ASC 825: Fair Value Option Election Transactions & Journal Entries Explained

Posted In | ASC Education | Gridlex Academy

Accounting Standards Codification (ASC) 825 is a financial reporting standard issued by the Financial Accounting Standards Board (FASB) that addresses the fair value option for financial instruments. The fair value option allows companies to elect to measure certain financial instruments at fair value, with changes in fair value recognized in the income statement. This article provides an overview of ASC 825, its benefits, and how to apply it with the help of journal entries.

 

Understanding ASC 825

ASC 825-10-25 provides entities with the option to report specific financial instruments at fair value rather than historical cost, amortized cost, or another measurement basis. 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.

 

The primary objectives of ASC 825 are:
 

  1. Simplify financial reporting by reducing the number of measurement methods for financial instruments.

 

  1. Enhance comparability of financial statements by enabling better comparisons among entities that choose different measurement attributes for similar types of financial instruments.

 

  1. Improve the relevance of financial statement information by providing more timely recognition of changes in the value of financial instruments.

 

Eligibility and Election

Entities can elect the fair value option for the following financial instruments:
 

  1. Recognized financial assets and financial liabilities, except for investments in subsidiaries, joint ventures, and associates.
     

  2. Firm commitments that involve only financial instruments.
     

  3. Written loan commitments.
     

  4. Host financial instruments resulting from separation of embedded derivatives.

 

The fair value option is generally irrevocable and must be applied to an entire instrument. The election must be made upon initial recognition of the financial instrument or when an entity enters into a firm commitment or a written loan commitment.

 

Benefits of Electing the Fair Value Option
 

  1. Reduces complexity: The fair value option simplifies accounting for financial instruments by reducing the need for complex hedge accounting.
     

  2. Improved comparability: Since it allows for a consistent measurement approach across different financial instruments, it enhances the comparability of financial statements.
     

  3. Timely recognition of changes in value: Fair value accounting reflects changes in the market value of financial instruments more promptly, providing users of financial statements with more relevant information.

 

Journal Entries: Example of Fair Value Option Election
 

Consider a company that purchases a debt security for $100,000 on January 1, 20X1, and elects the fair value option. The fair value of the debt security on December 31, 20X1, is $110,000.

 

Journal entry on January 1, 20X1 (purchase date):

Debit: Debt Security at Fair Value - $100,000

Credit: Cash - $100,000

 

Journal entry on December 31, 20X1 (fair value adjustment):

Debit: Debt Security at Fair Value - $10,000

Credit: Unrealized Gain on Debt Security - $10,000

 

The unrealized gain will be reported in the income statement, reflecting the change in the fair value of the debt security during the year.
 

ASC 825 provides entities with the option to report certain financial instruments at fair value, simplifying financial reporting and enhancing comparability across entities. Entities must carefully consider the benefits and drawbacks of electing the fair value option, as well as the impact on their financial statements. Understanding the journal entries involved in the fair value option election can help entities effectively apply ASC 825 in their financial reporting.