CVA and DVA are treated differently when you account for derivatives at fair value, decide whether to use hedge accounting, determine the fair value level, and calculate the capital adequacy ratio.

Why CVA and DVA enter fair value

Accounting standards put CVA and DVA into fair value because the fair value of a liability includes the risk that the firm will not meet the obligation. When a derivative is measured at fair value under IFRS 13, the valuation has to reflect the credit risk of both the firm and its counterparty, as a credit valuation adjustment1. Fair Value Measurement: IFRS 13, ASC 820 and the Fair Value Hierarchy covers the definition of fair value, the exit price, and the three levels.

The risk that an entity will not fulfill an obligation is called nonperformance risk, and it includes the entity's own credit risk. The fair value of a liability reflects the effect of nonperformance risk under both ASC 820 and IFRS 1323. Under ASC 820, nonperformance risk is assumed to be the same before and after the transfer of the liability. Earlier IFRS did not mention the reporting entity's own credit risk, but IFRS 13 made it clear that the entity's own credit risk is included in the fair value of a liability4.

On a derivative, the side with a positive fair value is an asset, and the side with a negative fair value is a liability. The counterparty's credit risk affects the asset, and the firm's own nonperformance risk affects the liability. The adjustment that reflects the counterparty's credit risk is CVA, and the adjustment that reflects the firm's own credit risk is DVA5. In accounting, it is common to consider the firm's own creditworthiness as well as the counterparty's, and a CVA that includes both is called a bilateral CVA6. The adjusted fair value, based on the fair value at the risk-free rate, can be written as follows.

Adjusted fair value=Risk-free fair value−CVA+DVA\text{Adjusted fair value} = \text{Risk-free fair value} - \mathrm{CVA} + \mathrm{DVA}

CVA rises when the counterparty's creditworthiness falls and lowers the fair value, and DVA rises when the firm's own creditworthiness falls and raises the fair value. CVA and DVA covers how they are calculated.

Under US GAAP (Topic 820) too, DVA is in principle reflected in fair value7. Accounting standards do not require FVA to be included in fair value, but as of a 2017 paper, many financial institutions had already built it into their accounting8.

The exception for measuring net exposure

There is an exception that lets a group of financial assets and financial liabilities be measured on a net basis for its net risk. To measure credit risk on a net basis under this exception, there must be an arrangement with the counterparty that reduces the exposure to credit risk in the event of default9.

CVA is usually calculated for each netting set, not for each individual trade. If the counterparty defaults, receivables and payables under the same agreement can be offset through close-out netting10.

Direction of profit and loss: a hypothetical example of Company P

IFRS 9 includes a liability that is a derivative among the liabilities measured at fair value through profit or loss11. Except for exceptions such as hedge accounting, gains and losses on financial assets and financial liabilities measured at fair value go to profit or loss12. For a derivative outside hedge accounting, changes in CVA and DVA go to profit or loss.

Consider a hypothetical example in which Company P holds a derivative with a counterparty and does not apply hedge accounting to it. The trades are under a single netting agreement, and the risk-free fair value is 10 million yen at both the start and the end of the period. At the start, CVA is 200 thousand yen and DVA is 80 thousand yen. The adjusted fair value at the start is 10,000 − 200 + 80 = 9,880 thousand yen. The profit or loss for each movement in creditworthiness at the end of the period is as follows.

Situation at period end CVA (thousand yen) DVA (thousand yen) Adjusted fair value (thousand yen) Profit or loss (thousand yen)
Counterparty's creditworthiness falls 300 80 10,000 − 300 + 80 = 9,780 −100
Company P's creditworthiness falls 200 120 10,000 − 200 + 120 = 9,920 +40
Both fall 300 120 10,000 − 300 + 120 = 9,820 −60
Company P's creditworthiness improves 200 50 10,000 − 200 + 50 = 9,850 −30

The profit or loss is the adjusted fair value at the end of the period minus the 9,880 thousand yen at the start, which equals −(the increase in CVA) + (the increase in DVA). If the counterparty's creditworthiness falls, CVA rises and Company P records a loss. If Company P's own creditworthiness falls, DVA rises and Company P records a gain. When creditworthiness improves, the direction reverses.

A gain from a fall in the firm's own creditworthiness is a counterintuitive result to report. Respondents to the exposure draft of IFRS 13 raised a concern. If changes in own credit risk are included in the fair value of a liability and recognized in profit or loss, the entity reports a gain when credit quality worsens and a loss when it improves, which is counterintuitive13. The IASB says it addressed this concern in developing IFRS 9, which it issued in 20103.

For a product whose fair value is always on the positive side, no DVA arises. The buyer of an interest rate cap only has a right to receive and has no obligation to pay. In the numerical test in Kawakami's paper, DVA is zero in this case and is not recognized14.

When the fair value of a hedging instrument includes CVA and DVA, the part the hedge cannot offset moves, and profit or loss can become more volatile15. One of the conditions for hedge accounting in IFRS 9 is that the effect of credit risk does not dominate the value changes that result from the economic relationship16.

Where DVA and own credit risk go

DVA on a derivative goes to profit or loss. A liability that a firm measures at fair value under the fair value option is treated differently for changes in its own credit risk. Under IFRS 9, an entity can, at initial recognition, designate a financial liability irrevocably as measured at fair value through profit or loss, for example when this eliminates an accounting mismatch17. For a designated liability, the part of the change in fair value that is attributable to changes in the credit risk of that liability goes to other comprehensive income (OCI). The remaining amount goes to profit or loss18.

There are exceptions. If presenting the credit risk change in OCI would create or enlarge an accounting mismatch in profit or loss, all gains and losses, including the credit risk change, go to profit or loss. For loan commitments and financial guarantee contracts, all gains and losses go to profit or loss even if they are designated18.

YesNoIs it designated asmeasured at fair value?Undesignated:in principlederivativeDVA to P&LNoYesIs it a loan commitmentor financial guaranteecontract?All, creditrisk changesincluded, toP&LNoYesWould OCI presentationcreate or enlarge anaccounting mismatch?All, creditrisk changesincluded, toP&LIn principle, the creditrisk change goes to OCI,the rest to profitor loss
Figure 1Where changes in the credit risk of a liability measured at fair value go (IFRS 9)
Figure description

Figure 1 shows whether the credit risk change on a liability measured at fair value goes to OCI or to profit or loss. Start from whether the liability is designated. In this figure, only the credit risk change on a designated liability passes through OCI. A designation is made irrevocably at initial recognition, for example when it eliminates an accounting mismatch.

DVA on a derivative is outside the OCI treatment because the provision that puts the change in OCI applies to a liability designated as measured at fair value. A liability that is a derivative is measured at fair value through profit or loss without any designation. That provision does not cover DVA on a derivative, so, unless the derivative is part of a hedging relationship, changes in DVA go to profit or loss19.

US GAAP also presents the part of the change that is due to own credit risk separately in OCI for a financial liability under the fair value option20. The difference from IFRS 9 is the treatment when the liability is extinguished. Under US GAAP, the cumulative credit risk amount that was in OCI is included in net income when the liability is extinguished. IFRS 9 does not allow the amounts presented in OCI to be transferred to profit or loss later (a transfer within equity is allowed)21. US GAAP also requires disclosure for a liability under the fair value option. The disclosure covers the change in fair value, for the period and cumulatively, that is attributable to instrument-specific credit risk, and how it was determined22.

Item DVA on a derivative Own credit risk of a fair value option liability (IFRS 9) Same (US GAAP)
Where changes go Profit or loss OCI in principle. Profit or loss if it creates or enlarges a mismatch OCI
Condition for the treatment No designation needed. A liability measured at fair value through profit or loss A liability designated at initial recognition A liability for which the fair value option is elected
When the liability is extinguished Already in profit or loss No transfer to profit or loss Included in profit or loss
Deep diveThe scope of a liability's credit risk and how to separate it

What IFRS 9 puts in OCI is the change in the risk that the issuer will not perform a particular liability. It does not necessarily match a change in the issuer's creditworthiness. A secured liability and an unsecured liability issued by the same issuer, with otherwise identical terms, have different credit risk23.

US GAAP permits treating the part of the change in fair value of a liability that remains after excluding the change due to underlying market risk, such as a risk-free rate or a benchmark rate, as the change due to instrument-specific credit risk. Another method that faithfully represents the amount may be used, and either method is applied to each liability consistently from period to period20.

Treatment under the Japanese fair value measurement standard

The Accounting Standards Board of Japan (ASBJ)'s Accounting Standard for Fair Value Measurement (ASBJ Statement No. 30) adopts the content of IFRS 13 almost in full24.

A liability's nonperformance risk is one of the factors that market participants consider in a present value technique25.

The net exception is also provided. Under ASBJ Statement No. 30, with the same intent as IFRS 13, fair value can be measured on the net position of financial assets and financial liabilities offset against each other. To measure credit risk on a net basis, there must be arrangements that reduce credit risk on default, and fair value reflects market participants' view of whether those arrangements are legally enforceable. Examples are a master netting agreement and a collateral agreement based on net credit risk26.

DVA in regulatory capital

In accounting, DVA enters fair value and profit or loss, but the capital adequacy ratio rules take DVA out of capital. A commentary in Kinyu Zaisei Jijo explains that in the calculation of regulatory capital, DVA is deducted from Common Equity Tier 1 (CET1) in order to prevent moral hazard27. Under Japan's FSA notice on capital adequacy too, the valuation difference on liabilities is an adjustment item on a consolidated basis for banks using the international standard. It covers the part of the difference that is based on changes in the credit risk of the bank or its consolidated subsidiaries themselves and is included in capital28.

The standardized approach to the CVA capital charge (SA-CVA) uses a one-sided CVA that assumes the bank itself does not default, does not take DVA into account, and deducts it directly from CET129. Accounting CVA is a fair value, so it is valued under risk-neutral probability. The regulatory internal model method and others may use historical data on real-world probability, and the commentary says this had created a gap between accounting and regulatory CVA30.

Observability and the fair value level

The level of a fair value that includes CVA and DVA is set by the lowest-level input that is significant to the measurement as a whole. If observable inputs are adjusted by unobservable inputs and the adjustment moves the fair value significantly, the whole measurement is Level 331.

Calculating CVA needs inputs for the counterparty's default probability and loss rate. In practice, the default probability is derived from observable spreads such as those on CDS, and the assumption used in that calculation is also used for the loss rate (1 − recovery rate)32. In SA-CVA, if the counterparty's credit spread is illiquid, a proxy spread is used instead33. Deloitte's commentary on ASC 820 says that if default rates can be derived from observable market data, an entity may not replace them with its own historical data or its own assumptions34.

Applying this rule to CVA, if the counterparty's spread is not liquid, the construction of the proxy includes unobservable assumptions, and those assumptions change CVA significantly, the whole derivative can be Level 3. Whether CVA is significant to the measurement as a whole is judged for each derivative.

The size of CVA and DVA depends on the model and the assumptions. Results differ depending on whether the calculation uses a risk-neutral measure or a real-world probability. According to Kawakami's paper, real-world probability was often used at first, but recently the mainstream is to calculate under the risk-neutral measure, in line with capital rules and accounting requirements35. In the post-implementation review of IFRS 13, some respondents also pointed to variation in practice in valuation adjustments for derivatives. The IASB does not see a significant issue that needs to be addressed in response36.

What this page does not cover

This page does not cover which method Japanese financial institutions use to calculate CVA and DVA, or in which accounts they present them.

Notes

  1. Takashi Kawakami, "ヘッジ取引におけるデリバティブ信用評価調整の影響についての考察" (A study of the effects of credit valuation adjustments of derivatives on hedging transactions), Kinyu Kenkyu, Institute for Monetary and Economic Studies, Bank of Japan (April 2018), Section 1 (page 120) (in Japanese). It explains that IFRS 13 requires an adjustment that builds the credit risk of both parties into the valuation of a derivative. ↩

  2. ASC 820-10-35-17 (Nonperformance Risk), as quoted in Deloitte, "Deloitte's Roadmap: Fair Value Measurements and Disclosures (Including the Fair Value Option)," 10.2 Definition of Fair Value. It provides that the fair value of a liability reflects nonperformance risk, assumed to be the same before and after the transfer, and the glossary quoted there says it includes, but may not be limited to, the entity's own credit risk. ↩

  3. IASB, "IFRS 13 Fair Value Measurement Project Summary and Feedback Statement" (May 2011), page 20. It says that the fair value of a liability reflects the effect of non-performance risk, and that the concern about own credit risk was addressed in developing IFRS 9. ↩ ↩2

  4. Kawakami, same paper, footnote 1 on page 120 (in Japanese). It describes the Basis for Conclusions of IFRS 13: that the previous standard did not mention an entity's own credit risk (BC92), and that the intent is to make clear that own credit risk is included in the fair value of a liability (BC93). ↩

  5. Kawakami, same paper, Section 2 (1) (page 123) (in Japanese). It says that credit valuation adjustment is the general term for adjustments that build the credit risk of the counterparty and of the firm into the valuation of a derivative, with the counterparty's part called CVA and the firm's part called DVA. ↩

  6. Soichi Maeda and Tatsuya Hasegawa, "ＣＶＡリスク計測の枠組みの見直し" (Review of the framework for measuring CVA risk), Kinzai Institute for Financial Affairs, Kinyu Zaisei Jijo (February 12, 2018 issue), "信用評価調整（ＣＶＡ）とは" (What is credit valuation adjustment (CVA)) (pages 32–33) (in Japanese). It says that a CVA that considers only the counterparty's creditworthiness is a unilateral CVA, that in accounting it is common to consider the firm's own creditworthiness as well, and that this is called a bilateral CVA. ↩

  7. Yuichi Saito, "金融規制の複合的影響を考慮したXVA" (XVA considering the combined effects of financial regulation), Kinyu Kenkyu, Institute for Monetary and Economic Studies, Bank of Japan (April 2017), Section 1 (page 110) (in Japanese). It says that accounting standards in Europe and the US require, in principle, that DVA be reflected in the fair value of the firm's own obligations too, and it cites IFRS 13 and Topic 820 of the US ASC. ↩

  8. Saito, same paper, Section 2 (1) (page 112) (in Japanese). It says that accounting standards do not require FVA to be included in fair value, but that in practice many financial institutions have already built it into their accounting. ↩

  9. IASB, "IFRS 13 Fair Value Measurement Project Summary and Feedback Statement," page 22. The exception covers financial instruments measured at fair value on a recurring basis, and for credit risk it requires an arrangement with the counterparty that mitigates the exposure in the event of default. ↩

  10. Maeda and Hasegawa, same article, page 32 (in Japanese). It explains that if the counterparty defaults, receivables and payables of multiple trades under the same agreement can be offset and margin is also exchanged for each agreement, so CVA is normally calculated for each agreement, not for each trade. ↩

  11. IFRS 9 (IFRS Foundation, 2025 edition), paragraph 4.2.1(a). It includes a liability that is a derivative among the financial liabilities at fair value through profit or loss. ↩

  12. IFRS 9, paragraph 5.7.1. A gain or loss on a financial asset or financial liability measured at fair value is recognized in profit or loss, unless it is part of a hedging relationship or covered by another exception. ↩

  13. IASB, "IFRS 13 Fair Value Measurement Project Summary and Feedback Statement," page 19. It records respondents' view that recognizing changes in own credit risk in profit or loss means a gain when credit quality worsens and a loss when it improves, which is counterintuitive. ↩

  14. Kawakami, same paper, Section 4 (page 138) (in Japanese). Its numerical test shows that for a trade without optionality, such as a swap, the exposure can be positive or negative, so both CVA and DVA are recognized, while for a bought cap the exposure stays positive because of the payoff structure, so DVA is zero and is not recognized. ↩

  15. Kawakami, same paper, Section 3 (2) (page 129) (in Japanese). It explains that the derivative used as a hedging instrument changes not only with market factors but also with changes in CVA and DVA, so the part the hedge does not cover moves and periodic profit or loss can become more volatile. ↩

  16. IFRS 9, paragraph 6.4.1(c)(ii). It makes it one of the hedge effectiveness requirements that the effect of credit risk does not dominate the value changes that result from the economic relationship between the hedged item and the hedging instrument. ↩

  17. IFRS 9, paragraph 4.2.2. It provides that at initial recognition, a financial liability can be irrevocably designated as measured at fair value through profit or loss, for example when this eliminates or significantly reduces an accounting mismatch. ↩

  18. IFRS 9, paragraphs 5.7.7 to 5.7.9. The credit risk change goes to OCI and the remainder to profit or loss (5.7.7), but all of it goes to profit or loss if an accounting mismatch is created or enlarged (5.7.8) and for loan commitments and financial guarantee contracts (5.7.9). ↩ ↩2

  19. A synthesis of IFRS 9 paragraphs 4.2.1(a), 4.2.2, 4.3.5, 5.7.1 and 5.7.7. Paragraph 5.7.7 covers a liability designated under 4.2.2 or 4.3.5; a derivative liability is measured at fair value without designation under 4.2.1(a), and its changes go to profit or loss under 5.7.1. ↩

  20. ASC 825-10-45-5, as quoted in Deloitte, "Deloitte's Roadmap: Fair Value Measurements and Disclosures (Including the Fair Value Option)," 12.4 Presentation. For a financial liability under the fair value option, the portion of the change due to instrument-specific credit risk is presented separately in OCI. The amount remaining after excluding underlying market risk may be treated as that change, and another method may be used, applied consistently in each period. ↩ ↩2

  21. Deloitte, "Deloitte's Roadmap: Fair Value Measurements and Disclosures (Including the Fair Value Option)," 12.6 Comparison of U.S. GAAP and IFRS Accounting Standards, 12.6.4. Under US GAAP, on extinguishment the credit risk change in OCI goes to profit or loss (ASC 825-10-45-6, quoted in 12.4). IFRS 9 does not allow that transfer, but B5.7.9 allows a transfer within equity. ↩

  22. ASC 825-10-50-30, as quoted in Deloitte, same commentary, 12.5 Disclosures. For a liability, the disclosures are the change in fair value for the period and cumulatively that is attributable to instrument-specific credit risk, how it was determined, and the amount included in net income from other comprehensive income when the liability was settled during the period. ↩

  23. IFRS 9, paragraph B5.7.13. It says that paragraph 5.7.7(a) relates to the risk that the issuer will fail to perform on a particular liability, which does not necessarily match the issuer's creditworthiness, and gives the example of a secured liability and an unsecured liability. ↩

  24. PwC Arata LLC, "日本基準トピックス 第378号" (Japanese GAAP Topics No. 378) (July 4, 2019), page 2 (in Japanese). It explains that the fair value standard adopts the provisions of IFRS 13 almost in full and adds individual treatments in consideration of Japanese practice. ↩

  25. "「時価の算定に関する会計基準」に対する批判的考察" (A critical study of the "Accounting Standard for Fair Value Measurement"), Keiei Rinsho (Hosei University Business Association), Vol. 57, No. 3 (October 2020), page 29 (in Japanese). It lists, as paragraph 35(1) of ASBJ Guidance No. 31, the nonperformance risk of the liability among the factors to consider in a present value technique. ↩

  26. The same paper, page 26 (in Japanese). It presents measurement on a net basis and its conditions as paragraph 7 of ASBJ Statement No. 30. The unit of measurement is in paragraph 32. ↩

  27. Maeda and Hasegawa, same article, page 33 (in Japanese). It says that in the calculation of regulatory capital, DVA is deducted in the CET1 calculation to avoid moral hazard, and that the CVA assumed is unilateral. ↩

  28. Financial Services Agency, "銀行法第十四条の二の規定に基づき、銀行がその保有する資産等に照らし自己資本の充実の状況が適当であるかどうかを判断するための基準" (Standards for determining whether a bank's capital adequacy is appropriate in light of the assets it holds, under Article 14-2 of the Banking Act, our translation; FSA Notice No. 19 of 2006, consolidated version updated on August 24, 2026), Article 5, paragraph 2, item 1, sub-item (he) (adjustment items for consolidated Common Equity Tier 1 capital of banks applying the international standard) (in Japanese). ↩

  29. Financial Services Agency and Bank of Japan, "「信用評価調整（CVA）リスクの最低所要自己資本」の概要" (Overview of "Minimum capital requirements for credit valuation adjustment (CVA) risk," our translation) (February 2018), page 8 (in Japanese). As one of the main requirements of SA-CVA, it shows that CVA is captured on a one-sided basis (the bank's own default is not considered), and that DVA is left out of the calculation and deducted directly from CET1. ↩

  30. Maeda and Hasegawa, same article, page 34 (in Japanese). It says that accounting CVA is based on risk-neutral probability because it is a fair value, whereas the internal model method and others may use historical data on real-world probability, creating a gap between accounting and regulation. SA-CVA is described as a method that values consistency with accounting. ↩

  31. ASC 820-10-35-37A and 35-38A, as quoted in Deloitte, "Deloitte's Roadmap: Fair Value Measurements and Disclosures (Including the Fair Value Option)," 8.1 Introduction. The application to CVA in the text is the author's; the source does not say this about CVA. ↩

  32. Maeda and Hasegawa, same article, page 33 (in Japanese). It explains that measuring CVA requires deriving the counterparty's default probability from spreads in the CDS market, and that the assumption made there is also used in calculating the loss rate. ↩

  33. Financial Services Agency and Bank of Japan, same document, page 8 (in Japanese). It says that SA-CVA estimates default probability, in principle, from observable market credit spreads, and uses a proxy spread when the credit spread is illiquid. ↩

  34. Deloitte, "Deloitte's Roadmap: Fair Value Measurements and Disclosures (Including the Fair Value Option)," 8.4 Level 3 Inputs, Example 8-11. In the example, when default rates can be derived from observable market data, the entity cannot rely on its own historical default data or on its own stressed assumptions. ↩

  35. Kawakami, same paper, Section 2 (page 126) (in Japanese). It says that frameworks for calculating CVA and DVA divide broadly into the real-world measure and the risk-neutral measure, and describes the trend toward using observable inputs to value model parameters, because IFRS 13 takes fair value to be an exit price. ↩

  36. IFRS Foundation, "Post-implementation Review of IFRS 13 Fair Value Measurement: IFRS Project Report and Feedback Statement" (December 2018), page 18. It says that a few respondents mentioned variation in practice in valuation adjustments in measuring derivatives, and that the IASB saw no significant issue to address at this time. ↩