In depth: Collateralized financing entities-FASB provides new

No. US2014-11
December 19, 2014
What’s inside:
Background ..................... 1
Key provisions .................2
Collateralized financing
entities.................................. 2
Measurement alternative ....... 3
Subsequent measurement ...... 5
Transition and
presentation ........................ 7
Disclosure................................ 7
What’s next ..................... 8
Collateralized financing entities
FASB provides new measurement alternative
At a glance
New FASB guidance provides an alternative for measuring the financial assets and
financial liabilities of a collateralized financing entity (CFE) that is consolidated by a
reporting entity. Under current GAAP, if a reporting entity elects the fair value option,
financial assets and financial liabilities of the CFE must be measured separately at their
fair values. As a result, the aggregate fair value of the financial assets may differ from
the aggregate fair value of the financial liabilities. The new guidance allows the use of
the more observable of the fair value of the financial assets or the fair value of the
financial liabilities of the CFE to measure both. This guidance eliminates the
measurement difference that may exist when the financial assets and the financial
liabilities are measured independently at fair value. The new guidance will be effective
in 2016 for calendar year-end public business entities and 2017 for all other calendar
year-end entities. Early adoption is permitted as of the beginning of an annual period.
Background
.1 On August 6, 2014, the FASB issued Accounting Standards Update No. 2014-13,
Consolidation (Topic 810): Measuring the Financial Assets and the Financial Liabilities
of a Consolidated Collateralized Financing Entity. This guidance provides a new
measurement alternative for consolidated CFEs. For those reporting entities that apply
the fair value option and do not adopt the measurement alternative, the guidance
clarifies how to account for the difference between the fair values of the financial assets
and liabilities of consolidated CFEs.
.2 Historically, some reporting entities that consolidated CFEs adopted the fair value
option when subsequently measuring all of the CFE’s financial assets and financial
liabilities. The principal reason for doing so was to eliminate asymmetries in the
accounting models for assets and liabilities. In some cases, the methodology and inputs
for determining the fair value of the individual financial assets and financial liabilities
were different, and as a result, the aggregate fair value of the CFE’s financial assets and
financial liabilities often differed and produced net gains (losses) that created volatility in
the reporting entity’s income statement. Constituents noted that this volatility did not
provide decision-useful information as it did not reflect the actual economic risks to
which the reporting entity was exposed.
.3 As a consequence of adopting Accounting Standards Update No. 2009-17 (FASB
Statement No. 167), Improvements to Financial Reporting by Enterprises Involved with
Variable Interest Entities, (now codified in ASC 810-10), more CFEs were required to be
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consolidated. The transition provisions of ASU 2009-17 required reporting entities to
recognize the difference between the fair value of the CFE’s financial assets and financial
liabilities directly in retained earnings upon consolidation. Some reporting entities opted
to present such amounts in appropriated retained earnings based on other GAAP.
.4 Reporting entities that consolidated CFEs and opted to continue recording
remeasurement gains and losses on the CFE’s financial assets and financial liabilities
owned by third parties directly to appropriated retained earnings avoided an impact on
consolidated earnings. Other reporting entities opted to include these amounts in
consolidated earnings; however, these remeasurement net gains (losses) were allocated
to noncontrolling interests. Using this approach, a reporting entity reflected
remeasurement net gains (losses) in consolidated earnings, but such amounts were
excluded from earnings per share. Others recorded all changes in fair value of the
consolidated CFE’s assets and liabilities in current earnings.
.5 To eliminate the diversity in practice, the new guidance allows entities the option to
use the more observable of the fair value of the financial assets or the fair value of the
financial liabilities of the CFE to measure both. By electing this approach, entities will be
able to eliminate the non-economic measurement differences and the associated income
volatility. If the new measurement alternative is not elected, entities will have to reflect
any measurement differences between the CFE’s financial assets and third party financial
liabilities in earnings and attribute them to the consolidated entity in the consolidated
income statement.
PwC observation:
The objective of the measurement alternative is to minimize the parent’s earnings
impact resulting from the remeasurement of a consolidated CFE’s financial assets
and financial liabilities owned by third parties. If a reporting entity elects the
measurement alternative, the net gains (losses) reflected in its consolidated earnings
will be limited to changes in the fair value of the beneficial interests it holds, as well
as compensation for services provided measured under other applicable guidance.
Key provisions
Collateralized financing entities
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.6 A CFE is defined in the FASB Master Glossary as:
“A variable interest entity that holds financial assets, issues beneficial interests that are
classified as financial liabilities and has no more than nominal equity. The beneficial
interests have contractual recourse only to the assets of the collateralized financing
entity and are classified as financial liabilities. A collateralized financing entity may
hold nonfinancial assets temporarily as a result of default by the debtor on the
underlying debt instruments held as assets by the collateralized financing entity or in
an effort to restructure the debt instruments held as assets by the collateralized
financing entity. A collateralized financing entity also may hold other financial assets
and financial liabilities that are incidental to the operations of the collateralized
financing entity and have carrying values that approximate fair value (for example,
cash, broker receivables, or broker payables).”
The FASB material included in this work is copyrighted by the Financial Accounting Foundation, 401 Merritt
7, Norwalk, CT 06856, and is reproduced with permission.
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PwC observation:
The measurement alternative provided by the new guidance is designed to address
the concerns about volatility related to consolidated securitization vehicles and assetbacked entities. However, any entity that consolidates a variable interest entity that
meets the definition of a CFE would be eligible for the election in the new guidance.
.7 Historically, a CFE’s financial assets and financial liabilities were measured based
upon existing GAAP for those instruments. This could result in items being measured at
amortized cost, fair value through OCI, or fair value through earnings. The financial
assets were also subject to different impairment models. In some cases, the reporting
entity could elect the fair value option to eliminate differences caused by asymmetrical
accounting models. In applying the fair value measurement provisions of ASC 820,
entities must measure the fair value of financial assets and the fair value of financial
liabilities.
.8 Because the fair value of the CFE’s financial assets and financial liabilities are
measured independently, the periodic remeasurement can produce net gains (losses)
each period not attributable to the beneficial interests held by the primary beneficiary.
Although the recourse for a holder of a CFE’s financial liabilities (beneficial interest
holder) may be limited to the financial assets within the CFE, and the financial assets of
the CFE may only be used to settle its financial liabilities, the methodologies and inputs
used to separately fair value the financial assets and financial liabilities may produce
different values for each.
PwC observation:
The fundamental premise behind the measurement alternative is that a CFE’s
financial assets and financial liabilities are inextricably linked (i.e., the CFE’s
financial assets can be used solely to settle its financial liabilities, and the CFE’s
financial liabilities can be settled only with its financial assets).
A CFE’s parent that has guaranteed all or a portion of the CFE’s beneficial interests
would not be eligible to elect the measurement alternative because the CFE’s financial
liabilities could potentially be settled with assets outside the CFE. Standard
representations and warranties by the transferor of the CFE’s collateral would not in
and of itself preclude the CFE’s parent from electing the measurement alternative.
Measurement alternative
.9 While the fair value option eliminates asymmetry in the accounting models between
assets and liabilities, as discussed above, it may not result in symmetry in measurement.
The new guidance provides a measurement alternative to address this potential
measurement asymmetry. The measurement alternative permits entities to measure both
the financial assets and financial liabilities owned by third parties of the CFE at the same
value—using either the fair value of the financial assets or the fair value of the financial
liabilities, whichever is more observable.
.10 To be eligible for the measurement alternative, a CFE must meet the following two
scope requirements:
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
All of the CFE’s financial assets and financial liabilities are required to be measured
at fair value. If a CFE has financial assets or financial liabilities that are incidental to
its operations (e.g., cash and payables due to/from brokers) that are not measured
at fair value, the parent would not be prohibited from applying the measurement
alternative if the book value of the incidental financial assets and financial liabilities
approximates their fair value.

Changes in the fair value of those financial assets and financial liabilities are
reflected in earnings.
.11 CFEs may also hold nonfinancial assets and liabilities in certain circumstances (for
example, assets acquired upon foreclosure). A CFE’s ownership of nonfinancial assets
would not prohibit its parent from electing the measurement alternative if the
nonfinancial assets will be held temporarily.
.12 Reporting entities that consolidate a CFE that meets the scope requirements may
choose to:
a) continue to measure the CFE’s financial assets and financial liabilities in accordance
with applicable GAAP,
b) continue to measure the CFE’s financial assets and financial liabilities at fair value
(through the fair value option), or
c) follow the measurement alternative.
Under any of the elections provided above, beneficial interests held by the parent and/or
received as compensation for services provided to the CFE will continue to impact the
income statement.
13. Entities may have various economic interests in a CFE, e.g., direct ownership of
beneficial interests and rights to compensation for services provided to the CFE. In the
application of this measurement alternative, changes in fair value of direct beneficial
ownership interests retained by the entity should be reflected in consolidated earnings.
However, as illustrated below, the carrying value of beneficial interests that represent
compensation for services, such as management fees or servicing fees, should be
calculated under other applicable GAAP.
14. When a reporting entity that elects the measurement alternative determines that the
fair value of a CFE’s financial assets is more observable, the CFE’s financial liabilities
(that are not eliminated in consolidation) are measured as:
The sum of:
 the fair value of the CFE’s financial assets
 the carrying value of the CFE’s nonfinancial assets
 the carrying value of any incidental financial assets
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Less the sum of:
 the fair value of the CFE’s beneficial interests held by the reporting entity, which are
not eligible for the measurement alternative
 the reporting entity’s carrying value of the CFE’s beneficial interests held by the
reporting entity that represent compensation for services (i.e., management or
servicing fees)
.15 When a reporting entity that elects the measurement alternative determines that the
fair value of a CFE’s financial liabilities is more observable, the CFE’s financial assets are
measured as:
The sum of:

the fair value of the CFE’s financial liabilities, excluding beneficial interests held by
the reporting entity

the fair value of beneficial interests held by the reporting entity other than
beneficial interests received as compensation for services provided to the CFE

the reporting entity’s carrying value of beneficial interests held by the reporting
entity that represent compensation for services (e.g., management fees or servicing
fees)

the carrying value of any incidental financial liabilities
Less:

the carrying value of the nonfinancial assets held temporarily by the CFE
.16 The result of the calculation in paragraphs 14 or 15, as applicable, should be allocated
to individual financial assets (if the liabilities are more observable) or individual
liabilities (if the assets are more observable) using a reasonable and consistent
methodology.
Subsequent measurement
.17 Upon the initial consolidation of a CFE, gains or losses resulting from the
remeasurement of the CFE’s financial assets and third party financial liabilities should be
recognized through earnings and attributed to the parent. This difference may not be
allocated to noncontrolling interest or appropriated retained earnings; it must be
reflected in the reporting entity's earnings and earnings per share.
.18 If the measurement alternative is elected upon initial consolidation, subsequent
remeasurement gains and losses will be limited to the CFE’s economic interests that are
held by the reporting entity (parent). This remeasurement includes the change in the fair
value of the beneficial interests held by the reporting entity, as well as changes in the
reporting entity’s carrying value of beneficial interests received that represent
compensation for services provided. The recognition and measurement of beneficial
interests representing compensation for services and of any nonfinancial assets are
accounted for in accordance with other areas of GAAP.
.19 Once a reporting entity adopts the measurement alternative, it is required to
consistently apply it for each subsequent reporting period as long as the consolidated
CFE continues to meet the necessary conditions to apply the measurement alternative.
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.20 If a reporting entity initially consolidates a CFE and does not elect the measurement
alternative, any initial or subsequent gains and losses arising on remeasurement of the
consolidated CFE’s financial assets and third party financial liabilities will be recognized
in earnings and attributed to the parent.
.21 If a reporting entity does not elect the measurement alternative for a CFE
consolidated prior to the effective date of the guidance, and that CFE’s financial assets
and financial liabilities have historically been accounted for at fair value, any subsequent
remeasurement gains or losses related to the CFE’s financial assets and financial
liabilities should be reflected in earnings and attributed to the parent.
.22 Some reporting entities have historically accounted for a consolidated CFE’s financial
assets and financial liabilities following an amortized cost model. If the measurement
alternative is not elected upon adoption of the ASU, or upon the initial consolidation of a
CFE in subsequent periods, the reporting entity should continue to follow an amortized
cost model when accounting for the CFE’s financial assets and financial liabilities.
.23 If a reporting entity that consolidates a CFE elects the measurement alternative, and
that CFE fails to meet the scope requirements to apply the measurement alternative at a
later date, application of the measurement alternative must be permanently discontinued
and ASC 820, Fair Value Measurement, should be applied prospectively to remeasure
that CFE’s financial assets and financial liabilities. Any subsequent remeasurement gains
or losses related to the CFE’s financial assets and third party financial liabilities should
be included in the reporting entity’s earnings and attributed to the reporting entity.
PwC observation:
If a reporting entity that consolidates a CFE elects the measurement alternative and
subsequently transfers financial assets into the CFE that are not accounted for at fair
value through earnings, it would be prohibited from continuing to apply the
measurement alternative in future periods. For example, a primary beneficiary of a
consolidated CFE may transfer loans into the CFE that must be accounted for at
amortized cost. In that scenario, the CFE would no longer meet the necessary
conditions to apply the measurement alternative, thus requiring the primary
beneficiary to remeasure both the CFE’s financial assets and financial liabilities,
which existed prior to the loan transfer, at fair value (i.e., ASC 825) pursuant to ASC
820 in future periods. Subsequent remeasurement of the CFE’s financial assets at fair
value would exclude the transferred loans that disqualified the CFE from continuing
to apply the measurement alternative, which must follow an amortized cost model.
Even if the financial assets that prevented the CFE from qualifying for the
measurement alternative are sold in subsequent periods, the parent may not resume
application of the measurement alternative. In other words, the measurement
alternative may only be elected on the date a CFE is initially consolidated, or for
existing CFEs, upon adoption of this ASU.
If the measurement alternative is elected for existing CFEs (transition) or newly
consolidated CFEs, a reporting entity is implicitly electing the ASC 825 fair value
option for the CFE’s financial assets and financial liabilities. Because that election is
irrevocable, the parent should “continue” application of the fair value option for the
CFE’s financial assets and financial liabilities if it is subsequently disqualified from
applying the measurement alternative pursuant to ASC 820 and ASC 825. Separately
measuring the individual financial assets and financial liabilities of the CFE could
give rise to measurement differences. In that scenario, any remeasurement
differences must be attributed to the parent for purposes of calculating earnings per
share.
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Transition and presentation
.24 The new guidance is effective for fiscal years, and interim periods within those fiscal
years, beginning after December 15, 2015 for public business entities. For all other
entities, the guidance is effective for fiscal years ending after December 15, 2016, and
interim periods beginning thereafter. Early adoption is permitted as of the beginning of
an annual period.
.25 Public and nonpublic business entities may early adopt the new guidance at any time.
If adoption occurs during an interim period after the first quarter, all prior interim
periods should be restated as if the guidance had been adopted at the beginning of the
annual period. This is to ensure comparability across interim periods within the year of
adoption.
.26 Reporting entities may elect to apply the guidance on a modified retrospective or full
retrospective basis. When a reporting entity elects to apply the modified retrospective
basis, it should remeasure the financial assets or the financial liabilities using the
guidance within the new standard as of the beginning of the annual period of adoption
and record a cumulative effect adjustment to retained earnings.
.27 If a reporting entity elects the measurement alternative and adopts the ASU on a full
retrospective basis, it must retrospectively adjust prior periods back to the initial year it
adopted FASB Statement No. 167.
.28 If a reporting entity that consolidates a CFE has historically allocated remeasurement
net gains (losses) to noncontrolling interests, and, subsequently to appropriated retained
earnings, and does not elect the measurement alternative, amounts currently in
appropriated retained earnings must be reclassified to retained earnings. Additionally,
those reporting entities that historically elected the fair value option will be required to
present the CFE’s financial assets and financial liabilities at fair value through profit and
loss pursuant to ASC’s 820 and 825. There is no ability to “unelect” the fair value option
that was previously elected.
PwC observation:
Reporting entities that consolidate a CFE whose financial assets and financial
liabilities were not previously accounted for at fair value (i.e., the fair value option
was not elected for eligible financial assets and financial liabilities) have a one-time
option to elect the measurement alternative upon adoption of the new guidance. If
the measurement alternative is not elected, then the reporting entity would be
prohibited from electing the fair value option and must continue to apply the historic
measurement basis. In other words, a reporting entity that did not previously elect
the fair value option is prohibited from doing so upon adoption of the new guidance
unless the measurement alternative is elected. If a reporting entity consolidates
multiple CFEs, this election can be made for each one independently.
For example, if a reporting entity applied an amortized cost measurement basis for a
consolidated CFE’s financial assets and financial liabilities, it may either continue to
account for the financial assets and financial liabilities at amortized cost or elect the
measurement alternative.
Disclosure
.29 Reporting entities that elect the measurement alternative are required to follow the
disclosure requirements within ASC 820 and ASC 825 for the CFE’s financial assets and
financial liabilities. As such, judgment will be required to determine at what level of the
fair value hierarchy the less observable financial element should be disclosed.
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PwC observation:
We believe a reporting entity needs to evaluate the significance of all the
unobservable inputs (in relation to the total fair value) of the more observable of the
financial assets or financial liabilities when determining the appropriate level within
the fair value hierarchy in which the less observable of the two would be disclosed.
For example, if the fair value of the financial liabilities are used to measure the
financial assets, and a significant amount of the financial liabilities valuations are
considered Level 3, the financial assets (considered one unit of account for
measurement purposes) would be disclosed as Level 3. Since identical inputs are not
used, the less observable will not be Level 1. There may be alternative ways to present
the required disclosures.
What’s next
.30 The FASB is expected to issue a new standard on consolidation in early 2015 that
may impact whether a reporting entity should consolidate a CFE.
PwC observation:
We expect that managers of a consolidated CFE whose interests are limited to
market-based fees that represent fair compensation for services provided, with no
additional significant interests held by the manager or any of its related parties, may
be able to deconsolidate their CFE upon adoption of the expected amendments to
ASC 810-10. Accordingly, reporting entities that are expecting to deconsolidate CFEs
as a result of the amendments may want to consider the expected amendments when
deciding whether to early adopt the measurement alternative.
Questions?
Authored by:
PwC clients who have questions about this
In depth should contact their engagement
partner. Engagement teams who have
questions should contact the Financial
Instruments team in the National
Professional Services Group (1-973-2367803).
Christopher R. May
Partner
Phone: 1-973-236-5729
Email: [email protected]
Robert Sidoti
Senior Manager
Phone: 1-973-236-7952
Email: [email protected]
Lee Vanderpool
Director
Phone: 1-973-236-5129
Email: [email protected]
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