Recently, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-13, which modifies disclosure requirements for assets and liabilities measured at fair value. This update marks the latest step in a broader project designed to improve the effectiveness of financial statement disclosures. It eliminates several disclosures, simplifies others, and adds new disclosures for public business entities.
Fair Value Refresher
FASB’s standards establish a three-tier hierarchy for measuring the value of assets and liabilities reported at fair value. In valuing these assets and liabilities, companies should consider the following (in descending order of priority):
- Level 1 inputs, which are the quoted prices in active markets for identical assets or liabilities,
- Level 2 inputs, defined as the quoted prices in active markets for similar assets or liabilities, or prices for identical assets or liabilities in inactive markets, and
- Level 3, or “unobservable” inputs, such as the reporting entity’s internal estimates or pricing models.
The standards also require companies to provide detailed disclosures about the inputs and methods they use to measure fair value.
ASU 2018-13 eliminates four disclosure requirements:
- The amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy,
- The policy for timing of transfers between hierarchy levels,
- The valuation processes for Level 3 fair value measurements, and
- For nonpublic entities, changes in unrealized gains and losses included in earnings for recurring Level 3 fair value measurements held at the end of the reporting period.
The FASB believes that the benefits of these disclosures don’t justify their costs.
The ASU also modifies three fair value disclosure requirements.
First, instead of reconciling opening and closing balances of Level 3 fair value measurements (known as a “roll-forward”), nonpublic entities will only be required to disclose transfers into and out of Level 3 and purchases and issues of Level 3 assets and liabilities.
Second, for investments in certain entities that calculate net asset value — such as hedge funds and private equity funds — reporting entities will no longer need to estimate the timing of liquidation of an investee’s assets or the date when redemption restrictions might lapse. Disclosure will be required only if the investee has communicated the timing to the entity or announced it publicly.
Third, disclosures of measurement uncertainty will only need to communicate uncertainty as of the reporting date. This modification is intended to clarify that entities don’t have to disclose sensitivity to expected future changes.
Additional Fair Value Disclosure Requirements
Finally, the ASU adds two fair value disclosure requirements for public business entities:
1. Changes in unrealized gains and losses for the period included in other comprehensive income (OCI) for recurring Level 3 fair value measurements held at the end of the reporting period.
2. The range and weighted average (or other appropriate measure) of significant unobservable inputs used to develop Level 3 fair value measurements.
Note that public investment companies generally recognize unrealized investment-related gains and losses on their income statement rather than OCI. Therefore, the first requirement isn’t likely to have a big impact.
Consider Early Adoption
These changes are effective for fiscal years beginning after Dec. 15, 2019, but early adoption is permitted. Some firms — particularly private investment funds and other nonpublic entities — may want to adopt the changes early to streamline their footnote disclosures in upcoming financial statements. Contact your Untracht Early advisor for additional details on these new fair value disclosure requirements.