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US GAAP versus IFRS - Financial instruments - EY - United States

US GAAP versus IFRS

Financial instruments

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Similarities

The US GAAP guidance for financial instruments is located in numerous ASC Topics, including ASC 310-10-35, Receivables — Overall — Subsequent Measurement; ASC 320, Investments — Debt and Equity Securities; ASC 470, Debt; ASC 480, Distinguishing Liabilities from Equity; ASC 815, Derivatives and Hedging; ASC 820, Fair Value Measurement; ASC 825-10-25, Financial Instruments — Overall — Recognition; ASC 825-10-50, Financial Instruments — Overall — Disclosures; ASC 860, Transfers and Servicing; and ASC 948, Financial Services — Mortgage Banking.

IFRS guidance for financial instruments, on the other hand, is limited to IAS 32, Financial Instruments: Presentation; IAS 39, Financial Instruments: Recognition and Measurement; IFRS 7, Financial Instruments: Disclosures; and, if early adopted, IFRS 9, Financial Instruments.

Both US GAAP and IFRS require financial instruments to be classified into specific categories to determine the measurement of those instruments, clarify when financial instruments should be recognized or derecognized in financial statements, require the recognition of all derivatives on the balance sheet and require detailed disclosures in the notes to the financial statements for the financial instruments reported in the balance sheet. Both sets of standards also allow hedge accounting and the use of a fair value option.

Significant differences


 US GAAPIFRS
Debt vs. equity
ClassificationUS GAAP specifically identifies certain instruments with characteristics of both debt and equity that must be classified as liabilities.

Certain other contracts that are indexed to, and potentially settled in, a company's own stock may be classified as equity if they either (1) require physical settlement or net-share settlement, or (2) give the issuer a choice of net-cash settlement or settlement in its own shares.
Classification of certain instruments with characteristics of both debt and equity focuses on the contractual obligation to deliver cash, assets or an entity's own shares. Economic compulsion does not constitute a contractual obligation.

Contracts that are indexed to, and potentially settled in, a company's own stock are classified as equity if settled by delivering a fixed number of shares for a fixed amount of cash.
Compound (hybrid) financial instrumentsCompound (hybrid) financial instruments (e.g., convertible bonds) are not split into debt and equity components unless certain specific conditions are met, but they may be bifurcated into debt and derivative components, with the derivative component subject to fair value accounting.Compound (hybrid) financial instruments are required to be split into a debt and equity component and, if applicable, a derivative component. The derivative component may be subject to fair value accounting.
Recognition and measurement
Impairment recognition — available-for-sale (AFS) debt instrumentsDeclines in fair value below cost may result in an impairment loss being recognized in the income statement on an AFS debt instrument due solely to a change in interest rates (risk-free or otherwise) if the entity has the intent to sell the debt instrument or it is more likely than not that it will be required to sell the debt instrument before its anticipated recovery. In this circumstance, the impairment loss is measured as the difference between the debt instrument's amortized cost basis and its fair value.

When a credit loss exists, but (1) the entity does not intend to sell the debt instrument, or (2) it is not more likely than not that the entity will be required to sell the debt instrument before the recovery of the remaining cost basis, the impairment is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total impairment related to the credit loss is recognized in the income statement and the amount related to all other factors is recognized in other comprehensive income, net of applicable taxes.

When an impairment loss is recognized in the income statement, a new cost basis in the instrument is established equal to the previous cost basis less the impairment recognized in earnings. Impairment losses recognized in the income statement cannot be reversed for any future recoveries.
Generally, only evidence of credit default results in an impairment being recognized in the income statement for an AFS debt instrument. The impairment loss is measured as the difference between the debt instrument's amortized cost basis and its fair value.

Impairment losses for AFS debt instruments may be reversed through the income statement if the fair value of the instrument increases in a subsequent period and the increase can be objectively related to an event occurring after the impairment loss was recognized.
Impairment recognition — available-for-sale (AFS) equity instrumentsImpairment of an AFS equity instrument is recognized in the income statement if the equity instrument's fair value is not expected to recover sufficiently in the near term to allow a full recovery of the entity's cost basis. An entity must have the intent and ability to hold an impaired equity instrument until such near-term recovery; otherwise an impairment loss must be recognized in the income statement. Impairment of an AFS equity instrument is recognized in the income statement when there is objective evidence that the AFS equity instrument is impaired and the cost of the investment in the equity instrument may not be recovered. A significant or prolonged decline in the fair value of an equity instrument below its cost is considered evidence of an impairment.
Impairment recognition — held-to-maturity (HTM) debt instrumentsThe impairment loss of an HTM instrument is measured as the difference between its fair value and amortized cost basis. The amount of the total impairment related to the credit loss is recognized in the income statement, and the amount related to all other factors is recognized in other comprehensive income.

The carrying amount of an HTM investment after recognition of an impairment is the fair value of the debt instrument at the date of the impairment. The new cost basis of the debt instrument is equal to the previous cost basis less the impairment recognized in the income statement. The impairment recognized in other comprehensive income is accreted to the carrying amount of the HTM instrument through other comprehensive income over its remaining life.
The impairment loss of an HTM instrument is measured as the difference between the carrying amount of the instrument and the present value of estimated future cash flows discounted at the instrument's original effective interest rate. The carrying amount of the instrument is reduced either directly or through the use of an allowance account. The amount of impairment loss is recognized in the income statement.
Derivatives and hedging
Definition of a derivative and scope exceptionsTo meet the definition of a derivative, an instrument must have one or more underlyings, one or more notional amounts or payment provisions or both, must require no initial net investment, as defined, and must be able to be settled net, as defined. Certain scope exceptions exist for instruments that would otherwise meet these criteria.The IFRS definition of a derivative does not include a requirement that a notional amount be indicated, nor is net settlement a requirement. Certain of the scope exceptions under IFRS differ from those under US GAAP.
Hedging a risk component of a financial instrumentThe risk components that may be hedged are specifically defined by the literature, with no additional flexibility.Allows risks associated with only a portion of the instrument's cash flows or fair value (such as one or more selected contractual cash flows or portions of them or a percentage of the fair value) provided that effectiveness can be measured: that is, the portion is identifiable and separately measurable.
Hedge effectivenessThe shortcut method for interest rate swaps hedging recognized debt instruments is permitted.The long-haul method of assessing and measuring hedge effectiveness for a fair value hedge of the benchmark interest rate component of a fixed rate debt instrument requires that all contractual cash flows be considered in calculating the change in the hedged item's fair value even though only a component of the contractual coupon payment is the designated hedged item.The shortcut method for interest rate swaps hedging recognized debt is not permitted.

Under IFRS, assessment and measurement of hedge effectiveness considers only the change in fair value of the designated hedged portion of the instrument's cash flows, as long as the portion is identifiable and separately measurable.
Hedge effectiveness — inclusion of option's time value Permitted.Not permitted.
Derecognition
Derecognition of financial assetsDerecognition of financial assets (i.e., sales treatment) occurs when effective control over the financial asset has been surrendered:
  • The transferred financial assets are legally isolated from the transferor
  • Each transferee (or, if the transferee is a securitization entity or an entity whose sole purpose is to facilitate an asset-backed financing, each holder of its beneficial interests), has the right to pledge or exchange the transferred financial assets (or beneficial interests)
  • The transferor does not maintain effective control over the transferred financial assets or beneficial interests (e.g., through a call option or repurchase agreement)


The derecognition criteria may be applied to a portion of a financial asset only if it mirrors the characteristics of the original entire financial asset.
Derecognition of financial assets is based on a mixed model that considers both transfer of risks and rewards and control. Transfer of control is considered only when the transfer of risks and rewards assessment is not conclusive. If the transferor has neither retained nor transferred substantially all of the risks and rewards, there is then an evaluation of the transfer of control. Control is considered to be surrendered if the transferee has the practical ability to unilaterally sell the transferred asset to a third party without restrictions. There is no legal isolation test.

The derecognition provisions may be applied to a portion of a financial asset if the cash flows are specifically identified or represent a pro rata share of the financial asset or specifically identified cash flows.
Loans and receivables
Measurement — effective interest methodRequires catch-up approach, retrospective method or prospective method of calculating the interest for amortized cost-based assets, depending on the type of instrument.Requires the original effective interest rate to be used throughout the life of the instrument for all financial assets and liabilities, except for certain reclassified financial assets, in which case the effect of increases in cash flows are recognized as prospective adjustments to the effective interest rate.
Measurement — loans and receivablesUnless the fair value option is elected, loans and receivables are classified as either (1) held for investment, which are measured at amortized cost, or (2) held for sale, which are measured at the lower of cost or fair value.Loans and receivables are carried at amortized cost unless classified into the "fair value through profit or loss" category or the "available for sale" category, both of which are carried at fair value on the balance sheet.
Fair value
MeasurementOne measurement model whenever fair value is used (with limited exceptions). Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Fair value is an exit price, which may differ from the transaction (entry) price.
Various IFRS standards use slightly varying wording to define fair value. Under IAS 39, fair value is defined as the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction.

At inception, transaction (entry) price generally is considered fair value.
Day one gains and lossesEntities are not precluded from recognizing day one gains and losses on financial instruments reported at fair value even when all inputs to the measurement model are not observable. For example, a day one gain or loss may occur when the transaction occurs in a market that differs from the reporting entity's exit market.Day one gains and losses are recognized only when all inputs to the measurement model are observable.
Bid-ask spreadThe price within the bid-ask spread that is the most representative of fair value in the circumstances is used to measure fair value. However, entities are not precluded from using mid-market pricing as a practical expedient for measuring fair value.The fair value of assets held (or liabilities to be issued) is generally determined using the current bid price, while liabilities held (or assets to be acquired) are measured using the current ask price. When an entity has assets and liabilities with offsetting market risks, it may use mid-market prices to determine the fair value of the offsetting positions, and apply the bid or ask price (as appropriate) to the net open position.
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Other differences include:

  • application of fair value measurement principles, including use of prices obtained in "principal" versus "most advantageous" markets and estimating the fair value of certain alternative investments (e.g., investments in private equity funds) using net asset value of the investment as a practical expedient
  • (ii) definitions of a derivative and embedded derivative
  • (iii) cash flow hedge — basis adjustment and effectiveness testing
  • (iv) normal purchase and sale exception
  • (v) foreign exchange gain and/or losses on AFS investments
  • (vi) recognition of basis adjustments when hedging future transactions
  • (vii) macro hedging
  • (viii) hedging net investments
  • (ix) cash flow hedge of intercompany transactions
  • (x) hedging with internal derivatives
  • (xi) impairment criteria for equity investments
  • (xii) puttable minority interest
  • (xiii) netting and offsetting arrangements
  • (xiv) unit of account eligible for derecognition
  • (xv) accounting for servicing assets and liabilities

Convergence

The FASB and the IASB are engaged in projects to simplify and improve the accounting for financial instruments.

Recognition and measurement

The Boards' joint project on accounting for financial instruments is addressing classification and measurement, impairment and hedge accounting. The IASB finalized its classification and measurement guidance in IFRS 9, Financial Instruments, which is not effective until annual periods beginning on or after 1 January 2015, although early application is permitted.

This publication does not address the differences between US GAAP and IFRS resulting from IFRS 9 because of the delayed effective date. The IASB issued separate exposure drafts on impairment and hedge accounting. In May 2010, the FASB issued an exposure draft that addresses classification and measurement, impairment and hedge accounting.

The FASB is redeliberating its classification and measurement guidance. The Boards are jointly developing an impairment model. The FASB issued a Discussion Paper (DP) requesting views from US constituents on the IASB's exposure draft on hedging. The IASB is close to finalizing its new hedging model.

Derecognition

In June 2010, the Boards reconsidered their strategies and plans for converging the requirements for derecognition, and agreed that their near-term priority would be on increasing the comparability of US GAAP and IFRS disclosure requirements for financial asset transfers.

This was accomplished in October 2010 through the issuance of Amendments to IFRS 7, Financial Instruments: Disclosures, which are effective for annual periods beginning on or after 1 July 2011. The amendments broadly align the derecognition disclosure requirements, in particular for transfers of financial assets involving securitizations.

Fair value

In May 2011, the FASB and the IASB each issued new standards to promote the convergence of fair value measurement guidance. Consistent with US GAAP, IFRS 13, Fair Value Measurement, establishes a single source of guidance for all fair value measurements that are required or permitted by other IFRS. ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, clarifies and amends how certain existing principles in ASC 820 should be applied. Once effective, these standards will provide a uniform framework for applying fair value measurement principles for companies around the world.

IFRS 13 becomes effective for annual periods beginning on or after 1 January 2013. ASU 2011-04 is effective in the first quarter of 2012 for calendar year-end public companies and in annual periods beginning after 15 December 2011 for nonpublic companies. Limited differences between US GAAP and IFRS will continue to exist even after the adoption of IFRS 13.

Note that the table above does not reflect adoption of IFRS 13 due to its delayed effective date.

Offsetting

In December 2011, the Boards issued guidance requiring new disclosures to help users of financial statements understand certain significant quantitative differences in balance sheets prepared under US GAAP and IFRS related to the offsetting of financial instruments. The IASB also amended the application guidance in IAS 32 to address inconsistencies in application.

Debt versus equity

The Boards' joint project to address financial instruments with characteristics of equity has been delayed due to resource constraints. No further action is expected in the near term.

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