ASC 825 provides reporting entities with the option to report long-term debt at fair value instead of on an amortized cost basis. A reporting entity may elect to report its long-term debt at fair value for a number of reasons, including a desire to achieve a natural hedge without having to apply the hedging requirements of ASC 815.
In evaluating the use of the fair value option for long-term debt instead of application of hedge accounting, reporting entities should consider the potential impact on the financial statements as follows:
- Debt issuance costs
When electing the fair value option, all debt issue costs must be expensed immediately, instead of amortized as part of the effective interest rate over the life of the debt.
- A full offset of fair value may not occur
When electing the fair value option on the debt, the entire fair value of the debt must be recorded. In contrast, in the case of a fair value hedge under ASC 815, only that portion of the long-term debt attributable to the risk being hedged (e.g., interest rate risk) must be recorded at fair value. For example, under ASC 815, the changes in fair value attributable to the reporting entityโs changes in credit would be ignored when determining the fair value of the debt to be recorded when the designated risk is the benchmark interest rate. However, if the reporting entity elects the fair value option, it will be required to reflect the impact of all changes in fair value of its debt in the income statement, except for changes in own credit risk, which must be presented in OCI.
- Income statement presentation
Under ASC 815, all changes in the fair value of the derivative, including changes from interest accruals or net interest cash flows, should be presented in a single line item in the income statement. For qualifying ASC 815 hedging relationships, reporting entities should record the change in fair value of the derivative and present the interest accrual component in the same line item as the hedged item.Only when the hedgeditem is reported in multiple income statement line items should the income from the derivative be reported in different income statement line items to match the hedged item.
Other FVO considerations
A reporting entity should consider other implications of applying the FVO to its long-term debt, which requires full mark-to-market as discussed above. For example, recognizing changes in the debtโs fair value in current earnings might adversely impact the entityโs compliance with debt covenants and/or its regulatory and capital requirements. Similarly, debt issuance costs, which are often significant, are expensed immediately under the FVO. Further, under the FVO, reporting entities are required to independently estimate the change in fair value of the debt in accordance with the fair valueguidance. Changes in the fair value of the derivative are not a proxy for the change in fair value of the debt.
