A downgrading of an entity's own credit standing will lead to a reduction in the fair value of any debt that it has issued.  If that debt is accounted for under the fair value option then this creates a gain in the books of the entity as the value of its liabilities reduces.  This counter-intuitive result has perplexed many for some time. 

The IASB is now proposing that all gains and losses resulting from changes in ‘own credit' for financial liabilities that an entity chooses to measure at fair value should be transferred to ‘other comprehensive income'. Changes in ‘own credit' will therefore not affect reported profit or loss.

No other changes are proposed for financial liabilities. Therefore, the proposals will affect only those entities that choose to apply the fair value option to their financial liabilities. Those entities who prefer to bifurcate (split into constituent parts) financial liabilities when relevant may continue to do so. That is consistent with the widespread view that the existing requirements for financial liabilities work well, other than the ‘own credit' issue that these proposals cover.

The exposure draft Fair Value Option for Financial Liabilities is open for comment until 16 July 2010.  The IASB plans to finalise amendments to IFRS 9 by mid-2011.

CIMA has previously supported the removal of gains and losses resulting from changes in own credit from profit and loss and I expect us to do the same in response to this exposure draft.

Your thoughts on the issues raised would be interesting.  I attach the IASB's snapshot summary of the proposals.  The full exposure draft can be viewed via the IASB website