The International Accounting Standards Board has published a proposed set of changes in the accounting standards for financial liabilities to address what it calls the “counter-intuitive” effects of fair value measurement.

Sir David Tweedie

The proposal follows work that has already been completed on the classification and measurement of financial assets in the IFRS 9 standards for financial instruments. The IASB is proposing limited changes to the accounting for liabilities, with the changes mostly confined to the fair value option.

The proposals respond to a viewpoint expressed by many investors and others in extensive consultations that the IASB has undertaken. They have told the IASB that volatility in profit or loss resulting from changes in the credit risk of liabilities that an entity chooses to measure at fair value is counter-intuitive and does not provide useful information to investors.

When the IASB introduced IFRS 9, many stakeholders around the world advised the IASB that the existing requirements for financial liabilities work well, except for the effects of changes in the credit risk of a financial liability (“own credit”) that an entity chooses to measure at fair value. 

Building on that global consultation on IFRS 9, the IASB sought the views of investors, preparers, audit firms, regulators and others on the “own credit” issue. The views received were consistent with the earlier consultations: that volatility in profit or loss resulting from changes in “own credit” does not provide useful information except for derivatives and liabilities that are held for trading.

“Whilst there are theoretical arguments for treating financial assets and liabilities in the same way, it is hard to defend the accounting as providing useful information when a company suffering deterioration in credit quality is able to book a corresponding large profit, especially when investors tell us that such information is often excluded from their financial models,” said IASB chairman Sir David Tweedie in a statement.

The IASB is therefore proposing that all gains and losses resulting from changes in “own credit” for financial liabilities that an entity chooses to measure at fair value should be transferred to “other comprehensive income.”  Changes in “own credit” will therefore not affect reported profit or loss.

No other changes have been proposed for financial liabilities. Therefore, the proposals will affect only those entities that choose to apply the fair value option to their financial liabilities. Those entities that prefer to bifurcate financial liabilities when relevant may continue to do so, which is consistent with the widespread view that the existing requirements for financial liabilities work well, other than the “own credit” issue that the new proposals cover.  

A summary of the proposals is available at http://go.iasb.org/financial+liabilities.

The exposure draft Fair Value Option for Financial Liabilities is open for comment until July 16, and can be accessed via the “Comment on a proposal” section of www.iasb.org.