4.1 Introduction

ASC 820-10

The Asset or Liability

35-2D The asset or liability measured at fair value might be either of the following:

A standalone asset or liability (for example, a financial instrument or a nonfinancial asset)
A group of assets, a group of liabilities, or a group of assets and liabilities (for example, a reporting unit or a business).

35-2E Whether the asset or liability is a standalone asset or liability, a group of assets, a group of liabilities, or a group of assets and liabilities for recognition or disclosure purposes depends on its unit of account. The unit of account for the asset or liability shall be determined in accordance with the Topic that requires or permits the fair value measurement, except as provided in this Topic.

The Fair Value Measurement Approach

55-1 The objective of a fair value measurement is to estimate the price at which an orderly transaction to sell the asset or to transfer the liability would take place between market participants at the measurement date under current market conditions. A fair value measurement requires a reporting entity to determine all of the following:

The particular asset or liability that is the subject of the measurement (consistent with its unit of account)
For a nonfinancial asset, the valuation premise that is appropriate for the measurement (consistent with its highest and best use)
The principal (or most advantageous) market for the asset or liability
The valuation technique(s) appropriate for the measurement, considering the availability of data with which to develop inputs that represent the assumptions that market participants would use when pricing the asset or liability and the level of the fair value hierarchy within which the inputs are categorized.

As discussed in Chapter 3, one of the requirements for a fair value measurement is that an entity must determine the particular asset, liability, or equity instrument that is subject to the measurement on the basis of its unit of account. ASC 820-10-20 defines the unit of account as “[t]he level at which an asset or a liability is aggregated or disaggregated in a Topic for recognition purposes.” The unit of account is used to determine what is being measured by reference to the level at which the asset or liability is aggregated (or disaggregated) for accounting recognition or disclosure purposes. The unit of account could be a stand-alone asset, liability, or equity instrument; a group of assets; a group of liabilities; or a group of assets and liabilities.

Although ASC 820 defines fair value and establishes a framework for measuring it, the standard does not specify what items should be recognized at fair value in an entity’s financial statements. The requirement (or ability) to measure an asset, liability, or equity instrument at fair value and the unit of account for such recognition is generally determined in accordance with the guidance in Codification topics other than ASC 820. With one exception, ASC 820 does not specify the unit of account to be used in a fair value measurement. See Table 2-1 for other Codification topics that specify the unit of account that applies to the recognition of an asset, liability, or equity instrument at fair value.

The examples below illustrate the determination of the unit of account.

Example 4-1

Unit of Account for Investments in Multiple Classes of an Investee Fund

Entity A holds equity investments in multiple classes of an investee fund. The investee fund uses multiple share classes to help investors distinguish between various liquidity restrictions pertaining to their investments.

Entity A holds $3 million in Class A of the investee fund, which is redeemable at any point, and $500,000 in Class B (a restricted class such as an investment that was side-pocketed or that has other redemption lock-up provisions) of the investee fund, which is subject to a six-month lockout period. Assume that A would categorize the Class A investment within Level 2 of the fair value hierarchy and the Class B investment within Level 3 of the fair value hierarchy. Further assume that neither investment is measured by using the practical expedient for assets measured at NAV.

While Class A and Class B may be part of the same subscription agreement, the characteristics of the equity investments in the two classes differ (i.e., Class B is restricted and Class A is not). Therefore, in this example, the two classes are considered separate units of account under ASC 321. Accordingly, it would not be appropriate to combine Class A and Class B into a single unit of account and, for example, classify the combined unit as Level 2 or Level 3 in its entirety. Rather, A must perform a separate analysis of Class A and Class B for ASC 820 disclosure purposes (i.e., A must separately determine the level in the fair value hierarchy in which each investment is categorized). This same principle would also apply to investments in partnership entities that have different classes of partnership interests.

Example 4-2

Debt Instrument With a Third-Party Credit Enhancement

Entity B, which is issuing $100 million in debt, has a B+ credit rating. As a result, B may be able to issue $100 million in debt at a 12 percent interest rate. However, if B obtains a third-party guarantee from an entity with an AA credit rating, it can issue $100 million in debt at a 6 percent interest rate. Entity B would have to pay the third-party guarantor $20 million to obtain the guarantee.

If B issues $100 million in debt at a 6 percent interest rate because it obtains a guarantee from a third party with an AA credit rating, and if B subsequently defaults on the debt, it is not released from its obligation. Rather, B would be required to reimburse the guarantor. That is, from B’s perspective, upon default to the investors in B’s debt, the only thing that has changed is the identity of the creditor (i.e., B owes the guarantor instead of the investors).

The guarantee is contractually incorporated into the debt agreement in such a way that any investor that acquires B’s debt would be entitled to the guarantee (i.e., the guarantee would be transferred with the debt instrument in transactions among investors).

Entity B’s Accounting

If fair value is the measurement attribute for B’s debt, the debt contains two units of accounting: (1) the debt without the guarantee and (2) the guarantee. This is consistent with ASC 825-10-25-13, which states:

For the issuer of a liability issued with an inseparable third-party credit enhancement (for example, debt that is issued with a contractual third-party guarantee), the unit of accounting for the liability measured or disclosed at fair value does not include the third-party credit enhancement. This paragraph does not apply to the holder of the issuer’s credit-enhanced liability or to any of the following financial instruments or transactions:

A credit enhancement granted to the issuer of the liability (for example, deposit insurance provided by a government or government agency)
A credit enhancement provided between reporting entities within a consolidated or combined group (for example, between a parent and its subsidiary or between entities under common control).

If B measures the fair value of the debt from the perspective of a market participant that holds the identical item as an asset (i.e., on the basis of the fair value of the debt from the perspective of an investor in B’s debt), an adjustment must be made because there is a factor that applies to the asset that does not apply to B’s liability for the debt. ASC 820-10-35-16D(b) indicates that an entity needs to make an adjustment when the unit of account for the asset is not the same as that for the liability. Further, ASC 820-10-35-16D(b) cites liabilities with third-party credit enhancements (e.g., B’s debt) as an example of a unit of account for which an adjustment is needed. Thus, in measuring the fair value of its debt, B would need to adjust an observed price for the asset to exclude the effect of the third-party guarantee.

Investor’s Accounting

If an investor measured its asset for the investment in B’s debt at fair value, it would not exclude the third-party guarantee. Rather, the debt with the inseparable third-party guarantee would be considered as consisting of a single unit of account. The guidance above on separate consideration of a third-party credit enhancement applies only to the issuer (obligor) of the debt.

See Section 4.3.2.2 for further discussion of liabilities with third-party credit enhancements.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.