method of accounting. Do
you agree with this proposed change to the criteria for equity method of
accounting? If not, why?
Questions for Users

Question 5: The proposed guidance would require financial liabilities of
investment companies to be measured at fair value with changes in fair value
recognized as a net increase (decrease) in net assets. Do you believe that the
effect on net asset value will provide decision-useful information? If yes, how will
the information provided influence your analysis of the entity? If not, why?
Question 6: The proposed guidance would require money market funds that
comply with Rule 2a-7 of the Investment Company Act of 1940 to measure their
investments at fair value rather than amortized cost. Do you believe that
reporting those investments at fair value rather than amortized cost will provide
decision-useful information? If yes, how will the information provided influence
your analysis of the fund? If not, why?
Question 7: The proposed guidance would require brokers and dealers in
securities to apply the proposed guidance for measuring financial liabilities, which
8
could mean that qualifying changes in fair value would be recognized in other
comprehensive income. Do you believe that this will provide decision-useful
information? If yes, how will the information provided influence your analysis of
the entity? If not, why?
Initial Measurement

Question 8: Do you agree with the initial measurement principles for financial
instruments? If not, why?
Question 9: For financial instruments for which qualifying changes in fair value
are recognized in other comprehensive income, do you agree that a significant
difference between the transaction price and the fair value on the transaction
date should be recognized in net income if the significant difference relates to
something other than fees or costs or because the market in which the
transaction occurs is different from the market in which the reporting entity would
transact? If not, why?
Question 10: Do you believe that there should be a single initial measurement
principle regardless of whether changes in fair value of a financial instrument are
recognized in net income or other comprehensive income? If yes, should that
principle require initial measurement at the transaction price or fair value? Why?
Question 11: Do you agree that transaction fees and costs should be (1)
expensed immediately for financial instruments measured at fair value with all
changes in fair value recognized in net income and (2) deferred and amortized as
an adjustment of the yield for financial instruments measured at fair value with
qualifying changes in fair value recognized in other comprehensive income? If
not, why?
Question for Preparers and Auditors

Question 12: For financial instruments initially measured at the transaction price,
do you believe that the proposed guidance is operational to determine whether
there is a significant difference between the transaction price and fair value? If
not, why?
Subsequent Measurement

Question 13: The Board believes that both fair value information and amortized
cost information should be provided for financial instruments an entity intends to
9
hold for collection or payment(s) of contractual cash flows. Most Board members
believe that this information should be provided in the totals on the face of the
financial statements with changes in fair value recognized in reported
stockholders’ equity as a net increase (decrease) in net assets. Some Board
members believe fair value should be presented parenthetically in the statement
of financial position. The basis for conclusions and the alternative views describe
the reasons for those views. Do you believe the default measurement attribute
for financial instruments should be fair value? If not, why? Do you believe that
certain financial instruments should be measured using a different measurement
attribute? If so, why?
Question 14: The proposed guidance would require that interest income or
expense, credit impairments and reversals (for financial assets), and realized
gains and losses be recognized in net income for financial instruments that meet
the criteria for qualifying changes in fair value to be recognized in other
comprehensive income. Do you believe that any other fair value changes should
be recognized in net income for these financial instruments? If yes, which
changes in fair value should be separately recognized in net income? Why?
Question 15: Do you believe that the subsequent measurement principles
should be the same for financial assets and financial liabilities? If not, why?
Question 16: The proposed guidance would require an entity to decide whether
to measure a financial instrument at fair value with all changes in fair value
recognized in net income, at fair value with qualifying changes in fair value
recognized in other comprehensive income, or at amortized cost (for certain
financial liabilities) at initial recognition. The proposed guidance would prohibit an
entity from subsequently changing that decision. Do you agree that
reclassifications should be prohibited? If not, in which circumstances do you
believe that reclassifications should be permitted or required? Why?
Question 17: The proposed guidance would require an entity to measure its core
deposit liabilities at the present value of the average core deposit amount
discounted at the difference between the alternative funds rate and the all-in-
cost-to-service rate over the implied maturity of the deposits. Do you believe that
this remeasurement approach is appropriate? If not, why? Do you believe that
the remeasurement amount should be disclosed in the notes to the financial
statements rather than presented on the face of the financial statements? Why or
why not?
Question 18: Do you agree that a financial liability should be permitted to be
measured at amortized cost if it meets the criteria for recognizing qualifying
changes in fair value in other comprehensive income and if measuring the liability
at fair value would create or exacerbate a measurement attribute mismatch? If
not, why?
Question 19: Do you believe that the correct financial instruments are captured
by the criteria in the proposed guidance to qualify for measurement at the
10
redemption amount for certain investments that can be redeemed only for a
specified amount (such as an investment in the stock of the Federal Home Loan
Bank or an investment in the Federal Reserve Bank)? If not, are there any
financial instruments that should qualify but do not meet the criteria? Why?
Question 20: Do you agree that an entity should evaluate the need for a
valuation allowance on a deferred tax asset related to a debt instrument
measured at fair value with qualifying changes in fair value recognized in other
comprehensive income in combination with other deferred tax assets of the entity
(rather than segregated and analyzed separately)? If not, why?
Question 21: The Proposed Implementation Guidance section of this proposed
Update provides an example to illustrate the application of the subsequent
measurement guidance to convertible debt (Example 10). The Board currently
has a project on its technical agenda on financial instruments with characteristics
of equity. That project will determine the classification for convertible debt from
the issuer’s perspective and whether convertible debt should continue to be
classified as a liability in its entirety or whether the Board should require
bifurcation into a liability component and an equity component. However, based
on existing U.S. GAAP, the Board believes that convertible debt would not meet
the criterion for a debt instrument under paragraph 21(a)(1) to qualify for changes
in fair value to be recognized in other comprehensive income because the
principal will not be returned to the creditor (investor) at maturity or other
settlement. Do you agree with the Board’s application of the proposed
subsequent measurement guidance to convertible debt? If not, why?
Questions for Users

Question 22: Do you believe that the recognition of qualifying changes in fair
value in other comprehensive income (measuring the effects of subsequent
changes in interest rates on fair value as well as reflecting differences between
management’s and the market’s expectations about credit impairments) will
provide decision-useful information for financial instruments an entity intends to
hold for collection or payment(s) of contractual cash flows? If yes, how will the
information provided influence your analysis of an entity? If not, why?
Question 23: The proposed guidance would establish fair value with all changes
in fair value recognized in net income as the default classification and
measurement category for financial instruments. An entity can choose to
measure any financial instrument within the scope of this proposed Update at fair
value with all changes in fair value recognized in net income, except for core
deposit liabilities which must be valued using a remeasurement approach. Do
you believe that a default classification and measurement category should be
provided for financial instruments that would otherwise meet the criteria for
qualifying changes to be recognized in other comprehensive income? If not,
why?
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Question 24: The proposed guidance would provide amortized cost and fair
value information on the face of the financial statements. The Board believes that
this would increase the likelihood that both measures are available to users of
public entity financial statements on a timely basis and that both measures are
given equal attention by preparers and auditors. Do you believe that this
approach will provide decision-useful information? If yes, how will the information
provided be used in the analysis of an entity? If not, would you recommend
another approach (for example, supplemental fair value financial statements in
the notes to the financial statements or dual financial statements)?
Question 25: For hybrid financial instruments that currently would require
bifurcation and separate accounting under Subtopic 815-15, do you agree that
recognizing the entire change in fair value in net income results in more decision-
useful information than requiring the embedded derivative to be bifurcated and
accounted for separately from the host contract? If yes, how will the information
provided be used in the analysis of an entity? If not, for which types of hybrid
financial instruments do you believe that it is more decision useful to account for
the embedded derivative separately from the host contract? Why?
Question 26: IFRS 9 requires hybrid financial assets to be classified in their
entirety on the basis of the overall classification approach for financial assets with
specific guidance for applying the classification approach to investments in
contractually linked instruments that create concentrations of credit risk. Also, for
hybrid financial liabilities, the IASB, in order to address the effects of changes in
the credit risk of a liability, tentatively has decided to retain existing guidance that
requires embedded derivatives to be bifurcated and accounted for separately
from a host liability contract if particular conditions are met. Do you believe that
the proposed guidance for hybrid financial instruments or the IASB’s model for
accounting for financial hybrid contracts will provide more decision-useful
information? Why?
Question 27: Do you believe that measuring certain short-term receivables and
payables at amortized cost (plus or minus any fair value hedging adjustments)
will provide decision-useful information? If yes, how will the information provided
be used in your analysis of an entity? If not, why?
Questions for Preparers and Auditors

Question 28: Do you believe that the proposed criteria for recognizing qualifying
changes in fair value in other comprehensive income are operational? If not,
why?
Question 29: Do you believe that measuring financial liabilities at fair value is
operational? If not, why?
Question 30: Do you believe that the proposed criteria are operational to qualify
for measuring a financial liability at amortized cost? If not, why?
12
Question 31: The proposed guidance would require an entity to measure its core
deposit liabilities at the present value of the average core deposit amount
cost-to-service rate over the implied maturity of the deposits. Do you believe that
this remeasurement approach is operational? Do you believe that the
remeasurement approach is clearly defined? If not, what, if any, additional
guidance is needed?
Presentation

Question 32: For financial liabilities measured at fair value with all changes in
fair value recognized in net income, do you agree that separate presentation of
changes in an entity’s credit standing (excluding changes in the price of credit) is
appropriate, or do you believe that it is more appropriate to recognize the
changes in an entity’s credit standing (with or without changes in the price of
credit) in other comprehensive income, which would be consistent with the
IASB’s tentative decisions on financial liabilities measured at fair value under the
fair value option? Why?
Question 33: Appendix B describes two possible methods for determining the
change in fair value of a financial liability attributable to a change in the entity’s
credit standing (excluding the changes in the price of credit). What are the
strengths and weaknesses of each method? Would it be appropriate to use either
method as long as it was done consistently, or would it be better to use Method 2
for all entities given that some entities are not rated? Alternatively, are there
better methods for determining the change in fair value attributable to a change
in the entity’s credit standing, excluding the price of credit? If so, please explain
why those methods would better measure that change.
Question 34: The methods described in Appendix B for determining the change
in fair value of a financial liability attributable to a change in an entity’s credit
standing (excluding the changes in the price of credit) assume that the entity
would look to the cost of debt of other entities in its industry to estimate the
change in credit standing, excluding the change in the price of credit. Is it
appropriate to look to other entities within an entity’s industry, or should some
other index, such as all entities in the market of a similar size or all entities in the
industry of a similar size, be used? If so, please explain why another index would
better measure the change in the price of credit.
Questions for Users

Question 35: For financial instruments measured at fair value with qualifying
changes in fair value recognized in other comprehensive income, do you believe
13
that the presentation of amortized cost, the allowance for credit losses (for
financial assets), the amount needed to reconcile amortized cost less the
allowance for credit losses to fair value, and fair value on the face of the
statement of financial position will provide decision-useful information? If yes,
how will the information provided be used in your analysis of an entity? If not,
why?
Question 36: Do you believe that separately presenting in the performance
statement significant changes in the fair value of financial liabilities for changes in
an entity’s credit standing (excluding the changes in the price of credit) will
provide decision-useful information? If yes, how will the information provided
influence your analysis of the entity? If not, why? Do you believe that changes in
the price of credit also should be included in this amount? If so, why?
Credit Impairment

Question 37: Do you believe that the objective of the credit impairment model in
this proposed Update is clear? If not, what objective would you propose and
why?
Question 38: The proposed guidance would require an entity to recognize a
credit impairment immediately in net income when the entity does not expect to
collect all contractual amounts due for originated financial asset(s) and all
amounts originally expected to be collected for purchased financial asset(s).
The IASB Exposure Draft, Financial Instruments: Amortised Cost and Impairment
(Exposure Draft on impairment), would require an entity to forecast credit losses
upon acquisition and allocate a portion of the initially expected credit losses to
each reporting period as a reduction in interest income by using the effective
interest rate method. Thus, initially expected credit losses would be recorded
over the life of the financial asset as a reduction in interest income. If an entity
revises its estimate of cash flows, the entity would adjust the carrying amount
(amortized cost) of the financial asset and immediately recognize the amount of
the adjustment in net income as an impairment gain or loss.
Do you believe that an entity should immediately recognize a credit impairment in
net income when an entity does not expect to collect all contractual amounts due
for originated financial asset(s) and all amounts originally expected to be
collected for purchased financial asset(s) as proposed in this Update, or do you
believe that an entity should recognize initially expected credit losses over the life
of the financial instrument as a reduction in interest income, as proposed in the
IASB Exposure Draft on impairment?
Question 39: Do you agree that a credit impairment should not result from a
decline in cash flows expected to be collected due to changes in foreign
14
exchange rates, changes in expected prepayments, or changes in a variable
interest rate? If not, why?
Question 40: For a financial asset evaluated in a pool, the proposed guidance
does not specify a particular methodology to be applied by individual entities for
determining historical loss rates. Should a specific method be prescribed for
determining historical loss rates? If yes, what specific method would you
recommend and why?
Question 41: Do you agree that if an entity subsequently expects to collect more
cash flows than originally expected to be collected for a purchased financial
asset, the entity should recognize no immediate gain in net income but should
adjust the effective interest rate so that the additional cash flows are recognized
as an increase in interest income over the remaining life of the financial asset? If
not, why?
Question 42: If a financial asset that is evaluated for impairment on an individual
basis has no indicators of being individually impaired, the proposed guidance
would require an entity to determine whether assessing the financial asset
together with other financial assets that have similar characteristics indicates that
a credit impairment exists. The amount of the credit impairment, if any, would be
measured by applying the historical loss rate (adjusted for existing economic
factors and conditions) applicable to the group of similar financial assets to the
individual financial asset. Do you agree with this requirement? If not, why?
Questions for Users

Question 43: The credit impairment model in this proposed Update would
remove the probable threshold. Thus, an entity would no longer wait until a credit
loss is probable to recognize a credit impairment. An entity would be required to
recognize a credit impairment immediately in net income when an entity does not
expect to collect all of the contractual cash flows (or, for purchased financial
assets, the amount originally expected). This will result in credit impairments
being recognized earlier than they are under existing U.S. GAAP.
Do you believe that removing the probable threshold so that credit impairments
are recognized earlier provides more decision-useful information?
Question 44: The proposed guidance would require that in determining whether
a credit impairment exists, an entity consider all available information relating to
past events and existing conditions and their implications for the collectibility of
the cash flows attributable to the financial asset(s) at the date of the financial
statements. An entity would assume that the economic conditions existing at the
end of the reporting period would remain unchanged for the remaining life of the
financial asset(s) and would not forecast future events or economic conditions
that did not exist at the reporting date. In contrast, the IASB Exposure Draft on
15
impairment proposes an expected loss approach and would require an entity to
estimate credit losses on the basis of probability-weighted possible outcomes.
Do you agree that an entity should assume that economic conditions existing at
the reporting date would remain unchanged in determining whether a credit
impairment exists, or do you believe that an expected loss approach that would
include forecasting future events or economic conditions that did not exist at the
end of the reporting period would provide more decision-useful information?
Question 45: The proposed guidance would require that an appropriate
historical loss rate (adjusted for existing economic factors and conditions) be
determined for each individual pool of similar financial assets. Historical loss
rates would reflect cash flows that the entity does not expect to collect over the
life of the financial assets in the pool. Do you agree with that approach?

Question 46: The proposed guidance would require that in determining whether
a credit impairment exists, an entity consider all available information relating to
past events and existing conditions and their implications for the collectibility of
the cash flows attributable to the financial asset(s) at the date of the financial
statements. An entity would assume that the economic conditions existing at the
end of the reporting period would remain unchanged for the remaining life of the
financial asset(s) and would not forecast future events or economic conditions
that did not exist at the reporting date. In contrast, the IASB Exposure Draft on
Impairment proposes an expected loss approach and would require an entity to
estimate credit losses on basis of probability-weighted possible outcomes.
Do you agree that an entity should assume that economic conditions existing at
the reporting date would remain unchanged in determining whether a credit
impairment exists, or do you believe that an expected loss approach that would
include forecasting future events or economic conditions that did not exist at the
end of the reporting period would be more appropriate? Are both methods
operational? If not, why?
Question 47: The proposed guidance would require that an appropriate
historical loss rate (adjusted for existing economic factors and conditions) be
determined for each individual pool of similar financial assets. Historical loss
rates would reflect cash flows that the entity does not expect to collect over the
life of the financial assets in the pool. Would such an approach result in a
significant change in practice (that is, do historical loss rates typically reflect cash
flows that the entity does not expect to collect over the life of the financial assets
in the pool or some shorter period)?
16
Interest Income

Question 48: The proposed guidance would require interest income to be
calculated for financial assets measured at fair value with qualifying changes in
fair value recognized in other comprehensive income by applying the effective
interest rate to the amortized cost balance net of any allowance for credit losses.
Do you believe that the recognition of interest income should be affected by the
recognition or reversal of credit impairments? If not, why?
Question 49: Do you agree that the difference in the amount of interest
contractually due that exceeds interest accrued on the basis of an entity’s current
estimate of cash flows expected to be collected for financial assets should be
recognized as an increase to the allowance for credit losses? If not, why?
Question 50: The proposed guidance would permit, but would not require,
separate presentation of interest income on the statement of comprehensive
income for financial assets measured at fair value with all changes in fair value
recognized in net income. If an entity chooses to present separately interest
income for those financial assets, the proposed guidance does not specify a
particular method for determining the amount of interest income to be recognized
on the face of the statement of comprehensive income. Do you believe that the
interest income recognition guidance should be the same for all financial assets?
Question 51: Do you believe that the implementation guidance and illustrative
examples included in this proposed Update are sufficient to understand the
proposed credit impairment and interest income models? If not, what additional
guidance or examples are needed?
Questions for Users

Question 52: Do you believe that the method for recognizing interest income on
financial assets measured at fair value with qualifying changes in fair value
recognized in other comprehensive income will provide decision-useful
information? If yes, how will the information provided be used in your analysis of
an entity? If not, why?
Question 53: The method of recognizing interest income will result in the
allowance for credit impairments presented in the statement of financial position
not equaling cumulative credit impairments recognized in net income because a
portion of the allowance will reflect the excess of the amount of interest
contractually due over interest income recognized. Do you believe that this is
understandable and will provide decision-useful information? If yes, how will the
information provided be used? If not, why?
17
Question 54: The proposed guidance would require interest income to be
calculated for financial assets measured at fair value with qualifying changes in
fair value recognized in other comprehensive income by applying the effective
interest rate to the amortized cost balance net of any allowance for credit losses.
Thus, the recognition of a credit loss would result in a decrease in interest
income recognized. Similarly, a reversal of a previously recognized credit loss
would increase the amount of interest income recognized. The IASB Exposure
Draft on Impairment proposes that an entity calculate interest by multiplying the
effective rate established at initial recognition by the amortized cost basis. The
IASB’s definition of amortized cost basis is the present value of expected future
cash flows discounted by the effective interest rate established at initial
recognition and, therefore, includes credit losses recognized to date. Thus, as
initially expected credit losses are allocated over the life of the instrument, the
amount of interest income decreases.
Both the FASB’s and the IASB’s models for interest income recognition are
similar in that the recognition of an impairment reduces the amount of interest
income recognized. However, as noted in the questions above, the timing of
credit impairments and the determination of the effective interest rate differ in the
two proposed models. Thus, the amount of interest income recognized under the
two proposed models will differ. Do you believe that the FASB’s model or the
IASB’s model provides more decision-useful information? Why?
Question 55: Do you agree that an entity should cease accruing interest on a
financial asset measured at fair value with qualifying changes in fair value
recognized in other comprehensive income if the entity’s expectations about cash
flows expected to be collected indicate that the overall yield on the financial asset
will be negative? If not, why?
Hedge Accounting

Question 56: Do you believe that modifying the effectiveness threshold from
highly effective to reasonably effective is appropriate? Why or why not?
Question 57: Should no effectiveness evaluation be required under any
circumstances after inception of a hedging relationship if it was determined at
inception that the hedging relationship was expected to be reasonably effective
over the expected hedge term? Why or why not?
Question 58: Do you believe that requiring an effectiveness evaluation after
inception only if circumstances suggest that the hedging relationship may no
longer be reasonably effective would result in a reduction in the number of times
hedging relationships would be discontinued? Why or why not?
18
Questions for Users
Question 59: Do you believe that a hedge accounting model that recognizes in
net income changes in the fair value and changes in the cash flows of the risk
being hedged along with changes in fair value of the hedging instrument provides
decision-useful information? If yes, how would that information be used? If not,
why?
Question 60: Do you believe that the proposed changes to the hedge
accounting model will provide more transparent and consistent information about
hedging activities? If yes, why and how would you use the information provided?
If not, what changes do you disagree with and why?

Question 61: Do you foresee any significant operational concerns or constraints
in calculating ineffectiveness for cash flow hedging relationships? If yes, what
constraints do you foresee and how would you alleviate them?
in creating processes that will determine when changes in circumstances
suggest that a hedging relationship may no longer be reasonably effective
without requiring reassessment of the hedge effectiveness at each reporting
period? If yes, what constraints do you foresee and how would you alleviate
them?
arising from the inability to discontinue fair value hedge accounting or cash flow
hedge accounting by simply dedesignating the hedging relationship? If yes, what
constraints do you foresee and how would you alleviate them?
arising from the required concurrent documentation of the effective termination of
a hedging derivative attributable to the entity’s entering into an offsetting
derivative instrument? If yes, what constraints do you foresee and how would you
alleviate them?
Disclosures
Question for All Respondents

Question 65: Do you agree with the proposed disclosure requirements? If not,
which disclosure requirement do you believe should not be required and why?
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Questions for Users
Question 66: For purchased financial assets, do you believe that the
requirement to disclose the principal balance, the purchaser’s assessment of the
discount related to credit losses inherent in the financial instrument at acquisition,
any additional difference between the amortized cost and the principal balance,
and the amortized cost in each period will provide decision-useful information? If
yes, how will the information provided influence your analysis of an entity? If not,
why?
Question 67: Are there any other disclosures that you believe would provide
decision-useful information and why?
Effective Date and Transition

Question 68: Do you agree with the transition provision in this proposed
Update? If not, why?
Question 69: Do you agree with the proposed delayed effective date for certain
aspects of the proposed guidance for nonpublic entities with less than $1 billion
in total consolidated assets? If not, why?

Question 70: How much time do you believe is needed to implement the
proposed guidance?
Question 71: Do you believe the proposed transition provision is operational? If
not, why?
Public Roundtable Meetings

The Board plans to hold four public roundtable meetings on this proposed
Update—two on October 12, 2010, and two on October 21, 2010. The purpose of
roundtable meetings is to listen to the views of, and obtain information from,
interested constituents about this proposed Update. The Board plans to seek
participants for the meetings that represent a wide variety of constituents,
including users, preparers, auditors, and others to ensure that it receives broad
input. Any individual or organization desiring to participate must notify the FASB
by sending an email to [email protected] and submitting its comments on the
proposed Update in writing by September 1, 2010. Roundtable meetings can
accommodate a limited number of participants. Depending on the number of
20
responses received, the Board may not be able to accommodate all requests to
participate.
Field Visit Volunteers

The Board also is soliciting entities that would be willing to participate with the
staff, on a confidential basis, in a field visit to discuss the provisions of this
proposed Update. The purpose of field visits is to assess the operationality and
the costs and benefits of the proposed guidance. Entities interested in
volunteering can contact Upaasna Laungani, Project Manager, at
[email protected].
21
Proposed Guidance
Introduction
1. The Proposed Guidance section of this proposed Accounting Standards
Update describes the accounting, hedging, presentation, and disclosure
requirements that would result from the related amendments to the FASB
Accounting Standards Codification™. The Board recognizes that the proposed
guidance will have a pervasive effect on the existing accounting guidance for
financial instruments. The table in Appendix C has been included to provide an
indication of the effect of the proposed guidance on relevant areas of the
Accounting Standards Codification. The table is based on a preliminary
assessment of the necessary updates to the Accounting Standards Codification.
It presents only the significant changes to the Accounting Standards Codification
that are expected to arise from the proposed guidance and is not intended to be
a comprehensive list of updates to the Accounting Standards Codification. The
amendments to implement the proposed requirements described in this
Proposed Guidance section are not included. The Board expects to issue those
proposed amendments and proposed amendments to the XBRL Taxonomy
during the comment period on this proposed Update.
Objective
2. The objective of the proposed guidance is to provide an improved and
consistent financial reporting model for the recognition, measurement, and
presentation of financial instruments in an entity’s financial statements. The
model increases the decision usefulness of the information provided in the
financial statements to users by recognizing and measuring many financial
instruments at fair value, without eliminating amortized cost information.
Scope
Entities
3. The proposed guidance applies to all entities. However, for a nonpublic
entity with less than $1 billion in total consolidated assets, the effective date for
particular requirements is deferred for 4 years. Paragraphs 134–136 explain that
deferral and the required accounting and disclosures in the interim.
23
Financial Instruments and Transactions
4. The proposed guidance applies to all financial instruments except for the
following:
a. An instrument held or issued by an entity that is classified in its
entirety in the entity’s stockholders’ equity. (See the guidance on
distinguishing liabilities from equity in Topic 480 and the guidance on
equity in Topic 505.)
b. An equity component that has been bifurcated from a hybrid
instrument and classified in an entity’s stockholders’ equity in
accordance with the guidance on debt in Topic 470, Topic 480, or
another Topic that requires separate accounting for the components
of a hybrid financial instrument.
c. An employer’s or plan’s obligation and the related assets, if any, that
are within the scope of any of the following Topics:
1. Topic 710 on compensation (see the guidance beginning in
paragraph 710-10-15-3)
2. Topic 712 on nonretirement postemployment benefits (see the
guidance beginning in paragraph 712-10-15-3)
3. Topic 715 on retirement benefits (see the guidance beginning in
4. Topic 718 on stock compensation (see the guidance beginning in
5. Topic 960 on accounting by defined benefit pension plans
6. Topic 962 on accounting by defined contribution pension plans
7. Topic 965 on accounting by health and welfare benefit plans.
d. An insurance contract within the scope of Topic 944 on financial
services and insurance. However, the following are included in the
scope of this proposed Update:
1. A contract within the scope of the deposit method of accounting
set forth in Subtopic 340-30 on insurance contracts that do not
transfer insurance risk
2. An investment contract accounted for in accordance with
paragraphs 944-825-25-1 through 25-2 on accounting for
insurance entities.
e. An investment in the equity instruments of another entity that qualifies
for use of the equity method in accordance with Topic 323 on the
equity method and joint ventures. (See paragraph 130 for the criteria
to qualify for use of the equity method of accounting.)
f. An equity investment in a consolidated subsidiary (see Subtopic 810-
10 on consolidation).
g. A noncontrolling interest in a consolidated subsidiary (see Subtopic
810-10).
h. An interest in a variable interest entity that the entity is required to
consolidate in accordance with Subtopic 810-10.
24
i. A financial asset or financial liability pertaining to a lease that is within
the scope of Topic 840 on leases.
j. A loan commitment and a financial standby letter of credit held by a
potential borrower.
k. A loan commitment related to a revolving line of credit issued under a
credit card arrangement.
l. The conditional obligation under a registration payment arrangement
that shall be accounted for separately from the financial instrument(s)
subject to the agreement in accordance with Subtopic 825-20 on
registration payment arrangements. However, a holder of a financial
instrument that is subject to a registration payment arrangement is
within the scope of this proposed Update.
m. A contingent consideration arrangement that is not based on an
observable market or an observable index. For example, a contingent
consideration arrangement that is based on the future stock price of
the acquirer that is observable in the market would be within the
scope of this proposed Update.
n. A not-for-profit entity’s pledge receivable or payable resulting from a
voluntary, nonreciprocal transfer.
o. The following financial guarantee contracts:
1. A contract that provides for payments that constitute a vendor
rebate (by the guarantor) based either on the sales revenues of
or the number of units sold by the guaranteed party, or on the
volume of purchases by the buyer
2. A guarantee or an indemnification, the existence of which
prevents the guarantor from being able either to account for a
transaction as the sale of an asset or to recognize the profit from
that sale transaction
3. A guarantee or an indemnification of an entity’s own future
performance (for example, a guarantee that the guarantor will not
take a specified action)
4. A product warranty or other guarantee for which the underlying is
related to the functional performance (and not the price) of
nonfinancial assets that are owned by the guaranteed party
5. A guarantee issued between a parent and its subsidiary or
between entities under common control
6. A parent’s guarantee of its subsidiary’s debt to a third party
7. A subsidiary’s guarantee of debt owed to a third party by either
its parent or another subsidiary of that parent.
p. Forward contracts that require physical settlement by repurchase of a
fixed number of the issuer’s equity shares in exchange for cash
accounted for in accordance with paragraph 480-10-35-3.
5. In addition, the following instruments or transactions that are excluded from
the scope of Topic 815 on derivatives and hedging also are excluded from the
25
scope of this proposed Update. Subtopic 815-10 describes criteria that must be
met for some of the following scope exceptions:
a. A forward contract related to a regular-way securities trade
b. A derivative that is an impediment to one party’s use of sale
accounting under Topic 860 on transfers and servicing
c. An investment contract that is subject to Topic 960
d. A contract that is not exchange-traded if the underlying is any of the
following:
1. A climatic or geological variable
2. The price or value of a nonfinancial asset or liability of one of the
parties to the contract provided that the asset is not readily
convertible to cash
3. Specified volumes of sales or service revenues of one of the
parties to the contract.
e. A policyholder’s investment in a life insurance contract that is
accounted for under Subtopic 325-30 on investments in insurance
contracts
f. A contract between a potential acquirer and seller to enter into a
business combination at a future date.
Glossary
6. The proposed guidance uses the terms in paragraphs 7–9 with the
specified meanings. The terms are organized whether they are new terms to be
added to the Master Glossary of the Accounting Standards Codification by this
proposed Update, existing terms from the Master Glossary that this proposed
Update would amend, or existing terms used without change.
7. Defined terms to be added to the Master Glossary include the following:
All-in-Cost-to-Service Rate
A rate that includes the net direct costs to service core deposit liabilities,
including all of the following:
a. Interest paid on the deposits;

b. The expense of maintaining a branch network; minus
c. Fee income earned on the deposit accounts.
26
Alternative Funds Rate
A rate associated with the next available source of funds if core deposit
liabilities are not an available source of funds. The alternative funds source
must be cost effective and sufficient in volume and duration to replace the
core deposit liabilities as a source of funds. A blended rate may be used if
one source alone is not sufficient in volume.
Core Deposit Liabilities
Deposits without a contractual maturity that management considers to be a

stable source of funds, which excludes transient and surge balances (these
balances are further described in paragraph IG22).
Debt Instrument
A receivable or payable that represents a contractual right to receive cash

(or other consideration) or a contractual obligation to pay cash (or other
consideration) on fixed or determinable dates, whether or not there is any
stated provision for interest.
Implied Maturity
For a core deposit liability, management’s assessment of the average life by

account type. Management may make that assessment on the basis of
either an analysis of internal data or an analysis of peer information.
Writeoff
A reduction of the amortized cost of a financial asset because of its

uncollectibility.
8. Existing terms and definitions to be amended as indicated by strike

throughs (deleted text) and underlines (new text):
Amortized Cost
The sum of the initial investment less cash collected less write-downs plus
yield accrued to date.
27
A cost-based measure of a financial asset or financial liability that adjusts
the initial cash inflow or outflow (or the noncash equivalent) for factors such
as amortization or other allocations. Amortized cost is calculated as the
initial cash outflow or cash inflow (or the noncash equivalent) of a financial
asset or financial liability adjusted over time as follows:
a. Decreased by principal repayments
b. Increased or decreased by the cumulative accretion or amortization
of any original issue discount or premium and cumulative
amortization of any transaction fees or costs not recognized in net
income in the period of acquisition or incurrence
c. Increased or decreased by foreign exchange adjustments
d. Decreased by writeoffs of the principal amount.
Amortized Cost Basis
The amount at which an investment is acquired, adjusted for accretion,

amortization, collection of cash, previous other-than-temporary impairments
recognized in earnings (Less any cumulative-effect adjustments), foreign
exchange, and fair value hedge accounting adjustments.
Collateral-Dependent Loan Financial Asset
A loanfinancial asset for which the repayment is expected to be provided

solely by the underlying collateral primarily or substantially through the
operation or sale of the collateral.
Direct Loan Origination Costs
Direct loan origination costs represent costs associated with successfully

originating a loan. Direct loan origination costs of a completed loan shall
include only the following:
a. Incremental direct costs of loan origination incurred in transactions

with independent third parties for that loan
b. Certain costs directly related to specified activities performed by the
lender for that loan. Those activities include all of the following:
1. Evaluating the prospective borrower’s financial condition
2. Evaluating and recording guarantees, collateral, and other
security arrangements
3. Negotiating loan terms
4. Preparing and processing loan documents
5. Closing the transaction.
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The costs directly related to those activities shall include only that portion of
the employees’ total compensation and payroll-related fringe benefits directly
related to time spent performing those activities for that loan and other costs
related to those activities that would not have been incurred but for that loan.
See Section 310-20-55 for examples of items.
Financial Instrument
Cash, evidence of an ownership interest in an entity, or a contract that both:
a. Imposes on one entity a contractual obligation either:

1. To deliver cash or another financial instrument to a second
entity
2. To exchange other financial instruments on potentially
unfavorable terms with the second entity.
b. Conveys to that second entity a contractual right either:
1. To receive cash or another financial instrument from the first
entity
2. To exchange other financial instruments on potentially
favorable terms with the first entity.
The use of the term financial instrument in this definition is recursive

(because the term financial instrument is included in it), though it is not
circular. The definition requires a chain of contractual obligations that ends
with the delivery of cash or an ownership interest in an entity. Any number
of obligations to deliver financial instruments can be links in a chain that
qualifies a particular contract as a financial instrument.
Contractual rights and contractual obligations encompass both those that

are conditioned on the occurrence of a specified event and those that are
not. All contractual rights (contractual obligations) that are financial
instruments meet the definition of asset (liability) set forth in FASB
Concepts Statement No. 6, Elements of Financial Statements, although
some may not be recognized as assets (liabilities) in financial statements—
that is, they may be off-balance-sheet—because they fail to meet some
other criterion for recognition.
For some financial instruments, the right is held by or the obligation is due
from (or the obligation is owed to or by) a group of entities rather than a
single entity.
29
Loan Commitment
Loan commitments are legally binding commitments to extend credit to a

counterparty under certain prespecified terms and conditions. They have
fixed expiration dates and may either be fixed-rate or variable-rate. Loan
commitments can be either of the following:
a. Revolving (in which the amount of the overall line of credit is

reestablished upon repayment of previously drawn amounts)
b. Nonrevolving (in which the amount of the overall line of credit is not
reestablished upon repayment of previously drawn amounts).
Loan commitments can be distributed through syndication arrangements, in
which one entity acts as a lead and an agent on behalf of other entities that
will each extend credit to a single borrower. Loan commitments generally
permit the lender to terminate the arrangement under the terms of
covenants negotiated under the agreement. This is not an authoritative or
all-encompassing definition.
Loan Origination Fees
Origination fees consist of all of the following:
a. Fees that are being charged to the borrower as prepaid interest or

to reduce the loan’s nominal interest rate, such as interest buy-
downs (explicit yield adjustments)
b. Fees to reimburse the lender for origination activities
c. Other fees charged to the borrower that relate directly to making
the loan (for example, fees that are paid to the lender as
compensation for granting a complex loan or agreeing to lend
quickly)
d. Fees that are not conditional on a loan being granted by the lender
that receives the fee but are, in substance, implicit yield
adjustments because a loan is granted at rates or terms that would
not have otherwise been considered absent the fee (for example,
certain syndication fees addressed in paragraph 310-20-25-19)
e. Fees charged to the borrower in connection with the process of
originating, refinancing, or restructuring a loan. This term includes,
but is not limited to, points, management, arrangement, placement,
application, underwriting, and other fees pursuant to a lending or
leasing transaction and also includes syndication and participation
fees to the extent they are associated with the portion of the loan
retained by the lender.
30
Effective Interest Rate
The rate of return implicit in the loanfinancial asset or financial liability, that
is, the contractual interest rate adjusted for any net deferred loan fees or
costs, premium, or discount existing at the origination or acquisition of the
loanfinancial asset or financial liability.
9. Existing terms and definitions used without change include the following:
Embedded Derivative
Implicit or explicit terms that affect some or all of the cash flows or the value
of other exchanges required by a contract in a manner similar to a derivative
instrument.
Financial Asset
Cash, evidence of an ownership interest in an entity, or a contract that

conveys to one entity a right to do either of the following:
a. Receive cash or another financial instrument from a second entity

b. Exchange other financial instruments on potentially favorable terms
with the second entity.
Financial Liability
A contract that imposes on one entity an obligation to do either of the

following:
a. Deliver cash or another financial instrument to a second entity

b. Exchange other financial instruments on potentially unfavorable
terms with the second entity.
Hybrid Instrument
A contract that embodies both an embedded derivative and a host contract.
31
Noncontrolling interest
The portion of equity (net assets) in a subsidiary not attributable, directly or

indirectly, to a parent. A noncontrolling interest is sometimes called a
minority interest.
Nonpublic Entity
An entity that does not meet any of the following conditions:
a. Its debt or equity securities trade in a public market either on a

stock exchange (domestic or foreign) or in the over-the-counter
market, including securities quoted only locally or regionally.
b. It is a conduit bond obligor for conduit debt securities that are
traded in a public market (a domestic or foreign stock exchange or
an over-the-counter market, including local or regional markets).
c. It files with a regulatory agency in preparation for the sale of any
class of debt or equity securities in a public market.
d. It is controlled by an entity covered by the preceding criteria.
Recognition
Recognition Principle
10. Upon acquisition or incurrence, an entity shall recognize a financial
instrument in its statement of financial position as either a financial asset
or a financial liability depending on the entity’s present rights or
obligations in the instrument.
11. The proposed guidance uses the terms acquisition and incurrence in their
broadest sense to refer to the obtaining of an asset or a liability, regardless of
how it is obtained. For example, a financial institution may acquire a loan by
originating it.
Initial Measurement
Initial Measurement Principle

12. An entity shall initially measure a financial instrument as follows:
a. A financial asset or financial liability at its fair value if all
subsequent changes in the fair value of the financial asset or
financial liability will be recognized in net income.
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b. A financial asset or financial liability at the transaction price if
the qualifying portion of subsequent changes in fair value of the
financial asset or financial liability will be recognized in other
comprehensive income. See paragraphs 14–17 for a discussion
of situations in which an entity has reason to expect that the fair
value of such a financial instrument may differ significantly from
the transaction price.
c. A financial liability at the transaction price if the financial liability
will be subsequently measured at either of the following:
1. Amortized cost in accordance with paragraph 28
2. Remeasurement amount in accordance with paragraph 31.
Accounting for Fees and Costs

13. An entity shall include in net income the transaction fees and costs related
to a financial instrument to which paragraph 12(a) applies. For financial assets
that meet the criteria to recognize qualifying changes in fair value in other
comprehensive income, certain loan origination fees, net of direct loan
origination costs, as defined in Subtopic 310-20, shall be deferred. Those fees
and costs shall be recognized in net income as a yield adjustment over the life of
the related financial asset. See paragraph 78 for further discussion of the
accounting for loan origination fees, net of direct loan origination costs.
If the Transaction Price Differs Significantly from the Fair

Value
14. An entity that has reason to expect that the transaction price of a financial
instrument to which paragraph 12(b) and (c) apply may differ significantly from
the fair value shall determine whether reliable evidence indicates that such a
significant difference does, in fact, exist. If reliable evidence indicates that the
transaction price differs significantly from the fair value, and the entity determines
that the difference is at least partially due to the existence of other elements in
the transaction as discussed in paragraph 820-10-30-3(c), the financial
instrument and the other element(s) in the transaction shall be measured
separately.
15. In circumstances where the difference in the transaction price and the fair
value are due, at least in part, to the existence of other elements in the
transaction, the entity shall initially measure the financial instrument at its fair
value and shall account for any other element or elements in the transaction in
accordance with their nature, recognizing any asset or liability that qualifies as
such under U.S. GAAP. Any other amount that does not represent an asset or
liability shall be accounted for in accordance with the guidance in paragraph 17,
33
except for differences due to the circumstances described in the following
paragraph.
16. The following shall not be considered significant differences between the
transaction price and the fair value of a financial instrument for the purposes of
applying this guidance:
a. Differences between the transaction price and the fair value
attributable to transaction fees and costs, as discussed in paragraph
820-10-30-3(c)
b. Differences between the transaction price and the fair value because
the market in which the transaction occurs is different from the market
in which the reporting entity would sell the asset or transfer the
liability, as discussed in paragraph 820-10-30-3(d).
17. If the difference between the transaction price and fair value is not
attributable to either of the factors in the preceding paragraph, and an entity
cannot identify another element in the transaction or cannot determine the value
of the other element or elements in the transaction, the entire difference between
the transaction price of the financial instrument and the fair value shall be
recognized in net income in the period of acquisition or incurrence. Paragraphs
IG7–IG9 provide additional implementation guidance for considering whether
reliable evidence indicates that the transaction price of a financial instrument
differs significantly from its fair value.
Application to Not-for-Profit Entities

18. In applying paragraph 12, a not-for-profit entity within the scope of Topic
958 on not-for-profit entities shall determine whether a particular financial asset
or financial liability meets the criteria in paragraph 21. If it does, the entity shall
initially measure it at the transaction price regardless of the fact that a not-for-
profit entity does not report net income and other comprehensive income. (Also
see paragraph 27, which deals with a similar issue in applying the guidance on
subsequent measurement.)
Subsequent Measurement Principle

19. An entity shall measure a financial asset or a financial liability at its
fair value (as described in Topic 820) on each reporting date after
acquisition or incurrence unless the financial asset or financial liability
qualifies for an exception under paragraphs 28–34.
34
Recognizing Changes in the Fair Value of Financial Instruments
20. An entity shall include in net income for the current period all changes in
the fair values of its financial instruments except for specified changes in the fair
value of a debt instrument that meets the criteria in paragraph 21. For example,
an entity shall report in net income all changes in the fair values of equity
instruments held (with the exception of investments in equity securities that are
accounted for using the equity method as described in Topic 323 or that result in
consolidation of an entity). Similarly, an entity shall report in net income all
changes in the fair values of derivatives (with the exception of derivatives
designated as the hedging instrument in a cash flow hedge or a hedge of a net
investment in a foreign operation).
Recognizing a Change in Fair Value in Other Comprehensive

Income
21. An entity may recognize the qualifying portion (see paragraph 24) of a
change in fair value of a financial instrument that meets all of the following criteria
in other comprehensive income rather than in net income:
a. It is a debt instrument held or issued with all of the following
characteristics:
1. There is an amount transferred to the debtor (issuer) at inception
that will be returned to the creditor (investor) at maturity or other
settlement, which is the principal amount of the contract adjusted
by any original issue discount or premium.
2. The contractual terms of the debt instrument identify any
additional contractual cash flows to be paid to the creditor
(investor) either periodically or at the end of the instrument’s
term.
3. The debt instrument cannot contractually be prepaid or otherwise
settled in such a way that the investor would not recover
substantially all of its initial investment, other than through its own
choice.
b. The entity’s business strategy for the instrument is to collect or pay
the related contractual cash flows rather than to sell the financial
asset or settle the financial liability with a third party. The possibility
that a debt instrument may be settled with the counterparty before the
stated maturity date (that is, the instrument may be prepaid) because
of exercise of an embedded call or put option would not prevent an
entity from having a business strategy to collect or pay the
instrument’s contractual cash flows.
c. It is not a hybrid instrument for which the guidance on derivatives
and hedging in Subtopic 815-15 would otherwise have required the
embedded derivative to be accounted for separately from the host
35
contract. The entire change in the fair value of a hybrid instrument for
which those criteria would have required separate accounting for the
embedded derivative shall be recognized in net income.
22. In applying the criterion in paragraph 21(b), an entity shall evaluate its
business strategy for a financial instrument on the basis of how the entity
manages its financial instruments rather than on its intent for an individual
instrument. For this purpose, the entity’s business strategy shall be to hold
instruments for a significant portion of their contractual terms.
23. At the time an entity initially recognizes a financial instrument that meets
the criteria in paragraph 21, it shall decide whether to recognize qualifying
subsequent changes in the financial instrument’s fair value in net income or in
other comprehensive income. The entity shall not subsequently change its
decision made at initial recognition.
Change in Fair Value That Qualifies for Recognition in Other

Comprehensive Income
24. An entity shall recognize in other comprehensive income in accordance
with paragraphs 21–23 only the following portion of the total change in fair value
during the reporting period of a debt instrument:
a. Total change in fair value during the reporting period
b. Minus current-period interest income or expense, including amortization
or accretion of both of the following:
1. Premium or discount upon acquisition
2. Certain deferred loan origination fees and costs as described in
paragraph 13.
c. Plus or minus current-period amount of credit impairment for financial
assets
d. Plus or minus the change in fair value attributable to the hedged risk if
the financial instrument is designated as the hedged item in a qualifying
fair value hedging relationship.
An entity shall recognize items (b), (c), and (d) in paragraph 24 in net income.
For changes in fair value that have been recognized in other comprehensive
income, an entity shall recognize in net income any realized gains or losses from
sales and settlements for the reporting period.
Application to Loan Commitments and Financial Standby

Letters of Credit
25. An entity that makes a loan commitment or issues a financial standby letter
of credit (the potential creditor) shall classify the loan commitment or standby
letter of credit in the same way that it will classify the underlying loan. For
36
example, the creditor shall report all changes in the fair value of a loan
commitment in net income if and only if it will report all changes in the fair value
of the underlying loan in net income.
Application to Specialized Industries

26. The proposed guidance in paragraphs 12–17 and 19–25 would apply to a
broker and dealer in securities and an investment company as follows:
a. A broker and dealer in securities that is subject to the guidance in

Topic 940 shall measure all of its financial assets at fair value and
include all changes in their fair value in net income in accordance with
that Topic. The option to report changes in the fair value of a
qualifying financial asset in other comprehensive income is not
available to a broker and dealer in securities. A broker and dealer in
securities shall apply the proposed guidance to all of its financial
liabilities.
b. An investment company that is subject to the guidance in Topic 946
shall measure both its financial assets and its financial liabilities at fair
value and include all changes in their fair value in the net increase
(decrease) in net assets for the period. Neither the option to report
changes in the fair value of a qualifying financial asset or financial
liability in other comprehensive income nor the amortized cost option
for qualifying financial liabilities is available to an investment
company.
Application to Not-for-Profit Entities

27. The proposed guidance in paragraphs 19–25, as well as related
presentation guidance in paragraphs 84–86 and 90–94, is structured in terms of
whether all changes in the fair value of a financial instrument are recognized in
net income or whether qualifying changes in the fair value of a financial
instrument are recognized both in net income and other comprehensive income.
A not-for-profit entity within the scope of Topic 958 does not report net income or
other comprehensive income, but a not-for-profit entity within the scope of Topic
954 on health care entities may report a performance indicator that is
comparable to net income. An entity within the scope of Topic 954 that reports a
performance indicator shall report amounts that a business entity would report in
net income within the performance indicator and amounts that a business entity
would report in other comprehensive income outside the performance indicator.
An entity within the scope of Topic 954 that does not report a performance
indicator shall report the total change in the fair value of a financial instrument as
a change in the appropriate net asset class in its statement of activities.
37
Exceptions to the Subsequent Measurement Principle
Qualifying Financial Liabilities

28. An entity may subsequently measure at amortized cost a financial liability
that meets both of the following criteria:
a. The liability meets the criteria in paragraph 21 to have the qualifying

portion of the changes in its fair value recognized in other
comprehensive income.
b. Measuring the liability at fair value would create or exacerbate a
measurement attribute mismatch of recognized assets and liabilities.
29. An entity shall decide whether to measure at amortized cost a liability that
meets those criteria when it issues or otherwise incurs the liability and shall not
subsequently change that decision.
30. Measurement of a financial liability at fair value would be deemed to create
or exacerbate a measurement attribute mismatch only if at least one of the
following criteria apply:
a. The financial liability is contractually linked to an asset not measured

at fair value. A financial liability that is collateralized by an asset, or
that is contractually required to be settled upon the derecognition of
an asset is contractually linked to that respective asset.
b. The financial liability is issued by and recorded in, or evaluated by the
chief operating decision-maker as part of an operating segment for
which less than 50 percent of the segment’s recognized assets are
subsequently measured at fair value.
c. The financial liability meets neither item (a) nor (b) but is the liability of
a consolidated entity for which less than 50 percent of consolidated
recognized assets are subsequently measured at fair value.
In applying the quantitative tests in this paragraph, recognized assets are the
assets recognized in accordance with U.S. GAAP as of the end of the
immediately preceding reporting period (less assets that are contractually linked
to a financial liability), plus any assets acquired by issuing the financial liability.
Cash (exclusive of cash equivalents) is not considered to be measured at fair
value for purposes of applying the quantitative tests in paragraphs 30(b) and
30(c).
Demand Deposit Liabilities

31. An entity shall measure its core deposit liabilities at the present value of
the average core deposit amount during the period discounted at the difference
38
between the alternative funds rate and the all-in-cost-to-service rate over the
implied maturity of the deposits (the core deposit liabilities remeasurement
approach). An entity shall determine that remeasurement amount separately for
each major type of demand deposit, such as noninterest-bearing checking,
savings, and money market accounts. Paragraphs IG20–IG24 provide additional
guidance on applying the remeasurement approach required for core deposit
liabilities.
32. A deposit liability that is not a core deposit liability shall be measured at its
fair value. The maturity of some deposit liabilities that are not core deposit
liabilities may be so short, however, that their face amount reasonably
approximates their fair value.
Short-Term Receivables and Payables

33. An entity may measure its receivables and payables arising in the normal
course of business that are due in customary terms not exceeding one year and
that also meet the criteria in paragraph 21 at their amortized cost (plus or minus
any fair value hedging adjustments). However, the exception for short-term
receivables and payables is not applicable to short-term lending arrangements,
such as credit card receivables, or investments in short-term debt securities.
Investments That Can Be Redeemed Only for a Specified

Amount
34. Particular types of investments are not held for capital appreciation and can
be redeemed with the issuer only for a specified amount. An entity shall
subsequently measure an investment that has all of the following characteristics
at its redemption value:
a. It has no readily determinable fair value because ownership is restricted

and it lacks a market.
b. It cannot be redeemed for an amount greater than the entity’s initial
investment.
c. It is not held for capital appreciation but rather to obtain other benefits,
such as access to liquidity or assistance with operations.
d. It must be held for the holder to engage in transactions or participate in
activities with the issuing entity.
One example of such an investment is the stock in the Federal Home Loan Bank
System that a financial institution must hold to qualify to borrow from a Federal
Home Loan Bank. Another example is stock in the Federal Reserve Banks that a
financial institution must hold as a condition of membership in the system. Other
examples may include investments in certain agricultural cooperatives.
39
Deferred Tax Assets
35. An entity shall evaluate the need for a valuation allowance on a deferred
tax asset related to a financial instrument for which qualifying changes in fair
value are recognized in other comprehensive income in combination with the
entity’s other deferred tax assets. (See Topic 740 for guidance on accounting for
income taxes.)
Credit Impairment of Financial Assets
Objective
36. The objective of the guidance related to credit impairment is to establish a
model for recognition and measurement of credit impairment of financial assets
comprehensive income on the basis of an entity’s expectations about the
collectibility of cash flows, including the determination of cash flows not expected
to be collected. An entity’s expectations about collectibility of cash flows shall
include all available information relating to past events and existing conditions
but shall not consider potential future events beyond the reporting date.
Applicability of Guidance
37. The guidance related to impairment applies to all of the following financial
assets that are subject to losses related to credit risk:
a. Financial assets measured at fair value with qualifying changes in fair

value recognized in other comprehensive income. Financial assets
shall meet the criteria discussed in paragraph 21 to be eligible to have
qualifying changes in fair value recognized in other comprehensive
income.
b. Short-term receivables measured at their amortized cost (plus or
minus any fair value hedging adjustments) as discussed in paragraph
33.
c. Financial assets that can be redeemed for a specified amount that are
measured at their redemption value as discussed in paragraph 34.
Evaluating Financial Assets for Credit Impairment

38. An entity shall recognize a credit impairment in net income for a
financial asset (or group of financial assets) when it does not expect to
collect all contractual amounts due for originated financial asset(s) and all
amounts originally expected to be collected upon acquisition for
purchased financial asset(s).
40
39. An entity shall assess at the financial reporting date the amount of cash
flows expected to be collected for its financial assets as compared with the
contractual amounts due for originated financial asset(s) and all amounts
originally expected to be collected upon acquisition of purchased financial
asset(s). An entity shall not wait until a credit loss is probable to recognize a
credit impairment.
40. For originated financial assets, the phrase all contractual amounts due
refers to both the contractual interest payments and the contractual principal
payments. An entity shall not automatically conclude that a financial asset is not
impaired because all of the contractual amounts due or all amounts originally
expected to be collected have been received to date.
41. An entity shall consider both the timing and amount of the cash flows
expected to be collected. If an entity’s expectation of the amount of cash flows
expected to be collected decreases, a financial asset shall be considered to be
impaired. If an entity expects that it will not collect amounts due on a financial
asset on the payment dates specified by contractual terms or when cash flows
were originally expected to be collected, but the entity expects to recover any
shortfall through the existence of sufficient collateral, the financial asset shall not
be considered to be impaired. If cash flows expected to be collected are delayed,
the change in timing is an adverse change in cash flows expected to be
collected. If the entity expects to not receive interest on the delayed cash flows
(that is, interest on both delayed principal and delayed interest cash flows), the
financial asset shall be considered to be impaired. However, a financial asset is
not impaired during a period of delay in payment if the entity expects to collect all
amounts due, including interest accrued for the period of the delay. An entity
need not consider an insignificant delay or insignificant shortfall in the amount of
payments as meeting the criteria in paragraph 38.
42. In determining whether a credit impairment exists, an entity shall consider
all available information relating to past events and existing conditions and their
implications for the collectibility of the cash flows attributable to the financial
asset(s) at the date of the financial statements. These conditions encompass
both economic conditions and factors specific to the borrower or issuer of a
financial asset that exist at the date of the financial statements. An entity shall
incorporate into the impairment assessment the effect of those known conditions
and factors in developing estimates of cash flows expected to be collected for
financial asset(s) over the remaining life of the asset(s). In estimating cash flows
expected to be collected for its financial assets at each reporting date, an entity
shall assume that the economic conditions existing at that point in time would
remain unchanged for the remaining life of the financial assets. An entity shall not
forecast future events or economic conditions that did not exist at the reporting
date in determining whether a credit impairment exists.
43. An entity shall consider all relevant information, circumstances, and
conditions in developing an expectation about the collectibility for financial
41
assets. Numerous factors shall be considered when evaluating whether a credit
impairment exists. The information to be considered by an entity includes all of
the following:
a. The financial condition of the borrower or the issuer of a financial

asset
b. Expectations (based on past events and existing conditions) about
potential default by the borrower or issuer of a financial asset
c. Failure of the borrower or issuer of a financial asset to make
scheduled interest or principal payments
d. Any changes by a rating agency to the credit rating of the borrower or
the issuer of a debt security
e. The level of delinquencies, bankruptcies, charge-offs, and recoveries
and changes in those levels compared with previous experience
f. The remaining payment terms of the financial asset and any changes
to the remaining payment terms (that is, modifications related to credit
such as those made in troubled debt restructurings)
g. The fair value of any underlying collateral if the financial asset is
collateralized
h. Current environmental factors, such as industry, geographical,
economic, and political data such as the following:
1. The existing business climate in a particular industry to which the
entity has exposure
2. Global, national, regional, or local economic conditions and
changes in such conditions compared with previous experience.
i. Effects of credit concentrations
j. The payment structure of the financial asset (for example,
nontraditional loan terms, such as terms that permit negative
amortization, a high loan-to-value ratio, or an initial interest rate that is
below the market interest rate for the initial period of the loan term
that may increase significantly when that period ends) and the
likelihood of the borrower or issuer of a financial asset being able to
satisfy the payment terms.
44. In assessing the factors in the preceding paragraph, the entity shall
consider available published data to the extent the data are relevant to the
collectibility of the financial asset. For example, the entity shall consider both of
the following:
a. Industry analyst and regulatory reports

b. Sector credit ratings.
45. Specific changes in circumstances may cause an entity to have an
expectation about credit impairment of financial assets that differs from its
expectation in the previous reporting period. For example, this may be in
response to the occurrence of an event or changes in specific conditions, such
42
as those described in paragraph 43. If an entity has previously recognized a
credit impairment in net income, but in a later period obtains information about
the collectibility of cash flows of financial assets that indicates that there is an
improvement in the amount and/or the timing of expected cash flows, the entity
shall recognize a reversal of credit impairment expense in net income, except as
indicated in paragraph 79.
46. Changes in cash flows expected to be collected that relate to any of the
following factors shall not in and of themselves give rise to a credit impairment:
a. For foreign-currency-denominated financial assets, changes in foreign
exchange rates used to remeasure financial assets under the guidance
in Subtopic 830-20
b. For financial assets that are contractually prepayable, changes in
expected prepayments
c. For financial assets with contractual interest rates that vary on the basis
of subsequent changes in an index or rate (such as the prime rate, the
London Interbank Offered Rate [LIBOR], or the U.S. Treasury bill’s
weekly average), changes in those variable indexes or rates.
47. As discussed in paragraph 92, for a foreign-currency-denominated financial
instrument that meets the criteria to have qualifying changes in fair value
recognized in other comprehensive income, the component of the overall change
in fair value of a financial instrument that relates to changes in currency
exchange rates shall be reported in other comprehensive income together with
other changes in fair value of a financial instrument. Therefore, an entity shall not
recognize as a credit impairment the decline in cash flows expected to be
collected due to changes in foreign exchange rates.
48. Changes in anticipated prepayments or actual prepayments on
contractually prepayable instruments affect cash flows expected to be collected.
However, those changes in cash flows expected to be collected shall not in and
of themselves give rise to a credit impairment because they are generally not
related to credit. As discussed in Subtopic 310-20, in certain circumstances, an
entity is permitted to consider the effect of anticipated prepayments in
determining the effective interest rate for a financial asset.
49. For financial assets with contractual interest rates that vary on the basis of
subsequent changes in an index or rate (such as the prime rate, LIBOR, or the
U.S. Treasury bill’s weekly average), estimates of cash flows expected to be
collected in future periods shall be recalculated at each reporting date on the
basis of the index or rate as it changes over the life of the financial asset. An
entity shall not project changes in the index or rate for purposes of estimating
cash flows expected to be collected.
50. In some circumstances it may be difficult to isolate the effect of a change in
one specific component from the overall change in cash flows. When changes in
expected cash flows due to variable rates or prepayments cannot be separated
43
from the overall decline in expected cash flows, an entity shall account for the
entire decline in cash flows expected to be collected as a credit impairment.
Measurement of Credit Impairment

51. An entity shall recognize in net income at the end of each financial
reporting period the amount of credit impairment related to all contractual
amounts due for originated financial asset(s) that the entity does not
expect to collect and all amounts originally expected to be collected for
purchased financial asset(s) that the entity does not expect to collect.
52. An entity shall assess its financial assets for credit impairment and shall
measure the amount of credit impairment at the end of each financial reporting
period. Measuring credit impairment requires judgment and estimates, and the
eventual outcomes may differ from those estimates.
53. An entity shall recognize any unfavorable change in cash flows expected to
be collected as a credit impairment during the reporting period in net income and
shall establish or increase the allowance for credit losses related to the financial
asset (presented as a contra-asset account) by an equal amount. In addition, if
the entity expects a favorable change in cash flows expected to be collected as
compared with its expectations in a previous reporting period, as discussed in
paragraph 45, an entity shall recognize a reversal of previously recognized credit
impairment expense and a corresponding decrease in the allowance for credit
losses (except as discussed in paragraph 79).
54. As discussed in paragraph 41, changes in expectations about both the
amount and timing of cash flows expected to be collected shall be considered in
assessing financial assets for impairment and measuring the amount of credit
impairment (or reversal of previously recognized credit impairment expense).
55. The total amount of credit impairment to be recognized in net income in
each financial reporting period is the sum of amounts measured for financial
assets that are evaluated for credit impairment on a collective pool basis and the
amounts measured for financial assets that are evaluated and considered
impaired on an individual basis.
Financial assets evaluated on a collective (pool) basis
56. Financial assets for which impairment is evaluated and measured

collectively are those groups of financial assets that, based on their shared
characteristics, may have some credit impairment even though that credit
impairment cannot be identified with a specific financial asset. If a credit
impairment exists, it shall be recognized in net income even though the particular
financial assets for which cash flows are uncollectible may not be separately
identifiable.
44
57. For the purpose of assessing and measuring impairment of pools of
financial assets, an entity shall aggregate financial assets on the basis of similar
risk characteristics. For example, similar risk characteristics include the following:
a. Internal or external (third-party) credit score or ratings

b. Risk ratings or classification
c. Financial asset type
d. Collateral type
e. Size
f. Interest rate
g. Term
h. Geographic location
i. Industry of the borrower.
58. In determining the amount of impairment to be recognized for a pool of
financial assets with similar risk characteristics, an entity shall consider historical
loss experience for financial assets that have those characteristics. The entity
shall develop historical loss rates, which shall be adjusted for all information
relevant to the collectibility of the financial assets, including the effect of past
events and existing economic factors and conditions. In determining the
adjustment of historical loss rates on the basis of past events and existing
conditions, the entity shall consider the factors discussed in paragraphs 43 and
44. In the case of an entity that has no experience of its own, reference to peer
group data may be appropriate if the attributes of the financial assets that
compose the peer group loss experience data are similar to the financial assets
held by the entity.
59. An appropriate historical loss rate (adjusted for existing economic factors
and conditions) shall be determined for each individual pool of similar financial
assets. Historical loss rates shall reflect cash flows that the entity does not
expect to collect over the life of the financial assets in the pool. An entity shall
select a historical time period appropriate for the specific financial assets in the
pool to determine a historical loss rate. This proposed guidance does not specify
a particular methodology to be applied by an entity for determining historical loss
rates. That methodology may vary depending on the size of the entity, the range
of the entity’s activities, the nature of the entity’s pools of financial assets, and
other factors.
60. The amount of credit impairment recognized for a particular pool of financial
assets shall be based on a historical loss rate for that pool adjusted for existing
economic factors and conditions. In each reporting period, the amount of credit
impairment (or the reversal of a credit impairment recognized in a previous
period) that shall be recognized in net income for a pool of financial assets is the
difference between the allowance for credit losses for the pool determined by
applying the historical loss rate adjusted for existing economic factors and
conditions to the current principal balance of the pool at the reporting date and
45
the existing balance of the allowance for credit losses attributable to the pool of
financial assets.
Financial assets evaluated individually
61. An entity may identify financial assets to be individually evaluated for credit
impairment. However, the proposed guidance does not provide a specific
requirement for how an entity should identify financial assets that are to be
evaluated individually for collectibility.
62. When an entity identifies an individually evaluated financial asset as
impaired, the entity shall measure the amount of credit impairment on the basis
of a present value technique, unless it elects the practical expedient for certain
loans described in paragraphs 71–74. In estimating the present value of cash
flows expected to be collected, an entity shall consider past events and existing
economic conditions, which may include historical statistics related to financial
assets with similar characteristics. The historical statistics shall reflect the nature
of the financial assets for which credit impairment is being measured and shall be
adjusted if existing economic factors and conditions differ from those on which
the statistics were based. If the present value of cash flows expected to be
collected is less than the amortized cost of the financial asset, an entity shall
recognize a credit impairment in net income and establish an allowance for credit
losses. The entity shall calculate the present value of cash flows expected to be
collected for the impaired financial asset discounted at the asset’s effective
interest rate.
63. Some financial assets that are identified for evaluation and are individually
considered impaired have risk characteristics that are unique to an individual
borrower or issuer, and an entity shall assess those financial assets and apply
the measurement methods on an asset-by-asset basis. Other financial assets
that are identified for evaluation and are individually considered impaired and
share similar risk characteristics (as described in paragraph 57) with other
impaired financial assets. An entity may aggregate those financial assets that
have similar risk characteristics for the purposes of measuring impairment and
shall use a present value technique as a means of measuring the amount of
credit impairment.
64. After the initial recognition of impairment in net income, an impairment (or
reversal of credit impairment expense) shall be measured and recognized in net
income on the basis of changes in the present value of cash flows expected to be
collected.
65. For a financial asset evaluated for impairment on an individual basis, where
there are no past events or existing conditions indicating that the financial asset
is impaired, an entity shall not automatically conclude that no credit impairment
exists. The entity shall determine whether assessing the financial asset together
with other financial assets that have similar characteristics indicates that a credit
46
impairment exists. If the entity determines that a credit impairment exists in that
circumstance, the entity shall recognize a credit impairment in net income. The
amount of the credit impairment shall be measured by applying to that financial
asset the historical loss rate (adjusted for existing economic factors and
conditions) applicable to the group of similar financial assets referenced by the
entity in its assessment.
Determination of the effective interest rate
66. For originated financial assets and financial assets purchased at an amount
that does not include a discount related to credit quality, the effective interest rate
is the rate that equates the contractual cash flows (adjusted for any net deferred
loan fees or costs, premium, or discount existing at the origination or acquisition
of the loan as required by the guidance on nonrefundable fees and other costs in
Subtopic 310-20) with the initial cash outflow. For financial assets acquired at an
amount that includes a discount related to credit quality, the effective interest rate
is the rate that equates the entity’s estimate of cash flows expected to be
collected with the purchase price of the financial asset. In measuring the amount
of credit impairment for fixed-rate financial assets, generally, an entity shall
discount the cash flows expected to be collected at the financial asset’s original
effective interest rate.
67. In measuring the amount of credit impairment for a financial asset with a
contractual interest rate that varies on the basis of subsequent changes in an
interest rate or index of interest rate (for example, the prime rate, LIBOR, or the
U.S. Treasury bill’s weekly average), an entity shall discount the cash flows
expected to be collected using the effective interest rate calculated on the basis
of the appropriate interest rate or index as it changes over the life of the asset.
For those financial assets, the effective interest rate is based on the contractual
cash flows over the life of the asset. Past cash flow amounts shall be based on
the historical rate or index in effect at each contractual payment date. Estimates
of cash flows expected to be collected in future periods shall be recalculated at
each reporting date on the basis of the index or rate as it changes over the life of
the financial asset. An entity shall not project changes in the index or rate for
purposes of determining the effective interest rate.
68. An entity shall discount the cash flows expected to be collected for
purchased financial assets at the effective interest rate implicit in the financial
asset at the date of acquisition. However, if the effective interest rate is adjusted
as a result of the circumstance described in paragraph 79, such that the entity
recalculates the effective interest rate for the financial asset on the basis of
revised cash flows expected to be collected, the entity shall discount the
expected cash flows at the revised effective interest rate on a prospective basis.
47
Loans that are modified or restructured in a troubled debt
restructuring
69. Subtopic 310-40 provides guidance on troubled debt restructurings. A loan

that is modified or restructured in a troubled debt restructuring is an impaired
loan. If a loan that was modified or restructured was previously included in a pool
of assets evaluated for impairment on a collective pool basis as described in
paragraphs 56–60, the loan shall be removed from the pool of financial assets
and the guidance in paragraphs 62–65 shall be applied to the individual loan
when it is modified or restructured.
70. For a loan that has been modified or restructured in a troubled debt
restructuring, the contractual terms of the loan agreement refers to the
contractual terms specified by the original loan agreement, not the contractual
terms specified by the restructuring agreement. The effective interest rate for a
loan restructured in a troubled debt restructuring is based on the original
contractual rate, not the rate specified in the restructuring agreement. A troubled
debt restructuring does not result in a new loan but rather represents part of an
entity’s ongoing effort to recover its investment in the original loan. Therefore, the
interest rate used to discount cash flows expected to be collected on a
restructured loan shall be the same interest rate used to discount cash flows
expected to be collected on an impaired loan.
Practical expedient for measurement of impairment
71. As a practical expedient, an entity may measure credit impairment for an

individually impaired financial asset on the basis of the fair value of the collateral
if the financial asset is a collateral-dependent financial asset. If an entity uses
the fair value of the collateral to measure impairment of a collateral-dependent
financial asset and repayment or satisfaction of the asset depends on the sale of
the collateral, the fair value of the collateral shall be adjusted to consider
estimated costs to sell (on a discounted basis). However, if repayment or
satisfaction of the financial asset depends only on the operation, rather than the
sale, of the collateral, the measure of impairment shall not incorporate estimated
costs to sell the collateral. Additionally, a creditor shall measure impairment on
the basis of the fair value of the collateral if the creditor determines that
foreclosure is expected to occur.
72. If the fair value of the collateral is less than the amortized cost of the
financial asset, an entity shall recognize a credit impairment in net income and
establish an allowance for credit losses. After the initial recognition of impairment
in net income, subsequent measurement of impairment (or reversal of previously
recognized impairment expense) shall be recognized in net income on the basis
of changes in the fair value of the collateral.
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73. Use of the practical expedient described in the preceding paragraph results
in no credit impairment for the individual financial asset if the fair value of the
collateral is greater than the amortized cost of the asset (that is, the measure of
impairment is zero). In that case, the entity shall recognize no additional credit
impairment in net income for that financial asset. That is, the entity shall not
include that financial asset in a pool of financial assets for which credit
impairment is measured on a collective pool basis.
74. The measurement method selected for an individual impaired financial
asset shall be applied consistently to that financial asset.
Measuring Interest Income on Debt Instruments Held
Applicability of Guidance
75. The guidance for recognition of interest income applies to all interest-
earning debt instruments (hereinafter referred to as financial assets for purposes
of paragraphs 76–82) that are measured at fair value with qualifying changes in
fair value recognized in other comprehensive income. Financial assets shall meet
the criteria discussed in paragraph 21 to be eligible for that classification.
Interest Income Recognition

76. An entity shall include in net income an amount of interest income related
to financial assets measured at fair value with qualifying changes in fair value
recognized in other comprehensive income. The amount of interest income to be
recognized in net income for these financial assets shall be determined by
applying the financial asset’s effective interest rate to the amortized cost balance
net of any allowance for credit losses. The effective interest rate for originated or
purchased financial assets (both fixed-rate and variable-rate financial assets)
shall be determined as discussed in paragraph 66–68.
77. As discussed in paragraph 66, for financial assets that meet the criteria to
recognize qualifying changes in fair value in other comprehensive income, the
amount recognized in net income as interest income for the period shall include
amortization or accretion of premium or discount upon acquisition. For purchased
financial assets, the purchase discount shall be recognized in net income over
the remaining contractual life of the financial asset or the estimated life of the
financial asset only for situations in which prepayments can be reliably estimated.
78. In addition, as discussed in paragraph 13, interest income determined on
the basis of the financial asset’s effective interest rate shall include the effects of
amortizing certain loan origination fees, net of direct loan origination costs. The
initial measurement of financial assets that meet the criteria to recognize
qualifying changes in fair value in other comprehensive income is based on the
transaction price, which includes amounts that qualify as loan origination fees
49
and direct loan origination costs as defined in Subtopic 310-20. By recognizing
the change in fair value of such financial assets, those loan origination fees and
direct loan origination costs are initially deferred in other comprehensive income
and recognized in net income as a yield adjustment over of the life of the related
financial asset.
79. For a financial asset acquired at an amount that includes a discount related
to credit quality, an assessment of current information based on past events and
existing conditions may indicate an improvement in cash flows expected to be
collected from the cash flows previously expected to be collected. If an allowance
for credit losses had been established previously for that financial asset (after
purchase of the financial asset), an increase in cash flows expected to be
collected shall be recognized in net income as a reversal of credit impairment
expense to the extent of the previously recognized allowance. If no allowance for
credit losses had been established for that financial asset since acquisition, or if
the amount of the increase in cash flow expected to be collected exceeds the
allowance for credit losses, an entity shall recalculate the effective interest rate
for the financial asset on the basis of the revised (increased) cash flows expected
to be collected. If, subsequently, the entity expects a decrease in cash flows
expected to be collected from the cash flows previously expected to be collected,
an entity shall recalculate the effective interest rate for the financial asset on the
basis of the revised (decreased) cash flows expected to be collected but shall not
revise the rate below the original effective interest rate. If the revised estimate of
cash flows expected to be collected is less than the original estimate of cash
flows expected to be collected, after reversing the adjustment of the effective
interest rate, the entity shall recognize any additional decrease in cash flows
expected to be collected as a credit impairment.
80. The method of recognizing interest income on the basis of a financial
asset’s amortized cost balance net of any allowance for credit losses results in a
difference between the amount of interest contractually due (or, for purchased
financial assets acquired at an amount that includes a discount related to credit
quality, interest cash flows originally expected to be collected) and the amount of
interest income accrued for the financial asset. The difference between the
amount of the accrued interest receivable based on the amount of interest
contractually due and the amount of interest income accrued shall be recognized
as an increase in the allowance for credit losses.
81. If, as a result of applying the requirement in paragraph 80, the allowance
for credit losses exceeds an entity’s estimate of cash flows not expected to be
collected related to its financial assets at the reporting date, the entity shall adjust
the allowance for credit losses and shall recognize the adjustment in net income
as a reversal of credit impairment expense. An entity shall not classify the
adjustment as interest income.
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Financial assets for which no accrual of interest shall be made
82. An entity shall cease accruing interest income on a financial asset only if
the entity’s expectations about cash flows expected to be collected indicate that
the overall yield on the financial asset will be negative. In this situation, an entity
shall use the cost recovery method. For example, if the total cash flows expected
to be collected that relate to a financial asset are less than the original principal
amount, no amount of interest income shall be recognized in net income once it
is determined that the overall yield will be negative. However, any previously
recognized interest income shall not be reversed. In all scenarios other than the
one discussed in this paragraph, an entity shall account for decreases in cash
flows expected to be collected as a credit impairment and shall not cease
accruing interest income.
Writeoffs of Financial Assets

83. An entity shall write off a financial asset or part of a financial asset in the
period in which the entity has no reasonable expectation of recovery of the
financial asset (or part of the financial asset). The allowance for credit losses
shall be reduced by the amount of the financial asset balance written off.
Recovery of a financial asset (or a part of a financial asset) previously written off
shall be recognized when cash is received. In this context, a recovery means that
an entity has received cash receipts in satisfaction of contractually required
interest or principal payments following a writeoff of the financial asset. Such
recoveries shall be recognized in net income.
Other Presentation Matters
Statement of Financial Position

84. An entity shall display financial assets and financial liabilities separately on
the face of the statement of financial position depending on whether all changes
in their fair value are recognized in net income or whether qualifying changes in
their fair value are recognized in other comprehensive income.
Financial Instruments for Which All Changes in Fair Value

Are Recognized in Net Income
85. An entity shall present on the face of the statement of financial position only
the following amounts for financial instruments for which all changes in fair value
are recognized in net income:
a. The fair value of the instrument
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b. The amortized cost of the entity’s own outstanding debt instruments.
Financial Instruments for Which Qualifying Changes in Fair

Value Are Recognized in Other Comprehensive Income
86. For financial assets and financial liabilities for which qualifying changes in
fair value are recognized in other comprehensive income, an entity shall, at a
minimum, present separately on the face of the statement of financial position all
of the following:
a. Amortized cost
b. Allowance for credit losses on financial assets
c. Accumulated amount needed to reconcile amortized cost less
allowance for credit losses to fair value
d. Fair value.

87. An entity shall present separately on the face of the statement of financial
position all of the following for its core deposit liabilities:
a. The amortized cost of the deposits (amount due on demand)

b. The amount needed to adjust amortized cost to the amount in item (c)
c. The amount of the deposits determined using the core deposit
liabilities remeasurement approach.
Accumulated Other Comprehensive Income

88. An entity shall present separately on the face of the statement of financial
position amounts included in accumulated other comprehensive income (and
allocated to noncontrolling interests, if applicable) related to the qualifying
changes in fair value or qualifying changes in the remeasurement amount for
financial instruments for which those changes are recognized in other
Statement of Comprehensive Income

89. The guidance in the proposed Accounting Standards Update,
Comprehensive Income (Topic 220): Statement of Comprehensive Income
(proposed Update on comprehensive income), would require an entity to present
a continuous statement of comprehensive income.
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Financial Instruments for Which All Changes in Fair Value
Are Recognized in Net Income
90. At a minimum, an entity shall separately present within net income on the
face of the statement of comprehensive income one aggregate amount for
realized and unrealized gains or losses on financial instruments for which all
changes in fair value are recognized in net income.

91. At a minimum, an entity shall present separately within net income on the
face of the statement of comprehensive income all of the following items for
financial assets and financial liabilities for which qualifying changes in fair value
are recognized in other comprehensive income:
a. Current-period interest income and expense, including amortization

(accretion) of premium (discount) recognized upon acquisition
b. Credit impairment for the current period on financial assets
c. Realized gains or losses (by means of an offsetting entry to other
comprehensive income if prior periods’ unrealized gains or losses on
the instruments were recognized in other comprehensive income).
92. The total change during a period in the fair value of a financial instrument
denominated in a foreign currency may be made up of both of the following
components:
a. A change in the price of the instrument in the currency in which it is
denominated
b. A change in the exchange rate between the currency of denomination
and the functional currency, which the guidance on foreign currency
matters in Topic 830 refers to as a transaction gain or loss.
An entity shall not separate the total change in the fair value of a foreign-
currency-denominated financial instrument for which qualifying changes in fair
value are recognized in other comprehensive income into the components in (a)
and (b) above. As a consequence, the entity shall not present separately a
transaction gain or loss in net income as otherwise would be required by Topic
830.
Financial Liabilities Measured at Amortized Cost

93. An entity that subsequently measures qualifying financial liabilities at
amortized cost in accordance with paragraphs 28–30 shall present separately
within net income both of the following:
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a. Current-period interest expense, including amortization (accretion) of
premium (discount) recognized upon acquisition
b. Realized gains or losses on settlement of the liabilities.
Changes in an Entity’s Own Credit Standing

94. An entity shall present separately on the face of the statement of
comprehensive income the amount of significant changes in the fair value of its
financial liabilities arising from changes in the entity’s own credit standing during
the period, excluding changes related to changes in the price of credit. Significant
changes in fair value arising from changes in the entity’s credit standing,
excluding changes in the price of credit, shall be presented separately for
financial liabilities for which all changes in fair value are recognized in net income
and for financial liabilities for which qualifying changes in fair value are
recognized in other comprehensive income.

95. An entity may present changes in the remeasured amount of its core
deposit liabilities in other comprehensive income if the deposits meet the criteria
in paragraph 21. An entity that chooses instead to present those changes in its
core deposit liabilities in net income shall present separately, at a minimum, on
the face of the statement of comprehensive income, an aggregate amount for
realized and unrealized gains or losses on the core deposit liabilities.
96. An entity that presents changes in the remeasured amount of its core
deposit liabilities in other comprehensive income shall present current-period
interest expense separately within net income on the face of the statement of
Disclosures
97. An entity shall disclose all the information in paragraphs 98–109 for each
interim and annual reporting period by class of financial instrument. In identifying
classes of financial assets and liabilities, the entity shall determine the
appropriate level of disaggregation on the basis of the nature, characteristics, or
risks of the financial instruments.
Financial Liabilities Measured at Fair Value

98. For financial liabilities with significant changes in the fair value arising from
changes in the entity’s own credit standing (excluding changes related to
changes in the price of credit), an entity shall disclose both of the following:
54
a. Qualitative information about the reasons for changes in fair value
attributable to changes in the entity’s credit standing, excluding
changes related to changes in the price of credit
b. How the gains and losses attributable to changes in the entity’s credit
standing, excluding changes related to changes in the price of credit,
were determined.

99. For financial assets for which qualifying changes in fair value are
recognized in other comprehensive income, an entity shall disclose information
about the contractual maturities of those instruments as of the date of the most
recent statement of financial position. Maturity information may be combined in
appropriate groupings on the basis of time to maturity. Instruments not due at a
single maturity date, such as mortgage-backed securities, may be disclosed
separately rather than allocated over several maturity groupings. If allocated, the
basis for allocation also shall be disclosed.
100. For financial assets and financial liabilities for which qualifying changes in
fair value are recognized in other comprehensive income that an entity sells or
settles before their contractual maturity, an entity shall disclose all of the
following by class:
a. The proceeds from sales of the financial assets, or cash paid to settle
the financial liabilities, and the gross realized gains and gross realized
losses that have been recognized in net income as a result of those
sales or settlements
b. The basis on which the cost of the instrument was determined (that is,
specific identification, average cost, or other method used)
c. Qualitative information about the reasons for the sale or settlement of
the financial instruments.
101. For purchased financial assets for which qualifying changes in fair value
are recognized in other comprehensive income, an entity shall disclose all of the
following:
a. The principal amount of the financial assets

b. The purchaser’s assessment of the discount related to credit losses
inherent in the financial assets at acquisition, if any, and qualitative
information on how the purchaser determined the discount related to
credit losses
c. Any additional difference between amortized cost and the principal
amount
d. The amortized cost basis of the financial assets.
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102. For interest-earning financial assets measured at fair value with qualifying
changes in fair value recognized in other comprehensive income, an entity shall
disclose both of the following:
a. The method used for calculating interest income on a pool of financial

assets that are collectively assessed for impairment
b. If interest income is calculated on a pool basis, the amortized cost
basis, allowance for credit losses, and weighted-average interest rate
of each pool.
103. An entity shall disclose the amortized cost and fair value of financial assets
for which no accrual of interest is made because the entity’s expectations about
cash flows expected to be collected indicate that the overall yield on the financial
asset will be negative.
Allowance for Credit Losses

104. For financial assets with an allowance for credit losses, an entity shall
disclose both of the following:
a. The activity in the allowance for credit losses by class and in the
aggregate, including the balance of the allowance at the beginning
and end of each period, additions charged to net income, additions
representing the amount by which interest contractually due (or, for
purchased financial assets acquired at an amount that includes a
discount related to credit quality, interest cash flows originally
expected to be collected) exceeds interest accrued, writeoffs charged
against the allowance, amounts due to changes in methods and
estimates, if any, and recoveries of amounts previously charged off.
This disclosure shall be provided separately for financial assets
assessed individually or on a pool basis for credit impairment.
b. A description of the accounting policies and methodology used to
estimate the allowance for credit losses. This shall include a
description of the factors that influenced management’s judgment as
well as quantitative and qualitative information about inputs and
assumptions used to measure credit impairments recognized in the
performance statement. Examples of significant inputs include
performance indicators of the underlying assets in the instrument
(including default rates, delinquency rates, and percentage of
nonperforming assets), collateral values, loan-to-collateral-value
ratios, third-party guarantees, current levels of subordination, vintage,
geographic concentration, and credit ratings. Any changes to a
creditor’s accounting policies or methodology from the prior period
shall be identified, and management’s rationale for the change should
be discussed.
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105. For financial assets that are individually considered to be impaired, an
entity shall disclose all of the following:
a. Management’s policy for determining which financial assets the entity

individually assesses for impairment
b. The cumulative allowance for credit losses and the related fair value,
amortized cost, and unpaid principal balance
c. The average carrying amount and the related amount of interest
income recognized during each reporting period for impaired financial
assets.

106. For its core deposit liabilities, an entity shall disclose the inputs and
assumptions (qualitative and quantitative) for all of the following by type of
deposit:
a. The calculation of the average core deposit balances

b. The determination of the implied maturity period
c. The alternative funds rate used and the reasons for its use
d. The all-in-cost-to-service rate
e. A measurement uncertainty analysis conducted in accordance with
the guidance in paragraph 107.
107. To comply with the measurement uncertainty analysis in paragraph 106(e),
an entity shall disclose the effect of a 10 percent increase and the effect of a 10
percent decrease in the discount rate (that is, the difference between the
alternative funds rate and the all-in-cost-to-service rate) used to remeasure core
deposit liabilities. For example, if the entity used a discount rate of 10 percent to
remeasure its core deposit liability, the reporting entity would disclose the effect
of using an 11 percent discount rate and a 9 percent discount rate to remeasure
its core deposit liabilities.
Financial Liabilities Measured at Amortized Cost

108. An entity that subsequently measures qualifying financial liabilities at
amortized cost in accordance with paragraph 28–30 shall disclose both of the
following:
a. An explanation of the reasons why measuring the financial liability at

fair value would create or exacerbate a measurement attribute
mismatch
b. The fair value of the financial liability.
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Level 3 Fair Value Measurement Uncertainty Analysis
109. For annual reporting periods, for all financial instruments measured at fair
value and classified as Level 3 in the fair value hierarchy, except investments in
unquoted equity instruments, an entity shall comply with the measurement
uncertainty disclosures in Topic 820 on fair value measurement. (The guidance
for disclosing measurement uncertainty will be included in a separate proposed
Accounting Standards Update on fair value measurement that will be issued
during the second quarter of 2010.) For interim periods, if the unobservable
inputs (Level 3) used to measure fair value have changed significantly from the
last reporting period, the reporting entity shall provide this disclosure in the
current period. If the unobservable inputs (Level 3) used to measure fair value
have not changed significantly from the last reporting period, the entity shall
disclose that fact and is not required to provide this disclosure in that interim
period.
Derivative Instruments and Hedging Activities
Structure and Applicability of Proposed Guidance for

110. The proposed guidance does not present the overall revised guidance on
derivatives and hedging. Only the proposed changes to the guidance on
derivatives and hedging in Topic 815 are described in this section (paragraphs
112–128). The proposed changes to the guidance affects all hedging
relationships, whether the hedging instrument is a financial derivative instrument
or a nonfinancial derivative instrument and whether the hedged item is (or
hedged transaction involves) a financial instrument or nonfinancial instrument.
111. All of the following main features of the derivative instruments and hedging
activities guidance in Topic 815 are retained by the proposed guidance:
a. The types of items and transactions that are eligible for hedge
accounting in Topic 815 would continue to apply.
b. An entity would be able to continue to designate particular risks in
financial items as the risks being hedged in a hedging relationship.
Only the effects of the risks hedged would be recognized in net
income.
c. The types of risks eligible as hedged risks in Topic 815 would
continue to apply.
Bifurcation of Embedded Derivative Features

112. Embedded derivative features in hybrid financial instruments within the
scope of the proposed guidance shall no longer be bifurcated and accounted for
58
separately as derivative instruments. Rather, hybrid financial instruments that
contain embedded derivative features that meet the criteria in paragraph 815-15-
25-1(a) and (c) shall be reported at fair value with all changes in fair value for the
entire hybrid financial instrument recognized in net income. Consequently, the
second criterion for bifurcation in paragraph 815-15-25-1(b) is not met.
Embedded derivative features in hybrid nonfinancial instruments shall continue to
be analyzed under existing guidance in paragraph 815-15-25-1 to determine
whether they are required to be bifurcated and accounted for separately.
Hedge Effectiveness
113. The qualifying criteria for designating a hedging relationship requires that
the hedging relationship, at its inception and on an ongoing basis, is expected to
be reasonably effective (rather than highly effective) in achieving offsetting
changes in fair values or cash flows attributable to the hedged risk during the
period of the hedging relationship. The risk management objective expected to
be achieved by the hedging relationship and how the hedging instrument is
expected to manage the risk or risks inherent in the hedged item or forecasted
transaction shall be documented. For most relationships, compliance with the
reasonably effective criterion is demonstrated by a qualitative (rather than
quantitative) assessment that establishes that an economic relationship exists
between the hedging instrument and either the hedged item in a fair value hedge
or the hedged transaction in a cash flow hedge. A quantitative assessment is
necessary if a qualitative assessment cannot establish compliance with the
reasonably effective criterion.
114. Although an entity may use a qualitative assessment to demonstrate that a
hedging relationship is reasonably effective, an entity shall not assume at
inception that there will never be any ineffectiveness to recognize in net income
during the period of the hedge. Similarly, an entity shall not ignore whether it will
collect the payments it is owed or make the payments it will owe under the
provisions of the hedging derivative instrument in determining fair value for
assessing effectiveness.
115. The shortcut method and critical terms matching method are eliminated and
shall not be used to assume either that a hedging relationship is completely
effective or that no ineffectiveness needs to be recognized in net income during
the term of the hedge.
116. When using a qualitative assessment of effectiveness, an entity shall
provide the basis for expecting that the hedging instrument is reasonably
effective in offsetting the changes in the hedged item’s fair value attributable to
the hedged risk or the variability in the hedged transaction’s cash flows
attributable to the hedged risk over the life of the hedging relationship. That basis
shall include identifying both of the following:
a. The sources of volatility associated with the fair value of the hedged
item or the cash flows of the forecasted transaction.
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b. The factors supporting a conclusion that the hedging instrument is
reasonably effective in offsetting changes in the hedged item’s fair
value or the variability in the hedged cash flows over the life of the
hedging relationship.
117. After inception of the hedging relationship, an entity shall qualitatively (or
quantitatively, if necessary) reassess effectiveness only if changes in
circumstances suggest that the hedging relationship is no longer reasonably
effective in offsetting.
118. For cash flow hedging relationships in which the designated forecasted
transaction is the variability in cash flows related to a group of transactions within
a specific time period (such as a hedge of forecasted foreign-currency-
denominated sales occurring over the course of a four-week period), an entity
may assess effectiveness using a method that includes a derivative that settles
within a reasonable period of time of the cash flows related to the hedged
transactions. That time period is reasonable if the difference is minimal between
the forward rate on that derivative and the forward rate on a derivative or
derivatives that exactly offset the changes in cash flows of the forecasted
transactions.
Dedesignation of a Hedging Relationship

119. An entity shall not remove the designation of an effective fair value or cash
flow hedging relationship after it has been established at inception. A hedging
relationship shall be discontinued only if either of the following criteria are met:
a. The qualifying criteria for designating a hedging relationship are no
longer met, such as if the relationship no longer is expected to be
reasonably effective in achieving offsetting changes in fair values or
cash flows.
b. The hedging instrument expires or is sold, terminated, or exercised.
120. A hedging derivative instrument may be considered to be effectively
terminated when an offsetting derivative instrument is entered into; however,
concurrent documentation of this effective termination is required to terminate the
hedging relationship. An offsetting derivative instrument shall be expected to fully
offset future changes in the fair value or cash flows of the original derivative
instrument. An entity shall not later designate either of those two derivative
instruments (that is, either the original hedging derivative instrument or the
offsetting derivative instrument) in a new hedging relationship.
121. An entity may modify the hedging instrument for an existing hedging
relationship by adding a derivative to that existing hedging relationship that would
not offset fully the existing hedging derivative and would not reduce the
effectiveness of the hedging relationship. That modification would not result in
the termination of the hedging relationship, although the documentation for the
hedging relationship would need to be updated.
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Measuring and Reporting Ineffectiveness in Cash Flow Hedging
Relationships
122. The measurement of hedge ineffectiveness shall be based on a
comparison of the change in fair value of the actual derivative designated as the
hedging instrument and the present value of the cumulative change in expected
future cash flows on the hedged transaction. For example, an entity could
compare the change in fair value of the actual derivative with the change in fair
value of a derivative that would mature on the date of the forecasted transaction,
be priced at market, and provide cash flows that would exactly offset the hedged
cash flows.
123. An entity shall adjust accumulated other comprehensive income associated
with the hedged transaction to a balance that reflects the amount necessary to
offset the present value of the cumulative change in expected future cash flows
on the hedged transaction from inception of the hedge less the amount
previously reclassified from accumulated other comprehensive income into net
income, if any. Thus, ineffectiveness is recognized for both overhedges and
underhedges.
124. When measuring the ineffectiveness to be recognized in net income by
using a derivative that would mature on the date of the forecasted transaction
and provide cash flows that would exactly offset the hedged cash flows, an entity
may use the same credit risk adjustment as that used in calculating the fair value
of the actual hedging derivative instrument.
125. When measuring ineffectiveness to be recognized in net income when a
purchased option contract (including a net purchased option contract) is used as
the hedging instrument in a cash flow hedge to provide only one-sided protection
against the hedged risk, an entity may use, as a benchmark to calculate
ineffectiveness, a purchased option derivative that would mature on the date of
the forecasted transaction and provide cash flows that would exactly offset the
one-sided change in the hedged cash flows. When measuring a purchased
option derivative that would mature on the date of the forecasted transaction and
provide cash flows that would exactly offset the one-sided change in the hedged
cash flows to determine ineffectiveness to be recognized in net income, an entity
may use total changes in the option’s cash flows or may include only changes in
the option’s intrinsic value. If the entity chooses to measure the total changes in
the option’s cash flows, it shall reclassify from other comprehensive income to
net income each period on a rational basis an amount that adjusts net income for
the amortization of the cost of the option.
126. For cash flow hedging relationships in which the designated forecasted
transaction is the variability in cash flows related to a group of transactions within
a specific time period, an entity may measure ineffectiveness by comparing the
change in fair value of the actual derivative designated as the hedging instrument
with the change in fair value of a derivative that would settle within a reasonable
61
time period of the cash flows related to the hedged transactions. That time period
is reasonable if the difference is minimal between the forward rate on that
derivative and the forward rate on a derivative or derivatives that would exactly
offset the changes in cash flows of the forecasted transactions.
Additional Disclosures Related to Derivative Instruments and

Hedging Activities
127. In annual and interim reporting periods, an entity shall disclose all of the
following for assets and liabilities reported within a single line item in the
statement of financial position for which the carrying amount includes fair value
adjustments related to fair value hedging in Subtopic 815-25:
a. The carrying amount of the assets or liabilities included within the line
item
b. Cumulative fair value adjustments related to fair value hedging
relationships discussed in Subtopic 815-25
c. Cumulative fair value adjustments other than those related to fair
value hedging relationships discussed in Subtopic 815-25
d. The carrying amount of the assets or liabilities excluding any fair
value adjustments.
128. In annual and interim reporting periods, an entity that designates interest
rate risk in a hedging relationship of its own issued debt or other liabilities that
are measured at amortized cost shall disclose all of the following as part of its
debt disclosure:
a. Its use of derivative contracts (interest rate swaps) to convert a
portion of its fixed-rate debt to variable-rate debt, its variable-rate debt
to fixed-rate debt, or both
b. The relationship of the maturity structure of the derivatives to the
maturity structure of the debt being hedged
c. The overall weighted-average interest rate both including and
excluding the effects of derivatives designated as a hedge of its debt
or the related interest payments.
Equity Method of Accounting
Structure of Proposed Guidance for Equity Method of

Accounting
129. The changes to the guidance on equity method of accounting in Topic 323
are described in this section (paragraphs 130–132). The proposed guidance
does not present the overall revised guidance on equity method of accounting.
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Criteria for Evaluating if an Investee Should Be Accounted for
under the Equity Method
130. An investor shall apply the equity method of accounting only if the investor
has significant influence over the investee as described in Topic 323 and if the
operations of the investee are considered related to the investor’s consolidated
operations. If only one of the two criteria is met, the investor shall account for the
investment in the equity security at fair value with all changes in fair value
recognized in net income. The following factors, which are not all inclusive, shall
be evaluated to determine if the operations of the investee are considered related
to the investor’s consolidated operations:
a. A significant portion of the operations of the investee involve the sale
of the investor’s products or services, including providing product
financing and providing access to markets that otherwise would be
inaccessible or more difficult to access.
b. A significant portion of the operations of the investee expand the
investor’s ability to purchase inputs for its products or services.
c. The operations of the investor and the investee are similar.
d. The investee’s management personnel are current or former
managers of the investor.
e. The investor and investee have common employees or employees
that transfer between the investor and investee.
f. The investor or investee provides significant management services to
the other entity.
g. There are significant intra-entity transactions between the investor
and the investee that are relevant to the consolidated operations of
the investor.
There is no one single factor that necessarily carries any more weight than the
others.
Elimination of the Fair Value Option for Equity Method

Investments
131. Upon the effective date of the proposed guidance, a reporting entity may
not elect the fair value option for investments in equity securities that are
accounted for using the equity method as described in Topic 323.
Additional Disclosures Related to Equity Method Investments

132. For each interim and annual reporting period, an entity shall disclose
management’s rationale for concluding how an investment in an equity security
over which it has significant influence is considered related to the entity’s
consolidated businesses. This disclosure shall include factors management
considered when making its assessment.
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Effective Dates and Transition
Effective Dates
133. The requirements in the proposed guidance shall be effective for financial
statements issued for fiscal years beginning after [date to be inserted after
exposure] and interim periods within those fiscal years, except as noted in
paragraphs 134–136. Early adoption is prohibited.
134. The effective date of specific requirements of the proposed guidance shall
be effective for financial statements issued for fiscal years beginning after [date
to be inserted that is 4 years later than the effective date for other entities] and
interim periods within those fiscal years for a nonpublic entity that reports less
than $1 billion of assets in its consolidated statement of financial position. An
entity that meets that criterion at the beginning of a fiscal year need not
subsequently measure in its financial statements for that fiscal year and interim
periods within it any of the following in accordance with the requirements in
paragraphs 21, 25, and 31:
a. Loans (including accounts receivable [with terms exceeding one year]

and notes receivable) to other entities for which qualifying changes in
their fair value would be recognized in other comprehensive income in
accordance with paragraph 21
b. Loan commitments made for which qualifying changes in the fair
value of the underlying loan would be recognized in other
comprehensive income in accordance with paragraphs 21 and 25
c. Core deposit liabilities for which qualifying changes in the remeasured
amount determined in accordance with paragraph 31 would be
recognized in other comprehensive income in accordance with
paragraph 21.
135. In financial statements for reporting periods in which an entity is not subject
to the specific requirements of the proposed guidance in accordance with the
preceding paragraph, an entity shall continue to apply U.S. GAAP requirements
in existence before [the deferred effective date in preceding paragraph of this
proposed Update to be inserted] to qualifying loans, loan commitments, and core
deposit liabilities. In addition, the entity shall disclose in the notes to the financial
statements the fair value of loans that meet the criteria in paragraph 134(a),
determined in accordance with the guidance in Topic 820, in a reporting period
for which application of the proposed guidance is deferred.
136. An entity shall determine whether it qualifies for the delayed effective date
of specific requirements of the proposed guidance at the beginning of each fiscal
year during the four-year delayed effective date period. If an entity determines
that it no longer meets the criteria for the delayed effective date of specific
requirements of the proposed guidance, it also shall no longer be eligible for the
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delayed effective date at the beginning of subsequent fiscal years during the
four-year delayed effective date period.
Transition
137. An entity shall apply the proposed guidance by means of a cumulative-
effect adjustment to the statement of financial position for the reporting period
that immediately precedes the effective date. The statement of financial position
for that reporting period shall be restated in the first set of financial statements
issued after the effective date. For example, an entity for which the effective date
is January 1, 20X4, would restate in its first quarter’s financial report its statement
of financial position as of December 31, 20X3.
138. An entity shall determine the amount of the cumulative-effect adjustment in
accordance with the guidance on accounting changes and error corrections in
Topic 250. An entity shall disclose all of the following in the fiscal period in which
the proposed guidance is adopted and, if the entity provides interim-period
financial statements and adopts the proposed guidance in an interim period, also
in the annual financial statement that include that interim period:
a. The nature and reason for the change in accounting principle,
including an explanation of the newly adopted accounting principle.
b. The method of applying the adoption.
c. The effect of the adoption on any line item in the statement of
financial position for the reporting period that immediately precedes
the effective date. Presentation of the effect on financial statement
subtotals is not required.
d. The cumulative effect of the change on retained earnings or other
components of equity in the statement of financial position as of the
reporting period that immediately precedes the effective date.
139. Financial statements of subsequent periods need not repeat the
disclosures required by the proposed guidance. If the proposed guidance has no
material effect in the period of adoption but is reasonably certain to have a
material effect in later periods, the preceding disclosures shall be provided
whenever the financial statements of the period of adoption are presented.
140. The transition requirements described in the preceding paragraphs shall
also be applied in the first reporting period an entity no longer qualifies for the
delayed effective date of specific requirements of the proposed guidance.
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Proposed Implementation Guidance
IG1. The implementation guidance below further explains and illustrates the
application of the proposed guidance. This implementation guidance does not
address all possible variations. The actual facts and circumstances of particular
financial instruments or transactions must be considered carefully in relation to
the proposed guidance.
Scope
IG2. The proposed guidance applies to financial assets and financial
liabilities that are not specifically excluded from the scope by paragraph 4. For
example, the scope of the proposed guidance would include the following types
of financial assets and liabilities:
a. Accounts receivable and payable
b. Other receivables and payables
c. Originated and purchased loans
d. Investments in debt securities
e. Investments in equity securities (except investments in equity
securities that qualify for the use of the equity method of accounting
as discussed in paragraph 129)
f. Core and noncore deposits
g. Issued debt
h. Hybrid financial instruments
i. Financial derivative instruments
j. Financial guarantees not covered by paragraph 4(d) and (o)
k. Loan commitments and standby letters of credit (except loan
commitments excluded from the scope by paragraph 4(j) and (k)).
IG3. With respect to financial derivative instruments, the proposed guidance
includes in its scope both those financial derivative assets and financial
derivative liabilities that meet the definition of a derivative in Topic 815 and those
financial derivative instruments that do not meet that definition because they do
not have one or more characteristics of a derivative.
IG4. Nonfinancial hybrid instruments are not subject to the scope of the
proposed guidance. In addition, the proposed guidance is not applicable to hybrid
instruments with insurance host contracts or lease host contracts because those
types of financial instruments are excluded from the scope of the proposed
guidance. In addition, the proposed guidance would require holders of hybrid
instruments containing equity hosts to be measured at fair value with all changes
in fair value recognized in net income.
66
IG5. In addition, hybrid financial instruments containing a liability component
and an equity component will continue to be evaluated under guidance in Topic
470, 480, or another Topic to determine whether separation of an equity
component is required. If so, the scope exception in paragraph 4(b) applies to
that equity component and the proposed guidance would apply to the liability
component.
IG6. The proposed guidance does not present the overall revised guidance
on derivatives and hedging. Only the changes to the guidance on derivatives and
hedging in Topic 815 are described. The changes affect all hedging relationships,
whether the hedging instrument is a financial derivative instrument or a
nonfinancial derivative instrument and whether the hedged item is (or hedged
transaction involves) a financial instrument or a nonfinancial instrument.
Initial Measurement
IG7. Paragraph 14 states that when an entity initially recognizes a financial
asset or financial liability that meets the criteria for qualifying changes in fair
value to be recognized in other comprehensive income, the entity must
determine whether there is reliable evidence to indicate that the transaction price
may be significantly different from the fair value of the financial instrument.
Paragraph 820-10-30-3 discusses conditions that may indicate that a transaction
price might not represent the fair value of an asset or liability. The proposed
guidance about whether a significant difference exists focuses on the condition
discussed in paragraph 820-10-30-3(c) that the financial instrument is only one
element of a transaction that may involve other elements. Accordingly, if no
reliable evidence indicates that there may be a significant difference between the
transaction price and the fair value, the entity would use the transaction price to
initially measure the financial instrument. However, if reliable evidence indicates
that there may be a significant difference between the transaction price and the
fair value, the entity would be required to determine if the difference is
attributable to the existence of other elements in the transaction.
IG8. In assessing whether reliable evidence exists that indicates that the
transaction price differs significantly from the fair value of a financial instrument,
such that other element(s) exist in the transaction, the factors that an entity
should consider include any of the following:
a. The terms of a financial instrument, such as upfront and ongoing
fees, duration, collateral, and restrictive covenants
b. Prevailing rates offered to other borrowers or offered by other
lenders for similar financial instruments that are not influenced by
unstated or stated rights and privileges
c. Prevailing rates of other financial instruments with the same
borrower or lender that are not influenced by unstated or stated
rights and privileges
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d. The price that a third-party buyer would be willing to pay to acquire
a financial asset or to assume a financial liability
e. If noncash items are exchanged, the current cash price for the
same or similar items exchanged in the transaction.
IG9. An entity should consider all relevant facts and circumstances to decide
whether the transaction price is significantly different from the fair value. An entity
should exercise judgment to decide what is considered a significant difference.
For example, if the market interest rate on a 30-year conforming loan is 5.50
percent and if an entity originates a similar loan at 4 percent with no fees or other
consideration to compensate the lender for the rate differential, the transaction
price of the loan may be significantly different from its fair value. Another
example would be a loan commitment with fees that are significantly less than
the price an entity would pay to a third party for assuming the liability, which
would include credit risk and interest risk associated with the commitment.
IG10. Consistent with the guidance in paragraph 820-10-30-3(c), if the
transaction involves a financial instrument and other elements, each element
must be separately recognized. As discussed in Section 835-30-25, the other
element or elements in the transaction may represent unstated rights and
privileges that should be given proper accounting recognition. One example of a
transaction that may include stated or unstated rights or privileges is a loan
offered at an off-market interest rate as sales incentives by a manufacturer, a
financing subsidiary of a manufacturer, or a financial entity. Another example is a
credit facility offered at an off-market rate in exchange for goods or services at
off-market prices.
IG11. In these circumstances, the financial instrument should be initially
recognized at its fair value in accordance with the fair value measurement
guidance in Topic 820 or Subtopic 835-30 if a present value technique is used.
The other elements in the transaction that gave rise to the significant difference
between the transaction price and the fair value (not attributable to transaction
fees or costs or because the market in which the transaction occurs is different
from the market in which the entity would sell the asset or transfer the liability)
should be recognized in net income unless any of those elements qualifies as an
asset or a liability under existing U.S. GAAP.
IG12. The following Examples illustrate the application of the initial
measurement principles.
Example 1
IG13. On March 1, 20X0, the financing subsidiary of an automobile
manufacturer issued a 3-year balloon loan of $30,000 at 2 percent interest rate to
a consumer to finance an automobile purchase from the manufacturer. The
financing subsidiary also provides financing to other consumers who do not
purchase vehicles from that particular automobile manufacturer. The loan meets
the criteria for being subsequently measured at fair value with qualifying changes
68
in fair value recognized in other comprehensive income, and the entity does not
choose to measure the loan at fair value with all changes in fair value recognized
in net income. The financing subsidiary should initially measure the loan at the
transaction price unless reliable evidence indicates that the transaction price of
the loan is significantly different from its fair value.
IG14. After reviewing evidence such as the borrower’s credit rating, loans of
similar terms to other borrowers, and the interest rates charged by other financial
institutions in the same geographic area for similar loans, the financing subsidiary
determines that several pieces of reliable evidence indicate that the market rate
for similar loans is approximately 5 percent. The financing subsidiary further
determines that because of the interest rate difference, there is a significant
difference between the transaction price and the fair value of the loan. Therefore,
the financing subsidiary should measure the loan at its fair value of $27,550,
calculated by discounting the net cash flow ($600 for Year 1, $600 for Year 2,
and $30,600 for Year 3) of the loan to the present value at the market rate of
5 percent.
IG15. Next, the financing subsidiary must determine what caused the
difference of $2,450 on the loan, which is the difference between the fair value of
the loan and its transaction price. After analyzing all facts and circumstances
relating to this transaction, the financing subsidiary determines that the difference
is associated with the agreement between the financing subsidiary and the
automobile manufacturer (parent company) through which it subsidizes the
financing subsidiary for any loans originated by the financing subsidiary for the
automobile manufacturer’s vehicles. In its separate financial statements, the
subsidiary should recognize an intra-entity receivable from the parent company.
The parent company should recognize a corresponding intra-entity payable and
recognize the difference of $2,450 as a loss in net income (for example, as a
reduction of sales revenue). Therefore, the difference of $2,450 should be
recognized as a loss in net income at the consolidated level.
Example 2
IG16. Entity A purchased 100,000 shares of Company C’s common stock
through Broker B for $5,005,000. The quoted market price for the same stock on
the day of the transaction is $50 per share. Because the stocks are subsequently
measured at fair value with all changes in fair value recognized in net income, at
initial measurement, these stocks are measured at their fair value of $5,000,000
($50 × 100,000). The remaining difference of $5,000 is attributable to
commissions charged by Broker B; therefore, that difference, which is a
transaction cost, should be immediately recognized as an expense.
Example 3
IG17. On November 1, 20X0, a lender charged a borrower $400 of
nonrefundable fees for entering into a 5-year fixed-rate mortgage loan with a face
69
value of $10,000. The lender incurred $300 of direct costs on appraisal,
underwriting, and so forth, in association with the loan. During the negotiation,
the borrower agreed to pay an upfront fee of $544 in exchange for a lower
interest rate of 3 percent, while the market rate without the upfront fee was 5
percent. On the closing date of December 31, 20X0, the lender funded the
borrower a net of $9,056 ($10,000 – $400 – $544) after deducting the fees. The
lender’s business strategy is to hold the loan for collection of interest and
principal and, therefore, classifies the loan as a loan that would be measured at
fair value with qualifying changes in fair value recognized in other comprehensive
income.
IG18. In this example, the lender determines that there is no reliable evidence
that indicates that there is a significant difference between the transaction price
of the loan and the initial fair value. The fees received, including the fee received
by the lender in exchange for a lower interest rate, and costs incurred by the
lender would not result in a significant difference between the transaction price
and the fair value of the loan. Therefore, the loan should be initially measured at
its transaction price.
IG19. Upon subsequent measurement at fair value, the net nonrefundable
fees and loan origination costs of $100 ($400 – $300) and the $544 fee paid by
the borrower to obtain a lower interest rate are deferred in other comprehensive
income and the yield of the loan should be adjusted during its term.
Remeasurement of Core Deposit Liabilities

IG20. For core deposit liabilities, a subsequent remeasurement is required at
each reporting date. In each subsequent remeasurement, management of the
reporting entity must use judgment in determining the appropriate inputs and
assumptions. The primary method for determining appropriate assumptions
would be the analysis of internal data. If the reporting entity has no appropriate
data (that is, its internal data prove to be unreliable or the entity has not been in
existence enough years), then the reporting entity may utilize peer data in
determining the appropriate assumptions.
IG21. An entity should remeasure the core deposit amount separately for each
major product type. In determining the appropriate level of disaggregation of
deposits, management should strike a balance between obscuring major product
types as a result of too much aggregation and disaggregating excessive detail
that may not assist financial statement users to understand the entity’s deposit
portfolio. At a minimum, management should consider all of the following in
determining the appropriate level of disaggregation:
a. Ownership (for example, public, private, interbank, or foreign)
b. Interest bearing (for example, interest bearing and noninterest
bearing)
c. Type (for example, demand, savings, or money market accounts).
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Inputs and Assumptions to Core Deposit Liabilities
Remeasurement Approach
IG22. Management should analyze its demand deposits to determine whether
the deposits are core deposit liabilities. Deciding which balances are not core
deposit liabilities is determined by type of deposit because there are varying
inputs (such as implied maturity) by type of deposit. For example, in determining
whether the demand deposits are core deposit liabilities, the following balances
would not be considered core deposit liabilities by type of deposit:
a. Surge balances due to seasonal factors or economic uncertainty
b. Temporary accounts for a specific purpose that are not expected to
be retained over the implied maturity (such as escrow funds)
c. Other accounts that management believes are transient (such as
highly interest-rate-sensitive accounts).
Management judgment is needed in determining which demand deposits are
core deposit liabilities. Core demand accounts include all balances that
management believes will provide a lower cost of funding versus alternative
funding sources over the implied maturity.
IG23. The alternative funds source should be cost-effective and sufficient in
volume and duration to replace core deposit liabilities as a funding source. The
alternative funds rate would be used as the next available source of funds if core
deposit liabilities are not an available source of funding. If one source of funding
alone is not sufficient in volume, a blended rate may be used. Management
should use judgment in considering sources of funds based on availability as well
as rates that would be available to the entity if such funding was needed.
IG24. In determining the all-in-cost-to-service rate, management should
consider direct income and expenses to service the core deposit liabilities,
including interest expense, branch maintenance expense, and fee income. For
purposes of this measurement, branch maintenance expense includes overhead
(building rent, building depreciation, utilities, administrative support, and
executive salaries) and selling costs (advertising, promotional expenses, and
salaries of branch employees).
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Classification and Measurement of Financial Instruments
Meeting the Criteria to Recognize Qualifying Changes in Fair

Value in Other Comprehensive Income
IG25. Paragraph 21 outlines the criteria that should be satisfied for an entity to
recognize the qualifying portion of a change in fair value of a financial instrument
in other comprehensive income rather than in net income. Under paragraph 21,
financial instruments that are not hybrid instruments containing an embedded
derivative feature must meet a business strategy criterion and a cash flow
characteristics criterion. Financial instruments that are hybrid instruments should
satisfy an additional criterion that Subtopic 815-15 would not otherwise have
required the embedded derivative to be accounted for separately from the host
contract.
Cash flow characteristics criteria
IG26. Paragraph 21(a) sets forth the criteria related to the cash flow
characteristics of a financial instrument that should be satisfied for an entity to
recognize the qualifying portion of a change in fair value of a financial instrument
in other comprehensive income. To meet these criteria, the financial instrument
should be a debt instrument with contractual cash flows issued or held by an
entity with a principal amount transferred initially and returned upon maturity or
other settlement. Investments in equity instruments do not meet these criteria
and, therefore, do not qualify to report any changes in fair value in other
comprehensive income. Instead, all fair value changes relating to investments in
equity instruments, other than those that qualify for accounting under the equity
method of accounting, should be recognized in net income in the period in which
they occur.
IG27. Paragraph 21(a)(1) indicates that the debt instrument issued or held
involves an amount transferred to the debtor (issuer) at inception that will be
returned to the creditor (investor) at maturity or other settlement, which is the
principal amount of the contract adjusted by any original issue discount or
premium. A debt instrument that meets this criterion involves an upfront transfer
of funds that is an initial investment of the principal amount and a return of the
principal at the maturity or other settlement of the instrument. This criterion
distinguishes debt instruments as contemplated from other instruments that
provide a return based on interest rates, such as derivatives in the scope of
Topic 815. Some derivative instruments may have a fairly significant initial net
investment. However, that initial net investment does not represent the notional
amount and the notional amount will not be returned at maturity or other
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settlement of the contract. In addition, this criterion distinguishes debt
instruments from instruments that have no initial transfer of funds or a two-way
transfer of funds at the inception of the contract, which occurs in some derivative
contracts.
IG28. Financial instruments that do not have the characteristic of a debt
instrument described in paragraph 21(a)(1) should be measured at fair value with
all changes in fair value recognized in net income. For example, derivatives
within the scope of Topic 815 should be measured at fair value with all changes
in fair value recognized in net income.
IG29. Paragraph 21(a)(2) indicates that the debt instrument held or issued has
contractual terms that identify any additional contractual cash flows to be paid to
the creditor (investor) either periodically or at the end of the instrument’s term.
For more traditional debt instruments, the contractual cash flows might be
determined by the application of an interest rate to the debt instrument’s principal
amount. For example, periodic interest cash flows on a traditional loan or bond
typically are determined by applying the contractual or stated interest rate to the
principal amount. The interest rate can be either fixed or variable. However, the
return on a debt instrument does not necessarily have to be computed on the
basis of the application of a rate to the principal amount to satisfy this
characteristic. That is, the return on the debt instrument may be determined in a
manner that does not involve application of a rate or index to a principal amount.
However, such instruments may need to be evaluated under the separate
criterion related to hybrid financial instruments. A financial instrument may satisfy
this characteristic if it involves a single cash flow at the maturity or settlement of
the instrument that includes both a return of principal plus an additional return,
rather than interim cash flows. For example, a principal-only strip and a zero
coupon bond could meet this characteristic.
IG30. Paragraph 21(a)(3) indicates that a debt instrument issued or held
cannot contractually be prepaid or otherwise settled in such a way that the
creditor (investor) would not recover substantially all of its initial investment, other
than through its own choice. Debt instruments often may include contractual
terms to allow prepayments or other features that will result in earlier settlement
of the instrument. If the contractual terms could result in the creditor’s not being
able to recover substantially all of its initial investment, even if the probability of
prepayment or another form of settlement is remote, the debt instruments would
not satisfy this characteristic. The probability of prepayment or other forms of
settlement that would result in the holder’s not recovering substantially all of its
initial investment is not relevant in determining whether the provisions apply to
those debt instruments.
IG31. The application of this characteristic focuses on the investor’s potential
for loss in accordance with the contractual terms; however, if the investor would
not recover substantially all of its initial investment, then both the issuer and the
investor would not satisfy this characteristic for a debt instrument to report
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qualifying changes in fair value in other comprehensive income. That is, the
characteristic described in paragraph 21(a)(3) applies symmetrically to both the
issuer and the holder of such instruments. In addition, the application of the
characteristic is at the initial recognition of the financial instruments. For the
issuer, this is at the date of issuance of the financial instrument. For the investor,
this is the date of acquisition of the financial instrument. Because the investor
may acquire the financial instrument in the secondary market, the investor’s and
issuer’s analyses of this characteristic of the financial instrument may occur at
different dates.
IG32. An entity should use judgment in assessing whether the investor will not
recover substantially all of its initial investment. For example, investments in
mortgage-backed securities or callable securities purchased at an insubstantial
premium may satisfy this criterion.
IG33. This characteristic does not encompass situations in which events that
are not the result of contractual provisions cause the holder not to recover
substantially all of its initial investment. Examples of such events are borrower
default or changes in the value of an instrument’s denominated currency relative
to the entity’s functional currency.
IG34. This characteristic results in the following financial assets not meeting
the qualifying criteria in paragraph 21(a):
a. Any debt instrument that has no principal balance and for which
payments are derived from prepayable financial assets
b. Any loan or debt instrument purchased at a substantial premium
over the amount at which it can be prepaid
c. Beneficial interests that due to prepayment risk in the securitization
structure reflected in the contractual terms of the interest result in
the potential that the investor may not recover substantially all of its
initial investment in the beneficial interest
d. Subordinated, non–pro rata beneficial interests if they can be
contractually prepaid or otherwise settled in such a way that the
investor may not recover substantially all of its initial investment.
Business strategy criterion
IG35. Paragraph 21(b) sets forth the criterion for recognizing qualifying
changes in fair value of a financial instrument in other comprehensive income on
the basis of an entity’s business strategy to collect or pay the related contractual
cash flows rather than to sell or settle the instrument with a third party. Paragraph
22 states that in complying with this guidance, an entity’s business strategy for
financial instruments is to evaluate those instruments on the basis of how the
entity manages its financial instruments on a portfolio basis rather than based on
the entity’s intent for an individual financial instrument. The business strategy
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determines how an entity manages its financial instruments, which encompasses
the reasons for which financial instruments are acquired and sold or settled.
IG36. Classification of financial instruments based on an entity’s business
strategy need not be determined on a reporting entity level. An entity may have
more than one business strategy for managing its financial instruments. For
example, a trading unit of a financial institution may hold debt securities as part
of a trading strategy or market-making activity, and another business unit within
the same entity may hold the same or similar debt instruments as part of an
investing strategy. An entity is not prevented from employing different business
strategies for the same or similar financial instruments, thereby creating a
difference in the accounting for those financial instruments. A portfolio of
instruments held to realize short-term gains and that has a high turnover would
not meet the qualifying criterion in paragraph 21(b), while a portfolio of financial
instruments held as part of a longer term investing strategy could meet that
criterion.
IG37. In order to meet the business strategy criterion, an entity’s strategy
should be to hold instruments in a portfolio designated as held for collection or
payment of contractual cash flows for a significant portion of their contractual
term. Within a portfolio of financial instruments that is held for collection or
payment of contractual cash flows, an occasional sale or settlement may occur
without preventing an entity from considering instruments acquired in the future
under the same business strategy as being held for collection or payment of
contractual cash flows. However, a large number of sales or settlements may be
an indication that an entity’s business strategy has changed. As stated in
paragraph 23, any instruments that previously met the criteria to recognize
qualifying changes in fair value in other comprehensive income that were
accounted for as such should not be reclassified.
IG38. Contractual terms of a financial instrument that affect the effective life of
the instrument do not contradict an entity’s business strategy for designating a
financial instrument for collection or payment of contractual cash flows and,
therefore, do not necessarily prohibit classification as such. For example, if the
contractual terms of a loan permit the debtor to prepay the loan, the entity (as
creditor) is not prevented from considering the loan as held for collection of the
contractual cash flows before prepayment. However, the entity would still be
required to consider the cash flow characteristics of the instrument, including
whether the instrument can be contractually prepaid or otherwise settled in such
a way that the entity would not recover substantially all of its initial investment,
before concluding that the qualifying portion of a change in fair value of the
instrument may be recognized in other comprehensive income.
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Hybrid financial instruments criterion
IG39. Paragraph 21(c) sets forth the criterion for recognizing qualifying
changes in fair value of a financial instrument in other comprehensive income on
the basis of whether the financial instrument is a hybrid instrument for which the
guidance on derivatives and hedging in Subtopic 815-15 would otherwise have
required the embedded derivative to be accounted for separately from the host
contract. If under Subtopic 815-15 the hybrid financial instrument requires
bifurcation, it would be measured in its entirety at fair value with all changes in
fair value recognized in net income. Only if bifurcation is not required under
Subtopic 815-15 would the hybrid financial instrument be eligible to have
qualifying changes in fair value recognized in other comprehensive income.
IG40. The proposed guidance related to the classification and measurement
of hybrid financial instruments relates to those hybrid financial instruments that
have debt host contracts. Hybrid financial instruments can be either investments
of an entity (assets) or obligations of an entity (liabilities). The guidance in
Subtopic 815-15 applies to both assets and liabilities. Certain provisions are
analyzed from the perspective of the holder, but the conclusion affects the
reporting by both parties to the instrument (that is, whether the embedded
derivative feature is clearly and closely related or not). However, certain scope
exceptions provided in Topic 815 may result in different outcomes for the investor
and the issuer.
IG41. The criteria for bifurcation are included in paragraph 815-15-25-1, which
states:
An embedded derivative shall be separated from the host

contract and accounted for as a derivative instrument pursuant
to Subtopic 815-10 if and only if all of the following criteria are met:
a. The economic characteristics and risks of the embedded
derivative are not clearly and closely related to the economic
characteristics and risks of the host contract.
b. The hybrid instrument is not remeasured at fair value
under otherwise applicable generally accepted accounting
principles (GAAP) with changes in fair value reported in
earnings as they occur.
c. A separate instrument with the same terms as the
embedded derivative would, pursuant to Section 815-10-15,
be a derivative instrument subject to the requirements of this
Subtopic. (The initial net investment for the hybrid instrument
shall not be considered to be the initial net investment for the
embedded derivative.)
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IG42. The criteria in paragraph 815-15-25-1(a) and (c) are relevant to the
analysis of hybrid financial instruments required by paragraph 21(c). The criterion
in paragraph 815-15-25-1(b) is not relevant because the proposed guidance
would be the primary source of guidance for determining whether a financial
instrument is required to be measured at fair value with all changes in fair value
recognized in net income.
IG43. As discussed in Subtopic 815-15, a hybrid instrument contains two
components: a host contract and an embedded derivative feature. The notion of
clearly and closely related in Subtopic 815-15 focuses on whether the economic
risks and characteristics of the embedded derivative feature within a contract are
related or unrelated to the host contract. If the embedded derivative feature
meets the definition of a derivative in Subtopic 815-10 (tested as if it was a
freestanding derivative), and the feature is deemed to be unrelated to the host
contract, the embedded derivative feature should be accounted for separately
from the host contract under existing U.S. GAAP.
IG44. Subtopic 815-15 generally results in no bifurcation of an embedded
derivative feature if that feature introduces no risk that is atypical of the type of
host contract. Therefore, an embedded derivative in a debt host contract is not
clearly and closely related to the host debt instrument if it introduces risk or risks
that are not characteristic of debt instruments. For debt hosts, the analysis mainly
focuses on whether the economic risks and characteristics of the embedded
derivative feature are related or unrelated to interest rates. If the embedded
derivative feature is related to interest rates, special tests apply to determine
whether bifurcation is required. The guidance on embedded derivatives
containing interest-rate-related embedded derivative features is included in
Section 815-15-25.
IG45. If the embedded derivative feature is unrelated to interest rates,
bifurcation of the hybrid financial instruments is generally required. This would be
the case, for example, if the hybrid financial instrument contained a debt host
contract and an embedded derivative feature based on changes in equity prices
or commodity prices. Therefore, such hybrid financial instruments would be
measured at fair value with all changes in fair value recognized in net income.
Section 815-15-25 also contains relevant guidance on the analysis of the non-
interest-rate-related embedded derivative features.
Interests in securitized financial assets
IG46. Paragraphs 815-15-25-11 through 25-13 require the cash flow

characteristics of interests in securitized financial assets (beneficial interests) to
be analyzed to determine the classification and measurement under the
proposed guidance. These paragraphs apply to senior interests, subordinated
interests, and residual interests. In addition, they apply to both purchased
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beneficial interests and those interests that continue to be held by a transferor of
financial assets in a transfer accounted for as a sale under Topic 860.
IG47. The interest would first be evaluated to determine if it is a derivative
under Topic 815 in its entirety, in which case it would be measured at fair value
with all changes in value recognized in net income. If the interest is not a
derivative in its entirety, the interest would be evaluated under Subtopic 815-15.
As required by paragraph 815-15-25-13, a holder of an interest in securitized
financial assets should obtain sufficient information about the payoff structure
and the payment priority of the interest to determine whether an embedded
derivative exists. If the interest contains an embedded derivative that would
otherwise have been required to be accounted for separately from the host
contract, then the proposed guidance would require all changes in the fair value
of the hybrid financial instrument to be recognized in net income.
Subsequent Measurement Illustrations

IG48. The following Examples illustrate the application of the guidance for
determining the subsequent measurement of financial instruments.
Example 4: Trade receivables/payables due within one year
IG49. Entity A is a manufacturing company that, in the ordinary course of

business, makes sales on credit with payment due within 120 days of the sale.
Most credit sales are due within 30 days, but in an effort to expand its customer
base, Entity A will occasionally make credit sales to a new customer with
payment due in 90 or 120 days.
IG50. Analysis: Because the customary payment terms of the trade
receivables arising from the credit sales transactions that arise in the normal
course of business require payment within one year, Entity A can measure those
trade receivables (including the receivables from new customers) at amortized
cost (plus or minus fair value hedging adjustments, if any) under the subsequent
measurement exception for receivables and payables in paragraph 33.
Example 5: Variable-rate originated loans
IG51. Entity B makes a 30-year loan with a variable interest rate at LIBOR
plus a fixed spread.
IG52. Analysis: If Entity B’s business strategy for the loan receivable is to hold
for collection of contractual cash flows (thereby meeting the business strategy
criterion in paragraph 21(b)), the fact that the interest is not a fixed amount does
not in itself disqualify the instrument from being measured at fair value with
qualifying changes in fair value recognized in other comprehensive income
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because the variable-rate loan meets the debt instrument criteria in paragraph
21(a). In this case, if the loan is not a hybrid financial instrument that requires
bifurcation under Subtopic 815-15, the loan would meet the criteria for fair value
with qualifying changes in fair value recognized in other comprehensive income.
IG53. Under paragraph 815-15-25-26(a) or (b), certain floors, caps, collars, or
other options on interest rates may result in meeting the requirements in
paragraph 815-15-25-1(a) and (c) for bifurcation of the embedded financial
derivative feature. If bifurcation would otherwise be required, the loan would not
meet the criterion in paragraph 21(c) and, thus, cannot be measured at fair value
with qualifying changes in fair value recognized in other comprehensive income.
In that case, the loan should be measured at fair value with all changes in fair
value recognized in net income and no embedded derivative features would be
bifurcated.
Example 6: Purchased loans (fixed-rate and variable-rate)
IG54. Entity C’s business strategy is to purchase portfolios of long-term

financial assets, such as mortgage loans, and to hold them to collect the cash
flows from those assets. Those portfolios may or may not include financial assets
for which Entity C does not expect to collect all amounts due according to the
contractual terms. After the purchase, Entity C monitors the credit risk of the
portfolios closely.
IG55. Analysis: The fact that the portfolio will not generate exactly the same
cash flows as stated in the contractual terms of the portfolio’s financial assets
does not in itself disqualify Entity C from meeting the business strategy criterion
in paragraph 21(b). Therefore, purchased loans may meet the criteria for fair
value with qualifying changes in fair value recognized in other comprehensive
income if the entity intends to hold them to collect the contractual cash flow
rather than sell them to collect cash and if the purchased loans do not include
embedded derivative features that would meet the bifurcation criteria in
paragraph 815-15-25-1(a) and (c).
Example 7: Debt securities (fixed-rate and variable-rate)
IG56. Entity D holds 15-year bonds issued by Entity E, which is a strategic

business partner of Entity D. The bonds pay interest semiannually and are
frequently traded on the secondary market. Entity D’s business strategy is to hold
the bonds to collect the contractual cash flows. The bonds do not include
embedded derivative features that would meet the bifurcation criteria in
paragraph 815-15-25-1(a) and (c).
IG57. Analysis: Some debt securities are traded in an active market and are
readily convertible to cash. Nevertheless, an entity holding those types of
investments may have a business strategy to hold the investments to collect the
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securities’ contractual cash flows rather than sell them before maturity. In this
example, Entity D has a long-term strategic business relationship with Entity E,
but such a relationship is not essential for an entity to have a business strategy to
hold debt securities to collect their contractual cash flows. Because the criteria in
paragraph 21 are met, the bonds may be measured at fair value with qualifying
changes in fair value recognized in other comprehensive income.
Example 8: Equity securities (including equity securities without a

readily available fair value, such as private equities or equities that
are not actively traded)
IG58. Entity F holds a 10 percent equity investment in the common stock of

Entity G (a start-up company) and does not exercise significant influence over
Entity G’s operating and financial policies. Entity G’s common stock is held by a
group of private investors and is not traded in the public marketplace.
IG59. Analysis: Entity F should measure its equity investment in Entity G at
fair value with all changes in fair value recognized in net income because the
investment does not meet the criteria in Subtopic 323-10 for application of the
equity method of accounting and is not a debt instrument that potentially could be
comprehensive income in accordance with paragraph 21.
Example 9: Loans held for sale and interest-only strip retained in a

transfer of financial assets
IG60. Entity H has a business strategy with the objective of originating

prepayable loans to customers and subsequently selling those loans to investors
as a portfolio. Entity H continues to service the loan portfolio in exchange for a
contractually specified periodic servicing fee, which is more than adequate
compensation for the service rendered. In addition, upon sale of the loans, Entity
H receives 1 percent interest on the loan payments (in the form of an interest-
only strip). Consolidation of the loans upon sale under Topic 810 is not required.
IG61. Analysis: Entity H has an objective to realize the cash flows on the loan
portfolio by selling the loans to other investors. Therefore, it does not meet the
business strategy criterion in paragraph 21(b) of holding the debt instruments to
collect contractual cash flows. The loans (before their sale) would not meet the
criteria for fair value with qualifying changes in fair value recognized in other
comprehensive income and, thus, should be measured at fair value with all
changes in fair value recognized in net income.
IG62. When the loan portfolio is sold and the loans are derecognized, Entity H
would recognize both a servicing asset relating to the servicing rights (which is
not a financial asset) and a financial instrument relating to the interest-only strip,
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which does not meet the criterion in paragraph 21(a)(3) for recognizing qualifying
changes in fair value in other comprehensive income because the interest-only
strip on the prepayable loans could be contractually prepaid or otherwise settled
in such a way that Entity H would not recover substantially all of its initial
investment (that is, the fair value of the interest-only strip upon its initial
recognition at the time the loans were sold).
IG63. If, when the loan portfolio is legally transferred to the investor, an entity
does not qualify for sale accounting under Topic 860 and should continue to
report the loans as its financial assets, the subsequent measurement of those
loans cannot change pursuant to paragraph 23. Those loans should continue to
be measured at fair value with all changes in fair value recognized in net income.
Example 10: Convertible debt
IG64. Entity I issues Instrument J, a fixed-rate debt instrument that is

convertible at the option of the investor into Entity I’s common stock on or after a
specified date and at a fixed conversion price. Interest is paid annually.
IG65. Analysis: From the perspective of the investor in the convertible debt,
Instrument J is a hybrid financial instrument subject to Subtopic 815-15 that
contains an embedded derivative (the conversion option) that meets the
bifurcation criteria in paragraph 815-15-25-1(a) and (c). Thus, under paragraph
21(c), the investor’s investment in Instrument J does not meet the criteria for fair
income. From the perspective of Entity I (the issuer of the convertible debt),
Instrument J does not meet the criterion under paragraph 21(a)(1) because the
principal will not be returned to the creditor (investor) at maturity or other
settlement in those cases in which the convertible debt is settled in accordance
with the investor’s exercise of the conversion option (which exercise is outside
the issuer’s control). Thus, the issuer’s convertible debt does not meet the criteria
for fair value with qualifying changes in fair value recognized in other
comprehensive income. Consequently, the fixed-rate convertible debt instrument
should be measured at fair value with all changes in fair value recognized in net
income by both the issuer and the investor.
Example 11: Financial instruments that are derivatives within the

scope of Topic 815
IG66. Instrument K is an option contract to buy the debt securities of Entity L

at a fixed price. The contract allows net settlement and requires a small upfront
fee.
IG67. Analysis: Because Instrument K meets the definition of a derivative
under Topic 815, it is not a debt instrument under paragraph 21(a) and,
consequently, does not meet the criteria for being measured at fair value with
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Instrument K should be measured by the holder (investor) at fair value with all
changes in fair value recognized in net income. If debt securities are eventually
purchased under exercise of Instrument K, the subsequent measurement of the
purchased debt securities is independent of the subsequent measurement of the
related option contract. Those debt securities may meet the criteria in paragraph
21 to be measured at fair value with qualifying changes in fair value recognized
in other comprehensive income.
Example 12: Interests in securitized debt instruments
IG68. Entity M holds fixed-rate bonds and issues three tranches of securities
to investors: a senior fixed-rate tranche, a subordinated fixed-rate tranche, and a
residual tranche that is entitled to the remainder of the fixed-rate payments from
the bonds after any credit losses on the fixed-rate bonds. The first two tranches
have a limited risk of loss to credit losses on the fixed-rate bonds.
IG69. Analysis: The senior, subordinated, and residual tranches may be
eligible for measurement at fair value with qualifying changes in fair value
recognized in other comprehensive income. None of the tranches could be
contractually settled in such a way that the creditor (investor) would not recover
substantially all of its initial investment. Only if the debtors under the fixed-rate
bonds held by the securitization structure (Entity M) default on their contractual
obligations would the investor in the residual tranche (or any of the other
tranches) potentially not recover substantially all of its initial investment.
Therefore, all of the tranches would meet the criteria in paragraph 21(a) and,
thus, all of the tranches may qualify to be measured at fair value with qualifying
changes in fair value recognized in other comprehensive income if the other
criteria for this subsequent measurement are met. The embedded credit
protection among tranches arising solely from subordination of a tranche does
not meet the bifurcation criteria in paragraph 815-15-25-1(a) and (c).
Example 13: Interests in various securitized financial assets
IG70. Entity N holds fixed-rate bonds and has issued a credit default swap on
a referenced credit that is unrelated to the fixed-rate bonds. The written credit
default swap has a smaller notional amount than the fixed-rate bonds held. Entity
N issues to investors three tranches of credit-linked beneficial interests that differ
in terms of priority for the distribution of cash flows from securities: a senior fixed-
rate tranche, a subordinated fixed-rate tranche, and a residual tranche. The
assets in Entity N are sufficient to fund any losses on the credit default swap.
Furthermore, none of the tranches expose the investors to potential future
payments related to defaults on the written credit default swap. Rather, the
investors are exposed to a potential reduction in future cash inflows, which is the
effect of both the credit risk related to the written credit default swap and the
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default risk on the fixed-rate bonds. That reduction in future cash flows is
allocated among the tranches by the subordination of one tranche to another.
IG71. Analysis: An investor’s investment in any tranche would not meet the
criteria for measuring the investment at fair value with qualifying changes in fair
value recognized in other comprehensive income because it includes an
embedded derivative feature that meets the bifurcation criteria in paragraph 815-
15-25-1(a) and (c). Consequently, the criterion in paragraph 21(c) is not met.
Thus, its investment in any tranche should be measured at fair value with all
IG72. Had an investor in the senior fixed-rate tranche or the subordinated
fixed-rate tranche decided to begin its analysis by first applying the criteria in
paragraph 21(a) to its investment in a tranche, the investor would initially analyze
at inception the maximum extent of possible losses under the contractual terms
of the written credit default swap to determine whether those possible losses
expose the investor in those two tranches to potentially not recovering
substantially all of its initial investment. (Because losses on the credit default
swap are allocated first to the residual tranche, an investor in the residual tranche
is clearly exposed to potentially not recovering substantially all of its initial
investment.) Any tranche for which the investor is exposed by the contractual
terms of the written credit default swap to potentially not recovering substantially
all of its initial investment in that tranche would not meet the criteria in paragraph
21(a). In contrast, if the investor in either the senior fixed-rate tranche or the
subordinated fixed-rate tranche is not exposed by the contractual terms of the
written credit default swap to potentially not recovering substantially all of its
initial investment in that tranche, that tranche would meet the criteria in
paragraph 21(a). However, as noted above, when the investor applies the
criterion in paragraph 21(c) to its investment in a tranche, the investor would
conclude that the investment in any tranche does not meet that criterion and
cannot be measured at fair value with qualifying changes in fair value recognized
Example 14: Perpetual instruments
IG73. Instrument O is a perpetual instrument (that is, an instrument not

required to be redeemed unless the entity decides to or is forced to liquidate its
assets and settle claims against the entity) that pays interest annually; however,
the issuer may call the instrument at any time and pay the holder the par amount
plus accrued interest due. Instrument O pays a market interest rate but payment
of interest is not required unless the issuer is able to remain solvent immediately
afterwards. No additional interest is accrued for deferred interest.
IG74. Analysis: The fact that the instrument can be called at any time by the
issuer of the instrument does not in itself indicate that the holder of the
instrument does not intend to hold the instrument to collect contractual cash flow.
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In this example, the holder of the instrument would be able to collect substantially
all the principal and interest either through holding the instrument or when the
instrument is called by the issuer. Therefore, the instrument would meet the
criterion in paragraph 21(b), but the instrument would not meet the criteria in
paragraph 21(a) because it does not have the characteristics of a debt
instrument as described in that paragraph. Therefore, Instrument O should be
measured at fair value with all changes in fair value recognized in net income.
Example 15: Financial assets with leverage features
IG75. Instrument P is a debt instrument that has an interest rate adjustment

feature that significantly increases the interest rate if LIBOR exceeds a specified
threshold.
IG76. Analysis: The provisions of paragraph 815-15-25-26(b), which generally
consider embedded interest rate derivative features to be not clearly and closely
related if the embedded interest rate derivative feature could potentially double
the initial rate of return on the host contract, would be applied to determine if the
embedded interest rate derivative feature is clearly and closely related to the
debt host contract. If it is not clearly and closely related, the instrument would
meet the bifurcation criteria in paragraph 815-15-25-1(a) and (c) and, thus, would
not meet the criterion in paragraph 21(c). Consequently, in that case, the
financial instrument would be measured at fair value with all changes in fair value
Example 16: Prepayable or puttable financial assets
IG77. Instrument Q is an interest-bearing debt instrument that was issued at

par and is prepayable by the debtor at par at the debtor’s option. Instrument R is
an interest-bearing debt instrument that was issued at par and is puttable by the
creditor at par at the creditor’s option.
IG78. Analysis: The embedded call option feature in Instrument Q and the
embedded put option feature in Instrument R are clearly and closely related to
their related debt host contract pursuant to paragraphs 815-15-25-40 through 25-
43. Consequently, the instruments would not meet the bifurcation criteria in
paragraph 815-15-25-1(a) and (c). Thus, Instruments Q and R would meet the
debt instrument criteria in paragraph 21(a) and the bifurcation criterion in
paragraph 21(c). If the creditor meets the business strategy criterion in paragraph
21(b) of holding the debt instruments to collect the contractual cash flows, the
debt instruments could be measured at fair value with qualifying changes in fair
value recognized in other comprehensive income. Similarly, if the debtor meets
the business strategy criterion in paragraph 21(b) of holding the debt instruments
to pay the contractual cash flows, the debt instruments could be measured at fair
84
income. The ability of the debtor or creditor to accelerate the payment or
collection of principal through exercise of the respective contractual call or put
option would not prevent the criterion in paragraph 21(b) from being met.
Example 17: Equity or commodity-indexed bonds
IG79. Instrument S is an interest-bearing debt instrument for which the

principal payable at maturity is adjusted for changes in the quoted market price of
the common stock of a referenced publicly traded entity. Instrument T is an
interest-bearing debt instrument for which the principal payable at maturity is
adjusted for changes in the quoted market price of a traded commodity.
IG80. Analysis: The embedded derivative features in Instruments S and T
related to the indexing of the principal to be paid at maturity are not clearly and
closely related to their related debt host contracts in accordance with paragraphs
815-15-25-48 through 25-49 and are effectively net settled at the host contract’s
maturity date. Consequently, the instruments meet the bifurcation criteria in
paragraph 815-15-25-1(a) and (c) and, thus, do not meet the criterion in
paragraph 21(c). Instruments S and T should be measured at fair value with all
Loan Commitments
IG81. Loan commitments should be measured at fair value and classified on
the basis of the business strategy for the underlying borrowing. From the
perspective of the writer of the loan commitment (potential lender), if changes in
fair value of the related loan would be recognized in net income, changes in fair
value of the related loan commitment also would be recognized in net income. If
the related loan is held for collection of contractual cash flows and meets the
criteria to report qualifying changes in fair value recognized in other
comprehensive income, qualifying changes in fair value of the related loan
commitment should be recognized in other comprehensive income. Issuers of
loan commitments should determine the classification of the potential loan at the
inception of the related loan commitment.
IG82. A loan commitment that relates to a funded loan with all changes in fair
value recognized in net income should be initially and subsequently measured at
its fair value. At initial measurement, any difference between the fair value of the
loan commitment and the commitment fee should be recognized in net income. If
the loan commitment is exercised, the funded loan should be initially recognized
at its fair value and the loan commitment should be derecognized with any
resulting gain or loss recognized in net income.
IG83. A loan commitment that relates to a funded loan that meets the criteria
to report qualifying changes in fair value in other comprehensive income should
be initially recognized at its transaction price. However, if the entity has reason to
expect at initial recognition that the transaction price of the loan commitment
85
differs significantly from the fair value, and the entity determines that there is
reliable evidence indicating that the transaction price is significantly different from
the fair value, the loan commitment should initially be measured at its fair value.
In that scenario, the entity should account for the other element in the transaction
in accordance with other U.S. GAAP. An amount that does not represent an
asset or liability under U.S. GAAP should be recognized in net income.
Subsequently, the qualifying changes in fair value of those loan commitments are
recognized in other comprehensive income. If the loan commitment is exercised,
any gain or loss previously recognized in accumulated other comprehensive
income during the commitment period should be deferred in other
comprehensive income together with changes in fair value of the related funded
loan until the loan is paid off or disposed of, at which time, the remaining gain or
loss, if any, should be recycled into net income.
IG84. Fees received for a commitment to originate a loan or establish a line of
credit in which the qualifying changes in fair value of the related funded loan are
recognized in other comprehensive income should be recognized in net income
in a manner that is generally consistent with the guidance in Subtopic 310-20.
Consistent with the guidance in Subtopic 310-20, fees received for a commitment
to originate a term loan should be recognized in interest income as an
adjustment of the yield of the related loan. As discussed in paragraph 310-20-25-
12, direct loan origination costs incurred to make a commitment to originate a
loan should be offset against any related commitment fee. Fees received for a
commitment to establish revolving lines of credit that have the characteristics
discussed in paragraph 310-20-35-3(b) (that is, the amount of the commitment
fee is determined retrospectively as a percentage of the line of credit available
but unused in a previous period, that percentage is nominal in relation to the
stated interest rate on any related borrowing, and that borrowing will bear a
market rate of interest at the date the loan is made) should be recognized in net
income as of the determination date.
IG85. Loan commitments associated with lines of credit under credit card and
similar charge card arrangements are excluded from the scope of the proposed
guidance. Therefore, fees received for a commitment to establish a line of credit
under such arrangements should be recognized in accordance with the guidance
in Subtopic 310-20.
IG86. If a loan commitment expires unexercised, any remaining loan
commitment liability (or asset) is derecognized and the value of the commitment
is recognized in net income.
Example 18: Loan Commitments

IG87. The following Example illustrates the accounting for loan commitments.
It does not address how loan commitments should be valued, which is covered
by the guidance in Topic 820.
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IG88. On March 1, 20X1, Entity A enters into a 45-day loan commitment with
a borrower to issue a 2-year balloon loan with a principal amount of $100,000 at
the current market rate of 5 percent. Entity A charges an upfront nonrefundable
fee of $1,000 for committing to fund the loan at the stated rate if the borrower
exercises the commitment within the stated period. For simplicity, this illustration
assumes that the commitment fee represents the fair value of the loan
commitment at inception; however, in reality, this may not always be the case.
On March 31, 20X1, the prevailing interest rate for similar loans increases to 5.8
percent, and the fair value of the loan commitment is $1,500. For simplicity, this
Example assumes there is no other change in interest rates or any other market
factors during the loan commitment period.
IG89. Based on the classification of the loan commitment and the underlying
loan, the following two scenarios could occur.
Case A: Changes in fair value of the loan commitment and the loan
are recognized in net income
Accounting for the loan commitment during the period the

commitment is outstanding
IG90. On March 1, 20X1, Entity A issues the loan commitment and recognizes
the loan commitment at its fair value of $1,000.
Dr. Cash $1,000
Cr. Loan commitment $1,000
IG91. On March 31, 20X1, the fair value of the loan commitment changes to
$1,500. Entity A recognizes the change in fair value of the loan commitment in
net income.
Dr. Net income $500
Cr. Loan commitment $500
Accounting for the expiration of the loan commitment
IG92. If the loan commitment expires unexercised on April 15, 20X1, the loan
commitment is derecognized.
Dr. Loan commitment $1,500
Cr. Net income $1,500
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Accounting for the exercise of the loan commitment
IG93. If the borrower exercised the loan commitment, for example, on April 1,
20X1, Entity A recognizes the loan at its initial fair value of $98,500 (according to
the initial recognition principle for financial instruments with all changes in fair
value recognized in net income) and the loan commitment balance is relieved.
Dr. Loan receivable $98,500
Dr. Loan commitment 1,500
Cr. Cash $100,000
Accounting for the drawn loan
IG94. During the next two years, Entity A recognizes interest on the funded
loan and adjusts the loan to its fair value at the end of each reporting period as
shown below. To simplify this Example, it assumes there is no credit loss on the
loan during the life of the loan.
Loan’s Fair Value

Cash Interest at March 31
20X2 $5,000 $99,000
20X3 5,000 $100,000
Total $10,000
IG95. On March 31, 20X2, Entity A accounts for subsequent changes in fair
value of the loan and recognizes interest.
Dr. Loan receivable $500
Cr. Net income $500
Dr. Cash $5,000

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value of the loan and recognizes interest.
Dr. Cash $5,000

Accounting for the derecognition of the loan
IG97. The loan is fully paid off on March 31, 20X3. Entity A derecognizes the
loan and records cash received.
Dr. Cash $100,000
Cr. Loan receivable $100,000
Case B: Qualifying changes in fair value of the loan commitment and

the loan are recognized in other comprehensive income
Accounting for the loan commitment during the period the

commitment is outstanding
IG98. On March 1, 20X1, Entity A issues the loan commitment and recognizes
the loan commitment at its transaction price, which is the same as its fair value of
$1,000.
Dr. Cash $1,000
Cr. Loan commitment $1,000
IG99. On March 31, 20X1, the fair value of the loan commitment changes to
$1,500. Entity A recognizes the change in fair value of the loan commitment in
other comprehensive income.
Dr. Other comprehensive income $500
Cr. Loan commitment $500
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Accounting for the expiration of the loan commitment
IG100. If the loan commitment expires unexercised on April 14, 20X1, the loan
commitment is derecognized. The balance in other comprehensive income is
relieved.
Dr. Loan commitment $1,500
Cr. Other comprehensive income $500
Cr. Net income 1,000
Accounting for the exercise of the loan commitment
IG101. If the borrower exercises the loan commitment, for example, on April 1,
20X1, Entity A recognizes the loan at its initial fair value of $98,500, and the loan
commitment balance is relieved. In this Example, according to the initial
recognition principle for financial instruments with qualifying changes in fair value
recognized in other comprehensive income, the loan’s transaction price must be
adjusted to its fair value, because there is another element to the transaction (the
loan commitment) that must be given separate recognition and that affects the
initial measurement of the loan.
Dr. Loan commitment 1,500
Cr. Cash $100,000
Accounting for the loss related to the loan commitment deferred in

other comprehensive income (not the fee)
IG102. When the commitment is exercised, the loss of $500 on the loan
commitment remains deferred in other comprehensive income. In this Example, it
will be net to zero in other comprehensive income with the changes in fair value
of the related loan.
Accounting for the drawn loan
IG103. During the next two years, Entity A recognizes interest on the funded
loan and adjusts the loan to its fair value at the end of each reporting period as
shown below. For simplicity, this Example assumes there is no credit loss on the
loan during the life of the loan.
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Loan’s Fair Value
Cash Interest at March 31
20X2 $5,000 $99,000
20X3 5,000 $100,000
Total $10,000
value of the loan and recognizes interest. The interest income includes the
amortization of the commitment fee as an adjustment of yield based on the
effective interest rate of approximately 5.54 percent (amortized cost of $99,000 ×
5.54 percent). The amortized cost is $100,000 less the initial loan commitment
fee of $1,000.
Dr. Loan receivable $500
Cr. Other comprehensive income $500
Dr. Cash $5,000

Dr. Other comprehensive income 500
Cr. Interest income $5,500
value of the loan and recognizes interest. The interest income includes the
amortization of the commitment fee as an adjustment of yield based on the
effective interest rate of approximately 5.54 percent (amortized cost of $99,500 ×
5.54 percent).
Cr. Other comprehensive income $1,000
Dr. Cash $5,000

Dr. Other comprehensive income 500
Cr. Interest income $5,500
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Accounting for the derecognition of the loan
IG106. The loan is fully paid off on March 31, 20X3. Entity A derecognizes the
loan and records cash received.
Dr. Cash $100,000

Cr. Loan receivable $100,000
Credit Impairment of Financial Assets and Interest

Income Recognition
Scope
IG107. The following are types of financial assets that may be eligible to have
qualifying changes in fair value recognized in other comprehensive income and,
therefore, are included in the scope of the guidance for impairment and interest
income recognition:
a. Accounts receivable
b. Originated loans
c. Purchased loans
d. Investments in debt securities, including investments in securitized
financial assets that are either of the following:
1. Purchased beneficial interests
2. Beneficial interests obtained by a transferor in securitized
transactions accounted for as sales in accordance with the
guidance in Topic 860.
e. Loans that have been restructured or modified.
Evaluation and Measurement of Credit Impairment of

Financial Assets
Assessing Declines in Fair Value of a Financial Asset

IG108. The fact that the fair value of a financial asset is less than its amortized
cost may be an indicator that a credit impairment exists. It is inappropriate to
conclude automatically that a financial asset is not impaired if its fair value is
greater than its amortized cost. It also is inappropriate to conclude automatically
that every decline in fair value represents a credit impairment. Further analysis
and judgment are required to assess whether a decline in fair value indicates that
the entity should recognize a credit impairment related to the collectibility of all of
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the contractual cash flows or cash flows expected to be collected from the
borrower or issuer.
Consideration of Guarantees or Other Credit Enhancements

IG109. An entity should not combine separate contracts (for example, a debt
security and a guarantee or other credit enhancement) to determine whether a
financial asset is impaired.
Evaluating Loans and Other Receivables for Credit

Impairment
IG110. Evidence of a deterioration in the credit quality of a loan, which is an
indicator of credit impairment, includes any of the following:
a. Changes in an internal or external (third party) credit score
b. A downgrade in credit rating
c. A decline in the fair value of collateral
d. Past due status.
IG111. A creditor should apply its normal review procedures in identifying loans
that are to be evaluated individually for collectibility. Sources of information that
may be useful in identifying individual loans for evaluation include all of the
following:
a. A specific-size criterion
b. Regulatory reports of examination
c. Internally generated listings such as watch lists, past due reports,
overdraft listings, and listings of loans to management
d. Management’s reports of total loan amounts by borrower
e. Historical loss experience by type of loan
f. Loan files lacking current financial data related to borrowers and
guarantors
g. Borrowers experiencing problems such as operating losses,
marginal working capital, inadequate cash flow, or business
interruptions
h. Loans secured by collateral that is not readily marketable or that is
susceptible to deterioration in realizable value
i. Loans to borrowers in industries or geographic regions
experiencing economic instability
j. Loan documentation and compliance exception reports.
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Evaluating Investments in Debt Securities for Credit
Impairment
Investments in asset-backed securities
IG112. An indicator of impairment of a debt security includes changes in the

financial condition of the issuer of the security or, in the case of an asset-backed
debt security, changes in the financial condition of the underlying loan obligors.
IG113. For asset-backed securities issued in securitization transactions, an
entity should consider how the existence of credit enhancements affects the
expected performance of the security, including consideration of the current
financial condition of the guarantor of a security (if the guarantee is not a
separate contract as discussed in paragraph IG109). Similarly, an entity should
consider whether any subordinated interests are capable of absorbing estimated
losses on the loans underlying the security. The remaining payment terms of the
security could be significantly different from the payment terms in prior periods
(such as for some securities backed by nontraditional loans as discussed in
paragraph 43(j)). Thus, an entity should consider whether a security backed by
currently performing loans will continue to perform when required payments
increase in the future (including balloon payments). An entity also should
consider how the value of any collateral would affect the expected performance
of the security. If the fair value of the collateral has declined, an entity should
assess the effect of that decline on the ability of the entity to collect the balloon
payment.
Determination of the Allowance for Credit Losses

IG114. The allowance for credit losses established for each class of financial
assets should be appropriate to cover the entity’s estimate of the credit
impairment for that class of financial assets at each financial reporting date. The
approach for determining the allowance for credit losses should be well
documented and applied consistently from period to period.
IG115. For financial assets that are individually evaluated for impairment, if
there has been a change in the entity’s estimate of cash flows expected to be
collected, the entity should adjust the allowance for credit losses presented on
the statement of financial position so that it represents the net present value of
cash flows not expected to be collected. Similarly, for financial assets evaluated
for impairment on a collective pool basis, changes in historical loss rates
adjusted for existing economic factors and conditions would necessitate an
adjustment of the allowance for credit losses.
IG116. The allowance for credit losses should be adjusted if an entity
recognizes a credit impairment or a reversal of credit impairment expense
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recognized in a previous period. To recognize a credit impairment, an entity
should increase the allowance for credit losses for impaired financial assets and
recognize a corresponding charge to expense for credit impairment. To
recognize a reversal of impairment expense, an entity should decrease the
allowance and recognize a corresponding credit to expense for credit
impairment.
IG117. The allowance for credit losses should be adjusted also as a result of
the method for determining the amount of interest recognized in net income on
impaired interest-earning financial assets. As discussed in paragraph 76,
recognition of interest in net income should be based on a financial asset’s
effective interest rate applied to the asset’s amortized cost, net of the allowance
for credit losses. To the extent a financial asset has an associated allowance for
credit losses, this method would result in the amount of interest income
contractually due for a financial asset exceeding the amount of interest accrued.
IG118. As discussed in paragraph 80, if there is any difference between the
amount of interest contractually due (or, for purchased financial assets acquired
at an amount that includes a discount related to credit quality, interest cash flows
originally expected to be collected) and the amount of interest income accrued,
an entity should recognize the difference as an increase in the allowance for
credit losses related to the financial assets. If, as a result of this approach to
recognizing interest income, the allowance for credit losses exceeds an entity’s
estimate of credit impairment related to its financial assets, the entity should
adjust the allowance for credit losses and recognize the reduction of credit
impairment expense in net income (however, this reversal of credit impairment
expense should not be recognized as interest income). Therefore, when
determining the amount of credit impairment to be recognized in net income in
each period, an entity may need to consider the effect on the allowance
attributable to the reduction of the amount of interest recognized in net income.
Illustrations
Example 19: Evaluating and Measuring Financial Assets for

Credit Impairment on a Collective (Pool) Basis
IG119. The following Cases illustrate the guidance in paragraphs 36–74:
a. Occurrence of specific event (Case A)
b. Change in current conditions (Case B)
c. Anticipated change in conditions (Case C).
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Case A: Occurrence of specific event
IG120. Entity A has a portfolio of commercial loans, which is composed

primarily of loans to a number of suppliers of Entity X and other retailers in Palm
Beach County, Florida. Entity X, which currently employs about 30 percent of the
workforce of the county, has announced that it is closing its plant in 6 months and
all employees will be terminated.
IG121. Entity X’s announcement to close its plant in Palm Beach County
represents a current economic condition that would adversely affect the
collectibility of loans to Entity X’s suppliers as well as loans to other retailers in
the county that would be affected by the termination of Entity X’s employees.
Even though Entity X has not yet closed its plant, Entity A would assess the
loans to the suppliers and other retailers that may be affected by the plant
closure in the current period rather than waiting six months for the actual closure.
IG122. If Entity A evaluates each loan individually and determines that some of
the loans are not impaired on an individual basis, Entity A would group those
loans with other loans with similar characteristics to determine whether
impairment should be recognized on the basis of historical loss experience.
Case B: Change in current conditions
IG123. Entity B has a portfolio of single-family mortgage loans concentrated in

the Northeast. The portfolio has experienced a significant decline in value
because home values have decreased 15 percent from 2 years ago, which in
turn brings the overall loan-to-value ratio on mortgages written over the last 4
years to 105 percent from 85 percent. Additionally, unemployment rates have
increased by two percentage points in the last year. Entity B has not experienced
an increase in writeoffs in the portfolio of loans. Entity B anticipates that
economic conditions will continue to decline for the next two years and then
begin to improve.
IG124. The declining values of single-family homes and the rising
unemployment rates represent both a past event and an existing condition that
Entity B would consider, among others, in its credit impairment analysis. Because
these loans are evaluated for impairment on a pool basis, the historical loss rate
used by Entity B in its impairment assessment would be adjusted to reflect
existing economic conditions. Entity B would not include its expectations about
future economic conditions in making its assessment.
Case C: Anticipated change in conditions
IG125. Entity C has made unsecured credit card loans of $120 million to
individuals with varying credit scores. The average interest rate on the credit card
balances is approximately 19 percent, given a range of 8 to 25 percent. The
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historical loss rate on credit cards with similar characteristics adjusted for existing
economic conditions is approximately 6 percent, and Entity C has recognized an
allowance of $7.2 million. Entity C predicts that the economy will decline and
unemployment rates will increase in the next 12 to 18 months, leading to
additional defaults. However, the economy has been stable over the last three
years, and there are no existing economic conditions that indicate additional
credit impairments have occurred.
IG126. Entity C would not include its expectations about future economic
conditions in making its assessment of credit impairments. Therefore, unless
there are specific past events or existing economic conditions that indicate
additional credit impairments have occurred, no additional amounts would be
recognized.
Example 20: Measuring and Recognizing Credit Impairment

and Interest Income on Individual Debt Instruments
IG127. This Example illustrates how the proposed impairment, interest income,
and presentation guidance would be applied to an individual debt instrument.
IG128. On January 1, 20X1, Entity D loans a manufacturing company $100,000
at a rate of 12 percent per year. The effective interest rate on the loan is also 12
percent. The loan is not collateralized. The loan agreement calls for interest-only
payments for the first five years with the principal due at the end of Year 6. The
contractual cash flows due under the loan agreement are as follows:
Year Ended Contractual
December 31 Cash Due
20X1 $ 12,000
20X2 12,000
20X3 12,000
20X4 12,000
20X5 12,000
20X6 112,000
$ 172,000
IG129. The manufacturer pays the $12,000 interest due in 20X1 and 20X2. At
the end of the 20X2, the fair value of the loan is $75,000 (for simplicity, assume
the fair value in the previous period was $100,000). There has been a significant
decline in demand for the manufacturer’s product as a result of the recent
emergence of a new competitor in the market. The manufacturer has reported
losses in the last two quarters, and its credit rating has been downgraded in the
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current period. Entity D does not expect to collect all of the contractual cash flows
due according to the contractual terms of the loan.
IG130. At the end of 20X2, Entity D estimates that it will receive $124,400 of
the remaining $148,000 in contractual principal and interest due on the loan as
follows:
Cash Fows
Year Ended Expected to
December 31 Be Collected
20X3 $ 12,000
20X4 12,000
20X5 12,000
20X6 88,400
$ 124,400
IG131. The net present value of the cash flows expected to be collected is
$85,000, calculated by discounting the remaining cash flows expected to be
collected at the effective interest rate of 12 percent.
IG132. Entity D would adjust the loan balance to fair value and recognize a
credit impairment of $15,000 and a $10,000 change in fair value in other
comprehensive income by recording the following journal entry:
Dr. Credit impairment $ 15,000
Dr. Other comprehensive income 10,000
Cr. Loan—allowance $15,000
Cr. Loan—fair value adjustment 10,000
IG133. Entity D would present the following information in the statement of

financial position for the year ended December 31, 20X2:
Amortized cost $100,000

Allowance (15,000)
Other fair value adjustments (10,000)
$75,000
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IG134. The cumulative credit impairment recognized in net income as of
December 31, 20X2, is $15,000. This amount, plus the $10,000 other fair value
adjustment, equals the total $25,000 decline in fair value of the loan.
IG135. During 20X3, Entity D would recognize interest income related to the
loan of $10,200 ($85,000 × 12 percent). Because the amount of interest that is
contractually due is $12,000, Entity D also would recognize an increase in the
allowance for credit losses of $1,800 at the time interest income accrual is
recognized. As a result, Entity D would record the following entry:
Dr. Accrued interest receivable $ 12,000
Cr. Interest income $ 10,200
Cr. Loan—allowance 1,800
IG136. If Entity D collects the $12,000 in contractual interest expected before
the end of 20X3, Entity D would record the following:
Dr. Cash $ 12,000
Cr. Accrued interest receivable $ 12,000
IG137. At the end of 20X3, the fair value of the loan is now $72,000, and the
amortized cost less the allowance for credit losses is $83,200 ($85,000 at the
end of 20X2 less the $1,800 additional allowance recognized in 20X3). Entity D’s
expectations about cash flows have not changed; however, the net present value
of the remaining cash flows expected to be collected is now $83,200 because of
the passage of time. Therefore, no additional adjustments to the allowance for
credit losses would be necessary. Because the fair value of the loan decreased
by $3,000 and the amortized cost less the allowance for credit losses only
decreased by $1,800, an additional $1,200 adjustment (loss) would be reflected
in other comprehensive income to adjust the fair value of the loan to $72,000 as
follows:
Dr. Other comprehensive income $ 1,200
Cr. Loan—fair value adjustment $ 1,200
IG138. Entity D would present the following information in the statement of
Amortized cost $100,000
Allowance (16,800)
$72,000
IG139. The cumulative amount recognized in net income as a credit impairment

(expense) as of December 31, 20X3, is $15,000. The cumulative amount
recognized as a credit impairment is unequal to the allowance because $1,800 of
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the overall cash flows not expected to be collected on this loan has been
reflected as a reduction of interest income.
IG140. At the end of the loan term, assuming the loan performs as expected,
Entity D would have an allowance of $23,600 for the cash flows that it expects
will not be collected, with $15,000 recognized in net income as a credit
impairment and $8,600 reflected as a reduction of interest income.
IG141. The following table summarizes the accounting by Entity D over the life
of the loan:
Amortized
Amortized Cost Less Credit Interest
Cost Allowance Allowance Impairment Cash Income
Origination $ 100,000 $ 100,000 $ (100,000)
20X1 collections 12,000 $ 12,000
Balance 100,000 100,000
20X2 collections 12,000 12,000
Credit impairment $ (15,000) (15,000) $ 15,000
Balance 100,000 (15,000) 85,000
20X3 collections (1,800) (1,800) 12,000 10,200
Balance 100,000 (16,800) 83,200
20X4 collections (2,000) (2,000) 12,000 10,000
Balance 100,000 (18,800) 81,200
20X5 collections (2,300) (2,300) 12,000 9,700
Balance 100,000 (21,100) 78,900
20X6 collections (76,400) (2,500) (78,900) 88,400 9,500
Balance 23,600 (23,600) $ 0 $ 15,000 $ 48,400 $ 63,400
Writeoff (23,600) 23,600
$ 0 $ 0
Example 21: Purchase of Debt Instrument at an Amount That

Includes a Discount Related to Credit Quality
IG142. This Example illustrates how the proposed impairment and presentation
guidance would be applied to a debt instrument acquired at an amount that
includes a discount related to credit quality. The following Cases display the
effects of various scenarios of cash flow activity over a five-year period:
a. Base case—no credit impairment (Case A)
b. Increase in cash flows expected to be collected (Case B)
c. Credit impairment (Case C).
IG143. This Example assumes that the acquisition involved the purchase of
one loan that was acquired at an amount that includes a discount related to credit
quality. However, the same guidance would apply to an individual debt security
or a pool of loans or debt securities acquired at an amount that includes a
discount related to credit quality. Additionally, the guidance illustrated in Case C
is the same as the guidance that would be applied to an originated loan or debt
instrument acquired at an amount that does not include a discount related to
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credit quality when a credit impairment occurs after origination or acquisition as
illustrated in Example 20.
Case A: Base case—no credit impairment
IG144. Entity E acquires a loan with a principal balance of $5,046,686 and

accrued delinquent interest of $500,000 at a discount because of concerns about
the debtor’s credit quality that have occurred since the loan’s origination. Entity E
pays $4,000,000 for the loan on December 31, 20X0. No fees were paid or
received as part of the acquisition. The contractual interest rate is 12 percent per
year. In addition to the delinquent interest, annual payments of $1,400,000 are
due in each of the 5 remaining years to maturity ($7,500,000 due in total). Entity
A expects to collect only $1,165,134 per year for 5 years ($5,825,670 in total).
For simplification, additional interest that would accrue under the contractual
terms of the loan for the debtor’s failure to make timely payments of the
contractual principal and interest is not illustrated.
IG145. On December 31, 20X0, the fair value and amortized cost of the loan
are $4,000,000, and the loan would be presented on the statement of financial
position at $4,000,000 with no allowance or fair value adjustment. Additionally, in
the notes to the financial statements, Entity E would disclose the principal
balance of $5,046,686, the net present value of the cash flows not expected to
be collected (excluding accrued delinquent interest) at acquisition discounted at
the original contractual rate of 12 percent ($846,639), the amount of the other
non-credit-related difference between the principal balance and the purchase
price (an additional discount) of $200,047, and the amortized cost of $4,000,000.
Entity E also would be required to provide any additional disclosures required by
the proposed disclosure guidance.
IG146. Entity E calculates the effective interest rate that equates all cash flows
expected to be collected ($5,825,670) with the purchase price of the loan
($4,000,000) as 14 percent.
IG147. During 20X1, Entity E would recognize interest income related to the
loan of $560,000 ($4,000,000 × 14 percent) as follows:
Dr. Accrued interest receivable $ 560,000
Cr. Interest income $ 560,000
IG148. If Entity E receives the $1,165,134 expected during the year, Entity E
would record the following entry:
Dr. Cash $ 1,165,134
Cr. Accrued interest receivable $ 560,000
Cr. Loan—amortized cost 605,134
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IG149. On December 31, 20X1, the fair value of the loan is $3,200,000
compared with the amortized cost of $3,394,866 ($4,000,000 – $605,134).
Therefore, Entity E would record the following entry:
Dr. Other comprehensive income $ 194,866
Cr. Loan—fair value adjustment $ 194,866
IG150. Entity E would present the following information in the statement of
Amortized cost $3,394,866
$3,200,000
IG151. Additionally, Entity E would disclose the principal balance, the net
present value of the cash flows not expected to be collected, and the amortized
cost in the notes to the financial statements.
IG152. If Entity E receives all the cash flows that it expected to collect, the
following is a summary of the effects of that activity (excluding the effects of any
fair value changes recognized in other comprehensive income):
Amortized
Acquisition $ 4,000,000 $ 4,000,000 $ (4,000,000)
20X1 Collections (605,134) (605,134) 1,165,134 $ 560,000
Balance 3,394,866 3,394,866
20X2 Collections (689,853) (689,853) 1,165,134 475,281
Balance 2,705,013 2,705,013
20X3 Collections (786,432) (786,432) 1,165,134 378,702
Balance 1,918,581 1,918,581
20X4 Collections (896,533) (896,533) 1,165,134 268,601
Balance 1,022,048 1,022,048
20X5 Collections (1,022,048) (1,022,048) 1,165,134 143,086
Balance $ 0 $ 0 $ 1,825,670 $ 1,825,670
Case B: Increase in cash flows expected to be collected
IG153. Assume that at December 31, 20X2, Entity E estimates that cash flows
expected to be collected will be $250,000 more in 20X3 than previously expected
but makes no changes to its expectations of cash flows in years 20X4 and 20X5.
IG154. Because Entity E has not previously recognized a credit impairment in
net income for cash flows not expected to be collected, the increase in the cash
flows expected to be collected should be reflected as an adjustment in the
effective interest rate used to calculate interest income and not as a reversal of
credit impairment expense in net income. The rate that equates all remaining
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cash flows expected to be collected ($1,415,134 in 20X3 and $1,165,134 in 20X4
and 20X5, for a total of $3,745,402) with the current amortized cost of the loan
($2,705,013) is 18.9603 percent.
IG155. If Entity E receives all cash flows that it expected to collect (including
the increase of $250,000 in 20X3), the following is a summary of the effects of
that activity (excluding the effects of any fair value changes recognized in other
comprehensive income):
Amortized
Acquisition $ 4,000,000 $ 4,000,000 $ (4,000,000)
20X1 Collections (605,134) (605,134) 1,165,134 $ 560,000
Balance 3,394,866 3,394,866
20X2 Collections (689,853) (689,853) 1,165,134 475,281
Balance 2,705,013 2,705,013
20X3 Collections (902,256) (902,256) 1,415,134 512,878
Balance 1,802,758 1,802,758
20X4 Collections (823,326) (823,326) 1,165,134 341,808
Balance 979,432 979,432
20X5 Collections (979,432) (979,432) 1,165,134 185,702
Balance $ 0 $ 0 $ 2,075,670 $ 2,075,670
Case C: Credit impairment
IG156. Assume instead that at December 31, 20X2, because of declining

market conditions, Entity E estimates that it will collect $100,000 less in each of
the remaining 3 years than expected at acquisition (that is, Entity E expects to
collect $1,065,134 per year).
IG157. The net present value of the cash flows expected to be collected
discounted at the effective interest rate of 14 percent is $2,472,850.
IG158. Entity E would recognize a credit impairment of $232,163 ($2,705,013
amortized cost – $2,472,850 cash flows expected to be collected) as follows:
Dr. Credit impairment $ 232,163
Cr. Loan—allowance $ 232,163
IG159. Fair value of the loan at December 31, 20X2, is $2,300,000. Therefore,
the cumulative amount that should be recognized in accumulated other
comprehensive income is a debit of $172,850. Because $194,866 was
recognized at December 31, 20X1, the following entry would be required:
Dr. Loan—fair value adjustment $ 22,016
Cr. Other comprehensive income $ 22,016
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IG160. Entity E would present the following information in the statement of
Amortized cost $2,705,013
Allowance (232,163)
$2,300,000
IG161. During 20X3, Entity E would recognize interest income related to the
loan of $346,199 ($2,472,850 × 14 percent). Because the amount of interest that
Entity E originally expected to receive was $378,702, Entity E also would
recognize an increase in the allowance for credit losses of $32,503 ($378,702 –
$346,199).
IG162. At the end of the loan term, assuming the loan performs as expected,
Entity E would have an allowance of $300,000 for the cash flows the entity
expects not to collect, with $232,163 recognized in net income as a credit
impairment and $67,837 reflected as a reduction of interest income.
IG163. If Entity E receives all the cash flows that it expected to be collected, the
following is a summary of the effects of that activity (excluding the effects of any
fair value changes recognized in other comprehensive income):
Amortized
Acquisition $ 4,000,000 $ 4,000,000 $ (4,000,000)
20X1 Collections (605,134) (605,134) 1,165,134 $ 560,000
Balance 3,394,866 3,394,866
20X2 Collections (689,853) (689,853) 1,165,134 475,281
Impairment $ (232,163) (232,163) $ 232,163
Balance 2,705,013 (232,163) 2,472,850
20X3 Collections (686,432) (32,503) (718,935) 1,065,134 346,199
Balance 2,018,581 (264,666) 1,753,915
20X4 Collections (796,533) (23,053) (819,586) 1,065,134 245,548
Balance 1,222,048 (287,719) 934,329
20X5 Collections (922,048) (12,281) (934,329) 1,065,134 130,805
Balance 300,000 (300,000) $ 0 $ 232,163 $ 1,525,670 $ 1,757,833
Writeoff (300,000) 300,000
$ 0 $ 0
Example 22: Financial Assets for Which No Accrual of Interest

Is Made
IG164. This Example illustrates the guidance in paragraph 82.
IG165. On January 1, 20X1, Entity F makes a $500,000 loan to a construction
company. Interest-only payments of 10 percent, or $50,000, are due annually
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with the principal of $500,000 due at the end of 3 years. The loan is secured by
the condominium complex that the construction company is building. At
origination, $150,000 is placed in an escrow account and will be used to pay the
yearly interest payments.
IG166. At the end of 20X1, there were no events or conditions that would
indicate the loan was impaired, and the lender collected $50,000 in interest from
the escrow account.
IG167. During 20X2, the construction company announces that construction is
behind progress, sales of condominium units are extremely low, and there is the
possibility that the project will be discontinued. Entity F estimates that it will not
collect the $500,000 principal due at the end of Year 3 although collection of the
remaining $100,000 in escrow is assured. (For simplicity, this Example assumes
that the collateral has no value.)
IG168. Because Entity F expects to have a negative overall return on this loan,
Entity F would cease recognizing any interest on the loan (that is, place the loan
on nonaccrual status) and recognize a credit impairment of $400,000 for the
difference between the loan balance and the remaining cash flows expected to
be collected. As cash is collected from escrow, Entity F would recognize a
reduction in the amortized cost, so that the amortized cost is equal to the
$400,000 allowance at the end of the term.
Disclosures
Level of Disaggregation
IG169. An entity should disaggregate its disclosures by nature, characteristics,
or risks of the financial instruments. At a minimum, an entity should segregate
financial instruments on the basis of subsequent measurement (fair value with all
changes in fair value recognized in net income, fair value with qualifying changes
in fair value recognized in other comprehensive income, remeasurement amount,
or amortized cost). Additional disaggregation should be in a manner consistent
with the level of disaggregation required by other Topics, allowing users of
financial statements to compare disclosures on a consistent basis across
footnotes. For example, the disclosures on accounting for financial instruments
should be disaggregated in a manner that is consistent with the disaggregation
by class in Topic 820.
IG170. When complying with the disclosure requirements, industry-specific
guidance requires certain institutions to provide a greater level of disaggregation.
An entity subject to specialized industry guidance should continue to follow that
guidance.
IG171. An entity should determine, in light of facts and circumstances, how
much detail it is required to provide to satisfy the disclosure requirements, and
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how it disaggregates information into classes for assets with different risk
characteristics. An entity should strike a balance between obscuring important
information as a result of too much aggregation and overburdening financial
statements with excessive detail that may not assist financial statement users in
understanding the entity’s financial instruments and allowance for credit losses.
For example, an entity should not obscure important information by including it
with a large amount of insignificant detail. Similarly, an entity should not disclose
information that is so aggregated that it obscures important differences between
the different types of financial instruments and associated risks.
Derivatives and Hedging Activities
Example 23: Cash Flow Hedge of Forecasted Purchase of

Natural Gas (to Illustrate Proposed Guidance on Overhedges
and Underhedges)
IG172. On January 1, 20X6, an entity forecasts the purchase of natural gas in
Iowa in one year. The 1-year forward price for natural gas to be delivered in Iowa
is $7.50 per MMBTU. A derivative that would mature on the date of the
forecasted transaction and be expected to exactly offset the hedged cash flows
would be a forward contract to purchase (lock in the price of) natural gas for
delivery in Iowa at $7.50 per MMBTU. The entity enters into an over-the-counter
forward contract to purchase natural gas for $7.00 per MMBTU as a hedge
against the forecasted purchase in Iowa. The difference between the two
contracts is attributed to transportation costs and location of delivery.
IG173. At December 31, 20X6, the spot price of natural gas for delivery in Iowa
is $8.50 per MMBTU. Thus, the derivative that would be expected to exactly
offset the hedged cash flows would be in a gain position of $1.00 per MMBTU.
The entity purchases the natural gas at the $8.50 per MMBTU price. Below is an
illustration of the journal entries for two situations: when the change in value of
the actual derivative is greater than the change in value of the derivative that
would be expected to exactly offset the hedged cash flows and when the change
in value of the derivative that would be expected to exactly offset the hedged
cash flows is greater than the change in value of the actual derivative.
Change in Value of the Actual Derivative Is Greater Than the

Change in Value of the Derivative That Would Be Expected to
Exactly Offset the Hedged Cash Flows
IG174. On December 31, 20X6, the spot price of natural gas for delivery under
the over-the-counter contract is $8.30 per MMBTU. Thus, the entity has a $1.30
per MMBTU gain on its derivative contract. Comparing the $1.30 gain on the
actual derivative with the $1.00 gain on the derivative that would exactly offset
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the hedged cash flows results in a $0.30 overhedge. On December 31, 20X6, the
entity would make the following journal entries to record the purchase of the
natural gas, the deferral of the effective portion of the hedge in other
comprehensive income, and the ineffective portion of the hedge in net income:
Dr. Natural gas inventory $8.50
Cr. Cash $8.50
Dr. Forward contract $1.30

Cr. Other comprehensive income $1.00
Cr. Net income 0.30
IG175. On January 1, 20X7, the entity would make the following journal entry
for the settlement of the forward contract:
Dr. Cash $1.30
Cr. Forward contract $1.30
IG176. Assume that the entity sold the natural gas on February 28, 20X7. The
entity would make the following journal entries on February 28, 20X7, to remove
the natural gas from inventory and reclassify the gain from accumulated other
comprehensive income to net income. The entity’s policy is to classify the
effective portion of the change in fair value of the hedging instrument in cost of
goods sold.
Dr. Cost of goods sold $8.50
Cr. Natural gas inventory $8.50
Dr. Accumulated other comprehensive income $1.00

Cr. Cost of goods sold $1.00
IG177. On February 28, 20X7, the day that the hedged forecasted transaction
affected net income, the statement of comprehensive income reflects cost of
goods sold at $7.50, which represents what would be the locked-in price of the
derivative that would exactly offset the hedged cash flows. Cumulatively, the
statement of comprehensive income reflects $7.20, the actual cash paid after
taking into account the $8.50 paid for the natural gas in the spot market and the
$1.30 received upon settlement of the derivative. However, that actual price is
reflected in the statement of comprehensive income over multiple reporting
periods.
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Change in Value of the Derivative That Would Be Expected to
Exactly Offset the Hedged Cash Flows Is Greater Than the
Change in Value of the Actual Derivative
IG178. On December 31, 20X6, the spot price of natural gas for delivery under
the over-the-counter contract is $7.80 per MMBTU. Thus, the entity has a $0.80
per MMBTU gain on its derivative contract. Comparing the $0.80 gain on the
actual derivative with the $1.00 gain on the derivative that would exactly offset
the hedged cash flows results in a $0.20 underhedge. On December 31, 20X6,
the entity would make the following journal entries to record the purchase of the
natural gas, the deferral of the effective portion of the hedge in other
comprehensive income, and the ineffective portion of the hedge in net income:
Dr. Natural gas inventory $8.50
Cr. Cash $8.50
Dr. Forward contract $0.80

Dr. Net income 0.20
Cr. Other comprehensive income $1.00
IG179. On January 1, 20X7, the entity would make the following journal entry
for the settlement of the forward contract:
Dr. Cash $0.80
Cr. Forward contract $0.80
IG180. Assume that the entity sold the natural gas on February 28, 20X7. The
entity would make the following journal entries on February 28, 20X7, to remove
the natural gas from its books and reclassify the gain from accumulated other
comprehensive income to net income. The entity’s policy is to classify the
effective portion of the change in fair value of the hedging instrument in cost of
goods sold.
Dr. Cost of goods sold $8.50
Cr. Natural gas inventory $8.50
Dr. Accumulated other comprehensive income $1.00

Cr. Cost of goods sold $1.00
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IG181. On February 28, 20X7, the day that the hedged forecasted transaction
affects net income, the statement of comprehensive income reflects cost of
goods sold at $7.50, which represents what would be the locked-in price of the
derivative that would exactly offset the hedged cash flows. Cumulatively, the
statement of comprehensive income reflects $7.70, the actual cash paid after
taking into account the $8.50 paid for the natural gas in the spot market and the
$0.80 received upon settlement of the derivative. However, it is reflected in the
statement of comprehensive income over multiple reporting periods and, in many
cases, in more than one line item.
The proposed guidance was approved for publication by three members of the
Financial Accounting Standards Board. Ms. Seidman and Mr. Smith voted
against publication of the proposed guidance. Their alternative views are set out
at the end of the basis for conclusions.
Members of the Financial Accounting Standards Board:
Robert H. Herz, Chairman

Thomas J. Linsmeier
Leslie F. Seidman
Marc A. Siegel
Lawrence W. Smith
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Background Information, Basis for
Conclusions, and Alternative Views
Introduction
BC1. The following summarizes the Board’s considerations in reaching the
conclusions in this proposed Update. It includes reasons for accepting certain
approaches and rejecting others. Individual Board members gave greater weight
to some factors than to others.
BC2. The Board concluded that the objective of the proposed guidance
should be to significantly improve the decision usefulness of financial instruments
reporting for users of financial statements.
BC3. The Board believes that simplification of the accounting requirements
for financial instruments should be an outcome of this improvement. Although the
project’s objective is comprehensive, it also is the Board’s objective that the
project should be completed expeditiously.
BC4. The proposed guidance covers the recognition, measurement,
classification, and impairment of financial instruments, as well as hedge
accounting for financial instruments.
Background Information
BC5. Over time, financial instruments have increased in complexity, risks, and
volume. Some constituents believe that accounting models have not been
appropriately modified during this time period to reflect those complexities and
risks in the financial statements. As a result, increases in risk, and the effect of
an entity’s risk management strategies on that risk, are not adequately captured
by or disclosed in the financial statements.
BC6. Since 2005, the FASB and the IASB have had a long-term objective to
improve and simplify the reporting for financial instruments. In March 2006, the
Boards further clarified their intentions to work together to improve and converge
financial reporting standards by issuing a Memorandum of Understanding (MoU),
A Roadmap for Convergence between IFRSs and US GAAP—2006–2008. As
part of the MoU, the Boards worked jointly on a research project to reduce the
complexity of the accounting for financial instruments. This joint effort resulted in
the IASB’s issuance of the March 2008 Discussion Paper, Reducing Complexity
in Reporting Financial Instruments, which the FASB also published for comment
by its constituents. That paper discussed the main causes of complexity in
reporting financial instruments and possible intermediate and long-term
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approaches to improving financial reporting and reducing complexity. The Boards
received 162 comment letters. In the discussions leading to this proposed
Update, the Board considered relevant recommendations and suggestions about
classification and measurement from those comment letters.
BC7. The Board also was asked on multiple occasions to address numerous
issues on many aspects of hedge accounting. As a result, in January 2007, the
Board directed the staff to research (a) issues causing difficulties in the
application of hedge accounting and (b) potential approaches to accounting for
hedging activities. On June 6, 2008, the Board issued an Exposure Draft,
Accounting for Hedging Activities, to address the identified issues. The Board
received 127 comment letters and considered concerns raised by respondents in
its deliberations on hedge accounting.
BC8. Although accounting requirements were not the cause of the recent
global financial crisis, the crisis highlighted particular issues with the present
mixed-attribute measurement model for financial instruments. In brief, the
present mixed-attribute measurement model sometimes provides inadequate
information that an entity and its advisors and investors need to effectively
assess risk. The present model relies too heavily on subjective classification of
financial instruments that determines either or both their measurement attribute
and how the resulting gains or losses are recognized.
BC9. In October 2008, as part of a joint approach to dealing with the
accounting and reporting issues arising from the global financial crisis, the FASB
and the IASB established the Financial Crisis Advisory Group (FCAG), which
comprises senior leaders with broad international experience in financial
markets. The FCAG was asked to consider how improvements in financial
reporting could help enhance investors’ confidence in financial markets. The
advisory group was asked to identify any accounting issues that require the
Boards’ urgent and immediate attention, as well as issues for longer term
consideration.
BC10. The FASB and the IASB also organized three roundtable meetings—
one each in London (November 14, 2008), Norwalk (November 25, 2008), and
Tokyo (December 3, 2008). The purpose of the roundtables was both to:
a. Receive input from a wide range of stakeholders, including users,
preparers, and auditors of financial statements, regulators, and others
b. Identify accounting issues to enhance investors’ confidence in
financial markets.
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BC11. Participants in the roundtables made general comments about the
importance of both:
a. Achieving convergence of U.S. GAAP and IFRS
b. Allowing sufficient due process before any changes to existing
guidance are made by the Boards.
BC12. Participants raised the following issues at the roundtables:
a. Impairment
b. Fair value option
c. Fair value as a measurement attribute
d. Clarification of the interaction between conflicting accounting
standards
e. Clarification for investments in collateralized debt obligations.
BC13. In addition to considering the potential for short-term responses to the
credit crisis, both Boards emphasized their commitment to working jointly to
provide greater transparency and reduce complexity in the accounting for
financial instruments.
BC14. In November 2008, the IASB added to its agenda a project on
accounting for financial instruments, with the understanding that the FASB would
soon consider adding a related project to its technical agenda. In December
2008, the FASB added such a project to its agenda. This proposed Update has
been issued as a result of that project.
BC15. The IASB decided to complete its deliberations on the project in three
phases:
a. Phase 1: Classification and measurement—In November 2009 the
IASB issued IFRS 9 for financial assets in time to allow, but not
require, early adoption for 2009 calendar year-end financial
statements. The IASB made a tentative decision to retain the existing
classification and measurement guidance in IAS 39 for financial
liabilities. However, the IASB also tentatively decided to propose
changes to the fair value option for financial liabilities and issued an
Exposure Draft on fair value option on May 11, 2010. The comment
period ends on July 16, 2010.
b. Phase 2: Impairment—The IASB has made tentative decisions about
impairment and issued an Exposure Draft on impairment, in
November 2009. The comment period ends on June 30, 2010.
c. Phase 3: Hedge accounting—The IASB is currently deliberating
hedge accounting issues and plans to issue an Exposure Draft in the
near term.
BC16. The FASB considered approaching the project in several phases and
issuing multiple exposure documents. However, the Board believes that these
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issues are interrelated and a comprehensive approach will result in requirements
that are more coherent, thereby making it easier for constituents to react to and
understand the proposed guidance. For example, the Board considered various
impairment models and selected one model for all financial instruments (see
paragraphs BC167–BC199). The Board’s decision on impairment depended on
the overall classification and measurement model for financial instruments
because the classification and measurement model influences the relevance and
the costs and benefits of each impairment model. The Board also considered
overlapping issues on hedge accounting. In addition, a comprehensive approach
to accounting for financial instruments may reduce the possibility of an entity
having to change its accounting policies and systems on several occasions.
Scope
Entities Included in the Scope

BC17. Although the issues that gave rise to the Board’s consideration of the
proposed guidance were raised in the context of financial institutions, the Board
believes that the proposed guidance should not be limited to the accounting by
those institutions. The Board’s approach to standard setting generally has been
to consider the accounting for a specific transaction or financial instrument and
try to develop an accounting method that can be applied to all industries,
particularly considering that the transactions generally are common to many
different industries.
BC18. The Board considered whether certain entities should be excluded from
the scope of the proposed guidance on the basis of industry, size, or nonpublic
status and decided that all entities that transact in financial instruments should
apply this comprehensive accounting model for financial instruments. Risks and
market forces have blurred the distinction between industries and have
heightened the need for greater comparability in the financial statements of
entities in different industries, including the consistency of reported information
within an entity’s financial statements. Those factors reinforced the Board’s belief
that all entities with similar financial instruments should account for those
instruments in a similar manner.
BC19. The Board also considered exempting from the scope of the proposed
guidance not-for-profit entities, such as health and welfare organizations,
hospitals, colleges and universities, religious institutions, trade associations, and
private foundations. The Board believes that a not-for-profit entity should be
subject to the proposed guidance because the model would represent an
improvement in financial reporting and also would further the comparability of
financial statements of not-for-profit entities.
BC20. The Board also understands that entities in certain industries apply
specialized accounting practices that include accounting for substantially all
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investments in debt and equity securities at fair value, with the changes in those
values recognized in net income or net assets. For brokers and dealers in
securities, the Board decided that the measurement and reporting guidance
should apply to the financial liabilities of those entities, thus permitting the
qualifying changes in fair value for some liabilities to be recognized in other
comprehensive income. However, the Board decided that the financial assets of
those entities should be reported at fair value with all changes in fair value
recognized only in net income. The Board’s proposal acknowledges that
accounting for financial assets of brokers and dealers in securities at fair value
with changes in fair value recognized only in net income provides more relevant
information for users of their financial statements and, as such, that requirement
is retained in the proposed guidance. For financial liabilities of brokers and
dealers in securities, the Board believes the proposed guidance would be an
improvement in financial reporting, and, as such, financial liabilities would be
required to follow the provisions of the proposed guidance.
BC21. For investment companies, the Board decided that the financial assets
and liabilities should be reported at fair value with all changes in fair value
included in determining the net increase (decrease) in net assets resulting from
operations. Because investment companies do not currently report other
comprehensive income, the Board believes that recognizing all financial assets
and liabilities at fair value with changes in fair value included in determining the
net increase (decrease) in net assets resulting from operations would provide the
most relevant information for users of their financial statements.
BC22. The Board decided to provide a delayed effective date to nonpublic
entities with less than $1 billion in total consolidated assets for certain aspects of
the accounting for financial instruments model included in the proposed guidance
because of cost-benefit concerns. The basis for that decision is discussed in the
effective date and transition section (see paragraphs BC236–BC238).
Financial Instruments Excluded from the Scope

BC23. The Board decided to exclude certain types of financial instruments
from the scope of the proposed guidance (see paragraphs 4 and 5). Many of the
excluded financial instruments, such as those stemming from share-based
compensation arrangements, would be subject to existing requirements that the
Board determined require no reconsideration at this time. Others, including
insurance (and related financial guarantees) and lease contracts, are the subject
of other projects on the Board’s agenda.
Equity Method Investments

BC24. The Board believes that an entity generally should measure investments
in equity securities at fair value with all changes in fair value recognized in net
income because the only way to realize gains or losses from equity securities is
114
to sell the equity securities as compared to debt securities, which can be held for
collection of contractual cash flows. However, the Board decided that for those
equity investments in which the entity has significant influence over the investee
and the investee’s operations are related to those of the entity’s consolidated
operations, it is appropriate to account for those investments in accordance with
the guidance on the equity method and joint ventures in Topic 323. For those
investments, the Board continues to believe that the equity method of accounting
would provide the most appropriate representation of the underlying economic
activity in the entity’s financial statements.
BC25. The Board decided to eliminate the option to measure at fair value
investments in equity securities that qualify for the equity method of accounting.
The Board believes that the additional criteria to qualify for the equity method of
accounting would result in an investor being required to recognize its investment
at fair value when this is appropriate, rather than allowing the reporting entity to
make such an election. The Board believes that reporting entities have
historically elected the fair value option when the investee’s operations were not
considered related to those of the investor’s consolidated operations.
Accordingly, those entities would now be required to measure such investments
at fair value rather than having the option to do so.
Pledge Receivables and Payables

BC26. The Board decided to exclude from the proposed guidance the
receivables and payables of a not-for-profit entity that represent pledges arising
from voluntary nonreciprocal transfers. At issue is whether the measurement
attribute for pledges arising from voluntary nonreciprocal transfers should be
articulated in the proposed guidance or in later guidance after the Board has
more fully considered recommendations related to the accounting for a not-for-
profit entity, including whether there are specific attributes or implementation
issues related to receivables and payables of a not-for-profit entity that represent
pledges arising from voluntary nonreciprocal transfers. Therefore, the Board
decided that it would be more efficient to address the measurement attribute for
receivables and payables of a not-for-profit entity after the Board has reviewed
broader recommendations as they relate to accounting for a not-for-profit entity.
Registration Payment Arrangements

BC27. Subtopic 825-20 addresses the accounting for financial instruments with
registration payment arrangements. Under the requirements of that Subtopic, a
registration payment arrangement is considered a separate unit of account and is
measured in accordance with the guidance on loss contingencies in Subtopic
450-20. Currently, registration payment arrangements are excluded from Topics
460 on guarantees, 480 on distinguishing liabilities from equity, and 815 on
derivatives and hedging.
115
BC28. The Board decided to exclude a registration payment arrangement from
the scope of the proposed guidance for similar reasons to those noted in Topic
825 on financial instruments, which include the following:
a. Some Board members noted concern about the relevance and
reliability of using a fair value measurement because similar
arrangements are not entered into on a standalone basis.
b. Some Board members were concerned about the ability to reasonably
estimate the price that would be paid to transfer the liability under a
registration payment arrangement in an orderly transaction between
market participants, considering that a key assumption is the entity’s
ability to obtain (and maintain) an effective registration statement.
c. Some Board members believe that, in many cases, the fair value of a
registration payment arrangement would be minimal at inception and
that the difficulties of determining fair value outweigh the costs,
particularly in circumstances in which the likelihood of payment is low
and the value is immaterial.
Financial Guarantees
BC29. The Board decided that the financial guarantees listed in paragraph 4(o)
would be excluded from the scope of the proposed guidance, consistent with its
decisions on the recognition and measurement of certain guarantees while
deliberating FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others.
Interaction between the Proposed Guidance and Topic 815

BC30. The Board believes that the accounting for financial instruments that
meet the definition of a derivative in Topic 815 would not be changed by the
proposed guidance. That is, derivatives that are within the scope of Topic 815
would continue to be measured at fair value with changes in value recognized in
net income (unless designated and effective as a cash flow hedging instrument
or as a hedge of a net investment in a foreign operation).
BC31. The Board believes that derivatives within the scope of Topic 815 do not
meet the criteria to have qualifying changes in fair value recognized in other
comprehensive income. One characteristic of a derivative instrument in the
scope of Topic 815 is that it requires no initial net investment or an initial net
investment that is smaller than would be required for other types of contracts that
would be expected to have a similar response to changes in market factors. This
characteristic distinguishes investments in debt instruments that have the
characteristics described in paragraph 21(a) from the investment that would be
required to enter into a contract that provides similar exposure to risk without
directly holding (or issuing) the asset related to the underlying. Another
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characteristic of a derivative instrument in the scope of Topic 815 is that it has a
notional amount or payment provision. For most derivatives, the notional amount
does not change hands as part of the contract. Some derivatives (such as cross-
currency swaps) involve a two-way exchange. In developing the criteria in
paragraph 21(a) for instruments that may have qualifying changes in fair value
recognized in other comprehensive income, the Board contemplated debt
instruments that involve a one-way exchange of principal rather than no
exchange or a two-way exchange as would occur for a derivative. Therefore, the
Board decided that derivatives included within the scope of Topic 815 would
continue to be subject to its recognition, measurement, presentation, and
disclosure requirements, subject to any specific changes to those requirements
resulting from the proposed guidance.
Financial Instruments That Are Excluded from the Scope of

Topic 815 by a Scope Exception
BC32. This section (paragraphs BC32–BC43) discusses certain exceptions
from the scope of Topic 815 for derivative instruments related to the following
and the Board’s decisions about whether such instruments should be excluded
from the scope of the proposed guidance:
a. Regular-way security trades
b. Certain contracts that are not traded on an exchange
c. Derivatives that prevent sale accounting
d. Investments in life insurance
e. Certain investment contracts
f. Contracts between an acquirer and seller to enter into a business
combination at a future date
g. Forward purchase contracts for the reporting entity’s shares that
require physical settlement.
Regular-way security trades and trade date versus settlement date

accounting
BC33. Existing U.S. GAAP has no requirement for an entity to consistently

recognize security purchases and sales at the trade date or settlement date.
Some transfers of securities are recognized as of the trade date, the date the
entity agrees to purchase or sell the securities, while others are recognized as of
the date the securities are actually transferred and the transaction is settled. For
entities operating in certain industries (for example, brokers and dealers in
securities and investment companies), security trades are required to be
recognized as of the trade date.
BC34. The Board considered that, while IFRS permits an entity to recognize
purchases and sales of securities at either the trade date or the settlement date,
117
if settlement date accounting is used, IAS 39 requires recognition of changes in
fair value of a purchased security between trade and settlement dates. More
specifically, between the trade date and the settlement date, although the asset
is not yet recognized, the entity is required to account for changes in its fair value
on the basis of the classification of the acquired asset once it is recognized (that
is, changes in fair value are recognized in profit and loss for assets classified as
fair value through profit and loss, in other comprehensive income for assets
classified as available for sale, and not recognized for assets carried at
amortized cost).
BC35. The Board decided not to address the issue of the trade date versus the
settlement date as part of the proposed guidance. Board members see merits to
both trade date and settlement date accounting. Board members acknowledged
that if the financial instrument is recognized at the trade date, any changes
between the trade date and the settlement date would be recognized according
to the classification of the financial instruments. In that case, if a substantial
security trade occurs before a reporting date but is not settled until after the
reporting date, under settlement date accounting the transfer of risk associated
with that security trade is not properly reflected in the financial statements. Board
members also acknowledge that for practical reasons, settlement date
accounting should be permitted. Board members observed that the period
between the trade date and the settlement date is very short for regular-way
security trades. The Board decided not to require a change to the existing
practice of recording security trades at the trade date or the settlement date. The
Board also decided to provide a scope exception from the proposed guidance for
forward contracts in regular-way security trades.
Certain contracts that are not traded on an exchange
BC36. Topic 815 provides a scope exception for contracts that are not
exchange-traded if the underlying is any of the following:
a. A climatic or geological variable
b. The price or value of a nonfinancial asset or liability of one of the
parties to the contract provided that the asset is not readily
convertible to cash
c. Specified volumes of sales or service revenues of one of the parties
to the contract.
BC37. Those instruments would meet the definition of the term financial
instrument if they are settled either in cash (including net cash settlement) or by
delivery of another financial instrument, even though the underlying (that is, the
reference price or index used to compute the gain or loss on the contract) may
be nonfinancial in nature. However, the Board believes that although these
contracts do not meet the definition of an insurance contract, they are similar to
an insurance contract. Insurance contracts are excluded from the scope of the
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proposed guidance. Therefore, the Board decided to provide a scope exception
for those instruments from applying the proposed guidance.
Derivatives that prevent sale accounting
BC38. Certain derivatives may prevent sale accounting under Topic 860. For
example, a call option that enables a transferor to repurchase transferred
financial assets can cause the transfer not to meet a criterion for sale accounting.
Topic 815 provides a scope exception for derivatives that prevent one party to a
transaction from achieving sale accounting under Topic 860. Accounting for the
derivative would effectively measure changes in the value of the transferred
assets twice because the holder continues to recognize in its financial statements
the assets that it has the option to purchase. Therefore, consistent with the
reason those derivatives were originally excluded from Topic 815, the Board
decided to provide a scope exception from the proposed guidance for derivative
financial instruments that would prevent sale accounting.
Investments in life insurance
BC39. Topic 815 provides a scope exception for a policyholder’s investment in

a life insurance contract or a life settlement contract that is accounted for under
Subtopic 325-30 on investments. The Board believes that investments in life
insurance contracts also should be excluded from the scope of the proposed
guidance because the contracts have an insurance element. Such contracts
generally are purchased for funding purposes, for example, to fund deferred
compensation agreements or postemployment death benefits, and the entity
purchasing life insurance is either the owner or beneficiary of the contract. The
Board determined that it would be inappropriate to address policyholder
accounting as part of this project. Furthermore, the Board understands there may
be significant practical issues about the measurement of these contracts at fair
value.
BC40. However, the Board believes that life settlement contracts do not have a
direct insurance element. These contracts do not involve an insurable interest,
and the investor is not a policyholder. The Board decided that life settlement
contracts should be included in the scope of the proposed guidance. The Board
observed that requiring fair value measurement would, in effect, eliminate the
option to use the investment method described in Subtopic 325-30.
Certain investment contracts
BC41. Investment contracts held by entities included within the scope of the
guidance on defined benefit pension plans in Topic 960 are excluded from the
scope of Topic 815. The Board observed that these investment contracts also
should be excluded from the scope of the proposed guidance to be consistent
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with its previous decision to exclude employers’ and plans’ obligations for
pension benefits and related assets as defined in Topics 960, 962 on defined
contribution pension plans, and 965 on health and welfare benefit plans. The
Board noted that, from the issuer’s perspective, these contracts are included in
the scope of the proposed guidance.
Contracts between an acquirer and a seller to enter into a business

combination at a future date
BC42. A scope exception for contracts between an acquirer and a seller to

enter into a business combination at a future date was added to Topic 815 as a
result of the issuance of FASB Statement No. 141 (revised 2007), Business
Combinations. The Board decided that for those contracts, a scope exception
would be necessary to preserve the objective of the guidance related to business
combinations to value all forms of consideration transferred on the date that the
assets acquired and liabilities assumed. Therefore, the Board decided to provide
a scope exception from the proposed guidance for financial derivative contracts
between an acquirer and a seller to enter into a business combination at a future
date.
Forward purchase contracts for the reporting entity’s shares that

require physical settlement
BC43. Forward contracts that require settlement by the reporting entity’s

delivery of cash in exchange for the acquisition of a fixed number of its equity
shares are excluded from the scope of Topic 815 on derivatives and hedging.
Those forward contracts are currently accounted for under Topic 480 on
distinguishing liabilities from equity. Those contracts were excluded from the
scope of Topic 815 because, as discussed in paragraph B27 in the basis for
conclusions of FASB Statement No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity, the Board rejected
the view that forward purchase contracts that must be physically settled by
delivering cash should be reported like other derivative instruments. The Board
concluded in that Statement that the unconditional obligation should result in
recognition of a liability that, like many other liabilities that require cash
payments, should be subsequently measured at the present value of the full
repurchase price, if the amounts to be paid and the settlement date are fixed, or
at the (undiscounted) amounts that would be paid under the conditions specified
in the contract if the shares were repurchased at the reporting date if the
amounts or settlement date can vary. The Board decided that the specialized
measurement guidance for these forward contracts, which results in accruing to
the forward contract amount over the life of the contract, should not be changed
as part of this project. Therefore, the Board decided that such contracts should
be excluded from the scope of the proposed guidance.
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Initial Measurement
Transaction Price
BC44. The Board decided that a financial instrument subsequently measured
at fair value with all changes in fair value recognized in net income should initially
be measured at its fair value. The Board believes that because all subsequent
changes in fair value of the instrument are recognized in net income, the initial
measurement should follow the same principle; therefore, any initial gain or loss
also would be recognized in net income.
BC45. The Board decided that a financial instrument for which qualifying
changes in fair value are recognized in other comprehensive income should
initially be measured at its transaction price. The Board observed that this would
result in recognizing the difference between a financial instrument’s transaction
price and its fair value (not attributable to other elements in the transaction) in
other comprehensive income upon the first remeasurement to fair value. The
Board believes this is most consistent with recognizing subsequent changes in
fair value for these financial instruments in other comprehensive income.
BC46. The Board observed that in many cases, the transaction price will equal
the exit price and, therefore, will represent the fair value of the financial
instrument at initial recognition. Paragraph 820-10-30-3 indicates that a
transaction price might not represent the fair value of an asset or liability at initial
recognition if any of the following conditions exist:
a. The transaction is between related parties.
b. The transaction occurs under duress or the seller is forced to accept
the price in the transaction. For example, that might be the case if the
seller is experiencing financial difficulty.
c. The unit of account represented by the transaction price is different
from the unit of account for the asset or liability measured at fair
value. For example, that might be the case if the asset or liability
measured at fair value is only one of the elements in the transaction,
the transaction includes unstated rights and privileges that should be
separately measured, or the transaction price includes transaction
costs.
d. The market in which the transaction occurs is different from the
market in which the reporting entity would sell the asset or transfer
the liability, that is, the principal market or most advantageous market.
For example, those markets might be different if the reporting entity is
a securities dealer that transacts in different markets, depending on
whether the counterparty is a retail customer (retail market) or
another securities dealer (interdealer market).
BC47. The Board decided that if the transaction price of a financial instrument
for which qualifying changes in fair value are recognized in other comprehensive
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income is significantly different from its fair value, and that difference is
attributable to other elements in the transaction, the financial instrument should
be measured at its fair value. This would ensure that any other elements in the
transaction or any stated or unstated rights or privileges involved in the
transaction would be accounted for properly in accordance with other applicable
U.S. GAAP.
BC48. However, the Board decided that differences between the transaction
price and the fair value of a financial instrument attributable to transaction costs
as discussed in paragraph BC46(c) or due to the market in which the transaction
occurs being different from the market in which the entity would sell the financial
asset as discussed in paragraph BC46(d) should not be considered significant
differences for the purpose of applying the initial measurement guidance. Any
differences attributable to factors other than the existence of other elements in
the transaction would be recognized in other comprehensive income upon the
first remeasurement of the financial instrument to fair value. This is consistent
with the decision that transaction costs related to financial instruments that have
qualifying fair value changes recognized in other comprehensive income be
deferred in other comprehensive income and recognized in net income over the
life of the related financial instrument. In cases in which there is a significant
difference between the transaction price and the fair value of a financial
instrument but the entity cannot reasonably identify the other element or
elements involved in a transaction, the Board decided that an entity should
recognize a day one gain or loss in net income.
BC49. The Board considered existing guidance in Subtopic 835-30 on
imputation of interest. The Board believes that the proposed guidance on initial
measurement is generally consistent with the guidance in Subtopic 835-30. The
Board decided to base the determination of whether there may be other elements
in the transaction on the existence of a significant difference between the
transaction price and fair value of a financial instrument rather than on the
concept of the stated interest rate being unreasonable as discussed in Section
835-30-25 on imputation of interest and in the initial measurement guidance for
receivables in Section 310-10-30. The Board believes that the comparison of the
transaction price and fair value of a financial instrument for this purpose is a
more robust approach and is also more consistent with the proposed
measurement guidance that is primarily based on fair value.
BC50. The Board reconsidered the exception in Section 835-30-15 for the
customary cash lending activities and demand or savings deposit activities of
financial institutions whose primary business is lending money. The Board
decided that these transactions should not be exempt from the initial
measurement principle for financial instruments.
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Transaction Costs and Fees
BC51. The Board decided that transaction costs and fees relating to financial
instruments measured at fair value with all changes in fair value recognized in
net income should be recognized as an expense in net income when incurred.
The Board believes that these transaction costs should be reflected as current-
period expenses rather than capitalized and deferred because such costs do not
directly relate to the financial asset or liability’s fair value, which is consistent with
the guidance in Topic 820.
BC52. The Board decided that certain transaction fees and costs relating to
financial instruments measured at fair value with qualifying changes in fair value
recognized in other comprehensive income should be deferred. The Board
decided that the deferred fees and costs should be limited to those loan
origination fees and direct loan as defined in Subtopic 320-10. The Board
continues to believe the statement in the basis for conclusions on FASB
Statement No. 91, Accounting for Nonrefundable Fees and Costs Associated
with Originating or Acquiring Loans and Initial Direct Costs of Leases, that the
fees and costs relating to a loan origination are integral to the lending transaction
and, therefore, should be recognized over the life of a loan. Accordingly, for
financial instruments whose qualifying changes in fair value are recognized in
other comprehensive income, the Board decided that the recognition of fees and
costs should be consistent with existing guidance in Subtopic 310-20. Therefore,
these net fees and costs would be accreted or amortized as an adjustment of
yield over the life of the financial instrument. The Board believes that deferring
these fees and costs and recognizing them in this manner would preserve net
interest margin for those financial instruments in a manner that is consistent with
existing accounting standards.
BC53. The Board believes that many of the reporting issues arising during the
current financial crisis stem from the existing mixed-attribute measurement model
for financial instruments in which the attribute used for a particular instrument
may vary depending on factors such as the nature of the entity that holds or
owes it and management’s stated purpose for holding a financial instrument. The
existing mixed-attribute measurement model prescribes different models for
similar financial instruments. Debt instruments may be measured at amortized
cost (for example, loans held for investment or held-to-maturity securities), at
lower of cost or fair value (for example, mortgage and nonmortgage loans held
for sale), or at fair value (for example, trading securities). The measurement
models for certain classes of instruments based on management’s intentions (for
example, debt and equity securities as defined in Topic 320, and mortgage loans
as defined in Topic 948) also cause differences in measurement of similar
instruments. The Board recognized at the outset that it might not be feasible to
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require the same attribute for all financial instruments in all situations, although it
should be able to at least reduce the factors or situations that result in a different
measurement attribute for particular instruments.
BC54. The Board considered the following three measurement attributes to
improve the measurement of financial instruments:
a. Fair value—defined as an exit price in Topic 820
b. Another remeasurement method—referred to as current value
c. Amortized cost.
BC55. In addition, the Board also considered two variations of fair value
measurement—one in which all changes in fair value are recognized in net
income in the period in which the change occurs and another in which qualifying
changes in fair value are recognized in other comprehensive income.
BC56. Paragraph BC3 of the Discussion Paper on reducing complexity states
that fair value is the only measurement attribute that is appropriate for all types of
financial instruments. Some investor groups have supported that view over time,
and virtually all constituents favor use of fair value for some financial instruments,
such as trading accounts. The Board also has at several times described fair
value as the most relevant attribute for financial instruments.
BC57. Fair value measurement has been a very controversial subject, one on
which many knowledgeable people hold differing and strongly held views.
Although most agree that fair value is a more relevant measure than amortized
cost for financial instruments that are part of a trading portfolio or are otherwise
held for sale, there are differences in views about using fair value for financial
instruments that are being held for collection or payment(s) of contractual cash
flows. Critics of fair value for these types of financial instruments argue that it
improperly reflects the business strategy or the way management runs the
business and that it results in misleading volatility in reporting and can misstate
underlying economic values. They also see issues about operationality and
auditability, particularly in estimating fair values for nontraded and illiquid items,
and about the effects of changes in an entity’s credit standing on the
measurement of financial liabilities. They express concerns over potential
negative effects on management’s incentives at financial institutions and on the
perceived stability of institutions and the financial system. At the same time,
many investors, financial analysts, economists, and others state that fair value is
more relevant than amortized cost even if the business strategy does not involve
the trading or sale of financial instruments. The supporters of fair value state that
fair value reflects the underlying economics better than amortized cost, that it
enhances relevance and comparability, and that it provides a better starting point
for understanding and analyzing credit risks, interest rate risks, duration
mismatches, sustainability of net interest margins, and liquidity risks. Some also
view fair value as an essential tool in proper risk management of financial
institutions and as providing an early warning system for developing problems at
institutions and across the financial system.
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BC58. The Board recognizes that there are strongly held views on both sides
of the fair value versus amortized cost debate and believes that the proposed
guidance reflects both viewpoints in the financial statements. The proposed
guidance would provide more transparent information about financial instruments
on the face of the financial statements. By continuing to reflect a “business
strategy” approach to what is recognized in net income, it enables entities to
preserve most of the current aspects of reporting net income and earnings per
share. Presenting both fair value information and amortized cost information on
the face of financial statements for instruments that are being held for collection
or payment(s) of contractual cash flows enables investors to more easily
incorporate either or both fair value and amortized cost information in their
analyses of an entity. Also, the Board believes that fair value information would
now likely be available at the time of earnings releases rather than only being
disclosed later in the notes to the financial statements for public entities. In
addition, the proposed guidance would continue to provide regulators with the
information necessary to compute regulatory capital using either fair value or
amortized cost amounts, if so desired.
BC59. The following discussion first describes the other two measurement
attributes the Board considered and their perceived advantages and
disadvantages. Then it discusses the benefits of fair value and explains the
Board’s reasons for choosing fair value as the default measurement attribute for
financial instruments, with qualifying changes in fair value recognized in other
BC60. The Board believes that the proposed classification and measurement
model would reduce the overall complexity in accounting for financial instruments
because it would simplify the existing mixed-attribute model and also would
obviate the need for a fair value option. The Board also believes that the
proposed classification and measurement model would increase
understandability, comparability, and decision usefulness of reported information
for financial instruments.
Current Value
BC61. The current value measurement method uses a discounted cash flows
technique to calculate the present value of expected future cash flows for a
financial instrument an entity intends to hold. This method excludes other,
sometimes unidentifiable, factors such as illiquidity risk and market imperfections,
addressing recent concerns about fair value measurements. The value
calculated by this method is not based on an exchange price but instead on the
basis of the cash flows in the instrument that an entity would realize through the
collection or payment of the cash flows with the counterparty to the instrument.
This method also addresses the shortcomings of the amortized cost model by
providing information in current financial reports about both the cash flows and
some components of value changes of the financial instrument as well as
eliminating the need for impairment and loan loss reserves guidance.
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BC62. Paragraph 25 of FASB Concepts Statement No. 7, Using Cash Flow
Information and Present Value in Accounting Measurements, states that the only
objective of present value, when used in accounting measurements at initial
recognition and fresh-start measurements, is to estimate fair value. Present value
should attempt to capture the elements that taken together would make up a
market price if one existed, that is, fair value. However, when Concepts
Statement 7 was written, fair value was not defined as an exit price as currently
defined in Topic 820. The current value measurement method would apply the
general concepts of present value as reflected in both Concepts Statement 7 and
Topic 820 to particular financial instruments but does not have the objective of
measuring exit price as currently specified in Topic 820.
BC63. The purpose of current value was not to create a new measurement
objective or to change the measurement objective for the present value
technique described in Concepts Statement 7, but instead to use the process in
that Concepts Statement to calculate a value for financial instruments in certain
situations in periods after initial measurement.
BC64. Paragraph 39 of Concepts Statement 7 describes the following
elements that together capture the economic differences between various assets
and liabilities:
a. An estimate of the future cash flow or, in more complex
cases, series of future cash flows at different times
b. Expectations about possible variations in the amount or
timing of those cash flows
c. The time value of money, represented by the risk-free rate of
interest
d. The price for bearing the uncertainty inherent in the asset or
liability
e. Other, sometimes unidentifiable, factors including illiquidity
and market imperfections.
The current value measurement method incorporates items (a)–(d) but excludes
item (e).
BC65. Some constituents noted that for particular financial instruments the
recent dislocated markets environment has highlighted the difficulties of
incorporating item (e) and questionable valuations resulting from including factors
in item (e).
BC66. The Board obtained feedback from users, preparers, auditors, and
others about the potential operationality and usefulness of a current value
measurement method. Although there was some support for current value, a
majority of the input received was that current value was not sufficiently defined,
resulting in wide-spread confusion about what it was meant to represent. Overall,
there was little support for its use as an alternative to either fair value or
amortized cost.
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BC67. The Board believes that to implement current value measurement, it
would need to develop a robust definition for consistent application, similar to the
exercise undertaken in defining fair value in Topic 820. The Board decided not to
undertake a project to further define current value because of the perceived
limited usefulness of current value as an alternate to fair value or amortized cost.
Therefore, the Board decided that it would consider only amortized cost as a
potential alternative to fair value measurement for financial instruments.
BC68. However, for the reasons discussed in paragraphs BC123–BC127, the
Board believes that a measurement attribute similar to current value would be
useful for core deposit liabilities. The Board decided to develop a remeasurement
approach for core deposit liabilities that incorporates the key features of current
value.
Amortized Cost
Definition of Amortized Cost

BC69. The term amortized cost has not been consistently defined in U.S.
GAAP. For example, the Master Glossary in the Accounting Standards
Codification defines amortized cost for loans in the scope of Subtopic 310-30 as:
The sum of the initial investment less cash collected less

write-downs plus yield accreted to date.
Amortized cost basis is defined as:
The amount at which an investment is acquired, adjusted

for accretion, amortization, collection of cash, previous other-
than-temporary impairments recognized in earnings (less any
cumulative-effect adjustments), foreign exchange, and fair
value hedge accounting adjustments.
BC70. Paragraph 11 of IAS 39 includes a definition of amortized cost that,
unlike the FASB’s existing definition, applies to liabilities as well as assets:
The amortized cost of a financial asset or financial liability

is the amount at which the financial asset or financial liability is
measured at initial recognition minus principal repayments,
plus or minus the cumulative amortization using the effective
interest rate method of any difference between that initial
amount and the maturity amount, and minus any reduction
(directly or through the use of an allowance account) for
impairment or uncollectibility.
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BC71. FASB Concepts No. Statement 5, Recognition and Measurement in
Financial Statements of Business Enterprises, refers to historical proceeds as the
measurement attribute for liabilities that is comparable to cost for assets, and the
related accounting method for liabilities would be amortized historical proceeds.
However, in practice, the term amortized cost often is applied to both assets and
liabilities, and both this project and other current or recent Board projects use the
term amortized cost for assets and liabilities.
BC72. The Board decided that the Master Glossary should include only one
definition of amortized cost, which should be consistent with the proposed
guidance. That definition is based on the previous definition of amortized cost
basis. The Board also decided to clarify that the definition of amortized cost
applies to both financial assets and liabilities.
BC73. In addition, the Board decided to clarify that amortized cost should not
be reduced for credit impairments (as credit impairments would be shown as a
separate line item on the statement of financial position) but would be reduced
for writeoffs of principal amounts. The definition now refers to writeoffs of the
principal amount rather than previous other-than-temporary impairments. In
addition, fair value hedge accounting adjustments have been deleted from the
definition. Those adjustments were in the previous definition because Topic 815
required them to be included in the amortized cost of the hedged item. The
hedge accounting adjustments then were amortized in net income. The
measurement attribute in the proposed guidance should be fair value, except for
financial instruments explicitly excluded from the subsequent measurement
principle in paragraph 19 by paragraphs 28–34. Fair value hedge accounting
adjustments are not needed for financial assets or financial liabilities measured at
fair value. (Also see paragraph BC235, which discusses fair value hedge
accounting adjustments for financial instruments designated as the hedged item
in a qualifying hedging relationship that continue to be measured at amortized
cost.)
Amortized Cost as a Measurement Attribute for Financial

Instruments
BC74. Under existing U.S. GAAP, the primary types of financial instruments
accounted for at amortized cost are loans not held for sale, receivables, debt
securities classified as held to maturity under Topic 320, and an entity’s own
issued debt.
BC75. Preparers have generally favored the use of amortized cost for
instruments that an entity intends to hold and realize its benefits through
collection of contractual cash flows. Amortized cost accounting recognizes
reported interest as the primary “earnings” of the entity and also places emphasis
on the timing of the realization of changes in value by the entity rather than
simply on the amount of the change in value. For example, an entity that is in the
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“spread” business is concerned about maximizing interest margin through
collection of interest income and payment of interest expense while minimizing
credit losses. Realizing temporary value changes is not the immediate goal of
that business strategy.
BC76. Some view the amortized cost method for financial instruments as
consistent with how a nonfinancial entity recognizes its profit—at the point of sale
(realization) of the value added through the manufacturing process rather than as
it builds or produces its inventory. In addition, in some situations, an entity may
be unable to realize changes in value through a mechanism other than collecting
or paying the contractual cash flow payments. For example, an entity may be
unable to transfer some types of its own debt to a third party at fair value or may
be restricted to settling it by making the contractual cash flows to the creditor.
BC77. Many contend that reporting volatility in the statement of comprehensive
income by recognizing short-term changes in fair value that an entity may never
realize is misleading and might create incentives to take short-term actions that
are not in its best interest over the long term. They note that use of amortized
cost avoids much of that volatility.
BC78. The primary perceived disadvantages of amortized cost can be
summarized as follows:
a. Amortized cost reflects a historical transaction price that is not
relevant for current investment decisions. For example, amortized
cost does not reflect current market conditions such as interest rates
and market prices. Some argue that an entity that relies on amortized
cost measures may not fully understand the risks inherent in its
financial instruments and may lose out on certain current
opportunities as a result. Fair value would provide information about
opportunity cost because it reflects current market conditions.
b. Under amortized cost, an entity can change its intent and realize in
net income short-term changes in value. Some view the use of
amortized cost as delaying the recognition of economic gains and
losses. An entity could sell assets that are performing favorably and
hold on to underperforming assets to meet short-term market
expectations.
c. The use of amortized cost relies on complex impairment models.
Estimating impairment losses and using valuation accounts are
complicated and subjective and could create opportunities to smooth
the recognition of income.
d. Complex tainting rules may be necessary if some instruments are
measured at amortized cost and others are measured at fair value
with management’s intentions used as the basis for determining
which measurement bases should be used for a particular instrument.
BC79. The Board acknowledges that amortized cost information may be
relevant for certain financial instruments that an entity intends to hold for
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collection or payment(s) of contractual cash flows. The Board also decided to
provide an amortized cost option for financial liabilities that an entity intends to
hold for payment of contractual cash flows if measuring that liability at fair value
would create or exacerbate a measurement attribute mismatch. The Board’s
decisions on financial liabilities are discussed in paragraphs BC106–BC122
below.
BC80. In addition to the narrow amortized cost option, the Board believes that
amortized cost should be prominently displayed in the financial statements for
certain financial instruments. The basis for that conclusion is discussed in
paragraphs BC103, BC112, and BC157.
Fair Value
BC81. The Board considered two variations of a fair value measurement
basis—one in which all changes in fair value are recognized in net income in the
period in which the change occurs and one in which qualifying changes in fair
value are recognized in other comprehensive income in the period in which the
change occurs. The Board decided to provide both categories for classification of
financial instruments in the proposed guidance.
Financial Instruments Measured at Fair Value with All

Changes in Fair Value Recognized in Net Income
BC82. Supporters of fair value measurement note that it provides users with
the most realistic depiction of the market’s assessment of the present value of
net future cash flows, discounted to reflect both current interest rates and the
market’s assessment of the risks that the cash flows will not occur. Furthermore,
fair value measurement provides information to enable investors to perform real-
time assessments of management’s decisions about the allocation of resources.
Paragraph 41 in the basis for conclusions of FASB Statement No. 107,
Disclosures about Fair Value of Financial Instruments, supports the requirement
to disclose fair value information for financial instruments. It states the following:
Information about fair values better enables investors,

creditors, and other users to assess the consequences of an
entity’s investment and financing strategies, that is, to assess
its performance. For example, information about fair value
shows the effects of a decision to borrow using fixed-rate
rather than floating-rate financial instruments or of a decision to
invest in long-term rather than short-term instruments. Also, in
a dynamic economy, information about fair value permits
continuous reassessment of earlier decisions in light of current
circumstances.
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BC83. Part A of Section 3 of the Discussion Paper on reducing complexity
notes that, for instruments with highly variable cash flows (such as many
derivatives), fair value is the only measurement attribute that helps in assessing
future cash flows. Because the cash flows of highly variable instruments may be
very small at inception or otherwise not highly correlated with the ultimate cash
flows of the instrument, a cost-based measure without adjustment has no value
in the assessment of future cash flows. It further states that for instruments with
fixed or slightly variable cash flows, a cost-based measure is a feasible
measurement attribute if the instruments are held to maturity and it is highly likely
that the contractual cash flows will occur. However, there is a risk that the
contractual cash flows will not occur, necessitating the need for an impairment
model and leading to some of the same complexity that exists in practice today.
Compared with cost-based measures, the fair value of a financial instrument
better reflects the price that would be received at the measurement date. Fair
value information is more useful because events and circumstances beyond
management’s control may create a need to sell the financial instrument.
Therefore, even if management has no plans to sell the financial instrument, it is
useful for users of financial statements to know the potential effects of such
events and transactions, even if they are not considered highly probable by
management.
BC84. Fair value measurement is favored by many users of financial
statements as the most transparent method for measuring financial instruments.
Fair value is the measure that exposes information about the risks assumed by
an institution. The use of fair value accounting imposes market discipline
because it forces an entity to cope with current market conditions (especially in
times of market turmoil, when fair value measurement of all financial instruments
would serve as an “early warning system”). As stated in the March 2009
International Monetary Fund (IMF) Working Paper, Procyclicality and Fair Value
Accounting:
FVA [fair value accounting] that captures and reflects

current market conditions on a timely basis could lead to a
better identification of a banks’ risk profile, if better information
is provided. An earlier warning that can prompt corrective
action by shareholders, management, and supervisors allows
for a timelier assessment of the impact of banks’ risky actions
on regulatory capital and financial stability. Moreover, since
FVA should lead to earlier recognition of bank losses, it could
have a less protracted impact on the economy than, for
example, loan portfolios whose provisions for losses are
usually made when the economy is already weak. [page 9]
BC85. Similarly, in an April 17, 2008 press release, CFA Institute Centre Says
Fair Value ‘Smoothing’ Will Mask the Reality of Market Conditions and Allow
Companies to Hide Risk, the CFA Institute stated that fair value measurement is
131
essential to building a more effective risk management system. The linkage
between fair value measurement and risk management practices cited by the
CFA Institute implies that fair value measurement of financial instruments for
reporting purposes would force the discipline in managing risk, to the extent such
discipline is lacking internally for entities that assume risk through financial
instrument transactions. Specifically, the CFA Institute stated:
We strongly agree that fair value accounting and

supportive disclosures are a cornerstone to building the
infrastructure needed for a more broadly effective risk
management system. Fair value measurement of financial
instruments will ultimately provide the market data necessary
for best-in-class risk management, by requiring companies to
more fully understand their risk profiles and communicate this
to investors and other providers of capital on a timely basis.
BC86. Today’s accounting framework for financial instruments is a mixed-

attribute model, meaning that there are multiple measurement attributes used for
financial instruments based on certain characteristics of the financial instruments,
such as their nature, legal form, or business purpose. In addition, because
financial instruments are not accounted for uniformly, the scope of existing
standards may cause economically similar instruments to be accounted for
differently. Users of financial statements need to understand not only the detailed
requirements and interaction of numerous standards, but also the existence of
elections available for certain financial instruments. Such elections may create a
lack of uniformity in accounting for classes of financial instruments.
BC87. Paragraph 33 of FASB Concepts Statement No. 1, Objectives of
Financial Reporting by Business Enterprises, states that “the role of financial
reporting requires it to provide evenhanded, neutral or unbiased information.” It
also states that it is not a function of financial reporting to try to determine or
influence the outcomes of the decisions of investors, creditors, and others who
make capital formation decisions. A fair value model is not dependent on
management’s intentions, realization, or other actions of the entity for timing and
measurement of gains and losses in value. As such, it removes the accounting
consequences of actions from the decision-making process of both investors and
management.
BC88. In a mixed-attribute model, management must weigh the accounting
consequences of its actions, in addition to the economic consequences. This can
limit management’s flexibility in responding to changes in the economic
environment in which the entity operates. For example, it may be in an entity’s
best interest to sell certain assets that were previously held to maturity. However,
management must consider either the gain or loss that would result from selling
an asset previously measured at amortized cost as well as the tainting that would
result from such an action.
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BC89. As noted earlier, virtually all constituents agree that at least some
financial instruments should be measured at fair value with all changes in fair
value recognized in net income. Specifically, virtually all constituents agree that
financial instruments included in an entity’s trading portfolio should be measured
at fair value with all changes in fair value recognized in net income. The same
cannot be said for any other measurement attribute, whether amortized cost,
current value, or any other measurement used or contemplated.
BC90. In light of all the factors noted, the Board concluded that fair value with
all changes in fair value recognized in net income should be considered the
default measurement for financial instruments. That is, a financial instrument
should be measured at fair value at each reporting date unless conceptual or
practical factors indicate that another attribute (that attribute would be amortized
cost in the proposed guidance) would provide additional relevant and more
representationally faithful information to investors and other capital providers.
Financial Instruments Measured at Fair Value with

Qualifying Changes in Fair Value Recognized in Other
Comprehensive Income
BC91. The Board concluded that certain changes in the fair values of some
financial instruments should be recognized in other comprehensive income. The
Board also concluded that an exception to fair value as the measurement
attribute should be made for certain financial liabilities. The reasons for that are
discussed in paragraphs BC117–BC127. The following paragraphs discuss why
the Board decided that qualifying changes in the fair value of financial
instruments may be recognized in other comprehensive income.
BC92. The Board’s decision to allow certain financial instruments to be
comprehensive income reflects an acknowledgment of the merits of both sides of
the fair value accounting debate. The Board concluded that it is not possible to
resolve that debate to everyone’s satisfaction at this time. Both sides make
reasonable points. Therefore, the Board decided that:
a. An entity should be required to report in its statement of financial
position the amortized cost as well as the fair value of financial
instruments for which qualifying changes in fair value are recognized
b. Certain changes in the fair value of financial instruments that satisfy
particular criteria may be recognized in other comprehensive income
rather than in net income.
BC93. The Board discussed various criteria to determine which financial
instruments should be eligible to recognize qualifying changes in fair value in
other comprehensive income. The Board decided that there should be two
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criteria for a financial instrument to be eligible to have qualifying changes in fair
value recognized in other comprehensive income—one related to the business
strategy employed for the instrument and one related to the characteristics of the
instrument itself. The Board believes that it would be insufficient to classify
financial instruments based on only one criterion.
Characteristics of the instrument
BC94. The Board believes that the characteristics of a financial instrument are
an important factor when deciding how to classify financial instruments. The
Board notes that the only way to realize the value of an equity security is to sell it.
However, the value of a debt security can be realized by holding the instrument
until maturity or a substantial portion of the life of the security, at which time the
fair value starts approaching par value. Therefore, the Board decided that in
order to qualify for certain changes to be recognized in other comprehensive
income, the financial instrument must be a debt instrument because the Board
believes that only for debt instruments could unrealized gain and loss reverse if
the instrument is held for collection or payment of contractual cash flows. This
decision would require equities and derivatives to be measured at fair value with
all changes in fair value recognized in net income because these instruments
only realize value by sale or settlement in a variable amount of cash. The
proposed classification decision on derivatives would be consistent with the
guidance in Topic 815.
BC95. The Board also believes that financial instruments subject to significant
prepayment risk should be measured at fair value with all changes in fair value
recognized in net income. To achieve that result, the Board decided to include in
the classification criteria the notion that the debt instrument cannot contractually
be prepaid or otherwise settled in such a way that the creditor (investor) would
not recover substantially all of its initial investment, other than through its own
choice according to the contract.
Business strategy of the entity
BC96. The Board refers to a business strategy as how an entity achieves its
business purpose. That is, a business strategy is how an entity uses the financial
instrument rather than management’s intentions for its use. It is a top-down
approach to management’s intentions in which management decides how to use
the entity’s assets and liabilities within the business strategy to achieve its
business purpose. Management’s intent is an application of the business strategy
to individual financial instruments. Both terms refer to management’s intended
manner of realizing the value of the financial instrument or its intended means of
settling financial instruments. At a high level, management determines how to
use assets and liabilities by deciding whether to sell assets and transfer liabilities
or whether to settle them through the receipt or delivery of the contractual cash
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flows on the basis of the terms of the agreement with the counterparty.
Management’s intentions related to the use of the entity’s assets and liabilities
provides management’s view of the utility of those financial instruments in
attaining the overall business purpose of the entity.
BC97. The Board believes that it is appropriate to distinguish between financial
instruments that an entity is trading or otherwise holding for sale and financial
instruments that are part of an entity’s long-term asset-liability management or
investment activities. The Board believes that fair value changes for financial
instruments that an entity intends to hold for collection or payment of cash flows
potentially will reverse during the life of the instrument and, therefore, should be
recognized in other comprehensive income. The Board believes that for financial
instruments that an entity intends to trade, the fair value changes are realized in
the near term and should be immediately reflected in net income. The Board also
decided not to require detailed guidelines about assertions of intent, holding
periods, and so forth, but rather to convey a principle that such instruments
should be held as part of a longer term business activity in which sales are
infrequent, therefore, eliminating the current tainting notion.
BC98. The Board also believes that asset-liability management is core to the
business strategy and analysis of financial institutions. The effects of changes in
market variables affect valuations of both financial assets and financial
obligations. Accordingly, like financial assets in the proposed model, many
financial liabilities of financial institutions would be measured at fair value (with
amortized cost also being presented for all financial liabilities). In addition, core
deposit liabilities would be remeasured each period using a current value method
that reflects the economic benefit that an entity receives from this lower cost,
stable funding source. Thus, under the proposed model for a financial institution,
the effects would be transparent on both core deposits and other financial
liabilities and the financial assets they fund as market interest rates change.
Classification and measurement
BC99. The Board believes that the approach to allow qualifying changes in fair
value for eligible financial instruments to be recognized in other comprehensive
income with the requirement to disclose the amortized cost for these financial
instruments would provide information on both:
a. Management’s expectations and intentions about how and when the
entity will realize the cash flows associated with the entity’s financial
instruments
b. The current changes in fair value of an entity’s financial instruments.
BC100. The Board believes that recognizing qualifying changes in fair value for
financial instruments for which an entity’s business strategy is to hold for
collection or payment of contractual cash flows in other comprehensive income
also would enable entities to preserve most of the traditional concept of net
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income (including net interest margin) and earnings per share. Also, the Board
believes that (a) information about the realization of cash flows is important for
financial instruments an entity intends to hold for collection or payment(s) of
contractual cash flows and (b) amortized cost would provide information on
current-period cash flow realizations in net income. The Board believes that the
portion of the change in fair value that is recognized in other comprehensive
income would provide additional information by indicating either (a) the gains or
losses that may be realized if the financial instruments cannot be held to
collection or payment(s) of contractual cash flows or (b) the amount of
opportunity gain or loss if the financial instruments are held to collection or
payment(s) of contractual cash flows. The fair value also would provide users
with the best available information of the market’s assessment of an entity’s
expectation of its future net cash flows, discounted to reflect both current interest
rates and the market’s assessment of the risk that the cash flows will not occur.
BC101. The Board also believes that amortized cost measurement with
recognition of impairment based on a probable threshold provides insufficient
warning to investors and regulators about when asset prices are declining and
when risk levels for financial institutions are increasing and, therefore, decided to
remove this threshold. The Board believes that the qualifying changes in fair
value recognized in other comprehensive income would provide additional
information to investors and regulators about interest rate sensitivities and
current market conditions.
BC102. The Government Accounting Office (GAO) issued its April 22, 1991
Report to Congressional Committees, “Failed Banks: Accounting and Auditing
Reforms Urgently Needed,” on 39 failed institutions that accounted for 80 percent
of the losses incurred by the bank insurance fund during 1988 and 1989
associated with the savings and loan crisis. When the institutions were put in
receivership, FDIC investigators determined that these institutions had suffered
losses of $8.1 billion on their loan portfolios. However, up until the point of
insolvency, the banks had reported losses of just $1.3 billion in their call reports
to banking regulators. Thus, the GAO Report noted:
Accounting rules are flawed in that they allow bank

management considerable latitude in determining carrying
amounts for problem loans and repossessed collateral.
Recognizing decreases from historical cost to market value
has an adverse effect on a bank’s reported financial condition.
This gives bank management an incentive to use the latitude in
accounting rules to delay loss recognition as long as possible.
[page 6]
The Board believes that providing both amortized cost and fair value information,
in addition to changes to the proposed impairment model would increase
transparency and possibly would provide the early-warning information about
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potential credit impairments that eluded investors and regulators in past crises.
The Board believes that without fair value information, which incorporates
market’s expectations about credit losses, an equally subjective and difficult-to-
measure impairment model would be required to meet the objective of reflecting
financial assets such as loans and debt securities at the discounted net amounts
expected to be collected. The Board believes that measuring these financial
assets at fair value would decrease the complex and subjective other-than-
temporary impairment rules in existing U.S. GAAP while preserving the traditional
concept of net income and increasing transparency.
BC103. The Board also believes that requiring presentation on the statement of
financial position of both amortized cost and fair value of financial instruments for
which qualifying changes in fair value are recognized in other comprehensive
income would permit users, including bank regulators, to select the number or
numbers to which they will pay most attention. In addition, the Board believes
that it would subject both measures to equal care in measurement by preparers
and equal scrutiny by auditors. Also, the Board believes that fair value
information now likely would be available at the time of earnings releases for
public entities rather than being disclosed only later in the notes to the financial
statements.
BC104. The Board believes that hybrid financial instruments are complex
instruments with significant cash flow variability and decided that they should be
measured at fair value. The Board decided that, rather than creating a new set of
criteria to assess whether the cash flow variability of a hybrid financial instrument
was incompatible with criteria developed for measuring a financial asset at fair
income, it would instead rely on the bifurcation and separate accounting
guidance on embedded derivatives in Subtopic 815-15. The Board decided that
for hybrid financial instruments to be measured at fair value with qualifying
changes in fair value recognized in other comprehensive income, all of the
following criteria must be met:
a. The hybrid financial instrument has a debt host contract with a
principal amount and contractual cash flows.
b. The entity’s business strategy is to hold the hybrid instrument for
collection or payment.
c. The hybrid financial instrument contains no embedded derivative that
requires bifurcation and separate accounting under Subtopic 815-15.
BC105. The Board decided not to allow an entity the option to reclassify
instruments from one classification category to another from period to period.
The Board is concerned that if reclassifications were allowed, entities may
measure financial instruments that they initially elected to measure at fair value
with qualifying changes in fair value recognized in other comprehensive income
at fair value with all changes in fair value recognized in net income to recognize
gains in net income on appreciated financial assets for which an entity is not
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recognizing losses. The Board believes that if reclassifications are allowed, an
entity may manage earnings by “selling winners and holding losers.” In addition,
because the Board took a top-down approach to management’s intentions for
classification purposes, the Board believes that presenting realized gains and
losses separately on the performance statement would be sufficient for users to
evaluate management’s financial instrument activities.
Financial Liabilities
Arguments for and against fair value measurement
BC106. The Board considered whether to require a different classification and

measurement model for financial liabilities than for financial assets. The Board
considered a number of arguments for and against measuring financial liabilities
at fair value that the Board considered, including relevance, measurement
attribute mismatch, volatility, and effects of changes in an entity’s own credit risk.
BC107. An asset-liability mismatch often is cited as an argument for measuring
financial liabilities at fair value. If an entity’s financial assets are measured at fair
value but its financial liabilities are not, then the model that results would not
promote identification of duration or other mismatches. For example, during the
savings and loan crisis, entities funded long-term, fixed-interest loans with short-
term deposits. When interest rates increased, the entities had to pay higher
interest on their deposits than they were receiving on their loans. If only the loans
were measured at fair value, financial statement users would be provided with
information about how the loans react to changes in interest rates but would not
be provided with information about how well or how poorly management has
economically managed that exposure with its liabilities.
BC108. An asset-liability mismatch also has been used as an argument against
recognizing financial liabilities, particularly long-term debt, at fair value. An entity
may have significant unrecognized assets, such as internally developed
intangible assets. Changes in the fair value of an entity’s long-term debt may
reflect changes in the value of those assets that the entity has not recognized or
changes in the value of assets that are not financial assets and, therefore, are
not recognized at fair value, such as recognized intangible assets and productive
assets. If all financial assets are recognized at fair value, with changes
recognized in either net income or other comprehensive income, measuring
financial liabilities at fair value would offset the volatility resulting from valuing
financial assets at fair value. However, if an entity has significant unrecognized
assets or nonfinancial assets that are not measured at fair value, measuring
financial liabilities at fair value may increase volatility.
BC109. A significant concern that constituents have raised about recognizing
financial liabilities at fair value relates to changes in fair value attributable to
changes in an entity’s own credit risk. When changes in an entity’s own credit
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risk are reflected in the measurement of a financial liability, an entity recognizes a
gain from a decrease in its own credit risk and a loss for an increase in its own
credit risk. Many constituents have stated that recognizing a gain due to a
decrease in credit risk is misleading and inappropriate, because an entity often
lacks the ability to realize such gains. Additionally, constituents who oppose
recognizing changes in fair value related to changes in an entity’s own credit risk
note that changes in an entity’s own credit risk are likely to be offset by changes
in unrecognized intangible assets or assets that are not recognized at fair value.
BC110. Constituents who favor measuring all financial liabilities at fair value
note that recognizing a financial liability at fair value, including changes
attributable to an entity’s own credit risk, provides information about effective
interest rates and likely refinancing requirements. Those constituents note that
the Discussion Paper on reducing complexity provides arguments for why an
unrealized gain should be recognized on a financial liability when negative things
happen. Paragraph 3.74 (a)–(d) of the Discussion Paper on reducing complexity
notes the following:
(a) The liability is a contract between two entities. Generally,

when circumstances change that result in one entity
incurring a loss, it might be expected that the other party
will have a gain. That leads to a conclusion that, when a
lender recognises a loss, the borrower should recognise a
gain.
(b) A financial liability’s fair value on initial recognition reflects
its credit risk. It seems inconsistent to include credit risk in
the initial fair value measurement of a financial liability but
not in the subsequent measurement of the financial
liability.
(c) The apparent gain does not occur in a vacuum. The
reason why a borrower is unable to pay is that it has
suffered losses or expects to have shortfalls in profits. If
those losses are fully recognised in the financial
statements of the borrower, the amount of the losses is
likely to exceed the amount of gain arising from a
decrease in the fair value of the liability. However, not all
of the losses or shortfalls are recognised in financial
statements. For example, losses arising from decreases in
value of unrecognised intangible assets are not
recognised. The gain on the liability might provide a signal
to users of the borrower’s financial statements that
unrecogised losses or shortfalls have been incurred.
(d) Equity holders of an entity are not required to make any
additional investment to cover losses incurred by the entity
except to the extent that the equity holders have a binding
obligation to do so. However, when the credit risk of an
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instrument increases, the lender might suffer a loss.
Therefore, the apparent gain to the borrower can be seen
as an allocation of deficits from the owners of the borrower
to the lender.
BC111. The Board believes that there is merit to both the arguments for and the
arguments against measuring financial liabilities at fair value. However, the
Board decided that fair value would be a more appropriate measurement
attribute than cost in situations in which the majority of an entity’s assets are
measured at fair value.
BC112. Additionally, the Board believes that its presentation decisions for
certain types of financial liabilities, which would permit changes in the fair value
to be recognized in other comprehensive income while requiring that current-
period interest expense accruals to be recognized in the net income, maintains
an emphasis on the timing and method of realization that the entity employs in its
business.
BC113. The Board considered an alternative measurement approach for
financial liabilities with principal amounts held for payment of contractual cash
flows that would have involved subsequently measuring those financial liabilities
at a current value that ignores changes in an entity’s own credit risk. The Board
rejected that alternative because it would have added complexity by introducing
another measurement attribute. Additionally, the Board believes that measuring
financial liabilities at an “adjusted” fair value excluding credit would continue to
contribute to asset-liability mismatches in situations in which the majority of an
entity’s assets are measured at fair value. Also, the Board believes that using this
alternative measurement attribute to measure financial liabilities would not
appropriately reflect equity.
BC114. The Board considered whether to retain existing bifurcation
requirements for financial liabilities with embedded derivatives that otherwise
would require bifurcation in accordance with Subtopic 815-15 that are held for
payment of contractual cash flows, so that the host would be measured at fair
income (or potentially at amortized cost if measurement at fair value would create
a measurement attribute mismatch). Retaining existing bifurcation requirements
would limit the effects of changes in an entity’s own credit risk recognized in net
income to derivatives. Instead, changes in the entity’s own credit risk related to
the host would be recognized in other comprehensive income or would not be
recognized if the liability qualified for the amortized cost option. However, the
Board decided not to retain existing bifurcation requirements for financial
liabilities because of the complexity involved in bifurcating a financial liability
between the host and derivative feature and then measuring the change in fair
value of each component so that the change could be bifurcated between net
income and other comprehensive income (unless the host qualified to be
measured at amortized cost). Additionally, the Board believes that retaining
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existing bifurcation requirements for financial liabilities while eliminating the
requirements for assets would add unnecessary complexity.
BC115. The Board decided that all changes in fair value of a financial liability
with an embedded derivative that otherwise would require bifurcation in
accordance with Subtopic 815-15 should be recognized in net income even if the
liability is being held for payment of contractual cash flows. The Board believes
that the variability caused by the embedded derivative is enough to require that
changes in the fair value of these instruments be recognized in net income.
BC116. To address concerns about changes in fair value attributable to changes
in an entity’s own credit risk, the Board decided to require an entity to separately
present significant changes in fair value that are attributable to changes in the
entity’s credit standing. That decision is further discussed in paragraphs BC160–
BC165.
Amortized cost option
BC117. The Board decided that financial liabilities should be classified using the
same criteria as financial assets unless measuring the financial liability at fair
value would create or exacerbate a measurement attribute mismatch. In those
situations, an entity would be permitted to measure the financial liability at
amortized cost. The Board believes that measuring these qualifying financial
instruments at amortized cost addresses many of the concerns raised about the
volatility introduced in income from an asset-liability mismatch arising from
measuring financial liabilities at fair value when significant nonfinancial assets
are not measured at fair value.
BC118. The Board decided that an entity may irrevocably elect to measure a
financial liability at amortized cost if the financial liability meets both of the
following criteria:
a. The financial liability meets the criteria to have the qualifying portion
of the changes in its fair value recognized in other comprehensive
income.
b. Measuring the financial liability at fair value would create or
exacerbate a measurement attribute mismatch of recorded assets
and liabilities.
BC119. Measuring a financial liability at fair value would be deemed to create or
exacerbate a measurement attribute mismatch only in the following
circumstances:
a. The financial liability is contractually linked to an asset not measured
at fair value. A financial liability that is collateralized by an asset, or is
contractually required to be settled upon the derecognition of an
asset, is contractually linked to that respective asset.
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b. The financial liability is issued by and recorded in, or evaluated by the
chief operating decision maker as part of an operating segment for
which less than 50 percent of the segment’s recognized assets are
subsequently measured at fair value.
c. The financial liability meets neither item (a) nor (b) but is the liability of
a consolidated entity for which less than 50 percent of consolidated
recognized assets are subsequently measured at fair value.
BC120. The Board believes that if a financial liability is contractually linked to an
asset that is not subsequently measured at fair value (for example, a mortgage
collateralized by a building), an entity should not be required to measure the
financial liability at fair value. Additionally, the Board believes that if the majority
of the assets of an entity are not measured at fair value, the entity should not be
required to measure at fair value financial liabilities that are held for payment of
contractual cash flows that would not otherwise require bifurcation in accordance
with Topic 815. The Board considered how an entity should determine whether
the majority of its assets are measured at fair value and decided that the
determination should be based on a 50 percent quantitative test. The Board
recognizes that by allowing this assessment to be based on a simple 50 percent
majority, measurement attribute mismatches will continue to exist (for example, if
40 percent of an entity’s assets are measured at fair value, an argument could be
made that 40 percent of the liabilities should be measured at fair value).
However, the Board notes that measurement attribute mismatches cannot be
entirely avoided unless all assets and liabilities are recognized at fair value
(including intangible assets that are currently unrecognized). The Board believes
that the proposed solution would improve financial reporting.
BC121. The Board discussed at what level an entity should perform the
quantitative test. The Board decided to first perform the test at the operating
segment level. The Board acknowledges that this approach may lead to a
measurement attribute mismatch at the consolidated level, but it believes that the
results better reflect an entity’s economics in the financial statements. The Board
determined that cash should not be considered to be measured at fair value for
purposes of applying the quantitative test because there are no changes in fair
value reflected in the performance statement.
BC122. The Board considered two alternative approaches for determining when
a financial liability could be measured at amortized cost—allowing all financial
liabilities that meet the criteria to have the qualifying portion of the changes in
their fair value recognized in other comprehensive income to be measured at
amortized cost or allowing all financial liabilities that are not trading, derivative
liabilities, or obligations to return securities sold short (short sales) to be
measured at amortized cost. However, the Board believes that these alternatives
would not have met the objective to effectively and faithfully represent the extent
of asset-liability matching.
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Core deposit liabilities
BC123. The Board decided that deposits with a maturity should be measured in
accordance with the proposed classification and measurement criteria applicable
to other liabilities. The Board decided that demand deposits, however, should be
split into their core and noncore components. Demand deposits that are not
considered core demand deposits would be valued at fair value, which the Board
believes is reasonably close to their face amount because of the short-term
nature of these deposit liabilities. The Board believes that core demand deposits
should be remeasured equal to the present value of the average core deposit
amount discounted at the difference between the alternative funds rate and the
all-in-cost-to-service rate over the implied maturity of the deposits. Many
constituents have noted that core deposits often are the main source of value for
a financial institution, and the Board believes that this remeasurement approach
for core demand deposits would demonstrate how interest rates affect the core
demand deposits, which is useful information for investors in reflecting asset-
liability exposure to a duration mismatch.
BC124. The Board also considered alternative measurement approaches for
demand deposits but determined that the remeasurement approach described in
the preceding paragraph would better reflect the economics of core deposit
liabilities as a stable funding source. While the Board acknowledges that even
though a customer could withdraw their deposit on demand, there is statistical
evidence that core deposit liabilities are held for longer time periods that are
reasonably predictable and relatively insensitive to interest rate conditions.
Additionally, the Board notes that the fair value of core deposit liabilities would
require measurement of significant nonfinancial components, for example, the
customer relationship. In contrast, the remeasurement approach proposed would
be focused on capturing the benefits associated with the liability that relates to its
value as a cheaper source of funding without considering the other intangible
benefits.
BC125. Present values reflecting remeasurement assumptions can be
significantly lower than the face value of the deposits. In support of such
valuations, financial institutions commonly buy and sell deposit liability accounts
at discounts; that is, a buyer will assume deposit liabilities in exchange for a
cash-equivalent amount that is less than their face value. In addition, financial
statement users would have better information to identify an asset-liability
funding mismatch and be able to more accurately analyze the funding base of an
institution with management’s own estimates.
BC126. Because the proposed guidance would not require a fair value
measurement for demand deposits, the proposed remeasurement approach
would represent an exception to the guidance in Concepts Statement 7, which
establishes that the objective of a present value technique is to measure fair
value. The proposed remeasurement approach would use the entity’s own
assumptions based on all information available to the entity. Those assumptions
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should consider all relevant facts and circumstances and, if applicable, be
consistent with information tracked and monitored through the entity’s asset-
liability management activities and used to assist in making operational
decisions.
BC127. The Board concluded that the average core deposit should be
cost-to-service rate over the implied maturity of the deposits. This calculated rate
would capture the value, if any, of the cost savings attributable to core demand
funds.
Application of Proposed Guidance to Specific Financial

Instruments
Loan commitments
BC128. The scope of the proposed guidance includes commitments to originate

and purchase loans. The Board understands that measuring all loan
commitments at fair value would be a significant change in practice for many
financial institutions that issue loan commitments. Topic 815 requires only those
loan commitments issued to originate mortgage loans that will be held for sale to
be accounted for as derivatives under Topic 815 and measured at fair value.
BC129. The Board discussed whether to require an entity that issues loan
commitments to recognize changes in fair value of the commitment in net income
or whether qualifying changes in fair value could be recognized in other
comprehensive income if the related funded loan would meet the criteria to have
Some Board members believe that conceptually, it would be appropriate to
account for loan commitments and other written options in a similar manner. The
Board considered the similarities between loan commitments and written options
and whether it would be appropriate to account for both as derivatives under
Topic 815. The Board determined that evaluating whether various types of loan
commitments meet the definition of a derivative under Topic 815 would create
complexity and could lead to potentially different outcomes for different types of
loan commitments. Therefore, the Board decided not to rely on a broader
application of the definition of a derivative to determine the method of accounting
for loan commitments.
BC130. The Board decided that the classification of the loan commitment should
be consistent with the classification of the related loan that would be funded
through exercise of the commitment. The Board believes that loan commitments
are integral to the funded loans. Therefore, for purposes of classifying loan
commitments under the proposed guidance in paragraph 25, the Board decided
that loan commitments should be classified on the basis of the business strategy
for the underlying borrowing.
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BC131. The Board decided that the original commitment fee should not be
separately recognized from other changes in fair value of the loan commitment
during the commitment period. The Board acknowledges that this pattern of
recognition of the fee differs from the Board’s decision on the accounting for
transaction costs and fees related to financial instruments with all changes in fair
value recognized in net income that fees and costs should be recognized in net
income at the date of initial recognition of the financial instrument.
BC132. The Board decided that under certain circumstances, fees received for a
commitment to originate a loan or establish a line of credit should be recognized
in net income in a manner that is generally consistent with the guidance in
Subtopic 310-20. For example, the Board decided that if a loan commitment
would result in funding a term loan that meets the criteria for recognition of
qualifying changes in fair value in other comprehensive income, the commitment
fee would be deferred in other comprehensive income until a loan is funded, at
which time, the commitment fee would be recognized in net income as an
adjustment of the yield on the loan. The Board observed that this would be most
consistent with the decision to preserve the treatment under Subtopic 310-20 of
non-refundable fees and costs as yield adjustments for financial instruments that
meet the criteria to report qualifying changes in fair value in other comprehensive
income.
BC133. The Board observed that an entity should apply the existing framework
in Topic 820 to measure the fair value of loan commitments that are within the
scope of the proposed guidance. In general, if Level 3 inputs are used in the
valuation of a loan commitment, an entity should consider, among other things,
inputs such as interest rates, credit risk of the borrower, costs of maintaining
availability of funds during the commitment period, and the probability that the
loan commitment will result in a drawn loan.
BC134. The Board considered implementation issues that could be encountered
by issuers in measuring certain types of loan commitments at fair value.
Conceptually, the Board believes that for potential lenders, all types of loan
commitments should be included within the scope of the proposed guidance.
However, the Board decided for practical reasons to provide a scope exception
for lines of credit under credit card arrangements, considering the generally small
balances of the associated credit card receivables, the revolving nature of these
lines of credit, and the high volume of these lines of credit and related
receivables. Therefore, credit card fees would continue to be accounted for under
Subtopic 310-20.
BC135. The Board considered specific implementation challenges that could be
encountered by potential borrowers. Conceptually, the Board believes that the
accounting for loan commitments by potential borrowers and potential lenders
should be symmetrical. However, the Board understands that it may be
impracticable for many borrowers to measure purchased loan commitments at
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fair value. Therefore, the Board decided to provide a scope exception for holders
of loan commitments (potential borrowers).
BC136. The Board decided to provide a delayed effective date up to 4 years
after the original effective date of certain provisions in the proposed guidance for
a nonpublic entity with less than $1 billion in total consolidated assets. In the
interim period, a nonpublic entity with less than $1 billion in total consolidated
assets should measure at amortized cost those loans that would meet the criteria
to recognize qualifying changes in fair value in other comprehensive income. To
be consistent with the delayed transition, the Board decided to permit the entity
to account for loan commitments issued during the interim period under existing
accounting guidance within Subtopic 310-20. In addition, the Board intends to
perform a post-implementation review two or three years after the effective date
and address any issues identified.
BC137. The Board decided that once the proposed guidance is effective, loan
commitments issued would be subject to the classification, measurement, and
disclosure proposed guidance and that no loan commitments would be subject to
the guidance in Topic 815. The Board believes that eliminating loan
commitments from the scope of Topic 815 would reduce complexity.
Standby letters of credit
BC138. The Board decided that a standby letter of credit would be accounted for
in a manner consistent with the Board’s decision on loan commitments because
a standby letter of credit has similar characteristics as a loan commitment such
as the obligation to fund the loan if certain criteria are met. The issuer would
account for the instrument at fair value and classify the instrument on the basis of
the classification that would result if the standby letter of credit was funded. The
Board decided that the potential borrower under a financial standby letter of
credit should be excluded from the scope of the proposed guidance.
Interest-only and principal-only strips
BC139. An interest-only strip or principal-only strip is excluded from the scope of

Topic 815 if it has both of the following characteristics:
a. It represents the right to receive only a specified proportion of the
contractual interest cash flows of a specific debt instrument or a
specified proportion of the contractual principal cash flows of that debt
instrument.
b. It does not incorporate any terms not present in the original debt
instrument.
BC140. An allocation of a portion of the interest or principal cash flows of a
specific debt instrument to provide for a guarantee of payments, for servicing in
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excess of adequate compensation, or for any other purpose would not meet the
intended narrow nature of the scope exception.
BC141. The Board acknowledged that the scope of the proposed guidance
would include interest-only and principal-only strips and may change the
recognition and measurement of some of those instruments. Consistent with the
classification proposed guidance, an entity would be permitted to measure
financial assets at fair value with qualifying changes in fair value recognized in
other comprehensive income if the entity’s business strategy is to hold the
instrument for collection of contractual cash flows and the additional criteria
related to cash flow characteristics of the instrument were satisfied. One
qualifying criterion discussed in paragraph 21(a)(3) is that the debt instrument
could not be contractually prepaid or otherwise settled in such a way that the
holder would not recover substantially all of its initial investment, other than
through its own choice. The Board believes that the consequence of applying the
criterion in paragraph 21(a)(3) is that a nonprepayable interest-only strip could
potentially meet the criteria in paragraph 21 to have qualifying changes in fair
value recognized in other comprehensive income, but prepayable interest-only
strips could not qualify for that treatment.
Contingent consideration arrangements
BC142. The Board believes that all contingent consideration arrangements

would be within the scope of the proposed guidance, unless they are specifically
excluded, because they would meet the definition of a financial instrument, which
encompasses all contractual rights and obligations that are financial assets and
liabilities, even those that are contingent on a specified event.
BC143. Topic 805 specifies the accounting for contingent consideration for the
acquirer in a business combination. Specifically, if contingent consideration is
classified as an asset or a liability, Topic 805 requires that it be remeasured to
fair value at each reporting date until the contingency is resolved. The changes in
fair value are recognized in net income (unless the arrangement is a hedging
instrument for which Topic 815 requires the changes to be initially recognized in
other comprehensive income). Therefore, the accounting for contingent
consideration by the acquirer in a business combination would not change as a
result of the proposed guidance.
BC144. Statement 141(R) eliminated the scope exception in Topic 815 for
contingent consideration issued in business combinations. Therefore, contingent
consideration arrangements that meet the definition of a derivative are measured
at fair value by both the acquirer and the seller with all changes in fair value
BC145. For contingent consideration arrangements accounted for by the seller
in a business combination and by both the acquirer and the seller in an asset
acquisition that do not meet the definition of a derivative, the Board decided that
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only those arrangements that are based on an observable market or observable
index should be within the scope of the proposed guidance. For example, a
requirement to make a payment on the basis of a specified level of future sales of
a product would not be subject to the requirements of the proposed guidance.
However, a requirement to make a payment on the basis of the observable share
price of the acquirer would be within the scope of the proposed guidance.
BC146. The Board acknowledges that including all contingent consideration
arrangements within the scope of the proposed guidance would result in
consistent accounting for all contingent consideration arrangements by both the
acquirer and the seller in a business combination or asset acquisition. However,
some Board members were concerned about the ability of a seller to reasonably
estimate fair value of such an arrangement that is not based on an observable
market or an observable index, because the seller may not have access to the
information necessary to make an estimate on a regular basis. Additionally, the
Board notes that there are other significant differences in the accounting for
business combinations and asset acquisitions, including the accounting for
transaction costs, goodwill, and in-process research and development. The
Board notes that the purpose of this project is not to address those differences
and decided that existing practice should continue for accounting for contingent
consideration arrangements in asset acquisitions unless the arrangement is
based on an observable market or observable index.
Short-term receivables and payables
BC147. The Board considered whether receivables and payables arising in the
normal course of business that are due in customary terms not exceeding one
year (excluding short-term lending arrangements, such as credit card
receivables, and short-term debt securities) for which an entity’s business
strategy is to hold the instrument for collection or payment of contractual cash
flows should be included within the scope of this project. The Board proposed
that they should be within the scope of the proposed guidance; however, such
instruments would be measured at amortized cost (plus or minus any fair value
hedging adjustments). The Board provided this practicability exception for cost-
benefit reasons because it believes that for these instruments, amortized cost
often would approximate fair value. The Board also noted that these instruments
would still be subject to the impairment model.
Investments that can be redeemed only for a specified maximum

amount
BC148. The Board considered whether particular types of investments that are
not held for purposes of capital appreciation and can be redeemed with the
issuer only for a specified maximum amount should be included within the scope
of the proposed guidance. The Board decided that an entity should subsequently
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measure such an investment at its redemption value if the investment exhibits
the following four characteristics:
a. It does not have a readily determinable fair value because ownership
is restricted and it lacks a market.
b. The holder must own the instrument in order to engage in
transactions or participate in activities with the entity or organization.
c. The investment cannot be exited at an amount greater than the initial
investment.
d. The investment is not held for capital appreciation. Rather, the
investment is held for other benefits, such as access to liquidity or
assistance with operations.
The Board proposed that those investments should be measured at redemption
value because this would approximate fair value. The Board believes these
instruments would include stock in the Federal Home Loan Bank System, stock
in the Federal Reserve Banks, National Credit Union Share Insurance Fund
Deposits, and investments in certain agricultural cooperatives.
Presentation
BC149. The Board decided that it is important for users to distinguish between
reported amounts for financial instruments measured at fair value with all
changes in fair value recognized in net income and reported amounts for
financial instruments measured at fair value with qualifying changes in fair value
recognized in other comprehensive income. The Board believes that information
helps users to understand an entity’s financial position and reported performance
for the period. It also provides predictive value in assessing future cash flows.
Therefore, the proposed guidance would require separate presentation of
financial assets and financial liabilities depending on whether the changes in their
fair value are recognized in net income or in other comprehensive income.
BC150. The Board also believes that the presentation requirements in the
proposed guidance would address differing needs of different financial statement
users and provide financial statement users with enough information so that they
would then be able to include or exclude amounts when they are analyzing
financial statements of different entities.
BC151. The Board decided that an entity should present a continuous
comprehensive performance statement because of the accounting for financial
instruments model developed. The Board believes that it is necessary for users
to see the changes in fair value for all financial instruments (those measured at
fair value with all changes in fair value recognized in net income and those
comprehensive income) in one statement to get a complete picture of an entity’s
performance for the period. On October 27, 2009, the Board added a joint project
to provide guidance on comprehensive income reporting. The Board issued a
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proposed Update on comprehensive income at the same time as the issuance of
BC152. The Board decided not to require an entity to perform two earnings-per-
share calculations—one based on net income and one based on comprehensive
income. The Board believes requiring two earnings-per-share calculations would
add complexity. Additionally, the Board believes that the requirement of
presenting one statement of financial performance with total comprehensive
income and a subtotal for net income would allow users to make their own
adjustments to the earnings-per-share calculations based on net income.
Financial Instruments Measured at Fair Value with All Changes

in Fair Value Recognized in Net Income
BC153. The Board considered whether the requirements for presenting financial
instruments on the face of the statement of financial position and the statement
of other comprehensive income should be the same or different for financial
instruments measured at fair value with all changes in fair value recognized in
net income and those measured at fair value with qualifying changes in fair value
recognized in other comprehensive income. The Board decided that less detailed
requirements would be needed for instruments measured at fair value with all
BC154. Financial instruments measured at fair value with all changes in fair
value recognized in net income generally would be those that the entity holds for
a relatively short period of time for purposes other than collecting interest or
dividends on assets. Payment of a return on liabilities in that category also
generally would be a relatively insignificant part of an entity’s financial
performance. An entity also often sells or settles assets and liabilities measured
at fair value with all changes in fair value recognized in net income before their
maturity. Those factors make amortized cost information relatively insignificant to
users in making decisions in their capacity as capital providers. Accordingly, the
Board decided not to require an entity to present the amortized cost of financial
instruments for which all changes in fair value are recognized in net income, with
one exception (discussed in paragraph BC154). Not requiring presentation of the
amortized cost of instruments measured at fair value with all changes in fair
value recognized in net income also would be consistent with the requirements in
Topic 320 for securities held for trading purposes. However, the Board also
decided that it would be inappropriate to restrict the information that an entity
voluntarily provides about instruments measured at fair value with all changes in
fair value recognized in net income. The proposed guidance, therefore, notes
that an entity may present amortized cost and the amount needed to adjust
amortized cost to fair value for any or all instruments that it measures at fair
value with all changes in fair value recognized in net income.
BC155. The one exception to not providing amortized cost information for
financial instruments measured at fair value with all changes in fair value
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recognized in net income is an entity’s own debt. The amortized cost of an
entity’s own debt may have predictive value for the amount, timing, and
uncertainty of future cash flows, regardless of where in the statement of
comprehensive income changes in its value are recognized. Rating agencies and
other users of financial statements have told the Board that they want that
information, and the proposed guidance would require entities to present it.
Disclosing the amortized cost of an entity’s own debt on the face of the statement
of financial position in addition to the fair value information would give the rating
agencies and other users information about cash flows the entity is required to
pay contractually in the future.
BC156. The reasons for presenting the required information about the changes
in the fair value of financial instruments measured at fair value with all changes in
fair value recognized in net income in the statement of comprehensive income
are essentially the same as those for presenting information on the statement of
financial position. The Board has heard from users that interest received or paid
and credit losses are relatively insignificant factors for instruments for which the
business strategy is not to hold them for collection or payment of contractual
cash flows but rather to sell or settle them with a third party before maturity.
Therefore, the Board decided not to require presentation of that information. In
contrast, gains and losses are of interest to users and would be presented under
the proposed requirements. However, the Board decided that it would not restrict
an entity from disaggregating changes in fair value related to interest, dividends,
credit losses, and unrealized or realized gains and losses in the statement of
Financial Instruments Measured at Fair Value with Qualifying

Changes in Fair Value Recognized in Other Comprehensive
Income
BC157. An important reason for reporting specified components of the change
in fair value of financial instruments that are measured at fair value with
qualifying changes in fair value recognized in other comprehensive income is that
both fair value information and amortized cost information are relevant for a debt
instrument that an entity’s business strategy is to hold for collection or payment
of contractual cash flows. Therefore, the Board decided that for financial
instruments measured at fair value with qualifying changes in fair value
recognized in other comprehensive income an entity should present on the face
of the statement of financial position the amortized cost, the allowance for credit
losses for financial assets, and the accumulated amount needed to reconcile
amortized cost less allowance for credit losses to fair value on those instruments
in addition to measuring them at fair value. The Board believes that this would
enable an entity to preserve the information available to users today, while also
providing additional relevant information about the fair value of those
instruments.
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BC158. The Board decided that an entity should present separately on the face
of the statement of financial position amounts in accumulated other
comprehensive income (and allocated to noncontrolling interests, if applicable)
related to the qualifying changes in the fair value or the qualifying changes in the
remeasurement amount for financial instruments for which those changes are
recognized in other comprehensive income. The Board believes that requiring
this presentation would provide users with information about the effects of
accumulated changes in fair value and changes in the remeasurement amount
on an entity’s equity. The Board believes this proposed presentation requirement
would allow the effects of both fair value and amortized cost on an entity’s equity
and comprehensive income to be transparent to users.
BC159. The Board also decided that information about interest earned or paid
and information about credit losses during the period on financial instruments
comprehensive income are important components of an entity’s financial
performance. If an entity’s strategy is to hold a debt instrument for collection or
payment of contractual cash flows, the amount of those cash flows earned or
paid and the change in the amount of cash flows the entity does not expect to
collect—its credit losses related to financial assets—during the period would be
relevant for assessing the amounts, timing, and uncertainty of future cash flows.
The Board decided that those amounts, therefore, should be separately
presented in the statement of comprehensive income.
Changes in an Entity’s Own Credit Standing

BC160. Concerns of some of the Board’s constituents about including the effect
of changes in an entity’s own credit risk in measuring the financial performance
of financial liabilities were discussed in paragraphs BC112 and BC113. The
Board decided that an entity should present on the face of the statement of
comprehensive income significant changes in fair value of a financial liability that
are attributable to changes in the entity’s own credit standing (excluding the
change in the price of credit), disaggregated according to whether changes in the
fair value of the liability are recognized in net income or in other comprehensive
income.
BC161. The Board believes that requiring separate presentation of significant
changes in fair value attributable to changes in the entity’s own credit standing
(excluding the change in the price of credit) would address differing needs of
different financial statement users and would provide financial statement users
with the ability to include or exclude those amounts when they are analyzing
financial statements of different entities.
BC162. The Board considered whether any entities should be required to
separately present all changes in fair value attributable to a change in an entity’s
own credit standing (that is, the portion of the discount rate that is not the
benchmark/risk-free interest rate). In FASB Statement No. 159, The Fair Value
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Option for Financial Assets and Financial Liabilities (included in Subtopic 825-
10), the Board decided that for financial liabilities for which the fair value option
has been elected with fair values that have been significantly affected during the
reporting period by changes in instrument-specific credit risk, an entity should
disclose all of the following:
a. The estimated amount of gains and losses from fair value changes
recognized in net income that are attributable to changes in the
instrument-specific credit risk
b. Qualitative information about the reasons for those changes
c. How the gains and losses attributable to changes in instrument-
specific credit risk were determined.
However, the Board decided not to provide guidance about when a change in
instrument-specific credit risk is considered significant or detailed computational
guidance about how to determine the approximation of the amount of the
liability’s fair value change attributable to the change in instrument-specific credit
risk. The Board understands that, in practice, changes in instrument-specific
credit risk are generally determined on the basis of changes in the reporting
entity’s own credit spreads or credit default swap spreads. However, the
approach can vary depending on the nature of the liability.
BC163. IFRS 7, Financial Instruments: Disclosures, requires an entity to
disclose for all liabilities measured at fair value the amount of change (during the
period and cumulatively) in fair value that is attributable to changes in the credit
risk of the liability. IFRS 7 indicates that the change in fair value attributable to
credit risk can be determined in either of two ways:
a. As the amount of change in the liability’s fair value that is not
attributable to changes in market conditions that give rise to market
risk
b. Using an alternative the entity believes more faithfully represents the
amount of change in its fair value that is attributable to changes in the
credit risk of the liability.
Under IFRS 7, changes in fair value other than changes related to a change in
the benchmark rate are generally attributed to a change in the credit risk.
BC164. The Board believes that the change in fair value attributable to the
change in an entity’s credit spread does not accurately reflect the change in an
entity’s own credit because it also measures the change in the price of credit,
which affects not just the individual entity, but also other entities in the industry
and the economy. Thus, the Board decided that an entity should present
separately on the face of the statement of comprehensive income significant
changes in fair value of a financial liability that are attributable to changes in the
entity’s own credit standing, excluding the price of credit. The Board believes
such information would be meaningful to users of the financial statements
because an entity would be required to present changes in fair value related to
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changes in its credit risk only when there has been a change in the entity’s own
credit standing. Changes in the price of credit solely related to changes in market
conditions would not be presented.
BC165. The Board recognizes that there may be several different methods to
determine the change in fair value attributable to a change in an entity’s own
credit standing excluding the change in the price of credit and the proposed
guidance does not prescribe a method for determining that change.
Deferred Tax Assets

BC166. The Board concluded that the assessment of a valuation allowance for a
deferred tax asset relating to the change in fair value recognized in other
comprehensive income of debt instruments measured at fair value with qualifying
changes in fair value recognized in other comprehensive income should be
performed in combination with other deferred tax assets and liabilities of the
entity. The Board believes that deferred tax assets relating to the change in fair
value of debt instruments measured at fair value with qualifying changes in fair
value recognized in other comprehensive income should be accounted for
consistently with other deferred tax assets and liabilities recognized for items
recognized in other comprehensive income under Topic 740 on income taxes.
The Board also believes this approach would be consistent with Topic 740’s
requirements that the ultimate income tax calculation be based on the entity’s
entire tax position. Therefore, the Board believes that the tax calculation should
not be segregated by tax amounts on the entity’s specific assets and liabilities.
Credit Impairment
BC167. The Board decided that if an entity’s business strategy is to hold a
financial asset for collection of contractual cash flows rather than to sell the
financial instrument to a third party, certain changes in fair value of the financial
asset may be recognized in other comprehensive income. The Board considered
whether all changes in fair value should be recognized in other comprehensive
income without a subsequent transfer (“recycling”) from other comprehensive
income to net income. The Board decided that if an entity is holding a financial
asset for collection of cash flows, the entity should recognize any credit
impairment of the financial asset in net income.
BC168. The Board decided that a single, comprehensive impairment model
should be developed for all financial assets that meet the criteria for recognizing
qualifying changes in fair value in other comprehensive income. The Board
observed that a credit impairment model is necessary for receivables, loans, and
investments in debt instruments for which qualifying changes in the fair value are
recognized in other comprehensive income. An impairment model would not be
necessary for investments in equity instruments because they do not satisfy the
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criteria for recognizing qualifying changes in fair value in other comprehensive
income.
BC169. The Board considered existing impairment models for debt securities
and loans in developing a comprehensive model. Existing impairment
requirements differ for different types of financial assets (for example, loans
versus debt securities) and for the same types of financial assets with different
characteristics (for example, beneficial interests, purchased debt securities
acquired at an amount that includes a discount related to credit quality, and other
debt securities). The guidance for impairments of loans and debt securities is
included in Topics 310, 320, 325, and 450.
BC170. The existing impairment model for loans is based on the recognition of
probable credit losses that have been incurred. Under that model, an entity does
not recognize impairment of a loan until, on the basis of current information and
events, it is probable that the entity will be unable to collect all contractual cash
flows due or, for purchased loans acquired at an amount that includes a discount
related to credit quality, all cash flows previously expected to be collected. Once
it is determined that it is probable that an impairment has occurred, the amount of
the impairment is estimated on the basis of expectations about the collectibility of
future cash flows.
BC171. The existing impairment model for debt securities is an other-than-
temporary impairment approach that focuses on the difference between fair value
and amortized cost basis. If fair value is less than the amortized cost basis and
an entity intends to sell a debt security or it is more likely than not that the entity
will be required to sell the debt security before the anticipated recovery of its
amortized cost basis, the entity is required to recognize the entire difference
between fair value and the amortized cost basis in net income. The Board
decided that because a financial asset would meet the criteria for recognizing
qualifying changes in fair value in other comprehensive income only if the entity’s
business strategy for the instrument is to collect the related contractual cash
flows rather than sell the financial asset, it would not be necessary to retain the
requirement that the entire difference between fair value and amortized cost be
recognized in net income. This would be the case even if the entity intends to sell
a debt security or it is more likely than not that the entity will be required to sell
the debt security before the anticipated recovery of its amortized cost basis. The
Board believes that retaining such a requirement could lead to a tainting notion in
the classification and measurement of financial instruments. Also, because all
financial instruments would be measured at fair value, the Board believes it
would not be necessary to retain an other-than-temporary impairment approach
to assess a financial asset for impairment when fair value is less than cost.
BC172. Existing impairment guidance for debt securities also requires that if a
credit impairment exists, an entity must present the entire difference between fair
value and amortized cost in net income with an offset for any amount of the total
other-than-temporary impairment that is recognized in other comprehensive
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income. The Board believes that such presentation would not be necessary
under the proposed guidance because the proposed Update on comprehensive
income would require an entity to display total comprehensive income in a
continuous statement of comprehensive income that will include a profit or loss or
net income section and an other comprehensive income section.
Objective of the Credit Impairment Model

BC173. The Board decided that the objective of the credit impairment model
should be based on an entity’s assessment of cash flows expected to be
collected related to its financial assets measured at fair value with qualifying
changes in fair value recognized in other comprehensive income. The Board
believes that an entity should recognize in net income a credit impairment when it
does not expect to collect all contractual amounts due for originated financial
asset(s) and all amounts originally expected to be collected for purchased
financial asset(s). An entity’s expectations on collectibility of cash flows would
consider all available information about past events and existing conditions but
would not consider potential future economic events beyond the reporting date.
BC174. The Board considered requiring an entity to continue to apply an
incurred loss model in accordance with Topic 310 on loan impairment. The Board
decided that the impairment model should not be based on a notion of incurred
losses. The Board decided that a credit loss need not be deemed probable of
occurring to recognize a credit impairment. The Board believes that removing the
probable threshold would result in an entity recognizing credit impairments in net
income earlier on the basis of its expectations about the collectibility of cash
flows rather than on a potentially arbitrary recognition threshold. Elimination of
the probable threshold would be consistent with the Board’s decisions in FASB
Staff Position FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-
Than-Temporary Impairments, issued in April 2009, which modified the
impairment guidance for debt securities. One of the changes made by that FSP
was to remove the probable threshold for assessing whether a debt security is
other than temporarily impaired. The Board made that change to clarify that an
entity should not wait for an event of default or other shortfall of cash flows to
conclude that a credit impairment exists. The Board believes that the credit
impairment model in the proposed guidance would differ from a probable
incurred loss model because recognition of credit impairment would not be based
on any triggering event.
BC175. The Board also considered requiring an entity to apply an expected loss
approach. Under an expected loss approach, an entity would forecast expected
cash flows over the life of a financial asset or pool of financial assets and would
recognize credit impairment of its financial assets in net income on the basis of
those expectations. The Board believes the model in the proposed guidance is
different from an expected loss model because it would require an entity to
consider the effects of past events and existing conditions in estimating the cash
flows it expects to collect in future periods that make up the remaining life of its
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financial assets, but it would not permit an entity to forecast future events or
economic conditions in developing those estimates as would occur in an
expected loss model. In addition, the Board understands that the timing of
recognition of credit impairments under an expected loss model would differ from
the timing of recognition of credit impairments under the model in the proposed
guidance. Under an expected loss model, the Board understands that an entity
would recognize a constant rate of credit impairments through the life of the
financial asset based on expectations about losses on the date of acquisition or
origination, with any changes from initial expected credit impairments recognized
in the period of the change. With respect to the timing of recognition, under the
model in the proposed guidance, all credit impairments would be recognized in
the period in which they are estimated, rather than being allocated and
recognized at a constant rate over the life of the financial asset on the basis of
expectations upon origination or acquisition. The Board decided not to pursue an
expected loss model because the Board believes that oftentimes it would be
difficult for an entity to accurately forecast expected cash flows through the life of
a financial asset on the basis of forecasted future events. The Board also
believes that it would be inappropriate to allocate an impairment loss over the life
of a financial asset.
Evaluating Financial Assets for Credit Impairment

BC176. The Board decided that an entity should recognize a credit impairment
for the amount of cash flows that an entity does not expect to collect. The Board
believes that an entity should consider both the timing and the amount of cash
flows expected to be collected in measuring credit impairments. However, in
considering the timing of cash flows expected to be collected, the Board believes
that a credit impairment would not generally exist unless there is an expected
delay in the collection of cash flows originally expected to be collected and the
entity will not be compensated for the delay.
BC177. The Board decided that in determining whether a credit impairment
exists, an entity should consider all available information about past events and
existing economic conditions and their implications for the collectibility of the
financial asset(s) at the date of the financial statements. The Board
acknowledges that judgment is required in determining whether factors exist that
indicate that a credit impairment exists at the end of the reporting period. Those
judgments are based on subjective as well as objective factors, including
knowledge and experience about past and current events and assumptions
about the future collection of cash flows.
BC178. The Board believes that an entity should consider past events and
existing conditions in assessing financial assets for impairment rather than
forecasting macroeconomic factors, such as future economic downturns, through
the life of the financial asset. However, the Board believes that when an event
has occurred, the entity should consider the implications of that event on future
cash flows. The entity should not wait until it is probable that cash flows will not
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be collected. For example, if a plant closure is announced, the entity would not
wait until an employee of the plant is laid off or is delinquent on a loan to assess
whether the entity expects a decrease in cash flows expected to be collected.
BC179. Topic 320 currently requires an entity to evaluate a debt security for
impairment only when the fair value of the debt security is less than its amortized
cost basis. However, the Board intends for all credit impairments to be
recognized in net income regardless of the fair value of the financial asset.
Therefore, although the fact that fair value is less than cost may be an indicator
that a credit impairment exists, an entity should not automatically assume that no
credit impairment exists if fair value is greater than amortized cost. If it is
determined that a credit impairment exists, that impairment should be recognized
in net income even if the fair value of the financial asset has increased (for
example, due to a decrease in interest rates).
BC180. For financial assets evaluated for impairment in a pool of financial
assets, the Board considers historical loss experience to be a past event that
should be considered, along with the implications of existing conditions, in
determining the collectibility of a pool of financial assets. Therefore, if an
individual financial asset is included in a pool of similar assets that is being
evaluated for impairment, an entity may recognize a credit impairment associated
with that pool of financial assets in the first reporting period after that individual
asset is originated or purchased on the basis of past events and current
conditions associated with the pool. However, the Board believes it is not
necessary for an entity to recognize an impairment loss for a pool of financial
assets in all circumstances. Determining whether an impairment loss should be
recognized should be based on the entity’s historical loss experience with
financial assets with similar risk characteristics.
BC181. Existing impairment guidance does not allow debt securities to be
evaluated for impairment in a pool. Rather, debt securities must be evaluated on
an individual basis. The Board believes that there should be one impairment
model for all financial assets and that there are insufficient reasons for prohibiting
the evaluation of debt securities in a pool if they have similar risk characteristics.
However, the Board believes that debt securities will more often have unique risk
characteristics that will result in their being evaluated individually.
BC182. The proposed guidance does not specify how an entity should identify
financial assets that are to be evaluated individually for impairment. The Board
believes that allowing an entity to apply its normal review procedures in making
that judgment would minimize the cost of implementing the proposed guidance.
BC183. The Board considered whether the effect of various factors that may
result in a decrease in cash flows expected to be collected should be recognized
as a credit impairment. The Board decided that an entity should not be required
to report foreign currency transaction gains or losses on a foreign-currency-
denominated financial instrument in net income. Instead, those changes in fair
value would be recognized in other comprehensive income with other changes in
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fair value for a financial instrument for which changes in the fair value are
recognized in other comprehensive income. Therefore, an entity would not
recognize a credit impairment only for a decline in cash flows expected to be
collected due to change in foreign exchange rates.
BC184. Subtopic 325-40 requires the consideration of prepayments in the
calculation of cash flows expected to be collected. Therefore, changes in
expectations about prepayments that would adversely affect the net present
value of cash flows expected to be collected for investments in beneficial
interests included in the scope of Subtopic 325-40 are reflected in the
measurement of credit impairment. The Board considered this and determined
that because changes in expectations about prepayment speeds are linked to
changes in interest rates and a decrease in the net present value of cash flows
expected to be collected because of an anticipated increase in prepayments
should generally be reflected as an adjustment to interest income and not as a
credit impairment. The Board notes that in situations in which an entity may not
recover substantially all of its investment because of prepayments (for example,
an interest only strip that allows for prepayment of the associated principal), an
increase in expected prepayment speeds could be considered similar to a credit
impairment. However, the Board decided that such instruments would not qualify
for measurement at fair value with changes in fair value recognized in other
comprehensive income. Therefore, all changes in fair value would be recognized
in net income, and it would be unnecessary to retain the existing requirements in
Subtopic 325-40 to consider anticipated prepayments in the calculation of cash
flows expected to be collected.
BC185. The Board decided to retain the guidance in Subtopic 310-20 that
permits an entity to consider estimates of future principal prepayments in the
calculation of the constant effective yield necessary to apply the interest method
if an entity holds a large number of similar loans for which prepayments are
probable and the timing and amount of prepayments can be reasonably
estimated. Under this guidance, if differences arise between the prepayments
anticipated and the actual prepayments received, the entity is required to adjust
the effective yield to reflect actual payments to date and anticipated future
payments. Additionally, the entity is required to adjust the net investment in the
loans to the amount that would have existed had the new effective yield been
applied and recognize a corresponding charge or credit to interest income.
Measurement of Credit Impairment

BC186. The Board decided that an entity should recognize in net income the
amount of credit impairment when it does not expect to collect all contractual
amounts due for originated financial asset(s) and all amounts originally expected
to be collected for purchased financial asset(s). The Board decided to allow for
latitude in the measurement of credit impairments on the basis of the facts and
circumstances of the entity. Specifically, the Board decided not to require the use
of the net present value method for measuring credit impairments in all
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situations. The Board believes that an entity should be permitted to use an
appropriate measurement technique to estimate the amount of losses expected,
including using a historical loss rate method to measure credit impairments for a
pool of financial assets. However, when a financial asset is individually identified
as impaired, the Board believes that the entity should measure the amount of
credit impairment as the difference between the amortized cost of the financial
asset and the present value of cash flows expected to be collected. The term
cash flows expected to be collected should represent the cash flows that the
entity expects to collect after a careful assessment of all available information.
The interest rate used to discount the cash flows expected to be collected should
be the same rate that is used to calculate interest income.
BC187. The Board decided to retain the practical expedient in existing loan
impairment guidance that allows an entity to measure impairment on the basis of
the fair value of the collateral if the loan is a collateral-dependent loan. The Board
decided to expand that practical expedient to include all collateral-dependent
financial assets. In addition, the Board decided to allow the practical expedient to
apply to financial assets for which repayment is expected to be provided primarily
or substantially through the operation or sale of the collateral rather than to
restrict the expedient to situations in which the repayment was expected to be
provided solely by the underlying collateral. The Board believes that for a
collateral-dependent financial asset, the fair value of the collateral, adjusted for
estimated costs to sell if repayment of the financial asset is dependent on the
sale of the collateral, is a reasonable approximation of the cash flows expected to
be collected on the loan. The Board decided to retain the existing guidance for
loans that an entity is required to measure impairment on the basis of the fair
value of the financial asset when the creditor determines that foreclosure is
expected to occur.
BC188. The Board acknowledges that applying judgment to determine cash
flows expected to be collected may be complex, but that complexity is the
unavoidable result of the need for information about the effect of credit
impairments on an entity’s results of operations. The Board believes that
practical decisions, such as permitting an entity to use the fair value of the
collateral of a collateral-dependent financial asset, should reduce cost and
complexity. Additionally, the Board believes that continuing to permit an entity to
aggregate loans with similar characteristics and use historical experience in
calculating the present value of cash flows expected to be collected also should
reduce cost and complexity.
BC189. In situations in which all or a portion of a loan portfolio consists of a
large number of small-dollar-value homogeneous loans (such as consumer
installment loans, residential mortgages, or credit card loans), creditors typically
use a formula based on various factors to estimate an allowance for loan losses.
Those factors include past loss experience, recent economic events and current
conditions, and portfolio delinquency rates. The Board recognizes the
established practice of using a formula approach for estimating losses related to
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these types of loans and the proposed guidance would not change that
approach.
BC190. If an entity determines that an impairment loss should be recognized on
a pool of financial assets, the Board decided that the amount recognized should
be determined by applying a loss rate that reflects cash flows the entity does not
expect to collect over the life of the financial assets in the pool to the principal
balance of the pool. The Board believes that it would be inappropriate for an
entity to apply an annual loss rate to the pool, which would result in allocating
losses over the life of the financial assets in the pool.
BC191. For financial assets evaluated for impairment individually, the Board
believes that an entity’s calculation of cash flows expected to be collected would
not be significantly different from current practice. Instead, the Board believes
that by eliminating the probable threshold for recognizing an impairment and
requiring that interest be calculated on amortized cost less the allowance,
impairments would be recognized earlier in net income. However, the Board
acknowledges that by developing one approach for all types of financial assets,
in situations in which cash flows expected to be collected have not been
calculated in the same manner for all types of financial assets (for example, due
to differences in the treatment of changes in expectations about prepayments)
there may be differences in an entity’s calculation of credit impairment under the
proposed model as compared with current practice.
BC192. For financial assets evaluated for impairment individually, it may be the
case that no past events or existing conditions currently exist that would indicate
that the financial asset is impaired (for example, when a loan is originated). In
those situations, the Board believes an entity should not automatically conclude
that no credit impairment exists. An entity should determine whether assessing
the financial asset together with other financial assets with similar risk
characteristics indicates that a credit impairment exists. The Board believes that
financial assets often are priced assuming a certain amount of losses on the total
pool even though the entity initially expects to collect on each individual asset.
The Board believes that an entity should not delay recognition of an impairment
loss on a group of financial assets by evaluating them individually when historical
experience indicates that a loss is likely to have occurred, but has not yet been
specifically identified.
Presentation of Credit Impairments and Recognition of

Recoveries
BC193. Existing impairment guidance for debt securities requires that if an entity
recognizes an other-than-temporary impairment, the portion of the impairment
that is recognized in net income (that is, the credit impairment) is reflected as an
adjustment to the amortized cost basis of the security. Any subsequent increases
in cash flows expected to be collected are reflected in net income on a
prospective basis as interest income through an adjustment of the effective
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interest rate. In contrast, existing impairment guidance for loans requires the
recognition of an allowance and permits an entity to reverse a previously
recognized allowance if there is an upward change in expectations about the
collection of future cash flows. The requirement to adjust the effective interest
rate on a prospective basis can result in an unusually high effective rate if a large
credit impairment is recognized and there are significant subsequent increases in
expectations about the collection of cash flows. Some constituents have
expressed concerns that this requirement has led to some entities recognizing
excessive writeoffs in one period in order to present higher yields in a future
period.
BC194. The Board decided that credit impairments should be recognized
through a valuation allowance for all financial assets. However, the Board
decided that an entity should write off a financial asset or part of a financial asset
in the period in which the entity has no reasonable expectation of recovery of the
financial asset (or part of the financial asset). The Board acknowledges that
determining whether there is a reasonable expectation of recovery of a financial
asset would require judgment based on specific facts and circumstances.
BC195. The Board also decided that an entity should be permitted to recognize
a reversal of credit impairment expense in net income for all financial assets if
there is an increase in cash flows expected to be collected. The Board believes
that if an impairment was initially recognized in net income as a credit
impairment, any changes to the entity’s expectations about the amount of the
impairment should be reflected as a decrease in credit impairments and not as
an increase in interest income.
Purchased Financial Assets

BC196. The Board intends for the calculation of credit impairments for
purchased financial assets to be the same as for originated financial assets
except that the effective interest rate used to discount cash flows expected to be
collected would be based on the purchase price and expectations about cash
collections on the acquisition date and not the contractual amounts due.
BC197. The Board acknowledges that the price an acquirer is willing to pay for a
debt instrument reflects the acquirer’s estimate of credit losses over the life of the
instrument and considered whether those estimated credit losses should be
reflected as an allowance for credit losses on the acquiring entity’s financial
statements. The Board decided that it would be inappropriate for an entity to
present credit impairments inherent in the instrument as an allowance for credit
losses at acquisition. Using an allowance for credit losses to address the
collectibility of cash flows the investor does not expect receive initially (and,
therefore, presumably did not pay for) would not faithfully represent the
substance of the underlying event. Rather, allowances for credit losses should
reflect only those impairments incurred by the investor after acquisition (that is,
the present value of cash flows expected at acquisition that ultimately are not to
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be received). The allowance for credit losses recorded by the acquirer should
reflect only impairments that have occurred after the acquisition of the asset,
rather than (a) impairments that occurred while the financial asset was held by
the transferor or (b) the acquirer’s estimate at acquisition of credit impairments
over the life of the financial asset. However, the Board decided that an entity
should disclose the net present value of the acquirer’s estimate of credit losses
inherent in the financial asset on the acquisition date.
BC198. The Board also considered whether in situations in which an entity
subsequently expects to collect more cash flows than originally expected, the
entity should recognize an immediate gain in net income (offset by an increase in
the amortized cost) instead of prospectively adjusting the effective interest rate.
The Board acknowledges that requiring an entity to adjust the effective interest
rate for increases in expected cash flows above original expectations and
recognize immediate credit impairments for decreases in expected cash flows
below original expected cash flows carries forward some of the complexity from
the existing impairment and interest recognition model for purchased financial
assets with evidence of credit deterioration. However, the Board notes that the
original effective rate depends on the amount of the difference between the
purchase price and the contractual cash flows due that is allocated to cash flows
not expected to be collected versus a premium or discount (accretable versus
nonaccretable yield). Therefore, if additional cash flows were expected at
acquisition, those additional cash flows would have been recognized through a
higher initial effective interest rate and not an immediate gain.
BC199. Given the judgment involved in initially estimating the cash flows not
expected to be collected and that a credit impairment is not initially recognized in
net income for cash flows not expected to be collected at acquisition, the Board
generally believes that it would be inappropriate to allow an entity to recognize an
immediate gain in net income for a change in the entity’s initial estimate. Some
Board members believe that an entity should be permitted to recognize an
immediate gain for an increase in cash flows expected to be collected if there is
evidence that the change in expectations is based on new information and not a
new evaluation or new interpretation by management of information that was
available on the acquisition date. However, the Board decided that such a
requirement would be difficult to apply and would create additional complexity.
Interest Income Recognition

BC200. Existing interest income recognition models vary on the basis of the
nature of the financial asset (for example, loans versus beneficial interests), the
credit quality, and whether the financial asset was purchased or originated. For
loans that are not impaired, interest income is generally calculated by multiplying
the recorded balance of the loan by an effective interest rate. The effective
interest rate is generally the contractual rate adjusted for any net deferred loan
fees or costs, premium, or discount existing at the purchase or origination. There
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is no existing guidance for how an entity should recognize, measure, or display
interest income on an individually impaired loan. However, methods may include
accruing interest on the net carrying value of the loan, a cost-recovery method, a
cash-basis method, or some combination of those methods. For debt securities,
interest income is calculated by multiplying the amortized cost of the security,
which includes any impairment previously recognized in net income, by the
appropriate effective rate. Additionally, for loans acquired with evidence of
deterioration in credit quality, interest income is calculated by multiplying the net
loan balance, including any allowance for credit losses recognized after
acquisition, by the effective interest rate.
BC201. The Board is concerned that the existing interest income recognition
method for loans (other than loans acquired with evidence of deterioration in
credit quality) is based on the initial investment without deducting the allowance
for credit impairments, which allows an entity to continue to recognize interest
income on principal that is not expected to be collected. Some Board members
believe that in recent years entities have relaxed their underwriting standards and
lent to borrowers with lower credit ratings at higher interest rates so that higher
interest income could be reflected in net income in earlier years even though the
entities expected to have losses in the future on some portion of the loans. Board
members also are concerned that because there is limited guidance on when an
entity should cease accruing interest on a loan, entities may delay putting a loan
on non-accrual status and accrue interest on loans even when a borrower has
failed to make contractual interest payments.
BC202. The Board believes that it is inappropriate for an entity to accrue interest
on an amount that it does not expect to collect. Therefore, the Board decided that
interest income should be calculated on the basis of the amortized cost less any
allowance for credit impairments of the financial asset. The Board notes that
because all financial assets would be measured at fair value, any interest income
recognition model, combined with the credit impairment model, would be a
means to allocate fair value changes between net income and other
comprehensive income. The Board notes that users of financial statements place
significant value on the reported net interest margin. The Board believes that net
interest margin should reflect the interest an entity expects to receive on the
basis of current assessments of credit impairments. The proposed impairment
model would result in the yield (or net interest margin) of a financial asset
changing as a result of changes in the credit impairments.
BC203. The Board considered an alternative approach that would permit an
entity to calculate interest income by multiplying amortized cost by the effective
interest rate and would provide guidance on when an entity should cease
accruing interest on financial assets (that is, when a financial asset should be
placed on nonaccrual status). However, the Board believes that general
nonaccrual guidance could not be developed to fit all situations. The Board
believes that interest income could be too high if nonaccrual policies allow
entities to continue to accrue interest on nonperforming loans or on performing
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loans for which cash shortfalls are expected. For example, an entity may have
received all contractual interest payments on a loan that requires interest-only
payments for a period of time but may not expect to receive all principal amounts
due. The Board believes that the entire estimated shortfall should not be
reflected as a credit impairment; rather, a portion of the expected loss should be
reflected through a lower effective interest rate. Additionally, the Board believes
that accruing interest on the basis of the effective rate multiplied by amortized
cost without deducting the allowance for credit impairments would result in an
upwardly biased number because any pool of financial assets with a single credit
impairment would have an actual yield net of credit impairments at less than the
effective rate. Because no individual asset would be identified as impaired when
financial assets are evaluated in a pool, it would not be possible to place a
financial asset on nonaccrual to prevent interest income from being overstated.
BC204. The Board decided to retain existing guidance on calculating the
effective interest rate that is used to calculate interest income (that is, the
contractual rate adjusted for any net deferred loan fees or costs, premium, or
discount existing at the purchase or origination for originated financial assets and
high-credit-quality purchased financial assets and the rate that equates the
present value of the investor’s estimate of the future cash flows of the financial
asset with the purchase price of the asset for financial assets acquired at an
amount that includes a discount related to credit quality). However, because the
effective interest rate would be multiplied by the amortized cost less any
allowance for credit impairments and not only the amortized cost of the financial
asset, the yield that would result from the application of the proposed model
would change for certain financial assets.
BC205. For purchased financial assets, the Board considered whether to require
an effective interest rate that would accrete from the purchase price to the
contractual amount of principal cash flows, which would effectively result in an
entity recognizing more interest income and credit impairments in net income for
credit losses on the financial asset that the entity expects on acquisition. The
Board believes that the effective interest rate for a purchased financial asset
should be based on expectations about cash flows at the date of acquisition and
not on the principal balance of the financial asset. However, the Board decided
that an entity should present additional information about the principal balance
and the net present value of cash flows not expected to be collected on the
acquisition as well as any increases in cash flows expected to be collected since
the acquisition date.
Differences between Contractual Interest and Interest Accrued

BC206. Because interest income would be recognized on amortized cost less
any allowance, there would be a difference in the amount of interest contractually
due (or, for purchased financial assets acquired at an amount that includes a
discount related to credit quality, interest cash flows originally expected to be
collected) and interest income accrued. In situations in which an entity expects
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cash shortfalls in later periods, the entity would likely collect cash in excess of
interest income recognized in earlier periods. The Board decided that an entity
should recognize an increase in the allowance for credit losses for the difference
in the amount of interest contractually due (or interest cash flows originally
expected to be collected) and interest income recognized at the time interest
income is accrued. For loans that are individually evaluated for impairment, if
there has been no change in the entity’s estimate of the collection of cash flows,
the Board believes that this difference would primarily be attributable to the
passage of time and would result in the amortized cost less the allowance for
credit losses equaling the net present value of cash flows expected to be
collected. If there has been a change in the entity’s estimate of the collection of
cash flows, it may be necessary to recognize a reversal of credit impairment
expense or additional credit impairment in net income so that the allowance
presented on the statement of financial position represents the net present value
of cash flows expected to not be collected. Similarly, for financial assets
evaluated in pools, it may be necessary for the entity to recognize a reversal of
credit impairment expense for the difference in the amount of interest
contractually due (or interest cash flows originally expected to be collected) and
interest income recognized if the entity determines that the allowance originally
recognized on the pool is adequate.
BC207. Because any difference in the amount of interest contractually due (or
interest cash flows originally expected to be collected) and interest income
recognized would be recognized as an increase in the allowance for credit losses
or as a reversal of credit impairment expense, cumulative credit impairments
recognized in net income would not equal the allowance for credit losses. The
allowance for credit losses would equal the cumulative credit impairments
recognized in net income plus a reduction in interest income compared to
contractual interest due. The Board believes that this presentation would be
appropriate because expected shortfalls in cash flows should be allocated
between principal and interest and should not just be reflected as a loss of
principal, which is the case under the current interest income recognition model.
Ceasing Accrual of Interest Income

BC208. Because interest income would be recognized on amortized cost less
any allowance under the proposed guidance, interest would be accrued only on
amounts expected to be collected. Therefore, the Board believes that it will
generally not be necessary to place financial assets on nonaccrual status.
However, in certain situations an entity may determine that the overall yield on a
financial asset will be negative (that is, the total cash flows expected to be
collected are less than the original cash outflow for the financial asset). In those
situations, the Board believes it would not be appropriate for the entity to
recognize any additional interest income on the financial asset once it is
determined that the yield would be negative. Instead, a credit impairment (and
allowance for credit losses) equal to the principal balance outstanding less the
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cash flows expected to be collected should be recognized. In this situation, an
entity should apply the cost recovery method.
Disclosures
BC209. The Board believes that the proposed financial statement disclosures
would provide information that is useful in analyzing an entity’s exposures to risks
from financial instruments. In considering the disclosures to be required, the
Board considered input from users of financial statements as well as disclosures
that are currently required.
BC210. The Board proposed that the disaggregation be based on nature,
characteristics, or risks of the financial instruments. The disaggregation principle
is designed to promote consistency and comparability within footnotes while
acknowledging the need for management judgment in determining the
appropriate disaggregation for each footnote.
BC211. The proposed disclosures would augment existing disclosures and were
designed to address the changing needs of financial statement users on the
basis of the proposed model of accounting for financial instruments.

BC212. Since the original effective date FASB Statement No. 133, Accounting
for Derivative Instruments and Hedging Activities (Topic 815), the Board has
been asked to address numerous issues on many aspects of hedge accounting,
including but not limited to, issues related to assessing hedge effectiveness and
measuring hedge ineffectiveness. As a result, in May 2007, the Board added a
project to its agenda to reconsider the hedge accounting guidance in Statement
133. The Board decided that (a) the accounting for hedging activities should be
simplified to make it easier for preparers of financial reports to comply with the
guidance and (b) the financial reporting of hedging activities should be improved
to make the hedge accounting results more useful and transparent to investors
and other users of financial information. The changes summarized in the
proposed guidance help accomplish those goals.
Scope
BC213. The Board decided that the types of items and transactions currently
eligible for hedge accounting under Topic 815 would continue to be eligible under
the proposed guidance. Because more financial instruments would be reported at
fair value with changes recognized in net income on the basis of the classification
and measurement approach included in the proposed guidance, fewer financial
instruments would be eligible for fair value hedges.
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Bifurcation of Embedded Derivative Features
BC214. The Board decided that, under the proposed classification and
measurement approach, hybrid financial instruments containing embedded
derivative features that would have otherwise required bifurcation and separate
accounting should be reported in their entirety at fair value with all changes
recognized in net income. The Board believes that fair value is the most relevant
measure for those hybrid instruments and that eliminating the requirement that
those embedded derivative features be bifurcated and accounted for separately
as derivative instruments would facilitate simplification. The Board is aware that,
because those embedded derivative features are not bifurcated, they may not be
designated as hedging instruments.
BC215. Hybrid instruments that have a nonfinancial host contract such as a
commodity purchase or sale contract are excluded from the scope of the
proposed guidance. For these instruments, Subtopic 815-15 would continue to
be applied to determine if bifurcation of an embedded derivative feature is
required. If so, the contract would be bifurcated into the nonfinancial host
contract and a derivative. The derivative component would be measured at fair
value with changes in value recognized in net income, unless it is designated and
effective as a cash flow hedging instrument or as a hedge of a net investment in
foreign operations. The Board noted that existing presentation and disclosure
guidance in Topic 815 related to bifurcated instruments would apply to this
subset of hybrid instruments.
Hedge Effectiveness Requirements

BC216. The proposed guidance would amend the hedge effectiveness guidance
in Topic 815 to no longer require that a hedging relationship be highly effective. It
also would no longer require a quantitative assessment of the effectiveness of a
hedging relationship or an ongoing effectiveness test (although in rare
circumstances the latter two may still be necessary). The proposed guidance
also would eliminate the shortcut method and critical terms match method.
Therefore, an entity would no longer have the ability upon compliance with strict
criteria to assume that a hedging relationship is completely effective and
recognize no ineffectiveness in net income during the term of the hedge.
Because of the high cost and complicated nature of complying with the hedge
accounting requirements as well as an entity’s desire to not recognize
ineffectiveness in net income, entities have applied the shortcut method and
critical terms match method to assume that a hedging relationship is highly
effective with no ineffectiveness being recognized in net income. However,
difficulties in complying with the strict criteria in the shortcut method and critical
terms matching have led to numerous practice problems and restatements.
BC217. The proposed guidance would require that a hedging relationship be
reasonably effective. It also would permit a qualitative assessment of the hedging
relationship’s effectiveness at inception of the hedging relationship. In certain
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situations, a quantitative assessment may be necessary at the inception of a
hedging relationship to demonstrate that changes in fair value of the hedging
instrument are expected to be reasonably effective in offsetting changes in fair
value of the hedged item or variability in cash flows of the hedged transaction.
BC218. The Board decided to amend the hedge effectiveness requirements in
Topic 815 to reduce the complexity of qualifying for hedge accounting, make it
easier for entities to consistently apply hedge accounting, and provide
comparability and consistency in financial statement results, but only if all
ineffectiveness is recognized in net income. For example, under the existing
requirements in Topic 815, an entity may apply hedge accounting in one period
because the hedging relationship is deemed highly effective, and then not meet
the highly effective criteria in the next period, resulting in hedge accounting being
applied inconsistently from period to period. Alternatively, an entity may not apply
hedge accounting to a hedging relationship that it believes is highly effective
because it is unable to demonstrate that the hedge will meet a specified level of
effectiveness in each reporting period of the hedging relationship. The Board
believes that amending the hedge effectiveness threshold to reasonably effective
would reduce the frequency of both those occurrences. In addition, to provide for
further simplification, the Board decided that, after inception of the hedging
relationship, an entity would need to qualitatively (or quantitatively, if necessary)
reassess effectiveness only if changes in circumstances suggest that the
hedging relationship may no longer be reasonably effective. Thus, the need for
reassessing effectiveness at least quarterly would be eliminated unless changes
in circumstances suggest that a hedging relationship may no longer be
reasonably effective. The Board believes that the costs of compliance would be
reduced because an entity would not have to develop sophisticated quantitative
statistical models to prove a hedging relationship is effective in situations in
which it is obvious that a hedging relationship is effective. Users of financial
statements also would be served by not having to deal with on-again, off-again
hedge accounting for the same derivative and hedged item.
BC219. The Board considered eliminating hedge effectiveness requirements
entirely. However, the Board rejected that approach because it could result in
creating a fair value option for assets and liabilities that the Board has not
decided should have that option. For example, without hedge effectiveness
requirements, an entity could designate an interest rate swap as a hedge against
changes in fair value of its tire inventory. The entity would then be able to
measure the tire inventory at fair value even though the changes in fair value of
the interest rate swap might not offset the changes in fair value of the tires. That
would result in effectively creating a fair value measurement option for the tire
inventory instead of achieving one of the objectives of hedge accounting, which
is to provide a means of compensating for situations in which measurement
anomalies between a hedged item and a hedging instrument result in recognizing
offsetting gains and losses in net income in different periods. The Board believes
that guidance resulting in a fair value option for all assets and liabilities, whether
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financial or nonfinancial, should not be promulgated in a proposed Update on
financial instruments and hedge accounting.
Reasonably Effective Criterion

BC220. The Board decided not to define reasonably effective for purposes of
determining when hedge accounting could be applied and when it could not be
applied. The Board believes that it is necessary to use judgment when
determining whether a hedging relationship is reasonably effective. That
judgment should include a holistic consideration of all the facts and
circumstances that led an entity to enter into a hedging relationship. That would
include, for example, consideration of whether the objective of applying hedge
accounting was to compensate for accounting anomalies or to achieve a fair
value measurement option for items not currently eligible for fair value
measurement.
Dedesignation of a Hedging Relationship

BC221. Paragraphs 815-25-40-1 and 815-30-40-1 require an entity to
discontinue the special accounting for fair value hedges and cash flow hedges if
(a) any criterion for fair value hedge accounting or for cash flow hedge
accounting is no longer met, (b) the derivative hedging instrument expires, is
sold, terminated, or exercised, or (c) the entity removes the designation of the fair
value or cash flow hedge. Criteria (a) and (b) relate to the termination of a
hedging relationship and the third criterion (c) relates to the dedesignation of a
BC222. The Board decided that an entity should not be permitted to discontinue
fair value hedge accounting or cash flow hedge accounting by simply
dedesignating (or removing the designation of) the hedging relationship. The
Board believes that discontinuing the special accounting that is permitted under
hedge accounting would be appropriate if criterion (a) or (b) above is met.
However, the Board believes that discontinuing the special accounting that is
permitted under hedge accounting is not appropriate if criterion (c) is met.
Because the economics of the relationship between the hedging instrument and
hedged item (or forecasted transaction) have not changed, the Board believes
that the accounting should not change. The Board acknowledges that an entity
could override the special accounting under fair value and cash flow hedges by
terminating the derivative designated as the hedging instrument and entering into
a similar new derivative, which action involves actual economic transactions.
However, the Board does not believe that arbitrary dedesignation (which does
not involve actual economic transactions) should be used as a tool for changing
measurement attributes and/or managing the classification of certain items
reported in net income.
BC223. Many hedging strategies would not be affected by the proposal to not
permit the dedesignation of a hedging relationship after it has been established.
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However, it may be necessary to change the way a hedging relationship is
designated in order to achieve the same financial statement results as are
currently being obtained under Topic 815.
Measuring and Reporting Ineffectiveness in Cash Flow Hedging

Relationships
BC224. Currently in a cash flow hedging relationship under Topic 815, the
actual derivative hedging instrument is measured at fair value on the statement
of financial position, and accumulated other comprehensive income is adjusted to
a balance that reflects the lesser of either the cumulative change in the fair value
of the actual derivative or the cumulative change in the fair value of a
hypothetical derivative.
BC225. The amount of ineffectiveness, if any, recognized in net income is equal
to the excess of the cumulative change in the fair value of the actual derivative
over the cumulative change in the fair value of the hypothetical derivative. Thus,
Topic 815 requires ineffectiveness to be recognized in net income only when the
cumulative change in fair value of the actual derivative exceeds the cumulative
change in fair value of the hypothetical derivative (referred to as an overhedge).
If the cumulative change in fair value of the actual derivative is less than the
cumulative change in fair value of the hypothetical derivative (referred to as an
underhedge), the balance of accumulated other comprehensive income equals
the cumulative change in fair value of the actual derivative; the ineffectiveness of
the cash flows related to the hypothetical derivative is not reported in the financial
statements. The basis for conclusions in Statement 133 states that the reason for
not recognizing ineffectiveness on underhedges is that only ineffectiveness due
to excess expected cash flows on the derivative should be reflected in net
income, because otherwise a nonexistent gain or loss on the derivative would be
deferred in other comprehensive income and recognized in net income.
BC226. The proposed guidance would require that measurement of hedge
ineffectiveness be based on a comparison of the change in fair value of the
actual derivative designated as the hedging instrument and the present value of
the cumulative change in expected future cash flows of the hedged transaction.
For example, that could be accomplished by comparing the change in fair value
of the actual derivative and the change in fair value of a derivative that would
mature on the date of the forecasted transaction and that would provide cash
flows that would exactly offset the hedged cash flows. The balance of
accumulated other comprehensive income would reflect the amount necessary to
offset the present value of the cumulative change in expected future cash flows
on the hedged transaction from inception of the hedge less the amount
previously reclassified from accumulated other comprehensive income into net
income. That would result in reporting ineffectiveness in net income regardless of
whether (a) the cumulative change in fair value of the actual derivative exceeded
the cumulative change in fair value of the derivative that would mature on the
171
date of the forecasted transaction and that would provide cash flows that would
exactly offset the hedged cash flows or (b) the cumulative change in fair value of
the derivative that would mature on the date of the forecasted transaction and
provide cash flows that would exactly offset the hedged cash flows exceeded the
cumulative change in fair value of the actual derivative.
BC227. The primary objective of cash flow hedge accounting is to manage the
timing of recognition in income of the gains and losses on a derivative instrument
used to lock in or fix the price of a future transaction. If the gains and losses on
the derivative are deferred until the forecasted transaction occurs, the effect of
locking in or fixing the price of the future transaction would be reflected in net
income in the same period or periods in which the forecasted transaction affects
net income. However, locking in or fixing the price of the future transaction would
occur only if an entity entered into a derivative that would mature on the date of
the forecasted transaction and that would provide cash flows that would exactly
offset the hedged cash flows. If an entity does not enter into a derivative that
would mature on the date of the forecasted transaction and that would provide
cash flows that would exactly offset the hedged cash flows, the effective price of
the future transaction would be different from the market price at the date the
forecasted transaction occurs and would not lock in a specific price at the
forecasted transaction date. The actual net price in that situation would not be
determined until the forecasted transaction occurs and the amount of the gain or
loss on the derivative is known.
BC228. The Board believes that ineffectiveness should be recognized in net
income if an entity enters into a derivative that would not mature on the date of
the forecasted transaction and provide cash flows that would exactly offset the
hedged cash flows (that is, not locking in or fixing the price). The Board also
believes that in those situations there should be no distinction between whether
the change in value of the actual derivative is greater than or less than the
change in value of a derivative that would mature on the date of the forecasted
transaction and provide cash flows that would exactly offset the hedged cash
flows. In both of those cases, the recognizing of ineffectiveness results in
consistently reflecting in the statement of comprehensive income the difference
between the actual price of the forecasted transaction and what would have been
the locked-in price if a derivative that would exactly offset the hedged cash flows
were used. The Board believes that it is preferable to treat overhedges and
underhedges consistently. In addition, amounts recognized in accumulated other
comprehensive income under the existing Topic 815 cash flow hedging model
are not limited solely to unrecognized gains or losses on the hedging derivative
that have not yet been reclassified to net income. Rather, the amounts in
accumulated other comprehensive income also can reflect the adjustments
necessary to, for example, adjust interest expense to achieve the synthetic fixed
interest rate on a debt instrument.
BC229. The Board also considered how ineffectiveness was reported when an
entity entered into a derivative that would not exactly offset the variability in
172
expected future cash flows on the hedged transaction within the net investment
foreign currency hedging model. The net investment foreign currency hedging
model in Topic 815 requires ineffectiveness to be recognized in net income when
the change in value of the actual derivative is either greater than or less than the
change in value of a derivative that would not exactly offset the variability in
expected future cash flows on the hedged transaction. The proposed guidance
for reporting ineffectiveness in a cash flow hedge would be consistent with other
areas of cash flow hedge accounting in Topic 815.
Purchased Options as Hedging Instruments in Cash Flow

Hedges
BC230. Eliminating of critical terms match method in this proposed guidance
would invalidate paragraphs 815-20-25-126 through 25-129 and paragraphs 815-
30-35 through 35-37 (originally issued as Statement 133 Implementation Issue
No. G20, “Assessing and Measuring the Effectiveness of a Purchased Option
Used in a Cash Flow Hedge”). The Board decided, however, to continue to
permit entities to defer the changes in fair value of a purchased option associated
with the time value component of the option when used in a cash flow hedge.
BC231. The Board believes that the time value component of a purchased
option represents ineffectiveness that should be recognized in net income.
However, to simplify the cash flow hedge accounting model and to provide
consistency with the way the time value component of a purchased option is
accounted for under the foreign currency cash flow hedging model, the Board
decided to allow deferral of the time value component. If an entity defers the time
value component in other comprehensive income, it would need to reclassify
from other comprehensive income to net income each period on a rational basis
an amount that adjusts net income for the amortization of the cost of the option.
Hedging Provisions That Are Not Changed
Hedged Risk
BC232. The Board considered modifying the criteria for assessing hedge
effectiveness and requiring an approach that permits hedging either all risks or
only (a) foreign currency risk for all hedged items or transactions and (b) interest
rate risk on an entity’s own debt at issuance as an approach that would facilitate
simplification of compliance. Some believe that approach, which would prohibit
hedging only interest rate risk or only credit risk, perhaps would provide the best
solution for resolving practice issues related to hedge accounting while
concurrently improving financial reporting to make the hedge accounting results
more useful to those who make economic decisions. However, the Board
rejected that proposed hedge accounting approach because it would no longer
provide hedge accounting for different hedgeable risks, which the Board wished
173
to retain at this time, especially in light of the classification and measurement
approach included in the proposed guidance. That decision was heavily
influenced by the relatively narrow application of amortized cost in measuring
financial instruments. If the use of amortized cost would be broadened, the Board
may choose to significantly limit hedge accounting for the variety of separate
risks currently permitted by Section 815-20-25.
BC233. Because the proposed guidance addresses the accounting and
reporting for financial instruments, the Board did not reconsider the hedged risks
for which hedge accounting is permitted with respect to nonfinancial instruments.
Fair Value Hedge Accounting

BC234. The Board also considered a special approach for fair value hedges of
hedged items that would be reported at fair value with qualifying changes in fair
value recognized in other comprehensive income. Under that approach, the
effective portion of the hedging instrument’s changes in fair value would be
recognized in other comprehensive income rather than net income. The Board
rejected that approach for various reasons, including the approach’s
inconsistency with the basic classification and measurement approach included
in the proposed guidance. Furthermore, the complexity arising from that
approach would require further guidance about determining the amounts for
reclassifications from other comprehensive income.
BC235. For financial instruments with qualifying changes in fair value not
recognized in net income, the accounting for fair value hedges is not changed.
For financial instruments whose qualifying changes in fair value are recognized in
other comprehensive income, the change in the hedged item’s fair value
attributable to the hedged risk would continue to be recognized immediately in
net income rather than in other comprehensive income as discussed in
paragraph 24. For other financial instruments that are reported at amortized cost,
the change in the hedged item’s fair value attributable to the hedged risk would
continue to be an adjustment of the hedged item’s carrying amount. Under
paragraph 86, an entity would be required to present as separate line items in the
statement of financial position the amortized cost and the accumulated amount
needed to reconcile amortized cost less allowance for credit losses to fair value
for the financial instruments whose changes in fair value are not recognized in
net income. That amortized cost amount is not the same as the hedged item’s
carrying amount under fair value hedge accounting.
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Effective Date and Transition
Effective Date
BC236. The Board decided that certain aspects of the measurement proposed
guidance should be effective for nonpublic entities that have less than $1 billion
in consolidated total assets as of the beginning of their fiscal year 4 years after
the effective date for all other entities. The Board considered several criteria to
determine which entities should have a delayed effective date. In outreach
performed by the staff, many constituents communicated that a delayed effective
date should be based on the consolidated asset size of the entity. These
constituents noted that regulatory agencies have different requirements for
entities of different sizes, thus acknowledging different levels of sophistication.
These constituents noted that at certain asset sizes, there is some change in the
level of sophistication. For example, financial institutions with total consolidated
assets greater than $1 billion are subject to the FDIC’s Improvement Act of 1991
requirement for management’s assessment of the effectiveness of internal
control over financial reporting as well as an auditor’s attestation on
management’s assessment requirements.
BC237. The Board decided that a delayed effective date should be provided for
those entities to accommodate transitioning them to the comprehensive model of
accounting for financial instruments as well as to allow the Board to consider
findings from its post-implementation review, which is tentatively scheduled
approximately two to three years after the initial effective date. The Board
acknowledges both:
a. The need for these entities to develop the infrastructure to effectively
remeasure core deposit liabilities in accordance with the proposed
guidance
b. The need for these entities to gain experience in estimating fair value
of loans and loan commitments in accordance with the exit price
notion in Topic 820 before it becomes the primary measurement
attribute for loans and loan commitments.
The Board believes that the costs, including resources associated with both
developing the infrastructure and implementing appropriate systems related to
these aspects of the measurement guidance, would be more significant for
nonpublic entities subject to the deferral of the effective date.
BC238. Additionally, the Board noted that the financial statements, as well as
the notes to the financial statements of these entities, generally would be
available at the same time so stakeholders in those entities would have access to
the fair value disclosures about loans at the same time as the financial
statements therefore alleviating the Board’s concern about the timing of public
dissemination of both amortized cost and fair value information applicable to
public companies. Nonpublic entities generally do not issue press releases.
175
Therefore, the fair value information disclosed in the notes to the financial
statements would be available at the same time as the amortized cost
information on the face of the financial statements.
Transition
BC239. The Board decided that the proposed guidance should require a
cumulative-effect adjustment to the statement of financial position immediately
before the effective date. The prior-period statement of financial position would
be restated in the first financial statements issued after the effective date of the
proposed guidance. The Board rejected other methods, including methods
requiring full retrospective transition. The Board acknowledged that retrospective
transition methods provide the most useful information. However, the Board
determined them to be impracticable to apply because of the requirements to
make significant estimates of amounts and assumptions about management’s
intentions.
Benefits and Costs

BC240. The objective of financial reporting is to provide information that is
useful to present and potential investors, creditors, donors, and other capital
market participants in making rational investment, credit, and similar resource
allocation decisions. However, the benefits of providing information for that
purpose should justify the related costs. Present and potential investors,
creditors, donors, and other users of financial information benefit from
improvements in financial reporting, while the costs to implement new guidance
are borne primarily by present investors. The Board’s assessment of the costs
and benefits of issuing new guidance is unavoidably more qualitative than
quantitative because there is no method to objectively measure the costs to
implement new guidance or to quantify the value of improved information in
financial statements.
BC241. Based on an extensive due process and significant input received from
more than 100 financial statement users employed by various organizations and
representing a variety of perspectives, the Board believes that the proposed
guidance would provide users with more relevant, reliable, and timely information
about an entity’s financial position and financial performance.
BC242. The Board recognizes that the proposed guidance may require
significant effort for many entities to gather the necessary data for application
and that the review and audit procedures to ensure compliance with the
proposed guidance may require significant additional effort. Additionally, the
Board also considered the operationality of the requirements of the proposed
guidance, especially the expanded fair value measurement for financial
instruments. The Board concluded that identifying the fair value of some
instruments for small entities may be particularly burdensome. In response, the
176
Board decided to allow these entities additional time to develop systems and
methods to comply with the requirements of this proposed guidance.
BC243. Notwithstanding these potential additional costs, the Board concluded
that the costs associated with complying with the proposed guidance do not
outweigh the significant benefits of improved information about financial
instruments. The Board developed this proposed guidance to provide users of
financial statements with relevant information about financial instruments held by
an entity. The proposed guidance is expected to improve:
a. The recognition and measurement of financial instruments under
different scenarios
b. The measurement of credit impairments for certain financial
instruments and the related interest income recognized by the entity
c. The transparency of both management’s and the market’s
expectations of cash flows to be received or paid related to its
involvement with financial instruments
d. The application of accounting for hedging relationships and
transactions
e. A user’s ability to understand and assess an entity’s financial
instruments, credit impairments, and hedging transactions.
Alternative Views
BC244. The existing accounting standards for financial instruments were
established on a piecemeal basis to address urgent reporting issues.
Accordingly, instruments that are economically similar, such as a loan and a debt
security, can be accounted for differently because of several possible factors,
including the legal form of the instrument, the nature of the reporting entity, and
whether specialized industry guidance applies. Ms. Seidman and Mr. Smith
strongly support the goal of establishing comprehensive principles to classify and
measure all financial instruments, which would simplify the accounting literature
and the financial statements in a manner that reflects the nature of the
instruments and the way they are used by the reporting entity. Ms. Seidman and
Mr. Smith agree with the proposed changes relating to impairment of debt
investments, which is widely agreed to be the most deficient and inconsistent
aspect of existing accounting standards, both in the United States and
internationally. Ms. Seidman and Mr. Smith dissent from several aspects of the
proposed guidance, primarily because it would introduce fair value accounting for
some nonmarketable, plain-vanilla debt instruments that are held for collection
(long-term investment), and most liabilities held for payment, which they believe
would not reflect the likely realization of those items in cash and, therefore, would
not be the most relevant way to measure those items in the statement of financial
position and comprehensive income.
177
BC245. Ms. Seidman and Mr. Smith believe there are three primary criteria that
should be considered to determine the measurement attribute and the
classification of financial assets. They believe that those criteria are the variability
of the cash flows, the marketability of the instrument, and the business practice
of the entity. Their model would require fair value accounting if the cash flows of
the instrument are variable (using the same proposed guidance on standalone
and embedded derivatives), a quoted market price is readily available, or the
business practice of the entity is not to hold the instrument to collect its
contractual cash flows. If any of these criteria are met, the instrument would be
carried at fair value because fair value appropriately reflects the cash flows that
the entity is likely to realize from the instrument. Ms. Seidman and Mr. Smith
would then classify instruments carried at fair value in a manner that is similar to
the proposed model (that is, the change in the fair value of instruments with
variable cash flows or that are not being held for collection of contractual cash
flows would be recorded in income, while changes in the fair value of instruments
being held for contractual cash flows that do not have variable cash flows would
be recorded in other comprehensive income). The main area of disagreement
between their proposed framework and the proposed guidance relates to
financial assets with the following characteristics: they do not have quoted prices
readily available, they do not have variable cash flows, and the reporting entity
intends to hold them (for example, traditional loans held for investment and
demand deposits). Ms. Seidman and Mr. Smith would carry these items at
amortized cost, not at fair value, with the improved approach to impairment of
debt investments and better disclosure about interest rate risk. They believe that
for these nonmarketable, plain-vanilla debt instruments that an entity holds as
part of a long-term business strategy, it is inappropriate for subjective, unrealized
gains and losses to form the basis for the entity’s statement of financial position,
including book equity, as well as comprehensive income, when those unrealized
gains and losses are expected to reverse. Ms. Seidman and Mr. Smith also
would carry liabilities that do not contain embedded derivatives at amortized cost,
unless they are part of a trading activity. They note that constituents have not
expressed concern about the accounting for financial liabilities, other than the
counterintuitive effect of reflecting gains and losses relating to changes in an
issuer’s own credit standing in net income (for the few liabilities that are currently
carried at fair value). Ms. Seidman and Mr. Smith would require that the fair value
of all financial instruments carried at amortized cost be presented parenthetically
on the face of the statement of financial position.
BC246. Ms. Seidman and Mr. Smith listened intently to the numerous points of
view expressed by investors on this central issue. The vast majority of investors
found both fair value information and amortized cost information useful. However,
the feedback was divided fairly evenly, with respect to illiquid, traditional loans,
core deposit liabilities, and other financial liabilities, between those who would
prefer that the statement of financial position and reported equity be based on
fair value for those items and those who would prefer that fair value information
be readily available, but not be the basis for reported equity and comprehensive
178
income. Some observed that the fair value estimates for those items would be
based primarily on unobservable inputs, which would introduce significant
subjectivity into comprehensive income and stockholders’ equity. In light of those
split views, Ms. Seidman and Mr. Smith would have preferred a standard based
on their proposed framework.
BC247. Ms. Seidman and Mr. Smith believe that having a coherent framework
that provides both historical and current information about all financial
instruments, and a consistent impairment test and approach to yields for debt
investments, represents a significant improvement and simplification in financial
reporting. While their preferred framework is not the same as IFRS 9 (because
they would carry marketable securities at fair value, whereas IFRS 9 permits cost
accounting if certain conditions are met and does not require fair value to be
presented parenthetically on the face of the statement of financial position for
instruments carried at amortized cost), it offers a much better starting point for a
converged accounting standard than the proposed guidance. World leaders have
requested that the Boards develop an improved, converged standard on financial
instruments, and Ms. Seidman and Mr. Smith believe that appeal must be
weighed heavily in evaluating alternative improvements.
BC248. Regarding the core deposit liabilities of a depository institution, Ms.
Seidman and Mr. Smith note that the guidance is proposing a new measurement
attribute for core deposit liabilities that would introduce a new element of
complexity in the accounting for financial instruments. Ms. Seidman and Mr.
Smith believe that the core deposit intangible asset can be a major source of
value for a depository institution, yet the measurement of the core deposit
intangible asset required by the proposed guidance would not be completely
captured by the computation being prescribed by the Board. Ms. Seidman and
Mr. Smith believe that the intent of the proposed guidance is to address the
accounting for financial instruments, not intangible assets. They believe that it is
inappropriate to address the accounting for internally generated intangible assets
on an ad hoc basis. Ms. Seidman and Mr. Smith would have preferred that
deposits be reported in the statement of financial position at the amount
withdrawable on demand. Furthermore, they believe that the issue of interest rate
sensitivity can be better addressed through improved disclosures.
BC249. Ms. Seidman and Mr. Smith believe the amortized cost exception
provided in the proposed guidance for some financial liabilities lacks an
underlying concept, is rules based in nature, and would not be operational. They
fear it would become an albatross for the Board, requiring interpretation and
causing compliance issues in practice. They would rather have a clear principle
behind the classification of liabilities that is primarily driven by the variability of
cash flows and the business model of the entity.
BC250. Ms. Seidman also dissents from the change in accounting for yields on
debt investments, which would be based on the original effective yield times the
amortized cost of the instrument net of the allowance for doubtful accounts. The
179
proposed approach commingles an allowance that sometimes explicitly
considers expected interest flows and sometimes does not (such as when a
statistical loss rate of principal charge-offs is used), which makes it difficult to
describe the objective of the yield calculation. The proposed approach also would
introduce subjectivity into both the allowance for doubtful accounts and reported
interest income. Mechanically, this approach would frequently give rise to interest
receipts on a performing loan that exceed the calculated interest income (net of
the allowance). The Board proposes to record any excess interest due over the
calculated interest income as an increase in the allowance for doubtful accounts,
which could then immediately be recorded as a reversal of credit impairment in
income (so, essentially, all of the coupon is recognized currently in income but
some of it is reclassified from interest to a reversal of bad debt expense). The
feedback received from users of financial statements was that they preferred that
yields be reported on the basis of the contractual terms of the instrument, thereby
signaling potentially risky instruments for further inquiry. They also preferred that
the subjectivity in the estimates be concentrated in the allowance for doubtful
accounts. The proposed approach is contrary to the views expressed by users
and would be costly to implement. Thus, Ms. Seidman seriously questions the
cost-benefit tradeoff of that proposed change.
BC251. Ms. Seidman and Mr. Smith also disagree with the proposed
requirement to present separately in the statement of financial position amounts
included in accumulated other comprehensive income related to the changes in
fair value for financial instruments held for collection. They believe that it is
inappropriate to effectively provide a pro forma measure of stockholder’s equity,
first including and then excluding fair value adjustments for these items. They
believe that this presentation sets a bad precedent for future controversial
accounting issues, because the Board could always decide to present the “other
view” as an adjustment to equity. Mr. Smith would not object if all other
comprehensive income items were presented separately, but he disagrees with
special presentation of this one item of other comprehensive income.
BC252. Ms. Seidman and Mr. Smith believe that the Board’s decision to defer
the application of the effective date of certain provisions of the proposed
guidance for nonpublic entities with less than $1 billion in assets raises significant
questions about the operationality of the proposed standard and whether the
improvements in financial reporting and related benefits intended would be
achieved in a timely fashion, if at all. The deferral would apply to over 90 percent
of banks and credit unions in the United States. The deferral of certain provisions
for 4 years to over 90 percent of the entities for which the standard was intended
calls into question whether the basic classification and measurement model of
the proposed guidance would meet the cost-benefit test.
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Appendix A: Comparison of the FASB’s and
the IASB’s Proposed Models for Financial
Instruments
A1. The following table provides a side-by-side comparison of the FASB’s and
the IASB’s proposed models for financial instruments. For a complete description
of the IASB’s model, see (1) IFRS 9 for the finalized requirements for classifying
and measuring financial assets and (2) the IASB’s financial instruments project
website (www.iasb.org) for a summary of its decisions made to date on all other
aspects of accounting for financial instruments (such as financial liabilities,
impairment, and hedge accounting). In the following table, the IASB’s published
proposals and tentative decisions are differentiated from finalized requirements.
IFRS 9 for Financial Assets and

The FASB’s Proposed the IASB’s Current Tentative
Update Decisions
Scope  All financial assets and  Items within the scope of IAS
financial liabilities, as 39.
defined (except those
for which a specific
scope exception has
been provided)
 Nonpublic entities with
less than $1 billion in
assets would apply
certain requirements in
this model relating to
loans, loan
commitments, and core
deposit liabilities 4
years after the original
effective date.
Measurement  Fair value  Fair value

Approaches  Amortized cost  Amortized cost
 Remeasurement  Separate accounting of
amount (only for core embedded derivatives from a
deposit liabilities). liability host if particular
1
conditions are met.
1
Unless the fair value option is applied.
181
Update Decisions
Classification  Fair value with all  Fair value through net income
and changes in fair value (FV-NI)
Measurement recognized in net  Amortized cost
Categories income (FV-NI)  Fair value through other
 Fair value with comprehensive income (FV-
qualifying changes in OCI) (limited option for some
fair value recognized in investments in equity
other comprehensive instruments).
income (FV-OCI)
 Amortized cost.
FV-OCI  Three qualifying criteria  Irrevocable election at initial

Classification must be satisfied to recognition for investments in
Criteria measure a financial equity instruments that are not
2 held for trading.
instrument at FV-OCI:
1. It is a debt
instrument held or
issued with all of the
following
characteristics:
a. There is an
amount
transferred to the
debtor (issuer) at
inception that
would be
returned to the
creditor (investor)
at maturity or
other settlement,
which is the
principal amount
of the contract
adjusted by any
original issue
discount or
premium.
2
Classification at FV-OCI is an option, not a requirement.
182
Update Decisions
b. The contractual
terms of the debt
instrument
identify any
additional
contractual cash
flows to be paid
to the creditor
(investor) either
periodically or at
the end of the
instrument’s
term.
c. The debt
instrument
cannot
contractually be
prepaid or
otherwise settled
in such a way
that the holder
would not recover
substantially all of
its initial
investment, other
than through its
own choice.
2. The entity’s
business strategy
for the instrument is
to collect or pay the
related contractual
cash flows rather
than to sell the
financial asset or to
settle the financial
liability with a third
party.
3. It is not a hybrid
instrument for which
applying Subtopic
815-15 on
embedded
derivatives would
otherwise have
required the
183
Update Decisions
embedded
derivative to be
accounted for
separately from the
host contract.
Amortized Cost  A financial liability may  A financial asset (including

Classification be carried at amortized hybrid financial assets) must
Criteria cost if: be subsequently measured at
3
1. The liability meets amortized cost if:
the criteria for 1. The objective of the entity’s
FV-OCI. business model is to hold
2. Measurement at fair the asset to collect the
value would create contractual cash flows.
or exacerbate a 2. The asset’s contractual
measurement cash flows are solely
attribute mismatch payments of principal and
between recognized interest.
assets and  Most financial liabilities must
liabilities. be subsequently measured at
 Irrevocable election 3
amortized cost if they are not
made at the issuance of
held for trading. Embedded
the financial liability.
derivatives are separated from
a liability host and accounted
for as derivatives if particular
criteria are met.
Fair Value  Not applicable to  Financial assets: Irrevocable

Option financial instruments in election available at initial
the scope of the recognition if measuring at fair
proposed guidance. value eliminates or significantly
 The fair value option reduces a measurement or
under Topic 825 applies recognition inconsistency (an
to a broader set of accounting mismatch).
instruments than the  Financial liabilities:
scope of the proposed Irrevocable election would be
guidance and would available at initial recognition if:
continue to apply to 1. Measuring at fair value
those instruments that eliminates or significantly
are not within the scope reduces an accounting
of the proposed mismatch.
3
184
Update Decisions
guidance except for 2. A group of financial

unconsolidated equity instruments is managed
investments. and its performance is
evaluated on a fair value
basis.
3. The liability contains one or
more separable embedded
derivatives and the entity
elects to account for the
hybrid (combined) contract
in its entirety.
 The IASB’s Exposure Draft on
fair value option proposes
changes to the fair value option
for financial liabilities and is
open for comment until July 16,
2010.
Hybrid Financial  Hybrid financial assets  Hybrids with financial hosts

Assets containing embedded would be classified in their
derivatives that would entirety based on the overall
otherwise require classification approach for
separate accounting financial assets.
under Topic 815 would  Specific guidance for applying
be measured in their the classification approach to
entirety at FV-NI. investments in contractually
 Hybrid financial assets linked instruments that create
containing embedded concentrations of credit risk.
derivatives that would
not require separate
accounting under Topic
815 would be eligible
for measurement in
their entirety at FV-OCI.
Hybrid Financial  Hybrid financial  An embedded derivative is

Liabilities liabilities should be separated from the host liability
measured using the contract if particular conditions
4
classification criteria are met.
described for hybrid
financial assets.
4
185
Update Decisions
Core Deposit  Subsequent  No special guidance; generally

Liabilities measurement at measured at amortized cost.
present value of
average core deposit
liability discounted at
the differential between
the alternative funds
rate and the all-in-cost-
to-service rate over
implied maturity.
 Qualifying changes in
the remeasurement
amount may be
recognized in other
comprehensive income
if classification criteria
are met.
Short-Term  Measured at amortized  No special guidance; generally

Receivables and cost (plus or minus any measured at amortized cost.
Payables fair value hedging
adjustments) if they
arise in the normal
course of business, if
they are due in
customary terms, and if
the business strategy is
to hold for collection or
payment of contractual
cash flows
 Subject to impairment.
Unconsolidated  Accounted for under  Not within the scope of IFRS 9;

Equity Topic 323 if the entity accounted for under IAS 28,
Investments has significant influence Investments in Associates.
over the investee and
the investment is
considered related to
the entity’s consolidated
business
186
Update Decisions
 Measured at fair value

with all changes in fair
value recognized in net
income if the
requirements under
Topic 323 are not met
 No fair value option for
these investments.
Loan  Potential lenders  Only some loan commitments

Commitments classify loan are within the scope of IFRS 9
commitments in the and IAS 39.
same manner as the  For those within the scope,
loan once funded was subsequent measurement
classified. would depend on the terms of
 If a loan measured at the instrument and the entity’s
FV-OCI is funded, circumstances.
accounting for the
commitment fee would
be a yield adjustment of
the related loan, which
is consistent with the
accounting in Subtopic
310-20.
 Potential borrowers and
issuers of lines of credit
issued as part of credit
card arrangements
would be excluded from
the scope.
Impairment  For financial  The comment period for the

instruments measured IASB’s Exposure Draft on
at FV-OCI, an entity impairment is open until June
would be required to 30, 2010.
determine if recognition  That Exposure Draft proposes
of a credit impairment is an expected loss model that
required at the end of would require an entity to
each reporting period. determine the expected credit
 In determining whether losses on a financial asset
a credit impairment when that asset is first
exists, an entity would recognized. Initial expectations
consider all available of credit losses would be
information relating to included in determining the
past events and existing effective interest rate.
187
Update Decisions
economic conditions  Contractual interest revenue,

and their implications less the initial expected credit
for the collectibility of losses, would be recognized
the financial asset(s). over the life of the instrument.
 An entity would  Expected credit losses would
recognize in net income be reassessed each period
the loss related to the and the effects of any changes
amount of credit in expectations would be
impairment for all recognized in net income
contractual amounts immediately.
due for originated
financial asset(s) and
amounts originally
expected to be
collected for purchased
financial asset(s) that
an entity does not
expect to collect.
 An entity would present
the allowance for credit
losses on the statement
of financial position as a
separate line item.
Realized Gains  Recognized in net  Financial assets: Recognized

and Losses from income for all financial in net income for all financial
Sales or instruments. assets, excluding those
Settlements classified as FV-OCI for which
all gains and losses are
recognized in other
comprehensive income and
are not recycled
 Financial liabilities:
Recognized in net income for
all financial liabilities except the
IASB tentatively decided that
for liabilities designated under
the fair value option that gains
and losses attributable to
changes in own credit risk will
be recognized in other
comprehensive income and not
recycled.
188
Update Decisions
Interest and  Recognized in net  Recognized in net income for

Dividend income for all financial all financial instruments except
Accruals instruments. However, for some dividends on financial
not required to be assets classified as FV-OCI.
presented separately For those assets, dividends are
for financial instruments recognized in other
measured at FV-NI. comprehensive income if they
Interest would be clearly represent a recovery of
presented separately part of the cost of the
for financial instruments investment.
measured at FV-OCI.
Transaction  For financial  Recognized in net income

Fees and Costs instruments measured immediately for assets and
at FV-NI, transaction liabilities that are measured at
fees and costs would be FV-NI
recognized in net  Included in the initial
income as expenses measurement of all assets and
upon initial recognition. liabilities that are not measured
 For financial at FV-NI.
instruments measured
at FV-OCI, transaction
fees and costs would be
recognized in other
and recognized in net
income as a yield
adjustment of the
related financial
instrument over the life
of the instrument.
Tainting  No tainting.  No tainting.
Reclassifications  Not permitted.  Required for financial assets if

the entity’s business model for
managing its financial assets
changes
 Prohibited for financial
liabilities.
Statement of  Financial instruments  No significant changes

Financial would be displayed proposed.
Position separately on the face
189
Update Decisions
depending on whether
they are classified as
FV-NI or FV-OCI.
 The following amounts
would be presented on
the face of the
statement of financial
position for financial
at FV-NI:
1. Fair value
2. Amortized cost of
the entity’s own
outstanding debt.
 The following amounts
would be presented on
the face of the
statement of financial
position for financial
at FV-OCI:
1. Amortized cost
2. Allowance for credit
losses
3. Amount needed to
adjust amortized
cost less allowance
for credit losses to
fair value
4. Fair value.
 Present separately on
the face amounts
included in accumulated
other comprehensive
income related to the
changes in fair value or
changes in the
remeasurement amount
for financial instruments
for which those
changes are recognized
in other comprehensive
income.
190
Update Decisions
Statement of  At the same time that it  IAS 1, Presentation of

Comprehensive issues this proposed Financial Statements, permits
Income Update, the FASB comprehensive income to be
expects to issue a presented in either a single
proposed Update that statement or two statements.
would require a  The IASB expects to publish
continuous statement of an Exposure Draft in the
comprehensive income second quarter of 2010 that
with total would require comprehensive
comprehensive income income to be presented,
and a subtotal for net partitioned into net income and
income. Under the other comprehensive income.
comprehensive income No changes to earnings per
proposal, earnings per share are proposed so it will
share would continue to continue to be based on net
be based on net income income only.
only.
Presentation of  Present separately  The IASB’s Exposure Draft on

Changes in Own significant current fair value option proposes that
Credit period change in fair for financial liabilities
value attributed to designated under the fair value
changes in the entity’s option, an entity:
credit standing, 1. Present the total fair value
excluding changes in change in net income
the price of credit. 2. Present the portion
attributable to changes in
own credit risk in other
(with an offsetting entry to
net income).
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Update Decisions
Hedge  The types of items and  The IASB expects to publish

Accounting transactions eligible for proposals resulting from its
(only main hedge accounting in comprehensive review of
features Topic 815 would hedge accounting
summarized) continue to apply. requirements that will allow
 The shortcut method finalization in the near term.
and critical terms match
method would be
eliminated. An entity
would no longer have
the ability to assume a
hedging relationship is
effective and recognize
no ineffectiveness in net
income during the term
of the hedge.
 An entity would not be
permitted to discontinue
hedge accounting by
simply removing the
designation of a
Hedge accounting can
be discontinued only if
the criteria for hedge
accounting are no
longer met or the
hedging instrument
expires, is sold,
terminated, or
exercised.
 An entity would be able
to designate particular
risks as the risk being
hedged in a hedging
relationship. Only the
effects of the risks
hedged would be
reflected in net income.
The types of risks
eligible as hedged risks
in Topic 815 would
continue to apply.
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Update Decisions
Hedge  After inception of the  The IASB expects to publish

Effectiveness hedging relationship, an proposals resulting from its
(only main entity would need to comprehensive review of
features qualitatively (or hedge accounting
summarized) quantitatively, if requirements that will allow
necessary) reassess finalization in the near term.
effectiveness only if
circumstances suggest
that the hedging
relationship may no
longer be reasonably
effective.
 An entity would be
required to perform a
qualitative (rather than
quantitative) test at
inception to
demonstrate that an
economic relationship
exists between the
hedging instrument and
the hedged item or
forecasted transaction.
However, in certain
situations, a quantitative
test may be necessary
at inception.
 As part of the hedge
effectiveness
assessment, an entity
would be required to
demonstrate that
changes in fair value of
the hedging instrument
would be reasonably
effective in offsetting
the changes in the
hedged item’s fair value
or the variability in the
hedged cash flows for
the risk or risks hedged
by the entity in that
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Update Decisions
Accounting  An entity that qualifies  Not applicable.

Guidance for for the delayed effective
Entities Subject date may measure
to the Delayed loans and loan
Transition commitments that meet
the criteria for FV-OCI
and core deposit
liabilities that qualify for
remeasurement
changes to be
recognized in other
comprehensive income,
in accordance with
existing U.S. GAAP
during the deferral
period. All other
provisions of the
proposed guidance
would apply on the
original effective date.
 An entity would disclose
in the notes to the
financial statements the
fair value of loans that
meet the criteria for
delayed transition,
determined in
accordance with the
guidance in Topic 820,
in a reporting period for
which application of the
proposed guidance is
deferred for those
loans.
194
Appendix B: Possible Methods for Measuring
Changes in an Entity’s Credit Standing
B1. To address concerns of some of the Board’s constituents about including
the effect of changes in an entity’s own credit risk in measuring its financial
performance, the Board decided that an entity should separately present the
effect of these changes on the face of the statement of comprehensive income.
To provide meaningful information to users, the Board considered whether to
require an entity to measure the effect of changes in an entity’s own credit risk by
determining the change in fair value attributable to a change in the entity’s own
credit spread (that is, the portion of the discount rate that is not the
benchmark/risk-free interest rate), which generally is consistent with current
practice for complying with similar requirements under Subtopic 825-10 and IFRS
7. However, the Board believes that the change in fair value attributable to the
change in an entity’s credit spread does not accurately reflect the change in the
entity’s own credit alone because it also measures the change in the price of
credit, which affects not just the individual entity, but also other entities in the
industry and the economy. Thus, the Board decided that an entity should present
separately on the face of the statement of comprehensive income significant
changes in fair value of a financial liability that are attributable to changes in the
entity’s credit standing, excluding the change in the price of credit. Such
information would be meaningful to users of the financial statements because an
entity would be required to present changes in fair value related to changes in its
credit risk only when there has been a change in the entity’s credit standing.
Changes in the price of credit solely due to changes in market conditions would
not be presented separately.
B2. The Board recognizes that there may be several different methods to
determine the change in fair value attributable to a change in an entity’s credit
standing, excluding the change in the price of credit, and the proposed guidance
does not prescribe a method for determining that change. This appendix
describes two methods that could be used to determine the change in fair value
attributable to a change in an entity’s credit standing, excluding the change in the
price of credit. The Board requests that constituents review this appendix in
considering Questions 32–34 and 36 in the summary.
Method 1
B3. Under Method 1, if there has been no change in an entity’s credit rating
from the beginning to the end of the period, the entity would assume that there
has been no change in fair value for the period attributable to a change in the
entity’s credit standing, excluding the change in the price of credit. If a financial
195
liability is not rated, the entity would estimate what the financial liability’s rating
would have been at the beginning and end of the period based on the basis of
market information.
B4. If an entity experiences a credit rating change from one period to another
(or estimates that it would have experienced a rating change had it been rated),
the entity would measure the change in the fair value of its liabilities attributable
to a change in the entity’s credit standing, excluding the price of credit, by
calculating the difference in the change in the reported fair values of the entity’s
liabilities (which are based on the entity’s actual discount rates and credit ratings
at the beginning and end of the period) and estimated changes in its fair value
based on measures of what its discount rate would have been at the end of the
period without a change in credit rating.
Method 2
B5. Under Method 2, the change in the fair value of the financial liability
attributable to a change in the entity’s credit standing, excluding a change in the
price of credit, would not be based on whether an entity has had a change in
credit rating. Instead, an entity would isolate the portion of the fair value changes
of its liabilities related to the change in the price of credit and deduct that amount
from the overall change in fair value. An entity would estimate the change in the
price of credit by looking to entities in the industry with the same credit standing.
Those entities may or may not have debt instruments with the same credit rating
as the entity for a number of reasons, including delays in changes in credit
ratings and the fact that not all debt instruments are rated.
B6. The Example illustrates the application of the methods described above.
Examples
B7. On January 1, 20X1, Entity A issues at par in a private placement a $2
million AA-rated 5-year fixed-rate debt instrument with an annual interest rate of
10 percent, which is 300 basis points above the risk-free interest rate. The
average spread for other entities in Entity A’s industry with AA-rated debt is also
300 basis points above the risk-free interest rate on January 1, 20X1.
Scenario A
B8. At December 31, 20X1, Entity A still carries an AA credit rating. Market
conditions, including the risk-free interest rate, remain unchanged from the
issuance date of the debt instrument. However, the average credit spread for
other entities in the industry for an AA credit rating has increased by 100 basis
points, and Entity A estimates that its credit spread also has increased by 100
basis points. After considering all market conditions, Entity A concludes that if it
196
was to issue the debt instrument at the measurement date, the debt instrument
would bear an interest rate of 11 percent, and Entity A would receive less than
par in proceeds from the issuance of the debt instrument.
B9. For the purpose of this Example, the fair value of Entity A’s liability is
calculated using a present value technique. Entity A believes a market participant
would use all of the following inputs in determining the price the market
participant would expect to receive to assume Entity A’s obligation:
a. Terms of the debt instrument, including all of the following:
1. Coupon interest rate of 10 percent
2. Principal amount of $2 million
3. Term of 4 years.
b. Change in credit spread from the date of issuance of 100 basis
points.
B10. Using a present value technique, Entity A concludes that the fair value of
its liability at December 31, 20X1, is $1,937,951, a change of $62,049 from
January 1, 20X1.
Method 1
B11. Because there has been no change in Entity A’s credit rating, under
Method 1, none of the $62,049 change in fair value would be considered
attributable to a change in the entity’s credit standing. All of the change would be
attributable to a change in the price of credit.
Method 2
B12. Under Method 2, the change in the fair value of the financial liability
attributable to a change in Entity A’s credit standing, excluding a change in the
price of credit, would not be based on whether Entity A has had a change in its
credit rating. Instead, Entity A would estimate the change in the price of credit by
looking to entities in its industry with the same credit standing. Those entities
may or may not have debt instruments with the same credit rating as Entity A for
a number of reasons, including delays in changes in credit ratings and because
not all debt instruments are rated. For example, Entity A may estimate that the
average discount rate for entities in its industry with the same credit standing is
10.9 percent at period end based on the effective interest rates on recent debt
issuances in the industry, which is a 90 basis points increase in the price of credit
during the period. Because the fair value of the debt instrument would have been
$1,944,037 if the discount rate was 10.9 percent, Entity A would consider
$55,963 ($2,000,000 – $1,944,037) of the change in the fair value of its financial
liability for the period to be attributable to a change in the price of credit and the
remaining $6,086 attributable to a change in the entity’s credit standing.
197
Scenario B
B13. At December 31, 20X1, Entity A now carries a BBB credit rating. Market
conditions, including the risk-free interest rate and average credit spreads for the
industry for an AA-quality credit rating remain unchanged from the issuance date
of the debt instrument. Entity A estimates that its credit spread has increased by
225 basis points (to 525 basis points over the risk-free interest rate) because of
its rating downgrade and a change in its risk of nonperformance. The average
spread for other entities in Entity A’s industry with BBB-rated debt is 500 basis
points above the risk-free interest rate on December 31, 20X1, which is
consistent with the average credit spreads for the industry on January 1, 20X1.
After considering all market conditions, Entity A concludes that if it was to issue
the debt instrument at the measurement date, the debt instrument would bear an
interest rate of 12.25 percent, and Entity A would receive less than par in
proceeds from the issuance of the debt instrument.
measured using a present value technique. Using a present value technique,
Entity A concludes that the fair value of its liability at December 31, 20X1, is
$1,864,036, a decrease of $135,964 from January 1, 20X1.
Method 1
B15. Because there has been a change in Entity A’s credit rating, Entity A
would calculate the portion of the change in fair value that relates to the change
in the entity’s credit standing. Entity A would estimate what fair value would have
been for the debt instrument had there been no change in its credit rating.
Because there have been no changes in market conditions, including the risk-
free interest rate and credit spreads for AA-rated instruments, Entity A calculates
that the fair value of the debt instrument absent the change in its credit rating
would have continued to be $2 million (that is, Entity A believes that its discount
rate would have remained at 10 percent if it had not been downgraded).
Therefore, the entire change in fair value of $135,964 would be considered
attributable to a change in Entity A’s credit standing.
Method 2
B16. Under Method 2, the change in the fair value of the debt instrument
price of credit, would not be based on whether Entity A has had a change in its
looking to entities in the industry with the same credit standing. For example,
Entity A may estimate that entities in its industry with the same credit standing
have experienced on average of 10 basis points increase in the price of credit
198
$1,993,674 if the discount rate changed by 10 basis points, Entity A would
consider $6,326 ($2,000,000 – $1,993,674) of the difference to be attributable to
a change in the price of credit and the remaining $129,638 attributable to a
change in the entity’s credit standing.
Scenario C
B17. At December 31, 20X1, Entity A now carries a BBB credit rating. Entity A
estimates that its credit spread has deteriorated by 225 basis points (to 525 basis
points over the risk-free interest rate) because of its rating downgrade and a
change in its risk of nonperformance. Credit spreads for the industry for an AA-
quality credit rating have increased from the issuance date of the debt
instrument. However, the risk-free interest rate has not changed. The average
spread for other entities in Entity A’s industry with AA-rated debt is 350 basis
points above the risk-free interest rate on December 31, 20X1. The average
spread for other entities in Entity A’s industry with BBB-rated debt is 500 basis
points above the risk-free interest rate on December 31, 20X1, compared with
average credit spreads for the industry on January 1, 20X1, of 400 basis points
over the risk-free interest rate. After considering all market conditions, Entity A
concludes that if it was to issue the debt instrument at the measurement date, the
debt instrument would bear an interest rate of 12.25 percent, and Entity A would
receive less than par in proceeds from the issuance of the debt instrument.
measured using a present value technique. Using a present value technique,
Entity A concludes that the fair value of its liability at December 31, 20X1, is
$1,864,036, a decrease of $135,964 from January 1, 20X1.
Method 1
B19. Because there has been a change in Entity A’s credit rating, Entity A
would calculate the portion of the change in fair value that relates to the change
in its credit standing. Entity A would estimate what fair value would have been for
the debt instrument had there been no change in its credit rating. Entity A
calculates that the fair value of the debt instrument without the change in credit
rating would have been $1,968,641, based on an interest rate of 10.5 percent
(risk-free interest rate of 7 percent plus 350 basis point spread for other entities
in the industry with AA-rated debt), which is a change of $31,359 from January 1,
20X1. Therefore, $104,605 ($135,964 – $31,359) of the change in fair value of
the debt instrument would be considered attributable to a change in Entity A’s
credit standing.
199
Method 2
B20. Under Method 2, the change in the fair value of the debt instrument
price of credit, would not be based on whether Entity A has had a change in
looking to entities in the industry with the same credit standing. For example,
Entity A may estimate that entities in its industry with the same credit standing
have experienced an average of 60 basis points increase in the price of credit
$1,962,450 if the discount rate changed by 60 basis points, Entity A would
consider $37,550 ($2,000,000 – $1,962,450) of the difference to be attributable
to a change in the price of credit and the remaining $98,414 attributable to a
change in the entity’s credit standing.
200
Appendix C: Summary of Proposed
Amendments to the FASB Accounting
TM
Standards Codification
C1. The proposed guidance section of this proposed Update describes the
accounting, hedging, presentation, and disclosure requirements that would result
from the related amendments to the Accounting Standards Codification. The
Board expects to issue the proposed amendments to the Accounting Standards
Codification during the comment period, which ends on September 30, 2010.
C2. The Board recognizes that the proposed guidance would have a pervasive
effect on the existing accounting guidance for financial instruments in the
Accounting Standards Codification. The table below is designed to provide an
indication of the effect of the proposed guidance on relevant areas of the
Accounting Standards Codification. The table is based on a preliminary
assessment of the necessary updates to the Accounting Standards Codification.
It presents only the significant changes to the Accounting Standards Codification
that are expected to arise from the proposed guidance and is not intended to be
a comprehensive list of updates to the Accounting Standards Codification.
Certain Subtopics that are not expected to be substantively affected are noted in
the table to provide that information to constituents. The Board expects to issue
an updated version of this table when it issues the proposed amendments to the
Accounting Standards Codification.
Codification Subtopic Action Nature of Changes
210-10 Balance Amended  The proposed guidance would amend

Sheet—Overall this Subtopic to reflect the proposed
requirement to separately present
amounts included in accumulated
other comprehensive income (and
allocated to noncontrolling interests, if
applicable) related to the qualifying
changes in fair value or qualifying
changes in the remeasurement
amount for financial instruments for
which those changes are recognized
201
310-10 Receivables— Amended  The proposed guidance would

Overall substantively change the initial
measurement and subsequent
measurement guidance.
 The proposed guidance would replace
the impairment guidance contained in
the general Subsection of this
Subtopic. Some guidance related to
the measurement of impairment on
individually assessed loans would be
incorporated into the new credit
impairment model.
 The practical expedient for measuring
impairment based on the fair value of
the collateral for collateral-dependent
loans would be incorporated into the
new credit impairment model and
would be broadened to apply to any
collateral-dependent financial asset.
 The guidance related to the
recognition of fees and interest
discussed in the Acquisition,
Development and Construction
Arrangements Subsection would be
amended.
 Certain disclosure requirements from
this Subtopic would remain.
 Disclosures from the project on the
credit quality of financing receivables
and the allowance for credit losses
would be included in this Subtopic and
would be carried forward for financial
assets for which qualifying changes in
fair value are recognized in other
310-20 Receivables— Amended  The guidance related to fees, costs,

Nonrefundable Fees and estimating principal prepayments
and Other Costs would be applicable to financial assets
in the scope of this Subtopic that have
qualifying changes in fair value
recognized in other comprehensive
income.
 The guidance for commitment fees
recognized over the commitment
period on a straightline basis related
202
to loan commitments for which the

entity’s experience with similar
arrangements indicates that the
likelihood that the commitment will be
exercised is remote would be
amended such that the commitment
fee would be recognized as part of the
fair value change of the commitment.
 The subsequent measurement
guidance related to a purchase of a
loan or group of loans would be
amended such that the difference
between the initial investment and the
cash flows expected to be collected
(rather than the principal amount)
would be recognized as an
adjustment of yield.
 The option to recognize yield for loans
with variable interest rates based on
the index or rate in effect at the
inception of the loan would be
eliminated.
 The proposed guidance would
necessitate other conforming changes
to this Subtopic to reflect the
proposed recognition guidance,
including the proposed interest
income recognition guidance.
310-30 Receivables— Amended  The guidance in this Subtopic, other

Loans and Debt than disclosures, would be
Securities Acquired with superseded by the new credit
Deteriorated Credit impairment model. This includes
Quality guidance from Accounting Standards
Update 2010-18, Receivables (Topic
310): Effect of a Loan Modification
When the Loan Is Part of a Pool That
Is Accounted for as a Single Asset.
(However, the new credit impairment
model would permit aggregation of
individually impaired loans for
measurement of impairment based on
a present value method and would not
require that a loan that is modified or
restructured be removed from such a
pool.)
203
 The disclosure requirements in this

Subtopic would be modified and
carried forward for financial assets
purchased at an amount that includes
a discount related to credit quality for
which qualifying changes in fair value
are recognized in other
310-40 Receivables— Amended  The guidance related to impairment

Troubled Debt and the effective interest rate would
Restructurings by be incorporated into the proposed
Creditors credit impairment model.
 The proposed guidance indicates that
if a loan included in a pool of financial
assets for which impairment is
determined based on a historical loss
rate (adjusted for existing conditions)
is restructured in a troubled debt
restructuring, the loan would be
removed from the pool and the
amount of impairment would be
measured on an individual asset
basis.
320-10 Investments— Amended  The proposed guidance would

Debt and Equity supersede the classification and
Securities—Overall measurement guidance in this
Subtopic.
 The impairment guidance in this
Subtopic would be superseded.
 The guidance on the calculation of
interest income on certain structured
notes would be eliminated.
 The proposed guidance would
preserve the guidance for recognizing
the entire change in fair value of
foreign-currency-denominated debt
securities in other comprehensive
income and would extend that
approach to all financial instruments
for which qualifying changes in fair
value would be recognized in other
comprehensive income. However,
unlike existing guidance, which
requires an entity holding a foreign-
204
currency denominated available-for-

sale security to consider changes in
foreign exchange rates since
acquisition in determining whether an
other-than-temporary impairment has
occurred, a change in foreign
exchange rates would not result in a
credit impairment under the proposed
guidance.
323-10 Investments— Amended  The proposed guidance would change

Equity Method and the criteria for an unconsolidated
Joint Ventures—Overall investment in an equity security to
qualify to be accounted for under the
equity method.
 The accounting for equity method
investments would not change.
323-30 Investments— Amended  The guidance in this Subtopic would

Equity Method and be amended to reflect proposed
Joint Ventures— changes to Subtopic 323-10.
Partnerships, Joint
Ventures, and Limited
Liability Entities
325-20 Investments— Superseded  The guidance in this Subtopic would

Other—Cost Method be superseded.
Investments
325-30 Investments— Amended  The proposed guidance would amend

Other—Investments in the guidance in the Life Settlement
Insurance Contracts Contract Subsections to eliminate the
investment method. Such contracts
would be within the scope of the
proposed guidance.
325-40 Investments— Superseded  The guidance in this Subtopic would

Other—Beneficial be superseded.
Interests in Securitized
Financial Assets
205
340-30 Other Assets Amended  Contracts within the scope of the

and Deferred Costs— deposit method of accounting would
Insurance Contracts be within the scope of the proposed
that Do Not Transfer guidance.
Insurance Risk
460-10 Guarantees— Amended  Guarantees not explicitly excluded

Overall from the scope of the proposed
guidance would be subject to the
proposed guidance.
 Guarantees that are explicitly
excluded from the scope of the
proposed guidance would continue to
follow the guidance in Subtopic 460-
10 and Topic 944.
 Disclosure requirements in this
Subtopic would continue to apply.
470-10 Debt—Overall Amended  The proposed guidance would amend

this Subtopic to indicate that issued
debt would subsequently be
measured at fair value, unless an
entity is able to elect the amortized
cost option.
 Other guidance in this Subtopic would
remain.
470-20 Debt—Debt Amended  If a financial instrument with an equity

with Conversion and component and a debt component
Other Options requires separation under the
guidance in this Subtopic, the liability
component would be within the scope
of the proposed guidance.
470-30 Debt— Amended  The proposed guidance would affect

Participating Mortgage the accounting for the liability.
Loans
470-60 Debt—Troubled Amended  For a liability that is reported at fair

Debt Restructurings by value (whether the changes in its fair
Debtors value are recognized in net income or
the qualifying portion of the changes
in its fair value recognized in other
comprehensive income), the debtor’s
accounting for a modification of terms
206
would be superseded. For a liability

that is reported at amortized cost, the
debtor’s accounting for a modification
of terms would not change.
480-10 Distinguishing Amended  The guidance in this Subtopic related

Liabilities from Equity— to forward contracts that require
Overall physical settlement by repurchase of
a fixed number of the issuer’s equity
shares in exchange for cash would
not be changed by the proposed
guidance.
 The measurement guidance for other
financial instruments in this Subtopic
would be affected by the proposed
guidance.
805-30 Business Amended  The proposed guidance would amend

Combinations— this Subtopic to indicate that
Goodwill or Gain from contingent consideration
Bargain Purchase, arrangements based on an
Including Consideration observable market or observable
Transferred index would be within the scope of the
proposed guidance.
815-10 Derivatives and Amended  This Subtopic would be substantially

Hedging—Overall unchanged. All freestanding derivative
financial instruments, while also in the
scope of the proposed guidance,
would continue to be measured at fair
value with changes in fair value
recognized in net income, with the
exception of derivatives designated
and effective as cash flow hedges and
hedges of a net investment in a
foreign operation.
 Derivative instruments that are not
financial instruments would continue
to be included in the scope of
Subtopic 815-10.
 All loan commitments would be
excluded from the scope of Subtopic
815-10 because they would be
subject to the scope of the proposed
guidance.
207
 The guidance in the Certain Contracts

on Debt and Equity Securities
Subsections would be amended to
reflect the new classification model.
815-15 Derivatives and Amended  Hybrid financial instruments in the

Hedging—Embedded scope of Subtopic 815-15 would be
Derivatives included in the scope of the proposed
guidance. Such hybrids would no
longer be bifurcated into a host
contract and an embedded derivative
feature.
 If a hybrid financial instrument with a
host contract that is a financial
instrument would be required by the
guidance in Subtopic 815-15 to be
accounted for separately, the
proposed guidance would require that
the hybrid be measured at fair value in
its entirety with changes in fair value
recognized in net income. If a hybrid
financial instrument would not be
required by the guidance in Subtopic
815-15 to be accounted for
separately, the proposed guidance
would require the hybrid to be
measured at fair value in its entirety
with qualifying changes in fair value
permitted to be recognized in other
 Hybrid financial instruments with a
host that would not be within the
scope of the proposed guidance (for
example, a lease host or an insurance
host) or a hybrid instrument with a
nonfinancial host contract would
continue to be bifurcated if required by
the guidance in this Subtopic.
815-20 Derivatives and Amended  This proposed guidance would amend

Hedging—Hedging— this Subtopic to reflect proposed
General changes to hedge accounting
requirements.
 The shortcut method and the critical
terms match method would be
eliminated.
208
 The guidance related to hedge

effectiveness would be modified to
indicate that the hedge must be
“reasonably effective” rather than
“highly effective.”
815-25 Derivatives and Amended  The proposed guidance would amend

Hedging—Fair Value this Subtopic to reflect proposed
Hedges changes to hedge accounting
requirements.
 The change in fair value of the
hedged item related to the hedged
risk would continue to be recognized
in earnings (net income) and would be
included in the carrying amount of the
hedged item (regardless of whether
the carrying amount is based on
amortized cost or fair value). The
guidance related to the interaction
between impairment and hedge
accounting would be modified to
reflect changes to the impairment
model.
815-30 Derivatives and Amended  The proposed guidance would amend

Hedging—Cash Flow this Subtopic to reflect changes to
Hedges cash flow hedge accounting.
 The guidance in this Subtopic would
be amended to reflect the requirement
that ineffectiveness from both
underhedges and overhedges should
be included in net income.
815-35 Derivatives and Substantially  The substance of the guidance in this

Hedging—Net unchanged Subtopic would not be changed.
Investment Hedges
815-40 Derivatives and Substantially  The substance of the guidance in this

Hedging—Contracts in unchanged Subtopic would not be changed.
an Entity’s Own Equity  Financial instruments in the scope of
this Subtopic that are classified as
assets and liabilities would be within
the scope of the proposed guidance
and would be measured at fair value
209
with changes in value recognized in

net income, in accordance with the
guidance in the Subsequent
Measurement Section of this
Subtopic.
815-45 Derivatives and Unchanged  The substance of the guidance in this

Hedging—Weather Subtopic would not be changed.
Derivatives
825 Financial New  This Topic would contain the majority

Instruments guidance to of the proposed guidance related to
be added classification, initial measurement,
subsequent measurement,
impairment, presentation, and
incremental disclosures for financial
instruments in the scope of the
proposed guidance.
825-10 Financial Amended  The proposed guidance would

Instruments—Overall establish fair value with all changes in
fair value recognized in net income as
the default classification and
measurement category for financial
instruments. Therefore, the fair value
option would not be needed for
financial instruments within the scope
of the proposed guidance. The fair
value option guidance would be
eliminated for equity method
investments and amended to apply
only to certain other instruments.
 The disclosures related to the fair
value of financial instruments would
be deleted.
 The disclosures related to
concentration of credit risk would not
be changed.
 The disclosures related to market risk
would not be changed.
825-20 Financial Unchanged  The substance of the guidance in this

Instruments— Subtopic would not be changed.
Registration Payment
Arrangements
210
835-30 Interest— Amended  The guidance in this Subtopic would

Imputation of Interest be amended to be consistent with the
guidance on initial measurement in
860-20 Transfers and Amended  The proposed guidance would

Servicing—Sales of supersede the guidance in Section
Financial Assets 860-20-35 related to the subsequent
measurement of financial assets
subject to prepayment.
940-320 Financial Unchanged  The guidance in this Subtopic would

Services—Broker and not be changed.
Dealers—
Investments—Debt and
Equity Securities

Services—Broker and not be changed.
Dealers—
Investments—Other
940-405 Financial Amended  The proposed guidance would amend

Services—Broker and this Subtopic to indicate that a broker
Dealers—Liabilities and dealer in securities should report
financial liabilities at fair value.

Services—Depository supersede the guidance related to
and Lending— impairment in this Subtopic.
Receivables
942-320 Financial Amended  The guidance related to level of

Services—Depository disaggregation for disclosures would
and Lending— be retained.
Investments—Debt and  The implementation guidance related
Equity Securities to a financial institution’s ability to hold
mortgage securities to maturity would
be superseded.

Services—Depository supersede guidance related to
and Lending— Federal Home Loan Bank or Federal
Investments—Other Reserve Bank Stock and National
211
Credit Union Share Insurance Fund

deposits. Those instruments would
apply the proposed measurement
guidance related to investments that
can be redeemed only for a specified
amount.
 The guidance for regular-way
purchases and sales securities would
not be affected.

Services—Depository this Subtopic to reflect the guidance
and Lending—Liabilities related to core and noncore deposit
liabilities.

Services—Depository the Disclosure of the Fair Value of
and Lending—Debt Core Deposit Liabilities Section of this
Subtopic. Core deposit liabilities
would now be accounted for under the
remeasurement approach.
942-825 Financial Amended  The proposed guidance would change

Services—Depository the accounting for written loan
and Lending—Financial commitments, standby letters of
Instruments credit, and financial guarantees that
are in the scope of the proposed
guidance that are not currently in the
scope of Subtopic 815-10 by requiring
fair value measurement. Therefore,
the disclosure requirements in this
Subtopic would be affected.
944-310 Financial Unchanged  The guidance related to financial

Services—Insurance— guarantee insurance contracts would
Receivables not be affected. Those contracts
would be excluded from the scope of

Services—Insurance— not be changed.
Investments—Debt and
Equity Securities
212

Services—Insurance— supersede guidance related to equity
Investments—Other investments.
944-815 Financial Amended  The implementation guidance on cash

Services—Insurance— flow hedges would be amended to
Derivatives and reflect changes to hedge
Hedging effectiveness.

Services—Insurance— this Subtopic to indicate that
Financial Instruments investment contracts would be
included within the scope of the
proposed guidance.

Services—Investment this Subtopic to require that financial
Companies— assets and financial liabilities of
Investments—Debt and investment companies initially be
Equity Securities measured at fair value.
946-323 Financial Amended  The guidance in this Subtopic would

Services—Investment be amended to reflect proposed
Companies— changes to Subtopic 323-10.
Investments—Equity
Method and Joint
Ventures

Services—Investment this Subtopic to require that financial
Companies—Liabilities liabilities of investment companies
initially and subsequently be
measured at fair value.

Services—Mortgage supersede the guidance in this
Banking—Receivables Subtopic related to measurement of
mortgage loans and loan impairment
and would amend the guidance
related to fee recognition.
213
954 Health Care Amended  A health care entity that reports a

Entities (various performance indicator would report in
Subtopics) the performance indicator the
amounts that a business entity would
report in net income. The amounts a
business entity would report in other
comprehensive income should be
reported outside the performance
indicator.
 An entity that does not report a
performance indicator would report
the total change in fair value of a
financial instrument as a change in
the appropriate net asset class in its
statement of activities.
958 Not-for-Profit Amended  The proposed guidance would amend

Entities (various the initial measurement guidance for a
Subtopics) not-for-profit entity.
 The proposed guidance would amend
these Subtopics to reflect the
proposed requirement to measure
hybrid financial instruments with
embedded derivatives at fair value in
their entirety.
214

FASB ED Accounting For Financial Instruments

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Proposed Accounting Standards Update

Issued: May 26, 2010

Accounting for Financial Instruments and

Financial Instruments (Topic 825) and

This Exposure Draft of a proposed Accounting Standards Update of Topic 825

Notice to Recipients of This Exposure Draft of a Proposed Accounting

Copyright © 2010 by Financial Accounting Foundation. All rights reserved.

Financial Accounting Standards Board

Accounting for Financial Instruments and Revisions

Financial Instruments (Topic 825) and Derivatives and

May 26, 2010

Comment Deadline: September 30, 2010

Why Is the FASB Issuing This Proposed Accounting

Who Would Be Affected by the Proposed Guidance?

What Are the Main Aspects of the Proposed Guidance?

How Do the Proposed Provisions Compare with IFRS?

When Would the Proposed Amendments Be Effective?

Questions for Respondents

Questions for All Respondents

Questions for Users

Questions for All Respondents

Question for Preparers and Auditors

Questions for All Respondents

Questions for Users

Questions for Preparers and Auditors

Questions for All Respondents

Questions for Users

Questions for All Respondents

Questions for Users

Questions for Preparers and Auditors

Questions for All Respondents

Questions for Users

Questions for All Respondents

Questions for Preparers and Auditors

Question for All Respondents

Effective Date and Transition

Questions for All Respondents

Questions for Preparers and Auditors

Public Roundtable Meetings

Field Visit Volunteers

a. Interest paid on the deposits;

Core Deposit Liabilities

Deposits without a contractual maturity that management considers to be a

A receivable or payable that represents a contractual right to receive cash

For a core deposit liability, management’s assessment of the average life by

A reduction of the amortized cost of a financial asset because of its

8. Existing terms and definitions to be amended as indicated by strike

Amortized Cost Basis

The amount at which an investment is acquired, adjusted for accretion,

Collateral-Dependent Loan Financial Asset

A loanfinancial asset for which the repayment is expected to be provided

Direct Loan Origination Costs

Direct loan origination costs represent costs associated with successfully

a. Incremental direct costs of loan origination incurred in transactions

Cash, evidence of an ownership interest in an entity, or a contract that both:

a. Imposes on one entity a contractual obligation either:

The use of the term financial instrument in this definition is recursive

Contractual rights and contractual obligations encompass both those that

Loan commitments are legally binding commitments to extend credit to a