The Fair Value Option

1. The Fair Value Option IAS 39 vs FAS 159 versus

2. Fair Value Option Compared IFRS US GAAP • Must meet criteria so that financial reporting is improved by fair value measurement • Precludes similar items as listed in FAS159 (leases, pensions, etc.) • Determination is made at initial recognition and cannot be changed • Instrument by instrument decision • Applies only to items within scope of FAS159 • Determination is made at initial recognition and cannot be changed

3. IFRS permits the fair value option when doing so results in more relevant information because • It eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring assets or liabilities or the gains and losses on them on different bases • A group of financial assets, financial liabilities or both is managed and its performance is evaluated on a fair value basis in accordance with a documented risk management or investment strategy

4. Loans Receivable, including Impairments IAS 39 vs FAS 114, 118, etc. versus

5. Loans Receivable • Considered a financial instrument under IFRS but not under US GAAP • Under IFRS, all “financial assets” are recognized at fair value EXCEPT for • Loans receivable • Held-to-maturity debt securities • Equity investments not traded in active market

6. Loan (Trade) Receivables IFRS US GAAP • Carried at amortized cost (using the effective interest method) minus any reduction (directly or through the use of an allowance account) for impairment or uncollectibility. • Carried at amortized cost (using the effective interest method) • An allowance for uncollectible amounts makes the carrying value = net realizable value

7. Impairment guidance is more extensive under IFRS • US GAAP (codification) merely says: • 310-10-35-16   A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest payments and the contractual principal payments of a loan will be collected as scheduled in the loan agreement. See Subtopic 310-40 for specific application of this guidance to loans restructured in a troubled debt restructuring.

8. IFRS: Impairment of loan • Impairment loss is recognized IF and only if, • There is objective evidence of impairment as a result of one or more events that occurred after initial recognition, and • The event has an impact on the estimated cash flows • Losses expected as a result of future events (no matter how likely) are not recognized

9. IFRS: Evidence of impairment • significant financial difficulty of the issuer or obligor; • a breach of contract, such as a default or delinquency in interest or principal payments; • the lender, for economic or legal reasons relating to the borrower’s financial difficulty, granting to the borrower a concession that the lender would not otherwise consider; • it becoming probable that the borrower will enter bankruptcy; • the disappearance of an active market for that financial asset because of financial difficulties; or

10. IFRS: Evidence of impairment (con’t) • observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets although the decrease cannot yet be identified with the individual financial assets in the group, including: • adverse changes in the payment status of borrowers in the group or • national or local economic conditions that correlate with defaults on the assets in the group

11. Measurement of Impairment IFRS US GAAP • The amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the financial asset’s original effective interest rate. • The impairment is measured based on the present value of expected future cash flows at the loan’s (original) effective interest rate • Practical expedients are permitted • Observable market price • Value of collateral

12. Important – use ORIGINAL i, not the re-negotiated interest rate • Lender may negotiate different terms with the borrower: • Lower interest rate • Extension of due date • Reduction in amount of principal owed • Other concessions that reduce cash flows • US GAAP justifies this because IT IS THE SAME LOAN rather than a new loan which would be accounted for at fair value at date of initial recognition

13. Examples • Pencil & paper if you printed the “doc” file • Use Excel if you brought laptop & the excel file