How Day-One Gains and Losses on Financial Instruments Are Recognized under IFRS 9 and ASC 820
- Graziano Stefanelli
- 16 hours ago
- 5 min read
When a financial instrument is initially recorded, the transaction price may differ from its fair value (exit price). This gap can arise with dealer quotes, model-based pricing, and structured trades that rely on unobservable inputs (Level 3). IFRS (IFRS 9 with IFRS 13) and US GAAP (ASC 820, with instrument-specific codification) both anchor on exit price, but they diverge on when a “day-one” difference may pass through profit or loss. The practical result: IFRS often defers unobservable day-one gains, whereas US GAAP permits recognition only with sufficient market corroboration, otherwise differences are unwound over time.
·····
.....
How the transaction price can differ from exit fair value
In active markets (Level 1) the deal price ≈ fair value. Divergences usually appear when:
A dealer quotes an entry price that embeds bid–ask spreads, funding, or distribution margins.
Valuation relies on internal models (DCF with credit/funding/Liquidity Valuation Adjustment (LVA), option models with non-observable volatilities, correlation).
The deal contains structured features (exotics, illiquid underlyings, bespoke credit tranches).
Example:
A bank originates a long-dated structured note at a customer price of 1,000. The model-based exit price using best-estimate inputs is 970. The 30 difference reflects distribution margin + unobservable model choices.
·····
.....
IFRS policy: recognize only observable day-one P&L
Under IFRS 13/IFRS 9, initial measurement is at fair value (exit price). If transaction price ≠ fair value, a day-one gain or loss is recognized only to the extent supported by observable market inputs. Any residual difference driven by unobservable inputs is deferred and recognized over time as those inputs become observable or as the instrument is remeasured through profit or loss.
Practical mechanics:
Identify the portion of the difference explainable by Level 1/Level 2 inputs → recognize immediately in P&L.
Defer the unobservable residual as an adjunct to the carrying amount (often called “day-one reserve” or “deferred difference”).
Release the deferred difference to P&L via:
Model inputs becoming observable, or
Changes in factors (passage of time, payoffs, settlements) that justify recognition, or
Derecognition of the instrument.
Illustrative entry at trade date:
Debit: Financial Asset at fair value 970
Debit: Day-One Deferred Difference (contra-asset) 30
Credit: Cash 1,000
If 10 of the difference is supported by observable inputs:
Debit: Financial Asset 970
Credit: Cash 1,000
Credit: Trading Gain (P&L) 10
Debit: Day-One Deferred Difference 20
Subsequent release (e.g., 5 becomes observable):
Debit: Day-One Deferred Difference 5
Credit: Trading Gain (P&L) 5
·····
.....
US GAAP policy: exit price governs but recognition requires market corroboration
ASC 820 also uses exit price for fair value. However, absent corroborating observable inputs, practice generally does not recognize day-one gains at inception. Instead, entities either:
Record at transaction price with a valuation allowance conceptually embedded, or
Record at fair value but defer the unobservable difference via a contra account or policy that systematically releases as market data emerges or the position unwinds.
Where sufficient market evidence exists (e.g., quoted prices for identical/similar items, observable volatilities, brokered transactions near trade date), day-one P&L may be recognized.
Illustrative entry (no corroboration):
Debit: Financial Asset 1,000
Credit: Cash 1,000
Internal controls maintain a valuation note evidencing that fair value estimate differs (970) but P&L is not recognized due to lack of observables. Over time, remeasurement through P&L will capture economics as inputs or market data update.
If corroboration supports recognizing 12 of the difference:
Debit: Financial Asset 988
Credit: Cash 1,000
Credit: Trading Gain (P&L) 12
·····
.....
Comparative framework — IFRS vs US GAAP
·····
.....
Worked example — exotic option with unobservable correlation
Facts:
Premium paid (cash) = 2,000.
Model exit fair value at trade = 1,920.
Of the 80 difference, 25 is supported by observable inputs (interest curve, implied vols). The remaining 55 arises from correlation not directly observable.
IFRS at day one:
Dr Derivative Asset (FV) 1,920
Dr Day-One Deferred Difference 55
Cr Cash 2,000
Cr Trading Gain (P&L) 25
Month 3: correlation proxy becomes observable for 20.
Dr Day-One Deferred Difference 20
Cr Trading Gain (P&L) 20
Remainder recognized over time/derecognition.
US GAAP at day one (no corroboration for correlation):
Dr Derivative Asset 2,000
Cr Cash 2,000
No day-one P&L. Subsequent remeasurement flows through earnings; as market data updates, the carrying amount moves toward model exit value and P&L is recognized then.
·····
.....
Presentation and disclosures that withstand audit
Fair value hierarchy (Level 1/2/3) with roll-forwards for Level 3: opening, total gains/losses in P&L, purchases/sales, transfers, closing.
Valuation techniques and inputs: models used (e.g., local/stochastic vol, correlation), input ranges, inter-relationships, and sensitivity.
Day-one difference policy: when P&L is recognized, how residuals are deferred, and the release pattern.
Quantification: aggregate amount of unrecognized day-one gains/losses at period end, and movement during the period (IFRS emphasis).
Example disclosure excerpt:
At 31 December 2025, unrecognized day-one net gains related to new Level 3 transactions totaled €4.8 million (prior year: €3.9 million). These differences will be recognized in profit or loss as relevant inputs become observable, on derecognition, or as risk factors unwind.
·····
.....
Journal entries summary
IFRS (observable portion recognized, residual deferred)
Trade date:
Dr Financial Asset (FV) xx
Dr Day-One Deferred Difference xx
Cr Cash xx
Cr Trading Gain (P&L) xx
Release of deferred portion:
Dr Day-One Deferred Difference xx
Cr Trading Gain (P&L) xx
Derecognition (any remaining):
Dr/Cr Trading Gain (P&L) xx
Cr/Dr Day-One Deferred Difference xx
US GAAP (no corroboration)
Trade date:
Dr Financial Asset xx
Cr Cash xx
Subsequent remeasurement:
Dr/Cr Trading Gain (P&L) xx
Cr/Dr Financial Asset xx
US GAAP (partial corroboration)
Recognize the corroborated portion in P&L similar to IFRS; defer the remainder via policy.
·····
.....
Impact on financial performance and ratios
Earnings timing: IFRS can smooth earnings by deferring unobservable portions; US GAAP often yields no inception P&L, pushing effects into later remeasurements.
Volatility: Heavy Level 3 activity amplifies future P&L swings as inputs become observable or as positions unwind.
Regulatory/analyst optics: Transparent policies and quantified day-one reserves improve comparability and reduce concerns about front-loading revenue.
Tax and capital: Day-one deferrals may not align with tax recognition; capital frameworks (e.g., for banks) may adjust for valuation uncertainty.
·····
.....
Operational considerations
Establish a price verification framework distinguishing observable vs unobservable inputs, with independent model validation.
Document calibration of models to the deal price and track Day-One Deferred Differences at position level.
Define clear release triggers (observability thresholds, time passage, settlements) and ensure consistent application.
Enhance governance: valuation committees, thresholds for recognizing inception P&L, and periodic back-testing against market exits.
A disciplined day-one recognition policy aligned to IFRS 13/ASC 820 principles delivers faithful measurement while avoiding premature profit recognition on illiquid, model-priced trades.
·····
.....
FOLLOW US FOR MORE
DATA STUDIOS
.....
