When should a company elect the fair value option for financial instruments?

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AcadiFi · Accepted Answer

The fair value option (FVO) allows entities to designate eligible financial assets or liabilities at fair value through profit or loss (FVTPL), even if they would otherwise be measured at amortized cost or at fair value through OCI. Under IFRS 9 and ASC 825, the election is irrevocable and made at initial recognition.

For Kestwick Bank, the FVO can be elected if one of three criteria is met under IFRS 9: (1) it eliminates or significantly reduces an accounting mismatch that would otherwise arise; (2) a group of financial instruments is managed and its performance is evaluated on a fair value basis; or (3) the instrument contains embedded derivatives that would otherwise require separation. ASC 825 is broader, allowing election for almost any eligible instrument.

Consequences: the entire instrument is measured at fair value, with changes recognized in P&L (except for own credit risk changes on financial liabilities under IFRS 9, which go to OCI). This introduces earnings volatility but aligns accounting with economic hedging or trading strategy.

Example: if Kestwick hedges its bond portfolio with interest rate swaps measured at FVTPL, electing FVO on the bonds eliminates the mismatch where swap gains hit P&L while bond losses stay in OCI or amortized cost. Without FVO, Kestwick would need to apply formal hedge accounting, which has strict documentation requirements.

Disclosure requires reporting fair value hierarchy, changes attributable to credit risk, and comparison to contractual cash flows.

When should a company elect the fair value option for financial instruments?

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