Accounting Standards Codification 460 (ASC 460) was released to address the more specific topic of recording liabilities for guarantees made by the company which may be exercised in the future.
Fair Value of Guarantees under ASC 460
The biggest part of this standard that exists is the statement that liabilities related to guarantees should be measured at fair value. The types of guarantees covered in the standard are related to those items in which a contingency exists requiring the guarantor to make payment that in one of the following forms:
Guaranteed Payment of
- Financial instruments
- Shares of its stock
- Other assets
Based on how broad the scope of these guarantees are, it is important to note that the standard denotes which circumstances must take place in order to trigger the events. These situations include changes in the price of any of the following:
Guarantees of Changes to
- Interest rates
- Prices of certain securities
- Commodity prices
- Foreign exchange rates
- Index of price rates
- Occurrence or non-occurrence of an event
Beyond just these price fluctuations which are noted, there are also other types of situations involved. These would include another entity failing to perform, for example when there is a standby letter of credit, creating a promise to make payment if another entity fails to. Another possibility is the occurrence of a specific event such as an unfavorable lawsuit.
Components of Guarantee Risk
Conceptually, the standard establishes that there are two components to the guarantee. The first being the obligation to be on standby over the term of an agreement for a potential triggering event. The second would be to make payments when those specific triggering events that do occur. Because of these two specific components, the liability will include contingent and non-contingent amounts to record at fair value.
The specific guidance under which the actual amount is recorded is subjective. It states that only the contingent portion of the amount of the liability which is “probable” need be recorded. This means that if it is deemed to be “remote” or only “reasonably possible”, then the only balance which would need to be recorded would relate to the non-contingent portion of the liability. Therefore, it should be noted that the standard attempts to not unreasonably gross up the liabilities for events which are not likely.
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