Deloitte's Roadmap: Fair Value Measurements and Disclosures (Including the Fair Value Option)
Preface
Preface
We are pleased to present the 2024
edition of Fair Value Measurements and Disclosures (Including the Fair Value
Option), which provides an overview of the accounting and disclosure
guidance in ASC 820 and ASC 825 as well as insights into how to apply this guidance
in practice.
Fair value measurements and
disclosures are generally relevant to the financial reporting of all entities. The
guidance on this topic in ASC 820 primarily reflects the outcome of the FASB’s joint
project with the International Accounting Standards Board (IASB®) to
substantially converge U.S. GAAP and IFRS® Accounting Standards. The FASB
has made certain amendments since the culmination of its joint project with the
IASB, including those in (1) ASU 2016-01, which amends the guidance in U.S. GAAP on the
classification and measurement of financial instruments and certain disclosure
requirements associated with the fair value of financial instruments; (2)
ASU
2018-13, which changes the fair value disclosure requirements
for all entities; and (3) ASU 2022-03, which clarifies the guidance on fair value
measurement of equity securities subject to contractual sale restrictions. Appendix F highlights all
changes made to this publication since the 2023 edition.
The guidance on application of the fair value option (FVO) originated in FASB Statement 159. The FASB has not made any
significant amendments to this guidance since the issuance of the original
pronouncement.
This Roadmap is intended to help entities navigate the accounting guidance related to
fair value measurements and disclosures, reduce complexity, and arrive at
appropriate accounting conclusions.
Be sure to check out On the Radar (also available as
a stand-alone
publication), which briefly summarizes emerging
issues and trends related to the accounting and financial
reporting topics addressed in the Roadmap.
We hope you find this Roadmap a useful resource, and we welcome your suggestions for
future improvements. If you need assistance with applying the fair value guidance or
have other questions about this topic, we encourage you to consult our technical
specialists and other professional advisers.
On the Radar
On the Radar
Most entities have amounts that are recognized at fair value in their financial
statements. ASC 820 defines fair value, sets out a framework for measuring it, and
establishes fair value disclosure requirements. However, ASC 820 does not specify
when an entity is required or permitted to measure assets, liabilities, equity
instruments, or transactions at fair value; this requirement is addressed in other
U.S. GAAP.
An entity must consider the
following issues in applying the fair value measurement framework in ASC 820:
Common Misconception
A fair value measurement is a market-based measurement based
on an exit price notion and is not entity-specific.
Therefore, a fair value measurement must be determined on
the basis of the assumptions that market participants would
use in pricing an item, regardless of whether those
assumptions are observable or unobservable. A measurement
based on “true value,” “economic value,” or management’s
perception of value is not consistent with a fair value
measurement. The fair value hierarchy in ASC 820 serves as a
basis for considering market-participant assumptions and
distinguishes between (1) market-participant assumptions
developed on the basis of market data that are independent
of the entity (observable inputs) and (2) an entity’s own
assumptions about market-participant assumptions developed
on the basis of the best information available in the
particular circumstances, including assumptions about the
risks inherent in inputs or valuation techniques.
Fair Value Measurement Framework
The fair value measurement guidance was
originally issued in September 2006. Although it has been subsequently amended
since its original issuance, the general framework has not changed and
significant future changes are not expected. An entity needs to perform various
steps to (1) prepare a fair value measurement that complies with the measurement
principles in ASC 820 and (2) meet the disclosure requirements in ASC 820. An
entity may apply the following step-by-step approach to measure and disclose
fair value when the initial or subsequent measurement of an asset, liability, or
equity instrument at fair value is required or permitted by other U.S. GAAP:
Fair Value
Measurement Application Framework
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Step 1: Identify the unit of account — The unit of account represents the level of aggregation or disaggregation of individual assets, liabilities, or equity instruments for recognition in the financial statements and, with the exception of items for which there are quoted prices in an active market, is determined on the basis of other U.S. GAAP.
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Step 2: Identify the unit of valuation — The unit of valuation is often consistent with the unit of account, but there are exceptions. The unit of valuation for nonfinancial assets (other than nonfinancial derivative assets) is the asset’s highest and best use. In addition, the unit of valuation for certain groups of financial assets, financial liabilities, and nonfinancial items accounted for as derivatives may represent a portfolio of items with offsetting risk positions.
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Step 3: Identify the principal or most advantageous market — Under ASC 820, it is assumed that an entity will transact in its principal market or, in the absence of a principal market, the most advantageous market. This determination is important because exit prices are not the same in different markets. In most situations, there will be a principal market, which represents the market with the greatest volume and level of activity for the item. The market in which the entity normally transacts is generally the principal (or most advantageous) market.
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Step 4: Develop assumptions that market participants would use to measure fair value — To meet the “exit price” measurement objective, an entity must develop assumptions that market participants would use to determine the price of an asset, liability, or equity instrument in an orderly transaction as of the measurement date, even if those assumptions are based on unobservable information. An entity may not substitute the assumptions of market participants with its own assumptions that differ from those of market participants.
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Step 5: Measure fair value on the basis of available inputs and appropriate valuation techniques — The initial fair value measurement of an item will often be equal to its transaction price. However, in certain situations, the transaction price does not equal an exit price on initial recognition. In subsequently measuring items at fair value, an entity must maximize the use of observable inputs and minimize the use of unobservable inputs. Entities must use valuation techniques that are consistent with the techniques that market participants would use to determine an exit price. Since a quoted market price for an identical item in an active market (i.e., a Level 1 input) constitutes the most reliable evidence of fair value, this price must be used to measure fair value when available. Although a significant decrease in the volume and level of activity in relation to normal market activity may affect the entity’s selection of techniques or inputs, it does not change the fair value measurement objective. Entities cannot incorporate measurements that are inconsistent with fair value on the basis that (1) an entire market is functioning in a disorderly manner or (2) an entity would not enter into a transaction to sell an asset or transfer a liability at the current market price.
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Step 6: Allocate fair value measurement to individual units of account (if necessary) — An entity may be required to allocate a fair value measurement when the unit of account for the item measured at fair value differs from the unit of valuation. In some cases, an allocation will be required even when the unit of account and unit of valuation are the same. Such allocations are performed in accordance with other U.S. GAAP.
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Step 7: Classify the fair value measurement within the fair value hierarchy and prepare disclosures — Under ASC 820, inputs used in fair value measurements are categorized into a three-level fair value hierarchy. In addition to requiring the disclosure of items measured at fair value within this hierarchy (i.e., Level 1, Level 2, or Level 3), ASC 820 requires entities to provide numerous quantitative and qualitative disclosures about fair value measurements.
As is evident in its comment letters
on registrants’ filings, the SEC staff closely
scrutinizes the fair value disclosures provided by
entities, focusing on missing or confusing
disclosures. The staff often will request entities
to modify or supplement disclosures.
Items Required or Eligible to Be Measured at Fair Value
With certain exceptions, the measurement guidance in ASC 820 applies whenever
another Codification topic uses the phrase “fair value” to describe how an
entity is required or permitted to measure financial and nonfinancial assets and
liabilities, instruments classified in a reporting entity’s stockholders’
equity, or specific transactions, regardless of whether this measurement
pertains to initial or subsequent recognition or to disclosure. Therefore,
before applying the fair value measurement framework in ASC 820, entities must
determine whether fair value measurement under ASC 820 is required or permitted
by other U.S. GAAP.
In addition, certain Codification topics permit, but do not
require, an entity to measure an asset or liability at fair value. Most notably,
ASC 825 permits entities to elect the FVO to account for certain financial
assets and financial liabilities at fair value. Entities may also elect to
account for certain assets or liabilities, including nonfinancial items, at fair
value according to other Codification topics (e.g., ASC 860-50 permits entities
to recognize servicing assets and servicing liabilities at fair value). Any
measurement of an item at fair value must be performed in accordance with ASC
820 unless the use of another measurement approach is specifically required by
U.S. GAAP.
This Roadmap comprehensively discusses
the scope, measurement, and disclosure guidance in ASC
820 and other U.S. GAAP.
Contacts
Contacts
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Jonathan Howard
Audit & Assurance
Partner
Deloitte & Touche
LLP
+1 203 761 3235
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Ashley Carpenter
Audit & Assurance
Partner
Deloitte & Touche
LLP
+1 203 761 3197
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Andrew Pidgeon
Audit & Assurance
Partner
Deloitte & Touche
LLP
+1 415 783 6426
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If you are interested in Deloitte’s fair value service offerings,
please contact:
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Jamie Davis
Audit & Assurance
Partner
Deloitte & Touche
LLP
+1 312 486 0303
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Chapter 1 — Background
Chapter 1 — Background
1.1 Introduction
Many Codification topics in U.S. GAAP require or permit fair value measurements or
disclosures about fair value measurements (as well as fair-value-based measurements,
such as fair value less costs to sell, or disclosures about those measurements).
This chapter gives an overview of the principles in ASC 820 and of the concepts
related to fair value measurements under U.S. GAAP. For a discussion of the scope of
ASC 820, see Chapter 2.
1.2 Objective of a Fair Value Measurement
ASC 820-10
05-1 This Topic contains only the
Overall Subtopic. This Topic does all of the following:
- Defines fair value
- Sets out in a single Topic a framework for measuring fair value
- Requires disclosures about fair value measurements.
05-1A This Topic explains how to
measure fair value for financial reporting. It does not
require fair value measurements in addition to those already
required or permitted by other Topics and is not intended to
establish valuation standards or affect valuation practices
outside of financial reporting.
05-1B Fair value is a market-based
measurement, not an entity-specific measurement. For some
assets and liabilities, observable market transactions or
market information might be available. For other assets and
liabilities, observable market transactions and market
information might not be available. However, the objective
of a fair value measurement in both cases is the same — 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 (that is, an exit price at the
measurement date from the perspective of a market
participant that holds the asset or owes the liability).
05-1C When a price for an identical
asset or liability is not observable, a reporting entity
measures fair value using another valuation technique that
maximizes the use of relevant observable inputs and
minimizes the use of unobservable inputs. Because fair value
is a market-based measurement, it is measured using the
assumptions that market participants would use when pricing
the asset or liability, including assumptions about risk. As
a result, a reporting entity’s intention to hold an asset or
to settle or otherwise fulfill a liability is not relevant
when measuring fair value.
05-1D
The definition of fair value focuses on assets and
liabilities because they are a primary subject of accounting
measurement. In addition, this Topic shall be applied to
instruments measured at fair value that are classified in
shareholders’ equity.
Before the issuance of FASB Statement 157 (the pre-Codification fair value standard that preceded ASC 820), various definitions of fair value existed in U.S. GAAP and the guidance on applying those definitions was limited. Statement 157 addressed the need for the consistency and comparability of fair value measurements and for expanded disclosures about those measurements. Specifically, Statement 157 (codified
in ASC 820) contained a single definition of fair value, established a
principles-based framework for measuring fair value that can be used by all
entities, and required entities to provide relevant disclosures about fair value
measurements. The definition of fair value and the measurement framework apply to
assets, liabilities, and items classified in stockholders’ equity.
ASC 820 emphasizes that fair value is a market-based measurement based on an exit
price notion and is not entity-specific. Therefore, a fair value measurement must be
determined on the basis of the assumptions that market participants would use in
pricing an asset or liability, whether those assumptions are observable or
unobservable. The fair value hierarchy in ASC 820 serves as a basis for considering
market-participant assumptions and distinguishes between (1) market-participant
assumptions developed on the basis of market data that are independent of the entity
(observable inputs) and (2) an entity’s own assumptions about market-participant
assumptions developed on the basis of the best information available in the
particular circumstances, including assumptions about risk inherent in inputs or
valuation techniques (unobservable inputs). In accordance with the fair value
hierarchy, entities are required to maximize the use of relevant observable inputs
and minimize the use of unobservable inputs. This focus on the observability of
inputs also often affects the valuation technique used to measure fair value.
The single definition of fair value, the fair value measurement framework, and the
disclosure requirements in ASC 820 are intended to result in increased consistency
and comparability of fair value measurements (as well as disclosures about fair
value measurements). Such consistency and comparability should result in information
that financial statement users (e.g., present and potential investors, creditors,
regulators, and others) find useful in making investment, credit, and similar
decisions. The fair value disclosure requirements are intended to increase the
transparency of the inputs and valuation techniques used in fair value measurements;
however, an entity will need to tailor its fair value disclosures to meet the needs
of users of its financial statements, depending on whether it is a public business
entity or a nonpublic entity.
1.2.1 Exit Price
ASC 820-10
30-2 When an asset is
acquired or a liability is assumed in an exchange
transaction for that asset or liability, the transaction
price is the price paid to acquire the asset or received
to assume the liability (an entry price). In contrast,
the fair value of the asset or liability is the price
that would be received to sell the asset or paid to
transfer the liability (an exit price). Entities do not
necessarily sell assets at the prices paid to acquire
them. Similarly, entities do not necessarily transfer
liabilities at the prices received to assume them.
Definition of Fair Value
35-2 This Topic defines fair
value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly
transaction between market participants at the
measurement date.
ASC 820-10 — Glossary
Exit Price
The price that would be received to sell an asset or paid
to transfer a liability.
The fundamental principle underlying the definition of fair value and the fair
value measurement framework is that a fair value measurement represents an exit
price, which ASC 820-10-35-2 describes as “the price that would be received to
sell an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date.” Thus, a fair value measurement is
not entity-specific. Furthermore, a “mark-to-model” measurement that does not
include an adjustment for risk does not represent a fair value measurement if
market participants would include such an adjustment in pricing the related
asset or liability (i.e., a fair value measurement must reflect all relevant
factors that market participants would consider in determining a price for an
asset or liability). ASC 820 also specifies that the fair value of an item
classified in stockholders’ equity is similarly determined from the perspective
of a market participant that holds the identical item as an asset as of the
measurement date (i.e., also on the basis of an exit price determined from the
perspective of the holder of the identical item as an asset).
Note that a transaction price (i.e., an entry price) differs
from an exit price. As discussed in Chapter 9, when an item is initially
measured at fair value, this measurement should represent an exit price in the
principal market in which an entity would transact or, in the absence of a
principal market, the most advantageous market. Accordingly, the exit price notion is applied consistently to both initial and subsequent measurements at fair value. Paragraph C52 in the Basis for Conclusions of FASB Statement 157
discusses the difference between an entry price and an exit price:
In this Statement, the Board clarified that in
situations in which the reporting entity acquires an asset or assumes a
liability in an exchange transaction, the transaction price represents
the price paid to acquire the asset or received to assume the liability
(an entry price). The fair value of the asset or liability represents
the price that would be received to sell the asset or paid to transfer
the liability (an exit price). Conceptually, entry and exit prices are
different. Entities do not necessarily sell or otherwise dispose of
assets at the prices paid to acquire them. Similarly, entities do not
necessarily transfer liabilities at the prices paid to assume them. The
Board agreed that in many cases the transaction price will equal the
exit price and, therefore, represent the fair value of the asset or liability at initial recognition, but not presumptively (a change to Concepts Statement 7). This Statement includes examples of factors the
reporting entity should consider in determining whether a transaction
price represents the fair value of the asset or liability at initial
recognition. The Board plans to consider those factors in assessing the
appropriate measurement attribute at initial recognition in individual
accounting pronouncements on a project-by-project basis.
1.3 History of Fair Value Requirements
Since the issuance of FASB Statement 157 (codified in ASC 820), the
FASB has amended its fair value requirements a number of times. Notably, the Board
issued ASU
2011-04 in May 2011 as part of its effort to converge its fair
value measurement and disclosure requirements with those of the IASB, which released
its counterpart standard, IFRS 13, in the same month. (However, while U.S. GAAP and
IFRS Accounting Standards on fair value are now largely converged, certain
differences remain. See Appendix
B for a summary of those differences.)
The table below summarizes the significant amendments made to the
fair value measurement and disclosure guidance since the issuance of FASB Statement
157.1
Table
1-1
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Standard
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Principal Amendments Made
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FSP FAS 157-1
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Excluded from the scope of the fair value
measurement guidance the use of fair value for lease
classification or measurement purposes.
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FSP FAS 157-2
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Delayed the effective date of FASB Statement
157 for nonfinancial assets and nonfinancial liabilities,
except for those items that are recognized or disclosed at
fair value in the financial statements on a recurring
basis.
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FSP FAS 157-3
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Clarified the application of the fair value
measurement guidance in an inactive market and provided a
related illustrative example. Subsequently superseded by FSP
FAS 157-4.
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FSP FAS 157-4
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Provided additional guidance on estimating
fair value when the volume and level of activity for an
asset or liability have significantly decreased and includes
guidance on identifying circumstances in which a transaction
is not orderly.
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FSP FAS 132(R)-1
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Provided guidance on an employer’s fair
value disclosures about plan assets of a defined benefit
pension or other postretirement plan.
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Clarifies guidance on the fair value
measurement of liabilities. Significant amendments
include:
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Provides a practical expedient for the fair
value measurement of investments in entities that calculate
net asset value (NAV) per share or its equivalent. This
practical expedient allows entities to measure fair value on
the basis of the investment’s NAV per share provided that
the NAV of the investment is calculated in a manner
consistent with the measurement guidance in ASC 946,
including measurement of all or substantially all of the
underlying investments of the investee in accordance with
ASC 820. Requires entities to provide additional disclosures
by category of investment, including information about
redemption restrictions and unfunded commitments.
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Eliminates the practicability exceptions
that allowed for (1) the use of the transaction price (an
entry price) to measure the fair value, at initial
recognition, of financial assets and liabilities under ASC
860 and (2) an exemption to the requirement to measure fair
value if it is not practicable to do so for financial assets
obtained and financial liabilities incurred in a sale under
ASC 860.
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Amends ASC 820 to require new disclosures
about (1) transfers between Levels 1 and 2 of the fair value
hierarchy and (2) activity in the Level 3 rollforward. Also
clarifies existing disclosure requirements related to (1)
the level of disaggregation of classes of assets and
liabilities and (2) inputs and valuation techniques used in
fair value measurements. Note that several of these
disclosure requirements were amended and simplified by later
ASUs.
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Amends ASC 820 to converge many of the fair value measurement and disclosure requirements in U.S. GAAP with those in IFRS Accounting Standards. Since IFRS 13 was developed on the basis of FASB Statement 157, the amendments
in this ASU primarily constitute (1) nonsubstantive wording
changes to many of the fair value measurement and disclosure
requirements in ASC 820 and other U.S. GAAP or (2)
clarifications of the FASB’s intended application of these
requirements. Specific amendments made by ASU 2011-04
include (1) introducing the concept of measuring the fair
value of financial instruments that are managed within a
portfolio on a net basis in certain circumstances, (2)
applying premiums and discounts in a fair value measurement
on the basis of the unit of account, and (3) requiring
additional disclosures about fair value measurements (i.e.,
valuation process and sensitivity disclosures for Level 3
measurements, use of a nonfinancial asset that differs from
its highest and best use, and the categorization by level
within the fair value hierarchy for items that are not
measured at fair value but for which fair value must be
disclosed). Note that several of these disclosure
requirements were amended and simplified by later ASUs.
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Clarifies the fair value disclosure
requirements applicable to certain nonpublic entities.
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Eliminates the requirement that an entity
incorporate into fair value measurements used in the
impairment tests of unamortized film costs the effects of
any changes in estimates resulting from the consideration of
subsequent evidence if the information would not have been
considered by market participants as of the measurement
date. These amendments align the impairment assessment of
unamortized film costs with the definition of fair value in
ASC 820 because, to the extent that uncertainties are
resolved or other information becomes known after the
balance sheet date but before the financial statements are
issued or available to be issued, such effects should not be
incorporated with certainty into the fair value measurement
as of the balance sheet date unless market participants
would have made such assumptions. The ASU also clarifies
that a valuation model used as of the measurement date
should incorporate assumptions that market participants
would have made about the uncertainty in timing and amount
of cash flows as of the measurement date in accordance with
ASC 820. Note that although the amendments in this ASU were
made to ASC 926, they provide guidance that is relevant to
the application of ASC 820 by analogy.
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Clarifies that the requirement to disclose
the level of the fair value hierarchy within which fair
value measurements are categorized in their entirety (i.e.,
Level 1, 2, or 3) does not apply to nonpublic entities for
items that are not measured at fair value but for which fair
value is disclosed.
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Defers indefinitely certain requirements to
disclose quantitative information about the significant
unobservable inputs used in Level 3 fair value measurements
for investments held by a nonpublic employee benefit plan in
its plan sponsor’s own nonpublic-entity equity securities,
including equity securities of its plan sponsor’s nonpublic
affiliated entities.
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Allows an entity that consolidates a
collateralized financing entity (CFE) to elect to measure
the financial assets and financial liabilities of the CFE by
using a measurement alternative. Under the measurement
alternative, the entity measures both the financial assets
and the financial liabilities of the CFE by using the more
observable of the fair value of the financial assets or the
fair value of the financial liabilities.
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Removes the requirement to categorize within
the fair value hierarchy all investments for which fair
value is measured by using the practical expedient related
to NAV per share.
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Makes the following amendments to ASC
820:
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Amends the fair value disclosure
requirements to:
ASUs 2018-03 and
2019-04 made additional amendments to
ASU 2016-01 that affect fair value measurements of equity
securities without readily determinable fair values;
however, those amendments did not affect ASC 820.
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Requires that fair value measurements under
ASC 842 conform to the fair value measurement guidance in
ASC 820. This guidance was later affected by ASU
2019-01.
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Clarifies the difference between a valuation
approach (i.e., cost, market, income) and a valuation
technique and requires specific disclosures at the valuation
technique level.
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Clarifies that when measuring the fair value
of a liability or item classified in stockholders’ equity on
the basis of the fair value of the corresponding asset from
the perspective of a market participant that holds the
identical item as an asset, any restrictions that affect the
fair value of the asset should also be included in the fair
value measurement of the liability or equity instrument.
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Simplifies and improves financial statement
disclosures as part of the FASB’s disclosure effectiveness
initiative. This ASU amends ASC 820 to (1) remove several
fair value disclosure requirements, (2) modify certain
disclosure requirements, and (3) add certain disclosure
requirements for public business entities.
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Clarifies that when measuring the fair value of equity
securities subject to contractual sale restrictions, an
entity should not consider those restrictions.
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Footnotes
1
Table
1-1 does not address certain insignificant amendments related
to (1) conforming changes to definitions associated with other Codification
topics, (2) minor conforming amendments resulting from changes made to other
Codification topics, (3) minor technical corrections, and (4) maintenance
updates.
Chapter 2 — Scope
Chapter 2 — Scope
2.1 Scope and Scope Exceptions
2.1.1 General
ASC 820-10
Overall Guidance
15-1 The Scope
Section of the Overall Subtopic establishes the scope
for the Fair Value Measurement Topic. Except as noted
below, this Topic applies when another Topic requires or
permits fair value measurements or disclosures about
fair value measurements (and measurements, such as fair
value less costs to sell, based on fair value or
disclosures about those measurements).
Other Considerations
Topics and Subtopics Not Within Scope
15-2 The Fair Value Measurement
Topic does not apply as follows:
-
To accounting principles that address share-based payment transactions (this includes all Subtopics in Topic 718 except for 718-40, which is within the scope of Topic 820)
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To Sections, Subtopics, or Topics that require or permit measurements that are similar to fair value but that are not intended to measure fair value, including both of the following:
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Sections, Subtopics, or Topics that permit measurements that are determined on the basis of, or otherwise use, standalone selling price
-
Topic 330.
-
-
Subparagraph superseded by Accounting Standards Update No. 2016-02.
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To the recognition and measurement of revenue from contracts with customers in accordance with Topic 606
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To the recognition and measurement of gains and losses upon the derecognition of nonfinancial assets in accordance with Subtopic 610-20.
ASC 820 establishes a framework for measuring fair value and requires disclosures
about fair value measurements. ASC 820 does not, however, include any
requirements related to initially or subsequently measuring an item at fair
value. Rather, with certain exceptions, ASC 820 applies when another
Codification topic requires or permits fair value measurements or disclosures
about fair value measurements.
Sections 2.1.2 and
2.1.3 discuss
the scope of ASC 820’s measurement and disclosure requirements. Section 2.2 discusses
practicability exceptions afforded by ASC 820. Section 2.3 discusses the application of
ASC 820 to specific assets, liabilities, equity instruments, and
transactions.
2.1.2 Measurement
With certain exceptions (see Sections 2.2 and 2.3), the measurement
guidance in ASC 820 applies whenever another Codification topic uses the phrase
“fair value” to describe how an entity is required or permitted to measure
financial and nonfinancial assets and liabilities, instruments classified in a
reporting entity’s stockholders’ equity, or specific transactions, regardless of
whether this measurement pertains to initial or subsequent recognition or to
disclosure. Fair value measurements that are within the scope of ASC 820 include
measurements at (1) fair value less costs to sell and (2) the lower of fair
value or cost.1 However, ASC 820 does not apply to measurement objectives under other
Codification topics when such objectives are related to an amount similar to
fair value but are not intended to represent a fair value measurement (e.g.,
measurement objectives related to share-based payment arrangements and revenue
recognition). When another Codification topic requires that an item be measured
at an allocated amount on the basis of relative fair value or by using a
residual allocation approach based on fair value, the item is not measured at a
fair value amount. However, any fair value amount used in such allocation should
be determined in accordance with the measurement guidance in ASC 820 in the
absence of a specific exception in the Codification topic requiring such
measurement.
Table 2-1 describes other
Codification topics that require or permit an entity to measure a recognized
item at fair value on the basis of the fair value measurement guidance in ASC
820. Note the following regarding the items in this table:
-
The table only includes items that are initially or subsequently measured at (1) fair value, (2) fair value less costs to sell, or (3) the lower of fair value or cost. (For more information about the specific type of fair value measurement, see the Codification paragraphs identified in the table.) The table does not include items initially or subsequently measured at (1) relative fair value, (2) a residual amount after the deduction of an item measured at fair value, or (3) an incremental amount on the basis of the change in fair value of an item that is not subsequently recognized at fair value and that has not been subject to a modification.
-
The table does not address situations in which other Codification topics require an entity to determine the appropriate accounting for an item or a transaction on the basis of a fair value measurement. For example, the table does not cover the requirement to use fair value in determining whether (1) an asset is impaired, (2) an acquisition or disposition involves a business, (3) an entity is a variable interest entity (VIE) or an investment company, (4) an investment is accounted for under the equity method, (5) a lease is classified as operating or capital, (6) an equity-linked instrument or instrument settleable in an issuer’s equity shares is classified within equity, and (7) a convertible instrument contains a beneficial conversion feature (for issuer’s that have not adopted ASU 2020-06). The table also does not address the use of a fair value measurement solely to calculate earnings per share (EPS). In such circumstances, the measurement guidance in ASC 820 applies unless the Codification topic contains a specific exception that permits an entity not to apply ASC 820.
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The table does not include transition guidance that applies to certain Codification subtopics. To determine any applicable transition guidance, see the specific Codification paragraphs identified in the table.
Table
2-1
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Items That an Entity Is Required or
Permitted to Recognize at Fair Value in Accordance With
ASC 820
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|---|---|---|
|
ASC Subtopic
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Initial Measurement or Subsequent
Nonrecurring Fair Value Measurement2
|
Subsequent Recurring Fair Value
Measurement3
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260-10
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310-10
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310-40
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320-10
|
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321-10
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323-10
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325-30
|
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325-40
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326-10
|
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326-20
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326-30
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350-20
|
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350-30
|
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350-40
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350-60
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360-10
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405-20
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410-20
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420-1011
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460-10
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470-20
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470-30
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470-50
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470-60
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480-10
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505-20
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505-30
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710-10
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712-10
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|
715-30
|
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|
715-60
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|
715-70
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|
715-80
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718-40
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720-25
|
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730-10
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|
730-20
|
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|
740-10
|
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|
805-10
|
| |
|
805-20
|
| |
|
805-30
|
|
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|
805-40
|
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|
805-50
|
| |
|
805-60
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|
810-10
|
|
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810-30
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|
815-1023
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|
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815-15
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|
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815-40
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|
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815-45
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825-10
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830-20
|
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835-30
|
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|
842-50
|
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845-10
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|
852-20
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860-20
|
|
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860-30
|
|
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860-50
|
|
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920-350
|
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|
920-405
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| |
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926-20
|
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|
932-360
|
| |
|
940-20
|
|
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940-320
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|
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940-325
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|
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|
940-340
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942-310
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|
942-405
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944-20
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|
944-40
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|
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944-80
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|
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|
944-360
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|
944-805
|
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|
944-815
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| |
|
946-10
|
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|
946-320
|
|
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|
946-325
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|
946-830
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948-310
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|
950-350
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|
958-30
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|
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|
958-310
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|
958-320
|
|
|
|
958-321
|
|
|
|
958-325
|
|
|
|
958-360
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|
958-605
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958-720
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|
958-805
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|
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958-810
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960-30
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960-325
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962-205
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|
962-325
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|
965-20
|
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|
965-320
|
| |
|
965-325
|
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|
965-360
|
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|
970-323
|
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|
972-360
|
| |
|
974-720
|
| |
|
985-20
|
| |
Changing Lanes
Formation of Joint Ventures
On August 23, 2023, the FASB issued ASU
2023-05, under which an entity that qualifies as a
joint venture or a corporate joint venture is required to apply a new
basis of accounting upon formation of the joint venture. Specifically,
the ASU stipulates that a joint venture must initially measure its
assets and liabilities at fair value on the formation date. The
amendments in ASU 2023-05 are effective for all joint ventures within
the ASU’s scope that are formed on or after January 1, 2025. Early
adoption is permitted. For more information about ASU 2023-05, see
Deloitte’s September 8, 2023, Heads
Up.
Certain Crypto Assets
On December 13, 2023, the FASB issued ASU
2023-08, which addresses the accounting and
disclosure requirements for certain crypto assets. The new guidance
requires entities to subsequently measure certain crypto assets at fair
value, with changes in fair value recorded in net income in each
reporting period. In addition, entities are required to provide
additional disclosures about the holdings of certain crypto assets.
The ASU applies to all entities that hold certain crypto assets,
including private companies and not-for-profit entities. In this
context, the term “crypto assets” refers to assets that meet the scope
criteria in the new guidance. As outlined in ASC 350-60-15-1 (added by
the ASU), these scope criteria are as follows:
- The crypto asset meets the U.S. GAAP definition of an intangible asset.
- The holder does not have “enforceable rights to or claims on underlying goods, services, or other assets.”
- The asset is created or resides on “a distributed ledger based on blockchain or similar technology.”
- The asset is secured by cryptography.
- The asset is fungible.
- The asset is “not created or issued by the reporting entity or its related parties.”38
For all entities, the ASU’s amendments are effective for fiscal years
beginning after December 15, 2024, including interim periods within
those years. Early adoption is permitted. If an entity adopts the
amendments in an interim period, it must adopt them as of the beginning
of the fiscal year that includes that interim period. For more
information about ASU 2023-08, see Deloitte’s December 15, 2023,
Heads Up.
2.1.3 Disclosure
ASC 820’s disclosure requirements do not apply to fair value
measurements at initial recognition (i.e., to initial measurements of assets,
liabilities, equity instruments, or transactions at fair value).39 However, with certain exceptions, assets and liabilities that are
subsequently measured at fair value on a recurring or nonrecurring basis in
accordance with ASC 820 are subject to ASC 820’s disclosure requirements (see
Section 2.3 for
more information). In addition, ASC 820 requires entities to disclose fair value
amounts measured in accordance with ASC 820 as well as other fair-value-related
information for certain assets and liabilities that are not measured at fair
value.40 Other Codification topics also require certain disclosures regarding fair
value amounts, including when an asset, liability, equity instrument, or
transaction is initially measured at fair value. In these circumstances, in the
absence of a specific scope exception in ASC 820 or another Codification topic,
the fair value information must be prepared on the basis of the measurement
guidance in ASC 820.
See Chapter 11 for more information about
the fair value disclosure requirements in ASC 820. See Appendix A for more information about other
Codification topics that require fair value disclosures.
Connecting the Dots
Entities in certain industries, such as real estate, may prepare basic
financial statements under U.S. GAAP and report fair value information
as a supplement to the financial statements. Other entities may disclose
fair value amounts related to particular assets, liabilities, and equity
instruments. ASC 820 applies to the disclosure of such supplemental fair
value information. ASC 820-10-15-1 states that the guidance in ASC 820
“applies when another Topic requires or permits fair value measurements
or disclosures about fair value measurements (and measurements, such as
fair value less costs to sell, based on fair value or disclosures about
those measurements).”
Footnotes
1
ASC 820 does not, however, apply to measurements based
on the lower of cost or market value, such as measurements of inventory
under ASC 330.
2
ASC 820-10-50-2(a) states that
“[n]onrecurring fair value measurements . . . are
those that other Topics require or permit in the
statement of financial position in particular
circumstances (for example, when a reporting
entity measures a long-lived asset or disposal
group classified as held for sale at fair value
less costs to sell in accordance with Topic 360
because the asset’s fair value less costs to sell
is lower than its carrying amount).” In some
cases, an item may be remeasured to fair value in
consecutive reporting periods; however, such
remeasurement is a nonrecurring fair value
measurement because the other Codification topic
that requires or permits such measurement does not
require or permit the measurement for all changes
in fair value. For example, a long-lived asset or
disposal group classified as HFS may be remeasured
to fair value less costs to sell in each financial
reporting period until its disposal because the
fair value less costs to sell declines in each
financial reporting period. However, such
measurement is not a recurring fair value
measurement because ASC 360 does not allow an
entity to remeasure a long-lived asset or disposal
group classified as HFS at a fair value amount
that exceeds the asset’s (or disposal group’s)
original cost basis. In the absence of a specific
exception, the disclosure requirements in ASC 820
apply to items subsequently measured at fair value
on a nonrecurring basis (see Sections
2.3 and 11.2.2.1 for
more information). Conversely, the disclosure
requirements in ASC 820 do not apply to items that
are initially measured at fair value. Other
Codification topics may, however, require specific
disclosures regarding initial measurements at fair
value under ASC 820 (see Appendix
A for more information).
3
ASC 820-10-50-2(a) states that
“[r]ecurring fair value measurements . . . are
those that other Topics require or permit in the
statement of financial position at the end of each
reporting period.” In the absence of a specific
exception, the disclosure requirements in ASC 820
apply to items subsequently measured at fair value
on a recurring basis (see Sections 2.3 and
11.2.2.1 for
more information).
4
See Section 2.3.10 for more information
about life-settlement contracts accounted for
under ASC 325-30.
5
See footnote 4.
6
Finite-lived intangible assets
may be tested for impairment as part of an asset
group. Any impairment loss is allocated to the
finite-lived intangible assets on a relative fair
value basis.
7
See Section 2.3.7 for more information
about the impairment of long-lived assets (asset
groups) under ASC 360-10.
8
See footnote 7.
9
See footnote 7.
10
See Section 2.3.9
for discussion of a practical expedient related to
the fair value measurement of an ARO under ASC
410-20.
11
See Section 2.3.13 for discussion of an
exception to the fair value measurement
requirements under ASC 420-10.
12
See Section 2.3.4
for discussion of a practical expedient related to
this fair value measurement under ASC 460-10.
13
See Section 2.3.17 for more information
about deferred compensation arrangements held in
rabbi trusts accounted for under ASC 710-10.
14
See Section 2.3.15 for more information
about plan assets and obligations accounted for
under ASC 712-10.
15
See Section 2.3.15 for more information
about plan assets and obligations accounted for
under ASC 715-30.
16
See Section 2.3.15 for more information
about the measurement of a participation right
under ASC 715-30.
17
See Section 2.3.15 for more information
about plan assets and obligations accounted for
under ASC 715-60.
18
See Section 2.3.15 for more information
about the measurement of a participation right
under ASC 715-60.
19
See Section 2.3.18 for more information
about contributions made accounted for under ASC
720-25.
20
See Section 2.3.6 for discussion of
exceptions to the measurement principle in ASC
805-20-30-1.
21
See Section 2.3.3 for more information
about financial assets and financial liabilities
of a CFE accounted for in accordance with ASC
810-10-30-11 through 30-15.
22
See footnote 21.
23
This table does not include any
references to the guidance in ASC 815-20, ASC
815-25, ASC 815-30, and ASC 815-35 regarding how
to recognize the change in fair value of a
derivative or nonderivative instrument designated
as a hedging instrument. ASC 815-10-35-2 states
that “[t]he accounting for changes in the fair
value (that is, gains or losses) of a derivative
instrument depends on whether it has been
designated and qualifies as part of a hedging
relationship.” When ASC 815-20, ASC 815-25, ASC
815-30, or ASC 815-35 refers to “fair value” with
respect to assessing, measuring, or recognizing
the effects of hedge accounting, the measurement
guidance in ASC 820 applies. However, depending on
how fair value is used in the application of hedge
accounting, a resulting measurement may not be a
fair value measurement. See Section 2.3.11 for
more information about the hedged item in a fair
value hedge accounted for under ASC 815-25.
24
Some instruments that possess
the characteristics of a derivative instrument
under ASC 815-10 are subject to an exception from
derivative accounting, while other instruments
that do not have these characteristics are
nevertheless subject to derivative accounting. As
discussed in ASC 815-10-15-71, a loan commitment
related to the origination of mortgage loans that
will be held for sale must be accounted for as a
derivative instrument regardless of whether it
possesses all the characteristics of a derivative
instrument.
25
See footnote 24.
26
See Section
2.3.2 and Chapter 12 for more information about
the FVO election under ASC 825.
27
See footnote 26.
28
See Section
2.3.1 for more information about notes
receivable or payable accounted for under ASC
835-30.
29
See Section 2.3.8
for more information about lease contracts
accounted for under ASC 842.
30
See Section 2.3.12
for more information about nonmonetary
transactions accounted for under ASC 845-10.
31
See Section 2.3.18
for more information about contributions accounted
for under ASC 958-605.
32
See footnote 32.
33
See Section 2.3.16
for more information about plan assets and
obligations accounted for under ASC 960-325.
34
See Section 2.3.16
for more information about plan assets and
obligations accounted for under ASC 962-325.
35
See Section 2.3.16
for more information about the accounting for plan
assets and obligations under ASC 965-320.
36
See Section 2.3.16
for more information about the accounting for plan
assets and obligations under ASC 965-325.
37
See Section 2.3.16
for more information about the accounting for plan
assets and obligations under ASC 965-360.
38
A reporting entity that performs mining
or validating services, and that receives newly created
crypto assets as consideration for those services, would
not be deemed the creator of those crypto assets as long
as the services constitute the entity’s only involvement
with the creation of the asset.
39
Items initially measured on the basis of a relative fair
value allocation are also not subject to ASC 820’s disclosure
requirements.
40
Under ASC 820-10-50-2E, certain disclosure provisions of
ASC 820 apply to classes of “assets and liabilities not measured at fair
value in the statement of financial position but for which the fair
value is disclosed,” including financial instruments for which fair
value is disclosed under ASC 825. These disclosure requirements have
been incorporated into ASC 825-10-50-10 through 50-15.
2.2 Practicability Exceptions
2.2.1 General
ASC 820-10
Practicability Exceptions to This Topic
15-3 The Fair Value Measurement
Topic does not eliminate the practicability exceptions
to fair value measurements within the scope of this
Topic. Those practicability exceptions to fair value
measurements in specified circumstances include, among
others, those stated in the following:
a. The use of a transaction price (an entry
price) to measure fair value (an exit price) at
initial recognition, including the
following:
1. Guarantees in
accordance with Topic 460
2. Subparagraph superseded
by Accounting Standards Update No. 2009-16.
b. Subparagraph superseded by Accounting
Standards Update No. 2016-01.
1. Subparagraph superseded
by Accounting Standards Update No. 2016-01.
2. Subparagraph superseded
by Accounting Standards Update No. 2009-16.
c. An exemption to the requirement to measure
fair value if fair value is not reasonably
determinable, such as all of the following:
1. Nonmonetary assets in
accordance with Topic 845 and Sections 605-20-25
and 605-20-50
2. Asset retirement
obligations in accordance with Subtopic 410-20 and
Sections 440-10-50 and 440-10-55
3. Restructuring
obligations in accordance with Topic 420
4. Participation rights in
accordance with Subtopics 715-30 and 715-60.
d. Subparagraph superseded by Accounting
Standards Update No. 2015-10.
e. The use of particular measurement methods
referred to in paragraph 805-20-30-10 that allow
measurements other than fair value for specified
assets acquired and liabilities assumed in a
business combination.
ee. Financial assets or financial liabilities
of a consolidated variable interest entity that is
a collateralized financing entity when the
financial assets or financial liabilities are
measured using the measurement alternative in
paragraphs 810-10-30-10 through 30-15 and
810-10-35-6 through 35-8.
f. An exemption to the requirement to measure
fair value if fair value cannot be reasonably
estimated, such as the following:
1. Noncash consideration
promised in a contract in accordance with the
guidance in paragraphs 606-10-32-21 through
32-24.
ASC 820-10-15-3 discusses various practicability exceptions that allow entities
to recognize certain items at amounts other than fair value. These practical
expedients merely acknowledge the measurement exceptions provided in other
Codification topics. See Section 2.3 for
further discussion of these practical expedients.
2.2.2 Certain Entities That Calculate NAV per Share (or Its Equivalent)
ASC 820-10
Fair Value Measurements of Investments in Certain
Entities That Calculate Net Asset Value per Share
(or Its Equivalent)
15-4 Paragraphs
820-10-35-59 through 35-62 and 820-10-50-6A shall apply
only to an investment that meets both of the following
criteria as of the reporting entity’s measurement
date:
- The investment does not have a readily determinable fair value
- The investment is in an investment company within the scope of Topic 946 or is an investment in a real estate fund for which it is industry practice to measure investment assets at fair value on a recurring basis and to issue financial statements that are consistent with the measurement principles in Topic 946.
15-5 The definition
of readily determinable fair value indicates that
an equity security would have a readily determinable
fair value if any one of three conditions is met. One of
those conditions is that sales prices or bid-and-asked
quotations are currently available on a securities
exchange registered with the U.S. Securities and
Exchange Commission (SEC) or in the over-the-counter
market, provided that those prices or quotations for the
over-the-counter market are publicly reported by the
National Association of Securities Dealers Automated
Quotations systems or by OTC Markets Group Inc. The
definition notes that restricted stock meets that
definition if the restriction expires within one year.
If an investment otherwise would have a readily
determinable fair value, except that the investment has
a restriction expiring in more than one year, the
reporting entity shall not apply paragraphs 820-10-35-59
through 35-62 and 820-10-50-6A to the investment.
Measuring the Fair Value of Investments in Certain
Entities That Calculate Net Asset Value per Share
(or Its Equivalent)
35-59 A reporting
entity is permitted, as a practical expedient, to
estimate the fair value of an investment within the
scope of paragraphs 820-10-15-4 through 15-5 using the
net asset value per share (or its equivalent, such as
member units or an ownership interest in partners’
capital to which a proportionate share of net assets is
attributed) of the investment, if the net asset value
per share of the investment (or its equivalent) is
calculated in a manner consistent with the measurement
principles of Topic 946 as of the reporting entity’s
measurement date.
35-60 If the net
asset value per share of the investment obtained from
the investee is not as of the reporting entity’s
measurement date or is not calculated in a manner
consistent with the measurement principles of Topic 946,
the reporting entity shall consider whether an
adjustment to the most recent net asset value per share
is necessary. The objective of any adjustment is to
estimate a net asset value per share for the investment
that is calculated in a manner consistent with the
measurement principles of Topic 946 as of the reporting
entity’s measurement date.
35-61 A reporting
entity shall decide on an investment-by-investment basis
whether to apply the practical expedient in paragraph
820-10-35-59 and shall apply that practical expedient
consistently to the fair value measurement of the
reporting entity’s entire position in a particular
investment, unless it is probable at the measurement
date that the reporting entity will sell a portion of an
investment at an amount different from net asset value
per share (or its equivalent) as described in the
following paragraph. In those situations, the reporting
entity shall account for the portion of the investment
that is being sold in accordance with this Topic (that
is, the reporting entity shall not apply the guidance in
paragraph 820-10-35-59).
35-62 A reporting
entity is not permitted to estimate the fair value of an
investment (or a portion of the investment) within the
scope of paragraphs 820-10-15-4 through 15-5 using the
net asset value per share of the investment (or its
equivalent) as a practical expedient if, as of the
reporting entity’s measurement date, it is probable that
the reporting entity will sell the investment for an
amount different from the net asset value per share (or
its equivalent). A sale is considered probable only if
all of the following criteria have been met as of the
reporting entity’s measurement date:
-
Management, having the authority to approve the action, commits to a plan to sell the investment.
-
An active program to locate a buyer and other actions required to complete the plan to sell the investment have been initiated.
-
The investment is available for immediate sale subject only to terms that are usual and customary for sales of such investments (for example, a requirement to obtain approval of the sale from the investee or a buyer’s due diligence procedures).
-
Actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.
The scoping conditions in ASC 810-20-15-4 and 15-5 allow certain
entities, as a practical expedient, to estimate the fair value of certain
investments that do not have a readily determinable fair value at NAV per share
(or its equivalent). As noted in ASC 820-10-35-61, the decision of whether to
apply this practical expedient is made on an investment-by-investment basis. An
entity that chooses to use this practical expedient must apply it consistently
to the fair value measurement of the entity’s entire position in a particular
investment, unless it is probable as of the measurement date that the entity
will sell a portion of the investment at an amount different from NAV value per
share (or its equivalent), in which case use of the practical expedient is not
permitted.
ASC 820-10-35-62 indicates that, for a sale of an investment to be probable, four
criteria must be met as of the measurement date. For these four criteria to be
met, the entity must identify the individual investment(s) to be sold. That is,
if the entity decides to sell a portion of a group of assets (e.g., 25 percent
of the total group) but has not identified the individual investments to be
sold, the entity could not conclude that it is probable that any individual
investment will be sold.
An entity must often use significant judgment in evaluating whether a sale for an
amount different from NAV per share (or its equivalent) is considered probable
and should establish consistent processes and documentation protocols for
evaluating and supporting its conclusions, including the probability assertion
based on the four criteria in ASC 820-10-35-62. Management should carefully
assess any changes in assertions. For example, a change in assertion that
results in the triggering of significant profits (or losses) in a particular
period could call into question the primary intent of the change and the
validity of the entity’s assertion.
If an entity subsequently determines that it is no longer
probable that the reporting entity will sell the investment for an amount
different from NAV per share (or its equivalent) (i.e., the criteria in ASC
820-10-35-62 are no longer met), the entity is permitted to use NAV as a
practical expedient in measuring the fair value of the investment provided that
the investment continues to be within the scope of ASC 820-10-15-4 and 15-5.
This conclusion is consistent with informal discussions with the FASB staff.
See Sections 10.9
and 11.2.2.3 for
further discussion of the NAV practical expedient.
2.2.3 Mid-Market and Other Pricing Conventions
ASC 820-10-35-36D states that “[t]his Topic [ASC 820] does not
preclude the use of mid-market pricing or other pricing conventions that are
used by market participants as a practical expedient for fair value measurements
within a bid-ask spread.” See Section 10.4.4 for more information.
2.2.4 Simplified Hedge Accounting Approach
ASC 815-10-35-1A contains a practical expedient related to the
requirement in ASC 815-10-35-1 to measure all derivative assets and liabilities
at fair value. Under the practical expedient, a receive-variable, pay-fixed
interest rate swap to which an entity applies the simplified method of hedge
accounting in ASC 815-20-25 (see Section
10.10.14) “may be measured subsequently at settlement value
instead of fair value.” ASC 815-10-35-1B states that “[t]he primary difference
between settlement value and fair value is that nonperformance risk is not
considered in determining settlement value.” ASC 815-10-35-1C clarifies that
“[i]f any of the conditions . . . for applying the simplified hedge accounting
approach subsequently cease to be met or the relationship otherwise ceases to
qualify for hedge accounting,” the interest rate swap must be recognized at fair
value both as of the date of the change and prospectively.
2.3 Application of ASC 820 to Specific Assets, Liabilities, and Equity Instruments
2.3.1 Notes Receivable and Notes Payable
2.3.1.1 Measurement
ASC 835-30 addresses the imputation of interest on notes receivable and notes payable. At initial recognition, an entity is required to calculate the appropriate discount or premium so that interest income or expense on the note receivable or note payable can be appropriately recognized in accordance with the interest method. When a note receivable or note payable is initially recognized on the basis of a present value technique (i.e., present value is used to initially recognize the note receivable or payable), the measurement is a fair value measurement. The discount rate used in the initial measurement (e.g., the rate commensurate with the risk) embodies the same notion as the discount rate used in the traditional approach (or the discount rate adjustment technique) described in FASB Concepts Statement 7 and clarified in ASC 820. Accordingly, the guidance in
ASC 820-10-55-4 through 55-20 and ASC 820-10-55-33 and 55-34 on using
present value techniques to measure fair value applies to initial
measurements required under ASC 835-30 as well as to similar measurements
required under other Codification topics.
The fair value measurement guidance in ASC 820 applies to the subsequent
measurement of a note receivable or note payable only if (1) it is
subsequently measured at fair value on a recurring basis in accordance with
the FVO in ASC 825 or another Codification topic or (2) an impairment loss
or recovery is recognized for a note receivable on the basis of a fair value
measurement (i.e., a nonrecurring fair value measurement).
Connecting the Dots
An impairment loss may be recognized for an
individual note or loan receivable on the basis of a present value
calculation in accordance with ASC 310-10 or ASC 326-20. In this
circumstance, the measurement attribute of the impaired note or loan
receivable is the present value of expected future cash flows
discounted at the instrument’s original effective interest rate.
This is not a fair value measurement because a fair value
measurement would incorporate the current market discount rate.
However, if impairment is measured on the basis of a practical
expedient, such as the fair value of the underlying collateral or,
for entities that have not yet adopted ASU 2016-13, the loan’s
observable market price, the fair value measurement guidance in ASC
820 does apply. Thus, the measurement and disclosure provisions of
ASC 820 do not apply to a present value measurement but do apply to
a measurement that is based on an observable market price or the
related collateral’s fair value (even if the impairment is
recognized on the basis of the fair value of collateral, less costs
to sell).
2.3.1.2 Disclosure
ASC 820’s disclosure requirements do not apply to fair value measurements at
initial recognition. Therefore, the initial measurement of notes receivable
or payable on the basis of a present value technique is not subject to the
disclosure requirements of ASC 820. ASC 820’s disclosure requirements
related to subsequent measurement would apply only if (1) a note receivable
or note payable is subsequently measured at fair value on a recurring basis
in accordance with the FVO in ASC 825 or another Codification topic or (2)
an impairment loss or recovery is recognized for a note receivable on the
basis of a fair value measurement (i.e., a nonrecurring fair value
measurement). The fair value disclosures required by ASC 825-10-50-10
through 50-15 apply to notes receivable and notes payable, which are
financial instruments.
2.3.2 Certain Financial Instruments
2.3.2.1 Measurement
2.3.2.1.1 Financial Instruments for Which the FVO Has Been Elected
ASC 825 allows entities to irrevocably elect to account
for some financial assets and financial liabilities at fair value, with
changes in fair value reported in earnings or other comprehensive income
(OCI) (i.e., the FVO).40 The measurement guidance in ASC 820 applies to such fair value
measurements. See Chapter 12 for more information about the FVO.
2.3.2.1.2 Equity Securities Without Readily Determinable Fair Values
Under ASC 321-10-35-2, entities can elect to measure
equity securities without readily determinable fair values at “cost
minus impairment, if any, plus or minus changes resulting from
observable price changes in orderly transactions for the identical or a
similar investment of the same issuer.” When the investment is
determined to be impaired on the basis of a qualitative assessment, or
there is an observable price change in an orderly transaction, entities
that have made the election in ASC 321-10-35-2 must remeasure such
equity securities at fair value in accordance with ASC 820. ASC
321-10-55-9 indicates that the adjustments to the carrying value of an
equity security without a readily determinable fair value should
“reflect the fair value of the security as of the date that the
observable transaction for the similar security took place.”
Regardless of whether the observable price arises from a
transaction involving the identical or a similar security, that
adjustment reflects a fair value measurement under ASC 820. Thus, any
adjustment to the carrying amount of an equity security that is
accounted for under the measurement alternative in ASC 321-10-35-2
represents a fair value measurement under ASC 820.
In paragraph BC112 of ASU 2019-04, the FASB addresses how to measure the
fair value change under ASC 321-10-35-2 that arises from an observable
price involving the identical or a similar security:
The Board believed that, in most cases, the observable price
change in an orderly transaction of the identical or similar
investment of the same issuer would generally represent the fair
value change in that investment. The Board intended a consistent
remeasurement at fair value for investments accounted for under
the measurement alternative upon identifying (a) an orderly
transaction of the identical or similar investment of the same
issuer, (b) an orderly transaction of a similar investment of
the same issuer, and (c) impairment. Therefore, the Board
intended to require a nonrecurring fair value measurement in
accordance with Topic 820 upon the occurrence and identification
of any remeasurement event described in Topic 321 for equity
securities without readily determinable fair value accounted for
under the measurement alternative.
See Section 10.10.2 for further discussion of fair
value measurements related to observable price changes.
2.3.2.2 Disclosure
2.3.2.2.1 Disclosures About Financial Instruments Under ASC 825
ASC 825 requires certain fair value disclosures about
financial instruments, including disclosures related to (1) financial
instruments measured at fair value on a recurring basis under the FVO or
another Codification topic and (2) certain financial instruments that
are not measured at fair value on a recurring basis. As discussed in
Section
11.2.2, there are exceptions to these disclosure
requirements for certain financial instruments and the fair value
disclosure requirements for financial instruments that are not measured
at fair value on a recurring basis apply only to public business
entities. The measurement guidance in ASC 820 applies to all fair value
measurements of financial instruments that are disclosed under ASC 825.
For example, an entity that is disclosing the fair value of a financial
liability under ASC 825 must incorporate the instrument’s nonperformance
risk (i.e., the effect of the entity’s own credit standing, taking into
account, when appropriate, any credit enhancements related to the
liability) in accordance with ASC 820-10-35-17 and 35-18.
2.3.2.2.2 Cash Equivalents
The disclosure requirements for cash equivalents under ASC 820 and ASC
825 depend on whether the cash equivalents are reported at fair value in
the statement of financial position.
2.3.2.2.2.1 Cash Equivalents Measured at Fair Value
If a cash equivalent is measured at fair value in the statement of
financial position, an entity should provide all of the ASC 820
disclosures required for assets measured at fair value on a
recurring basis as well as the financial instrument disclosures
required by ASC 825. For example, assume that an entity has an
investment in a debt security that meets the definition of a cash
equivalent and is presented as such in accordance with ASC
320-10-45-13. If the debt security is classified as trading under
ASC 320, it is recognized at fair value in the statement of
financial position. Therefore, in such cases, the entity would
classify the debt security within the ASC 820 fair value hierarchy
and provide the related fair value disclosures for recurring fair
value measurements reported in the statement of financial position.
See Chapter 11 for more
information.
2.3.2.2.2.2 Cash Equivalents Measured at Amortized Cost
If a cash equivalent is measured at amortized cost
in the statement of financial position, an entity is only required
to provide the ASC 825 disclosures for financial instruments that
are not measured at fair value (if applicable). For example, assume
that an entity invests in a traditional CD from a bank (i.e., not a
“brokered CD”) and that the CD’s original maturity is 60 days. The
CD does not meet the definition of a security and therefore is not
within the scope of ASC 320.41 The entity has determined that it will present the CD in cash
equivalents in the statement of financial position, at amortized
cost, in accordance with the definition of cash equivalents and ASC
320-10-45-13. However, the CD is a financial instrument; therefore,
the disclosure requirements in ASC 825-10-50-10 apply to the CD held
as a cash equivalent. For more information about the applicability
of the disclosure requirements in ASC 825, see Section
11.2.2.2.
2.3.2.2.3 Equity Securities Without Readily Determinable Fair Values
As discussed in Section 2.3.2.1.2, an adjustment
to the carrying amount of an equity security that is accounted for
by using the measurement alternative under ASC 321-10-35-2,
regardless of whether the adjustment is related to an observable
price change or an impairment, represents a fair value measurement
under ASC 820. Therefore, the nonrecurring disclosure requirements
of ASC 820 are applicable during any financial reporting period for
which such an adjustment is recognized. However, ASC 825’s
disclosure requirements related to financial instruments that are
not measured at fair value do not apply to equity securities that
are accounted for by using the measurement alternative under ASC
321-10-35-2.
2.3.2.2.4 Equity Method Investments
An entity does not need to provide the fair value
disclosures required by ASC 820 or ASC 825 for an equity method
investment accounted for under ASC 323. However, if the investment
is recognized at fair value through earnings in accordance with the
ASC 825 FVO or as a result of the application of specialized
accounting guidance (e.g., ASC 946), an entity must provide all
relevant fair value disclosures in ASC 820 that pertain to items
measured at fair value on a recurring basis.42 In addition, if an equity method investment recognized under
ASC 323 is other-than-temporarily impaired (resulting in a
write-down to fair value), the entity must provide all relevant ASC
820 fair value disclosures pertaining to items measured at fair
value on a nonrecurring basis.
While the ASC 820 and ASC 825 fair value disclosures
are not required for equity method investments recognized under ASC
323 that have not been written down to fair value as a result of an
other-than-temporary impairment, an entity can voluntarily provide
these disclosures for investments accounted for under the equity
method. One purpose of providing such disclosures may be to give a
more complete picture of the investment’s value.
An entity that elects to provide fair value disclosures for equity
method investments should apply a rational and consistent policy of
doing so (e.g., across reporting periods and across investment
types). Further, an entity that elects to present fair value
disclosures for certain equity method investments should consider
presenting these disclosures for all other similar investments. The
entity should also (1) ensure that its disclosures clearly indicate
that such equity method investments for which fair value is
voluntarily disclosed are not recognized at fair value on a
recurring basis in the statement of financial position and (2)
separately identify the associated carrying amounts reported in the
statement of financial position. This is especially important when
an entity has equity method investments of a similar type and some
but not all of those investments are recognized at fair value in the
statement of financial position. For example, if an entity has
multiple equity method investments, some but not all of which are
measured at fair value on a recurring basis, the entity should
disclose the fair value of the investments accounted for under the
equity method (along with the associated carrying amounts)
separately from the fair value of the investments that are recorded
at fair value on a recurring basis.
The application of the disclosure requirements in ASC 820 and ASC 825
to equity method investments is further discussed below.
2.3.2.2.4.1 ASC 820 Disclosures
The guidance in ASC 820-10-15-1 applies when another Codification
topic requires or permits “fair value measurements or
disclosures about fair value measurements (and measurements,
such as fair value less costs to sell, based on fair value or
disclosures about those measurements).” Since ASC 825 permits
disclosure of the fair value of investments accounted for under
the equity method, an entity can also provide ASC 820
disclosures for such investments. (See Section 2.1.3 for additional
guidance on applying the provisions of ASC 820 to ASC 825
disclosures.) An entity that chooses to disclose the fair value
of an equity method investment may disclose the following
information related to the fair value measurement (see ASC 820-10-50-2E):
-
The valuation’s level in the fair value hierarchy.
-
A description of the valuation technique and inputs used in the fair value measurement.
2.3.2.2.4.2 ASC 825 Disclosures
ASC 825-10-50-8(g) exempts entities from the fair value disclosure requirements related to “investments accounted for under the equity method” because ASC 323-10-50-3(b) already requires disclosure of the quoted market price of such investments when it is available. Paragraph 75 of the Background Information and Basis for Conclusions of FASB Statement 107
(superseded) addressed this issue, stating that the “incremental
benefits of estimating fair value for unquoted investments
accounted for under the equity method do not outweigh the
related costs” of determining those fair values. However, ASC
825 does not prohibit an entity from disclosing the fair value
of an investment accounted for under the equity method (i.e.,
from providing the disclosures discussed in ASC
825-10-50-10).
2.3.2.2.5 Investments of Feeder Funds
Many investment companies adopt complex capital structures to
increase pricing flexibility as well as access to alternative
distribution channels for their shares. Master-feeder structures
permit distribution of a common investment vehicle (1) through
different channels, (2) with different distribution charges to the
shareholder, or (3) both. In such structures, the investment
companies that perform the investment management function are often
separate from those that perform the distribution function. Feeder
investment companies have similar investment objectives but
different distribution channels for their shares (such as retail or
institutional customers) and invest substantially all of their
assets in another investment company, known as the master fund.
Investment management functions are conducted by the master fund,
whereas distribution, shareholder-servicing, and transfer agent
functions are conducted by the feeder funds.
ASC 946-235-50-3 specifies the information a feeder
fund is required to include in its financial statement notes. A
feeder fund’s stand-alone financial statements generally do not have
to include ASC 820 fair value disclosures, including fair value
hierarchy classification and presentation of the rollforward of
Level 3 assets, provided that the feeder fund invests solely in the
master fund and has no other direct investments. Registered
investment companies that have entered into master-feeder
arrangements (as defined by the SEC)43 must provide the master fund’s financial statements, along
with those of each feeder fund, in accordance with SEC
requirements.44 Nonregistered investment companies should attach the financial
statements of the master fund to those of the feeder fund.
Therefore, as long as the feeder fund’s disclosures refer to the
fair value disclosures in the master fund’s provided or attached
financial statements, a feeder fund would not have to comply with
ASC 820’s disclosure requirements. However, in some circumstances, a
feeder fund maintains direct investments in addition to its
investment in the master fund (e.g., an interest rate swap). In such
cases, the feeder fund would be required to include in its financial
statements the appropriate ASC 820 disclosures for those direct
investments.
2.3.3 Collateralized Financing Entities
2.3.3.1 Measurement
ASC 820-10-15-3(ee) contains a practicability exception related to the
initial and subsequent measurement of “[f]inancial assets or financial
liabilities of a consolidated [VIE] that is a collateralized financing
entity when the financial assets or financial liabilities are measured using
the measurement alternative in paragraphs 810-10-30-10 through 30-15 and
810-10-35-6 through 35-8.” When a CFE meets the scope requirements in ASC
810-10-15-17D and this measurement alternative is elected, the reporting
entity measures both the financial assets and the financial liabilities of
the CFE by using the more observable of the fair value of the financial
assets or the fair value of the financial liabilities. The fair value
measurement guidance in ASC 820 applies to the more observable of the fair
value of the financial assets or the fair value of the financial
liabilities. See Section 8.1.2 for further discussion
of this practicability exception.
2.3.3.2 Disclosure
ASC 810-10-50-20 through 50-22 address the disclosures an entity is required
to provide when the measurement alternative in ASC 810-10-30-10 through
30-15 and ASC 810-10-35-6 through 35-8 is applied to a CFE. For instance,
ASC 810-10-50-20 indicates that the entity “shall disclose the information
required by Topic 820 on fair value measurement and Topic 825 on financial
instruments for the financial assets and the financial liabilities of the
consolidated collateralized financing entity.” Further, ASC 810-10-50-21
states that “[f]or the less observable of the fair value of the financial
assets and the fair value of the financial liabilities of the collateralized
financing entity that is measured in accordance with the measurement
alternative in paragraphs 810-10-30-10 through 30-15 and 810-10-35-6 through
35-8, a reporting entity shall disclose that the amount was measured on the
basis of the more observable of the fair value of the financial liabilities
and the fair value of the financial assets.” See Section A.19 for further discussion of the disclosures an
entity is required to provide when applying this practicability
exception.
2.3.4 Guarantees
2.3.4.1 Measurement
The objective of initially measuring a guarantee liability
under ASC 460-10 is to determine the fair value of the guarantee at its
inception. However, ASC 460-10-30-2(a) and (b) state:
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If a guarantee is issued in a standalone arm’s-length transaction with an unrelated party, the liability recognized at the inception of the guarantee shall be the premium received or receivable by the guarantor as a practical expedient.
-
If a guarantee is issued as part of a transaction with multiple elements with an unrelated party (such as in conjunction with selling an asset), the liability recognized at the inception of the guarantee should be an estimate of the guarantee’s fair value. In that circumstance, a guarantor shall consider what premium would be required by the guarantor to issue the same guarantee in a standalone arm’s-length transaction with an unrelated party as a practical expedient.
The recognition of a guarantee liability on the basis of the premium received
or receivable represents a practical expedient because this amount reflects
an entry price rather than an exit price. This practical expedient is
acknowledged in ASC 820-10-15-3(a)(1).
Read literally, ASC 460-10-30-2(a) and (b) require an entity
to initially recognize the guarantee liability on the basis of an entry
price. However, in discussions, the FASB staff has indicated that the use of
the entry price in the initial measurement of a guarantee liability is only
intended to be an accommodation. Therefore, although the language may imply
that an entity is required to perform initial recognition on the basis of
the transaction price, the entity is not precluded from initially
recognizing the guarantee liability at fair value in such circumstances
(i.e., on the basis of an exit price).
See Section 10.10.9 for further discussion of the fair
value measurement of guarantees.
2.3.4.2 Disclosure
ASC 820’s disclosure requirements do not apply to fair value measurements at
initial recognition. Therefore, the initial measurement of the liability for
a guarantee obligation is not subject to these requirements. However, the
fair value disclosures required by ASC 825-10-50-10 through 50-15 would be
applicable. In addition, the disclosure requirements in ASC 460-10 apply to
guarantees. See Section A.12 for
further discussion of fair value disclosures related to guarantees.
2.3.5 Share-Based Payments
2.3.5.1 Measurement
As discussed in ASC 820-10-15-2, the guidance in ASC 820
does not apply to measurements of share- based payment awards in accordance
with ASC 718. Measurements under ASC 718 are “fair-value-based”
measurements. Valuation techniques and certain assumptions used in a
fair-value-based measurement in accordance with ASC 718 may be consistent
with those used in a fair value measurement under ASC 820. However, a
fair-value-based measurement excludes the impact of certain conditions,
restrictions, and contingencies that a fair value measurement under ASC 820
would include (e.g., service conditions, performance conditions and other
restrictions that apply during the vesting period, reload features, and
contingent features that may require the employee to return equity
instruments). Under ASC 718, the effect of such items is taken into account
not in the fair-value-based measurement but through the recognition of
compensation cost only for awards for which the requisite service (or goods
or services) is received.
2.3.5.2 Disclosure
Since a measurement of a share-based payment award is not
subject to ASC 820, the disclosure requirements of ASC 820 do not apply to
share-based payments, regardless of whether such payments are granted to
employees or nonemployees. Rather, fair-value-based measurements of
share-based payments are subject to the disclosure requirements of ASC
718.
2.3.6 Assets Acquired and Liabilities Assumed in a Business Combination
2.3.6.1 Measurement
ASC 805-20-30-1 states that the acquirer in a business combination must
measure the “identifiable assets acquired, the liabilities assumed, and any
noncontrolling interest in the acquiree at their acquisition-date fair
values.” However, ASC 820-10-15-3(e) notes that ASC 805-20-30-10 through
30-26 cite the following exceptions to this measurement principle:
-
Income taxes — ASC 805-740-30-1 states that “[a]n acquirer shall measure a deferred tax asset or deferred tax liability arising from the assets acquired and liabilities assumed in a business combination in accordance with Subtopic 740-10.”
-
Employee benefits — Under ASC 805-20-30-14 and 30-15, “[t]he acquirer shall measure a liability (or asset, if any) related to the acquiree’s employee benefit arrangements in accordance with other GAAP.” For example, an acquirer recognizes “an asset or a liability [equal to] the funded status of a single-employer defined benefit pension or postretirement plan” in accordance with ASC 805-20-25-23, ASC 805-20-25-25, and ASC 805-20-30-15. ASC 805-20-30-17 provides measurement-related guidance that applies to other employee benefit arrangements.
-
Indemnification assets — The acquirer measures an indemnification asset on the same basis as the indemnified item. For example, if the seller in a business combination contractually indemnifies the acquirer for the outcome of an uncertain tax position, the indemnification asset would be measured on the same basis as the uncertain tax position (provided that there are no contractual limitations or collectibility is not in doubt). Also see the “Income taxes” bullet above. If the indemnified item is not measured at fair value, the indemnification asset would also not be measured at fair value.
-
Reacquired rights — ASC 805-20-30-20 indicates that the acquirer measures the value of a reacquired right “on the basis of the remaining contractual term of the related contract regardless of whether market participants would consider potential contractual renewals in determining its fair value.”
-
Share-based payment awards — Under ASC 805-20-30-21, the acquirer measures “a liability or an equity instrument related to the replacement of an acquiree’s share-based payment awards with share-based payment awards of the acquirer in accordance with the method in Topic 718.”
-
Assets HFS — Under ASC 805-20-30-22, the acquirer measures “an acquired long-lived asset (or disposal group) that is classified as held for sale at the acquisition date in accordance with Subtopic 360-10, at fair value less cost to sell.” The fair value measurement would be performed on the basis of the measurement guidance in ASC 820.
-
Certain assets and liabilities arising from contingencies — ASC 805-20-30-23 indicates that if the fair value of an asset or liability assumed in a business combination that arises from a contingency cannot be determined during the measurement period, the asset or liability should be measured in accordance with ASC 450.
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Lease assets and lease liabilities — ASC 805-20-30-24 and 30-25 contain specific guidance on measuring lease assets and lease liabilities when the acquiree is a lessee or lessor. Upon an entity’s adoption of ASU 2016-13, an additional exception to the measurement principle in ASC 805-20-30-1 is also applicable. An entity that uses this exception applies the guidance in ASC 805-20-30-26 to recognize purchased financial assets with credit deterioration (including beneficial interests meeting the conditions in paragraph 325-40-30-1A) in accordance with Section 326-20-30 for financial instruments measured at amortized cost or Section 326-30-30 for available-for-sale debt securities.”
See Section 10.10.13 and Deloitte’s Roadmap Business
Combinations for further discussion of the initial
recognition of assets acquired and liabilities assumed in a business
combination.
2.3.6.2 Disclosure
Except for assets HFS, assets acquired and liabilities
assumed that are within the scope of the above exceptions would not be
measured at fair value; the fair value disclosure requirements in ASC 820
thus would not apply to such assets and liabilities. While assets HFS are
measured on a fair value basis under ASC 820 (i.e., fair value less costs to
sell), ASC 820’s disclosure requirements do not apply to fair value
measurements at initial recognition. Rather, ASC 805 addresses the
disclosures required for the assets acquired and liabilities assumed listed
in Section
2.3.6.1 (see Section A.18).
2.3.7 Impairment Testing of Long-Lived Assets
2.3.7.1 Measurement
2.3.7.1.1 Long-Lived Assets Classified as Held and Used
When evaluating a long-lived asset (asset group) classified as held and
used for impairment under ASC 360-10-35-16 through 35-36, an entity
first performs a recoverability test by using undiscounted cash flows.
If the long-lived asset (asset group) is not recoverable, the entity
records an impairment loss, which is measured as the difference between
the carrying amount and fair value of the long-lived asset (asset
group). The fair value measurement guidance in ASC 820 applies to the
measurement of the impairment loss. However, an impairment loss is not
recognized if the carrying amount of the long-lived asset (asset group)
is recoverable on the basis of the undiscounted cash flows expected to
result from the asset’s use. The recoverability test is based on
management’s intended use of the assets. If a long-lived asset (asset
group) fails the recoverability test, the impairment loss is measured on
the basis of market-participant assumptions in accordance with ASC
820.
When determining the fair value of a long-lived asset (asset group),
entities must consider the highest and best use of the nonfinancial
asset(s) from a market-participant perspective. ASC 820-10-35-10C states
that the “[h]ighest and best use is determined from the perspective of
market participants, even if the reporting entity intends a different
use,” but clarifies that “a reporting entity’s current use of a
nonfinancial asset is presumed to be its highest and best use unless
market or other factors suggest that a different use by market
participants would maximize the value of the asset.” ASC 820 does not
require entities to use a specific valuation technique when measuring
the fair value of an asset or liability. However, ASC 360-10-35-36
indicates that for long-lived assets (asset groups) with uncertain cash
flows, an expected-present-value technique is often the appropriate
technique for measuring the fair value of long-lived assets. Simply
discounting the cash flow projections used in the recoverability
analysis may not be appropriate under ASC 820 because management may use
assumptions in the recoverability analysis that are not
market-participant assumptions. This is particularly the case when a
market participant’s highest and best use is different from management’s
intended use. To reflect market-participant assumptions, entities may
need to adjust internally developed assumptions regarding their intended
use of the asset when such assumptions are included in the projection of
undiscounted cash flows and differ from market-participant
assumptions.
2.3.7.1.2 Long-Lived Assets Classified as HFS
A long-lived asset (asset group) classified as HFS is
measured at the lower of cost or fair value less costs to sell in
accordance with ASC 360-10-35-37 through 35-45. The fair value
measurement is subject to the measurement guidance in ASC 820.
2.3.7.1.3 Long-Lived Assets to Be Exchanged or to Be Distributed to Owners in a Spin-Off
ASC 360-10-40-4 addresses the accounting for long-lived assets (disposal
groups) to be exchanged or distributed to owners in a spin-off. ASC
360-10-40-4 states, in part, that “[i]n addition to any impairment
losses required to be recognized while the asset is classified as held
and used, an impairment loss, if any, shall be recognized when the asset
is disposed of if the carrying amount of the asset (disposal group)
exceeds its fair value.” ASC 820 applies to the determination of fair
value for this purpose.
2.3.7.2 Disclosure
The recognition of an impairment loss on a long-lived asset
(asset group or disposal group) represents a nonrecurring fair value
measurement that is subject to ASC 820’s disclosure requirements pertaining
to nonrecurring fair value measurements. In addition, the disclosures
required by ASC 360-10-50 include certain disclosures regarding fair value
measurements. The disclosures in ASC 825-10-50-10 through 50-15 do not apply
to long-lived assets. See Section A.9 for more information about the fair value
disclosure requirements of ASC 360.
2.3.8 Leases
2.3.8.1 Measurement
With one exception, ASC 820’s measurement guidance applies
to any fair value measurement under ASC 842, including a fair value
measurement used to determine lease classification.45 ASC 842 contains guidance on fair value estimates required under ASC
842 (see also Section
10.10.15 and Deloitte’s Roadmap Leases). It should also be
noted, however, that ASC 805-20 contains specific guidance on the acquirer’s
measurement of lease assets and lease liabilities in a business combination
(see Section
2.3.6.1).
2.3.8.2 Disclosure
ASC 820’s disclosure requirements apply only to a
nonrecurring fair value measurement determined in accordance with ASC 820 in
connection with a lease arrangement. ASC 825-10-50-8(d) exempts lease
contracts (other than a contingent obligation associated with a canceled
lease and a guarantee of a third-party lease obligation, which are not lease
contracts) from the fair value disclosure requirements in ASC 825-10-50-10
through 50-15. ASC 842 prescribes other lease-related disclosure
requirements.
2.3.9 Asset Retirement Obligations
2.3.9.1 Measurement
Generally, ASC 820 applies to the initial measurement of an ARO. ASC
410-20-25-4 states that an entity should recognize the liability at its fair
value “in the period in which it is incurred if a reasonable estimate of
fair value can be made.” In addition, ASC 410-20-30-1 states, in part:
An expected present value technique will usually be the only
appropriate technique with which to estimate the fair value of a
liability for an asset retirement obligation. An entity, when using
that technique, shall discount the expected cash flows using a
credit-adjusted risk-free rate. Thus, the effect of an entity’s
credit standing is reflected in the discount rate rather than in the
expected cash flows.
Further, ASC 410-20-25-4 states, in part, that “[i]f a reasonable estimate of
fair value cannot be made in the period the [ARO] is incurred, the liability
shall be recognized when a reasonable estimate of fair value can be made.”
This practical expedient, which provides for a delay in the recognition of
the ARO until its fair value is reasonably estimable, is also addressed in
ASC 820-10-15-3(c).
The subsequent measurement of an ARO liability is subject to the guidance in
ASC 410-20. ASC 410-20-35-3 through 35-8 provide guidance on recognizing the
period-to-period changes in the liability as a result of (1) the passage of
time and (2) revisions to the timing or amount of the estimated original
undiscounted cash flows. This guidance can be summarized as follows.
-
Passage of time — To measure changes in the liability related to the passage of time, an entity should apply an “interest method of allocation to the . . . liability at the beginning of the period” by using the “credit-adjusted risk-free rate that existed when the liability . . . was initially measured.”
-
Revisions to timing or amount of estimated undiscounted cash flows — Upward revisions that create an incremental change in the undiscounted estimated cash flows should be discounted by using the current credit-adjusted risk-free rate, which adds an additional “layer” to the ARO liability. Downward revisions in estimated undiscounted cash flows are “discounted using the credit-adjusted risk-free rate that existed when the original liability was recognized.”
The changes resulting from the passage of time and revisions to estimated
undiscounted cash flows are then incorporated into a remeasurement of the
ARO. Although the fair value measurement concepts in ASC 820 apply to upward
revisions to the ARO, the incremental layers are not separate liabilities.
Therefore, subsequent measurements of the entire ARO are not fair value
measurements.
See Section 10.10.7 for more information about the fair
value measurement of AROs.
2.3.9.2 Disclosure
Because ASC 820’s disclosure requirements do not apply to fair value
measurements at initial recognition and the subsequent measurement of an ARO
is not a fair value measurement of the entire obligation, ASC 820’s
disclosure requirements do not apply to AROs. However, ASC 410-20-50-2
states that “[i]f the fair value of an asset retirement obligation cannot be
reasonably estimated, that fact and the reasons therefor shall be
disclosed.” ASC 410-20-55-57 through 55-62 give examples of situations in
which sufficient information is not available at the time the liability is
incurred, as discussed in ASC 410-20-25-4. ASC 410-20-50 does not contain
any disclosure requirements specific to fair value measurements of AROs (see
Section A.10). The disclosures
required by ASC 825-10-50-10 through 50-15 apply only to financial
liabilities.
2.3.10 Life Insurance Contracts
2.3.10.1 Measurement
The measurement of a company-owned life insurance contract
at cash surrender value (CSV) under ASC 325-30-35-2 does not represent a
fair value measurement under ASC 820. Rather, CSV is a settlement value, not
an amount that a market participant would pay to purchase the insurance
contract from the policyholder. Company-owned life insurance contracts that
are measured at fair value would, however, be subject to the measurement
guidance in ASC 820.
ASC 325-30 discusses the accounting when a third-party investor purchases the
future payment streams of life insurance policies from the policies’ owners
(referred to as life settlement contracts). Investors account for life
settlement contracts by using either the investment method or fair value
method. When using the investment method, an investor may write an
investment down to fair value if it is impaired (see ASC 325-30-35-11). When
an investment is impaired under the investment method or when the fair value
method is used, the measurement guidance in ASC 820 applies.
Note that the above guidance related to CSV measurements under ASC 325-30
does not apply to sponsors of pension and other postretirement benefit
plans. Under ASC 715-30-35-60 and ASC 715-60-35-120, CSV is presumed to be
fair value if the life insurance contract is a pension plan asset or other
postretirement plan asset, respectively.
In the financial statements of a pension or other postretirement benefit plan
(under ASC 960, ASC 962, and ASC 965), company-owned life insurance
contracts are “[measured] in the same manner as specified in the annual
report filed by the plan with certain governmental agencies pursuant to the
Employee Retirement Income Security Act; that is, either at fair value or at
amounts determined by the insurance entity (contract value).” See ASC
960-325-35-3, ASC 962-325-35-6, and ASC 965-325-35-3 for more
information.
2.3.10.2 Disclosure
Company-owned life insurance contracts recognized at CSV are not subject to
ASC 820’s disclosure requirements since such contracts are not carried at
fair value. Company-owned life insurance contracts that are measured at fair
value are subject to the disclosure requirements in ASC 820.
Life settlement contracts that are recognized at fair value are subject to
ASC 820’s disclosure requirements related to recurring fair value
measurements. Life settlement contracts that are not recognized at fair
value would be subject to ASC 820’s disclosure requirements related to
nonrecurring fair value measurements only in periods in which such contracts
have been impaired and written down to their fair value.
Although CSV is considered fair value for pension reporting
purposes, the disclosure requirements of ASC 820 do not apply to pension and
other postretirement benefit plan assets within the plan sponsor’s financial
statements.46
ASC 825-10-50-8(c) exempts insurance contracts from the disclosure
requirements in ASC 825-10-50-10 through 50-15.
2.3.11 Hedged Item in a Fair Value Hedge
2.3.11.1 Measurement
ASC 815-20-25-11 states that “[a]n entity may designate a derivative
instrument as hedging the exposure to changes in the fair value of an
asset or a liability or an identified portion thereof (hedged item) that is
attributable to a particular risk” (emphasis added). The carrying
value of the hedged item in a fair value hedge will generally not equal its
fair value for two reasons. First, in a fair value hedge, an entity attempts
to hedge the change in fair value of an asset or liability. Second, in a
fair value hedge, an entity typically only hedges the change in fair value
due to a particular risk (or risks), thereby excluding factors that would be
included in a fair value measurement of the entire hedged item. Accordingly,
the hedged item will equal fair value only if, (1) at inception of the
hedging relationship, the hedged item is recorded at its fair value and (2)
the entity hedges the entire change in fair value of the hedged item. These
conditions are typically not met. In fact, in many cases in which the hedged
item is a financial asset or liability, the entity would apply the FVO in
lieu of hedge accounting.
Note that the measurement guidance in ASC 820 would always apply to the
measurement of the change in fair value of the hedged item, even if the
hedged item is not carried at fair value.
2.3.11.2 Disclosure
The remeasurement of the hedged item in a fair value hedge is subject to ASC
820’s disclosure requirements related to recurring fair value measurements
only if the designated hedge results in recognition of the hedged item at
fair value. Otherwise, only the disclosure requirements in ASC 815 and ASC
825 are applicable.
2.3.12 Nonmonetary Transactions
2.3.12.1 Measurement
ASC 845-10-30-1 states, in part, that “[i]n general, the
accounting for nonmonetary transactions should be based on the fair values
of the assets (or services) involved, which is the same basis as that used
in monetary transactions.” When fair value is the basis of recognition for a
nonmonetary transaction, the fair value measurement guidance in ASC 820
applies (i.e., the initial fair value measurement of the nonmonetary asset
received should be determined in accordance with ASC 820). However, ASC
845-10-30-3 requires measurement of a nonmonetary exchange “based on the
recorded amount . . . of the nonmonetary asset(s) relinquished, and not on
the fair values of the exchanged assets,” if (1) the fair value is not
“determinable within reasonable limits,” (2) the “transaction is an exchange
of a product or property held for sale in the ordinary course of business
for a product or property to be sold in the same line of business to
facilitate sales to customers other than the parties to the exchange,” or
(3) the “transaction lacks commercial substance.” These exceptions related
to fair value measurements are acknowledged in ASC 820-10-15-3(c)(1). In the
absence of an exception, the ASC 820 measurement guidance applies to fair
value measurements recognized for nonmonetary transactions.47 See Section
10.10.16 for further discussion of the fair value measurement
of nonmonetary transactions.
2.3.12.2 Disclosure
ASC 820’s disclosure requirements do not apply to a nonmonetary transaction,
even if it is recognized on the basis of a fair value measurement that is
calculated in accordance with ASC 820, because ASC 820’s disclosure
requirements do not apply to the initial recognition of an item at fair
value. ASC 845-10-50-3 contains one fair-value-related disclosure
requirement applicable to nonmonetary transactions (see Section A.21).
2.3.13 Exit or Disposal Cost Obligations
2.3.13.1 Measurement
ASC 420 requires an entity to initially measure a liability for a cost
associated with an exit or disposal activity at fair value in the period in
which the liability is incurred, except for certain one-time termination
benefits that are incurred over time, which are initially recognized as of
the communication date on the basis of the fair value of the liability as of
the termination date. However, ASC 420-10-25-1 states the following about
measuring restructuring obligations at fair value: “In the unusual
circumstance in which fair value cannot be reasonably estimated, the
liability shall be recognized initially in the period in which fair value
can be reasonably estimated.” See Section 10.10.8 for
further discussion of the fair value measurement of exit or disposal cost
obligations.
2.3.13.2 Disclosure
ASC 820’s disclosure requirements do not apply to the initial recognition of
an item at fair value. However, under ASC 420-10-50-1(e), “[i]f a liability
for a cost associated with [an exit or disposal] activity is not recognized
because fair value cannot be reasonably estimated,” an entity is required to
disclose “that fact and the reasons why.” ASC 420-10-50 does not contain any
disclosure requirements that apply to fair value measurements of exit or
disposal obligations.
2.3.14 Noncash Consideration in a Revenue Contract
2.3.14.1 Measurement
ASC 820-10-15-2(d) contains an exception related to applying the fair value
measurement guidance in ASC 820 to “the recognition and measurement of
revenue from contracts with customers in accordance with Topic 606.” ASC 606
notes that fair value is the relevant measurement attribute in the following circumstances:
-
The determination of the transaction price for contracts in which a customer promises a form of noncash consideration (ASC 606-10-32-21 and 32-22 and ASC 606-10-55-250).
-
Changes in the fair value of noncash consideration after contract inception (ASC 606-10-32-23).
-
Consideration that is payable to a customer and that is a payment for a distinct good or service received from the customer, which may reduce the transaction price (ASC 606-10-32-26).
ASC 606-10-32-21 states, in part, that “the transaction
price for contracts in which a customer promises consideration in a form
other than cash [is] the estimated fair value of the noncash consideration
at contract inception (that is, the date at which the criteria in paragraph
606-10-25-1 are met).” However, as noted in ASC 820-10-15-3(f)(1), ASC
606-10-32-22 contains an exception to initial measurement at fair value for
entities that cannot reasonably estimate the fair value of the noncash
consideration. ASC 606-10-32-22 indicates that entities that apply this
practical expedient must “measure the consideration indirectly by reference
to the standalone selling price of the goods or services promised to the
customer (or class of customer) in exchange for the consideration.”
ASC 606 does not define fair value. While the ASC 820 fair value measurement
guidance does not explicitly apply to the measurement of noncash
consideration in a revenue contract, it may be relevant for entities to
consider the measurement principles in ASC 820 in such circumstances. In
addition, if another Codification topic requires an entity to measure a
change in the fair value of noncash consideration, and such a change has no
impact on the transaction price under ASC 606, the ASC 820 fair value
measurement guidance must be applied to the recognition of such fair value
measurements in the absence of a specific exception in the other
Codification topic or ASC 820.
2.3.14.2 Disclosure
ASC 820’s disclosure requirements do not apply to any fair value measurements
under ASC 606 because (1) the initial recognition of an item at fair value
is not subject to ASC 820’s disclosure requirements and (2) any fair value
measurement required under ASC 606 is not within the scope of ASC 820.
However, ASC 606-10-50-20 specifies that entities are required to disclose
the methods, inputs, and assumptions related to the transaction price in a
revenue contract with a customer. In addition, when another Codification
topic requires the fair value measurement of noncash consideration and such
measurement is performed in accordance with ASC 820, the measurement is
subject to ASC 820’s disclosure requirements in the absence of a specific
exception in the other Codification topic or ASC 820.
2.3.15 Defined Benefit Pension and Other Postretirement Plans in the Sponsor’s Financial Statements
2.3.15.1 Measurement
2.3.15.1.1 Plan Assets
Under ASC 715-30 and ASC 715-60, sponsors of defined
benefit pension and other postretirement plans recognize, in the
statement of financial position, the funded status of the plan by
offsetting the fair value of plan assets and the benefit obligation.
Because plan assets are measured at fair value as of the measurement
date, the measurement guidance in ASC 820 applies.48 Sponsors with postemployment benefits accounted for under ASC 712
that apply the measurement provisions of ASC 715-30 or ASC 715-60 should
also apply the measurement guidance in ASC 820.
ASC 715-30 and ASC 715-60 contain an exemption related to the requirement
to subsequently measure participation rights at fair value. ASC
715-30-35-58 and ASC 715-60-35-116 state, in part:
[T]he participation right shall be measured at its fair value if
the contract is such that fair value is reasonably estimable.
Otherwise, the participation right shall be measured at its
amortized cost (not in excess of its net realizable value), and
the cost shall be amortized systematically over the expected
dividend period under the contract.
2.3.15.1.2 Plan Obligations
The pension or postretirement benefit obligation under ASC 715 is not
measured at fair value; rather, it is an actuarial present value
calculation of estimated future benefit costs that is based on employee
services rendered to date. Therefore, ASC 820 does not apply to such
measurement.
2.3.15.2 Disclosure
Although ASC 820 applies to the measurement of plan assets,
the disclosure requirements of ASC 820 do not apply to plan assets accounted
for under ASC 715 in the sponsor’s financial statements. ASC 820-10-50-10
states that “[p]lan assets of a defined benefit pension or other
postretirement plan that are accounted for in accordance with Topic 715 are
not subject to the disclosure requirements [of ASC 820]. Instead, the
disclosures required in paragraphs 715-20-50-1(d)(iv) and 715-20-50-5(c)(iv)
shall apply for fair value measurements of plan assets of a defined benefit
pension or other postretirement plan.” Sponsors with postemployment benefits
accounted for under ASC 712 that apply the measurement provisions of ASC
715-30 or ASC 715-60 should also apply the disclosure requirements of ASC
715-20-50. The disclosure requirements in ASC 825-10-50-10 through 50-15
apply to plan assets (except for insurance contracts and FBRICs), which are
generally measured at fair value. However, ASC 825-10-50-8(a) exempts
benefit obligations from these disclosure requirements. Rather, benefit
obligations are subject to the disclosure requirements of ASC 715. See
Section
A.16 for further discussion of the fair value disclosure
requirements in ASC 715-20-50.
2.3.16 Financial Statements of Defined Benefit Plans, Defined Contribution Plans, and Health and Welfare Plans
2.3.16.1 Measurement
2.3.16.1.1 Plan Assets
ASC 820 applies to the fair value measurement of pension
plan investments in accordance with ASC 96049 as well as to that of plan investments held within a defined
contribution pension plan, which must be measured at fair value as of
the reporting date in accordance with ASC 962. However, participant
loans are not considered plan investments and should not be measured at
fair value.50 The measurement guidance in ASC 820 further applies to investments
held within health and welfare benefit plans, which must be measured at
fair value in accordance with ASC 965. See Sections 10.10.19.9 and 10.10.19.10 for
further discussion of fair value measurements under ASC 962 and ASC
965.
2.3.16.1.2 Plan Obligations
ASC 820 does not apply to accumulated plan benefit obligations, which are
not measured at fair value; rather, such obligations are measured on the
basis of an actuarial present value calculation of future benefits that
are attributable to plan participants for services rendered to date in
accordance with the provisions of the plan.
2.3.16.2 Disclosure
ASC 820’s disclosure requirements apply to pension plan investments that an
entity must measure at fair value in accordance with ASC 960, plan
investments held within a defined contribution pension plan that must be
measured at fair value in accordance with ASC 962, and investments held
within health and welfare benefit plans that must be measured at fair value
in accordance with ASC 965. Because such plan assets must be measured at
fair value as of each reporting date, the financial statements of such plans
must include the recurring fair value disclosures required under ASC 820.
ASC 960, ASC 962, and ASC 965 also contain specific disclosure requirements,
including those related to fair value and certain references to the
disclosures required by ASC 820. The disclosures in ASC 825-10-50-10 through
50-15 also apply to plan investments, except for insurance contracts and
FBRICs. See Sections A.32 through A.34
for further discussion of the incremental fair-value-related disclosures
required by ASC 960, ASC 962, and ASC 965.
The fair value disclosures required by ASC 820 do not apply to plan benefit
obligations under ASC 960, ASC 962, and ASC 965. Furthermore, ASC
825-10-50-8(a) exempts such plan obligations from the disclosure
requirements of ASC 825-10-50-10 through 50-15. In such cases, entities
should look to the respective disclosure requirements of ASC 960, ASC 962,
and ASC 965.
2.3.17 Deferred Compensation Obligations in Rabbi Trusts
2.3.17.1 Measurement
Many employers enter into deferred compensation arrangements that allow
employees to defer some or all of their earned compensation (i.e., salary or
bonus). Deferred compensation contracts that are not considered equivalent
to a postretirement income or health or welfare benefit plan are generally
accounted for under ASC 710 or ASC 718.
Sometimes the employer uses a “rabbi trust” to hold assets from which
distributions will be made as part of a nonqualified deferred compensation
plan. ASC 710 provides guidance on deferred compensation arrangements in
which assets equal to compensation amounts earned by employees are placed in
a rabbi trust. ASC 710-10-25-15 describes four types of such arrangements
and states:
The following are the four types of deferred compensation
arrangements involving rabbi trusts covered by this Subsection:
-
Plan A — The plan does not permit diversification and must be settled by the delivery of a fixed number of shares of employer stock.
-
Plan B — The plan does not permit diversification and may be settled by the delivery of cash or shares of employer stock.
-
Plan C — The plan permits diversification; however, the employee has not diversified (the plan may be settled in cash, shares of employer stock, or diversified assets).
-
Plan D — The plan permits diversification and the employee has diversified (the plan may be settled in cash, shares of employer stock, or diversified assets).
ASC 710-10-35-2 states that changes in the fair value of the
deferred compensation obligation of Plan A “shall not be recognized,” and
ASC 825-10-15-5(c) and (f) preclude an entity from applying the FVO to this
obligation. ASC 710-10-35-3 and 35-4 state that the deferred compensation
obligations of Plans B, C, and D “shall be adjusted with a corresponding
charge (or credit) to compensation cost, to reflect the changes in the fair
value of the amount owed to the employee.”51 ASC 710-10-45-2 further states that “[f]or Plan D only, changes in the
fair value of the deferred compensation obligation shall not be recorded in
other comprehensive income, even if changes in the fair value of the assets
held by the rabbi trust are recorded, pursuant to Subtopic 320-10, in other
comprehensive income.”
While the fair value adjustments to the deferred
compensation obligations of Plans B and C must be measured in accordance
with ASC 820, the deferred compensation obligation of Plan D does not need
to represent a fair value measurement in accordance with ASC 820.
Discussions with the FASB staff have indicated that obligations for Plan D
deferred compensation arrangements, as described in ASC 710, are not fair
value measurements subject to the requirements of ASC 820. The intent of the guidance was to have the obligation match the fair value of the amounts earned and assets held in the rabbi trust. This intent is consistent with the original transition guidance in EITF Issue 97-14, which states, in part,
“For Plan D, the diversified assets held by the rabbi trust should be
recorded at fair value at September 30, 1998 with a
corresponding amount recorded as a deferred compensation liability”
(emphasis added). In other words, the liability was not reported at fair
value as of the transition; rather, it was set to equal the fair value of
the assets held in the rabbi trust.52 Thus, the nonperformance risk associated with the obligation would not
be reflected in its measurement.
Note that other deferred compensation arrangements allow participants to
“invest” their earned compensation into “phantom” investments indexed to
employer stock, nonemployer securities, or a combination of both; however,
the employer does not purchase investments that are held separately in a
trust. The amount due (i.e., the obligation) to employees in each reporting
period represents deferred pay plus or minus the changes in fair value of
the phantom investments. Entities with phantom deferred compensation
arrangements whose employees have diversified their accounts into
nonemployer securities may apply, by analogy, the Plan D accounting guidance
in ASC 710 to measure the obligation.
2.3.17.2 Disclosure
For Plan A, the fair value measurement disclosures required by ASC 820 and
ASC 825 do not apply, since both the employer stock held by the rabbi trust
and any deferred compensation obligation are classified in equity in
accordance with ASC 710-10-25-16. ASC 825-10-50-8(i) exempts equity
instruments from the disclosure requirements of ASC 825-10-50-10 through
50-15.
For Plans B and C, the fair value measurement disclosures required by ASC 820
and ASC 825 do not apply to the employer stock held by the rabbi trust since
those shares are classified in equity. ASC 825-10-50-8(i) exempts equity
instruments from the disclosure requirements of ASC 825-10-50-10 through
50-15. The deferred compensation obligation, however, is subject to ASC
820’s disclosure requirements related to recurring fair value measurements.
ASC 825-10-50-8(a) exempts the obligation from the disclosure requirements
of ASC 825-10-50-10 through 50-15.
For Plan D, the fair value measurement disclosures required by ASC 820 and
ASC 825 apply to the assets held by the rabbi trust in the absence of a
specific exception. Because the obligations are not fair value measurements,
the ASC 820 fair value disclosures are not required. ASC 825-10-50-8(a) also
exempts the obligation from the disclosure requirements of ASC 825-10-50-10
through 50-15.
ASC 710 does not require entities to provide any specific disclosures about
these arrangements.
2.3.18 Contributions
2.3.18.1 Measurement
ASC 720-25-30-2 states that an entity’s obligation for “[u]nconditional
promises to give that are expected to be paid in less than one year may be
measured at net settlement value because that amount, although not
equivalent to the present value of estimated future cash flows, results in a
reasonable estimate of fair value.” This provision effectively represents a
practical expedient related to a fair value measurement.
ASC 958-605-25-4 states, with respect to an NFP entity’s
revenue recognition, that “[a] major uncertainty about the existence of
value may indicate that an item received or given should not be recognized.”
The AICPA Industry Audit Guide Audits of Voluntary Health and Welfare
Organizations indicates that “[b]ecause of the difficulty of placing
a monetary value on donated services, and the absence of control over them,
the value of these services often is not recorded as contributions and
expense.” This provision represents an exception from the requirement for an
NFP entity to measure contributions received at fair value in accordance
with ASC 958-605-30-2. See Section 10.10.19.8 for further discussion of the fair value
measurement requirements of ASC 958.
2.3.18.2 Disclosure
ASC 820’s fair value disclosure requirements do not apply to the measurements
referred to in Section 2.3.18.1
because these requirements do not apply to initial measurements. ASC 720
does not have any specific disclosure requirements for unconditional
promises to give. Further, ASC 958 also does not have any specific
disclosure requirements related to situations in which a contribution
received is not recognized as a result of a major uncertainty. However,
entities may find that the disclosure in ASC 958-605-50-2 is relevant by
analogy. ASC 958 does contain other fair-value-related disclosure
requirements (see Section A.31).
Footnotes
40
ASC 825-10-45-5 through 45-7 address the
requirement to present separately, in OCI, the portion of the
total change in fair value of a liability that results from a
change in the instrument-specific credit risk.
41
Certain CDs (e.g., brokered CDs) may meet
the definition of a security and therefore may be within the
scope of ASC 320. Accordingly, an entity must evaluate the
specific terms of a CD.
42
See Section 12.5.3.2 for
discussion of the disclosures that an entity must provide
under ASC 323 when electing the FVO for an investment that
would otherwise be accounted for under the equity
method.
43
The AICPA Audit and Accounting Guide
Investment Companies defines a master-feeder
arrangement as “one in which a registered investment company
that invests in a single investment vehicle.” Master-feeder
structures are specifically permitted by Section
12(d)(1)(E)(ii) of the Investment Company Act of 1940.
44
See the SEC’s December 30, 1998,
“Annual Industry Comment Letter From
the Division of Investment
Management.”
45
ASU 2019-01 added ASC
842-30-55-17A to require lessors that are not manufacturers or
dealers to use the cost of the underlying asset as the asset’s fair
value at lease commencement. This cost would reflect any applicable
volume or trade discounts as well as costs related to acquiring the
asset, including sales taxes and delivery charges. ASC 842-30-55-17A
states, in part, “However, if there has been a significant lapse of
time between the acquisition of the underlying asset and lease
commencement, the definition of fair value [in ASC 820] shall be
applied.” As a result of the amendments made by ASU 2019-01, the
guidance on this topic in ASC 842 is similar to that in ASC 840.
Moreover, ASC 842-10-55-3 and ASC 842-10-55-13 address
considerations related to how a lease should be classified when it
is not practical to determine the fair value of the underlying
asset.
46
Although a plan sponsor’s disclosures about the fair
value of pension and other postretirement benefit plan assets are
not within the scope of ASC 820, ASC 715-20-50 contains similar
applicable disclosure requirements.
47
ASC 845-10-30-15 and 30-16 address the types of
purchases and sales of inventory with the same counterparty that are
measured at fair value.
48
ASC 715-30-35-50 indicates that the fair value
of an investment should reflect “brokerage commissions and other
costs normally incurred in a sale if those costs are significant
(similar to fair value less cost to sell).” See Section
10.10.11 for further discussion of the fair value
measurement of assets in a defined benefit pension or other
postretirement plan.
49
ASC 960-325-35-2 indicates that “[i]f
significant, the fair value of an investment shall be reduced by
brokerage commissions and other costs normally incurred in a
sale (similar to fair value less cost to sell).”
50
In accordance with ASC 962-310-35-2,
“participant loans [are] measured at their unpaid principal
balance plus any accrued but unpaid interest.”
51
For Plans A, B, and C, the employer stock held by
the rabbi trust is classified as equity in a manner similar to the
accounting for treasury stock (see ASC 710-10-25-16 and 25-17). For
Plan D, assets held by the rabbi trust are accounted for in
accordance with other Codification topics (e.g., ASC 320 or ASC 321)
(see ASC 710-10-25-18).
52
On the basis of inquiries with the FASB staff, we
believe that ASC 815 did not change the Plan D accounting guidance
in ASC 710; therefore, deferred compensation arrangements in which
an entity applies the Plan D accounting guidance in ASC 710 are not
within the scope of ASC 815.
Chapter 3 — Application Framework
Chapter 3 — Application Framework
3.1 Introduction
ASC 820 establishes a framework for measuring fair value and requires disclosures
about fair value measurements. ASC 820-10-20 defines fair value as the “price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.” Thus, a fair value
measurement is an “exit price.” As discussed below, an entity needs to perform
various steps to (1) prepare a fair value measurement that complies with the
measurement principles in ASC 820 and (2) meet the disclosure requirements in ASC
820.
3.2 Fair Value Application Framework
3.2.1 Step-by-Step Application Framework
An entity may apply the following step-by-step approach to measure and disclose
fair value when other Codification topics require (or permit) the initial or
subsequent measurement of an asset, liability, or equity instrument at fair
value.
Certain of the steps described above may be interrelated; therefore, these steps
do not necessarily have to be performed in the order shown.
3.2.2 Step 1 — Identify the Unit of Account
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.
An asset, liability, or instrument classified in stockholders’ equity that is
measured at fair value should be identified on the basis of its unit of account.
Although ASC 820 defines fair value and establishes a framework for measuring
it, the standard does not specify when items should be recognized at fair value
in an entity’s financial statements. With one exception, ASC 820 also does not
specify the unit of account that applies to a particular fair value
measurement.1 Therefore, entities must consult other Codification topics to determine
(1) when an entity is required (or permitted) to initially or subsequently
measure an asset, liability, or equity instrument at fair value and (2) the unit
of account that applies to such a fair value measurement.
As discussed in Chapter 4, the unit of account represents
the level of aggregation or disaggregation of individual assets, liabilities, or
equity instruments for recognition in the financial statements and, with one
exception, is determined on the basis of the guidance in other Codification
topics.2 As discussed in Chapter
5, the unit of valuation is the grouping of assets, liabilities,
or equity instruments for fair value measurement purposes. ASC 820 provides
guidance on determining the unit of valuation (see Section 3.2.3 and Chapter 5 for more information). The unit of
account may differ from the unit of valuation. In addition, entities may need to
allocate fair value measurements even when the unit of account and unit of
valuation are the same.
Example 3-1
Impairment of Long-Lived Assets
Under ASC 360, the unit of account for impairment testing
is the asset group. However, the asset group is not the
unit of account for recognition purposes. Rather, each
of the individual long-lived assets represents a single
unit of account. Therefore, in accordance with ASC
360-10-35-28, an entity must allocate the difference
between the fair value of the asset group and the
carrying amount of the asset group (i.e., the amount of
impairment) to individual long-lived assets within the
asset group. This allocation is required even if the
unit of valuation for purposes of the fair value
measurement is the asset group.
Example 3-2
Groups of Financial Assets and Financial Liabilities
With Offsetting Risk Positions
An entity may have the option of grouping financial
assets, financial liabilities, and nonfinancial items
accounted for as derivatives under ASC 815, or a
combination of those items, and measuring the
portfolio’s fair value on the basis of its net risk
position. In this case, the portfolio is the unit of
valuation (see ASC 820-10-35-18D through 35-18L).
However, each individual item in the portfolio
represents a single unit of account. As a result, the
portfolio-based fair value measurement must be allocated
to the individual units of account within the
portfolio.
See Chapter 4 for more information about the unit of account.
3.2.2.1 Liabilities With Third-Party Credit Enhancements
The unit of account for a liability issued with an
inseparable third-party credit enhancement is the liability, excluding the
credit enhancement. See Section 4.3.2.2 for further discussion.
3.2.3 Step 2 — Identify the Unit of Valuation
3.2.3.1 Financial Assets, Nonfinancial Derivative Assets, Liabilities, and Equity Instruments
As discussed in Section 4.3.2, the unit of valuation for
financial assets, nonfinancial derivative assets, liabilities, and equity
instruments is the individual asset, liability, or equity instrument, which
is generally also its unit of account under other GAAP. The concept of the
“highest and best use” does not apply to fair value measurements of
financial assets, nonfinancial derivative assets, liabilities, or
instruments classified in stockholders’ equity.
Note that for liabilities and instruments classified in stockholders’ equity,
an entity performing a fair value measurement assumes that the liabilities
or equity instruments are transferred to a market participant on the
measurement date. That is, ASC 820 requires entities measuring the fair
value of a liability to assume that the liability remains outstanding and is
transferred to a market-participant transferee that would be required to
fulfill the obligation. Similarly, entities must assume that an instrument
classified in stockholders’ equity would remain outstanding and that a
market-participant transferee would take on the rights and responsibilities
associated with the instrument. A liability being measured at fair value
would not be assumed to be settled, and an instrument classified in
shareholders’ equity would not be assumed to be canceled or otherwise
extinguished. However, when a quoted price for the transfer of an identical
or similar liability or an entity’s own equity instrument is not available
and the identical item is held by another party as an asset, the entity must
measure the fair value of the liability or its own equity instrument from
the perspective of a market participant that holds the identical item as an
asset. See Section 10.2.7 for more information.
3.2.3.1.1 Portfolio Valuation Exception for Certain Groups of Assets and Liabilities With Offsetting Risk Positions
ASC 820-10
Application to Financial Assets and Financial
Liabilities With Offsetting Positions in Market
Risks or Counterparty Credit Risk
35-18D A reporting entity
that holds a group of financial assets, financial
liabilities, nonfinancial items accounted for as
derivatives in accordance with Topic 815, or
combinations of these items is exposed to market
risks (that is, interest rate risk, currency risk,
or other price risk) and to the credit risk of
each of the counterparties. If the reporting
entity manages that group of financial assets,
financial liabilities, nonfinancial items
accounted for as derivatives in accordance with
Topic 815, or combinations of these items on the
basis of its net exposure to either market risks
or credit risk, the reporting entity is permitted
to apply an exception to this Topic for measuring
fair value. That exception permits a reporting
entity to measure the fair value of a group of
financial assets, financial liabilities,
nonfinancial items accounted for as derivatives in
accordance with Topic 815, or combinations of
these items on the basis of the price that would
be received to sell a net long position (that is,
an asset) for a particular risk exposure or paid
to transfer a net short position (that is, a
liability) for a particular risk exposure in an
orderly transaction between market participants at
the measurement date under current market
conditions. Accordingly, a reporting entity shall
measure the fair value of the group of financial
assets, financial liabilities, nonfinancial items
accounted for as derivatives in accordance with
Topic 815, or combinations of these items
consistently with how market participants would
price the net risk exposure at the measurement
date.
An exception to ASC 820’s general principles related to
the unit of valuation is available for groups of financial assets,
financial liabilities, and nonfinancial items accounted for as
derivatives in accordance with ASC 815 if an entity (1) manages the
group of assets and liabilities on the basis of net exposure to a market
risk (or risks) or counterparty credit risk, (2) provides information on
that basis to management, and (3) measures those assets and liabilities
at fair value in the statement of financial position. To use the
exception, an entity must make an accounting policy decision. Once the
policy is established, the entity must consistently apply the policy
from period to period for a particular portfolio. See Sections 4.3.2.1
and 5.3 for
more information.
3.2.3.2 Nonfinancial Assets Other Than Nonfinancial Derivative Assets
ASC 820-10
Highest and Best Use for
Nonfinancial Assets
35-10A A fair value
measurement of a nonfinancial asset takes into
account a market participant’s ability to generate
economic benefits by using the asset in its highest
and best use or by selling it to another market
participant that would use the asset in its highest
and best use.
The unit of valuation (also referred to as the “valuation premise”) for
nonfinancial assets (other than nonfinancial derivative assets) is the
asset’s highest and best use. ASC 820-10-20 defines the highest and best use
as the “use of a nonfinancial asset by market participants that would
maximize the value of the asset or the group of assets and liabilities (for
example, a business) within which the asset would be used.” The highest and
best use must be determined from the market participant’s perspective,
regardless of the reporting entity’s current use. However, an entity is not
required to perform an exhaustive search to identify the highest and best
use and may presume that its current use is the highest and best use unless
market or other factors suggest otherwise. The highest and best use of an
asset might provide maximum value through its use either (1) in combination
with other assets or other assets and liabilities or (2) on a stand-alone
basis. See Section 5.2 for more information.
3.2.4 Step 3 — Identify the Principal or Most Advantageous Market
ASC 820-10
Definition of Fair Value
35-5 A fair value
measurement assumes that the transaction to sell the
asset or transfer the liability takes place either:
-
In the principal market for the asset or liability
-
In the absence of a principal market, in the most advantageous market for the asset or liability.
Underlying the fair value measurement objective in ASC 820 is
the concept of an entity transacting in the principal market for the asset or
liability (or equity instrument), or in the absence of a principal market, the
most advantageous market. ASC 820-10-20 defines the principal market as the
“market with the greatest volume and level of activity for the asset or
liability” and the most advantageous market as the “market that maximizes the
amount that would be received to sell the asset or minimizes the amount that
would be paid to transfer the liability, after taking into account transaction
costs and transportation costs.” The determination of the principal (or most
advantageous) market for an asset, liability, or equity instrument can affect
the fair value measurement since the exit price may differ from market to
market. The concept of a most advantageous market is relevant only if there is
no principal market for the asset, liability, or equity instrument subject to
the fair value measurement.
An entity identifies the principal (or most advantageous) market for the asset or
liability (or equity instrument) by first identifying all markets that it can
access to sell the asset or transfer the liability. ASC 820-10-35-6A requires
that an entity have access to the principal (or most advantageous) market. Then,
the entity determines, from the perspective of market participants, which market
has the greatest volume or level of activity (or in the absence of a principal
market, which market maximizes the fair value of the asset or minimizes the fair
value of the liability). If there is a principal market, the fair value
measurement should represent the price in that market, even if the price in a
different market is potentially more advantageous. ASC 820-10-35-5A clarifies
that an entity is not required to perform an exhaustive search to identify all
markets. In fact, unless contradictory evidence exists, it is generally presumed
that the market in which the reporting entity normally transacts is the
principal (or most advantageous) market. See Chapter 6 for more information.
3.2.5 Step 4 — Develop Assumptions That Market Participants Would Use to Measure Fair Value
ASC 820-10
Market Participants
35-9 A
reporting entity shall measure the fair value of an
asset or a liability using the assumptions that market
participants would use in pricing the asset or
liability, assuming that market participants act in
their economic best interest. In developing those
assumptions, a reporting entity need not identify
specific market participants. Rather, the reporting
entity shall identify characteristics that distinguish
market participants generally, considering factors
specific to all of the following:
-
The asset or liability
-
The principal (or most advantageous) market for the asset or liability
-
Market participants with whom the reporting entity would enter into a transaction in that market.
To meet the “exit price” measurement objective, an entity is
required to develop assumptions that market participants would use to determine
the price of an asset, liability, or equity instrument in an orderly transaction
as of the measurement date. ASC 820-10-20 defines market participants as
“[b]uyers and sellers in the [entity’s] principal (or most advantageous) market
for the asset or liability” that are (1) ”independent of each other,” (2)
knowledgeable, (3) ”able to enter into a transaction for the asset or
liability,” and (4) ”willing to enter into a transaction for the asset or
liability.” As noted in ASC 820-10-35-9, an entity “need not identify specific
market participants” but should “identify characteristics that distinguish
market participants generally.” The assumptions that market participants would
use when measuring the fair value of the asset, liability, or equity instrument
are relevant in the determination of the inputs to the fair value measurement.
An entity may not substitute the assumptions of market participants with its own
assumptions that differ from those of market participants. See Chapter 7 for more
information.
3.2.6 Step 5 — Measure Fair Value on the Basis of Available Inputs and Appropriate Valuation Techniques
ASC 820-10
30-2 When an asset is
acquired or a liability is assumed in an exchange
transaction for that asset or liability, the transaction
price is the price paid to acquire the asset or received
to assume the liability (an entry price). In contrast,
the fair value of the asset or liability is the price
that would be received to sell the asset or paid to
transfer the liability (an exit price). Entities do not
necessarily sell assets at the prices paid to acquire
them. Similarly, entities do not necessarily transfer
liabilities at the prices received to assume them.
30-3 In many cases, the
transaction price will equal the fair value (for
example, that might be the case when on the transaction
date the transaction to buy an asset takes place in the
market in which the asset would be sold). . . .
30-3A When determining
whether fair value at initial recognition equals the
transaction price, a reporting entity shall take into
account factors specific to the transaction and to the
asset or liability. For example, the transaction price
might not represent the fair value of an asset or a
liability at initial recognition if any of the following
conditions exist:
-
The transaction is between related parties, although the price in a related party transaction may be used as an input into a fair value measurement if the reporting entity has evidence that the transaction was entered into at market terms.
-
The transaction takes place under duress or the seller is forced to accept the price in the transaction. For example, that might be the case if the seller is experiencing financial difficulty.
-
The unit of account represented by the transaction price is different from the unit of account for the asset or liability measured at fair value. For example, that might be the case if the asset or liability measured at fair value is only one of the elements in the transaction (for example, in a business combination), the transaction includes unstated rights and privileges that are measured separately, in accordance with another Topic, or the transaction price includes transaction costs.
-
The market in which the transaction takes place is different from the principal market (or most advantageous market). For example, those markets might be different if the reporting entity is a dealer that enters into transactions with customers in the retail market, but the principal (or most advantageous) market for the exit transaction is with other dealers in the dealer market.
35-16AA In all cases, a
reporting entity shall maximize the use of relevant
observable inputs and minimize the use of unobservable
inputs to meet the objective of a fair value
measurement, which is to estimate the price at which an
orderly transaction to transfer the liability or
instrument classified in shareholders’ equity would take
place between market participants at the measurement
date under current market conditions.
Valuation Techniques
35-24 A reporting entity
shall use valuation techniques that are appropriate in
the circumstances and for which sufficient data are
available to measure fair value, maximizing the use of
relevant observable inputs and minimizing the use of
unobservable inputs.
35-24A The objective of
using a valuation technique 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. Three widely used valuation
approaches are the market approach, cost approach, and
income approach. The main aspects of valuation
techniques consistent with those approaches are
summarized in paragraphs 820-10-55-3A through 55-3G. An
entity shall use valuation techniques consistent with
one or more of those approaches to measure fair
value.
ASC 820 applies at both initial recognition and subsequent
measurement if fair value is required or permitted by other Codification topics.
On initial recognition, the transaction price, which is an entry price, will
often equal fair value, which is an exit price. However, as discussed in ASC
820-10-30-3A, the transaction price may not equal fair value at initial
recognition in certain situations. In such cases, an inception gain or loss may
arise upon initial recognition of an asset or liability. See Chapter 9 for more information about the initial
measurement of an item at fair value.
Since a fair value measurement is an exit price, a quoted market price for the
identical asset, liability, or equity instrument (i.e., a Level 1 input)
constitutes the most reliable evidence of fair value and, when available, must
be used to measure fair value without being adjusted, except in limited
circumstances. When a Level 1 input is not available to measure the fair value
of an asset, liability, or equity instrument in its entirety, an entity will
need to measure fair value by using one or more appropriate valuation techniques
that incorporate available inputs. An entity must maximize relevant observable
inputs (i.e., Level 1 and Level 2 inputs) and use unobservable inputs (i.e.,
Level 3 inputs) only when relevant observable inputs are not available. See
Chapter 8 for more information about the fair value
hierarchy.
An entity measures fair value on the basis of one or more of the three valuation
approaches outlined in ASC 820-10-35-24A: (1) the market approach, (2) the
income approach, or (3) the cost approach. Further, the entity selects one or
more techniques “that are appropriate in the circumstances and for which
sufficient data are available” to maximize the use of observable inputs while
minimizing the use of unobservable inputs. If multiple techniques are used, the
entity should evaluate the resultant range and should select a point within the
range that is most representative of fair value.
The entity should evaluate the factors listed in ASC 820-10-35-54C to determine
whether there has been a significant decrease in the volume and level of
activity for the asset or liability in relation to normal market activity. This
determination will affect the entity’s selection of techniques or inputs and the
weight placed on quoted prices. If the volume and level of activity for the
asset or liability have significantly decreased, the entity may need to
significantly adjust the transaction or quoted price. Regardless, the entity’s
objective is to select an estimate that is most representative of fair
value.
See Chapter 10 for more information about the measurement of fair
value on the basis of available inputs and appropriate valuation techniques.
3.2.7 Step 6 — Allocate Fair Value Measurement to Individual Units of Account (if Necessary)
As discussed in step 1, the unit of account may differ from the unit of
valuation. In addition, an entity may need to perform allocations of fair value
measurements even when the unit of account and unit of valuation are the same.
In these circumstances, once the fair value is calculated at the level of the
unit of valuation (see step 5), the entity must allocate the fair value
measurement to the individual units of account that are subject to the fair
value measurement. Since ASC 820 does not specify how to perform this
allocation, the entity must consider the individual facts and circumstances,
along with other relevant Codification topics, in such cases. See
Section 4.3 for more information.
3.2.8 Step 7 — Classify the Fair Value Measurement Under the Fair Value Hierarchy and Prepare Disclosures
ASC 820 categorizes inputs used in fair value measurements into a three-level
fair value hierarchy. An unadjusted quoted price in an active market is the most
reliable measure of fair value and is categorized as Level 1. Fair value
measurements that incorporate observable inputs (i.e., quoted market prices in
active markets for similar assets or liabilities, quoted prices in inactive
markets for identical or similar assets or liabilities, or other inputs that are
observable or that can be corroborated through observable market data or in
other ways for substantially the entire term of the assets or liabilities)
represent Level 2 fair value measurements. Fair value measurements that
incorporate unobservable inputs represent Level 3 fair value measurements. A
fair value measurement that includes multiple inputs is categorized in its
entirety on the basis of the lowest-level input that is significant to the
entire measurement. In addition to requiring entities to classify fair value
measurements within the fair value hierarchy, ASC 820 requires entities to
provide various disclosures on the basis of such classification. See Chapters 8 and 11 for more information.
Footnotes
1
ASC 820-10-35-44 specifies the unit of account (which is also the unit of
valuation) that exists when an entity “holds a position in a single
asset or liability (including a position comprising a large number of
identical assets or liabilities, such as a holding of financial
instruments) and the asset or liability is traded in an active market.”
See Section 4.2 for more information.
2
See footnote 1.
Chapter 4 — Unit of Account
Chapter 4 — Unit of Account
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.
4.2 Unit of Account Prescribed by ASC 820
ASC 820-10
Level 1 Inputs
35-44 If a
reporting entity holds a position in a single asset or
liability (including a position comprising a large number of
identical assets or liabilities, such as a holding of
financial instruments) and the asset or liability is traded
in an active market, the fair value of the asset or
liability shall be measured within Level 1 as the product of
the quoted price for the individual asset or liability and
the quantity held by the reporting entity. That is the case,
even if a market’s normal daily trading volume is not
sufficient to absorb the quantity held and placing orders to
sell the position in a single transaction might affect the
quoted price.
As discussed in Section 4.1, ASC 820 specifies
one circumstance in which the unit of account is determined for an asset, liability,
or equity instrument for fair value measurement or disclosure purposes. In all other
instances, entities must determine the unit of account on the basis of other GAAP
under which fair value measurement of an item is required (or permitted). ASC
820-10-35-44 specifies the unit of account (and the unit of valuation) for holdings
of a single asset or liability traded in an active market. For such assets or
liabilities, fair value is measured as “the product of the quoted price for the
individual asset or liability and the quantity held by the . . . entity.”
Paragraph C80 of the Basis for Conclusions of FASB Statement 157 (codified in ASC
820) discusses this unit-of-account requirement and states, in part:
This Statement precludes the use of blockage factors and eliminates the
exception to P×Q in the Guides for a financial instrument that trades in an
active market (within Level 1). In other words, the unit of account for an
instrument that trades in an active market is the individual trading unit.
This Statement amends Statements 107, 115, 124, 133, and 140 to remove the
similar unit-of-account guidance in those accounting pronouncements, which
referred to a fair value measurement using P×Q for an instrument that trades
in any market, including a market that is not active, for example, a thin
market (within Level 2). In this Statement, the Board decided not to specify
the unit of account for an instrument that trades in a market that is not
active.
The FASB addressed inactive markets in subsequently issued guidance. See Section 10.6 for further discussion.
4.3 Allocation to Multiple Units of Account
4.3.1 General
The unit of account (see Section 4.1)
represents what is being measured for financial reporting purposes and is
related to the level at which assets, liabilities, or equity instruments are
aggregated or disaggregated for recognition in the financial statements. With
one exception, the unit of account is determined on the basis of guidance in
other Codification topics.
The unit of valuation (see Section 5.1) is
the grouping of assets, liabilities, or equity instruments for fair value
measurement purposes. ASC 820 provides guidance on determining the unit of
valuation (see Chapter 5 for more
information).
The unit of account may differ from the unit of valuation. Furthermore, even when
the unit of account and unit of valuation are the same, the unit of account for
fair value measurement purposes may be at a more aggregated level than the unit
of account for recognition purposes (e.g., an entity may determine the fair
value of a reporting unit to recognize a goodwill impairment loss, in which case
the unit of account for the impairment loss is at a more disaggregated level
than the unit of account for the fair value measurement, which is the reporting
unit). In these circumstances, an entity must allocate the fair value
measurement to the individual units of account subject to this measurement. ASC
820 is silent on how to perform this allocation. To do so, an entity must
therefore consider the individual facts and circumstances, along with other
relevant Codification topics. The Codification topic that specifies the
requirement (or ability) to measure an asset, liability, or equity instrument at
fair value will generally provide guidance on how to allocate fair value
measurements to the appropriate units of account. See Section
4.3.3 for more information.
4.3.2 Financial Assets, Nonfinancial Derivative Assets, Liabilities, and Equity Instruments
The unit of account and unit of valuation are generally the same for financial
assets, nonfinancial derivative assets, liabilities, and instruments classified
in stockholders’ equity. For such instruments, both the unit of account and the
unit of valuation are generally the individual asset, liability, or equity
instrument. Therefore, no allocation is necessary for such instruments.
However, as discussed below, there are exceptions to the general principle that
the unit of account and unit of valuation are the same for financial assets,
nonfinancial derivative assets, liabilities, and instruments classified in
stockholders’ equity. Note also that when a derivative instrument must be
bifurcated from its host contract, there are two units of account under ASC
815-15 (i.e., the host contract and the embedded derivative) even though the
hybrid instrument is considered a freestanding financial instrument. However,
when the embedded derivative is measured at fair value, the unit of account and
unit of valuation for the embedded derivative are the same.
4.3.2.1 Portfolio Valuation Exception for Certain Groups of Assets and Liabilities With Offsetting Risk Positions
One exception to the general principle discussed above applies to the unit of
account and unit of valuation for certain financial instruments and
nonfinancial derivatives. The exception is available for certain groups of
assets and liabilities if an entity (1) manages the group of assets and
liabilities on the basis of a net exposure to a market risk (or risks) or
counterparty credit risk, (2) provides information on that basis to
management, and (3) measures those assets and liabilities at fair value in
the statement of financial position. To use this exception, an entity must
make an accounting policy decision. Once the accounting policy is
established, the entity must consistently apply it from period to period for
a particular portfolio. If an entity has made this accounting policy
election, the unit of valuation is the entire portfolio of assets and
liabilities with offsetting risk exposures. After measuring the fair value
of the entire portfolio, the entity must allocate portfolio-based fair value
measurement to the individual units of account within the portfolio. Under
ASC 820-10-35-18F, such allocations must be performed “on a reasonable and
consistent basis using a methodology appropriate in the circumstances.”
See Sections 5.3 and
10.2.8 for more information about this
unit-of-valuation exception and how an allocation may be made to the
individual units of account for disclosure purposes.
AICPA Technical Q&As Section 6910.34 discusses a similar portfolio-level
valuation approach in which an investment company owns a controlling
interest in an investee company and holds both equity and debt instruments
issued by the investee.
4.3.2.2 Liabilities With Third-Party Credit Enhancements
As discussed in Section 10.2.7, an entity may measure
the fair value of a liability on the basis of the identical item held as an
asset by another party. If the asset includes an inseparable third-party
credit enhancement, the unit of account for the liability excludes this
credit enhancement. As a result, the valuation premise for the liability is
different from the unit of account. Accordingly, an entity must adjust the
observed price of the asset so that the fair value measurement of the
liability is determined in accordance with its unit of account.
4.3.3 Nonfinancial Assets Other Than Nonfinancial Derivative Assets
ASC 820-10
Valuation Premise for Nonfinancial Assets
35-10E The highest and best
use of a nonfinancial asset establishes the valuation
premise used to measure the fair value of the asset, as
follows:
-
The highest and best use of a nonfinancial asset might provide maximum value to market participants through its use in combination with other assets as a group (as installed or otherwise configured for use) or in combination with other assets and liabilities (for example, a business).
-
If the highest and best use of the asset is to use the asset in combination with other assets or with other assets and liabilities, the fair value of the asset is the price that would be received in a current transaction to sell the asset assuming that the asset would be used with other assets or with other assets and liabilities and that those assets and liabilities (that is, its complementary assets and the associated liabilities) would be available to market participants.
-
Liabilities associated with the asset and with the complementary assets include liabilities that fund working capital, but do not include liabilities used to fund assets other than those within the group of assets.
-
Assumptions about the highest and best use of a nonfinancial asset shall be consistent for all of the assets (for which highest and best use is relevant) of the group of assets or the group of assets and liabilities within which the asset would be used.
-
-
The highest and best use of a nonfinancial asset might provide maximum value to market participants on a standalone basis. If the highest and best use of the asset is to use it on a standalone basis, the fair value of the asset is the price that would be received in a current transaction to sell the asset to market participants that would use the asset on a standalone basis.
35-11A The fair value
measurement of a nonfinancial asset assumes that the
asset is sold consistent with the unit of account
specified in other Topics (which may be an individual
asset). That is the case even when that fair value
measurement assumes that the highest and best use of the
asset is to use it in combination with other assets or
with other assets and liabilities because a fair value
measurement assumes that the market participant already
holds the complementary assets and associated
liabilities.
For nonfinancial assets other than nonfinancial derivative assets, ASC 820
establishes a valuation premise on the basis of the “highest and best use.” As a
result, the fair value measurement may encompass a combination of assets and
liabilities, including financial instruments. That combination may not be
consistent with the unit of account for fair value measurement purposes.
Accordingly, an entity will need to allocate the fair value measurement to
individual units of account. Other Codification topics will generally specify
how to allocate the fair value measurement to individual units of account when
either (1) the fair value measurement is performed on the basis of the highest
and best use, which is at a level that differs from the unit of account for fair
value measurement purposes, or (2) the unit of account for fair value
measurement purposes differs from the unit of account for recognition
purposes.1 Below are two situations in which (1) a fair value measurement of
nonfinancial assets is performed at a level that is more aggregated than the
unit of account for recognition purposes and (2) that fair value amount must
therefore be allocated to the units of account. In other situations, entities
should determine how to allocate the fair value measurement to the individual
units of account by evaluating the facts and circumstances in the context of the
guidance in the relevant Codification topic that requires the fair value measurement.
-
Goodwill — ASC 350 provides guidance on impairment of goodwill. In testing goodwill for impairment under ASC 350, an entity that has not adopted the private company alternative that allows for goodwill impairment testing at the entity level must measure the fair value of the reporting unit to which the goodwill has been allocated.2 Thus, the reporting unit is the unit of account for fair value measurement purposes. The reporting unit may or may not be the unit of valuation depending on the facts and circumstances. If an impairment of goodwill exists, only goodwill is written down. ASC 350 provides guidance on how to calculate the goodwill impairment loss. As noted in ASC 350-20-35-9, an entity measures the goodwill impairment loss by comparing the implied fair value of the goodwill of the reporting unit with the carrying amount of goodwill. The implied fair value of the goodwill of the reporting unit, which represents only a subset of the overall fair value of the reporting unit, is determined in accordance with ASC 350-20-35-14 through 35-17.Changing LanesUnder ASC 350, before the amendments made by ASU 2017-04, impairment of goodwill was “the condition that exists when the carrying amount of goodwill exceeds its implied fair value.” The implied fair value of goodwill was determined in the same manner as the amount of goodwill recognized in a business combination. The process of measuring the implied fair value of goodwill was referred to as step 2 of the goodwill impairment test. To perform step 2, an entity was required to “assign the fair value of a reporting unit to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination.” Accordingly, performing step 2 sometimes resulted in significant cost and complexity since the “fair value of goodwill can be measured only as a residual and cannot be measured directly.”ASU 2017-04 simplified the accounting for goodwill impairments by eliminating step 2 from the goodwill impairment test. As amended, ASC 350 states that if “the carrying amount of a reporting unit exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess, limited to the total amount of goodwill allocated to that reporting unit.” As a result, in measuring the amount of any goodwill impairment loss, an entity no longer needs to allocate the fair value of a reporting unit to individual assets and liabilities to determine the implied fair value of goodwill.
-
Long-lived assets — ASC 360 requires entities to test long-lived assets for impairment at the asset group level if the assets are held and used and at the disposal group level if the assets are HFS. Thus, the asset (disposal) group is the unit of account for impairment testing purposes. However, each individual long-lived asset represents an individual unit of account for recognition purposes. Furthermore, the unit of valuation (on the basis of the “highest and best use” concept) could be at a different level than the asset (disposal) group that is being measured at fair value. Accordingly, if there is an impairment loss (e.g., the fair value of an asset [disposal] group is less than its carrying amount), in accordance with ASC 360-10-35-28, the “loss shall be allocated to the long-lived assets of the group on a pro rata basis using the relative carrying amounts of those assets, except that the loss allocated to an individual long-lived asset of the group shall not reduce the carrying amount of that asset below its fair value whenever that fair value is determinable without undue cost and effort.” In addition, ASC 360 provides guidance on how to allocate the fair value of an asset (disposal) group to financial instruments that are reported at fair value.3 See also Example 3-1.
If the unit of valuation is at a more aggregated level than the unit of account
and the Codification topic requiring the fair value measurement does not provide
guidance on how to allocate the fair value measurement to the unit (or units) of
account, an entity must evaluate the facts and circumstances and use judgment to
determine how to appropriately allocate this fair value measurement. In many
situations, the use of a relative fair value or another pro rata basis may be
appropriate. However, before allocating on such a basis, an entity must ensure
that (1) none of the individual assets or liabilities within the group must (or
will) be recognized at fair value on an ongoing basis and (2) the allocation
would not inappropriately result in the recognition of an asset at more than its
fair value. When individual assets or liabilities within a larger group are
subsequently measured at fair value, an allocation on the basis of a relative
fair value approach will lead to an immediate gain or loss in earnings for the
difference between the amount allocated and the then fair value of the asset or
liability. This is generally not appropriate. Similarly, if an amount in excess
of fair value is allocated to an asset that is not subsequently measured at fair
value, the asset may have an immediate impairment loss that must be
recognized.
Footnotes
1
For example, the unit of valuation and unit of account for the purpose of
testing a film group for impairment may be the film group. However, if
an impairment loss is recognized, that loss must be allocated to the
films and license agreements within the film group. ASC 926-20-35-19
specifies how to allocate an impairment loss attributable to a film
group.
2
ASU 2019-06
extended the accounting alternatives available to private
entities to NFP entities.
3
ASC 360 also provides guidance on situations
in which an asset (disposal) group contains other assets
that are not long-lived assets (e.g., inventory or
receivables).
Chapter 5 — Unit of Valuation
Chapter 5 — Unit of Valuation
5.1 Introduction
As discussed in Chapter 4, the unit of account
is the grouping of assets and liabilities that are being measured for financial
reporting purposes. The unit of account is generally determined in accordance with
the guidance in Codification topics other than ASC 820 and is related to the level
of aggregation or disaggregation for recording assets and liabilities.
The unit of valuation (also sometimes referred to as the unit of measurement) is the
grouping of assets, liabilities, or equity instruments that are being measured for
valuation purposes. The unit of valuation may differ from the unit of account
depending on the asset, liability, or equity instrument subject to the fair value
measurement. Other Codification topics will generally dictate the unit of account,
whereas the unit of valuation is generally addressed in ASC 820. For example, the
unit of valuation for nonfinancial assets (other than nonfinancial derivative
assets) is based on an asset’s highest and best use, which may be on a stand-alone
basis or in combination with other assets or other assets and liabilities. An entity
may also have the option of grouping certain financial assets, financial
liabilities, and nonfinancial items accounted for as derivatives under ASC 815, or a
combination of those items, and the portfolio’s fair value may be measured on the
basis of its net risk position. In this case, the portfolio is the unit of valuation
(see Section 5.3).
5.2 Highest and Best Use of Nonfinancial Assets Other Than Nonfinancial Derivative Assets
5.2.1 General
ASC 820-10
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.
Highest and Best Use for Nonfinancial
Assets
35-10A A fair value
measurement of a nonfinancial asset takes into account a
market participant’s ability to generate economic
benefits by using the asset in its highest and best use
or by selling it to another market participant that
would use the asset in its highest and best use.
To satisfy the fair value measurement objective, an entity, for nonfinancial
assets (other than nonfinancial derivative assets), must determine the fair
value on the basis of the valuation premise that is appropriate for the
measurement (in a manner consistent with the asset’s highest and best use).
The unit of valuation (also referred to as the “valuation
premise”) for nonfinancial assets (other than nonfinancial derivative assets) is
the asset’s highest and best use. ASC 820-10-20 defines a nonfinancial asset’s
highest and best use as the “use of a nonfinancial asset by market participants
that would maximize the value of the asset or the group of assets and
liabilities (for example, a business) within which the asset would be used.” The
highest and best use must be determined from a market participant’s perspective,
regardless of the entity’s current or intended use of the nonfinancial asset.
The fair value measurement takes into account a market participant’s ability to
generate economic benefits by putting the asset to its highest and best use or
by selling it to another market participant that would do so.1 However, an entity is not required to perform an exhaustive search to
identify the asset’s highest and best use and may presume that its current use
is the highest and best use if market or other factors do not suggest
otherwise.
In determining the highest and best use of a nonfinancial asset, an entity must
consider whether the nonfinancial asset’s value is maximized through its use
either (1) in combination with other assets or other assets and liabilities or
(2) on a stand-alone basis. To make such a determination, the entity will need
to evaluate the potential use of the asset. Such an evaluation involves
consideration of the following:
- Uses of the asset that are physically possible, legally permissible, and financially feasible.
- The entity’s current and intended use of the asset.
These concepts are further discussed in Sections 5.2.2 and
5.2.3.
The concept of the highest and best use does not apply to financial assets,
nonfinancial derivative assets, liabilities, or instruments classified in
stockholders’ equity. ASU
2011-04 removed from ASC 820 the application of this concept
to financial assets and financial liabilities. Paragraphs BC45 through BC47 of
ASU 2011-04 explain the rationale for this decision and state:
BC45. Before the amendments, Topic 820 specified that
the concepts of highest and best use and valuation premise applied when
measuring the fair value of assets, but it did not distinguish between
financial assets and nonfinancial assets.
BC46. In its discussions with the IASB, the Board
considered the IASB’s rationale for proposing in its Exposure Draft on
fair value measurement that those concepts would not apply to financial
assets or to liabilities. The IASB reached that conclusion for the
following reasons:
-
Financial assets do not have alternative uses because a financial asset has specific contractual terms and can have a different use only if the characteristics of the financial asset (that is, the contractual terms) are changed. However, a change in characteristics causes that particular asset to become a different asset. The objective of a fair value measurement is to measure the asset that exists at the measurement date.
-
Even though a reporting entity may be able to change the cash flows associated with a liability by relieving itself of the obligation in different ways, the different ways of doing so are not alternative uses. Moreover, although a reporting entity might have entity-specific advantages or disadvantages that enable it to fulfill a liability more or less efficiently than other market participants, those entity-specific factors do not affect fair value.
-
Those concepts were originally developed within the valuation profession to value nonfinancial assets, such as land.
BC47. The Board agreed with the IASB that the concepts
of highest and best use and valuation premise are relevant when
measuring the fair value of nonfinancial assets and are not relevant
when measuring the fair value of financial assets or the fair value of
liabilities. The Boards also concluded that those concepts do not apply
to instruments classified in shareholders’ equity because those
arrangements, similar to financial instruments, typically have specific
contractual terms. Paragraphs BC50–BC69 below describe the Boards’
rationale in developing the requirements for measuring the fair value of
financial assets and financial liabilities with offsetting positions in
market risks and counterparty credit risk.
5.2.2 Use in Combination or on a Stand-Alone Basis
ASC 820-10
Valuation Premise for Nonfinancial Assets
35-10E The highest and best
use of a nonfinancial asset establishes the valuation
premise used to measure the fair value of the asset, as
follows:
- The highest and best use of a nonfinancial asset
might provide maximum value to market participants
through its use in combination with other assets
as a group (as installed or otherwise configured
for use) or in combination with other assets and
liabilities (for example, a business).
-
If the highest and best use of the asset is to use the asset in combination with other assets or with other assets and liabilities, the fair value of the asset is the price that would be received in a current transaction to sell the asset assuming that the asset would be used with other assets or with other assets and liabilities and that those assets and liabilities (that is, its complementary assets and the associated liabilities) would be available to market participants.
-
Liabilities associated with the asset and with the complementary assets include liabilities that fund working capital, but do not include liabilities used to fund assets other than those within the group of assets.
-
Assumptions about the highest and best use of a nonfinancial asset shall be consistent for all of the assets (for which highest and best use is relevant) of the group of assets or the group of assets and liabilities within which the asset would be used.
-
- The highest and best use of a nonfinancial asset might provide maximum value to market participants on a standalone basis. If the highest and best use of the asset is to use it on a standalone basis, the fair value of the asset is the price that would be received in a current transaction to sell the asset to market participants that would use the asset on a standalone basis.
35-11A The fair value
measurement of a nonfinancial asset assumes that the
asset is sold consistent with the unit of account
specified in other Topics (which may be an individual
asset). That is the case even when that fair value
measurement assumes that the highest and best use of the
asset is to use it in combination with other assets or
with other assets and liabilities because a fair value
measurement assumes that the market participant already
holds the complementary assets and associated
liabilities.
In accordance with ASC 820, the fair value of a nonfinancial asset (other than a
nonfinancial derivative asset) may be determined on a combined or stand-alone
basis, whichever maximizes the asset’s value. There are various ways in which an
asset can be combined either with a group of assets or with other assets or
liabilities (such as a business). ASC 820-10-35-10E(a) outlines certain
considerations related to situations in which the highest and best use of a
nonfinancial asset reflects its use in combination with other assets or with
other assets and liabilities.
ASC 820-10-55-3 states that the effect on the fair value measurement of “a
nonfinancial asset used in combination with other assets as a group (as
installed or otherwise configured for use) or in combination with other assets
and liabilities (for example, a business) . . . depends on the circumstances”
and gives the following five examples related to this topic:
-
The fair value of the asset might be the same whether the asset is used on a standalone basis or in combination with other assets or with other assets and liabilities. That might be the case if the asset is a business that market participants would continue to operate. In that case, the transaction would involve valuing the business in its entirety. The use of the assets as a group in an ongoing business would generate synergies that would be available to market participants (that is, market participant synergies that, therefore, should affect the fair value of the asset on either a standalone basis or in combination with other assets or with other assets and liabilities).
-
An asset’s use in combination with other assets or with other assets and liabilities might be incorporated into the fair value measurement through adjustments to the value of the asset used on a standalone basis. That might be the case if the asset is a machine and the fair value measurement is determined using an observed price for a similar machine (not installed or otherwise configured for use), adjusted for transportation and installation costs so that the fair value measurement reflects the current condition and location of the machine (installed and configured for use).
-
An asset’s use in combination with other assets or with other assets and liabilities might be incorporated into the fair value measurement through the market participant assumptions used to measure the fair value of the asset. For example, if the asset is work-in-process inventory that is unique and market participants would convert the inventory into finished goods, the fair value of the inventory would assume that market participants have acquired or would acquire any specialized machinery necessary to convert the inventory into finished goods.
-
An asset’s use in combination with other assets or with other assets and liabilities might be incorporated into the valuation technique used to measure the fair value of the asset. That might be the case when using the multiperiod excess earnings method to measure the fair value of an intangible asset because that valuation technique specifically takes into account the contribution of any complementary assets and the associated liabilities in the group in which such an intangible asset would be used.
-
In more limited situations, when a reporting entity uses an asset within a group of assets, the reporting entity might measure the asset at an amount that approximates its fair value when allocating the fair value of the asset group to the individual assets of the group. That might be the case if the valuation involves real property and the fair value of improved property (that is, an asset group) is allocated to its component assets (such as land and improvements).
In a speech at the 2009 AICPA Conference on Current SEC and
PCAOB Developments, Evan Sussholz, then a professional accounting fellow in the
SEC’s Office of the Chief Accountant, addressed the determination of the highest
and best use of a nonfinancial asset. Mr. Sussholz stated, in part:
Question #2: What is the highest and best use for the
asset?
To answer this question, a reporting entity should
identify all of the potential uses of the asset within each potential
exit market and determine if the value of the asset would be maximized
by using the asset on a standalone basis (that is, an in-exchange
valuation premise) or in conjunction with other assets (that is, an
in-use valuation premise).
For example, market participants may derive value from a
customer related intangible asset through its use as a stand-alone asset
such as renting the customer list to third parties. Alternatively, a
market participant may derive value from a customer related intangible
asset through its use in combination with other assets such as
trademarks, fixed assets, and goodwill. The reporting entity should
determine the asset’s highest and best use based on the use that
maximized the fair value of the individual asset or group of assets in
which the asset is being used.
The highest and best use of a nonfinancial asset (other than a nonfinancial
derivative asset) might result in maximum value for market participants on a
stand-alone basis. If the fair value is determined on a stand-alone basis, the
fair value of the asset is the price that would be received in a current
transaction to sell the asset to market participants that would use the asset on
a stand-alone basis.
ASC 820-10-35-11A clarifies that regardless of whether the highest and best use
of a nonfinancial asset is on a combined or stand-alone basis, the fair value of
the nonfinancial asset must be measured on the basis of a sale of the
nonfinancial asset that is consistent with its unit of account, as specified in
other Codification topics. The reason for this requirement is that when fair
value is determined under an assumption that the highest and best use of the
asset is in combination with other assets or with other assets and liabilities,
it is assumed that “the market participant already holds the complementary
assets and associated liabilities.”
5.2.3 Potential Uses of the Asset
5.2.3.1 General
In determining the valuation premise (i.e., the highest and best use of a
nonfinancial asset), an entity must consider the asset’s potential uses. The
entity then uses this information to determine whether the nonfinancial
asset’s highest and best use is on a combined or stand-alone basis.
5.2.3.2 Physically Possible, Legally Permissible, and Financially Feasible
ASC 820-10
Highest and Best Use for Nonfinancial Assets
35-10B The
highest and best use of a nonfinancial asset takes
into account the use of the asset that is physically
possible, legally permissible, and financially
feasible, as follows:
-
A use that is physically possible takes into account the physical characteristics of the asset that market participants would take into account when pricing the asset (for example, the location or size of a property).
-
A use that is legally permissible takes into account any legal restrictions on the use of the asset that market participants would take into account when pricing the asset (for example, the zoning regulations applicable to a property).
-
A use that is financially feasible takes into account whether a use of the asset that is physically possible and legally permissible generates adequate income or cash flows (taking into account the costs of converting the asset to that use) to produce an investment return that market participants would require from an investment in that asset put to that use.
In determining the highest and best use of a nonfinancial asset (other than a
nonfinancial derivative asset), an entity must assess the following two characteristics:
-
Physical possibility — ASC 820 requires an entity to consider the physical characteristics of the asset. In doing so, an entity must take certain considerations into account, including the asset’s location or size and whether its physical characteristics allow for potential alternative uses that would maximize its value from a market-participant perspective. The highest and best use of a nonfinancial asset should not represent a use that is physically impossible. For example, it would not be physically possible to relocate a parcel of land, though it may be physically possible to relocate certain other types of nonfinancial assets, such as machinery or equipment. However, an entity would determine the cost of such relocation (including any installation or other relevant costs) in determining whether it would maximize value to a market participant. See further discussion of financial feasibility below.
-
Legal permissibility — ASC 820 requires an entity to consider the legally permissible uses of a nonfinancial asset to determine fair value from a market-participant perspective. The highest and best use of a nonfinancial asset should represent a use that is legally permissible. The consideration of legal permissibility takes into account whether a particular use is legally permissible both currently and in the future. That is, an entity is not necessarily precluded from considering legally permissible uses in the future. For example, market participants may consider the possibility that current legal restrictions, such as zoning ordinances, may change in the future and adjust the pricing of an asset accordingly. Therefore, the fair value measurement should take into account the risk of uncertainty that legal restrictions may change and the costs a market participant would incur to transform the asset’s use. Such costs may include, but are not limited to, costs imposed by a governmental entity or regulator. See Example 5-1 for a related illustration.
In evaluating physically possible and legally permissible uses of a
nonfinancial asset (other than a nonfinancial derivative asset), entities
must consider “financial feasibility” from a market-participant perspective
in accordance with ASC 820-10-35-10B(c). As part of this evaluation, an
entity determines whether the asset would generate adequate investment
returns (e.g., cash flows) that market participants would demand to put the
asset to that use. In performing this evaluation, an entity effectively
would need to assess the return on invested capital, including the risks and
uncertainties related to both the investment returns and the potential costs
of generating such returns. Further, an entity would have to consider the
targeted return on market participants’ invested capital.
Example 5-1
Zoning Requirements That Apply to a Parcel of
Land
Entity A holds a parcel of land that is zoned for
residential use as of the measurement date; however,
the highest and best use of the land is commercial
use. Although A may consider the possibility that
the land could be rezoned at some point in the
future when performing its fair value measurement,
it would also need to consider the risks of rezoning
(e.g., the risk that the land might not be rezoned)
and the cost of transforming the asset. Depending on
the cost of transforming the asset, the fair value
of A’s land would be between the residential value
and the commercial value.
5.2.3.3 Current or Intended Use
ASC 820-10
Highest and Best Use for Nonfinancial Assets
35-10C
Highest and best use is determined from the
perspective of market participants, even if the
reporting entity intends a different use. However, a
reporting entity’s current use of a nonfinancial
asset is presumed to be its highest and best use
unless market or other factors suggest that a
different use by market participants would maximize
the value of the asset.
35-10D To
protect its competitive position, or for other
reasons, a reporting entity may intend not to use an
acquired nonfinancial asset actively, or it may
intend not to use the asset according to its highest
and best use. For example, that might be the case
for an acquired intangible asset that the reporting
entity plans to use defensively by preventing others
from using it. Nevertheless, the reporting entity
shall measure the fair value of a nonfinancial asset
assuming its highest and best use by market
participants.
Nonfinancial assets should be valued on the basis of the assumptions market
participants would use. In performing this valuation, a market participant
would consider its ability to generate economic benefits by putting the
asset to its highest and best use or by selling it to another market
participant that would do so. Further, the assessment should be from a
market participant’s perspective, even if the entity determines that it
would use the asset differently. In other words, an entity should consider a
market participant’s, but not its own, assumptions regarding the use or
disposition of a nonfinancial asset. While a market participant could use
the asset in a different way than the entity does, if no market or other
factors suggest a different use by market participants, the current use of
the asset by the entity is presumed to be its highest and best use.
ASC 820-10-35-10D provides guidance on nonfinancial assets whose intended use
differs from their highest and best use (e.g., defensive intangible assets).
Even if they are intangible rather than tangible, these assets must still be
measured at fair value in accordance with ASC 820. That is, even if an
entity does not intend to use a nonfinancial asset or intends to use it in a
way other than its highest and best use, the entity must measure the asset
at fair value under ASC 820 on the basis of its highest and best use.
For example, an entity may decide not to use the acquired trade name of a
competitor but may intend to keep the name (rather than sell it) solely to
prevent others from using it. In this case, the asset is determined to have
value to the acquirer, albeit this value is defensive (i.e., because others
are prevented from using the asset). When measuring the fair value of a
defensive intangible asset in accordance with ASC 820, an acquirer should
assume its highest and best use by market participants.
5.2.3.4 ASC 820 Examples
ASC 820-10
Example 1: Highest and Best Use and Valuation
Premise
Case B: Land
55-30 A
reporting entity acquires land in a business
combination. The land is currently developed for
industrial use as a site for a factory. The current
use of land is presumed to be its highest and best
use unless market or other factors suggest a
different use. Nearby sites have recently been
developed for residential use as sites for high-rise
apartment buildings. On the basis of that
development and recent zoning and other changes to
facilitate that development, the reporting entity
determines that the land currently used as a site
for a factory could be developed as a site for
residential use (that is, for high-rise apartment
buildings) because market participants would take
into account the potential to develop the site for
residential use when pricing the land.
55-31 The
highest and best use of the land would be determined
by comparing both of the following:
-
The value of the land as currently developed for industrial use (that is, the land would be used in combination with other assets, such as the factory, or with other assets and liabilities)
-
The value of the land as a vacant site for residential use, taking into account the costs of demolishing the factory and other costs (including the uncertainty about whether the reporting entity would be able to convert the asset to the alternative use) necessary to convert the land to a vacant site (that is, the land is to be used by market participants on a standalone basis).
The highest and best use of the land would be
determined on the basis of the higher of those
values. In situations involving real estate
appraisal, the determination of highest and best use
might take into account factors relating to the
factory operations, including its assets and
liabilities.
Case C: In-Process Research and Development
Project
55-32 A
reporting entity acquires an in-process research and
development project in a business combination. The
reporting entity does not intend to complete the
project. If completed, the project would compete
with one of its own projects (to provide the next
generation of the reporting entity’s commercialized
technology). Instead, the reporting entity intends
to hold (that is, lock up) the project to prevent
its competitors from obtaining access to the
technology. In doing this, the project is expected
to provide defensive value, principally by improving
the prospects for the reporting entity’s own
competing technology. To measure the fair value of
the project at initial recognition, the highest and
best use of the project would be determined on the
basis of its use by market participants. For
example:
-
The highest and best use of the in-process research and development project would be to continue development if market participants would continue to develop the project and that use would maximize the value of the group of assets or of assets and liabilities in which the project would be used (that is, the asset would be used in combination with other assets or with other assets and liabilities). That might be the case if market participants do not have similar technology, either in development or commercialized. The fair value of the project would be measured on the basis of the price that would be received in a current transaction to sell the project, assuming that the in-process research and development would be used with its complementary assets and the associated liabilities and that those assets and liabilities would be available to market participants.
-
The highest and best use of the in-process research and development project would be to cease development if, for competitive reasons, market participants would lock up the project and that use would maximize the value of the group of assets or of assets and liabilities in which the project would be used. That might be the case if market participants have technology in a more advanced stage of development that would compete with the project if completed and the project would be expected to improve the prospects for their own competing technology if locked up. The fair value of the project would be measured on the basis of the price that would be received in a current transaction to sell the project, assuming that the in-process research and development would be used (that is, locked up) with its complementary assets and the associated liabilities and that those assets and liabilities would be available to market participants.
-
The highest and best use of the in-process research and development project would be to cease development if market participants would discontinue its development. That might be the case if the project is not expected to provide a market rate of return if completed and would not otherwise provide defensive value if locked up. The fair value of the project would be measured on the basis of the price that would be received in a current transaction to sell the project on its own (which might be zero).
Footnotes
5.3 Certain Groups of Assets and Liabilities With Offsetting Risk Positions
ASC 820-10
Application to
Financial Assets and Financial Liabilities With
Offsetting Positions in Market Risks or Counterparty
Credit Risk
35-18D A
reporting entity that holds a group of financial assets,
financial liabilities, nonfinancial items accounted for as
derivatives in accordance with Topic 815, or combinations of
these items is exposed to market risks (that is, interest
rate risk, currency risk, or other price risk) and to the
credit risk of each of the counterparties. If the reporting
entity manages that group of financial assets, financial
liabilities, nonfinancial items accounted for as derivatives
in accordance with Topic 815, or combinations of these items
on the basis of its net exposure to either market risks or
credit risk, the reporting entity is permitted to apply an
exception to this Topic for measuring fair value. That
exception permits a reporting entity to measure the fair
value of a group of financial assets, financial liabilities,
nonfinancial items accounted for as derivatives in
accordance with Topic 815, or combinations of these items on
the basis of the price that would be received to sell a net
long position (that is, an asset) for a particular risk
exposure or paid to transfer a net short position (that is,
a liability) for a particular risk exposure in an orderly
transaction between market participants at the measurement
date under current market conditions. Accordingly, a
reporting entity shall measure the fair value of the group
of financial assets, financial liabilities, nonfinancial
items accounted for as derivatives in accordance with Topic
815, or combinations of these items consistently with how
market participants would price the net risk exposure at the
measurement date.
As discussed in Section 4.3.2, the unit of
valuation for financial assets, nonfinancial derivative assets, all liabilities, and
equity instruments is generally the individual instrument, which is generally also
its unit of account under other GAAP. As stated in Section 5.2.1, the concept of the highest and best use does not
apply to financial assets, nonfinancial derivative assets, liabilities, or
instruments classified in stockholders’ equity.
An exception to ASC 820’s general principles related to the unit of
valuation is available for groups of financial assets, financial liabilities, and
nonfinancial items accounted for as derivatives in accordance with ASC 815. if an
entity (1) manages the group of assets and liabilities on the basis of net exposure
to a market risk (or risks) or counterparty credit risk, (2) provides information on
that basis to management, and (3) measures those assets and liabilities at fair
value in the statement of financial position. ASC 820-10-35-18D discusses this
exception.2
An entity must elect the exception as an accounting policy and
consistently apply it from period to period for a particular portfolio. See
Section 10.2.8.1
for further discussion of the application of this portfolio valuation exception.
Footnotes
2
See Section 10.4.4 for discussion of the use of mid-market
pricing as a practical expedient.
5.4 Liabilities and Instruments Classified in Equity
ASC 820-10
Application to Liabilities and Instruments Classified in a
Reporting Entity’s Shareholders’ Equity
35-16
A fair value measurement assumes that a financial or
nonfinancial liability or an instrument classified in a
reporting entity’s shareholders’ equity (for example, equity
interests issued as consideration in a business combination)
is transferred to a market participant at the measurement
date. The transfer of a liability or an instrument
classified in a reporting entity’s shareholders’ equity
assumes the following: . . .
b. A liability would remain outstanding and the
market participant transferee would be required to
fulfill the obligation. The liability would not be
settled with the counterparty or otherwise
extinguished on the measurement date.
c. An instrument classified in a reporting entity’s
shareholders’ equity would remain outstanding and
the market participant transferee would take on the
rights and responsibilities associated with the
instrument. The instrument would not be cancelled or
otherwise extinguished on the measurement
date.
When a liability or an instrument classified within an entity’s stockholders’ equity
is measured at fair value, it is assumed that the liability or equity instrument is
transferred to a market participant on the measurement date. Specifically, ASC
820-10-35-16 requires entities measuring the fair value of a liability to assume
that the liability remains outstanding and is transferred to a market participant
transferee that “would be required to fulfill the obligation.” Similarly, entities
must assume that an “instrument classified in . . . shareholders’ equity would
remain outstanding and the market participant transferee would take on the rights
and responsibilities associated with the instrument.” A liability being measured at
fair value would not be assumed to be settled, and an instrument classified in
shareholders’ equity would not be assumed to be canceled or otherwise extinguished.
However, ASC 820-10-35-16B points out that “[w]hen a quoted price for the transfer
of an identical or a similar liability or [an entity’s own equity instrument] is not
available and the identical item is held by another party as an asset, a reporting
entity shall measure the fair value of the liability or [the entity’s own] equity
instrument from the perspective of a market participant that holds the identical
item as an asset at the measurement date.” See Section 10.2.7
for further discussion of the fair value measurement of liabilities and equity
instruments.
Chapter 6 — The Principal or Most Advantageous Market
Chapter 6 — The Principal or Most Advantageous Market
6.1 General
ASC 820-10
The Transaction
35-5 A
fair value measurement assumes that the transaction to sell
the asset or transfer the liability takes place either:
- In the principal market for the asset or liability
- In the absence of a principal market, in the most advantageous market for the asset or liability.
35-5A
A reporting entity need not undertake an exhaustive search
of all possible markets to identify the principal market or,
in the absence of a principal market, the most advantageous
market, but it shall take into account all information that
is reasonably available. In the absence of evidence to the
contrary, the market in which the reporting entity normally
would enter into a transaction to sell the asset or to
transfer the liability is presumed to be the principal
market or, in the absence of a principal market, the most
advantageous market.
35-6
If there is a principal market for the asset or liability,
the fair value measurement shall represent the price in that
market (whether that price is directly observable or
estimated using another valuation technique), even if the
price in a different market is potentially more advantageous
at the measurement date.
35-6A
The reporting entity must have access to the principal (or
most advantageous) market at the measurement date. Because
different entities (and businesses within those entities)
with different activities may have access to different
markets, the principal (or most advantageous) market for the
same asset or liability might be different for different
entities (and businesses within those entities). Therefore,
the principal (or most advantageous) market (and thus,
market participants) shall be considered from the
perspective of the reporting entity, thereby allowing for
differences between and among entities with different
activities.
35-6B
Although a reporting entity must be able to access the
market, the reporting entity does not need to be able to
sell the particular asset or transfer the particular
liability on the measurement date to be able to measure fair
value on the basis of the price in that market.
Pending Content (Transition Guidance: ASC
820-10-65-13)
35-6B Although a reporting entity must
be able to access the market, the reporting entity
does not need to be able to sell the particular
asset or transfer the particular liability on the
measurement date to be able to measure fair value
on the basis of the price in that market. For
example, an equity security that an entity cannot
sell on the measurement date because of a
contractual sale restriction shall be measured at
fair value on the basis of the price in the
principal (or most advantageous) market. A
contractual sale restriction does not change the
market in which that equity security would be sold
(see paragraphs 820-10-55-52 through 55-52A).
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.
Underlying the fair value measurement objective in ASC 820 is the concept that an
entity would transact in the principal market for the asset, liability, or equity
instrument subject to the fair value measurement, or in the absence of a principal
market, the most advantageous market. The determination of the principal (or most
advantageous) market for an asset, liability, or equity instrument can affect the
fair value measurement since the exit price may differ from market to market. (See
Sections 6.2 and 6.3 for a discussion of the concepts of the
principal market and most advantageous market.) In evaluating which of two or more
accessible markets is the principal (or most advantageous) market, an entity must
apply the market-participant approach.
6.1.1 Access Considerations
For a market to represent the principal (or most advantageous) market, an entity
must have access to it as of the measurement date. However, ASC 820-10-35-6B
indicates that an entity is not required “to be able to sell the particular
asset or transfer the particular liability on the measurement date” in that
market. An example of a situation in which an entity has access to a market but
is unable to sell an asset in that market is one in which an entity is precluded
from transferring an asset as of the measurement date. See Section
10.2.2.2 for further discussion of restrictions on the sale or
use of an asset.
In a speech at the 2015 AICPA Conference on Current SEC and
PCAOB Developments, Kris Shirley, then a professional accounting fellow in the
SEC’s Office of the Chief Accountant, outlined certain factors that may prevent
an entity from accessing a particular price within a market as of the
measurement date:
The fair value measurement guidance also indicates a
reporting entity must have access to the principal or most advantageous
market at the measurement date. [Footnote omitted] If the reporting
entity cannot transact in a particular market on the measurement date,
then that market may not constitute the principal or most advantageous
market.
Being able to transact in a market on the measurement
date, I would like to point out, is something that may need to be
considered even when relying on observable pricing as an input into a
fair value measurement. An entity may need to consider any different
characteristics associated with its asset or liability being measured at
fair value and the observable pricing. Different characteristics may
prevent an entity from accessing the observable market on the
measurement date at the price observed within the market and may lead to
a different principal or most advantageous market for fair value
measurement purposes.
Some observations regarding common characteristics that
may prevent an entity from accessing a particular price within a market
include, but are not limited to, the following:
-
a reporting entity’s need to transform the asset or liability in some way to match the asset or liability in the observable market;
-
restrictions that may be unique to the reporting entity’s asset or liability that are not embedded in the asset or liability in the observable market; and
-
marketability or liquidity differences between the asset or liability in the observable market relative to the reporting entity’s asset or liability.
A reporting entity may not be precluded from using
observable prices from a particular market as one input into its fair
value measurement (even if the market does not constitute the principal
market); however, an entity may need to make appropriate adjustments to
the fair value measurement for any differences in the characteristics of
the asset or liability being measured and the price observed within a
market. For example, an entity that is measuring the fair value of a
loan may look to the securitization market when measuring the value of
the loan, but would need to make appropriate adjustments to the observed
securities prices to reflect the fact that the loan has not been
securitized as of the measurement date.
For purposes of determining the reporting entity’s
principal or most advantageous market, I would consider starting with
the initial transaction. There may be situations when the market in
which the initial transaction occurs is different than the principal or
most advantageous market. In those situations, a reporting entity may
need to consider whether it is able to access the principal or most
advantageous market for the asset or liability on the measurement
date.
Note that an entity would evaluate market access from its own perspective rather
than from a market-participant perspective. Example 4 in ASC 820-10-55-42
through 55-45A illustrates a scenario in which two entities measure the same
instrument differently because each entity identifies a different principal
market on the basis of its own activities. For further discussion, see Section 6.5.
Connecting the Dots
An entity’s determination of its principal (or most
advantageous) market will affect whether a Level 1 fair value
measurement must be used to value an asset, liability, or item
classified in stockholder’s equity that is subsequently measured at fair
value. While there is a presumption that a Level 1 fair value
measurement must be used, when available, to measure the fair value of
an item for which a Level 1 quote is available, if the entity does not
have access to the market in which such a quote is available, it would
not be required to use this quote as the determinative measure of fair
value.
6.1.2 Market-Participant Considerations
ASC 820-10
The Transaction
35-5A A reporting entity
need not undertake an exhaustive search of all possible
markets to identify the principal market or, in the
absence of a principal market, the most advantageous
market, but it shall take into account all information
that is reasonably available. In the absence of evidence
to the contrary, the market in which the reporting
entity normally would enter into a transaction to sell
the asset or to transfer the liability is presumed to be
the principal market or, in the absence of a principal
market, the most advantageous market.
35-6C Even when there is no
observable market to provide pricing information about
the sale of an asset or the transfer of a liability at
the measurement date, a fair value measurement shall
assume that a transaction takes place at that date,
considered from the perspective of a market participant
that holds the asset or owes the liability. That assumed
transaction establishes a basis for estimating the price
to sell the asset or to transfer the liability.
As noted in ASC 820-10-35-6C above, an entity needs to determine the fair value
of an asset, liability, or equity instrument from a market-participant
perspective. However, ASC 820-10-35-6C also points out that there may be
situations in which “there is no observable market to provide pricing
information about the sale of an asset or the transfer of a liability at the
measurement date.” When an observable market for an asset does not exist, an
entity must develop a hypothetical (assumed) transaction as of the measurement
date in accordance with the fair value objective in ASC 820. In doing so, an
entity must consider characteristics of potential market participants (the
entity does not have to identify specific market participants) that would
transact for the asset and, in the case of nonfinancial assets, maximize the
asset’s value. An entity may need to make adjustments to reflect factors
specific to an asset or liability (e.g., the location and condition of a
nonfinancial asset, synergies specific to the entity but not available to market
participants, growth rates, and risk adjustments). These adjustments would be
made on the basis of market-participant assumptions. See Section
10.2.2.1 for further discussion of the characteristics of an
asset or liability that market participants would consider in pricing the asset
or liability as of the measurement date.
6.1.3 Different Markets Within a Reporting Entity
The principal (or most advantageous) market for the same asset, liability, or
equity instrument might vary from entity to entity (and from business to
business within an entity) given that entities with different activities may
have access to different markets. The analysis of the principal (or most
advantageous) market does not differ for subsidiaries. A subsidiary identifies
its principal (or most advantageous) market when it measures the fair value of
assets and liabilities by considering both of the following:
-
Its own perspective on identifying markets that it can access.
-
Market participants’ perspectives on assessing which of two or more accessible markets is the principal (or most advantageous) market.
An entity should consider all markets that can be accessed
through its parent or related subsidiary, taking into account any restrictions
that prohibit the entity from transferring the asset or liability to its parent
or related subsidiary, including excessive transportation costs. That is, it
should not be assumed that a subsidiary can access a given market through its
parent or related subsidiary if there are legal restrictions against (1)
transferring the asset to that parent or subsidiary or (2) selling the asset in
that market. However, legal restrictions are not the only barriers to accessing
a given market. An entity must consider other relevant circumstances, such as
cost-prohibitive import tariffs or other transportation costs that make the
likelihood of accessing a different market less than reasonably possible. A
subsidiary should also consider the guidance in ASC 820-10-35-5A, which
indicates that an entity does not need to perform “an exhaustive search of all
possible markets” and that, in the absence of information to the contrary, it is
presumed that the market in which the transaction occurs would be its principal
market. See Example 6-4 for a scenario
involving multiple principal markets in an entity’s consolidated financial
statements.
6.2 The Principal Market
ASC 820-10 — Glossary
Principal Market
The market with the greatest volume and level of activity for
the asset or liability.
An entity identifies the principal market for an asset, liability, or equity
instrument by first identifying all markets that it can access to sell the asset or
transfer the liability or equity instrument. The principal market is the market
that, from a market-participant perspective, has the greatest volume or level of
activity. While there will generally be a principal market, in the absence of a
principal market, the entity identifies the most advantageous market, which is the
market that maximizes the fair value of the asset or minimizes the fair value of the
liability.
The glossary in ASC 820-10 gives
several examples of markets that could be the principal market for an entity.
ASC 820-10 — Glossary
Brokered Market
A market in which brokers attempt to match buyers with
sellers but do not stand ready to trade for their own
account. In other words, brokers do not use their own
capital to hold an inventory of the items for which they
make a market. The broker knows the prices bid and asked by
the respective parties, but each party is typically unaware
of another party’s price requirements. Prices of completed
transactions are sometimes available. Brokered markets
include electronic communication networks, in which buy and
sell orders are matched, and commercial and residential real
estate markets.
Dealer Market
A market in which dealers stand ready to trade (either buy or
sell for their own account), thereby providing liquidity by
using their capital to hold an inventory of the items for
which they make a market. Typically, bid and ask prices
(representing the price at which the dealer is willing to
buy and the price at which the dealer is willing to sell,
respectively) are more readily available than closing
prices. Over-the-counter markets (for which prices are
publicly reported by the National Association of Securities
Dealers Automated Quotations systems or by OTC Markets Group
Inc.) are dealer markets. For example, the market for U.S.
Treasury securities is a dealer market. Dealer markets also
exist for some other assets and liabilities, including other
financial instruments, commodities, and physical assets (for
example, used equipment).
Exchange Market
A market in which closing prices are both readily available
and generally representative of fair value. An example of
such a market is the New York Stock Exchange.
Principal-to-Principal Market
A market in which transactions, both originations and
resales, are negotiated independently with no intermediary.
Little information about those transactions may be made
available publicly.
An entity is not required to perform an exhaustive search to identify all markets
that could potentially be the principal market. In fact, unless contradictory
evidence exists, it is presumed that the market in which the entity normally
transacts is the principal market for the asset or liability. This concept is
discussed in paragraph BC23 of ASU
2011-04, which states:
In addition, the Boards concluded that a reporting entity normally enters
into transactions in the principal market for the asset or liability (that
is, the most liquid market, assuming that the reporting entity can access
that market). As a result, the Boards decided to specify that a reporting
entity can use the price in the market in which it normally enters into
transactions, unless there is evidence that the principal market and that
market are not the same. Consequently, a reporting entity does not need to
perform an exhaustive search for markets that might have more activity for
the asset or liability than the market in which that reporting entity
normally enters into transactions. Thus, the amendments address practical
concerns about the costs of searching for the market with the greatest
volume and level of activity for the asset or liability.
In a speech at the 2009 AICPA Conference on Current SEC and PCAOB
Developments, Evan Sussholz, then a professional accounting fellow in the SEC’s
Office of the Chief Accountant, addressed questions for entities to consider in
determining the principal (or most advantageous) market. Specifically, Mr. Sussholz
stated:
Question #1: What are the potential exit markets for an
asset and what is the asset’s principal or most advantageous
market?
For an actively-traded financial asset, the principal (or
most advantageous) market may simply be an exchange such as the NYSE or
NASDAQ. However, for many assets such as non-financial assets, determining
the principal (or most advantageous) market could be more difficult as the
market for these assets may be inactive or non-existent and observable
pricing information may not be readily available. Furthermore, certain
defining characteristics of individual markets may have an impact on the
timing and ultimate selling price of an asset. When performing an analysis
of each potential exit market, it may be important for a reporting entity to
understand the following:
-
Is the market for the asset active, inactive, or has it recently become inactive?
-
Are there distinct groups of potential market participants in that market such as strategic buyers and financial buyers? Within these groups, are there clusters of potential participants (i.e. small vs. large, profitable vs. unprofitable, etc.)
-
What is the competitive nature of the market (i.e. perfect competition, monopolistic or oligopolistic competition, fragmented markets)?
To begin our example, let’s assume that there are two
potential exit markets for the customer related intangible asset being
measured including the customer list broker market and the mergers and
acquisitions (M&A) market. Each of these markets has defining
characteristics such as level of activity, groups of market participants,
and differing levels of competitiveness. While a reporting entity may be
able to obtain some pricing information from both markets, significant
adjustments may be required to determine an estimated selling pricing for
the specific customer related intangible asset being measured.
In most cases, the principal market is the same as the most advantageous market.
Entities would generally change markets, unless impractical, if there was a more
advantageous market. However, if there is a principal market, the fair value
measurement should represent the fair value in that market even if the fair value in
a different market is potentially more advantageous.
6.3 Most Advantageous Market
ASC 820-10 — Glossary
Most Advantageous Market
The market that maximizes the amount that would be received
to sell the asset or minimizes the amount that would be paid
to transfer the liability, after taking into account
transaction costs and transportation costs.
The concept of a most advantageous market is relevant only when there is no principal
market for an asset, liability, or equity instrument. In identifying the most
advantageous market, an entity must consider both its own and market participants’
perspectives. An entity considers its own perspective in identifying markets that it
can access. An entity then considers market-participant perspectives in assessing
which of two or more accessible markets is the most advantageous market. Thus, the
assessment and considerations in Section 6.2
that pertain to determining the principal market are also relevant in an entity’s
determination of the most advantageous market. Note that while an entity considers
both transaction and transportation costs in determining the most advantageous
market, transaction costs are not included in a fair value measurement under ASC 820
(as discussed in Section 10.2.5.3).
6.4 Changes in the Principal or Most Advantageous Market
Events that could indicate a change in the principal (or most
advantageous) market include (1) a significant change in market conditions, (2) the
development of a new market, and (3) the entity’s obtaining access to a market to
which it previously did not have access. An entity must evaluate all facts and
circumstances in determining whether there has been a change in the principal (or
most advantageous) market. Events could lead to a conclusion that there is no longer
a principal market for an asset in which an entity would have to identify the most
advantageous market. Examples 6-2 and 6-3
illustrate scenarios in which potential changes in the principal (or most
advantageous) market have occurred.
At the 2023 AICPA Conference on Current SEC and PCAOB Developments, Gaurav
Hiranandani, senior associate chief accountant in the SEC’s Office of the Chief
Accountant, addressed various aspects of fair value measurement under ASC 820. He
noted that for more traditional markets, such as those for equities and commodities,
there may be a limited number of venues in which an entity can transact, and the
total volume and level of activity may be concentrated in just one or two of those
venues. In addition, market characteristics for those venues, such as pricing,
regulatory oversight, and the general availability and reliability of information,
may be fairly consistent; thus, a market participant may be able to make an informed
determination about the total overall transaction volume and about which one of
those venues is the principal or most advantageous market. However, such consistency
may not exist for crypto asset markets because of their continuing rapid evolution.
Further, the facts and circumstances relevant to the identification of the principal
or most advantageous market for crypto assets may change over time and may differ
from asset to asset as well as from entity to entity, depending on the activities in
which the entity engages.
6.5 Examples
Example 4 in ASC 820-10-55-42 through 55-45A illustrates a scenario in which two
entities may measure the same instrument differently because each entity identifies
a different principal (or most advantageous) market.
ASC 820-10
Example 4: Level 1 Principal (or Most Advantageous)
Market
55-42
Example 4 illustrates the use of Level 1 inputs to measure
the fair value of an asset that trades in different active
markets at different prices.
55-43
An asset is sold in two different active markets at
different prices. A reporting entity enters into
transactions in both markets and can access the price in
those markets for the asset at the measurement date. In
Market A, the price that would be received is $26,
transaction costs in that market are $3, and the costs to
transport the asset to that market are $2 (that is, the net
amount that would be received is $21). In Market B, the
price that would be received is $25, transaction costs in
that market are $1, and the costs to transport the asset to
that market are $2 (that is, the net amount that would be
received in Market B is $22).
55-44
If Market A is the principal market for the asset (that is,
the market with the greatest volume and level of activity
for the asset), the fair value of the asset would be
measured using the price that would be received in that
market, after taking into account transportation costs
($24).
55-45
If neither market is the principal market for the asset, the
fair value of the asset would be measured using the price in
the most advantageous market. The most advantageous market
is the market that maximizes the amount that would be
received to sell the asset after taking into account
transaction costs and transportation costs (that is, the net
amount that would be received in the respective
markets).
55-45A
Because the reporting entity would maximize the net amount
that would be received for the asset in Market B ($22), the
fair value of the asset would be measured using the price in
that market ($25), less transportation costs ($2), resulting
in a fair value measurement of $23. Although transaction
costs are taken into account when determining which market
is the most advantageous market, the price used to measure
the fair value of the asset is not adjusted for those costs
(although it is adjusted for transportation costs).
Further, Example 5 in ASC 820-10-55-46 through 55-49 illustrates a scenario in which
an entity’s principal entry markets differ from its principal exit markets.
ASC 820-10
Example 5:
Transaction Prices and Fair Value at Initial
Recognition — Interest Rate Swap at Initial
Recognition
55-46 This Topic (see paragraphs
820-10-30-3 through 30-3A) clarifies that in many cases the
transaction price, that is, the price paid (received) for a
particular asset (liability), will represent the fair value
of that asset (liability) at initial recognition, but not
presumptively. This Example illustrates when the price in a
transaction involving a derivative instrument might (and
might not) equal the fair value of the instrument at initial
recognition.
55-47 Entity A (a retail
counterparty) enters into an interest rate swap in a retail
market with Entity B (a dealer) for no initial consideration
(that is, the transaction price is zero). Entity A can
access only the retail market. Entity B can access both the
retail market (that is, with retail counterparties) and the
dealer market (that is, with dealer counterparties).
55-48 From the perspective of
Entity A, the retail market in which it initially entered
into the swap is the principal market for the swap. If
Entity A were to transfer its rights and obligations under
the swap, it would do so with a dealer counterparty in that
retail market. In that case, the transaction price (zero)
would represent the fair value of the swap to Entity A at
initial recognition, that is, the price that Entity A would
receive to sell or pay to transfer the swap in a transaction
with a dealer counterparty in the retail market (that is, an
exit price). That price would not be adjusted for any
incremental (transaction) costs that would be charged by
that dealer counterparty.
55-49 From the perspective of
Entity B, the dealer market (not the retail market) is the
principal market for the swap. If Entity B were to transfer
its rights and obligations under the swap, it would do so
with a dealer in that market. Because the market in which
Entity B initially entered into the swap is different from
the principal market for the swap, the transaction price
(zero) would not necessarily represent the fair value of the
swap to Entity B at initial recognition.
Below are four additional examples illustrating the determination of the principal
(or most advantageous) market.
Example 6-1
Multiple Markets in Different Countries
Entity A, a global commodity company that connects commodity
buyers around the world, has a commodity sourcing strategy
for customers located in Country Z. The commodities are
recognized at fair value by A.
As part of A’s commodity sourcing strategy, a wholly owned
subsidiary of A that is domiciled in Country Y buys the
commodities in Country Y and executes intercompany sales of
the commodities to a wholly owned subsidiary in Country Z.
Country Z faces certain heightened economic risks stemming
from uncertainty in its access to foreign currency in the
amounts necessary to satisfy large-scale contracts as well
as other limitations that have resulted from economic
sanctions placed on it by other countries.
Commodities are delivered to Country Z through Country Y,
which is adjacent to Country Z. There is an active market in
Country Y that can rapidly absorb significant amounts of a
particular commodity. Because A readily has access to, and
the ability to transact in, the active market in Country Y,
it can sell the commodity to buyers in Country Z after
incurring insignificant transportation costs. Entity A may
also purchase the commodity in Country Z; however, the
market in Country Z is not active. As a result, the
commodities sold to customers in Country Z are purchased in
Country Y.
Entity A should assess its principal market for the commodity
from its own perspective. Only in the absence of a principal
market may A look to prices in the most advantageous market.
Two entities may measure the same commodity differently
because each entity identifies a different principal market
on the basis of its own activities.
Entity A purchases and stores in Country Y the commodities
that it sells to Country Z. Although A may purchase
quantities of the commodity in Country Z to sell to
customers in that country, A should look to Country Y when
determining the fair value of the commodities sold to
customers in Country Z, given the presence of an active
market in Country Y (i.e., the market with the greatest
level of activity and volume exists for the commodity).
Although there is a market for the commodity in Country Z,
it could not represent the market in the determination of
the fair value of the commodity, since there is a principal
market for the commodity in Country Y.
Example 6-2
Purchases in Multiple
Markets
Entity B is a global commodity company that
holds commodities in several different storage facilities in
different geographic regions. These commodities are carried
at fair value.
Entity B holds a certain quantity of
commodities in Country W that it expects to sell to
customers in that country. Country W has an active market
for the commodities that can rapidly absorb significant
amounts of them, and B readily has access to, as well as the
ability to transact in, that market. While the market for
the commodity in Country W is considered active and is the
market in which B sells the commodity, in certain instances,
B will sell the commodities held in storage in Country W on
the F Exchange, which is in a neighboring country and is an
active market for the commodity that can rapidly absorb
significant amounts of it. The F Exchange is the commodities
exchange that is closest to Country W and is the primary
exchange for the commodity in the broader geographic area.
Entity B incurs transportation costs to deliver commodities
to the F Exchange, and those costs typically result in a
lower margin than when the commodities are sold in the
active market in Country W. However, B sells the commodities
on the F Exchange in certain instances, primarily when its
transaction volume is seasonally abnormal or it is balancing
its sales activities.
Typically, Country W would be considered the principal market
for the commodity. However, identification of the principal
market should be reassessed in each reporting period. If, in
response to larger macroeconomic or other relevant factors,
B were to temporarily cease transacting in Country W, the F
Exchange could be viewed as the principal market.
Country W would generally be considered the principal market
for the commodity on the basis of the following:
-
There is a rebuttable presumption that, in the absence of evidence to the contrary, the market in which an entity normally would transact (i.e., the market in Country W) is the principal market.
-
Country W has an active market that can rapidly absorb significant amounts of the commodity, and B has ready access to, as well as the ability to transact in, that market.
-
Although the F Exchange constitutes an active market that B transacts in and has the ability to access, the F Exchange would not constitute B’s principal market because:
-
Entity B normally transacts in the active market in Country W.
-
Transactions that B enters into on the F Exchange are executed primarily when B’s transaction volumes are seasonally abnormal or it wants to balance its sales activities.
-
Given the transportation costs that it would incur to sell the commodity on the F Exchange, B concludes that the value is maximized when the sales occur on the active market in Country W.
-
Entity B typically has access to the market in Country W; from time to time, however, B may choose to sell the commodity on the F Exchange. Periodic ebbs and flows of activity are not an indication that B must change the identification of its principal market.
-
If, however, there was a significant economic event, which
caused a significant change in market conditions, including
a lack of liquidity in the market in Country W, B may
temporarily cease transacting in the market in Country W and
may transact on the F Exchange. As a result, B may conclude
that its principal market for the commodity has changed even
if the change is temporary. However, in reaching such a
conclusion, B should consider how long it expects to
primarily transact on the F Exchange.
Example 6-3
Reassessment of Principal Market
Entity C buys and sells credit default
swaps. The credit default swap market for some exposures is
primarily a principal-to-principal or over-the-counter (OTC)
market. The volume and level of activity for credit default
swaps in the exchange market increase and decrease over
time. In such cases, C may need to reassess the principal
market and would not necessarily be limited by past volume
or level of transactions in determining its principal
market. In performing this assessment, C should consider the
current activity level and expectations about how market
participants will transact in the future as well as its
ability to access the exchange market.
Example 6-4
Multiple Principal
Markets in Consolidated Financial Statements
Parent D owns Subsidiary A, based in the
United States, and Subsidiary B, based in Hong Kong. Both A
and B own shares of XYZ, which is publicly traded on the
NYSE and the Hong Kong Exchange (HKEx), and each market in
shares of XYZ is considered active. Subsidiary A purchased
its shares of XYZ on the NYSE, and B purchased its shares of
XYZ on the HKEx. Both A and B are legally prohibited from
transferring their investments in shares of XYZ to D or
other subsidiaries of D. Both A and B recognize their XYZ
shares at fair value through earnings. As of the end of the
reporting period, A and B both measure the fair value of XYZ
by using the price in the principal market, which they have
determined to be their respective local stock exchanges
because of differences in the ability to access the
respective exchanges. ASC 820 specifies that if there is a
principal market for the asset, the fair value measurement
should represent the price in that market, even if the price
in a different market is potentially more advantageous on
the measurement date. Therefore, A would use the quoted
price from the NYSE, which may be greater or less than the
quoted price from the HKEx. Subsidiary B should use the
quoted price from the HKEx, which may be greater or less
than the quoted price from the NYSE.
If A and B were not legally prohibited from
transferring their investments in shares of XYZ to D or
related subsidiaries, both A and B would consider access to
the HKEx and NYSE exchanges, respectively, through
transfers. As a result, the reporting entity might have a
single principal (or most advantageous) market for all
subsidiaries (businesses) within the consolidated group that
have invested in XYZ.
Chapter 7 — Market-Participant Assumptions
Chapter 7 — Market-Participant Assumptions
7.1 Characteristics of Market Participants
ASC 820-10
Market Participants
35-9 A
reporting entity shall measure the fair value of an asset or
a liability using the assumptions that market participants
would use in pricing the asset or liability, assuming that
market participants act in their economic best interest. In
developing those assumptions, a reporting entity need not
identify specific market participants. Rather, the reporting
entity shall identify characteristics that distinguish
market participants generally, considering factors specific
to all of the following:
-
The asset or liability
-
The principal (or most advantageous) market for the asset or liability
-
Market participants with whom the reporting entity would enter into a transaction in that market.
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.
To meet the fair value measurement objective in ASC 820, an entity must develop
assumptions that market participants would use to determine the price of an asset,
liability, or equity instrument in an orderly transaction as of the measurement
date. ASC 820 defines the term “market participants” as follows:
Buyers and sellers in the principal (or most advantageous) market for the
asset or liability that have all of the following characteristics:
-
They are independent of each other, that is, they are not related parties, although the price in a related-party transaction may be used as an input to a fair value measurement if the reporting entity has evidence that the transaction was entered into at market terms [see Section 7.1.1]
-
They are knowledgeable, having a reasonable understanding about the asset or liability and the transaction using all available information, including information that might be obtained through due diligence efforts that are usual and customary [see Section 7.1.2]
-
They are able to enter into a transaction for the asset or liability [see Section 7.1.3]
-
They are willing to enter into a transaction for the asset or liability, that is, they are motivated but not forced or otherwise compelled to do so [see Section 7.1.4].
See Chapter 6 for discussion of the
determination of the principal (or most advantageous) market.
7.1.1 Independence
As noted in the glossary definition above, market participants are considered
independent when “they are not related parties.” However, the definition also
indicates that “the price in a related-party transaction may be used as an input
to a fair value measurement if the reporting entity has evidence that the
transaction was entered into at market terms.” The determination that an exit
price is at market terms can be considered comparable to the determination that
a transaction between two parties was at arm’s length.
Paragraph BC25 of ASU 2011-04
discusses the requirement for market participants to be independent and states,
in part:
Before the amendments, Topic 820 described market
participants as being independent of the reporting entity.
Because fair value assumes an orderly transaction between market
participants at the measurement date and not an orderly
transaction between the reporting entity and another market
participant, the Board decided to clarify that the term
independence in the definition of market participant means
that market participants are independent of each other (that is,
they are not related parties).
7.1.2 Knowledgeability
Market participants must be knowledgeable about the transaction. That is, they
must have a “reasonable understanding about” the asset, liability, or equity
instrument subject to the fair value measurement and, accordingly, need
sufficient information to make a reasoned economic decision. In making such a
decision, a market participant would perform the usual and customary due
diligence that is part of an orderly transaction. An entity should use judgment
in determining whether a potential buyer or seller is knowledgeable and has the
necessary information to make a reasoned economic decision.
7.1.3 Ability to Enter Into a Transaction
Market participants must be capable of entering into a transaction for the asset,
liability, or equity instrument subject to the fair value measurement. An entity
must consider all relevant facts and circumstances in determining whether a
potential buyer or seller is able to enter into a transaction, including the
financial capabilities related to acquiring the asset, any potential legal
restrictions, and any operational issues that would prevent the transaction from
occurring.
7.1.4 Willingness to Enter Into a Transaction
Market participants must be “willing to enter into a transaction for” the asset,
liability, or equity instrument subject to the fair value measurement (i.e.,
they must be “motivated but not forced or otherwise compelled to do so”). An
entity must ensure that the potential buyer or seller is willing to enter into
the transaction by considering all relevant facts and circumstances.
In a speech at the 2008 AICPA Conference on Current SEC and
PCAOB Developments, Muneera Carr, then a professional accounting fellow in the
SEC’s Office of the Chief Accountant, provided some of the SEC staff’s views on
the willingness of market participants to enter into a transaction. Ms. Carr
stated, in part:
The [ASC 820] definition of fair value contemplates a
hypothetical transaction that is both orderly and conducted between
willing market participants. An orderly transaction is one where the
asset or liability is marketed to potential buyers for a period that is
usual and customary. In any environment but especially in the current
one, transactions may result in pricing that potential sellers may not
view as “favorable”. Unfavorable pricing or reduced liquidity do not
constitute, in and of themselves, a distressed sale or a forced
liquidation under [ASC 820] if the asset can be sold in a period that is
usual and customary. Reduced transaction volume and wide bid-ask spreads
may be helpful indicators in understanding whether market participants
are willing to transact for the asset. However, judgment should be
exercised to determine whether buyers and sellers in orderly
transactions are those who are motivated but not forced to transact and
therefore can be considered ‘willing market participants’. Said
differently, while [ASC 820’s] definition of fair value is based on an
orderly transaction, it also states that such transactions should be
between market participants and market participants are defined as both
buyers and sellers willing to transact for an asset or liability because
they are motivated rather than because they are forced to do so.
[Footnotes omitted]
7.1.4.1 Unwillingness of a Seller to Transact at Current Prices
ASC 820-10
Measuring Fair Value When the Volume or Level of
Activity for an Asset or a Liability Has
Significantly Decreased
35-54H Estimating the
price at which market participants would be willing
to enter into a transaction at the measurement date
under current market conditions if there has been a
significant decrease in the volume or level of
activity for the asset or liability depends on the
facts and circumstances at the measurement date and
requires judgment. A reporting entity’s intention to
hold the asset or to settle or otherwise fulfill the
liability is not relevant when measuring fair value
because fair value is a market-based measurement,
not an entity-specific measurement.
An entity’s unwillingness to transact at current prices for an asset it owns
or a liability it owes is not a sufficient reason for such observable prices
to be disregarded. ASC 820-10-35-54H states that “[a] reporting entity’s
intention to hold the asset or to settle or otherwise fulfill the liability
is not relevant when measuring fair value because fair value is a
market-based measurement, not an entity-specific measurement.” However, an
entity is responsible for determining fair value and must assess whether a
price from an external source is representative of fair value as of the
measurement date.
See Section 10.6.3.2 for further discussion of an
entity’s unwillingness to transact at current prices.
7.2 Determining Market-Participant Assumptions
A fair value measurement is not entity-specific; rather, as indicated in ASC
820-10-35-9, an entity must “identify characteristics that distinguish market
participants generally” by considering the asset, liability, or equity instrument
subject to the fair value measurement; the principal (or most advantageous) market;
and the “[m]arket participants with whom the reporting entity would enter into a
transaction in that market.” This approach is consistent with the fair value
objective (i.e., fair value is measured on the basis of assumptions used by market
participants). An entity may not substitute its own assumptions for those of market
participants.
In a speech at the 2009 AICPA Conference on Current SEC and PCAOB
Developments, Evan Sussholz, then a professional accounting fellow in the SEC’s
Office of the Chief Accountant, discussed factors an entity should consider in
determining market-participant assumptions and whether its own assumptions are
comparable or different. Mr. Sussholz stated, in part:
Question #3: Who are the potential market participants
and what are their distinguishing characteristics?
As you may know, Codification Topic 820 does not require a
reporting entity to identify specific market participants. However, when
measuring fair value it is important to understand the characteristics that
distinguish market participants. The identification of these characteristics
will play a significant role in understanding how market participants would
use the asset being measured, along with the value that those market
participants would place on that asset.
For example, let’s say there are two broad groups of market
participants within the M&A market for a customer related intangible
asset: financial buyers and strategic buyers. The strategic buyer group can
be divided further into two categories: regional competitors and national
competitors. In this example, the financial buyers, the regional
competitors, and the national competitors would acquire this asset as a part
of an M&A transaction for the entire entity and maximize value by
operating this asset in conjunction with the other assets of the target
business. However, the ultimate value that each group would place on the
customer related intangible may depend on many factors including financial
capacity, acquisition strategy, market participant synergies, market share,
complementary assets, management capabilities, etc.
Question #4: How do the market participant
characteristics compare to the reporting entity’s own
characteristics?
To answer this last question, a reporting entity should
reconcile the significant distinguishing characteristics of the identified
market participant groups to those of the reporting entity. The results of
this reconciliation process will determine if the entity’s own assumptions
should be adjusted to appropriately measure the fair value of an asset.
In our example, the reporting entity has determined the
principal (or most advantageous) market, the highest and best use of the
asset, along with the distinguishing characteristics of the potential market
participants. For illustrative purposes, let’s say that the reporting entity
has determined that a regional competitor would be the most likely market
participant to acquire the customer related intangible asset and maximize
value by operating this asset in conjunction with other assets. The
reporting entity would then compare its own characteristics (both
quantitative and qualitative factors) to those of a regional competitor to
determine if its own assumptions are representative of market participant
assumptions.
We anticipate that there may be instances when a reporting
entity determines that its own assumptions are not significantly different
than those of market participants. However, it is our expectation that a
reporting entity will apply reasonable judgment when making this
determination. The items that I just highlighted are just examples of the
questions that I anticipate a reporting entity would consider in determining
market participant assumptions. There are likely to be additional factors
that one could consider when performing this analysis. Additionally, I would
like to point out that the process of determining market participant
assumptions can be iterative. Therefore, it is likely that questions will
not always be answered sequentially, but will be answered continuously
throughout the process of determining market participant assumptions.
Lastly, I think it is reasonable to anticipate that the
staff will continue to inquire about the process employed and judgments made
by a reporting entity when developing market participant assumptions.
Furthermore, we have observed that conversations are generally more
productive when a reporting entity has documented how market participant
assumptions were developed when performing a fair value measurement.
The example below further illustrates these concepts.
Example 7-1
Credit Risk of Receivables
Entity A, a financial institution that has loan receivables
from borrowers, is determining whether to include the
borrower’s credit standing in the fair value measurement of
the receivables. Because market participants would
incorporate the borrower’s credit standing into the
valuation of a loan receivable, A must consider the
borrower’s credit standing in performing this measurement in
accordance with ASC 820. The reason for this requirement is
that the borrower’s credit standing can potentially affect
the proceeds that will be received from the borrower and
market participants would take such considerations into
account in determining the transaction price for these
receivables.
7.3 Lack of Market Participants
In certain situations, there may be either a lack of market
participants or limited information about the assumptions used by available market
participants. Evan Sussholz, then a professional accounting fellow in the SEC’s
Office of the Chief Accountant, addressed such situations in a speech at the 2009 AICPA Conference on Current SEC and PCAOB
Developments. Mr. Sussholz stated, in part:
Now, I’d like to provide a few thoughts on developing market
participant assumptions when measuring fair value.
As many of you know, Codification Topic 820 requires that
fair value measurements be performed from the perspective of market
participants. While this requirement is easy to understand conceptually, the
staff understands that some practitioners have encountered challenges trying
to implement it in practice for assets and liabilities where observable
pricing information is not available. In limited instances, market
participant assumptions may not be readily available without undue cost and
effort. Furthermore, it is possible that assumptions may vary substantially
based on the facts and circumstances of each category of market
participants. As a result, the lack of information or inability to obtain
consistent information may present challenges in developing market
participant assumptions when measuring fair value.
Understanding these challenges, I wanted to provide you with
our views of how one could look at developing market participant assumptions
for fair value measurements. In general, I anticipate that most fair value
measurements of assets or liabilities that trade in inactive markets or for
which a market doesn’t exist will begin by looking at a reporting entity’s
own assumptions. These assumptions may include the reporting entity’s
expected use of the asset, the asset’s life, and any related cash flow
estimates from the use or sale of the asset. Using those assumptions as a
starting point, reasonable judgment should be applied to determine if an
entity’s own assumptions are representative of market participant
assumptions. We would suggest a reporting entity consider the following
questions when performing this analysis. In order to illustrate how one
might consider these questions in practice, I have also included a
simplified example of a customer related intangible asset.
7.4 Multiple Market Participants With Different Assumptions
The following example from ASC 820-10-55-26 through 55-29
illustrates a situation in which there are multiple potential market participants
and the entity is required to identify and consider the market-participant
assumptions that maximize the fair value on the basis of the unit of valuation:
ASC 820-10
Example 1: Highest and Best Use and Valuation
Premise
Case A: Asset Group
55-26
A reporting entity acquires assets and assumes liabilities
in a business combination. One of the groups of assets
acquired comprises Assets A, B, and C. Asset C is billing
software integral to the business developed by the acquired
entity for its own use in conjunction with Assets A and B
(that is, the related assets). The reporting entity measures
the fair value of each of the assets individually,
consistent with the specified unit of account for the
assets. The reporting entity determines that the highest and
best use of the assets is their current use and that each
asset would provide maximum value to market participants
principally through its use in combination with other assets
or with other assets and liabilities (that is, its
complementary assets and the associated liabilities). There
is no evidence to suggest that the current use of the assets
is not their highest and best use.
55-27
In this situation, the reporting entity would sell the
assets in the market in which it initially acquired the
assets (that is, the entry and exit markets from the
perspective of the reporting entity are the same). Market
participant buyers with whom the reporting entity would
enter into a transaction in that market have characteristics
that are generally representative of both strategic buyers
(such as competitors) and financial buyers (such as private
equity or venture capital firms that do not have
complementary investments) and include those buyers that
initially bid for the assets. Although market participant
buyers might be broadly classified as strategic or financial
buyers, in many cases there will be differences among the
market participant buyers within each of those groups,
reflecting, for example, different uses for an asset and
different operating strategies.
55-28
As discussed below, differences between the indicated fair
values of the individual assets relate principally to the
use of the assets by those market participants within
different asset groups:
-
Strategic buyer asset group. The reporting entity determines that strategic buyers have related assets that would enhance the value of the group within which the assets would be used (that is, market participant synergies). Those assets include a substitute asset for Asset C (the billing software), which would be used for only a limited transition period and could not be sold on its own at the end of that period. Because strategic buyers have substitute assets, Asset C would not be used for its full remaining economic life. The indicated fair values of Assets A, B, and C within the strategic buyer asset group (reflecting the synergies resulting from the use of the assets within that group) are $360, $260, and $30, respectively. The indicated fair value of the assets as a group within the strategic buyer asset group is $650.
-
Financial buyer asset group. The reporting entity determines that financial buyers do not have related or substitute assets that would enhance the value of the group within which the assets would be used. Because financial buyers do not have substitute assets, Asset C (that is, the billing software) would be used for its full remaining economic life. The indicated fair values of Assets A, B, and C within the financial buyer asset group are $300, $200, and $100, respectively. The indicated fair value of the assets as a group within the financial buyer asset group is $600.
55-29
The fair values of Assets A, B, and C would be determined on
the basis of the use of the assets as a group within the
strategic buyer group ($360, $260, and $30). Although the
use of the assets within the strategic buyer group does not
maximize the fair value of each of the assets individually,
it maximizes the fair value of the assets as a group
($650).
Chapter 8 — Fair Value Hierarchy
Chapter 8 — Fair Value Hierarchy
8.1 Introduction
8.1.1 General
ASC 820-10
Fair Value Hierarchy
35-37 To
increase consistency and comparability in fair value
measurements and related disclosures, this Topic
establishes a fair value hierarchy that categorizes into
three levels (see paragraphs 820-10-35-40 through 35-41,
820-10-35-41B through 35-41C, 820-10-35-44, 820-10-35-46
through 35-51, and 820-10-35-52 through 35-54A) the
inputs to valuation techniques used to measure fair
value. The fair value hierarchy gives the highest
priority to quoted prices (unadjusted) in active markets
for identical assets or liabilities (Level 1 inputs) and
the lowest priority to unobservable inputs (Level 3
inputs).
35-38 The
availability of relevant inputs and their relative
subjectivity might affect the selection of appropriate
valuation techniques (see paragraph 820-10-35-24).
However, the fair value hierarchy prioritizes the inputs
to valuation techniques, not the valuation techniques
used to measure fair value. For example, a fair value
measurement developed using a present value technique
might be categorized within Level 2 or Level 3,
depending on the inputs that are significant to the
entire measurement and the level of the fair value
hierarchy within which those inputs are categorized.
ASC 820-10 — Glossary
Level 1 Inputs
Quoted prices (unadjusted) in active markets for
identical assets or liabilities that the reporting
entity can access at the measurement date.
Level 2 Inputs
Inputs other than quoted prices included within Level 1
that are observable for the asset or liability, either
directly or indirectly.
Level 3 Inputs
Unobservable inputs for the asset or liability.
The FASB established the fair value hierarchy in FASB Statement 157 (codified in
ASC 820) to increase the consistency and comparability of fair value
measurements and disclosures about such measurements. The hierarchy is divided
into three categories on the basis of the relative observability and reliability
of the inputs used in a fair value measurement. The categorization of inputs is
important both to estimating fair value and to providing disclosures about such
measurements.
With respect to measuring fair value, the fair value hierarchy focuses on inputs
rather than valuation techniques. However, ASC 820-10-35-38 indicates that the
availability of inputs and their relative subjectivity might affect the
selection of the valuation technique. For example, a valuation technique in
which an entity uses relevant inputs classified within Level 2 of the fair value
hierarchy takes precedence over a valuation technique containing significant
unobservable inputs (i.e., Level 3 inputs). In addition, with limited
exceptions, an entity is precluded from using a valuation technique that employs
Level 2 or Level 3 inputs if a Level 1 quoted market price in an active market
is available for an asset, liability, or equity instrument subject to fair value
measurement.
As discussed in Chapter 11, for recurring
and nonrecurring fair value measurements, all entities are required to disclose
the level of the fair value hierarchy within which the measurements are
categorized in their entirety (i.e., Level 1, 2, or 3). Such disclosures are
provided on the basis of the inputs used in the fair value measurements. As a
result, it is critical that entities apply the guidance appropriately in
assessing the appropriate level of the fair value hierarchy within which an item
is measured or disclosed at fair value.
8.1.2 Determining the Classification of a Fair Value Measurement
ASC 820-10
Fair Value Hierarchy
35-37A In
some cases, the inputs used to measure the fair value of
an asset or a liability might be categorized within
different levels of the fair value hierarchy. In those
cases, the fair value measurement is categorized in its
entirety in the same level of the fair value hierarchy
as the lowest level input that is significant to the
entire measurement. Assessing the significance of a
particular input to the entire measurement requires
judgment, taking into account factors specific to the
asset or liability. Adjustments to arrive at
measurements based on fair value, such as costs to sell
when measuring fair value less costs to sell, shall not
be taken into account when determining the level of the
fair value hierarchy within which a fair value
measurement is categorized.
35-38A If an
observable input requires an adjustment using an
unobservable input and that adjustment results in a
significantly higher or lower fair value measurement,
the resulting measurement would be categorized within
Level 3 of the fair value hierarchy. For example, if a
market participant would take into account the effect of
a restriction on the sale of an asset when estimating
the price for the asset, a reporting entity would adjust
the quoted price to reflect the effect of that
restriction. If that quoted price is a Level 2 input and
the adjustment is an unobservable input that is
significant to the entire measurement, the measurement
would be categorized within Level 3 of the fair value
hierarchy.
As noted in ASC 820-10-35-37A, inputs used in a fair value measurement “might be
categorized within different levels of the fair value hierarchy.” As a result,
the asset, liability, or equity instrument will be categorized in its entirety
within a level of the fair value hierarchy on the basis of the lowest-level
input that is significant to the fair value measurement.
To assess the level of the fair value hierarchy in which an
asset, liability, or equity instrument should be categorized, an entity should
first determine the inputs that it will use as part of its valuation technique
for that instrument. The entity should then assess the level of the fair value
hierarchy in which each input would be categorized in accordance with ASC
820-10-35-37 through 35-54A. See Sections
8.2, 8.3, and 8.4 for more information about Level 1, Level 2,
and Level 3 inputs.
After assessing the level of the fair value hierarchy in which each input should
be categorized, the entity should determine the lowest level of the fair value
hierarchy in which an input that is significant to the fair value measurement is
categorized. The entity should classify the entire asset, liability, or equity
instrument in that level of the fair value hierarchy. For example, a fair value
measurement that includes significant Level 2 inputs and significant Level 3
inputs would be classified in its entirety within Level 3.
ASC 820-10 does not establish a bright line for significance or
mandate that significance be determined quantitatively. Rather, as noted in ASC
820-10-35-37A, an entity must use judgment in making this determination, “taking
into account factors specific to the asset or liability.” Therefore, an entity
should establish a method for determining whether an input is significant to a
fair value measurement in its entirety and should apply this method
consistently. The method might include a threshold or percentage of the overall
measurement amount as a benchmark for significance. The threshold should
represent a percentage of the overall measurement and not a percentage of a
particular component of the measurement or the income statement effect of the
measurement (i.e., the threshold should be based on a balance sheet approach).
In determining significance for particularly complex valuations, an entity may
need to consider how a particular input or inputs behave within a reasonable
range of expected outcomes (i.e., a sensitivity analysis). The three examples
below illustrate how an entity might determine whether an unobservable input is
significant to a fair value measurement.
Example 8-1
Evaluation of Unobservable Volatility Input
Entity A is evaluating whether the unobservable
volatility input to a valuation technique used to
measure the fair value of a hybrid financial instrument
that contains an embedded option is significant to the
overall fair value measurement. Entity A should consider
the significance of the unobservable volatility relative
to the hybrid financial instrument in its entirety and
not solely the embedded option. Depending on the nature
of the inputs to the hybrid financial instrument, A may
need to perform a sensitivity analysis of the
unobservable volatility input to determine its
significance. Such an analysis might include considering
how the unobservable volatility input affects the fair
value of the hybrid financial instrument within a range
of reasonable expected outcomes.
Example 8-2
Evaluation of Adjustment Made to an Observable
Transaction Price
Recent transactions between independent third parties or
between the entity and third parties (e.g., quoted
prices in an inactive market, privately negotiated
acquisitions, or dispositions of the entity’s equity or
debt) may be considered Level 2 inputs. This is the case
if the transaction price meets the definition of fair
value (i.e., the price represents an exit price for the
item as of the date of the transaction, the transaction
is not executed under duress, and the transaction is
executed at terms that are consistent with how other
market participants would transact).
In addition, an investor’s recent acquisition or
disposition of interests in the entity may be considered
a Level 2 input if it meets the criteria above. For
example, an investor may own a 25 percent equity
investment in an entity that it recognizes at fair
value. If the investor acquires another 10 percent
equity investment in the entity and the acquisition
meets the definition of fair value, the investor may use
the price at which it acquired the additional 10 percent
interest as a basis for valuing its entire 35 percent
equity investment as of the next reporting date.
The investor must adjust the transaction price, if
necessary, to appropriately measure the investment at
fair value as of the reporting date. For example, the
investor would adjust the transaction price for changes
in the entity’s financial position or for events that
have occurred since the date of the transaction that
would affect the fair value of the entity’s shares.
Unobservable adjustments that are significant to the
measurement would render the fair value measurement of
the investment a Level 3 measurement.
Example 8-3
Evaluation of Adjustment Made to a Level 2
Input
ASC 820-10-55-21(h) indicates that a “Level 2 input would
be a valuation multiple (for example, a multiple of
earnings or revenue or a similar performance measure)
derived from observable market data, for example,
multiples derived from prices in observed transactions
involving comparable (that is, similar) businesses,
taking into account operational, market, financial, and
nonfinancial factors.” The market-derived multiple may
be considered a Level 2 input; however, the historical
financial measure (i.e., earnings or EBITDA) and any
adjustments needed to reflect differences between the
entity and comparable entities would most likely be
Level 3 inputs because these factors are entity-specific
and are not considered market-observable data.
Therefore, the fair value measurement of the investment
would most likely be classified within Level 3 of the
fair value hierarchy.
Connecting the Dots
As discussed in Section 2.3.3,
under ASC 810, a reporting entity that consolidates an eligible CFE may
elect to measure the less observable of the fair value of the CFE’s
financial assets or the fair value of the CFE’s financial liabilities by
using the more observable of the two measurements (the “CFE fair value
measurement alternative”). See ASC 810-10-15-17D for discussion of the
eligibility requirements related to this fair value measurement
alternative. In addition, ASC 810-10-30-10 through 30-16 and ASC
810-10-35-6 through 35-9 provide guidance on applying the CFE fair value
measurement alternative to initial and subsequent fair value
measurements, respectively.
When applying the CFE fair value measurement alternative, a reporting
entity must disclose, for the financial assets and the financial
liabilities of the CFE, the information required by ASC 820 on fair
value measurement and by ASC 825 on financial instruments. Accordingly,
the required disclosures apply to both the less observable and the more
observable of the two measurements (although disclosures are not
required for certain assets and liabilities that are incidental to the
operations of the CFE and have carrying values that approximate fair
value). In providing such disclosures, an entity must categorize the
fair value measurement by level within the fair value hierarchy. ASC
810-10-50-21 states that for the less observable fair value measurement,
the reporting entity must “disclose that the amount was measured on the
basis of the more observable of the fair value of the financial
liabilities and the fair value of the financial assets.”
To determine the level of the fair value hierarchy in which an entity
should categorize the less observable fair value measurement, the
reporting entity must first identify the inputs to the more observable
fair value measurement. Such inputs include all of those used to
calculate the fair value of the more observable measurement, which is
described in the guidance in ASC 810-10-30-10 through 30-16 and ASC
810-10-35-6 through 35-9 on applying the CFE fair value measurement
alternative.
For example, if the fair value of the CFE’s financial assets is more
observable than the fair value of the CFE’s financial liabilities, the
reporting entity should treat all of the following as inputs to the less
observable fair value measurement (if applicable) in a manner consistent
with ASC 810-10-30-12:
-
The fair value of the financial assets, including (1) loans, (2) derivatives, and (3) the carrying values of any financial assets that are incidental to the CFE’s operations because the financial assets’ carrying values approximate their fair values.
-
The carrying value of any nonfinancial assets held temporarily (e.g., real estate measured at historical cost less impairment).
-
The fair value of any beneficial interests retained by the reporting entity (other than those that represent compensation for services).
-
The reporting entity’s carrying value of any beneficial interests that represent compensation for services.
Next, the reporting entity must assess the observability of these inputs
and determine whether the unobservable inputs are significant to the
less observable fair value measurement. In performing this assessment,
the entity must also consider any method used to allocate the amounts to
the less observable fair value measurement, since such allocation is
considered an input to the fair value measurement. The allocation may be
performed on the basis of significant unobservable inputs, which would
render the fair value measurement of the less observable measurement as
a Level 3 measurement even if the fair value measurement of the more
observable measurement is not categorized within Level 3.
The less observable fair value measurement cannot be categorized within
Level 1 because the fair value measurement does not apply to the
identical asset or liability.
8.2 Level 1 Inputs
8.2.1 General
ASC 820-10
Level 1 Inputs
35-40 Level 1 inputs are
quoted prices (unadjusted) in active markets for
identical assets or liabilities that the reporting
entity can access at the measurement date.
35-41 A quoted price in an
active market provides the most reliable evidence of
fair value and shall be used without adjustment to
measure fair value whenever available, except as
specified in paragraph 820-10-35-41C.
35-41C A reporting entity
shall not make an adjustment to a Level 1 input except
in the following circumstances:
-
When a reporting entity holds a large number of similar (but not identical) assets or liabilities (for example, debt securities) that are measured at fair value and a quoted price in an active market is available but not readily accessible for each of those assets or liabilities individually (that is, given the large number of similar assets or liabilities held by the reporting entity, it would be difficult to obtain pricing information for each individual asset or liability at the measurement date). In that case, as a practical expedient, a reporting entity may measure fair value using an alternative pricing method that does not rely exclusively on quoted prices (for example, matrix pricing). However, the use of an alternative pricing method results in a fair value measurement categorized within a lower level of the fair value hierarchy.
-
When a quoted price in an active market does not represent fair value at the measurement date. That might be the case if, for example, significant events (such as transactions in a principal-to-principal market, trades in a brokered market, or announcements) take place after the close of a market but before the measurement date. A reporting entity shall establish and consistently apply a policy for identifying those events that might affect fair value measurements. However, if the quoted price is adjusted for new information, the adjustment results in a fair value measurement categorized within a lower level of the fair value hierarchy.
-
When measuring the fair value of a liability or an instrument classified in a reporting entity’s shareholders’ equity using the quoted price for the identical item traded as an asset in an active market and that price needs to be adjusted for factors specific to the item or the asset (see paragraph 820-10-35-16D). If no adjustment to the quoted price of the asset is required, the result is a fair value measurement categorized within Level 1 of the fair value hierarchy. However, any adjustment to the quoted price of the asset results in a fair value measurement categorized within a lower level of the fair value hierarchy.
For a fair value measurement to qualify as a Level 1 measurement, or for an input
into a fair value measurement to qualify as a Level 1 input, the price (input)
must be a quoted price (unadjusted) in an active market for an identical asset
or liability that the reporting entity can access as of the measurement date.
Additional criteria for a Level 1 input are as follows:
-
Quoted price in an active market — See Section 8.2.2 for more information about what constitutes an active market.
-
Unadjusted — ASC 820-10-35-41C indicates that any adjustment (regardless of significance) to a fair value measurement (input) that would otherwise meet the Level 1 criteria results in a fair value measurement (input) that must be “categorized within a lower level of the fair value hierarchy.” See Section 8.2.3 for more information about adjustments to Level 1 inputs.
-
Identical asset or liability — For a fair value measurement (input) to qualify as a Level 1 measurement (input), the price used in the fair value measurement must be for an identical asset or liability held by the reporting entity. See Examples 8-4 through 8-7 for more information.
-
Access to the price as of the measurement date — The reporting entity must have access to the price as of the measurement date. For example, an entity has access to the price if it has the ability to transact at the price in an exchange market. An entity also has access if there are dealers that stand ready to transact with the entity at the price. Broker quotes alone are not sufficient evidence that the entity has access to the price if those brokers do not stand ready to transact at the price. Any adjustment made to a quoted price in an active market, because of limited or no market access, would result in a Level 2 or Level 3 measurement (input) depending on the nature of the adjustment. In addition, even if a quoted price in an active market is available, such pricing may not be readily accessible for each item being measured given the volume of instruments held by the reporting entity. As a result, a reporting entity may use alternative pricing (e.g., matrix pricing) as a practical expedient to measure fair value, but such a valuation would constitute a lower measurement within the fair value hierarchy. See Section 8.2.3 for more information.
Connecting the Dots
There is a presumption that a Level 1 input should be used when it is
available and the entity can access the market in which such a quote is
available. However, this may not always be the case. For example, if an
entity purchases an equity security in the United States that is not
traded on a U.S. exchange but is traded on the Cyprus Stock Exchange,
the entity would not use a Level 1 quote from the Cyprus Stock Exchange
if its principal (or most advantageous) market is not the Cyprus Stock
Exchange.
See Section 10.4.4 for discussion of Level
1 fair value measurements on the basis of bid-and-ask inputs.
The example below illustrates the fair value measurement of a
debt security that is traded in a dealer market, which represents a Level 1
measurement.
Example 8-4
Debt Security That Is Traded in a Dealer
Market
Entity A holds a debt security that is traded in a dealer
market in which bid and ask prices are available. Assume
that the market is active for the debt security, no
adjustments have been made to the price, and the price
is accessible by A.
If the price used to measure the fair
value of the debt security is for the identical debt
security held by A (i.e., the identical Committee on
Uniform Securities Identification Procedures [CUSIP]),
the debt security should be classified in Level 1 of the
fair value hierarchy. The fact that the debt security is
traded in a dealer market, as opposed to an exchange
market, does not preclude the measurement of the debt
security from being classified as a Level 1
measurement.
The ASC master glossary indicates that
“[o]ver-the-counter markets (for which prices are
publicly reported by the National Association of
Securities Dealers Automated Quotations systems or by
OTC Markets Group Inc.) [and] the market for U.S.
Treasury securities” are dealer markets. Prices in
dealer markets may be Level 1 measurements if all of the
above criteria are met and the dealer market is
active.
The example below illustrates the fair value measurement of an
exchange-traded debt security, which represents a Level 1 measurement.
Example 8-5
Exchange-Traded Debt
Security Recognized as a Liability
Entity B has issued an exchange-traded
debt security and has elected to account for the
liability for such issuance at fair value in accordance
with the FVO. The identical instrument is currently
trading as an asset in an active market. Entity B uses
the quoted price for the asset as its initial input into
the fair value measurement of its liability for the debt
security. Entity B also evaluates whether the quoted
price for the asset must be adjusted for factors such as
third-party credit enhancements, which would not apply
to the fair value measurement of the liability. Entity B
determines that no adjustments need to be made to the
quoted price of the asset.
Since the price used to measure the fair
value of the debt security is for the identical debt
security issued by B (i.e., the identical CUSIP) that
actively is traded as an asset in an exchange market,
and no adjustments to the quoted price of the instrument
are required, the measurement of the debt security
should be classified as a Level 1 measurement.
The example below illustrates an OTC forward contract that is
classified as a Level 2 measurement because quoted prices in active markets are
available only for similar securities.
Example 8-6
OTC Forward Contract
Entity C holds an OTC “look-alike” forward contract. The
counterparty to this contract is contractually obligated
to settle it on the basis of the quoted price for a
similar futures contract traded on an active futures
exchange. The forward contract meets the definition of a
derivative and is therefore recorded at fair value.
While the look-alike forward contract mirrors — and its
value is intended to approximate the quoted price for —
the exchange-traded futures contract, the forward and
futures contracts are not identical. Even if the
counterparties to the forward contract both have the
highest credit quality (resulting in the same level of
credit risk as the exchange-traded futures contract),
the forward contract is not considered identical because
(1) the counterparties are different and (2) C cannot
sell the forward contract on the futures exchange (i.e.,
the counterparty and liquidity risk related to the
forward contract are greater than those related to the
futures contract). While the measurement of a futures
contract may be classified as a Level 1 measurement (in
an active market), the measurement of the look-alike
forward contract can only be classified as Level 2 or
below.
The example below illustrates an interest rate swap for which
observable inputs are used to determine fair value. Because the interest rate
swap itself is not traded on an OTC market, the measurement of the swap cannot
be classified as a Level 1 measurement.
Example 8-7
OTC Interest Rate
Swap
Entity D is a party to an interest rate
swap transacted on an OTC market. The OTC market does
not quote prices for interest rate swaps. Entity D
measures the fair value of the swap by using either (1)
a discounted cash flow approach on the basis of
observable market-based yield curves or (2) the price at
which a similar swap was exchanged on the OTC market.
While similar swaps may have been exchanged on the OTC
market, these swaps would have different counterparties
and would therefore not be identical to D’s swap.
The price at which D would be able to
transfer the swap would result from a negotiated
transaction in which the credit standings of the two
parties to the swap, as well as the terms of the
specific swap, are contemplated. Because the swap is not
identical to the similar swap for which there are
transactions on the OTC market, the fair value
measurement of the swap would be classified as a Level 2
measurement (or a Level 3 measurement if any of the
inputs that are significant to the measurement are
unobservable inputs).
8.2.2 Active Markets
8.2.2.1 Active Versus Inactive Markets
ASC 820-10 — Glossary
Active Market
A market in which transactions for the asset or
liability take place with sufficient frequency and
volume to provide pricing information on an ongoing
basis.
ASC 820-10
Measuring Fair Value When the Volume or Level of
Activity for an Asset or a Liability Has
Significantly Decreased
35-54C The
fair value of an asset or a liability might be
affected when there has been a significant decrease
in the volume or level of activity for that asset or
liability in relation to normal market activity for
the asset or liability (or similar assets or
liabilities). To determine whether, on the basis of
the evidence available, there has been a significant
decrease in the volume or level of activity for the
asset or liability, a reporting entity shall
evaluate the significance and relevance of factors
such as the following:
-
There are few recent transactions.
-
Price quotations are not developed using current information.
-
Price quotations vary substantially either over time or among market makers (for example, some brokered markets).
-
Indices that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability.
-
There is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, taking into account all available market data about credit and other nonperformance risk for the asset or liability.
-
There is a wide bid-ask spread or significant increase in the bid-ask spread.
-
There is a significant decline in the activity of, or there is an absence of, a market for new issues (that is, a primary market) for the asset or liability or similar assets or liabilities.
-
Little information is publicly available (for example, for transactions that take place in a principal-to-principal market).
ASC 820-10-20 defines “active market,” and ASC 820-10-35-54C
lists factors that may indicate that a market is not active because of a
significant decrease in the volume or level of activity relative to normal
market activity for the asset or liability (or similar assets or
liabilities). In determining whether a market is active, an entity would
focus on the trading activity of the individual asset or liability being
measured rather than on the market in which it is traded. Therefore, a
security that is traded infrequently on the Nasdaq could represent an asset
that is not traded in an active market. In determining whether an active
market exists for an asset or liability (or similar assets or liabilities),
an entity should consider the factors discussed in ASC 820-10-35-54C only
when the frequency and volume of the transactions for the asset or liability
are not sufficient to provide ongoing relevant pricing information.
The presence of one or more of the factors in ASC 820-10-35-54C does not in
itself mean that a market is not active. An entity should evaluate the
relevance and significance of these factors to the individual asset,
liability, or equity instrument measured at fair value to determine whether
the market for the asset, liability, or equity instrument is not active. A
market is not deemed inactive simply because of insufficient trading volume
relative to the size of an entity’s position.
The characterization of a market as “active” or “inactive” may change as
market conditions change. However, a decline in the volume of transactions
for a particular asset or liability does not automatically make a market
inactive. A market is considered active as long as the frequency and volume
of transactions are sufficient to provide reliable ongoing pricing
information.
Connecting the Dots
The level of market activity does not change the objective of a fair
value measurement under ASC 820. ASC 820-10-35-54H states:
Estimating the price at which market participants would be
willing to enter into a transaction at the measurement date
under current market conditions if there has been a
significant decrease in the volume or level of activity for
the asset or liability depends on the facts and
circumstances at the measurement date and requires judgment.
A reporting entity’s intention to hold the asset or to
settle or otherwise fulfill the liability is not relevant
when measuring fair value because fair value is a
market-based measurement, not an entity-specific
measurement.
A measurement that does not meet these objectives (e.g., a holder’s
estimate of economic or fundamental value) is not a fair value
measurement. An entity must consider market-participant assumptions
when measuring fair value. If an entity determines that a market is
inactive, it cannot use entity-specific assumptions instead of
relevant observable market information in measuring fair value. See
Section 10.6 for more
information about measuring fair value when the volume or level of
activity for an asset or liability has significantly decreased.
8.2.2.2 Multiple Active Markets
ASC 820-10
Level 1
Inputs
35-41B A Level 1 input will
be available for many financial assets and financial
liabilities, some of which might be exchanged in
multiple active markets (for example, on different
exchanges). Therefore, the emphasis within Level 1
is on determining both of the following:
-
The principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability
-
Whether the reporting entity can enter into a transaction for the asset or liability at the price in that market for the asset or liability at the measurement date.
35-46 Paragraph 820-10-55-42
illustrates the use of Level 1 inputs to measure the
fair value of a financial asset that trades in
multiple active markets with different prices.
An asset or liability may be exchanged in multiple active markets. For
example, a security may be traded on several different exchanges. In these
circumstances, fair value is measured on the basis of the entity’s principal
market, or if a principal market does not exist, the most advantageous
market for the asset or liability. An entity must be able to access a market
as of the measurement date for this market to be the principal or most
advantageous market.
Example 4 in ASC 820-10-55-42 through 55-45A illustrates how
an entity would measure fair value for an asset that is sold in two
different active markets. That example states that if one of the two markets
is the entity’s principal market, that market must be used to measure the
fair value of the asset. If neither market is considered the entity’s
principal market, the fair value measurement is based on the most
advantageous market. The example shows that the entity, in making this
determination, must consider the transaction costs and transportation costs
that would be incurred in each market. However, the fair value measurement
in the most advantageous market is reduced only for transportation costs.
See Chapter 6 for more information about the
determination of the principal or most advantageous market. See Sections 10.2.5.3
and 10.2.5.4
for discussion of transaction costs and transportation costs.
8.2.2.3 Active Market That Is Not a Secondary Market
A fair value measurement could be a Level 1 measurement even
if there is no secondary market (e.g., an exchange market for the asset does
not exist). This situation commonly applies to investments in registered
open-ended mutual funds, which are illustrated in the example below.
Example 8-8
Investment in Registered Open-Ended Mutual
Fund
Entity E has an investment in an open-ended mutual
fund, Fund B, that is registered under the
Investment Company Act of 1940. Fund B is not listed
on an exchange but publishes daily quotations of its
NAV. Units are redeemed and purchased at the
published NAV without any adjustment (i.e., Fund B’s
price is readily determinable since the published
NAV is the basis for current transactions). There is
no secondary market for the units because they are
not transferable (i.e., the sole transactions are
redemptions and purchases of the units by Fund
B).
The fact that there is no secondary market for the
units in Fund B (i.e., all transactions are between
the fund and the unit holders) does not prevent E
from classifying the fair value of its investment in
Fund B within Level 1 of the fair value hierarchy if
the conditions for Level 1 classification are met.
In this example, E must evaluate whether the quoted
price (i.e., the published NAV) is in an active
market. For Fund B, pricing information is provided
on an ongoing basis (and thus the active-market
criteria are met), since the fund itself is a
registered investment company, is obligated to stand
ready to transact in either purchases or redemptions
at the published NAV, and settles within seven days
of investor redemption. In the absence of any
evidence to the contrary (e.g., the fund is not able
to settle an investor redemption in accordance with
normal conventions because of underlying fund
investment liquidity constraints), the investment in
the registered open-ended investment company would
meet the “active” criteria.
The assumption that the active-market criteria have
been met is only related to determining the level of
investments in open-ended mutual funds that are
registered under the Investment Company Act of 1940.
It should also be noted that in this example, NAV is
not being used as a practical expedient; rather, it
represents fair value since the published NAV
amounts reflect readily determinable fair
values.
8.2.3 Adjustments to Level 1 Inputs
Generally, an entity should not adjust a Level 1 input in measuring the fair
value of an asset or liability. However, ASC 820-10-35-41C notes the following
three circumstances in which an adjustment may be made to a Level 1 input:
-
A reporting entity holds a large number of similar (but not identical) assets or liabilities (e.g., debt securities) that are measured at fair value and, while a quoted price in an active market is available for each asset or liability, such quoted prices are not readily accessible for each of those assets or liabilities individually given the large number of similar assets or liabilities held by the entity as of the measurement date. Therefore, the entity uses an alternative pricing method such as matrix pricing.
-
A quoted price in an active market does not represent fair value as of the measurement date because a significant event takes place after the close of a market but before the measurement date.
-
The fair value measurement pertains to a liability or equity instrument, and the quoted price for the identical item traded as an asset in an active market must be adjusted for factors specific to the item or asset (see ASC 820-10-35-16D).
Further, the FASB stated the following in paragraph C68 of the Basis for Conclusions of Statement 157:
The Exposure Draft emphasized that a quoted price
(unadjusted) in an active market should be used to measure fair value
whenever it is available. Some respondents interpreted the related
guidance as requiring the use of a quoted price in an active market
without regard to whether that price is readily available or
representative of fair value. Those respondents referred to possible
conflicts with ASR 118, which requires adjustments to a quoted price in
those situations (fair value pricing). In its redeliberations, the Board
affirmed that its intent was not to preclude adjustments to a quoted
price if that price is not readily available or representative of fair
value, noting that in those situations, the market for the particular
asset or liability might not be active. To convey its intent more
clearly, the Board clarified that in those situations, the fair value of
the asset or liability should be measured using the quoted price, as
adjusted, but within a lower level of the fair value hierarchy.
In any of the above three situations, any adjustment to the quoted price renders
the fair value measurement a Level 2 or Level 3 measurement.
8.2.4 Requirement to Use Level 1 Inputs
ASC 820-10
Level 1
Inputs
35-44 If a reporting entity
holds a position in a single asset or liability
(including a position comprising a large number of
identical assets or liabilities, such as a holding of
financial instruments) and the asset or liability is
traded in an active market, the fair value of the asset
or liability shall be measured within Level 1 as the
product of the quoted price for the individual asset or
liability and the quantity held by the reporting entity.
That is the case, even if a market’s normal daily
trading volume is not sufficient to absorb the quantity
held and placing orders to sell the position in a single
transaction might affect the quoted price.
The size of a position held by an entity does not affect the categorization of
the asset or liability within the fair value hierarchy, even if the normal daily
trading or transaction volume would not be sufficient to absorb the entity’s
position. Fair value is not an entity-specific measurement; therefore, even if
an entity expects to be unable to exit the position in a single transaction
without adjusting the observable price, it would be inappropriate to use an
input other than the quoted price in an active market. That is, a quoted market
price (i.e., a Level 1 input) must be used to measure the fair value of an asset
or liability that is traded in an active market on the basis of the product of
the quoted price for the individual asset or liability and the quantity held by
the entity.
8.3 Level 2 Inputs
8.3.1 General
ASC 820-10
Level 2 Inputs
35-47 Level 2 inputs are
inputs other than quoted prices included within Level 1
that are observable for the asset or liability, either
directly or indirectly.
35-48 If the asset or
liability has a specified (contractual) term, a Level 2
input must be observable for substantially the full term
of the asset or liability. Level 2 inputs include the
following:
-
Quoted prices for similar assets or liabilities in active markets
-
Quoted prices for identical or similar assets or liabilities in markets that are not active
-
Inputs other than quoted prices that are observable for the asset or liability, for example:
-
Interest rates and yield curves observable at commonly quoted intervals
-
Implied volatilities
-
Subparagraph superseded by Accounting Standards Update No. 2011-04.
-
Subparagraph superseded by Accounting Standards Update No. 2011-04.
-
Credit spreads.
-
Subparagraph superseded by Accounting Standards Update No. 2011-04.
-
- Market-corroborated inputs.
35-49 Paragraph 820-10-55-21
discusses Level 2 inputs for particular assets and
liabilities.
Level 2 Inputs
55-21 Examples of Level 2
inputs for particular assets and liabilities include the
following:
-
Receive-fixed, pay-variable interest rate swap based on the London Interbank Offered Rate (LIBOR) swap rate. A Level 2 input would be the LIBOR swap rate if that rate is observable at commonly quoted intervals for substantially the full term of the swap.
-
Receive-fixed, pay-variable interest rate swap based on a yield curve denominated in a foreign currency. A Level 2 input would be the swap rate based on a yield curve denominated in a foreign currency that is observable at commonly quoted intervals for substantially the full term of the swap. That would be the case if the term of the swap is 10 years and that rate is observable at commonly quoted intervals for 9 years, provided that any reasonable extrapolation of the yield curve for Year 10 would not be significant to the fair value measurement of the swap in its entirety.
-
Receive-fixed, pay-variable interest rate swap based on a specific bank’s prime rate. A Level 2 input would be the bank’s prime rate derived through extrapolation if the extrapolated values are corroborated by observable market data, for example, by correlation with an interest rate that is observable over substantially the full term of the swap.
-
Three-year option on exchange-traded shares. A Level 2 input would be the implied volatility for the shares derived through extrapolation to Year 3 if both of the following conditions exist:
-
Prices for one-year and two-year options on the shares are observable.
-
The extrapolated implied volatility of a three-year option is corroborated by observable market data for substantially the full term of the option.
In that case, the implied volatility could be derived by extrapolating from the implied volatility of the one-year and two-year options on the shares and corroborated by the implied volatility for three-year options on comparable entities’ shares, provided that correlation with the one-year and two-year implied volatilities is established. -
-
Licensing arrangement. For a licensing arrangement that is acquired in a business combination and was recently negotiated with an unrelated party by the acquired entity (the party to the licensing arrangement), a Level 2 input would be the royalty rate in the contract with the unrelated party at inception of the arrangement.
-
Finished goods inventory at a retail outlet. For finished goods inventory that is acquired in a business combination, a Level 2 input would be either a price to customers in a retail market or a price to retailers in a wholesale market, adjusted for differences between the condition and location of the inventory item and the comparable (that is, similar) inventory items so that the fair value measurement reflects the price that would be received in a transaction to sell the inventory to another retailer that would complete the requisite selling efforts. Conceptually, the fair value measurement will be the same, whether adjustments are made to a retail price (downward) or to a wholesale price (upward). Generally, the price that requires the least amount of subjective adjustments should be used for the fair value measurement.
-
Building held and used. A Level 2 input would be the price per square foot for the building (a valuation multiple) derived from observable market data, for example, multiples derived from prices in observed transactions involving comparable (that is, similar) buildings in similar locations.
-
Reporting unit. A Level 2 input would be a valuation multiple (for example, a multiple of earnings or revenue or a similar performance measure) derived from observable market data, for example, multiples derived from prices in observed transactions involving comparable (that is, similar) businesses, taking into account operational, market, financial, and nonfinancial factors.
As noted in the guidance above, a Level 2 input represents an observable input
that is not a Level 1 input. Level 2 inputs include:
-
A quoted price for an identical asset or liability in an inactive market (see Section 8.2.2.1 for discussion of when a market is considered inactive).
-
A quoted price for a similar asset or liability in an active or inactive market (see Section 8.3.1.1 for discussion of the meaning of a similar asset or liability).
-
Inputs other than quoted market prices that are observable for the asset or liability, such as interest rates, volatilities, and credit spreads.
-
Market-corroborated inputs (see Section 8.3.1.2).
8.3.1.1 Similar Assets or Liabilities
In measuring the fair value of an asset, liability, or equity instrument for
which a Level 1 measurement does not exist, an entity might use a quoted
price for a “similar” asset or liability. As discussed in ASC 820-10-35-48,
quoted prices for similar assets or liabilities represent Level 2 inputs. If
an entity observes a quoted price in an inactive market for an identical
asset or liability and determines that it is a relevant observable input for
which no significant adjustment is required, typically little, if any,
weight would be given to quoted prices for similar assets or liabilities.
However, if a quoted price for the identical item being measured does not
exist or must be adjusted (e.g., because the quoted price is not current),
the entity may use quoted prices for similar assets or liabilities when
applying a valuation technique to measure fair value.
An entity must use judgment in determining whether an asset or liability is
“similar” to the asset or liability being measured at fair value. In making
this determination, the entity must (1) understand the terms and other
factors that affect the fair value of the asset or liability being measured
and the asset or liability for which a quoted price exists and (2) identify
and assess any differences in these terms and factors. Entities should also
consider the extent to which adjustments to the quoted price may be
necessary to reflect the effects of such differences. For example, entities
may need to make adjustments to reflect differences in the condition,
location, or risks (including nonperformance risk and liquidity risk) of the
comparable items. Although a quoted price for a similar asset or liability
is a Level 2 input, significant unobservable adjustments to that quoted
price may render the fair value measurement a Level 3 measurement.
An entity may measure the fair value of a liability or equity instrument from
the perspective of a market participant holding the item as an asset. In
doing so, the entity might use the quoted price of an identical or similar
liability or equity instrument that is traded as an asset. However, the
quoted price should be adjusted for factors specific to the asset that do
not apply to the fair value measurement of the entity’s liability or equity
instrument. ASC 820-10-35-16D(b) indicates, for example, that an adjustment
may be required when “[t]he unit of account for the asset is not the same as
for the liability or equity instrument. For example, for liabilities, in
some cases the price for an asset reflects a combined price for a package
comprising both the amounts due from the issuer and a third-party credit
enhancement.” In addition, if the entity is measuring the fair value of a
liability or equity instrument from the perspective of a market participant
holding the identical item as an asset, and the asset held by another party
includes a characteristic restricting its sale, in accordance with ASC
820-10-35-16D, “the fair value of the corresponding liability or equity
instrument also would include the effect of the restriction.” However, if
the liability or equity instrument is being measured on the basis of the
quoted price of a similar asset, an adjustment to remove the effect of the
restriction would generally be required if a quoted price for the identical
asset, had it been available, would not have included a characteristic
restricting its sale. Such adjustment may render the fair value measurement
a Level 3 measurement.
Connecting the Dots
In October 2008, the IASB’s Expert Advisory Panel issued a report,
Measuring and Disclosing the Fair Value of Financial
Instruments in Markets That Are No Longer
Active (the “IASB Expert Advisory Panel
report”), which describes practices entities use when measuring
financial instruments at fair value. Paragraph 32 of the report
gives the following examples of the basic terms of a financial
instrument with contractual cash flows (entities may consider these
terms, and any associated differences, when assessing whether the
instrument being measured is “similar” to the instrument for which a
quoted price exists):
(a) the timing of the cash flows: when the entity
expects to realise the cash flows related to the
instrument.
(b) the calculation of the cash flows: for example,
for a debt instrument the interest rate that applies (ie the
coupon), or for a derivative instrument how the cash flows
are calculated in relation to the underlying instrument or
index (or indices).
(c) the timing and conditions for any options in the
contract: for example:
(i) prepayment options (one or both parties can
demand or make an early payment).
(ii) extension options (one or both parties can
extend the period of the instrument).
(iii) conversion options (one or both parties can
convert the instrument into another
instrument).
(iv) put or call options (one or both parties can
exchange the instrument for a defined amount of cash
or other assets or liabilities).
(d) protection of the rights of the parties to the
instrument: for example:
(i) terms relating to credit risk in debt
instruments, such as collateral, event of default
and margin call triggers.
(ii) subordination of the instrument, for example
the priority of the instruments in the event of a
winding up.
(iii) the legal enforceability of the cash
flows.
Further, paragraph 33 of the report notes that “to
measure the fair value of an instrument it is necessary to assess
the return that market participants would require on the instrument
to compensate for the risk related to:
(a) the amount and timing of the cash flows for the
instrument.
(b) uncertainty about the ability of the counterparty to
make payments when due (credit risk). This is a factor even
if the counterparty is a financial institution.
(c) the liquidity of the instrument.”
This principle is consistent with the fair value measurement
principles in ASC 820. Accordingly, in determining whether
instruments are similar and whether an adjustment to a quoted price
is necessary, an entity should consider any differences between (1)
compensation that market participants would require for the risk
associated with the instrument being measured and (2) compensation
required for the instrument for which a quoted price exists. For
example, the instrument being measured may be in greater relative
supply than the instrument for which a quoted price exists. In this
situation, a liquidity risk difference would need to be factored
into the fair value calculation as an adjustment to the quoted price
for the similar instrument.
See Section 10.1 for further
discussion of the IASB Expert Advisory Panel report.
8.3.1.2 Market-Corroborated Inputs
ASC 820-10-35-48(d) indicates that Level 2 inputs can be
market-corroborated inputs, which are defined in ASC 820-10-20 as “[i]nputs
that are derived principally from or corroborated by observable market data
by correlation or other means.” It may be difficult to determine whether an
input is correlated to observable market data. Correlation is a statistical
concept indicating the strength and direction of a linear relationship
between two variables. The same statistical thresholds (e.g., number of data
points, 95 percent confidence level) applied in establishing that a hedging
relationship under ASC 815 is highly effective under a regression analysis
should be used in establishing correlation under ASC 820. For more
information about performing a regression analysis, see Section 2.5.2.1.1.2
of Deloitte’s Roadmap Hedge Accounting.
8.3.1.2.1 Inputs With Shorter Terms
An input used to measure the fair value of an asset or liability may only
be observable for a portion of the life of the asset or liability. In
these circumstances, the fair value measurement is a Level 2 measurement
only if both of the following conditions are met:
-
Condition 1: The input is observable for substantially the full term of the asset or liability — ASC 820-10-35-48 states, in part, “If the asset or liability has a specified (contractual) term, a Level 2 input must be observable for substantially the full term of the asset or liability.” While not a bright line, if the input is observable for 90 percent or more of the term of the asset or liability, it would meet this condition.
-
Condition 2: The impact of the unobservable period is not significant to the fair value of the asset or liability — When the input meets condition 1, the entity must consider ASC 820-10-55-21(b), which indicates that the effect of the unobservable term must not be significant to the measurement in its entirety for the measurement to be classified as Level 2. An entity must use judgment in determining whether the effect of the unobservable period is significant.
The example below illustrates how to consider
market-corroborated inputs used in a fair value measurement.
Example 8-9
Power Purchase Agreement — Quoted Price for
Substantially Full Term
Entity E enters into a fixed-price four-year
agreement to sell 50 MW of on-peak power for
delivery at location ABC beginning on January 1,
20X2, and continuing through December 31, 20X5. On
March 31, 20X2, E is determining the fair value of
the agreement. Active market quotes are available
for forward contracts to sell power at location
ABC for three years (March 31, 20X2, to March 31,
20X5). Accordingly, E will use the three years of
observable forward pricing data and develop an
expectation for the remaining nine months (i.e.,
April 1 to December 31, 20X5) by employing a model
that relies on pricing data and weather patterns
from the previous four years. The model also
incorporates all relevant physical constraints
(e.g., capacity of existing and planned power
plants near location ABC and projected supply and
demand). The estimate for the remaining nine
months represents an unobservable input.
Since the forward price curve is
observable for only 36 of the 45 months (i.e., 80
percent of the term), it does not meet condition
1, which requires that the input be observable for
substantially the full term. Therefore, the fair
value measurement is a Level 3 measurement. Note
that if the forward price curve had been
observable for 90 percent or more of the term, E
would still need to consider whether the effect of
the unobservable term is significant to the fair
value measurement to conclude that the measurement
is a Level 2 measurement.
8.3.2 Adjustments to Level 2 Inputs
ASC 820-10
Level 2 Inputs
35-50
Adjustments to Level 2 inputs will vary depending on
factors specific to the asset or liability. Those
factors include the following:
-
The condition or location of the asset
-
The extent to which inputs relate to items that are comparable to the asset or liability (including those factors described in paragraph 820-10-35-16D)
-
The volume or level of activity in the markets within which the inputs are observed.
35-51 An
adjustment to a Level 2 input that is significant to the
entire measurement might result in a fair value
measurement categorized within Level 3 of the fair value
hierarchy if the adjustment uses significant
unobservable inputs.
An entity may need to adjust Level 2 inputs to measure the fair value of an
asset, liability, or equity instrument. Depending on the nature and significance
of the adjustment, the fair value measurement of the entire asset, liability, or
equity instrument may need to be categorized within Level 3 of the fair value
hierarchy. See Section 8.4 for discussion
of Level 3 inputs and Section 8.1.2 for discussion of how
to categorize a fair value measurement containing multiple inputs that differ in
terms of the categorization within the fair value hierarchy.
8.4 Level 3 Inputs
8.4.1 General
ASC 820-10
Level 3 Inputs
35-52 Level 3 inputs are
unobservable inputs for the asset or liability.
35-53 Unobservable inputs
shall be used to measure fair value to the extent that
relevant observable inputs are not available, thereby
allowing for situations in which there is little, if
any, market activity for the asset or liability at the
measurement date. However, the fair value measurement
objective remains the same, that is, an exit price at
the measurement date from the perspective of a market
participant that holds the asset or owes the liability.
Therefore, unobservable inputs shall reflect the
assumptions that market participants would use when
pricing the asset or liability, including assumptions
about risk.
Level 3 Inputs
55-22 Examples of Level 3
inputs for particular assets and liabilities include the
following:
-
Long-dated currency swap. A Level 3 input would be an interest rate in a specified currency that is not observable and cannot be corroborated by observable market data at commonly quoted intervals or otherwise for substantially the full term of the currency swap. The interest rates in a currency swap are the swap rates calculated from the respective countries’ yield curves.
-
Three-year option on exchange-traded shares. A Level 3 input would be historical volatility, that is, the volatility for the shares derived from the shares’ historical prices. Historical volatility typically does not represent current market participants’ expectations about future volatility, even if it is the only information available to price an option.
-
Interest rate swap. A Level 3 input would be an adjustment to a mid-market consensus (nonbinding) price for the swap developed using data that are not directly observable and cannot otherwise be corroborated by observable market data.
-
Asset retirement obligation at initial recognition. A Level 3 input would be a current estimate using the reporting entity’s own data about the future cash outflows to be paid to fulfill the obligation (including market participants’ expectations about the costs of fulfilling the obligation and the compensation that a market participant would require for taking on the asset retirement obligation) if there is no reasonably available information that indicates that market participants would use different assumptions. That Level 3 input would be used in a present value technique together with other inputs, for example, a current risk-free interest rate or a credit-adjusted risk-free rate if the effect of the reporting entity’s credit standing on the fair value of the liability is reflected in the discount rate rather than in the estimate of future cash outflows.
-
Reporting unit. A Level 3 input would be a financial forecast (for example, of cash flows or earnings) developed using the reporting entity’s own data if there is no reasonably available information that indicates that market participants would use different assumptions.
Level 3 inputs are unobservable inputs used by an entity to
measure the fair value of an asset, liability, or equity instrument. These
inputs have the lowest level of priority under the fair value hierarchy and
should only be used to the extent that observable inputs are not available. ASC
820-10-55-22 gives examples of Level 3 inputs. The example below illustrates the
use of Level 3 inputs.
Example 8-10
Financial Forecast as Input Into a Fair Value
Measurement
ASC 820-10-55-22(e) indicates that a “Level 3 input would
be a financial forecast (for example, of cash flows or
earnings) developed using the reporting entity’s own
data if there is no reasonably available information
that indicates that market participants would use
different assumptions.” While certain information an
entity uses in applying a valuation technique may be
observable (e.g., interest rate curves), the entity’s
projected cash flows will most likely be significant to
the fair value measurement. Therefore, the measurement
would most likely be classified as Level 3.
8.4.2 Use of Best Data Available
8.4.2.1 General
ASC 820-10
Level 3
Inputs
35-54A A reporting entity
shall develop unobservable inputs using the best
information available in the circumstances, which
might include the reporting entity’s own data. In
developing unobservable inputs, a reporting entity
may begin with its own data, but it shall adjust
those data if reasonably available information
indicates that other market participants would use
different data or there is something particular to
the reporting entity that is not available to other
market participants (for example, an entity-specific
synergy). A reporting entity need not undertake
exhaustive efforts to obtain information about
market participant assumptions. However, a reporting
entity shall take into account all information about
market participant assumptions that is reasonably
available. Unobservable inputs developed in the
manner described above are considered market
participant assumptions and meet the objective of a
fair value measurement.
An entity must use the best available data in estimating unobservable inputs
when a fair value measurement cannot be developed solely on the basis of
observable inputs. The fair value hierarchy prioritizes inputs on the basis
of their observability. Level 1 is the highest priority and Level 3 is the
lowest priority. When an entity has concluded that a single valuation
technique results in the most relevant information in terms of the fair
value hierarchy (e.g., a Level 2 measurement vs. a Level 3 measurement), it
should use that technique to calculate fair value. It would be inconsistent
with the fair value hierarchy principles in ASC 820 for an entity to
conclude that a Level 3 measurement is superior to a Level 2 measurement
because relevant observable information about current market transactions is
superior to entity-specific measurements.
For example, if management is able to use relevant observable market
information to measure fair value under a market approach (a Level 2
measurement) and it uses significant unobservable information to measure
fair value under an income approach (a Level 3 measurement), ASC 820 would
require use of the Level 2 measurement even if the market is not active.
However, in an inactive market, (1) there may be a lack of current
observable market transactions for identical or similar assets or
liabilities or (2) observable transactions may not be orderly. To produce a
fair value measurement in such circumstances, an entity needs to perform
further analysis and may have to adjust the market approach. If these
adjustments are significant, they would render the fair value estimate under
the market approach a Level 3 measurement. In such cases, entities may
consider using multiple valuation techniques (e.g., a market approach and an
income approach) to measure fair value.
When an entity considers multiple valuation techniques and determines that no
one technique results in a superior fair value measurement under the fair
value hierarchy, in accordance with ASC 820-10-35-24B, the entity is
required to evaluate the results (or respective indications of fair value)
of all techniques and weigh them, as appropriate. An entity may sometimes
place more weight on one technique because it uses more relevant observable
inputs and therefore the fair value measurement determined under that
technique is more indicative of fair value.
8.4.2.2 Use of Internal Information
An entity should not rely on internally developed assumptions or information
if it has information indicating that market participants would use
different assumptions or information in measuring the fair value of an
asset, liability, or equity instrument. A fair value measurement is
market-based but not entity-specific, as evident in the definition of fair
value and discussed in a number of paragraphs in ASC 820, including the following:
-
ASC 820-10-05-1C states that “[b]ecause fair value is a market-based measurement, it is measured using the assumptions that market participants would use when pricing the asset or liability, including assumptions about risk. As a result, a reporting entity’s intention to hold an asset or to settle or otherwise fulfill a liability [or instrument classified in a reporting entity’s shareholders’ equity] is not relevant when measuring fair value.”
-
ASC 820-10-35-53 states that “[u]nobservable [Level 3] inputs shall be used to measure fair value to the extent that relevant observable [Level 1 and Level 2] inputs are not available.”
-
ASC 820-10-35-54A states that “a reporting entity shall take into account all information about market participant assumptions that is reasonably available.”
-
ASC 820-10-35-54E states that “[r]egardless of the valuation technique used [in measuring fair value], a reporting entity shall include appropriate risk adjustments, including a risk premium reflecting the amount that market participants would demand as compensation for the uncertainty inherent in the cash flows of an asset or a liability.”
For example, under an income approach, an entity generally uses a discounted
cash flow technique to calculate the fair value of a financial asset and
incorporates relevant observable inputs when available. Any unobservable
inputs used in the fair value measurement, such as estimated future cash
flows or risk adjustments incorporated into the discount rate, should be
developed on the basis of management’s estimate of assumptions that market
participants would use in pricing the asset in a current transaction as of
the measurement date. If market data indicate that a significant liquidity
discount applies in transactions involving comparable assets as of the
measurement date, the entity should incorporate that information into its
cash flow model (e.g., through an adjustment to the discount rate to
compensate for the difficulty in selling the assets under current market
conditions).
The example below illustrates when an entity’s own data
should not be used because market-observable data are available.
Example 8-11
Reliance on Internally Developed Assumptions When
Market Assumptions Are Readily Available
Entity F is using a valuation model to measure the
fair value of its holdings of privately placed
corporate debt securities issued by Entity X. No
quoted price for identical securities is available.
Entity F’s valuation model uses assumptions about
default rates and discount rates. Assumptions about
default rates can be readily derived from current,
relevant, observable market data for actively traded
credit default swaps on X’s publicly traded bonds.
To measure fair value, F cannot rely either on its
own historical default data (for issuers with credit
quality similar to X’s) or on its own default
assumptions, even if the default assumptions are
“stressed.” Instead, F should use the relevant
market-observable assumptions about default
rates.
8.4.3 Consideration of Risk in Inputs
ASC 820-10
Level 3 Inputs
35-54 Assumptions about risk
include the risk inherent in a particular valuation
technique used to measure fair value (such as a pricing
model) and the risk inherent in the inputs to the
valuation technique. A measurement that does not include
an adjustment for risk would not represent a fair value
measurement if market participants would include one
when pricing the asset or liability. For example, it
might be necessary to include a risk adjustment when
there is significant measurement uncertainty (for
example, when there has been a significant decrease in
the volume or level of activity when compared with
normal market activity for the asset or liability, or
similar assets or liabilities, and the reporting entity
has determined that the transaction price or quoted
price does not represent fair value, as described in
paragraphs 820-10-35-54C through 35-54J).
In accordance with ASC 820-10-35-54, a fair value measurement should be adjusted
for assumptions about risks that market participants would consider when valuing
an asset, liability, or equity instrument. It may be difficult to determine what
a market participant would demand as a risk adjustment in an assumed
transaction, since such inputs may not be directly observable. In these
situations, an entity should look beyond its own policies and transactions and
consider the risks from a market participant’s perspective.
When using Level 3 inputs, an entity may need to consider the following items,
when applicable, to incorporate market-participant assumptions:
-
Recent transactions of a similar nature and duration.
-
Common industry practices.
-
Historical trends and settlements of past transactions.
See Section 10.4.2 for further discussion of the inclusion
of risk adjustments in fair value measurements. See also Section 10.6 for further discussion of measuring
fair value when the volume or level of activity for an asset or liability has
significantly decreased.
8.5 Use of Pricing Services and Broker Quotes
8.5.1 General
Entities may use pricing service quotes or broker quotes to determine the fair
value of certain assets, liabilities, or equity instruments. For example, mutual
funds that carry large portfolios of investments at fair value and produce a
daily NAV often obtain fair value information from third-party pricing service
firms, brokers, or both.
The categorization in the fair value hierarchy of a broker quote or a quote
obtained from a pricing service may be observable. However, without sufficient
evidence, an entity cannot conclude that such quotes are observable and
therefore represent Level 1 or Level 2 inputs. Likewise, an entity should not
assume that such quotes are unobservable (i.e., Level 3 inputs). It is
ultimately management’s responsibility to understand the fair value measurement
techniques and inputs used so that it can (1) appropriately determine the level
of the fair value hierarchy in which such fair value measurements are
categorized and (2) conclude that the fair value measurements appropriately
prioritize observable inputs.
8.5.2 Level 1 Inputs
Broker or pricing service quotes may only be considered Level 1 inputs if they
represent the quoted price for an identical asset, liability, or equity
instrument in an active market (see Sections
8.2.1 and 8.2.2).
8.5.3 Level 2 and Level 3 Inputs
Observable inputs are inputs that are developed by using market data and that
reflect the assumptions market participants would use when pricing an asset,
liability, or equity instrument. Level 2 inputs are inputs that are observable
for the asset, liability, or equity instrument (other than Level 1 quoted
prices), whereas Level 3 inputs are not observable.
If a quote from a pricing service or broker meets either of the following
criteria, it is considered a Level 2 input:
-
The entity can determine that market participants (i.e., a broker or others) have transacted, in an orderly transaction, for the asset or liability at the quoted price. For example, an entity might be able to corroborate the quoted price with the same or similar transactions that a broker or others have entered into. ASC 820-10-35-54I and 35-54J provide guidance on determining whether a transaction is or is not orderly when the market activity for an asset or liability has significantly declined (relative to normal market activity).1 If an entity is unable to determine whether a quoted price reflects a transaction that is or is not orderly, it must consider the quoted price in determining fair value, but the quoted price may not be the sole or primary basis for estimating fair value. In such cases, the quoted price needs to be significantly adjusted, potentially resulting in a Level 3 measurement.
-
The entity can determine that the inputs the broker or pricing service used to arrive at the quoted price are observable and the Level 3 inputs used do not have a significant effect.
Depending on the item being measured at fair value, a quote from a broker or
pricing service may represent one of many inputs or may be the only input into
the fair value measurement. ASC 820-10-35-37A requires that “[i]n those cases,
the fair value measurement [be] categorized in its entirety in the same level of
the fair value hierarchy as the lowest level input that is significant to the
entire measurement.” See Section 8.1.2 for
more information.
ASC 820-10-35-54D clarifies that a quoted price (e.g., a quote from a broker or
pricing service) may not be determinative of fair value if the volume or level
of market activity relative to normal market activity for the asset, liability,
or equity instrument (or similar assets, liabilities, or equity instruments) has
significantly declined. An entity should perform further analysis to determine
whether it must significantly adjust the quoted price to measure fair value in
accordance with ASC 820. For instance, if the only transactions underlying a
quote are not orderly, the quote may not reflect fair value and little, if any,
weight should be placed on it. In addition, a significant adjustment to the
quoted price may be required if the price is not based on (1) current
information that reflects orderly transactions or (2) a valuation technique that
reflects market-participant assumptions (including assumptions about risks).
Note that unobservable adjustments to a Level 2 input would render the entire
measurement Level 3 if the adjustments are significant to the measurement in its
entirety.
To determine whether a quote represents fair value, entities should also consider
whether the quote is binding on the party making the quote or is available from
more than one broker or pricing service. However, such facts do not necessarily
indicate that the quote is “observable.” In other words, a binding quote does
not necessarily meet one of the conditions described above. ASC 820-10-35-54M
states that, when measuring fair value, an entity must take into account “the
nature of a quote (for example, whether the quote is an indicative price or a
binding offer) . . . when weighting the available evidence, with more weight
given to quotes provided by third parties that represent binding offers.” See
Section 10.8 for more information
about the use of pricing services and broker quotes.
Footnotes
1
See Section 10.6 for
more information.
8.6 Certain Entities That Calculate NAV per Share (or Its Equivalent)
ASC 820-10
Investments in Certain Entities That Calculate Net Asset
Value per Share (or Its Equivalent)
35-54B
An investment within the scope of paragraphs 820-10-15-4
through 15-5 for which fair value is measured using net
asset value per share (or its equivalent, for example member
units or an ownership interest in partners’ capital to which
a proportionate share of net assets is attributed) as a
practical expedient, as described in paragraph 820-10-35-59,
shall not be categorized within the fair value hierarchy. In
addition, the disclosure requirements in paragraph
820-10-50-2 do not apply to that investment. Disclosures
required for an investment for which fair value is measured
using net asset value per share (or its equivalent) as a
practical expedient are described in paragraph 820-10-50-6A.
Although the investment is not categorized within the fair
value hierarchy, a reporting entity shall provide the amount
measured using the net asset value per share (or its
equivalent) practical expedient to permit reconciliation of
the fair value of investments included in the fair value
hierarchy to the line items presented in the statement of
financial position in accordance with paragraph
820-10-50-2B.
As discussed in Section 2.2.2, ASC 820 provides a practical expedient for certain
investments without a readily determinable fair value. An entity that elects this
practical expedient should not categorize the asset within the fair value hierarchy
when providing the disclosures required by ASC 820. See Sections 10.9 and 11.2.2.3 for further discussion of the use of
this practical expedient.
Chapter 9 — Initial Measurement
Chapter 9 — Initial Measurement
9.1 Introduction
ASC 820-10
30-1 The fair
value measurement framework, which applies at both initial
and subsequent measurement if fair value is required or
permitted by other Topics, is discussed primarily in Section
820-10-35. This Section sets out additional guidance
specific to applying the framework at initial
measurement.
30-2 When an
asset is acquired or a liability is assumed in an exchange
transaction for that asset or liability, the transaction
price is the price paid to acquire the asset or received to
assume the liability (an entry price). In contrast, the fair
value of the asset or liability is the price that would be
received to sell the asset or paid to transfer the liability
(an exit price). Entities do not necessarily sell assets at
the prices paid to acquire them. Similarly, entities do not
necessarily transfer liabilities at the prices received to
assume them.
30-3 In many cases, the transaction
price will equal the fair value (for example, that might be
the case when on the transaction date the transaction to buy
an asset takes place in the market in which the asset would
be sold).
30-6 If another
Topic requires or permits a reporting entity to measure an
asset or a liability initially at fair value and the
transaction price differs from fair value, the reporting
entity shall recognize the resulting gain or loss in
earnings unless that Topic specifies otherwise.
35-3 A fair
value measurement assumes that the asset or liability is
exchanged in an orderly transaction between market
participants to sell the asset or transfer the liability at
the measurement date under current market conditions.
As discussed in earlier chapters, fair value represents an exit price under the
assumption that an asset is sold or a liability or equity instrument is transferred
(assumed) in an orderly transaction between unrelated market participants under
current market conditions. In many cases, the transaction price for an asset,
liability, or equity instrument equals its fair value on initial recognition.
However, in certain situations, it is not appropriate to assume that the transaction
price (which is an entry price) is the initial fair value (which is an exit price)
of an asset, liability, or equity instrument. That is, the entry price sometimes is
not the exit price.
Paragraph C26 of the Basis for Conclusions of FASB Statement 157
states the following regarding the exit price notion that underlies a fair value
measurement:
The transaction to sell the asset or transfer
the liability is a hypothetical transaction at the measurement date, considered
from the perspective of a market participant that holds the asset or owes the
liability. Therefore, the objective of a fair value measurement is to determine
the price that would be received for the asset or paid to transfer the liability
at the measurement date, that is, an exit price. The Board concluded that an
exit price objective is appropriate because it embodies current expectations
about the future inflows associated with the asset and the future outflows
associated with the liability from the perspective of market
participants.
Note that the guidance in ASC 820 on initial fair value measurement
only applies when other Codification topics require the initial recognition of an
asset, liability, or equity instrument at fair value (see Table 2-1). However, because other Codification topics often do not
require initial recognition at fair value, assets, liabilities, or equity
instruments may be initially recognized at their transaction price even if that
price differs from an exit price on initial recognition. Section 9.2 discusses the accounting in
situations in which an asset, liability, or equity instrument must be initially
recognized at fair value and the transaction price is not equal to the exit price on
initial recognition. See Section
10.2.7 for further discussion of the application of ASC 820 to
liabilities and instruments classified in an entity’s stockholders’ equity.
9.2 Transaction Price Is Not Fair Value
ASC 820-10
30-3A When
determining whether fair value at initial recognition equals
the transaction price, a reporting entity shall take into
account factors specific to the transaction and to the asset
or liability. For example, the transaction price might not
represent the fair value of an asset or a liability at
initial recognition if any of the following conditions
exist:
-
The transaction is between related parties, although the price in a related party transaction may be used as an input into a fair value measurement if the reporting entity has evidence that the transaction was entered into at market terms.
-
The transaction takes place under duress or the seller is forced to accept the price in the transaction. For example, that might be the case if the seller is experiencing financial difficulty.
-
The unit of account represented by the transaction price is different from the unit of account for the asset or liability measured at fair value. For example, that might be the case if the asset or liability measured at fair value is only one of the elements in the transaction (for example, in a business combination), the transaction includes unstated rights and privileges that are measured separately, in accordance with another Topic, or the transaction price includes transaction costs.
-
The market in which the transaction takes place is different from the principal market (or most advantageous market). For example, those markets might be different if the reporting entity is a dealer that enters into transactions with customers in the retail market, but the principal (or most advantageous) market for the exit transaction is with other dealers in the dealer market.
30-5 Paragraph
820-10-55-46 illustrates situations in which the price in a
transaction involving a derivative instrument might (and
might not) equal the fair value of the instrument.
As discussed above, transaction prices often will equal fair value on initial
recognition. However, if a transaction is carried out under duress or is between
related parties, or if other factors are present, the transaction price may not
equal fair value on initial recognition.1 Therefore, an entity needs to take additional considerations into account in
determining the fair value on initial recognition of an asset, liability, or equity
instrument.
The table below gives examples of factors that may suggest that the
transaction price does not represent the fair value of an asset, liability, or
equity instrument on initial recognition.
Table
9-1
|
Factor
|
Example(s)
|
|---|---|
|
The transaction is between related parties, although the
price in a related-party transaction may be used as an input
into a fair value measurement if the entity has evidence
that the transaction was entered into at market terms.
|
A parent company purchases a portfolio of troubled loans from
its wholly owned subsidiary. The price exceeds the fair
value because it incorporates a capital contribution from
the parent to the subsidiary. ASC 850 contains guidance on
determining whether a transaction is a related-party
transaction.
|
|
The transaction takes place under duress or the seller is
forced to accept the price in the transaction because of
urgency (e.g., the seller is experiencing financial
difficulty).
|
A hedge fund divests itself of nonmarketable assets to stave
off a liquidity crisis. Thus, there was not adequate
exposure to the market before the measurement date to allow
for usual and customary marketing activities for
transactions involving such assets or liabilities.
|
|
The unit of account represented by the transaction price
differs from the unit of account for the asset or liability
measured at fair value.
|
A multiple-element transaction in which the asset or
liability measured at fair value is only one of the elements
in the transaction (e.g., in a business combination).
A transaction includes unstated rights and privileges that
should be separately measured (e.g., the seller of real
estate grants a non-interest-bearing loan to the buyer).
A debt instrument is issued with an inseparable third-party
credit enhancement (see Section
4.3.2.2).
The transaction price includes transaction costs. See
Section 10.2.5.3 for further
discussion of transaction costs.
|
|
The market in which the transaction takes place differs from
the principal or most advantageous market.
|
The transaction price of the interest rate swap (e.g., zero)
does not necessarily represent fair value from the dealer’s
perspective at initial recognition. The dealer has access to
the dealer market (i.e., with dealer counterparties).
|
ASC 820-10-55-46 through 55-49 also include the following example
illustrating a situation in which it would not be appropriate to presume that the
transaction price represents fair value as of the date of initial recognition:
ASC 820-10
Example 5: Transaction Prices and Fair Value at Initial
Recognition — Interest Rate Swap at Initial
Recognition
55-46 This
Topic (see paragraphs 820-10-30-3 through 30-3A) clarifies
that in many cases the transaction price, that is, the price
paid (received) for a particular asset (liability), will
represent the fair value of that asset (liability) at
initial recognition, but not presumptively. This Example
illustrates when the price in a transaction involving a
derivative instrument might (and might not) equal the fair
value of the instrument at initial recognition.
55-47 Entity A
(a retail counterparty) enters into an interest rate swap in
a retail market with Entity B (a dealer) for no initial
consideration (that is, the transaction price is zero).
Entity A can access only the retail market. Entity B can
access both the retail market (that is, with retail
counterparties) and the dealer market (that is, with dealer
counterparties).
55-48 From the
perspective of Entity A, the retail market in which it
initially entered into the swap is the principal market for
the swap. If Entity A were to transfer its rights and
obligations under the swap, it would do so with a dealer
counterparty in that retail market. In that case, the
transaction price (zero) would represent the fair value of
the swap to Entity A at initial recognition, that is, the
price that Entity A would receive to sell or pay to transfer
the swap in a transaction with a dealer counterparty in the
retail market (that is, an exit price). That price would not
be adjusted for any incremental (transaction) costs that
would be charged by that dealer counterparty.
55-49 From the
perspective of Entity B, the dealer market (not the retail
market) is the principal market for the swap. If Entity B
were to transfer its rights and obligations under the swap,
it would do so with a dealer in that market. Because the
market in which Entity B initially entered into the swap is
different from the principal market for the swap, the
transaction price (zero) would not necessarily represent the
fair value of the swap to Entity B at initial
recognition.
An initial difference between the transaction price and fair value
may also result from an entity’s election to use mid-market pricing or other pricing
conventions as a practical expedient in accordance with ASC 820-10-35-36D. See
Example 9-2 for an illustration of this
concept.
Connecting the Dots
ASC 946 requires investment companies to report investments (including
investments in securities, common stock, or partnership interests for which
market quotations are not readily available, such as private equity
investments) at fair value as of each reporting date. An entity may also
measure equity investments at fair value through earnings under ASC 321.
At initial recognition, an entity may be able to conclude that the initial
transaction price (excluding transaction costs) is fair value (or may
conclude that the equity security should be initially recognized at the
transaction price). For subsequent reporting periods, ASC 820 requires
entities to (1) use an appropriate valuation technique or combination of
techniques to measure fair value (see ASC 820-10-35-24B) and (2) apply the
valuation technique(s) consistently unless a change results in a measurement
that is equally or more representative of fair value (see ASC 820-10-35-25).
For private equity investments, valuation techniques that may be appropriate
include market approaches (such as multiples of earnings) and income
approaches (such as free cash flows-to-equity discount). While an entity may
use the initial transaction price (excluding transaction costs) as a
starting point for valuations on subsequent reporting dates (e.g., by
calibrating certain parameters of its valuation model), it cannot assume
that the initial transaction price (excluding transaction costs) equals fair
value for subsequent reporting periods.
In applying valuation techniques, an entity should consider whether any
change has occurred in factors affecting the investment’s fair value and
should update its fair value measurement accordingly. Such considerations
include market conditions (such as equity market conditions, discount rates,
or market risk premiums) and investment-specific factors (such as projected
cash flows or entity-specific risk factors). The following nonexhaustive
list of factors for entities to consider in estimating the fair value of
securities for which market quotations are not available is based, in part,
on ASC 940-820-30-1:
-
The issuer’s financial standing.
-
The issuer’s business and financial plan.
-
The cost as of the purchase date.
-
The liquidity of the market.
-
Contractual restrictions on salability.
-
Pending public offerings for the financial instrument.
-
Pending reorganization activity affecting the financial instrument (such as merger proposals, tender offers, debt restructurings, and conversions).
-
Reported prices and the extent of public trading in similar financial instruments of the issuer or comparable entities.
-
The issuer’s ability to obtain needed financing.
-
Changes in the economic conditions affecting the issuer.
-
A recent purchase or sale of the entity’s security.
-
Pricing by other dealers in similar securities.
9.2.1 Inception Gains and Losses
If fair value is the initial measurement attribute under other Codification
topics, an entity needs to assess whether the transaction price represents fair
value at inception by considering factors specific to the transaction, including
whether one or more of the factors in ASC 820-10-30-3A are present. In many
cases, it is inappropriate to record an inception gain or loss as of the date of
initial recognition of an asset or liability.
At the 2006 AICPA Conference on Current SEC and PCAOB
Developments, Joseph McGrath, then a professional accounting fellow in the SEC’s
Office of the Chief Accountant, stated the following:
Given [ASC 820’s] exit price notion, fair value at
initial recognition is [not] limited to transaction price. Rather, [ASC
820] states that the entity “shall consider factors specific to the
transaction and the asset or liability.” [Footnote omitted] One such
factor is whether the transaction occurs in a market other than the
entity’s principal market. [Example 5 in ASC 820-10-55-46 through 55-49]
illustrates this concept with the example of a securities dealer
transacting with a customer in the retail market. In this example, the
dealer’s fair value is not necessarily transaction price, since its
principal market to exit the transaction may be different. . . .
[W]e have heard that some believe that it is “open
season” on inception gains. I would caution those constituents that
there continue to be many instances in which day one gains are not
appropriate. [ASC 820] does not allow the practice of “marking to model”
when the transaction occurs in the entity’s principal market. Rather,
transaction prices would generally be used in such a circumstance, and
the model would be calibrated to match transaction price. Continuing
with the previous example, if the securities dealer transacts with
another in the dealer market, absent satisfaction of any of the criteria
in [ASC 820-10-30-3A], transaction price would likely be the best
estimate of the fair value. As a result, there would not be any
inception gain.
Some have asserted that the use of a pricing model would
automatically lead to day two gains even in situations where there was
not an inception gain. Again, a word of caution, assuming that an entity
uses a pricing model to value its transaction in subsequent periods,
[ASC 820] would indicate that the pricing model should be calibrated, so
that the model value at initial recognition equals transaction price. As
a result of calibrating the model, simply using a pricing model to
determine fair value would not result in day two gains, unless there
were changes in the underlying market conditions. [Footnote omitted]
Mr. McGrath’s remarks indicate that if none of the factors in ASC 820-10-30-3A
are present, the transaction price is most likely the best estimate of fair
value. However, if any of the criteria in ASC 820-10-30-3A are met, there may be
a difference between the transaction price and fair value. For example, ASC
820-10-30-3A(c) indicates that the transaction price might not represent fair
value at initial recognition if “the transaction price includes transaction
costs.” That might be the case in a transaction that includes a structuring fee.
In such a situation, entities should consider adjusting a model value for the
profit margin that another market participant would demand in a transaction to
transfer the instrument. This is consistent with the risk adjustment discussion
in the ASC 820-10-20 definition of inputs.
The examples below illustrate the concepts discussed above
related to the recognition of inception gains and losses.
Example 9-1
Interest Rate Swap Entered Into Between Retail
Counterparty and Dealer
A retail counterparty enters into an interest rate swap
with a dealer for no initial consideration (i.e., the
transaction price is zero). Assume that the valuation
model used to determine the fair value of the interest
rate swap at inception is significantly influenced by
unobservable inputs. The initial model value is a $1
million loss. The retail counterparty should not
conclude that the transaction price represents fair
value on initial recognition without further
consideration. Instead, the retail counterparty needs to
assess whether the transaction price represents fair
value by considering factors specific to the
transaction, including whether one or more of the
following factors in ASC 820-10-30-3A are present:
-
The retail counterparty and the dealer are related parties.
-
The retail counterparty enters into the transaction under duress or is otherwise forced to accept the price in the transaction.
-
The transaction price is related to a unit of account that includes elements other than the asset or liability measured at fair value, such as an unstated right or privilege, another element, or transaction costs. For example, a retail counterparty may agree to a price that includes an embedded structuring fee (i.e., a transaction cost) for services that have already been rendered by a dealer. In this case, the retail counterparty would separately account for the structuring fee in accordance with another Codification topic. Depending on the nature of the structuring fee, the retail counterparty may recognize a separate expense (i.e., a loss) at inception.
-
The retail counterparty’s transaction does not occur in the principal or most advantageous market.
Notwithstanding the preceding
discussion, inception gains for retail counterparties
that are due to factors specific to the financial
instrument with significant unobservable inputs are
expected to be infrequent, and all entities should
clearly document their ASC 820-10-30-3A analysis and
assertions. Inception losses, however, are more common
for retail counterparties as a result of bid-ask spread
differences between the entry transaction and the
hypothetical exit transaction. This is illustrated in
the example below.
Example 9-2
Debt Security Purchased by Nondealer
Assume the following:
-
A nondealer purchases a debt security from a dealer at the ask price of $101.
-
The current market-observable bid price is $99.
-
The nondealer’s policy is to use a mid-level price ($100) for its fair value measurements.
By paying $101 (the ask price) and then
immediately measuring the fair value at the mid-level
price of $100, the nondealer will have incurred an
inception loss of $1. This example illustrates how a
nondealer might incur a loss at inception because of its
policy for determining fair value within the bid-ask
spread. That is, a nondealer may incur an inception loss
depending on (1) where it has initially transacted
within or outside the bid-ask spread and (2) its bid-ask
pricing policy. An entity should apply the guidance in
ASC 820-10-35-36C and 35-36D to determine its bid-ask
pricing policy.
In some cases, an entity is prohibited from recognizing an inception gain or loss
even if the transaction price is not fair value at inception of the contract.
For example, ASC 815-15-30-2 provides guidance on determining the initial
carrying amount of a host contract and an embedded derivative when separate
accounting is required by ASC 815-15. ASC 815-15-30-2 requires that an entity
use the “with-and-without” method to calculate the initial carrying amount of
the host contract. Under the with-and-without method, the initial carrying
amount of the embedded derivative component of a hybrid instrument is equal to
its fair value at inception of the contract (as determined under ASC 820), and
the initial carrying amount of the host contract equals the excess of the
transaction price for the hybrid instrument over the initial fair value of the
embedded derivative.
In a speech at the 2003 AICPA Conference on Current SEC
Developments, John James, then a fellow in the SEC’s Office of the Chief
Accountant, clarified that when using the with-and-without method, an entity is
not permitted to recognize an “immediate gain or loss that would occur if the
relative fair value method were used” (the relative fair value method is not
permitted). Mr. James discussed a situation in which the SEC staff objected to
an entity’s recognition of a day 1 gain on an embedded derivative when the
entity believed that if that embedded derivative were issued on a freestanding
basis, the entity would have met the conditions to recognize such a gain. The
staff believed that ASC 815 was prescriptive regarding the initial measurement
for both the host contract and bifurcated derivative (i.e., the with-and-without
method).
On the basis of this speech, it would not be appropriate for an entity to record
an inception gain or loss for a hybrid instrument with an embedded derivative
that must be bifurcated and accounted for separately in accordance with ASC
815-15. Rather, the difference between the basis of the hybrid instrument and
the inception-date fair value of the embedded derivative should be recorded as
the initial carrying amount of the host contract. As a result, any day 1 gains
and losses (observable or unobservable) related to separately measured embedded
derivatives effectively would be applied to the basis of the host contract and
recognized as the host contract affects earnings (e.g., amortized as a yield
adjustment to a nonderivative host financial instrument). For hybrid instruments
not carried at fair value in their entirety, entities should apply the guidance
from ASC 815-15-30-2 and the related SEC speech. These requirements do not apply
to hybrid instruments recognized at fair value in their entirety.
Footnotes
1
In the absence of such factors, the initial fair value of an asset,
liability, or equity instrument would be its transaction price.
9.3 Model Calibration
ASC 820-10
Valuation Techniques
35-24C If the transaction price is
fair value at initial recognition and a valuation technique
that uses unobservable inputs will be used to measure fair
value in subsequent periods, the valuation technique shall
be calibrated so that at initial recognition the result of
the valuation technique equals the transaction price.
Calibration ensures that the valuation technique reflects
current market conditions, and it helps a reporting entity
to determine whether an adjustment to the valuation
technique is necessary (for example, there might be a
characteristic of the asset or liability that is not
captured by the valuation technique). After initial
recognition, when measuring fair value using a valuation
technique or techniques that use unobservable inputs, a
reporting entity shall ensure that those valuation
techniques reflect observable market data (for example, the
price for a similar asset or liability) at the measurement
date.
When an entity determines that a transaction price represents fair value on initial
recognition, but the valuation model that the entity expects to use for subsequent
measurement yields an initial estimate of fair value that differs from the
transaction price, the valuation model should be calibrated in such a way that it
yields the same estimate of fair value as the transaction price. An entity should
not recognize a gain or loss at inception because of a difference between the
valuation model and the transaction price. An inception gain or loss would only be
recognized as a result of subsequent changes in circumstances.
ASC 820-10-35-24C does not specify how to calibrate a model or model inputs.
Accordingly, various calibration methods may be acceptable under ASC 820-10-35-24C
depending on the valuation technique used, the availability of information about
market-participant assumptions (e.g., relevant observable inputs), the terms of the
instrument, and the nature of the entity’s portfolio. However, regardless of the
method an entity uses, if the transaction price represents the fair value of a
contract at inception and the initial fair value differs from the entity’s
inception-date model value, the inception difference should not be recognized (1)
upon the initial recognition of the transaction or (2) after initial recognition
unless there has been a subsequent change in circumstances. Instead, the inception
difference should be recognized as the uncertainty in the inputs, the uncertainty in
the model, or both are eliminated. The calibration method chosen should be applied
systematically, rationally, and consistently.
As noted above, the appropriate method for calibrating a model
depends on an entity’s circumstances. Entities often employ valuation adjustments to
reflect the factors that market participants would consider in setting a price when
those factors are not otherwise captured in the model (e.g., adjustments for
uncertainty in model inputs or model complexity). Appropriate use of valuation
adjustments should result in an estimate of fair value that reflects the price at
which market participants would transact as of the reporting date. Similarly, to
comply, at initial recognition, with the fair value measurement objective prescribed
by ASC 820-10-30-3A and ASC 820-10-35-24C, an entity may determine that it needs to
make a separate valuation adjustment to calibrate its model (and to ensure that the
inception difference is not recognized). In these situations, the entity should
review the valuation adjustment periodically to ensure that it reflects any new
information and is consistent with ASC 820’s exit price notion. ASC 820-10-35-24C
indicates that “[a]fter initial recognition, when measuring fair value using a
valuation technique or techniques that use unobservable inputs, a reporting entity
shall ensure that those valuation techniques reflect observable market data (for
example, the price for a similar asset or liability) at the measurement date.”
The example below illustrates a model calibration approach that may
be acceptable when the inception difference can be isolated to a particular
unobservable input. Entities should follow the steps in the example below regardless
of whether the calibration approach results in direct adjustments to model inputs or
valuation adjustments to the modeled estimate of fair value.
Example 9-3
Model Calibration for
Electricity Contract
Entity A enters into an electricity forward
contract to purchase 100 MW of electricity (daily) at
Location X for a 10-year term. The forward contract is
accounted for at fair value because it meets the definition
of a derivative and does not qualify for (or the entity did
not elect) the scope exception for normal purchases and
normal sales under ASC 815-10-15-22 through 15-26. There are
three years of observable forward prices at Location X.
Entity A’s model value at inception is a gain of $1 million;
however, no cash was exchanged between the parties. On the
basis of an analysis under ASC 820-10-30-3A, A determines
that the transaction price equals the exit price (i.e., fair
value equals zero at inception) and that it must apply ASC
820-10-35-24C. The only unobservable input with a
significant effect on the model value at inception is the
forward electricity price for Location X.
In this scenario, A might apply ASC 820’s
calibration guidance as follows:
-
Step 1: Identify the source of the inception difference — Entity A has established that the only unobservable input that significantly affects the model value is forward electricity prices.
-
Step 2: Adjust the unobservable inputs or establish valuation adjustments in such a way that the adjusted model value equals the transaction price at inception — In a systematic, rational, and consistently applied manner, adjust the unobservable forward price points (i.e., years 4–10) on the forward price curve in such a way that the model produces a fair value equal to zero (i.e., the exit price equals the transaction price).When calibration results in direct adjustment to model inputs, entities should consider the impact of such adjustments on the valuation of other instruments in their portfolio (e.g., instruments valued under different models but by using the same or similar pricing inputs). The calibration may affect the valuation of other instruments because the calibrated inputs may replace or supersede the assumptions previously used for unobservable inputs. Recall that in step 1, A determined that the inception difference was driven solely by the unobservable Location X electricity prices; therefore, any resulting “calibration adjustment” represents a calibration of these unobservable electricity prices to the most recent available information (the forward contract’s transaction price). As a result, if A derives the fair value of a portfolio of contracts by using long-dated (in this example, beyond three years) Location X electricity prices, the calibration adjustment to the electricity forward prices would most likely affect the fair value of the other long-dated Location X contracts. The considerations noted above for calibration techniques that result in direct adjustment to model inputs may also apply when a calibration results in valuation adjustments to the modeled estimate of fair value. In other words, calibration adjustments result in updated information about assumptions market participants use in assessing unobservable inputs or valuation adjustments and may have relevance beyond the recently executed transaction.
-
Step 3: Recognize subsequent changes in model value — The inception difference will be recognized when (1) unobservable inputs become observable or (2) unobservable inputs or valuation adjustments are adjusted to reflect new information (e.g., through calibration of the model or model inputs to reflect new transaction data or through the passage of time). In this example, in the absence of further calibration or changes in input observability, one would expect the inception difference to be recognized over the first seven years of the contract (as years 4–10 become observable). Note that no inception difference should remain for a period in which settlement has occurred. In addition, no portion of the inception difference should remain once all the unobservable inputs become observable.
Chapter 10 — Subsequent Measurement
Chapter 10 — Subsequent Measurement
10.1 Introduction
ASC 820-10
35-1 The fair value measurement
framework, which applies at both initial and subsequent
measurement if fair value is required or permitted by
another Topic, is discussed primarily in this Section.
Section 820-10-30 sets out additional guidance specific to
applying the framework at initial measurement. This Section
is organized as follows:
-
Definition of fair value
-
Valuation techniques
-
Inputs to valuation techniques
-
Fair value hierarchy
-
Measuring fair value when the volume or level of activity for an asset or a liability has significantly decreased
-
Identifying transactions that are not orderly
-
Using quoted prices provided by third parties
-
Measuring the fair value of investments in certain entities that calculate net asset value per share (or its equivalent).
Many Codification topics require or permit the subsequent measurement of assets or
liabilities at fair value (see Section 2.1.2
for more information). ASC 820-10-35 provides guidance on the subsequent measurement
of items at fair value and applies to both recurring and nonrecurring measurements.
This chapter discusses the subsequent-measurement requirements of ASC 820 as well as
the application of these requirements to specific types of items or transactions.
See Chapter 9 for discussion of initial
measurements at fair value.
In addition to the guidance in ASC 820, the AICPA has issued fair value measurement
guidance1 in the form of technical questions and answers, practice aids, and guides,
including the following accounting and valuation guides:
Further, because ASC 820 is substantially converged with IFRS 13,
the IASB Expert Advisory Panel report may also be helpful for entities that apply U.S. GAAP to
use in measuring or disclosing fair value (since the best practices outlined in the
report were incorporated into IFRS 13). The IASB’s project summary and feedback statement for IFRS 13 describes
how the report is related to IFRS 13:
In May 2008 we established a Fair Value Expert Advisory
Panel that included preparers, auditors and users of financial statements,
as well as regulators.
The Panel’s remit was to help us:
-
review best practices in the area of valuation techniques; and
-
formulate any necessary additional practice guidance on valuation methods for financial instruments and related disclosures when markets are no longer active.
In October 2008 our staff published a report summarising the
Panel’s discussions. The report . . . summarised the valuation and
disclosure practices undertaken by large financial institutions in the
financial crisis. The requirements in IFRS 13 are
consistent with that report. [Emphasis added]
Footnotes
1
Note that while such AICPA guidance constitutes an additional resource for
entities to use in measuring or disclosing fair value, it is
nonauthoritative, has not been approved by the FASB or SEC, and is not a
substitute for the application of ASC 820.
10.2 Definition of Fair Value
10.2.1 General
ASC 820-10
Definition of Fair Value
35-2 This Topic defines fair
value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly
transaction between market participants at the
measurement date. . . .
35-2A The
remainder of this guidance is organized as follows:
-
The asset or liability
-
The transaction
-
Market participants
-
The price
-
Application to nonfinancial assets
-
Application to liabilities and instruments classified in a reporting entity’s shareholders’ equity
-
Application to financial assets, financial liabilities, and nonfinancial items accounted for as derivatives under Topic 815 with offsetting positions in market risks or counterparty credit risk.
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 Section 1.2, the definition
of fair value is based on an exit price notion. An asset, liability, or equity
instrument is measured at fair value on the basis of market-participant
assumptions; such measurement is not entity-specific. Entities must consider all
the characteristics of the asset, liability, or equity instrument that a market
participant would consider in determining an exit price in the principal or most
advantageous market. The measurement of the asset, liability, or equity
instrument at fair value for recognition purposes is at the level of the unit of
account, which may differ from the unit of valuation. The concepts underlying
the definition of fair value are discussed in the subsections below.
10.2.2 The Asset or Liability
10.2.2.1 General
ASC 820-10
The Asset or
Liability
35-2B A fair value
measurement is for a particular asset or liability.
Therefore, when measuring fair value a reporting
entity shall take into account the characteristics
of the asset or liability if market participants
would take those characteristics into account when
pricing the asset or liability at the measurement
date. Such characteristics include, for example, the
following:
-
The condition and location of the asset
-
Restrictions, if any, on the sale or use of the asset.
35-2C The effect on the
measurement arising from a particular characteristic
will differ depending on how that characteristic
would be taken into account by market participants.
Paragraph 820-10-55-51 illustrates a restriction’s
effect on fair value measurement.
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.
Depending on the unit of account, which is generally determined in accordance
with other Codification topics, the asset or liability being measured at
fair value might be a stand-alone asset or liability, a group of assets, a
group of liabilities, or a group of assets and liabilities. See Chapter 4 for further discussion of the unit
of account.
In addition to applying the appropriate unit of account to a fair value
measurement, entities may need to consider other asset-specific
characteristics that affect fair value. According to ASC 820-10-35-2B,
examples of potential asset-specific characteristics that may affect a fair
value measurement include (1) the condition and location of the asset (see
Section 10.2.5.4) and (2) restrictions on the sale
or use of the asset (see Section 10.2.2.2).
10.2.2.2 Restrictions on the Sale or Use of an Asset
ASC 820-10
Example 6:
Restricted Assets
55-51 The effect on a fair
value measurement arising from a restriction on the
sale or use of an asset by a reporting entity will
differ depending on whether the restriction would be
taken into account by market participants when
pricing the asset. Cases A and B illustrate the
effect of restrictions when measuring the fair value
of an asset. . . .
Pending Content (Transition
Guidance: ASC 820-10-65-13)
55-51
The effect on a fair value measurement arising
from a restriction on the sale or use of an asset
by a reporting entity will differ depending on
whether the restriction would be taken into
account by market participants when pricing the
asset. When the restriction is included within the
unit of account of the asset, the restriction is a
characteristic of the asset and should be
considered in measuring the fair value of the
asset. Cases A and B illustrate the effect of
restrictions when measuring the fair value of an
asset. . . .
Case A: Restriction on the Sale of
an Equity Instrument
Restriction Taken Into Account
55-52 A reporting entity
holds an equity instrument (a financial asset) for
which sale is legally or contractually restricted
for a specified period. (For example, such a
restriction could limit sale to qualifying
investors, as may be the case in accordance with
Rule 144 or similar rules of the Securities and
Exchange Commission [SEC].) The restriction is a
characteristic of the instrument and, therefore,
would be transferred to market participants. In that
case, the fair value of the instrument would be
measured on the basis of the quoted price for an
otherwise identical unrestricted equity instrument
of the same issuer that trades in a public market,
adjusted to reflect the effect of the restriction.
The adjustment would reflect the amount market
participants would demand because of the risk
relating to the inability to access a public market
for the instrument for the specified period. The
adjustment will vary depending on all of the
following:
-
The nature and duration of the restriction
-
The extent to which buyers are limited by the restriction (for example, there might be a large number of qualifying investors)
-
Qualitative and quantitative factors specific to both the instrument and the issuer.
Pending Content
(Transition Guidance: ASC 820-10-65-13)
Editor’s Note: The content of paragraph
820-10-55-52 will change upon transition, together
with a change in the heading noted below.
Case A: Restriction on the
Sale of an Equity Security
55-52
Company X issues Class A shares through a sale on
a national securities exchange or an
over-the-counter market as well as through a
private placement transaction. Because the Class A
shares issued through the private placement are
not registered and are legally restricted from
being sold on a national securities exchange or an
over-the-counter market until the shares are
registered or the conditions necessary for an
exemption from registration have been satisfied, a
market participant would sell the private
placement Class A shares in a different market
than the market used for registered Class A shares
on the measurement date. Because that restriction
would be included within the unit of account of
the equity security, a market participant would
consider the inability to resell the security on a
national securities exchange or an
over-the-counter market when pricing the equity
security; therefore, the reporting entity that
holds the Class A shares acquired through a
private placement transaction would consider that
restriction a characteristic of the asset. In that
case, the reporting entity should measure the fair
value of the equity security on the basis of the
market price of the similar unrestricted equity
security adjusted to reflect the effect of the
restriction. The adjustment will vary depending on
all of the following:
- The nature and remaining duration of the restriction
- The extent to which buyers are limited by the restriction (for example, there might be a large number of qualifying investors)
- Qualitative and quantitative factors specific to both the instrument and the issuer.
55-52A
A reporting entity holds Class A shares of Company
X that are eligible for sale on a national
securities exchange or an over-the-counter market.
Separately, the reporting entity enters into a
contractual arrangement in which it agrees that it
will not sell the Class A shares for a certain
time period. That arrangement may be referred to
as a lock-up agreement or a market standoff
agreement or may be the result of a provision
within a separate agreement between certain
shareholders (that is, separate from the legal
documents that establish the rights and
obligations of all holders of a particular class
of stock). In that instance, the restriction is
not included in the unit of account and therefore
is not a characteristic of the asset. The equity
security subject to the contractual sale
restriction is identical to an equity security
that is not subject to a contractual sale
restriction. Therefore, consistent with the
guidance in paragraphs 820-10-35-6B and
820-10-35-36B, the fair value of the equity
security subject to the contractual sale
restriction should be measured on the basis of the
market price of the same equity security without
the contractual sale restriction and should not be
adjusted to reflect the reporting entity’s
inability to sell the equity security on the
measurement date.
55-53 As discussed in
paragraph 820-10-15-5, this Topic applies for equity
securities with restrictions that expire within one
year that are measured at fair value in accordance
with Subtopics 320-10 and 958-320.
Case B: Restrictions on the Use of
an Asset
55-54 A donor contributes
land in an otherwise developed residential area to a
not-for-profit neighborhood association. The land is
currently used as a playground. The donor specifies
that the land must continue to be used by the
association as a playground in perpetuity; however,
the association is not restricted from selling the
land. Upon review of relevant documentation (for
example, legal and other), the association
determines that the fiduciary responsibility to meet
the donor’s restriction would not be transferred to
market participants if the association sold the
asset, that is, the donor restriction on the use of
the land is specific to the association. Without the
restriction on the use of the land by the
association, the land could be used as a site for
residential development. In addition, the land is
subject to an easement (that is, a legal right that
enables a utility to run power lines across the
land). Following is an analysis of the effect on the
fair value measurement of the land arising from the
restriction and the easement:
-
Donor restriction on use of land. Because in this situation the donor restriction on the use of the land is specific to the association, the restriction would not be transferred to market participants. Therefore, the fair value of the land would be the higher of its fair value used as a playground (that is, the fair value of the asset would be maximized through its use by market participants in combination with other assets or with other assets and liabilities) and its fair value as a site for residential development (that is, the fair value of the asset would be maximized through its use by market participants on a standalone basis), regardless of the restriction on the use of the land by the association.
-
Easement for utility lines. Because the easement for utility lines is specific to (that is, a characteristic of) the land, it would be transferred to market participants with the land. Therefore, the fair value measurement of the land would take into account the effect of the easement, regardless of whether the highest and best use is as a playground or as a site for residential development.
55-55 The donor restriction,
which is legally binding on the association, would
be indicated through classification of the
associated net assets and disclosure of the nature
of the restriction in accordance with paragraphs
958-210-45-8 through 45-9, 958-210-50-1, and
958-210-50-3.
In some cases, it is appropriate to consider a restriction
on the sale or use of an asset as a characteristic of the asset that affects
its fair value. Only a legal or contractual restriction on the sale or use
of an asset that is specific to the asset (an instrument-specific
restriction) and that would be transferred to market participants should be
incorporated into the asset’s fair value measurement. Thus, an entity should
consider the effect of a restriction on the sale or use of an asset that it
owns only if market participants would consider such a restriction in
pricing the asset because they would also be subject to the restriction if
they acquired the asset. Entity-specific restrictions that would not be
transferred to market participants should not be considered in the
determination of the asset’s fair value, since doing so would be
inconsistent with the exit price notion underlying the definition of fair
value. The table below gives examples of restrictions on the sale of assets
and addresses whether they are instrument-specific or entity-specific.
Section
5.2.3 discusses considerations related to the potential uses
of nonfinancial assets that may affect the highest-and-best-use valuation
premise for nonfinancial assets.
Table 10-1
|
Examples of Restrictions on the Sale of Assets
| ||
|---|---|---|
|
Nature of Restriction
|
Description of Restriction
|
Impact of Restriction on Fair Value
|
|
Restriction on the sale of
securities offered in a private offering in
accordance with Rule 144 of the Securities Act of
1933 or similar rules (private placements)
|
SEC Rule 144 legally restricts the sale of certain
securities to buyers that meet specified
criteria.
|
As discussed in ASC 820-10-55-52, this type of
restriction is a characteristic of the security and
would be transferred to market participants.
Therefore, the fair value measurement of the
security should take this instrument-specific
restriction into account.
An instrument-specific restriction on a security
affects a fair value measurement by the amount that
a market participant would demand because of the
inability to access a public market for the security
for the specified period. As discussed in ASC
820-10-55-52, that amount depends on the nature and
duration of the restriction, the extent to which
buyers are limited by the restriction, and
qualitative and quantitative factors specific to
both the instrument and the issuer. Quoted prices
for such securities would reflect the resale
restriction; therefore, there should be no further
adjustment to reflect the restriction.
|
|
Founder’s shares in an initial
public offering (IPO) of equity securities
|
Founders may be contractually restricted from selling
their shares for a period after an IPO. Such
restrictions may be outlined in the IPO
prospectus.
|
If this restriction is not embedded
in the contractual terms of the shares (which it
generally is not) and thus would not be transferred
in a hypothetical sale of the shares, the
restriction is specific to the founders and not a
characteristic of the security. Therefore, the
founders should not consider this restriction in
determining fair value.2
|
|
Security sale restriction related to a seat on the
board of directors
|
An entity (Entity A) has an equity investment in
another entity (Entity B) and is represented on its
board of directors. Because officers of A are
directors of B, A is restricted from selling any of
its investment securities in B during each period
that is two weeks before the end of each quarter
through 48 hours after B’s earnings are released
(also referred to as a “blackout period”).
|
Other market participants would not face this
restriction. Because the restriction is
entity-specific (i.e., it is not a characteristic of
the security) and would not be transferred with the
security, an entity should not consider the
restriction in measuring the security at fair
value.
|
|
Assets pledged as collateral
|
An entity has a borrowing arrangement in which assets
must be pledged as collateral.
|
Other market participants would not face this
restriction. Because the restriction is
entity-specific (i.e., it is not a characteristic of
the assets) and would not be transferred with the
assets, an entity should not consider the
restriction in measuring the assets at fair
value.
|
The determination of whether a contractual or legal restriction on the sale
or use of an asset is instrument-specific or entity-specific is sometimes
straightforward; other times, an entity may need to exercise judgment or
consult a legal specialist in making this determination.
Changing Lanes
In June 2022, the FASB issued ASU
2022-03, which clarifies that an entity would
not consider contractual sale restrictions when measuring the fair
value of equity securities subject to those restrictions. The ASU is
effective for public business entities in fiscal years beginning
after December 15, 2023, and interim periods within those fiscal
years. For all other entities, it is effective in fiscal years
beginning after December 15, 2024, and interim periods within those
fiscal years. Early adoption of the ASU is permitted. See Deloitte’s
July 1, 2022, Heads Up for further discussion.
10.2.3 The Transaction
ASC 820-10
The Transaction
35-3 A fair
value measurement assumes that the asset or liability is
exchanged in an orderly transaction between market
participants to sell the asset or transfer the liability
at the measurement date under current market
conditions.
35-5 A fair
value measurement assumes that the transaction to sell
the asset or transfer the liability takes place
either:
-
In the principal market for the asset or liability
-
In the absence of a principal market, in the most advantageous market for the asset or liability.
35-5A A
reporting entity need not undertake an exhaustive search
of all possible markets to identify the principal market
or, in the absence of a principal market, the most
advantageous market, but it shall take into account all
information that is reasonably available. In the absence
of evidence to the contrary, the market in which the
reporting entity normally would enter into a transaction
to sell the asset or to transfer the liability is
presumed to be the principal market or, in the absence
of a principal market, the most advantageous market.
35-6 If there
is a principal market for the asset or liability, the
fair value measurement shall represent the price in that
market (whether that price is directly observable or
estimated using another valuation technique), even if
the price in a different market is potentially more
advantageous at the measurement date.
35-6A The
reporting entity must have access to the principal (or
most advantageous) market at the measurement date.
Because different entities (and businesses within those
entities) with different activities may have access to
different markets, the principal (or most advantageous)
market for the same asset or liability might be
different for different entities (and businesses within
those entities). Therefore, the principal (or most
advantageous) market (and thus, market participants)
shall be considered from the perspective of the
reporting entity, thereby allowing for differences
between and among entities with different
activities.
35-6B
Although a reporting entity must be able to access the
market, the reporting entity does not need to be able to
sell the particular asset or transfer the particular
liability on the measurement date to be able to measure
fair value on the basis of the price in that market.
35-6C Even
when there is no observable market to provide pricing
information about the sale of an asset or the transfer
of a liability at the measurement date, a fair value
measurement shall assume that a transaction takes place
at that date, considered from the perspective of a
market participant that holds the asset or owes the
liability. That assumed transaction establishes a basis
for estimating the price to sell the asset or to
transfer the liability.
As discussed in ASC 820-10-35-5, in a fair value measurement, it is assumed that
an orderly transaction to sell the asset or transfer the liability has occurred
in the principal market for the asset or liability (or, in the absence of a
principal market, the most advantageous market). While a fair value measurement
is not entity-specific, the principal (or most advantageous) market for the
asset or liability is determined from the perspective of the entity estimating
fair value for recognition or disclosure purposes. See Chapter 6 for discussion of the concept of the
principal or most advantageous market. Also see Example
10-9, which illustrates how to identify the most advantageous
market for a nonfinancial asset.
10.2.4 Market Participants
ASC 820-10
Market
Participants
35-9 A reporting entity shall
measure the fair value of an asset or a liability using
the assumptions that market participants would use in
pricing the asset or liability, assuming that market
participants act in their economic best interest. In
developing those assumptions, a reporting entity need
not identify specific market participants. Rather, the
reporting entity shall identify characteristics that
distinguish market participants generally, considering
factors specific to all of the following:
-
The asset or liability
-
The principal (or most advantageous) market for the asset or liability
-
Market participants with whom the reporting entity would enter into a transaction in that market.
To reflect an exit price in accordance with the definition and objective of a
fair value measurement, an asset or liability must be measured on the basis of
assumptions that market participants would use in pricing the asset or
liability. See Chapter 7 for further
discussion of market-participant assumptions and Section 10.4 for information about inputs into a valuation
technique.
10.2.5 The Price
10.2.5.1 General
ASC 820-10
The Price
35-9A Fair
value is the price that would be received to sell an
asset or paid to transfer a liability in an orderly
transaction in the principal (or most advantageous)
market at the measurement date under current market
conditions (that is, an exit price) regardless of
whether that price is directly observable or
estimated using another valuation technique.
35-9B The
price in the principal (or most advantageous) market
used to measure the fair value of the asset or
liability shall not be adjusted for transaction
costs. Transaction costs shall be accounted for in
accordance with other Topics. Transaction costs are
not a characteristic of an asset or a liability;
rather, they are specific to a transaction and will
differ depending on how a reporting entity enters
into a transaction for the asset or liability.
35-9C
Transaction costs do not include transportation
costs. If location is a characteristic of the asset
(as might be the case, for example, for a
commodity), the price in the principal (or most
advantageous) market shall be adjusted for the
costs, if any, that would be incurred to transport
the asset from its current location to that
market.
In the principal (or most advantageous) market, the price used to measure the
fair value of an asset, liability, or instrument classified in an entity’s
stockholders’ equity is determined as of the measurement date under current
market conditions. This price should not be adjusted for transaction costs
but may be adjusted for transportation costs.
10.2.5.2 Subsequent Information and Events
ASC 820-10-35-9A indicates that a fair value measurement
represents “the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction . . . at the measurement date
under current market conditions.” In estimating fair value, an entity should
develop inputs on the basis of the assumptions that market participants
would make as of the measurement date, provided that such participants
performed usual and customary due diligence procedures.3 In making assumptions about the inputs that market participants would
use in estimating fair value, an entity is responsible for analyzing and
considering “any relevant subsequent events and information to assess
whether the fair value measurement reflects all relevant information and
assumptions that market participants would have considered under the current
conditions at the measurement date.”4
Relevant information related to the assumptions about the
inputs used to estimate fair value may include general market and economic
data, industry data, and investment-specific data. Relevant information
obtained after the measurement date but before the financial statements are
issued (or available to be issued) may serve as additional evidence of the
assumptions that market participants would have made in developing inputs as
of the measurement date after making usual and customary due diligence
efforts. Conversely, such information may represent information that market
participants would not have considered as of the measurement date after
making these efforts. In all cases, a fair value measurement as of the
measurement date should incorporate assumptions about risk, including risks
inherent in (1) a particular valuation technique and (2) the inputs to the
valuation technique.5 If uncertainty is inherent in the inputs used to estimate fair value
as of the measurement date, the entity cannot disregard such uncertainty in
estimating fair value even if the uncertainty is not resolved until after
the measurement date. In some cases, it may be difficult to determine the
appropriate risk adjustments that market participants may make to reflect
the uncertainty inherent in the inputs used in a fair value measurement;
however, the degree of difficulty is not a sufficient basis for excluding a
risk adjustment.6
In evaluating how to consider relevant information obtained
after the measurement date in estimating fair value as of the measurement
date, an entity should consider the guidance in ASC 855, which distinguishes
between recognized and unrecognized subsequent events. The definition of
subsequent events in the ASC master glossary indicates that recognized
subsequent events are those that “provide additional evidence about
conditions that existed at the date of the balance sheet, including the
estimates inherent in the process of preparing financial statements.”
Nonrecognized subsequent events, on the other hand, are those that “provide
evidence about conditions that did not exist at the date of the balance
sheet but arose subsequent to that date.” Entities should adjust their
financial statements only to reflect the impact of recognized subsequent
events. For nonrecognized subsequent events, entities should evaluate the
completeness of their financial statement disclosures.
In applying ASC 855 to a fair value measurement, an entity
must consider the following questions:7
-
Does the information obtained after the measurement date constitute evidence of a condition that existed as of the measurement date?Subsequent events or transactions that reflect changes in circumstances occurring after the balance sheet date do not constitute evidence of the fair value measurement as of the balance sheet date. Only information obtained after the measurement date that constitutes evidence of a condition that existed as of the measurement date can be relevant to the determination of fair value.If the information obtained after the measurement date constitutes evidence of a condition that existed as of the measurement date, go to question 2. If the information serves as evidence of a condition that did not exist as of the measurement date, the information obtained after the measurement date represents a nonrecognized subsequent event. Nonrecognized subsequent events do not result in adjustments of the financial statements; however, disclosures may be required under ASC 855-10-50-2 and 50-3.
-
Does the information obtained after the measurement date represent information that would have been available to market participants as of the measurement date (under an assumption that market participants performed usual and customary due diligence efforts)?If the information obtained by an entity after the measurement date would have been available to market participants as of the measurement date, the entity should directly consider the information in developing the inputs into the fair value measurement as of the measurement date. If, however, the information obtained by the entity after the measurement date reflects only the resolution of a particular uncertainty that existed as of the measurement date, the information itself should not be used with certainty as an input into the fair value measurement as of the measurement date. However, the entity should ensure that the estimation of fair value as of the measurement date appropriately includes assumptions about risks related to the uncertainty that existed as of the measurement date.
The summary section of ASU 2012-07 further elaborates on how an entity
considers information obtained after the measurement date that resolves an
uncertainty that existed as of the measurement date:
[An] entity should include, in a valuation model, assumptions that
market participants would have made about uncertainty in timing and
amount of cash flows as of the measurement date. To the extent that
uncertainties are resolved or other information becomes known after
the balance sheet date, but before the financial statements are
issued or available to be issued, such effects should not be
incorporated with certainty into the fair value measurement as of
the balance sheet date unless market participants would have made
such assumptions.
The examples below illustrate the application of the guidance discussed
above.
Example 10-1
Information Not Available as of the Measurement
Date
Entity A holds marketable securities and records them
at fair value in its balance sheet on the basis of a
quoted market price. As of A’s year-end (i.e., the
measurement date), these securities had a quoted
price per share of $150. After the measurement date,
the securities’ quoted price per share dropped to
$120. In this example, it is assumed that the
decline occurs after the measurement date; events
that occur after market close but before the end of
the measurement date are not considered subsequent
events.
The decline in the quoted price is a nonrecognized
subsequent event because it represents information
that market participants would not have had as of
the measurement date; therefore, A should not adjust
its fair value measurement of the marketable
securities as of the measurement date. However, if
the investment in marketable securities or decline
in their fair value is significant to A, A should
consider the decline in determining whether its
financial statement disclosures are adequate.
Example 10-2
Information Both
Available and Not Available as of the Measurement
Date
Entity B holds a limited partnership
interest in Partnership Z, which is a nonpublic
entity that invests in real estate in southeast Asia
(the “investment”). Entity B recognizes the
investment at fair value through earnings in its
financial statements. Entity B’s fiscal year-end is
December 31, 20X5, and it issues its financial
statements on February 28, 20X6. Entity B receives a
financial information package from the general
partner (GP) of Z on a 30-day lag. The financial
information received from Z includes financial
statements as of the prior month-end and updated
projections of Z’s future cash flows (the “cash flow
projections”). Entity B estimates the fair value of
Z by using a present value technique that
incorporates the cash flow projections received from
Z, which represent a significant unobservable input
into the valuation technique. As part of its
year-end closing process, B uses the cash flow
projections received from Z as part of the November
30, 20X5, financial information package (the
“original projections”) to estimate the fair value
of the investment as of the December 31, 20X5,
measurement date. On February 1, 20X6, B receives
the December 31, 20X5, financial information package
from Z, which includes revised cash flow projections
(the “updated cash flow projections”). The updated
cash flow projections are significantly revised
downward from the original cash flow projections.
The negative revisions in both the amount and timing
of Z’s estimated future cash flows are primarily
attributable to two factors: (1) adverse economic
developments in the general real estate market in
southeast Asia that occurred in December 20X5 and
(2) a discrete decision made by the GP of Z on
January 15, 20X6, to abandon two real estate
projects in process. In the analysis below, it is
assumed that as part of the usual and customary due
diligence procedures that would be performed before
a decision is made to invest in Z, market
participants would (1) be knowledgeable about
general economic conditions in the southeast Asian
real estate market that would affect Z and (2) have
access to the same financial information that B
receives from Z. The GP of Z would not, however,
provide access to confidential information that is
not made available to existing investors in Z.
The receipt of the updated cash flow
projections from Z constitutes evidence of both a
condition that existed as of the December 31, 20X5,
measurement date (i.e., the impact of adverse
economic developments in the southeast Asian real
estate market) and a condition that did not exist as
of the December 31, 20X5, measurement date (i.e.,
the discrete decision to abandon two real estate
projects in process). In determining a transaction
price for the investment in Z as of the December 31,
20X5, measurement date, market participants would
not have had access to the updated cash flow
projections, although they would have been
knowledgeable of the fact that deteriorating
economic conditions in the southeast Asian real
estate market would affect Z’s future business
prospects. Therefore, while it would be
inappropriate to directly incorporate the updated
cash flow projections as an input into the valuation
technique, B should appropriately incorporate
assumptions about the risks that market participants
would consider inherent in the original projections
(including the compensation for bearing such risks).
Given the usual and customary due diligence
procedures that market participants would perform in
determining a transaction price for the investment,
the assumptions market participants would make about
the risks inherent in the original cash flow
projections would be expected to include risk
adjustments pertaining to the adverse economic
developments in the southeast Asian real estate
market in December 20X5 as well as the execution
risks involved in Z’s real estate projects in
process. Market participants would have incorporated
assumptions regarding the risks inherent in the
original cash flow projections on the basis of
judgments regarding the uncertainty in the timing
and amounts of cash flows as of the measurement date
without the benefit of any resolution of these
uncertainties that may have been provided once the
updated cash flow projections were made
available.
Example 10-3
Observable
Transaction After the Measurement Date
Entity C holds a common equity
ownership interest in a private company, X, that C
recognizes at fair value through earnings in its
financial statements. Entity C’s fiscal year-end is
December 31, 20X5, and it issues its financial
statements on February 28, 20X6. In performing its
year-end closing, C used both the market approach
and the income approach to estimate the fair value
of its investment in X. For both techniques,
significant unobservable (Level 3) inputs were
required because no observable market transactions
for the asset occurred during the reporting period
and no comparable market information was available.
(See Section 10.3.2
for a discussion of the use of multiple valuation
techniques.)
An observable market transaction in
X’s common equity occurred between unrelated
entities on January 15, 20X6. (Note that as
discussed in Section 10.4.1,
ASC 820-10-35-36 requires entities to maximize the
use of relevant observable inputs [i.e., Level 1 and
Level 2 inputs that do not need to be significantly
adjusted] and minimize the use of unobservable
inputs in their valuation techniques.) Entity C
should evaluate significant differences between (1)
its estimate of the fair value of its investment in
X under the market approach and income approach and
(2) the observable transaction price. The subsequent
transaction and related information may constitute
additional evidence of the fair value of C’s
investment in X as of the measurement date,
indicating that an adjustment would be
appropriate.
However, in evaluating whether the
subsequent transaction price is relevant to the fair
value of C’s investment in X as of the measurement
date, C should consider whether (1) significant
events (e.g., market changes or changes in the
investee’s business, including the industry in which
X operates) have occurred between the measurement
date and the subsequent transaction date and (2) the
transaction represents an orderly transaction (as
opposed to a forced liquidation or distressed sale).
If significant events have occurred after the
measurement date or C is unable to determine whether
the transaction represents an orderly transaction, C
should place less weight on the subsequent market
transaction. In addition, the further from the
measurement date that the market transaction takes
place, the less weight C should place on the input.
If it is determined that the subsequent transaction
represented an orderly transaction that provides
relevant information regarding the fair value of C’s
investment in X as of the measurement date, C should
consider whether it needs to adjust this input for
the effect of significant events that occurred after
the measurement date. See Section 10.7 for
more information about identifying whether
transactions are orderly transactions.
Such transactions may also represent
an opportunity for an entity to calibrate its
valuation technique (including the significant
inputs into the valuation technique). In doing so,
the entity may become aware that inputs it developed
on the basis of its own assumptions differ
significantly from inputs developed on the basis of
market-participant assumptions. ASC 820-10-35-24C
addresses such calibration:
Calibration ensures that the
valuation technique reflects current market
conditions, and it helps a reporting entity to
determine whether an adjustment to the valuation
technique is necessary (for example, there might
be a characteristic of the asset or liability [or
instrument classified within an entity’s
shareholders’ equity] that is not captured by the
valuation technique). After initial recognition,
when measuring fair value using a valuation
technique or techniques that use unobservable
inputs, a reporting entity shall ensure that those
valuation techniques reflect observable market
data (for example, the price for a similar asset
or liability [or own equity instrument]) at the
measurement date.
10.2.5.3 Transaction Costs
10.2.5.3.1 General
ASC 820-10 — Glossary
Transaction Costs
The costs to sell an asset or transfer a
liability in the principal (or most advantageous)
market for the asset or liability that are
directly attributable to the disposal of the asset
or the transfer of the liability and meet both of
the following criteria:
-
They result directly from and are essential to that transaction.
-
They would not have been incurred by the entity had the decision to sell the asset or transfer the liability not been made (similar to costs to sell, as defined in paragraph 360-10-35-38).
As noted in ASC 820-10-35-9B, a fair value measurement
does not include the effects of transaction costs. As a result, as
discussed in ASC 820-10-30-3A(c), the transaction price (i.e., the price
paid) may not represent fair value at initial recognition. Because
transaction costs may be embedded in the price paid (received) for an
asset (liability), entities should use judgment in identifying
transaction costs. Transaction costs are recognized in earnings as
incurred when they are related to an item that is subsequently
recognized at fair value, with changes in fair value reported in
earnings.8
An entity should consider transaction costs in determining the most
advantageous market in which to measure fair value when there is no
principal market for an asset, liability, or equity instrument. Such
costs may influence the net proceeds received or paid in a transaction
and therefore the selection of the most advantageous market in which to
transact. However, once the most advantageous market is determined,
transaction costs do not result in adjustments to the price in this
market. See Section 10.2.5.3.2 for discussion of
the accounting for transaction costs.
Furthermore, although ASC 820-10-35-9B indicates that
the price used to measure fair value is not adjusted for transaction
costs, when an entity uses a discounted cash flow technique to measure
the fair value of a nonfinancial asset, the entity may appropriately
include the costs of disposing of the asset when these costs are one of
the cash flow assumptions that market participants would use in pricing
the asset (see the example below for an illustration). However, this
approach would not apply to a fair value measurement of a financial
asset or financial liability.
Example 10-4
Accounting
for Selling Costs When a Discounted Cash Flow
Model Is Used to Measure the Fair Value of a
Nonfinancial Asset
Entity D uses a discounted cash
flow model to measure the fair value of an
investment property. In doing so, D develops a
10-year cash flow projection for the property’s
operations, with an assumed sale at the end of the
10-year period because D believes that this is how
market participants would price the investment
property and has no knowledge of any available
evidence to the contrary. The net cash inflow from
the assumed sale would include the impact of
selling costs (i.e., selling costs would be
subtracted from the cash inflow of the estimated
sales price). In measuring the fair value of its
investment property, D would use an appropriate
rate to discount the resulting cash flows to
present value.
Transaction costs differ from transportation and installation costs. See
Section 10.2.5.4 for discussion of
transportation and installation costs. Also see Example
10-9, which illustrates how an entity would consider
transaction, transportation, and installation costs in determining the
most advantageous market and the fair value of a nonfinancial asset.
10.2.5.3.2 Accounting for Transaction Costs
Entities should consider other Codification topics in accounting for
transaction costs. Although transaction costs are recognized in earnings
as incurred for items subsequently measured at fair value through
earnings, such recognition may not be appropriate when an item is
subsequently measured by using an attribute other than fair value
through earnings. For example, when an asset is recognized at amortized
cost, it may be appropriate to capitalize transaction costs as part of
the cost of the asset.
Furthermore, some Codification topics require the subsequent recognition
of an asset at fair value less costs to sell (i.e., the subsequent
measurement of the asset is reduced by anticipated transaction costs
related to selling the asset). Thus, both the transaction costs incurred
to acquire the asset and the transaction costs that will be incurred to
sell the asset may be recognized in earnings while the entity owns the
asset.
The subsections below discuss other Codification topics (not
all-inclusive) that address the accounting for transaction costs.
10.2.5.3.2.1 Investments in Debt Securities
Under ASC 320, an entity may classify investments in
debt securities as held to maturity, available for sale, or trading.
The table below discusses the accounting for transaction costs
incurred when a debt security is acquired.
Table 10-2
|
Accounting for Transaction
Costs Incurred in Connection With Acquiring a Debt
Security
| |
|---|---|
|
Classification of Security
|
Accounting for Transaction
Costs
|
|
Held to maturity
|
Capitalized. In accordance
with ASC 310-20-15-2 and 15-3, nonrefundable fees
and costs associated with acquiring debt
securities classified as held to maturity are
within the scope of ASC 310-20. ASC 310-20-30-5
states that the “initial investment in a purchased
loan or group of loans shall include the amount
paid to the seller plus any fees paid or less any
fees received.” Because transaction costs
associated with the acquisition of
held-to-maturity debt securities are within the
scope of ASC 320, fees paid to a third party that
are directly related to the acquisition (e.g.,
brokerage fees paid to a broker-dealer) would be
capitalized as part of the original carrying
amount. In accordance with ASC 310-20, entities
should separately expense any other costs incurred
in connection with acquiring securities (e.g.,
internal costs, portfolio management fees,
investment consultation, or due diligence costs
paid to an adviser).
Held-to-maturity debt
securities are subsequently measured at amortized
cost and are subject to evaluation for
impairment.
|
|
Available for sale
|
Capitalized initially. In
accordance with ASC 310-20-15-2 and 15-3,
nonrefundable fees and costs associated with
acquiring debt securities classified as available
for sale are within the scope of ASC 310-20. ASC
310-20-30-5 states that the “initial investment in
a purchased loan or group of loans shall include
the amount paid to the seller plus any fees paid
or less any fees received.” Because transaction
costs associated with the acquisition of
available-for-sale debt securities are within the
scope of ASC 320, fees paid to a third party that
are directly related to the acquisition (e.g.,
brokerage fees paid to a broker-dealer) would be
capitalized as part of the original carrying
amount. In accordance with ASC 310-20, entities
should separately expense any other costs incurred
in connection with acquiring securities (e.g.,
internal costs, portfolio management fees,
investment consultation, or due diligence costs
paid to an adviser).
An entity must subsequently
measure debt securities classified as available
for sale at fair value, with changes in fair value
recognized in OCI (provided that there is no
impairment). This fair value should not include
any transaction costs because ASC 820 indicates
that such costs are not a characteristic of an
asset or liability measured at fair value.
Therefore, entities will immediately recognize an
unrealized loss in OCI after the purchase of a
debt security classified as available for sale.
Given the security’s classification as available
for sale, such a loss will be reported in
accumulated other comprehensive income (AOCI)
unless the security is subsequently impaired and
measured at fair value on the basis of the
entity’s conclusion that it is more likely than
not that the security will be sold or that there
is an intent to sell it.
|
|
Trading
|
Expensed as incurred. ASC 820
indicates that transaction costs are not a
characteristic of an asset or liability measured
at fair value. ASC 310-20-15-3(c) states that ASC
310-20 does not apply to securities that are
subsequently measured at fair value through
earnings.
|
10.2.5.3.2.2 Investments in Equity Securities Not Subject to the Equity Method
Unless the measurement alternative in ASC
321-10-35-2 is applied or the investment qualifies for the equity
method of accounting, investments in equity securities must be
initially and subsequently recognized at fair value, with changes in
fair value reported in earnings. Since ASC 820 indicates that
transaction costs are not a characteristic of an asset or liability
measured at fair value, transaction costs incurred to acquire an
equity security that is not measured under the measurement
alternative in ASC 321-10-35-2 are immediately expensed. See
Example 10-5 for an
illustration of this concept.
ASC 321-10-35-2 indicates that when the measurement alternative is
applied to an equity security without a readily determinable fair
value, that security is measured at “cost minus impairment, if any,”
and adjustments are also made for “observable price changes in
orderly transactions for the identical or a similar investment of
the same issuer.” Thus, securities measured according to this
measurement alternative are initially measured at the transaction
price, which includes incremental direct costs related to acquiring
the security (i.e., transaction costs). However, these capitalized
transaction costs would be subsequently expensed in earnings upon
(1) a remeasurement event under ASC 321, which includes an
impairment or an observable price change (as indicated in Section 2.3.2.1.2, such a change
represents a fair value measurement accounted for under ASC 820);
(2) a sale of the security; or (3) a reclassification of the
security to fair value through earnings (see Section
12.3.2.1).
Example 10-5
Acquisition of Equity Security Subsequently
Accounted for at Fair Value
Entity E acquires an
investment in an exchange-traded equity security
on December 31, 20X7. The asset will be accounted
for at fair value through earnings on a recurring
basis in accordance with ASC 321. Entity E paid
$100 for the security (which was also the
security’s closing price), plus a $1 broker
commission, for a total transaction price of $101.
Entity E transacted in its principal market for
the security. However, in accordance with ASC
820-10-30-3A(c), E determines that the transaction
price does not represent fair value at initial
recognition because of the transaction costs. The
closing price on December 31, 20X7, is $100. If E
were to subsequently sell the security, it would
incur a $1 broker commission.
The fair value of the security
as of the December 31, 20X7, reporting date is the
security’s $100 closing price. Since ASC 321 does
not indicate otherwise, E should record a $1
expense for the broker commission paid to acquire
the security. The broker commission is not a
characteristic of the security and does not add
value to it. Transaction costs are a separate unit
of account and therefore do not enter into the
fair value measurement of the security. The $1
broker commission indicates that the transaction
price of $101 is not fair value at inception.
Another market participant would not reimburse E
for the broker commission; instead, it would pay E
the closing market price of $100 for the security.
In a manner consistent with ASC 820-10-35-9B and
Example 4 in ASC 820-10-55-42 through 55-45A, E
should not adjust the security for the $1 broker
commission it would incur to sell the security. In
other words, E should not write down the security
to $99 (the net proceeds it would receive upon
selling the security).
10.2.5.3.2.3 Investment Securities Owned by an Investment Company
ASC 946-320-35-1 states that “[a]n investment
company shall measure investments in debt and equity securities
subsequently at fair value.” In addition, ASC 946-320-30-1 states
that “[a]n investment company shall initially measure its
investments in debt and equity securities at their transaction
price. The transaction price shall include commissions and other
charges that are part of the purchase transaction.” According to
this guidance, investment companies initially recognize investments
in debt and equity securities at the transaction price, including
related commissions and other direct costs incurred in connection
with acquisition of the securities (i.e., an entry price and not
fair value), and subsequently measure the investments at fair value
under ASC 820. If any other potential differences between entry and
exit prices are ignored, the capitalization of transaction costs
into the initial measurement of investment securities by investment
companies will result in a loss on initial recognition. For example,
assume that Mutual Fund X purchases a publicly traded equity
security for $99 immediately before the market closing (the fair
value is therefore also $99). Also assume that X incurred a $1
commission in purchasing the security. Under ASC 946, the initial
cost basis is $100 ($99 plus the $1 transaction cost). The fair
value would be $99; therefore, a $1 loss would be recognized on the
acquisition date. This loss on initial recognition is presented as a
“net change in unrealized appreciation (depreciation) on
investments” rather than as a separate expense in the investment
company’s statement of operations.
Some have questioned whether ASC 820’s exit price
notion and guidance indicating that transaction costs are not a
characteristic of an asset measured at fair value conflict with the
guidance in ASC 946-320-30-1. The implication is that investment
companies would not be permitted to present transaction costs as
part of the net change in unrealized appreciation (depreciation) on
investments. However, we believe that investment companies that
apply ASC 946 should present commissions and other charges that are
directly related to the acquisition of investment securities in the
net change in unrealized appreciation (depreciation) on investments.
ASC 820-10-35-9B states, in part, “Transaction costs shall be
accounted for in accordance with other Topics.” ASC 946-320-30-1
specifies that the initial amount recorded for investment purchases
“shall include commissions and other charges that are part of the
purchase transaction.” ASC 820 does not affect this guidance.
Accordingly, ASC 946 continues to require investment companies to
include commissions and other charges incurred as part of securities
purchase transactions in the net change in unrealized appreciation
(depreciation) on investments. After initial recognition, an
investment company measures its investment at the exit price in
accordance with ASC 820. The difference between the initial
recognized amount and subsequent fair value measurement would be
presented as a “net change in unrealized appreciation (depreciation)
on investments” rather than as a separate expense in the statement
of operations.
10.2.5.3.2.4 Plan Assets of Pension and Other Postretirement Benefit Plans
Unlike other fair value measurements, the fair value measurement of
investments held by a pension or other postretirement plan should be
reduced by the costs of disposing of the assets. ASC 715-30-35-50
states, in part:
The fair value of an investment shall be reduced by brokerage
commissions and other costs normally incurred in a sale if
those costs are significant (similar to fair value less cost
to sell).
The example below illustrates the accounting for
transaction costs of a defined benefit pension plan.
Example 10-6
Transaction Costs of Pension Plan
Entity F’s defined benefit pension plan owns a
suburban office complex with an appraised value of
$18 million. To recognize this real estate
property in accordance with ASC 715-30-35-50, F
would need to consider the estimated transaction
costs (real estate broker fees) that would be
incurred to dispose of the property. If the real
estate broker fee is 6 percent of the transaction
price ($1,080,000), the suburban office complex
would be recognized at $16,920,000.
10.2.5.3.2.5 Assets Measured at Lower of Cost or Fair Value
Under certain Codification topics, assets, asset
groups, or disposal groups must be measured at the lower of cost or
fair value. Those Codification topics specify whether the fair value
measurement should be reduced for transaction costs. For example,
under ASC 310-10-35-48, nonmortgage loans classified as HFS must be
reported at the lower of amortized cost or fair value. ASC
310-10-35-48 does not indicate that fair value should be reduced for
anticipated costs to sell. Conversely, under ASC 310-10-35-23 (or
ASC 326-20-35-4 for entities that have adopted ASU 2016-13), when a
held-for-investment classified loan receivable is measured for
impairment on the basis of the fair value of the collateral and
repayment of the loan depends on the sale of the collateral,
impairment measurement must be based on fair value less costs to
sell. With respect to nonfinancial assets, ASC 360-10-35-17 requires
that an impairment loss on a long-lived asset (or asset group)
classified as held and used be measured on the basis of fair value
without adjustment for costs to sell; however, an impairment loss on
a disposal group is measured on the basis of fair value less costs
to sell in accordance with ASC 360-10-35-40.
10.2.5.4 Transportation and Installation Costs
ASC 820-10 — Glossary
Transportation Costs
The costs that would be incurred to transport an
asset from its current location to its principal (or
most advantageous) market.
As noted above, the ASC master glossary defines transportation costs (e.g.,
freight costs, handling fees, or other similar costs) as the costs of moving
an asset “from its current location to its principal (or most advantageous)
market.” Like transaction costs, transportation costs may be embedded in the
transaction price for an asset. However, transportation costs are treated
differently than transaction costs for fair value measurement purposes.
Under ASC 820, an entity that is measuring fair value must
consider the characteristics of an asset or liability, which, in the case of
a nonfinancial asset (e.g., a commodity), may include the asset’s physical
location. Thus, in determining the fair value of an asset for which location
is a characteristic, an entity may need to adjust an observable price or
input for the costs that would be incurred to transport the asset from its
current location to the principal (or most advantageous) market. Similarly,
in determining the fair value of a nonfinancial asset that must be
customized or configured to be placed into service and ready for use, an
entity may need to adjust an observable price or input to reflect the
associated installation costs. Such an adjustment is appropriate when the
degree of customization or configuration (i.e., installation) is a
characteristic of the asset.9
Examples 10-7 and
10-8 illustrate how transportation
costs may be added to or subtracted from a quoted price to arrive at a fair
value measurement (e.g., how an observable market price may be adjusted to
arrive at fair value in the principal or most advantageous market for an
asset). While these examples focus on assets, a contract that is an asset
from one party’s perspective will represent a liability from the
counterparty’s perspective. In addition, note that these examples do not
address whether it is appropriate to recognize inventories at fair value
under U.S. GAAP.
Example 10-7
Location Is a Subtractive Input
Entity G has commodity inventory at
Location 1. In performing its fair value
measurement, G determines that Location 2 is the
principal market for sale of this inventory.
Location 2 is an active market for which pricing
quotes are readily accessible. Entity G observes a
price of $100 per unit of inventory at Location 2.
Entity G determines that transporting the inventory
from Location 1 to Location 2 would cost $5 per unit
of inventory. The fair value of the inventory at its
current location would thus be $95 per unit (i.e.,
$100 per unit at Location 2 less $5 per unit to
bring the asset to the principal market at Location
2).
Example 10-8
Location Is an Additive Input
Entity H has commodity inventory at
Location 1. In performing its fair value
measurement, H determines that Location 1 is its
principal market for sale of this inventory.
However, no recent observable pricing information is
available at Location 1. Accordingly, H uses a
valuation technique to determine the fair value of
the inventory at Location 1 on the basis of quoted
prices at Location 2, from which a more recent price
quote can be obtained. The valuation technique is
used to adjust the quoted price at Location 2 for
the cost of transportation from Location 2 to
Location 1. As in the example above, the current
price at Location 2 is $100 per unit of inventory.
The transportation cost from Location 2 to Location
1 is $5 per unit of inventory. Entity H validates
its valuation technique on the basis of past market
transactions at Location 1. The fair value of the
inventory at its current location would thus be $105
per unit (i.e., $100 per unit at Location 2 plus $5
per unit to bring the asset to H’s principal market
at Location 1).
The example below illustrates how an entity would consider
transaction, transportation, and installation costs in determining the most
advantageous market and fair value for a nonfinancial asset.
Example 10-9
Transaction, Transportation, and Installation
Costs for a Nonfinancial Asset
Entity I owns an uninstalled machine for which it is
measuring fair value for impairment purposes. Entity
I has determined the following:
-
There are observable prices for the machine on an installed basis in Market A and Market B.
-
Entity I has access to transact in both markets, although neither market is I’s principal market.
-
To sell the machine in either market, I would need to transport the machine to the market and configure and install the machine so that it is ready for use.
-
Entity I would also incur a commission (i.e., a transaction cost) to sell the machine on an installed basis in either market.
-
The observable prices and costs of selling the machine in Markets A and B on an installed basis are as follows:
ASC 820 specifies that an entity
should make an adjustment for transportation and
installation costs when measuring the fair value of
an asset if location and condition are
characteristics of the asset. Transaction costs are
not part of a fair value measurement, but they do
affect the determination of the most advantageous
market when there is no principal market for an
asset. (As discussed in Section
10.2.5.3.1, when the fair value of a
nonfinancial asset is calculated by using a
discounted cash flow technique, the cost of
disposing of the asset, which represents a type of
transaction cost, may reduce the cash flows used in
the model to estimate fair value. However, that
guidance does not apply to this example.)
Under ASC 820, the fair value of the machine is $22
in Market A ($28 observable price less the $4
transportation costs and $2 installation costs that
would be incurred for I to obtain that price) and
$23 in Market B ($26 observable price less the $1
transportation costs and $2 installation costs that
I would incur to obtain that price). The net
proceeds would be $21 in Market A (fair value of $22
less $1 transaction costs) and $20 in Market B (fair
value of $23 less $3 transaction costs). Because the
price in Market A results in greater net proceeds,
from I’s perspective, Market A is the most
advantageous market for the machine; therefore, the
fair value of the machine is $22.
10.2.6 Application to Nonfinancial Assets
ASC 820-10
Highest and Best Use for Nonfinancial Assets
35-10A A fair
value measurement of a nonfinancial asset takes into
account a market participant’s ability to generate
economic benefits by using the asset in its highest and
best use or by selling it to another market participant
that would use the asset in its highest and best
use.
35-10B The
highest and best use of a nonfinancial asset takes into
account the use of the asset that is physically
possible, legally permissible, and financially feasible,
as follows:
-
A use that is physically possible takes into account the physical characteristics of the asset that market participants would take into account when pricing the asset (for example, the location or size of a property).
-
A use that is legally permissible takes into account any legal restrictions on the use of the asset that market participants would take into account when pricing the asset (for example, the zoning regulations applicable to a property).
-
A use that is financially feasible takes into account whether a use of the asset that is physically possible and legally permissible generates adequate income or cash flows (taking into account the costs of converting the asset to that use) to produce an investment return that market participants would require from an investment in that asset put to that use.
35-10C
Highest and best use is determined from the perspective
of market participants, even if the reporting entity
intends a different use. However, a reporting entity’s
current use of a nonfinancial asset is presumed to be
its highest and best use unless market or other factors
suggest that a different use by market participants
would maximize the value of the asset.
35-10D To
protect its competitive position, or for other reasons,
a reporting entity may intend not to use an acquired
nonfinancial asset actively, or it may intend not to use
the asset according to its highest and best use. For
example, that might be the case for an acquired
intangible asset that the reporting entity plans to use
defensively by preventing others from using it.
Nevertheless, the reporting entity shall measure the
fair value of a nonfinancial asset assuming its highest
and best use by market participants.
Valuation Premise for Nonfinancial Assets
35-10E The
highest and best use of a nonfinancial asset establishes
the valuation premise used to measure the fair value of
the asset, as follows:
- The highest and best use of a
nonfinancial asset might provide maximum value to
market participants through its use in combination
with other assets as a group (as installed or
otherwise configured for use) or in combination
with other assets and liabilities (for example, a
business).
-
If the highest and best use of the asset is to use the asset in combination with other assets or with other assets and liabilities, the fair value of the asset is the price that would be received in a current transaction to sell the asset assuming that the asset would be used with other assets or with other assets and liabilities and that those assets and liabilities (that is, its complementary assets and the associated liabilities) would be available to market participants.
-
Liabilities associated with the asset and with the complementary assets include liabilities that fund working capital, but do not include liabilities used to fund assets other than those within the group of assets.
-
Assumptions about the highest and best use of a nonfinancial asset shall be consistent for all of the assets (for which highest and best use is relevant) of the group of assets or the group of assets and liabilities within which the asset would be used.
-
- The highest and best use of a nonfinancial asset might provide maximum value to market participants on a standalone basis. If the highest and best use of the asset is to use it on a standalone basis, the fair value of the asset is the price that would be received in a current transaction to sell the asset to market participants that would use the asset on a standalone basis.
35-11A The
fair value measurement of a nonfinancial asset assumes
that the asset is sold consistent with the unit of
account specified in other Topics (which may be an
individual asset). That is the case even when that fair
value measurement assumes that the highest and best use
of the asset is to use it in combination with other
assets or with other assets and liabilities because a
fair value measurement assumes that the market
participant already holds the complementary assets and
associated liabilities.
35-14
Paragraph 820-10-55-25 illustrates the application of
the highest and best use and valuation premise concepts
for nonfinancial assets.
An entity must measure the fair value of nonfinancial assets (other than
nonfinancial derivative assets) on the basis of the appropriate valuation
premise. The unit of valuation (also referred to as the “valuation premise”) for
nonfinancial assets (other than nonfinancial derivative assets) is the asset’s
highest and best use. See Chapter 5 for
more information about the valuation premise for nonfinancial assets, including
the illustrations in ASC 820-10-55.
10.2.7 Application to Liabilities and Instruments Classified in Equity
10.2.7.1 General
ASC 820-10
General Principles
35-16 A fair
value measurement assumes that a financial or
nonfinancial liability or an instrument classified
in a reporting entity’s shareholders’ equity (for
example, equity interests issued as consideration in
a business combination) is transferred to a market
participant at the measurement date. The transfer of
a liability or an instrument classified in a
reporting entity’s shareholders’ equity assumes the
following: . . .
b. A liability would remain outstanding and
the market participant transferee would be
required to fulfill the obligation. The liability
would not be settled with the counterparty or
otherwise extinguished on the measurement
date.
c. An instrument classified in a reporting
entity’s shareholders’ equity would remain
outstanding and the market participant transferee
would take on the rights and responsibilities
associated with the instrument. The instrument
would not be cancelled or otherwise extinguished
on the measurement date.
35-16A Even
when there is no observable market to provide
pricing information about the transfer of a
liability or an instrument classified in a reporting
entity’s shareholders’ equity (for example, because
contractual or other legal restrictions prevent the
transfer of such items), there might be an
observable market for such items if they are held by
other parties as assets (for example, a corporate
bond or a call option on a reporting entity’s
shares).
35-16AA In
all cases, a reporting entity shall maximize the use
of relevant observable inputs and minimize the use
of unobservable inputs to meet the objective of a
fair value measurement, which is to estimate the
price at which an orderly transaction to transfer
the liability or instrument classified in
shareholders’ equity would take place between market
participants at the measurement date under current
market conditions.
ASC 820-10-35-16 indicates that when a liability or instrument classified in
an entity’s equity is measured at fair value, it is assumed that the
instrument is transferred to a market participant as of the measurement date
(i.e., the liability or equity instrument remains outstanding and is not
extinguished or canceled). ASC 820-10-35-16A clarifies that this is the case
even if (1) “there is no observable market to provide pricing information”
regarding the transfer of a liability or equity-classified instrument or (2)
there are “contractual or other legal restrictions” preventing a transfer.
Further, in accordance with the general principles related to fair value
measurements, ASC 820-10-35-16AA indicates that an entity should “maximize
the use of relevant observable inputs and minimize the use of unobservable
inputs.” An entity may estimate the fair value of a liability instrument or
instrument classified in an entity’s equity on the basis of the fair value
of the item when held by another party as an asset.
10.2.7.2 Liabilities and Instruments Classified in Equity That Are Held by Other Parties as Assets
ASC 820-10
Liabilities and Instruments Classified in a
Reporting Entity’s Shareholders’ Equity Held by
Other Parties as Assets
35-16B When a quoted price
for the transfer of an identical or a similar
liability or instrument classified in a reporting
entity’s shareholders’ equity is not available and
the identical item is held by another party as an
asset, a reporting entity shall measure the fair
value of the liability or equity instrument from the
perspective of a market participant that holds the
identical item as an asset at the measurement date.
. . .
35-16BB In
such cases, a reporting entity shall measure the
fair value of the liability or equity instrument as
follows:
-
Using the quoted price in an active market for the identical item held by another party as an asset, if that price is available
-
If that price is not available, using other observable inputs, such as the quoted price in a market that is not active for the identical item held by another party as an asset
-
If the observable prices in (a) and (b) are not available, using another valuation approach, such as:
- An income approach (for example, a present value technique that takes into account the future cash flows that a market participant would expect to receive from holding the liability or equity instrument as an asset; see paragraph 820-10-55-3F)
- A market approach (for example, using quoted prices for similar liabilities or instruments classified in shareholders’ equity held by other parties as assets; see paragraph 820-10-55-3A).
35-16D When measuring the
fair value of a liability or an equity instrument
held by another party as an asset, a reporting
entity shall adjust the quoted price of the asset
only if there are factors specific to the asset that
are not applicable to the fair value measurement of
the liability or equity instrument. When the asset
held by another party includes a characteristic
restricting its sale, the fair value of the
corresponding liability or equity instrument also
would include the effect of the restriction. Some
factors that may indicate that the quoted price of
the asset should be adjusted include the
following:
-
The quoted price for the asset relates to a similar (but not identical) liability or equity instrument held by another party as an asset. For example, the liability or equity instrument may have a particular characteristic (for example, the credit quality of the issuer) that is different from that reflected in the fair value of the similar liability or equity instrument held as an asset.
-
The unit of account for the asset is not the same as for the liability or equity instrument. For example, for liabilities, in some cases the price for an asset reflects a combined price for a package comprising both the amounts due from the issuer and a third-party credit enhancement. If the unit of account for the liability is not for the combined package, the objective is to measure the fair value of the issuer’s liability, not the fair value of the combined package. Thus, in such cases, the reporting entity would adjust the observed price for the asset to exclude the effect of the third-party credit enhancement. See paragraph 820-10-35-18A for further guidance.
Pending Content (Transition
Guidance: ASC 820-10-65-13)
35-16D When measuring
the fair value of a liability or an equity
instrument held by another party as an asset, a
reporting entity shall adjust the quoted price of
the asset only if there are factors specific to
the asset that are not applicable to the fair
value measurement of the liability or equity
instrument. When the asset held by another party
includes a characteristic restricting its sale,
(see paragraphs 820-10-35-6B and 820-10-35-36B),
the fair value of the corresponding liability or
equity instrument also would include the effect of
the restriction. Some factors that may indicate
that the quoted price of the asset should be
adjusted include the following:
- The quoted price for the asset relates to a similar (but not identical) liability or equity instrument held by another party as an asset. For example, the liability or equity instrument may have a particular characteristic (for example, the credit quality of the issuer) that is different from that reflected in the fair value of the similar liability or equity instrument held as an asset.
- The unit of account for the asset is not the same as for the liability or equity instrument. For example, for liabilities, in some cases the price for an asset reflects a combined price for a package comprising both the amounts due from the issuer and a third-party credit enhancement. If the unit of account for the liability is not for the combined package, the objective is to measure the fair value of the issuer's liability, not the fair value of the combined package. Thus, in such cases, the reporting entity would adjust the observed price for the asset to exclude the effect of the third-party credit enhancement. See paragraph 820-10-35-18A for further guidance.
Quoted prices for the transfer of a liability or instrument classified in
stockholders’ equity are generally not available. Therefore, ASC
820-10-35-16B specifies that an entity should measure the fair value of
liabilities and instruments classified in equity “from the perspective of a
market participant that holds the identical item as an asset at the
measurement date.” As with other measurements under ASC 820, the fair value
of a liability or instrument classified in equity that is determined from
the perspective of a market participant that holds the item as an asset
should be measured by maximizing observable inputs and minimizing
unobservable inputs. ASC 820-10-35-16BB provides the following hierarchy for
such measurement:
-
Use “the quoted price in an active market for the identical item held by another party as an asset, if that price is available.” Otherwise, proceed to the next step.
-
Use “the quoted price in a market that is not active for the identical item held by another party as an asset,” if that price is available. Otherwise, proceed to the next step.
-
Use a valuation approach to measure the fair value of the identical item held by another party as an asset (i.e., an income or market approach).
An entity sometimes may need to adjust the quoted price of
an asset to properly reflect factors that do not apply to the fair value of
a liability or instrument classified in equity. As discussed in ASC
820-10-35-16D, the need for such an adjustment usually arises because either
(1) the observed price is related to a similar, but not identical, asset
that is used to measure the fair value of a liability or equity instrument
or (2) the unit of account for the asset differs from the unit of account
for the liability or equity instrument.10 ASC 820-10-35-16D also clarifies how restrictions preventing the sale
of an asset should be considered when the quoted price of the asset is used
to measure the fair value of a liability or equity instrument. See Section 10.2.7.4 for
discussion of the incorporation of adjustments for risk and transferability
restrictions into the measurement of the fair value of liability
instruments. See Section
10.6 for discussion of situations in which the volume or
level of activity for an asset or a liability has significantly
decreased.
When any adjustment is made to a quoted price of an item
held as an asset, the fair value measurement of the liability or equity
instrument cannot be classified within Level 1 of the fair value hierarchy.
Rather, the entity must evaluate the nature of any such adjustments to
determine whether the fair value measurement in its entirety should be
classified within Level 2 or Level 3 of the fair value hierarchy. See
Chapter 8
for further discussion of the fair value hierarchy.
Case D of Example 7 in ASC 820 illustrates the measurement of the fair value
of a liability on the basis of a quoted price of the identical item held by
another party as an asset (see Section 10.2.7.5).
10.2.7.3 Liabilities and Instruments Classified in Equity That Are Not Held by Other Parties as Assets
ASC 820-10
Liabilities and Instruments
Classified in a Reporting Entity’s Shareholders’
Equity Not Held by Other Parties as Assets
35-16H When a
quoted price for the transfer of an identical or a
similar liability or instrument classified in a
reporting entity’s shareholders’ equity is not
available and the identical item is not held by
another party as an asset, a reporting entity shall
measure the fair value of the liability or equity
instrument using a valuation technique from the
perspective of a market participant that owes the
liability or has issued the claim on equity.
35-16I For example, when
applying a present value technique, a reporting
entity might take into account either of the
following:
-
The future cash outflows that a market participant would expect to incur in fulfilling the obligation, including the compensation that a market participant would require for taking on the obligation (see paragraphs 820-10-35-16J through 35-16K).
-
The amount that a market participant would receive to enter into or issue an identical liability or equity instrument, using the assumptions that market participants would use when pricing the identical item (for example, having the same credit characteristics) in the principal (or most advantageous) market for issuing a liability or an equity instrument with the same contractual terms.
35-16J When
using a present value technique to measure the fair
value of a liability that is not held by another
party as an asset (for example, an asset retirement
obligation), a reporting entity shall, among other
things, estimate the future cash outflows that
market participants would expect to incur in
fulfilling the obligation. Those future cash
outflows shall include market participants’
expectations about the costs of fulfilling the
obligation and the compensation that a market
participant would require for taking on the
obligation. Such compensation includes the return
that a market participant would require for the
following:
- Undertaking the activity (that is, the value of fulfilling the obligation — for example, by using resources that could be used for other activities)
- Assuming the risk associated with the obligation (that is, a risk premium that reflects the risk that the actual cash outflows might differ from the expected cash outflows; see paragraph 820-10-35-16L).
35-16K For
example, a nonfinancial liability does not contain a
contractual rate of return and there is no
observable market yield for that liability. In some
cases, the components of the return that market
participants would require will be indistinguishable
from one another (for example, when using the price
a third-party contractor would charge on a fixed-fee
basis). In other cases, a reporting entity needs to
estimate those components separately (for example,
when using the price a third-party contractor would
charge on a cost-plus basis because the contractor
in that case would not bear the risk of future
changes in costs).
35-16L A
reporting entity can include a risk premium in the
fair value measurement of a liability or an
instrument classified in a reporting entity’s
shareholders’ equity that is not held by another
party as an asset in one of the following ways:
-
By adjusting the cash flows (that is, as an increase in the amount of cash outflows)
-
By adjusting the rate used to discount the future cash flows to their present values (that is, as a reduction in the discount rate).
A reporting entity shall ensure that it does not
double count or omit adjustments for risk. For
example, if the estimated cash flows are increased
to take into account the compensation for assuming
the risk associated with the obligation, the
discount rate should not be adjusted to reflect that
risk.
ASC 820-10-35-16H through 35-16L address how to measure the fair value of a
liability or instrument classified in stockholders’ equity when (1) “a
quoted price for the transfer of an identical or [similar] instrument . . .
is not available” and (2) “the identical item is not held by another party
as an asset.” This guidance will generally apply only to nonfinancial
liabilities because financial liabilities and instruments that an entity
classifies in equity would be expected to be held by another party on an
identical basis as an asset. However, an entity would not be precluded from
estimating the fair value of a liability or equity instrument in accordance
with ASC 820-10-35-16H through 35-16L so that it can calibrate the fair
value measurement to the estimate in accordance with ASC 820-10-35-16BB(c).
As with other fair value measurements under ASC 820, a fair
value measurement estimated in accordance with ASC 820-10-35-16H through
35-16L should maximize observable inputs and minimize unobservable inputs.
Such measurement should also incorporate the entity’s nonperformance risk
and relevant risk premiums (see Section
10.2.7.4 for more information). A fair value measurement in
accordance with ASC 820-10-35-16H through 35-16L can never be classified as
a Level 1 measurement in its entirety.
Case C of Example 7 in ASC 820 illustrates the use of a
valuation technique to estimate the fair value of an ARO liability (see
Section
10.2.7.5).
10.2.7.4 Adjustments for Risk and Transferability Restrictions
10.2.7.4.1 General
ASC 820-10
Liabilities and Instruments
Classified in a Reporting Entity’s Shareholders’
Equity Not Held by Other Parties as Assets
35-16J When using a present
value technique to measure the fair value of a
liability that is not held by another party as an
asset (for example, an asset retirement
obligation), a reporting entity shall, among other
things, estimate the future cash outflows that
market participants would expect to incur in
fulfilling the obligation. Those future cash
outflows shall include market participants’
expectations about the costs of fulfilling the
obligation and the compensation that a market
participant would require for taking on the
obligation. Such compensation includes the return
that a market participant would require for the
following:
-
Undertaking the activity (that is, the value of fulfilling the obligation — for example, by using resources that could be used for other activities)
-
Assuming the risk associated with the obligation (that is, a risk premium that reflects the risk that the actual cash outflows might differ from the expected cash outflows; see paragraph 820-10-35-16L).
35-16L A reporting entity can
include a risk premium in the fair value
measurement of a liability or an instrument
classified in a reporting entity’s shareholders’
equity that is not held by another party as an
asset in one of the following ways:
-
By adjusting the cash flows (that is, as an increase in the amount of cash outflows)
-
By adjusting the rate used to discount the future cash flows to their present values (that is, as a reduction in the discount rate).
A reporting entity shall ensure
that it does not double count or omit adjustments
for risk. For example, if the estimated cash flows
are increased to take into account the
compensation for assuming the risk associated with
the obligation, the discount rate should not be
adjusted to reflect that risk.
Nonperformance Risk
35-17 The fair value of a
liability reflects the effect of nonperformance
risk. Nonperformance risk includes, but may not be
limited to, a reporting entity’s own credit risk.
Nonperformance risk is assumed to be the same
before and after the transfer of the
liability.
35-18 When measuring the fair
value of a liability, a reporting entity shall
take into account the effect of its credit risk
(credit standing) and any other factors that might
influence the likelihood that the obligation will
or will not be fulfilled. That effect may differ
depending on the liability, for example:
-
Whether the liability is an obligation to deliver cash (a financial liability) or an obligation to deliver goods or services (a nonfinancial liability)
-
The terms of credit enhancements related to the liability, if any.
Paragraph 820-10-55-56
illustrates the effect of credit risk on the fair
value measurement of a liability.
35-18A The fair value of a
liability reflects the effect of nonperformance
risk on the basis of its unit of account. In
accordance with Topic 825, the issuer of a
liability issued with an inseparable third-party
credit enhancement that is accounted for
separately from the liability shall not include
the effect of the credit enhancement (for example,
a third-party guarantee of debt) in the fair value
measurement of the liability. If the credit
enhancement is accounted for separately from the
liability, the issuer would take into account its
own credit standing and not that of the
third-party guarantor when measuring the fair
value of the liability.
Restriction Preventing the
Transfer of a Liability or an Instrument
Classified in a Reporting Entity’s Shareholders’
Equity
35-18B When measuring the
fair value of a liability or an instrument
classified in a reporting entity’s shareholders’
equity, a reporting entity shall not include a
separate input or an adjustment to other inputs
relating to the existence of a restriction that
prevents the transfer of the item. The effect of a
restriction that prevents the transfer of a
liability or an instrument classified in a
reporting entity’s shareholders’ equity is either
implicitly or explicitly included in the other
inputs to the fair value measurement.
35-18C For example, at the
transaction date, both the creditor and the
obligor accepted the transaction price for the
liability with full knowledge that the obligation
includes a restriction that prevents its transfer.
As a result of the restriction being included in
the transaction price, a separate input or an
adjustment to an existing input is not required at
the transaction date to reflect the effect of the
restriction on transfer. Similarly, a separate
input or an adjustment to an existing input is not
required at subsequent measurement dates to
reflect the effect of the restriction on
transfer.
ASC 820-10 — Glossary
Credit Risk
For purposes of a hedged item in a fair value
hedge, credit risk is the risk of changes in the
hedged item’s fair value attributable to both of
the following:
-
Changes in the obligor’s creditworthiness
-
Changes in the spread over the benchmark interest rate with respect to the hedged item’s credit sector at inception of the hedge.
For purposes of a hedged transaction in a cash
flow hedge, credit risk is the risk of changes in
the hedged transaction’s cash flows attributable
to all of the following:
-
Default
-
Changes in the obligor’s creditworthiness
-
Changes in the spread over the contractually specified interest rate or the benchmark interest rate with respect to the related financial asset’s or liability’s credit sector at inception of the hedge.
Nonperformance Risk
The risk that an entity will not fulfill an
obligation. Nonperformance risk includes, but may
not be limited to, the reporting entity’s own
credit risk.
Risk Premium
Compensation sought by risk-averse market
participants for bearing the uncertainty inherent
in the cash flows of an asset or a liability. Also
referred to as a risk adjustment.
A liability or equity-classified instrument may be subject to various
risks, including instrument-specific (e.g., issuer-specific),
industry-specific, and market risks (e.g., risks related to general
economic conditions). ASC 820-10-35-16J through 35-18C address the
incorporation of risk adjustments into the fair value of a liability or
an instrument classified in stockholders’ equity. According to that guidance:
-
A risk premium should be incorporated into the fair value measurement of a liability to the extent that market participants would demand a premium as compensation for assuming the risk of uncertain cash flows. Risk premiums are also relevant to fair value measurements of instruments classified in stockholders’ equity.
-
The fair value of a liability takes into account the impact of nonperformance risk, including, but not limited to, credit risk. Nonperformance risk could also be relevant to fair value measurements of instruments classified in stockholders’ equity if those equity instruments are redeemable.
-
In determining fair value, an entity should not make an adjustment for the nontransferability of a liability instrument or instrument classified in stockholders’ equity (see further clarification in Section 10.2.7.4.4).
While the above guidance from ASC 820 addresses fair value measurements
performed on the basis of a present value technique used to measure the
fair value of a liability instrument or instrument classified in
stockholders’ equity when such an instrument is not held by another
entity as an asset, the same concepts apply when the liability
instrument or instrument classified in stockholders’ equity is measured
on the basis of the identical item held by another entity as an asset.
However, in the latter case, the relevant adjustments for nonperformance
risk, risk premiums, and transferability restrictions will be reflected
explicitly or implicitly in the fair value measurement of the related
asset.
10.2.7.4.2 Risk Premiums
The cash flows associated with certain liability instruments and
instruments classified in stockholders’ equity (and the corresponding
items held as an asset by another entity, if applicable) are uncertain
(i.e., there are risks related to either the amount or timing of cash
flows). In these situations, the fair value measurement of the liability
must incorporate an adjustment that reflects a risk premium on the basis
of market-participant assumptions (i.e., the compensation market
participants would demand for bearing such risks). Note that risk
premiums are intended to reflect premiums for compensation related to
bearing the risk of the instrument’s uncertain cash flows that arise
because the cash flows are indexed to an underlying other than
nonperformance risk (e.g., a liability whose principal and interest are
indexed to the price of gold). The premium demanded by a market
participant to bear nonperformance risk is reflected by adjusting a fair
value measurement to take such risk into account. To reflect that
premium as both a risk premium and a premium for nonperformance risk
would be inappropriate since it would double-count the risk’s
impact.
ASC 820-10-35-16L indicates that a risk premium may be incorporated into
a discounted cash flow technique by (1) adjusting the cash flows (i.e.,
the use of probability-weighted cash flows), (2) adjusting the rate used
to discount cash flows, or (3) aspects of both. However, an entity is
not permitted to double-count or omit such risk adjustments. Such risk
adjustments would be incorporated, as necessary, regardless of whether
the fair value of a liability or instrument classified in stockholders’
equity is measured by using a present value technique under ASC
820-10-35-16BB(c) (i.e., to measure the fair value of the corresponding
identical item held by another party as an asset) or ASC 820-10-35-16H
through 35-16L (i.e., to measure the fair value of the liability because
it is not held as an asset by another party). A separate adjustment for
a risk premium is unnecessary when the fair value of a liability or
instrument classified in stockholders’ equity is measured on the basis
of a quoted price for the identical item held by another party as an
asset, since the quoted price will already reflect compensation for such
risk. If the fair value of a liability or instrument classified in
stockholders’ equity is measured on the basis of a quoted price for a
similar, but not identical, item held by another party as an asset, an
adjustment for a risk premium would also be unnecessary unless the
difference arises because of uncertain cash flows.
Case C of Example 7 in ASC 820 illustrates the impact that a market risk
premium may have on the fair value of an ARO liability (see
Section 10.2.7.5).
10.2.7.4.3 Nonperformance Risk
The ASC master glossary defines nonperformance risk as
“[t]he risk that an entity will not fulfill an obligation.”
Nonperformance risk includes, but is a broader concept than, credit
risk, which is the risk that an entity will not make payments of cash or
other financial instruments in accordance with the terms of an
obligation.
Nonperformance risk is associated with all liabilities. For some
liabilities (i.e., financial liabilities), nonperformance risk consists
entirely of the credit risk of the obligor (e.g., a financial liability
that requires the obligor to make contractual principal and interest
payments). Other liabilities (i.e., nonfinancial liabilities) pose
nonperformance risks for reasons other than credit risk. In addition to
an entity’s own credit risk, nonperformance risk might include the risk
associated with the entity’s ability to deliver a good or perform a
service. Consider a derivative liability associated with a contract for
the delivery of a commodity (e.g., oil, natural gas, electricity) that
is carried at fair value. Nonperformance risk would include the risk
that the entity will not be able to obtain and deliver the commodity to
the counterparty.
ASC 820-10-35-17 and 35-18 and ASC 820-10-55-56 indicate that the fair
value of a liability must reflect the nonperformance risk of the
instrument. For example, an entity must take into account the effect of
credit risk (credit standing) on the fair value of a financial liability
in all periods in which the liability is measured at fair value because
other entities would take into account the effect of the entity’s credit
risk when estimating the price they would be willing to pay to own the
instrument as an asset. Entities should consider nonperformance risk
when measuring both financial and nonfinancial liabilities at fair
value. ASC 820-10-35-16 states, in part, that “[a] fair value
measurement assumes that a financial or nonfinancial liability . . . is
transferred to a market participant [that assumes the obligation] at the
measurement date.” ASC 820-10-35-17 adds that “[n]onperformance risk is
assumed to be the same before and after the transfer of the liability.”
Thus, under ASC 820, it is assumed that the transferor’s credit risk is
similar to that of the transferee. Accordingly, to the extent that the
fair value of a liability is not determined on the basis of the fair
value of the identical item owned as an asset by another party, the
entity must ensure that adjustments for nonperformance risk do not
result in a change in the nonperformance risk for the liability.
The extent to which nonperformance risk affects the fair value of a
liability depends on various factors, including the unit of account for
the liability, credit spreads, entity-specific credit standing, and
credit enhancements. Collateral is a form of credit enhancement that is
contractually linked to an obligation (i.e., the provisions of the
obligation require a lien on the collateral until the obligation is
settled). It typically affects the stated terms of liabilities (e.g.,
the interest rate charged to a borrower). Thus, in estimating the fair
value of a collateralized liability, an entity should assume that the
lender would require the borrower, to whom the obligation would be
transferred, to post the amount of collateral that is stipulated in that
particular arrangement. However, the unit of account for a liability
excludes an inseparable third-party credit enhancement that is accounted
for separately from the liability. Therefore, the fair value of such
liabilities should not take into account the third-party credit
enhancement. Rather, an entity measures the fair value of such
liabilities under the assumption that the third-party credit enhancement
did not exist (i.e., the issuer would take into account its own credit
standing and not that of the third-party guarantor when measuring the
fair value of the liability). See Section
12.3.1.1.1.1 for further discussion of when third-party
credit enhancements are treated as a separate unit of account. See
Section 10.2.7.2 for
discussion of the need to make adjustments to the quoted price of an
asset that includes the impact of a third-party credit enhancement when
the fair value of a liability is measured on the basis of the identical
item held by another party as an asset.
Nonperformance risks related to nonfinancial liabilities, such as
commodity delivery contracts or service contracts may be mitigated by
“make-whole” or other default provisions that require an entity to make
cash payments for damages incurred if it fails to meet its delivery or
service obligation. However, the entity must still consider credit risk
since it may be unable to meet such cash payment obligations.
Connecting the Dots
As discussed in Section
10.1, the best practices and guidance in the
IASB’s Expert Advisory Panel report are useful to entities that
measure and disclose the fair values of financial instruments in
accordance with ASC 820. Paragraph 35 of the report addresses
factors an entity may consider in evaluating the credit risk of
a debt instrument and states the following:
Understanding the credit risk of a debt
instrument involves evaluating the credit quality and
financial strength of both the issuer and the credit
support providers. There are many factors an entity
might consider and some of the more common factors are
as follows:
(a) collateral asset
quality: the assets to which the holder of an
instrument has recourse in the event of
non-payment or default could be either all of the
assets of the issuing entity or specified assets
that are legally separated from the issuer
(ring-fenced). The greater the value and quality
of the assets to which an entity has recourse in
the event of default, the lower the credit risk of
the instrument. Measuring the fair value of a debt
instrument therefore involves assessing the
quality of the assets that support the instrument
(the collateral) and the level of the
collateralisation, and evaluating the likelihood
that the assigned collateral will generate
adequate cash flows to make the contractual
payments on the instrument.
(b) subordination: the
level of subordination of an instrument is
critical to assessing the risk of non-payment of
an instrument. If other more senior instruments
have higher claims over the cash flows and assets
that support the instrument, this increases the
risk of the instrument. The lower the claim on the
cash flows and assets, the more risky an
instrument is and the higher the return the market
will demand on the instrument.
(c) non-payment
protection: many instruments contain some form
of protection to reduce the risk of non-payment to
the holder. In measuring fair value, both the
issuer and the holder of the instrument consider
the effect of the protection on the fair value of
the instrument, unless the entity accounts for the
protection as a separate instrument. Protection
might take the form of a guarantee or a similar
undertaking (eg when a parent guarantees the debt
of a subsidiary), an insurance contract, a credit
default swap or simply the fact that more assets
support the instrument than are needed to make the
payments (this is commonly referred to as
over-collateralisation). The risk of nonpayment is
also reduced by the existence of more subordinated
tranches of instruments that take the first losses
on the underlying assets and therefore reduce the
risk of more senior tranches absorbing losses.
When protection is in the form of a guarantee, an
insurance contract or a credit default swap [and
that protection is not accounted for as a separate
instrument], it is necessary to identify the party
providing the protection and assess that party’s
creditworthiness (to the extent that the
protection is not accounted for separately). The
protection will be more valuable if the credit
risk of the protection provider is low. This
analysis involves considering not only the current
position of the protection provider but also the
effect of other guarantees or insurance contracts
that it might have written. For example, if the
provider has guaranteed many correlated debt
securities, the risk of its non-performance might
increase significantly with increases in defaults
on those securities. In addition, the credit risk
of some protection providers moves as market
conditions change. Thus, an entity evaluates the
credit risk of each protection provider at each
measurement date.
Although the above guidance is relevant to evaluating the
nonperformance risk associated with an asset or liability, this
evaluation is complex. Accordingly, an entity should consider
engaging those with specialized knowledge (e.g., valuation
experts, credit risk management specialists) to perform this
analysis.
Cases A, B, C, and E of Example 7 in ASC 820 and Examples 10-10
through 10-12 in Section 10.2.7.5
illustrate the impact that nonperformance risk may have on the fair
value measurement of liabilities.
10.2.7.4.3.1 Debt Assumed in a Business Combination
ASC 805-20-30-1 requires an acquirer to initially
measure an acquiree’s debt that is assumed in a business combination
at fair value. If the acquirer guarantees the acquiree’s debt, the
credit characteristics of the combined entity should be considered when the fair value of the assumed debt obligation is initially measured. (This guidance is consistent with the discussion in EITF Issue 98-1.11) However, if the debt remains solely the acquiree’s obligation
(i.e., the acquirer does not guarantee or collateralize the debt),
only the acquiree’s credit risk should be considered as of the
measurement date used to measure the fair value of the assumed
debt.
10.2.7.4.4 Transferability Restrictions
Under ASC 820-10-35-18B, the fair value measurement of a liability
instrument or instrument classified in stockholders’ equity should not
include a separate input or adjustment related to a contractual
restriction that prevents the entity from transferring the item. ASC
820-10-35-18B states, in part, that “[t]he effect of a restriction that
prevents the transfer of a liability or an instrument classified in a
reporting entity’s shareholders’ equity is either implicitly or
explicitly included in the other inputs to the fair value
measurement.”
The fair value measurement of a liability instrument or instrument
classified in stockholders’ equity will often be determined on the basis
of the fair value of the identical item held as an asset by another
entity. In these circumstances, if there is a restriction on the
transferability of the asset that is instrument-specific (as opposed to
entity-specific), the fair value measurement of the asset will be
affected by the restriction. In this circumstance, the fair value
measurement of a liability instrument or instrument classified in
stockholders’ equity would similarly be affected by the restriction
(i.e., the fair value measurement of the liability or equity instrument
would not be adjusted to remove the impact of the restriction on the
fair value of the identical item held by another party as an asset
because the restriction does not represent a factor specific to the
asset in accordance with ASC 820-10-35-16D). In summary, a restriction
that prevents the holder of an asset from transferring, or affects its
ability to transfer, this asset — when this restriction is appropriately
incorporated into the fair value measurement of the asset — will also be
incorporated into the fair value measurement of the liability or equity
instrument from the perspective of the entity that has issued the
liability or equity instrument. However, neither of the following
transferability restrictions should have any impact on the fair value of
a liability or equity instrument:
-
A restriction on the transferability of an asset that is entity-specific.
-
A restriction only on the issuer’s ability to transfer its liability or own equity instruments.
See Section 10.2.2.2 for further
discussion of how transfer restrictions affect fair value measurements
of assets.
10.2.7.5 Examples
Example 7 in ASC 820 consists of several cases illustrating
the fair value measurement of liabilities.
ASC 820-10
Example 7:
Measuring Liabilities
55-55A A fair value
measurement of a liability assumes that the
liability, whether it is a financial liability or a
nonfinancial liability, is transferred to a market
participant at the measurement date (that is, the
liability would remain outstanding and the market
participant transferee would be required to fulfill
the obligation; it would not be settled with the
counterparty or otherwise extinguished on the
measurement date).
55-56 The fair value of a
liability reflects the effect of nonperformance
risk. Nonperformance risk relating to a liability
includes, but may not be limited to, the reporting
entity’s own credit risk. A reporting entity takes
into account the effect of its credit risk (credit
standing) on the fair value of the liability in all
periods in which the liability is measured at fair
value because those that hold the reporting entity’s
obligations as assets would take into account the
effect of the reporting entity’s credit standing
when estimating the prices they would be willing to
pay. Cases A–E illustrate the measurement of
liabilities and the effect of nonperformance risk
(including a reporting entity’s own credit risk) on
a fair value measurement. . . .
Case A: Liabilities and Credit Risk
— General
55-57 This Case has the
following assumptions:
-
Entity X and Entity Y each enter into a contractual obligation to pay cash ($500) to Entity Z in 5 years.
-
Entity X has a AA credit rating and can borrow at 6 percent, and Entity Y has a BBB credit rating and can borrow at 12 percent. . . .
55-57A Entity X will receive
about $374 in exchange for its promise (the present
value of $500 in 5 years at 6 percent). Entity Y
will receive about $284 in exchange for its promise
(the present value of $500 in 5 years at 12
percent). The fair value of the liability to each
entity (that is, the proceeds) incorporates that
reporting entity’s credit standing.
Case B:
Structured Note
55-59 On January 1, 20X7,
Entity A, an investment bank with a AA credit
rating, issues a five-year fixed rate note to Entity
B. The contractual principal amount to be paid by
Entity A at maturity is linked to the Standard and
Poor’s S&P 500 index. No credit enhancements are
issued in conjunction with or otherwise related to
the contract (that is, no collateral is posted and
there is no third-party guarantee). Entity A elects
to account for the entire note at fair value in
accordance with paragraph 815-15-25-4. The fair
value of the note (that is, the obligation of Entity
A) during 20X7 is measured using an expected present
value technique. Changes in fair value are as
follows:
-
Fair value at January 1, 20X7. The expected cash flows used in the expected present value technique are discounted at the risk-free rate using the treasury yield curve at January 1, 20X7, plus the current market observable AA corporate bond spread to treasuries, if nonperformance risk is not already reflected in the cash flows, adjusted (either up or down) for Entity A’s specific credit risk (that is, resulting in a credit-adjusted risk-free rate). Therefore, the fair value of Entity A’s obligation at initial recognition takes into account nonperformance risk, including that reporting entity’s credit risk, which presumably is reflected in the proceeds.
-
Fair value at March 31, 20X7. During March 20X7, the credit spread for AA corporate bonds widens, with no changes to the specific credit risk of Entity A. The expected cash flows used in the expected present value technique are discounted at the risk-free rate using the treasury yield curve at March 31, 20X7, plus the current market observable AA corporate bond spread to treasuries if nonperformance risk is not already reflected in the cash flows, adjusted for Entity A’s specific credit risk (that is, resulting in a credit-adjusted risk-free rate). Entity A’s specific credit risk is unchanged from initial recognition. Therefore, the fair value of Entity A’s obligation changes as a result of changes in credit spreads generally. Changes in credit spreads reflect current market participant assumptions about changes in nonperformance risk generally, changes in liquidity risk, and the compensation required for assuming those risks.
-
Fair value at June 30, 20X7. As of June 30, 20X7, there have been no changes to the AA corporate bond spreads. However, on the basis of structured note issues corroborated with other qualitative information, Entity A determines that its own specific creditworthiness has strengthened within the AA credit spread. The expected cash flows used in the expected present value technique are discounted at the risk-free rate using the treasury yield curve at June 30, 20X7, plus the current market observable AA corporate bond spread to treasuries (unchanged from March 31, 20X7), if nonperformance risk is not already reflected in the cash flows, adjusted for Entity A’s specific credit risk (that is, resulting in a credit-adjusted risk-free rate). Therefore, the fair value of the obligation of Entity A changes as a result of the change in its own specific credit risk within the AA corporate bond spread.
Case C: Asset Retirement
Obligation
55-77 On January 1, 20X1,
Entity A assumes an asset retirement obligation in a
business combination. The reporting entity is
legally required to dismantle and remove an offshore
oil platform at the end of its useful life, which is
estimated to be 10 years.
55-78 On the basis of
paragraph 410-20-30-1, Entity A uses the expected
present value technique to measure the fair value of
the asset retirement obligation.
55-79 If Entity A was
contractually allowed to transfer its asset
retirement obligation to a market participant,
Entity A concludes that a market participant would
use all of the following inputs,
probability-weighted as appropriate, when estimating
the price it would expect to receive:
-
Labor costs
-
Allocation of overhead costs
-
The compensation that a market participant would require for undertaking the activity and for assuming the risk associated with the obligation to dismantle and remove the asset. Such compensation includes both of the following:
-
Profit on labor and overhead costs
-
The risk that the actual cash outflows might differ from those expected, excluding inflation.
-
-
Effect of inflation on estimated costs and profits
-
Time value of money, represented by the risk-free rate
-
Nonperformance risk relating to the risk that Entity A will not fulfill the obligation, including Entity A’s own credit risk.
55-80 The significant
assumptions used by Entity A to measure fair value
are as follows:
-
Labor costs are developed on the basis of current marketplace wages, adjusted for expectations of future wage increases, required to hire contractors to dismantle and remove offshore oil platforms. Entity A assigns probability assessments to a range of cash flow estimates as follows.The probability assessments are developed on the basis of Entity A’s experience with fulfilling obligations of this type and its knowledge of the market.
-
Entity A estimates allocated overhead and equipment operating costs using the rate it applies to labor costs (80 percent of expected labor costs). This is consistent with the cost structure of market participants.
-
Entity A estimates the compensation that a market participant would require for undertaking the activity and for assuming the risk associated with the obligation to dismantle and remove the asset as follows:
-
A third-party contractor typically adds a markup on labor and allocated internal costs to provide a profit margin on the job. The profit margin used (20 percent) represents Entity A’s understanding of the operating profit that contractors in the industry generally earn to dismantle and remove offshore oil platforms. Entity A concludes that this rate is consistent with the rate that a market participant would require as compensation for undertaking the activity.
-
A contractor would typically require compensation for the risk that the actual cash outflows might differ from those expected because of the uncertainty inherent in locking in today’s price for a project that will not occur for 10 years. Entity A estimates the amount of that premium to be 5 percent of the expected cash flows, including the effect of inflation.
-
-
Entity A assumes a rate of inflation of 4 percent over the 10-year period on the basis of available market data.
-
The risk-free rate of interest for a 10-year maturity on January 1, 20X1, is 5 percent. Entity A adjusts that rate by 3.5 percent to reflect its risk of nonperformance (that is, the risk that it will not fulfill the obligation), including its credit risk. Therefore, the discount rate used to compute the present value of the cash flows is 8.5 percent.
55-81 Entity A concludes that
its assumptions would be used by market
participants. In addition, Entity A does not adjust
its fair value measurement for the existence of a
restriction preventing it from transferring the
liability. As illustrated in the following table,
Entity A measures the fair value of its liability
for the asset retirement obligation as $194,879.
Case D: Debt Obligation — Quoted
Price
55-82 On January 1, 20X1,
Entity B issues at par a $2 million BBB-rated
exchange-traded 5-year fixed-rate debt instrument
with an annual 10 percent coupon. Entity B has
elected to account for this instrument using the
fair value option.
55-83 On December 31, 20X1,
the instrument is trading as an asset in an active
market at $929 per $1,000 of par value after payment
of accrued interest. Entity B uses the quoted price
of the asset in an active market as its initial
input into the fair value measurement of its
liability ($929 × [$2 million ÷ $1,000] =
$1,858,000).
55-84 In determining whether
the quoted price of the asset in an active market
represents the fair value of the liability, Entity B
evaluates whether the quoted price of the asset
includes the effect of factors not applicable to the
fair value measurement of a liability, for example,
whether the quoted price of the asset includes the
effect of a third-party credit enhancement that
would be separately accounted for from the
perspective of the issuer. Entity B determines that
no adjustments are required to the quoted price of
the asset. Accordingly, Entity B concludes that the
fair value of its debt instrument at December 31,
20X1, is $1,858,000. Entity B categorizes and
discloses the fair value measurement of its debt
instrument within Level 1 of the fair value
hierarchy.
Case E: Debt Obligation — Present
Value Technique
55-85 On January 1, 20X1,
Entity C issues at par in a private placement a $2
million BBB-rated 5-year fixed-rate debt instrument
with an annual 10 percent coupon. Entity C has
elected to account for this instrument using the
fair value option.
55-86 At December 31, 20X1,
Entity C still carries a BBB credit rating. Market
conditions, including available interest rates,
credit spreads for a BBB-quality credit rating and
liquidity, remain unchanged from the date the debt
instrument was issued. However, Entity C’s credit
spread has deteriorated by 50 basis points because
of a change in its risk of nonperformance. After
taking into account all market conditions, Entity C
concludes that if it was to issue the instrument at
the measurement date, the instrument would bear a
rate of interest of 10.5 percent or Entity C would
receive less than par in proceeds from the issue of
the instrument.
55-87 For the purpose of this
example, the fair value of Entity C’s liability is
calculated using a present value technique. Entity C
concludes that a market participant would use all of
the following inputs (consistent with paragraph
820-10-55-5) when estimating the price the market
participant would expect to receive to assume Entity
C’s obligation:
- The terms of the debt
instrument, including all of the following:
-
Coupon rate of 10 percent
-
Principal amount of $2 million
-
Term of 4 years.
-
-
The market rate of interest of 10.5 percent (which includes a change of 50 basis points in the risk of nonperformance from the date of issue).
55-88 On the basis of its
present value technique, Entity C concludes that the
fair value of its liability at December 31, 20X1, is
$1,968,641.
55-89 Entity C does not
include any additional input into its present value
technique for risk or profit that a market
participant might require for compensation for
assuming the liability. Because Entity C’s
obligation is a financial liability, Entity C
concludes that the interest rate already captures
the risk or profit that a market participant would
require as compensation for assuming the liability.
Furthermore, Entity C does not adjust its present
value technique for the existence of a restriction
preventing it from transferring the liability.
Below are some additional
examples illustrating the impact of collateral on the fair value
measurements of liabilities.
Example 10-10
How Collateral
Affects Fair Value of Liabilities
Entity J has unsecured obligations.
If these obligations were rated by a nationally
recognized credit agency, a below-investment-grade
rating (e.g., BB) would be warranted. On January 1,
20X3, J borrows $10 million in exchange for a
fixed-rate, five-year bullet maturity debt at a
125-basis-point spread over the prevailing interest
rate on five-year U.S. Treasury bonds (for
simplicity, transaction costs are ignored). The
lender requires J to collateralize its obligation by
granting a security interest in designated machinery
and equipment. Management estimates that J could
have arranged a similar loan with no collateral at a
200-basis-point spread to five-year U.S. Treasury
bonds. On January 1, 20X3, five-year U.S. Treasury
bonds yielded 7 percent.
As of January 1, 20X3, the fair
value of the loan (including any impact from the
collateral) is $10 million. The present value of the
loan’s contractual cash flows, discounted at J’s
unsecured borrowing rate of 9 percent (7 percent
plus 200 basis points), is $9.7 million. This
example illustrates that both an issuer’s credit
standing and the effect of credit enhancements must
be considered in the determination of the fair value
of the liability. If J ignored the reduction in the
interest rate attributable to the effect of
collateral, it would have mistakenly concluded that
the fair value of its debt was $9.7 million rather
than $10 million.
Impact of
Collateral and Other Factors on the Fair Value of
a Liability
In subsequent periods, J should
consider factors that affect the fair value of the
obligation, including the following:
-
Current levels of the benchmark interest rate.
-
Credit spreads on comparable, collateralized obligations.
-
Other terms of the obligation (e.g., put or call rights).
-
Other current, relevant market information (e.g., regulatory considerations).
-
The collateral’s current fair value.
Note that, in this example, the
liability would be held as an identical asset by
another party. The fair value measurement of such an
asset would not differ from that in the discussion
above.
Example 10-11
Effect of a
Decline in Collateral’s Fair Value on a
Collateralized Debt Instrument
On January 1, 20X3, Entity K issues
$100 million of notes collateralized by a portion of
its aircraft fleet. As of September 30, 20X3, there
has been a substantial decline in the fair value of
the aircraft that serves as collateral for the
notes. Assume that K’s credit standing remains
unchanged and that all other stated terms of the
notes represent current market conditions for the
remaining term of the obligation (e.g., benchmark
rate or spread over benchmark rates).
In determining the fair value of the
obligation, K will have to consider the decline in
the fair value of the collateral. While considering
this effect, K determines that the fair value of the
identical item held as an asset by another party
would only represent a payment of $80 million for
the asset and therefore that no adjustments are
necessary under ASC 820-10-35-16D. Thus, the fair
value of the notes has decreased by $20 million even
though K’s credit standing remains unchanged.
Example 10-12
Effect of a
Decline in the Borrower’s Credit Standing on a
Collateralized Obligation
Assume the same facts as in the
previous example except that the fair value of the
aircraft has not changed; instead, the credit
standing of K has declined. In determining the fair
value of the obligation, K will have to consider the
effect of the decline in its credit standing. Entity
K will also need to consider the fact that the fair
value of the collateral has not changed.
10.2.8 Application to Financial Assets and Financial Liabilities With Offsetting Risk Positions
10.2.8.1 General
ASC 820-10
Application
to Financial Assets and Financial Liabilities With
Offsetting Positions in Market Risks or
Counterparty Credit Risk
35-18D A
reporting entity that holds a group of financial
assets, financial liabilities, nonfinancial items
accounted for as derivatives in accordance with
Topic 815, or combinations of these items is exposed
to market risks (that is, interest rate risk,
currency risk, or other price risk) and to the
credit risk of each of the counterparties. If the
reporting entity manages that group of financial
assets, financial liabilities, nonfinancial items
accounted for as derivatives in accordance with
Topic 815, or combinations of these items on the
basis of its net exposure to either market risks or
credit risk, the reporting entity is permitted to
apply an exception to this Topic for measuring fair
value. That exception permits a reporting entity to
measure the fair value of a group of financial
assets, financial liabilities, nonfinancial items
accounted for as derivatives in accordance with
Topic 815, or combinations of these items on the
basis of the price that would be received to sell a
net long position (that is, an asset) for a
particular risk exposure or paid to transfer a net
short position (that is, a liability) for a
particular risk exposure in an orderly transaction
between market participants at the measurement date
under current market conditions. Accordingly, a
reporting entity shall measure the fair value of the
group of financial assets, financial liabilities,
nonfinancial items accounted for as derivatives in
accordance with Topic 815, or combinations of these
items consistently with how market participants
would price the net risk exposure at the measurement
date.
35-18E A
reporting entity is permitted to use the exception
in paragraph 820-10-35-18D only if the reporting
entity does all of the following:
-
Manages the group of financial assets, financial liabilities, nonfinancial items accounted for as derivatives in accordance with Topic 815, or combinations of these items on the basis of the reporting entity’s net exposure to a particular market risk (or risks) or to the credit risk of a particular counterparty in accordance with the reporting entity’s documented risk management or investment strategy
-
Provides information on that basis about the group of financial assets, financial liabilities, nonfinancial items accounted for as derivatives in accordance with Topic 815, or combinations of these items to the reporting entity’s management
-
Is required or has elected to measure those financial assets, financial liabilities, nonfinancial items accounted for as derivatives in accordance with Topic 815, or combinations of these items at fair value in the statement of financial position at the end of each reporting period.
35-18F The
exception in paragraph 820-10-35-18D does not
pertain to financial statement presentation. In some
cases, the basis for the presentation of financial
instruments in the statement of financial position
differs from the basis for the measurement of
financial instruments, for example, if a Topic does
not require or permit financial instruments to be
presented on a net basis. In such cases, a reporting
entity may need to allocate the portfolio-level
adjustments (see paragraphs 820-10-35-18I through
35-18L) to the individual assets or liabilities that
make up the group of financial assets, financial
liabilities, nonfinancial items accounted for as
derivatives in accordance with Topic 815, or
combinations of these items managed on the basis of
the reporting entity’s net risk exposure. A
reporting entity shall perform such allocations on a
reasonable and consistent basis using a methodology
appropriate in the circumstances.
35-18G A
reporting entity shall make an accounting policy
decision to use the exception in paragraph
820-10-35-18D. A reporting entity that uses the
exception shall apply that accounting policy,
including its policy for allocating bid-ask
adjustments (see paragraphs 820-10-35-18I through
35-18K) and credit adjustments (see paragraph
820-10-35-18L), if applicable, consistently from
period to period for a particular portfolio.
35-18H The
exception in paragraph 820-10-35-18D applies only to
financial assets and financial liabilities within
the scope of Topic 815 or Topic 825 and nonfinancial
items accounted for as derivatives in accordance
with Topic 815.
As discussed in Section 4.3.2, the unit of valuation
for financial assets, nonfinancial derivative assets, all liabilities, and
equity instruments is generally the individual instrument, which is
generally also its unit of account under other GAAP. An exception to this
general principle is available for groups of financial assets, financial
liabilities, and nonfinancial items accounted for as derivatives under ASC
815, if an entity (1) manages the group of assets and liabilities on the
basis of net exposure to a market risk (or risks) or counterparty credit
risk, (2) provides information on that basis to management, and (3) measures
those assets and liabilities at fair value in the statement of financial
position. One of the requirements for using this exception is that there
must be a “group” of eligible assets and liabilities (i.e., a number of such
assets and liabilities, and always more than two). ASC 820-10-35-18D
indicates that an entity that uses this exception is permitted “to measure
the fair value of a group of financial assets, financial liabilities,
nonfinancial items accounted for as derivatives in accordance with Topic
815, or combinations of these items on the basis of the price that would be
received to sell a net long position (that is, an asset) for a particular
risk exposure or paid to transfer a net short position (that is, a
liability) for a particular risk exposure in an orderly transaction between
market participants at the measurement date under current market
conditions.” Accordingly, an entity that elects this exception should
“measure the fair value of the group of financial assets, financial
liabilities, nonfinancial items accounted for as derivatives in accordance
with Topic 815, or combinations of these items consistently with how market
participants would price the net risk exposure at the measurement date.”
This valuation exception may only be applied to a portfolio that includes
eligible assets and eligible liabilities.
This exception applies only to valuation. It does not apply to financial
statement presentation or disclosures required under other GAAP; thus,
entities that apply this exception will be required to allocate the
portfolio-level adjustments to the individual assets and liabilities that
make up the portfolio managed on the basis of a net risk exposure. ASC 820
does not prescribe how an entity should allocate such portfolio adjustments
but requires that any allocation approach be reasonable and consistently
applied. See Section 11.2.3.5.5 for further discussion.
An entity must make an accounting policy decision to use the portfolio
valuation exception. Once the policy is established for a particular
portfolio, the entity must consistently apply that policy to the portfolio
and must consistently apply its policy for allocating bid-ask adjustments
and credit adjustments to the individual eligible items within the
portfolio. Note, however, that although the portfolio valuation exception
must be applied consistently, it may be appropriate for an entity to change
its policy decision if its risk preferences change. Paragraph BC59 of
ASU 2011-04 addresses this issue:
The Boards decided to require a reporting entity to provide evidence
that it manages its net risk exposure consistently from period to
period. The Boards decided this because a reporting entity that can
provide evidence that it manages its financial instruments on the
basis of its net risk exposure would do so consistently for a
particular portfolio from period to period, and not on a net basis
for that portfolio in some periods and on a gross basis in other
periods. Some respondents found that requirement limiting because
they noted that the composition of a portfolio changes continually
as the reporting entity rebalances the portfolio and changes its
risk exposure preferences over time. Although the reporting entity
does not need to maintain a static portfolio, the Boards decided to
clarify that the reporting entity must make an accounting policy
decision to use the exception described in paragraphs BC56 and BC57.
The Boards also decided that the accounting policy decision
could be changed if the reporting entity’s risk exposure
preferences change. In that case, the reporting entity can
decide not to use the exception but instead to measure the fair
value of its financial instruments on an individual instrument
basis. However, if the reporting entity continues to value a
portfolio using the exception, it must do so consistently from
period to period. [Emphasis added]
If an entity’s risk exposure preferences change and the entity no longer
applies the portfolio valuation exception as an accounting policy, the
change does not represent a change in accounting principle under ASC 250;
rather, it would generally reflect the application of U.S. GAAP to different
facts and circumstances. Nevertheless, we believe that once the policy
election is made, changes would be infrequent and would be necessitated by
either significant changes in facts and circumstances or a conclusion that
the conditions for applying the portfolio valuation exception are no longer
met.
See Sections 10.2.8.2
and 10.2.8.3 for discussion of the
nature of the risks that qualify for the portfolio valuation exception and
the price within a bid-ask spread that is used to value a portfolio under
this exception. See Example 10-16 for an illustration of the application of the
portfolio valuation exception.
10.2.8.1.1 Disclosure
ASC 820-10-50-2D requires entities that make an
accounting policy decision to use the portfolio valuation exception in
ASC 820-10-35-18D to disclose that fact. See further discussion in
Section
11.2.2.1. Section 11.2.3.5.5 discusses the
allocation of portfolio-level adjustments to the individual items within
a portfolio.
10.2.8.2 Exposure to Market Risks
ASC 820-10
Exposure to Market Risks
35-18I When
using the exception in paragraph 820-10-35-18D to
measure the fair value of a group of financial
assets, financial liabilities, nonfinancial items
accounted for as derivatives in accordance with
Topic 815, or combinations of these items managed on
the basis of the reporting entity’s net exposure to
a particular market risk (or risks), the reporting
entity shall apply the price within the bid-ask
spread that is most representative of fair value in
the circumstances to the reporting entity’s net
exposure to those market risks (see paragraphs
820-10-35-36C through 35-36D).
35-18J When
using the exception in paragraph 820-10-35-18D, a
reporting entity shall ensure that the market risk
(or risks) to which the reporting entity is exposed
within that group of financial assets, financial
liabilities, nonfinancial items accounted for as
derivatives in accordance with Topic 815, or
combinations of these items is substantially the
same. For example, a reporting entity would not
combine the interest rate risk associated with a
financial asset with the commodity price risk
associated with a financial liability, because doing
so would not mitigate the reporting entity’s
exposure to interest rate risk or commodity price
risk. When using the exception in paragraph
820-10-35-18D, any basis risk resulting from the
market risk parameters not being identical shall be
taken into account in the fair value measurement of
the financial assets, financial liabilities,
nonfinancial items accounted for as derivatives in
accordance with Topic 815, or combinations of these
items within the group.
35-18K
Similarly, the duration of the reporting entity’s
exposure to a particular market risk (or risks)
arising from the financial assets, financial
liabilities, nonfinancial items accounted for as
derivatives in accordance with Topic 815, or
combinations of these items shall be substantially
the same. For example, a reporting entity that uses
a 12-month futures contract against the cash flows
associated with 12 months’ worth of interest rate
risk exposure on a 5-year financial instrument
within a group made up of only those financial
assets, financial liabilities, nonfinancial items
accounted for as derivatives in accordance with
Topic 815, or combinations of these items measures
the fair value of the exposure to 12-month interest
rate risk on a net basis and the remaining interest
rate risk exposure (that is, years 2 through 5) on a
gross basis.
The ASC master glossary defines “market risk” as comprising interest rate
risk, currency risk, and other price risk. To apply the portfolio valuation
exception in ASC 820-10-35-18D, an entity must ensure that the particular
market risk of the eligible items for which the exception is being applied
are substantially the same. In doing so, the entity must consider both the
nature and duration of the relevant market risk. Thus, the portfolio
valuation exception should only be applied to a portfolio that includes
eligible assets and liabilities for which the type of market risk is the
same and that share that market risk for a similar period. It would be
inappropriate to establish a portfolio that contains assets and liabilities
subject to different market risks (i.e., different types of market risks or
different durations of the same type of market risk) because of the lack of
risk exposure mitigation. However, as indicated in ASC 820-10-35-18K, an
entity could potentially measure an exposure to a particular type of market
risk on a partial-net, partial-gross basis so that duration risk is
appropriately taken into account.
When the portfolio valuation exception is applied to a portfolio of eligible
items with offsetting market risks, an entity applies the guidance in ASC
820-10-35-36C and 35-36D to determine the price within the bid-ask spread
that is most representative of the fair value of the portfolio (i.e., the
net price to sell or transfer the portfolio). See Section
10.4.4 for discussion of the use of mid-market pricing as a
practical expedient. See also Section 10.4.3.3 for
discussion of the use of blockage factors when the portfolio valuation
exception is applied.
10.2.8.3 Exposure to the Credit Risk of a Particular Counterparty
ASC 820-10
35-18L
When using the exception in paragraph 820-10-35-18D
to measure the fair value of a group of financial
assets, financial liabilities, nonfinancial items
accounted for as derivatives in accordance with
Topic 815, or combinations of these items entered
into with a particular counterparty, the reporting
entity shall include the effect of the reporting
entity’s net exposure to the credit risk of that
counterparty or the counterparty’s net exposure to
the credit risk of the reporting entity in the fair
value measurement when market participants would
take into account any existing arrangements that
mitigate credit risk exposure in the event of
default (for example, a master netting agreement
with the counterparty or an agreement that requires
the exchange of collateral on the basis of each
party’s net exposure to the credit risk of the other
party). The fair value measurement shall reflect
market participants’ expectations about the
likelihood that such an arrangement would be legally
enforceable in the event of default.
In addition to being applicable to offsetting positions in
market risk, the portfolio valuation exception in ASC 820-10-35-18D can be
used for a portfolio of eligible assets and liabilities entered into with a
single counterparty so that this portfolio can be valued on the basis of the
entity’s net exposure to the counterparty’s credit risk or the net exposure
of the counterparty’s credit risk to the entity provided that market
participants would take into account existing arrangements between the
parties that mitigate credit risk exposure (e.g., collateral posting or
master netting arrangements). In this circumstance, the individual eligible
assets and liabilities must be with the same counterparty but do not need to
share the same exposures to market risk. Those assets and liabilities are
first measured at fair value, with the exception of consideration of credit
risk. The portfolio valuation exception is then applied to measure the net
credit risk of the portfolio. The determination of the net credit risk
valuation adjustment should take into account the relevant arrangements
between the parties that result in a mitigation of credit risk. Such
portfolio-level credit risk valuation adjustments must be allocated to the
individual assets and liabilities within the portfolio (see Section 11.2.3.5.5
for more information about such allocations).
Footnotes
2
ASU 2022-03 (issued in June
2022) clarified this concept and added an example
illustrating it (see ASC 820-10-55-22A). This
clarification is consistent with our historical
guidance.
3
The definition of a market participant in ASC
820-10-20 refers to parties that have a “reasonable understanding
about the asset or liability and the transaction using all available
information, including information that might be obtained through
due diligence efforts that are usual and customary.” ASC
820-10-35-54A notes that “[a] reporting entity need not undertake
exhaustive efforts to obtain information about market participant
assumptions. However, a reporting entity shall take into account all
information about market participant assumptions that is reasonably
available.”
4
Quoted from the Background Information and Basis for
Conclusions of ASU 2012-07. While this
ASU specifically applies to impairment assessments of unamortized
film costs, the requirement to consider all relevant information
that is obtained after the measurement date but before the financial
statements are issued (or available to be issued) is broadly
applicable to all fair value measurements.
5
See ASC 820-10-35-54 in Section 10.4.2.
6
See ASC 820-10-35-54E in Section 10.6.1.
7
Note that this framework for evaluating subsequent
information and events would not apply to (1) investments that are
measured at NAV per share in accordance with the practical expedient
in ASC 820-10-35-59 through 35-62 or (2) Level 1 inputs.
8
See Section 12.3.1.2 for
discussion of the accounting for up-front costs when the FVO is
elected for an eligible item.
9
For example, ASC 820-10-55-3(b) indicates that if an
entity determines a fair value measurement for a machine that is
installed and ready for use by using an observed price for a similar
machine that is not installed or ready for use, the observed price
should be “adjusted for transportation and installation costs so
that the fair value measurement reflects the current condition and
location of the machine (installed and configured for use).”
Similarly, if an entity is estimating the fair value of a machine
that is not installed and ready to use by using an observed price
for a similar machine that is installed and ready for use, the
observed price may need to be adjusted to reflect the fair value of
the uninstalled machine. Thus, like the adjustments for
transportation costs illustrated in Examples 10-7 and 10-8,
adjustments for installation costs could be additive or
subtractive.
10
As discussed in Section 4.3.2.2, the unit of
account for a liability instrument that is measured at fair value
excludes inseparable third-party credit enhancements in accordance
with ASC 825-10-25-13. See also Section 10.2.7.3.
11
Although this EITF Issue was not codified,
the concepts in it are consistent with the
market-participant approach in ASC 820.
10.3 Valuation Techniques
10.3.1 General
ASC 820-10
Valuation Techniques
35-24 A
reporting entity shall use valuation techniques that are
appropriate in the circumstances and for which
sufficient data are available to measure fair value,
maximizing the use of relevant observable inputs and
minimizing the use of unobservable inputs.
35-24A The
objective of using a valuation technique 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. Three widely used
valuation approaches are the market approach, cost
approach, and income approach. The main aspects of
valuation techniques consistent with those approaches
are summarized in paragraphs 820-10-55-3A through 55-3G.
An entity shall use valuation techniques consistent with
one or more of those approaches to measure fair
value.
35-27 The
Examples in Section 820-10-55 illustrate the judgments
that might apply when a reporting entity measures assets
and liabilities at fair value in different valuation
situations.
Fair Value Hierarchy
35-38 The
availability of relevant inputs and their relative
subjectivity might affect the selection of appropriate
valuation techniques (see paragraph 820-10-35-24).
However, the fair value hierarchy prioritizes the inputs
to valuation techniques, not the valuation techniques
used to measure fair value. For example, a fair value
measurement developed using a present value technique
might be categorized within Level 2 or Level 3,
depending on the inputs that are significant to the
entire measurement and the level of the fair value
hierarchy within which those inputs are categorized.
ASC 820-10 — Glossary
Cost
Approach
A valuation approach that reflects the
amount that would be required currently to replace the
service capacity of an asset (often referred to as
current replacement cost).
Income
Approach
Valuation approaches that convert future
amounts (for example, cash flows or income and expenses)
to a single current (that is, discounted) amount. The
fair value measurement is determined on the basis of the
value indicated by current market expectations about
those future amounts.
Market
Approach
A valuation approach that uses prices
and other relevant information generated by market
transactions involving identical or comparable (that is,
similar) assets, liabilities, or a group of assets and
liabilities, such as a business.
An entity must use judgment, and will often need to engage valuation specialists,
to determine the appropriate valuation technique(s) for measuring the fair value
of an asset, liability, or equity instrument in accordance with ASC 820. This
determination will often depend on the nature of the item being valued, As
discussed in Section 10.3.2, an entity may determine that
it is appropriate to use multiple valuation techniques to measure the fair value
of an asset, liability, or equity instrument. Further, as discussed in ASC
820-10-35-38, an entity should consider the observability of the inputs into a
specific valuation technique in determining which technique(s) to use.
ASC 820-10-55-3A through 55-3G below describe three widely used valuation
techniques — the market approach, cost approach, and income approach.
ASC 820-10
Market Approach
55-3A The
market approach uses prices and other relevant
information generated by market transactions involving
identical or comparable (that is, similar) assets,
liabilities, or a group of assets and liabilities, such
as a business.
55-3B For
example, valuation techniques consistent with the market
approach often use market multiples derived from a set
of comparables. Multiples might be in ranges with a
different multiple for each comparable. The selection of
the appropriate multiple within the range requires
judgment, considering qualitative and quantitative
factors specific to the measurement.
55-3C
Valuation techniques consistent with the market approach
include matrix pricing. Matrix pricing is a mathematical
technique used principally to value some types of
financial instruments, such as debt securities, without
relying exclusively on quoted prices for the specific
securities, but rather relying on the securities’
relationship to other benchmark quoted securities.
Cost Approach
55-3D The
cost approach reflects the amount that would be required
currently to replace the service capacity of an asset
(often referred to as current replacement cost).
55-3E From
the perspective of a market participant seller, the
price that would be received for the asset is based on
the cost to a market participant buyer to acquire or
construct a substitute asset of comparable utility,
adjusted for obsolescence. That is because a market
participant buyer would not pay more for an asset than
the amount for which it could replace the service
capacity of that asset. Obsolescence encompasses
physical deterioration, functional (technological)
obsolescence, and economic (external) obsolescence and
is broader than depreciation for financial reporting
purposes (an allocation of historical cost) or tax
purposes (using specified service lives). In many cases,
the current replacement cost method is used to measure
the fair value of tangible assets that are used in
combination with other assets or with other assets and
liabilities.
Income Approach
55-3F The
income approach converts future amounts (for example,
cash flows or income and expenses) to a single current
(that is, discounted) amount. When the income approach
is used, the fair value measurement reflects current
market expectations about those future amounts.
55-3G Those
valuation techniques include, for example, the
following:
-
Present value techniques
-
Option-pricing models, such as the Black-Scholes-Merton formula or a binomial model (that is, a lattice model), that incorporate present value techniques and reflect both the time value and the intrinsic value of an option
-
The multiperiod excess earnings method, which is used to measure the fair value of some intangible assets.
10.3.1.1 Present Value Techniques
ASC 820-10
Present Value Techniques
55-4
Paragraphs 820-10-55-5 through 55-20 describe the
use of present value techniques to measure fair
value. Those paragraphs focus on a discount rate
adjustment technique and an expected cash flow
(expected present value) technique. Those paragraphs
neither prescribe the use of a single specific
present value technique nor limit the use of present
value techniques to measure fair value to the
techniques discussed. The present value technique
used to measure fair value will depend on facts and
circumstances specific to the asset or liability
being measured (for example, whether prices for
comparable assets or liabilities can be observed in
the market) and the availability of sufficient
data.
The Components of a Present Value
Measurement
55-5 Present
value (that is, an application of the income
approach) is a tool used to link future amounts (for
example, cash flows or values) to a present amount
using a discount rate. A fair value measurement of
an asset or a liability using a present value
technique captures all of the following elements
from the perspective of market participants at the
measurement date:
-
An estimate of future cash flows for the asset or liability being measured.
-
Expectations about possible variations in the amount and timing of the cash flows representing the uncertainty inherent in the cash flows.
-
The time value of money, represented by the rate on risk-free monetary assets that have maturity dates or durations that coincide with the period covered by the cash flows and pose neither uncertainty in timing nor risk of default to the holder (that is, a risk-free interest rate). For present value computations denominated in nominal U.S. dollars, the yield curve for U.S. Treasury securities determines the appropriate risk-free interest rate.
-
The price for bearing the uncertainty inherent in the cash flows (that is, a risk premium).
-
Other factors that market participants would take into account in the circumstances.
-
For a liability, the nonperformance risk relating to that liability, including the reporting entity’s (that is, the obligor’s) own credit risk.
General Principles
55-6 Present
value techniques differ in how they capture the
elements in the preceding paragraph. However, all of
the following general principles govern the
application of any present value technique used to
measure fair value:
-
Cash flows and discount rates should reflect assumptions that market participants would use when pricing the asset or liability.
-
Cash flows and discount rates should take into account only the factors attributable to the asset or liability being measured.
-
To avoid double counting or omitting the effects of risk factors, discount rates should reflect assumptions that are consistent with those inherent in the cash flows. For example, a discount rate that reflects the uncertainty in expectations about future defaults is appropriate if using contractual cash flows of a loan (that is, a discount rate adjustment technique). That same rate should not be used if using expected (that is, probability-weighted) cash flows (that is, an expected present value technique) because the expected cash flows already reflect assumptions about the uncertainty in future defaults; instead, a discount rate that is commensurate with the risk inherent in the expected cash flows should be used.
-
Assumptions about cash flows and discount rates should be internally consistent. For example, nominal cash flows, which include the effect of inflation, should be discounted at a rate that includes the effect of inflation. The nominal risk-free interest rate includes the effect of inflation. Real cash flows, which exclude the effect of inflation, should be discounted at a rate that excludes the effect of inflation. Similarly, after-tax cash flows should be discounted using an after-tax discount rate. Pretax cash flows should be discounted at a rate consistent with those cash flows.
-
Discount rates should be consistent with the underlying economic factors of the currency in which the cash flows are denominated.
Risk and Uncertainty
55-7 A fair
value measurement using present value techniques is
made under conditions of uncertainty because the
cash flows used are estimates rather than known
amounts. In many cases, both the amount and timing
of the cash flows are uncertain. Even contractually
fixed amounts, such as the payments on a loan, are
uncertain if there is risk of default.
55-8 Market
participants generally seek compensation (that is, a
risk premium) for bearing the uncertainty inherent
in the cash flows of an asset or a liability. A fair
value measurement should include a risk premium
reflecting the amount that market participants would
demand as compensation for the uncertainty inherent
in the cash flows. Otherwise, the measurement would
not faithfully represent fair value. In some cases,
determining the appropriate risk premium might be
difficult. However, the degree of difficulty alone
is not a sufficient reason to exclude a risk
premium.
55-9 Present
value techniques differ in how they adjust for risk
and in the type of cash flows they use. For
example:
-
The discount rate adjustment technique (see paragraphs 820-10-55-10 through 55-12) uses a risk-adjusted discount rate and contractual, promised, or most likely cash flows.
-
Method 1 of the expected present value technique (see paragraph 820-10-55-15) uses risk-adjusted expected cash flows and a risk-free rate.
-
Method 2 of the expected present value technique (see paragraph 820-10-55-16) uses expected cash flows that are not risk adjusted and a discount rate adjusted to include the risk premium that market participants require. That rate is different from the rate used in the discount rate adjustment technique.
Discount Rate Adjustment Technique
55-10 The
discount rate adjustment technique uses a single set
of cash flows from the range of possible estimated
amounts, whether contractual or promised (as is the
case for a bond) or most likely cash flows. In all
cases, those cash flows are conditional upon the
occurrence of specified events (for example,
contractual or promised cash flows for a bond are
conditional on the event of no default by the
debtor). The discount rate used in the discount rate
adjustment technique is derived from observed rates
of return for comparable assets or liabilities that
are traded in the market. Accordingly, the
contractual, promised, or most likely cash flows are
discounted at an observed or estimated market rate
for such conditional cash flows (that is, a market
rate of return).
55-11 The
discount rate adjustment technique requires an
analysis of market data for comparable assets or
liabilities. Comparability is established by
considering the nature of the cash flows (for
example, whether the cash flows are contractual or
noncontractual and are likely to respond similarly
to changes in economic conditions), as well as other
factors (for example, credit standing, collateral,
duration, restrictive covenants, and liquidity).
Alternatively, if a single comparable asset or
liability does not fairly reflect the risk inherent
in the cash flows of the asset or liability being
measured, it may be possible to derive a discount
rate using data for several comparable assets or
liabilities in conjunction with the risk-free yield
curve (that is, using a build-up methodology).
Paragraph 820-10-55-33 illustrates the build-up
methodology.
55-12 When
the discount rate adjustment technique is applied to
fixed receipts or payments, the adjustment for risk
inherent in the cash flows of the asset or liability
being measured is included in the discount rate. In
some applications of the discount rate adjustment
technique to cash flows that are not fixed receipts
or payments, an adjustment to the cash flows may be
necessary to achieve comparability with the observed
asset or liability from which the discount rate is
derived.
Expected Present Value Technique
55-13 The
expected present value technique uses as a starting
point a set of cash flows that represents the
probability-weighted average of all possible future
cash flows (that is, the expected cash flows). The
resulting estimate is identical to expected value,
which, in statistical terms, is the weighted average
of a discrete random variable’s possible values with
the respective probabilities as the weights. Because
all possible cash flows are probability-weighted,
the resulting expected cash flow is not conditional
upon the occurrence of any specified event (unlike
the cash flows used in the discount rate adjustment
technique).
55-14 In
making an investment decision, risk-averse market
participants would take into account the risk that
the actual cash flows may differ from the expected
cash flows. Portfolio theory distinguishes between
two types of risk:
-
Unsystematic (diversifiable) risk
-
Systematic (nondiversifiable) risk.
55-15 Method
1 of the expected present value technique adjusts
the expected cash flows of an asset for systematic
(that is, market) risk by subtracting a cash risk
premium (that is, risk-adjusted expected cash
flows). Those risk-adjusted expected cash flows
represent a certainty equivalent cash flow, which is
discounted at a risk-free interest rate. A certainty
equivalent cash flow refers to an expected cash flow
(as defined), adjusted for risk so that a market
participant is indifferent to trading a certain cash
flow for an expected cash flow. For example, if a
market participant was willing to trade an expected
cash flow of $1,200 for a certain cash flow of
$1,000, the $1,000 is the certainty equivalent of
the $1,200 (that is, the $200 would represent the
cash risk premium). In that case, the market
participant would be indifferent as to the asset
held.
55-16 In
contrast, Method 2 of the expected present value
technique adjusts for systematic (that is, market)
risk by applying a risk premium to the risk-free
interest rate. Accordingly, the expected cash flows
are discounted at a rate that corresponds to an
expected rate associated with probability-weighted
cash flows (that is, an expected rate of return).
Models used for pricing risky assets, such as the
capital asset pricing model, can be used to estimate
the expected rate of return. Because the discount
rate used in the discount rate adjustment technique
is a rate of return relating to conditional cash
flows, it is likely to be higher than the discount
rate used in Method 2 of the expected present value
technique, which is an expected rate of return
relating to expected or probability-weighted cash
flows.
55-17 To
illustrate Methods 1 and 2, assume that an asset has
expected cash flows of $780 in 1 year determined on
the basis of the possible cash flows and
probabilities shown below. The applicable risk-free
interest rate for cash flows with a 1-year horizon
is 5 percent, and the systematic risk premium for an
asset with the same risk profile is 3 percent.
55-18 In this
simple illustration, the expected cash flows ($780)
represent the probability-weighted average of the 3
possible outcomes. In more realistic situations,
there could be many possible outcomes. However, to
apply the expected present value technique, it is
not always necessary to take into account
distributions of all possible cash flows using
complex models and techniques. Rather, it might be
possible to develop a limited number of discrete
scenarios and probabilities that capture the array
of possible cash flows. For example, a reporting
entity might use realized cash flows for some
relevant past period, adjusted for changes in
circumstances occurring subsequently (for example,
changes in external factors, including economic or
market conditions, industry trends, and competition
as well as changes in internal factors affecting the
reporting entity more specifically), taking into
account the assumptions of market participants.
55-19 In
theory, the present value (that is, the fair value)
of the asset’s cash flows is the same whether
determined using Method 1 or Method 2, as
follows:
-
Using Method 1, the expected cash flows are adjusted for systematic (that is, market) risk. In the absence of market data directly indicating the amount of the risk adjustment, such adjustment could be derived from an asset pricing model using the concept of certainty equivalents. For example, the risk adjustment (that is, the cash risk premium of $22) could be determined using the systematic risk premium of 3 percent ($780 – [$780 × (1.05/1.08)]), which results in risk-adjusted expected cash flows of $758 ($780 – $22). The $758 is the certainty equivalent of $780 and is discounted at the risk-free interest rate (5 percent). The present value (that is, the fair value) of the asset is $722 ($758/1.05).
-
Using Method 2, the expected cash flows are not adjusted for systematic (that is, market) risk. Rather, the adjustment for that risk is included in the discount rate. Thus, the expected cash flows are discounted at an expected rate of return of 8 percent (that is, the 5 percent risk-free interest rate plus the 3 percent systematic risk premium). The present value (that is, the fair value) of the asset is $722 ($780/1.08).
55-20 When
using an expected present value technique to measure
fair value, either Method 1 or Method 2 could be
used. The selection of Method 1 or Method 2 will
depend on facts and circumstances specific to the
asset or liability being measured, the extent to
which sufficient data are available, and the
judgments applied.
Example 2: Discount Rate Adjustment Technique —
The Build-Up Methodology
55-33 To
illustrate a build-up methodology (as discussed in
paragraph 820-10-55-11), assume that Asset A is a
contractual right to receive $800 in 1 year (that
is, there is no timing uncertainty). There is an
established market for comparable assets, and
information about those assets, including price
information, is available. Of those comparable
assets:
-
Asset B is a contractual right to receive $1,200 in 1 year and has a market price of $1,083. Thus, the implied annual rate of return (that is, a 1-year market rate of return) is 10.8 percent [($1,200/$1,083) – 1].
-
Asset C is a contractual right to receive $700 in 2 years and has a market price of $566. Thus, the implied annual rate of return (that is, a 2-year market rate of return) is 11.2 percent [($700/$566)^0.5 – 1].
-
All three assets are comparable with respect to risk (that is, dispersion of possible payoffs and credit).
55-34 On the
basis of the timing of the contractual payments to
be received for Asset A relative to the timing for
Asset B and Asset C (that is, one year for Asset B
versus two years for Asset C), Asset B is deemed
more comparable to Asset A. Using the contractual
payment to be received for Asset A ($800) and the
1-year market rate derived from Asset B (10.8
percent), the fair value of Asset A is $722
($800/1.108). Alternatively, in the absence of
available market information for Asset B, the
one-year market rate could be derived from Asset C
using the build-up methodology. In that case, the
2-year market rate indicated by Asset C (11.2
percent) would be adjusted to a 1-year market rate
using the term structure of the risk-free yield
curve. Additional information and analysis might be
required to determine whether the risk premiums for
one-year and two-year assets are the same. If it is
determined that the risk premiums for one-year and
two-year assets are not the same, the two-year
market rate of return would be further adjusted for
that effect.
ASC 820-10-55-4 through 55-20 contain guidance on the application of present value techniques (i.e., an income approach). An entity should consider such guidance, which is derived from FASB Concepts Statement 7, when measuring
the fair value of an asset, liability, or equity instrument on the basis of
future cash flows. In addition, ASC 820-10-55-33 and 55-34 contain an
example illustrating the application of a discount-rate adjustment
technique. See also the examples in Section 10.2.7.5 and Section 10.6.4.
For discussion of the valuation technique applied to determine the fair
value of a customer-relationship intangible asset, see Section
10.10.4.
10.3.2 Using a Single Technique or Multiple Techniques
ASC 820-10
Valuation
Techniques
35-24B In some cases, a
single valuation technique will be appropriate (for
example, when valuing an asset or a liability using
quoted prices in an active market for identical assets
or liabilities). In other cases, multiple valuation
techniques will be appropriate (for example, that might
be the case when valuing a reporting unit). If multiple
valuation techniques are used to measure fair value, the
results (that is, respective indications of fair value)
shall be evaluated considering the reasonableness of the
range of values indicated by those results. A fair value
measurement is the point within that range that is most
representative of fair value in the circumstances.
In some cases, it is appropriate to use more than one valuation
technique to determine the fair value of an asset, liability, or instrument
classified in stockholders’ equity. An entity that employs multiple valuation
techniques should consider both supporting and contradictory evidence in
determining the relevancy of the results of the individual techniques. An entity
must use judgment to determine the “weighting” to give to each valuation
technique used. When evaluating the reasonableness of the range of values
arrived at by using multiple techniques, an entity should consider a value to be
more reasonable if it is produced by a technique that maximizes the use of
observable inputs and minimizes the use of unobservable inputs. For each
measurement calculated, the entity must consider the fair value hierarchy and
choose the most reliable inputs available. When two or more sources for the same
input are in the same level of the fair value hierarchy, the entity chooses the
source that reflects the least amount of subjectivity and that provides the most
reliable information for the given input.
The FASB did not intend for Statement 157 to require the use of multiple valuation techniques; rather, the Board wanted to suggest that in certain situations, it may be necessary to use multiple techniques to determine fair value, as discussed in paragraphs C54 through C56 of FASB Statement 157:
The Board affirmed that its intent was not to require
the use of multiple valuation techniques. To convey its intent more
clearly, the Board clarified that, consistent with existing valuation
practice, valuation techniques that are appropriate in the circumstances
and for which sufficient data are available should be used to measure
fair value. This Statement does not specify the valuation technique that
should be used in any particular circumstances. Determining the
appropriateness of valuation techniques in the circumstances requires
judgment.
The Exposure Draft referred to the cost and effort
involved in obtaining the information used in a particular valuation
technique as a basis for determining whether to use that valuation
technique. Some respondents pointed out that the most appropriate
valuation technique also might be the most costly valuation technique
and that cost and effort should not be a basis for determining whether
to use that valuation technique. Moreover, a cost-and-effort criterion
likely would not be consistently applied. The Board agreed and removed
that cost-and-effort criterion from this Statement.
The Board expects that in some cases, a single valuation
technique will be used. In other cases, multiple valuation techniques
will be used, and the results of those techniques evaluated and
weighted, as appropriate, in determining fair value. The Board
acknowledged that valuation techniques will differ, depending on the
asset or liability and the availability of data. However, in all cases,
the objective is to use the valuation technique (or combination of
valuation techniques) that is appropriate in the circumstances and for
which there are sufficient data.
The example below illustrates factors to consider in the
determination of whether multiple valuation techniques should be used to measure
fair value.
Example 10-13
Use of Multiple
Valuation Techniques
Entity L, a private equity firm, is
required to account for its investments at fair value on
a recurring basis in accordance with ASC 946. Entity L
holds a number of investments, two of which are in the
common stock of:
-
Company A, a clothing retailer that operates in a niche market of the baby clothing industry. Quoted prices are not available for A’s stock, and most of A’s competitors are either privately held or subsidiaries of larger publicly traded clothing retailers. Company A is similar to two other organizations whose shares are thinly traded in an observable market.
-
Company B, a retailer that operates in the competitive consumer electronics industry. Although quoted prices are not available for B’s stock, B is considered comparable to many companies whose shares are actively traded.
Entities commonly use the market
approach and income approach to value equity investments
that are not publicly traded. Under the market approach,
entities use prices and other relevant information
generated by market transactions involving identical or
comparable assets or liabilities, including a business
(e.g., market-multiple approach). Under the income
approach, entities use valuation techniques to convert
future amounts to a single present amount (e.g.,
discounted cash flows model). Generally, the cost
approach is not relevant to the valuation of equity
investments.
Entity L should evaluate each investment
individually to determine the appropriate valuation
technique(s) used to measure fair value. Whether L
should use both a market approach and an income approach
to calculate the fair value of each investment (as
opposed to using only a single valuation technique)
depends on the facts and circumstances and could change
over time.
Some factors that L should consider in
evaluating the appropriateness of valuation techniques,
including whether a single technique or multiple
techniques should be employed, include the following:
-
Relevance and applicability of the technique — Since the cost approach is not relevant to the valuation of equity investments, only valuation techniques that reflect market and income approaches should be considered. The appropriateness of each specific valuation technique will depend on the facts and circumstances. While L would assess the appropriateness of each valuation technique individually, it would also compare the techniques to each other.
-
Availability and reliability of data — If L, for example, does not have sufficient reliable data to support an income approach but does have sufficient reliable data to support a market approach, a single approach (market approach) might be appropriate.
-
Comparative level of the alternative approaches in the fair value hierarchy — Entity L should determine the level in the ASC 820 fair value hierarchy in which (1) each input to each technique would be classified and (2) each measurement would fall in its entirety. For example, L may conclude that a single approach (market approach) is appropriate if it uses (1) a market approach based entirely on market-observable inputs, which places the fair value measurement in Level 2 in its entirety, and (2) the income approach, which in this example includes an unobservable input that is significant to the entire measurement and causes the measurement to be categorized in Level 3 of the fair value hierarchy. On the other hand, if both measurements are Level 3, L may conclude, after considering other factors, that it could use both approaches. However, to support the unobservable inputs used, it would still evaluate the availability and reliability of data. Even when all inputs are unobservable, L would choose the most reliable data available and the measurement technique or techniques that use the most reliable data available after it considers all inputs significant to the measurement.As discussed above, when evaluating the reasonableness of the range of values arrived at by using multiple techniques, L should consider a value to be more reasonable if it is produced by a technique that maximizes the use of observable inputs and minimizes the use of unobservable inputs.
-
Significant decline in volume and level of market activity — If, on the basis of ASC 820-10-35-54C, L concludes that there has been a significant decline in volume and level of market activity relative to normal market activity for the investment being measured, it might be appropriate for L to change its valuation technique (e.g., shift from a market approach to an income approach) or use multiple valuation techniques (e.g., use both an income approach and a market approach) in determining fair value. However, regardless of the technique(s) used, the resulting fair value measurement must reflect market-participant assumptions under current market conditions.
-
Views of market participants on the relevance of valuation techniques — Market transactions involving the specific investment or similar investments may highlight the use of a single technique or multiple techniques by market participants. Entity L may observe approaches used by market participants to help them determine a bid price for similar investments (i.e., through discussions with other private equity firms or valuation specialists) and to gain an understanding of techniques that are used by market participants in determining the fair value at which they will transact.
Entity L should consider the above
factors in identifying an appropriate approach for
measuring the fair value of its investment in A. For
example, assume that when using a market approach, L
estimates that market participants would incorporate
significant entity-specific adjustments into the
valuation of A’s stock (e.g., risk adjustments for
illiquidity/uncertainty of A’s stock relative to that of
comparable companies as well as other adjustments to
reflect business model differences between A and
comparable companies). These adjustments are calculated
on the basis of L’s assumptions, rendering the fair
value measurement Level 3. Similarly, assume that in
using an income approach based on discounted cash flows
to measure fair value, L must make significant
entity-specific assumptions in forecasting A’s future
cash flows. In such a case, the fair value measurement
under the income approach is also Level 3.
In addition, because (1) the cost
approach would not be relevant and (2) the market and
income approaches are common valuation techniques used
by prospective buyers to help them bid on acquisitions,
L would generally conclude that both valuation
techniques are appropriate in this circumstance.
Further, it should use both approaches in estimating
fair value (even if one approach is only used to
corroborate the results of the other) provided that
relevant and reliable inputs are available and there are
no other factors that would cause L to conclude that one
of the approaches is superior.
Likewise, in determining an appropriate
approach for measuring the fair value of its investment
in B, L should consider the above factors. For example,
assume that when using a market approach, L estimates
that market participants would not incorporate
significant adjustments into the valuation of B’s stock,
resulting in a Level 2 measurement (e.g., because of the
large number of similar companies and high trading
volume of the comparable companies’ stock). Similarly,
assume that when measuring fair value by using an income
approach based on discounted cash flows, L must use
significant entity-specific assumptions in forecasting
B’s future cash flows. These assumptions would result in
a Level 3 fair value measurement under the income
approach.
As a result, L may conclude that using a
single valuation technique (e.g., market approach) may
be appropriate in this circumstance because it results
in a more reliable fair value measurement (Level 2 vs.
Level 3). (Note that in practice it would be atypical
for an entity not to incorporate significant adjustments
into a market approach to value an equity investment;
this example is intended to illustrate the concept of
maximizing the use of relevant observable inputs in a
fair value measurement.)
Entity L should also consider using a
valuation specialist, when appropriate, and should
document its conclusions and considerations related to
the application of valuation techniques (as part of its
internal control policies and procedures).
Cases A and B of Example 3 in ASC 820 also illustrate the use of
multiple valuation techniques.
ASC 820-10
Example 3: Use of Multiple Valuation
Approaches
Case A: Machine Held and Used
55-36 A reporting entity
acquires a machine in a business combination. The
machine will be held and used in its operations. The
machine was originally purchased by the acquired entity
from an outside vendor and, before the business
combination, was customized by the acquired entity for
use in its operations. However, the customization of the
machine was not extensive. The acquiring entity
determines that the asset would provide maximum value to
market participants through its use in combination with
other assets or with other assets and liabilities (as
installed or otherwise configured for use). There is no
evidence to suggest that the current use of the machine
is not its highest and best use. Therefore, the highest
and best use of the machine is its current use in
combination with other assets or with other assets and
liabilities.
55-37 The reporting entity
determines that sufficient data are available to apply
the cost approach and, because the customization of the
machine was not extensive, the market approach. The
income approach is not used because the machine does not
have a separately identifiable income stream from which
to develop reliable estimates of future cash flows.
Furthermore, information about short-term and
intermediate-term lease rates for similar used machinery
that otherwise could be used to project an income stream
(that is, lease payments over remaining service lives)
is not available. The market and cost approaches are
applied as follows:
-
The market approach is applied using quoted prices for similar machines adjusted for differences between the machine (as customized) and the similar machines. The measurement reflects the price that would be received for the machine in its current condition (used) and location (installed and configured for use). The fair value indicated by that approach ranges from $40,000 to $48,000.
-
The cost approach is applied by estimating the amount that would be required currently to construct a substitute (customized) machine of comparable utility. The estimate takes into account the condition of the machine and the environment in which it operates, including physical wear and tear (that is, physical deterioration), improvements in technology (that is, functional obsolescence), conditions external to the condition of the machine such as a decline in the market demand for similar machines (that is, economic obsolescence), and installation costs. The fair value indicated by that approach ranges from $40,000 to $52,000.
55-38 The reporting entity
determines that the higher end of the range indicated by
the market approach is most representative of fair value
and, therefore, ascribes more weight to the results of
the market approach. That determination is made on the
basis of the relative subjectivity of the inputs, taking
into account the degree of comparability between the
machine and the similar machines. In particular:
-
The inputs used in the market approach (quoted prices for similar machines) require fewer and less subjective adjustments than the inputs used in the cost approach.
-
The range indicated by the market approach overlaps with, but is narrower than, the range indicated by the cost approach.
-
There are no known unexplained differences (between the machine and the similar machines) within that range.
Accordingly, the reporting entity
determines that the fair value of the machine is
$48,000.
55-38A If customization of
the machine was extensive or if there were not
sufficient data available to apply the market approach
(for example, because market data reflect transactions
for machines used on a standalone basis, such as, a
scrap value for specialized assets, rather than machines
used in combination with other assets or with other
assets and liabilities), the reporting entity would
apply the cost approach. When an asset is used in
combination with other assets or with other assets and
liabilities, the cost approach assumes the sale of the
machine to a market participant buyer with the
complementary assets and the associated liabilities. The
price received for the sale of the machine (that is, an
exit price) would not be more than either of the
following:
-
The cost that a market participant buyer would incur to acquire or construct a substitute machine of comparable utility
-
The economic benefit that a market participant buyer would derive from the use of the machine.
Case B: Software Asset
55-39 A reporting entity
acquires a group of assets. The asset group includes an
income-producing software asset internally developed for
licensing to customers and its complementary assets
(including a related database with which the software
asset is used) and the associated liabilities. To
allocate the cost of the group to the individual assets
acquired, the reporting entity measures the fair value
of the software asset. The reporting entity determines
that the software asset would provide maximum value to
market participants through its use in combination with
other assets or with other assets and liabilities (that
is, its complementary assets and the associated
liabilities). There is no evidence to suggest that the
current use of the software asset is not its highest and
best use. Therefore, the highest and best use of the
software asset is its current use. (In this case, the
licensing of the software asset, in and of itself, does
not indicate that the fair value of the asset would be
maximized through its use by market participants on a
standalone basis.)
55-40 The reporting entity
determines that, in addition to the income approach,
sufficient data might be available to apply the cost
approach but not the market approach. Information about
market transactions for comparable software assets is
not available. The income and cost approaches are
applied as follows:
-
The income approach is applied using a present value technique. The cash flows used in that technique reflect the income stream expected to result from the software asset (license fees from customers) over its economic life. The fair value indicated by that approach is $15 million.
-
The cost approach is applied by estimating the amount that currently would be required to construct a substitute software asset of comparable utility (that is, taking into account functional and economic obsolescence). The fair value indicated by that approach is $10 million.
55-41 Through its application
of the cost approach, the reporting entity determines
that market participants would not be able to construct
a substitute software asset of comparable utility. Some
characteristics of the software asset are unique, having
been developed using proprietary information, and cannot
be readily replicated. The reporting entity determines
that the fair value of the software asset is $15
million, as indicated by the income approach.
10.3.3 Model Calibration
ASC 820-10
Valuation Techniques
35-24C If the transaction
price is fair value at initial recognition and a
valuation technique that uses unobservable inputs will
be used to measure fair value in subsequent periods, the
valuation technique shall be calibrated so that at
initial recognition the result of the valuation
technique equals the transaction price. Calibration
ensures that the valuation technique reflects current
market conditions, and it helps a reporting entity to
determine whether an adjustment to the valuation
technique is necessary (for example, there might be a
characteristic of the asset or liability that is not
captured by the valuation technique). After initial
recognition, when measuring fair value using a valuation
technique or techniques that use unobservable inputs, a
reporting entity shall ensure that those valuation
techniques reflect observable market data (for example,
the price for a similar asset or liability) at the
measurement date.
Section 9.3 discusses the requirement in
ASC 820-10-35-24C to calibrate a valuation technique to the transaction price.
While that discussion focuses primarily on calibration of a valuation technique
to the initial amount recognized for an asset or liability that is subsequently
measured at fair value, entities should also calibrate valuation techniques to
other relevant transactions, such as:
-
Observable market transactions (e.g., calibration of a valuation technique used to measure the fair value of mortgage servicing rights to observed market transactions involving the sale of mortgage servicing rights).
-
An entity’s own sale transactions (e.g., calibration of a valuation technique used to measure fair value of private equity investments to amounts received upon disposition of such investments).
See Section 10.7 for discussion of how an
entity considers whether observable transactions represent orderly transactions
between market participants. See Section 10.8.2 for
discussion of an entity’s use of quotes from brokers or pricing services to
calibrate its valuation techniques.
10.3.4 Changes in Valuation Techniques
ASC 820-10
Valuation
Techniques
35-25 Valuation techniques used
to measure fair value shall be applied consistently.
However, a change in a valuation technique or its
application (for example, a change in its weighting when
multiple valuation techniques are used or a change in an
adjustment applied to a valuation technique) is
appropriate if the change results in a measurement that
is equally or more representative of fair value in the
circumstances. That might be the case if, for example,
any of the following events take place:
-
New markets develop.
-
New information becomes available.
-
Information previously used is no longer available.
-
Valuation techniques improve.
-
Market conditions change.
35-26 Revisions resulting from
a change in the valuation technique or its application
shall be accounted for as a change in accounting
estimate. (See paragraph 250-10-45-17. However,
paragraph 250-10-50-5 explains that the disclosures in
Topic 250 for a change in accounting estimate are not
required for revisions resulting from a change in a
valuation technique or its application.)
ASC 820 does not preclude an entity from changing its valuation technique or the
application thereof. However, before making such a change, the entity must
determine that doing so would yield a measurement that is equally or more
representative of fair value. ASC 820-10-35-25 gives examples of circumstances
in which an entity may need to change its valuation technique or how it applies
such a technique.
A change in valuation technique from one in which a quoted price is used would
generally not be appropriate when there is a quote from an active market for an
identical asset. As discussed in ASC 820-10-35-41, if a quoted price in an
active market exists, it “shall be used without adjustment to measure fair value
whenever available,” with limited exceptions. Decreased volumes in a market are
not necessarily indicative of an inactive market (see Section
10.6.2.1 for more information).
Depending on the circumstances, a change from a valuation
technique in which a quoted price (or a direct adjustment to a quoted price) is
used to a different valuation technique (e.g., a discounted cash flow technique)
may be appropriate in the following cases:
-
When a quoted price is no longer available.
-
When a quoted price is available but the market is not active (see ASC 820-10-35-48(b)). ASC 820-10-35-54C states that entities must “evaluate the significance and relevance” of the following factors to determine whether the volume or level of activity for an asset or liability has significantly decreased:
-
There are few recent transactions.
-
Price quotations are not developed using current information.
-
Price quotations vary substantially either over time or among market makers (for example, some brokered markets).
-
Indices that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability.
-
There is a significant increase in implied liquidity risk premiums, yields, or performance indicators . . . for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, taking into account all available market data about credit and other nonperformance risk for the asset or liability.
-
There is a wide bid-ask spread or significant increase in the bid-ask spread.
-
There is a significant decline in the activity of, or there is an absence of, a market for new issues . . . for the asset or liability or similar assets or liabilities [or own equity instruments].
-
Little information is publicly available (for example, for transactions that take place in a principal-to-principal market).
Note, however, that an entity must consider prices from relevant observable transactions in determining fair value even if the market is not active. See Chapter 7 and Section 10.6.3 for more information. -
-
The entity is not able to access the price in the market in which it is quoted (see ASC 820-10-35-6B and ASC 820-10-35-41B(b)).
-
The price is not based on relevant observable market data and does not reflect assumptions that market participants would make in pricing the asset as of the measurement date. (As discussed in Section 10.8, an entity cannot necessarily assume that a price provided by an external source is representative of fair value as of the measurement date.)
When there is no quoted price in an active market, it is sometimes appropriate
for an entity to use multiple valuation techniques to measure fair value (as
discussed in ASC 820-10-35-24B). Like other changes in valuation technique, a
change in the application of multiple valuation techniques (such as a change in
how they are weighted) is permitted if it results in a measurement that is
equally or more representative of fair value in the circumstances. For instance,
if the entity employs both a market approach (e.g., market multiples for
comparable assets) and an income approach (e.g., a discounted cash flow model)
in determining fair value, the method of weighting the two approaches should be
consistent over time unless the conditions for a change in valuation technique
are met. Furthermore, an entity would consider the reasonableness of the range
of fair value measurements resulting from the approaches. ASC 820-10-35-54F
states that “[t]he objective is to determine the point within the range that is
most representative of fair value under current market conditions. A wide range
of fair value measurements may be an indication that further analysis is
needed.”
ASC 820 also requires disclosure of the valuation techniques and inputs used to
measure fair value as well as a discussion of changes in valuation techniques
(including the justification for making them) during interim and annual periods
(see ASC 820-10-50-2(bbb)). See Chapter 11
for more information.
10.4 Inputs to Valuation Techniques
10.4.1 General
ASC 820-10
General Principles
35-36 Valuation techniques
used to measure fair value shall maximize the use of
relevant observable inputs and minimize the use of
unobservable inputs.
35-36A Examples of markets
in which inputs might be observable for some assets and
liabilities (for example, financial instruments) include
exchange markets, dealer markets, brokered markets, and
principal-to-principal markets.
35-36B A reporting entity
shall select inputs that are consistent with the
characteristics of the asset or liability that market
participants would take into account in a transaction
for the asset or liability (see paragraphs 820-10-35-2B
through 35-2C). In some cases, those characteristics
result in the application of an adjustment, such as a
premium or discount (for example, a control premium or
noncontrolling interest discount). However, a fair value
measurement shall not incorporate a premium or discount
that is inconsistent with the unit of account in the
Topic that requires or permits the fair value
measurement. Premiums or discounts that reflect size as
a characteristic of the reporting entity’s holding
(specifically, a blockage factor that adjusts the quoted
price of an asset or a liability because the market’s
normal daily trading volume is not sufficient to absorb
the quantity held by the entity, as described in
paragraph 820-10-35-44) rather than as a characteristic
of the asset or liability (for example, a control
premium when measuring the fair value of a controlling
interest) are not permitted in a fair value measurement.
In all cases, if there is a quoted price in an active
market (that is, a Level 1 input) for an asset or a
liability, a reporting entity shall use that quoted
price without adjustment when measuring fair value,
except as specified in paragraph 820-10-35-41C.
Pending Content (Transition
Guidance: ASC 820-10-65-13)
35-36B A reporting entity shall select
inputs that are consistent with the
characteristics of the asset or liability that
market participants would take into account in a
transaction for the asset or liability (see
paragraphs 820-10-35-2B through 35-2C). In some
cases, those characteristics result in the
application of an adjustment, such as a premium or
discount (for example, a control premium or
noncontrolling interest discount). However, a fair
value measurement shall not incorporate a premium
or discount that is inconsistent with the unit of
account in the Topic that requires or permits the
fair value measurement. Premiums or discounts that
reflect size as a characteristic of the reporting
entity’s holding (specifically, a blockage factor
that adjusts the quoted price of an asset or a
liability because the market’s normal daily
trading volume is not sufficient to absorb the
quantity held by the entity, as described in
paragraph 820-10-35-44) rather than as a
characteristic of the asset or liability (for
example, a control premium when measuring the fair
value of a controlling interest) are not permitted
in a fair value measurement. Similarly, a discount
applied to the price of an equity security because
of a contractual sale restriction is inconsistent
with the unit of account being the equity
security. A contractual sale restriction is a
characteristic of the reporting entity holding the
equity security rather than a characteristic of
the asset and, therefore, is not considered in
measuring the fair value of an equity security
(see paragraphs 820-10-55-52 through 55-52A). A
contractual sale restriction prohibiting the sale
of an equity security is a characteristic of the
reporting entity holding the equity security and
shall not be separately recognized as its own unit
of account. In all cases, if there is a quoted
price in an active market (that is, a Level 1
input) for an asset or a liability, a reporting
entity shall use that quoted price without
adjustment when measuring fair value, except as
specified in paragraph 820-10-35-41C.
Under ASC 820, a fair value measurement should maximize the use of observable
inputs and minimize the use of unobservable inputs. Furthermore, the inputs used
in a valuation technique must be selected on the basis of the inputs that market
participants in the principal (or most advantageous) market would select after
considering the characteristics of the asset, liability, or equity-classified
instrument that is being measured at fair value.
If an entity is using a valuation technique to determine fair value and has
information indicating that market participants would use different inputs or
assumptions, the entity cannot choose to rely on its own information in
determining what inputs or assumptions to use, because a fair value measurement
is market-based rather than entity-specific. These concepts are addressed in the
definition of fair value as well as in a number of paragraphs in ASC 820 (e.g.,
ASC 820-10-05-1C, ASC 820-10-35-53, ASC 820-10-35-54A, and ASC 820-10-35-54E).
For more information, see Section
8.4.2.2.
10.4.2 Risk Adjustments When Significant Unobservable Inputs Are Used in Valuation Techniques
In accordance with the prioritization of inputs required by the
fair value hierarchy, an entity’s valuation technique should incorporate
relevant observable inputs (i.e., Level 1 and Level 2 inputs) whenever they are
available; however, if relevant observable inputs are not available, the entity
uses unobservable inputs (i.e., Level 3 inputs). ASC 820-10-35-53 indicates that
unobservable inputs must “reflect the assumptions that market participants would
use when pricing” an asset, liability, or instrument classified in an entity’s
stockholders’ equity. When using unobservable inputs, entities should consider
whether risk adjustments are necessary on the basis of whether market
participants would require such adjustments. ASC 820-10-35-54 states:
Assumptions about risk include the risk inherent in a
particular valuation technique used to measure fair value (such as a
pricing model) and the risk inherent in the inputs to the valuation
technique. A measurement that does not include an adjustment for risk
would not represent a fair value measurement if market participants
would include one when pricing the asset or liability. For example, it
might be necessary to include a risk adjustment when there is
significant measurement uncertainty (for example, when there has been a
significant decrease in the volume or level of activity when compared
with normal market activity for the asset or liability, or similar
assets or liabilities, and the reporting entity has determined that the
transaction price or quoted price does not represent fair value, as
described in paragraphs 820-10-35-54C through 35-54J).
Nonperformance and liquidity are risks that market participants may consider
under ASC 820. For an example illustrating how these risks may affect the fair
value measurement, see ASC 820-10-55-90 through 55-98 (also see
Section 10.6.4). Market participants may also consider
other risks, including, but not limited to, model uncertainty risk and risks
arising from the inability to hedge an underlying risk in an asset, liability,
or instrument classified in an entity’s stockholders’ equity.
It may be difficult to determine a risk adjustment that a market participant
would demand in an assumed transaction because the inputs in such a transaction
might not be directly observable. In such situations, an entity should look
beyond its own policies and transactions and consider the risks from a market
participant’s point of view.
When using Level 3 inputs, an entity may need to consider the following items,
when applicable, to incorporate market participants’ assumptions:
-
Recent transactions of a similar nature and duration.
-
Common industry practices.
-
Historical trends and settlements of past transactions.
An entity may be able to calibrate its valuation technique to observed
transaction prices to determine whether the risks that market participants would
demand to be compensated for have been appropriately incorporated into the
technique (see Section 10.3.3). See
Section 10.6 for further discussion of
adjustments that may be necessary when the volume or level of activity for an
asset or liability has significantly decreased.
10.4.3 Premiums or Discounts Based on Size of a Position
10.4.3.1 General
ASC 820-10-35-36B addresses when a fair value measurement should include a
premium or discount as a result of the size of an asset, liability, or
instrument classified in an entity’s stockholders’ equity. In a manner
consistent with the guidance on transfer restrictions (see Section 10.2.2.2), a fair value measurement
includes a premium or discount that reflects the size of the item only if
size is a characteristic of the asset, liability, or instrument classified
in stockholders’ equity. A fair value measurement cannot include “[p]remiums
or discounts that reflect size as a characteristic of the . . . entity’s
holding” (i.e., a blockage factor) rather than as a characteristic of the
asset, liability, or instrument classified in stockholders’ equity that is
determined on the basis of its unit of account under other Codification
topics (e.g., a control premium or minority interest discount that is
appropriate on the basis of its unit of account). ASC 820-10-35-36B
indicates that when “there is a quoted price in an active market . . . for
an asset or a liability” (i.e., a Level 1 input), an entity must “use that
quoted price without adjustment when measuring fair value, except as
specified in paragraph 820-10-35-41C.” However, even if a fair value
measurement is categorized within Level 2 or Level 3 of the fair value
hierarchy in its entirety, the fair value measurement cannot include a
premium or discount for size (e.g., a blockage factor) when this premium or
discount results from the size of an entity’s holding rather than from a
characteristic of the item being valued.
10.4.3.2 Unit of Account
The determination of whether size is a characteristic of an asset, liability,
or instrument classified within an entity’s stockholders’ equity (and thus
whether the fair value measurement should include a premium or discount for
size) must be made on the basis of the unit of account for the item subject
to the fair value measurement. The unit of account is generally determined
under other Codification topics. See Chapter
4 for discussion of the unit of account.
ASC 820-10-35-44 addresses the unit of account for an asset or liability that
is traded in an active market:
If a reporting entity holds a position in a single asset or liability
(including a position comprising a large number of identical assets
or liabilities, such as a holding of financial instruments) and the
asset or liability is traded in an active market, the fair value of
the asset or liability shall be measured within Level 1 as the
product of the quoted price for the individual asset or liability
and the quantity held by the reporting entity. That is the case,
even if a market’s normal daily trading volume is not sufficient to
absorb the quantity held and placing orders to sell the position in
a single transaction might affect the quoted price.
The same “price times quantity” (or “P × Q”) approach must
be applied in other situations for which the unit of account is an
individual asset or liability. Thus, as discussed in Section 10.4.3.3, blockage factors are
generally prohibited under ASC 820.
10.4.3.3 Blockage Factors
As described in ASC 820-10-35-36B, a blockage factor represents a discount
that “adjusts the quoted price of an asset or a liability because the
market’s normal daily trading volume is not sufficient to absorb the
quantity held by the entity.” The basic principle in ASC 820-10-35-36B is
that blockage factors are prohibited at all levels of the fair value
hierarchy. An adjustment to a quoted price of an individual asset or
liability to reflect a blockage factor is not permitted under ASC 820 when
the unit of account for the asset or liability is the individual instrument
(i.e., the unit of account for the holding under U.S. GAAP is aligned with
the unit of account related to the quoted price). For example, if an entity
holds a large position in a publicly traded common stock and would expect to
sell the position in a single transaction (i.e., a large block), the price
it would receive would reflect a discount to the product of the quoted
market price and the number of shares held; however, that discount should
not be reflected in a fair value measurement because it reflects the size of
the entity’s holding as opposed to a characteristic of the asset held.
However, if the unit of account for fair value measurement purposes is the
entire holding (i.e., entire position), an adjustment to reflect the size of
the holding may be appropriate. Furthermore, if the unit of valuation
reflects the entire holding, an adjustment to reflect the size of the
holding may be appropriate even if the unit of account differs from the unit
of valuation and application of a blockage factor at the unit-of-account
level would be inappropriate. Thus, a discount that adjusts a quoted price
of an asset or liability to reflect a blockage factor could, in certain
circumstances, be consistent with the definition of fair value in ASC
820.
An entity would use a blockage factor (if market participants would
incorporate one) when it applies the portfolio valuation exception in ASC
820-10-35-18D through 35-18L. ASC 820-10-35-18D permits an entity “to
measure the fair value of a group of financial assets, financial
liabilities, nonfinancial items accounted for as derivatives in accordance
with Topic 815, or combinations of these items on the basis of the price
that would be received to sell a net long position (that is, an
asset) for a particular risk exposure or paid to transfer a net short
position (that is, a liability) for a particular risk exposure in an
orderly transaction between market participants at the measurement date
under current market conditions” (emphasis added). See Section 10.2.8.1 for more information about
the portfolio valuation exception.
The three examples below further illustrate the application
of blockage factors in fair value measurements.
Example 10-14
Bond Forward Contract — Blockage Factor Is
Appropriate
Entity M enters into a single-bond forward contract
for the purchase of $1 billion in U.S. Treasury
bonds. The contract is accounted for as a derivative
instrument under ASC 815 and cannot be separated
into denominations.
Quotes are available for futures contracts based on
U.S. Treasury bonds that have a face value or
notional amount of $100,000. Entity M might
determine the fair value of its investment by
multiplying the available quote by 10,000. However,
this approach would not accurately reflect the
characteristics of the contract, namely that the
notional amount of M’s contract is $1 billion.
According to ASC 820-10-35-36B, “[a] reporting
entity [should] select inputs that are consistent
with the characteristics of the asset or liability
that market participants would take into account in
a transaction for the asset or liability.” In this
case, market participants would consider that, given
the acquisition of the investment from M, a purchase
of the entire contract would be required, of which
the $1 billion notional amount is a
characteristic.
Thus, it would be appropriate for M to adjust the
observed $100,000 notional prices related to the
bond forward contract for the size of its holding
(i.e., one contract with a notional amount of $1
billion) because the size of the holding is a
characteristic of the investment and both the unit
of account and the unit of valuation are the $1
billion contract.
Example 10-15
Bond Futures Contract — Blockage Factor Is Not
Appropriate
Entity N enters into 10,000 bond futures contracts,
each with a notional amount of $100,000 (i.e., total
notional amount of all contracts is $1 billion). The
contracts are accounted for as derivative
instruments under ASC 815. Quotes are available for
futures contracts based on U.S. Treasury bonds that
have a face value or notional amount of
$100,000.
In this case, under ASC 820, N would not be permitted
to consider its entire holding of 10,000 bond
futures contracts as the unit of valuation in a fair
value measurement because ASC 815 establishes the
unit of account as each individual bond futures
contract. Aggregating the bond futures contracts
into a single unit of valuation would be
inconsistent with ASC 820-10-35-36B. As a result, a
blockage factor is not permitted. Rather, the fair
value of N’s aggregate holding is equal to the
quoted price of a single bond futures contract with
a $100,000 notional amount multiplied by the 10,000
bond futures contracts held.
Example 10-16
Application of the Portfolio Valuation
Exception
Entity O holds 15 long-term fixed-interest notes
receivable with various counterparties. To manage
its interest rate risk, O enters into 10 bond
futures contracts. Information about its risk
management strategies and related investments is
provided to management. The notes receivable and
futures contracts are both measured at fair value.
Further, quoted prices are available for the bond
futures contracts. However, O must use a combination
of observable and unobservable inputs to determine
the fair value for individual fixed-interest notes
receivable. Entity O must first determine the unit
of valuation to assess whether it may apply a
discount that reflects size as a characteristic of
its holding.
Generally, each individual note receivable, as well
as each individual bond futures contract, represents
a single unit of account and should be valued
separately (i.e., the unit of valuation would be
consistent with the unit of account). However, ASC
820-10-35-18D contains an exception to the ASC 820
measurement requirements regarding the unit of
valuation. As discussed in Section 10.2.8.1, O
must meet the following criteria in ASC
820-10-35-18E to apply this exception:
-
It manages the group on the basis of the net exposure to interest rate risk in accordance with its documented risk management or investment strategy.
-
It provides information on that basis about the group to the reporting entity’s management.
-
It is required or has elected to measure the assets and liabilities in the group at fair value in the statement of financial position at the end of each reporting period.
In addition, O must consider whether the portfolio
that consists of 15 notes receivable and 10 bond
futures contracts achieves substantive offset. It
would not be appropriate for O to apply the
portfolio valuation exception in ASC 820-10-35-18D
if the portfolio is not substantive. For example, a
portfolio might not be substantive if it consisted
of 15 notes receivable and one bond futures
contract. In this example, without evidence to the
contrary, it would appear that the portfolio was
established to avoid the prohibition against
blockage factors.
Entity O meets these criteria with respect to the 15
notes receivable and 10 bond futures contracts and
measures the fair value of the portfolio on the
basis of its net exposure (i.e., net asset basis).
In this case, the net exposure is O’s unit of
valuation for this fair value measurement even if
prices are available for individual notes receivable
and bond futures contracts. Thus, it would be
appropriate for O to apply a discount that reflects
size as a characteristic of its holding because size
is a characteristic of the net exposure (the
portfolio) that is being measured at fair value.
Entity O should measure the fair value of the group
in a manner consistent with how market participants
would price the net risk exposure as of the
measurement date.
10.4.3.4 Control Premiums
A control premium represents the amount a buyer is willing to pay for the
synergies and other potential benefits that would be derived from
controlling another entity. For example, incremental value could be
associated with a controlling interest in a publicly traded company. The
incremental value, or control premium, would represent the amount a buyer
may be willing to pay in excess of the market capitalization of the publicly
traded company (i.e., the product of the number of outstanding shares and
the quoted price per share) to obtain a 100 percent ownership interest in
that public company.
ASC 820-10-35-36B indicates that control premiums are not
permitted as adjustments to Level 1 measurements. However, for other fair
value measurements (i.e., Level 2 and Level 3 measurements), a control
premium may be appropriate. For example, in fair value measurements of
reporting units, a control premium may be relevant (see further discussion
in Section
10.10.3.2). As another example, when the fair value of a
noncontrolling interest is measured, a control premium and corresponding
minority interest discount may be appropriate. Entities must evaluate
relevant factors to determine whether a control premium is appropriate and,
if so, must estimate the amount of the control premium.
See AICPA Technical Q&As Section 6910.35 for guidance on the inclusion of
control premiums by investment companies when measuring the fair value of an
investee.
10.4.4 Inputs Based on Bid and Ask Prices
ASC 820-10
Inputs Based on Bid and Ask Prices
35-36C If an asset or a
liability measured at fair value has a bid price and an
ask price (for example, an input from a dealer market),
the price within the bid-ask spread that is most
representative of fair value in the circumstances shall
be used to measure fair value regardless of where the
input is categorized within the fair value hierarchy
(that is, Level 1, 2, or 3). The use of bid prices for
asset positions and ask prices for liability positions
is permitted but is not required.
35-36D This Topic does not
preclude the use of mid-market pricing or other pricing
conventions that are used by market participants as a
practical expedient for fair value measurements within a
bid-ask spread. For example, paragraphs 820-10-35-25
through 35-26 apply to a change from the use of
mid-market pricing or other pricing conventions to
another valuation technique. In addition, the disclosure
requirements in paragraph 820-10-50-2(bbb) apply to such
changes.
Pricing conventions are commonly used in certain industries. ASC 820-10-35-36C
states that the “use of bid prices for asset positions and ask prices for
liability positions is permitted but is not required.” Further, ASC
820-10-35-36D allows an entity to use “mid-market pricing or other pricing
conventions that are used by market participants as a practical expedient for
fair value measurements within a bid-ask spread.” An entity does not need to
meet any qualifying criteria to use such conventions.
The decision to use such pricing as a practical expedient is an accounting policy
election that should be consistently applied. It is generally inappropriate for
an entity to change to using a practical expedient once it has established a
policy of using the price that is most representative of fair value in the
circumstances. For an entity to change its approach, the change must result in
“a measurement that is equally or more representative of fair value in the
circumstances” in accordance with ASC 820-10-35-25. Typically, such a change
would not result in an equally or more representative measure of fair value.
In addition to establishing and consistently applying a policy
for fair value measurements within a bid-ask spread, an entity should disclose
its policy, if material.
The bid-ask spread practical expedient in ASC 820 is intended to be consistent
with the SEC’s ASR 118, which states, in part:
Some companies as a matter of general policy use the bid
price, others use the mean of the bid and asked prices, and still others
use a valuation within the range considered best to represent the value
in the circumstances; each of these policies is acceptable if
consistently applied.
A fair value measurement that represents the midpoint between an unadjusted Level
1 bid price as of the measurement date and an unadjusted Level 1 ask price as of
the measurement date may be categorized as a Level 1 fair value measurement. In
addition, a price within a bid-ask spread that is most representative of fair
value may be categorized as a Level 1 fair value measurement provided that both
the bid price and ask price represent Level 1 inputs as of the measurement
date.
Example 10-17
Use of Pricing Convention Practical Expedient
Entity P and Broker-Dealer Y hold the same debt security.
Broker-Dealer Y is a market maker in the debt security.
Entity P is not a market maker in the debt security.
Broker-dealers, including Y, trade the debt security in
an active market by using the bid and ask prices. Entity
P and Broker-Dealer Y’s respective policies are as follows:
-
Although P would most likely sell the debt security at or close to the bid price, P may establish and consistently apply a policy of using the mid-market price as the fair value of the debt security (and other similar securities). However, in accordance with ASR 118, which states, “[n]ormally, it is not acceptable to use the asked price alone,” it would be inappropriate for P to use the ask price for its long position.
-
Although Y may be able to exit at a price greater than the bid price, Y may have a consistently applied policy of carrying the same debt security (and other similar securities) by using the bid price.
See Section 9.2.1 for discussion of
inception gains and losses.
10.4.5 Income Taxes
10.4.5.1 Income Tax Rate Used When an Income Approach Is Applied
When a fair value measurement is determined under an income approach on the
basis of the present value of expected future cash flows, an entity may need
to include an adjustment for income taxes. Such an adjustment would be most
common in the valuation of nonfinancial assets or asset groups, such as a
business, reporting unit, long-lived asset group, or intangible asset.
When income taxes are reflected in a fair value measurement by using an
income approach, an entity would generally use the statutory rate unless
there is substantial evidence that another tax rate should be used. Under
ASC 820, fair value is determined from a market participant’s perspective.
Therefore, entity-specific data, such as an entity’s own effective tax rate
or the fact that the entity is not taxable (i.e., a partnership), are
usually irrelevant. The above guidance is consistent with that in Chapter 6
of the AICPA Accounting and Valuation Guide Assets Acquired in a Business
Combination to Be Used in Research and Development Activities, which
states, in part:
When choosing the appropriate tax rate, it is important to ensure
that it does not reflect specific tax circumstances of the subject
company, reporting entity, or both, which may occur by consideration
of net operating loss carryforwards, tax penalties, special
payments, and so forth. Instead, industry data demonstrating the tax
rates experienced by market participants would need to be considered
and compared with company-specific data and statutory rates.
The “tax rate experienced by market participants” would typically be the
statutory income tax rate unless there is substantial evidence that another
tax rate should be used.
10.4.5.2 Income Tax Benefits From Amortization of Intangible Assets
When an entity uses an income approach to measure the fair value of an
intangible asset, the measurement should include tax benefits that a market
participant would expect to receive for amortization expense that will be
deducted on its tax return(s) in the future. That is, when using an income
approach on a post-tax basis to measure the fair value of an intangible
asset, an entity should include all incremental cash flows. These would
include positive cash flows resulting from future income tax deductions for
the asset’s amortization expense (commonly referred to as tax amortization
benefits or “TABs”) that a market participant would expect to receive. A
market participant would expect to receive the TABs if the jurisdiction in
which the transaction is consummated allows for a deduction for amortization
expense of intangible assets. An entity must use judgment in determining
which jurisdiction should be considered from a market-participant
perspective.
At the 2006 AICPA Conference on Current SEC and PCAOB
Developments, Cheryl Tjon-Hing, a valuation specialist in the SEC’s Office
of the Chief Accountant, discussed how an entity should treat TABs in measuring
an asset’s fair value. She stated, in part:
Tax amortization benefits (TAB) represents, as its
name implies, the cash flow generated to an owner of an asset as a
result of being able to write-off the full fair value of that asset
for tax purposes — generally, this benefit may impact a fair value
conclusion, derived using an income approach, by as much as 20% to
30%. Now, it seems logical that the fair value of an asset should
not change just because of the way a transaction is structured. So TABs should be taken into account, in
determining asset fair values, no matter what the tax attributes
of a transaction are. But for those requiring more specific
guidance, FAS 109, paragraph A129 [footnote omitted] implicitly
states that TABs should be factored into an asset’s fair value. To
the extent that a portion of the step-up value is not deductible for
tax purposes, that is what deferred tax liabilities are for. In
fact, preparers of fair value measurements should be aware that if a
TAB is not factored into the fair value of an asset, there may be a
mismatch if any associated deferred tax liability is recorded, for
accounting purposes, in an acquisition transaction. Now, despite the
aforementioned accounting guidance, we often see that TABs are
excluded from asset fair values measured for business combinations
effected through a purchase of shares — usually, this is because
preparers argue that any step-up in fair value over tax value is not
deductible for tax purposes. [Emphasis added]
The AICPA Accounting and Valuation Guide Assets Acquired in a Business
Combination to Be Used in Research and Development Activities
includes a discussion of TABs and is a valuable resource for understanding
and applying valuation techniques to intangible assets. See Section 10.1 for more information about the
use of this practice aid.
10.4.6 Measuring the Fair Value of an Option
The term of an option that is measured at fair value under ASC 820 is one of the
many inputs into a fair value measurement. Before determining whether it should
use the expected term or the contractual term, an entity first needs to identify
and select a valuation technique (or techniques) that is appropriate in the
circumstances and for which sufficient data are available (see Section 10.3.2 for discussion of the use of
multiple valuation techniques). The valuation technique should incorporate the
inputs that market participants would consider when setting a price for the
instrument.
If market participants would consider the contractual term in pricing the option,
the entity’s valuation technique also must incorporate the contractual term as
an input, as might be the case, for example, with an option that can only be
exercised at maturity and that is valued by using the Black-Scholes-Merton
closed-form option pricing formula.
For options that may be terminated early, either upon early exercise or upon the
occurrence of a contingent event (e.g., an IPO, a change in control, or a
situation in which the share price exceeds a certain level), the entity may need
to use a valuation technique that can incorporate dynamic assumptions about the
term of the option. The fact that the term of the option is not fixed but
depends on future conditions or events can be explicitly modeled. For example,
an entity may use a binomial (lattice) model or simulation model that has been
designed to reflect not only the option’s contractual term but also early
exercise behavior (e.g., as a function of the stock price level) or the
likelihood that a contingency provision will be met at different points in time.
Depending on the facts and circumstances, the Black-Scholes-Merton closed-form
formula may not be an appropriate valuation technique for such an option,
irrespective of whether the contractual term or the expected term is used as an
input.
Entities should consider using a valuation specialist, as appropriate, and should
document their process of selecting a valuation technique and its associated
inputs, including their assumptions about the term used.
10.5 Fair Value Hierarchy
ASC 820-10
Fair Value Hierarchy
35-37
To increase consistency and comparability in fair value
measurements and related disclosures, this Topic establishes
a fair value hierarchy that categorizes into three levels
(see paragraphs 820-10-35-40 through 35-41, 820-10-35-41B
through 35-41C, 820-10-35-44, 820-10-35-46 through 35-51,
and 820-10-35-52 through 35-54A) the inputs to valuation
techniques used to measure fair value. The fair value
hierarchy gives the highest priority to quoted prices
(unadjusted) in active markets for identical assets or
liabilities (Level 1 inputs) and the lowest priority to
unobservable inputs (Level 3 inputs).
35-37A
In some cases, the inputs used to measure the fair value of
an asset or a liability might be categorized within
different levels of the fair value hierarchy. In those
cases, the fair value measurement is categorized in its
entirety in the same level of the fair value hierarchy as
the lowest level input that is significant to the entire
measurement. Assessing the significance of a particular
input to the entire measurement requires judgment, taking
into account factors specific to the asset or liability.
Adjustments to arrive at measurements based on fair value,
such as costs to sell when measuring fair value less costs
to sell, shall not be taken into account when determining
the level of the fair value hierarchy within which a fair
value measurement is categorized.
35-38
The availability of relevant inputs and their relative
subjectivity might affect the selection of appropriate
valuation techniques (see paragraph 820-10-35-24). However,
the fair value hierarchy prioritizes the inputs to valuation
techniques, not the valuation techniques used to measure
fair value. For example, a fair value measurement developed
using a present value technique might be categorized within
Level 2 or Level 3, depending on the inputs that are
significant to the entire measurement and the level of the
fair value hierarchy within which those inputs are
categorized.
35-38A
If an observable input requires an adjustment using an
unobservable input and that adjustment results in a
significantly higher or lower fair value measurement, the
resulting measurement would be categorized within Level 3 of
the fair value hierarchy. For example, if a market
participant would take into account the effect of a
restriction on the sale of an asset when estimating the
price for the asset, a reporting entity would adjust the
quoted price to reflect the effect of that restriction. If
that quoted price is a Level 2 input and the adjustment is
an unobservable input that is significant to the entire
measurement, the measurement would be categorized within
Level 3 of the fair value hierarchy.
ASC 820-10 — Glossary
Level 1 Inputs
Quoted prices (unadjusted) in active markets for identical
assets or liabilities that the reporting entity can access
at the measurement date.
Level 2 Inputs
Inputs other than quoted prices included within Level 1 that
are observable for the asset or liability, either directly
or indirectly.
Level 3 Inputs
Unobservable inputs for the asset or liability.
The FASB established the fair value hierarchy in Statement 157 (codified in ASC 820)
to increase the consistency and comparability of fair value measurements and
disclosures about such measurements. The hierarchy is divided into three categories
on the basis of the relative observability and reliability of the inputs used in a
fair value measurement. The categorization of inputs is important both to estimating
fair value and to providing the related disclosures.
With respect to measuring fair value, the fair value hierarchy focuses on inputs
rather than valuation techniques. However, ASC 820-10-35-38 indicates that the
availability of inputs and their relative subjectivity might affect the selection of
the valuation technique. For example, a valuation technique in which an entity uses
relevant inputs classified within Level 2 of the fair value hierarchy takes
precedence over a valuation technique containing significant unobservable inputs
(i.e., Level 3 inputs). In addition, with limited exceptions, an entity is precluded
from using a valuation technique that employs Level 2 or Level 3 inputs if a Level 1
quoted market price in an active market is available for an asset, liability, or
equity instrument subject to fair value measurement.
ASC 820-10-35-37 through 35-38A give an overview of the fair value hierarchy,
including the prioritization of inputs used in valuation techniques (which is
relevant to the measurement of fair value) and the determination of the
categorization of a fair value measurement in its entirety (which is relevant to
disclosures about fair value measurements regardless of whether the item is measured
or only disclosed at fair value). ASC 820-10-35-40 through 35-54D provide
interpretive guidance on the categorization of inputs into the three levels of the
fair value hierarchy. For more detailed discussion of the fair value hierarchy, see
Chapter 8.
10.6 Measuring Fair Value When the Volume or Level of Activity for an Asset or Liability Has Significantly Decreased
10.6.1 General
ASC 820-10
Measuring Fair Value When the Volume or Level of
Activity for an Asset or a Liability Has
Significantly Decreased
35-54C The fair value of an
asset or a liability might be affected when there has
been a significant decrease in the volume or level of
activity for that asset or liability in relation to
normal market activity for the asset or liability (or
similar assets or liabilities). To determine whether, on
the basis of the evidence available, there has been a
significant decrease in the volume or level of activity
for the asset or liability, a reporting entity shall
evaluate the significance and relevance of factors such
as the following:
-
There are few recent transactions.
-
Price quotations are not developed using current information.
-
Price quotations vary substantially either over time or among market makers (for example, some brokered markets).
-
Indices that previously were highly correlated with the fair values of the asset or liability are demonstrably uncorrelated with recent indications of fair value for that asset or liability.
-
There is a significant increase in implied liquidity risk premiums, yields, or performance indicators (such as delinquency rates or loss severities) for observed transactions or quoted prices when compared with the reporting entity’s estimate of expected cash flows, taking into account all available market data about credit and other nonperformance risk for the asset or liability.
-
There is a wide bid-ask spread or significant increase in the bid-ask spread.
-
There is a significant decline in the activity of, or there is an absence of, a market for new issues (that is, a primary market) for the asset or liability or similar assets or liabilities.
-
Little information is publicly available (for example, for transactions that take place in a principal-to-principal market).
35-54D If a reporting entity
concludes that there has been a significant decrease in
the volume or level of activity for the asset or
liability in relation to normal market activity for the
asset or liability (or similar assets or liabilities),
further analysis of the transactions or quoted prices is
needed. A decrease in the volume or level of activity on
its own may not indicate that a transaction price or
quoted price does not represent fair value or that a
transaction in that market is not orderly. However, if a
reporting entity determines that a transaction or quoted
price does not represent fair value (for example, there
may be transactions that are not orderly), an adjustment
to the transactions or quoted prices will be necessary
if the reporting entity uses those prices as a basis for
measuring fair value and that adjustment may be
significant to the fair value measurement in its
entirety. Adjustments also may be necessary in other
circumstances (for example, when a price for a similar
asset requires significant adjustment to make it
comparable to the asset being measured or when the price
is stale).
35-54E This Topic does not
prescribe a methodology for making significant
adjustments to transactions or quoted prices. See
paragraphs 820-10-35-24 through 35-27 and 820-10-55-3A
through 55-3G for a discussion of the use of valuation
techniques when measuring fair value. Regardless of the
valuation technique used, a reporting entity shall
include appropriate risk adjustments, including a risk
premium reflecting the amount that market participants
would demand as compensation for the uncertainty
inherent in the cash flows of an asset or a liability
(see paragraph 820-10-55-8). Otherwise, the measurement
does not faithfully represent fair value. In some cases,
determining the appropriate risk adjustment might be
difficult. However, the degree of difficulty alone is
not a sufficient basis on which to exclude a risk
adjustment. The risk adjustment shall be reflective of
an orderly transaction between market participants at
the measurement date under current market
conditions.
35-54F If there has been a
significant decrease in the volume or level of activity
for the asset or liability, a change in valuation
technique or the use of multiple valuation techniques
may be appropriate (for example, the use of a market
approach and a present value technique). When weighting
indications of fair value resulting from the use of
multiple valuation techniques, a reporting entity shall
consider the reasonableness of the range of fair value
measurements. The objective is to determine the point
within the range that is most representative of fair
value under current market conditions. A wide range of
fair value measurements may be an indication that
further analysis is needed.
35-54G Even when there has
been a significant decrease in the volume or level of
activity for the asset or liability, the objective of a
fair value measurement remains the same. Fair value is
the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction
(that is, not a forced liquidation or distress sale)
between market participants at the measurement date
under current market conditions.
35-54H Estimating the price
at which market participants would be willing to enter
into a transaction at the measurement date under current
market conditions if there has been a significant
decrease in the volume or level of activity for the
asset or liability depends on the facts and
circumstances at the measurement date and requires
judgment. A reporting entity’s intention to hold the
asset or to settle or otherwise fulfill the liability is
not relevant when measuring fair value because fair
value is a market-based measurement, not an
entity-specific measurement.
ASC 820-10 — Glossary
Active Market
A market in which transactions for the asset or liability
take place with sufficient frequency and volume to
provide pricing information on an ongoing basis.
ASC 820-10-35-54C through 35-54H contain guidance12 on the measurement of fair value when the volume or level of transactional
activity for an asset or liability has significantly decreased. Note that even
in these circumstances, the measurement must meet the objective in ASC
820-10-35-54G to be considered a fair value measurement. ASC 820-10-35-54G
defines fair value as “the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction (that is, not a forced
liquidation or distress sale) between market participants at the measurement
date under current market conditions.”
In addition to the discussion in the subsections that follow,
see Section 10.8
for discussion of the use of quotes from brokers or pricing services to measure
the fair value of assets or liabilities for which the volume of transactional
activity has significantly decreased.
10.6.2 Inactive Markets
10.6.2.1 Active Versus Inactive Markets
ASC 820-10-20 defines the term “active market,” and ASC 820-10-35-54C lists
factors that may indicate that “there has been a significant decrease in the
volume or level of activity . . . in relation to normal market activity for
the asset or liability (or similar assets or liabilities).” An entity should
evaluate these factors to determine whether their “significance and
relevance” to the asset or liability are such that they result in an
inactive market; however, the presence of one or more of these factors does
not in itself mean that a market is not active. Further, a decline in the
volume of transactions for a particular asset or liability does not
automatically make a market inactive. A market is inactive only when the
frequency and volume of the transactions for the asset or liability are not
sufficient to provide ongoing relevant pricing information. The
characterization of a market as “active” or “inactive” may change as market
conditions change.
In determining whether a market is active or inactive, an
entity should focus on the trading activity of the individual asset or
liability being measured rather than on the market in which it is traded.
Therefore, a security that is traded infrequently on the Nasdaq could
represent an asset that is not traded in an active market. However, a market
is not deemed inactive simply because of insufficient trading volume
relative to the size of an entity’s position.
If an entity determines that a market is inactive, it must adhere to the fair
value measurement objectives addressed in ASC 820-10-35-54G and 35-54H.
Accordingly, the entity cannot use entity-specific assumptions instead of
relevant observable market information in measuring fair value. See
Section 10.6.3.2 for discussion of
the impact on a fair value measurement of an entity’s unwillingness to
transact at current prices.
10.6.2.2 Distressed Sales Versus Inactive Markets
A low market demand for an asset (such as a debt security) may force prices
down (i.e., supply-demand imbalances create pressure on market prices).
However, in accordance with ASC 820-10-35-54I, in determining whether a
transaction is orderly (and thus whether it meets the fair value objective
described in ASC 820-10-35-54G), an entity cannot assume that an entire
market is “distressed” (i.e., that all transactions in the market are forced
or distressed transactions) and place less weight on observable transaction
prices in measuring fair value. See Section
10.7 for more information about identifying transactions that
are not orderly.
An entity must evaluate whether an observable transaction is not orderly
(i.e., whether one of the parties is forced or otherwise compelled to
transact) on a transaction-by-transaction basis, not on a market-wide basis.
If orderly transactions are occurring between market participants in a
manner that is usual and customary for transactions involving such assets,
the entity can conclude that those transactions are not forced even if the
market for such transactions is not active. An entity cannot, however,
measure fair value by taking a “longer view” of the market in which the
entity assumes that supply and demand will return to a reasonable
balance.
In determining the price that would be received to sell an asset on the
measurement date, an entity uses the assumptions that market participants
would use, even if these assumptions differ from those the entity would use.
For instance, if there is a quoted price in an active market for an
identical asset, that quoted price generally provides the most reliable
evidence of fair value and should be used to measure fair value even if the
entity believes that the quoted price does not reflect long-term economic
fundamentals. Alternatively, if there is no active market, the entity
determines fair value by using a valuation technique (or multiple valuation
techniques) that reflects current assumptions market participants would use,
even if the assumptions differ from those that the entity would use in
making decisions about transactions or for risk management purposes. Note
that if the entity determines that the volume and level of activity for the
asset have significantly decreased, transactions or quoted prices may not be
determinative of fair value and the entity may be required to perform
further analyses to determine whether transactions or quoted prices are
orderly and whether a significant adjustment is necessary. If, after further
analysis, the entity determines that the transactions are not orderly, it
should place little to no weight on those transactions or quoted prices. See
Section 10.7 for more information.
See also Example 10-18 for an illustration.
10.6.3 Observable Transactions in Inactive Markets
10.6.3.1 General
Even if the market for an asset or liability is not active,
observable transactions are relevant inputs to a fair value measurement when
they reflect market participants’ assumptions in orderly transactions. Under
ASC 820, an entity prioritizes relevant observable inputs when measuring
fair value. ASC 820-10-35-36 states that “[v]aluation techniques used to
measure fair value shall maximize the use of relevant observable inputs and
minimize the use of unobservable inputs.” Further, ASC 820-10-35-53 states,
in part, that “[u]nobservable inputs [Level 3] shall be used to measure fair
value to the extent that relevant observable inputs [Level 1 and Level 2]
are not available.”
However, when the volume and level of activity have significantly decreased
and the market is not active, observable transactions may not be
representative of fair value. One possible reason for this is increased
instances of transactions that are not orderly (e.g., forced liquidations or
distress sales). Because the level of market activity does not affect the
objective of a fair value measurement (i.e., the price in an orderly
transaction between market participants as of the measurement date under
current market conditions), an entity must further analyze the transactions
or quoted prices under ASC 820-10-35-54D to determine whether they are
orderly transactions representative of fair value. See Section 10.7 for more information about
identifying transactions that are not orderly.
If an entity determines that a transaction is orderly, it should consider the
transaction price when estimating fair value. However, the entity may also
need to adjust those transactions when determining fair value. ASC
820-10-35-54J(b) states that the “amount of weight placed on that [orderly]
transaction price when compared with other indications of fair value will
depend on the facts and circumstances.”
If the entity determines that it does not need to significantly adjust the
transaction price on the basis of unobservable inputs to arrive at the fair
value of the asset or liability as of the measurement date, the transaction
price represents a relevant observable input and the measurement would be
classified as a Level 2 measurement. As discussed in Section 8.4.2.1, when an entity concludes
that a single valuation technique results in superior information in terms
of the fair value hierarchy (e.g., this technique results in a Level 2
measurement and alternative valuation techniques would result in Level 3
measurements), it should use that measurement technique to calculate fair
value. However, if the entity must significantly adjust the transaction
price on the basis of unobservable inputs, the measurement would be
classified as a Level 3 measurement. In such circumstances, it may be
appropriate for the entity to use multiple valuation techniques and weigh
different indications of fair value to determine the amount that is most
representative of fair value under current market conditions.
In some circumstances, a change in valuation technique or the use of multiple
valuation techniques may be appropriate (e.g., the use of a market approach
and a present value technique). For example, if an entity previously used
quoted prices to determine fair value and there are no available quoted
prices from orderly transactions, the entity may need to change its
valuation technique or use multiple valuation techniques. If the entity
determines fair value by using the transaction price from a disorderly
transaction, adjusted to reflect the assumptions that market participants
would use in pricing the asset or liability in an orderly transaction, the
resulting measurement would generally be classified as a Level 3
measurement. See Section 10.3.4 for
further discussion of changes in valuation techniques.
10.6.3.2 Unwillingness to Transact at Current Prices
As discussed in Section 7.1.4, market
participants must be willing to enter into a transaction for the asset,
liability, or equity instrument subject to the fair value measurement. They
therefore must be motivated, but not forced or otherwise compelled, to enter
into the transaction. An entity that owns an asset cannot merely disregard a
price from an external source simply because the entity is not a “willing”
seller at that price. ASC 820-10-35-54H indicates that an entity’s intention
to hold an asset is not relevant to a fair value measurement, which is
market-based and not entity-specific. If the best information available in
the circumstances indicates that market participants would transact at the
price from an external source, it does not matter whether the entity is
willing to transact at that price.
See Section 10.6.3.3
for discussion of adjustments to observable transaction prices. See also
Example
10-19.
10.6.3.3 Adjustments to Observable Transaction Prices
The extent to which an entity can rely on a price obtained from an external
source, and the potential adjustments necessary, depends on the facts and
circumstances related to the price. The following are some considerations
relevant to this evaluation:
-
If the price is a quoted price (unadjusted) in an active market for an identical asset or liability, or for an identical liability when traded as an asset (i.e., it is a Level 1 input), the price should be used to determine fair value unless the exception in ASC 820-10-35-41C applies (see Section 8.2.1).
-
If the price is the quoted price in an active market for a similar asset or liability, or for a similar liability when traded as an asset (i.e., it is a Level 2 input), the price generally serves as reliable evidence of fair value after the quoted price is adjusted for differences between the instrument being measured and the instrument underlying the quoted price (see Section 8.3.1.1).
-
If there is no active market but the price is for an observed transaction as of the measurement date, the entity would need to assess whether that price reflects an orderly transaction. As discussed in Section 10.7, this evaluation would affect the significance or weight that the entity would assign to that price in measuring fair value. Note that, as discussed in ASC 820-10-35-54D, a decrease in the volume or level of activity on its own does not indicate that (1) a transaction price does not represent fair value or (2) the transaction was not orderly. However, if the entity determines that the observed transaction price does not reflect an orderly transaction, an adjustment to that price will be necessary if the entity uses that price as a basis for measuring fair value. In addition, if the observed transaction price is determined to represent an orderly market transaction but that transaction did not occur on the measurement date, adjustments to reflect differences in market conditions between the date of the transaction and the measurement date will also be necessary (i.e., to reflect fair value under current conditions as of the measurement date).ASC 820-10-35-50 through 35-54M discuss when adjustments to Level 2 inputs may be appropriate (e.g., to reflect the volume and level of activity in the market in which the input is observed). A significant decline in volume and level of market activity may indicate that an entity needs to conduct further analysis to determine whether (1) the transaction or quoted price is determinative of fair value and (2) a significant adjustment to the transaction or quoted price may be necessary for the entity to measure the fair value in accordance with ASC 820.
-
If a price is not based on observable market data (i.e., it is a Level 3 input), the entity may need to adjust the price or use a different valuation technique altogether to measure fair value. This may be the case if the price from the external source is not based on observable market data and the best available information in the circumstances suggests that the assumptions made by the external source differ from those a market participant would make in pricing the asset. ASC 820-10-35-54K states that in estimating fair value, an entity is not precluded from using “quoted prices provided by third parties, such as pricing services or brokers, if a reporting entity has determined that the quoted prices provided by those parties are developed in accordance with this Topic [ASC 820].” See Section 8.5 for further discussion of where prices from a broker or pricing service are categorized within the fair value hierarchy. See also Example 10-20.
In determining the types of adjustments that it may need to make to observed
transaction prices, an entity may find it helpful to consider the guidance
in the IASB Expert Advisory Panel report, which describes practices entities
use when measuring the fair value of financial instruments. Paragraph 44 of
this report states:
Factors that might lead to an adjustment to an observed transaction
price for a similar instrument include (these might also be useful
consideration in evaluating transactions in the same instrument):
(a) the timing of the transaction: if time has
elapsed since the observed transaction, movements in market
factors in the intervening period are considered and
adjusted for.
(b) the terms of the instruments subject to the
transaction: as economic and market conditions
change, for example, market participants might require
covenants for a new instrument that are different from those
that were required for a previous instrument. This
difference in terms affects the relative fair value of the
two instruments. Furthermore, if a transaction contains
complex terms and requires extensive documentation to
explain the terms, market participants might demand a larger
premium to compensate them for the effort required to
understand and evaluate the terms of the specific
instrument, or the potential additional hedging costs that
might be incurred.
(c) any related transactions: for example, if a
seller provides the finance for a sale to a buyer, and this
finance is not at a market rate (and assuming there is no
other transaction taking place), an adjustment is made to
the transaction price to reflect the effect of the funding
on that price.
(d) the correlation between the price of the instrument
that is the subject of the observed transaction and the
price of the instrument being measured: in general,
the greater the correlation between the two instruments, the
more relevant the observed transaction price is likely to
be. When assessing correlations, it is important to remember
that observed historical correlations cannot always be
expected to continue, particularly if market conditions have
changed.
In addition, if an entity uses a quoted price for a similar instrument in its
valuation technique, the entity may need to make an adjustment to reflect
differences in risk, including liquidity differences. For example, the
instrument being measured may be in greater relative supply than a similar
instrument for which a quoted price exists. In this situation, a liquidity
risk difference would need to be factored into the fair value calculation as
an adjustment to the quoted price of the other instrument.
An entity may also measure the fair value of a liability or instrument
classified in its stockholders’ equity by using the quoted price of a
similar but not identical item traded as an asset. In this case, the quoted
price should be adjusted for factors specific to the asset that do not apply
to the fair value measurement of the liability or equity instrument. ASC
820-10-35-16D indicates that an adjustment may be required when (1) the
quoted price for the asset is related to a similar (but not identical)
liability or equity instrument held by another party as an asset or (2) the
unit of account for the asset is not the same as that for the liability or
equity instrument. See Section 10.2.7
for further discussion.
See also Section 10.8.3 for discussion
of the use of multiple quotes from brokers or pricing services.
10.6.4 Examples
Example 10-18
Distressed Sale Versus Inactive Market
Entity P holds an asset-backed debt security for which
there is no active market. As a result of uncertainty
about current and future prospects for the assets
backing the security, there has been a sharp reduction
in the number of potential investors for these
securities in the market, increased price volatility,
and a severe decline in liquidity. Investor demand for
other similar debt securities has also decreased
significantly. The decline in market demand forces
prices down significantly, and risk premiums increase.
Entity P believes that the “true value” of the debt
security is substantially higher than current observable
transaction prices. In estimating the fair value of the
debt security, P wants to take a “longer view” of the
market under which supply and demand will return to a
reasonable balance (sometimes known as “base value”).
Such a view is premised on a conclusion that the entire
market is “distressed.” Therefore, P plans to disregard
current liquidity conditions and risk premiums in
determining fair value.
In accordance with ASC 820, P is not permitted to
determine fair value on the basis of a “longer view” of
the market and cannot assume that an entire market is
distressed. Rather, P should determine fair value by
considering the price a willing market participant would
pay for the debt security in an orderly transaction on
the measurement date under current market conditions.
Accordingly, P must evaluate whether any observable
transactions, even if there are not very many, are
orderly. Entity P is required to consider the impact
that current market conditions, including illiquidity
and imbalances in supply and demand (and the associated
risk premiums), have on the price that would be received
to sell the asset on the measurement date. Because a
hypothetical transaction is assumed to be on the
measurement date in a fair value measurement, it would
generally be inappropriate for P to conclude that there
are no willing buyers and no willing sellers.
Example 10-19
Valuation of Debt
Securities by Using Income Approach on the Basis of
Observable Market Data
Entity Q is using a valuation technique
to determine the fair value of its holdings of privately
placed corporate debt securities issued by Entity X. No
quoted price for identical securities is available.
Entity Q’s valuation technique takes into account
assumptions about default rates and discount rates.
Default rate assumptions can be readily derived from
current observable market data for actively traded
credit default swaps on X’s publicly traded bonds. In
determining fair value, Q cannot disregard such market
data even if it would not be willing to transact at a
price consistent with the data. For a discussion of the
use of internal data when market data exist, see
Section 8.1.2.
Example 10-20
Distressed Sale Versus Inactive Market
Entity R holds distressed debt securities. There is no
active market for the securities, but transactions occur
infrequently and there are active markets for similar
securities. Entity R’s own valuation model, which is
based on observable Level 2 inputs current as of the
measurement date, indicates that market participants
would be willing to buy and sell the debt for $30 on the
measurement date provided that marketing activities are
usual and customary for transactions in similar
securities. Entity R has calibrated the model by using
the best information available as of the measurement
date (including transaction prices related to comparable
securities and risk premiums).
On the measurement date, a potential buyer provides an
unsolicited bid to buy the securities for $20. While R
cannot disregard the bid price simply because it is not
willing to transact at that price, R cannot assume that
the bid price serves as better evidence of fair value
than its own model. The bid price is the price one
potential buyer would be willing to pay for R’s asset
but is not necessarily the price at which market
participants (buyers and sellers) would be willing to
transact on the measurement date.
ASC 820 requires that valuation techniques used to
measure fair value maximize the use of relevant
observable inputs (i.e., Level 1 and Level 2 inputs that
do not require significant adjustment) and minimize the
use of unobservable inputs (Level 3 inputs). If the bid
price is classified as a Level 3 input and R’s own model
is based on Level 2 inputs, it may be appropriate for R
to place less weight on the bid price in determining
fair value. If R obtains several bid prices and the
model amount is not in the range of prices obtained,
however, it may be appropriate to challenge whether the
model is valid and identify the reasons for the
discrepancy.
If R’s valuation technique involves obtaining prices
periodically from potential buyers to determine fair
value and validate the model amount, R should continue
to apply this technique consistently unless a change
would result in a measurement that is equally or more
representative of fair value in the circumstances.
Example 8 in ASC 820-10-55-90 comprehensively illustrates how an entity measures
fair value when the volume or level of activity for an asset or liability has
significantly decreased:
ASC 820-10
Example 8:
Measuring Fair Value When the Volume or Level of
Activity for an Asset or a Liability Has
Significantly Decreased
55-90 This Example illustrates
the use of judgment when measuring the fair value of a
financial asset when there has been a significant
decrease in the volume or level of activity for the
asset when compared with normal market activity for the
asset (or similar assets). (See paragraphs 820-10-35-54C
through 35-54H.) This Example has all of the following
assumptions:
-
Entity A invests in a junior AAA-rated tranche of a residential mortgage-backed security on January 1, 20X8 (the issue date of the security).
-
The junior tranche is the third most senior of a total of seven tranches.
-
The underlying collateral for the residential mortgage-backed security is unguaranteed nonconforming residential mortgage loans that were issued in the second half of 20X6.
-
At March 31, 20X9 (the measurement date), the junior tranche is now A-rated. This tranche of the residential mortgage-backed security was previously traded through a brokered market. However, trading volume in that market was infrequent, with only a few transactions taking place per month from January 1, 20X8, to June 30, 20X8, and little, if any, trading activity during the nine months before March 31, 20X9.
Pending Content (Transition Guidance: ASC
820-10-65-13)
55-90 This Example illustrates the use
of judgment when measuring the fair value of a
financial asset when there has been a significant
decrease in the volume or level of activity for
the asset when compared with normal market
activity for the asset (or similar assets). (See
paragraphs 820-10-35-54C through 35-54H.) This
Example has all of the following assumptions:
-
Entity A invests in a junior AAA-rated tranche of a residential mortgage-backed security on January 1, 20X8 (the issue date of the security).
-
The junior tranche is the third most senior of a total of seven tranches.
-
The underlying collateral for the residential mortgage-backed security is unguaranteed nonconforming residential mortgage loans that were issued in the second half of 20X6.
-
At March 31, 20X9 (the measurement date), the junior tranche is now A-rated. This tranche of the residential mortgage-backed security was previously traded through a brokered market. However, trading volume in that market was infrequent, with only a few transactions taking place per month from January 1, 20X8, to June 30, 20X8, and little, if any, trading activity during the nine months before March 31, 20X9.
55-91 Entity A takes into
account the factors in paragraph 820-10-35-54C to
determine whether there has been a significant decrease
in the volume or level of activity for the junior
tranche of the residential mortgage-backed security in
which it has invested. After evaluating the significance
and relevance of the factors, Entity A concludes that
the volume and level of activity of the junior tranche
of the residential mortgage-backed security have
significantly decreased. Entity A supported its judgment
primarily on the basis that there was little, if any,
trading activity for an extended period before the
measurement date.
55-92 Because there is little,
if any, trading activity to support a valuation
technique using a market approach, Entity A decides to
use an income approach using the discount rate
adjustment technique described beginning in paragraph
820-10-55-10 to measure the fair value of the
residential mortgage-backed security at the measurement
date. (See also paragraphs 820-10-35-36 through 35-36A.)
Entity A uses the contractual cash flows from the
residential mortgage-backed security. The discount rate
adjustment technique described beginning in paragraph
820-10-55-10 would not be appropriate when determining
whether there has been a credit loss and/or a change in
yield in accordance with paragraph 325-40-35-4 when that
technique uses contractual cash flows rather than most
likely cash flows.
55-93 Entity A then estimates a
discount rate (that is, a market rate of return) to
discount those contractual cash flows. The market rate
of return is estimated using both of the following:
-
The risk-free rate of interest
-
Estimated adjustments for differences between the available market data and the junior tranche of the residential mortgage-backed security in which Entity A has invested. Those adjustments reflect available market data about expected nonperformance and other risks (for example, default risk, collateral value risk, and liquidity risk) that market participants would take into account when pricing the asset in an orderly transaction at the measurement date under current market conditions.
55-94 Entity A took into
account the following information when estimating the
adjustments in the preceding paragraph:
-
The credit spread for the junior tranche of the residential mortgage-backed security at the issue date as implied by the original transaction price
-
The change in credit spread implied by any observed transactions from the issue date to the measurement date for comparable residential mortgage-backed securities or on the basis of relevant indices
-
The characteristics of the junior tranche of the residential mortgage-backed security compared with comparable residential mortgage-backed securities or indices, including all of the following:
-
The quality of the underlying assets, that is, information about all of the following:
-
Delinquency rates
-
Foreclosure rates
-
Loss experience
-
Prepayment rates.
-
-
The seniority or subordination of the residential mortgage-backed security tranche held
-
Other relevant factors.
-
-
Relevant reports issued by analysts and rating agencies
-
Quoted prices from third parties such as brokers or pricing services.
55-95 Entity A estimates that
one indication of the market rate of return that market
participants would use when pricing the junior tranche
of the residential mortgage-backed security is 12
percent (1,200 basis points). This market rate of return
was estimated as follows:
-
Begin with 300 basis points for the relevant risk-free rate of interest at March 31, 20X9.
-
Add 250 basis points for the credit spread over the risk-free rate when the junior tranche was issued in January 20X8.
-
Add 700 basis points for the estimated change in the credit spread over the risk-free rate of the junior tranche between January 1, 20X8, and March 31, 20X9. This estimate was developed on the basis of the change in the most comparable index available for that time period.
-
Subtract 50 basis points (net) to adjust for differences between the index used to estimate the change in credit spreads and the junior tranche. The referenced index consists of subprime mortgage loans, whereas Entity A’s residential mortgage-backed security consists of similar mortgage loans with a more favorable credit profile (making it more attractive to market participants). However, the index does not reflect an appropriate liquidity risk premium for the junior tranche under current market conditions. Thus, the 50 basis point adjustment is the net of two adjustments.
-
The first adjustment is a 350 basis point subtraction, which was estimated by comparing the implied yield from the most recent transactions for the residential mortgage-backed security in June 20X8 with the implied yield in the index price on those same dates. There was no information available that indicated that the relationship between Entity A’s security and the index has changed.
-
The second adjustment is a 300 basis point addition, which is Entity A’s best estimate of the additional liquidity risk inherent in its security (a cash position) when compared with the index (a synthetic position). This estimate was derived after taking into account liquidity risk premiums implied in recent cash transactions for a range of similar securities.
-
55-96 As an additional
indication of the market rate of return, Entity A also
takes into account 2 recent indicative quotes (that is,
nonbinding quotes) provided by reputable brokers for the
junior tranche of the residential mortgage-backed
security that imply yields of 15 to 17 percent. Entity A
is unable to evaluate the valuation technique(s) or
inputs used to develop the quotes. However, Entity A is
able to confirm that the quotes do not reflect the
results of transactions.
55-97 Because Entity A has
multiple indications of the market rate of return that
market participants would take into account when
measuring fair value, it evaluates and weights the
respective indications of the rate of return,
considering the reasonableness of the range indicated by
the results.
55-98 Entity A concludes that
13 percent is the point within the range of indications
that is most representative of fair value under current
market conditions. Entity A places more weight on the 12
percent indication (that is, its own estimate of the
market rate of return) for the following reasons:
-
Entity A concluded that its own estimate appropriately incorporated the risks (for example, default risk, collateral value risk, and liquidity risk) that market participants would use when pricing the asset in an orderly transaction under current market conditions.
-
The broker quotes were nonbinding and did not reflect the results of transactions, and Entity A was unable to evaluate the valuation technique(s) or inputs used to develop the quotes.
Footnotes
12
This guidance, which amended FASB Statement 157, was
issued in 2009 in response to fair value measurement issues that arose
during the credit crisis that began in 2007.
10.7 Identifying Transactions That Are Not Orderly
10.7.1 General
ASC 820-10
Identifying Transactions That Are Not Orderly
35-54I The determination of
whether a transaction is orderly (or is not orderly) is
more difficult if there has been a significant decrease
in the volume or level of activity for the asset or
liability in relation to normal market activity for the
asset or liability (or similar assets or liabilities).
In such circumstances, it is not appropriate to conclude
that all transactions in that market are not orderly
(that is, forced liquidations or distress sales).
Circumstances that may indicate that a transaction is
not orderly include the following:
-
There was not adequate exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities under current market conditions.
-
There was a usual and customary marketing period, but the seller marketed the asset or liability to a single market participant.
-
The seller is in or near bankruptcy or receivership (that is, the seller is distressed).
-
The seller was required to sell to meet regulatory or legal requirements (that is, the seller was forced).
-
The transaction price is an outlier when compared with other recent transactions for the same or a similar asset or liability.
A reporting entity shall evaluate the circumstances to
determine whether, on the weight of the evidence
available, the transaction is orderly.
35-54J A reporting entity
shall consider all of the following when measuring fair
value or estimating market risk premiums:
-
If the evidence indicates the transaction is not orderly, a reporting entity shall place little, if any, weight (compared with other indications of fair value) on that transaction price.
-
If the evidence indicates that a transaction is orderly, a reporting entity shall take into account that transaction price. The amount of weight placed on that transaction price when compared with other indications of fair value will depend on the facts and circumstances, such as the following:
-
The volume of the transaction
-
The comparability of the transaction to the asset or liability being measured
-
The proximity of the transaction to the measurement date.
-
-
If a reporting entity does not have sufficient information to conclude whether a transaction is orderly, it shall take into account the transaction price. However, that transaction price may not represent fair value (that is, the transaction price is not necessarily the sole or primary basis for measuring fair value or estimating market risk premiums). When a reporting entity does not have sufficient information to conclude whether particular transactions are orderly, the reporting entity shall place less weight on those transactions when compared with other transactions that are known to be orderly.
A reporting entity need not undertake exhaustive efforts
to determine whether a transaction is orderly, but it
shall not ignore information that is reasonably
available. When a reporting entity is a party to a
transaction, it is presumed to have sufficient
information to conclude whether the transaction is
orderly.
In an orderly transaction, there is a sufficient period of exposure to the market
before the measurement date to allow for usual and customary marketing
activities involving similar assets or liabilities. The length of the exposure
period depends on the amount of time it takes market participants in typical
transactions to agree on a transaction price for the type of asset or liability
being measured.
For some assets (such as many financial instruments), the required period may
elapse instantaneously or be measured in hours. For instance, no exposure may be
required for an asset quoted in an active market (such as stock quoted on the
NYSE) if current transaction prices are immediately available and no additional
marketing activities are required for a transaction to occur. Accordingly, ASC
820-10-35-41 generally requires that an entity use a quoted price in an active
market to measure fair value whenever such a price is available, with limited
exceptions. In addition, even if an active market does not exist for an
identical instrument, the period of market exposure required for many types of
financial instruments is often relatively short (e.g., when standard
documentation exists and relevant observable market data are available to price
the financial instrument). However, the period of market exposure for some types
of financial instruments could be somewhat longer (e.g., a large portfolio of
commercial loans that are measured by using significant unobservable inputs). In
addition, a longer period of market exposure may be required for certain assets
(e.g., servicing rights, real estate, or intangibles). In some markets, it is
usual and customary for information dissemination, promotion, selling, and due
diligence activities to take some time before a typical transaction can
close.
While a period of exposure to the market is assumed in an
orderly transaction, this does not mean that an entity can disregard changes in
market conditions during that period or take a “longer view” of the market. Even
when there is no observable market to provide pricing information about the sale
of an asset or the transfer of a liability on the measurement date, in
accordance with ASC 820-10-35-3, “[a] fair value measurement assumes that the
asset or liability is exchanged in an orderly transaction between market
participants to sell the asset or transfer the liability at the measurement date
under current market conditions” (i.e., the fair value measurement objective).
For instance, if the volume or level of activity in a market decreases because
of a decline in investor demand, transaction prices in orderly transactions may
also decrease. However, because those transaction prices are orderly, they are
still relevant.13 In addition, if an entity uses a valuation technique to determine fair
value, a decline in market liquidity might justify a higher risk premium or
discount rate to reflect the increased risk inherent in the valuation technique
or in the inputs to the valuation technique.
A transaction that is forced (e.g., a forced liquidation or distress sale) is not
orderly. ASC 820-10-35-54J discusses the considerations an entity should take
into account when the evidence indicates that a transaction is either (1) not
orderly (in which case the entity should place little, if any, weight on the
transaction price) or (2) orderly (in which case the entity must take the
transaction price into account). ASC 820-10-35-54J also discusses the
considerations related to situations in which an entity cannot conclude whether
a transaction is orderly, in which case the entity must take the transaction
price into account but place less weight on it than on other indications of fair
value. In these situations, the transaction price cannot be the sole or primary
basis for estimating fair value. Because the transaction price might not reflect
the assumptions that market participants would use, it may be appropriate for
the entity to use multiple valuation techniques and weigh different indications
of fair value to determine the amount that is most representative of fair value
under current market conditions.
10.7.2 Determining Whether a Transaction Is Orderly
When measuring fair value, an entity assumes that the asset or liability is
exchanged in an orderly transaction (i.e., not a forced liquidation or distress
sale). Accordingly, an observable price based on transactions that are not
orderly may not represent fair value. In measuring fair value, an entity may
therefore need to adjust or place little, if any, weight on observable market
data for transactions that are not orderly.
An entity evaluates whether a transaction is orderly on the basis of factors
specific to the parties entering into the transaction (e.g., the seller’s
financial difficulties). This evaluation is not based on general market
conditions. For instance, it would not be appropriate to assume that a decline
in an asset’s or liability’s volume or level of activity indicates that all
sales or transfers of those assets or liabilities are not orderly. In other
words, an entity cannot assume that an entire market is in “distress” (see
Section 10.6.2.2). Thus, the entity
should evaluate whether each transaction is orderly on the basis of the weight
of the evidence available, as discussed in ASC 820-10-35-54I. In performing this
evaluation, an entity will need to consider its specific facts and circumstances
and may need to use significant judgment.
An entity must overcome a high hurdle to conclude that an observable transaction
is not an orderly transaction. Although ASC 820-10-35-54I includes a list of
factors that may indicate a transaction is not orderly, there is an implicit
presumption that observable transactions between unrelated parties are orderly.
This presumption generally is not overcome in practice. To overcome such a
presumption, an entity needs to have compelling evidence to support its
conclusion that the transaction was not orderly. However, it is never
appropriate to conclude that observable transactions in active markets (i.e.,
Level 1 fair value measurements) do not represent orderly transactions. This is
the case even in times of significantly market volatility.
Footnotes
13
Observable transactions as of or near the measurement
date for an identical or similar asset or liability represent the most
reliable evidence of the fair value of an asset or liability that is not
transacted in an active market, provided that such transactions are
orderly. However, an entity might need to make adjustments to such
observable prices to reflect (1) differences between the item being
measured at fair value and the asset or liability whose transaction
price is observable or (2) changes in market conditions if the
observable transaction is not as of or near the measurement date. If
such adjustments are made on the basis of significant unobservable
inputs, the fair value measurement in its entirety would be classified
within Level 3 of the fair value hierarchy. In these circumstances, an
entity may appropriately consider another valuation technique in
measuring fair value. See also Section 10.6.3.3.
10.8 Using Quoted Prices by Third Parties
10.8.1 General
ASC 820-10
Using Quoted Prices Provided by Third Parties
35-54K This
Topic does not preclude the use of quoted prices
provided by third parties, such as pricing services or
brokers, if a reporting entity has determined that the
quoted prices provided by those parties are developed in
accordance with this Topic.
35-54L If
there has been a significant decrease in the volume or
level of activity for the asset or liability, a
reporting entity shall evaluate whether the quoted
prices provided by third parties are developed using
current information that reflects orderly transactions
or a valuation technique that reflects market
participant assumptions (including assumptions about
risk). In weighting a quoted price as an input to a fair
value measurement, a reporting entity places less weight
(when compared with other indications of fair value that
reflect the results of transactions) on quotes that do
not reflect the result of transactions.
35-54M
Furthermore, the nature of a quote (for example, whether
the quote is an indicative price or a binding offer)
shall be taken into account when weighting the available
evidence, with more weight given to quotes provided by
third parties that represent binding offers.
Although entities may engage third-party advisers, such as pricing services or
brokers, to help discharge management’s responsibilities, management must assume
overall responsibility for determining both (1) the fair value of all assets,
liabilities, or instruments classified within an entity’s stockholders’ equity
that are measured at fair value and (2) the fair value measurement’s
classification within the hierarchy. ASC 820-10-35-54K through 35-54M address
management’s responsibilities related to using a pricing service or broker.
The requirement that management take responsibility for fair
value measurements reported in the financial statements was also emphasized in a
speech by Mark Shannon, then associate chief accountant in the SEC’s Division of
Corporation Finance, at the 2011 AICPA Conference on Current SEC and PCAOB
Developments. Mr. Shannon provided a sample of the types of comments that are
typically issued to registrants that use third-party pricing information. The
SEC staff in both the Division of Corporation Finance and the Division of
Investment Management asks similar questions of registrants and registered
investment companies. Such questions address topics such as how the entity uses
the pricing services in complying with financial statement accounting and
disclosure requirements, MD&A disclosure, management’s assessment of
internal control over financial reporting, and the basic requirement to maintain
books and records. Most notably, the staff has commented and asked questions
about:
-
Management’s evaluation of the appropriateness of the third-party models as well as the accuracy and completeness of the data used in the valuation.
-
The assessment of the observability of the data used in the valuation and how the information affected the determination of the level within the fair value hierarchy.
-
Third-party pricing service caveats regarding the use or reliability of the fair value estimates.
-
The internal controls governing the use of the third-party pricing service.
-
Management’s determination that assumptions used in the valuation are consistent with management’s accounting framework as well as with GAAP.
As indicated in ASC 820-10-35-54K and the SEC staff’s remarks, to take overall
responsibility for determining fair value and the related disclosures when using
a pricing service or broker, management will need to (1) understand whether the
method the pricing service or broker uses to determine fair value is based on
current information that reflects orderly transactions or a valuation technique
that reflects market-participant assumptions (including assumptions about risks)
and (2) assess the appropriateness of the values. On the basis of this
understanding, management should determine the classification of the fair value
measurement within the hierarchy. As noted in Section
8.5.1, an entity cannot assume that the pricing service or broker
information is observable (i.e., Level 1 or Level 2) solely because the
information comes from a third party. Rather, an entity needs to determine the
proper classification within the fair value hierarchy as part of its process for
determining that third-party information, such as broker quotes or pricing
services, was developed in accordance with ASC 820. Management should also
consider the implementation guidance in ASC 820-10-55-104(b), which suggests
that in complying with the disclosure requirements in ASC 820, an entity might
disclose “[h]ow third-party information such as broker quotes, pricing services,
net asset values, and relevant market data was taken into account when measuring
fair value.”
See Section 8.5 for
further discussion of the classification within the fair value hierarchy of fair
value measurements developed on the basis of pricing services or broker
quotes.
10.8.2 When Broker or Pricing Service Quotes Represent Fair Value
ASC 820-10-35-54K indicates that an entity may use quoted prices provided by
third parties, such as pricing services or brokers, provided that the entity has
determined that those prices represent fair value under ASC 820. In addition, in
a September 30, 2008, joint press
release addressing ASC 820 application issues, the SEC’s
Office of the Chief Accountant and the FASB staff indicated that “broker quotes
may be an input when measuring fair value, but are not necessarily determinative
if an active market does not exist for the security.”
In assessing whether a broker or pricing service quote is determinative of fair
value, an entity needs to understand (1) how the broker or pricing service
arrived at the quote and (2) the inputs or other information used. In a manner
consistent with ASC 820-10-35-41, if a broker or pricing service quote
represents the price quoted in an active market to which the entity has access,
and the quote is for an identical asset, liability, or instrument classified in
an entity’s stockholders’ equity, the entity is required to use this quote to
determine fair value. Such a quote would represent a Level 1 input.
A broker or pricing service quote would not represent a Level 1 input in the
absence of an active market or if a Level 1 input is adjusted in accordance with
the criteria in ASC 820-10-35-41C. If the quote is not based on a Level 1 input
but on a valuation technique that is used by market participants, reflects
market-participant assumptions, and uses market-observable or
market-corroborated inputs, the quote would be determinative of fair value
provided that it does not need to be significantly adjusted. If a significant
adjustment is needed, the quote is not determinative of fair value but could
represent a relevant observable input into management’s determination of fair
value.
The following are a few possible questions that entities should consider in
evaluating whether a quote is determinative:
-
Are there differences between the item being measured at fair value and the item for which a quote is available (e.g., differences in the terms or risk attributes)? Such differences may necessitate adjustments to the price quoted by the broker or pricing service.
-
Does the quote reflect current orderly transactions for the item being measured? That is, are market participants currently transacting for the asset or liability at the price quoted by the broker or pricing service or does the quote reflect “stale” information or transactions that are not orderly? ASC 820-10-35-54L clarifies that an entity should place “less weight . . . on quotes that do not reflect the result of transactions.”
-
Is the broker or pricing service using a valuation technique that complies with the fair value measurement principles in ASC 820? For example, does the valuation technique used by the broker or pricing service reflect market-participant assumptions, including assumptions about risk; maximize the use of relevant observable inputs; and minimize the use of unobservable inputs? If the valuation technique does not reflect the assumptions market participants would use in pricing the asset or liability, the price quoted by the broker or pricing service may not be relevant or may need to be adjusted.
-
Is the quote provided by the broker or pricing service an indicative price or a binding offer? That is, does the broker or another market participant (or participants) stand ready to transact at the price quoted by the broker or pricing service? ASC 820-10-35-54M indicates that quotes based on binding offers should be weighted more heavily. Typically, a quote obtained from a broker or pricing service is an indicative price and not a binding offer (unless the broker is a market maker). If, however, a quote is a binding offer for an asset, the quote only definitively represents the “floor” for the fair value of the asset.
-
Does the quote come from a reputable broker or pricing service that has a substantial presence in the market and the experience and expertise to provide a representationally faithful quote for the asset or liability being measured? An entity might place more weight on a quote from a broker or pricing service that has more experience and expertise related to the asset or liability being measured.
As the number of market transactions decreases, brokers or pricing services may
rely more heavily on proprietary models to arrive at their quotes. An entity
should determine how brokers or pricing services have arrived at their
valuations as well as whether these valuations reflect market-participant
assumptions (including assumptions about risk). This information may be
difficult to obtain if quotes are based on proprietary models that brokers or
pricing services might not be willing to share. However, although brokers or
pricing services might not wish to share detailed information about their
models, it might still be possible to obtain information about the nature of the
assumptions and inputs used in the model (see Section
10.8.1 for more information about management’s responsibilities
related to using third-party information to measure fair value). If the quote
does not reflect assumptions that market participants would use in pricing the
asset or liability, the quote may be a data point in the estimation of fair
value but would most likely not be determinative since adjustments might be
required. In addition, other indications of fair value, such as a valuation
based on management’s own estimates of the inputs that market participants would
use in pricing the asset or liability, may be equally or more useful to an
estimation of fair value.
An entity will need to perform additional analysis when quotes for an individual
security are obtained from different brokers or pricing services. Multiple
quotes within a narrow range constitute stronger evidence of fair value than
multiple quotes that are widely dispersed. If an entity’s own measurement of
fair value is outside the range of broker or pricing service quotes, the entity
should understand the cause(s) of such a difference. In addition, entities may
find broker or pricing service quotes useful when calibrating their own
models.
See Section 10.8.3 for
additional discussion of the evaluation an entity performs when multiple quotes
are obtained. See Section
10.6 for discussion of considerations related to measuring fair
value when the volume or level of activity for an asset or liability has
significantly decreased.
10.8.3 Multiple Broker or Pricing Service Quotes
If an entity is using multiple quotes from brokers or pricing
services to determine the fair value of a financial asset for which no active
market exists (i.e., Level 2 or Level 3 inputs), the entity should consider the
reasonableness of the range of quotes obtained regardless of whether the
entity’s purpose is to measure fair value or to calibrate its valuation
technique. Using multiple sources may yield a wide range of quoted prices. If
differences in quoted amounts are significant, it would be inappropriate to
merely use an average of the quotes to determine fair value or calibrate a
valuation technique.
As indicated in ASC 820-10-35-54F, if there are significant differences in the
quoted amounts, the entity may need to further analyze the quotes. Further,
paragraphs 55–57 of the IASB Expert Advisory Panel report note that when
significant differences exist, an average does not represent a price at which a
transaction would take place; it is likely that one of the quotes obtained
better represents fair value than the other(s).
One possible cause of the discrepancy in pricing could be that different brokers
or pricing services possess different amounts of information. For example, a
broker that was involved in the original sale of an instrument might have
information about that instrument that enables the broker to assess its fair
value better than another broker or pricing service without that information.
The more information an entity has about the basis for a quote, the easier it is
to validate and rely on it.
If the volume and level of market activity for the asset or
liability have significantly decreased and the market is not active, the entity
should perform further analysis to determine whether the quotes are based on
current information that reflects orderly transactions or a valuation technique
that reflects market-participant assumptions (including assumptions about risk).
In addition, ASC 820-10-35-54L states, in part, “In weighting a quoted price as
an input to a fair value measurement, a reporting entity places less weight
(when compared with other indications of fair value that reflect the results of
transactions) on quotes that do not reflect the result of transactions.” See
Section 10.6
for more information about measuring fair value when the volume or level of
activity for an asset or liability has significantly decreased.
10.9 Investments in Certain Entities That Calculate NAV per Share (or Its Equivalent)
ASC 820-10
Measuring the Fair Value of Investments in Certain
Entities That Calculate Net Asset Value per Share (or
Its Equivalent)
35-59
A reporting entity is permitted, as a practical expedient,
to estimate the fair value of an investment within the scope
of paragraphs 820-10-15-4 through 15-5 using the net asset
value per share (or its equivalent, such as member units or
an ownership interest in partners’ capital to which a
proportionate share of net assets is attributed) of the
investment, if the net asset value per share of the
investment (or its equivalent) is calculated in a manner
consistent with the measurement principles of Topic 946 as
of the reporting entity’s measurement date.
Investments in Certain Entities That Calculate Net Asset
Value per Share (or Its Equivalent)
35-54B
An investment within the scope of paragraphs 820-10-15-4
through 15-5 for which fair value is measured using net
asset value per share (or its equivalent, for example member
units or an ownership interest in partners’ capital to which
a proportionate share of net assets is attributed) as a
practical expedient, as described in paragraph 820-10-35-59,
shall not be categorized within the fair value hierarchy. In
addition, the disclosure requirements in paragraph
820-10-50-2 do not apply to that investment. Disclosures
required for an investment for which fair value is measured
using net asset value per share (or its equivalent) as a
practical expedient are described in paragraph 820-10-50-6A.
Although the investment is not categorized within the fair
value hierarchy, a reporting entity shall provide the amount
measured using the net asset value per share (or its
equivalent) practical expedient to permit reconciliation of
the fair value of investments included in the fair value
hierarchy to the line items presented in the statement of
financial position in accordance with paragraph
820-10-50-2B.
ASC 820 allows entities, as a practical expedient, to measure the
fair value of certain investments by using NAV per share (or its equivalent). When
NAV per share (or its equivalent) is used to measure the fair value of an
investment, the investment is not categorized within the fair value hierarchy and an
entity does not need to provide certain disclosures that are otherwise required for
assets measured at fair value on a recurring basis. See Section 2.2.2 for further discussion of the
scope of this practical expedient. See Section 11.2.2.3 for discussion of the
disclosures an entity is required to provide when it uses this practical
expedient.
10.10 Additional Fair Value Measurement Considerations
This section addresses the fair value measurement of specific types of assets,
liabilities, or instruments classified in stockholders’ equity that are covered in
other Codification topics and that have not otherwise been discussed in this
Roadmap.
10.10.1 Loan Receivables
10.10.1.1 General
Some entities, such as banks, mortgage banking entities,
broker-dealers, and other financial services companies, recognize loan
receivables (e.g., mortgage loans) at fair value through earnings in
accordance with the FVO or specialized industry accounting practices.
Entities that do not measure loan receivables at fair value may be required
to disclose fair value amounts (see Section 11.2.2.2).
An entity may estimate the fair value of a loan portfolio on the basis of one
or more of the following approaches:
-
Securitization pricing.
-
Whole-loan pricing.
-
Another income approach (e.g., a present value technique).
While entities may use different methods to measure the fair
value of loans, paragraph BC46(a) of ASU 2011-04 states that “[t]he
objective of a fair value measurement is to measure the
asset that exists at the measurement date” (emphasis added).
Entities should select their valuation method on the basis of the facts and
circumstances. In accordance with ASC 820, in selecting the valuation
method, an entity should consider (1) its principal (or most advantageous)
market (see Chapter
6) and (2) the observability of relevant inputs.14 Regardless of the valuation technique(s) used, entities should
consider calibration to (1) the transaction price if the transaction price
equals fair value at initial recognition (see ASC 820-10-30-3A) and (2)
prices received by the entity upon subsequent sales of loans. See Section 10.3.3 for
further discussion of calibration.
The sections below discuss methods that may be used to
determine the fair value of loans. See also Section 10.10.19.7.
10.10.1.2 Securitization Pricing
10.10.1.2.1 General
Paragraph BC49 of ASU 2011-04 supports the use of securitization pricing
and portfolio-level inputs:
The Boards decided to clarify that although
there are no excess returns available from holding financial
assets and financial liabilities within a portfolio (because in
an efficient market, the price reflects the benefits that market
participants would derive from holding the asset or liability in
a diversified portfolio), a fair value measurement assumes that
market participants seek to maximize the fair value of a
financial or nonfinancial asset or to minimize the fair value of
a financial or nonfinancial liability by acting in their
economic best interest in a transaction to sell the asset or to
transfer the liability in the principal (or most advantageous)
market for the asset or liability. Such a
transaction might involve grouping assets and liabilities in
a way in which market participants would enter into a
transaction, if the unit of account specified in other
Topics does not prohibit that grouping. [Emphasis
added]
However, as discussed in Section
10.10.1.1, the objective of a fair value measurement is
to measure the asset that exists as of the measurement date. Thus, while
an entity could measure the fair value of a portfolio of loans on the
basis of the sales proceeds that would be received in a hypothetical
securitization, the objective is to arrive at a fair value measurement
of the loans in their current condition and not the securities
(beneficial interests in the loans) that may be issued in the future.
Accordingly, a securitization price would need to be adjusted so that
the price used to measure fair value reflects the current condition of
the loans.
Use of an appropriately adjusted securitization price allows an entity to
evaluate all inputs available and select the most reliable inputs (e.g.,
risk adjustments, the margin inherent in securitization, or the cost of
guarantees or servicing). It is not appropriate for an entity to
determine the fair value for a portfolio of loans by using a
securitization price if the entity cannot make appropriate adjustments
to the securitization price with the support of sufficient data.
10.10.1.2.2 Additional Factors to Consider
As discussed in Section
10.10.1.2.1, an entity may measure the fair value of a loan
portfolio on the basis of the estimated sales price of an executable
securitization (i.e., securitization pricing), provided that the
appropriate adjustments are made to the estimated securitization price.
An entity that uses this approach to estimate the fair value of a loan
portfolio is responsible for attaining relevant and reliable (i.e.,
observable) information to develop an appropriately adjusted
securitization price.
An entity must evaluate estimated securitization prices to (1) understand
whether they reflect orderly transactions in active markets for a
portfolio of loans with characteristics that are identical or similar to
the portfolio being valued, (2) make adjustments to account for
differences between the quoted pool of loans and the portfolio of loans
being valued, and (3) make other relevant adjustments as discussed
below. In accordance with ASC 820, entities need to maximize the use of
relevant observable inputs and minimize the use of unobservable inputs.
When an entity uses a securitization price, it should understand and
evaluate the source and reliability of inputs to prepare a fair value
measurement for a portfolio of loans in their current form.
When using a securitization price to measure the fair value of a loan
portfolio, an entity should consider the following:
-
The securitization market must be the entity’s principal (or most advantageous) market — ASC 820-10-35-6 states, in part, that “[i]f there is a principal market for the asset or liability, the fair value measurement shall represent the price in that market (whether that price is directly observable or estimated using another valuation technique).” An entity’s principal market is the market that (1) the entity can access on the measurement date and (2) has the greatest volume or level of activity for the asset from a market participant’s perspective, which may be the securitization market. In the absence of a principal market, an entity should use the most advantageous market that it can access (in considering transaction costs, which are also further discussed below). See Chapter 6 for more information about the principal or most advantageous market.
-
Entities that are new to the securitization market — An entity must have access to the securitization market for the securitization market to be the principal or most advantageous market; however, an entity does not need to have loans that are actually securitized to demonstrate such access. However, loan securitization involves many complex steps in which significant legal, underwriting, and other activities must be performed. Generally, the securitizer provides credit enhancement, usually by retaining certain beneficial interests. An entity that does not regularly securitize loans will need to provide evidence that a transaction is feasible and attainable. An entity that has not previously securitized loans would generally need evidence of significant progress toward effecting an actual securitization to demonstrate access to the securitization market.
-
An entity needs to make appropriate adjustments when using a securitization price — Entities will need to adjust the securitization price for items that market participants would factor into the determination of fair value (because the portfolio of loans has not yet been transformed into securities). These items include the following:
-
Risk adjustments, including the effect of any uncertainty related to the ultimate securitization, model risk, or other risks.
-
Costs incurred to securitize the loan, whether transformation costs or transaction costs. Because the objective is to measure the portfolio of loans in their current condition, any costs related to accessing the securitization price should be incorporated into the fair value measurement of the whole-loan portfolio.
-
The cost of any guarantees (or other liabilities assumed) that the entity will provide (e.g., when a guarantee is contemplated as part of the securitization price used). One example of a guarantee is an early payment default (EPD) or early prepayment provision. See Section 10.10.1.3.2 for additional information about such provisions.
-
Interests in the securitization that the entity may retain at their estimated current fair value, determined in accordance with ASC 820.
-
Other adjustments. According to ASC 820-10-30-3, the transaction price will often equal the exit price and therefore represents fair value at initial recognition. An entity should consider the conditions in ASC 820-10-30-3A to determine whether the fair value of a loan (or portfolio of loans) is equal to the transaction price at initial recognition. ASC 820-10-35-24C states that “[i]f the transaction price is fair value at initial recognition and a valuation technique that uses unobservable inputs will be used to measure fair value in subsequent periods [as may be the case for a valuation technique based on an appropriately adjusted securitization price], the valuation technique shall be calibrated so that at initial recognition the result of the valuation technique equals the transaction price.” Therefore, other adjustments to inputs used in a fair value measurement based on an appropriately adjusted securitization price are necessary if the fair value measurement would differ from the transaction price when the transaction price equals fair value at initial recognition. See Chapter 9 for further discussion of initial measurement.
-
The fair value measurement should be the price that would be received as
of the measurement date; therefore, spot securitization prices should be
used when available. An entity that uses forward prices should make
adjustments to arrive at an estimate of the spot price on the
measurement date. An appropriately adjusted securitization price would
typically eliminate the margin or “gain” from the actual
securitization.
Entities will need to determine a securitization price’s level within the
fair value hierarchy by considering the lowest level of inputs
significant to the measurement. One or more of the adjustments described
above may be based on unobservable inputs. If these inputs are
significant to the fair value measurement, they would cause the
resulting fair value to be categorized within Level 3 of the fair value
hierarchy.
10.10.1.3 Whole-Loan Pricing
10.10.1.3.1 General
In considering whether it is appropriate to measure the fair value of a
portfolio of loans on the basis of whole-loan prices, an entity must
consider whether:
-
It has access to the whole-loan market.
-
The whole-loan prices are identical or sufficiently similar to the loan portfolio being valued.
-
The whole-loan prices reflect orderly transactions in an active market.
-
Adjustments to observable whole-loan prices are necessary.
In evaluating whether whole-loan prices are identical or sufficiently
similar to the loans being valued, an entity should consider whether it
has retained or released servicing rights. Whole-loan prices may vary on
the basis of whether servicing is retained or released, so an entity
must ensure that it uses the correct price or make appropriate
adjustments.
10.10.1.3.2 Additional Factors to Consider
Originators of certain loans (e.g., certain mortgage
loans) have EPD and early prepayment agreements with purchasers
(aggregators) of such whole loans. The purchaser pays a premium for
these rights. These arrangements typically stipulate that if the obligor
under the loan fails to make the initial payment on the loan (30 days or
more past due) or prepays within a stipulated time frame (e.g., within
60 days of origination), the originator will repurchase the loan or
refund the premium paid but the buyer will not incur a loss.
A portfolio of whole loans that is covered by such arrangements
economically represents two elements: (1) a portfolio of whole loans and
(2) short-term, contingent put (refund) rights under the EPD and early
prepayment provisions. The rights under the EPD and early prepayment
provisions are not characteristics of the loans since they are not part
of the original loan agreements between the originator and the
borrower.
These provisions are valuable to whole-loan buyers because loan sale
transactions with these provisions command a higher price than those
without the guarantee. The fair value of a portfolio of whole loans
should not include any amounts related to the value of these
provisions.
Entities will need to determine a whole-loan price’s level within the
fair value hierarchy by considering the lowest level of inputs
significant to the measurement. One or more adjustments to observable
whole-loan prices may be based on unobservable inputs. If these inputs
are significant to the fair value measurement, the resulting fair value
would be categorized within Level 3 of the fair value hierarchy.
10.10.1.4 Present Value Technique
An entity that uses a discounted cash flow model would need to evaluate the
reliability of inputs (e.g., prepayment and default assumptions) that are
used to develop projected cash flows. In addition, the entity should
evaluate the source and reliability of the information used to develop an
appropriate discount rate on the basis of the risk profile, prepayment and
default rates, and other characteristics of the portfolio being valued.
10.10.2 Equity Securities
Fair value measurements of investments in equity securities without readily
determinable fair values will represent Level 2 or Level 3 measurements (or
measurements on the basis of NAV per share). Either a market approach or an
income approach will be used in such fair value measurements. In preparing such
measurements, an entity may find it useful to consult the AICPA Accounting and
Valuation Guide Valuation of Privately-Held-Company Equity Securities Issued
as Compensation. See also Sections
9.2 and 10.10.19.3.
As discussed in Section 2.3.2.1.2, when the
measurement alternative in ASC 321-10-35-2 is applied to an investment in an
equity security that does not have a readily determinable fair value, the
measurement adjustment that is recognized upon a remeasurement event (i.e., an
impairment or observable price change in an identical or similar investment of
the same issuer) represents a fair value measurement under ASC 820. An entity is
also required to comply with the nonrecurring disclosure requirements in ASC 820
when such a remeasurement event occurs.
A fair value measurement used to recognize an impairment on an equity security
for which the measurement alternative in ASC 321-10-35-2 is applied may be
estimated on the basis of either a market approach or income approach. Entities
must consider the lowest-level significant input used in the valuation technique
to determine the appropriate classification of the measurement within the fair
value hierarchy (see Chapter 8 for more
information).
A fair value measurement used to recognize an observable price change for an
equity security to which the measurement alternative in ASC 321-10-35-2 is
applied will be based on either an observable transaction in an identical
security or a similar investment of the same issuer. Paragraph BC112 of
ASU 2019-04 addresses how to
measure the fair value change under ASC 321-10-35-2 that arises from an
observable price involving the identical or similar security:
The Board
believed that, in most cases, the observable price change in an orderly
transaction of the identical or similar investment of the same issuer would
generally represent the fair value change in that investment. The Board
intended a consistent remeasurement at fair value for investments accounted
for under the measurement alternative upon identifying (a) an orderly
transaction of the identical or similar investment of the same issuer, (b)
an orderly transaction of a similar investment of the same issuer, and (c)
impairment. Therefore, the Board intended to require a nonrecurring fair
value measurement in accordance with Topic 820 upon the occurrence and
identification of any remeasurement event described in Topic 321 for equity
securities without readily determinable fair value accounted for under the
measurement alternative.
If the equity investment is remeasured on the basis of the observable price
change without adjustment, this nonrecurring fair value measurement would
represent a Level 1 or Level 2 fair value measurement. However, if unobservable
inputs are used to make significant adjustments to the observable price, the
nonrecurring fair value measurement would be classified within Level 3 of the
fair value hierarchy.
10.10.3 Reporting Units
10.10.3.1 General
ASC 350-20
Determining the Fair Value of a Reporting
Unit
35-22 The
fair value of a reporting unit refers to the price
that would be received to sell the unit as a whole
in an orderly transaction between market
participants at the measurement date. Quoted market
prices in active markets are the best evidence of
fair value and shall be used as the basis for the
measurement, if available. However, the market price
of an individual equity security (and thus the
market capitalization of a reporting unit with
publicly traded equity securities) may not be
representative of the fair value of the reporting
unit as a whole.
35-23
Substantial value may arise from the ability to take
advantage of synergies and other benefits that flow
from control over another entity. Consequently,
measuring the fair value of a collection of assets
and liabilities that operate together in a
controlled entity is different from measuring the
fair value of that entity’s individual equity
securities. An acquiring entity often is willing to
pay more for equity securities that give it a
controlling interest than an investor would pay for
a number of equity securities representing less than
a controlling interest. That control premium may
cause the fair value of a reporting unit to exceed
its market capitalization. The quoted market price
of an individual equity security, therefore, need
not be the sole measurement basis of the fair value
of a reporting unit.
35-24 In
estimating the fair value of a reporting unit, a
valuation technique based on multiples of earnings
or revenue or a similar performance measure may be
used if that technique is consistent with the
objective of measuring fair value. Use of multiples
of earnings or revenue in determining the fair value
of a reporting unit may be appropriate, for example,
when the fair value of an entity that has comparable
operations and economic characteristics is
observable and the relevant multiples of the
comparable entity are known. Conversely, use of
multiples would not be appropriate in situations in
which the operations or activities of an entity for
which the multiples are known are not of a
comparable nature, scope, or size as the reporting
unit for which fair value is being estimated.
Deferred Income Tax Considerations
35-25 Before estimating the
fair value of a reporting unit, an entity shall
determine whether that estimation should be based on
an assumption that the reporting unit could be
bought or sold in a nontaxable transaction or a
taxable transaction. Making that determination is a
matter of judgment that depends on the relevant
facts and circumstances and must be evaluated
carefully on a case-by-case basis (see Example 1
[paragraphs 350-20-55-10 through 55-23]).
35-26 In
making that determination, an entity shall consider
all of the following:
-
Whether the assumption is consistent with those that marketplace participants would incorporate into their estimates of fair value
-
The feasibility of the assumed structure
-
Whether the assumed structure results in the highest and best use and would provide maximum value to the seller for the reporting unit, including consideration of related tax implications.
35-27 In
determining the feasibility of a nontaxable
transaction, an entity shall consider, among other
factors, both of the following:
-
Whether the reporting unit could be sold in a nontaxable transaction
-
Whether there are any income tax laws and regulations or other corporate governance requirements that could limit an entity’s ability to treat a sale of the unit as a nontaxable transaction.
10.10.3.2 Impact of Control Premium on Measuring the Fair Value of a Reporting Unit
When the fair value of a reporting unit is measured by reference to quoted
market prices of that reporting unit’s individual equity securities, the
presence of a control premium must be evaluated and, if deemed appropriate,
factored into the fair value measurement.
The concept of a control premium is addressed in ASC 350-20-35-22 and 35-23,
which state, in part:
[T]he market price of an individual equity security (and thus the
market capitalization of a reporting unit with publicly traded
equity securities) may not be representative of the fair value of
the reporting unit as a whole.
Substantial value may arise from the ability to take advantage of
synergies and other benefits that flow from control over another
entity. Consequently, measuring the fair value of a collection of
assets and liabilities that operate together in a controlled entity
is different from measuring the fair value of that entity’s
individual equity securities. An acquiring entity often is willing
to pay more for equity securities that give it a controlling
interest than an investor would pay for a number of equity
securities representing less than a controlling interest. That
control premium may cause the fair value of a reporting unit to
exceed its market capitalization. The quoted market price of an
individual equity security, therefore, need not be the sole
measurement basis of the fair value of a reporting unit.
Under ASC 350-20-35-22 and 35-23, when measuring the fair value of a
reporting unit by referring to the quoted market price of the reporting
unit’s individual equity securities (price multiplied by quantity), an
entity may need to adjust the measurement for a control premium. An
adjustment for the control premium, if deemed applicable, lowers the fair
value measurement below Level 1. ASC 820-10-55-21(h) and ASC 820-10-55-22(e)
give examples of Level 2 and Level 3 inputs, respectively, for a reporting
unit. In addition, if individual reporting units do not have separately
traded equity securities, it would be inappropriate to allocate the
per-share market value of the consolidated entity’s equity to the individual
reporting units.
In a speech at the 2008 AICPA Conference on Current SEC and
PCAOB Developments, Robert G. Fox III, then a professional accounting fellow
in the SEC’s Office of the Chief Accountant, addressed the SEC staff’s view
on determining the reasonableness of control premiums:
[T]he amount of a control premium in excess of a registrant’s market
capitalization can require a great deal of judgment. Contrary to some
rumors I have heard, the staff does not have “bright line” tests that we
use in determining the reasonableness of a control premium. Instead, we
believe that a registrant needs to carefully analyze the facts and
circumstances of their particular situation when determining an
appropriate control premium and that there is normally a range of
reasonable judgments a registrant might reach. While it would be prudent
to reconcile the combined fair value of your reporting units to your
market capitalization, I believe that this should not be viewed as the
only factor to consider in assessing goodwill for impairment.
See Section 10.4.3.4 for further
discussion of control premiums.
10.10.3.3 Determining Fair Value When an Entity Has Only One Reporting Unit
Even if an entity has only one reporting unit, it may not be appropriate to
measure the fair value of that reporting unit solely on the basis of a
quoted market price in an active market. While ASC 350-20-35-22 states that
“[q]uoted market prices in active markets are the best evidence of fair
value,” it also notes that these market prices may not represent fair value
as a whole. Therefore, in certain instances in which an entity has only one
reporting unit, the current quoted market price of the entity’s publicly
traded securities may not represent the entity’s fair value. For example, a
market participant may be willing to pay a premium over the current market
price to obtain the synergies and other benefits that control would provide
(i.e., a control premium). Such a control premium is appropriate when the
unit of account is the reporting unit. See Section 10.10.3.2 for discussion of the incorporation of a
control premium into the fair value of a reporting unit.
10.10.3.4 Equity Value Versus Enterprise Value
ASC 350 does not require entities to use an equity value or enterprise value
when calculating the fair value of a reporting unit to evaluate the unit for
impairment or recognize an impairment loss. This conclusion is consistent
with paragraph BC26 of ASU
2017-04, which states:
GAAP does not prescribe the
valuation premise that an entity must use in the impairment test. It
only mandates that the same assets and liabilities be used to determine
both the carrying amount and fair value and that the methodology be
consistently applied.
Further, paragraph BC4 of ASU 2010-28 states, in part:
The Task Force evaluated the different approaches used
to calculate the carrying amount of reporting units. Some Task Force
members thought choosing an approach for calculating the carrying amount
of a reporting unit was an accounting principle choice, while others
thought it was a choice of estimation methods. One Task Force member was
concerned that this diversity would effectively allow a publicly traded
single reporting unit to look to something other than its quoted market
price as evidence of fair value. The Task Force decided to address the
concerns about diversity in practice without
mandating an approach for calculating the carrying amount of a
reporting unit for purposes of Step 1 of the goodwill impairment
test, even for entities with single reporting units. The Task
Force observed that the manner in which the fair value and carrying
amount of the reporting unit is determined should be consistent.
[Emphasis added]
In addition, in a speech at the 2009 AICPA Conference on Current SEC and
PCAOB Developments, Evan Sussholz, then a professional accounting fellow in
the SEC’s Office of the Chief Accountant, discussed whether the fair value
of a reporting unit refers to the unit’s equity value or enterprise value.
He stated that enterprise value is “commonly defined as the sum of the fair
value of debt and equity” and further indicated that the SEC staff would not
expect the results of a goodwill impairment assessment to be affected if an
entity uses equity value instead of enterprise value.
10.10.3.5 Changing the Method of Determining the Fair Value of a Reporting Unit
Although ASC 350-20 provides guidance on determining the fair value of a
reporting unit, it does not indicate whether the same method must be used
every time an entity performs the goodwill impairment test. While the method
entities use to calculate the fair value of a reporting unit should
generally be consistent, a different method may yield more reliable results
in certain instances. For example, instead of or in addition to using a
present value technique, a reporting unit that completes a public offering
of its common stock may wish to measure the stock’s fair value by using a
market approach in which the stock’s quoted market price is used as an
input. However, entities should not change their methods to avoid
recognizing, or accelerate the recording of, a goodwill impairment
charge.
10.10.4 Intangible Assets
As discussed in Section 10.3.1, the three widely used
valuation techniques are the market approach, cost approach, and income
approach. It is generally not appropriate to use the market approach in
measuring the fair value of a customer-relationship intangible asset because, in
such circumstances, there may be an absence of market transactions involving
identical or comparable assets. Use of the cost approach also may not be
appropriate in such cases, as indicated in a speech by Chad Kokenge, then a professional accounting
fellow in the SEC’s Office of the Chief Accountant, at the 2003 AICPA Conference
on Current SEC Developments:
[T]he [cost] approach only focuses on the entity’s
specific costs that are necessary to “establish” the relationship. Such
an approach would not be sensitive to the volume of business that might
be generated by the customer, other relationship aspects, such as
referral capability, or other factors that may be important to how a
marketplace participant might assess the asset. If these factors are
significant, we believe the use of such an approach would generally be
inconsistent with the . . . definition of fair value.
Accordingly, the income approach will generally be used to
measure the fair value of a customer-relationship intangible asset. However, in
applying the income approach, an entity should also consider the following
prepared remarks made by SEC staff member Joseph Ucuzoglu at the
2006 AICPA Conference on Current SEC and PCAOB Developments:
Some have suggested that the SEC staff always requires
the use of an income approach to value customer relationship intangible
assets. The staff has even heard some suggest that, as long as a
registrant characterizes its valuation method as an income approach, the
specific assumptions used or results obtained will not be challenged by
the staff, because one has complied with a perceived bright line
requirement to use an income approach. Let me assure you, these
statements are simply false. While an income approach often provides the
most appropriate valuation of acquired customer relationship intangible
assets, circumstances may certainly indicate that a different method
provides a better estimate of fair value. On the flipside, even when a
registrant concludes that an income approach is the most appropriate
valuation methodology, the staff may nevertheless question the result
obtained when the underlying assumptions, such as contributory asset
charges, do not appear reasonable in light of the circumstances.
When determining the appropriate valuation of a customer
relationship intangible asset, I believe that the first step in the
process should be to obtain a thorough understanding of the value
drivers in the acquired entity. That is, why is it that customers
continually return to purchase products or services from the acquired
entity? In some cases, the nature of the relationship may be such that
customers are naturally “sticky,” and tend to stay with the same vendor
over time without frequently reconsidering their purchasing decisions.
In that circumstance, it would appear that a significant portion of the
ongoing cash flows that the acquired entity will generate can be
attributed to the strength of its customer relationships.
At the other end of the spectrum, relationships may be a
less significant value driver in an environment where customers
frequently reassess their purchasing decisions and can easily switch to
another vendor with a lower price or a superior product. In that
environment, if customers continually return to buy products from the
acquired entity, perhaps they do so in large part due to factors other
than the relationship, such as a well-know[n] tradename, strong brands,
and proprietary technologies. As a result, the value of the customer
relationship intangible asset may be less than would be the case in a
circumstance where the relationship is stronger. However, the staff
would generally expect that the amount attributed to other intangible
assets would be commensurately higher, reflecting the increasingly
important role of those assets in generating cash flows.
10.10.5 Internal-Use Software
ASC 350-40
Impairment
35-3 When it
is no longer probable that computer software being
developed will be completed and placed in service, the
asset shall be reported at the lower of the carrying
amount or fair value, if any, less costs to sell. The
rebuttable presumption is that such uncompleted software
has a fair value of zero. Indications that the software
may no longer be expected to be completed and placed in
service include the following:
-
A lack of expenditures budgeted or incurred for the project.
-
Programming difficulties that cannot be resolved on a timely basis.
-
Significant cost overruns.
-
Information has been obtained indicating that the costs of internally developed software will significantly exceed the cost of comparable third-party software or software products, so that management intends to obtain the third-party software or software products instead of completing the internally developed software.
-
Technologies are introduced in the marketplace, so that management intends to obtain the third-party software or software products instead of completing the internally developed software.
-
Business segment or unit to which the software relates is unprofitable or has been or will be discontinued.
If an entity ceases development of software and there is reliable evidence that
the project can be marketed in its present state, the related capitalized cost
balance should be reported in accordance with ASC 360-10-35 at the lower of the
carrying amount or fair value less costs to sell. In all cases, as noted in ASC
350-40-35-3, there is a rebuttable presumption that an uncompleted software
project “has a fair value of zero.”
If an entity continues development because it has decided to market the software
to others, the entity should apply the guidance in ASC 985-20, regardless of
whether it is probable that the software will be completed and placed in service
by the entity itself. ASC 350-40-35-9 requires that the carrying amount be
evaluated as of each balance sheet date in accordance with ASC 985-20-35-4.
10.10.6 Property, Plant, and Equipment
ASC 360-10
Fair Value
35-36 For
long-lived assets (asset groups) that have uncertainties
both in timing and amount, an expected present value
technique will often be the appropriate technique with
which to estimate fair value.
Measurement of Expected Disposal Loss or
Gain
35-38 Costs
to sell are the incremental direct costs to transact a
sale, that is, the costs that result directly from and
are essential to a sale transaction and that would not
have been incurred by the entity had the decision to
sell not been made. Those costs include broker
commissions, legal and title transfer fees, and closing
costs that must be incurred before legal title can be
transferred. Those costs exclude expected future losses
associated with the operations of a long-lived asset
(disposal group) while it is classified as held for
sale. Expected future operating losses that marketplace
participants would not similarly consider in their
estimates of the fair value less cost to sell of a
long-lived asset (disposal group) classified as held for
sale shall not be indirectly recognized as part of an
expected loss on the sale by reducing the carrying
amount of the asset (disposal group) to an amount less
than its current fair value less cost to sell. If the
sale is expected to occur beyond one year as permitted
in limited situations by paragraph 360-10-45-11, the
cost to sell shall be discounted.
Long-Lived Assets to Be Abandoned
35-48 Because
the continued use of a long-lived asset demonstrates the
presence of service potential, only in unusual
situations would the fair value of a long-lived asset to
be abandoned be zero while it is being used. When a
long-lived asset ceases to be used, the carrying amount
of the asset should equal its salvage value, if any. The
salvage value of the asset shall not be reduced to an
amount less than zero.
Management Expects to Sell Asset and Remediation Costs
Not Required
55-11
Management expects to sell the asset in the future, and
the asset’s sale will not require the environmental
remediation costs to be incurred. (Although the
environmental remediation costs are excluded from this
Subtopic’s recoverability test, the fair value of the
asset is likely to be affected by the existence of those
costs. The diminished fair value shall be considered in
estimating the cash flows expected to arise from the
eventual sale of the asset.)
Example 2: Probability-Weighted Cash Flows
Case B: Expected Cash Flows Technique
55-30 This
Case illustrates the application of an expected present
value technique to estimate the fair value of a
long-lived asset in an impairment situation.
55-31 The
following table shows by year the computation of the
expected cash flows used in the measurement. They
reflect the possible cash flows (probability-weighted)
used to test the manufacturing facility for
recoverability in Case A, adjusted for relevant
marketplace assumptions, which increases the possible
cash flows in total by approximately 15 percent.
55-32 The following table
shows the computation of the expected present value;
that is, the sum of the present values of the expected
cash flows by year, each discounted at a risk-free
interest rate determined from the yield curve for U.S.
Treasury instruments. In this Case, a market risk
premium is included in the expected cash flows; that is,
the cash flows are certainty equivalent cash flows. As
shown, the expected present value is $42.3 million,
which is less than the carrying amount of $48 million.
In accordance with paragraph 360-10-35-17 the entity
would recognize an impairment loss of $5.7 million.
See Section 2.3.7 for more information about the testing of
long-lived assets for impairment.
10.10.7 Asset Retirement and Environmental Obligations
ASC 410-20
Fair Value Is Reasonably Estimated
25-6 An
entity shall identify all its asset retirement
obligations. An entity has sufficient information to
reasonably estimate the fair value of an asset
retirement obligation if any of the following conditions
exist:
-
It is evident that the fair value of the obligation is embodied in the acquisition price of the asset.
-
An active market exists for the transfer of the obligation.
-
Sufficient information exists to apply an expected present value technique.
Obligations With Uncertainty in Timing or Method of
Settlement
25-7 The
obligation to perform the asset retirement activity is
unconditional even though uncertainty exists about the
timing and (or) method of settlement. Thus, the timing
and (or) method of settlement may be conditional on a
future event. Accordingly, an entity shall recognize a
liability for the fair value of a conditional asset
retirement obligation if the fair value of the liability
can be reasonably estimated. In some cases, sufficient
information about the timing and (or) method of
settlement may not be available to reasonably estimate
fair value. An expected present value technique
incorporates uncertainty about the timing and method of
settlement into the fair value measurement. Uncertainty
is factored into the measurement of the fair value of
the liability through assignment of probabilities to
cash flows.
25-8 An entity
would have sufficient information to apply an expected
present value technique and therefore an asset retirement
obligation would be reasonably estimable if either of the
following conditions exists:
-
The settlement date and method of settlement for the obligation have been specified by others. For example, the law, regulation, or contract that gives rise to the legal obligation specifies the settlement date and method of settlement. In this situation, the settlement date and method of settlement are known and therefore the only uncertainty is whether the obligation will be enforced (that is, whether performance will be required). In certain cases, determining the settlement date for the obligation that has been specified by others is a matter of judgment that depends on the relevant facts and circumstances. For example, a contract that provides the entity with an ability to extend its term through renewal should be evaluated to determine whether the settlement date should take into consideration renewal periods. Uncertainty about whether performance will be required does not defer the recognition of an asset retirement obligation because a legal obligation to stand ready to perform the retirement activities still exists, and it does not prevent the determination of a reasonable estimate of fair value because the only uncertainty is whether performance will be required.
-
The information is available to reasonably estimate all of the following:
-
The settlement date or the range of potential settlement dates
-
The method of settlement or potential methods of settlement (The term potential methods of settlement refers to methods of settling the obligation that are currently available to the entity. Therefore, uncertainty about future methods yet to be developed would not prevent the entity from estimating the fair value of the asset retirement obligation.)
-
The probabilities associated with the potential settlement dates and potential methods of settlement. (The entity should have a reasonable basis for assigning probabilities to the potential settlement dates and potential methods of settlement to reasonably estimate the fair value of the asset retirement obligation. If the entity does not have a reasonable basis of assigning probabilities, it is expected that the entity would still be able to reasonably estimate fair value when the range of time over which the entity may settle the obligation is so narrow and (or) the cash flows associated with each potential method of settlement are so similar that assigning probabilities without having a reasonable basis for doing so would not have a material impact on the fair value of the asset retirement obligation.)
-
25-9 In many
cases, the determination as to whether the entity has
the information to reasonably estimate the fair value of
the asset retirement obligation is a matter of judgment
that depends on the relevant facts and circumstances. It
is expected that the narrower the range of time over
which the entity may settle the obligation and the fewer
potential methods of settlement the entity has available
to it, the more likely it is that the entity will have
the information to reasonably estimate the fair value of
an asset retirement obligation. For an illustration of
this guidance, see Example 3 (paragraph
410-20-55-47).
25-10
Instances may occur in which sufficient information to
estimate the fair value of an asset retirement
obligation is unavailable. For example, if an asset has
an indeterminate useful life, sufficient information to
estimate a range of potential settlement dates for the
obligation might not be available. In such cases, the
liability would be initially recognized in the period in
which sufficient information exists to estimate a range
of potential settlement dates that is needed to employ a
present value technique to estimate fair value.
25-11
Examples of information that is expected to provide a
basis for estimating the potential settlement dates,
potential methods of settlement, and the associated
probabilities include, but are not limited to,
information that is derived from the entity’s past
practice, industry practice, management’s intent, or the
asset’s estimated economic life. The estimated economic
life of the asset might indicate a potential settlement
date for the asset retirement obligation. However, the
original estimated economic life of the asset may not,
in and of itself, establish that date because the entity
may intend to make improvements to the asset that could
extend the life of the asset or the entity could defer
settlement of the obligation beyond the economic life of
the asset. In those situations, the entity would look
beyond the economic life of the asset in determining the
settlement date or range of potential settlement dates
to use when estimating the fair value of the asset
retirement obligation.
Uncertainty in Performance Obligations
25-15 An
unambiguous requirement that gives rise to an asset
retirement obligation coupled with a low likelihood of
required performance still requires recognition of a
liability. Uncertainty about the conditional outcome of
the obligation is incorporated into the measurement of
the fair value of that liability, not the recognition
decision. Uncertainty about performance of conditional
obligations shall not prevent the determination of a
reasonable estimate of fair value. A past history of
nonenforcement of an unambiguous obligation does not
defer recognition of a liability, but its measurement is
affected by the uncertainty over the requirement to
perform retirement activities.
Determination of a Reasonable Estimate of Fair
Value
30-1 An expected present value
technique will usually be the only appropriate technique
with which to estimate the fair value of a liability for
an asset retirement obligation. An entity, when using
that technique, shall discount the expected cash flows
using a credit-adjusted risk-free rate. Thus, the effect
of an entity’s credit standing is reflected in the
discount rate rather than in the expected cash flows.
Proper application of a discount rate adjustment
technique entails analysis of at least two liabilities —
the liability that exists in the marketplace and has an
observable interest rate and the liability being
measured. The appropriate rate of interest for the cash
flows being measured shall be inferred from the
observable rate of interest of some other liability, and
to draw that inference the characteristics of the cash
flows shall be similar to those of the liability being
measured. Rarely, if ever, would there be an observable
rate of interest for a liability that has cash flows
similar to an asset retirement obligation being
measured. In addition, an asset retirement obligation
usually will have uncertainties in both timing and
amount. In that circumstance, employing a discount rate
adjustment technique, where uncertainty is incorporated
into the rate, will be difficult, if not impossible. See
paragraphs 410-20-55-13 through 55-17 and Example 2
(paragraph 410-20-55-35). For further information on
present value techniques, see the guidance beginning in
paragraph 820-10-55-4.
Allocation of Asset Retirement Cost
35-6 The
subsequent measurement provisions require an entity to
identify undiscounted estimated cash flows associated
with the initial measurement of a liability. Therefore,
an entity that obtains an initial measurement of fair
value from a market price or from a technique other than
an expected present value technique must determine the
undiscounted cash flows and estimated timing of those
cash flows that are embodied in that fair value amount
for purposes of applying the subsequent measurement
provisions. Example 1 (see paragraph 410-20-55-31)
provides an illustration of the subsequent measurement
of a liability that is initially obtained from a market
price. (See paragraph 410-20-25-14 for a discussion on
conditional outcomes.)
35-7
Paragraph 410-20-25-14 explains how uncertainty
surrounding conditional performance of a retirement
obligation is factored into its measurement by assessing
the likelihood that performance will be required. As the
time for notification approaches, more information and a
better perspective about the ultimate outcome will
likely be obtained. Consequently, reassessment of the
timing, amount, and probabilities associated with the
expected cash flows may change the amount of the
liability recognized. See paragraphs 410-20-55-18
through 55-19.
Components of a Larger System
55-11 If
assets with asset retirement obligations are components
of a larger group of assets (for example, a number of
oil wells that make up an entire oil field operation),
aggregation techniques may be necessary to derive a
collective asset retirement obligation. This Subtopic
does not preclude the use of estimates and computational
shortcuts that are consistent with the fair value
measurement objective when computing an aggregate asset
retirement obligation for assets that are components of
a larger group of assets. This implementation guidance
illustrates paragraph 410-20-30-1.
Obligations With Uncertainty About Government
Enforcement
55-12 This
implementation guidance illustrates Section 410-20-15.
If, for example, a governmental unit retains the right
(an option) to decide whether to require a retirement
activity, there is some uncertainty about whether those
retirement activities will be required or waived.
Regardless of the uncertainty attributable to the
option, a legal obligation to stand ready to perform
retirement activities still exists, and the governmental
unit might require them to be performed. Although the
timing and method of settlement of the retirement
obligation may depend on future events that may or may
not be within the control of the entity, a legal
obligation to stand ready to perform retirement
activities still exists. The entity should consider the
uncertainty about the timing and method of settlement in
the measurement of the liability, consistent with a fair
value measurement objective, regardless of whether the
event that will trigger the settlement is partially or
wholly under the control of the entity.
Expected Present Value Technique
55-13 This
implementation guidance illustrates paragraph
410-20-30-1. In estimating the fair value of a liability
for an asset retirement obligation using an expected
present value technique, an entity shall begin by
estimating the expected cash flows that reflect, to the
extent possible, a marketplace assessment of the cost
and timing of performing the required retirement
activities. Considerations in estimating those expected
cash flows include developing and incorporating explicit
assumptions, to the extent possible, about all of the
following:
-
The costs that a third party would incur in performing the tasks necessary to retire the asset
-
Other amounts that a third party would include in determining the price of the transfer, including, for example, inflation, overhead, equipment charges, profit margin, and advances in technology
-
The extent to which the amount of a third party’s costs or the timing of its costs would vary under different future scenarios and the relative probabilities of those scenarios
-
The price that a third party would demand and could expect to receive for bearing the uncertainties and unforeseeable circumstances inherent in the obligation, sometimes referred to as a market-risk premium.
55-14 It is
expected that uncertainties about the amount and timing
of future cash flows can be accommodated by using the
expected present value technique and therefore will not
prevent the determination of a reasonable estimate of
fair value.
Credit-Adjusted Risk-Free Rate
55-15 This
implementation guidance illustrates paragraph
410-20-30-1. An entity shall discount expected cash
flows using an interest rate that equates to a risk-free
interest rate adjusted for the effect of its credit
standing (a credit-adjusted risk-free rate). In
determining the adjustment for the effect of its credit
standing, an entity should consider the effects of all
terms, collateral, and existing guarantees on the fair
value of the liability.
55-16
Adjustments for default risk can be reflected in either
the discount rate or the expected cash flows. In most
situations, an entity will know the adjustment required
to the risk-free interest rate to reflect its credit
standing. Consequently, it would be easier and less
complex to reflect that adjustment in the discount
rate.
55-17 In
addition, because of the requirements in paragraph
410-20-35-8 relating to upward and downward adjustments
in expected cash flows, it is essential to the
operationality of this Subtopic that the credit standing
of the entity be reflected in the discount rate. For
those reasons, the risk-free rate shall be adjusted for
the credit standing of the entity to determine the
discount rate.
Historical Waste on Electrical and Electronic
Equipment Associated With EU Directive
2002/96/EC
55-27 If the
asset is subsequently replaced, with the obligation
being transferred to the producer of the replacement
equipment, the commercial user should determine the
portion of the total amount paid to the producer that
relates to the replacement equipment (the new asset) and
the portion that relates to the transfer of the asset
retirement obligation. That determination should be
based on the fair value of the asset retirement
obligation, without the sale of the new asset. The price
paid by the commercial user would not include any costs
associated with the transfer of the obligation in
situations in which the law in the EU-member country
obligates commercial users to pay all of the costs
associated with the historical waste even if the
equipment is replaced. In those situations, the
commercial user would not derecognize the liability from
its balance sheet upon replacement, but rather when the
obligation is ultimately settled.
ASC 410-20-55-31 through 55-67 contain several examples
illustrating fair value estimates. See Section 10.2.7.5 for an example from ASC
820 that illustrates the application of the guidance in ASC 420-10 to an ARO
liability. For further discussion of fair value estimates related to AROs, see
Deloitte’s Roadmap Environmental Obligations and Asset Retirement
Obligations.
10.10.8 Exit or Disposal Cost Obligations
10.10.8.1 General
ASC 420-10
Fair
Value
30-1 A liability for a cost
associated with an exit or disposal activity shall
be measured initially at its fair value in the
period in which the liability is incurred, except as
indicated in paragraphs 420-10-30-4 and 420-10-30-6
(for a liability for one-time termination benefits
that is incurred over time).
30-2 Quoted market prices are
the best representation of fair value. However, for
many of the liabilities covered by this Subtopic,
quoted market prices will not be available.
Consequently, in those circumstances, fair value
will be estimated using some other valuation
technique. A present value technique is often the
best available valuation technique with which to
estimate the fair value of a liability for a cost
associated with an exit or disposal activity. For a
liability that has uncertainties both in timing and
amount, an expected present value technique
generally will be the appropriate technique.
30-3 In some situations, a
fair value measurement for a liability associated
with an exit or disposal activity obtained using a
valuation technique other than a present value
technique may not be materially different from a
fair value measurement obtained using a present
value technique. In those situations, this Subtopic
does not preclude the use of estimates and
computational shortcuts that are consistent with a
fair value measurement objective.
Example 1:
One-Time Employee Termination Benefits — No Future
Service Required
55-2 This Example assumes
that an entity has a one-time benefit arrangement
established by a plan of termination that meets the
criteria in paragraph 420-10-25-4 and has been
communicated to employees.
55-3 An entity plans to cease
operations in a particular location and determines
that it no longer needs the 100 employees that
currently work in that location. The entity notifies
the employees that they will be terminated in 90
days. Each employee will receive as a termination
benefit a cash payment of $6,000, which will be paid
at the date an employee ceases rendering service
during the 90-day period. In accordance with
paragraph 420-10-25-8, a liability would be
recognized at the communication date and, in
accordance with paragraph 420-10-30-5, measured at
its fair value. In this case, because of the short
discount period, $600,000 may not be materially
different from the fair value of the liability at
the communication date.
Example 2:
One-Time Employee Termination Benefits — Stay
Bonus-Future Service Required
55-4 This Example assumes
that an entity has a one-time benefit arrangement
established by a plan of termination that meets the
criteria in paragraph 420-10-25-4 and has been
communicated to employees.
55-5 An entity plans to shut
down a manufacturing facility in 16 months and, at
that time, terminate all of the remaining employees
at the facility. To induce employees to stay until
the facility is shut down, the entity establishes a
one-time stay bonus arrangement. Each employee that
stays and renders service for the full 16-month
period will receive as a termination benefit a cash
payment of $10,000, which will be paid 6 months
after the termination date. An employee that leaves
voluntarily before the facility is shut down will
not be entitled to receive any portion of the
termination benefit. In accordance with paragraph
420-10-25-9, a liability for the termination
benefits would be measured initially at the
communication date and, in accordance with paragraph
420-10-30-6, based on the fair value of the
liability as of the termination date and recognized
ratably over the future service period. The fair
value of the liability as of the termination date
would be adjusted cumulatively for changes resulting
from revisions to estimated cash flows over the
future service period, measured using the
credit-adjusted risk-free rate that was used to
measure the liability initially (as illustrated in
this Example).
55-6 The fair value of the
liability as of the termination date is $962,240,
estimated at the communication date using an
expected present value technique. The expected cash
flows of $1 million (to be paid 6 months after the
termination date), which consider the likelihood
that some employees will leave voluntarily before
the facility is shut down, are discounted for 6
months at the credit-adjusted risk-free rate of 8
percent. In this case, a risk premium is not
considered in the present value measurement. Because
the amounts of the cash flows will be fixed and
certain as of the termination date, marketplace
participants would not demand a risk premium.
55-7 Therefore, a liability
of $60,140 would be recognized in each month during
the future service period (16 months).
55-8 After eight months, more
employees than originally estimated leave
voluntarily. The entity adjusts the fair value of
the liability as of the termination date to $769,792
to reflect the revised expected cash flows of
$800,000 (to be paid 6 months after the termination
date), discounted for 6 months at the
credit-adjusted risk-free rate that was used to
measure the liability initially (8 percent). Based
on that revised estimate, a liability (expense) of
$48,112 would have been recognized in each month
during the future service period. Thus, the
liability recognized to date of $481,120 ($60,140 ×
8) would be reduced to $384,896 ($48,112 × 8) to
reflect the cumulative effect of that change (of
$96,224). A liability of $48,112 would be recognized
in each month during the remaining future service
period (8 months). Accretion expense would be
recognized after the termination date in accordance
with the guidance beginning in paragraph 420-10-35-1
and in paragraph 420-10-45-5.
Example 3:
One-Time Employee Termination Benefits — Voluntary
and Involuntary Benefits Offered
55-9 This Example assumes
that an entity has a one-time benefit arrangement
established by a plan of termination that meets the
criteria of paragraph 420-10-25-4 and has been
communicated to employees.
55-10 An entity initiates
changes to streamline operations in a particular
location and determines that, as a result, it no
longer needs 100 of the employees that currently
work in that location. The plan of termination
provides for both voluntary and involuntary
termination benefits (in the form of cash payments).
Specifically, the entity offers each employee (up to
100 employees) that voluntarily terminates within 30
days a voluntary termination benefit of $10,000 to
be paid at the separation date. Each employee that
is involuntarily terminated thereafter (to reach the
target of 100) will receive an involuntary
termination benefit of $6,000 to be paid at the
termination date. The entity expects all 100
employees to leave (voluntarily or involuntarily)
within the minimum retention period. In accordance
with paragraphs 420-10-25-6 through 25-8, a
liability for the involuntary termination benefit
(of $6,000 per employee) would be recognized at the
communication date and, in accordance with
paragraphs 420-10-30-4 through 30-6, measured at its
fair value. In this case, because of the short
discount period, $600,000 may not be materially
different from the fair value of the liability at
the communication date. As noted in paragraph
420-10-25-10, a liability for the incremental
voluntary termination benefit (of $4,000 per
employee) would be recognized in accordance with
paragraph 712-10-25-1 through 25-3 (that is, when
employees accept the offer).
10.10.9 Guarantees
ASC 460-10
Fair Value Objective
30-2 Except as indicated in
paragraphs 460-10-30-3 through 30-5, the objective of
the initial measurement of a guarantee liability is the
fair value of the guarantee at its inception. For
example:
-
If a guarantee is issued in a standalone arm’s-length transaction with an unrelated party, the liability recognized at the inception of the guarantee shall be the premium received or receivable by the guarantor as a practical expedient.
-
If a guarantee is issued as part of a transaction with multiple elements with an unrelated party (such as in conjunction with selling an asset), the liability recognized at the inception of the guarantee should be an estimate of the guarantee’s fair value. In that circumstance, a guarantor shall consider what premium would be required by the guarantor to issue the same guarantee in a standalone arm’s-length transaction with an unrelated party as a practical expedient.
-
If a guarantee is issued as a contribution to an unrelated party, the liability recognized at the inception of the guarantee shall be measured at its fair value, consistent with the requirement to measure the contribution made at fair value, as prescribed in Section 720-25-30. For related implementation guidance, see paragraph 460-10-55-14.
Probable Contingent Losses for Which the Amount of
Loss Can Be Reasonably Estimated
30-4 For many
guarantors, it would be unusual at the inception of the
guarantee for the contingent liability amount under (b)
in the preceding paragraph to exceed the amount that
satisfies the fair value objective under (a) in the
preceding paragraph. An example of that unusual
circumstance is a guarantee for which, at inception,
there is a high (probable) likelihood that the guarantor
will be required to pay the maximum potential settlement
at the end of the six-month term and a low likelihood
that the guarantor will not be required to make any
payment at the end of the six-month term. The amount
that satisfies the fair value objective would include
consideration of the low likelihood that no payment will
be required, but the accrual of the contingent loss
under Section 450-20-30 would be based solely on the
best estimate of the settlement amount whose payment is
probable (the maximum potential settlement amount in
this case). This example is considered to be an unusual
circumstance because of the high likelihood at inception
that the maximum potential settlement amount will be
paid, resulting in a substantial initial fair value for
that guarantee. Another example in which the contingent
liability amount required to be recognized under (b) in
the preceding paragraph exceeds the fair value at
inception under (a) in the preceding paragraph would
involve an undiscounted accrual under Subtopic 450-20
for a guarantee payment that is expected to occur many
years in the future.
Recognition and Measurement Guidance — Overall
Guidance
55-21 In many
cases, the one-time premium received by a guarantor for
issuing a guarantee will be an appropriate practical
expedient for the initial measurement of the guarantee
obligation (see paragraph 460-10-30-2[a]). However, if a
one-time premium is specified for a guarantee that is
issued in conjunction with another transaction (such as
the sale of assets by the guarantor), the specified
premium may not be an appropriate initial measurement of
the guarantor’s liability because the amount specified
as being applicable to the guarantee may or may not be
its fair value (see paragraph 460-10-30-2[b]).
10.10.10 Other Liabilities
10.10.10.1 Convertible Debt
ASC 470-20
Instrument Issued as Repayment for Nonconvertible
Instrument
30-19 If a
convertible instrument is issued as repayment of a
nonconvertible instrument at the nonconvertible
instrument’s maturity, the fair value of the newly
issued convertible instrument shall be the
redemption amount owed at the maturity date of the
original instrument if both of the following
conditions exist:
-
The original instrument has matured.
-
The exchange of debt instruments is not a troubled debt restructuring that would be accounted for by the issuer under Subtopic 470-60.
Pending Content (Transition Guidance: ASC
815-40-65-1)
30-19 Paragraph superseded by Accounting
Standards Update No. 2020-06.
Convertible Instruments Issued to Nonemployees for
Goods and Services
30-25 Both of
the following guidelines for determining the fair
value of convertible instruments shall be used: . . .
b. Recent issuances of similar convertible
instruments for cash to parties that only have an
investor relationship with the issuer may provide
the best evidence of fair value of the convertible
instrument.
c. If reliable information under (b) is not
available, the fair value of the convertible
instrument shall be deemed to be no less than the
fair value of the equity shares into which it can
be converted.
Pending Content (Transition Guidance: ASC
815-40-65-1)
30-25 Paragraph superseded by Accounting
Standards Update No. 2020-06.
Liability Component
35-14 If,
under Subtopic 820-10, an issuer uses a valuation
technique consistent with an income approach to
measure the fair value of the liability component at
initial recognition, the issuer shall consider the
periods of cash flows used in the fair value
measurement when determining the appropriate
discount amortization period.
Pending Content (Transition Guidance: ASC
815-40-65-1)
35-14 Paragraph superseded by Accounting
Standards Update No. 2020-06.
For additional discussion of the borrowing rate used to
determine the fair value of the liability component of a convertible debt
instrument within the scope of the cash conversion subsections of ASC
470-20, see Section
6.3.2 of Deloitte’s Roadmap Convertible Debt.
10.10.10.2 Physically Settled Forward Purchase Contracts
ASC 480-10
Certain Physically Settled Forward Purchase
Contracts
30-3 Forward
contracts that require physical settlement by
repurchase of a fixed number of the issuer’s equity
shares in exchange for cash shall be measured
initially at the fair value of the shares at
inception, adjusted for any consideration or
unstated rights or privileges.
30-4 Two ways
to obtain the adjusted fair value include:
-
Determining the amount of cash that would be paid under the conditions specified in the contract if the shares were repurchased immediately
-
Discounting the settlement amount, at the rate implicit at inception after taking into account any consideration or unstated rights or privileges that may have affected the terms of the transaction.
10.10.11 Assets of a Defined Benefit Pension or Other Postretirement Plan
ASC 715-30
Annuity and Other
Contracts
35-60 Insurance contracts that
are in substance equivalent to the purchase of annuities
shall be accounted for as such. Other contracts with
insurance entities shall be accounted for as investments
and measured at fair value. For some contracts, the best
available evidence of fair value may be contract value.
If a contract has a determinable cash surrender value or
conversion value, that is presumed to be its fair
value.
Selection of
Discount Rates
55-30 Use of assumed discount
rates based on historical rates of return is
inconsistent with the paragraph 715-30-35-50 requirement
to value plan assets at fair value. If interest rates
decline or rise, the effect of the requirement to use
current rates is to increase or decrease the present
value of the projected benefit obligation. That increase
or decrease in the obligation is a loss or gain that
would be offset to the extent of the gain or loss in the
fair value of the plan’s dedicated portfolio of
fixed-income investments. Any net gain or loss is
subject to amortization as a component of net periodic
pension cost.
Insurance
Contracts
55-42 Guaranteed investment
contracts are not annuity contracts because they
transfer only investment risk to the insurer. The
insurer does not unconditionally undertake a legal
obligation to provide specified pension benefits to
specific individuals. For a guaranteed investment
contract with a specified maturity date and for which
there is no intent to liquidate the contract before that
date, evidence of the fair value of the guaranteed
investment contract might be obtained by looking to
current yields on fixed-maturity securities having
similar risk characteristics and duration.
55-43 In an immediate
participation guarantee investment contract, the market
value adjustment should be considered in determining its
fair value because, in effect, the contract value
adjusted for any such market value adjustment represents
the cash surrender value referred to in paragraph
715-30-35-60. If an immediate participation guarantee
investment contract can be converted into an annuity
contract, the conversion value of the contract should be
considered in determining its fair value. The evidence
of fair value noted for guaranteed investment contracts
in the preceding paragraph should also be considered for
immediate participation guarantee investment
contracts.
ASC 715-60
Insurance
Contracts
35-120 Other contracts with
insurance entities may not meet the definition of an
insurance contract because the insurance entity does not
unconditionally undertake a legal obligation to provide
specified benefits to specified individuals. Those
contracts shall be accounted for as investments and
measured at fair value. If a contract has a determinable
cash surrender value or conversion value, that is
presumed to be its fair value. For some contracts, the
best available estimate of fair value may be contract
value.
10.10.12 Contributions
ASC 720-25
30-2
Unconditional promises to give that are expected to be
paid in less than one year may be measured at net
settlement value because that amount, although not
equivalent to the present value of estimated future cash
flows, results in a reasonable estimate of fair
value.
10.10.13 Business Combinations
ASC 805-20
Measuring the Fair Values of Particular Identifiable
Assets and a Noncontrolling Interest in an
Acquiree
30-3 The
following guidance demonstrates the application of the
measurement principle in paragraph 805-20-30-1 to
specific situations in a business combination including
guidance on measuring the fair values of particular
identifiable assets and a noncontrolling interest in an
acquiree.
Assets With Uncertain Cash Flows (Valuation
Allowances)
30-4 The acquirer shall not
recognize a separate valuation allowance as of the
acquisition date for assets acquired in a business
combination that are measured at their acquisition-date
fair values because the effects of uncertainty about
future cash flows are included in the fair value
measure, unless the assets acquired are financial assets
for which the acquirer shall refer to the guidance in
paragraphs 805-20-30-4A through 30-4B.
30-4A For acquired financial
assets that are not purchased financial assets with
credit deterioration, the acquirer shall record the
purchased financial assets at the acquisition-date fair
value. Additionally, for these financial assets within
the scope of Topic 326, an allowance shall be recorded
with a corresponding charge to credit loss expense as of
the reporting date.
30-4B For assets accounted
for as purchased financial assets with credit
deterioration (which includes beneficial interests that
meet the criteria in paragraph 325-40-30-1A), an
acquirer shall recognize an allowance in accordance with
Topic 326 with a corresponding increase to the amortized
cost basis of the financial asset(s) as of the
acquisition date.
Assets Subject to Operating Leases in Which the
Acquiree Is the Lessor
30-5 The
acquirer shall measure the acquisition-date fair value
of an asset, such as a building or a patent or other
intangible asset, that is subject to an operating lease
in which the acquiree is the lessor separately from the
lease contract. In other words, the fair value of the
asset shall be the same regardless of whether it is
subject to an operating lease. In accordance with
paragraph 805-20-25-12, the acquirer separately
recognizes an asset or a liability if the terms of the
lease are favorable or unfavorable relative to market
terms.
Assets That the Acquirer Intends Not to Use or to
Use in a Way Other Than Their Highest and Best
Use
30-6 To
protect its competitive position, or for other reasons,
the acquirer may intend not to use an acquired
nonfinancial asset actively, or it may not intend to use
the asset according to its highest and best use. For
example, that might be the case for an acquired research
and development intangible asset that the acquirer plans
to use defensively by preventing others from using it.
Nevertheless, the acquirer shall measure the fair value
of the nonfinancial asset in accordance with Subtopic
820-10 assuming its highest and best use by market
participants in accordance with the appropriate
valuation premise, both initially and for purposes of
subsequent impairment testing.
Measuring the Fair Value of a Noncontrolling
Interest in an Acquiree
30-7
Paragraph 805-20-30-1 requires the acquirer to measure a
noncontrolling interest in the acquiree at its fair
value at the acquisition date. An acquirer sometimes
will be able to measure the acquisition-date fair value
of a noncontrolling interest on the basis of a quoted
price in an active market for the equity shares (that
is, those not held by the acquirer). In other
situations, however, a quoted price in an active market
for the equity shares will not be available. In those
situations, the acquirer would measure the fair value of
the noncontrolling interest using another valuation
technique.
30-8 The fair
values of the acquirer’s interest in the acquiree and
the noncontrolling interest on a per-share basis might
differ. The main difference is likely to be the
inclusion of a control premium in the per-share fair
value of the acquirer’s interest in the acquiree or,
conversely, the inclusion of a discount for lack of
control (also referred to as a noncontrolling interest
discount) in the per-share fair value of the
noncontrolling interest if market participants would
take into account such a premium or discount when
pricing the noncontrolling interest.
Measurement of Assets and Liabilities Arising From
Contingencies
30-9
Paragraphs 805-20-25-18A through 25-20B establish the
requirements related to recognition of certain assets
and liabilities arising from contingencies. Initial
measurement of assets and liabilities meeting the
recognition criteria in paragraph 805-20-25-19 shall be
at acquisition-date fair value. Guidance on the initial
measurement of other assets and liabilities from
contingencies not meeting the recognition criteria of
that paragraph, but meeting the criteria in paragraph
805-20-25-20 is at paragraph 805-20-30-23.
Indemnification Assets
30-18
Paragraph 805-20-25-27 requires that the acquirer
recognize an indemnification asset at the same time that
it recognizes the indemnified item, measured on the same
basis as the indemnified item, subject to the need for a
valuation allowance for uncollectible amounts. That
paragraph also requires that, if the indemnification
relates to an asset or a liability that is recognized at
the acquisition date and measured at its
acquisition-date fair value, the acquirer recognize the
indemnification asset at the acquisition date measured
at its acquisition-date fair value. For an
indemnification asset measured at fair value, the
effects of uncertainty about future cash flows because
of collectibility considerations are included in the
fair value measure and a separate valuation allowance is
not necessary, as noted in paragraph 805-20-30-4.
Reacquired Rights
30-20 The
acquirer shall measure the value of a reacquired right
recognized as an intangible asset in accordance with
paragraph 805-20-25-14 on the basis of the remaining
contractual term of the related contract regardless of
whether market participants would consider potential
contractual renewals in determining its fair value.
Recognition of Intangible Assets Separately From
Goodwill
55-2 Paragraph 805-20-25-10
establishes that an intangible asset is identifiable if
it meets either the separability criterion or the
contractual-legal criterion described in the definition
of identifiable. An intangible asset that meets the
contractual-legal criterion is identifiable even if the
asset is not transferable or separable from the acquiree
or from other rights and obligations. For example:
-
An acquiree leases a manufacturing facility to a lessee under an operating lease that has terms that are favorable relative to market terms. The lease terms explicitly prohibit transfer of the lease (through either sale or sublease). The amount by which the lease terms are favorable compared with the pricing of current market transactions for the same or similar items is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even though the acquirer cannot sell or otherwise transfer the lease contract. See also paragraph 805-20-25-12.
-
An acquiree owns and operates a nuclear power plant. The license to operate that power plant is an intangible asset that meets the contractual-legal criterion for recognition separately from goodwill, even if the acquirer cannot sell or transfer it separately from the acquired power plant. An acquirer may recognize the fair value of the operating license and the fair value of the power plant as a single asset for financial reporting purposes if the useful lives of those assets are similar.
-
An acquiree owns a technology patent. It has licensed that patent to others for their exclusive use outside the domestic market, receiving a specified percentage of future foreign revenue in exchange. Both the technology patent and the related license agreement meet the contractual-legal criterion for recognition separately from goodwill even if selling or exchanging the patent and the related license agreement separately from one another would not be practical.
Assembled Workforce and Other Items That Are Not
Identifiable
55-9 The
identifiability criteria determine whether an intangible
asset is recognized separately from goodwill. However,
the criteria neither provide guidance for measuring the
fair value of an intangible asset nor restrict the
assumptions used in measuring the fair value of an
intangible asset. For example, the acquirer would take
into account the assumptions that market participants
would use when pricing the intangible asset, such as
expectations of future contract renewals, in measuring
fair value. It is not necessary for the renewals
themselves to meet the identifiability criteria.
(However, see paragraph 805-20-30-20, which establishes
an exception to the fair value measurement principle for
reacquired rights recognized in a business
combination.)
Servicing Contracts Such as Mortgage Servicing
Contracts
55-35 If
mortgage loans, credit card receivables, or other
financial assets are acquired in a business combination
with the servicing obligation, the inherent servicing
rights are not a separate intangible asset because the
fair value of those servicing rights is included in the
measurement of the fair value of the acquired financial
asset.
Example 1: Customer Contract and Customer
Relationship Intangible Assets Acquired in a
Business Combination
Case B: One Customer, Contract in One of Two Lines of
Business
55-55 Target
manufactures goods in two distinct lines of business:
sporting goods and electronics. Customer purchases both
sporting goods and electronics from Target. Target has a
contract with Customer to be its exclusive provider of
sporting goods but has no contract for the supply of
electronics to Customer. Both Target and Acquirer
believe that only one overall customer relationship
exists between Target and Customer. The contract to be
Customer’s exclusive supplier of sporting goods, whether
cancelable or not, meets the contractual-legal
criterion. Additionally, because Target establishes its
relationship with Customer through a contract, the
customer relationship with Customer meets the
contractual-legal criterion. Because Target has only one
customer relationship with Customer, the fair value of
that relationship incorporates assumptions about
Target’s relationship with Customer related to both
sporting goods and electronics. However, if Acquirer
determines that the customer relationships with Customer
for sporting goods and for electronics are separate from
each other, Acquirer would assess whether the customer
relationship for electronics meets the separability
criterion for identification as an intangible asset.
ASC 805-30
Measurement of
Goodwill
30-2 In a business combination
in which the acquirer and the acquiree (or its former
owners) exchange only equity interests, the
acquisition-date fair value of the acquiree’s equity
interests may be more reliably measurable than the
acquisition-date fair value of the acquirer’s equity
interests. If so, the acquirer shall determine the
amount of goodwill by using the acquisition-date fair
value of the acquiree’s equity interests instead of the
acquisition-date fair value of the equity interests
transferred.
30-3 To determine the amount of
goodwill in a business combination in which no
consideration is transferred, the acquirer shall use the
acquisition-date fair value of the acquirer’s interest
in the acquiree determined using a valuation technique
in place of the acquisition-date fair value of the
consideration transferred (see paragraph
805-30-30-1(a)(1)). Paragraphs 805-30-55-3 through 55-5
provide additional guidance on applying the acquisition
method to combinations of mutual entities, including
measuring the acquisition-date fair value of the
acquiree’s equity interests using a valuation
technique.
Consideration
Transferred
30-7 The
consideration transferred in a business combination
shall be measured at fair value, which shall be
calculated as the sum of the acquisition-date fair
values of the assets transferred by the acquirer, the
liabilities incurred by the acquirer to former owners of
the acquiree, and the equity interests issued by the
acquirer. (However, any portion of the acquirer’s
share-based payment awards exchanged for awards held by
the acquiree’s grantees that is included in
consideration transferred in the business combination
shall be measured in accordance with paragraph
805-20-30-21 rather than at fair value.) Examples of
potential forms of consideration include the
following:
-
Cash
-
Other assets
-
A business or a subsidiary of the acquirer
-
Contingent consideration (see paragraphs 805-30-25-5 through 25-7)
-
Common or preferred equity instruments
-
Options
-
Warrants
-
Member interests of mutual entities.
30-8 The consideration
transferred may include assets or liabilities of the
acquirer that have carrying amounts that differ from
their fair values at the acquisition date (for example,
nonmonetary assets or a business of the acquirer). If
so, the acquirer shall remeasure the transferred assets
or liabilities to their fair values as of the
acquisition date and recognize the resulting gains or
losses, if any, in earnings. However, sometimes the
transferred assets or liabilities remain within the
combined entity after the business combination (for
example, because the assets or liabilities were
transferred to the acquiree rather than to its former
owners), and the acquirer therefore retains control of
them. In that situation, the acquirer shall measure
those assets and liabilities at their carrying amounts
immediately before the acquisition date and shall not
recognize a gain or loss in earnings on assets or
liabilities it controls both before and after the
business combination.
Measuring the
Acquisition-Date Fair Value of the Acquirer’s
Interest in the Acquiree Using Valuation
Techniques
55-2 In a business combination
achieved without the transfer of consideration, the
acquirer must substitute the acquisition-date fair value
of its interest in the acquiree for the acquisition-date
fair value of the consideration transferred to measure
goodwill or a gain on a bargain purchase (see paragraphs
805-30-30-1 through 30-4). Subtopic 820-10 provides
guidance on using valuation techniques to measure fair
value.
Special
Consideration in Applying the Acquisition Method
to Combinations of Mutual Entities
55-3 When two mutual entities
combine, the fair value of the equity or member
interests in the acquiree (or the fair value of the
acquiree) may be more reliably measurable than the fair
value of the member interests transferred by the
acquirer. In that situation, paragraph 805-30-30-2
through 30-3 requires the acquirer to determine the
amount of goodwill by using the acquisition-date fair
value of the acquiree’s equity interests instead of the
acquisition-date fair value of the acquirer’s equity
interests transferred as consideration. In addition, the
acquirer in a combination of mutual entities shall
recognize the acquiree’s net assets as a direct addition
to capital or equity in its statement of financial
position, not as an addition to retained earnings, which
is consistent with the way in which other types of
entities apply the acquisition method.
55-4 Although they are similar
in many ways to other businesses, mutual entities have
distinct characteristics that arise primarily because
their members are both customers and owners. Members of
mutual entities generally expect to receive benefits for
their membership, often in the form of reduced fees
charged for goods and services or patronage dividends.
The portion of patronage dividends allocated to each
member is often based on the amount of business the
member did with the mutual entity during the year.
55-5 A fair value measurement
of a mutual entity should include the assumptions that
market participants would make about future member
benefits as well as any other relevant assumptions
market participants would make about the mutual entity.
For example, an estimated cash flow model may be used to
determine the fair value of a mutual entity. The cash
flows used as inputs to the model should be based on the
expected cash flows of the mutual entity, which are
likely to reflect reductions for member benefits, such
as reduced fees charged for goods and services.
ASC 805-40
Measuring the
Consideration Transferred
30-2 In a reverse acquisition,
the accounting acquirer usually issues no consideration
for the acquiree. Instead, the accounting acquiree
usually issues its equity shares to the owners of the
accounting acquirer. Accordingly, the acquisition-date
fair value of the consideration transferred by the
accounting acquirer for its interest in the accounting
acquiree is based on the number of equity interests the
legal subsidiary would have had to issue to give the
owners of the legal parent the same percentage equity
interest in the combined entity that results from the
reverse acquisition. Example 1, Case A (see paragraph
805-40-55-8) illustrates that calculation. The fair
value of the number of equity interests calculated in
that way can be used as the fair value of consideration
transferred in exchange for the acquiree.
Example 1: Reverse Acquisitions
Case A: All the Shares of the Legal
Subsidiary Are Exchanged
55-8 This Case illustrates the
accounting for a reverse acquisition if all of the
shares of the legal subsidiary, the accounting acquirer,
are exchanged in a business combination. The accounting
illustrated in this Case includes the calculation of the
fair value of the consideration transferred, the
measurement of goodwill and the calculation of earnings
per share (EPS).
55-9 The calculation of the
fair value of the consideration transferred follows.
55-10 As a result of the
issuance of 150 common shares by Entity A (legal parent,
accounting acquiree), Entity B’s shareholders own 60
percent of the issued shares of the combined entity,
that is, 150 of 250 issued shares. The remaining 40
percent are owned by Entity A’s shareholders. If the
business combination had taken the form of Entity B
issuing additional common shares to Entity A’s
shareholders in exchange for their common shares in
Entity A, Entity B would have had to issue 40 shares for
the ratio of ownership interest in the combined entity
to be the same. Entity B’s shareholders would then own
60 of the 100 issued shares of Entity B — 60 percent of
the combined entity. As a result, the fair value of the
consideration effectively transferred by Entity B and
the group’s interest in Entity A is $1,600 (40 shares
with a per-share fair value of $40). The fair value of
the consideration effectively transferred should be
based on the most reliable measure. In this Case, the
quoted market price of Entity A’s shares provides a more
reliable basis for measuring the consideration
effectively transferred than the estimated fair value of
the shares in Entity B, and the consideration is
measured using the market price of Entity A’s shares ―
100 shares with a per-share fair value of $16.
55-11 Goodwill is measured as
follows.
55-12 Goodwill is measured as
the excess of the fair value of the consideration
effectively transferred (the group’s interest in Entity
A) over the net amount of Entity A’s recognized
identifiable assets and liabilities, as follows.
55-13 The consolidated
statement of financial position immediately after the
business combination is as follows.
55-14 In accordance with
paragraph 805-40-45-2(c) through (d), the amount
recognized as issued equity interests in the
consolidated financial statements ($2,200) is determined
by adding the issued equity of the legal subsidiary
immediately before the business combination ($600) and
the fair value of the consideration effectively
transferred, measured in accordance with paragraph
805-40-30-2 ($1,600). However, the equity structure
appearing in the consolidated financial statements (that
is, the number and type of equity interests issued) must
reflect the equity structure of the legal parent,
including the equity interests issued by the legal
parent to effect the combination.
55-15 The calculation of EPS
follows.
55-16 Entity B’s earnings for
the annual period ended December 31, 20X5, were $600,
and the consolidated earnings for the annual period
ended December 31, 20X6, are $800. There was no change
in the number of common shares issued by Entity B during
the annual period ended December 31, 20X5, and during
the period from January 1, 20X6, to the date of the
reverse acquisition on September 30, 20X6. EPS for the
annual period ended December 31, 20X6, is calculated as
follows.
55-17 Restated EPS for the
annual period ending December 31, 20X5, is $4.00
(calculated as the earnings of Entity B of 600 divided
by the 150 common shares Entity A issued in the reverse
acquisition).
Case B: Not All the Shares of the Legal
Subsidiary Are Exchanged
55-18 This Case illustrates the
accounting for a reverse acquisition if not all of the
shares of the legal subsidiary, the accounting acquirer,
are exchanged in a business combination and a
noncontrolling interest results.
55-19 Assume the same facts as
in Case A except that only 56 of Entity B’s 60 common
shares are exchanged. Because Entity A issues 2.5 shares
in exchange for each common share of Entity B, Entity A
issues only 140 (rather than 150) shares. As a result,
Entity B’s shareholders own 58.3 percent of the issued
shares of the combined entity (140 of 240 issued
shares). The fair value of the consideration transferred
for Entity A, the accounting acquiree, is calculated by
assuming that the combination had been effected by
Entity B’s issuing additional common shares to the
shareholders of Entity A in exchange for their common
shares in Entity A. That is because Entity B is the
accounting acquirer, and paragraphs 805-30-30-7 through
30-8 require the acquirer to measure the consideration
exchanged for the accounting acquiree.
55-20 In calculating the number
of shares that Entity B would have had to issue, the
noncontrolling interest is ignored. The majority
shareholders own 56 shares of Entity B. For that to
represent a 58.3 percent equity interest, Entity B would
have had to issue an additional 40 shares. The majority
shareholders would then own 56 of the 96 issued shares
of Entity B and, therefore, 58.3 percent of the combined
entity. As a result, the fair value of the consideration
transferred for Entity A, the accounting acquiree, is
$1,600 (that is, 40 shares each with a fair value of
$40). That is the same amount as when all 60 of Entity
B’s shareholders tender all 60 of its common shares for
exchange. The recognized amount of the group’s interest
in Entity A, the accounting acquiree, does not change if
some of Entity B’s shareholders do not participate in
the exchange.
55-21 The noncontrolling
interest is represented by the 4 shares of the total 60
shares of Entity B that are not exchanged for shares of
Entity A. Therefore, the noncontrolling interest is 6.7
percent. The noncontrolling interest reflects the
noncontrolling shareholders’ proportionate interests in
the precombination carrying amounts of the net assets of
Entity B, the legal subsidiary. Therefore, the
consolidated statement of financial position is adjusted
to show a noncontrolling interest of 6.7 percent of the
precombination carrying amounts of Entity B’s net assets
(that is, $134 or 6.7 percent of $2,000).
55-22 The consolidated
statement of financial position at September 30, 20X6,
reflecting the noncontrolling interest is as
follows.
55-23 The noncontrolling
interest of $134 has 2 components. The first component
is the reclassification of the noncontrolling interest’s
share of the accounting acquirer’s retained earnings
immediately before the acquisition ($1,400 × 6.7% or
$93.80). The second component represents the
reclassification of the noncontrolling interest’s share
of the accounting acquirer’s issued equity ($600 × 6.7%
or $40.20).
ASC 805-50
Determining Cost
30-2 Asset
acquisitions in which the consideration given is cash
are measured by the amount of cash paid, which generally
includes the transaction costs of the asset acquisition.
However, if the consideration given is not in the form
of cash (that is, in the form of noncash assets,
liabilities incurred, or equity interests issued) and no
other generally accepted accounting principles (GAAP)
apply (for example, Topic 845 on nonmonetary
transactions or Subtopic 610-20), measurement is based
on either the cost which shall be measured based on the
fair value of the consideration given or the fair value
of the assets (or net assets) acquired, whichever is
more clearly evident and, thus, more reliably
measurable. For transactions involving nonmonetary
consideration within the scope of Topic 845, an acquirer
must first determine if any of the conditions in
paragraph 845-10-30-3 apply. If the consideration given
is nonfinancial assets or in substance nonfinancial
assets within the scope of Subtopic 610-20, the assets
acquired shall be treated as noncash consideration and
any gain or loss shall be recognized in accordance with
Subtopic 610-20.
In addition to the Codification guidance above, the following guidance may be
relevant to the determination of fair value amounts in a business combination:
-
Chapters 4 and 5 of Deloitte’s Roadmap Business Combinations, which provide additional guidance on fair value measurements in a business combination.
-
Section 10.2.7.4.3.1, which discusses the fair value measurement of assumed debt.
-
Cases A, B, and C of Example 1 in ASC 820-10-55 (see Sections 5.2.3.4 and 7.4).
10.10.14 Derivatives
ASC 815-10
35-1A As a practical expedient,
a receive-variable, pay-fixed interest rate swap for
which the simplified hedge accounting approach (see
paragraphs 815-20-25-133 through 25-138 for scope) is
applied may be measured subsequently at settlement value
instead of fair value.
35-1B The
primary difference between settlement value and fair
value is that nonperformance risk is not considered in
determining settlement value. One approach for
estimating the receive-variable, pay-fixed interest rate
swap’s settlement value is to perform a present value
calculation of the swap’s remaining estimated cash flows
using a valuation technique that is not adjusted for
nonperformance risk.
ASC 815-15
Hybrid Instruments That Are Separated
30-2 The
allocation method that records the embedded derivative
at fair value and determines the initial carrying value
assigned to the host contract as the difference between
the basis of the hybrid instrument and the fair value of
the embedded derivative shall be used to determine the
carrying values of the host contract component and the
embedded derivative component of a hybrid instrument if
separate accounting for the embedded derivative is
required by this Subtopic. (Note that Section 815-15-25
allows for a fair value election for hybrid financial
instruments that otherwise would require
bifurcation.)
30-3 The
objective is to estimate the fair value of the
derivative features separately from the fair value of
the nonderivative portions of the contract. Estimates of
fair value shall reflect all relevant features of each
component. For example, an embedded purchased option
that expires if the contract in which it is embedded is
prepaid would have a different value than an option
whose term is a specified period that is not subject to
truncation.
Limitation on Sum of Component Fair
Values
35-3 If the
host contract component of a hybrid instrument is
reported at fair value with changes in fair value
recognized in earnings or other comprehensive income,
then the sum of the fair values of the host contract
component and the embedded derivative shall not exceed
the overall fair value of the hybrid instrument.
10.10.15 Leases
ASC 842-30
Fair Value of the Underlying Asset
55-17A
Notwithstanding the definition of fair value, if a
lessor is not a manufacturer or a dealer, the fair value
of the underlying asset at lease commencement is its
cost, reflecting any volume or trade discounts that may
apply. However, if there has been a significant lapse of
time between the acquisition of the underlying asset and
lease commencement, the definition of fair value shall
be applied.
ASC 842-50
Leveraged Lease Involving an Existing Asset of a
Regulated Entity
55-1 Although
the carrying amount of an asset acquired previously may
not differ significantly from its fair value, it is
unlikely that the two will be the same. However,
regulated utilities have argued that the carrying
amounts of certain of their assets always equal the fair
value based on the utility’s ability to recover that
cost in conjunction with a franchise to sell a related
service in a specified area. That argument is not valid
when considering the value of the asset to a third-party
purchaser that does not own that franchise.
For more information about how an entity should consider fair
value estimates in applying ASC 842, see Deloitte’s Roadmap Leases.
10.10.16 Nonmonetary Transactions
ASC 845-10
Basic Principle
30-1 In
general, the accounting for nonmonetary transactions
should be based on the fair values of the assets (or
services) involved, which is the same basis as that used
in monetary transactions. Thus, the cost of a
nonmonetary asset acquired in exchange for another
nonmonetary asset is the fair value of the asset
surrendered to obtain it, and a gain or loss shall be
recognized on the exchange. The fair value of the asset
received shall be used to measure the cost if it is more
clearly evident than the fair value of the asset
surrendered. Similarly, a nonmonetary asset received in
a nonreciprocal transfer shall be recorded at the fair
value of the asset received. A transfer of a nonmonetary
asset to a stockholder or to another entity in a
nonreciprocal transfer shall be recorded at the fair
value of the asset transferred and a gain or loss shall
be recognized on the disposition of the asset.
30-2 The fair
value of an entity’s own stock reacquired may be a more
clearly evident measure of the fair value of the asset
distributed in a nonreciprocal transfer if the
transaction involves distribution of a nonmonetary asset
to eliminate a disproportionate part of owners’
interests (that is, to acquire stock for the treasury or
for retirement). If one of the parties in a nonmonetary
transaction could have elected to receive cash instead
of the nonmonetary asset, the amount of cash that could
have been received may be evidence of the fair value of
the nonmonetary assets exchanged.
Commercial Substance
30-4 A
nonmonetary exchange has commercial substance if the
entity’s future cash flows are expected to significantly
change as a result of the exchange. The entity’s future
cash flows are expected to significantly change if
either of the following criteria is met:
-
The configuration (risk, timing, and amount) of the future cash flows of the asset(s) received differs significantly from the configuration of the future cash flows of the asset(s) transferred. The configuration of future cash flows is composed of the risk, timing, and amount of the cash flows. A change in any one of those elements would be a change in configuration.
-
The entity-specific value of the asset(s) received differs from the entity-specific value of the asset(s) transferred, and the difference is significant in relation to the fair values of the assets exchanged. An entity-specific value (referred to as an entity-specific measurement in FASB Concepts Statement No. 7, Using Cash Flow Information and Present Value in Accounting Measurements) is different from a fair value measurement. As described in paragraph 24(b) of Concepts Statement No. 7, an entity-specific value attempts to capture the value of an asset or liability in the context of a particular entity. For example, an entity computing an entity-specific value of an asset would use its expectations about its use of that asset rather than the use assumed by marketplace participants. If it is determined that the transaction has commercial substance, the exchange would be measured at fair value, rather than at the entity-specific value.
A qualitative assessment will, in some cases, be
conclusive in determining that the estimated cash flows
of the entity are expected to significantly change as a
result of the exchange.
Applying the Basic Principle
30-8 Fair
value should be regarded as not determinable within
reasonable limits if major uncertainties exist about the
realizability of the value that would be assigned to an
asset received in a nonmonetary transaction accounted
for at fair value. An exchange involving parties with
essentially opposing interests is not considered a
prerequisite to determining a fair value of a
nonmonetary asset transferred; nor does an exchange
ensure that a fair value for accounting purposes can be
ascertained within reasonable limits. If neither the
fair value of a nonmonetary asset transferred nor the
fair value of a nonmonetary asset received in exchange
is determinable within reasonable limits, the recorded
amount of the nonmonetary asset transferred from the
entity may be the only available measure of the
transaction.
ASC 845-10-30-2 states that “[i]f one of the parties in a nonmonetary transaction
could have elected to receive cash instead of the nonmonetary asset, the amount
of cash that could have been received may be evidence of the fair value of the
nonmonetary assets exchanged.” The cash that could have been received in lieu of
the nonmonetary asset exchanged may constitute evidence of fair value; however,
it should not be considered a substitute for, or an expedient way of
determining, fair value. The initial fair value measurement of the nonmonetary
asset exchanged should be determined in accordance with ASC 820.
10.10.17 Reorganizations
10.10.17.1 General
ASC 852-20
30-2 A
write-down of assets below amounts that are likely
to be subsequently realized, though it may result in
conservatism in the balance sheet at the
readjustment date, may also result in overstatement
of earnings or of retained earnings when the assets
are subsequently realized. Therefore, in general,
assets shall be carried forward as of the date of
readjustment at fair and not unduly conservative
amounts, determined with due regard for the
accounting to be subsequently employed by the
entity.
30-3 If the
fair value of any asset is not readily determinable
a conservative estimate may be made, but in that
case the amount shall be described as an estimate.
Paragraph 852-20-35-2 describes the subsequent
accounting for any material difference arising
through realization or otherwise and not
attributable to events occurring or circumstances
arising after that date.
General
35-2 If the
fair value of any asset was not readily determinable
and a conservative estimate was made at the date of
the readjustment, any material difference arising
through realization or otherwise and not
attributable to events occurring or circumstances
arising after that date shall not be carried to
income or retained earnings. Similarly, if
provisions for losses or charges established at the
date of readjustment are subsequently found to have
been excessive or insufficient, the difference shall
not be carried to retained earnings nor used to
offset losses or gains originating after the
readjustment, but shall be recorded as additional
paid-in capital.
SEC Staff Accounting Bulletin
SAB Topic 5.S, Quasi-Reorganization
[Reproduced in ASC 852-20-S99-2]
Question 3: In connection with a
quasi-reorganization, may there be a write-up of net
assets?
Interpretive Response: No. The staff
believes that increases in the recorded values of
specific assets (or reductions in liabilities) to
fair value are appropriate providing such
adjustments are factually supportable, however, the
amount of such increases are limited to offsetting
adjustments to reflect decreases in other assets (or
increases in liabilities) to reflect their new fair
value. In other words, a quasi-reorganization should
not result in a write-up of net assets of the
registrant.
10.10.17.2 Determining Fair Value of Net Assets in a Quasi-Reorganization
ASC 852-20-30-2 and 30-3 provide guidance on the valuation of assets (and
liabilities) in a quasi-reorganization. In a quasi-reorganization, an
entity’s assets and liabilities (net assets) should be remeasured to fair
value. Generally, an entity should calculate the fair value of net assets
the same way it measures assets acquired and liabilities assumed in a
business combination, as described in ASC 805-20-25 and ASC 805-20-30. (See
Section 2.3.6.1 for a discussion of exceptions to applying
the guidance in ASC 805-20-25 and ASC 805-20-30.) In addition, disposition
of an asset shortly after a quasi-reorganization (e.g., generally within one
year) serves as persuasive evidence of the value of the asset as of the date
of the quasi-reorganization unless a significant event validates a change in
the value of the asset in the intervening period.
Accordingly, some assets may be written up and others may be written down in
value. However, the quasi-reorganization adjustments in total must not
result in a write-up of net assets. If the calculated fair value adjustments
would result in a write-up of net assets, the entity should first reduce
goodwill, then other intangible assets, and then other noncurrent assets
until the adjustment of net assets equals zero.
10.10.17.2.1 Determining Fair Value of Inventories
As discussed in Section
10.10.17.2, the process for calculating the fair value of
an entity’s net assets in a quasi-reorganization should generally be the
same as that for adjusting assets and liabilities to fair value in a
business combination. ASC 805-20-30-1 requires that finished goods and
works-in-process inventories be measured at fair value. However, the
guidance in ASC 805-20-30-1 should not necessarily be used to value
inventories in a quasi-reorganization. An entity effecting a
quasi-reorganization may either use the approach in ASC 805-20-30-1 or
value its inventories on the basis of replacement costs. The
replacement-costs valuation technique is appropriate for inventories
because the entity is a continuing entity that, in fact, manufactured
the inventories in question.
10.10.17.3 Impact of Quasi-Reorganization Fair Value Adjustments on Impairment Testing
ASC 360-10-35-21 states that “[a] long-lived asset (asset group) shall be
tested for recoverability whenever events or changes in circumstances
indicate that its carrying amount may not be recoverable.” An impairment
loss that would result from such an evaluation is treated differently than a
fair value adjustment recognized in a quasi-reorganization. An entity must
use significant judgment in determining whether an asset is impaired when a
fair value write-down would otherwise be made in a quasi-reorganization.
When an asset impairment, rather than an adjustment of fair value, is
recorded in a quasi-reorganization, impairment losses are reflected in the
statement of operations for the period before the effective date of the
reorganization and fair value adjustments in a quasi-reorganization are
reflected as direct entries to the accumulated deficit. A pending
quasi-reorganization should be regarded as an impairment indicator and,
accordingly, impairment should be assessed immediately before the effective
date of the reorganization.
10.10.18 Transfers and Servicing
ASC 860-20
Estimating the Fair Value of Certain Beneficial
Interests
55-16 Trust
liquidation methods that allocate receipts of principal
or interest between beneficial interest holders and
transferors in proportions different from their stated
percentage of ownership interests do not affect whether
the transferor should obtain sale accounting and
derecognize those transferred assets, assuming the trust
is not required to be consolidated by the transferor.
However, both turbo and bullet provisions in
securitization structures (as discussed in paragraph
860-10-05-3) should be taken into consideration in
determining the fair values of assets obtained by the
transferor and transferee.
ASC 860-50
30-1 An
entity shall initially measure at fair value, a
servicing asset or servicing liability that qualifies
for separate recognition regardless of whether explicit
consideration was exchanged.
30-2
Typically, the benefits of servicing are expected to be
more than adequate compensation to a servicer for
performing the servicing, and the contract results in a
servicing asset. However, if the benefits of servicing
are not expected to adequately compensate a servicer for
performing the servicing, the contract results in a
servicing liability. Paragraph 860-50-35-1A states that
a servicing asset may become a servicing liability, or
vice versa, if circumstances change. The initial measure
for servicing may be zero if the benefits of servicing
are just adequate to compensate the servicer for its
servicing responsibilities. A servicing contract that
entitles the servicer to receive benefits of servicing
just equal to adequate compensation, regardless of the
servicer’s own servicing costs, does not result in
recognizing a servicing asset or a servicing liability.
A purchaser would neither pay nor receive payment to
obtain the right to service for a rate just equal to
adequate compensation.
30-3 The
determination of whether the servicer is adequately
compensated for servicing specified assets is based on
the amount demanded by the marketplace, not the
contractual amount to be paid to a replacement servicer.
However, that contractual provision would be relevant
for determining the amount of contractually specified
servicing fees. Therefore, the amount that would be paid
to a replacement servicer under the terms of the
servicing contract can be more or less than adequate
compensation.
30-4 Whether
a servicing asset or servicing liability is recorded is
a function of the marketplace, not the servicer’s cost
of servicing. For example, a loss shall not be
recognized if a servicing fee that is equal to or
greater than adequate compensation is to be received but
the servicer’s anticipated cost of servicing would
exceed the fee.
30-6 When
valuing the right to receive future cash flows from
ancillary sources such as late fees, an entity shall
estimate the value of the right to benefit from the cash
flows of potential future transactions, not the value of
the expected cash flows to be derived from future
transactions.
30-7 Entities
shall consider the nature of the assets being serviced
as a factor in determining the fair value of a servicing
asset or servicing liability. The types of assets being
serviced affect the amount required to adequately
compensate the servicer. Several variables, including
the nature of the underlying assets, shall be considered
in determining whether a servicer is adequately
compensated. For example, the amount of effort required
to service a home equity loan likely would be different
from the amount of effort required to service a credit
card receivable or a small business administration
loan.
In initially recognizing an asset for a servicing right (or a liability for a
servicing obligation) under ASC 860-50, an entity must compare the (1) estimated
future revenues from contractually specified servicing fees, late charges, and
other ancillary revenues (benefits of servicing) with (2) adequate compensation.
The concept of “adequate compensation” focuses on the benefits that fairly
compensate a substitute servicer if one is required, including the profit that
would be demanded in the marketplace. Since adequate compensation is determined
in the marketplace, a servicer’s internal costs of servicing financial assets do
not factor into the determination of the fair value of servicing assets or
liabilities.
The cost of servicing financial assets varies among servicers and depends on
factors such as the volume of financial assets serviced, the geographic location
of the servicer, and the efficiency of the servicer. Accordingly, a servicer’s
own cost of servicing financial assets is not relevant in the determination of
adequate compensation. The determination of adequate compensation in an illiquid
market often involves significant analysis and should be well documented.
Adequate compensation is also discussed in ASC 860-50-30-2 through 30-7.
The approach in ASC 860 is consistent with the guidance in ASC
820, emphasizing that fair value measurement is market-based, not
entity-specific. Therefore, a fair value measurement would also be determined on
the basis of assumptions that market participants would use in pricing the
servicing asset or liability. For more information about the accounting for
servicing rights, see Chapter 6 of
Deloitte’s Roadmap Transfers and Servicing of Financial Assets.
10.10.19 Industry Guidance
10.10.19.1 ASC 926, Entertainment — Films
ASC 926-20
Film Costs Valuation
35-14 A discounted cash flow
model may be used to estimate fair value. If
applicable, future cash flows based on the terms of
any existing contractual arrangements, including
cash flows over existing license periods without
consideration of the limitations set forth in
paragraph 926-20-35-5, shall be included.
An entity shall consider the
following factors, among others, in estimating
future cash inflows for a film:
-
If previously released, the film’s performance in prior markets
-
The public’s perception of the film’s story, cast, director, or producer
-
Historical results of similar films
-
Historical results of the cast, director, or producer on prior films
-
Running time of the film.
In determining a film’s (or film
group’s) fair value, it is also necessary to
consider those cash outflows necessary to generate
the film’s (or film group’s) cash inflows.
Therefore, an entity shall incorporate, if
applicable, its estimates of future costs to
complete a film, future exploitation and
participation costs, or other necessary cash
outflows in its determination of fair value when
using a discounted cash flow model.
35-16 When using the
traditional discounted cash flow approach to
estimate the fair value of a film (or film group),
the relevant future cash inflows and outflows shall
represent the entity’s estimate of the most likely
cash flows. When determining the fair value of a
film (or film group) using the expected cash flow
approach, all possible relevant future cash inflows
and outflows shall be probability-weighted by period
and the estimated mean or average by period shall be
used.
35-17 When determining the
fair value of a film (or film group) using a
traditional discounted cash flow approach, the
discount rate(s) shall not be an entity’s
incremental borrowing rate(s), liability settlement
rate(s), or weighted average cost of capital because
those rates typically do not reflect the risks
associated with a particular film (or film group).
The discount rate(s) shall consider the time value
of money and the expectations about possible
variations in the amount or timing of the most
likely cash flows and an element to reflect the
price market participants would seek for bearing the
uncertainty inherent in such an asset, as well as
other factors, sometimes unidentifiable, including
illiquidity and market imperfections. When
determining the fair value of a film (or film group)
using the expected cash flow approach, the discount
rate(s) also would consider the time value of money.
Because they are reflected in the expected cash
flows, there would be no adjustment for possible
variations in the amounts or timing of those cash
flows. If not reflected in risk-adjusted expected
cash flows, an additional element to reflect the
price market participants would seek for bearing the
uncertainty inherent in such an asset as well as
other factors, sometimes unidentifiable, including
illiquidity and market imperfections, shall be added
to the discount rate(s).
Film Properties
40-3 An
entity shall measure the loss as the amount by which
the carrying amount of the project exceeds its fair
value. Unless management, having the authority to
approve the action, has committed to a plan to sell
such property, the rebuttable presumption is that
the entity will abandon the property and, as such,
its fair value shall be zero.
10.10.19.2 ASC 930, Extractive Activities
ASC 930-805
Value Beyond Proven and Probable Reserves
30-1 An
entity shall include value beyond proven and
probable reserves in the value allocated to mining
assets in a purchase price allocation to the extent
that a market participant would include value beyond
proven and probable reserves in determining the fair
value of the asset.
Anticipated Future Price Fluctuations
30-2 An
entity shall include the effects of anticipated
fluctuations in the future market price of minerals
in determining the fair value of mining assets in a
purchase price allocation in a manner that is
consistent with the expectations of marketplace
participants. Generally, an entity should consider
all available information including current prices,
historical averages, and forward pricing curves.
Those marketplace assumptions typically should be
consistent with the acquiring entity’s operating
plans with respect to developing and producing
minerals. It generally would be inappropriate for an
entity to use a single factor, such as the current
price or a historical average, as a surrogate for
estimating future prices without considering other
information that a market participant would
consider.
10.10.19.3 ASC 940, Financial Services — Brokers and Dealers
ASC 940-820
30-1 This Section does not
purport to delineate all factors that may be
considered by management in determining the fair
value assigned to a particular financial instrument.
However, the following is a list of certain factors
that have been taken into consideration by
broker-dealers as part of the determination of fair
value:
-
Financial standing of the issuer
-
Business and financial plan of the issuer
-
Cost at date of purchase
-
The liquidity of the market
-
Contractual restrictions on salability
-
Pending public offering with respect to the financial instrument
-
Pending reorganization activity affecting the financial instrument (such as merger proposals, tender offers, debt restructurings, and conversions)
-
Reported prices and the extent of public trading in similar financial instruments of the issuer or comparable entities
-
Ability of the issuer to obtain needed financing
-
Changes in the economic conditions affecting the issuer
-
A recent purchase or sale of a security of the entity
-
Pricing by other dealers in similar securities.
Pending Content (Transition Guidance: ASC
820-10-65-13)
This Section does not purport to delineate all
factors that may be considered by management in
determining the fair value assigned to a
particular financial instrument. However, the
following is a list of certain factors that have
been taken into consideration by broker-dealers as
part of the determination of fair value:
-
Financial standing of the issuer
-
Business and financial plan of the issuer
-
Cost at date of purchase
-
The liquidity of the market
-
Restrictions on salability (see paragraphs 820-10-35-6B and 820-10-35-36B)
-
Pending public offering with respect to the financial instrument
-
Pending reorganization activity affecting the financial instrument (such as merger proposals, tender offers, debt restructurings, and conversions)
-
Reported prices and the extent of public trading in similar financial instruments of the issuer or comparable entities
-
Ability of the issuer to obtain needed financing
-
Changes in the economic conditions affecting the issuer
-
A recent purchase or sale of a security of the entity
-
Pricing by other dealers in similar securities.
See also Sections 9.2 and 10.10.2.
10.10.19.4 ASC 942, Financial Services — Depository and Lending
ASC 942-310
Debt-Equity Swap Programs
30-2 Since
the secondary market for debt of financially
troubled countries may be considered to be thin, it
may not be the best indicator of the fair value of
the equity investment or of net assets received. In
light of this thin secondary market and of the
unique nature of the transaction, it is also
necessary to examine the fair value of the equity
investment or net assets received. In arriving at
the fair value of a debt-equity swap, both the
secondary market price of the loan given up and the
fair value of the equity investment or net assets
received shall be considered.
30-3 It is
the responsibility of management to measure fair
value considering all of the circumstances and to
see that the measurement of fair value is based on
reasonable methods and assumptions consistent with
Topic 820, including, as needed, information from
independent appraisals. Factors to consider in
measuring fair values include the following:
-
Similar transactions for cash
-
Estimated cash flows from the equity investment or net assets received
-
Fair value of similar equity investments, if any
-
Currency restrictions, if any, affecting dividends, the sale of the investment, or the repatriation of capital.
ASC 942-470
Fair Value of Deposit Liabilities
50-1 In
estimating the fair value of deposit liabilities, a
financial entity shall not take into account the
value of its long-term relationships with
depositors, commonly known as core deposit
intangibles, which are separate intangible assets,
not financial instruments.
10.10.19.5 ASC 944, Financial Services — Insurance
ASC 944-40
Pending Content (Transition Guidance: ASC
944-40-65-2)
Discount Rate
55-13E An insurance entity
should maximize the use of current observable
market prices of upper-medium-grade
(low-credit-risk) fixed-income instruments with
durations similar to the liability for future
policy benefits.
-
An insurance entity should not substitute its own estimates for observable market data unless the market data reflect transactions that are not orderly (see paragraphs 820-10-35-54I through 35-54J for additional guidance on determining whether transactions are not orderly).
-
In determining points on the yield curve for which there are limited or no observable market data for upper-medium-grade (low-credit-risk) fixed-income instruments, an insurance entity should use an estimate that is consistent with existing guidance on fair value measurement in Topic 820, particularly for Level 3 fair value measurement.
10.10.19.6 ASC 946, Financial Services — Investment Companies
ASC 946-320
Dividends
35-6 Stock splits and stock
dividends in shares of the same class as the shares
owned are not income to the investment company.
However, dividends for which the recipient has the
choice to receive cash or stock are usually
recognized as investment income in the amount of the
cash option, because in such cases cash is usually
the best evidence of fair value of the stock.
ASC 946-320-S99-12, ASC 946-320-S99-13, ASC 946-320-S99-17, ASC
946-320-S99-21, and ASC 946-320-S99-22 contain additional SEC guidance on
the valuation of securities of a registered investment company, including
the guidance in ASR 118.
ASC 946-830
Purchased
Interest
45-14 Purchased interest
represents the interest accrued between the last
coupon date and the settlement date of the purchase.
It should be recorded in the functional currency as
interest receivable at the spot rate on the purchase
trade date, and subsequently measured at fair value
using each valuation date’s spot rate. After the
settlement date, daily interest income should be
accrued at the daily spot rate. It may be
impractical to prepare the foregoing calculations
daily, and, therefore, the use of a weekly or
monthly average rate may be appropriate in many
cases, especially if the exchange rate does not
fluctuate significantly. However, if the exchange
rate fluctuation is significant, the calculation
should be made daily.
Subsequently
Measuring at Fair Value
45-16 The fair value of
securities shall initially be determined in the
foreign currency and translated at the spot rate on
the purchase trade date. The unrealized gain or loss
between the original cost (translated on the trade
date) and the fair value (translated on the
valuation date) comprises both of the following
elements:
-
Changes in the fair value of securities before translation
-
Movement in foreign currency rate.
10.10.19.7 ASC 948, Financial Services — Mortgage Banking
ASC 948-310
Loans Held for Sale
35-3 The fair value of
mortgage loans and mortgage-backed securities held
for sale shall be measured by type of loan. At a
minimum, the fair value of residential (one- to
four-family dwellings) and commercial mortgage loans
shall be measured separately. Either the aggregate
or individual loan basis may be used in determining
the lower of amortized cost basis or fair value for
each type of loan. Fair value for loans subject to
investor purchase commitments (committed loans) and
loans held on a speculative basis (uncommitted
loans) shall be measured separately as follows:
-
Committed loans. Mortgage loans covered by investor commitments shall be based on the fair values of the loans.
-
Uncommitted loans. Fair value for uncommitted loans shall be based on principal market or, in the absence of a principal market, in the most advantageous market (see paragraphs 820-10-35-5 through 35-6C). That determination relies on the principles in Topic 820 and would include consideration of the following:
-
Market prices and yields sought by market participants in the principal or most advantageous market
-
Quoted Government National Mortgage Association (GNMA) security prices or other public market quotations for long-term mortgage loan rates
-
Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA) current delivery prices.
-
- Subparagraph superseded by Accounting Standards Update No. 2012-04.
Other Considerations
35-6
Capitalized costs of acquiring rights to service
mortgage loans, associated with the purchase or
origination of mortgage loans (see paragraph
860-50-25-1), shall be excluded from the cost of
mortgage loans for the purpose of determining the
lower of cost or fair value.
10.10.19.8 ASC 958, Not-for-Profit Entities
ASC 958-30
Fair Value
Measurement
30-1 Topic 820 establishes a
framework for measuring fair value. This Subtopic
uses present value techniques as one possible
technique to measure the contribution revenue and
obligation to other beneficiaries of a
split-interest agreement. See paragraphs 820-10-55-4
through 55-20 for implementation guidance for using
present value techniques if the measurement
objective is fair value. Other valuation techniques
are also available, as discussed in Section
820-10-35.
Split-Interest
Agreements Other Than Pooled Income Funds or
Net-Income Unitrusts
30-5 If the split-interest
agreement is other than a pooled income fund or net
income unitrust (for example, a charitable gift
annuity, a charitable lead trust, or a charitable
remainder trust), the transferred assets, or a
portion of those assets, are being held for the
benefit of others, such as the donor or third
parties designated by the donor. That liability
shall be measured at fair value at the date of
initial recognition. If present value techniques are
used to measure fair value, the liability is
measured at the present value of the future payments
to be made to the other beneficiaries.
30-6 Any present value
technique for measuring the fair value of the
contribution or payments to be made to other
beneficiaries shall consider the elements described
in paragraph 820-10-55-5, including the
following:
-
The estimated return on the invested assets during the expected term of the agreement
-
The contractual payment obligations under the agreement
-
A discount rate commensurate with the risks involved.
30-7 Under a lead interest
agreement, the fair value of the contribution can be
estimated directly based on the present value of the
future distributions to be received by the NFP as a
beneficiary. Under lead interest agreements, the
future payments to be made to other beneficiaries
will be made by the NFP only after the NFP receives
its benefits. In those situations, the present value
of the future payments to be made to other
beneficiaries may be estimated by the fair value of
the assets contributed by the donor under the
agreement less the fair value of the benefits to be
received by the NFP. If present value techniques are
used, the fair value of the benefits to be received
by the NFP shall be measured at the present value of
the benefits to be received over the expected term
of the agreement.
30-8 Under remainder interest
agreements, the present value of the future payments
to be made to other beneficiaries can be estimated
directly based on the terms of the agreement. Future
distributions will be received by the NFP only after
obligations to other beneficiaries are satisfied. In
those cases, the fair value of the contribution may
be estimated based on the fair value of the assets
contributed by the donor less the fair value of the
payments to be made to other beneficiaries.
Pooled Income Funds or Net-Income
Unitrusts
30-10 The contributed assets
received from the donor under a pooled income fund
agreement or a net income unitrust shall be
recognized at fair value. The contribution shall be
measured at fair value. Present value techniques are
one valuation technique for measuring the fair value
of the contribution; other valuation techniques are
also available, as described in Topic 820. If
present value techniques are used, the contribution
may be measured at the fair value of the assets to
be received, discounted for the estimated time
period until the donor’s death.
Fair Value
Measurement
35-1 Topic 820 establishes a
framework for measuring fair value. This Subtopic
uses present value techniques as one possible
technique to measure the obligation to other
beneficiaries of a split-interest agreement. See
paragraphs 820-10-55-4 through 55-20 for
implementation guidance for using present value
techniques if the measurement objective is fair
value.
35-2 The measurement
objective is fair value for the following
split-interest obligations:
-
Embedded derivatives subject to the measurement provisions of Topic 815
-
Obligations for which the not-for-profit entity (NFP) elects the fair value option pursuant to the Fair Value Option Subsections of Subtopic 825-10
-
Obligations containing embedded derivatives that the NFP has irrevocably elected to measure in their entirety at fair value in conformity with Section 815-15-25.
Additionally, in circumstances in
which cash or other assets contributed by donors
under split-interest agreements are held by
independent trustees, such as a charitable trust for
which a bank is a trustee, or by other fiscal agents
of the donors or otherwise not controlled by the
NFP, the measurement objective for the beneficial
interest in periods after the period of initial
recognition is fair value.
35-3 In circumstances in
which the fair value is measured at the present
value of the future cash flows, all elements
discussed in paragraph 820-10-55-5, including
discount rate assumptions, shall be revised at each
measurement date to reflect current market
conditions.
Split-Interest Agreements With
Embedded Derivatives
35-7 If an NFP does not elect
to report a split-interest obligation at fair value
as described in paragraph 958-30-35-2, a
split-interest obligation with an embedded
derivative is bifurcated into its debt host contract
and embedded derivative. The debt host contract is
the liability for the payment to the beneficiary
that would be required if the fair value of the
trust assets does not change over the specified
period. The embedded derivative represents the
liability (or contraliability) for the increase (or
decrease) in the payments to the beneficiary due to
changes in the fair value of the trust assets over
the specified period. In circumstances in which the
liability is measured using present value
techniques, the discount rate assumptions on the
debt host contract shall not be revised after
initial recognition, consistent with the preceding
paragraph. In accordance with paragraph 815-10-35-1,
the embedded derivative is subsequently measured at
fair value. If the fair value of the embedded
derivative is measured using present value
techniques, all elements discussed in paragraph
820-10-55-5, including the discount rate assumptions
on the embedded derivative, shall be revised at each
measurement date to reflect current market
conditions.
35-8 In conformity with
paragraph 815-15-25-53, if an NFP cannot reliably
identify and measure the embedded derivative, the
entire split-interest liability shall be measured at
fair value (that is, all elements discussed in
paragraph 820-10-55-5, including discount rate
assumptions, shall be revised to reflect current
market conditions).
Assets Held
by a Third Party
35-10 Pursuant to paragraph
958-605-35-3, if an NFP is the beneficiary of a
split-interest agreement held by a third party and
has an unconditional right to receive all or a
portion of the specified cash flows from the assets
held pursuant to that agreement, the NFP shall
subsequently remeasure that beneficial interest at
fair value. Changes in the fair value of the
beneficial interest shall be recognized in the
statement of activities. The change in the value of
split-interest agreements is the change in the fair
value of the NFP’s beneficial interest, which shall
be determined using the same valuation technique
that was used to measure the asset initially.
Distributions from the trust shall be reflected as a
reduction in the beneficial interest.
ASC 958-310
Fair Value
Measurement
35-1 The Fair Value Option
Subsections of Subtopic 825-10 create a fair value
option under which a not-for-profit entity (NFP) may
irrevocably elect fair value as the initial and
subsequent measure for most receivables. If an NFP
elects to measure a receivable at fair value and
uses a present value technique to measure fair
value, the discount rate assumptions, and all other
elements discussed in paragraph 820-10-55-5 shall be
revised at each measurement date to reflect current
market conditions. Paragraph 820-10-35-2B states
that a fair value measurement takes into account the
effect of a restriction on the sale or use of an
asset if market participants would take into account
the effect of the restriction when pricing the
asset. Example 6 (see paragraph 820-10-55-51)
illustrates that restrictions that are a
characteristic of an asset and, therefore, would
transfer to a market participant are the only
restrictions reflected in fair value. Donor
restrictions that are specific to the donee are
reflected in the classification of net assets, not
in the measurement of fair value.
Changes in
the Fair Value of Underlying Noncash Assets —
Gifts of Certain Securities
35-11 The value of a
contribution receivable arising from an
unconditional promise to give equity securities with
readily determinable fair values or debt securities
may change between the date the unconditional
promise to give is recognized and the date the asset
promised is received because of changes in the
future fair value of the underlying securities. For
purposes of subsequent measurement, the method of
determining the future fair value of the underlying
securities shall be the same as the method used for
determining that amount for purposes of initial
measurement. Thus, if a promise to give securities
is measured based on the fair value of the
underlying securities at the date of gift, as
described in paragraph 958-605-30-8, an observed
change in the current fair value of the underlying
securities shall be recognized. The change shall be
reported as an increase or a decrease in
contribution revenue in the period(s) in which the
change occurs. The change shall be recognized in the
net asset class in which the contribution was
originally reported or in the net asset class in
which the net assets are represented.
Changes in
the Fair Value of Underlying Noncash Assets —
Gifts of Other Assets
35-12 The value of a
contribution receivable arising from an
unconditional promise to give noncash assets other
than equity securities with readily determinable
fair values or debt securities may change between
the date the unconditional promise to give is
recognized and the date the asset promised is
received because of changes in the future fair value
of the underlying noncash assets. For purposes of
subsequent measurement, the method for determining
the future fair value of the underlying noncash
asset shall be the same as the method used for
determining that amount for purposes of initial
measurement. Accordingly, assumed relationships,
such as the relationship between the market price of
the noncash asset at the time the initial
measurement is made and its projected market price
at the date the asset is expected to be received,
shall be presumed to continue in determining whether
the future fair value of the underlying noncash
asset has changed.
ASC 958-405
Liability for
Promises to Give
35-1 If the present value of
the amounts to be paid is used to measure fair value
of an unconditional promise to give at initial
recognition, in conformity with paragraphs
835-30-25-10 through 25-11, the discount rate shall
be determined at the time the unconditional promise
to give is initially recognized and shall not be
revised, unless the promise to give is subsequently
remeasured at fair value pursuant to the Fair Value
Option Subsections of Subtopic 825-10.
ASC 958-605
30-3
Paragraph 820-10-35-2B states that a fair value
measurement takes into account the effect of a
restriction on the sale or use of an asset if market
participants would take into account the effect of
the restriction when pricing the asset. Example 6
(see paragraph 820-10-55-51) illustrates that
restrictions that are a characteristic of an asset,
and, therefore, would transfer to a market
participant, are the only restrictions reflected in
fair value. Donor restrictions that are specific to
the donee are reflected in the classification of net
assets, not in the measurement of fair value.
Unconditional Promises to Give
30-4 If
present value techniques are used to measure the
fair value of unconditional promises to give, the
entity shall determine the amount and timing of the
future cash flows of unconditional promises to give
cash (or, for promises to give noncash assets, the
quantity and nature of assets expected to be
received). In making that determination, the entity
shall consider all the elements in paragraph
820-10-55-5, including the following:
-
When the receivable is expected to be collected
-
The creditworthiness of the other parties
-
The entity’s past collection experience
-
The entity’s policies concerning the enforcement of promises to give
-
Expectations about possible variations in the amount or timing of the cash flows (that is, the uncertainty inherent in the cash flows)
-
Other factors concerning the receivable’s collectibility.
30-5 If
present value techniques are used to measure fair
value, the present value of unconditional promises
to give should be measured using a discount rate
that is consistent with the general principles for
present value measurement discussed in paragraphs
820-10-55-5 through 55-9. In conformity with
paragraph 835-30-25-11, the discount rate shall be
determined at the time the unconditional promise to
give is initially recognized and shall not be
revised subsequently unless the entity has elected
to measure the promise to give at fair value in
conformity with the Fair Value Option Subsections of
Subtopic 825-10.
30-6
Unconditional promises to give that are expected to
be collected in less than one year may be measured
at net realizable value because that amount results
in a reasonable estimate of fair value.
30-7 If a
promise to give has not previously been recognized
as contribution revenue because it was conditional,
fair value shall be measured when the conditions are
met.
Unconditional Promises to Give Noncash
Assets
30-8 A
present value technique is one valuation technique
for measuring the fair value of an unconditional
promise to give noncash assets; other valuation
techniques also are available, as described in Topic
820. If present value techniques are used, the fair
value of contributions arising from unconditional
promises to give noncash assets might be determined
based on the present value of the projected fair
value of the underlying noncash assets at the date
that those assets are expected to be received (that
projected fair value is referred to in this Section
as the future fair value) and in the
quantities that those assets are expected to be
received, if the date is one year or more after the
financial statement date. Both the likelihood of the
promise being fulfilled and the future fair value of
those underlying assets, such as the future fair
value per share of a promised equity security,
should be considered in determining the future
amount to be discounted. The quantity, nature, and
timing of assets expected to be received, such as
the number of shares of a promised equity security,
the entity in which those shares represent an equity
interest, and when those shares will be received
should be considered in determining the likelihood
of the promise being fulfilled. In cases in which
the future fair value of the underlying asset is
difficult to determine, the fair value of an
unconditional promise to give noncash assets may be
based on the fair value of the underlying asset at
the date of initial recognition. No discount for the
time value of money shall be reported if an asset’s
fair value at the date of initial recognition is
used to measure the fair value of the
contribution.
Inventory Items
30-9 Inputs
for measuring fair value of contributed inventory
items may be obtained from published catalogs,
vendors, independent appraisals, and other sources.
If methods such as estimates, averages, or
computational approximations, such as average value
per pound or subsequent sales, can reduce the cost
of measuring the fair value of inventory, use of
those methods is appropriate, provided the methods
are applied consistently, and the results of
applying those methods are reasonably expected not
to be materially different from the results of a
detailed measurement of the fair value of
contributed inventory.
Contributed Services
30-10
Contributions of services that create or enhance
nonfinancial assets may be measured by referring to
either the fair value of the services received or
the fair value of the asset or of the asset
enhancement resulting from the services. Fair value
should be used for the measure regardless of whether
the NFP could afford to purchase the services at
their fair value.
Gifts in Kind
30-11 Gifts
in kind that can be used or sold shall be measured
at fair value. In determining fair value, entities
should consider the quality and quantity of the
gifts, as well as any applicable discounts that
would have been received by the entity, including
discounts based on that quantity if the assets had
been acquired in exchange transactions. Fair value
would generally not increase when a gift in kind is
passed from one entity to another. However, fair
value could increase if an entity adds value to the
gift, such as by cleaning and packaging the gift.
Any increases should be evaluated to determine
whether the entity did, in fact, add to the fair
value of the assets.
Specified Beneficiary
30-14 If the
beneficiary has an unconditional right to receive
all or a portion of the specified cash flows from a
charitable trust or other identifiable pool of
assets, the beneficiary shall measure that
beneficial interest at fair value. The fair value of
a perpetual trust held by a third party generally
can be measured using the fair value of the assets
contributed to the trust, unless facts and
circumstances indicate that the fair value of the
beneficial interest differs from the fair value of
the assets contributed to the trust. If the
beneficiary recognizes a receivable pursuant to
paragraph 958-605-25-30, the beneficiary shall
measure its rights to the assets held by a recipient
entity at fair value in accordance with paragraph
958-605-30-2 and paragraphs 958-605-30-4 through
30-7 for unconditional promises to give.
Specified Beneficiary
35-3 If the
beneficiary has an unconditional right to receive
all or a portion of the specified cash flows from a
charitable trust or other identifiable pool of
assets, the beneficiary shall subsequently remeasure
that beneficial interest at fair value (see
paragraph 958-30-35-10). The fair value of a
perpetual trust held by a third party generally can
be measured using the fair value of the assets of
the trust at the date of remeasurement, unless facts
and circumstances indicate that the fair value of
the beneficial interest differs from the fair value
of the assets contributed to the trust. Annual
distributions from a perpetual trust held by a third
party are reported as investment income.
Example 1: Contribution of Real
Property
55-34 Mission
A would recognize the contributed property as an
asset and as support and measure that property at
its fair value (see paragraph 958-605-30-2).
Information necessary to estimate the fair value of
that property could be obtained from various
sources, including amounts recently paid for similar
properties in the locality, and estimates of its
replacement cost adjusted to reflect the price that
would be received for the contributed property. This
contribution is revenue without donor restrictions
because the donated assets may be used for any
purpose and the donor did not impose a time
restriction.
Example 4: Contribution of
Utilities
55-44 The
simultaneous receipt and use of electricity or other
utilities is a form of contributed assets and not
services. Foundation D would recognize the fair
value of the contributed electricity as both revenue
and expense in the period it is received and used
(see paragraph 958-605-30-2). Foundation D could
estimate the fair value of the electricity received
by using rates normally charged to a consumer of
similar usage requirements.
Example 7: Contribution of Services to
Construct a Building
55-54
Institute G would recognize the services contributed
by the construction entity because the contributed
services received meet the condition in paragraph
958-605-25-16(a) (the services received create or
enhance nonfinancial assets) or because the services
meet the condition in paragraph 958-605-25-16(b)
(the services require specialized skills, are
provided by individuals possessing those skills, and
would typically need to be purchased if not provided
by donation). Contributions of services that create
or enhance nonfinancial assets may be measured by
referring to either the fair value of the services
received or the fair value of the asset or of the
asset enhancement resulting from the services (see
paragraph 958-605-30-10). In this Example, the fair
value of the contributed services received could be
determined by subtracting the cost of the purchased
services, materials, and permits ($400,000) from the
fair value of the asset created ($725,000), which
results in contributed services received of
$325,000. Alternatively, the amount the construction
entity would have charged could be used if more
readily available.
Example 8:
Contribution of Teaching Services
55-58
University H would recognize both revenue and
expense for the services contributed by the
uncompensated faculty members because the
contribution meets the condition in paragraph
958-605-25-16(b). Teaching requires specialized
skills; the religious personnel are qualified and
trained to provide those skills; and University H
typically would hire paid instructors if the
religious personnel did not donate their services.
University H could refer to the salaries it pays
similarly qualified compensated faculty members to
determine fair value of the services received.
55-59
Similarly, if the uncompensated faculty members were
given a nominal stipend to help defray certain of
their out-of-pocket expenses, University H still
would recognize both revenue and expense for the
services contributed. The contribution received
would be measured at the fair value of the services
received less the amount of the nominal stipend
paid.
Example 7: Donor Establishes a Charitable
Trust
55-98 The
Contribution Received Subsections of this Subtopic
do not establish standards for the trustee, National
Bank J (see paragraph 958-605-15-9). Because Museum
I is unable to influence the operating or financial
decisions of the trustee, Museum I and National Bank
are not financially interrelated entities.
Therefore, Museum I would recognize its asset (a
beneficial interest in the trust) and contribution
revenue that increases net assets with donor
restrictions (see paragraph 958-605-35-3). Museum I
would measure its beneficial interest at fair value.
That value generally can be measured by the fair
value of the assets contributed to the trust.
Example 10:
Resource Provider Names Itself as the Specified
Beneficiary
55-110 If a
resource provider transfers assets to a recipient
entity and specifies itself or its affiliate as the
beneficiary, a presumption that the transfer is
reciprocal, and therefore not a contribution, is
necessary even if the resource provider explicitly
grants the recipient entity variance power. Thus,
Symphony Orchestra M would recognize an asset and
Community Foundation N would recognize a liability
because the transaction is deemed to be reciprocal.
Symphony Orchestra M transfers its securities to
Community Foundation N in exchange for future
distributions. Community Foundation N, by its
acceptance of the transfer, agrees that at the time
of the transfer distributions to Symphony Orchestra
M are capable of fulfillment and consistent with the
foundation’s mission. Although the fair value of
those future distributions may not be commensurate
with the fair value of the securities given up
(because Symphony Orchestra M is at risk of
cessation of the distributions), the transaction is
accounted for as though those values are
commensurate. In comparison, the donors to Community
Foundation F in Example 5 (see paragraph
958-605-55-88) explicitly grant variance power to
Community Foundation F in a nonreciprocal transfer.
In that Example, it is clear that the donors have
made a contribution because they retain no
beneficial interests in the transferred assets.
Because the donors in that Example explicitly grant
variance power to Community Foundation F, it, rather
than City Botanical Society E, is the recipient of
that contribution.
10.10.19.9 ASC 962, Plan Accounting — Defined Contribution Pension Plans
ASC 962-325
Reporting at Fair
Value
35-2 Some
plan investments may not have Level 1 inputs to measure
fair value. Therefore, they will need to be measured in
accordance with the other valuation techniques described
in Topic 820. Examples include all of the following:
-
Real estate
-
Mortgages or other loans
-
Limited partnerships
-
Restricted securities
-
Unregistered securities
-
Securities that are traded in inactive markets
-
Nontransferable investment contracts.
35-3 Both of
the following are the obligation of the plan’s trustees,
the administrator, and the corporate trustee:
-
To satisfy themselves that all appropriate factors relevant to the value of the investments have been considered
-
To select a method to measure the fair value of the investments.
35-4 To the
extent considered necessary, the plan may use the
services of a specialist to assist the plan (or the
administrators) in measuring the fair value of
investments. Topic 820 provides guidance on how to
measure fair value.
Implementation
Guidance
55-1 The
following illustrate fair value and contract value
reporting guidance in paragraphs 962-325-35-5 through
35-12 (also see fully benefit-responsive investment
contract) for defined-contribution plan investments.
55-2 The
value is determined within the context of the objectives
of financial statements for a defined contribution plan.
The valuation must reflect the ability of the plan to
pay benefits from the perspective of the participants.
This value is then reflected on participants’ statements
to disclose the amount they can expect to receive when
they exercise their rights to withdraw, borrow, or
transfer funds under the terms of the plan.
A Five-Year
Public Bond (or Portfolio of Bonds) Guaranteed by
a Third Party to Have a Fixed Value at the End of
Three Years
55-3 A
five-year public bond (or portfolio of bonds) is
guaranteed by a third party to have a fixed value at the
end of three years. The guarantee applies only to the
extent that the bond (or portfolio) is not liquidated
before the end of three years. Liquidation within three
years is at fair value.
55-4 Because
guaranteed proceeds from the bond are not available for
benefit withdrawals or transfers prior to maturity, the
contract is not fully benefit-responsive and, therefore,
net assets available for benefits shall reflect the fair
value for this investment contract. Fair value should be
measured in accordance with Topic 820.
A
Benefit-Responsive Investment Contract
55-5 A
contract provides a fixed crediting interest rate, and a
financially responsible entity guarantees liquidity at
contract value before maturity for any and all
participant-initiated benefit withdrawals, loans, or
transfers arising under the terms of the plan, which
allows access for all participants on a quarterly
basis.
55-6 The net
assets available for benefits should reflect the
contract value for this investment contract, because the
plan will receive such value and only such value if the
contract is accessed to pay participant benefits or
transfers.
55-7 This
contract would be viewed as fully benefit-responsive.
Examples of some variations on this contract, and their
impact on the valuation, include the following:
-
Liquidity at contract value is not guaranteed for benefits that are attributable to termination of the plan, a plan spinoff to a new employer plan, or amendments to plan provisions. Net assets available for benefits should reflect the contract value for this investment contract, unless it is probable that the plan will be terminated, spun off, or amended.
-
Liquidity at contract value is not guaranteed for benefits that are attributable to the layoff of a large group of workers or an early retirement program. Net assets available for benefits should reflect the contract value for this investment contract, unless it is probable that termination of the employment of a significant number of employees will occur.
-
The contract will pay for benefits of up to 30 percent of the contract at contract value, and any excess benefits will be at some adjusted value. Net assets available for benefits should reflect the fair value for this investment contract because they are not fully benefit-responsive.
-
The contract will pay benefits at contract value, but only if the issuer of the contract determines that there is sufficient liquidity in the portfolio of assets that backs the contract. Because the third party has not guaranteed liquidity for participant-initiated withdrawals, net assets available for benefits should reflect the fair value for this investment contract because they are not fully benefit-responsive.
-
The contract will not pay benefits at contract value if benefits are due to participant transfers to another fixed income investment option, unless the funds are invested in an equity option for at least three months (equity wash provisions). Net assets available for benefits shall reflect the contract value for this investment contract because the contract would be considered fully benefit-responsive.
A Five-Year,
Non-Benefit-Responsive Investment Contract That
Has No Liquid Market for Trading
55-8 Net
assets available for benefits should reflect the fair
value for such an investment contract because there is
no guarantee of liquidity at contract value. Fair value
would be measured in the same manner as for an illiquid
bond. Topic 820 includes a discussion of methods used to
measure the fair values of illiquid instruments.
A
Benefit-Responsive, Participating, Separate
Account Investment Contract
55-9 A
financially responsible issuer pays contract value for
participant withdrawals, regardless of the value of the
assets in the separate account. The credited interest
rate is a function of the relationship between the
contract value and the value of the assets in the
separate account. The rate is reset periodically, daily,
monthly, quarterly, and so on, by the issuer and cannot
be less than zero. There may or may not be a specified
maturity date on the contract. The contract holder may
terminate the contract at any time, and receive the
value of the assets in the separate account.
55-10 Net
assets available for benefits should reflect the
contract value for this investment contract because
participants are guaranteed return of principal and
accrued interest.
A Synthetic
Investment Contract — Managed Type
55-11 Such a
contract operates similarly to a separate account
guaranteed investment contract, except that the assets
are placed in a trust (with ownership by the plan)
rather than a separate account of the issuer and a
financially responsible third party issues a wrapper
contract that provides that participants can, and must,
execute plan transactions at contract value.
55-12 Net
assets available for benefits should reflect the
contract value for this investment contract because
participants are guaranteed return of principal and
accrued interest.
A Synthetic
Investment Contract — Repurchase Type
55-13 Under
such a contract, the plan purchases a bond and places it
in trust. The plan then contracts with a financially
responsible third party to provide benefit
responsiveness. Under the contract, should the bond need
to be sold to meet a participant-initiated withdrawal
benefit, loan, or transfer, the plan is obligated to
sell the bond to the contract issuer, and the issuer is
obligated to buy the bond. The transaction price is
defined under the contract (for example, amortized
cost).
55-14 Net
assets available for benefits should reflect the
contract value for this investment contract because
return of principal and accrued interest has been
guaranteed to participants.
55-15 If the
contract provided only an option for the sponsor to sell
the bond to the issuer, rather than an obligation to do
so, reflecting net assets available for benefits at
contract value for this investment contract would also
apply.
See also Example 2 in ASC 962-325-55-17 for an illustration of
the application of ASC 962-325 to the financial statements of a defined
contribution plan.
10.10.19.10 ASC 965, Plan Accounting — Health and Welfare Benefit Plans
ASC 965-325
Implementation Guidance
55-1
Implementation guidance in Section 962-325-55
illustrates the guidance in paragraphs 965-325-35-6
through 35-8 for the application of fair value less
costs to sell, if significant, and contract value
reporting for health and welfare plan investments.
In each situation, value is determined within the
context of the objectives of financial statements
for a defined contribution plan. The valuation must
reflect the ability of the plan to pay benefits from
the perspective of the participants. This value is
then reflected on participants’ statements to
disclose the amount they can expect to receive when
they exercise their rights to withdraw, borrow, or
transfer funds under the terms of the plan.
55-2 See
paragraph 962-325-55-3 for implementation guidance
on a five-year public bond (or portfolio of bonds)
that is guaranteed by a third party to have a fixed
value at the end of three years.
55-3 See
paragraphs 962-325-55-5 through 55-7 for
implementation guidance on a fully
benefit-responsive investment contract.
55-4 See
paragraph 962-325-55-8 for implementation guidance
on a five-year, non-benefit-responsive investment
contract that has no liquid market for trading.
55-5 See
paragraph 962-325-55-10 for implementation guidance
on a benefit-responsive participating separate
account investment contract.
55-6 See
paragraph 962-325-55-12 for implementation guidance
on a synthetic contract (managed type).
55-7 See
paragraph 962-325-55-13 for implementation guidance
on a synthetic investment contract (repurchase
type).
Illustrations
55-8 See
Example 2 (paragraph 962-325-55-17) for financial
statements that illustrate certain applications of
the provisions of this Subtopic that apply to the
annual financial statements of a defined
contribution plan.
10.10.19.11 ASC 970, Real Estate — General
ASC 970-340
Amenities
25-10 Costs
of amenities shall be allocated among land parcels
benefited and for which development is probable. A
land parcel may be considered to be an individual
lot or unit, an amenity, or a phase. The fair value
of a parcel is affected by its physical
characteristics, its highest and best use, and the
time and cost required for the buyer to make such
use of the property considering access, development
plans, zoning restrictions, and market absorption
factors.
10.10.19.12 ASC 972, Real Estate — Common Interest Realty Associations
ASC 972-360
30-1 Common
property recognized as assets of a common interest
realty association shall be initially measured at
the common interest realty association’s cost to
acquire it if the common interest realty association
acquired the property in a monetary transaction. If
the common interest realty association acquired the
property in a nonmonetary transaction, such as by a
nonreciprocal transfer from the developer, and if
the property is recognized as an asset of the common
interest realty association, the common interest
realty association shall initially measure the
property using fair value at the date of its
acquisition. It may be helpful to consider the
developer’s cost, if it is known, in determining the
fair value.
Footnotes
14
ASC 820-10-35-16AA states that “[i]n all cases, a
reporting entity [should] maximize the use of relevant observable
inputs and minimize the use of unobservable inputs.” As a result, an
entity is required to identify the most reliable (i.e., observable)
inputs in determining the valuation technique(s) used to measure
fair value. See further discussion in Section 10.3.
Chapter 11 — Disclosure
Chapter 11 — Disclosure
11.1 Introduction
11.1.1 Background
The disclosure requirements in ASC 820 apply to items (1) measured at fair value
on a recurring or nonrecurring basis and (2) not measured at fair value on a
recurring or nonrecurring basis but for which fair value is disclosed in the
financial statements. However, they do not apply to fair value measurements at
initial recognition. ASC 820’s disclosure requirements related to recurring or
nonrecurring fair value measurements after initial recognition apply to all
entities other than the plan assets of a defined benefit pension or other
postretirement plan in the sponsor’s financial statements. ASC 715 contains fair
value disclosure requirements that apply to the plan assets of a defined benefit
pension plan or other postretirement plan that is accounted for in accordance
with ASC 715.
Under ASC 825, an entity also must provide incremental disclosures about the following:
- The fair value of certain financial instruments, whether recognized or unrecognized in an entity’s statement of financial position.
- Concentrations of credit risk of financial instruments.
- The market risk of financial instruments.
- Eligible items measured at fair value in accordance with the FVO.
This chapter discusses the fair value disclosures required by ASC 820 and the
incremental fair value disclosures required by ASC 825 for certain financial
instruments. Chapter 12 discusses the
incremental disclosures required for eligible items measured at fair value in
accordance with the FVO. Appendix A
addresses the disclosures required by ASC 715 for plan assets of a defined
benefit pension plan or other postretirement plan as well as fair-value-related
disclosures required by other Codification topics. The disclosure requirements
in ASC 825-10-50-20 through 50-23 related to concentrations of credit risk and
market risk of financial instruments are outside the scope of this
publication.
Since the issuance of FASB Statement 157, the FASB has amended
the fair value disclosure requirements in ASC 715, ASC 820, and ASC 825 on
numerous occasions. As of the date of this publication, all entities subject to
these requirements will have adopted all of the relevant amendments made in
various ASUs except for those made by ASU 2022-03 (issued in June 2022), which
requires entities to provide specific disclosures about equity securities that
are subject to contractual sale restrictions. Section 11.1.2 provides more information
about the disclosure requirements and transition provisions of ASU 2022-03.
Section 11.2
addresses the disclosure requirements in ASC 820 and ASC 825 for all
entities.
11.1.2 ASU 2022-03
ASC 820-10
Transition Related to Accounting
Standards Update No. 2022-03, Fair Value
Measurement (Topic 820): Fair Value Measurement of
Equity Securities Subject to Contractual Sale
Restrictions
65-13 The following
represents the transition and effective date information
related to Accounting Standards Update No. 2022-03,
Fair Value Measurement (Topic 820): Fair Value
Measurement of Equity Securities Subject to
Contractual Sale Restrictions:
-
For public business entities, the pending content that links to this paragraph shall be effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2023. Early adoption is permitted.
-
For all other entities, the pending content that links to this paragraph shall be effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2024. Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance.
-
An entity shall apply the pending content that links to this paragraph to equity securities within the scope of the pending content that links to this paragraph as follows:
-
For entities that meet the definition of an investment company in accordance with the guidance in paragraphs 946-10-15-4 through 15-9, on a prospective basis to an equity security in which the contractual restriction that prohibits the sale of the equity security is executed or modified on or after the date at which the investment company first applies the pending content that links to this paragraph. An investment company that holds an equity security that is subject to a contractual sale restriction executed before the date at which the investment company first applies the pending content that links to this paragraph shall continue to account for that equity security using the accounting policy applied before the adoption of the pending content that links to this paragraph until the contractual sale restriction expires or is modified. An entity shall account for a modification to a contractual sale restriction in accordance with (c)(2) on the date of modification. Any adjustments as a result of applying the pending content that links to this paragraph shall be recognized as an adjustment to current-period earnings on the date the contractual sale restriction is modified.
-
For all other entities, on a prospective basis to all equity securities. Any adjustments as a result of applying the pending content that links to this paragraph shall be recognized as an adjustment to current-period earnings on the date at which an entity first applies the pending content that links to this paragraph.
-
- An entity that adopts the
pending content that links to this paragraph in
accordance with (c)(1) shall disclose the
following in each period that the entity continues
to apply a discount to equity securities subject
to contractual sale restrictions executed before
adopting the pending content that links to this
paragraph:
-
The fair value of equity securities subject to a contractual sale restriction on the statement of financial position to which the entity continues to apply a discount.
-
The nature and remaining duration of the contractual sale restriction.
-
The circumstances that could cause a lapse in the restriction.The equity securities included in (d)(1) through (3) shall be excluded from the amounts disclosed as required by paragraph 820-10-50-6B.
-
-
An entity that adopts the pending content that links to this paragraph in accordance with (c)(2) shall disclose the amount recognized as an adjustment to earnings in the period that the entity first applies the pending content that links to this paragraph.
ASU 2022-03 clarifies that a “contractual sale restriction
prohibiting the sale of an equity security is a characteristic of the reporting
entity holding the equity security” and is not included in the equity security’s
unit of account. Accordingly, an entity should not consider the contractual sale
restriction when measuring the equity security’s fair value. That is, in
accordance with ASC 820-10-35-36B (as amended by the ASU), the entity should not
apply a discount related to the contractual sale restriction. In addition, the
ASU prohibits an entity from recognizing a contractual sale restriction as a
separate unit of account.
ASU 2022-03 requires entities to disclose certain information about equity
securities that are subject to contractual sale restrictions. Such information
includes (1) the fair value of those equity securities that is reflected in the
balance sheet, (2) the nature and remaining duration of the corresponding
restrictions, and (3) any circumstances that could cause a lapse in the
restrictions.
For investment companies (as defined in ASC 946), the amendments in ASU 2022-03
should be applied to equity securities with a contract containing a sale
restriction that is executed or modified on or after the adoption date. For
equity securities with a contract containing a sale restriction that was
executed before the adoption date, investment companies should continue to apply
the historical accounting policy for measuring such securities until the
contractual restriction expires or is modified. In addition, if an investment
company continues to apply a discount to equity securities subject to a
contractual sale restriction, it should provide the disclosures required by ASU
2022-03 for those equity securities separately from similar equity securities to
which a discount is no longer applied.
ASU 2022-03 is effective for public business entities in fiscal
years beginning after December 15, 2023, and interim periods within those fiscal
years. For all other entities, the ASU is effective in fiscal years beginning
after December 15, 2024, and interim periods within those fiscal years. Early
adoption is permitted.
11.1.3 Applicability of Disclosure Requirements to Certain Entities
ASC 820’s disclosure requirements apply to all entities other than the plan
assets of a defined benefit or other postretirement plan that are accounted for
in accordance with ASC 715. The disclosure requirements of ASC 820 differ
depending on whether an entity is a nonpublic entity. ASC 820-10-20 defines the
term “nonpublic entity” as follows:
Any entity that does not meet any of the following conditions:
-
Its debt or equity securities trade in a public market either on a stock exchange (domestic or foreign) or in an over-the-counter market, including securities quoted only locally or regionally.
-
It is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets).
-
It files with a regulatory agency in preparation for the sale of any class of debt or equity securities in a public market.
-
It is required to file or furnish financial statements with the Securities and Exchange Commission.
-
It is controlled by an entity covered by criteria (a) through (d).
In this chapter, any entity that is not a nonpublic entity is referred to as an
“other-than-nonpublic entity.”
The ASC 825 fair value disclosure requirements pertaining to financial
instruments not recognized at fair value apply only to public business entities.
ASC 825-10-20 defines the term “public business entity” as follows:
A public business entity is a business entity meeting any one of the
criteria below. Neither a not-for-profit entity nor an employee benefit
plan is a business entity.
-
It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
-
It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
-
It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
-
It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
-
It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including notes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.
An entity may meet the definition of a public business entity solely
because its financial statements or financial information is included in
another entity’s filing with the SEC. In that case, the entity is only a
public business entity for purposes of financial statements that are
filed or furnished with the SEC.
11.1.4 Applicability of Disclosure Requirements to Interim Financial Information of Publicly Traded Companies
ASC 270-10
Disclosure of
Summarized Interim Financial Data by Publicly Traded
Companies
50-1 Many publicly traded
companies report summarized financial information at
periodic interim dates in considerably less detail than
that provided in annual financial statements. While this
information provides more timely information than would
result if complete financial statements were issued at
the end of each interim period, the timeliness of
presentation may be partially offset by a reduction in
detail in the information provided. As a result, certain
guides as to minimum disclosure are desirable. (It
should be recognized that the minimum disclosures of
summarized interim financial data required of publicly
traded companies do not constitute a fair presentation
of financial position and results of operations in
conformity with generally accepted accounting principles
[GAAP].) If publicly traded companies report summarized
financial information at interim dates (including
reports on fourth quarters), the following data should
be reported, as a minimum: . . .
k. The information about the use of fair value
to measure assets and liabilities recognized in
the statement of financial position pursuant to
Section 820-10-50 . . .
m. The information about financial instruments
as required by Section 825-10-50 . . . .
Publicly traded companies (e.g., SEC registrants) should include
the fair value disclosures required by ASC 820 and ASC 825 in their interim
financial statements in accordance with ASC 270-10-50-1(k) and (m). Disclosures
related to amounts as of the end of the reporting period (or, for nonrecurring
fair value measurements, disclosures related to amounts as of the measurement
date) should be provided for the most current date, and any preceding dates, of
the statement of financial position that are included in the interim financial
statements. The activity-related disclosures (e.g., the Level 3 fair value
rollforward information) should be included on a quarterly and year-to-date
basis for the current quarter and current year-to-date period, as well as any
preceding quarters and year-to-date periods, included in the interim financial
statements. Qualitative disclosures should also include information that applies
to all the financial reporting periods included in the interim financial
statements. The scope of the fair value disclosure requirements for interim
financial statements is the same as their scope for annual financial statements
(i.e., any exceptions that apply to an entity’s annual financial statements
would similarly apply to its interim financial statements).
While the above guidance pertains to publicly traded companies, if interim
financial statements are issued by an entity that does not meet the definition
of a publicly traded company, those financial statements must also include the
disclosures required by ASC 820 and ASC 825 to comply with ASC 270.
11.1.5 Recurring Versus Nonrecurring Fair Value Measurements
An entity must provide the disclosures required by ASC 820 for both recurring and
nonrecurring fair value measurements. ASC 820-10-50-2(a) defines recurring and
nonrecurring, as used in this context, as follows:
Recurring fair value measurements of assets or
liabilities are those that other [Codification topics] require or permit
in the statement of financial position at the end of each reporting
period. Nonrecurring fair value measurements of assets or liabilities
are those that other [Codification topics] require or permit in the
statement of financial position in particular circumstances (for
example, when a reporting entity measures a long-lived asset or disposal
group classified as held for sale at fair value less costs to sell in
accordance with Topic 360 because the asset’s fair value less costs to
sell is lower than its carrying amount).
In other words, assets and liabilities measured at fair value on
a recurring basis are those that are remeasured at fair value, after initial
recognition, in each financial reporting period. Assets and liabilities measured
at fair value on a nonrecurring basis are those that, because of a specific
event or circumstance, must be remeasured after initial recognition at fair
value in accordance with other Codification topics. An entity must apply the
disclosure requirements in ASC 820 for nonrecurring fair value measurements of
assets and liabilities in reporting periods in which (1) those assets or
liabilities are subject to fair value remeasurement after initial recognition
and (2) the resulting measurement is recognized in the financial statements. In
some cases, an item may be remeasured to fair value in consecutive reporting
periods but the remeasurement is nonrecurring because the provision in the other
Codification topic that requires or permits such measurement does not apply to
all changes in fair value (e.g., a long-lived asset or disposal group classified
as HFS may be remeasured to fair value less costs to sell in each financial
reporting period until its disposal because there is a decrease in the fair
value less costs to sell in each financial reporting period).
For certain assets, other Codification topics require that
entities recognize recoveries (not to exceed the original cost basis) of
previously recognized impairment losses or lower-of-cost-or-fair-value
adjustments (e.g., a recovery of an impairment of a loan classified as HFS). In
such circumstances, the recognized amounts of recoveries that do not exceed the
prior write-downs are considered nonrecurring fair value measurements that are
subject to ASC 820’s nonrecurring fair value disclosure requirements. However,
to the extent that the fair value amount exceeds the original cost basis, the
fair value measurement is not subject to these requirements because the amount
reflected in the financial statements (i.e., the cost basis) is not a
nonrecurring fair value measurement.
The disclosure requirements for nonrecurring fair value measurements are
generally less extensive than those for recurring fair value measurements. For
example, all entities are exempt from disclosing the following for nonrecurring
fair value measurements:
-
Transfers between categories of the fair value hierarchy.
-
The Level 3 rollforward.
-
Unrealized gains and losses for the period that are recognized in income or OCI.
-
The narrative description of the uncertainty (or sensitivity) of a Level 3 fair value measurement that results from unobservable inputs.
However, entities must disclose the reason for each nonrecurring
fair value measurement and the date or period of the measurement’s recognition,
if not as of the date of the statement of financial position. See Section 11.2.2.1 for
further discussion of the disclosures required for nonrecurring fair value
measurements.
The table below lists examples of recurring and nonrecurring
fair value measurements, and Example 11-1 illustrates a nonrecurring fair value measurement
of a finite-lived intangible asset. See Section 2.1.2 for further discussion of
other Codification topics that permit or require measurement of an item at fair
value.
Table
11-1
|
Examples of Recurring Fair Value Measurements
|
Examples of Nonrecurring Fair Value Measurements
|
|---|---|
|
Trading or available-for-sale debt securities within the
scope of ASC 320.
|
Mortgage loans HFS or mortgage-backed
securities HFS that are remeasured at the lower of cost
or fair value in accordance with ASC 948-310-35-1
through 35-3.
|
|
Investments in equity securities that are periodically
measured at fair value under ASC 321 (i.e., those with
readily determinable fair values or without readily
determinable fair values to which the measurement
alternative in ASC 321-10-35-2 is not applied).
|
Investments in equity securities that
are accounted for by using the measurement alternative
in ASC 321-10-35-2 when (1) an observable price change
occurs for the identical or a similar security in
accordance with ASC 321-10-35-2 or (2) the security is
impaired in accordance with ASC 321-10-35-3.1
|
|
Investments in equity securities with readily
determinable fair values or debt securities owned by NFP
entities in accordance with ASC 958-320 and ASC
958-321.
|
Other-than-temporarily impaired equity method investments
in accordance with ASC 323-10-35-31 and 35-32.
|
|
Derivative assets and liabilities within the scope of ASC
815, including bifurcated embedded derivatives and
hybrid financial instruments that an entity has elected
to remeasure at fair value in their entirety.
|
Impaired loan receivables that, as a practical expedient,
are remeasured on the basis of (1) their observable
market price in accordance with ASC 310-10-35-22 or (2)
the fair value of the collateral if the loan is
collateral-dependent in accordance with ASC 310-10-35-22
and ASC 310-10-35-32.
|
|
Investments owned by investment companies in accordance
with ASC 946.
|
Impaired finite-lived intangible assets in accordance
with ASC 350-30-35-14.
|
|
Liabilities measured at fair value, with changes in fair
value recognized in earnings, in accordance with ASC
480-10-35-5.
|
Impaired indefinite-lived intangible assets in accordance
with ASC 350-30-35-19.
|
|
Nonderivative written call options carried at fair value
in accordance with the SEC staff’s long-standing
position that written options should be initially and
subsequently recognized at fair value.
|
Impaired goodwill in accordance with ASC 350-20-35-4
through 35-19.
|
|
Financial assets or financial liabilities for which an
entity has elected the FVO in accordance with ASC 825
(e.g., certain equity method investments or an entity’s
own debt).
|
Impaired (1) long-lived assets to be held and used, (2)
long-lived assets to be disposed of other than by sale,
or (3) long-lived assets to be disposed of by sale in
accordance with ASC 360-10-35-17 through 35-43.
|
|
Classes of servicing assets or liabilities for which an
entity has elected the fair value measurement method in
accordance with ASC 860-50-35-1.
|
Classes of servicing assets or liabilities for which an
entity has elected the amortization method in accordance
with ASC 860-50-35-1 when those servicing assets are
impaired or the fair value of those servicing
liabilities has increased above the carrying amount in
accordance with ASC 860-50-35-9 through 35-12.
|
Example 11-1
Nonrecurring Fair Value Measurement of a Finite-Lived
Intangible Asset
Company X (which has a calendar year-end) acquires
Company Y on December 31, 20X7. In the purchase price
allocation, X allocates $100,000 to a finite-lived
intangible asset on the basis of its fair value. Assume
straight-line amortization of $1,250 per quarter. As of
December 31, 20X7, X is not required to include the
finite-lived intangible asset in the nonrecurring
disclosure table because the only fair value measurement
recognized in the financial statements related to the
asset occurred at initial recognition.
As of September 30, 20X8, (1) the finite-lived intangible
asset is recorded at $96,250 ($3,750 of amortization has
occurred since initial recognition); (2) an event or
change in circumstances has occurred, indicating that
the carrying amount of the asset may not be recoverable
(e.g., adverse changes in the business climate); and (3)
X has tested the asset for impairment and determined
that no impairment exists. The finite-lived intangible
asset is not included in the ASC 820 disclosures because
no nonrecurring fair value measurement of the asset was
recognized in the financial statements during the
reporting period.
Because of continued concerns regarding the business
climate, X tests the finite-lived intangible asset for
impairment as of December 31, 20X8, and records an
impairment charge of $5,000 to reduce the carrying
amount of the asset to its fair value of $90,000. As of
this date, X should include the finite-lived intangible
asset in its ASC 820 disclosures (see ASC 820-10-50-2)
because a nonrecurring fair value measurement of the
asset was reflected in the statement of financial
position during the period.
Because of improvements in the business climate, as of
March 31, 20X9, X no longer tests the finite-lived
intangible asset for impairment. Company X does not
include the asset in the ASC 820 disclosures for the
March 31, 20X9, reporting period because a nonrecurring
fair value measurement was not recognized in the
financial statements during the reporting period.
Footnotes
1
ASU 2019-04
clarified that the occurrence of any remeasurement
event in ASC 321 for equity securities without
readily determinable fair values accounted for
under the measurement alternative in accordance
with ASC 321-10-35-2 represents a nonrecurring
fair value measurement under ASC 820. ASU 2019-04
also added ASC 321-10-50-2B, which states:
“To the extent that the
disclosure requirements in this Subtopic [ASC
321-10] achieve the fair value disclosure
requirements described in Section 820-10-50 on
disclosing fair value measurement, an entity need
not duplicate the related fair value
disclosure.”
11.2 Fair Value Disclosures Requirements
11.2.1 Objectives and Scope
ASC 820-10
50-1C The
objective of the disclosure requirements in this
Subtopic is to provide users of financial statements
with information about assets and liabilities measured
at fair value in the statement of financial position or
disclosed in the notes to financial statements:
-
The valuation techniques and inputs that a reporting entity uses to arrive at its measures of fair value, including judgments and assumptions that the entity makes
-
The uncertainty in the fair value measurements as of the reporting date
-
How changes in fair value measurements affect an entity’s performance and cash flows.
50-1D When
complying with the disclosure requirements of this
Subtopic, a reporting entity shall consider all of the
following:
-
The level of detail necessary to satisfy the disclosure requirements
-
How much emphasis to place on each of the various requirements
-
How much aggregation or disaggregation to undertake
-
Whether users of financial statements need additional information to evaluate the quantitative information disclosed.
50-2 A
reporting entity shall disclose . . . information for
each class of assets and liabilities (see paragraph
820-10-50-2B for information on determining appropriate
classes of assets and liabilities) measured at fair
value (including measurements based on fair value within
the scope of this Topic) in the statement of financial
position after initial recognition. . . .
50-2E For
each class of assets and liabilities not measured at
fair value in the statement of financial position but
for which the fair value is disclosed, a reporting
entity shall disclose the information required by
paragraph 820-10-50-2(b) and (h). . . .
50-10 Plan
assets of a defined benefit pension or other
postretirement plan that are accounted for in accordance
with Topic 715 are not subject to the disclosure
requirements in paragraphs 820-10-50-1C through 50-8.
Instead, the disclosures required in paragraphs
715-20-50-1(d)(iv) and 715-20-50-5(c)(iv) shall apply
for fair value measurements of plan assets of a defined
benefit pension or other postretirement plan.
ASC 825-10
50-1
Paragraph 825-10-05-3 identifies various Topics within
the Codification that address financial instruments
matters. Those and other Topics in the Codification
require disclosures about specific financial
instruments. This Subsection addresses incremental
disclosures about all of the following:
- Fair value of financial instruments . . . .
Applicability of This Subsection
50-2 This
guidance discusses the applicability of the disclosure
requirements in this Subsection to entities and
transactions.
Entities
50-2A The
disclosure guidance in this Subsection applies to public
business entities . . . .
Transactions
50-8 In part,
this Subsection requires disclosures about fair value
for all financial instruments, whether recognized or not
recognized in the statement of financial position,
except that the disclosures about fair value prescribed
in paragraphs 825-10-50-10 through 50-13 and
825-10-50-15 are not required for any of the
following:
-
Employers’ and plans’ obligations for pension benefits, other postretirement benefits including health care and life insurance benefits, postemployment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements (see Topics 710, 712, 715, 718, and 960)
-
Substantively extinguished debt subject to the disclosure requirements of Subtopic 405-20
-
Insurance contracts, other than financial guarantees (including financial guarantee insurance contracts within the scope of Topic 944) and investment contracts, as discussed in Subtopic 944-20
-
Lease contracts as defined in Topic 842 (a contingent obligation arising out of a cancelled lease and a guarantee of a third-party lease obligation are not lease contracts and are subject to the disclosure requirements in this Subsection)
-
Warranty obligations (see Topic 450 and the Product Warranties Subsections of Topic 460)
-
Unconditional purchase obligations as defined in paragraph 440-10-50-2
-
Investments accounted for under the equity method in accordance with the requirements of Topic 323
-
Noncontrolling interests and equity investments in consolidated subsidiaries (see Topic 810)
-
Equity instruments issued by the entity and classified in stockholders’ equity in the statement of financial position (see Topic 505)
-
Receive-variable, pay-fixed interest rate swaps for which the simplified hedge accounting approach is applied (see Topic 815)
-
Fully benefit-responsive investment contracts held by an employee benefit plan
-
Investments in equity securities accounted for under the measurement guidance for equity securities without readily determinable fair values (see Topic 321)
-
Trade receivables and payables due in one year or less
-
Deposit liabilities with no defined or contractual maturities
-
Liabilities resulting from the sale of prepaid stored-value products within the scope of paragraph 405-20-40-3.
50-9
Generally accepted accounting principles (GAAP) require
disclosure of or subsequent measurement at fair value
for many classes of financial instruments. Those
requirements are not superseded or modified by this
Subsection.
ASC 820 and ASC 825 require entities to disclose fair value information about the
following assets and liabilities:
-
Those that are measured at fair value in the statement of financial position in a financial reporting period after initial recognition (except for the plan assets of a defined benefit pension or other postretirement plan that is subject to the fair value disclosure requirements in ASC 715).
-
Those that are not measured at fair value in the statement of financial position but for which the fair value is disclosed.
All assets and liabilities that are measured at fair value on a recurring or
nonrecurring basis are subject to the disclosure requirements in ASC 820. An
entity is not required to provide fair value disclosures for assets,
liabilities, and instruments classified in a reporting entity’s shareholders’
equity that are initially recognized at fair value in accordance with ASC 820.
However, other Codification topics may require specific fair value disclosures.
See Chapter 2 for more information about
the scope of ASC 820, including the application of the ASC 820 disclosure
requirements to specific types of assets and liabilities. See Appendix A for a discussion of other
Codification topics that require incremental fair value disclosures, including
disclosures about fair value on initial recognition.
ASC 825 specifies the fair value disclosure requirements that apply to certain
financial instruments, regardless of whether they are recognized in the
statement of financial position. These disclosures, which only public business
entities are required to provide, include disclosures about financial
instruments that are not measured at fair value on a recurring or nonrecurring
basis (e.g., financial assets and financial liabilities measured at amortized
cost). ASC 825-10-50-8 provides exceptions from the disclosure requirements for
certain financial instruments. See Chapter
2 for more information about the scope of ASC 825, including the
application of its disclosure requirements to specific types of financial assets
and financial liabilities.
ASC 820-10-50-1C and 50-1D outline the objective of the fair value disclosure
requirements in ASC 820, along with matters for entities to consider in
complying with these requirements. An entity may need to use significant
judgment in determining the information to disclose and the level of detail (and
aggregation or disaggregation) at which to provide such disclosures. In using
such judgment, entities should consider the needs of present and potential
investors, creditors, donors, and other financial statement users. Entities may
determine that it is necessary to provide supplemental information (i.e.,
disclosures in addition to those required by ASC 820) in certain circumstances.
See Section 11.2.3.1 for more information about determining
classes of assets and liabilities for disclosure purposes.
Connecting the Dots
ASC 820-10-15-1 indicates that in the absence of a
specific exception, “[t]his Topic [ASC 820] applies when another
[Codification] Topic requires or permits fair value measurements or
disclosures about fair value measurements (and measurements, such as
fair value less costs to sell, based on fair value or disclosures about
those measurements).” Thus, entities have the option of providing ASC
820 and ASC 825 disclosures for assets or liabilities for which such
disclosures are not required. An entity may wish to disclose fair value
information for certain assets and liabilities to give a more complete
picture of their value or to provide supplemental information that is
considered helpful to users of the entity’s financial statements.
There are various matters to consider regarding the voluntary disclosure
of fair value information for assets and liabilities for which the
disclosures in ASC 820 or ASC 825 are not required. Such considerations
include the following:
-
In addition to disclosing a fair value amount, an entity should consider the incremental disclosure requirements in ASC 820-10-50-2E for assets and liabilities not measured at fair value in the statement of financial position but for which the fair value is disclosed (see ASC 820-10-50-2(b) and ASC 820-10-50-2(h)). For such assets and liabilities, ASC 820-10-50-2E would not require the disclosure of other fair value information, such as the valuation technique, the inputs used in the valuation technique, and the quantitative disclosures about significant unobservable inputs for fair value amounts classified in Level 3 of the fair value hierarchy. However, entities can voluntarily include such disclosures for any asset or liability that is not measured at fair value in the statement of financial position.
-
An entity should apply a rational and consistent policy when disclosing such fair value information (e.g., from one reporting period and asset or liability to another). The entity should also ensure that its disclosures clearly indicate that such assets and liabilities for which fair value is voluntarily disclosed are not recognized at fair value on a recurring or nonrecurring basis in the statement of financial position and should separately identify the associated carrying amounts reported in the statement of financial position. This is especially important when an entity has assets or liabilities of a similar type and some but not all of those assets or liabilities are recognized at fair value in the statement of financial position.
See Section 2.3.2.2.4 for
discussion of voluntary fair value disclosures of equity method
investments.
The remaining discussion in this section focuses on the disclosure requirements
in ASC 820 and ASC 825 (for financial assets and financial liabilities of public
business entities). Also see ASC 820-10-55-99 through 55-107 for examples
illustrating disclosures that are not reproduced in the discussion below.
11.2.2 Disclosure Requirements
11.2.2.1 Assets and Liabilities Measured at Fair Value in the Statement of Financial Position
ASC 820-10
50-2 A reporting entity shall
disclose the following information for each class of
assets and liabilities (see paragraph 820-10-50-2B
for information on determining appropriate classes
of assets and liabilities) measured at fair value
(including measurements based on fair value within
the scope of this Topic) in the statement of
financial position after initial recognition. These
disclosure requirements shall not apply to an
investment within the scope of paragraphs
820-10-15-4 through 15-5 for which fair value is
measured using net asset value per share (or its
equivalent, for example, member units or an
ownership interest in partners’ capital to which a
proportionate share of net assets is attributed) as
a practical expedient, in accordance with paragraph 820-10-35-59.
a. For recurring fair value measurements, the
fair value measurement at the end of the reporting
period, and for nonrecurring fair value
measurements, the fair value measurement at the
relevant measurement date and the reasons for the
measurement. Recurring fair value measurements of
assets or liabilities are those that other Topics
require or permit in the statement of financial
position at the end of each reporting period.
Nonrecurring fair value measurements of assets or
liabilities are those that other Topics require or
permit in the statement of financial position in
particular circumstances (for example, when a
reporting entity measures a long-lived asset or
disposal group classified as held for sale at fair
value less costs to sell in accordance with Topic
360 because the asset’s fair value less costs to
sell is lower than its carrying amount). For
nonrecurring measurements estimated at a date
during the reporting period other than the end of
the reporting period, a reporting entity shall
clearly indicate that the fair value information
presented is not as of the period’s end as well as
the date or period that the measurement was
taken.
b. For recurring and nonrecurring fair value
measurements, the level of the fair value
hierarchy within which the fair value measurements
are categorized in their entirety (Level 1, 2, or
3). . . .
bbb. The information shall include:
-
For recurring and nonrecurring fair value measurements categorized within Level 2 and Level 3 of the fair value hierarchy, a description of the valuation technique(s) and the inputs used in the fair value measurement. If there has been a change in either or both a valuation approach and a valuation technique (for example, changing from matrix pricing to the binomial model or the use of an additional valuation technique), the reporting entity shall disclose that change and the reason(s) for making it.
-
For recurring and nonrecurring fair value measurements categorized within Level 3 of the fair value hierarchy, a reporting entity shall provide quantitative information about the significant unobservable inputs used in the fair value measurement. A reporting entity is not required to create quantitative information to comply with this disclosure requirement if quantitative unobservable inputs are not developed by the reporting entity when measuring fair value (for example, when a reporting entity uses prices from prior transactions or third-party pricing information without adjustment). However, when providing this disclosure, a reporting entity cannot ignore quantitative unobservable inputs that are significant to the fair value measurement and are reasonably available to the reporting entity. Employee benefit plans, other than those plans that are subject to the U.S. Securities and Exchange Commission’s (SEC) filing requirements, are not required to provide this disclosure for investments held by an employee benefit plan in their plan sponsor’s own nonpublic equity securities, including equity securities of their plan sponsor’s nonpublic affiliated entities.
-
In complying with (bbb)(2), a reporting entity shall provide the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. A reporting entity shall disclose how it calculated the weighted average (for example, weighted by relative fair value). For certain unobservable inputs, a reporting entity may disclose other quantitative information, such as the median or arithmetic average, in lieu of the weighted average, if such information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop the Level 3 fair value measurement. An entity does not need to disclose its reason for omitting the weighted average in these cases.
-
A nonpublic entity is not required to provide the information described in (bbb)(2)(i), but is required to provide quantitative information about the significant unobservable inputs used in the fair value measurement in accordance with (bbb)(2).
-
c. For recurring fair value measurements
categorized within Level 3 of the fair value
hierarchy, a reconciliation from the opening
balances to the closing balances, disclosing
separately changes during the period attributable
to the following:
1. Total gains or losses
for the period recognized in earnings (or changes
in net assets), and the line item(s) in the
statement of income (or activities) in which those
gains or losses are recognized
1a. Total gains or
losses for the period recognized in other
comprehensive income, and the line item(s) in
other comprehensive income in which those gains or
losses are recognized
2. Purchases, sales,
issues, and settlements (each of those types of
changes disclosed separately)
3. The amounts of any
transfers into or out of Level 3 of the fair value
hierarchy and the reasons for those transfers.
Transfers into Level 3 shall be disclosed and
discussed separately from transfers out of Level
3. See paragraph 820-10-50-2C for additional
guidance. . . .
d. For recurring fair value measurements
categorized within Level 3 of the fair value
hierarchy, the amount of the total gains or losses
for the period in (c)(1) included in earnings (or
changes in net assets) and in (c)(1a) included in
other comprehensive income that is attributable to
the change in unrealized gains or losses relating
to those assets and liabilities held at the end of
the reporting period, and the line item(s) in the
statement(s) of comprehensive income (or
activities) in which those unrealized gains or
losses are recognized. . . .
g. For recurring fair value measurements
categorized within Level 3 of the fair value
hierarchy, a narrative description of the
uncertainty of the fair value measurement from the
use of significant unobservable inputs if those
inputs reasonably could have been different at the
reporting date. For example, how a change in those
significant unobservable inputs to a different
amount might result in a significantly higher or
lower fair value measurement at the reporting
date. If there are interrelationships between
those inputs and other unobservable inputs used in
the fair value measurement, a reporting entity
shall also provide a description of those
interrelationships and of how they might magnify
or mitigate the effect of changes in the
unobservable inputs on the fair value measurement.
To comply with that disclosure requirement, the
narrative description of the uncertainty of the
fair value measurement that would result from
using unobservable inputs shall include the
unobservable inputs disclosed when complying with
paragraph 820-10-50-2(bbb).
h. For recurring and nonrecurring fair value
measurements, if the highest and best use of a
nonfinancial asset differs from its current use, a
reporting entity shall disclose that fact and why
the nonfinancial asset is being used in a manner
that differs from its highest and best use.
50-2B . . . A class of assets
and liabilities will often require greater
disaggregation than the line items presented in the
statement of financial position. However, a
reporting entity shall provide information
sufficient to permit reconciliation to the line
items presented in the statement of financial
position. . . .
50-2D If a
reporting entity makes an accounting policy decision
to use the exception in paragraph 820-10-35-18D, it
shall disclose that fact.
50-2F A
nonpublic entity is not required to disclose the
information required by paragraph
820-10-50-2(bbb)(2)(i), (d), and (g) and paragraph
820-10-50-2E unless required by another Topic.
50-2G In lieu
of paragraph 820-10-50-2(c), a nonpublic entity
shall disclose separately changes during the period
attributable to the following:
- Purchases and issues (each of those types of changes disclosed separately)
- The amounts of any transfers into or out of Level 3 of the fair value hierarchy and the reasons for those transfers. Transfers into Level 3 shall be disclosed and discussed separately from transfers out of Level 3. See paragraph 820-10-50-2C for additional guidance.
50-2H See
paragraph 958-605-50-1A(d) through (e), which
provides disclosures for a not-for-profit entity
(NFP) that recognizes contributed nonfinancial
assets within the scope of Subtopic 958-605.
Paragraph 958-605-50-1A(d) requires that an NFP
disclose a description of the valuation techniques
and inputs used in fair value measurement of those
assets in accordance with paragraph
820-10-50-2(bbb)(1) at initial recognition.
50-3 For
derivative assets and liabilities, the reporting
entity shall present both of the following:
-
The fair value disclosures required by paragraph 820-10-50-2(a) through (b) on a gross basis (which is consistent with the requirement of paragraph 815-10-50-4B(a))
-
The reconciliation disclosure required by paragraph 820-10-50-2(c) through (d) on either a gross or a net basis.
50-4A For a
liability measured at fair value and issued with an
inseparable third-party credit enhancement, an
issuer shall disclose the existence of that credit
enhancement.
50-7 As
discussed in paragraph 250-10-50-5, the disclosures
required by Topic 250 for a change in accounting
estimate are not required for revisions resulting
from a change in a valuation technique or its
application.
50-8 A
reporting entity shall present the quantitative
disclosures required by this Topic in a tabular
format.
All assets and liabilities measured in the statement of financial position at
fair value after initial recognition are subject to the disclosure
requirements in ASC 820-10-50-2. The nature and extent of such disclosures
differ depending on the following:
-
Whether the reporting entity is a nonpublic entity (see Section 11.1.3).
-
Whether the fair value measurement is recurring or nonrecurring (see Section 11.1.5).
The table below summarizes the disclosures an entity is
required to provide under ASC 820 when, in accordance with other
Codification topics, an asset or liability is measured at fair value in the
statement of financial position after initial recognition. This table
distinguishes between (1) other-than-nonpublic and nonpublic entities and
(2) recurring and nonrecurring fair value measurements. As noted in ASC
820-10-50-8, the quantitative disclosures must be presented in a tabular
format. See the remaining subsections of Section 11.2 for more information
about these required disclosures.
Table
11-2
|
Required Disclosures and Applicable
References
|
Entities Other Than Nonpublic Entities
|
Nonpublic Entities
| ||
|---|---|---|---|---|
|
Recurring
|
Nonrecurring
|
Recurring
|
Nonrecurring
| |
|
Fair value as of the reporting date or relevant
measurement date (ASC 820-10-50-2(a) and ASC
825-10-50-10)
|
X
|
X(a)
|
X
|
X(a)
|
|
The reason for the fair value measurement (ASC
820-10-50-2(a))
|
X
|
X
| ||
|
The level in the fair value hierarchy (ASC
820-10-50-2(b) and ASC 825-10-50-10)
|
X
|
X
|
X
|
X
|
|
For fair value measurements in Levels 2 and 3 of the
fair value hierarchy, a description of the valuation
techniques and inputs used in the fair value
measurement (ASC 820-10-50-2(bbb)(1))
|
X
|
X
|
X
|
X
|
|
For fair value measurements in Levels 2 and 3 of the
fair value hierarchy, if there has been a change in
a valuation approach, a valuation technique, or
both, the nature of, and reason for, that change
(ASC 820-10-50-2(bbb)(1))
|
X
|
X
|
X
|
X
|
|
If the highest and best use of a nonfinancial asset
differs from its current use, disclosure of that
fact and why the asset is being used in such a way
(ASC 820-10-50-2(h))
|
X
|
X
|
X
|
X
|
|
Information sufficient to permit reconciliation of
(1) disclosures about classes of assets and
liabilities by level in the fair value hierarchy and
(2) line items presented in the statement of
financial position (ASC 820-10-50-2B)
|
X
|
X
|
X
|
X
|
|
If an entity makes an accounting policy decision to
use the net risk position valuation exception in ASC
820-10-35-18D, disclosure of that fact (ASC
820-10-50-2D)
|
X
|
X
| ||
|
For liabilities measured at fair value, the existence
of any credit enhancement and whether it is
reflected in the fair value measurement (ASC
820-10-50-4A)
|
X
|
X
|
X
|
X
|
|
The disclosures below apply only to Level 3 fair
value measurements.
| ||||
|
Quantitative information about the significant
unobservable inputs used in the fair value
measurement (ASC 820-10-50-2(bbb)(2))
|
X(b)
|
X(b),(c)
|
X(b)
|
X(b),(d)
|
|
In complying with the requirement in ASC
820-10-50-2(bbb)(2) to disclose quantitative
information about significant unobservable inputs,
an entity would disclose the range and weighted
average of significant unobservable inputs used to
develop Level 3 fair value measurements and how the
weighted average was calculated. For certain
unobservable inputs, an entity may disclose other
quantitative information, such as the median or
arithmetic average, in lieu of the weighted average,
if using such information would be a more reasonable
and rational method for reflecting the distribution
of unobservable inputs used to develop the fair
value measurement (ASC 820-10-50-2(bbb)(2)(i))
|
X
|
X
|
(e)
|
(e)
|
|
The Level 3 fair value rollforward (ASC
820-10-50-2(c))
|
X
|
(f)
| ||
|
Total amount of gains and losses for the period,
recorded in current income and OCI, that is
attributable to the change in unrealized gains and
losses for assets or liabilities held at the end of
the reporting period and the line items in which
such amounts are recognized (ASC 820-10-50-2(d))
|
X
|
(e)
| ||
|
Narrative description of the uncertainty of the fair
value measurement with respect to the use of
significant unobservable inputs (i.e., those
disclosed in ASC 820-10-50-2(bbb)), if those inputs
could reasonably have been different on the
reporting date, and a description of the
interrelationships between unobservable inputs,
including how such interrelationships might magnify
or mitigate the impact of changes in such inputs on
fair value (ASC 820-10-50-2(g))
|
X
|
(e)
| ||
|
Notes to table:
(a) ASC 820-10-50-2(a) requires
disclosure of a nonrecurring fair value measurement
amount as of the date of the measurement (e.g., the
impairment or recovery date), which may differ from
the end of the reporting period. ASC 820-10-50-2(a)
states, in part, that “[f]or nonrecurring
measurements estimated at a date during the
reporting period other than the end of the reporting
period, a reporting entity shall clearly indicate
that the fair value information presented is not as
of the period’s end as well as the date or period
that the measurement was taken.” ASC 820-10-50-2B
further states, in part, that “a reporting entity
shall provide information sufficient to permit
reconciliation to the line items presented in the
statement of financial position.” These disclosure
requirements address situations for which the
amounts disclosed under ASC 820 for assets or
liabilities measured at fair value on a nonrecurring
basis during the period are not consistent with the
amounts recorded in the statement of financial
position for such assets or liabilities. See also
Section 11.2.3.3.2.
(b) ASC 820-10-50-2(bbb)(2) states,
in part:
A reporting entity is not
required to create quantitative information to
comply with this disclosure requirement if
quantitative unobservable inputs are not developed
by the reporting entity when measuring fair value
(for example, when a reporting entity uses prices
from prior transactions or third-party pricing
information without adjustment). However, when
providing this disclosure, a reporting entity
cannot ignore quantitative unobservable inputs
that are significant to the fair value measurement
and are reasonably available to the reporting
entity. Employee benefit plans, other than those
plans that are subject to the U.S. Securities and
Exchange Commission’s (SEC) filing requirements,
are not required to provide this disclosure for
investments held by an employee benefit plan in
their plan sponsor’s own nonpublic equity
securities, including equity securities of their
plan sponsor’s nonpublic affiliated entities.
(c) This disclosure is not required
for fair value measurements related to the financial
accounting and reporting for goodwill after its
initial recognition (see ASC 350-20-50-3).
(d) For nonpublic entities, this
disclosure is not required for fair value
measurements related to the financial accounting and
reporting for (1) goodwill after its initial
recognition (see ASC 350-20-50-3) and (2)
indefinite-lived intangible assets after their
initial recognition (ASC 350-30-50-3A).
(e) ASC 820-10-50-2F exempts
nonpublic entities from providing this disclosure
unless it is required by another Codification
topic.
(f) In lieu of providing this
disclosure, in accordance with ASC 820-10-50-2G, a
nonpublic entity should separately disclose changes
during the period that are attributable to (1)
purchases and issues (each of these types of changes
should be disclosed separately) and (2) the amounts
of any transfers into or out of Level 3 of the fair
value hierarchy and the reasons for those transfers
(transfers into Level 3 should be disclosed
separately from transfers out of Level 3).
| ||||
See ASC 820-10-50-3 for additional disclosure requirements related to
derivative assets and liabilities.
SEC Considerations
Section 9700 of the SEC
Division of Corporation Finance’s Financial Reporting Manual (FRM)
states:
In March and September 2008, the Division of Corporation
Finance sent illustrative letters to certain public companies
that reported significant amounts of asset-backed securities,
loans carried at fair value or the lower of cost or market, and
derivative assets and liabilities in their recent 10-K filings.
The letters highlight disclosure matters relating to ASC 820,
and suggest disclosures that companies may consider in preparing
their MD&A.
These letters highlight disclosure matters that SEC registrants
should consider in complying with SEC Regulation S-K, Item 303,
which addresses the preparation of MD&A. While certain of the
recommended disclosures are now required under U.S. GAAP as a result
of amendments to ASC 820, SEC registrants should consider the
disclosures suggested in these letters that are not otherwise
provided in the notes to the financial statements.
11.2.2.2 Assets and Liabilities Not Measured at Fair Value in the Statement of Financial Position
ASC 820-10
50-2E For
each class of assets and liabilities not measured at
fair value in the statement of financial position
but for which the fair value is disclosed, a
reporting entity shall disclose the information
required by paragraph 820-10-50-2(b) and (h).
However, a reporting entity is not required to
provide the quantitative disclosures about
significant unobservable inputs used in fair value
measurements categorized within Level 3 of the fair
value hierarchy required by paragraph
820-10-50-2(bbb)(2). For such assets and
liabilities, a reporting entity does not need to
provide the other disclosures required by this
Topic.
50-2F A
nonpublic entity is not required to disclose the
information required by paragraph
820-10-50-2(bbb)(2)(i), (d), and (g) and paragraph
820-10-50-2E unless required by another Topic.
ASC 825-10
50-2A The
disclosure guidance in this Subsection applies to
public business entities . . . .
50-9
Generally accepted accounting principles (GAAP)
require disclosure of or subsequent measurement at
fair value for many classes of financial
instruments. Those requirements are not superseded
or modified by this Subsection.
50-10 A reporting entity
shall disclose either in the body of the financial
statements or in the accompanying notes, the fair
value of financial instruments and the level of the
fair value hierarchy within which the fair value
measurements are categorized in their entirety
(Level 1, 2, or 3). . . .
For financial instruments recognized at fair value in
the statement of financial position, the disclosure
requirements of Topic 820 also apply.
50-11 Fair
value disclosed in the notes shall be presented
together with the related carrying amount in a form
that clarifies both of the following:
-
Whether the fair value and carrying amount represent assets or liabilities
-
How the carrying amounts relate to what is reported in the statement of financial position.
Pending Content (Transition Guidance: ASC
815-40-65-1)
50-11A See paragraph
470-20-50-1D for additional guidance on
disclosures about fair value of convertible debt
instruments.
50-12 If the
fair value of financial instruments is disclosed in
more than a single note, one of the notes shall
include a summary table. The summary table shall
contain the fair value and related carrying amounts
and cross-references to the location(s) of the
remaining disclosures required by this Section.
50-13 This
Subtopic does not prohibit an entity from disclosing
separately the estimated fair value of any of its
nonfinancial intangible and tangible assets and
nonfinancial liabilities.
50-15 In
disclosing the fair value of a financial instrument,
an entity shall not net that fair value with the
fair value of other financial instruments — even if
those financial instruments are of the same class or
are otherwise considered to be related (for example,
by a risk management strategy) — except to the
extent that the offsetting of carrying amounts in
the statement of financial position is permitted
under either of the following:
-
The general principle in paragraph 210-20-45-1
-
The exceptions for master netting arrangements in paragraph 815-10-45-5 and for amounts related to certain repurchase and reverse repurchase agreements in paragraphs 210-20-45-11 through 45-17.
Public business entities must provide additional fair value disclosures for
certain financial assets and financial liabilities that are not measured at
fair value in the statement of financial position, which may include
financial assets or financial liabilities that were subject to a
nonrecurring fair value measurement during a financial reporting period.
This disclosure requirement is included in ASC 825-10-50-10 and is also
addressed in ASC 820-10-50-2E. In accordance with that guidance, public
business entities must disclose the following for financial assets and
financial liabilities that are not (1) recognized at fair value in the
statement of financial position and (2) subject to an exception in ASC 825-10-50-8:
-
The fair value as of the reporting date (i.e., the date of the statement of financial position).
-
The level of the fair value hierarchy (Level 1, 2, or 3) within which each fair value measurement is categorized in its entirety.2
These disclosures can be included in the body of the financial statements or
in the notes and may be provided by classes of assets and liabilities (see
Section 11.2.3.1), subject to the
prohibitions against netting described in ASC 825-10-50-15. ASC 825-10-50-11
and 50-12 address considerations related to including such disclosures in
the notes to the financial statements.
The fair value disclosures should be consistent with the
unit of account. For example, as discussed in ASC 825-10-25-13, “[f]or the
issuer of a liability issued with an inseparable third-party credit
enhancement . . . , the unit of accounting for the liability . . . disclosed
at fair value does not include the third-party credit enhancement.” See
Section 12.3.1.1.1.2 for
discussion of debt issued with government-provided guarantees.
While an entity is not precluded from also disclosing information about the
valuation technique and inputs used, changes in the valuation approach or
valuation technique, and significant unobservable inputs, these disclosures
are not required for financial assets and financial liabilities that are not
measured at fair value in the statement of financial position.
ASU 2018-09 clarified
that the disclosure addressed in ASC 820-10-50-2(bbb) is not required for
financial assets and financial liabilities that are not measured at fair
value.
Entities other than public business entities are not required to provide
disclosures about the fair value of financial assets and financial
liabilities that are not measured at fair value in the statement of
financial position. Further, ASU 2019-04 clarified that such entities do not
need to disclose the fair values of held-to-maturity classified debt
securities.
See Section 11.3 for examples of financial instruments that are
subject to the disclosure requirements of ASC 825-10-50-10.
11.2.2.3 Certain Entities That Calculate NAV per Share (or Its Equivalent)
ASC 820-10
Fair Value Measurements of Investments in Certain
Entities That Calculate Net Asset Value per Share
(or Its Equivalent)
50-6A For
investments that are within the scope of paragraphs
820-10-15-4 through 15-5 and that are measured using
the practical expedient in paragraph 820-10-35-59 on
a recurring or nonrecurring basis during the period,
a reporting entity shall disclose information that
helps users of its financial statements to
understand the nature and risks of the investments
and whether the investments, if sold, are probable
of being sold at amounts different from net asset
value per share (or its equivalent, such as member
units or an ownership interest in partners’ capital
to which a proportionate share of net assets is
attributed). A reporting entity shall disclose the
following information for each class of investment:
a. The fair value measurement (as determined
by applying paragraphs 820-10-35-59 through 35-62)
of the investments in the class at the reporting
date and a description of the significant
investment strategies of the investee(s) in the
class.
b. For each class of investment that includes
investments that can never be redeemed with the
investees, but the reporting entity receives
distributions through the liquidation of the
underlying assets of the investees, the period of
time over which the underlying assets are expected
to be liquidated by the investees if the investee
has communicated the timing to the reporting
entity or announced the timing publicly. If the
timing is unknown, the reporting entity shall
disclose that fact.
c. The amount of the reporting entity’s
unfunded commitments related to investments in the
class.
d. A general description of the terms and
conditions upon which the investor may redeem
investments in the class (for example, quarterly
redemption with 60 days’ notice).
e. The circumstances in which an otherwise
redeemable investment in the class (or a portion
thereof) might not be redeemable (for example,
investments subject to a lockup or gate). Also,
for those otherwise redeemable investments that
are restricted from redemption as of the reporting
entity’s measurement date, the reporting entity
shall disclose when the restriction from
redemption might lapse if the investee has
communicated that timing to the reporting entity
or announced the timing publicly. If the timing is
unknown, the reporting entity shall disclose that
fact and how long the restriction has been in
effect.
f. Any other significant restriction on the
ability to sell investments in the class at the
measurement date. . . .
h. If a group of investments would otherwise
meet the criteria in paragraph 820-10-35-62 but
the individual investments to be sold have not
been identified (for example, if a reporting
entity decides to sell 20 percent of its
investments in private equity funds but the
individual investments to be sold have not been
identified), so the investments continue to
qualify for the practical expedient in paragraph
820-10-35-59, the reporting entity shall disclose
its plans to sell and any remaining actions
required to complete the sale(s).
ASC 820-10-35-59 permits entities, as a practical expedient, to estimate the
fair value of an investment within the scope of ASC 820-10-15-4 and 15-5 by
using the NAV per share (or its equivalent, such as member units or an
ownership interest in partners’ capital to which a proportionate share of
net assets is attributed) of the investment, provided that it is calculated
in a manner consistent with the measurement principles of ASC 946 as of the
reporting entity’s measurement date.3 To help financial statement users understand the nature and risks of
the investments and whether it is probable that they will be sold (if they
are sold) at amounts that differ from the NAV per share (or its equivalent),
ASC 820-10-50-6A requires specific disclosures, for each interim and annual
period, for investment classes within the scope of ASC 820-10-15-4 and 15-5
that an entity measured during the period on a recurring or nonrecurring
basis by using the practical expedient in ASC 820-10-35-59. See ASC
820-10-55-107 for an example illustrating such disclosures.
Although investments that an entity records when using the practical
expedient in ASC 820-10-35-59 are not categorized within the fair value
hierarchy, ASC 820-10-35-54B still requires such an entity to provide the
amounts that it measured by using the practical expedient so that the fair
value of investments included in the fair value hierarchy can be reconciled
to the line items presented in the statement of financial position in
accordance with ASC 820-10-50-2B.
Entities are not required to apply the practical expedient
in ASC 820-10-35-59 to all investments within the scope of ASC 820-10-15-4
and 15-5. When the practical expedient is not used for such investments, the
disclosures outlined in ASC 820-10-50-6A are not required. Rather, as stated
in paragraph BC11 of ASU 2015-07, “the fair value of the investment will be
included in the fair value hierarchy on the basis of the relative
observability of the inputs used in the valuation and subject to the
disclosure requirements of paragraph 820-10-50-2.”
11.2.3 Interpretive Guidance
11.2.3.1 Identifying Classes of Assets and Liabilities
11.2.3.1.1 General
ASC 820-10
50-2B A reporting entity
shall determine appropriate classes of assets and
liabilities on the basis of the following:
-
The nature, characteristics, and risks of the asset or liability
-
The level of the fair value hierarchy within which the fair value measurement is categorized.
The number of classes may need to be greater for
fair value measurements categorized within Level 3
of the fair value hierarchy because those
measurements have a greater degree of uncertainty
and subjectivity. Determining appropriate classes
of assets and liabilities for which disclosures
about fair value measurements should be provided
requires judgment. A class of assets and
liabilities will often require greater
disaggregation than the line items presented in
the statement of financial position. However, a
reporting entity shall provide information
sufficient to permit reconciliation to the line
items presented in the statement of financial
position. If another Topic specifies the class for
an asset or a liability, a reporting entity may
use that class in providing the disclosures
required in this Topic if that class meets the
requirements in this paragraph.
In complying with the fair value disclosure requirements of ASC
820-10-50-2, an entity must determine appropriate classes of assets and
liabilities in accordance with ASC 820-10-50-2B. An entity must use
judgment and carefully consider the facts and circumstances in
disaggregating assets and liabilities into separate classes. Such
disaggregation often results in a more granular presentation for fair
value disclosure purposes than the line items in the statement of
financial position. Under ASC 820-10-50-2B, the classes of assets and
liabilities should generally be consistent throughout all the fair value
disclosures provided in accordance with ASC 820-10-50-2(a)–(h).
Therefore, the classes of assets and liabilities used to prepare the
quantitative disclosures required by ASC 820-10-50-2(bbb)(2) should
generally not differ from the classes included in the other disclosures
required by ASC 820-10-50-2.
When determining the appropriate level of disaggregation into classes of
assets and liabilities, entities should consider the nature,
characteristics, and risk profile of the assets and liabilities, as well
as the level of the fair value hierarchy within which each fair value
measurement has been categorized. Entities may also consider guidance in
other Codification topics (e.g., ASC 320, ASC 815) when making this
determination. ASC 320-10-50-1B provides guidance on class determination
and useful considerations related to assessing the nature of and risks
associated with debt securities. On the basis of those requirements,
concentrations are likely to be important in the determination of class
for all assets and liabilities.
When preparing quantitative disclosures about significant unobservable
inputs used in Level 3 fair value measurements, an entity may discover that:
-
Different techniques are used for individual assets, liabilities, or subclasses within a previously identified class of asset or liability.
-
Different inputs are being used even when the same technique is used to measure different assets, liabilities, or subclasses within a class.
-
The quantitative information varies significantly between one asset, liability, or subclass and others within a class.
Such differences may indicate that the nature, characteristics, or risks
of assets, liabilities, or subclasses within a previously identified
class differ and that it would be appropriate to create more classes.
When disaggregating an asset or liability class because techniques,
inputs, or quantitative information about inputs differs, an entity
should consider disaggregating the class in other disclosures required
by ASC 820-10-50-2(a)–(h) to ensure consistency.
An entity that does not use the same classes throughout its fair value
disclosures should consider reconciling, for example, the classes of
assets and liabilities categorized in Level 3 of the fair value
hierarchy between the leveling disclosures (see ASC 820-10-50-2(b)) and
the quantitative disclosures about significant unobservable inputs (see
ASC 820-10-50-2(bbb)(2)). Entities should also keep in mind the
requirement from ASC 820-10-50-2B to “provide information sufficient to
permit reconciliation to the line items presented in the statement of
financial position.”
The examples below
illustrate disaggregation of assets into classes by using various
approaches.
Example 11-2
Aggregation by Valuation Technique
Entity A holds residential
mortgage-backed securities (RMBSs) backed by both
prime (i.e., higher credit quality) and subprime
(i.e., lower credit quality) mortgages. When
identifying the class of asset for disclosure
purposes, A concludes that the nature, risks, and
characteristics (including valuation technique) of
these assets are sufficiently similar to allow
aggregation of all RMBSs into one class. Entity A
prepares the disclosure below. However, if A holds
material amounts of RMBSs backed by mortgages of
significantly differing credit quality, this
disclosure may not provide sufficient information
for financial statement users to understand and
evaluate the quantitative information provided. In
such a case, A could consider an alternative such
as the one presented in Example 11-3.
Example 11-3
Disaggregation by Risk
This presentation alternative
results in more relevant information for financial
statement users than the approach in the example
above, enabling them to better understand and
evaluate the techniques and inputs used. In
particular, disaggregating the asset class gives
users insight into the different assumptions used
when risk and other characteristics differ.
Because the guidance that applies to determination
of class for this disclosure is the same as the
guidance that applies to determination of class
for a disclosure of fair value by level in the
fair value hierarchy (i.e., the requirement in ASC
820-10-50-2(b)), it would be a best practice to
use the same classes for both. When an entity does
not use the same classes (e.g., in providing
disclosures about fair value by level in the fair
value hierarchy and quantitative disclosures about
significant unobservable inputs), the entity
should provide a reconciliation so that the
relationship between the classes is clear.
11.2.3.1.2 Derivative Contracts
ASC 815-10-50 requires entities to provide tabular disclosures about
derivatives by “type of contract.” Depending on the facts and
circumstances, the classes of derivative contracts under the ASC 820
fair value disclosure requirements may differ from the type of contracts
used to provide tabular disclosures under ASC 815. The classes of
derivative contracts may be more disaggregated under ASC 820 than the
type of contract under ASC 815 but generally should not be more
condensed.
An entity should consider the types of derivative contracts it holds.
Under ASC 820-10-50-2B, class is based on the derivatives’
characteristics, nature, risks, and classification in the fair value
hierarchy. Class is often at a greater level of disaggregation than the
line items in the statement of financial position. Therefore, in
determining the characteristics, nature, and risks of its derivative
contracts, an entity should consider the following factors (in addition
to the type of contracts):
-
The valuation techniques and inputs used to determine fair value.
-
The classification in the fair value hierarchy.
-
The level of disaggregation in the statement of financial position.
An entity may also consider the level of disaggregation it uses for other
ASC 815 disclosures (e.g., qualitative and volume), which may vary from
the level of disaggregation it uses for the ASC 815 tabular
disclosures.
ASC 320-10-50-1B provides guidance on class determination and useful
considerations related to assessing nature and risks for debt
securities. On the basis of those requirements, concentrations are
likely to be important in the determination of class for all assets and
liabilities. For example, an entity that engages in material commodity
transactions may consider concentrations by commodity type, or an entity
with a material foreign exchange portfolio may consider concentrations
by discrete currencies.
11.2.3.1.3 Disposal Group or Assets to Be Disposed Of
An entity may have a long-lived asset disposal group
classified as HFS under ASC 360 (which may include or represent a
discontinued operation). The individual assets and liabilities within a
disposal group that are measured at fair value on a recurring or
nonrecurring basis are subject to the disclosure requirements in ASC
820.4
When considering the appropriate classes of assets and
liabilities under ASC 820-10-50-2B and preparing fair value disclosures,
an entity should distinguish assets and liabilities that are part of a
disposal group classified as HFS from its other assets and liabilities.
This separate presentation is consistent with the requirements in ASC
205-20-45-10 and 45-11 and ASC 360-10-45-14, under which an entity must
separately disclose the major classes of assets and liabilities of the
discontinued operation (or the major classes of assets and liabilities
classified as HFS) either on the face of the statement of financial
position or in the notes to the financial statements. The ASC 820
disclosures required for certain items within a disposal group should be
consistent with the disclosures under ASC 205-20-45-10 and 45-11 or ASC
360-10-45-14.
ASC 360-10-35-43 requires an entity to measure a
disposal group at the lower of its carrying amount or fair value less
costs to sell. Furthermore, ASC 360-10-35-40 states:
A loss shall be recognized for any initial or
subsequent write-down to fair value less cost to sell. A gain
shall be recognized for any subsequent increase in fair value
less cost to sell, but not in excess of the cumulative loss
previously recognized (for a write-down to fair value less cost
to sell). The loss or gain shall adjust only the carrying amount
of a long-lived asset, whether classified as held for sale
individually or as part of a disposal group.
ASC 820-10-50-2(a) requires an entity to disclose,
“[f]or recurring fair value measurements, the fair value measurement at
the end of the reporting period, and for nonrecurring fair value
measurements, the fair value measurement at the relevant measurement
date and the reasons for the measurement.” ASC 820-10-55-100 includes an
example of a nonrecurring disclosure.
In certain circumstances, an impairment loss may be
recognized for some assets within a disposal group that also includes
assets and liabilities measured at fair value on a recurring basis.
Thus, the asset group contains assets that are measured on both a
recurring and nonrecurring basis. In periods in which an impairment of a
disposal group is recognized, the nonrecurring fair value disclosures
related to that impairment should reflect the incremental amount beyond
what has already been disclosed in the recurring and nonrecurring fair
value tables for the other assets and liabilities that are included in
the disposal group.5 See the example below.
Example 11-4
Disposal
Group for Which There Are Recurring and
Nonrecurring Fair Value Measurements
In November 20X9, Entity B, a
calendar-year-end company, enters into an
agreement to sell Subsidiary X. The transaction is
expected to close in May 201X. In accordance with
ASC 360-10-45-9, X is a disposal group that B
presents as HFS in its December 31, 20X9, balance
sheet.
Assume the following:
-
The disposal group consists of property, plant, and equipment (PP&E) and equity securities (real estate industry) measured at fair value through earnings. Subsidiary X does not have intangible assets, goodwill, or liabilities.
-
The PP&E has a carrying value of $30 million.
-
The fair value of the equity securities (real estate industry) is $65 million, measured on the basis of a quoted price in an active market (Level 1).
-
The fair value of the disposal group is $80 million, measured on the basis of significant unobservable inputs (Level 3).
-
The cost of selling the disposal group is $10 million.
Therefore, on B’s balance sheet,
the disposal group is shown as consisting of $70
million of assets HFS ($80 million fair value less
$10 million costs to sell). The disclosures
required by ASC 820-10-50-2(a) and (b) could be
presented in the manner described below.
For the assets measured at fair
value on a recurring basis during the period, B
would present the following:
For the assets measured at fair
value on a nonrecurring basis during the period,
in addition to narrative disclosures about why
this remeasurement was made, B would present the
following:
In calculating the fair value
amounts for the above disclosure, X considers the
guidance in ASC 360 on impairment or disposal of
long-lived assets. Subsidiary X (i.e., the
disposal group) has a carrying amount of $95
million (PP&E of $30 million and equity
securities [real estate industry] of $65 million)
and a fair value of $80 million (which includes
$65 million of equity securities in real estate).
When considering the costs to sell of $10 million,
X recognizes an impairment loss of $25 million in
earnings for the period (i.e., $80 million fair
value, less $95 million carrying cost, less
selling costs of $10 million). This loss is
recorded as a write-down of the carrying amount of
the long-lived assets within the disposal
group.
Note that the above
presentations represent one alternative; entities
should determine that the disclosure objectives in
ASC 205-20, ASC 360, and ASC 820, as appropriate,
are met for an asset group or disposal group. The
entity would also be subject to (1) the disclosure
requirements in both ASC 205-20-50 and ASC
360-10-50 and (2) other relevant fair value
disclosure requirements in ASC 820-10-50-2.
11.2.3.2 Disclosures Related to the Fair Value Hierarchy
11.2.3.2.1 General
ASC 820-10-50-2(b) requires all entities to disclose the level of the
fair value hierarchy within which all recurring and nonrecurring fair
value measurements are categorized.6 ASC 820-10-50-2E and ASC 825-10-50-10 also require public business
entities to disclose the level of the fair value hierarchy for assets
and liabilities that are not measured at fair value but for which fair
value is disclosed. Such classifications in the fair value hierarchy are
made on the basis of the classification of the asset or liability in its
entirety.
Fair value measurements often consist of multiple inputs that span
multiple levels within the fair value hierarchy. In these circumstances,
the asset or liability is classified in its entirety on the basis of the
lowest-level input that is deemed significant to the fair value
measurement. See Section 8.1.2 for more information.
11.2.3.2.2 Transfers Between Levels
ASC 820-10
50-2C A
reporting entity shall consistently follow its
policy for determining when transfers between
levels of the fair value hierarchy are deemed to
have occurred. The policy about the timing of
recognizing transfers shall be the same for
transfers into the levels as for transfers out of
the levels. Examples of policies for determining
the timing of transfers include the following:
-
The date of the event or change in circumstances that caused the transfer
-
The beginning of the reporting period
-
The end of the reporting period.
ASC 820-10-50-2C requires all entities to develop and consistently apply
a “policy for determining when transfers between levels of the fair
value hierarchy are deemed to have occurred.” However, ASC 820 does not
prescribe a method for determining the timing of transfers between
levels. Rather, ASC 820-10-50-2C indicates that to determine when
transfers have occurred, entities may use the fair value of the asset,
liability, or instrument classified in a reporting entity’s
shareholders’ equity as of (1) the “date of the event or change in
circumstances that caused the transfer,” (2) the “beginning of the
reporting period,” or (3) the “end of the reporting period,” provided
that the approach applied is used consistently. Accordingly, it is not
appropriate for an entity to determine the amount of “transfers in” by
using the beginning-of-period fair value and the amount of “transfers
out” by using the end-of-period fair value, or vice versa. Such an
approach is not acceptable because no gain or loss would be attributed
to items transferred into or out of Level 3, thus diminishing the
usefulness of the Level 3 rollforward disclosure.
Entities may, but are not required to, disclose either
of the following:
-
Transfers between Levels 1 and 2 of the fair value hierarchy for assets and liabilities held at the end of the reporting period that are measured at fair value on a recurring basis (other-than-nonpublic entities were previously required to provide this disclosure).
-
Their accounting policy for determining when transfers are deemed to have occurred.
Thus, in accordance with ASC 820-10-50-2(c)(3) and ASC
820-10-50-2G(b), all entities are only required
to disclose the “amounts of any transfers into or out of Level 3 of the
fair value hierarchy and the reasons for those transfers.” Further,
transfers into Level 3 would be “disclosed and discussed separately from
transfers out of Level 3.” While entities are not required to disclose
their accounting policy for determining when transfers between levels
are recognized, they may determine that such disclosure is useful and
provide it anyway.
Connecting the Dots
An entity commonly measures the fair value of its assets and
liabilities more frequently (e.g., monthly) for internal
management reporting purposes than for external reporting
purposes. As part of its periodic fair value measurement
processes, the entity may incorporate a system for identifying
the date of the transfers into or out of Level 3. The fair value
amount for transfers determined through the entity’s periodic
(i.e., monthly) process could then be used to furnish the
disclosures required by ASC 820-10-50-2(c)(3) and ASC
820-10-50-2G(b) at the end of the reporting period.
The example below illustrates how an entity may
determine the date of transfers into or out of Level 3.
Example 11-5
Transfers Into or Out of Level 3 of the Fair
Value Hierarchy
Assume the following:
-
Entity C holds two securities and is preparing its quarterly financial statements for the period ended September 30, 20X0.
-
Security A, which is classified in Level 2 at the beginning of the period (July 1, 20X0), is transferred into Level 3 on July 15, 20X0.
-
Security B, which is classified in Level 3 at the beginning of the period (July 1, 20X0), is transferred out of Level 3 (into Level 2) on August 15, 20X0.
The following table illustrates the fair values
under the three acceptable methods for disclosing
the relevant transfers into and out of Level 3 in
accordance with ASC 820-10-50-2C:
Analysis
11.2.3.2.3 Cash Collateral Receivables and Payables
See Section 11.2.3.5.2.3.5 for discussion of the
presentation of cash collateral receivables and payables related to
derivative instruments.
11.2.3.2.4 Assets and Liabilities of a CFE
Under ASC 810, an entity that consolidates an eligible CFE may elect to
measure the less observable of the fair value of the CFE’s financial
assets or the fair value of the CFE’s financial liabilities by using the
more observable of the two measurements. See Section A.19 for information about the additional
disclosures an entity is required to provide when it makes this
election. See Section 8.1.2 for discussion of the determination of the
level of the fair value hierarchy in which an entity should categorize
the less observable fair value measurement.
11.2.3.3 Reconciliation of Disclosures to the Statement of Financial Position
11.2.3.3.1 General
Under ASC 820, entities must reconcile the disclosed fair value amounts
to the statement of financial position when:
-
The classes of assets or liabilities are more disaggregated than the line items in the statement of financial position (see Section 11.2.3.1).
-
The amount of an asset or liability on the date of the statement of financial position does not equal the amount of a nonrecurring fair value measurement that was recognized for the asset or liability during the financial reporting period (see Section 11.2.3.3.2).
-
An entity estimates the fair value of certain investments by using NAV per share as a practical expedient (see Section 11.2.3.3.3).
11.2.3.3.2 Nonrecurring Fair Value Measurements
ASC 820-10-50-2(a) requires entities to disclose, for nonrecurring fair
value measurements, the fair value as of the measurement date and the
reasons for the measurement. ASC 820-10-50-2(b) further requires
disclosure of the level of the nonrecurring fair value measurement
within the fair value hierarchy, which is also determined as of the
measurement date. If a nonrecurring fair value measurement occurs on any
date other than the date of an entity’s statement of financial position,
the entity must, as stated in ASC 820-10-50-2(a), “clearly indicate that
the fair value information presented is not as of the period’s end as
well as the date or period that the measurement was taken.” In meeting
this objective, entities should consider the guidance in ASC
820-10-50-2B, which states, in part, that “a reporting entity shall
provide information sufficient to permit reconciliation to the line
items presented in the statement of financial position.” Thus, the
entity should provide supplemental information that reconciles (1) the
ASC 820 nonrecurring fair value amounts disclosed and (2) the carrying
amount as of the date of the statement of financial position.
For example, assume that a long-lived asset classified as held and used
is impaired from its current carrying value of $100 to its fair value of
$75 as of November 30, 20X7 (assume a calendar-year-end entity). In this
case, the amount disclosed as a nonrecurring fair value measurement will
be $75. However, since the asset is held and used, subsequent
amortization through December 31, 20X7 (the balance sheet date), is
recognized. Assume that $1 of subsequent amortization is recognized in
December 20X7. The balance sheet will reflect the amortization, while
the nonrecurring disclosure will not. The entity should provide
supplemental information that reconciles the ASC 820 nonrecurring amount
disclosed to the recorded amount as of the balance sheet date.
In addition, the amount of a nonrecurring fair value
measurement may not equal the recognized amount of the asset or
liability subject to such measurement on the date the measurement is
recognized. For example, ASC 360-10-35-43 requires that a disposal group
classified as HFS be measured at the lower of its carrying amount or
fair value less costs to sell. However, ASC 820 clarifies that costs to
sell (transaction costs) are not included in a fair value measurement.
Thus, when an impairment of a long-lived asset classified as HFS has
occurred during a financial reporting period, the nonrecurring fair
value amount disclosed under ASC 820 will not be consistent with the
carrying amount reflected in the balance sheet as of the reporting date.
As previously stated, entities should provide supplemental information
that reconciles the ASC 820 nonrecurring disclosure amount to the
recorded amount as of the balance sheet date. See notes (c)–(e) of
Example 9 in ASC 820-10-55-100 for an illustration of such
disclosure.
11.2.3.3.3 Certain Entities That Calculate NAV per Share (or Its Equivalent)
As discussed in Section 11.2.2.3,
although investments that an entity records when using the practical
expedient in ASC 820-10-35-59 are not categorized within the fair value
hierarchy, an entity is still required under ASC 820-10-35-54B to
provide the amounts that it measured by using the practical expedient so
that the fair value of investments included in the fair value hierarchy
can be reconciled to the line items presented in the statement of
financial position in accordance with ASC 820-10-50-2B. ASC 820-10-50-6A
further requires that entities “disclose [additional] information that
helps users of [their] financial statements to understand the nature and
risks of the investments.” See Note (f) of Example 9 in ASC
820-10-55-100 for an illustration of such disclosure.
11.2.3.4 Disclosure of Valuation Techniques and Inputs
ASC 820-10-50-2(bbb)(1) requires entities to disclose (1) a description of
the valuation technique(s) and inputs for each class of assets and
liabilities measured at fair value on a recurring or nonrecurring basis and
classified within Level 2 or Level 3 of the fair value hierarchy and (2) any
changes in a valuation approach, valuation technique, or both in connection
with such measurements, as well as the reasons for such changes. In
accordance with ASC 820-10-50-7, a change in the valuation approach or
valuation technique does not cause an entity to be subject to the disclosure
requirements in ASC 250 related to a change in accounting estimate.
The objective of these disclosure requirements is to help financial statement
users understand not only the valuation techniques and inputs but also the
judgments the entity uses when measuring fair value. To meet this objective,
entities should consider disclosing the following information about the
valuation techniques and inputs used in Level 2 and Level 3 fair value measurements:
-
Whether the entity can choose between various valuation techniques and how it makes that choice.
-
A description of the valuation techniques selected and the risks or shortcomings (if any) of those techniques.
-
When a model is used, a description of the model and related inputs, as well as how the inputs are sourced.
-
If the valuation technique has changed since previous reporting periods, the reason why the entity made the change and a quantification of the change’s impact on the financial statements.
-
The methods the entity uses to calibrate models to market prices and how frequently it uses these methods.
-
A description of the use of broker quotes or pricing services. Such a description may include:
-
How many quotes were obtained, how these quotes were verified, and which brokers or pricing services the entity used and why.
-
A summary of known valuation techniques used by brokers and pricing services and to what extent observable market information, as opposed to unobservable market information, was used to determine the quote.
-
Whether quotes are adjusted and how the ultimate fair value was determined.
-
Whether a quote is binding or nonbinding.
-
-
When an entity measures fair value by using prices for similar instruments, how the entity adjusts these prices to reflect the characteristics of the instruments subject to the measurement.
-
The key drivers of value for each significant Level 2 and Level 3 asset/liability class and the extent to which the inputs used are observable or unobservable.
-
An entity’s consideration of illiquidity when performing the valuation. Factors to consider include:
-
Specific assumptions used.
-
How the assumptions were developed.
-
How and why assumptions changed from period to period.
-
Whether valuation techniques/models changed as a result of the lack of liquidity.
-
Whether alternative valuation techniques for illiquid instruments would have resulted in materially different fair values.
-
-
How the entity’s and counterparty’s nonperformance risk was taken into consideration in the valuation (e.g., for derivatives or debt instruments).
ASC 820-10-55-103 and 55-104 provide examples illustrating how an entity
might comply with the requirement to disclose the valuation techniques and
inputs used in the measurement of fair value.
For Level 3 fair value measurements, entities are also required to disclose
quantitative information about the significant unobservable inputs used in
the measurement (see ASC 820-10-50-2(bbb)(2)), and for recurring fair value
measurements, other-than-nonpublic entities must provide a narrative
description of the uncertainty of the fair value measurement with respect to
the use of significant unobservable inputs (see ASC 820-10-50-2(g)).
Entities are permitted, but not required, to disclose quantitative
information about inputs used in Level 1 or Level 2 fair value measurements
(i.e., the information that must be disclosed about Level 2 fair value
measurements in ASC 820-10-50-2(bbb)(1) may be qualitative instead of
quantitative). See Sections 11.2.3.5.1 and
11.2.3.5.4 for more information about the
disclosures of unobservable inputs related to Level 3 fair value
measurements.
11.2.3.5 Level 3 Measurements
11.2.3.5.1 Quantitative Information About Significant Unobservable Inputs
ASC 820-10-50-2(bbb)(2) requires entities to disclose,
for each class of assets and liabilities measured at fair value on a
recurring or nonrecurring basis in the statement of financial position
after initial recognition, “quantitative information about the
significant unobservable inputs used” in those Level 3 fair value
measurements.7 In complying with this requirement, other-than-nonpublic entities
must, in accordance with ASC 820-10-50-2(bbb)(2)(i), “provide the range
and weighted average of significant unobservable inputs used to develop”
those Level 3 fair value measurements. ASC 820-10-50-2(bbb)(2)(ii)
clarifies that nonpublic entities are exempt from disclosing this
information but are still required to provide quantitative information
about significant unobservable inputs used in Level 3 fair value
measurements. All entities are exempt from disclosing quantitative
information about inputs used in Level 1 and Level 2 fair value
measurements; however, entities are permitted to provide disclosures for
those measurements when they are similar to the quantitative disclosures
of significant inputs required for Level 3 fair value measurements.
In a manner consistent with the FASB’s stated objectives
in requiring the aforementioned disclosures, entities must determine the
following in providing the Level 3 disclosures required for significant
unobservable inputs:8
-
The types of quantitative information to disclose (see Section 11.2.3.5.1.1).
-
How detailed the disclosures should be (i.e., the level of aggregation or disaggregation) (see Section 11.2.3.5.1.2).
-
What information should be provided, if any, when the entity uses prices from prior transactions or third-party pricing information (see Section 11.2.3.5.1.3).
11.2.3.5.1.1 Types of Quantitative Information
Entities must use judgment in deciding what types of quantitative
information to provide about significant unobservable inputs. In
complying with the guidance in ASC 820-10-50-2(bbb)(2)(i),
other-than-nonpublic entities are required to disclose the following:
-
The range and weighted average used to develop these inputs.
-
How that weighted average was calculated for each fair value measurement categorized within Level 3 of the fair value hierarchy.
However, entities may disclose other quantitative
information, such as median or arithmetic average, in lieu of the
weighted average if they determine that providing such disclosures
constitutes a more reasonable and rational method of reflecting the
distribution of significant unobservable inputs used to develop
Level 3 fair value measurements. Paragraph BC51 of ASU 2018-13 cites the use of
unobservable inputs to develop fair value measurements of derivative
instruments as an example of when it would be more reasonable and
rational to use other quantitative information, rather than a
weighted average, to reflect the distribution of significant
unobservable inputs used to develop Level 3 fair value measurements.
In this and similar cases, entities are not required to disclose
their reasons for omitting the weighted average. See ASC
820-10-55-103 for an example illustrating this disclosure
requirement.
In determining which disclosures to provide, an entity should
consider whether the information it plans to furnish would enable a
reasonable investor (or another financial statement user, such as a
regulator) to assess the entity’s views on individual inputs. An
entity may determine that it needs to provide information in
addition to that required in ASC 820-10-50-2(bbb)(2) to
appropriately convey the nature and significance of inputs used.
Such information may include narrative disclosures, other types of
quantitative information (e.g., mean, median, standard deviation),
and other alternatives.
In addition, ASC 820-10-55-104 states that “a reporting entity should
provide additional information that will help users of its financial
statements to evaluate the quantitative information disclosed.” For
example, ASC 820-10-55-104(a) lists the following information that
an entity might consider disclosing for RMBSs:
-
The types of underlying loans (for example, prime loans or subprime loans)
-
Collateral
-
Guarantees or other credit enhancements
-
Seniority level of the tranches of securities
-
The year of issue
-
The weighted-average coupon rate of the underlying loans and the securities
-
The weighted-average maturity of the underlying loans and the securities
-
The geographical concentration of the underlying loans
-
Information about the credit ratings of the securities.
Further, ASC 820-10-55-104(b) indicates that for all assets and
liabilities, entities should consider disclosing “[h]ow third-party
information such as broker quotes, pricing services, net asset
values, and relevant market data was taken into account when
measuring fair value.” In doing so, entities should consider clearly
identifying the fair value of assets and liabilities measured by
using third-party information.
11.2.3.5.1.2 Disaggregation of Inputs
Entities must disclose quantitative information about all significant
unobservable inputs. The meaning of the term “significant” in this
context is the same as that in ASC 820-10-35-37A, which states, in part:
[A] fair value measurement is categorized in its entirety in
the same level of the fair value hierarchy as the lowest
level input that is significant to the entire measurement.
Assessing the significance of a particular input to the
entire measurement requires judgment, taking into account
factors specific to the asset or liability.
ASC 820 does not establish a bright line for
significance or mandate that significance be determined
quantitatively or be based on any specific quantitative approach.
ASC 820-10-35-37A notes that an entity must use judgment in
determining significance, “taking into account factors specific to
the asset or liability.” Entities should establish a method for
determining whether an input is significant to a fair value
measurement in its entirety and should apply it consistently. As
discussed in Section 8.1.2, one possible method for determining
whether an input is significant to a fair value measurement is to
use a threshold or percentage of the overall measurement amount as a
benchmark for significance.9 In determining significance when using a particularly complex
valuation technique, an entity may need to consider how a particular
input or inputs behave within a reasonable range of expected
outcomes (i.e., by performing a sensitivity analysis).
While the process described in Section 8.1.2
is generally used to identify only the lowest-level input that is
significant to the measurement in its entirety, the same process can
be used to identify all significant unobservable inputs. The
following is a summary of the process described in Section 8.1.2, modified to highlight
considerations uniquely relevant to ASC 820-10-50-2(bbb)(2):
-
Determine a threshold or percentage of the overall measurement amount as a benchmark for significance. An entity may determine the threshold by considering whether a reasonable investor would believe that variations in underlying inputs and the resultant variations in fair value measurements would significantly alter the total mix of information available. In making this determination, entities may consider SAB Topic 1.M and PCAOB Auditing Standard 11. “Significance” is not the same as “materiality,” but entities can apply similar concepts to this determination.
-
Inventory all inputs used in a Level 3 fair value measurement (i.e., make a list and ensure that it is complete).
-
Perform a sensitivity analysis for each unobservable input by recalculating fair value, altering the unobservable input so that fair value is calculated by using the low and high values in a range of reasonably possible alternative values for that input. In identifying a range of reasonably possible alternative values, entities could consider (1) prevailing market conditions, (2) input from internal or external specialists, or (3) known or implied amounts in sales or transfer transactions observed for similar assets or liabilities.
-
Determine whether the percentage change in fair value resulting from the sensitivity analysis in step 3 exceeds the benchmark for significance identified in step 1.
-
Because SEC and PCAOB guidance on materiality clearly notes that materiality is not solely a quantitative concept, supplement the quantitative analysis in step 4 with a consideration of qualitative factors such as the nature of the input (e.g., for certain derivatives, all inputs may be considered significant).
-
If the input is determined to be significant on the basis of the above steps, include the input in the tabular fair value disclosure.
-
Repeat these steps for other unobservable inputs identified in step 2.
-
Aggregate individually insignificant inputs by level to determine whether a combination of such inputs is significant to the measurement in its entirety. If so, disclose these inputs.
This process would not need to be repeated in each reporting period
unless facts and circumstances change. In identifying significant
inputs, management may also consider (1) specialists’ input; (2)
competitors’ disclosures, analyst reports, or both; and (3) its own
judgment based on experience with the products.
11.2.3.5.1.3 Third-Party Pricing Information
Paragraph BC90 of ASU 2011-04 states the following regarding
quantitative disclosures about significant unobservable inputs
related to use of third-party pricing information:
[T]he Boards understand that fair value is
sometimes measured on the basis of prices in prior
transactions (for example, adjustments to the last round of
financing for a venture capital investment) or third-party
pricing information (for example, broker quotes). Such
measurements might be categorized within Level 3 of the fair
value hierarchy. In such cases, the Boards concluded that
the reporting entity should be required to disclose how it
has measured the fair value of the asset or liability, but
that it should not need to create quantitative information
(for example, an implied market multiple or future cash
flows) to comply with the disclosure requirement if
quantitative information other than the prior transaction
price or third-party pricing information is not used when
measuring fair value. However, the Boards concluded that
when using a prior transaction price or third-party pricing
information a reporting entity cannot ignore other
quantitative information that is reasonably available. If
there was an adjustment to the price in a prior transaction
or third-party pricing information that is significant to
the fair value measurement in its entirety, that adjustment
would be an unobservable input about which the reporting
entity would disclose quantitative information, even if the
reporting entity does not disclose the unobservable
information used when pricing the prior transaction or
developing the third-party pricing information.
In considering the guidance in paragraph BC90 of ASU 2011-04, an
entity must disclose the following information about its Level 3
fair value measurements:
-
How it has used third-party pricing information to measure the fair value of assets or liabilities.
-
Quantitative information about significant unobservable inputs used to develop significant adjustments, if any, that the entity applies to third-party pricing information (or prior transactions).
-
Quantitative information about significant unobservable inputs used by the third party if such information is reasonably available to the entity.
Entities should make a reasonable effort to gather sufficient
qualitative and quantitative information to determine whether fair
value measurements based on third-party information are prepared in
accordance with ASC 820 and to prepare applicable disclosures about
fair value measurements. If, despite an entity’s efforts,
quantitative information about significant unobservable inputs used
by third-party pricing services is not reasonably available, the
entity would not be required to create such information.
Specifically, ASC 820-10-50-2(bbb)(2) states, in part:
A reporting entity is not required to create quantitative
information to comply with this disclosure requirement if
quantitative unobservable inputs are not developed by the
reporting entity when measuring fair value (for example,
when a reporting entity uses prices from prior transactions
or third-party pricing information without adjustment).
However, when providing this disclosure, a reporting entity
cannot ignore quantitative unobservable inputs that are
significant to the fair value measurement and are reasonably
available to the reporting entity.
Notwithstanding this guidance, management must understand the
information furnished by third-party service providers. If
third-party service providers supply entities with details about the
methods and assumptions used and with quantitative information to
support the entity’s efforts to comply with the disclosure
requirements in ASC 820, quantitative information about significant
unobservable inputs may be reasonably available and should be
disclosed.
Quantitative information about significant unobservable inputs used
by a third party may become reasonably available to the entity in
various ways, including, but not limited to:
-
Recalculation of substantially all fair value measurements provided by third parties for a given class of asset or liability as part of the reporting entity’s process to ensure that these measurements are developed in accordance with ASC 820 or to comply with management’s responsibilities outlined in ASC 820-10-35-54K through 35-54M.10
-
Inquiry and examination of supplemental information provided by third parties to either (1) comply with management’s responsibilities or (2) support a leveling disclosure (ASC 820-10-50-2(b)) and other required disclosures.
ASC 820 does not clearly address whether an other-than-nonpublic
entity is subject to the requirement in ASC 820-10-50-2(g) to
disclose qualitative information about the uncertainty of a Level 3
fair value measurement that results from the use of unobservable
inputs when the entity does not also disclose quantitative
information about significant unobservable inputs used by a
third-party pricing service to develop the fair value measurement.
In the absence of further clarification from standard setters or
regulatory bodies, an entity should make a reasonable effort to
disclose useful qualitative information about the uncertainty of a
Level 3 fair value measurement that results from the use of
unobservable inputs. Such information might be obtained as part of
management’s process for understanding the valuation techniques and
assumptions that the third party used in measuring fair value. See
Section 10.8 for more
information about management’s responsibilities when it uses fair
value information provided by a third party.
11.2.3.5.1.4 Examples
ASC 820-10-55-103 and 55-104 illustrate the
disclosure of quantitative information about significant
unobservable inputs. Below is an additional example.
Example 11-6
Disclosure
of Quantitative Information About Significant
Unobservable Inputs
Entity D invests in various
equity securities and RMBSs. In accordance with
ASC 820-10-50-2B, D identifies three classes of
equity securities, differentiating each class on
the basis of the investees’ industry, and three
classes of RMBSs based on the creditworthiness of
underlying mortgage holders. (Note that an entity
is not required to differentiate classes of debt
investments on the basis of creditworthiness but
should consider disaggregating classes when
nature, characteristics, or risks differ in
accordance with ASC 820-10-50-2B.) The following
table presents the fair value by level within the
fair value hierarchy for corresponding
measurements as of December 31, 20X2:
For the $25 million in Level 3
RMBSs, D uses unadjusted third-party information
to measure the $16 million fair value of the RMBSs
as follows: (1) $12 million of agency-backed RMBSs
and (2) $4 million (of the $6 million) of subprime
RMBSs. In preparing its fair value disclosures, D
makes reasonable efforts to gather qualitative and
quantitative information about the methods and
assumptions used by third parties to price these
RMBSs. Entity D concludes that it has sufficient
information to comply with all other disclosure
requirements but is not able to gather sufficient
quantitative information about significant
unobservable inputs used by third parties in their
fair value measurements. Entity D has qualified
for the disclosure exception in ASC
820-10-50-2(bbb)(2). Paragraph BC90 of ASU 2011-04
provides additional information on this issue.
For the remaining $9,000 of
Level 3 RMBSs (i.e., the $7 million of prime RMBSs
and $2 million of subprime RMBSs), D measures fair
value on the basis of a discounted cash flow
technique. The significant unobservable input in
these Level 3 fair value measurements is the
discount rate. Entity D uses multiple assumptions
(i.e., underlying inputs) to develop the discount
rates on these debt investments. Entity D performs
the process described in Section
11.2.3.5.1.2 and determines that the
following inputs underlying the discount rates are
individually significant to each fair value
measurement:
-
Level 2 risk-free interest rate based on U.S. Treasury yields.
-
Level 3 assumptions about prepayment speeds.
-
Level 3 assumptions about loss severities.
-
Level 3 assumptions about default rates.
Entity D separately discloses
such inputs in accordance with ASC
820-10-50-2(bbb)(2) as follows:
This presentation provides
relevant information about the techniques and
inputs used. In particular:
-
Disclosing the fair value for measurements derived by using a given technique when multiple techniques were used makes it clear what technique was used to measure the fair value for respective portions of D’s RMBSs.
-
Disaggregating the asset class gives users insight into the different assumptions used when risk and other characteristics differ.
-
Disaggregating the discount rate into individually significant inputs increases the transparency of the assumptions used by management and the sources of potential uncertainty in the fair value measurements.
-
Disclosing a weighted-average value for each input helps users understand the values applied to a majority of the securities in a given class. (Note that ASC 820-10-50-2(bbb)(2)(i) requires an other-than-nonpublic entity to disclose how it calculated the weighted average. Thus, D would also need to disclose how it calculated the weighted averages in the table above.)
11.2.3.5.2 Level 3 Fair Value Rollforward
11.2.3.5.2.1 General
As discussed in Section 11.2.2.1, ASC
820-10-50-2(c) requires other-than-nonpublic entities to disclose a
“reconciliation from the opening balances to the closing balances”
(i.e., beginning-of-period to end-of-period balances) for all
classes of assets and liabilities measured at fair value on a
recurring basis that are classified within Level 3 of the fair value
hierarchy. In that reconciliation, the following must be disclosed
in tabular format:
-
“Total gains or losses for the period recognized in earnings” by income statement line item.
-
“Total gains or losses for the period recognized” in OCI by line item in the statement of OCI.
-
“Purchases, sales, issues, and settlements” (each of which is separately disclosed).
-
The amount of transfers “into or out of Level 3 of the fair value hierarchy” and the reasons for those transfers (with transfers into Level 3 disclosed and discussed separately from transfers out of Level 3).
The example in ASC 820-10-55-101 illustrates how an
entity might comply with this requirement.
ASC 820-10-50-2G states that, in lieu of providing
the Level 3 rollforward, nonpublic entities “shall disclose
separately changes during the period attributable to the
following:
-
Purchases and issues (each of those types of changes disclosed separately)
-
The amounts of any transfers into or out of Level 3 of the fair value hierarchy and the reasons for those transfers. Transfers into Level 3 shall be disclosed and discussed separately from transfers out of Level 3.”
In paragraph BC71 of ASU 2018-13, the FASB
acknowledged that users of nonpublic-entity financial statements “do
not seek the same level of detailed information as users of public
company financial statements” but that any information that “could
signal an increase or decrease in the uncertainty of the fair value
measurements” is relevant. The FASB believes that disclosing Level 3
purchases, issues, and transfers could enhance a user’s
understanding of such uncertainty. Therefore, in lieu of applying
ASC 820-10-50-2(c), nonpublic entities are subject to the disclosure
requirements in ASC 820-10-50-2G.
11.2.3.5.2.2 Day 1 Gains or Losses
When the transaction price differs from the exit
price at initial recognition of an asset or liability that is
recognized at fair value on a recurring basis, an inception (or “day
1”) gain or loss is recognized in earnings. Other-than-nonpublic
entities should include the impact of day 1 gains and losses in the
Level 3 rollforward disclosure as well as in the disclosure required
by ASC 820-10-50-2(d).11 A separate line item identifying the impact of day 1 gains or
losses is not required unless an entity reports a “dealer profit”
(i.e., day 1 gain) in an income statement line item separate from
other gains and losses on derivatives. See the example below for a
related illustration. Also see Section 9.2 for further
discussion of when the transaction price differs from the exit price
at initial recognition of an asset or liability.
Example 11-7
Impact of
Day 1 Gain on Level 3 Rollforward
Entity E, a broker-dealer,
enters into a long-dated derivative contract with
a counterparty in which it pays the counterparty
$5 million at execution of the trade. However, E
determines that it has not transacted in the
principal (or most advantageous) market for the
long-dated derivative (i.e., E can exit the
long-dated derivative in the interdealer market at
a higher price). Entity E determines that the fair
value at inception is $8 million and that the
inputs to the valuation of the long-dated
derivative have a significant impact as a result
of Level 3 inputs. At the end of the reporting
period, E determines that the fair value of the
long-dated derivative is $12 million (still with
significant effects from Level 3 inputs). Entity E
would provide the following disclosure regarding
the long-dated derivative at the end of the period
(in millions):
Under ASC 820, E would not be
required to separately identify the day 1 gain or
loss (i.e., the $3 million profit at inception
calculated as the difference between the $8
million fair value at inception and the $5 million
transaction price) in the rollforward or
supplemental disclosures unless it reports a
“dealer profit” (i.e., day 1 gain) in a separate
income statement line item. In either case, in the
period of the transaction, the day 1 gain or loss
is a component of the rollforward.
11.2.3.5.2.3 Derivatives
11.2.3.5.2.3.1 General
In preparing the Level 3 rollforward, an entity
needs to take additional considerations into account for classes
of assets and liabilities that meet the definition of a
derivative instrument under ASC 815. Those considerations are
explained below.
11.2.3.5.2.3.2 Determination of Gains and Losses on Financial and Physical Derivatives
ASC 820-10-50-2(c)(1) requires
other-than-nonpublic entities to disclose “[t]otal gains or
losses for the period recognized in earnings . . . and the line
item(s) in the statement of income . . . in which those gains or
losses are recognized,” and ASC 820-10-50-2(c)(1a) requires
other-than-nonpublic entities to disclose “[t]otal gains or
losses for the period recognized in other comprehensive income,
and the line item(s) in other comprehensive income in which
those gains or losses are recognized.” Further, ASC 815-10-50-4A
through 50-4F require entities to provide separate disclosures
about the location and amount of all gains and losses reported
in the income statement for derivatives. Specifically, ASC
815-10-50-4A(b) requires the following disclosures:
The location and amount of the gains and
losses on derivative instruments (and such nonderivative
instruments) and related hedged items reported in any of
the following:
- The statement of financial performance
-
The statement of financial position (for example, gains and losses initially recognized in other comprehensive income).
The objectives of the gain and loss disclosure
requirements of ASC 820 and ASC 815 are to provide information
about the performance of an entity’s derivative instruments from
an economic perspective (i.e., the impact of derivative
instruments on the equity of the entity through net earnings or
OCI).12 Neither the disclosure requirement in ASC
820-10-50-2(c)(1) and (c)(1a) nor that in ASC 815-10-50-4A(b)
distinguishes between financially and physically settled
derivatives (i.e., those that are settled gross through the
receipt or delivery of the underlying asset in exchange for
cash). Thus, the objectives of the gain and loss disclosure
requirements for derivative instruments in ASC 820 are the same
as those in ASC 815, regardless of whether the instruments are
financially or physically settled. Moreover, although the scope
of ASC 820-10-50-2(c)(1) and (c)(1a) is broader than that of ASC
815-10-50 in one respect (i.e., it applies to all recurring fair
value measurements, not just derivative instruments) and
narrower in another respect (i.e., it applies only to Level 3
measurements), the method an entity uses to determine the amount
of gains or losses to disclose under ASC 820-10-50-2(c)(1) and
(c)(1a) should be consistent with the method it uses to
determine the amount of gains or losses under ASC
815-10-50-4A(b). ASC 815-10-50 implicitly suggests that the
amount of gains and losses to be disclosed includes both
realized and unrealized gains and losses, which is consistent
with the disclosure requirement in ASC 820-10-50-2(c)(1) and
(c)(1a).
For financial derivatives, economic performance
is demonstrated by the changes in fair value and resulting net
settlements that occur over the life of the instrument. The
determination of gains or losses on financial derivatives is
based on the cash settlement activity. In contrast, physical
fixed-price derivatives feature a gross exchange of an
underlying asset (e.g., a physical commodity) and cash based on
a pre-established price. However, the objective of the gain or
loss disclosure remains the same — that is, to require entities
to provide information about the performance of the derivative
instrument from an economic perspective.
For example, a physical fixed-price forward
commodity contract economically consists of two elements:13
- A physical purchase or sale of the underlying commodity at the market price on the date of delivery. This results in a physical receipt or delivery of the commodity at its spot market price at the time of the settlement of the contract.
- A financial fixed-price forward contract based on the same underlying commodity as the physical purchase or sale. This results in a hypothetical net cash settlement based on the difference between the spot market price of the commodity at the time of the settlement of the contract and the fixed price established by the physical derivative contract.
The second element’s change in fair value during
the reporting period (i.e., the financial fixed-price forward
contract) should be reflected as a gain or loss in the required
disclosures. This approach achieves symmetry between financial
and physical derivatives and provides financial statement users
with relevant information about derivative performance.
Reflecting gross settlement amounts for physical
derivatives in the settlement line of the ASC 820 Level 3
rollforward (i.e., the full settlement amount, including cash
flows from the physical market purchase or sale element) would
constitute an overstatement of gains or losses and would fail to
reflect the economic impact of the contract on an entity’s
equity. For example, a physical sale that is accounted for as a
derivative instrument, that does not contain a financing element
(e.g., that does not contain off-market terms or necessitate an
up-front cash payment), and that is settled at the money (i.e.,
the spot market price equals the fixed price at the time of the
settlement of the contract) does not result in any net economic
benefit or detriment. An entity that enters any amount other
than zero in the settlement line of the ASC 820 Level 3
rollforward would be required to increase or decrease another
line of the reconciliation (presumably the gain or loss) to
balance the reconciliation. However, reflecting the gross sales
price established by the contract as a derivative gain would be
a misrepresentation because it would ignore the fact that the
entity delivered an asset of equal value. Likewise, a physical
purchase that is accounted for as a derivative, that does not
contain a financing element, and that is settled at the money
does not result in an economic detriment, and reflecting the
gross purchase price established by the contract as a derivative
loss would be misrepresentative because the entity received an
asset of equal value.
The example below illustrates the application of
this guidance to financial derivatives and physical derivatives.
In contemplating how gains or losses are determined and
ultimately disclosed, an entity should also consider the
guidance in ASC 820-10-50-2B and assess the appropriate classes
of assets and liabilities for disclosure.
Example 11-8
Financial
Contract
Level 3
Rollforward
Physical
Contract
Level 3
Rollforward
See Section 11.2.3.5.2.3.3 for
discussion of how to determine the amounts of purchases, sales,
issues, and settlements of derivative instruments that
other-than-nonpublic entities must reflect in the Level 3
rollforward. (Note that nonpublic entities are only required to
present purchases and issues of derivative instruments in
accordance with ASC 820-10-50-2G.)
11.2.3.5.2.3.3 Determination of Purchases, Sales, Issues, and Settlements for Derivatives
ASC 820-10-50-2(c)(2) requires
other-than-nonpublic entities to disclose “[p]urchases, sales,
issues, and settlements (each of those types of changes
disclosed separately)” as part of the Level 3 rollforward. Note
that ASC 820-10-50-2G states that nonpublic entities are not
required to complete Level 3 rollforward disclosures. Rather, in
lieu of applying ASC 820-10-50-2(c), nonpublic entities must
separately disclose changes during the period attributable to
purchases and issues (each type separately) in accordance with
ASC 820-10-50-2G(a).
When determining the amounts to disclose for
individual derivative contracts for purchases, sales, issues,
and settlements, an entity should evaluate the consideration
exchanged (e.g., cash) between the counterparty and itself.
However, an entity should not offset cash collateral receivables
and payables with derivative assets and liabilities (see
Section
11.2.3.5.2.3.5).
Typically, a derivative transaction that does
not involve an up-front exchange of consideration (e.g., an
at-market swap) should not be disclosed in the purchases, sales,
or issues line items. Any ongoing payments under the contract
would be reflected in the settlements line item. An up-front
premium payment may not be required for an option acquired by an
entity; instead, the entity may be required to make periodic
premium payments to the counterparty over the term of the
contract (i.e., the option premium is effectively financed by
the counterparty). In this situation, the entity should consider
the deferred premium payments as ongoing settlements rather than
an up-front exchange of consideration, which the entity would
typically present in the purchases line item.
The guidance below outlines the presentation of
various types of payments related to derivative contracts within
the Level 3 rollforward as purchases, sales, issues, or
settlements.
-
Purchases — An entity should present a derivative requiring an initial cash outlay (or other up-front consideration) in the purchases line item. Such presentation would include premium payments to purchase an option or up-front payments related to an off-market swap asset. Payments to acquire a derivative asset (through a contract assignment) should also be presented in the purchases line item.
-
Sales — If an entity assigns a derivative asset to a third party for consideration, the payment should be presented in the sales line item. An assignment of a derivative liability should be disclosed as a settlement rather than as a sale (see the discussion in the “Settlements” bullet below for further details).
-
Issues — If an entity executes a derivative and receives an initial cash inflow (or other up-front consideration), the up-front payment should be presented in the issues line item. In this situation, the entity has issued a derivative liability in return for consideration. Such presentation would include receipt of premium payments on written options or receipt of up-front payments related to an off-market swap liability. Payments received to assume a derivative contract liability (through a contract assignment) should also be presented in the issues line item and accompanied by separate disclosure describing the nature of the assignment transaction and the assignment amount related to the transaction. Alternatively, an entity may adopt a policy of presenting the consideration related to assignments of derivative liabilities in a separate line item other than purchases, sales, issues, or settlements, along with a disclosure describing the nature of the assignment transactions.
-
Settlements — All ongoing contractual cash payments (or other consideration) made under the derivative contract should be disclosed in the settlements line item. Such disclosure would include payments on a multiperiod settled derivative (e.g., interest rate swaps that are net-cash-settled on a quarterly basis) or payments between the entity and counterparty to terminate a derivative or to exercise an option. In addition, if an entity assigns a derivative liability to a third party and is required to make a payment to the third party as part of the transaction, the payment should be presented in the settlements line item and accompanied by separate disclosure describing the nature of the assignment transaction and the settlement amount related to the transaction. An assignment of a derivative liability is akin to an early termination and thus a settlement of the original derivative. Alternatively, an entity may present the consideration related to assignments of derivative liabilities in a separate line item other than purchases, sales, issues, or settlements, along with a disclosure describing the nature of the assignment transactions.
The table below summarizes the application of
ASC 820-10-50-2(c)(2) to various derivative transactions and
highlights the concept of symmetry between the entity and
counterparty.
Table 11-3
|
Transaction (From Reporting
Entity’s Perspective)
|
Presentation by:
| |
|---|---|---|
|
Reporting Entity
|
Counterparty (or Third-Party
Assignee)
| |
|
Purchase of an option for
up-front premium
|
Purchases
|
Issues
|
|
Writing of an option for
up-front premium
|
Issues
|
Purchases
|
|
Assignment of derivative asset
contract to a third party (assignee makes
payment)
|
Sales
|
Purchases
|
|
Assignment of derivative
liability contract to a third party (assignee
receives payment)
|
Settlements*
| Issues* |
|
Periodic cash settlement of a
swap contract
|
Settlements
|
Settlements
|
|
Early termination of
derivative contract between parties to original
contract
|
Settlements
|
Settlements
|
|
* If an entity
adopts a policy of disclosing the consideration
related to assignments of derivative liabilities
as settlements (for assignments to third parties)
or issues (for assignments from third parties),
the entity should also include a separate
disclosure describing the nature of the assignment
transactions and the settlement amounts related to
the transactions. Alternatively, an entity may
adopt a policy of presenting the consideration
related to assignments of derivative liabilities
in a separate line item other than purchases,
sales, issues, or settlements, along with a
disclosure describing the nature of the assignment
transactions. This policy should be disclosed and
consistently applied.
| ||
The example below illustrates the application of
this guidance to financial derivative instruments.
Example 11-9
Determination of Purchases, Sales, Issues, and
Settlements for Financial Derivative
Instruments
Assume the following:
-
Financial Derivative 1 — Beginning balance of $100 asset; $10 change in fair value during period (i.e., increase in the fair value of the asset); termination cash payment of $110; zero ending balance.
-
Financial Derivative 2 — Beginning balance of $0; entity wrote a strip of interest rate caps and received consideration of $100; $500 change in fair value of derivative during period (i.e., increase in the fair value of the liability); one cap was exercised by the counterparty, for which a cash outflow of $75 during the period was required; ending derivative liability of $525.
-
Financial Derivative 3 — Beginning balance of $0; entity purchased an option for $50 up front; $30 change in fair value during period (decrease in the fair value of the asset); no settlement or exercise during the period; ending derivative asset of $20.
The entity has determined that
Financial Derivative 1, Financial Derivative 2,
and Financial Derivative 3 are separate classes
(separate rollforwards are therefore required).
See Section
11.2.3.1.2 for guidance on determining
classes of derivative contracts.
Level 3
Rollforward in Period 1*
Assume the following
additional facts (related to preparation of the
disclosures for the second reporting period):
-
Financial Derivative 1 — Settled in prior period.
-
Financial Derivative 2 — Beginning liability balance of $525; $80 change in fair value of derivative during period (decrease in the fair value of the liability); no regular settlements during the period.
-
Financial Derivative 3 — Beginning asset balance of $20; $5 change in fair value during period (decrease in the fair value of the asset); no settlement or exercise during the period.
Upon downgrade of its credit
rating by a rating agency, the entity is forced to
terminate its entire portfolio of derivatives. The
entity makes one cash payment of $430 to assign
Financial Derivative 2 and Financial Derivative 3
to an independent third party.
Level 3
Rollforward in Period 2*
11.2.3.5.2.3.4 Gross Versus Net Presentation of Purchases, Sales, Issues, and Settlements for Derivatives
In accordance with ASC 820-10-50-2(c)(2),
other-than-nonpublic entities must present, as part of the Level
3 rollforward, purchases, sales, issues, and settlements related
to derivative instruments.14 ASC 820-10-50-3(b) addresses whether derivative assets and
derivative liabilities must be presented on a gross or net basis
in the Level 3 rollforward and allows entities to present
derivative instruments on either a gross or net basis. Whether
an entity chooses to present derivative instruments net (i.e.,
in one table) or gross (i.e., derivative assets and liabilities
in two separate tables), the entity must still present
purchases, sales, issues, and settlements separately for each
class of derivative contract. That is, an entity that chooses to
present derivative instruments on a net basis under ASC
820-10-50-3(b)is still required to separate the purchases,
sales, issues, and settlements related to those derivatives in
complying with the Level 3 rollforward requirement in ASC
820-10-50-2(c)(2). See also the two examples below.
Example 11-10
Entity
Purchases an Option and Writes an Option
Assume the following:
-
Entity F has a policy of presenting derivative contracts on a net basis in accordance with ASC 820-10-50-3(b).
-
Entity F acquires an option for a $50 up-front payment and separately writes an option in return for a $100 up-front payment during the same period.
-
In aggregating the fair value disclosures, F determines the class to be the same for each option.
It would not be appropriate
for F to net the $50 purchase with the $100 issue
and present a net $50 issue. Rather, F should, in
the Level 3 rollforward, separately present the
$50 purchase and $100 issue that occurred during
the period.
Further assume that in a
subsequent period, offsetting cash payments are
made on these options. In this situation, because
both option contracts are considered to be in the
same class for aggregation purposes, F should net
the subsequent payments associated with these
contracts and present the net amount separately in
the “settlements” line item.
Example 11-11
Entity
Assigns Derivative Asset and Derivative
Liability
Assume the following:
-
Entity G chooses to present derivative contracts on a net basis in accordance with ASC 820-10-50-3(b).
-
Entity G has a derivative asset with a fair value of $100 and a derivative liability with a fair value of $25.
-
In aggregating the fair value disclosures, G determines the class to be the same for each derivative.
-
During the period, G assigns the derivative asset and derivative liability to an independent third party in return for a cash payment of $75.
In this scenario, it would be
acceptable for G to present the $75 payment
received in the “sales” line item. Alternatively,
G could allocate the $75 payment between the
derivative asset and derivative liability and
present these amounts separately in the Level 3
rollforward; the $100 related to the derivative
asset would be presented in the sales line item,
and the $25 related to the derivative liability
would be presented in the settlements line item.
Entity G could also present the derivative
liability portion in a separate line item within
the rollforward (e.g., a line item called
“assignments of liabilities”). See Section
11.2.3.5.2.3.3 for additional guidance
on presenting various types of payments related to
derivative contracts within the Level 3
rollforward as purchases, sales, issues, or
settlements. Regardless of the policy it selects,
G should also include a separate disclosure
describing the nature of the assignment
transaction and the settlement amounts related to
the transaction.
If G were instead to make a
net payment to the third party in this example to
assign a net derivative liability, G should
present such a payment as a settlement. An
allocation between the settlement of a derivative
liability and sale of a derivative asset would
also be acceptable.
11.2.3.5.2.3.5 Presentation of Cash Collateral Receivables and Payables
Under ASC 815-10-45-3 through 45-7, an entity
may elect to offset, in its statement of financial position,
fair value amounts recognized for its derivative instruments
with fair value amounts recognized for the right or obligation
to reclaim or return cash collateral (i.e., offset its
derivative assets and liabilities with cash collateral
receivables and payables). An entity that makes this election
should not offset cash collateral receivables and payables with
derivative assets and liabilities in ASC 820 disclosures,
including the Level 3 rollforward. Although such fair value
amounts are offset in the statement of financial position, such
offsetting is inappropriate in the ASC 820 disclosures because
doing so would be misleading. For example, assume that the net
amount is the credit exposure under a particular master netting
arrangement rather than the fair value amounts (measurements) of
the derivative positions. Disclosure of the net amount would not
allow financial statement users to identify the fair value
amounts of the derivative instruments and where they are
categorized in the fair value hierarchy. The example below
illustrates an acceptable way of presenting the cash collateral
receivables and payables in the ASC 820 disclosures.
Example 11-12
Presentation of Cash Collateral on Derivative
Instruments
Cash collateral receivables
and payables are presented in a separate column
with other counterparty netting adjustments made
under ASC 815-10-45-3 through 45-7. The entity
uses the separate column to facilitate
reconciliation with the balance sheet.
Note that this presentation
method for cash collateral receivables and
payables and other counterparty netting
adjustments made under ASC 815-10-45-3 through
45-7 does not apply in other circumstances (e.g.,
portfolio-level adjustments). See Section
11.2.3.5.5 for guidance on the
allocation of portfolio-level adjustments.
11.2.3.5.3 Unrealized Gains and Losses on Level 3 Assets and Liabilities
ASC 820-10-50-2(d) requires other-than-nonpublic
entities to separately disclose, for recurring fair value measurements
categorized within Level 3 of the fair value hierarchy, “the amount of
the total gains or losses for the period . . . included in earnings [or
in comprehensive income] that is attributable to the change in
unrealized gains or losses relating to those assets and liabilities held
at the end of the reporting period, and the line item(s) . . . in which
those unrealized gains or losses are recognized.”
In determining the unrealized portion of total gains or
losses on Level 3 assets or liabilities held at the end of the reporting
period, an entity should follow its established policy for determining
when transfers between levels of the fair value hierarchy are deemed to
have occurred (see Section 11.2.3.2.2) to ensure that amounts are
reconciled to the amounts presented in the Level 3 rollforward (see
Section
11.2.3.5.2). ASC 820-10-55-102 contains an example
illustrating how an entity might separately disclose the unrealized
portion of total gains and losses, by respective financial statement
line item, as required by ASC 820-10-50-2(d).
In accordance with ASC 820-10-50-2F, nonpublic entities
are not required to disclose the information required by ASC
820-10-50-2(d) unless another Codification topic requires them to do
so.
11.2.3.5.4 Qualitative Uncertainty Disclosure for Level 3 Assets and Liabilities
ASC 820-10-50-2(g) requires other-than-nonpublic
reporting entities to disclose “a narrative description of the
uncertainty of [a] fair value measurement from the use of significant
unobservable inputs if those inputs reasonably could have been different
at the reporting date.” Entities should consider, at a minimum, the
uncertainty of those unobservable inputs disclosed in accordance with
ASC 820-10-50-2(bbb) when complying with this disclosure requirement and
should also disclose any interrelationships between significant
unobservable inputs that might exacerbate those measurement differences.
The objective of such disclosure(s) is to help financial statement users
understand not only the valuation techniques and inputs but also the
judgments the entity uses when measuring fair value. See ASC
820-10-55-106 for further implementation guidance, including a sample
disclosure about RMBSs.
In accordance with ASC 820-10-50-2F, nonpublic entities
are not required to disclose the information required by ASC
820-10-50-2(g) unless another Codification topic requires them to do so.
11.2.3.5.5 Use of Net Risk Exception for Portfolio-Based Fair Value Measurements
Under ASC 820-10-35-18D, the fair value of a group of
financial assets, financial liabilities, nonfinancial items accounted
for as derivatives in accordance with ASC 815, or combinations of these
items, can be measured on the basis of what would be received to exit a
net-long or net-short risk position, provided that certain provisions
are met. ASC 820-10-50-2D requires an entity to disclose the fact that
it made an accounting policy decision to use the exception in ASC
820-10-35-18D. See Section 10.2.8 for further discussion of this valuation
approach.
Credit valuation adjustments (CVAs) are commonly made at
the portfolio level as long as the requirements outlined in ASC
820-10-35-18E through 35-18H are met. An entity might incorporate the
effect of exposure to a particular counterparty’s credit by netting its
derivative asset and liability contracts with a given counterparty in
accordance with a master netting arrangement and then calculate a CVA on
the basis of the net position with the counterparty.15 Thus, a CVA might apply to, and be calculated on the basis of, a
portfolio of contracts that are individually classified in different
levels of the fair value hierarchy. ASC 820-10-35-18L provides the
following additional guidance about CVAs:
[T]he reporting entity shall include the effect
of the reporting entity’s net exposure to the credit risk of
that counterparty or the counterparty’s net exposure to the
credit risk of the reporting entity in the fair value
measurement when market participants would take into account any
existing arrangements that mitigate credit risk exposure in the
event of default (for example, a master netting agreement with
the counterparty or an agreement that requires the exchange of
collateral on the basis of each party’s net exposure to the
credit risk of the other party). The fair value measurement
shall reflect market participants’ expectations about the
likelihood that such an arrangement would be legally enforceable
in the event of default.
As long as the requirements outlined in ASC
820-10-35-18E through 35-18H are met, mid-to-bid or mid-to-ask
adjustments can also be made at the portfolio level. A derivatives
dealer might initially use the midpoint in the bid-ask spread to value a
portfolio of both its long (buys) and short (sells) derivative positions
with the same underlying. The derivatives dealer would then make a
mid-to-bid or mid-to-ask adjustment to effectively move the net open
position of the portfolio to the bid or ask depending on whether the
portfolio is net long or net short in each period. Thus, a mid-to-bid or
mid-to-ask adjustment might apply to, and be calculated on the basis of,
all of a portfolio’s derivative contracts that are individually
classified in different levels of the fair value hierarchy. ASC
820-10-35-18I through 35-18K discuss additional considerations related
to when an entity that uses the exception in ASC 820-10-35-18D is
exposed to market risks and measures fair value.
An entity must allocate portfolio-level adjustments to
the individual assets and liabilities in complying with ASC 820’s
disclosure requirements. ASC 820-10-35-18G indicates the following:
A reporting entity shall make an accounting
policy decision to use the exception in paragraph 820-10-35-18D.
A reporting entity that uses the exception shall apply that
accounting policy, including its policy for
allocating bid-ask adjustments (see paragraphs 820-10-35-18I
through 35-18K) and credit adjustments (see paragraph
820-10-35-18L), if applicable, consistently from period
to period for a particular portfolio. [Emphasis added]
The ASC 820 disclosure requirements must be applied in a
manner consistent with the asset’s, liability’s, or own equity
instrument’s unit of account (which is generally specified by
Codification topics other than ASC 820). This is the case even when the
ASC 820-10-35-18D exception has been applied. The unit of account under
ASC 815 is each individual derivative. Accordingly, a CVA related to a
portfolio of derivatives must be allocated to each individual derivative
contract within the portfolio.
ASC 820 does not prescribe an approach for allocating
portfolio-level adjustments to individual assets and liabilities.
However, ASC 820-10-35-18G requires that an entity’s policy be
consistently applied. Entities must apply a reasonable method for
allocating portfolio-level adjustments and should consider disclosing
their policy in the notes to the financial statements.
An allocated portfolio adjustment is an input in the
measurement of the fair value of the contract. Accordingly, an allocated
portfolio adjustment that is a Level 3 input (i.e., either the portfolio
adjustment or the allocation itself is unobservable) and that has a
significant effect on the measurement of fair value of an individual
asset, liability, or own equity instrument would cause the fair value of
the entire individual asset, liability, or own equity instrument to be
considered Level 3. Therefore, if a CVA is made on the basis of
unobservable inputs, and that amount is allocated to individual
derivative instruments within a portfolio, each individual derivative
would represent a Level 3 fair value measurement solely on the basis of
the CVA allocation if that allocation is significant to the measurement
of this individual derivative instrument in its entirety.
Footnotes
2
ASC 820-10-50-2E also refers to the
disclosure requirement in ASC 820-10-50-2(h). However,
since public business entities are not required to
disclose the fair value of nonfinancial assets that are
not recognized at fair value, it is unlikely that this
disclosure will be relevant to the disclosure of the
fair values of items not recognized at fair value.
3
See Sections 2.2.2 and 10.9 for further discussion of this
practical expedient.
4
The assets and liabilities of an asset group to
be held and used in an entity’s business would also be subject
to ASC 820’s disclosure requirements if they are measured at
fair value on a recurring or nonrecurring basis.
5
The same approach would apply to long-lived
assets held and used that constitute an asset group.
6
Assets measured on a recurring basis by using the NAV practical
expedient are not subject to such disclosure requirements. See
Section 11.2.2.3 for more information.
7
See footnotes (c) and (d) of Table
11-2 for exceptions to this disclosure
requirement.
8
Paragraph BC86 of ASU
2011-04 states, in part:
“The Boards noted that the objective of
the disclosure is not to enable users of financial
statements to replicate the reporting entity’s pricing
models but to provide enough information for users to
assess whether the reporting entity’s views about
individual inputs differed from their own and, if so, to
decide how to incorporate the reporting entity’s fair
value measurement in their decisions. The Boards
concluded that the information required by the
disclosure will facilitate comparison of the inputs used
over time, providing users with information about
changes in management’s views about particular
unobservable inputs and about changes in the market for
the assets and liabilities within a particular class. In
addition, that disclosure might facilitate comparison
between reporting entities with similar assets and
liabilities categorized within Level 3 of the fair value
hierarchy.”
9
As noted in Section 8.1.2, an
entity should not use a percentage of a particular component
of a fair value measurement or the income statement effect
of a fair value measurement (i.e., the threshold should be
based on a balance sheet approach).
10
Note that entities are generally
not required to disclose quantitative inputs about
techniques that are used to validate other
valuation techniques (e.g., secondary techniques
that are not weighted in the fair value
measurement).
11
Nonpublic entities are subject to the
disclosure requirement in ASC 820-10-50-2G, with which they
must comply in lieu of the Level 3 rollforward.
12
Paragraphs E82 and E83 of FASB Concepts Statement 8, Chapter 4, define gains (or losses) as
increases (or decreases) in “equity (net assets) from
transactions and other events and circumstances
affecting an entity except those that result from
revenues [or expenses] or investments by [or
distributions to] owners.”
13
For simplicity, physical delivery risk
(sometimes referred to as “index” risk), which is
typically considered in the fair value calculation of a
physical derivative, is not discussed here.
14
Nonpublic entities are not required to
complete the Level 3 rollforward disclosure. However, in
accordance with ASC 820-10-50-2G(a), they must still
disclose purchases and issues (each type separately) for
assets and liabilities classified within Level 3 of the
fair value hierarchy.
15
Because some derivatives can be assets or
liabilities depending on changes in market conditions, entities
may employ more sophisticated techniques that factor in
reasonably possible market fluctuations in determining the
appropriate CVA. For simplicity, this guidance assumes that
current exposure approximates expected exposure.
11.3 Examples of Financial Instruments Subject to the Disclosure Requirements of ASC 825-10-50-10
The following are examples of financial instruments that are subject to the fair
value disclosure requirements of ASC 825-10-50-10 (i.e., financial instruments of
public business entities that are not measured at fair value but for which fair
value disclosures are required):
-
Cash equivalents and short-term investments.
-
Investment securities.
-
Long-term investments.
-
Loan receivables.
-
Note receivables.
-
Long-term receivables.
-
Short-term debt.
-
Long-term debt.
-
Long-term payables.
-
Commitments to extend credit.
-
Standby letters of credit.
-
Written financial guarantees.
-
Foreign currency contracts.
-
Tender option bonds.
-
Repurchase agreements.
-
Reverse repurchase agreements.
-
Treasury rolls.
-
Mortgage dollar rolls.
-
Lines of credit.
-
Variable-rate demand preferred shares.
-
Variable-rate muni term preferred shares.
Chapter 12 — Fair Value Option
Chapter 12 — Fair Value Option
12.1 Introduction
ASC 825-10
05-5 The Fair Value
Option Subsections of this Subtopic address both of the
following:
- Circumstances in which entities may choose, at specified election dates, to measure eligible items at fair value (the fair value option)
- Presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities.
05-6 See Topic 820
for guidance on fair value measurements.
10-1 The objective
of the guidance in the Fair Value Option Subsections of this
Subtopic is to improve financial reporting by providing entities
with the opportunity to mitigate volatility in reported earnings
caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions.
Entities
15-2 The guidance
in this Subtopic applies to all entities.
Under ASC 825, entities can elect the FVO to account for certain financial assets and
financial liabilities at fair value.1 The change in fair value of the eligible item that is elected under the FVO is
recognized in net income (or, for certain financial liabilities, in net income and OCI
as discussed in Section 12.4.1.2).
The FVO may be elected for any eligible item within the scope of ASC 825 (see Section 12.2). The ability to elect the FVO is not
predicated on the reliability of the fair value measurement. In ASC 820, the FASB
rejected a minimum-reliability threshold for items that are carried at fair value (under
the FVO or otherwise). That is, the FASB decided to allow fair value measurements for
items in financial statements even when they are not based on market-observable data. In
such circumstances, however, the data used for the measurement must reflect assumptions
that market participants would use in pricing the asset or liability (including
adjustments that market participants demand for the risk associated with the
unobservable data or the model used to determine fair value). In addition, entities are
required to disclose the categorization of fair value measurements within the fair value
hierarchy, which indicates whether significant inputs to those measurements are
observable or unobservable.
Footnotes
1
In these circumstances, the entity applies the fair value measurement guidance in
ASC 820.
12.2 Scope
12.2.1 General
ASC 825-10
Instruments
15-4 All
entities may elect the fair value option for any of the
following eligible items:
- A recognized financial asset and financial liability, except any listed in the following paragraph
- A firm commitment that would otherwise not be recognized at inception and that involves only financial instruments (for example, a forward purchase contract for a loan that is not readily convertible to cash — that commitment involves only financial instruments — a loan and cash — and would not otherwise be recognized because it is not a derivative instrument)
- A written loan commitment
- The rights and obligations
under an insurance contract that has both of the
following characteristics:
- The insurance contract is not a financial instrument (because it requires or permits the insurer to provide goods or services rather than a cash settlement).
- The insurance contract’s terms permit the insurer to settle by paying a third party to provide those goods or services.
- The rights and obligations
under a warranty that has both of the following
characteristics:
- The warranty is not a financial instrument (because it requires or permits the warrantor to provide goods or services rather than a cash settlement).
- The warranty’s terms permit the warrantor to settle by paying a third party to provide those goods or services.
- A host financial instrument resulting from the separation of an embedded nonfinancial derivative from a nonfinancial hybrid instrument under paragraph 815-15-25-1, subject to the scope exceptions in the following paragraph (for example, an instrument in which the value of the bifurcated embedded derivative is payable in cash, services, or merchandise but the debt host is payable only in cash).
12.2.1.1 Financial Asset or Financial Liability
Generally, all entities may elect the FVO for all financial assets or financial
liabilities. However, there are certain exceptions, as discussed in
Section 12.2.2.
12.2.1.1.1 Equity Method Investees That Hold Nonfinancial Assets and Nonfinancial Liabilities
An equity method investment meets the definition of a financial asset. An
investor is not required to “look through” the investment to the investee’s
assets and liabilities to determine eligibility for the FVO. The FVO is
available for equity method investments regardless of the nature of the
investee’s assets and liabilities. However, certain nonconsolidated equity
investments subject to the equity method may be ineligible for the FVO under
ASC 825 because of a significant future-services component, as discussed in
Section 12.2.2.6.
12.2.1.2 Written Loan Commitment
An entity should consider the definition of a “loan commitment”
in the ASC master glossary when determining whether an item represents a written
loan commitment for which the FVO may be elected. Only the writer of a loan
commitment can elect the FVO. The FVO is not available to the holder of the loan
commitment.
12.2.1.3 Warranty Contracts
An entity should consider the definition of a “warranty” in the ASC master
glossary when determining whether an item represents a warranty contract for
which the FVO may be elected.
12.2.1.4 Host Financial Instrument
12.2.1.4.1 Hybrid Financial Instrument
A host financial instrument that is recognized separately because an embedded
financial derivative in the hybrid financial instrument has been separated
under ASC 815-15 is not eligible for the FVO. However, the entire
hybrid financial instrument is eligible for the FVO provided that none of
the exceptions in ASC 825-10-15-5 apply to the instrument.
12.2.1.4.2 Hybrid Nonfinancial Instrument
A host financial instrument that is recognized separately because an embedded
nonfinancial derivative in the hybrid nonfinancial hybrid instrument has
been separated under ASC 815-15 is eligible for the FVO under ASC
825-10-15-4(f) provided that none of the exceptions in ASC 825-10-15-5 apply
to the instrument. Such eligibility depends on both (1) the bifurcation and
separate accounting for the embedded derivative instrument under ASC 815-15
and (2) the determination that what remains after such bifurcation is a
financial instrument (i.e., the host contract is a financial instrument).
Thus, the FVO is not available for an embedded derivative that is subject to
an exception in ASC 815 (i.e., an embedded feature that is not separately
accounted for under ASC 815-15).
It is important for an entity to identify the features of the separated
embedded derivative and the remaining host contract. If the appropriately
identified embedded derivative contains all of the nonfinancial features of
the hybrid nonfinancial instrument and the host contract is receivable or
payable only in cash, the host contract would be considered a financial
asset or liability. If the identified features of the host contract contain
any nonfinancial items (e.g., delivery of commodities, services), the host
contract is not a financial instrument and the entity may not elect to apply
the FVO under ASC 825-10-15-4. An entity must use judgment in determining
the features of the embedded derivative and host contract.
12.2.1.4.3 Examples
Example 12-1
Prepaid Forward Commodity Contract — Embedded
Derivative Is Not Bifurcated
Entity A enters into a prepaid contract to sell a
commodity. The contract must be physically settled,
and the commodity is not readily convertible to
cash. The contract is a hybrid nonfinancial
instrument that does not meet the definition of a
derivative instrument in its entirety.
Entity A may not elect the FVO for
the contract because (1) the hybrid instrument is
not a financial instrument (since the contract must
be physically settled by delivering a nonfinancial
asset) and (2) the embedded commodity is not
separated from the host debt contract under ASC
815-15. If the commodity had met the definition of a
derivative and been bifurcated from the host
contract, A would have been able to apply the FVO to
the host financial instrument. See Example 12-2 for a
scenario in which the embedded derivative is
bifurcated from the host contract.
Example 12-2
Prepaid Forward Commodity Contract — Embedded
Derivative Is Bifurcated
Entity B enters into a prepaid contract to sell a
commodity. Under the contract, B receives $1 million
from the counterparty at inception of the contract
and will deliver a fixed quantity of the commodity
every month for the next 60 months. The contract
must be physically settled, and the commodity is
readily convertible to cash. The contract is a
hybrid nonfinancial instrument that does not meet
the definition of a derivative instrument in its
entirety.
Entity B determines that the embedded derivative is
bifurcated as a commodity forward in which B
receives a fixed dollar amount and delivers the
fixed quantity of the commodity every month. Entity
B will separately account for the bifurcated
derivative at fair value in accordance with ASC
815-15-25-1. Entity B identifies the host contract
as a payable in which it received $1 million at
inception in return for future deliveries of the
commodity to the counterparty. Because the
identified host contract is a financial asset, B may
elect to apply the FVO under ASC 825-10-15-4 to the
host contract upon initial recognition (or on
another eligible election date).
Example 12-3
Prepaid Services Contract — Embedded Derivative Is
Bifurcated
Entity C enters into a contract to buy a fixed dollar
amount of services from Entity D every month for 60
months. Entity C will pay an amount each month for
six months that comprises a fixed dollar amount
multiplied by an index linked to a foreign currency,
Y, which is not the functional currency of either
party and whose economic characteristics and risks
are not clearly and closely related to either
party’s services. Entity C identifies the embedded
derivative as a net-cash-settled foreign-currency
derivative and the host contract as a contract for
services. The embedded derivative will be accounted
for at fair value in accordance with ASC
815-15-25-1. Because the host contract is not a
financial instrument, C may not elect to account for
it at fair value under ASC 825-10-15-4.
12.2.2 Exceptions
ASC 825-10
Instruments
15-5 No entity may elect the
fair value option for any of the following financial assets
and financial liabilities:
- An investment in a subsidiary that the entity is required to consolidate.
- An interest in a variable interest entity (VIE) that the entity is required to consolidate.
- Employers’ and plans’ obligations (or assets representing net overfunded positions) for pension benefits, other postretirement benefits (including health care and life insurance benefits), postemployment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements, as defined in Topics 420; 710; 712; 715; 718; and 960.
- Financial assets and financial liabilities recognized under leases as defined in Subtopic 842-10. (This exception does not apply to a guarantee of a third-party lease obligation or a contingent obligation arising from a cancelled lease.)
- Deposit liabilities, withdrawable on demand, of banks, savings and loan associations, credit unions, and other similar depository institutions.
- Financial instruments that are, in whole or in part, classified by the issuer as a component of shareholders’ equity (including temporary equity) (for example, a convertible debt instrument within the scope of the Cash Conversion Subsections of Subtopic 470-20 or a convertible debt security with a noncontingent beneficial conversion feature).
Pending Content (Transition Guidance: ASC
815-40-65-1)
15-5 No entity may elect the fair value
option for any of the following financial assets
and financial liabilities:
- An investment in a subsidiary that the entity is required to consolidate.
- An interest in a variable interest entity (VIE) that the entity is required to consolidate.
- Employers’ and plans’ obligations (or assets representing net overfunded positions) for pension benefits, other postretirement benefits (including health care and life insurance benefits), postemployment benefits, employee stock option and stock purchase plans, and other forms of deferred compensation arrangements, as defined in Topics 420; 710; 712; 715; 718; and 960.
- Financial assets and financial liabilities recognized under leases as defined in Subtopic 842-10. (This exception does not apply to a guarantee of a third-party lease obligation or a contingent obligation arising from a cancelled lease.)
- Deposit liabilities, withdrawable on demand, of banks, savings and loan associations, credit unions, and other similar depository institutions.
- Financial instruments that are, in whole or in part, classified by the issuer as a component of shareholders’ equity (including temporary equity).
12.2.2.1 Consolidated Entities
An entity cannot elect the FVO to avoid consolidating another entity under the voting or VIE consolidation model in ASC 810. In the Background Information and Basis for Conclusions of Statement 159, the FASB noted that an “interest in an
entity (principally an investment in a subsidiary or a primary beneficiary’s
variable interest in a variable interest entity) that would otherwise be
consolidated” would be outside the scope of the FVO because the FVO “should not
be used to make significant changes to consolidation practices.” While an entity
cannot elect the FVO for the entire consolidated entity, it is permitted to
elect the FVO for underlying financial assets and financial liabilities held by
the consolidated entity that are eligible items.
12.2.2.2 Employers’ and Plans’ Obligations
As noted in ASC 825-10-15-5(c), entities may not elect the FVO for “[e]mployers’
and plans’ obligations (or assets representing net overfunded positions) for
pension benefits, other postretirement benefits (including health care and life
insurance benefits), postemployment benefits, employee stock option and stock
purchase plans, and other forms of deferred compensation arrangements.” Rather,
these items must be recognized in accordance with the relevant guidance in ASC
420, ASC 710, ASC 712, ASC 715, ASC 718, or ASC 960.
12.2.2.3 Financial Assets and Financial Liabilities Related to Leases
Financial assets and financial liabilities associated with lease
accounting are not eligible for the FVO. Rather, they must be accounted for
under ASC 842. However, the FVO may be elected for a guarantee of a third-party
lease obligation or a contingent obligation arising from a canceled lease.
12.2.2.4 Deposit Liabilities
Under ASC 825-10-15-5(e), “[d]eposit liabilities, withdrawable on demand, of
banks, savings and loan associations, credit unions, and other similar
depository institutions” are not eligible for the FVO. Rather, they must be
accounted for under ASC 942-405.
12.2.2.5 Financial Instruments Classified in Equity
ASC 825-10-15-5(f) excludes “[f]inancial instruments that are, in whole or in
part, classified by the [entity] as a component of shareholders’ equity
(including temporary equity)” from the scope of the FVO. Such financial
instruments include the following:
- Common stock.
- Equity-classified derivatives indexed to an entity’s common stock.
- Convertible preferred stock.
- Redeemable preferred stock (not mandatorily redeemable).
- Convertible debt within the scope of the cash conversion subsections of ASC 470-20.
- Convertible debt with a beneficial conversion feature that is recognized in equity.
- Convertible debt with a previously bifurcated conversion option that was reclassified to equity.
- Convertible debt issued at a substantial premium that is recognized in equity.
- Convertible debt with a modified conversion feature that is recognized in equity.
- Noncontrolling interest (e.g., common stock, preferred stock, or equity-classified derivatives issued by a consolidated subsidiary).
The above financial instruments would be measured at fair value
through earnings only in the unusual circumstance in which the guidance in ASC
815-15-35-2 was applicable (see Section 12.2.3.2.3 for further
discussion). The two examples below illustrate how an entity would consider
beneficial conversion features in determining whether convertible debt
instruments qualify for the FVO.
Example 12-4
Convertible Debt Instrument — No Beneficial Conversion
Feature
Entity D has issued a debt instrument that is convertible
by the holder into shares of D’s common stock. Before
considering whether to elect the FVO for this
convertible debt instrument, D must determine whether
the instrument would be classified, in whole or in part,
within stockholders’ equity. In this example, assume the following:
- There is no beneficial conversion feature under ASC 470-20 that must be recognized as of the issuance date of the convertible debt instrument.
- There is no cash conversion feature within the scope of ASC 470-20.
Since no part of the convertible debt instrument is
classified in stockholders’ equity at issuance, D is
permitted to elect the FVO for the instrument. ASC 825
does not preclude an entity from electing the FVO for a
convertible debt instrument if the conversion option, on
a freestanding basis, would have been classified in
stockholders’ equity, provided that there is no
component of the convertible debt instrument that must
be separately classified in stockholders’ equity.
Connecting the Dots
A convertible debt instrument may contain an embedded conversion feature
that is beneficial (i.e., “in-the-money”) upon issuance. If that
beneficial conversion feature is separately recognized in equity, the
FVO is not available. However, if that embedded conversion feature would
need to be bifurcated under ASC 815-15, no beneficial conversion feature
would be recognized in equity upon issuance (i.e., the beneficial
element would constitute a component of the liability that would be
recognized for the embedded conversion option); therefore, the FVO could
be elected for the entire convertible debt instrument. That is, in
accordance with ASC 815-15 and ASC 825, if a convertible debt instrument
contains an embedded derivative that must be bifurcated, the entity can
avoid such bifurcation by electing to apply a fair value measurement to
the convertible debt instrument in its entirety. If the entity decides
to bifurcate the embedded derivative in lieu of electing the FVO, the
entity cannot apply the FVO to the bifurcated host contract because ASC
825-10-25-11 prohibits an entity from separating a financial instrument
that is legally a single contract into parts to apply the FVO. (Because
the convertible debt instrument is a financial instrument, ASC
825-10-15-4(f), which permits an entity to elect the FVO for a host
financial instrument that remains after an embedded nonfinancial
derivative instrument is bifurcated from a nonfinancial hybrid
instrument, does not apply.)
Example 12-5
Convertible Debt Instrument — Contingent Beneficial
Conversion Feature
Entity E issues a convertible debt instrument that
contains a contingent beneficial conversion feature.
Because a contingent beneficial conversion feature is
not separately recognized within stockholders’ equity
upon issuance, a convertible debt instrument with a
contingent beneficial conversion feature is eligible for
the FVO provided that no other exceptions in ASC
825-10-15-5 are applicable. Thus, E can elect the FVO
for the convertible debt instrument.
If, after election of the FVO, the contingency is
triggered, the instrument would continue to be subject
to fair value measurement, because the FVO (1) may be
elected only one time, (2) is irrevocable, and (3) is
applied to the entire instrument. In this situation, ASC
825 effectively overrides the guidance on contingent
beneficial conversion features in ASC 470-20 once the
FVO has been elected.
12.2.2.6 Significant Future-Services Component
Nonconsolidated equity investments that are subject to the
equity method of accounting meet the definition of a financial asset because
they represent an ownership interest. However, in addition to providing the
holder with an equity-like return, such instruments may compensate the investor
for significant future services. An example of such a financial instrument is a
general partnership interest in which the GP has significant management
responsibilities (such as managing the partnership’s assets) and is entitled to
a return that includes compensation for those future services (e.g., that is
disproportionate to the capital invested). Another example is a venture in which
(1) an investor will provide future services to the venture and (2) the return
from the venture is greater than it would be if the venture paid an unrelated
third party for those services.
Because service contracts are not eligible for the FVO under ASC 825, financial
instruments with significant service components are also not eligible for the
FVO. An entity that applied the FVO to these types of instruments would
recognize a day 1 gain (i.e., profit at inception) that represents, in part,
compensation for future services. As a result, revenue would be recognized
before the performance of related services. This conclusion is consistent with
that reached in informal discussions with the SEC and FASB staffs.
An entity should consider all relevant circumstances and exercise judgment when
determining whether a financial instrument includes a significant
future-services component, particularly when the component is not explicitly
stated in the contract terms or the investee’s articles of incorporation. The
investor’s obligation to provide services may be established in a contract
different from that of the equity ownership interest, or the service contract
may contain only a portion of the economic compensation, with the remainder
intended to be an element of the “equity instrument.” Entities should consider
the substance of the arrangement and whether the financial instrument and the
contract for services are interdependent or inseparable.
The following are some indicators that a significant component of an equity
investment consists of compensation for the investor’s future services:
- The fair value of the investment includes a return that is disproportionately greater than the return to other passive investors, and the services that the investor provides to the investee affect the future payout under the provision.
- The fair value of the interest at inception is greater than the investor’s investment, and the investor is expected to provide services to the investee that are beyond those ordinarily expected of an investor acting solely as a nonmanagement owner.
Because ASC 825-10-25-2 requires an entity to apply the FVO to an entire
instrument unless the instrument must be bifurcated under other U.S. GAAP, there
is no opportunity for the entity to separate the element for future services and
elect the FVO for the portion of the instrument that is purely financial.
Example 12-6
General Partnership Interest
Manager A, the only GP of Partnership X,
has invested a nominal amount, 1 percent of the total
capital, for its general partnership interest. This
interest entitles A to 5 percent of X’s net income.
Manager A does not provide any services to X other than
some insignificant administrative tasks; X’s assets are
managed by an unrelated third party. Manager A receives
a disproportionately higher return than the limited
partners (LPs) because of its unlimited liability as GP
for the partnership’s obligations. Manager A estimates
the fair value of its general partnership interest to be
equal to the amount invested at inception. The general
partnership interest does not appear to include
significant future services and therefore is eligible
for the FVO under ASC 825.
Example 12-7
General Partnership Interest and Limited Partnership
Interest
Manager B, the GP of Partnership Y, has invested a
nominal amount, 1 percent of the total capital, for its
general partnership interest. This interest entitles B
to 10 percent of Y’s net income and provides significant
additional compensation if Y’s operating margin reaches
certain thresholds. Manager B estimates that the fair
value of the general partnership interest is greater
than the amount invested at inception. Manager B also
manages Y’s assets through a separate services contract
and receives a servicing fee. In addition, there are
certain restrictions on the sale of the general
partnership interest during the term of the services
contract. Moreover, B holds a limited partnership
interest in Y that can be transferred independently of
the general partnership interest. Manager B invested the
same amount as other LPs for its limited partnership
interest and receives the same return on its interest as
the other LPs. Manager B estimates that the fair value
of the limited partnership interest is equal to the
amount invested for this instrument. In this example, B
could not elect to measure the general partnership
interest at fair value under the FVO in ASC 825 because
this interest appears to include compensation for
significant future services. However, B could elect to
measure its limited partnership interest at fair value
under the FVO in ASC 825 because this interest does not
appear to include significant future services.
Example 12-8
Securitization Entity
Bank C transfers financial assets to a securitization
trust in a transfer that is accounted for as a sale.
Bank C provides servicing of the financial assets (e.g.,
collection) for the trust. The servicing contract is
initially measured at fair value under ASC 860. (Note
that C may elect to subsequently measure a class of
servicing assets or servicing liabilities at fair value
in accordance with ASC 860-50.) Bank C holds the
residual beneficial interest issued by the trust and
determines that the fair value of its residual interest
is greater than the allocated cost of this retained
interest. Bank C also determines that the residual
interest meets the definition of a debt security under
ASC 320. Bank C could classify its residual interest as
a trading security under ASC 320 and measure it at fair
value, with changes in fair value recognized in
earnings. Because C may classify the security as trading
under ASC 320, it would not elect to measure the
security at fair value under ASC 825.
12.2.2.6.1 Investments in Affordable Housing Projects
Section 42 of the Internal Revenue Code allows for affordable housing
credits. ASC 323-740-05-3 describes these tax credits as follows:
The
following discussion refers to and describes a provision within the
Revenue Reconciliation Act of 1993; however, it shall not be considered
a definitive interpretation of any provision of the Act for any purpose.
The Revenue Reconciliation Act of 1993, enacted in August 1993,
retroactively extended and made permanent the affordable housing credit.
Investors in entities that manage or invest in qualified affordable
housing projects receive tax benefits in the form of tax deductions from
operating losses and tax credits. The tax credits are allowable on the
tax return each year over a 10-year period as a result of renting a
sufficient number of units to qualifying tenants and are subject to
restrictions on gross rentals paid by those tenants. These credits are
subject to recapture over a 15-year period starting with the first year
tax credits are earned. Corporate investors generally purchase an
interest in a limited liability entity that manages or invests in the
qualified affordable housing projects.
An entity that has an ownership interest in an affordable housing entity may
elect the FVO for this interest provided that all of the following
conditions are met:
- The investment is not consolidated (e.g., it is otherwise subject to the equity method of accounting).
- The ownership interest is a financial asset. Although the FVO is not permitted for current or deferred income tax assets and liabilities because they are not contractual, the amount of tax credits to be received by the investor in a qualified affordable housing project is generally known as part of the partnership/investment agreement. Therefore, the tax benefits are conveyed to the investor through a contractual arrangement and an equity ownership interest meets the definition of a financial asset.
- The election of the FVO will not cause income recognition of tax credits before they are earned. Recognition in income of any benefit of the tax credits to be received over the term of the investment would preclude an entity from being eligible to elect the FVO for such an interest. Such preclusion is similar to the prohibition on electing the FVO for an equity investment that contains a significant component related to future services.
While the above discussion focuses on investments in affordable housing
projects, the same concepts may be applied to investments in other
tax-credit equity structures.
12.2.3 Interaction of ASC 825 With Other Codification Topics
12.2.3.1 General
ASC 825-10
Interaction With
Other Topics
15-6 The Fair
Value Option Subsections:
- Do not affect any existing accounting literature that requires certain assets and liabilities to be carried at fair value
- Do not establish requirements for recognizing and measuring dividend income, interest income, or interest expense
- Do not eliminate disclosure requirements included in other Subtopics, including requirements for disclosures about fair value measurements included in Topic 820.
ASC 825-10-15-6 states that the FVO guidance in ASC 825 does not (1) affect any
existing U.S. GAAP under which certain assets or liabilities must be recognized
at fair value or (2) eliminate disclosure requirements of other Codification
topics. However, incremental disclosures are required for items accounted for at
fair value by using the FVO. See Section
12.5 for further discussion.
ASC 825-10-15-6 also indicates that ASC 825 does not address the recognition or
measurement of dividend income, interest income, or expense on items recognized
at fair value under the FVO. For further discussion of the recognition of
interest on an interest-bearing financial instrument for which the FVO is
elected, see Section 12.4.1.1.1.
12.2.3.2 Hybrid Instruments That Are Not Separated Under ASC 815-15
12.2.3.2.1 General
ASC 815-15
Fair Value Election for Hybrid Financial
Instruments
25-4 An
entity that initially recognizes a hybrid financial
instrument that under paragraph 815-15-25-1 would be
required to be separated into a host contract and a
derivative instrument may irrevocably elect to
initially and subsequently measure that hybrid
financial instrument in its entirety at fair value
(with changes in fair value recognized in earnings
and, if paragraph 825-10-45-5 is applicable, other
comprehensive income). A financial instrument shall
be evaluated to determine that it has an embedded
derivative requiring bifurcation before the
instrument can become a candidate for the fair value
election.
25-5 The fair value election
shall be supported by concurrent documentation or a
preexisting documented policy for automatic
election. That recognized hybrid financial
instrument could be an asset or a liability and it
could be acquired or issued by the entity. The fair
value election is also available when a previously
recognized financial instrument is subject to a
remeasurement event (new basis event) and the
separate recognition of an embedded derivative. The
fair value election may be made instrument by
instrument. For purposes of this paragraph, a
remeasurement event (new basis event) is an event
identified in generally accepted accounting
principles, other than the recording of a credit
loss under Topic 326, or measurement of an
impairment loss through earnings under Topic 321 on
equity investments, that requires a financial
instrument to be remeasured to its fair value at the
time of the event but does not require that
instrument to be reported at fair value on a
continuous basis with the change in fair value
recognized in earnings. Examples of remeasurement
events are business combinations and significant
modifications of debt as defined in Subtopic
470-50.
25-6 The fair
value election shall not be applied to the hybrid
instruments described in paragraph 825-10-50-8.
Hybrid Instruments That Are Not Separated
30-1 An
entity shall measure both of the following initially
at fair value:
- A hybrid financial instrument that under paragraph 815-15-25-1 would be required to be separated into a host contract and a derivative instrument that an entity irrevocably elects to initially and subsequently measure in its entirety at fair value (with changes in fair value recognized in earnings)
- An entire hybrid instrument if an entity cannot reliably identify and measure the embedded derivative that paragraph 815-15-25-1 requires be separated from the host contract.
Fair Value
Election
35-1 If an
entity irrevocably elected to initially and
subsequently measure a hybrid financial instrument
in its entirety at fair value, changes in fair value
for that hybrid financial instrument shall be
recognized in earnings. Paragraph 815-20-25-71(a)(3)
states that the entire contract shall not be
designated as a hedging instrument pursuant to
Subtopic 815-20.
Inability to Reliably Identify and Measure
Embedded Derivative
35-2 If an
entity cannot reliably identify and measure the
embedded derivative that paragraph 815-15-25-1
requires be separated from the host contract, the
entire contract shall be measured subsequently at
fair value with gain or loss recognized in earnings.
Paragraph 815-20-25-71(a)(4) states that the entire
contract shall not be designated as a hedging
instrument pursuant to Subtopic 815-20.
Under ASC 815-15-25-1, an entity may be required to bifurcate and separately
account for an embedded derivative contained within a hybrid instrument. In
lieu of such separation, ASC 815-15-25-4 allows an entity to account for the
entire hybrid instrument at fair value, provided that the instrument is a
financial asset or financial liability, with changes recognized in earnings
and, if applicable, OCI. Further, ASC 815-15-30-1(b) and ASC 815-15-35-2
address the accounting in the unusual circumstance in which an entity is
unable to reliably identify and separately measure the embedded derivative
in a hybrid instrument that must be accounted for separately as a derivative
instrument.
12.2.3.2.2 Fair Value Election
The fair value election in ASC 815-15 originated from the guidance in FASB Statement 155, which was issued before FASB Statement 159
(the pre-Codification FVO guidance now contained in ASC 825). The fair value
election in ASC 815-15 can be made on an instrument-by-instrument basis, or
an entity can elect this option for all qualifying hybrid financial
instruments on some other basis, such as an entity-wide policy decision or a
type-of-instrument basis. In all scenarios, the fair value election under
ASC 815-15 must be supported with appropriate concurrent documentation that
eliminates any question regarding whether the entity elected to apply fair
value measurement to a particular instrument.
For the following reasons, the fair value election in ASC 815-15 applies to a
narrower population (scope) of items than the FVO in ASC 825:
- The fair value election in ASC 815-15 applies only to hybrid financial instruments for which bifurcation of an embedded derivative would otherwise be required. An entity that elects the FVO in ASC 825 is not required to determine that an embedded derivative would need to be accounted for separately under ASC 815-15.
- ASC 815-15-25-6 prohibits the fair value election for any hybrid instrument that is discussed in ASC 825-10-50-8, which describes 15 items for which public business entities are not required to provide fair value disclosures. The scope of ASC 825-10-50-8 is more restrictive than the scope of the FVO in ASC 825-10-15-4 and 15-5.
Like ASC 825, ASC 815-15 allows the fair value election for an eligible item
only upon (1) initial recognition or (2) the occurrence of a subsequent
remeasurement event (i.e., a subsequent remeasurement of the entire
instrument at fair value under other U.S. GAAP). Therefore, under both ASC
815-15 and ASC 825, an entity is prohibited from making the fair value
election upon determining that an embedded derivative that was previously
not bifurcated under ASC 815-15 subsequently must be bifurcated (e.g., a
hybrid financial instrument containing an embedded derivative that meets the
net settlement condition in ASC 815-10-15-83(c) after initial recognition).
There are no situations for which an entity could make the fair value
election for a hybrid instrument under ASC 815-15 but would be prohibited
from electing the FVO for the same instrument under ASC 825. In addition,
regardless of whether the entity uses ASC 815-15 or ASC 825 in applying fair
value accounting, the hybrid financial instrument cannot be designated as a
hedging instrument under ASC 815-20. Furthermore, the documentation and
disclosure requirements related to the fair value election in ASC 815-15 are
the same as those related to the FVO in ASC 825.2
Connecting the Dots
Since the fair value election under ASC 815-15
applies to a narrower population of items than the FVO under ASC
825, entities can effectively disregard the fair value election
guidance in ASC 815-15-25-4. While ASC 815-15 requires an entity to
first determine that a hybrid financial instrument contains an
embedded derivative for which bifurcation would otherwise be
required under ASC 815-15, entities can bypass this assessment
because — regardless of whether such bifurcation is required — the
hybrid financial instruments that are eligible for the fair value
election in ASC 815-15 are also eligible for the FVO in ASC 825 (and the FVO in ASC 825 can be elected regardless of whether an entity has identified an embedded derivative for which bifurcation would otherwise be required). Furthermore, the disclosure requirements applicable to a hybrid financial instrument for which the fair value election is made under ASC 815-15 are consistent with the disclosure requirements of ASC 825. Regardless of whether an FVO election is made under ASC 815-15 or ASC 825, it is subject to the applicable incremental disclosure requirements for (1) derivatives in ASC 815 and (2) items for which the FVO has been elected in ASC 825. We believe that the guidance on fair value elections in ASC 815-15 (which was derived from FASB Statement 155) was retained in U.S. GAAP because that guidance was available (and may have been used) before the effective date of FASB Statement 159 (codified in ASC
825). Thus, entities may still have hybrid financial instruments
that are being recognized at fair value in their entirety in
accordance with ASC 815-15 because those instruments were issued
before the effective date of the FVO guidance in ASC 825.
12.2.3.2.3 Inability to Reliably Identify and Measure Embedded Derivatives
The fair value election in ASC 815-15 is available only for hybrid financial
instruments with an embedded derivative for which bifurcation would
otherwise be required. (As discussed in Section
12.2.3.2.2, hybrid financial instruments that would qualify
for the fair value election in ASC 815-15 would also qualify for the FVO in
ASC 825, regardless of whether an entity has identified an embedded
derivative for which bifurcation would otherwise be required.) However,
there may be hybrid nonfinancial instruments that are not eligible for the
fair value election in ASC 815-15 or the FVO in ASC 825 and for which the
entity cannot reliably identify and measure the embedded derivative that
must be bifurcated under ASC 815-15. ASC 815-15-30-1(b) and ASC 815-15-35-2
states that, in these circumstances, an entity should measure the entire
hybrid instrument at fair value. The resulting accounting is the same as it
would be if the entity had made the fair value election in ASC 815-15 or
elected the FVO in ASC 825. Note that under no circumstance can such an
instrument be designated as a hedging instrument under ASC 815-20.
Connecting the Dots
The provision of ASC 815-15-30-1(b) and ASC 815-15-35-2 that requires
fair value accounting for a hybrid instrument for which the entity
cannot reliably identify and measure the embedded derivative that
the entity would otherwise be required to bifurcate is necessary
because, for example, fair value accounting for a hybrid
nonfinancial instrument under the fair value election in ASC 815-15
or the FVO in ASC 825 would be prohibited. In practice, however,
this provision is rarely applied.
12.2.3.3 Other Codification Topics
Other Codification topics may give entities the option of measuring assets or
liabilities at fair value through earnings. Such assets or liabilities include,
but are not necessarily limited to, the following:
- Investments in debt securities that are classified as trading under ASC 320.
- Investments in equity securities without readily determinable fair values under ASC 321.
- Investments in life settlement contracts that are accounted for by using the fair value method under ASC 325-30.
- Classes of servicing assets or servicing liabilities that are accounted for by using the fair value measurement method in ASC 860-50.
An entity that elects fair value accounting for such assets or liabilities under
a Codification topic other than ASC 825 only needs to comply with the disclosure
requirements of that topic and is not subject to ASC 825’s FVO disclosure
requirements. See further discussion in Section 12.5.1.
12.2.3.4 NFP Entities
ASC 825-10
Application by
Not-for-Profit Entities
15-7 Not-for-profit entities
(NFPs) shall apply the provisions of the Fair Value
Option Subsections with the following modifications:
- References to an income statement shall be replaced with references to a statement of activities, statement of changes in net assets, or statement of operations.
- References to earnings shall be replaced with references to changes in net assets, except as indicated in (c).
- Paragraph 954-825-45-1 explains that health care entities subject to Topic 954 shall report unrealized gains and losses on items for which the fair value option has been elected within the performance indicator or as a part of discontinued operations, as appropriate. Unlike other NFPs, health care entities subject to that Topic present performance indicators analogous to income from continuing operations. Consistent with the provisions of Subtopic 958-10, NFPs may present such gains and losses either within or outside of other intermediate measures of operations unless such gains or losses are part of discontinued operations. This includes intermediate measures of operations presented by NFPs other than health care entities and any additional intermediate measures of operations presented within the performance indicator by not-for-profit health care entities.
- The disclosure requirements in paragraph 825-10-50-30 shall apply not only with respect to the effect on performance indicators or other intermediate measures of operations, if presented, but also with respect to the effect on the change in each of the net asset classes (without donor restrictions or with donor restrictions), as applicable.
ASC 825-10-15-7 explains the FVO presentation requirements for NFP entities,
including health care entities, which do not present an income statement. ASC
825-10-15-7 also clarifies the disclosure requirements that apply to NFP
entities that have elected the FVO. See Section
12.5 for further discussion of the FVO disclosure requirements.
Footnotes
2
ASC 815-15-25-5 states that “[t]he fair value
election shall be supported by concurrent
documentation or a preexisting documented policy for
automatic election” (emphasis added). The term “concurrent
documentation” is analogous to the term “contemporaneous
documentation,” as used in the hedge accounting requirements of ASC
815. Therefore, the fair value election for hybrid financial
instruments under ASC 815-15 must be documented at the time a hybrid
financial instrument is acquired or issued or when a previously
recognized hybrid financial instrument is subject to a remeasurement
(new basis) event. If the documentation does not exist at that time,
the FVO may not be elected. We believe that entities applying the
guidance in ASC 815-15 on the fair value election would also be
subject to the requirements related to the FVO in ASC 825.
12.3 Recognition
12.3.1 Overall Guidance
ASC 825-10
Overall Guidance
25-1 This
Subtopic permits all entities to choose, at specified
election dates, to measure eligible items at fair value
(the fair value option).
25-2 The
decision about whether to elect the fair value
option:
- Shall be applied instrument by instrument, except as discussed in paragraph 825-10-25-7
- Shall be irrevocable (unless a new election date occurs, as discussed in paragraph 825-10-25-4)
- Shall be applied only to an entire instrument and not to only specified risks, specific cash flows, or portions of that instrument.
An entity may decide whether to elect the fair value
option for each eligible item on its election date.
Alternatively, an entity may elect the fair value option
according to a preexisting policy for specified types of
eligible items.
25-3 Upfront
costs and fees related to items for which the fair value
option is elected shall be recognized in earnings as
incurred and not deferred.
12.3.1.1 Election of the FVO
An entity is permitted to elect the FVO for eligible financial assets and
financial liabilities (see Section 12.2.1) on the election
dates discussed in Section 12.3.2. ASC 825 provides little
guidance on the documentation an entity is required to maintain to support its
election of the FVO but indicates that the decision to elect the FVO should be
made as of the election date for each eligible item. An entity also may
establish an automatic election policy for certain eligible items. For example,
an entity may document in a written policy that it will elect the FVO for all
single-family mortgages that it originates. In deciding to permit entities to
elect the FVO, the Board noted that maintaining evidence of compliance with the
election requirements of ASC 825 is a matter of internal control. Although ASC
825 leaves room for discretion regarding documentation, an entity that does not
have a well-developed preexisting policy for election should document evidence
of the election concurrently with the recognition or remeasurement of eligible
items.
12.3.1.1.1 Application on an Instrument-by-Instrument Basis
In the absence of specific exceptions addressed in ASC 825-10-25-7, an entity
can elect the FVO on an instrument-by-instrument basis. This election is
made on the basis of the unit of account for eligible instruments under
other applicable U.S. GAAP. Thus, entities may elect the FVO for a single
eligible item without electing the FVO for other identical items. Entities
also have the flexibility to establish an automatic election policy for
certain eligible items of an identical or similar nature. Section
12.3.1.1.1.1 includes additional discussion of the unit of
account with respect to FVO elections, including exceptions to the general
ability to elect the FVO on an instrument-by-instrument basis.
The FVO election approach applied will affect the nature and
extent of documentation related to FVO elections. For example, if an entity
makes an FVO election decision each time it initially recognizes an eligible
item within a group of identical or similar eligible items, the entity would
need to concurrently document the FVO elections more frequently than an
entity that has a policy of always electing the FVO for such an item.
Further, this documentation would need to be sufficiently clear on the items
for which the FVO has been elected. An entity that does not apply the FVO to
all eligible items within a group of similar eligible items would also be
required to provide additional disclosures (see Section 12.5.3).
In all scenarios, an entity must support its FVO election under ASC 825 with
appropriate concurrent documentation that eliminates any question regarding
whether the entity elected to apply fair value measurement to a particular
instrument.
12.3.1.1.1.1 Unit of Account
ASC 825-10
Unit of
Accounting
25-7 The fair value option
may be elected for a single eligible item without
electing it for other identical items with the
following four exceptions:
- If multiple advances are made to one borrower pursuant to a single contract (such as a line of credit or a construction loan) and the individual advances lose their identity and become part of a larger loan balance, the fair value option shall be applied only to the larger balance and not to each advance individually.
- If the fair value option is applied to an investment that would otherwise be accounted for under the equity method of accounting, it shall be applied to all of the investor’s financial interests in the same entity (equity and debt, including guarantees) that are eligible items.
- If the fair value option is applied to an eligible insurance or reinsurance contract, it shall be applied to all claims and obligations under the contract.
- If the fair value option is elected for an insurance contract (base contract) for which integrated or nonintegrated contract features or coverages (some of which are called riders) are issued either concurrently or subsequently, the fair value option also must be applied to those features or coverages. The fair value option cannot be elected for only the nonintegrated contract features or coverages, even though those features or coverages are accounted for separately under Subtopic 944-30. Paragraph 944-30-35-30 defines a nonintegrated contract feature in an insurance contract. For purposes of applying this Subtopic, neither an integrated contract feature or coverage nor a nonintegrated contract feature or coverage qualifies as a separate instrument.
25-10 The fair value option
need not be applied to all instruments issued or
acquired in a single transaction (except as
required by paragraph 825-10-25-7(a) through (b)).
For example, investors in shares of stock and
registered bonds might apply the fair value option
to only some of the shares or bonds issued or
acquired in a single transaction. For this
purpose, an individual bond is considered to be
the minimum denomination of that debt
security.
25-11 A financial instrument
that is legally a single contract may not be
separated into parts for purposes of applying the
fair value option. In contrast, a loan syndication
arrangement may result in multiple loans to the
same borrower by different lenders. Each of those
loans is a separate instrument, and the fair value
option may be elected for some of those loans but
not others.
25-12 An investor in an
equity security may elect the fair value option
for its entire investment in that equity security,
including any fractional shares issued by the
investee (for example, fractional shares that are
acquired in a dividend reinvestment program).
25-13 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).
An entity can generally elect the FVO for a single eligible item without
electing it for other identical items (with four exceptions addressed in
ASC 825-10-25-7, which are discussed below). Note that the determination
of what constitutes a “single eligible item” is made on the basis of the
unit of account under U.S. GAAP. The unit of account is generally
determined under other applicable Codification topics; however, ASC 825
does contain the following unit-of-account guidance that applies to
application of the FVO:
- The FVO may be applied to a “host financial instrument resulting from the separation of an embedded nonfinancial derivative from a nonfinancial hybrid instrument” (ASC 825-10-15-4(f)).
- An “individual bond is considered . . . the minimum denomination of [a] debt security” (ASC 825-10-25-10).3
- A “financial instrument that is legally a single contract may not be separated” into its component parts when the FVO is applied (ASC 825-10-25-11).
- The unit of account for a liability issued with an inseparable third-party credit enhancement “does not include the third-party credit enhancement” (ASC 825-10-25-13).
Connecting the Dots
In applying ASC 825-10-25-11, which states, in part, that “[a]
financial instrument that is legally a single contract may not
be separated into parts for purposes of applying the fair value
option,” an entity must consider the definition of the term
“freestanding financial instrument” in the ASC master glossary.
For example, a debt instrument with a $1 million principal
amount and a warrant on 100,000 shares of common stock may be
entered into with a single investor and documented in the same
contract. If the warrant is legally detachable and separately
exercisable, the debt instrument and warrant would individually
represent freestanding financial instruments (i.e., the debt
instrument would be considered an individual contract under ASC
825-10-25-11). The entity could therefore apply the FVO to its
liability related to the $1 million debt instrument provided
that none of the FVO exceptions in ASC 825-10-15-5 are
applicable. The warrant would be separately evaluated as a
liability or equity instrument under other applicable U.S. GAAP
(e.g., ASC 480, ASC 815, and ASC 815-40). The entity could not,
however, apply the FVO to only $500,000 of the $1 million
principal amount of debt, because the entire principal amount
represents a single unit of account and ASC 825-10-25-11
prohibits the election of the FVO for only a portion of the
amount of an individual bond. If, however, the entity had
entered into the aforementioned contract with 10 different
investors, it could individually make the FVO election for the
$1 million principal amount of the debt component of each of the
10 different contracts (e.g., it could elect the FVO for the $1
million debt component related to five investors and not elect
the FVO for the $1 million debt component for the other five
investors).
ASC 825-10-25-7 describes the following four situations in which it is
not appropriate to elect the FVO for only a single eligible item without
electing the FVO for other identical items:
- Multiple advances to a single borrower — “If multiple advances are made to one borrower pursuant to a single contract (such as a line of credit or a construction loan) and the individual advances lose their identity and become part of a larger loan balance, the [FVO] shall be applied only to the larger balance and not to each advance individually.” See Example 12-9 for a related illustration.
- Equity method investments — If the FVO “is applied to an investment that would otherwise be accounted for” by using the equity method, the FVO must be applied to all of the investor’s financial interests in the investee that are eligible for the FVO (e.g., equity, debt, guarantees). Note that this requirement is one-directional. That is, if an entity has not elected the FVO for an equity method investment, it could still elect the FVO for a financial guarantee issued on the investee’s debt.
- Insurance or reinsurance contracts — If the FVO “is applied to an eligible insurance or reinsurance contract,” it must be applied to all “claims and obligations under the contract.”
- Insurance contracts with integrated or nonintegrated contract features or coverages — If the FVO “is elected for an insurance contract (base contract) for which integrated or nonintegrated contract features or coverages (some of which are called riders) are issued either concurrently or subsequently, the [FVO] also must be applied to those features or coverages. The [FVO] cannot be elected for only the nonintegrated contract features or coverages, even though those features or coverages are accounted for separately under Subtopic 944-30.”
Example 12-9
Electing the FVO for Portions of a Financial
Instrument That Includes Multiple Lendings to the
Same Borrower
Entity F has a $5 million line-of-credit
agreement with Bank A. On March 1, 20X7, F draws
$500,000 on its line of credit and chooses not to
elect the FVO. On April 1, 20X7, F draws another
$1 million. Because the $1 million is added to the
$500,000 and becomes part of the larger balance,
the FVO may not be elected for the $1 million.
When F chose not to elect the FVO for the
$500,000, it also chose not to elect the FVO for
any subsequent draws on that line of credit. Under
ASC 825-10-25-4, that election is irrevocable
unless a new election date occurs.
12.3.1.1.1.2 Debt Guaranteed by a Governmental Entity
The guidance in ASC 825-10-25-13 on inseparable third-party credit
enhancements does not specifically apply to a guarantee provided by
a government entity, but it may inform the borrower’s accounting. We
believe that there are two acceptable views regarding the impact of
government-provided guarantees on a loan payable (or other debt
obligation) for which the FVO is elected (or for which fair value
amounts are disclosed). These two views are premised on the notion
that if the government entity makes a payment on an obligation, the
borrower is required to reimburse the government entity that made
the guarantee payment.
The two views are as follows:
-
View A: Exclude the guarantee in measuring or disclosing the debt’s fair value — This view is premised on an analogy to the guidance in ASC 825-10-25-13 on inseparable third-party credit enhancements. This analogy is made because the guarantee represents an arrangement that is consistent with third-party credit enhancements. If the occurrence of a triggering event requires the government entity to make unpaid principal and interest payments to holders of the obligation, the government entity effectively becomes a creditor to the issuer. The issuer’s debt obligation continues with the government entity, and the issuer is required to reimburse the government entity for insured payments made on its behalf. Therefore, from the issuer’s perspective, the debt issued is not considered to be guaranteed and is treated as a unit of account that is separate from the guarantee (i.e., under the contractual obligation, the issuer is not released from its debt obligation; rather, the issuer’s obligation in connection with the debt liability is transferred to the government entity that provided the guarantee if the guarantee is triggered).This view is appropriate because when the guidance in ASC 825-10-25-13 was developed, the scope exception in ASC 825-10-25-13(a) was created with a focus on government guarantees that are inherent in all instruments of a specific type, usually as a result of statutory requirements. The background materials for EITF Issue 08-5 (which is codified in ASC 825-10-25-13) listed deposit insurance as an example of a guarantee that meets this criterion. Deposits held at U.S. depository institutions are required by law to be insured by the FDIC. In addition, rather than simply paying out the guarantee if the depository institution fails, the FDIC may take other actions to ensure that depositors are paid. Unlike liabilities that are insured or guaranteed under statutory rules that cover all such liabilities, debt issued with a government-provided guarantee is guaranteed under a contractual arrangement with a government entity that is specific to the debt instrument.
-
View B: Include the guarantee in measuring or disclosing the debt’s fair value — The debt issued with the government-provided guarantee is outside the scope of ASC 825-10-25-13 since the guarantee is issued by a government entity. Thus, in accordance with ASC 820-10-35-16B and 35-16BB, the borrower would determine the fair value of the loan on the basis of the fair value as determined by an investor that holds the identical item as an asset. However, the issuing entity must still analyze the economic substance of the guarantee to determine how to apply the guidance in ASC 820 when determining the debt’s fair value.
Borrowers that elect the FVO in ASC 825-10 and apply View B will most
likely not recognize an “inception gain” on the debt obligation.
However, borrowers that apply View A may find that when the
guarantee is ignored, the debt’s initial fair value is less than the
proceeds received. This may suggest that an “inception gain” should
be recognized. However, any “inception gain” that may exist as a
result of initially recognizing a loan liability at fair value could
potentially result from an element of the lending transaction that
is akin to a government grant. Therefore, it may be viewed as
inappropriate to recognize any such amount in earnings immediately.
Accordingly, entities that elect the FVO under ASC 825-10 and apply
View A should exercise caution in determining the appropriate
accounting and disclosure regarding any “inception gain.”
Consultation with an entity’s accounting advisers is therefore
encouraged.
Entities should consider disclosing their accounting policy in
accordance with ASC 235. Entities should also consider the
disclosures required under ASC 820 and ASC 825-10 for liabilities
that are measured or disclosed at fair value. See Chapter 11 and Section 12.5 for more information.
Note that the guidance on inseparable credit enhancements discussed
above applies only to the debtor. Investors in debt obligations that
are entitled to an inseparable government-provided guarantee would
always consider the guarantee in their accounting for the investment
in the loan regardless of whether that investment is accounted for
at amortized cost or at fair value. Investors would not separately
account for any benefit received in the form of credit support as a
result of an inseparable government guarantee (i.e., the guarantee
would be considered embedded in the investment).
12.3.1.1.2 Application on an Irrevocable Basis
Once an entity makes an FVO election for an eligible item, fair value
accounting is required and may not be revoked unless a new election date
occurs under ASC 825-10-25-4. See Section 12.3.2 for
discussion of election dates.
12.3.1.1.3 Application to an Entire Instrument
ASC 825-10-25-2(c) requires entities to apply the FVO “to an entire
instrument and not to only specified risks, specific cash flows, or portions
of that instrument.” There is one exception to this requirement.
Specifically, as noted in ASC 825-10-15-4(f), the FVO may be applied to a
“host financial instrument resulting from the separation of an embedded
nonfinancial derivative from a nonfinancial hybrid instrument” (see
Section 12.2.1.4 for more information). See
Section 12.3.1.1.1.1 for more information about the
unit of account.
12.3.1.1.3.1 Accrued Interest on an Interest-Bearing Financial Instrument
An entity cannot separately elect the FVO for accrued interest
(receivable or payable) on an interest-bearing financial asset or
financial liability. Similarly, an entity cannot elect the FVO for an
interest-bearing financial asset or financial liability and exclude the
accrued interest component from such election. (Accrued interest simply
represents one or more future interest cash flows of an interest-bearing
financial asset or financial liability that have already been earned.)
Rather, in accordance with ASC 825-10-25-2(c), an entity must either (1)
elect the FVO for an interest-bearing financial asset or financial
liability that includes any accrued interest or (2) not elect the FVO
for any component of an interest-bearing financial asset or financial
liability.
Certain Codification topics permit entities to defer and
amortize up-front costs over the life of an interest-bearing financial
asset or financial liability. However, if an entity elects the FVO, any
such up-front costs and fees related to the asset or liability that the
entity incurs must be recognized in earnings as incurred and not
deferred. See Section 12.3.1.2 for
more information.
12.3.1.2 Up-Front Costs
ASC 825-10-25-3 requires that up-front costs and fees related to items for which
the FVO is elected be recognized in earnings as incurred and not deferred. This
requirement is consistent with ASC 820-10-35-9B, which indicates that
transaction costs are not part of a fair value measurement. Thus, loan
origination fees and costs will be recognized in earnings as incurred and not
capitalized under ASC 310-20. Similarly, acquisition costs will not be
capitalized when the FVO is elected for an insurance contract.
As a result of the requirement to expense (or recognize in income), rather than
defer, incremental direct costs or origination fees or costs associated with the
origination or acquisition of an interest-bearing financial instrument that is
accounted for at fair value by using the FVO, the reported amounts of interest
expense or interest income (if separately reported) will differ from those that
are reported when the same asset or liability is accounted for at amortized
cost. See Section 12.4.1.1.1.2 for further discussion of
the measurement of interest income or expense related to an interest-bearing
financial instrument for which the FVO is elected.
12.3.2 Election Dates
12.3.2.1 General
ASC 825-10
Election Dates
25-4 An entity may choose to
elect the fair value option for an eligible item only on
the date that one of the following occurs:
- The entity first recognizes the eligible item.
- The entity enters into an eligible firm commitment.
- Financial assets that have been reported at fair value with unrealized gains and losses included in earnings because of specialized accounting principles cease to qualify for that specialized accounting (for example, a transfer of assets from a subsidiary subject to Subtopic 946-10 to another entity within the consolidated reporting entity not subject to that Subtopic).
- The accounting treatment for an investment in another entity changes because the investment becomes subject to the equity method of accounting. . . .
- An event that requires an eligible item to be measured at fair value at the time of the event but does not require fair value measurement at each reporting date after that, excluding the recognition of impairment under lower-of-cost-or-market accounting or accounting for securities in accordance with either Topic 321 on investments — equity securities or Topic 326 on measurement of credit losses.
25-5 Some of
the events that require remeasurement of eligible items
at fair value, initial recognition of eligible items, or
both, and thereby create an election date for the fair
value option as discussed in paragraph 825-10-25-4(e)
are:
- Business combinations, as defined in Subtopic 805-10
- Consolidation or deconsolidation of a subsidiary or VIE
- Significant modifications of debt, as defined in Subtopic 470-50.
In accordance with ASC 825-10-25-4, an entity can elect the FVO only upon (1) the
initial recognition of an eligible item or the date an entity enters into a firm
commitment or (2) the occurrence of a qualifying event. Those qualifying events
are specified in the items in ASC 825-10-25-4(c)–(e) and include the following:
- Fair value accounting ceases under specialized accounting guidance.
- An equity investment becomes subject to the equity method.
- An event occurs that “requires an eligible item to be measured at fair value at the time of the event but does not require fair value measurement at each reporting date after that, excluding the recognition of impairment” on financial assets not accounted for at fair value. (ASC 820-10-20 defines these events as “remeasurement events.”)
Upon the occurrence of any of these qualifying events, an entity has, in addition
to the ability to elect the FVO, the option to cease applying the FVO to an
eligible item to which it was previously applied. See Section
12.3.2.2 for interpretive guidance on these election dates. See
Section 12.5.4 for discussion of the incremental
disclosures an entity is required to provide when electing the FVO upon the
occurrence of the qualifying events in ASC 825-10-25-4(d) and (e).
In addition, the transition provisions of certain ASUs may allow
for a one-time FVO election. For example, ASU
2019-05 allows entities to elect the FVO in lieu of applying
the guidance in ASC 326 on expected credit losses.
Connecting the Dots
As discussed in Section 12.2.3.3, other
Codification topics may give entities the option of measuring an asset
or liability at fair value through earnings. An entity should consult
such other U.S. GAAP to determine whether it may elect fair value
accounting after initial recognition of the related item. For example,
ASC 321, as amended by ASU
2018-03, allows an entity that is measuring an
equity security without a readily determinable fair value, and that is
using the measurement alternative, to change its measurement approach to
a fair value method in accordance with ASC 820. This election would be
irrevocable and would apply to that security and all identical or
similar investments of the same issuer. Once an entity makes this
election, the entity should measure all future purchases of identical or
similar investments of the same issuer by using a fair value method in
accordance with ASC 820.
12.3.2.2 Interpretive Guidance
12.3.2.2.1 Entity Enters Into an Eligible Firm Commitment
ASC 825-10-25-4(b) allows an entity to elect the FVO on the date it “enters
into an eligible firm commitment.” We believe that this date is that on
which the definition of a firm commitment is met. This date could not occur
before the date on which the commitment is binding on both parties and is
legally enforceable.
12.3.2.2.2 Fair Value Accounting Under Specialized Accounting Guidance Ceases
Under ASC 825-10-25-4(c), an entity can elect the FVO when
“[f]inancial assets that have been reported at fair value with unrealized
gains and losses included in earnings because of specialized accounting
principles cease to qualify for that specialized accounting.” This new
election date may be relevant when an entity ceases to be an investment
company under ASC 946, which can occur for a number of reasons.
12.3.2.2.3 Matters Related to Equity Method Accounting
12.3.2.2.3.1 Investment Becomes Subject to Equity Method of Accounting
Under ASC 825-10-25-4(d), if an entity’s investment in another entity
“becomes subject to the equity method of accounting,” the entity may
elect the FVO for its investment in lieu of applying the equity method.
An investment could become subject to the equity method for various
reasons, including (1) an acquisition of an additional interest in an
investee that causes the investor to obtain significant influence over
the investee; (2) a change in an investee’s governing provisions in such
a way that an investor obtains significant influence over the investee;
(3) an investee’s repurchase of its outstanding equity shares, resulting
in an increase in an investor’s ownership percentage in the investee in
such a way that the investor obtains significant influence over the
investee; or (4) an investor’s loss of control, but retention of
significant influence, over an investee.4 If an investor elects the FVO when its investment becomes subject
to the equity method of accounting, the investor must elect the FVO for
all other interests in the investee that are eligible items in
accordance with ASC 825-10-25-7(b). For this purpose, we believe that
other preexisting interests in the investee that would not otherwise
become subject to the equity method of accounting are not eligible items
unless they are subject to another remeasurement event as of the date on
which the entity becomes subject to the equity method of accounting.
12.3.2.2.3.2 Investment Is No Longer Subject to Equity Method of Accounting
The FVO election dates listed in ASC 825-10-25-4 do not
include the date on which an investor loses significant influence over
an investee (through either a decline in the investor’s holding of
voting stock or other changes in circumstances that cause an investor to
lose its ability to influence an investee’s policies). Thus, if an
investor concludes that it would no longer be subject to the equity
method of accounting for an investee, it does not have a new election
date for the FVO under ASC 825. The table below describes how an
investor would account for the retained investment if it determines that
it loses significant influence and therefore is no longer subject to the
equity method of accounting.
Table
12-2
|
Accounting While Having Significant Influence
|
Accounting for Retained Investment After Losing
Significant Influence
|
|---|---|
|
Equity method of accounting
|
The investor should account for
the equity investment in accordance with ASC 321.
If the investment has a readily determinable fair
value, it must be recognized at fair value, with
changes in fair value reported in earnings. If the
investment does not have a readily determinable
fair value, the investor can either account for
the equity investment at fair value, with changes
in fair value reported in earnings, or elect the
measurement alternative in ASC 321-10-35-2. When
the measurement alternative is elected, the
investor should account for observable price
changes that necessitate its discontinuation of
the equity method immediately before discontinuing
the application of equity method accounting under
ASC 323.
When there is not a new FVO
election, if the investor applies ASC 321 to
account for the investment at fair value, with
changes in fair value recognized in earnings, the
result will be the same as it would when the FVO
is applied.
|
|
FVO was elected
|
The investor must continue to
apply the FVO to any retained investment that was
previously accounted for at fair value by using
the FVO, because the loss of significant influence
does not warrant a new election date.
|
12.3.2.2.4 Remeasurement Events
12.3.2.2.4.1 General
ASC Master Glossary
Remeasurement
Event
A remeasurement (new basis) event is
an event identified in other authoritative
accounting literature, other than the measurement of
an impairment under Topic 321 or credit loss under
Topic 326, that requires a financial instrument to
be remeasured to its fair value at the time of the
event but does not require that financial instrument
to be reported at fair value continually with the
change in fair value recognized in earnings.
Examples of remeasurement events are business
combinations and significant modifications of debt
as discussed in paragraph 470-50-40-6.
In accordance with ASC 825-10-25-4(e), an entity may
make a new FVO election upon the occurrence of a remeasurement event.
Thus, upon a remeasurement event, an entity can elect the FVO for, or
cease applying it to, an eligible item. ASC 825-10-25-5 lists examples
of remeasurement events. See below for further discussion of certain
types of remeasurement events.
12.3.2.2.4.2 Initial Consolidation of a Subsidiary or VIE
The initial consolidation of a subsidiary or VIE
represents a remeasurement event only for eligible financial assets or
financial liabilities that are initially recognized at fair value. For
example, under ASC 810-10-30-1 and ASC 810-10-30-3, assets and
liabilities recognized upon initial consolidation of a VIE may not be
measured at fair value (i.e., the amounts are recognized on the basis of
their historical carrying amounts). In these situations, a remeasurement
event allowing for a new FVO election does not exist. Further, we
believe that, in initial consolidation transactions among entities under
common control, it would not be appropriate for the receiving entity to
elect to cease applying the FVO to elected items of the transferring
entity, since common-control transactions do not meet the definition of
a remeasurement event in ASC 825-10-20.
12.3.2.2.4.3 Debtors’ and Creditors’ Considerations When a Loan Is Refinanced or Modified
The determination of whether an entity’s refinancing or modification of a loan (in situations other than a troubled debt restructuring) qualifies under ASC 825-10-25-4(e) as a remeasurement event for the borrower or creditor depends on the facts and circumstances. Paragraph A15 of the Basis for Conclusions of FASB Statement 159 states:
When a contract
is modified (or a rider added to it) after it has been initially
recognized, the question arises as to whether that modification
would permit election of the fair value option for the related asset
or liability. The Board decided that the availability of the fair
value option should be based on whether, under GAAP, the
modification is accounted for as the continuation of the original
contract or as the termination of the original contract and the
origination of a new contract. If the modification is considered the
origination of a new contract, the fair value option could be
elected on the date of its initial recognition. Otherwise, the
entity’s previous decision about electing the fair value option for
the original contract would govern the accounting for the
continuation of that original contract.
12.3.2.2.4.3.1 Debtor’s Evaluation
ASC 470-50
Modifications and Exchanges
40-10 From the debtor’s
perspective, an exchange of debt instruments
between or a modification of a debt instrument by
a debtor and a creditor in a nontroubled debt
situation is deemed to have been accomplished with
debt instruments that are substantially different
if the present value of the cash flows under the
terms of the new debt instrument is at least 10
percent different from the present value of the
remaining cash flows under the terms of the
original instrument. If the terms of a debt
instrument are changed or modified and the cash
flow effect on a present value basis is less than
10 percent, the debt instruments are not
considered to be substantially different, except
in the following two circumstances:
- A modification or an exchange affects the terms of an embedded conversion option, from which the change in the fair value of the embedded conversion option (calculated as the difference between the fair value of the embedded conversion option immediately before and after the modification or exchange) is at least 10 percent of the carrying amount of the original debt instrument immediately before the modification or exchange.
- A modification or an exchange of debt instruments adds a substantive conversion option or eliminates a conversion option that was substantive at the date of the modification or exchange. (For purposes of evaluating whether an embedded conversion option was substantive on the date it was added to or eliminated from a debt instrument, see paragraphs 470-20-40-7 through 40-9.)
ASC 470-50 indicates that a modification of an
existing debt instrument or an exchange of debt instruments is an
extinguishment of the original debt instrument if (1) the
modification or exchange is not a troubled debt restructuring and
(2) the new debt instrument is substantially different from the
existing debt instrument.5 If a debt instrument has been refinanced or modified in such a
way that it is substantially different from the original instrument,
a remeasurement under ASC 825 has occurred and the FVO could be
elected (or no longer applied if it was previously elected).
If the modification represents a troubled debt restructuring, the
debt instrument is not considered a new instrument and, therefore, a
new election date for the FVO is not available.
12.3.2.2.4.3.2 Creditor’s Evaluation
ASC 310-20
Loan
Refinancing or Restructuring
35-9 If
the terms of the new loan resulting from a loan
refinancing or restructuring, are at least as
favorable to the lender as the terms for
comparable loans to other customers with similar
collection risks who are not refinancing or
restructuring a loan with the lender, the
refinanced loan shall be accounted for as a new
loan. This condition would be met if the new
loan's effective yield is at least equal to the
effective yield for such loans and modifications
of the original debt instrument are more than
minor. Any unamortized net fees or costs and any
prepayment penalties from the original loan shall
be recognized in interest income when the new loan
is granted. The effective yield comparison
considers the level of nominal interest rate,
commitment and origination fees, and direct loan
origination costs and would also consider
comparison of other factors where appropriate,
such as compensating balance arrangements.
35-10 If the
refinancing or restructuring does not meet the
condition set forth in paragraph 310-20-35-9 or if
only minor modifications are made to the original
loan contract, the unamortized net fees or costs
from the original loan and any prepayment
penalties shall be carried forward as a part of
the net investment in the new loan. In this case,
the investment in the new loan shall consist of
the remaining net investment in the original loan,
any additional funds advanced to the borrower, any
fees received, and direct loan origination costs
associated with the refinancing or
restructuring.
ASC 310-20 addresses when an entity should consider
a refinancing or restructuring of a loan receivable to represent a
“new loan” for accounting purposes. (This guidance is used in
determining how to recognize unamortized net fees or costs and any
prepayment penalties from the original loan.) An entity should apply
this guidance in determining whether a refinancing or restructuring
of a loan receivable represents a remeasurement event under ASC
825-10-25-4(e). If the two criteria in ASC 310-20-35-9 are met in a
refinancing or modification of a loan receivable, a remeasurement
event under ASC 825 has occurred and the FVO can be elected (or no
longer applied if it was previously elected).6 Otherwise, as stated in ASC 310-20-35-10, the refinanced or
restructured loan receivable is not considered a new loan and a
remeasurement event under ASC 825 therefore has not occurred.
12.3.3 Differences Between FVO Election for Investors and That for Investees
12.3.3.1 Consolidated and Separate Financial Statements
ASC 825-10
Consolidation
25-6 An
acquirer, parent, or primary beneficiary decides whether
to apply the fair value option to eligible items of an
acquiree, subsidiary, or consolidated VIE, but that
decision applies only in the consolidated financial
statements. Fair value option choices made by an
acquired entity, subsidiary, or VIE continue to apply in
separate financial statements of those entities if they
issue separate financial statements.
Upon a business combination or consolidation of a VIE, the acquirer, parent, or
primary beneficiary may elect whether to apply the FVO in its consolidated
financial statements provided that the initial consolidation of the acquiree,
subsidiary, or consolidated VIE represents a remeasurement event (see
Section 12.3.2.2.4.2 for more information). However,
for the separate financial statements, the acquired entity, subsidiary, or VIE
cannot make or change any FVO election unless pushdown accounting under ASC 805
is applied as of the date of the change-of-control event. Thus, a parent and a
subsidiary may have different accounting bases for an eligible asset or
liability of the subsidiary (i.e., the FVO has been elected in the consolidated
financial statements but not in the separate financial statements of the
subsidiary).
ASC 825-10-25-6 only specifically addresses the FVO election as of the date of a
change-of-control event (e.g., when an acquirer obtains control of an acquiree
in a business combination). Thus, questions have arisen regarding whether the
FVO can be elected in the consolidated financial statements upon a subsidiary’s
initial recognition of an eligible item if the subsidiary does not elect the FVO
in its separate financial statements. Although an FVO election for the
consolidated financial statements is generally consistent with that for a
subsidiary’s separate financial statements, we believe that it is acceptable for
the FVO election to be made in the consolidated financial statements without
being made in the subsidiary’s separate financial statements. Similarly, we
believe that it is generally acceptable for a subsidiary to elect the FVO for an
eligible item even if that same election is not made in the parent’s
consolidated financial statements. (However, such situations are not expected to
be common.) These potential differences between the FVO election in the
consolidated financial statements and that in the subsidiary’s separate
financial statements may arise when the FVO is not elected on the basis of
management’s intent.
12.3.3.2 Equity Method Investees
As discussed in Section 12.2.1.1.1, an investor can apply
the FVO to an equity method investee without needing to “look through” to the
investee’s assets and liabilities to determine whether they are financial in
nature. However, when the equity method of accounting is applied to an investee,
an investor may not, in determining equity method earnings and losses, (1) elect
the FVO for otherwise eligible financial assets and financial liabilities of the
investee (e.g., elect the FVO at the investee level and therefore adjust the
reported results of the investee) or (2) “unwind” the investee’s FVO elections
(e.g., adjust the reported results of the investee to exclude mark-to-market
adjustments to the investee’s financial assets or financial liabilities for
which the investee elected the FVO).
Footnotes
3
An entity may elect the FVO for one eligible debt
instrument (such as an individual loan or an individual
bond) and not elect the FVO for a separate but identical
debt instrument, provided that the debt instrument
reflects a separate and distinct contract (i.e., the
debt instrument has a different counterparty or is
legally detachable and separately transferable). For
instance, the FVO may be applied to only some of the
individual bonds issued or acquired in a single
transaction even though the terms of each bond are
identical. If a group of lenders jointly fund a loan to
a single borrower and each lender loans a specific
amount to the borrower and has the right to demand
repayment from the borrower, the loan from each lender
is considered separate and distinct from the loans from
other lenders even if each of the loans forms part of
the same overall loan syndication agreement. Thus, ASC
825-10-25-11 permits election of the FVO for each loan
in a loan syndication arrangement in which the loans are
made to the same borrower by different lenders.
4
This would also represent a remeasurement event under ASC
825-10-25-4(e).
5
ASC 470-50 provides guidance on calculating the present value
of cash flows for the 10 percent test.
6
ASC 310-20-35-11 provides guidance on how a
creditor should evaluate whether a modification of the terms
of a debt instrument as a result of a refinancing or
restructuring (other than a troubled debt restructuring) is
“more than minor” under ASC 310-20-35-9.
12.4 Presentation
12.4.1 Statement of Comprehensive Income
12.4.1.1 General
ASC 825-10
Statement of Comprehensive Income
45-4 A
business entity shall report unrealized gains and losses
on items for which the fair value option has been
elected in earnings (or another performance indicator if
the business entity does not report earnings) at each
subsequent reporting date.
ASC 825-10-45-4 states that the changes in fair value of an item for which the
FVO is elected should be recognized in net income (or another performance
indicator if an entity does not report net income). However, see
Section 12.4.1.2 for discussion of the recognition of a
component of the change in fair value of a financial liability in OCI.
12.4.1.1.1 Presentation of Interest on Interest-Bearing Financial Instruments Accounted for at Fair Value Through Earnings
12.4.1.1.1.1 General
Under U.S. GAAP, an entity is not required to separately present, in its
income statement, interest income or interest expense for
interest-bearing financial assets or financial liabilities accounted for
at fair value through earnings, unless (1) the entity must do so in
accordance with regulatory guidance or (2) it is industry practice to do
so.7 However, the entity may elect, as an accounting policy, to present
interest income or interest expense separately from other changes in the
fair value of financial instruments measured at fair value through
earnings. This election would apply to interest-bearing financial
instruments that are measured at fair value through earnings under the
FVO in ASC 825 or ASC 815, as well as interest-bearing financial
instruments that are measured at fair value under other relevant GAAP
(e.g., trading debt securities under ASC 320).
The following U.S. GAAP guidance indicates that separate presentation of
interest is a policy election:
- ASC 825-10-50-28(e)(2), which requires disclosure of the aggregate fair value of loans in nonaccrual status held as assets, and for which the FVO has been elected, if the “entity’s policy is to recognize interest income separately from other changes in fair value.”
- ASC 325-40-15-7, which notes that “it is practice for certain industries (such as banks and investment companies) to report interest income as a separate item in their income statements, even though the investments are accounted for at fair value.”
If an entity’s elected accounting policy related to
separate recognition of interest income or interest expense is
considered significant, the entity should disclose that policy in
accordance with ASC 235-10-50-1. Section
12.4.1.1.1.2 contains guidance on how to measure interest
income or interest expense when it is separately presented in the income
statement for an interest-bearing financial instrument recognized at
fair value through earnings.
12.4.1.1.1.2 Measurement
If an entity elects, as an accounting policy, to separately present
interest income or interest expense on an interest-bearing financial
instrument accounted for at fair value through earnings, the entity
should, with one exception, include amortization or accretion of any
premium or discount on the instrument as part of the separately reported
interest income or interest expense.8 If the fair value initially recognized for an interest-bearing
financial instrument (e.g., debt) differs from the principal amount due
at maturity (“par”), this difference is a premium or discount that
should be amortized or accreted. An entity should recognize the
amortization or accretion in interest income or interest expense if it
is separately presented. Under ASC 320-10-35-4 and ASC 325-40-35-2, the
method used to measure interest income or interest expense on an
interest-bearing financial instrument (including any amortization or
accretion of a premium or discount) should be the same regardless of the
measurement attribute (e.g., amortized cost) used to measure the
financial instrument. Thus, the premium or discount should be amortized
by using the interest method that would have applied to the
interest-bearing financial asset or financial liability if it had not
been recognized at fair value through earnings.
The guidance above does not apply to the following:
- The portion of the difference between fair value and par at inception attributable to embedded features that are not indexed to interest rates or the issuer’s own credit (e.g., an in-the-money option that permits the holder to convert the debt instrument into a fixed number of the issuer’s equity shares). Entities should exclude such features from the discount or premium to be accreted or amortized.
- Any transaction costs and fees, such as debt issuance costs, origination costs, and origination fees (i.e., up-front costs and fees) are not part of the initial measurement of a financial instrument that is recognized at fair value and therefore are not included in any premium or discount of the financial instrument in accordance with ASC 825-10-25-3. That is, the interest method is used only for applicable discounts and premiums since up-front costs and fees are recognized in earnings as they are incurred or received (see Section 12.3.1.2 for discussion of the initial recognition of up-front costs and Section 12.4.1.1.2 for discussion of the income statement presentation of fees received and costs incurred that are associated with the origination of loans receivable).
Example 12-10
Measurement of Interest Income on Acquired
Loans With Deteriorated Credit Quality That Are
Recognized at Fair Value Through Earnings
Entity G acquires a portfolio of loans from a
third party at a significant discount (at a
transaction price equal to fair value) and has
elected to account for the loans at fair value
through earnings under the FVO in ASC 825. In
accordance with G’s previously elected accounting
policy, G separately presents interest income on
these loans in its income statement.
If G had not elected to account for the loans
under the FVO, a portion of the loans would have
been accounted for under ASC 310-30 (which
addresses the accounting for acquired loans with
deteriorated credit quality) and the remaining
portion would have been accounted for under ASC
310-20.
On the basis of these facts, G should measure
interest income on the loans by applying ASC
310-30 to the portion of the portfolio that would
have otherwise been accounted for under that
guidance and applying ASC 310-20 to measure
interest income on the remaining portion of the
loan portfolio. In addition, G should not
capitalize any transaction fees or costs related
to the acquisition since the loans are recognized
at fair value through earnings. Instead, G should
apply the effective-yield guidance in ASC 310-30
and ASC 310-20 on the basis of a net investment in
the loan portfolio equal to the initial fair value
(in this case, the transaction price is fair value
on initial recognition). Entity G will need to
allocate the transaction price to the portions of
the portfolio accounted for under ASC 310-30 and
ASC 310-20 so that it can appropriately apply the
applicable interest recognition guidance to each
component.
Note that in this example, it is assumed that in
the absence of electing the FVO, G would have
applied ASC 310-30. If, instead, G had adopted ASU
2016-13, it would have applied the guidance
relevant to purchased credit-deteriorated
financial assets.
Example 12-11
Measurement of Interest Income on HFS Mortgage
Loans That Are Recognized at Fair Value Through
Earnings
Entity H is a financial institution that
originates and purchases conforming mortgage loans
that are held temporarily until they are sold or
securitized. Entity H has elected to account for
the mortgage loans at fair value through earnings
under the FVO in ASC 825. In accordance with its
previously elected accounting policy, H separately
presents interest income on these HFS mortgage
loans in its income statement. In this example, it
is assumed that the collectibility of principal
and interest on H’s HFS mortgage loans is not in
question.
On the basis of these facts, H would measure
interest income on the HFS mortgage loans by using
the loan’s stated (coupon) rate without amortizing
any original issue (purchase) discounts. Such
measurement is consistent with how H would measure
interest income if it had recognized the loans at
the lower of cost or market in accordance with ASC
948-310.
12.4.1.1.2 Presentation of Fees Received and Costs Incurred That Are Associated With the Origination of Loan Receivables HFS
A bank, savings institution, or similar financial institution (a “banking
institution”) often originates a loan receivable as a principal, intending
to sell the originated loan. (This practice is particularly common in
mortgage banking operations.) In these lending arrangements, when banking
institutions do not elect the FVO under ASC 825, they classify the
originated loans initially and subsequently as HFS and measure them at the
lower of cost or fair value. In accordance with ASC 310-20, when banking
institutions do not elect the FVO, they capitalize certain fees charged and
costs incurred that are associated with origination into the carrying amount
of the loans (referred to hereafter as “loan origination fees and costs”).
As a result of such capitalization, the loan origination fees and costs
enter into the calculation of the gain or loss upon the sale of the loans.
In accordance with generally accepted accounting practices for banking
institutions (and in a manner consistent with the reporting requirements of
the SEC and banking regulators), the net gain or loss on the sale of loans
is classified within a single line item as a component of noninterest income
(e.g., “gain on sale of loans, net”).9
A banking institution may, however, elect to account for its HFS originated
loans at fair value through earnings in accordance with the FVO in ASC 825.
Under ASC 820 and ASC 825, up-front fees charged and costs incurred are
excluded from the measurement of the fair value of financial assets and
liabilities and, therefore, are recognized in earnings as charged or
incurred.10 There is no specific U.S. GAAP guidance on how loan origination fees
and costs should be classified in the income statement when the FVO is
elected for the related loans. Nevertheless, in accordance with generally
accepted accounting practices for banking institutions that account for HFS
loans at the lower of cost or fair value, the loan origination fees and
costs, which are recognized immediately in earnings as charged or incurred,
should not be classified within interest income or interest expense.
However, there is diversity in practice related to the classification within
noninterest income and noninterest expense of loan origination fees and
costs related to HFS loans for which the FVO in ASC 825 has been
elected.
Given the lack of specific guidance on this topic, either of the following
two alternatives is considered acceptable as an accounting policy that
should be consistently applied and disclosed if considered significant in
accordance with ASC 235-10-50-1:
- Alternative A: Net-basis classification within noninterest income — Proponents of this view believe that the income statement classification of loan origination fees and costs should not be affected by whether the banking institution has elected to account for the related HFS loans at fair value through earnings under ASC 825. Rather, such loan origination fees and costs should be classified, and should have an income statement caption, as if the amounts had been capitalized and deferred under ASC 310-20 (i.e., on a net basis within a single line item that is a component of noninterest income). Proponents of this view note that a similar view applies to the classification of interest income and interest expense on loans for which the FVO in ASC 825 has been elected. This approach permits consistent classification regardless of whether the FVO in ASC 825 has been elected, thereby promoting comparability.
- Alternative B: Gross-basis classification within noninterest income and noninterest expense — Proponents of this view believe that, in the absence of specific guidance that permits net presentation, the loan origination fees and costs related to HFS loans accounted for at fair value through earnings under the FVO in ASC 825 should be classified on a gross basis. The fees associated with loan origination would be classified as a component of noninterest income, and the costs would be classified as a component of noninterest expense. This view is consistent with the outcome that would result from the application of principal-agent considerations.
Note that the above alternatives apply only when all of the following
conditions are met:
- The banking institution prepares an income statement that includes separate totals for interest income, interest expense, noninterest income, and noninterest expense.11
- The loans are originated for sale (i.e., the loans are HFS loans).
- If the FVO had not been elected, the fees charged and costs incurred would have been capitalized into the carrying amount of the loans in accordance with ASC 310-20.
- The banking institution is acting as a principal in the origination of the loans.12
12.4.1.2 Financial Liabilities for Which FVO Is Elected
12.4.1.2.1 Overall Guidance
ASC 825-10
Financial Liabilities for Which Fair Value
Option Is Elected
45-5 If an
entity has designated a financial liability under
the fair value option in accordance with this
Subtopic or Subtopic 815-15 on embedded derivatives,
the entity shall measure the financial liability at
fair value with qualifying changes in fair value
recognized in net income. The entity shall present
separately in other comprehensive income the portion
of the total change in the fair value of the
liability that results from a change in the
instrument-specific credit risk. The entity may
consider the portion of the total change in fair
value that excludes the amount resulting from a
change in a base market risk, such as a risk-free
rate or a benchmark interest rate, to be the result
of a change in instrument-specific credit risk.
Alternatively, an entity may use another method that
it considers to faithfully represent the portion of
the total change in fair value resulting from a
change in instrument-specific credit risk. The
entity shall apply the method consistently to each
financial liability from period to period.
45-5A When
changes in instrument-specific credit risk are
presented separately from other changes in fair
value of a liability denominated in a currency other
than an entity’s functional currency, the component
of the change in fair value of the liability
resulting from changes in instrument-specific credit
risk shall first be measured in the liability’s
currency of denomination, and then the cumulative
amount shall be adjusted to reflect the current
exchange rate in accordance with paragraph
830-20-35-2. The remeasurement of the component of
the change in fair value of the liability resulting
from the cumulative changes in instrument-specific
credit risk shall be presented in accumulated other
comprehensive income.
45-6 Upon
derecognition of a financial liability designated
under the fair value option in accordance with this
Subtopic, an entity shall include in net income the
cumulative amount of the gain or loss on the
financial liability that resulted from changes in
instrument-specific credit risk.
45-7 The
guidance in paragraph 825-10-45-5 does not apply to
financial liabilities of a consolidated
collateralized financing entity measured using the
measurement alternative in paragraphs 810-10-30-10
through 30-15 and 810-10-35-6 through 35-8.
ASC 815-15
45-2 If an entity has
designated a financial liability under the fair
value election in accordance with paragraphs
815-15-25-4 through 25-6, the entity shall apply the
guidance in paragraph 825-10-45-5 on the
presentation of changes in the liability’s fair
value that result from changes in
instrument-specific credit risk.
ASC 830-20
Financial Liabilities for Which the Fair Value
Option Is Elected
35-7A
Paragraph 825-10-45-5A requires that for a financial
liability for which the fair value option is
elected, the change in the liability’s fair value
resulting from changes in instrument-specific credit
risk shall be presented separately in other
comprehensive income from other changes in the
liability’s fair value presented in current
earnings. The component of the change in fair value
of the liability resulting from changes in
instrument-specific credit risk shall first be
measured in the liability’s currency of
denomination, and then the cumulative amount shall
be adjusted to reflect the current exchange rate in
accordance with paragraph 830-20-35-2. The
remeasurement of the component of the change in fair
value of the liability resulting from the cumulative
changes in instrument-specific credit risk shall be
presented in accumulated other comprehensive
income.
ASC 470-50
Extinguishments of Debt
40-1 As
indicated in paragraph 470-50-15-4, the general
guidance for the extinguishment of liabilities is
contained in Subtopic 405-20 and defines
transactions that the debtor shall recognize as an
extinguishment of a liability.
40-2 A
difference between the reacquisition price of debt
and the net carrying amount of the extinguished debt
shall be recognized currently in income of the
period of extinguishment as losses or gains and
identified as a separate item. Gains and losses
shall not be amortized to future periods. If upon
extinguishment of debt the parties also exchange
unstated (or stated) rights or privileges, the
portion of the consideration exchanged allocable to
such unstated (or stated) rights or privileges shall
be given appropriate accounting recognition.
Moreover, extinguishment transactions between
related entities may be in essence capital
transactions.
40-2A In an
early extinguishment of debt for which the fair
value option has been elected in accordance with
Subtopic 815-15 on embedded derivatives or Subtopic
825-10 on financial instruments, the net carrying
amount of the extinguished debt shall be equal to
its fair value at the reacquisition date. In
accordance with paragraph 825-10-45-6, upon
extinguishment an entity shall include in net income
the cumulative amount of the gain or loss previously
recorded in other comprehensive income for the
extinguished debt that resulted from changes in
instrument-specific credit risk.
ASC 825-10-45-5 requires an entity that has elected to measure a financial
liability at fair value in accordance with the FVO to separately present in
OCI the portion of the total change in fair value of the liability that is
attributable to the change in instrument-specific credit risk, but only if
the financial liability contains an instrument-specific credit risk
component (see Section 12.4.1.2.2 for discussion of the
scope of this special presentation guidance). An entity must determine the
portion of the total change in fair value of the financial liability that is
attributable to the instrument-specific credit risk so that it can bifurcate
the amounts to properly record the amounts in net income and OCI (see
Section 12.4.1.2.3 for discussion of how to
determine the amount to be recognized in OCI). Upon derecognition of the
financial liability, any amounts accumulated in OCI are recognized in net
income (see Section 12.4.1.2.4 for discussion of the
accounting upon derecognition).
12.4.1.2.2 Scope of Special Presentation Guidance
12.4.1.2.2.1 Nonrecourse Financial Liabilities
The guidance in ASC 825-10-45-5 and 45-5A that requires separate
presentation in OCI of the portion of the change in fair value of a
financial liability that is attributable to instrument-specific credit
risk does not apply to liabilities that do not contain
instrument-specific credit risk. A liability that is nonrecourse to the
issuer (i.e., the debtor or the borrower) does not contain
instrument-specific credit risk. Therefore, changes in fair value
associated with a nonrecourse financial liability designated under the
FVO should be recognized entirely in earnings. This view was discussed
with the FASB staff, which agreed with the conclusion reached.
It is important for an entity to differentiate between
instrument-specific credit risk and asset-specific performance risk when
assessing a financial liability whose amounts are payable only upon
receipt of cash flows from specified assets (e.g., securitization
structures). This distinction is important because, in some
circumstances, a financial liability may have little or no
instrument-specific credit risk and substantially all the changes in the
fair value of the liability may be attributable to asset-specific
performance risk. We believe that, in such cases, when the issuer or
borrower does not have any obligation to make a payment if the assets to
which the obligation is contractually linked fail to perform, changes in
the fair value of the liability would be recognized in earnings. For
example, an entity that issues a note whose cash flows are contractually
linked to an underlying pool of assets (e.g., loans, corporate bonds)
would have no obligation to make payments unless amounts are received on
the underlying pool of assets. In such circumstances, all changes in
fair value would be recognized in earnings.
Depending on how the obligation is structured, there may still be some
instrument-specific credit risk when there is also asset-specific
performance risk. For example, if amounts received on the underlying
pool of assets are not immediately payable to the lender (i.e., there is
a timing difference between the receipt of cash flows from the assets
and the payment on the obligation), the issuer or borrower will owe
amounts to the lender even when the assets have performed. Depending on
whether the issuer or borrower is able to use the cash received on the
assets for purposes other than to pay its obligation under the financial
liability, there may be some residual instrument-specific credit risk,
which may sometimes be minimal.
12.4.1.2.2.1.1 Financial Liabilities of CFEs
ASC 825-10-45-7 states that the guidance in ASC 825-10-45-5 on
separately presenting in OCI the portion of the change in fair value
of a financial liability that is attributable to instrument-specific
credit risk does not apply to “financial liabilities of a
consolidated [CFE] measured using the measurement alternative in
paragraphs 810-10-30-10 through 30-15 and 810-10-35-6 through 35-8.”
While ASC 825-10-45-7 does not specifically address how the
financial liabilities of a CFE are accounted for when the
measurement alternative in ASC 810-10-30-10 through 30-15 and ASC
810-10-35-6 through 35-8 is not applied (i.e., when the financial
liabilities are measured at fair value in accordance with ASC 820),
the guidance in ASC 825-10-45-5 on separately presenting in OCI the
portion of the change in fair value of a financial liability that is
attributable to instrument-specific credit risk would also generally
not apply in such situations. This conclusion is based on the
description of a CFE in the ASC master glossary as an entity that
issues “beneficial interests [that] have contractual recourse only
to the related assets of the collateralized financing entity and are
classified as financial liabilities.” Thus, the only
instrument-specific credit risk that could exist in the financial
liabilities of a CFE would be the timing difference between the
receipt of cash flows from the assets and the payment on the
obligations for the beneficial interests, as discussed in
Section 12.4.1.2.2.1. However, it would be
unlikely that even this instrument-specific credit risk component
would exist in CFEs.
12.4.1.2.2.2 Hybrid Financial Liabilities
As clarified in ASU 2018-03, ASC 825-10-45-5 and ASC 815-15-45-2 indicate
that the requirement to separately present in OCI the portion of the
change in fair value of a financial liability that is attributable to
instrument-specific credit risk should also be applied to hybrid
financial liabilities for which the FVO has been elected under ASC
815-15-25-4 through 25-6. Furthermore, on the basis of discussions with
the FASB staff, this guidance also applies before adoption of ASU
2018-03.
We believe that the scope of the requirement to separately present in OCI
the portion of the change in fair value of a financial liability that is
attributable to instrument-specific credit risk also encompasses hybrid
nonfinancial liabilities to which fair value accounting is applied under
ASC 815-15-30-1(b) and ASC 815-15-35-2. However, no portion of the
change in fair value of such nonfinancial hybrid instruments would be
recognized in OCI if the instrument does not contain any
instrument-specific credit risk.
12.4.1.2.3 Measuring Instrument-Specific Credit Risk
The change in fair value attributable to instrument-specific credit risk of a
financial asset or financial liability represents the component of the
change in fair value of the financial instrument attributable to changes in
the specific credit risk of that instrument (e.g., changes in “credit
spread” associated with the instrument).13 As noted in ASC 825-10-45-5, one acceptable method of isolating the
change attributable to instrument-specific credit risk is to calculate the
hypothetical change in fair value of the instrument during the period that
is attributable to changes in the risk-free or benchmark rate and to
calculate the difference between that amount and the total change in fair
value.14
Alternatively, an entity may use another method that it considers to
faithfully represent the portion of the total change in fair value resulting
from a change in instrument-specific credit risk. However, the entity must
apply that method consistently to each financial instrument from period to
period. Although the guidance in ASC 825-10-45-5 applies specifically to
financial liabilities, we believe that it is applicable by analogy to loans
and other receivables held as assets.
See the example below for an illustration of the calculation
of instrument-specific credit risk on the basis of a calculation of the
hypothetical change in fair value of the instrument during the period that
is attributable to changes in the risk-free or benchmark rate and a
comparison of that change to the total change in fair value of the
instrument. As discussed above, an entity is not required to use this method
to calculate the change in fair value attributable to instrument-specific
credit risk.
Example 12-12
Measurement of Instrument-Specific Credit Risk
On January 1, 20X8, Entity I issues an
uncollateralized five-year bond with a par value and
fair value of $500 million and an interest rate of 8
percent and elects to record the bond at fair value
in accordance with the FVO in ASC 825.
Assume the following:
- Interest is paid annually; the bond has a bullet maturity.
- Three-month LIBOR, a benchmark rate, is 5 percent on January 1, 20X8. As of March 31, 20X8, three-month LIBOR has increased to 5.5 percent. (Although LIBOR is used in this example, the entity could also have selected the U.S. Treasury rate as a benchmark rate.)
- The change in three-month LIBOR is the only relevant change in general market conditions.
- The fair value of the bond as of March 31, 20X8, is $495 million, which indicates an 8.3 percent market rate of interest on the bond.
- Entity I computes the change in fair value that is attributable to instrument-specific credit risk by calculating the portion of the total change in fair value of the instrument during the period that is not attributable to changes in general market conditions.
- For simplicity, it is assumed that (1) there is a flat yield curve, (2) all changes in interest rates result from a parallel shift in the yield curve, and (3) the changes in three-month LIBOR are the only relevant changes in general market conditions. An entity should base its calculations on actual market conditions.
Upon issuance of the bond, the market rate of
interest on it is 8 percent. The components of the
market rate include (1) the benchmark rate
(three-month LIBOR) of 5 percent and (2) 3 percent,
which represents the bond’s credit risk or “credit
spread.” At the end of the period, three-month LIBOR
increases to 5.5 percent and there are no other
changes in general market conditions that would
affect the valuation of the bond.
To determine the change in fair value of the bond
attributable to instrument-specific credit risk, I
calculates the present value of the remaining
contractual cash flows by using an 8.5 percent rate
consisting of the benchmark interest rate at the end
of the period (5.5 percent) and the initial spread
from the benchmark rate upon issuance of the bond (3
percent). The resulting present value of the
remaining cash flows discounted at 8.5 percent is
$492 million.
The fair value of the bond as of
December 31, 20X8, is $495 million. Thus, the
portion of the change in fair value of the bond
attributable to instrument-specific credit risk
during the period is $3 million. In other words, the
fair value of the bond decreased by $8 million
because of a change in general market conditions
(the increase in LIBOR) and increased by $3 million
because of the narrowing of the credit spread on the
bond. Accordingly, in accordance with ASC
825-10-45-5, in preparing its financial statements
and recognizing the bond at fair value, I would
reduce the carrying amount of the bond by $5 million
and would recognize a loss in earnings of $8 million
and a gain in OCI of $3 million. Note that I is also
required to determine instrument-specific credit
risk for disclosure purposes.
In the absence of other changes in general market
conditions, the change in fair value that is
attributable to instrument-specific credit risk in
the next period would be based on a comparison of
the fair value of the bond at the end of the period
with the present value of future cash flows
discounted at three-month LIBOR at the end of the
period, added to an instrument-specific credit
spread of 2.8 percent (8.3% – 5.5%). The 8.3 percent
represents the implicit market yield on the bond at
the end of the previous period (i.e., the effective
yield of the bond, which is based on discounting the
remaining cash flows and a fair value of $495
million at the beginning of the period). To
determine the credit spread at the end of the
previous period, I subtracts the 5.5 percent (the
benchmark rate at the end of the previous
period).
12.4.1.2.3.1 Foreign-Denominated Financial Liabilities
ASC 825-10-45-5A and ASC 830-20-35-7A provide guidance on the measurement
of the instrument-specific credit risk component of a
foreign-denominated financial liability. In accordance with that
guidance, entities are required to apply the following two-step
measurement approach:
- Measure the instrument-specific credit risk component of the change in fair value of the liability in the liability’s currency of denomination.
- Adjust the cumulative amount of changes in instrument-specific credit risk in the currency of denomination of the liability to the entity’s functional currency by using the exchange rate as of the measurement date (i.e., the balance sheet date).
12.4.1.2.4 Extinguishments of Financial Liabilities Measured at Fair Value
If a financial liability is repaid at its maturity, there
will generally not be any remaining component in AOCI related to the
cumulative changes in fair value of the financial liability attributable to
instrument-specific credit risk. However, if a financial liability
recognized at fair value is extinguished before its stated maturity, there
will often be a component in AOCI related to the cumulative changes in fair
value of the financial liability attributable to instrument-specific credit
risk. ASC 470-50-40-2A states that in an early extinguishment of debt for
which the FVO has been elected in accordance with ASC 825 or ASC 815-15, an
entity should include in net income the cumulative amount of any gain or
loss previously recognized in OCI for the extinguished debt that resulted
from changes in instrument-specific credit risk.
12.4.2 Statement of Financial Position
12.4.2.1 General
ASC 825-10
Statement of Financial Position
45-1A An
entity shall separately present financial assets and
financial liabilities by measurement category and form
of financial asset (that is, securities or loans and
receivables) in the statement of financial position or
the accompanying notes to the financial statements.
45-1B
Entities shall report assets and liabilities that
are measured at fair value pursuant to the fair value
option in this Subtopic in a manner that separates those
reported fair values from the carrying amounts of
similar assets and liabilities measured using another
measurement attribute.
45-2 To
accomplish that, an entity shall either:
- Present the aggregate of fair value and non-fair-value amounts in the same line item in the statement of financial position and parenthetically disclose the amount measured at fair value included in the aggregate amount
- Present two separate line items to display the fair value and non-fair-value carrying amounts.
ASC 815-15
45-1 In each
statement of financial position presented, an entity
shall report hybrid financial instruments measured at
fair value under the election and under the
practicability exception in paragraph 815-15-30-1 in a
manner that separates those reported fair values from
the carrying amounts of assets and liabilities
subsequently measured using another measurement
attribute on the face of the statement of financial
position. To accomplish that separate reporting, an
entity may do either of the following:
- Display separate line items for the fair value and non-fair-value carrying amounts
- Present the aggregate of the fair value and non-fair-value amounts and parenthetically disclose the amount of fair value included in the aggregate amount.
ASC 825-10-45-1A requires entities to separately present financial assets and
financial liabilities by measurement category (e.g., fair value, amortized cost)
and form of financial asset (i.e., securities or loans). Such information may be
presented either on the face of the statement of financial position or in the
notes to the financial statements. Furthermore, an entity that has measured
assets or liabilities at fair value under ASC 825 or ASC 815-15 (including those
measured at fair value because the entity is unable to reliably identify and
measure an embedded derivative that would otherwise need to be bifurcated) must
present those assets and liabilities in the statement of financial position in a
manner that separates them from the carrying amounts of similar assets and
liabilities that are measured by using an attribute other than fair value. ASC
825 and ASC 815-15 identify two ways to accomplish such presentation.
12.4.2.2 Accrued Interest
In the absence of regulations that require separate presentation of accrued
interest, the fair value amount presented in the statement of financial position
for an interest-bearing financial asset or financial liability accounted for at
fair value through earnings should include any interest earned or incurred but
not paid (accrued interest). It would, however, be acceptable for an entity to
parenthetically disclose the amount of the fair value measurement that
represents accrued interest in the financial statement line item for which the
interest-bearing financial asset or financial liability accounted for under the
FVO is presented.
If there are regulations that require presentation of accrued interest separately
from the related interest-bearing financial asset or financial liability for
which the FVO has been elected, an entity must do one of the following to comply
with the disclosure requirements in ASC 825:
- Present the aggregate amount of accrued interest, which represents part of the fair value of the asset or liability, in a separate line item in the statement of financial position.
- Parenthetically disclose the amount of the fair value measurement that represents accrued interest in the financial statement line item for which the interest-bearing financial asset or financial liability is presented.
See Section 12.4.1.1.1.2 for discussion of how to measure
interest income or interest expense when interest is separately presented in the
income statement for an interest-bearing financial asset or financial liability
that is recognized at fair value through earnings.
12.4.2.3 Netting Under ASC 210-20
The netting of financial assets and financial liabilities under
ASC 210-20 is a presentation issue and is not affected by the measurement base
of such assets and liabilities. See the example below for an illustration.
Example 12-13
Offsetting Repurchase Agreements and Reverse
Repurchase Agreements
Entity J has outstanding repurchase agreements (“repos”)
and reverse repurchase agreements (“reverse repos”) with
the same counterparty. The repos and reverse repos meet
the conditions for offsetting in ASC 210-20-45-11 and
45-12. Entity J can net the repos and reverse repos in
the statement of financial position even if it elects to
account for them at fair value under the FVO. Since the
repos and reverse repos are carried at fair value, the
offsetting is based on the fair value carrying amounts
and not on the contractual or par amounts.
Further, assume that J has repos and reverse repos with
the same counterparty but that only some of the repos
and reverse repos are measured at fair value under the
FVO. It would be acceptable to apply ASC 825 to measure
the repos and reverse repos by using different
measurement attributes, provided that J discloses the
reasons for electing the FVO for certain contracts and
not others. Under these circumstances, and provided that
the criteria for offsetting contracts under ASC 210-20
are met, J could net the fair values for contracts for
which the FVO was elected with the amortized cost of
contracts for which the FVO was not elected.
12.4.3 Statement of Cash Flows
ASC 825-10
Statement of Cash Flows
45-3 Entities
shall classify cash receipts and cash payments related to
items measured at fair value according to their nature and
purpose as required by Topic 230.
An entity’s election of the FVO for financial assets and liabilities does not affect the cash flow statement classification of receipts and payments associated with such financial assets or financial liabilities. In developing Statement 159, the FASB contemplated requiring that cash receipts and cash payments
related to financial assets and financial liabilities for which the FVO has been
elected be classified as operating activities; however, the Board ultimately
rejected this approach. Paragraph A42 of the Basis for Conclusions of FASB Statement
159 states, in part:
The Board concluded that the cash receipts
and cash payments related to trading securities as well as to financial assets
and financial liabilities for which the fair value option has been elected
should be classified pursuant to Statement 95 (as amended) based on the nature
and purpose for which the related financial assets and financial liabilities
were acquired or incurred.
See Deloitte’s Roadmap Cash Flows for further discussion of
the classification of cash flows in the statement of cash flows.
Footnotes
7
Industry or regulatory guidance may require that certain entities
separately present interest from other changes in fair value for
certain interest-bearing financial instruments. For example,
bank holding companies, brokers and dealers in securities, and
investment companies generally present interest separately from
other changes in fair value in their income statements.
8
ASC 948-310-35-2 establishes interest recognition guidance for
HFS mortgage loans. That guidance precludes an entity from
amortizing purchase discounts. See further discussion in
Example 12-11.
9
Banking institutions may use a different title for this line item
(e.g., amounts related to mortgage loans may be presented as a line
item titled “mortgage banking income”).
10
ASC 310-20 requires entities to defer loan origination fees and
direct loan origination costs (see ASC 310-20-25-2). However, ASC
310-20-15-3 explicitly states that ASC 310-20 does not apply to
“[n]onrefundable fees and costs associated with originating or
acquiring loans that are carried at fair value if the changes in
fair value are included in earnings of a business entity or change
in net assets of a not-for-profit entity.”
11
SEC Regulation S-X, Article 9, requires bank
holding companies that are SEC registrants to present
separate totals for interest income, interest expense, other
income, and other expenses. The U.S. banking regulators’
call report instructions similarly require that regulated
banking institutions present separate totals for interest
income, interest expense, noninterest income, and
noninterest expense.
12
If the banking institution is merely acting as an agent in
the origination of a loan, it would generally be required to
report fees and costs associated with the origination of a
loan on a net basis.
13
The guidance in this section is also relevant to loans and
receivables that have been recognized at fair value by using the FVO
in ASC 825 or ASC 815-15 because, as discussed in Section
12.5.2, ASC 825 requires disclosure of “[t]he
estimated amount of gains and losses [for the period] that are
attributable to changes in the instrument-specific credit risk” when
these financial assets are recognized at fair value by using the
FVO.
14
This method of computing the component of the total change in fair
value that is attributable to instrument-specific credit risk is
illustrated in paragraphs B5.7.18 and IE1–IE5 of IFRS 9.
12.5 Disclosures
12.5.1 General
ASC 825-10
Transactions
50-9
Generally accepted accounting principles (GAAP) require
disclosure of or subsequent measurement at fair value
for many classes of financial instruments. Those
requirements are not superseded or modified by this
Subsection.
Fair Value
Option
50-23A This
guidance discusses the applicability of the disclosure
requirements in this Subsection to all entities that
have elected the fair value option.
50-24 The
principal objectives of the disclosures required by
paragraphs 825-10-50-28 through 50-32 are to facilitate
both of the following comparisons:
- Comparisons between entities that choose different measurement attributes for similar assets and liabilities
- Comparisons between assets and liabilities in the financial statements of an entity that selects different measurement attributes for similar assets and liabilities.
50-25 Those
disclosure requirements are expected to result in the
following:
- Information to enable users of its financial statements to understand management’s reasons for electing or partially electing the fair value option
- Information to enable users to understand how changes in fair values affect earnings for the period
- The same information about certain items (such as equity investments and nonperforming loans) that would have been disclosed if the fair value option had not been elected
- Information to enable users to understand the differences between fair values and contractual cash flows for certain items.
To meet those objectives, the disclosures described in
paragraphs 825-10-50-28 through 50-32 are required for
items measured at fair value under the option in this
Subtopic and the option in paragraph 815-15-25-4. Those
disclosures are not required for securities classified
as trading securities under Topic 320, life settlement
contracts measured at fair value pursuant to Subtopic
325-30, or servicing rights measured at fair value
pursuant to Subtopic 860-50. Those Subtopics include
disclosure requirements not affected by this
Subtopic.
50-26
Entities shall provide the disclosures required by
paragraphs 825-10-50-28 through 50-32 in both interim
and annual financial statements.
50-27 The
disclosure requirements in paragraphs 825-10-50-28
through 50-30 do not eliminate disclosure requirements
included in other Subtopics, including other disclosure
requirements relating to fair value measurement.
Entities are encouraged but are not required to present
the disclosures required by this Subtopic in combination
with related fair value information required to be
disclosed by other Subtopics (for example, the General
Subsection of this Section and Topic 820).
Both ASC 820 and ASC 825 contain fair value disclosure requirements that pertain
to (1) items measured at fair value on a recurring or nonrecurring basis and (2)
items not measured at fair value but for which fair values are disclosed. The
fair value disclosures in ASC 825 consist of two types — general fair value
disclosures and incremental disclosures required for items measured at fair
value in accordance with the FVO in ASC 825 or ASC 815-15. As discussed in ASC
825-10-50-9 and ASC 825-10-50-27, the disclosure requirements of other U.S. GAAP
are not superseded by the incremental disclosure requirements in ASC 825 for
items measured at fair value by using the FVO. Thus, for items elected under the
FVO, an entity must provide the general fair value disclosures required by ASC
820 and ASC 825 in addition to the incremental disclosures required by ASC 825.
See Chapter 11 for more information
about the other fair value disclosures required by ASC 820 and ASC 825.
ASC 825-10-50-24 through 50-27 outline the objectives of the disclosure
requirements for items measured at fair value in accordance with the FVO in ASC
825 or ASC 815-15. Entities must provide these disclosures in interim and annual
financial statements. As noted in ASC 825-10-50-25, these disclosures do not
apply to certain items measured at fair value in accordance with other
Codification topics. ASC 825-10-50-25 lists examples of such items, including
debt securities classified as trading under ASC 320, life settlement contracts
measured at fair value under ASC 325-30, and servicing rights measured at fair
value under ASC 860-50. In addition, we believe that the FVO disclosure
requirements do not apply to equity securities measured at fair value under ASC
321. Entities should look to the disclosure requirements of other Codification
topics that permit entities to measure these other items at fair value. See
further discussion in Appendix A.
12.5.2 Income Statement Disclosures
ASC 825-10
Required Disclosures for Each Period for Which an Interim
or Annual Income Statement Is Presented
50-30 For each
period for which an income statement is presented, entities
shall disclose all of the following about items for which
the fair value option has been elected:
- For each line item in the statement of financial position, the amounts of gains and losses from fair value changes included in earnings during the period and in which line in the income statement those gains and losses are reported. This Subtopic does not preclude an entity from meeting this requirement by disclosing amounts of gains and losses that include amounts of gains and losses for other items measured at fair value, such as items required to be measured at fair value.
- A description of how interest and dividends are measured and where they are reported in the income statement. This Subtopic does not address the methods used for recognizing and measuring the amount of dividend income, interest income, and interest expense for items for which the fair value option has been elected.
- For loans and other receivables
held as assets, both of the following:
- The estimated amount of gains or losses included in earnings during the period attributable to changes in instrument-specific credit risk
- How the gains or losses attributable to changes in instrument-specific credit risk were determined.
- For liabilities, all of the
following about the effects of the
instrument-specific credit risk and changes in it:1. The amount of change, during the period and cumulatively, of the fair value of the liability that is attributable to changes in the instrument-specific credit risk . . .3. How the gains and losses attributable to changes in instrument-specific credit risk were determined.4. If a liability is settled during the period, the amount, if any, recognized in other comprehensive income that was recognized in net income at settlement.
For each interim or annual period with an income statement, the disclosures above are
required for items accounted for at fair value by using the FVO. See ASC 825-10-55-6
through 55-13 for examples illustrating these disclosures.
12.5.3 Disclosures in the Statement of Financial Position
12.5.3.1 Required Disclosures
ASC 825-10
Required Disclosures as of Each Date for Which an
Interim or Annual Statement of Financial Position Is
Presented
50-28 As of
each date for which a statement of financial position is
presented, entities shall disclose all of the
following:
- Management’s reasons for electing a fair value option for each eligible item or group of similar eligible items
- If the fair value option is
elected for some but not all eligible items within
a group of similar eligible items, both of the
following:
- A description of those similar items and the reasons for partial election
- Information to enable users to understand how the group of similar items relates to individual line items on the statement of financial position.
- For each line item in the
statement of financial position that includes an
item or items for which the fair value option has
been elected, both of the following:
- Information to enable users to understand how each line item in the statement of financial position relates to major classes of assets and liabilities presented in accordance with the fair value disclosure requirements of Topic 820. (Paragraph 825-10-50-11 also requires an entity to relate carrying amounts that are disclosed in accordance with that paragraph to what is reported in the statement of financial position.)
- The aggregate carrying amount of items included in each line item in the statement of financial position that are not eligible for the fair value option, if any.
- The difference between the
aggregate fair value and the aggregate unpaid
principal balance of each of the following:
- Loans and long-term receivables (other than securities subject to Topic 320) that have contractual principal amounts and for which the fair value option has been elected
- Long-term debt instruments that have contractual principal amounts and for which the fair value option has been elected.
- For loans held as assets for
which the fair value option has been elected, all
of the following:
- The aggregate fair value of loans that are 90 days or more past due
- If the entity’s policy is to recognize interest income separately from other changes in fair value, the aggregate fair value of loans in nonaccrual status
- The difference between the aggregate fair value and the aggregate unpaid principal balance for loans that are 90 days or more past due, in nonaccrual status, or both.
- For investments that would have been accounted for under the equity method if the entity had not chosen to apply the fair value option, the information required by paragraph 323-10-50-3 (excluding the disclosures in paragraph 323-10-50-3(a)(3); (b); and (d)).
50-29 The
disclosure in paragraph 825-10-50-28(f) applies to
investments in common stock, investments in in-substance
common stock, and other investments (for example,
partnerships and certain limited liability corporations)
that both:
- Would otherwise be required to be accounted for under the equity method under other generally accepted accounting principles (GAAP)
- Would be required to satisfy the disclosure requirements of paragraph 323-10-50-3.
When applying paragraph 825-10-50-28(f), an entity shall
apply the guidance from paragraphs 323-10-50-2 and
323-10-50-3(a) and (c).
For each interim or annual period with a statement of financial position, the
disclosures above are required for items accounted for at fair value by using
the FVO. See ASC 825-10-55-6 through 55-13 for examples illustrating these
disclosures.
12.5.3.2 Investments That Would Have Otherwise Been Accounted for by Using the Equity Method
Note that for investments that would have been accounted for under the equity
method if the entity had not elected the FVO, the investor must still disclose
the information required by ASC 323-10-50-3 except for that in ASC
323-10-50-3(a)(3), ASC 323-10-50-3(b), and ASC 323-10-50-3(d). Thus, for such
investments, the following information must be disclosed in the notes to the
financial statements or in separate statements or schedules:
- “The name of each investee and percentage of ownership of common stock” (ASC 323-10-50-3(a)(1)).
- “The accounting policies of the investor with respect to investments in common stock. Disclosure shall include the names of any significant investee entities in which the investor holds 20 percent or more of the voting stock, but the common stock is not accounted for on the equity method, together with the reasons why the equity method is not considered appropriate, and the names of any significant investee corporations in which the investor holds less than 20 percent of the voting stock and the common stock is accounted for on the equity method, together with the reasons why the equity method is considered appropriate” (ASC 323-10-50-3(a)(2)).
- “If investments in common stock of corporate joint ventures or other investments accounted for under the equity method are, in the aggregate, material in relation to the financial position or results of operations of an investor, it may be necessary for summarized information as to assets, liabilities, and results of operations of the investees to be disclosed in the notes or in separate statements, either individually or in groups, as appropriate” (ASC 323-10-50-3(c)).
Further, paragraph 2400.4 of the FRM states, in part, that “the
[SEC] staff believes that the significance tests in S-X 3-09 and S-X 4-08(g),
with the modifications described in Section 2435, should be used by analogy as
presumptive thresholds for when the disclosures in ASC 323-10-50-3c should be
provided for an equity method investment accounted for using fair value in
accordance with ASC 825.” Section 2435 of the FRM describes in detail the
modifications that an entity should make to the significance tests in SEC
Regulation S-X, Rules 3-09 and 4-08(g), when applying the disclosure
requirements in those rules to equity investments that would have been accounted
for by using the equity method if the FVO is not elected.
12.5.4 Other Disclosures
ASC 825-10
Other Required Disclosures
50-31 In annual
periods only, an entity shall disclose the methods and
significant assumptions used to estimate the fair value of
items for which the fair value option has been elected. For
required disclosures about the method(s) and significant
assumptions used to estimate the fair value of financial
instruments, see paragraph 820-10-50-2(bbb) except that an
entity is not required to provide the quantitative
disclosures about significant unobservable inputs used in
fair value measurements categorized within Level 3 of the
fair value hierarchy required by that paragraph.
50-32 If an
entity elects the fair value option at the time one of the
events in paragraph 825-10-25-4(d) through (e) occurs, the
entity shall disclose both of the following in financial
statements for the period of the election:
- Qualitative information about the nature of the event
- Quantitative information by line item in the statement of financial position indicating which line items in the income statement include the effect on earnings of initially electing the fair value option for an item.
ASC 825-10-50-31 indicates that ASC 820-10-50-2(bbb) addresses the requirement for
entities to provide, only for annual periods, disclosures about “the methods and
significant assumptions used to estimate the fair value of items for which the [FVO]
has been elected.” However, ASC 825-10-50-31 also contains an exception to this
requirement under which an entity does not need to “provide the quantitative
disclosures about significant unobservable inputs used in fair value measurements
categorized within Level 3 of the fair value hierarchy.” Such quantitative
disclosures would, however, be required for items measured at fair value under the
FVO that are categorized as Level 3 fair value measurements in accordance with ASC
820-10-50-2(bbb). See Chapter 11 for more
information about these disclosures.
ASC 825-10-50-32 contains additional disclosure requirements related to FVO elections
that occur after a qualifying event under ASC 825-10-25-4(d) and (e). Those events
are discussed in Sections 12.3.2.1 and
12.3.2.2.
12.6 Comparison of U.S. GAAP and IFRS Accounting Standards
12.6.1 General
As discussed above, ASC 825 and ASC 815-15 address the FVO under U.S. GAAP.
Under IFRS Accounting Standards, IFRS 9 is the primary source of guidance on the
election of and accounting for the FVO. The FVO under U.S. GAAP is similar to
the FVO under IFRS 9. Like U.S. GAAP, IFRS Accounting Standards permit election
of the FVO for certain financial assets and financial liabilities under specific
circumstances. Under both U.S. GAAP and IFRS 9, election of the FVO:
- May be made at initial recognition.
- Is generally irrevocable.
- Causes recognition of changes in fair value in earnings and OCI, as applicable.
- Requires that up-front fees and costs related to items for which the FVO is elected be recognized in earnings as incurred and not deferred.
The table below summarizes the differences between U.S. GAAP and
IFRS Accounting Standards with respect to the FVO and is followed by a detailed
explanation of each difference.15
|
Subject
|
U.S. GAAP
|
IFRS Accounting Standards
|
|---|---|---|
|
Scope and qualifying criteria
|
Entities may elect the FVO for most financial assets and
financial liabilities; the ability to elect the FVO for
eligible financial instruments is generally not
limited.
|
Entities may elect the FVO for most financial assets and
financial liabilities, but only when qualifying criteria
are met.
|
|
Election dates
|
Entities may elect the FVO at initial recognition of a
financial instrument or upon the occurrence of certain
specified events (see Section
12.3.2).
|
Entities may elect the FVO at initial recognition of a
financial instrument. For financial instruments that
represent credit exposures, the FVO may be elected after
initial recognition or while the instrument is
unrecognized.
|
|
Presentation of fair value changes of financial
liabilities
|
For financial liabilities for which the FVO has been
elected, entities defer fair value changes associated
with instrument-specific credit risk through OCI. The
balance in accumulated AOCI is released into
earnings upon derecognition of the financial
liability.
|
For financial liabilities for which the FVO has been
elected, entities defer fair value changes associated
with credit risk through OCI unless doing so would
create or increase an “accounting mismatch” (i.e., an
inconsistency in measurement or recognition). The
balance in AOCI is not released into earnings upon
derecognition of the financial liability.
|
12.6.2 Scope and Qualifying Criteria
12.6.2.1 Scope
The items to which the FVO can be applied under U.S. GAAP are similar to those
under IFRS 9. In both cases, the FVO can be applied to financial assets and
financial liabilities that are not otherwise outside the scope of the guidance.
Neither U.S. GAAP nor IFRS 9 permits election of the FVO for (1) an investment
in an entity for which consolidation is required, (2) employers’ rights and
obligations under employee benefit plans, (3) rights and obligations under
leases, and (4) financial instruments classified in shareholders’ equity.
However, because the scope of U.S. GAAP guidance on the FVO differs from that of
IFRS 9 in certain respects, election of the FVO is not always permitted for the
same items. For example, under U.S. GAAP, an entity is permitted to elect the
FVO for certain contracts that are outside the scope of IFRS 9, such as
insurance contracts and warranties that are not financial instruments.
Furthermore, an entity can apply the FVO to equity method investments under U.S.
GAAP. With limited exceptions, equity method investments (referred to as
“associates”) are outside the scope of the FVO under IFRS 9.
12.6.2.2 Qualifying Criteria
IFRS 9 requires entities to meet certain qualifying criteria before they can
elect the FVO for an otherwise eligible item; there are no such qualifying
criteria in U.S. GAAP. IFRS 9 provides separate qualifying criteria for
financial assets, financial liabilities, and financial instruments for which an
entity manages credit risk by using credit derivatives:
- Financial assets — IFRS 9 permits an entity to elect the FVO if it “eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an ‘accounting mismatch’) that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases.”
- Financial liabilities — IFRS 9 permits an entity to elect the FVO
“when doing so results in more relevant information,” which may occur in
either of the following situations:
- The FVO “eliminates or significantly reduces a measurement or recognition inconsistency . . . that would otherwise arise from measuring assets or liabilities or recognising the gains and losses on them on different bases.”
- A “group of financial liabilities or financial assets and financial liabilities is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the entity’s key management personnel.”
Further, IFRS 9 specifies that if “the host is not an asset” within the
standard’s scope, an entity may use the FVO for a hybrid contract that contains
one or more embedded derivatives unless either of the following conditions is met:
- “[T]he embedded derivative(s) do(es) not significantly modify the cash flows that otherwise would be required by the contract.”
- “[I]t is clear with little or no analysis . . . that separation of the embedded derivative(s) is prohibited, such as a prepayment option embedded in a loan that permits the holder to prepay the loan for approximately its amortised cost.”
Moreover, IFRS 9 permits an entity to elect the FVO for all or part of a
financial instrument, even if it is outside the scope of IFRS 9 (e.g., an
unrecognized instrument), provided that the following criteria are met:
- The credit risk of the designated financial instrument, or part of the financial instrument, is managed by using a “credit derivative that is measured at fair value through profit or loss.”
- The reference entity associated with the credit derivative matches the entity associated with the financial instrument that gives rise to the credit risk (e.g., a borrower or holder of a loan commitment).
- The financial instrument has the same seniority as the financial instrument that can be delivered to the counterparty associated with the credit derivative in accordance with the terms of IFRS 9.
Under U.S. GAAP, an entity is only permitted to apply the FVO to “an entire
instrument and not to only specified risks, specific cash flows, or portions of
that instrument.” See further discussion in Section
12.3.1.1.3.
12.6.3 Election Dates
Both U.S. GAAP and IFRS 9 permit the election of the FVO at initial recognition.
Unlike the election under IFRS 9, the election under U.S. GAAP can also be made for
an existing financial instrument when the instrument becomes subject to the equity
method of accounting (e.g., because the investor now has significant influence over
the investee). Under U.S. GAAP, the FVO can also be elected upon the occurrence of
certain other qualifying events, including remeasurement events. See further
discussion in Section 12.3.2.
IFRS 9 also permits the election of the FVO for financial instruments to the extent
that a credit derivative is used to manage credit risk, at initial recognition,
after initial recognition, or while the financial instrument is unrecognized. There
is no similar guidance under U.S. GAAP.
Note that when first adopting IFRS 9, an entity is also permitted, in accordance with
certain transitional provisions, to designate financial assets and financial
liabilities at fair value through profit or loss as of the date of the standard’s
initial application. The transition guidance of certain ASUs issued by the FASB may
allow one-time FVO elections (see Section 12.3.2.1). In
addition, other standards in U.S. GAAP may allow entities to make elections to
account for certain items at fair value through earnings after initial recognition
and in the absence of a remeasurement event.
12.6.4 Presentation of Fair Value Changes of Financial Liabilities
Under both U.S. GAAP and IFRS Accounting Standards, changes in the
fair value of a financial asset or financial liability for which the FVO has been
elected are recognized in earnings (profit or loss). Further, for qualifying
financial liabilities for which the FVO has been elected, both U.S. GAAP and IFRS
Accounting Standards require that the fair value change associated with the
liability’s credit risk be recognized in OCI.
However, unlike U.S. GAAP, IFRS 9 contains an exception under which deferral of the
credit risk component through OCI is precluded if the deferral would “create or
enlarge an accounting mismatch in profit or loss.”
Under U.S. GAAP, upon derecognition of a liability for which fair
value changes attributable to the liability’s credit risk have been recognized
through OCI, the credit risk component must be released through earnings upon
derecognition of the financial liability (see Section 12.4.1.2.4). However, under IFRS
Accounting Standards, an entity is not permitted to subsequently release the AOCI
component into earnings (or profit or loss) upon derecognition of the liability.
Footnotes
15
Differences are based on comparison of authoritative
literature under U.S. GAAP and IFRS Accounting Standards and do not
necessarily include interpretations of such literature.
Appendix A — Fair Value Disclosure Requirements of Other Codification Topics
Appendix A — Fair Value Disclosure Requirements of Other Codification Topics
This appendix addresses fair value or fair-value-related presentation
and disclosure requirements from Codification topics other than ASC 820 and ASC 825. In
some cases, the entire Codification paragraphs are not excerpted below (i.e., only the
fair value or fair-value-related guidance is included). In other cases, additional
paragraphs from the Codification are included for context. This appendix should not be
considered a substitute for the guidance in the Codification.
A.1 ASC 210, Balance Sheet
ASC 210-20
Offsetting of Derivatives,
Repurchase Agreements, and Securities Lending
Transactions
50-3 . . . [A]n entity shall disclose
at the end of the reporting period the following quantitative
information separately for assets and liabilities that are
within the scope of paragraph 210-20-50-1:
- The gross amounts of those recognized assets and those recognized liabilities
- The amounts offset in accordance with the guidance in Sections 210-20-45 and 815-10-45 to determine the net amounts presented in the statement of financial position
- The net amounts presented in the statement of financial position
- The amounts subject to an enforceable
master netting arrangement or similar agreement not
otherwise included in (b):
- The amounts related to
recognized financial instruments and other
derivative instruments that either:
- Management makes an accounting policy election not to offset.
- Do not meet some or all of the guidance in either Section 210-20-45 or Section 815-10-45.
- The amounts related to financial collateral (including cash collateral).
- The amounts related to
recognized financial instruments and other
derivative instruments that either:
- The net amount after deducting the amounts in (d) from the amounts in (c).
Disclosure of Amounts
Subject to an Enforceable Master Netting Arrangement or
Similar Agreement Not Otherwise Included in Paragraph
210-20-50-3(b)
55-12 An entity should also disclose
the fair value amounts related to cash or financial instrument
collateral received or pledged (see paragraph
210-20-50-3(d)(2)).
A.2 ASC 270, Interim Reporting
ASC 270-10
Disclosure of Summarized
Interim Financial Data by Publicly Traded Companies
50-1 Many publicly traded companies
report summarized financial information at periodic interim
dates in considerably less detail than that provided in annual
financial statements. While this information provides more
timely information than would result if complete financial
statements were issued at the end of each interim period, the
timeliness of presentation may be partially offset by a
reduction in detail in the information provided. As a result,
certain guides as to minimum disclosure are desirable. (It
should be recognized that the minimum disclosures of summarized
interim financial data required of publicly traded companies do
not constitute a fair presentation of financial position and
results of operations in conformity with generally accepted
accounting principles [GAAP].) If publicly traded companies
report summarized financial information at interim dates
(including reports on fourth quarters), the following data
should be reported, as a minimum: . . .
k. The information about the use of fair value to
measure assets and liabilities recognized in the
statement of financial position pursuant to Section
820-10-50 . . .
m. The information about financial instruments as
required by Section 825-10-50 . . . .
See Section 11.1.4 for more information about this
disclosure requirement.
A.3 ASC 310, Receivables
ASC 310-10
Fair Value
Disclosures
50-26 Section 825-10-50 provides
guidance on the required disclosure of fair values of certain
assets and liabilities. Paragraph 825-10-50-8 explains that, for
trade receivables and payables, no disclosure is required under
that Subtopic if the trade receivable or payable is due in one
year or less.
ASC 310-30
50-2 Paragraph superseded by Accounting
Standards Update No. 2016-13.
A.4 ASC 320, Investments — Debt Securities
ASC 320-10
Balance Sheet Classification
45-1 An
entity shall report its investments in available-for-sale
securities and trading securities separately from similar assets
that are subsequently measured using another measurement
attribute on the face of the statement of financial position. To
accomplish that, an entity shall do either of the following:
- Present the aggregate of those fair value and non-fair-value amounts in the same line item and parenthetically disclose the amount of fair value included in the aggregate amount
- Present two separate line items to display the fair value and non-fair-value carrying amounts.
Entities also shall refer to the guidance in paragraph
825-10-45-1A on disaggregation of financial assets and financial
liabilities by measurement category and form of financial asset
(that is, securities or loans and receivables).
Securities Classified as Available for Sale
50-2 For
securities classified as available for sale, all reporting
entities shall disclose all of the following by major security
type as of each date for which a statement of financial position
is presented:
a. Amortized cost basis
aa. Aggregate fair value . . . .
50-2A If for the purposes of
identifying and measuring an impairment the applicable accrued
interest is excluded from both the fair value and amortized cost
basis of the available-for-sale debt security, an entity may, as
a practical expedient, exclude the applicable accrued interest
that is included in the amortized cost basis for the purposes of
the disclosure requirements in paragraph 320-10-50-2. If an
entity elects this practical expedient, it shall disclose the
total amount of accrued interest, net of the allowance for
credit losses (if any), excluded from the disclosed amortized
cost basis.
50-3
Maturity information may be combined in appropriate groupings.
In complying with this requirement, financial institutions (see
paragraph 942-320-50-1) shall disclose the fair value and the
net carrying amount (if different from fair value) of debt
securities on the basis of at least the following four maturity
groupings:
- Within one year
- After one year through five years
- After 5 years through 10 years
- After 10 years.
Securities not due at a single maturity date, such as
mortgage-backed securities, may be disclosed separately rather
than allocated over several maturity groupings; if allocated,
the basis for allocation also shall be disclosed.
Securities Classified as Held to Maturity
50-5 All reporting entities shall
disclose the following for securities classified as held to
maturity by major security type as of each date for which a
statement of financial position is presented:
a. Amortized cost basis
aa. Subparagraph superseded by Accounting Standards
Update No. 2019-04.
aaa. Total allowance for credit losses
b. Subparagraph superseded by Accounting Standards
Update No. 2019-04.
c. Subparagraph superseded by Accounting Standards
Update No. 2019-04.
d. Net carrying amount
dd. Subparagraph superseded by Accounting Standards
Update No. 2016-13.
e. Gross gains and losses in accumulated other
comprehensive income for any derivatives that hedged the
forecasted acquisition of the held-to-maturity
securities
f. Information about the contractual maturities of
those securities as of the date of the most recent
statement of financial position presented. (Maturity
information may be combined in appropriate groupings. In
complying with this requirement, financial institutions
[see paragraph 942-320-50-1] shall disclose the net
carrying amount of debt securities on the basis of at
least the following four maturity groupings:
1. Within one year
2. After one year through five
years
3. After 5 years through 10
years
4. After 10 years.
Securities not due at a single maturity date,
such as mortgage-backed securities, may be disclosed separately
rather than allocated over several maturity groupings; if
allocated, the basis for allocation also shall be
disclosed.)
50-5A A public
business entity shall disclose the following information for
securities classified as held to maturity, by major security
type, as of each date for which a statement of financial
position is presented:
- Aggregate fair value
- Gross unrecognized holding gains
- Gross unrecognized holding losses.
50-5B A financial institution that is a
public business entity shall disclose the fair value of the debt
securities classified as held to maturity, by major security
type, on the basis of at least the following four maturity
groupings:
- Within 1 year
- After 1 year through 5 years
- After 5 years through 10 years
- After 10 years.
Securities not due at a single maturity date,
such as mortgage-backed securities, may be disclosed separately
rather than allocated over several maturity groupings; if
allocated, the basis for allocation also shall be disclosed.
50-5C If for the purposes of
identifying and measuring an impairment the applicable accrued
interest is excluded from the amortized cost basis of
held-to-maturity securities, an entity may, as a practical
expedient, exclude the accrued interest receivable balance that
is included in the amortized cost basis of the held-to-maturity
securities for the purposes of the disclosure requirements in
paragraph 320-10-50-5. If an entity applies this practical
expedient, it shall disclose the total amount of accrued
interest, net of the allowance for credit losses (if any),
excluded from the disclosed amortized cost basis.
Impairment of Securities
50-6 Paragraph superseded by Accounting
Standards Update No. 2016-13.
ASU 2019-04 deleted the
requirement in ASC 320-10-50-5 under which entities other than public business entities
must disclose the fair value of held-to-maturity debt securities.
A.5 ASC 321, Investments — Equity Securities
ASC 321-10
50-2B To the extent that the disclosure
requirements in this Subtopic achieve the fair value disclosure
requirements described in Section 820-10-50 on disclosing fair
value measurement, an entity need not duplicate the related fair
value disclosure.
50-3 An
entity that applies the guidance in paragraph 321-10-35-2 for
equity securities without readily determinable fair values shall
disclose all of the following:
- The carrying amount of investments without readily determinable fair values
- The amount of impairments and downward adjustments, if any, both annual and cumulative
- The amount of upward adjustments, if any, both annual and cumulative
- As of the date of the most recent statement of financial position, additional information (in narrative form) that is sufficient to permit financial statement users to understand the quantitative disclosures and the information that the entity considered in reaching the carrying amounts and upward or downward adjustments resulting from observable price changes.
Note that the adjustments referred to in ASC 321-10-50-3(b) and (c), as
well as the narrative disclosure referred to in ASC 321-10-50-3(d), are based on fair
value measurements. See Sections
2.3.2.1.2 and 2.3.2.2.3 for more information.
A.6 ASC 325, Investments — Other
ASC 325-30
Statement of Financial Position
45-1 An
investor shall report its investments that are remeasured at fair
value on the face of the statement of financial position separately
from those accounted for under the investment method. To accomplish
that separate reporting, an investor shall do either of the
following:
- Display separate line items on the statement of financial position for the fair value method and investment method carrying amounts
- Present the aggregate of those fair value method and investment method carrying amounts and parenthetically disclose the amount of those investments accounted for under the fair value method included in the aggregate amount.
Income Statement
45-3 An
investor shall report the investment income from its investments in
life settlement contracts that are remeasured at fair value on the
face of the income statement separately from the investment income
from those accounted for under the investment method. To accomplish
that separate reporting, an investor shall do either of the
following:
- Display separate line items on the income statement for the investment income from the investments in life settlement contracts that are accounted for under the fair value method and investment method
- Present the aggregate of the investment income in life settlement contracts and parenthetically disclose the investment income from those investments accounted for under the fair value method that are included in the aggregate amount.
45-4 An
investor applying the fair value method shall account for premiums
paid and life insurance proceeds received on the same financial
reporting line as the changes in fair value are reported.
50-3 The disclosure requirements in
this Subsection do not eliminate disclosure requirements included in
other Topics, including other disclosure requirements on the use of
fair value.
Fair Value Method
50-7 An
investor shall disclose the method(s) and significant assumptions
used to estimate the fair value of investments in life settlement
contracts, including any mortality assumptions.
50-8 An
investor shall disclose all of the following for life settlement
contracts accounted for under the fair value method based on
remaining life expectancy for each of the first five succeeding
years from the date of the statement of financial position and
thereafter, as well as in the aggregate:
- The number of life settlement contracts
- The carrying value of the life settlement contracts
- The face value (death benefits) of the life insurance policies underlying the contracts.
50-10 An
investor shall disclose both of the following for each reporting
period presented in the income statement:
- The gains or losses recognized during the period on investments sold during the period
- The unrealized gains or losses recognized during the period on investments that are still held at the date of the statement of financial position.
A.7 ASC 326, Financial Instruments — Credit Losses
ASC 326-30
45-1 An entity shall present
available-for-sale debt securities on the statement of financial
position at fair value. In addition, an entity shall present
parenthetically the amortized cost basis and the allowance for
credit losses. If for the purposes of identifying and measuring
an impairment the applicable accrued interest is excluded from
both the fair value and the amortized cost basis of the
available-for-sale debt security, an entity may present
separately on the statement of financial position or within
another statement of financial position line item the accrued
interest receivable balance, net of the allowance for credit
losses (if any). An entity that presents the accrued interest
receivable balance, net of the allowance for credit losses (if
any), within another statement of financial position line item
shall apply the disclosure requirements in paragraph
326-30-50-3A.
Available-for-Sale Debt
Securities in Unrealized Loss Positions Without an Allowance
for Credit Losses
50-4 For available-for-sale debt
securities, including those that fall within the scope of
Subtopic 325-40 on beneficial interests in securitized financial
assets, in an unrealized loss position for which an allowance
for credit losses has not been recorded, an entity shall
disclose all of the following in its interim and annual
financial statements:
- As of each date for which a statement
of financial position is presented, quantitative
information, aggregated by category of investment — each
major security type that the entity discloses in
accordance with this Subtopic — in tabular form:
- The aggregate related fair value of investments with unrealized losses
- The aggregate amount of unrealized losses (that is, the amount by which amortized cost basis exceeds fair value). . . .
A.8 ASC 350, Intangibles — Goodwill and Other
ASC 350-20
Goodwill Impairment Loss
50-2 For each
goodwill impairment loss recognized, all of the following
information shall be disclosed in the notes to the financial
statements that include the period in which the impairment loss
is recognized:
- A description of the facts and circumstances leading to the impairment
- The amount of the impairment loss and the method of determining the fair value of the associated reporting unit (whether based on quoted market prices, prices of comparable businesses or nonprofit activities, a present value or other valuation technique, or a combination thereof) . . . .
50-3 The quantitative
disclosures about significant unobservable inputs used in fair value
measurements categorized within Level 3 of the fair value hierarchy
required by paragraph 820-10-50-2(bbb) are not required for fair
value measurements related to the financial accounting and reporting
for goodwill after its initial recognition in a business
combination.
Goodwill Impairment Loss
50-6 For each
goodwill impairment loss recognized, the following information
shall be disclosed in the notes to financial statements that
include the period in which the impairment loss is
recognized:
- A description of the facts and circumstances leading to the impairment
- The amount of the impairment loss and the method of determining the fair value of the entity or the reporting unit (whether based on prices of comparable businesses or nonprofit activities, a present value or other valuation technique, or a combination of those methods)
- The caption in the income statement or statement of activities in which the impairment loss is included
- The method of allocating the impairment loss to the individual amortizable units of goodwill.
50-7 The
quantitative disclosures about significant unobservable inputs
used in fair value measurements categorized within Level 3 of
the fair value hierarchy required by paragraph 820-10-50-2(bbb)
are not required for fair value measurements related to the
financial accounting and reporting for goodwill after its
initial recognition in a business combination or an acquisition
by not-for-profit entity.
ASC 350-30
Disclosures Relating to Impairment Losses
50-3 For
each impairment loss recognized related to an intangible asset,
all of the following information shall be disclosed in the notes
to financial statements that include the period in which the
impairment loss is recognized:
- A description of the impaired intangible asset and the facts and circumstances leading to the impairment
- The amount of the impairment loss and the method for determining fair value
- The caption in the income statement or the statement of activities in which the impairment loss is aggregated
- If applicable, the segment in which the impaired intangible asset is reported under Topic 280.
50-3A A nonpublic
entity is not required to disclose the quantitative information
about significant unobservable inputs used in fair value
measurements categorized within Level 3 of the fair value
hierarchy required by paragraph 820-10-50-2(bbb) that relate to
the financial accounting and reporting for an indefinite-lived
intangible asset after its initial recognition.
ASC 350-60
Pending Content (Transition Guidance: ASC
350-60-65-1)
50-1 At interim and annual
reporting periods, an entity shall disclose the
following for each significant (as determined by
the fair value) crypto asset holding:
- Name of the crypto asset
- Cost basis
- Fair value
- Number of units held.
An entity shall disclose the aggregated cost
bases and fair values of the crypto asset holdings
that are not individually significant.
50-6 For interim and annual
reporting periods, an entity shall disclose the
following information for crypto assets subject to
contractual sale restrictions at the balance sheet
date:
- The fair value of the crypto assets that are subject to contractual sale restrictions
- The nature and remaining duration of the restriction(s)
- Circumstances that could cause the restriction(s) to lapse.
A.9 ASC 360, Property, Plant, and Equipment
ASC 360-10
Impairment of Long-Lived Assets Classified as Held and
Used
50-2 All
of the following information shall be disclosed in the notes to
financial statements that include the period in which an
impairment loss is recognized:
- A description of the impaired long-lived asset (asset group) and the facts and circumstances leading to the impairment
-
If not separately presented on the face of the statement, the amount of the impairment loss and the caption in the income statement or the statement of activities that includes that loss
- The method or methods for determining fair value (whether based on a quoted market price, prices for similar assets, or another valuation technique)
- If applicable, the segment in which the impaired long-lived asset (asset group) is reported under Topic 280.
A.10 ASC 410, Asset Retirement and Environmental Obligations
ASC 410-20
50-1 An
entity shall disclose all of the following information about its
asset retirement obligations:
- A general description of the asset retirement obligations and the associated long-lived assets
- The fair value of assets that are legally restricted for purposes of settling asset retirement obligations
- A reconciliation of the beginning and ending aggregate
carrying amount of asset retirement obligations showing
separately the changes attributable to the following
components, whenever there is a significant change in
any of these components during the reporting period:
- Liabilities incurred in the current period
- Liabilities settled in the current period
- Accretion expense
- Revisions in estimated cash flows.
50-2 If the fair
value of an asset retirement obligation cannot be reasonably
estimated, that fact and the reasons therefor shall be
disclosed.
A.11 ASC 420, Exit or Disposal Cost Obligations
ASC 420-10
50-1 All
of the following information shall be disclosed in notes to
financial statements that include the period in which an exit or
disposal activity is initiated and any subsequent period until
the activity is completed: . . .
e. If a liability for a cost associated with the
activity is not recognized because fair value cannot be
reasonably estimated, that fact and the reasons
why.
A.12 ASC 460, Guarantees
ASC 460-10
Effect of the Guarantee Disclosure Requirements on the
Disclosure Requirements of Other Topics
50-5 The
disclosures required by this Subsection do not eliminate or
affect the following disclosure requirements:
- The requirements in the General Subsection of Section 825-10-50 that certain entities disclose the fair value of their financial guarantees issued . . .
A.13 ASC 470, Debt
ASC 470-20
Pending Content (Transition Guidance: ASC
815-40-65-1)
50-1D An entity shall
disclose the following information for each
convertible debt instrument as of each date for
which a statement of financial position is
presented.
- The unamortized premium, discount, or issuance costs and, if applicable, the premium amount recorded as paid-in capital in accordance with paragraph 470-20-25-13
- The net carrying amount
- For public business entities, the fair value of the entire instrument and the level of the fair value hierarchy in accordance with paragraphs 825-10-50-10 through 50-15.
See Example 11 (paragraph 470-20-55-69A) for an
illustration of this disclosure requirement.
50-1H If a
convertible debt instrument is measured at fair
value in accordance with the Fair Value Option
Subsections of Subtopic 825-10, an entity shall
provide disclosures in accordance with Subtopic
820-10 and Subtopic 825-10 in addition to the
disclosures required by this Section, if
applicable.
Own-Share Lending
Arrangements Issued in Contemplation of Convertible Debt
Issuance
50-2A An entity that enters into a
share-lending arrangement on its own shares in contemplation of
a convertible debt offering or other financing shall disclose
all of the following. The disclosures must be made on an annual
and interim basis in any period in which a share-lending
arrangement is outstanding. . . .
d. The fair value of the outstanding loaned shares as
of the balance sheet date . . . .
50-2C In
the period in which an entity concludes that it is probable that
the counterparty to its share-lending arrangement will default,
the entity shall disclose the amount of expense reported in the
statement of earnings related to the default. The entity shall
disclose in any subsequent period any material changes in the
amount of expense as a result of changes in the fair value of
the entity’s shares or the probable recoveries. If default is
probable but has not yet occurred, the entity shall disclose the
number of shares related to the share-lending arrangement that
will be reflected in basic and diluted earnings per share when
the counterparty defaults.
Example 11: Disclosure of the Information in the Statement
of Financial Position
Pending Content (Transition Guidance: ASC
815-40-65-1)
55-69A This Example provides
an illustration of the guidance in paragraph
470-20-50-1D based on the assumption that Entity A
is a public business entity and has two
convertible debt instruments outstanding as of
December 31, 20X7, and 20X6.
55-69B The following
illustrates the disclosures in a tabular
format.
The following is a summary of
Entity A’s convertible debt instruments as of
December 31, 20X7 (in thousands).
The following is a summary of
Entity A’s convertible debt instruments as of
December 31, 20X6 (in thousands).
55-69C The disclosures may be
provided alternatively in narrative descriptions.
1.2 Percent Convertible
Debt Instrument Due on December 31, 20X8
As of December 31, 20X7, and 20X6, the net
carrying amount of the convertible debt instrument
was $982,000 and $965,000, respectively, with
unamortized debt discount and issuance costs of
$18,000 and $35,000. The estimated fair value
(Level 2) of the convertible debt instrument was
$1,100,000 and $1,015,000, respectively, as of
December 31, 20X7, and 20X6.
Zero-Coupon Convertible
Debt Instrument Due on December 31, 20X9
As of December 31, 20X7, and 20X6, the net
carrying amount of the convertible debt instrument
was $491,000 and $486,000, respectively, with
unamortized debt discount and issuance costs of
$9,000 and $14,000. The estimated fair value
(Level 3) of the convertible debt instrument was
$462,000 and $450,000, respectively, as of
December 31, 20X7, and 20X6.
ASC 470-30
50-1 The
borrower’s financial statements shall disclose both of the
following:
- The aggregate amount of participating mortgage obligations at the balance sheet date, with separate disclosure of the aggregate participation liabilities and related debt discounts
- Terms of the participations by the lender in either the appreciation in the fair value of the mortgaged real estate project or the results of operations of the mortgaged real estate project, or both.
A.14 ASC 480, Distinguishing Liabilities From Equity
ASC 480-10
50-2
Additionally, for all outstanding financial instruments
recognized under the guidance in Section 480-10-25 and for each
settlement alternative, issuers shall disclose all of the
following:
- The amount that would be paid, or the number of shares that would be issued and their fair value, determined under the conditions specified in the contract if the settlement were to occur at the reporting date
- How changes in the fair value of the issuer’s equity shares would affect those settlement amounts (for example, “the issuer is obligated to issue an additional X shares or pay an additional Y dollars in cash for each $1 decrease in the fair value of one share”) . . . .
A.15 ASC 505, Equity
ASC 505-10
Contingently Convertible Securities
50-8
Additionally, the issuer shall disclose in the notes to
financial statements the terms of the transaction, including the
excess of the aggregate fair value of the instruments that the
holder would receive at conversion over the proceeds received
and the period over which the discount is amortized.
Pending Content (Transition Guidance: ASC
815-40-65-1)
50-8 Paragraph superseded by
Accounting Standards Update No. 2020-06.
A.16 ASC 715, Compensation — Retirement Benefits
ASC 715-20
Disclosures by Public Entities
50-1 An employer
that sponsors one or more defined benefit pension plans or one
or more defined benefit other postretirement plans shall provide
the following information, separately for pension plans and
other postretirement benefit plans. Amounts related to the
employer’s results of operations shall be disclosed for each
period for which a statement of income is presented. Amounts
related to the employer’s statement of financial position shall
be disclosed as of the date of each statement of financial
position presented. All of the following shall be disclosed: . .
.
b. A reconciliation of
beginning and ending balances of the fair value of plan assets
showing separately, if applicable, the effects during the period
attributable to each of the following:
- Actual return on plan assets
- Foreign currency exchange rate changes (see (a)(5))
- Contributions by the employer
- Contributions by plan participants
- Benefits paid
- Business combinations
- Divestitures
- Settlements. . . .
d. The objectives of the disclosures about
postretirement benefit plan assets are to provide users of
financial statements with an understanding of:
-
How investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies
-
The classes of plan assets
-
The inputs and valuation techniques used to measure the fair value of plan assets
-
The effect of fair value measurements using significant unobservable inputs (Level 3) on changes in plan assets for the period
-
Significant concentrations of risk within plan assets.An employer shall consider those overall objectives in providing the following information about plan assets:
- A narrative description of investment policies and strategies, including target allocation percentages or range of percentages considering the classes of plan assets disclosed pursuant to (ii) below, as of the latest statement of financial position presented (on a weighted-average basis for employers with more than one plan), and other factors that are pertinent to an understanding of those policies and strategies such as investment goals, risk management practices, permitted and prohibited investments including the use of derivatives, diversification, and the relationship between plan assets and benefit obligations. For investment funds disclosed as classes as described in (ii) below, a description of the significant investment strategies of those funds shall be provided.
-
The fair value of each class of plan assets as of each date for which a statement of financial position is presented. For additional guidance on determining appropriate classes of plan assets, see paragraph 820-10-50-2B. Examples of classes of assets could include, but are not limited to, the following: cash and cash equivalents; equity securities (segregated by industry type, company size, or investment objective); debt securities issued by national, state, and local governments; corporate debt securities; asset-backed securities; structured debt; derivatives on a gross basis (segregated by type of underlying risk in the contract, for example, interest rate contracts, foreign exchange contracts, equity contracts, commodity contracts, credit contracts, and other contracts); investment funds (segregated by type of fund); and real estate. Those examples are not meant to be all inclusive. An employer should consider the overall objectives in paragraph 715-20-50-1(d)(1) through (5) in determining whether additional classes of plan assets or further disaggregation of classes should be disclosed. If an employer determines the measurement date of plan assets in accordance with paragraph 715-30-35-63A or 715-60-35-123A and the employer contributes assets to the plan between the measurement date and its fiscal year-end, the employer shall not adjust the fair value of each class of plan assets for the effects of the contribution. Instead, the employer shall disclose the amount of the contribution to permit reconciliation of the total fair value of all the classes of plan assets to the ending balance of the fair value of plan assets. For example, the contribution could be disclosed as follows:
- A narrative description of the basis used to determine the overall expected long-term rate-of-return-on-assets assumption, such as the general approach used, the extent to which the overall rate-of-return-on-assets assumption was based on historical returns, the extent to which adjustments were made to those historical returns in order to reflect expectations of future returns, and how those adjustments were determined. The description should consider the classes of assets as described in (ii) above, as appropriate.
- Information that enables users of financial
statements to assess the inputs and valuation
techniques used to develop fair value measurements
of plan assets at the reporting date. For fair
value measurements using significant unobservable
inputs, an employer shall disclose the effect of
the measurements on changes in plan assets for the
period. To meet those objectives, the employer
shall disclose the following information for each
class of plan assets disclosed pursuant to (ii)
above for each annual period:01. The level of the fair value hierarchy within which the fair value measurements are categorized in their entirety, segregating fair value measurements using quoted prices in active markets for identical assets or liabilities (Level 1), significant other observable inputs (Level 2), and significant unobservable inputs (Level 3). The guidance in paragraphs 820-10-35-37 through 35-37A is applicable. Investments for which fair value is measured using the net asset value per share (or its equivalent) practical expedient in paragraph 820-10-35-59 shall not be categorized within the fair value hierarchy, as noted by paragraph 820-10-35-54B. If an employer determines the measurement date of plan assets in accordance with paragraph 715-30-35-63A or 715-60-35-123A and the employer contributes assets to the plan between the measurement date and its fiscal year-end, the employer shall not adjust the fair value of each class of plan assets for the effects of the contribution. Instead, the employer shall disclose the amount of the contribution to permit reconciliation of the total fair value of all plan assets in the fair value hierarchy to the ending balance of the fair value of plan assets. For example, the contribution could be disclosed as follows:02. For fair value measurements of plan assets using significant unobservable inputs (Level 3), a reconciliation from the opening balances to the closing balances, disclosing separately changes during the period attributable to the following:A. Actual Return on Plan Assets (Component of Net Periodic Postretirement Benefit Cost) or Actual Return on Plan Assets (Component of Net Periodic Pension Cost), separately identifying the amount related to assets still held at the reporting date and the amount related to assets sold during the periodB. Purchases, sales, and settlements, netC. The amounts of any transfers into or out of Level 3 (for example, transfers due to changes in the observability of significant inputs).03. Information about the valuation technique(s) and inputs used to measure fair value and a discussion of changes in valuation techniques and inputs, if any, during the period. . . .
Entities (Public and Nonpublic) With Two or More Plans
50-2 The disclosures required by
this Subtopic shall be aggregated for all of an employer’s
defined benefit pension plans and for all of an employer’s other
defined benefit postretirement plans unless disaggregating in
groups is considered to provide useful information or is
otherwise required by the following paragraph and paragraph
715-20-50-4.
50-3 If aggregate disclosures are
presented, an employer shall disclose, as of the date of each
statement of financial position presented, both of the
following:
- For pension plans, the projected benefit obligation and fair value of plan assets for plans with projected benefit obligations in excess of plan assets, and the accumulated benefit obligation and fair value of plan assets for plans with accumulated benefit obligations in excess of plan assets
- For other postretirement benefit plans, the accumulated postretirement benefit obligation and fair value of plan assets for plans with accumulated postretirement benefit obligations in excess of plan assets.
50-4 A U.S. reporting entity may
combine disclosures about pension plans or other postretirement
benefit plans outside the United States with those for U.S.
plans unless the benefit obligations of the plans outside the
United States are significant relative to the total benefit
obligation and those plans use significantly different
assumptions. A foreign reporting entity that prepares financial
statements in conformity with U.S. generally accepted accounting
principles (GAAP) shall apply the preceding guidance to its
domestic and foreign plans.
Disclosures by Nonpublic
Entities
50-5 A nonpublic entity is not
required to disclose the information required by paragraph
715-20-50-1(a) through (c), 715-20-50-1(h), 715-20-50-1(o)
through (q), and 715-20-50-1(r)(2). A nonpublic entity that
sponsors one or more defined benefit pension plans or one or
more other defined benefit postretirement plans shall provide
all of the following information, separately for pension plans
and other postretirement benefit plans. Amounts related to the
employer’s results of operations shall be disclosed for each
period for which a statement of income is presented. Amounts
related to the employer’s statement of financial position shall
be disclosed as of the date of each statement of financial
position presented.
a. The benefit obligation, fair value of plan assets,
and funded status of the plan. . . .
c. The objectives of the disclosures about
postretirement benefit plan assets are to provide users
of financial statements with an understanding of:
1. How investment allocation
decisions are made, including the factors that are
pertinent to an understanding of investment policies and
strategies
2. The classes of plan
assets
3. The inputs and valuation
techniques used to measure the fair value of plan
assets
4. The effect of fair value
measurements using significant unobservable inputs
(Level 3) on changes in plan assets for the period
5. Significant concentrations of
risk within plan assets.
An employer shall consider those
overall objectives in providing the following
information about plan assets:
i. A narrative description of
investment policies and strategies, including target
allocation percentages or range of percentages
considering the classes of plan assets disclosed
pursuant to (ii) below, as of the latest statement of
financial position presented (on a weighted-average
basis for employers with more than one plan), and other
factors that are pertinent to an understanding of those
policies and strategies such as investment goals, risk
management practices, permitted and prohibited
investments including the use of derivatives,
diversification, and the relationship between plan
assets and benefit obligations. For investment funds
disclosed as classes as described in (ii) below, a
description of the significant investment strategies of
those funds shall be provided.
ii. The fair value of each class
of plan assets as of each date for which a statement of
financial position is presented. For additional guidance
on determining appropriate classes of plan assets, see
paragraph 820-10-50-2B. Examples of classes of assets
could include, but are not limited to, the following:
cash and cash equivalents; equity securities (segregated
by industry type, company size, or investment
objective); debt securities issued by national, state,
and local governments; corporate debt securities;
asset-backed securities; structured debt; derivatives on
a gross basis (segregated by type of underlying risk in
the contract, for example, interest rate contracts,
foreign exchange contracts, equity contracts, commodity
contracts, credit contracts, and other contracts);
investment funds (segregated by type of fund); and real
estate. Those examples are not meant to be all
inclusive. An employer should consider the overall
objectives in paragraph 715-20-50-5(c)(1) through (5) in
determining whether additional classes of plan assets or
further disaggregation of classes should be disclosed.
If an employer determines the measurement date of plan
assets in accordance with paragraph 715-30-35-63A or
715-60-35-123A and the employer contributes assets to
the plan between the measurement date and its fiscal
year-end, the employer shall not adjust the fair value
of each class of plan assets for the effects of the
contribution. Instead, the employer shall disclose the
amount of the contribution to permit reconciliation of
the total fair value of all the classes of plan assets
to the ending balance of the fair value of plan assets.
For example, the contribution could be disclosed as
follows:
iii. A narrative description of
the basis used to determine the overall expected
long-term rate-of-return-on-assets assumption, such as
the general approach used, the extent to which the
overall rate-of-return-on-assets assumption was based on
historical returns, the extent to which adjustments were
made to those historical returns in order to reflect
expectations of future returns, and how those
adjustments were determined. The description should
consider the classes of assets described in (ii) above,
as appropriate.
iv. Information that enables users
of financial statements to assess the inputs and
valuation techniques used to develop fair value
measurements of plan assets at the reporting date. For
fair value measurements using significant unobservable
inputs, an employer shall disclose the effect of the
measurements on changes in plan assets for the period.
To meet those objectives, the employer shall disclose
the following information for each class of plan assets
disclosed pursuant to (ii) above for each annual
period:
01. The level of the fair value
hierarchy within which the fair value measurements are
categorized in their entirety, segregating fair value
measurements using quoted prices in active markets for
identical assets or liabilities (Level 1), significant
other observable inputs (Level 2), and significant
unobservable inputs (Level 3). The guidance in
paragraphs 820-10-35-37 through 35-37A is applicable.
Investments for which fair value is measured using the
net asset value per share (or its equivalent) practical
expedient in paragraph 820-10-35-59 shall not be
categorized within the fair value hierarchy, as noted by
paragraph 820-10-35-54B. If an employer determines the
measurement date of plan assets in accordance with
paragraph 715-30-35-63A or 715-60-35-123A and the
employer contributes assets to the plan between the
measurement date and its fiscal year-end, the employer
shall not adjust the fair value of each class of plan
assets for the effects of the contribution. Instead, the
employer shall disclose the amount of the contribution
to permit reconciliation of the total fair value of all
plan assets in the fair value hierarchy to the ending
balance of the fair value of plan assets. For example,
the contribution could be disclosed as follows:
02. For fair value measurements of
plan assets using significant unobservable inputs (Level
3), the amounts of purchases and any transfers into or
out of Level 3 (for example, transfers due to changes in
the observability of significant inputs), disclosed
separately. . . .
03. Information about the
valuation technique(s) and inputs used to measure fair
value and a discussion of changes in valuation
techniques and inputs, if any, during the period. . .
.
ASC 820-10-50-10 states that “[p]lan assets of a defined benefit pension
or other postretirement [benefit] plan that are accounted for in accordance with Topic
715 are not subject to the disclosure requirements [of ASC 820]. Instead, the
disclosures required in paragraphs 715-20-50-1(d)(iv) and 715-20-50-5(c)(iv) shall
apply.” Sponsors with postemployment benefits accounted for under ASC 712 that apply the
measurement provisions of ASC 715-30 or ASC 715-60 would also be subject to the
disclosure requirements in ASC 715.
ASC 715-20-55-16 through 55-18 contain examples illustrating the fair value disclosure
requirements of ASC 715-20.
A.17 ASC 718, Compensation — Stock Compensation
ASC 718-40
50-1 An
employer sponsoring an employee stock ownership plan shall
disclose all of the following information about the plan, if
applicable: . . .
e. The fair value of unearned employee stock ownership
plan shares at the balance-sheet date for shares
accounted for under this Subtopic. (Future tax
deductions will be allowed only for the employee stock
ownership plan’s cost of unearned employee stock
ownership plan shares.) This disclosure need not be made
for old employee stock ownership plan shares for which
the employer does not apply the guidance in this
Subtopic.
f. The existence and nature of any repurchase
obligation, including disclosure of the fair value (see
paragraph 718-40-30-4) of the shares allocated as of the
balance sheet date, which are subject to a repurchase
obligation. . . .
A.18 ASC 805, Business Combinations
ASC 805-10
Business Combinations Occurring During a Current Reporting
Period or After the Reporting Date but Before the Financial
Statements Are Issued
50-2 To meet the
objective in the preceding paragraph, the acquirer shall
disclose the following information for each business combination
that occurs during the reporting period: . . .
g. In a business combination achieved in
stages, all of the following:
- The acquisition-date fair value of the equity interest in the acquiree held by the acquirer immediately before the acquisition date
- The amount of any gain or loss recognized as a result of remeasuring to fair value the equity interest in the acquiree held by the acquirer immediately before the business combination (see paragraph 805-10-25-10) and the line item in the income statement in which that gain or loss is recognized
- The valuation technique(s) used to measure the acquisition-date fair value of the equity interest in the acquiree held by the acquirer immediately before the business combination
- Information that enables users of the acquirer’s financial statements to assess the inputs used to develop the fair value measurement of the equity interest in the acquiree held by the acquirer immediately before the business combination. . . .
ASC 805-20
Business Combinations Occurring During a Current Reporting
Period or After the Reporting Date but Before the Financial
Statements Are Issued
50-1 Paragraph 805-10-50-1 identifies
one of the objectives of disclosures about a business
combination. To meet that objective, the acquirer shall disclose
all of the following information for each business combination
that occurs during the reporting period: . . .
b. For acquired receivables
not subject to the requirements of Subtopic 326-20 relating to
purchased financial assets with credit deterioration, all of the
following:
- The fair value of the receivables (unless those receivables arise from sales-type leases or direct financing leases by the lessor for which the acquirer shall disclose the amounts recognized as of the acquisition date)
- The gross contractual amounts receivable
- The best estimate at the acquisition date of the contractual cash flows not expected to be collected.
The disclosures shall be
provided by major class of receivable, such as loans, net
investment in sales-type or direct financing leases in
accordance with Subtopic 842-30 on leases — lessor, and any
other class of receivables. . . .
d. For contingencies, the
following disclosures shall be included in the note that
describes the business combination:
- For assets and liabilities arising from
contingencies recognized at the acquisition date:
- The amounts recognized at the acquisition date and the measurement basis applied (that is, at fair value or at an amount recognized in accordance with Topic 450 and Section 450-20-25)
- The nature of the contingencies.
An acquirer may aggregate
disclosures for assets or liabilities arising from contingencies
that are similar in nature. . .
e. For each business
combination in which the acquirer holds less than 100 percent of
the equity interests in the acquiree at the acquisition date,
both of the following:
- The fair value of the noncontrolling interest in the acquiree at the acquisition date
- The valuation technique(s) and significant inputs used to measure the fair value of the noncontrolling interest.
ASC 805-30
Business Combinations Occurring During a Current Reporting
Period or After the Reporting Date but Before the Financial
Statements Are Issued
50-1 Paragraph
805-10-50-1 identifies one of the objectives of disclosures
about a business combination. To meet that objective, the
acquirer shall disclose all of the following information for
each business combination that occurs during the reporting
period: . . .
b. The acquisition-date fair value of the
total consideration transferred and the acquisition-date fair
value of each major class of consideration, such as the
following:
- Cash
- Other tangible or intangible assets, including a business or subsidiary of the acquirer
- Liabilities incurred, for example, a liability for contingent consideration
- Equity interests of the acquirer, including the number of instruments or interests issued or issuable and the method of determining the fair value of those instruments or interests. . . .
ASC 805-50
50-5 If an
acquiree elects the option to apply pushdown accounting in its
separate financial statements, it shall disclose information in
the period in which the pushdown accounting was applied (or in
the current reporting period if the acquiree recognizes
adjustments that relate to pushdown accounting) that enables
users of financial statements to evaluate the effect of pushdown
accounting. To meet this disclosure objective, the acquiree
shall consider the disclosure requirements in other Subtopics of
Topic 805.
50-6
Information to evaluate the effect of pushdown accounting may
include the following: . . .
c. The acquisition-date fair value of the
total consideration transferred by the acquirer. . . .
ASC 805-60
Pending Content (Transition Guidance: ASC
805-60-65-1)
50-2 In the period of
formation, a joint venture shall disclose the
following:
- The formation date
- A description of the purpose for which the joint venture was formed (for example, to share risks and rewards in developing a new market, product, or technology; to combine complementary technological knowledge; or to pool resources in developing production or other facilities)
- The formation-date fair value of the joint venture as a whole
- A description of the assets and liabilities recognized by the joint venture at the formation date
- The amounts recognized by the joint venture for each major class of assets and liabilities as a result of accounting for its formation, either presented on the face of financial statements or disclosed in the notes to financial statements (see paragraph 805-60-45-1)
- A qualitative description of the factors that make up any goodwill recognized, such as expected synergies from combining operations of the contributed assets or businesses, intangible assets that do not qualify for separate recognition, or other factors.
50-3 If the initial
accounting for a joint venture formation is
incomplete (see paragraph 805-60-25-14) for
particular assets, liabilities, noncontrolling
interests, or the formation-date fair value of the
joint venture as a whole and the amounts
recognized in the financial statements for the
joint venture formation thus have been determined
only provisionally, the joint venture shall
disclose the following information:
- The reasons why the initial accounting is incomplete
- The assets, liabilities, noncontrolling interests, or the formation-date fair value of the joint venture as a whole for which the initial accounting is incomplete
- The nature and amount of any measurement period adjustments recognized during the reporting period, including separately the amount of adjustment to current-period income statement line items relating to the income effects that would have been recognized in previous periods if the adjustment to provisional amounts was recognized as of the formation date.
A.19 ASC 810, Consolidation
ASC 810-10
Deconsolidation of a Subsidiary
50-1B In
the period that either a subsidiary is deconsolidated or a group
of assets is derecognized in accordance with paragraph
810-10-40-3A, the parent shall disclose all of the following:
- The amount of any gain or loss recognized in accordance with paragraph 810-10-40-5
- The portion of any gain or loss related to the remeasurement of any retained investment in the former subsidiary or group of assets to its fair value
- The caption in the income statement in which the gain or loss is recognized unless separately presented on the face of the income statement
- A description of the valuation technique(s) used to measure the fair value of any direct or indirect retained investment in the former subsidiary or group of assets
- Information that enables users of the parent’s financial statements to assess the inputs used to develop the fair value in item (d)
- The nature of continuing involvement with the subsidiary or entity acquiring the group of assets after it has been deconsolidated or derecognized
- Whether the transaction that resulted in the deconsolidation or derecognition was with a related party
- Whether the former subsidiary or entity acquiring a group of assets will be a related party after deconsolidation.
Collateralized Financing Entities
50-20 A
reporting entity that consolidates a collateralized financing
entity and measures the financial assets and the financial
liabilities using the measurement alternative in paragraphs
810-10-30-10 through 30-15 and 810-10-35-6 through 35-8 shall
disclose the information required by Topic 820 on fair value
measurement and Topic 825 on financial instruments for the
financial assets and the financial liabilities of the
consolidated collateralized financing entity.
50-21 For
the less observable of the fair value of the financial assets
and the fair value of the financial liabilities of the
collateralized financing entity that is measured in accordance
with the measurement alternative in paragraphs 810-10-30-10
through 30-15 and 810-10-35-6 through 35-8, a reporting entity
shall disclose that the amount was measured on the basis of the
more observable of the fair value of the financial liabilities
and the fair value of the financial assets.
50-22 The
disclosures in paragraphs 810-10-50-20 through 50-21 do not
apply to the financial assets and the financial liabilities that
are incidental to the operations of the collateralized financing
entity and have carrying values that approximate fair value.
A.20 ASC 815, Derivatives and Hedging
ASC 815-10
Income Statement Classification
45-8 Except for the guidance in the
following paragraph and paragraph 815-10-45-10, this Subtopic
does not provide guidance about the classification in the income
statement of a derivative instrument’s gains or losses,
including the adjustment to fair value for a contract that newly
meets the definition of a derivative instrument.
Derivative Instruments Held for Trading
Purposes
45-9 Gains
and losses (realized and unrealized) on all derivative
instruments within the scope of this Subtopic shall be shown net
when recognized in the income statement, whether or not settled
physically, if the derivative instruments are held for trading
purposes. On an ongoing basis, reclassifications into and out of
trading shall be rare.
Options Granted to
Employees and Nonemployees
45-10 Subsequent
changes in the fair value of an option that was granted to a
grantee and is subject to or became subject to this Subtopic
shall be included in the determination of net income. (See
paragraphs 815-10-55-46 through 55-48A and 815-10-55-54 through
55-55 for discussion of such an option.) Changes in fair value
of the option award before vesting shall be characterized as
compensation cost in the grantor’s income statement. Changes in
fair value of the option award after vesting may be reflected
elsewhere in the grantor’s income statement.
50-4A An entity that holds or issues
derivative instruments (and nonderivative instruments that are
designated and qualify as hedging instruments pursuant to
paragraphs 815-20-25-58 and 815-20-25-66) shall disclose all of
the following for every annual and interim reporting period for
which a statement of financial position and statement of
financial performance are presented:
- The location and fair value amounts of derivative instruments (and such nonderivative instruments) reported in the statement of financial position
- The location and amount of the gains
and losses on derivative instruments (and such
nonderivative instruments) and related hedged items
reported in any of the following:
- The statement of financial performance
- The statement of financial position (for example, gains and losses initially recognized in other comprehensive income).
- The total amount of each income and expense line item presented in the statement of financial performance in which the results of fair value or cash flow hedges are recorded.
50-4B The
disclosures required by item (a) in the preceding paragraph
shall comply with all of the following:
- The fair value of derivative instruments (and nonderivative instruments that are designated and qualify as hedging instruments pursuant to paragraphs 815-20-25-58 and 815-20-25-66) shall be presented on a gross basis, even when those instruments are subject to master netting arrangements and qualify for net presentation in the statement of financial position in accordance with Subtopic 210-20 or paragraphs 815-10-45-5 through 45-7, as applicable.
- Cash collateral payables and receivables associated with those instruments shall not be added to or netted against the fair value amounts.
- Fair value amounts shall be presented as separate asset
and liability values segregated between each of the
following:
- Those instruments designated and qualifying as hedging instruments under Subtopic 815-20, presented separately by type of contract (for example, interest rate contracts, foreign exchange contracts, equity contracts, commodity contracts, credit contracts, other contracts, and so forth)
- Those instruments not designated as hedging instruments, presented separately by type of contract.
- The disclosure shall identify the line item(s) in the statement of financial position in which the fair value amounts for these categories of derivative instruments are included.
Amounts required to be reported for nonderivative instruments
that are designated and qualify as hedging instruments pursuant
to paragraphs 815-20-25-58 and 815-20-25-66 shall be the
carrying value of the nonderivative hedging instrument, which
includes the adjustment for the foreign currency transaction
gain or loss on that instrument.
50-4C For qualifying fair value and
cash flow hedges, the gains and losses disclosed pursuant to
paragraph 815-10-50-4A(b) shall be presented separately for all
of the following by type of contract (as discussed in paragraph
815-10-50-4D) and by income and expense line item (if
applicable):
a. Derivative instruments (and nonderivative
instruments) designated and qualifying as hedging
instruments in fair value hedges and related hedged
items designated and qualifying in fair value
hedges.
b. The gains and losses on derivative instruments
designated and qualifying in cash flow hedges included
in the assessment of effectiveness that were recognized
in other comprehensive income during the current
period.
bb. Amounts excluded from the assessment of
effectiveness that were recognized in other
comprehensive income during the period for which an
amortization approach is applied in accordance with
paragraph 815-20-25-83A.
c. The gains and losses on derivative instruments
designated and qualifying in cash flow hedges that are
included in the assessment of effectiveness and recorded
in accumulated other comprehensive income during the
term of the hedging relationship and reclassified into
earnings during the current period.
d. The portion of gains and losses on derivative
instruments designated and qualifying in fair value and
cash flow hedges representing the amount, if any,
excluded from the assessment of hedge effectiveness that
is recognized in earnings. When disclosing this amount,
an entity shall disclose separately amounts that are
recognized in earnings through an amortization approach
in accordance with paragraph 815-20-25-83A and amounts
recognized through changes in fair value in earnings in
accordance with paragraph 815-20-25-83B. . . .
f. The gains and losses reclassified into earnings as a
result of the discontinuance of cash flow hedges because
it is probable that the original forecasted transactions
will not occur by the end of the originally specified
time period or within the additional period of time
discussed in paragraphs 815-30-40-4 through 40-5.
g. The amount of net gain or loss recognized in
earnings when a hedged firm commitment no longer
qualifies as a fair value hedge.
Credit-Risk-Related Contingent Features
50-4H An
entity that holds or issues derivative instruments (or
nonderivative instruments that are designated and qualify as
hedging instruments pursuant to paragraphs 815-20-25-58 and
815-20-25-66) shall disclose all of the following for every
annual and interim reporting period for which a statement of
financial position is presented:
- The existence and nature of credit-risk-related contingent features
- The circumstances in which credit-risk-related contingent features could be triggered in derivative instruments (or such nonderivative instruments) that are in a net liability position at the end of the reporting period
- The aggregate fair value amounts of derivative instruments (or such nonderivative instruments) that contain credit-risk-related contingent features that are in a net liability position at the end of the reporting period
- The aggregate fair value of assets that are already posted as collateral at the end of the reporting period
- The aggregate fair value of additional assets that would be required to be posted as collateral if the credit-risk-related contingent features were triggered at the end of the reporting period
- The aggregate fair value of assets needed to settle the instrument immediately if the credit-risk-related contingent features were triggered at the end of the reporting period.
Amounts required to be reported for nonderivative instruments
that are designated and qualify as hedging instruments pursuant
to paragraphs 815-20-25-58 and 815-20-25-66 shall be the
carrying value of the nonderivative hedging instrument, which
includes the adjustment for the foreign currency transaction
gain or loss on that instrument. Example 23 (see paragraph
815-10-55-185) illustrates a credit-risk-related contingent
feature disclosure.
Credit Derivatives
50-4K A
seller of credit derivatives shall disclose information about
its credit derivatives and hybrid instruments (for example, a
credit-linked note) that have embedded credit derivatives to
enable users of financial statements to assess their potential
effect on its financial position, financial performance, and
cash flows. Specifically, for each statement of financial
position presented, the seller of a credit derivative shall
disclose all of the following information for each credit
derivative, or each group of similar credit derivatives, even if
the likelihood of the seller’s having to make any payments under
the credit derivative is remote: . . .
c. The fair value of the credit derivative as of the
date of the statement of financial position . . .
.
However, the disclosures required by this paragraph do not apply
to an embedded derivative feature related to the transfer of
credit risk that is only in the form of subordination of one
financial instrument to another, as described in paragraph
815-15-15-9.
ASC 815-10-45-5 through 45-7 provide guidance on offsetting fair value amounts for
derivative instruments and fair value amounts recognized for the right to reclaim cash
collateral (a receivable) or the obligation to return cash collateral (a payable)
arising from a derivative instrument (or instruments) recognized at fair value and
executed with the same counterparty under a master netting arrangement. One of the
conditions for offsetting receivables and payables for cash collateral with derivative
instruments is that the cash collateral amounts must be fair value amounts in accordance
with the definition of fair value in ASC 820. ASC 815-10-50-8 contains disclosure
requirements related to offsetting cash collateral amounts with derivative
instruments.
ASC 815-10-55-181 through 55-185 provide examples illustrating the disclosures required
by ASC 815-10-50-4A through 50-4H.
ASC 815-15
45-1 In
each statement of financial position presented, an entity shall
report hybrid financial instruments measured at fair value under
the election and under the practicability exception in paragraph
815-15-30-1 in a manner that separates those reported fair
values from the carrying amounts of assets and liabilities
subsequently measured using another measurement attribute on the
face of the statement of financial position. To accomplish that
separate reporting, an entity may do either of the following:
- Display separate line items for the fair value and non-fair-value carrying amounts
- Present the aggregate of the fair value and non-fair-value amounts and parenthetically disclose the amount of fair value included in the aggregate amount.
Hybrid Instruments That Are Not Separated
50-1 For those
hybrid financial instruments measured at fair value under the
election and under the practicability exception in paragraph
815-15-30-1, an entity shall also disclose the information
specified in paragraphs 825-10-50-28 through 50-32.
50-2 An entity
shall provide information that will allow users to understand
the effect of changes in the fair value of hybrid financial
instruments measured at fair value under the election and under
the practicability exception in paragraph 815-15-30-1 on
earnings (or other performance indicators for entities that do
not report earnings).
Embedded Conversion Option That Is No Longer
Bifurcated
50-3 An issuer
shall disclose both of the following for the period in which an
embedded conversion option previously accounted for as a
derivative instrument under this Subtopic no longer meets the
separation criteria under this Subtopic:
- A description of the principal changes causing the embedded conversion option to no longer require bifurcation under this Subtopic
-
The amount of the liability for the conversion option reclassified to stockholders’ equity.
The amount that ASC 815-15-50-3(b) requires entities to disclose will represent the fair
value of the conversion option immediately before its reclassification from a liability
to stockholders’ equity.
ASC 815-20
Income Statement
Classification
45-1A For qualifying fair value and
cash flow hedges, an entity shall present both of the following
in earnings in the same income statement line item that is used
to present the earnings effect of the hedged item:
- The change in the fair value of the hedging instrument that is included in the assessment of hedge effectiveness
- Amounts excluded from the assessment of hedge effectiveness in accordance with paragraphs 815-20-25-83A through 25-83B.
See paragraphs 815-20-55-79W through 55-79AD for
related implementation guidance.
ASC 815-40
50-1 Changes in the
fair value of all contracts classified as assets or liabilities
shall be disclosed in the financial statements as long as the
contracts remain classified as assets or liabilities.
Pending Content (Transition Guidance: ASC
815-40-65-1)
50-1 Paragraph superseded by Accounting
Standards Update No. 2020-06.
50-2 Some contracts
that are classified as assets or liabilities meet the definition
of a derivative instrument under the provisions of Subtopic
815-10. The related disclosures that are required by Sections
815-10-50, 815-25-50, 815-30-50, and 815-35-50 also are required
for those contracts.
Pending Content (Transition Guidance: ASC
815-40-65-1)
50-2 The disclosure guidance in this
Subtopic applies to freestanding instruments that
are potentially indexed to, and potentially
settled in, an entity’s own equity, regardless of
whether the contract meets the criteria to qualify
for the scope exception in Sections 815-40-15 and
815-40-25. Some contracts that are classified as
assets or liabilities meet the definition of a
derivative instrument under the provisions of
Subtopic 815-10. The related disclosures that are
required by Sections 815-10-50, 815-25-50,
815-30-50, and 815-35-50 also are required for
those contracts. Equity-classified contracts under
the provisions of this Subtopic are not required
to provide the disclosures required by Section
505-10-50, other than those described in paragraph
815-40-50-5.
Pending Content (Transition Guidance: ASC
815-40-65-1)
50-2A Changes in the fair
value of all contracts classified as assets or
liabilities shall be disclosed in the financial
statements as long as the contracts remain
classified as assets or liabilities.
Reclassifications and Related Accounting Policy
Disclosures
50-3 Contracts
within the scope of this Subtopic may be required to be
reclassified into (or out of) equity during the life of the
instrument (in whole or in part) pursuant to the provisions of
paragraphs 815-40-35-8 through 35-13. An issuer shall disclose
contract reclassifications (including partial
reclassifications), the reason for the reclassification, and the
effect on the issuer’s financial statements.
50-4 The
determination of how to partially reclassify contracts subject
to this Subtopic is an accounting policy decision that shall be
disclosed pursuant to Topic 235.
Interaction With Disclosures About Capital Structure
50-5 The
disclosures required by Section 505-10-50 apply to all contracts
within the scope of this Subtopic as follows: . . .
d. A contract’s current fair value for each settlement
alternative (denominated, as relevant, in monetary
amounts or quantities of shares) and how changes in the
price of the issuer’s equity instruments affect those
settlement amounts (for example, the issuer is obligated
to issue an additional X shares or pay an additional Y
dollars in cash for each $1 decrease in stock price)
shall be disclosed under Section 505-10-50. (For some
issuers, a tabular format may provide the most concise
and informative presentation of these data.) . . .
Pending Content (Transition Guidance: ASC
815-40-65-1)
50-5 The disclosures required by Section
505-10-50 apply to all contracts within the scope
of this Subtopic as follows: . . .
d. For each settlement alternative, the
amount that would be paid, or the number of shares
that would be issued and their fair value,
determined under the conditions specified in the
contract if the settlement were to occur at the
reporting date and how changes in the fair value
of the issuer’s equity shares affect those
settlement amounts (for example, the issuer is
obligated to issue an additional X shares or pay
an additional Y dollars in cash for each $1
decrease in the fair value of one share) shall be
disclosed under Section 505-10-50. (For some
issuers, a tabular format may provide the most
concise and informative presentation of these
data.) . . .
A.21 ASC 845, Nonmonetary Transactions
ASC 845-10
50-3 An entity shall disclose the
amount of revenue and costs (or gains and losses) associated
with inventory exchanges recognized at fair value.
A.22 ASC 860, Transfers and Servicing
ASC 860-20
Disclosures for Each
Income Statement Presented
50-3 For each income statement
presented, the entity shall disclose all of the following: . .
.
b. The characteristics of the transfer
including all of the following:
- A description of the transferor’s continuing involvement with the transferred financial assets
- The nature and initial fair value of both of the
following:
- The asset obtained as proceeds
- The liabilities incurred in the transfer.
- The gain or loss from sale of transferred financial assets.
bb. For the initial fair value measurements
in item (b)(2), the level within the fair value hierarchy in
Topic 820 in which the fair value measurements fall, segregating
fair value measurements using each of the following:
- Quoted prices in active markets for identical assets or liabilities (Level 1)
- Significant other observable inputs (Level 2)
- Significant unobservable inputs (Level 3).
c. For the initial fair value measurements
in item (b)(2), the key inputs and assumptions used in measuring
the fair value of assets obtained and liabilities incurred as a
result of the sale that relate to the transferor’s continuing
involvement, including quantitative information about all of the
following:
- Discount rates.
- Expected prepayments including the expected weighted-average life of prepayable financial assets. The weighted-average life of prepayable assets in periods (for example, months or years) can be calculated by multiplying the principal collections expected in each future period by the number of periods until that future period, summing those products, and dividing the sum by the initial principal balance.
- Anticipated credit losses, including expected static pool losses.
If an entity has aggregated transfers during
a period in accordance with the guidance beginning in paragraph
860-10-50-5, it may disclose the range of assumptions.
cc. For the initial fair value measurements
in item (b)(2), the valuation technique(s) used to measure fair
value.
d. Cash flows between a transferor and
transferee, including all of the following:
- Proceeds from new transfers
- Proceeds from collections reinvested in revolving-period transfers
- Purchases of previously transferred financial assets
- Servicing fees
- Cash flows received from a transferor’s interests.
Disclosures for Each Statement of Financial Position
Presented
50-4 For
each statement of financial position presented, regardless of
when the transfer occurred, an entity shall disclose all of the
following: . . .
b. The key inputs and assumptions used in
measuring the fair value of assets or liabilities that relate to
the transferor’s continuing involvement including, at a minimum,
but not limited to, quantitative information about all of the
following:
- Discount rates
- Expected prepayments including the expected weighted-average life of prepayable financial assets (see paragraph 860-20-50-3(c)(2))
- Anticipated credit losses, including expected static pool losses, if applicable. Expected static pool losses can be calculated by summing the actual and projected future credit losses and dividing the sum by the original balance of the pool of assets.
If an entity has aggregated transfers during
a period in accordance with the guidance beginning in paragraph
860-10-50-5, it may disclose the range of assumptions.
c. For the transferor’s interest in the
transferred financial assets, a sensitivity analysis or stress
test showing the hypothetical effect on the fair value of those
interests (including any servicing assets or servicing
liabilities) of two or more unfavorable variations from the
expected levels for each key assumption that is reported under
item (b) of this paragraph independently from any change in
another key assumption.
d. A description of the objectives,
methodology, and limitations of the sensitivity analysis or
stress test. . . .
50-4D To
provide an understanding of the nature of the transactions, the
transferor’s continuing exposure to the transferred financial
assets, and the presentation of the components of the
transaction in the financial statements, an entity shall
disclose the following for outstanding transactions at the
reporting date that meet the scope guidance in paragraphs
860-20-50-4A through 50-4B by type of transaction (for example,
repurchase agreement, securities lending transaction, and sale
and total return swap) (except for those transactions that are
excluded from the scope, as described in paragraph
860-20-50-4C): . . .
c. Information about the transferor’s
ongoing exposure to the economic return on the transferred
financial assets:
- As of the reporting date, the fair value of assets derecognized by the transferor.
-
Amounts reported in the statement of financial position arising from the transaction (for example, the carrying value or fair value of forward repurchase agreements or swap contracts). To the extent that those amounts are captured in the derivative disclosures presented in accordance with paragraph 815-10-50-4B, an entity shall provide a cross-reference to the appropriate line item in that disclosure.
- A description of the arrangements that result in the transferor retaining substantially all of the exposure to the economic return on the transferred financial assets and the risks related to those arrangements.
Sales of Loans and Trade Receivables
50-5 The aggregate amount of gains or
losses on sales of loans or trade receivables (including
adjustments to record loans held for sale at the lower of
amortized cost basis or fair value) shall be presented
separately in the financial statements or disclosed in the notes
to financial statements. See Topic 310 on receivables and Topic
326 on measurement of credit losses for a full discussion of
disclosure requirements for loans and trade receivables.
ASC 860-30
50-1A An
entity shall disclose all of the following for collateral: . .
.
c. If the entity has accepted collateral
that it is permitted by contract or custom to sell or repledge,
it shall disclose all the following:
- The fair value as of the date of each statement of financial position presented of that collateral
- The fair value as of the date of each statement of financial position presented of the portion of that collateral that it has sold or repledged . . . .
Disclosures for Repurchase Agreements, Securities Lending
Transactions, and Repurchase-to-Maturity
Transactions
50-7 To
provide an understanding of the nature and risks of short-term
collateralized financing obtained through repurchase agreements,
securities lending transactions, and repurchase-to-maturity
transactions, that are accounted for as secured borrowings at
the reporting date, an entity shall disclose the following
information for each interim and annual period about the
collateral pledged and the associated risks to which the
transferor continues to be exposed after the transfer: . . .
c. A discussion of the potential risks
associated with the agreements and related collateral pledged,
including obligations arising from a decline in the fair value
of the collateral pledged and how those risks are managed.
ASC 860-50
45-1 An
entity shall report recognized servicing assets and servicing
liabilities that are subsequently measured using the fair value
measurement method in a manner that separates those carrying
amounts on the face of the statement of financial position from
the carrying amounts for separately recognized servicing assets
and servicing liabilities that are subsequently measured using
the amortization method.
45-2 To
accomplish that separate reporting, an entity may do either of
the following:
- Display separate line items for the amounts that are subsequently measured using the fair value measurement method and amounts that are subsequently measured using the amortization method
- Present the aggregate of those amounts that are subsequently measured at fair value and those amounts that are subsequently measured using the amortization method (see paragraphs 860-50-35-9 through 35-11) and disclose parenthetically the amount that is subsequently measured at fair value that is included in the aggregate amount.
All Servicing Assets and Servicing Liabilities
50-2 For
all servicing assets and servicing liabilities, all of the
following shall be disclosed:
- Management’s basis for determining its classes of servicing assets and servicing liabilities.
- A description of the risks inherent in servicing assets and servicing liabilities and, if applicable, the instruments used to mitigate the income statement effect of changes in fair value of the servicing assets and servicing liabilities.
- The amount of contractually specified servicing fees, late fees, and ancillary fees recognized for each period for which results of operations are presented, including a description of where each amount is reported in the statement of income.
- Quantitative and qualitative information about the assumptions used to estimate fair value (for example, discount rates, anticipated credit losses, and prepayment speeds).
Disclosure of quantitative information about the instruments used
to manage the risks inherent in servicing assets and servicing
liabilities, including the fair value of those instruments at
the beginning and end of the period, is encouraged but not
required. An entity that provides such quantitative information
is also encouraged, but not required, to disclose quantitative
and qualitative information about the assumptions used to
estimate the fair value of those instruments. Section 235-10-50
provides guidance on disclosures of accounting policies.
Servicing Assets and Servicing Liabilities Subsequently
Measured at Fair Value
50-3 For servicing assets and servicing
liabilities subsequently measured at fair value, the following
shall be disclosed:
- For each class of servicing assets and
servicing liabilities, the activity in the balance of
servicing assets and the activity in the balance of
servicing liabilities (including a description of where
changes in fair value are reported in the statement of
income for each period for which results of operations
are presented), including, but not limited to, the
following:
- The beginning and ending balances
- Additions through any of the
following:
- Purchases of servicing assets
- Assumptions of servicing obligations
- Recognition of servicing obligations that result from transfers of financial assets.
- Disposals
- Changes in fair value during
the period resulting from either of the
following:
- Changes in valuation inputs or assumptions used in the valuation model
- Other changes in fair value and a description of those changes.
- Other changes that affect the balance and a description of those changes.
Servicing Assets and Servicing Liabilities Subsequently
Amortized
50-4 For
servicing assets and servicing liabilities measured subsequently
under the amortization method in paragraph 860-50-35-1(a), all
of the following shall be disclosed:
a. For each class of servicing assets and
servicing liabilities, the activity in the balance of servicing
assets and the activity in the balance of servicing liabilities
(including a description of where changes in the carrying amount
are reported in the statement of income for each period for
which results of operations are presented), including, but not
limited to, the following: . . .
5. Application of valuation allowance to adjust
carrying value of servicing assets
6. Other-than-temporary impairments
7. Other changes that affect the balance and a
description of those changes.
b. For each class of servicing assets and
servicing liabilities, the fair value of recognized servicing
assets and servicing liabilities at the beginning and end of the
period. . . .
d. The risk characteristics of the
underlying financial assets used to stratify recognized
servicing assets for purposes of measuring impairment in
accordance with paragraph 860-50-35-9. If the predominant risk
characteristics and resulting stratums are changed, that fact
and the reasons for those changes shall be included in the
disclosures about the risk characteristics of the underlying
financial assets used to stratify the recognized servicing
assets in accordance with this paragraph.
e. For each period for
which results of operations are presented, the activity by class
in any valuation allowance for impairment of recognized
servicing assets, including all of the following:
1. Beginning and ending balances
2. Aggregate additions charged and recoveries credited
to operations
3. Aggregate write-downs charged against the
allowance.
Servicing Assets and Servicing Liabilities for Which
Subsequent Measurement at Fair Value Is Elected as of
the Beginning of the Fiscal Year
50-5 If an
entity elects under paragraph 860-50-35-3(d) to subsequently
measure a class of servicing assets and servicing liabilities at
fair value at the beginning of the fiscal year, the amount of
the cumulative-effect adjustment to retained earnings shall be
separately disclosed.
A.23 ASC 920, Entertainment — Broadcasters
ASC 920-350
License Agreements for
Program Material
50-1 An entity shall disclose its
methods of accounting for the rights acquired under a license
agreement, including, but not limited to, the following
methods:
- The method or method(s) used in computing amortization
- For impairment, a description of the unit(s) of account used for impairment testing and the method(s) used for determining fair value.
50-4 For impairment amounts recognized
for a license agreement that is not included in a film group,
the following information shall be disclosed in the notes to
financial statements that include the period in which the
impairment losses are recognized:
- A description of the facts and circumstances leading to the impairment
- The amount of impairment losses
- The caption in the income statement where the impairment losses are recorded
- If applicable, the segment(s) under Topic 280 where the impairment losses are recorded.
A.24 ASC 926, Entertainment — Films
ASC 926-20
50-1A An entity shall disclose its
methods of accounting for film costs, including, but not limited
to, the following:
- The method(s) used in computing amortization
- For impairment, a description of the unit(s) of account used for impairment testing and the method(s) used for determining fair value.
50-4C For impairment amounts recognized
for films or film groups, an entity shall disclose the following
information in the notes to financial statements that include
the period in which the impairment is recognized:
- A general description of the facts and circumstances leading to the impairment
- The aggregate amount of impairment losses
- The caption in the income statement where the impairment losses are recorded
- If applicable, the segment(s) under Topic 280 where the impairment losses are recorded.
A.25 ASC 940, Financial Services — Brokers and Dealers
ASC 940-320
Income Statement
45-4 The
changes in the fair value of fixed-income securities owned that
were purchased at a discount or premium is composed of accreted
interest income or changes in the fair value of the securities
or both. Consideration should be given to reporting these
components separately as interest income and trading gains and
losses, respectively.
ASC 940-820
50-1 Notes
to the financial statements shall disclose all of the following
if financial instruments’ fair values are measured at lower than
quoted prices (see Example in paragraph 820-10-55-52):
- Description of the financial instrument
- The quoted price of the financial instrument
- Fair value reported in the statement of financial condition
- Methods and significant assumptions used to value the instrument at lower than the quoted price.
A.26 ASC 942, Financial Services — Depository and Lending
ASC 942-320
50-1 For purposes of the disclosure
requirements of paragraphs 320-10-50-1 through 50-3 and
320-10-50-5 through 50-5C, the term financial
institutions includes banks, savings and loan
associations, savings banks, credit unions, finance companies,
and insurance entities.
50-1A The
disclosures in paragraphs 942-320-50-1 through 50-3 are required
for interim and annual periods.
50-2 In
complying with the requirements in the preceding paragraph,
financial institutions shall include in their disclosure all of
the following major security types, although additional types
also may be necessary:
a. Equity securities, segregated by any one of the
following:
1. Industry type
2. Entity size
3. Investment objective.
b. Debt securities issued by the U.S. Treasury and
other U.S. government corporations and agencies
c. Debt securities issued by states of the United
States and political subdivisions of the states
d. Debt securities issued by foreign governments
e. Corporate debt securities
f. Residential mortgage-backed securities
ff. Commercial mortgage-backed securities
fff. Collateralized debt obligations
g. Other debt obligations.
50-2A
Investments in mutual funds that invest only in U.S. government
debt securities may be shown separately rather than grouped with
other equity securities in the disclosures by major security
type required by paragraph 942-320-50-2.
50-3 In complying
with this requirement, financial institutions shall disclose the
net carrying amount of debt securities based on at least 4
maturity groupings:
- Within 1 year
- After 1 year through 5 years
- After 5 years through 10 years
- After 10 years.
Securities not due at a single maturity date,
such as mortgage-backed securities, may be disclosed separately
rather than allocated over several maturity groupings. If
allocated, the basis for allocation also shall be disclosed.
50-3A A financial
institution that is a public business entity shall disclose the
fair value of the debt securities based on at least 4 maturity
groupings:
- Within 1 year
- After 1 year through 5 years
- After 5 years through 10 years
- After 10 years.
Securities not due at a single maturity date,
such as mortgage-backed securities, may be disclosed separately
rather than allocated over several maturity groupings. If
allocated, the basis for allocation also shall be disclosed.
ASC 942-405
Short Sales of Securities
45-1 The
fair value adjustment on short sales of securities shall be
classified in the income statement with gains and losses on
securities.
A.27 ASC 944, Financial Services — Insurance
ASC 944-40
Pending Content (Transition Guidance: ASC
944-40-65-2)
Market Risk Benefits
45-3 The carrying amount of
market risk benefits shall be presented separately
in the statement of financial position. The change
in fair value related to market risk benefits
shall be presented separately in net income,
except fair value changes attributable to a change
in the instrument-specific credit risk of market
risk benefits in a liability position. The portion
of a fair value change attributable to a change in
the instrument-specific credit risk of market risk
benefits in a liability position shall be
presented separately in other comprehensive
income.
Pending Content (Transition Guidance: ASC
944-40-65-2)
Disclosures
55-13K The
tabular rollforward of the beginning to the ending
balance related to market risk benefits as
required in paragraph 944-40-50-7B could include
the following line items:
- Issuances
- Interest accrual
- Attributed fees collected
- Benefit payments
- Effect of changes in interest rates
- Effect of changes in equity markets
- Effect of changes in equity index volatility
- Actual policyholder behavior different from expected behavior
- Effect of changes in future expected policyholder behavior
- Effect of changes in other future expected assumptions
- Effect of changes in the instrument-specific credit risk.
To the extent that the tabular
rollforward of the beginning to the ending balance
related to market risk benefits achieves the fair
value disclosure requirements described in Section
820-10-50, an insurance entity need not duplicate
the related fair value disclosure.
ASC 944-80
50-1 The
following information shall be disclosed in the financial
statements of the insurance entity: . . .
e. The aggregate fair value of assets, by major
investment asset category, supporting separate accounts
with additional insurance benefits and minimum
investment return guarantees as of each date for which a
statement of financial position is presented . . .
.
Pending Content (Transition Guidance: ASC
944-40-65-2)
50-1 The following information shall be
disclosed in the financial statements of the
insurance entity: . . .
e. The aggregate fair value of assets, by
major investment asset category, supporting
separate accounts as of each date for which a
statement of financial position is presented . . .
.
A.28 ASC 946, Financial Services — Investment Companies
ASC 946-205
Separate Accounts
50-31
Separate accounts with more than two levels of contract charges
or net unit values per subaccount may elect to present the
required financial highlights for contract expense levels that
had units issued or outstanding during the reporting period
(including number of units, unit fair value, net assets, expense
ratio, investment income ratio, and total return), for either of
the following:
- Each contract expense level that results in a distinct net unit value and for which units were issued or outstanding during each reporting period
- The range of the lowest and highest level of expense ratio and the related total return and unit fair values during each reporting period.
The calculation of the ranges for the total return ratio and unit
fair values should correspond to the groupings that produced the
lowest and highest expense ratios.
50-33 If
the ranges of expense ratios, total returns, and unit fair
values are presented, the entity should disclose instances in
which individual contract values do not fall within the ranges
presented (for example, if a new product is introduced late in a
reporting period and the total return does not fall within the
range).
ASC 946-210
Fully Benefit-Responsive Investment Contracts
45-14
Under Rule 2a-4 of the Investment Company Act of 1940, current
net asset value is computed using the fair value of the
investment company’s portfolio securities.
45-15 The
following line items shall be separately reported on the
statement of assets and liabilities with a parenthetical
reference that such amounts are being reported at fair value:
- Investments (including traditional guaranteed investment contracts)
- Wrapper contracts.
45-16 The
statement of assets and liabilities of the fund shall present
amounts for all of the following:
- Total assets
- Total liabilities
- Net assets reflecting all investments at fair value
- Net assets.
Amount (d) represents the amount at which participants can
transact with the fund. That amount shall be used also for
purposes of preparing the per-share disclosures required by
Section 946-205-50 and as the beginning and ending balance in
the statement of changes in net assets of the fund. The amount
representing the difference between (c) and (d) shall be
presented on the face of the statement of assets and liabilities
as a single amount, calculated as the sum of the amounts
necessary to adjust the portion of net assets attributable to
each fully benefit-responsive investment contract from fair
value to contract value.
45-18 The
following information shall be disclosed in the financial
statements as part of the schedule of investments, to the extent
that schedule is already required under paragraph 946-210-50-1,
and shall reconcile to corresponding line items on the statement
of assets and liabilities:
- The fair value of each investment contract, including
separate disclosure of both of the following:
- The fair value of the wrapper contract
- The fair value of each of the corresponding underlying investments, if held by the fund, included in that investment contract.
- Adjustment from fair value to contract value for each investment contract (if the investment contract is fully benefit-responsive)
- Major credit ratings of the issuer or wrapper provider for each investment contract.
Investment Companies Other Than Nonregistered Investment
Partnerships
50-1 In
the absence of regulatory requirements, investment companies
other than nonregistered investment partnerships shall do all of
the following:
- Disclose the name, number of shares, or principal amount
of all of the following:
- Each investment (including short sales, written options, futures contracts, forward contracts, and other investment-related liabilities) whose fair value constitutes more than 1 percent of net assets. In applying the 1-percent test, total long and total short positions in any one issuer should be considered separately.
- All investments in any one issuer whose fair values aggregate more than 1 percent of net assets. In applying the 1-percent test, total long and total short positions in any one issuer should be considered separately.
- At a minimum, the 50 largest investments.
- Categorize investments by both of the following
characteristics:
- The type of investment (such as common stocks, preferred stocks, convertible securities, fixed income securities, government securities, options purchased, options written, warrants, futures contracts, loan participations and assignments, short-term securities, repurchase agreements, short sales, forward contracts, other investment companies, and so forth)
- The related industry, country, or geographic region of the investment. . . .
Investment Companies That Are Nonregistered Investment
Partnerships
50-6 The
financial statements of an investment partnership meeting the
condition in paragraph 946-210-50-4 shall, at a minimum, include
a condensed schedule of investments in securities owned by the
partnership at the close of the most recent period. Such a
schedule shall do all of the following:
- Categorize investments by all of the following:
- Type (such as common stocks, preferred stocks, convertible securities, fixed-income securities, government securities, options purchased, options written, warrants, futures, loan participations, short sales, other investment companies, and so forth)
- Country or geographic region, except for derivative instruments for which the underlying is not a security (see (a)(4))
- Industry, except for derivative instruments for which the underlying is not a security (see (a)(4))
- For derivative instruments for which the underlying is not a security, by broad category of underlying (for example, grains and feeds, fibers and textiles, foreign currency, or equity indexes) in place of the categories in (a)(2) and (a)(3).
- Report the percent of net assets that each such category represents and the total fair value and cost for each category in (a)(1) and (a)(2).
- Disclose the name, number of shares or principal amount,
fair value, and type of both of the following:
- Each investment (including short sales) constituting more than 5 percent of net assets, except for derivative instruments (see (e) and (f)). In applying the 5-percent test, total long and total short positions in any one issuer should be considered separately.
- All investments in any one issuer aggregating more than 5 percent of net assets, except for derivative instruments (see (e) and (f)). In applying the 5-percent test, total long and total short positions in any one issuer shall be considered separately.
- Aggregate other investments (each of which is 5 percent or less of net assets) without specifically identifying the issuers of such investments, and categorize them in accordance with the guidance in (a). In applying the 5-percent test, total long and total short positions in any one issuer shall be considered separately.
- Disclose the number of contracts, range of expiration dates, and cumulative appreciation (depreciation) for open futures contracts of a particular underlying (such as wheat, cotton, specified equity index, or U.S. Treasury Bonds), regardless of exchange, delivery location, or delivery date, if cumulative appreciation (depreciation) on the open contracts exceeds 5 percent of net assets. In applying the 5-percent test, total long and total short positions in any one issuer shall be considered separately.
- Disclose the range of expiration dates and fair value for all other derivative instruments of a particular underlying (such as foreign currency, wheat, specified equity index, or U.S. Treasury Bonds) regardless of counterparty, exchange, or delivery date, if fair value exceeds 5 percent of net assets. In applying the 5-percent test, total long and total short positions in any one issuer shall be considered separately.
- Provide both of the following additional qualitative
descriptions for each investment in another
nonregistered investment partnership whose fair value
constitutes more than 5 percent of net assets:
- The investment objective
- Restrictions on redemption (that is, liquidity provisions).
Fully Benefit-Responsive Investment Contracts
50-14
Investment companies identified in paragraph 946-210-45-11 shall
disclose all of the following in connection with fully
benefit-responsive investment contracts, in the aggregate: . .
.
e. A reconciliation between the beginning
and ending balance of the amount presented on the statement of
assets and liabilities that represents the difference between
net assets reflecting all investments at fair value and net
assets for each period in which a statement of changes in net
assets is presented. This reconciliation shall include both of
the following:
- The change in the difference between the fair value and contract value of all fully benefit-responsive investment contracts
- The increase or decrease due to changes in the fully benefit-responsive status of the fund’s investment contracts.
f. The average yield earned by the entire
fund (which may differ from the interest rate credited to
participants in the fund) for each period for which a statement
of assets and liabilities is presented. This average yield shall
be calculated by dividing the annualized earnings of all
investments in the fund (irrespective of the interest rate
credited to participants in the fund) by the fair value of all
investments in the fund. . . .
ASC 946-830
Overall Guidance
45-4 The
practice of not separately disclosing the portion of the changes
in fair values of investments and realized gains and losses
thereon that result from foreign currency rate changes is
permitted. However, separate reporting of such gains and losses
is allowable and, if adopted by the reporting entity, shall
conform to the guidance in this Subtopic.
Subsequently Measuring at Fair Value
45-15 A
fund investing in foreign securities generally invests in such
securities to reap the potential benefits offered by the local
capital market. It may also invest in such securities as a means
of investing in the foreign currency market or of benefiting
from the foreign currency rate fluctuation. The extent to which
separate information regarding foreign currency gains or losses
will be meaningful will vary depending on the circumstances, and
separate information may not measure with precision foreign
exchange gains or losses associated with the economic risks of
foreign currency exposures. A foreign currency rate fluctuation,
however, may be an important consideration in the case of
foreign investments, and a reporting entity may choose to
identify and separately report any resulting foreign currency
gains or losses as a component of unrealized fair value gains or
losses on investments.
45-16 The
fair value of securities shall initially be determined in the
foreign currency and translated at the spot rate on the purchase
trade date. The unrealized gain or loss between the original
cost (translated on the trade date) and the fair value
(translated on the valuation date) comprises both of the
following elements:
- Changes in the fair value of securities before translation
- Movement in foreign currency rate.
45-17 Such
movements may be combined as permitted by paragraph
946-830-45-4. If separate disclosure of the foreign currency
gains and losses is chosen, the changes in the fair value of
securities before translation should be measured as the
difference between the fair value in foreign currency and the
original cost in foreign currency translated at the spot rate on
the valuation date. The effect of the movement in the foreign
exchange rate shall be measured as the difference between the
original cost in foreign currency translated at the current spot
rate and the historical functional currency cost. These values
can be computed as follows:
- (Fair value in foreign currency – original cost in foreign currency) × valuation date spot rate = unrealized fair value appreciation or depreciation.
- (Cost in foreign currency times valuation date spot rate) – cost in functional currency = the unrealized foreign currency gain or loss.
Sale of Securities
45-20 If
separate reporting of foreign currency gains and losses on sales
of securities is chosen by the reporting entity, the computation
of the effects of the changes in fair value and the foreign
currency rate is similar to that described in paragraphs
946-830-45-17 through 45-18. Fair value in the formula given in
those paragraphs should be replaced with sale proceeds and
valuation date shall be replaced with sale trade date.
Accordingly, the values shall be computed as follows:
- (Sale proceeds in foreign currency – original cost in foreign currency) × sale trade date spot rate = realized fair value gain or loss on sale of security.
- (Cost in foreign currency × sale trade date spot rate) – cost in functional currency = realized foreign currency gain or loss.
50-2
Foreign currency risk associated with investing in foreign
securities shall be assessed continuously by management and
considered for financial statement disclosure, including
disclosures about all of the following:
- Liquidity. Because certain foreign markets are illiquid, market prices may not necessarily represent fair value.
- Size. If market capitalization is low, a fund’s share in the entire market (particularly if single-country funds are involved) or in specific securities may be proportionately very large, and the fair value, consistent with Topic 820, may not be representative of the price that would be received if the fund sold its large proportion of the specific security (“block”) at the measurement date.
- Valuation. Because of liquidity problems as well as other factors, such as securities that are unlisted or securities that are traded in inactive markets, funds are required to develop procedures consistent with Topic 820 for measuring the fair values of such securities. Doing so may be difficult in a foreign environment; while others may perform the research and provide supporting documentation for fair values, the ultimate responsibility for determining the fair values of securities rests with the management.
A.29 ASC 948, Financial Services — Mortgage Banking
ASC 948-310
50-1 The method used in determining the
lower of amortized cost basis or fair value of mortgage loans
(that is, aggregate or individual loan basis) shall be
disclosed.
A.30 ASC 954, Health Care Entities
ASC 954-220
Performance Indicator and
Intermediate Operating Measures
45-8 Health care
entities shall report the following items separately from the
performance indicator: . . .
e. Items that are required to be reported in or
reclassified from other comprehensive income in
accordance with paragraph 220-10-45-10A, which includes,
but is not limited to, gains or losses, prior service
costs or credits, and transition assets or obligations
recognized in accordance with Topic 715; foreign
currency translation adjustments; the portion of the
gain or loss on derivative instruments designated and
qualifying as cash flow hedging instruments included in
the assessment of effectiveness, and for all qualifying
hedging relationships amounts excluded from the
assessment of effectiveness and recognized in earnings
through an amortization approach in accordance with
paragraph 815-20-25-83A. . . .
g. Unrealized gains and losses on investments on other
than trading debt securities, in accordance with
paragraph 954-220-45-9. . . .
l. The portion of the total change in the fair value of
the liability resulting from a change in the
instrument-specific credit risk, in accordance with
paragraph 825-10-45-5.
ASC 954-805
35-1 An
acquirer that is a not-for-profit, business-oriented health care
entity shall report the changes in the fair value of contingent
consideration recognized in accordance with paragraph
958-805-35-3 within the performance indicator unless the
arrangement is a hedging instrument for which Subtopic 954-815
requires the entity to recognize the changes outside the
performance indicator.
ASC 954-825
45-1 Not-for-profit, business-oriented
health care entities shall report unrealized gains and losses on
items for which the fair value option has been elected within
the performance indicator or as a part of discontinued
operations, as appropriate. See paragraph 825-10-15-7 for
further guidance.
A.31 ASC 958, Not-for-Profit Entities
ASC 958-30
50-1 The notes to
financial statements shall include all of the following
disclosures related to split-interest agreements: . . .
c. The basis used (for example, cost, lower of cost or
fair value, fair value) for recognized assets . .
.
f. Changes in the value of split-interest agreements
recognized, if not reported as a separate line item in a
statement of activities
g. The disclosures required by the Fair Value Option
Subsections of Subtopic 825-10, if a not-for-profit
entity (NFP) elects the fair value option pursuant to
paragraph 958-30-35-2(b) or 958-30-35-2(c)
h. The disclosures required by paragraphs 820-10-50-1C
through 50-2 and 820-10-50-2B through 50-2E in the
format described in paragraph 820-10-50-8, if the assets
and liabilities of split-interest agreements are
measured at fair value on a recurring basis in periods
after initial recognition.
ASC 958-205
Reporting Endowment Funds
50-2 For
each period for which a statement of financial position is
presented, an NFP shall disclose each of the following, in the
aggregate, for all underwater endowment funds:
- The fair value of the underwater endowment funds
- The original endowment gift amount or level required to be maintained by donor stipulations or by law that extends donor restrictions
- The amount of the deficiencies of the underwater endowment funds ((a) less (b)).
ASC 958-310
Accrual of the Interest Element
35-6 If a
present value technique is used to measure the fair value of
unconditional promises to give cash, subsequent accruals of the
interest element pursuant to Section 835-30-35 shall be
accounted for as contribution revenue by donees.
Changes in the Fair Value of Underlying Noncash Assets —
Gifts of Other Assets
35-13 If
the future fair value of the underlying noncash asset decreases,
that decrease shall be reported as a decrease in contribution
revenue in the period(s) in which the decrease occurs. The
decrease shall be reported in the net asset class in which the
contribution was originally reported or in the net asset class
in which the net assets are represented. Thus, if a promise to
give noncash assets is measured based on the fair value of those
underlying noncash assets at the date of gift, as described in
paragraph 958-605-30-8, an observed decrease in the current fair
value of the underlying noncash asset shall be recognized. If
the future fair value of the underlying noncash asset increases
between the date the unconditional promise to give is recognized
and the date the asset promised is received, no additional
revenue shall be recognized.
ASC 958-321
50-2 The
disclosure guidance in Section 321-10-50, except for paragraph
321-10-50-4, applies to investments in equity securities held by
NFPs.
ASC 958-325
50-2 For
each period for which a statement of financial position is
presented, an NFP shall disclose all of the following:
- The basis for determining the carrying amount for other investments
- The method(s) and significant assumptions used to estimate the fair values of investments other than financial instruments if those other investments are reported at fair value . . . .
ASC 958-360
Accounting Policies
50-1 A
not-for-profit entity (NFP) shall disclose the following
accounting policies: . . .
e. The basis of valuation of property, plant, and
equipment — for example, cost for purchased items and
fair value for contributed items.
Works of Art, Historical Treasures, and Similar Assets
50-6 An
NFP that does not recognize and capitalize its collections or
that capitalizes collections prospectively shall describe its
collections, including their relative significance, and its
stewardship policies for collections. If collection items not
capitalized are deaccessed during the period, it also shall
describe the items given away, damaged, destroyed, lost, or
otherwise deaccessed during the period or disclose their fair
value.
ASC 958-605
Contributed Services
50-1 Paragraph superseded by Accounting
Standards Update No. 2020-07.
50-1A A not-for-profit entity (NFP)
shall disclose in the notes to financial statements a
disaggregation of the amount of contributed nonfinancial assets
recognized within the statement of activities by category that
depicts the type of contributed nonfinancial assets. For each
category of contributed nonfinancial assets, an NFP also shall
disclose the following:
-
Qualitative information about whether contributed nonfinancial assets were either monetized or utilized during the reporting period. If utilized, a description of the programs or other activities in which those assets were used shall be disclosed.
-
The NFP’s policy (if any) about monetizing rather than utilizing contributed nonfinancial assets.
-
A description of any donor-imposed restrictions associated with the contributed nonfinancial assets.
-
A description of the valuation techniques and inputs used to arrive at a fair value measure in accordance with paragraph 820-10-50-2(bbb)(1), at initial recognition.
-
The principal market (or most advantageous market) used to arrive at a fair value measure if it is a market in which the recipient NFP is prohibited by a donor-imposed restriction from selling or using the contributed nonfinancial assets.
See paragraph 958-605-50-1B for additional
disclosures for contributed services.
ASC 958-605-55-70U through 55-70W provide an example that illustrates
the disclosure required by ASC 958-605-50-1A.
ASC 958-805
50-11 Instead of the information
required by Section 805-30-50, an NFP acquirer shall disclose
the following information for each acquisition that occurs
during the reporting period: . . .
b. The acquisition-date fair value of the
total consideration transferred (or if no consideration was
transferred, that fact) and the acquisition-date fair value of
each major class of consideration, such as:
- Cash
- Other tangible or intangible assets, including a business or subsidiary of the acquirer
- Liabilities incurred, for example, a liability for contingent consideration. . . .
A.32 ASC 960, Plan Accounting — Defined Benefit Pension Plans
ASC 960-30
Changes in Net Assets Available for Benefits
45-2
Information about changes in net assets available for benefits
is intended to present the effects of significant changes in net
assets during the year and shall present, at a minimum, all of
the following:
- The net appreciation (depreciation) in fair value. Net appreciation or depreciation includes realized gains and losses on investments that were both purchased and sold during the period as well as unrealized appreciation or depreciation of the investments held at year-end.
- Investment income (exclusive of (a)).
- Contributions from the employer, segregated between cash and noncash contributions. A noncash contribution shall be recorded at fair value. The nature of noncash contributions shall be described, either parenthetically or in a note. . . .
ASC 960-325
45-1
Information regarding a plan’s investments that are measured
using fair value shall indicate whether reported fair values
have been measured by quoted prices in an active market or are
fair values otherwise determined.
45-2
Investments measured using fair value in the statement of net
assets available for benefits or in the notes shall be presented
by general type, such as the following:
- Registered investment companies (for example, mutual funds)
- Government securities
- Common-collective trusts
- Pooled separate accounts
- Short-term securities
- Corporate bonds
- Common stocks
- Mortgages
- Real estate.
50-1
Disclosure of the plan’s accounting policies shall include a
description of valuation techniques and inputs used to measure
the fair value of investments (as required by Section 820-10-50)
and a description of the methods and significant assumptions
used to measure the reported value of contracts with insurance
entities. However, defined benefit pension plans are exempt from
the requirements in paragraph 820-10-50-2B(a) to disaggregate
assets by nature, characteristics, and risks. The disclosures of
information by classes of assets required by Section 820-10-50
shall be provided by general type of plan assets consistent with
paragraph 960-325-45-2.
50-3 The
historical cost of plan investments presented at fair value is
neither required nor proscribed.
Interests in Master
Trusts
50-7 A plan shall disclose the
following in the notes to financial statements for each period
for which a statement of changes in net assets available for
benefits is presented:
- Net appreciation or depreciation in the fair value of investments of the master trust. Net appreciation or depreciation includes realized gains and losses on investments that were both purchased and sold during the period as well as unrealized appreciation or depreciation of the investments held at year-end.
- Investment income (exclusive of (a)).
50-9 In the notes to financial
statements a plan shall include the investments of a master
trust measured using fair value presented by general type of
investment, such as the following, as of the date of each
statement of net assets available for benefits presented:
- Registered investment companies (for example, mutual funds)
- Government securities
- Common-collective trusts
- Pooled separate accounts
- Short-term securities
- Corporate bonds
- Common stocks
- Mortgages
- Real estate.
A.33 ASC 962, Plan Accounting — Defined Contribution Pension Plans
ASC 962-205
Changes in Net Assets Available for Benefits
45-7
Information about changes in net assets available for benefits
is intended to present the effects of significant changes in net
assets during the year and shall present, at a minimum, all of
the following:
- The net appreciation or depreciation in fair value. Net appreciation or depreciation includes realized gains and losses on investments that were both purchased and sold during the period as well as unrealized appreciation or depreciation of the investments held at year end.
- Investment income, exclusive of changes in fair value described in (a). . . .
ASC 962-310
Participant Loans
50-1 The
fair value disclosures prescribed in paragraphs 825-10-50-10
through 50-16 are not required for participant loans.
ASC 962-325
45-5
Investments measured using fair value in the statement of net
assets available for benefits or in the notes shall be presented
by general type, such as the following:
a. Registered investment companies (for example, mutual
funds)
b. Government securities
c. Common-collective trusts
d. Pooled separate accounts
e. Short-term securities
f. Corporate bonds
g. Common stocks
h. Mortgages . . .
j. Real estate
k. Self-directed brokerage accounts (that is, an
investment option that allows participants to select
investments outside the plan’s core options).
For the presentation of fully benefit-responsive investment
contracts, which are measured at contract value, see paragraphs
962-325-35-5A and 962-325-50-3.
45-6 The
presentation shall indicate whether the fair values of the
investments have been measured by quoted market prices in an
active market or were determined otherwise.
50-1
Disclosure of a defined contribution plan’s accounting policies
shall include a description of the valuation techniques and
inputs used to measure the fair value less costs to sell, if
significant, of investments (as required by Section 820-10-50)
and a description of the methods and significant assumptions
used to measure the reported value of insurance contracts (if
any). . . .
Interests in Master
Trusts
50-7 A plan shall
disclose the following in the notes to financial statements for
each period for which a statement of changes in net assets
available for benefits is presented:
- Net appreciation or depreciation in the fair value of investments of the master trust. Net appreciation or depreciation includes realized gains and losses on investments that were both purchased and sold during the period as well as unrealized appreciation or depreciation of the investments held at year-end.
- Investment income (exclusive of (a)).
50-8A In the notes to financial
statements a plan shall include the investments of a master
trust measured using fair value presented by general type of
investment, such as the following, as of the date of each
statement of net assets available for benefits presented:
- Registered investment companies (for example, mutual funds)
- Government securities
- Common-collective trusts
- Pooled separate accounts
- Short-term securities
- Corporate bonds
- Common stocks
- Mortgages
- Real estate
- Self-directed brokerage accounts (that is, an investment option that allows participants to select investments outside the plan’s core options).
For the presentation of fully benefit-responsive
investment contracts, which are measured at contract value, see
paragraphs 962-325-35-5A and 962-325-50-3.
Investments Measured Using the Net Asset Value per Share
Practical Expedient
50-9 If an
investment is measured using the net asset value per share (or
its equivalent) practical expedient in paragraph 820-10-35-59
and that investment is in a fund that files U.S. Department of
Labor Form 5500 as a direct filing entity, disclosure of that
investment’s significant investment strategy, as discussed in
paragraph 820-10-50-6A(a), is not required.
A.34 ASC 965, Plan Accounting — Health and Welfare Benefit Plans
ASC 965-20
Statement of Changes in Net Assets Available for
Benefits
45-3 The
statement of changes in net assets available for benefits shall
be presented in enough detail to identify the significant
changes during the year, including, as applicable, the
following: . . .
e. The net appreciation or depreciation in fair value.
Net appreciation or depreciation includes realized gains
and losses on investments that were both purchased and
sold during the period as well as unrealized
appreciation or depreciation of the investments held at
year-end.
f. Investment income, excluding the net appreciation or
depreciation . . . .
45-5 The
statement of changes in net assets available for benefits shall
be prepared on a basis that reflects income credited to
participants in the plan and net appreciation or depreciation in
the fair value of only those investment contracts that are not
deemed to be fully benefit responsive.
ASC 965-205
50-1 The plan’s financial statements
shall disclose other information as described in this Subtopic.
Certain of the disclosures relate to plans with accumulated
assets rather than those with trusts that act more as conduits
for benefit payments or insurance premiums. Separate disclosures
may be made to the extent that the plan provides both health and
other welfare benefits. The disclosures shall include, if
applicable, all of the following: . . .
h. Unusual or infrequent events or
transactions occurring after the financial statement date, but
before the financial statements are issued or are available to
be issued (as discussed in Section 855-10-25), that might
significantly affect the usefulness of the financial statements
in an assessment of the plan’s present and future ability to pay
benefits. For example, all of the following shall be
disclosed:
- A plan amendment adopted after the latest financial statement date that significantly increases future benefits attributable to an employee’s service rendered before that date
- A significant change in the fair value of a significant portion of the plan’s assets
- The emergence of a catastrophic claim.
If reasonably determinable, the effects of such events or
transactions shall be disclosed. If such effects are not
reasonably determinable, the reasons why they are not
quantifiable shall be disclosed. . . .
401(h) Accounts
50-5 A plan is not required to provide
investment disclosures (for example, the disclosures required by
Topic 815 on derivatives and hedging and Topic 820 on fair value
measurement) for 401(h) account assets. A plan shall disclose
the name of the defined benefit pension plan that allocated the
funds to the health and welfare benefit plan and that provides
the related investment disclosures.
ASC 965-320
50-1
Ordinarily, information regarding the net appreciation or
depreciation in the fair value less costs to sell, if
significant, of investments shall be disclosed in the notes to
financial statements.
ASC 965-325
45-1
Information regarding a plan’s investments shall be presented in
enough detail to identify the types of investments and shall
indicate whether reported fair values have been measured by
quoted prices in an active market or have been determined
otherwise (paragraph 965-325-50-2 specifies additional
disclosures related to investments).
45-2
Investments measured using fair value in the statement of net
assets available for benefits or in the notes shall be presented
by general type, including the following:
a. Registered investment companies (also known as
mutual funds)
b. Government securities
c. Short-term securities
d. Corporate bonds
e. Common stocks
f. Mortgages . . .
h. Real estate.
For the presentation of fully benefit-responsive investment
contracts, which are measured at contract value, see paragraphs
965-325-35-8 and 965-325-50-2.
50-1
Disclosure of a health and welfare benefit plan’s accounting
policies shall include a description of the valuation techniques
and inputs used to measure the fair value less costs to sell, if
significant, of investments (as required by Section 820-10-50)
and a description of the methods and significant assumptions
used to measure the reported value of insurance contracts.
However, health and welfare benefit plans are exempt from the
requirements in paragraph 820-10-50-2B(a) to disaggregate assets
by nature, characteristics, and risks. The disclosures of
information by classes of assets required by Section 820-10-50
shall be provided by general type of plan assets consistent with
paragraph 965-325-45-2.
Interests in Master
Trusts
50-5 A plan shall disclose the
following in the notes to financial statements for each period
for which a statement of changes in net assets available for
benefits is presented:
- Net appreciation or depreciation in the fair value of investments of the master trust. Net appreciation or depreciation includes realized gains and losses on investments that were both purchased and sold during the period as well as unrealized appreciation or depreciation of the investments held at year-end.
- Investment income (exclusive of (a)).
50-7 In the notes to financial
statements a plan shall include the investments of a master
trust measured using fair value presented by general type of
investment, such as the following, as of the date of each
statement of net assets available for benefits presented:
- Registered investment companies (for example, mutual funds)
- Government securities
- Common-collective trusts
- Pooled separate accounts
- Short-term securities
- Corporate bonds
- Common stocks
- Mortgages
- Real estate.
For the presentation of fully benefit-responsive
investment contracts, which are measured at contract value, see
paragraphs 965-325-35-8 and 965-325-50-2.
Illustrations
55-8 See
Example 2 (paragraph 962-325-55-17) for financial statements
that illustrate certain applications of the provisions of this
Subtopic that apply to the annual financial statements of a
defined contribution plan.
Appendix B — Comparison of U.S. GAAP and IFRS Accounting Standards
Appendix B — Comparison of U.S. GAAP and IFRS Accounting Standards
ASC 820 is the primary source of guidance on how to measure fair value
under U.S. GAAP. IFRS 13 is the primary source of guidance on how to measure fair value
under IFRS Accounting Standards. IFRS 13 was the result of a joint project between the
FASB and the IASB to develop common requirements for measuring fair value and disclosing
information about fair value measurements.
The fair value measurement and disclosure requirements under U.S. GAAP
are largely converged with, but are not identical to, those under IFRS Accounting
Standards. For example, the two sets of standards differ with respect to when an entity
is required or permitted to measure items at fair value and the extent of the
disclosures an entity must provide. The table below summarizes some of the key
differences between IFRS Accounting Standards and U.S. GAAP regarding fair value
measurement.1
Table B-1
|
Subject
|
U.S. GAAP
|
IFRS Accounting Standards
|
|---|---|---|
|
Inception gains and losses (see Section
B.1)
|
If an asset or a liability is measured initially
at fair value, any difference between the transaction price and
fair value is recognized immediately as a gain or loss in
earnings unless otherwise specified.
|
An entity cannot recognize inception gains or
losses for a financial instrument unless the instrument’s fair
value is demonstrated by a quoted price in an active market for
an identical asset or liability or is based on a valuation
technique in which an entity uses only observable market
data.
|
|
NAV practical expedient (see Section
B.2)
|
An entity with an investment in an investment
company may elect to use, as a measure of fair value in specific
circumstances, the reported NAV without adjustment.
|
An NAV practical expedient for investments in
investment entities is not provided.
|
|
Disclosures (see Section B.3)
|
There are differences between the disclosure
requirements under U.S. GAAP and those under IFRS Accounting
Standards. See Section B.3
for more information.
| |
Footnotes
1
Differences are based on comparison of authoritative literature
under U.S. GAAP and IFRS Accounting Standards and do not necessarily include
interpretations of such literature.
B.1 Inception Gains and Losses
The accounting requirements for inception gains and losses under U.S.
GAAP differ from those under IFRS Accounting Standards in the following respects:
- Under U.S. GAAP, inception gains and losses may occur if an asset or liability is measured at initial recognition at fair value in the financial statements and the entity acquired or issued the asset or liability at an amount other than fair value (i.e., if the initial transaction price is different from fair value). ASC 820-10-30-6 states that “if another Topic requires or permits a reporting entity to measure an asset or a liability initially at fair value and the transaction price differs from fair value, the reporting entity shall recognize the resulting gain or loss in earnings unless that Topic specifies otherwise.”
- Under IFRS Accounting Standards, paragraph B5.1.2A of IFRS 9 prohibits recognition of inception gains or losses for a financial asset or financial liability if fair value is demonstrated by a Level 2 or Level 3 input or is based on a valuation technique in which an entity uses unobservable market data. In such cases, the measurement is adjusted to defer the inception gain or loss. The deferred gain or loss is recognized “only to the extent that it arises from a change in a factor (including time) that market participants would take into account when pricing the asset or liability.”
See Section 9.2.1 for further discussion of the
recognition of inception gains and losses under U.S. GAAP.
B.2 NAV Practical Expedient
The accounting requirements for measuring the fair value of investments
in investment companies under U.S. GAAP differ from those under IFRS Accounting
Standards.
- Under U.S. GAAP, ASC 820-10-35-59 contains a practical expedient that permits entities to measure the fair value of an investment that (1) does not have a readily determinable fair value and (2) is in an investment company within the scope of ASC 946 or a real estate fund for which it is industry practice to apply investment-company accounting at NAV.
-
The IASB decided against providing any such practical expedient. In the U.S. GAAP–IFRS comparison section in the opening summary in ASU 2011-04, the FASB explains the IASB’s decision as follows:[T]he IASB decided that it would be difficult to identify when such a practical expedient could be applied given the different practices for calculating net asset values in jurisdictions around the world. For example, . . . investment companies may report in accordance with national GAAP, which may have recognition and measurement requirements that differ from those in IFRSs (that is, the underlying investments might not be measured at fair value or they might be measured at fair value in accordance with national GAAP, not IFRSs).
See Section 2.2.2 for further discussion of when
this practical expedient may be applied under U.S. GAAP.
B.3 Disclosures
As indicated above, the measurement guidance in ASC 820 is largely
converged with that in IFRS 13. However, there are differences between the disclosure
requirements in ASC 820 and those in IFRS 13, largely because of the guidance in
ASU 2018-13.
(Very few of these differences existed before ASU 2018-13.) ASU 2018-13 updated several
aspects of the U.S. GAAP fair value disclosure requirements; however, the same updates
were not made to IFRS Accounting Standards. The Background Information and Basis for
Conclusions of ASU 2018-13 provides the rationale for the divergence between the two
sets of standards. Paragraph BC78 of ASU 2018-13 states:
The
amendments in this Update relate to disclosures only and remove disclosures that are
no longer considered cost beneficial, clarify the specific requirements of
disclosures, and add disclosure requirements identified as broadly relevant. The
amendments create differences in disclosures based on the FASB’s and the IASB’s
differing assessments on financial statement users’ needs and the application of the
concepts in the Concepts Statement to the disclosures required by Topic
820.
Therefore, because the disclosure requirements under IFRS 13 and other
IFRS Accounting Standards differ from those under U.S. GAAP, entities reporting under
IFRS Accounting Standards should carefully consider these disclosure requirements as
part of their annual and interim reporting.
One notable difference between the disclosure requirements under U.S.
GAAP and those under IFRS Accounting Standards is that IFRS Accounting Standards require
that entities provide a quantitative sensitivity analysis for recurring fair value
measurements of financial instruments classified in Level 3 of the fair value hierarchy.
ASU 2018-13 only requires entities that are not nonpublic entities to provide a
narrative description of the uncertainty of a Level 3 fair value measurement that
results from the use of unobservable inputs if those inputs reasonably could have been
different as of the reporting date.
Appendix C — Glossary of Selected Terms
Appendix C — Glossary of Selected Terms
This appendix contains selected glossary terms from ASC 820 and the
ASC master glossary.
ASC 820-10 Glossary and ASC Master
Glossary
Accretion Expense
An amount recognized as an expense classified as an operating
item in the statement of income resulting from the increase
in the carrying amount of the liability associated with the
asset retirement obligation.
Acquiree
The business or businesses that the acquirer obtains control
of in a business combination. This term also includes a
nonprofit activity or business that a not-for-profit
acquirer obtains control of in an acquisition by a
not-for-profit entity.
Acquirer
The entity that obtains control of the acquiree. However, in
a business combination in which a variable interest entity
(VIE) is acquired, the primary beneficiary of that entity
always is the acquirer.
Acquisition by a Not-for-Profit Entity
A transaction or other event in which a not-for-profit
acquirer obtains control of one or more nonprofit activities
or businesses and initially recognizes their assets and
liabilities in the acquirer’s financial statements. When
applicable guidance in Topic 805 is applied by a
not-for-profit entity, the term business combination has the
same meaning as this term has for a for-profit entity.
Likewise, a reference to business combinations in guidance
that links to Topic 805 has the same meaning as a reference
to acquisitions by not-for-profit entities.
Acquisition Date
The date on which the acquirer obtains control of the
acquiree.
Active Market
A market in which transactions for the asset or liability
take place with sufficient frequency and volume to provide
pricing information on an ongoing basis.
Actuarial Present Value
The value, as of a specified date, of an amount or series of
amounts payable or receivable thereafter, with each amount
adjusted to reflect the time value of money (through
discounts for interest) and the probability of payment (by
means of decrements for events such as death, disability,
withdrawal, or retirement) between the specified date and
the expected date of payment.
Adequate Compensation
The amount of benefits of servicing that would fairly
compensate a substitute servicer should one be required,
which includes the profit that would be demanded in the
marketplace. It is the amount demanded by the marketplace to
perform the specific type of servicing. Adequate
compensation is determined by the marketplace; it does not
vary according to the specific servicing costs of the
servicer.
Affiliate
A party that, directly or indirectly through
one or more intermediaries, controls, is controlled by, or
is under common control with an entity. See Control.
Affiliated Entity
An entity that directly or indirectly controls, is controlled
by, or is under common control with another entity; also, a
party with which the entity may deal if one party has the
ability to exercise significant influence over the other’s
operating and financial policies as discussed in Section
323-10-15.
Agency Transaction
A type of exchange transaction in which the reporting entity
acts as an agent, trustee, or intermediary for another party
that may be a donor or donee.
Agent
Definition 1
A party that acts for and on behalf of another party. For
example, a third-party intermediary is an agent of the
transferor if it acts on behalf of the transferor.
Definition 2
An entity that acts for and on behalf of another. Although
the term agency has a legal definition, the term is used
broadly to encompass not only legal agency, but also the
relationships described in Topic 958. A recipient entity
acts as an agent for and on behalf of a donor if it receives
assets from the donor and agrees to use those assets on
behalf of or transfer those assets, the return on investment
of those assets, or both to a specified beneficiary. A
recipient entity acts as an agent for and on behalf of a
beneficiary if it agrees to solicit assets from potential
donors specifically for the beneficiary’s use and to
distribute those assets to the beneficiary. A recipient
entity also acts as an agent if a beneficiary can compel the
recipient entity to make distributions to it or on its
behalf.
Allocated Contract
A contract with an insurance entity under
which payments to the insurance entity are currently used to
purchase immediate or deferred annuities for individual
participants. See Annuity
Contract.
Amortized Cost Basis
The amortized cost basis is the amount at
which a financing receivable or investment is originated or
acquired, adjusted for applicable accrued interest,
accretion, or amortization of premium, discount, and net
deferred fees or costs, collection of cash, writeoffs,
foreign exchange, and fair value hedge accounting
adjustments.
Annuity Contract
A contract in which an insurance entity unconditionally
undertakes a legal obligation to provide specified pension
benefits to specific individuals in return for a fixed
consideration or premium. An annuity contract is irrevocable
and involves the transfer of significant risk from the
employer to the insurance entity. Annuity contracts are also
called allocated contracts.
Asset Group
An asset group is the unit of accounting for a long-lived
asset or assets to be held and used, which represents the
lowest level for which identifiable cash flows are largely
independent of the cash flows of other groups of assets and
liabilities.
Asset Retirement Obligation
An obligation associated with the retirement of a tangible
long-lived asset.
Available-for-Sale Securities
Investments not classified as either trading securities or as
held-to-maturity securities.
Bankruptcy Court
The United States Bankruptcy Court is an adjunct of the
United States District Courts. Under the jurisdiction of the
District Court, the Bankruptcy Court is generally
responsible for cases filed under Chapters 7, 11, 12, and 13
of the Bankruptcy Code.
Benchmark Interest Rate
A widely recognized and quoted rate in an active financial
market that is broadly indicative of the overall level of
interest rates attributable to high-credit-quality obligors
in that market. It is a rate that is widely used in a given
financial market as an underlying basis for determining the
interest rates of individual financial instruments and
commonly referenced in interest-rate-related
transactions.
In theory, the benchmark interest rate should be a risk-free
rate (that is, has no risk of default). In some markets,
government borrowing rates may serve as a benchmark. In
other markets, the benchmark interest rate may be an
interbank offered rate.
Beneficial Conversion Feature
A nondetachable conversion feature that is in the money at
the commitment date.
Pending Content (Transition Guidance: ASC
815-40-65-1)
Glossary term superseded by
Accounting Standards Update No. 2020-06.
Beneficial Interests
Rights to receive all or portions of specified cash inflows
received by a trust or other entity, including, but not
limited to, all of the following:
- Senior and subordinated shares of interest, principal, or other cash inflows to be passed-through or paid-through
- Premiums due to guarantors
- Commercial paper obligations
- Residual interests, whether in the form of debt or equity.
Benefits
The monetary or in-kind benefits or benefit coverage to which
participants may be entitled under a pension plan or a
health and welfare plan (which can include active,
terminated, and retired employees or their dependents or
beneficiaries). Examples of benefits may include, but are
not limited to, health care benefits, life insurance, legal,
educational, and advisory services, pension benefits,
disability benefits, death benefits, and benefits due to
termination of employment.
Benefits of Servicing
Revenues from contractually specified servicing fees, late
charges, and other ancillary sources, including float.
Brokered Market
A market in which brokers attempt to match buyers with
sellers but do not stand ready to trade for their own
account. In other words, brokers do not use their own
capital to hold an inventory of the items for which they
make a market. The broker knows the prices bid and asked by
the respective parties, but each party is typically unaware
of another party’s price requirements. Prices of completed
transactions are sometimes available. Brokered markets
include electronic communication networks, in which buy and
sell orders are matched, and commercial and residential real
estate markets.
Business
Paragraphs 805-10-55-3A through 55-6 and 805-10-55-8 through
55-9 define what is considered a business.
Business Combination
A transaction or other event in which an
acquirer obtains control of one or more businesses.
Transactions sometimes referred to as true mergers or
mergers of equals also are business combinations. See also
Acquisition by a
Not-for-Profit Entity.
Call Option
A contract that allows the holder to buy a
specified quantity of stock from the writer of the contract
at a fixed price for a given period. See Option and Purchased Call Option.
Carrying Amount
Definition 1
For a receivable, the face amount increased or decreased by
applicable accrued interest and applicable unamortized
premium, discount, finance charges, or issue costs and also
an allowance for uncollectible amounts and other valuation
accounts.
For a payable, the face amount increased or
decreased by applicable accrued interest and applicable
unamortized premium, discount, finance charges, or issue
costs.
Definition 2
The amount of an item as displayed in the financial
statements.
Cash
Consistent with common usage, cash includes not only currency
on hand but demand deposits with banks or other financial
institutions. Cash also includes other kinds of accounts
that have the general characteristics of demand deposits in
that the customer may deposit additional funds at any time
and also effectively may withdraw funds at any time without
prior notice or penalty. All charges and credits to those
accounts are cash receipts or payments to both the entity
owning the account and the bank holding it. For example, a
bank’s granting of a loan by crediting the proceeds to a
customer’s demand deposit account is a cash payment by the
bank and a cash receipt of the customer when the entry is
made.
Cash Equivalents
Cash equivalents are short-term, highly liquid investments
that have both of the following characteristics:
- Readily convertible to known amounts of cash
- So near their maturity that they present insignificant risk of changes in value because of changes in interest rates.
Generally, only investments with original maturities of three
months or less qualify under that definition. Original
maturity means original maturity to the entity holding the
investment. For example, both a three-month U.S. Treasury
bill and a three-year U.S. Treasury note purchased three
months from maturity qualify as cash equivalents. However, a
Treasury note purchased three years ago does not become a
cash equivalent when its remaining maturity is three months.
Examples of items commonly considered to be cash equivalents
are Treasury bills, commercial paper, money market funds,
and federal funds sold (for an entity with banking
operations).
Cash Flow Hedge
A hedge of the exposure to variability in the cash flows of a
recognized asset or liability, or of a forecasted
transaction, that is attributable to a particular risk.
Cease-Use Date
The date the entity ceases using the right conveyed by the
contract, for example, to receive future goods or
services.
Charitable Gift Annuity
A transfer of assets to a not-for-profit entity (NFP) in
connection with a split-interest agreement that is in part a
contribution and in part an exchange transaction. The NFP
accepts the contribution and is obligated to make periodic
stipulated payments to the donor or a third-party
beneficiary for a specified period of time, usually either a
specified number of years or until the death of the donor or
third-party beneficiary.
Charitable Lead Trust
A trust established in connection with a split-interest
agreement, in which a not-for-profit entity (NFP) receives
distributions during the agreement’s term. Upon termination
of the trust, the remainder of the trust assets is paid to
the donor or to third-party beneficiaries designated by the
donor.
Charitable Remainder Trust
A trust established in connection with a split-interest
agreement, in which the donor or a third-party beneficiary
receives specified distributions during the agreement’s
term. Upon termination of the trust, a not-for-profit entity
(NFP) receives the assets remaining in the trust.
Collateral
Personal or real property in which a security interest has
been given.
Collateralized Financing Entity
A variable interest entity that holds financial assets,
issues beneficial interests in those financial assets, and
has no more than nominal equity. The beneficial interests
have contractual recourse only to the related assets of the
collateralized financing entity and are classified as
financial liabilities. A collateralized financing entity may
hold nonfinancial assets temporarily as a result of default
by the debtor on the underlying debt instruments held as
assets by the collateralized financing entity or in an
effort to restructure the debt instruments held as assets by
the collateralized financing entity. A collateralized
financing entity also may hold other financial assets and
financial liabilities that are incidental to the operations
of the collateralized financing entity and have carrying
values that approximate fair value (for example, cash,
broker receivables, or broker payables).
Committed-to-Be-Released Shares
Committed-to-be-released shares are shares that, although not
legally released, will be released by a future scheduled and
committed debt service payment and will be allocated to
employees for service rendered in the current accounting
period. The period of employee service to which shares
relate is generally defined in the employee stock ownership
plan documents. Shares are legally released from suspense
and from serving as collateral for employee stock ownership
plan debt as a result of payment of debt service. Those
shares are required to be allocated to participant accounts
as of the end of the employee stock ownership plan’s fiscal
year. Formulas used to determine the number of shares
released can be based on either of the following:
- The ratio of the current principal amount to the total original principal amount (in which case unearned employee stock ownership plan shares and debt balance will move in tandem)
- The ratio of the current principal plus interest amount to the total original principal plus interest to be paid.
Shares are released more rapidly under the second method than
under the first. Tax law permits the first method only if
the employee stock ownership plan debt meets certain
criteria.
Common Interest Realty Association
An association, also known as a community association,
responsible for the governance of the common interest
community, for which it was established to serve. A common
interest realty association is generally funded by its
members via periodic assessments by the common interest
realty association so that it can perform its duties, which
include management services and maintenance, repair, and
replacement of the common property, among other duties
established in the governing documents and by state
statute.
Common Property
A common interest realty association’s real or personal
property to which title or other evidence of ownership is
held by either:
- Individual members in common
- The common interest realty association directly.
Communication Date
The date the plan of termination for one-time employee
termination benefits meets all of the criteria in paragraph
420-10-25-4 and has been communicated to employees.
Comprehensive Income
The change in equity (net assets) of a business entity during
a period from transactions and other events and
circumstances from nonowner sources. It includes all changes
in equity during a period except those resulting from
investments by owners and distributions to owners.
Comprehensive income comprises both of the following:
- All components of net income
- All components of other comprehensive income.
Conditional Asset Retirement Obligation
A legal obligation to perform an asset retirement activity in
which the timing and (or) method of settlement are
conditional on a future event that may or may not be within
the control of the entity.
Conditional Contribution
A contribution that contains a donor-imposed condition.
Conduit Debt Securities
Certain limited-obligation revenue bonds, certificates of
participation, or similar debt instruments issued by a state
or local governmental entity for the express purpose of
providing financing for a specific third party (the conduit
bond obligor) that is not a part of the state or local
government’s financial reporting entity. Although conduit
debt securities bear the name of the governmental entity
that issues them, the governmental entity often has no
obligation for such debt beyond the resources provided by a
lease or loan agreement with the third party on whose behalf
the securities are issued. Further, the conduit bond obligor
is responsible for any future financial reporting
requirements.
Contingency
An existing condition, situation, or set of circumstances
involving uncertainty as to possible gain (gain contingency)
or loss (loss contingency) to an entity that will ultimately
be resolved when one or more future events occur or fail to
occur.
Contingent Consideration
Usually an obligation of the acquirer to transfer additional
assets or equity interests to the former owners of an
acquiree as part of the exchange for control of the acquiree
if specified future events occur or conditions are met.
However, contingent consideration also may give the acquirer
the right to the return of previously transferred
consideration if specified conditions are met.
Continuing Involvement
Any involvement with the transferred financial assets that
permits the transferor to receive cash flows or other
benefits that arise from the transferred financial assets or
that obligates the transferor to provide additional cash
flows or other assets to any party related to the transfer.
For related implementation guidance, see paragraph
860-10-55-79A.
Contract
An agreement between two or more parties that creates
enforceable rights and obligations.
Contract Value
The value of an unallocated contract that is determined by
the insurance entity in accordance with the terms of the
contract.
Contractually Required Payments Receivable
The total undiscounted amount of all uncollected contractual
principal and contractual interest payments both past due
and scheduled for the future, adjusted for the timing of
prepayments, if considered, less any reduction by the
investor. For an acquired asset-backed security with
required contractual payments of principal and interest, the
contractually required payments receivable is represented by
the contractual terms of the security. However, when
contractual payments of principal and interest are not
specified by the security, it is necessary to consider the
contractual terms of the underlying loans or assets.
Contractually Specified Servicing Fees
All amounts that, per contract, are due to the servicer in
exchange for servicing the financial asset and would no
longer be received by a servicer if the beneficial owners of
the serviced assets (or their trustees or agents) were to
exercise their actual or potential authority under the
contract to shift the servicing to another servicer.
Depending on the servicing contract, those fees may include
some or all of the difference between the interest rate
collectible on the financial asset being serviced and the
rate to be paid to the beneficial owners of those financial
assets.
Contribution
An unconditional transfer of cash or other assets, as well as
unconditional promises to give, to an entity or a reduction,
settlement, or cancellation of its liabilities in a
voluntary nonreciprocal transfer by another entity acting
other than as an owner. Those characteristics distinguish
contributions from:
- Exchange transactions, which are reciprocal transfers in which each party receives and sacrifices approximately commensurate value
- Investments by owners and distributions to owners, which are nonreciprocal transfers between an entity and its owners
- Other nonreciprocal transfers, such as impositions of taxes or legal judgments, fines, and thefts, which are not voluntary transfers.
In a contribution transaction, the resource
provider often receives value indirectly by providing a
societal benefit although that benefit is not considered to
be of commensurate value. In an exchange transaction, the
potential public benefits are secondary to the potential
direct benefits to the resource provider. The term
contribution revenue is used to apply to
transactions that are part of the entity’s ongoing major or
central activities (revenues), or are peripheral or
incidental to the entity (gains). See also Inherent Contribution and
Conditional
Contribution.
Contributory Plan
A plan under which retirees or active employees contribute
part of the cost. In some contributory plans, retirees or
active employees wishing to be covered must contribute; in
other contributory plans, participants’ contributions result
in increased benefits.
Control
Definition 1
The possession, direct or indirect, of the power to direct or
cause the direction of the management and policies of an
entity through ownership, by contract, or otherwise.
Definition 2
The direct or indirect ability to determine the direction of
management and policies through ownership, contract, or
otherwise.
Definition 3
The same as the meaning of controlling financial interest in
paragraph 810-10-15-8.
Corporate Joint Venture
A corporation owned and operated by a small group of entities
(the joint venturers) as a separate and specific business or
project for the mutual benefit of the members of the group.
A government may also be a member of the group. The purpose
of a corporate joint venture frequently is to share risks
and rewards in developing a new market, product or
technology; to combine complementary technological
knowledge; or to pool resources in developing production or
other facilities. A corporate joint venture also usually
provides an arrangement under which each joint venturer may
participate, directly or indirectly, in the overall
management of the joint venture. Joint venturers thus have
an interest or relationship other than as passive investors.
An entity that is a subsidiary of one of the joint venturers
is not a corporate joint venture. The ownership of a
corporate joint venture seldom changes, and its stock is
usually not traded publicly. A noncontrolling interest held
by public ownership, however, does not preclude a
corporation from being a corporate joint venture.
Cost Approach
A valuation approach that reflects the amount that would be
required currently to replace the service capacity of an
asset (often referred to as current replacement cost).
Credit Derivative
A derivative instrument that has both of the following
characteristics:
- One or more of its underlyings are related to any of
the following:
- The credit risk of a specified entity (or a group of entities)
- An index based on the credit risk of a group of entities.
- It exposes the seller to potential loss from credit-risk-related events specified in the contract.
Examples of credit derivatives include, but
are not limited to, credit default swaps, credit spread
options, and credit index products.
Credit Risk
For purposes of a hedged item in a fair value hedge, credit
risk is the risk of changes in the hedged item’s fair value
attributable to both of the following:
- Changes in the obligor’s creditworthiness
- Changes in the spread over the benchmark interest rate with respect to the hedged item’s credit sector at inception of the hedge.
For purposes of a hedged transaction in a cash flow hedge,
credit risk is the risk of changes in the hedged
transaction’s cash flows attributable to all of the
following:
- Default
- Changes in the obligor’s creditworthiness
- Changes in the spread over the contractually specified interest rate or the benchmark interest rate with respect to the related financial asset’s or liability’s credit sector at inception of the hedge.
Currency Risk
The risk that the fair value or future cash flows of a
financial instrument will fluctuate because of changes in
foreign exchange rates.
Customer
A party that has contracted with an entity to obtain goods or
services that are an output of the entity’s ordinary
activities in exchange for consideration.
Dealer Market
A market in which dealers stand ready to trade (either buy or
sell for their own account), thereby providing liquidity by
using their capital to hold an inventory of the items for
which they make a market. Typically, bid and ask prices
(representing the price at which the dealer is willing to
buy and the price at which the dealer is willing to sell,
respectively) are more readily available than closing
prices. Over-the-counter markets (for which prices are
publicly reported by the National Association of Securities
Dealers Automated Quotations systems or by OTC Markets Group
Inc.) are dealer markets. For example, the market for U.S.
Treasury securities is a dealer market. Dealer markets also
exist for some other assets and liabilities, including other
financial instruments, commodities, and physical assets (for
example, used equipment).
Debt-Equity Swap
A debt-equity swap is an exchange
transaction of a monetary asset for a nonmonetary asset.
Debt Security
Any security representing a creditor relationship with an
entity. The term debt security also includes all of the
following:
- Preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor
- A collateralized mortgage obligation (or other instrument) that is issued in equity form but is required to be accounted for as a nonequity instrument regardless of how that instrument is classified (that is, whether equity or debt) in the issuer’s statement of financial position
- U.S. Treasury securities
- U.S. government agency securities
- Municipal securities
- Corporate bonds
- Convertible debt
- Commercial paper
- All securitized debt instruments, such as collateralized mortgage obligations and real estate mortgage investment conduits
- Interest-only and principal-only strips.
The term debt security excludes all of the following:
- Option contracts
- Financial futures contracts
- Forward contracts
- Lease contracts
- Receivables that do not meet the definition of
security and, so, are not debt securities,
for example:
- Trade accounts receivable arising from sales on credit by industrial or commercial entities
- Loans receivable arising from consumer, commercial, and real estate lending activities of financial institutions.
Defensive Intangible Asset
An acquired intangible asset in a situation in which an
entity does not intend to actively use the asset but intends
to hold (lock up) the asset to prevent others from obtaining
access to the asset.
Defined Benefit Plan
A defined benefit plan provides participants with a
determinable benefit based on a formula provided for in the
plan.
- Defined benefit health and welfare plans — Defined benefit health and welfare plans specify a determinable benefit, which may be in the form of a reimbursement to the covered plan participant or a direct payment to providers or third-party insurers for the cost of specified services. Such plans may also include benefits that are payable as a lump sum, such as death benefits. The level of benefits may be defined or limited based on factors such as age, years of service, and salary. Contributions may be determined by the plan’s actuary or be based on premiums, actual claims paid, hours worked, or other factors determined by the plan sponsor. Even when a plan is funded pursuant to agreements that specify a fixed rate of employer contributions (for example, a collectively bargained multiemployer plan), such a plan may nevertheless be a defined benefit health and welfare plan if its substance is to provide a defined benefit.
- Defined benefit pension plan — A pension plan that defines an amount of pension benefit to be provided, usually as a function of one or more factors such as age, years of service, or compensation. Any pension plan that is not a defined contribution pension plan is, for purposes of Subtopic 715-30, a defined benefit pension plan.
- Defined benefit postretirement plan — A plan that defines postretirement benefits in terms of monetary amounts (for example, $100,000 of life insurance) or benefit coverage to be provided (for example, up to $200 per day for hospitalization, or 80 percent of the cost of specified surgical procedures). Any postretirement benefit plan that is not a defined contribution postretirement plan is, for purposes of Subtopic 715-60, a defined benefit postretirement plan. (Specified monetary amounts and benefit coverage are collectively referred to as benefits.)
Defined Contribution Plan
A plan that provides an individual account
for each participant and provides benefits that are based on
all of the following: amounts contributed to the
participant’s account by the employer or employee;
investment experience; and any forfeitures allocated to the
account, less any administrative expenses charged to the
plan.
- Defined contribution health and welfare plans — Defined contribution health and welfare plans maintain an individual account for each plan participant. They have terms that specify the means of determining the contributions to participants’ accounts, rather than the amount of benefits the participants are to receive. The benefits a plan participant will receive are limited to the amount contributed to the participant’s account, investment experience, expenses, and any forfeitures allocated to the participant’s account. These plans also include flexible spending arrangements.
- Defined contribution postretirement plan — A plan that provides postretirement benefits in return for services rendered, provides an individual account for each plan participant, and specifies how contributions to the individual’s account are to be determined rather than specifies the amount of benefits the individual is to receive. Under a defined contribution postretirement plan, the benefits a plan participant will receive depend solely on the amount contributed to the plan participant’s account, the returns earned on investments of those contributions, and the forfeitures of other plan participants’ benefits that may be allocated to that plan participant’s account.
Derecognize
Remove previously recognized assets or liabilities from the
statement of financial position.
Derivative Financial Instrument
A derivative instrument that is a financial instrument.
Derivative Instrument
Paragraphs 815-10-15-83 through 15-139 define the term
derivative instrument.
Direct Financing Lease
From the perspective of a lessor, a lease that meets none of
the criteria in paragraph 842-10-25-2 but meets the criteria
in paragraph 842-10-25-3(b).
Direct Financing Leases
From the perspective of a lessor, a lease that meets none of
the criteria in paragraph 842-10-25-2 but meets the criteria
in paragraph 842-10-25-3(b) and is not an operating lease in
accordance with paragraph 842-10-25-3A.
Discount Rate
A rate or rates used to reflect the time
value of money. Discount rates are used in determining the
present value as of the measurement date of future cash
flows currently expected to be required to satisfy the
pension obligation or other postretirement benefit
obligation. See Actuarial Present
Value.
Discount Rate Adjustment Technique
A present value technique that uses a risk-adjusted discount
rate and contractual, promised, or most likely cash
flows.
Disposal Group
A disposal group for a long-lived asset or assets to be
disposed of by sale or otherwise represents assets to be
disposed of together as a group in a single transaction and
liabilities directly associated with those assets that will
be transferred in the transaction. A disposal group may
include a discontinued operation along with other assets and
liabilities that are not part of the discontinued
operation.
Donor-Imposed Condition
A donor stipulation (donors include other types of
contributors, including makers of certain grants) that
represents a barrier that must be overcome before the
recipient is entitled to the assets transferred or promised.
Failure to overcome the barrier gives the contributor a
right of return of the assets it has transferred or gives
the promisor a right of release from its obligation to
transfer its assets.
Donor-Imposed Restriction
A donor stipulation (donors include other types of
contributors, including makers of certain grants) that
specifies a use for a contributed asset that is more
specific than broad limits resulting from the following:
- The nature of the not-for-profit entity (NFP)
- The environment in which it operates
- The purposes specified in its articles of incorporation or bylaws or comparable documents for an unincorporated association.
Some donors impose restrictions that are temporary in nature,
for example, stipulating that resources be used after a
specified date, for particular programs or services, or to
acquire buildings or equipment. Other donors impose
restrictions that are perpetual in nature, for example,
stipulating that resources be maintained in perpetuity. Laws
may extend those limits to investment returns from those
resources and to other enhancements (diminishments) of those
resources. Thus, those laws extend donor-imposed
restrictions.
Embedded Credit Derivative
An embedded derivative that is also a credit derivative.
Embedded Derivative
Implicit or explicit terms that affect some or all of the
cash flows or the value of other exchanges required by a
contract in a manner similar to a derivative instrument.
Employee Stock Ownership Plan
An employee stock ownership plan is an employee benefit plan
that is described by the Employee Retirement Income Security
Act of 1974 and the Internal Revenue Code of 1986 as a stock
bonus plan, or combination stock bonus and money purchase
pension plan, designed to invest primarily in employer
stock. Also called an employee share ownership plan.
Entry Price
The price paid to acquire an asset or received to assume a
liability in an exchange transaction.
Equity Interests
Used broadly to mean ownership interests of investor-owned
entities; owner, member, or participant interests of mutual
entities; and owner or member interests in the net assets of
not-for-profit entities.
Equity Security
Definition 1
Any security representing an ownership interest in an entity
(for example, common, preferred, or other capital stock) or
the right to acquire (for example, warrants, rights, forward
purchase contracts, and call options) or dispose of (for
example, put options and forward sale contracts) an
ownership interest in an entity at fixed or determinable
prices. The term equity security does not include any of the
following:
- Written equity options (because they represent obligations of the writer, not investments)
- Cash-settled options on equity securities or options on equity-based indexes (because those instruments do not represent ownership interests in an entity)
- Convertible debt or preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor.
Definition 2
Any security representing an ownership interest in an entity
(for example, common, preferred, or other capital stock) or
the right to acquire (for example, warrants, rights, forward
purchase contracts, and call options) or dispose of (for
example, put options and forward sale contracts) an
ownership interest in an entity at fixed or determinable
prices. However, the term does not include convertible debt
or preferred stock that by its terms either must be redeemed
by the issuing entity or is redeemable at the option of the
investor.
Exchange
An exchange (or exchange transaction) is a reciprocal
transfer between two entities that results in one of the
entities acquiring assets or services or satisfying
liabilities by surrendering other assets or services or
incurring other obligations.
Exchange Market
A market in which closing prices are both readily available
and generally representative of fair value. An example of
such a market is the New York Stock Exchange.
Exit Price
The price that would be received to sell an asset or paid to
transfer a liability.
Expected Cash Flow
The probability-weighted average (that is, mean of the
distribution) of possible future cash flows.
Fail-to-Receive
A fail-to-receive is a securities purchase from another
broker-dealer not received from the selling broker-dealer by
the close of business on the settlement date.
Fair Value
The price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between
market participants at the measurement date.
Fair Value Hedge
A hedge of the exposure to changes in the fair value of a
recognized asset or liability, or of an unrecognized firm
commitment, that are attributable to a particular risk.
Federal Home Loan Mortgage Corporation
Often referred to as Freddie Mac, FHLMC is a private
corporation authorized by Congress to assist in the
development and maintenance of a secondary market in
conventional residential mortgages. FHLMC purchases mortgage
loans and sells mortgages principally through mortgage
participation certificates representing an undivided
interest in a group of conventional mortgages. FHLMC
guarantees the timely payment of interest and the collection
of principal on the participation certificates.
Federal National Mortgage Association
Often referred to as Fannie Mae, FNMA is an investor-owned
corporation established by Congress to support the secondary
mortgage loan market by purchasing mortgage loans when other
investor funds are limited and selling mortgage loans when
other investor funds are available.
Film Group
The unit of account used for impairment testing for a film or
a license agreement for program material when the film or
license agreement is expected to be predominantly monetized
with other films and/or license agreements instead of being
predominantly monetized on its own. A film group represents
the lowest level for which identifiable cash flows are
largely independent of the cash flows of other films and/or
license agreements.
Films
Feature films, television specials, television series, or
similar products (including animated films and television
programming) that are sold, licensed, or exhibited, whether
produced on film, video tape, digital, or other video
recording format.
Finance Lease
From the perspective of a lessee, a lease that meets one or
more of the criteria in paragraph 842-10-25-2.
Financial Asset
Cash, evidence of an ownership interest in an entity, or a
contract that conveys to one entity a right to do either of
the following:
- Receive cash or another financial instrument from a second entity
- Exchange other financial instruments on potentially favorable terms with the second entity.
Financial Instrument
Cash, evidence of an ownership interest in an entity, or a
contract that both:
- Imposes on one entity a contractual obligation
either:
- To deliver cash or another financial instrument to a second entity
- To exchange other financial instruments on potentially unfavorable terms with the second entity.
- Conveys to that second entity a contractual right
either:
- To receive cash or another financial instrument from the first entity
- To exchange other financial instruments on potentially favorable terms with the first entity.
The use of the term financial instrument in this definition
is recursive (because the term financial instrument is
included in it), though it is not circular. The definition
requires a chain of contractual obligations that ends with
the delivery of cash or an ownership interest in an entity.
Any number of obligations to deliver financial instruments
can be links in a chain that qualifies a particular contract
as a financial instrument.
Contractual rights and contractual obligations encompass both
those that are conditioned on the occurrence of a specified
event and those that are not. All contractual rights
(contractual obligations) that are financial instruments
meet the definition of asset (liability) set forth in FASB
Concepts Statement No. 6, Elements of Financial Statements,
although some may not be recognized as assets (liabilities)
in financial statements — that is, they may be
off-balance-sheet — because they fail to meet some other
criterion for recognition.
For some financial instruments, the right is held by or the
obligation is due from (or the obligation is owed to or by)
a group of entities rather than a single entity.
Financial Liability
A contract that imposes on one entity an obligation to do
either of the following:
- Deliver cash or another financial instrument to a second entity
- Exchange other financial instruments on potentially unfavorable terms with the second entity.
Financial Statements Are Available to Be Issued
Financial statements are considered available to be issued
when they are complete in a form and format that complies
with GAAP and all approvals necessary for issuance have been
obtained, for example, from management, the board of
directors, and/or significant shareholders. The process
involved in creating and distributing the financial
statements will vary depending on an entity’s management and
corporate governance structure as well as statutory and
regulatory requirements.
Firm Commitment
Definition 1
An agreement with a third party that is binding on both
parties. The agreement specifies all significant terms,
including items to be exchanged, consideration, and timing
of the transaction. The agreement includes a disincentive
for nonperformance that is sufficiently large to ensure the
expected performance. In the context of episodic television
series, a firm commitment for future production includes
only episodes to be delivered within one year from the date
of the estimate of ultimate revenue.
Definition 2
An agreement with an unrelated party, binding on both parties
and usually legally enforceable, with the following
characteristics:
- The agreement specifies all significant terms, including the quantity to be exchanged, the fixed price, and the timing of the transaction. The fixed price may be expressed as a specified amount of an entity’s functional currency or of a foreign currency. It may also be expressed as a specified interest rate or specified effective yield. The binding provisions of an agreement are regarded to include those legal rights and obligations codified in the laws to which such an agreement is subject. A price that varies with the market price of the item that is the subject of the firm commitment cannot qualify as a fixed price. For example, a price that is specified in terms of ounces of gold would not be a fixed price if the market price of the item to be purchased or sold under the firm commitment varied with the price of gold.
- The agreement includes a disincentive for nonperformance that is sufficiently large to make performance probable. In the legal jurisdiction that governs the agreement, the existence of statutory rights to pursue remedies for default equivalent to the damages suffered by the nondefaulting party, in and of itself, represents a sufficiently large disincentive for nonperformance to make performance probable for purposes of applying the definition of a firm commitment.
Forward Commitment Dollar Roll
Forward Exchange Contract
A forward exchange contract is an agreement between two
parties to exchange different currencies at a specified
exchange rate at an agreed-upon future date.
Freestanding Financial Instrument
A financial instrument that meets either of the following
conditions:
- It is entered into separately and apart from any of the entity’s other financial instruments or equity transactions.
- It is entered into in conjunction with some other transaction and is legally detachable and separately exercisable.
Fully Benefit-Responsive Investment Contract
An investment contract is considered fully benefit-responsive
if all of the following criteria are met for that contract,
analyzed on an individual basis:
- The investment contract is effected directly between the plan and the issuer and prohibits the plan from assigning or selling the contract or its proceeds to another party without the consent of the issuer.
- Either of the following conditions exists:
- The repayment of principal and interest credited to participants in the plan is a financial obligation of the issuer of the investment contract.
- Prospective interest crediting rate adjustments are provided to participants in the plan on a designated pool of investments held by the plan or the contract issuer, whereby a financially responsible third party, through a contract generally referred to as a wrapper, must provide assurance that the adjustments to the interest crediting rate will not result in a future interest crediting rate that is less than zero.
If an event has occurred such that realization of full contract value for a particular investment contract is no longer probable (for example, a significant decline in creditworthiness of the contract issuer or wrapper provider), the investment contract shall no longer be considered fully benefit-responsive. - The terms of the investment contract require all
permitted participant-initiated transactions with
the plan to occur at contract value with no
conditions, limits, or restrictions. Permitted
participant-initiated transactions are those
transactions allowed by the plan, such as any of the
following:
- Withdrawals for benefits
- Loans
- Transfers to other funds within the plan.
- An event that limits the ability of the plan to
transact at contract value with the issuer and that
also limits the ability of the plan to transact at
contract value with the participants in the plan,
such as any of the following, must be probable of
not occurring:
- Premature termination of the contracts by the plan
- Plant closings
- Layoffs
- Plan termination
- Bankruptcy
- Mergers
- Early retirement incentives.
- The plan itself must allow participants reasonable access to their funds.
If access to funds is substantially restricted by plan
provisions, investment contracts held by those plans may not
be considered to be fully benefit-responsive. For example,
if plan participants are allowed access at contract value to
all or a portion of their account balances only upon
termination of their participation in the plan, it would not
be considered reasonable access and, therefore, investment
contracts held by that plan would generally not be deemed to
be fully benefit-responsive. However, in plans with a single
investment fund that allow reasonable access to assets by
inactive participants, restrictions on access to assets by
active participants consistent with the objective of the
plan (for example, retirement or health and welfare
benefits) will not affect the benefit responsiveness of the
investment contracts held by those single-fund plans. Also,
if a plan limits participants’ access to their account
balances to certain specified times during the plan year
(for example, semiannually or quarterly) to control the
administrative costs of the plan, that limitation generally
would not affect the benefit responsiveness of the
investment contracts held by that plan. In addition,
administrative provisions that place short-term restrictions
(for example, three or six months) on transfers to competing
fixed-rate investment options to limit arbitrage among those
investment options (equity wash provisions) would not affect
a contract’s benefit responsiveness.
Gain Contingency
An existing condition, situation, or set of circumstances
involving uncertainty as to possible gain to an entity that
will ultimately be resolved when one or more future events
occur or fail to occur.
General Account
Definition 1
An undivided fund maintained by an insurance entity that
commingles plan assets with other assets of the insurance
entity for investment purposes. That is, funds held by an
insurance entity that are not maintained in a separate
account are in its general account.
Definition 2
All operations of an insurance entity that are not reported
in the separate account(s).
Goodwill
An asset representing the future economic benefits arising
from other assets acquired in a business combination or an
acquisition by a not-for-profit entity that are not
individually identified and separately recognized. For ease
of reference, this term also includes the immediate charge
recognized by not-for-profit entities in accordance with
paragraph 958-805-25-29.
Pending Content (Transition
Guidance: ASC 805-60-65-1)
An asset representing the
future economic benefits arising from other assets
acquired in a business combination, acquired in an
acquisition by a not-for-profit entity, or
recognized by a joint venture upon formation that
are not individually identified and separately
recognized. For ease of reference, this term also
includes the immediate charge recognized by
not-for-profit entities in accordance with
paragraph 958-805-25-29.
Government National Mortgage Association
Often referred to as Ginnie Mae, GNMA is a U.S. governmental
agency that guarantees certain types of mortgage-backed
securities and provides funds for and administers certain
types of low-income housing assistance programs.
Government National Mortgage Association Rolls
The term Government National Mortgage Association (GNMA)
rolls has been used broadly to refer to a variety of
transactions involving mortgage-backed securities,
frequently those issued by the GNMA. There are four basic
types of transactions:
- Type 1. Reverse repurchase agreements for which the exact same security is received at the end of the repurchase period (vanilla repo)
- Type 2. Fixed coupon dollar reverse repurchase agreements (dollar repo)
- Type 3. Fixed coupon dollar reverse repurchase agreements that are rolled at their maturities, that is, renewed in lieu of taking delivery of an underlying security (GNMA roll)
- Type 4. Forward commitment dollar rolls (also referred to as to-be-announced GNMA forward contracts or to-be-announced GNMA rolls), for which the underlying security does not yet exist.
Group Participating Pension Contracts
Contracts between insurance entities and pension plans that
have account balance crediting provisions that give the
contract holder the total return based on a referenced pool
of assets over the life of the contract either through
crediting rates or termination adjustments.
Health and Welfare Benefit Plans
Health and welfare benefit plans include plans that provide
the following:
- Any of the following benefits:
- Medical, dental, visual, psychiatric, or long-term health care
- Life insurance (offered separately from a pension plan)
- Certain severance benefits
- Accidental death or dismemberment benefits.
- Benefits for unemployment, disability, vacations, or holidays
- Other benefits such as apprenticeships, tuition assistance, day care, dependent care, housing subsidies, or legal services.
Highest and Best Use
The use of a nonfinancial asset by market participants that
would maximize the value of the asset or the group of assets
and liabilities (for example, a business) within which the
asset would be used.
Hybrid Instrument
A contract that embodies both an embedded derivative and a
host contract.
Identifiable
An asset is identifiable if it meets either of the following
criteria:
- It is separable, that is, capable of being separated or divided from the entity and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract, identifiable asset, or liability, regardless of whether the entity intends to do so.
- It arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
Impairment
Impairment is the condition that exists when the carrying
amount of a long-lived asset (asset group) exceeds its fair
value.
Income Approach
Valuation approaches that convert future amounts (for
example, cash flows or income and expenses) to a single
current (that is, discounted) amount. The fair value
measurement is determined on the basis of the value
indicated by current market expectations about those future
amounts.
Inherent Contribution
A contribution that results if an entity voluntarily
transfers assets (or net assets) or performs services for
another entity in exchange for either no assets or for
assets of substantially lower value and unstated rights or
privileges of a commensurate value are not involved.
Inputs
The assumptions that market participants would use when
pricing the asset or liability, including assumptions about
risk, such as the following:
- The risk inherent in a particular valuation technique used to measure fair value (such as a pricing model)
- The risk inherent in the inputs to the valuation technique.
Inputs may be observable or unobservable.
Insurance Contract
A contract in which an insurance entity unconditionally
undertakes a legal obligation to provide specified benefits
to specific individuals in return for a fixed consideration
or premium. An insurance contract is irrevocable and
involves the transfer of significant risk from the employer
(or the plan) to the insurance entity.
Intangible Assets
Assets (not including financial assets) that lack physical
substance. (The term intangible assets is used to refer to
intangible assets other than goodwill.)
Interest Rate Risk
For recognized variable-rate financial instruments and
forecasted issuances or purchases of variable-rate financial
instruments, interest rate risk is the risk of changes in
the hedged item’s cash flows attributable to changes in the
contractually specified interest rate in the agreement.
For recognized fixed-rate financial instruments, interest
rate risk is the risk of changes in the hedged item’s fair
value attributable to changes in the designated benchmark
interest rate. For forecasted issuances or purchases of
fixed-rate financial instruments, interest rate risk is the
risk of changes in the hedged item’s cash flows attributable
to changes in the designated benchmark interest rate.
Intermediary
Although in general usage the term intermediary encompasses a
broad range of situations in which an entity acts between
two or more other parties, in this usage, it refers to
situations in which a recipient entity acts as a facilitator
for the transfer of assets between a potential donor and a
potential beneficiary (donee) but is neither an agent or
trustee nor a donee and donor.
Investee
An entity that issued an equity instrument that is held by an
investor.
Issuer
The entity that issued a financial instrument or may be
required under the terms of a financial instrument to issue
its equity shares.
Issuer’s Equity Shares
The equity shares of any entity whose financial statements
are included in the consolidated financial statements.
Lead Interest
The right to the benefits (cash flows or use) of assets
during the term of a split-interest agreement, which
generally starts upon the signing of the agreement and
terminates at either of the following times:
- After a specified number of years (period-certain)
- Upon the occurrence of a certain event, commonly either the death of the donor or the death of the lead interest beneficiary (life-contingent).
Lease
A contract, or part of a contract, that conveys the right to
control the use of identified property, plant, or equipment
(an identified asset) for a period of time in exchange for
consideration.
Legal Entity
Any legal structure used to conduct activities or to hold
assets. Some examples of such structures are corporations,
partnerships, limited liability companies, grantor trusts,
and other trusts.
Legal Obligation
An obligation that a party is required to settle as a result
of an existing or enacted law, statute, ordinance, or
written or oral contract or by legal construction of a
contract under the doctrine of promissory estoppel.
Lessee
An entity that enters into a contract to obtain the right to
use an underlying asset for a period of time in exchange for
consideration.
Lessor
An entity that enters into a contract to provide the right to
use an underlying asset for a period of time in exchange for
consideration.
Level 1 Inputs
Quoted prices (unadjusted) in active markets for identical
assets or liabilities that the reporting entity can access
at the measurement date.
Level 2 Inputs
Inputs other than quoted prices included within Level 1 that
are observable for the asset or liability, either directly
or indirectly.
Level 3 Inputs
Unobservable inputs for the asset or liability.
Liability Issued With an Inseparable Third-Party Credit
Enhancement
A liability that is issued with a credit enhancement obtained
from a third party, such as debt that is issued with a
financial guarantee from a third party that guarantees the
issuer’s payment obligation.
License Agreement
A typical license agreement for program material (for
example, features, specials, series, or cartoons) covers
several programs (a package) and grants a television
station, group of stations, network, pay television, or
cable television system (licensee) the right to broadcast
either a specified number or an unlimited number of showings
over a maximum period of time (license period) for a
specified fee.
Life Settlement Contract
A life settlement contract is a contract between the owner of
a life insurance policy (the policy owner) and a third-party
investor (investor), and has all of the following
characteristics:
- The investor does not have an insurable interest (an interest in the survival of the insured, which is required to support the issuance of an insurance policy).
- The investor provides consideration to the policy owner of an amount in excess of the current cash surrender value of the life insurance policy.
- The contract pays the face value of the life insurance policy to an investor when the insured dies.
Liquidity
An asset’s or liability’s nearness to cash. Donor-imposed
restrictions may influence the liquidity or cash flow
patterns of certain assets. For example, a donor stipulation
that donated cash be used to acquire land and buildings
limits an entity’s ability to take effective actions to
respond to unexpected opportunities or needs, such as
emergency disaster relief. On the other hand, some
donor-imposed restrictions have little or no influence on
cash flow patterns or an entity’s financial flexibility. For
example, a gift of cash with a donor stipulation that it be
used for emergency-relief efforts has a negligible impact on
an entity if emergency relief is one of its major ongoing
programs.
Loan
Definition 1
A contractual right to receive money on demand or on fixed or
determinable dates that is recognized as an asset in the
creditor’s statement of financial position. Examples include
but are not limited to accounts receivable (with terms
exceeding one year) and notes receivable. This definition
encompasses loans accounted for as debt securities.
Definition 2
A contractual right to receive money on demand or on fixed or
determinable dates that is recognized as an asset in the
creditor’s statement of financial position. Examples include
but are not limited to accounts receivable (with terms
exceeding one year) and notes receivable.
Loan Commitment
Loan commitments are legally binding
commitments to extend credit to a counterparty under certain
prespecified terms and conditions. They have fixed
expiration dates and may either be fixed-rate or
variable-rate. Loan commitments can be either of the
following:
- Revolving (in which the amount of the overall commitment is reestablished upon repayment of previously drawn amounts)
- Nonrevolving (in which the amount of the overall commitment is not reestablished upon repayment of previously drawn amounts).
Loan commitments can be distributed through
syndication arrangements, in which one entity acts as a lead
and an agent on behalf of other entities that will each
extend credit to a single borrower. Loan commitments
generally permit the lender to terminate the arrangement
under the terms of covenants negotiated under the
agreement.
Loan Origination Fees
Origination fees consist of all of the following:
- Fees that are being charged to the borrower as prepaid interest or to reduce the loan’s nominal interest rate, such as interest buy-downs (explicit yield adjustments)
- Fees to reimburse the lender for origination activities
- Other fees charged to the borrower that relate directly to making the loan (for example, fees that are paid to the lender as compensation for granting a complex loan or agreeing to lend quickly)
- Fees that are not conditional on a loan being granted by the lender that receives the fee but are, in substance, implicit yield adjustments because a loan is granted at rates or terms that would not have otherwise been considered absent the fee (for example, certain syndication fees addressed in paragraph 310-20-25-19)
- Fees charged to the borrower in connection with the process of originating, refinancing, or restructuring a loan. This term includes, but is not limited to, points, management, arrangement, placement, application, underwriting, and other fees pursuant to a lending or leasing transaction and also includes syndication and participation fees to the extent they are associated with the portion of the loan retained by the lender.
Loan Syndication
A transaction in which several lenders share in lending to a
single borrower. Each lender loans a specific amount to the
borrower and has the right to repayment from the borrower.
It is common for groups of lenders to jointly fund those
loans when the amount borrowed is greater than any one
lender is willing to lend.
Loss Contingency
An existing condition, situation, or set of circumstances
involving uncertainty as to possible loss to an entity that
will ultimately be resolved when one or more future events
occur or fail to occur. The term loss is used for
convenience to include many charges against income that are
commonly referred to as expenses and others that are
commonly referred to as losses.
Management
Persons who are responsible for achieving the objectives of
the entity and who have the authority to establish policies
and make decisions by which those objectives are to be
pursued. Management normally includes members of the board
of directors, the chief executive officer, chief operating
officer, vice presidents in charge of principal business
functions (such as sales, administration, or finance), and
other persons who perform similar policy making functions.
Persons without formal titles also may be members of
management.
Mandatorily Redeemable Financial Instrument
Any of various financial instruments issued in the form of
shares that embody an unconditional obligation requiring the
issuer to redeem the instrument by transferring its assets
at a specified or determinable date (or dates) or upon an
event that is certain to occur.
Market Approach
A valuation approach that uses prices and other relevant
information generated by market transactions involving
identical or comparable (that is, similar) assets,
liabilities, or a group of assets and liabilities, such as a
business.
Market-Corroborated
Inputs
Inputs that are derived principally from or
corroborated by observable market data by correlation or
other means.
Market Participants
Buyers and sellers in the principal (or most advantageous)
market for the asset or liability that have all of the
following characteristics:
- They are independent of each other, that is, they are not related parties, although the price in a related-party transaction may be used as an input to a fair value measurement if the reporting entity has evidence that the transaction was entered into at market terms
- They are knowledgeable, having a reasonable understanding about the asset or liability and the transaction using all available information, including information that might be obtained through due diligence efforts that are usual and customary
- They are able to enter into a transaction for the asset or liability
- They are willing to enter into a transaction for the asset or liability, that is, they are motivated but not forced or otherwise compelled to do so.
Market Risk
The risk that the fair value or future cash flows of a
financial instrument will fluctuate because of changes in
market prices. Market risk comprises the following:
- Interest rate risk
- Currency risk
- Other price risk.
Market Risk Benefit
Pending Content (Transition Guidance: ASC
944-40-65-2)
A contract or contract feature
in a long-duration contract issued by an insurance
entity that both protects the contract holder from
other-than-nominal capital market risk and exposes
the insurance entity to other-than-nominal capital
market risk.
Mining Assets
Mining assets include mineral properties and rights.
Mortgage-Backed Securities
Securities issued by a governmental agency or corporation
(for example, Government National Mortgage Association
[GNMA] or Federal Home Loan Mortgage Corporation [FHLMC]) or
by private issuers (for example, Federal National Mortgage
Association [FNMA], banks, and mortgage banking entities).
Mortgage-backed securities generally are referred to as
mortgage participation certificates or pass-through
certificates. A participation certificate represents an
undivided interest in a pool of specific mortgage loans.
Periodic payments on GNMA participation certificates are
backed by the U.S. government. Periodic payments on FHLMC
and FNMA certificates are guaranteed by those corporations,
but are not backed by the U.S. government.
Most Advantageous Market
The market that maximizes the amount that would be received
to sell the asset or minimizes the amount that would be paid
to transfer the liability, after taking into account
transaction costs and transportation costs.
Multiemployer Plan
A pension or postretirement benefit plan to
which two or more unrelated employers contribute, usually
pursuant to one or more collective-bargaining agreements. A
characteristic of multiemployer plans is that assets
contributed by one participating employer may be used to
provide benefits to employees of other participating
employers since assets contributed by an employer are not
segregated in a separate account or restricted to provide
benefits only to employees of that employer. A multiemployer
plan is usually administered by a board of trustees composed
of management and labor representatives and may also be
referred to as a joint trust or union plan. Generally, many
employers participate in a multiemployer plan, and an
employer may participate in more than one plan. The
employers participating in multiemployer plans usually have
a common industry bond, but for some plans the employers are
in different industries and the labor union may be their
only common bond. Some multiemployer plans do not involve a
union. For example, local chapters of a not-for-profit
entity (NFP) may participate in a plan established by the
related national organization.
Mutual Entity
An entity other than an investor-owned entity that provides
dividends, lower costs, or other economic benefits directly
and proportionately to its owners, members, or participants.
Mutual insurance entities, credit unions, and farm and rural
electric cooperatives are examples of mutual entities.
Net Asset Value per Share
Net asset value per share is the amount of net assets
attributable to each share of capital stock (other than
senior equity securities, that is, preferred stock)
outstanding at the close of the period. It excludes the
effects of assuming conversion of outstanding convertible
securities, whether or not their conversion would have a
diluting effect.
Net Assets
The excess or deficiency of assets over
liabilities of a not-for-profit entity, which is divided
into two mutually exclusive classes according to the
existence or absence of donor-imposed restrictions. See
Net Assets With Donor
Restrictions and Net Assets Without Donor Restrictions.
Net Assets Available for Benefits
The difference between a plan’s assets and its liabilities.
For purposes of this definition, a plan’s liabilities do not
include participants’ accumulated plan benefits.
Net Assets With Donor Restrictions
The part of net assets of a not-for-profit entity that is
subject to donor-imposed restrictions (donors include other
types of contributors, including makers of certain
grants).
Net Assets Without Donor Restrictions
The part of net assets of a not-for-profit entity that is not
subject to donor-imposed restrictions (donors include other
types of contributors, including makers of certain
grants).
Net Carrying Amount of Debt
Net carrying amount of debt is the amount
due at maturity, adjusted for unamortized premium, discount,
and cost of issuance.
Net Income
A measure of financial performance resulting from the
aggregation of revenues, expenses, gains, and losses that
are not items of other comprehensive income. A variety of
other terms such as net earnings or earnings may be used to
describe net income.
Net Income Unitrust
A trust established in connection with a split-interest
agreement, in which the donor or a third-party beneficiary
receives distributions during the agreement’s term of the
lesser of the net income earned by the trust or a fixed
percentage of the fair value of the trust’s assets, with or
without recovery and distribution of the shortfall in a
subsequent year. Upon termination of the trust, a
not-for-profit entity (NFP) receives the assets remaining in
the trust.
Net Investment in an Original Loan
The net investment in an original loan includes the unpaid
loan principal, any remaining unamortized net fees or costs,
any remaining unamortized purchase premium or discount, and
any accrued interest receivable.
Net Periodic Pension Cost
The amount recognized in an employer’s financial statements
as the cost of a pension plan for a period. Components of
net periodic pension cost are service cost, interest cost,
actual return on plan assets, gain or loss, amortization of
prior service cost or credit, and amortization of the
transition asset or obligation existing at the date of
initial application of Subtopic 715-30. The term net
periodic pension cost is used instead of net pension expense
because the service cost component recognized in a period
may be capitalized as part of an asset such as
inventory.
Net Periodic Postretirement Benefit Cost
The amount recognized in an employer’s financial statements
as the cost of a postretirement benefit plan for a period.
Components of net periodic postretirement benefit cost
include service cost, interest cost, actual return on plan
assets, gain or loss, amortization of prior service cost or
credit, and amortization of the transition obligation or
asset.
Network Affiliation Agreement
A broadcaster may be affiliated with a network under a
network affiliation agreement. Under the agreement, the
station receives compensation for the network programming
that it carries based on a formula designed to compensate
the station for advertising sold on a network basis and
included in network programming. Program costs, a major
expense of television stations, are generally lower for a
network affiliate than for an independent station because an
affiliate does not incur program costs for network
programs.
New Basis Event
See Remeasurement
Event.
Noncontrolling Interest
The portion of equity (net assets) in a subsidiary not
attributable, directly or indirectly, to a parent. A
noncontrolling interest is sometimes called a minority
interest.
Nonfinancial Asset
An asset that is not a financial asset. Nonfinancial assets
include land, buildings, use of facilities or utilities,
materials and supplies, intangible assets, or services.
Nonmonetary Assets and Liabilities
Nonmonetary assets and liabilities are assets and liabilities
other than monetary ones. Examples are inventories;
investments in common stocks; property, plant, and
equipment; and liabilities for rent collected in
advance.
Nonperformance Risk
The risk that an entity will not fulfill an obligation.
Nonperformance risk includes, but may not be limited to, the
reporting entity’s own credit risk.
Nonpublic Entity
Any entity that does not meet any of the following
conditions:
- Its debt or equity securities trade in a public market either on a stock exchange (domestic or foreign) or in an over-the-counter market, including securities quoted only locally or regionally.
- It is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets).
- It files with a regulatory agency in preparation for the sale of any class of debt or equity securities in a public market.
- It is required to file or furnish financial statements with the Securities and Exchange Commission.
- It is controlled by an entity covered by criteria (a) through (d).
Nonreciprocal Transfer
Definition 1
Nonreciprocal transfer is a transfer of assets or services in
one direction, either from an entity to its owners (whether
or not in exchange for their ownership interests) or to
another entity, or from owners or another entity to the
entity. An entity’s reacquisition of its outstanding stock
is an example of a nonreciprocal transfer.
Definition 2
A transaction in which an entity incurs a liability or
transfers an asset to another entity (or receives an asset
or cancellation of a liability) without directly receiving
(or giving) value in exchange.
Not-for-Profit Entity
An entity that possesses the following characteristics, in
varying degrees, that distinguish it from a business
entity:
- Contributions of significant amounts of resources from resource providers who do not expect commensurate or proportionate pecuniary return
- Operating purposes other than to provide goods or services at a profit
- Absence of ownership interests like those of business entities.
Entities that clearly fall outside this definition include
the following:
- All investor-owned entities
- Entities that provide dividends, lower costs, or other economic benefits directly and proportionately to their owners, members, or participants, such as mutual insurance entities, credit unions, farm and rural electric cooperatives, and employee benefit plans.
Observable Inputs
Inputs that are developed using market data, such as publicly
available information about actual events or transactions,
and that reflect the assumptions that market participants
would use when pricing the asset or liability.
One-Time Employee Termination Benefits
Benefits provided to current employees that are involuntarily
terminated under the terms of a one-time benefit
arrangement.
Operating Lease
From the perspective of a lessee, any lease other than a
finance lease.
From the perspective of a lessor, any lease other than a
sales-type lease or a direct financing lease.
Option
Unless otherwise stated, a call option that
gives the holder the right to purchase shares of common
stock from the reporting entity in accordance with an
agreement upon payment of a specified amount. Options
include, but are not limited to, options granted and stock
purchase agreements entered into with grantees. Options are
considered securities. See Call
Option.
Orderly Transaction
A transaction that assumes exposure to the market for a
period before the measurement date to allow for marketing
activities that are usual and customary for transactions
involving such assets or liabilities; it is not a forced
transaction (for example, a forced liquidation or distress
sale).
Other Comprehensive Income
Revenues, expenses, gains, and losses that under generally
accepted accounting principles (GAAP) are included in
comprehensive income but excluded from net income.
Other Price Risk
The risk that the fair value or future cash flows of a
financial instrument will fluctuate because of changes in
market prices (other than those arising from interest rate
risk or currency risk), whether those changes are caused by
factors specific to the individual financial instrument or
its issuer or by factors affecting all similar financial
instruments traded in the market.
Owners
Used broadly to include holders of ownership interests
(equity interests) of investor-owned entities, mutual
entities, or not-for-profit entities. Owners include
shareholders, partners, proprietors, or members or
participants of mutual entities. Owners also include owner
and member interests in the net assets of not-for-profit
entities.
Participating Insurance
Insurance in which the policyholder is entitled to
participate in the earnings or surplus of the insurance
entity. The participation occurs through the distribution of
dividends to policyholders.
Participating Interest
Paragraph 860-10-40-6A defines the term participating
interest.
Participation Costs
Parties involved in the production of a film may be
compensated in part by contingent payments based on the
financial results of a film pursuant to contractual formulas
(participations) and by contingent amounts due under
provisions of collective bargaining agreements (residuals).
Such parties are collectively referred to as participants,
and such costs are collectively referred to as participation
costs. Participations may be given to creative talent, such
as actors or writers, or to entities from whom distribution
rights are licensed.
Participation Right
A purchaser’s right under a participating insurance contract
to receive future dividends or retroactive rate credits from
the insurance entity.
Performance Indicator
A performance indicator reports results of operations. A
performance indicator and the income from continuing
operations reported by for-profit health care entities
generally are consistent, except for transactions that
clearly are not applicable to one kind of entity (for
example, for-profit health care entities typically would not
receive contributions, and not-for-profit health care
entities would not award stock compensation). That is, a
performance indicator is analogous to income from continuing
operations of a for-profit entity.
Perpetual Trust Held by a Third Party
An arrangement in which a donor establishes and funds a
perpetual trust administered by an individual or entity
other than the not-for-profit entity (NFP) that is the
beneficiary. Under the terms of the trust, the NFP has the
irrevocable right to receive the income earned on the trust
assets in perpetuity, but never receives the assets held in
trust. Distributions received by the NFP may be restricted
by the donor.
Phase
A contractually or physically distinguishable portion of a
real estate project (including time-sharing projects). That
portion is distinguishable from other portions based on
shared characteristics such as:
- Units a developer has declared or legally registered to be for sale
- Units linked to an owners association
- Units to be constructed during a particular time period
- How a developer plans to build the real estate project.
Physical Settlement
Definition 1
A form of settling a financial instrument under which both of
the following conditions are met:
- The party designated in the contract as the buyer delivers the full stated amount of cash or other financial instruments to the seller.
- The seller delivers the full stated number of shares of stock or other financial instruments or nonfinancial instruments to the buyer.
Definition 2
The party designated in the contract as the buyer delivers
the full stated amount of cash to the seller, and the seller
delivers the full stated number of shares to the buyer.
Plan
An arrangement that is mutually understood
by an employer and its employees, whereby an employer
undertakes to provide its employees with benefits after they
retire in exchange for their services over a specified
period of time, upon attaining a specified age while in
service, or a combination of both. A plan may be written or
it may be implied by a well-defined, although perhaps
unwritten, practice of paying postretirement benefits or
from oral representations made to current or former
employees. See Substantive
Plan.
Plan Assets
Definition 1
Assets — usually stocks, bonds, and other investments (except
certain insurance contracts as noted in paragraph
715-60-35-109) — that have been segregated and restricted
(usually in a trust) to be used for a health and welfare
plan (which can include active, terminated, and retired
employees or their dependents or beneficiaries). The amount
of plan assets includes amounts contributed by the employer,
and by plan participants for a contributory plan, and
amounts earned from investing the contributions, less
benefits, income taxes, and other expenses incurred. Plan
assets ordinarily cannot be withdrawn by the employer except
under certain circumstances when a plan has assets in excess
of obligations and the employer has taken certain steps to
satisfy existing obligations. Securities of the employer
held by the plan are includable in plan assets provided they
are transferable.
Assets not segregated in a trust, or otherwise effectively
restricted, so that they cannot be used by the employer for
other purposes are not plan assets, even though the employer
may intend that those assets be used to provide health and
welfare benefits, which may include postretirement benefits.
Those assets shall be accounted for in the same manner as
other employer assets of a similar nature and with similar
restrictions. If a plan has liabilities other than for
benefits, those nonbenefit obligations are considered as
reductions of plan assets. Amounts accrued by the employer
but not yet paid to the plan are not plan assets. If a trust
arrangement explicitly provides that segregated assets are
available to satisfy claims of creditors in bankruptcy, such
a provision would effectively permit those assets to be used
for other purposes at the discretion of the employer. It is
not necessary to determine that a trust is bankruptcy-proof
for the assets of the trust to qualify as plan assets.
However, assets held in a trust that explicitly provides
that such assets are available to the general creditors of
the employer in the event of the employer’s bankruptcy would
not qualify as plan assets.
Definition 2
Assets — usually stocks, bonds, and other investments — that
have been segregated and restricted, usually in a trust, to
provide for pension benefits. The amount of plan assets
includes amounts contributed by the employer, and by
employees for a contributory plan, and amounts earned from
investing the contributions, less benefits paid. Plan assets
ordinarily cannot be withdrawn by the employer except under
certain circumstances when a plan has assets in excess of
obligations and the employer has taken certain steps to
satisfy existing obligations. Assets not segregated in a
trust or otherwise effectively restricted so that they
cannot be used by the employer for other purposes are not
plan assets even though it may be intended that such assets
be used to provide pensions. If a plan has liabilities other
than for benefits, those nonbenefit obligations may be
considered as reductions of plan assets. Amounts accrued by
the employer but not yet paid to the plan are not plan
assets. Securities of the employer held by the plan are
includable in plan assets provided they are
transferable.
Pooled Income Fund
A trust in which donors are assigned a specific number of
units based on the proportion of the fair value of their
contributions to the total fair value of the pooled income
fund on the date of the donor’s entry to the pooled fund.
Until a donor’s death, the donor (or the donor’s designated
beneficiary or beneficiaries) is paid the actual income (as
defined under the arrangement) earned on the donor’s
assigned units. Upon the donor’s death, the value of these
assigned units reverts to the NFP.
Postretirement Benefit Plan
See Plan.
Prepaid Reinsurance Premiums
Amounts paid to the reinsurer relating to the unexpired
portion of reinsured contracts.
Present Value
A tool used to link future amounts (cash
flows or values) to a present amount using a discount rate
(an application of the income approach). Present value
techniques differ in how they adjust for risk and in the
type of cash flows they use. See Discount Rate Adjustment Technique.
Primary Beneficiary
An entity that consolidates a variable interest entity (VIE).
See paragraphs 810-10-25-38 through 25-38J for guidance on
determining the primary beneficiary.
Principal Market
The market with the greatest volume and
level of activity for the asset or liability.
Principal-to-Principal Market
A market in which transactions, both originations and
resales, are negotiated independently with no intermediary.
Little information about those transactions may be made
available publicly.
Probable
The future event or events are likely to
occur.
Probable Reserves
Probable reserves are reserves for which quantity and grade
and/or quality are computed from information similar to that
used for proven reserves, but the sites for inspection,
sampling, and measurement are farther apart or are otherwise
less adequately spaced. The degree of assurance, although
lower than that for proven (measured) reserves, is high
enough to assume continuity between points of
observation.
Proceeds
Cash, beneficial interests, servicing assets, derivative
instruments, or other assets that are obtained in a transfer
of financial assets, less any liabilities incurred.
Producer
An individual or an entity that produces and has a financial
interest in films for exhibition in movie theaters, on
television, or elsewhere.
Promise to Give
A written or oral agreement to contribute cash or other
assets to another entity. A promise carries rights and
obligations — the recipient of a promise to give has a right
to expect that the promised assets will be transferred in
the future, and the maker has a social and moral obligation,
and generally a legal obligation, to make the promised
transfer. A promise to give may be either conditional or
unconditional.
Proven Reserves
Proven reserves are reserves for which both of the following
conditions are met:
- Quantity is computed from dimensions revealed in outcrops, trenches, workings, or drill holes; grade and/or quality are computed from the results of detailed sampling.
- The sites for inspection, sampling, and measurement are spaced so closely and the geologic character is so well defined that size, shape, depth, and mineral content of reserves are well established.
Public Business Entity
A public business entity is a business entity meeting any one
of the criteria below. Neither a not-for-profit entity nor
an employee benefit plan is a business entity.
- It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including other entities whose financial statements or financial information are required to be or are included in a filing).
- It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations promulgated under the Act, to file or furnish financial statements with a regulatory agency other than the SEC.
- It is required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities that are not subject to contractual restrictions on transfer.
- It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market.
- It has one or more securities that are not subject to contractual restrictions on transfer, and it is required by law, contract, or regulation to prepare U.S. GAAP financial statements (including notes) and make them publicly available on a periodic basis (for example, interim or annual periods). An entity must meet both of these conditions to meet this criterion.
An entity may meet the definition of a public business entity
solely because its financial statements or financial
information is included in another entity’s filing with the
SEC. In that case, the entity is only a public business
entity for purposes of financial statements that are filed
or furnished with the SEC.
Publicly Traded Company
A publicly traded company includes any company whose
securities trade in a public market on either of the
following:
- A stock exchange (domestic or foreign)
- In the over-the-counter market (including securities quoted only locally or regionally), or any company that is a conduit bond obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets).
Additionally, when a company is required to file or furnish
financial statements with the SEC or makes a filing with a
regulatory agency in preparation for sale of its securities
in a public market it is considered a publicly traded
company for this purpose.
Conduit debt securities refers to certain limited-obligation
revenue bonds, certificates of participation, or similar
debt instruments issued by a state or local governmental
entity for the express purpose of providing financing for a
specific third party (the conduit bond obligor) that is not
a part of the state or local government’s financial
reporting entity. Although conduit debt securities bear the
name of the governmental entity that issues them, the
governmental entity often has no obligation for such debt
beyond the resources provided by a lease or loan agreement
with the third party on whose behalf the securities are
issued. Further, the conduit bond obligor is responsible for
any future financial reporting requirements.
Purchased Call Option
A contract that allows the reporting entity
to buy a specified quantity of its own stock from the writer
of the contract at a fixed price for a given period. See
Call Option.
Purchased Financial Assets With Credit
Deterioration
Acquired individual financial assets (or
acquired groups of financial assets with similar risk
characteristics) that as of the date of acquisition have
experienced a more-than-insignificant deterioration in
credit quality since origination, as determined by an
acquirer’s assessment. See paragraph 326-20-55-5 for more
information on the meaning of similar risk characteristics
for assets measured on an amortized cost basis.
Pushdown Accounting
Use of the acquirer’s basis in the preparation of the
acquiree’s separate financial statements.
Rabbi Trusts
Rabbi trusts are grantor trusts generally set up to fund
compensation for a select group of management or highly paid
executives. To qualify as a rabbi trust for income tax
purposes, the terms of the trust agreement must explicitly
state that the assets of the trust are available to satisfy
the claims of general creditors in the event of bankruptcy
of the employer.
Reacquisition Price of Debt
The amount paid on extinguishment, including a call premium
and miscellaneous costs of reacquisition. If extinguishment
is achieved by a direct exchange of new securities, the
reacquisition price is the total present value of the new
securities.
Readily Determinable Fair Value
An equity security has a readily determinable fair value if
it meets any of the following conditions:
- The fair value of an equity security is readily determinable if sales prices or bid-and-asked quotations are currently available on a securities exchange registered with the U.S. Securities and Exchange Commission (SEC) or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by OTC Markets Group Inc. Restricted stock meets that definition if the restriction terminates within one year.
- The fair value of an equity security traded only in a foreign market is readily determinable if that foreign market is of a breadth and scope comparable to one of the U.S. markets referred to above.
- The fair value of an equity security that is an investment in a mutual fund or in a structure similar to a mutual fund (that is, a limited partnership or a venture capital entity) is readily determinable if the fair value per share (unit) is determined and published and is the basis for current transactions.
Recipient Entity
A not-for-profit entity (NFP) or charitable trust that
accepts assets from a donor or other resource provider and
agrees to use those assets on behalf of or transfer those
assets, the return on investment of those assets, or both to
a beneficiary that is specified by the donor or resource
provider.
Reinsurance
A transaction in which a reinsurer (assuming entity), for a
consideration (premium), assumes all or part of a risk
undertaken originally by another insurer (ceding entity).
For indemnity reinsurance, the legal rights of the insured
are not affected by the reinsurance transaction and the
insurance entity issuing the insurance contract remains
liable to the insured for payment of policy benefits.
Assumption or novation reinsurance contracts that are legal
replacements of one insurer by another extinguish the ceding
entity’s liability to the policyholder.
Reinsurance Recoverable
All amounts recoverable from reinsurers for paid and unpaid
claims and claim settlement expenses, including estimated
amounts receivable for unsettled claims, claims incurred but
not reported, or policy benefits.
Related Parties
Related parties include:
- Affiliates of the entity
- Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section 825-10-15, to be accounted for by the equity method by the investing entity
- Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management
- Principal owners of the entity and members of their immediate families
- Management of the entity and members of their immediate families
- Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests
- Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests.
Remainder Interest
The right to receive all or a portion of the assets of a
split-interest agreement remaining at the end of the
agreement’s term.
Remeasurement Event
A remeasurement (new basis) event is an
event identified in other authoritative accounting
literature, other than the measurement of an impairment
under Topic 321 or credit loss under Topic 326, that
requires a financial instrument to be remeasured to its fair
value at the time of the event but does not require that
financial instrument to be reported at fair value
continually with the change in fair value recognized in
earnings. Examples of remeasurement events are business
combinations and significant modifications of debt as
discussed in paragraph 470-50-40-6.
Reporting Entity
An entity or group whose financial statements are being
referred to. Those financial statements reflect any of the
following:
- The financial statements of one or more foreign operations by combination, consolidation, or equity accounting
- Foreign currency transactions.
Repurchase Agreement
An agreement under which the transferor (repo party)
transfers a financial asset to a transferee (repo
counterparty or reverse party) in exchange for cash and
concurrently agrees to reacquire that financial asset at a
future date for an amount equal to the cash exchanged plus
or minus a stipulated interest factor. Instead of cash,
other securities or letters of credit sometimes are
exchanged. Some repurchase agreements call for repurchase of
financial assets that need not be identical to the financial
assets transferred.
Research and Development
Research is planned search or critical investigation aimed at
discovery of new knowledge with the hope that such knowledge
will be useful in developing a new product or service
(referred to as product) or a new process or technique
(referred to as process) or in bringing about a significant
improvement to an existing product or process.
Development is the translation of research findings or other
knowledge into a plan or design for a new product or process
or for a significant improvement to an existing product or
process whether intended for sale or use. It includes the
conceptual formulation, design, and testing of product
alternatives, construction of prototypes, and operation of
pilot plants.
Residual Value
The estimated fair value of an intangible asset at the end of
its useful life to an entity, less any disposal costs.
Revenue
Inflows or other enhancements of assets of
an entity or settlements of its liabilities (or a
combination of both) from delivering or producing goods,
rendering services, or other activities that constitute the
entity’s ongoing major or central operations.
Reverse Acquisition
An acquisition in which the entity that issues securities
(the legal acquirer) is identified as the acquiree for
accounting purposes based on the guidance in paragraphs
805-10-55-11 through 55-15. The entity whose equity
interests are acquired (the legal acquiree) must be the
acquirer for accounting purposes for the transaction to be
considered a reverse acquisition.
Risk Premium
Compensation sought by risk-averse market participants for
bearing the uncertainty inherent in the cash flows of an
asset or a liability. Also referred to as a risk
adjustment.
Sales-Type Lease
From the perspective of a lessor, a lease that meets one or
more of the criteria in paragraph 842-10-25-2 and is not an
operating lease in accordance with paragraph
842-10-25-3A.
Securitization
The process by which financial assets are transformed into
securities.
Security
Definition 1
The evidence of debt or ownership or a related right. It
includes options and warrants as well as debt and stock.
Definition 2
A share, participation, or other interest in property or in
an entity of the issuer or an obligation of the issuer that
has all of the following characteristics:
- It is either represented by an instrument issued in bearer or registered form or, if not represented by an instrument, is registered in books maintained to record transfers by or on behalf of the issuer.
- It is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment.
- It either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations.
Separate Account
Definition 1
A special account established by an insurance entity solely
for the purpose of investing the assets of one or more
plans. Funds in a separate account are not commingled with
other assets of the insurance entity for investment
purposes.
Definition 2
A separate investment account established and maintained by
an insurance entity under relevant state insurance law to
which funds have been allocated for certain contracts of the
insurance entity or similar accounts used for foreign
originated products. The term separate accounts includes
separate accounts and subaccounts or investment divisions of
separate accounts.
Separate Account Arrangement
An arrangement under which all or a portion of a contract
holder’s funds is allocated to a specific separate account
maintained by the insurance entity.
Servicing Assets
A contract to service financial assets under which the
benefits of servicing are expected to more than adequately
compensate the servicer for performing the servicing. A
servicing contract is either:
- Undertaken in conjunction with selling or securitizing the financial assets being serviced
- Purchased or assumed separately.
Servicing Liabilities
A contract to service financial assets under which the
estimated future revenues from contractually specified
servicing fees, late charges, and other ancillary revenues
(benefits of servicing) are not expected to adequately
compensate the servicer for performing the servicing.
Shares
Shares includes various forms of ownership that may not take
the legal form of securities (for example, partnership
interests), as well as other interests, including those that
are liabilities in substance but not in form. (Business
entities have interest holders that are commonly known by
specialized names, such as stockholders, partners, and
proprietors, and by more general names, such as investors,
but all are encompassed by the descriptive term owners.
Equity of business entities is, thus, commonly known by
several names, such as owners’ equity, stockholders’ equity,
ownership, equity capital, partners’ capital, and
proprietorship. Some entities [for example, mutual
organizations] do not have stockholders, partners, or
proprietors in the usual sense of those terms but do have
participants whose interests are essentially ownership
interests, residual interests, or both.)
Significant Influence
Paragraphs 323-10-15-6 through 15-11 define significant
influence.
Spinoff
The transfer of assets that constitute a business by an
entity (the spinnor) into a new legal spun-off entity (the
spinnee), followed by a distribution of the shares of the
spinnee to its shareholders, without the surrender by the
shareholders of any stock of the spinnor.
Split-Interest Agreement
An agreement in which a donor enters into a trust or other
arrangement under which a not-for-profit entity (NFP)
receives benefits that are shared with other beneficiaries.
A typical split-interest agreement has the following two
components:
- A lead interest
- A remainder interest.
Split-Off
A transaction in which a parent entity exchanges its stock in
a subsidiary for parent entity stock held by its
shareholders.
Sponsor
In the case of a pension plan established or maintained by a
single employer, the employer; in the case of a plan
established or maintained by an employee entity, the
employee entity; in the case of a plan established or
maintained jointly by two or more employers or by one or
more employers and one or more employee entities, the
association, committee, joint board of trustees, or other
group of representatives of the parties that have
established or that maintain the pension plan.
Standalone Selling Price
The price at which an entity would sell a promised good or
service separately to a customer.
Stock Dividend
An issuance by a corporation of its own common shares to its
common shareholders without consideration and under
conditions indicating that such action is prompted mainly by
a desire to give the recipient shareholders some ostensibly
separate evidence of a part of their respective interests in
accumulated corporate earnings without distribution of cash
or other property that the board of directors deems
necessary or desirable to retain in the business. A stock
dividend takes nothing from the property of the corporation
and adds nothing to the interests of the stockholders; that
is, the corporation’s property is not diminished and the
interests of the stockholders are not increased. The
proportional interest of each shareholder remains the
same.
Structured Note
A debt instrument whose cash flows are linked to the movement
in one or more indexes, interest rates, foreign exchange
rates, commodities prices, prepayment rates, or other market
variables. Structured notes are issued by U.S.
government-sponsored enterprises, multilateral development
banks, municipalities, and private entities. The notes
typically contain embedded (but not separable or detachable)
forward components or option components such as caps, calls,
and floors. Contractual cash flows for principal, interest,
or both can vary in amount and timing throughout the life of
the note based on nontraditional indexes or nontraditional
uses of traditional interest rates or indexes.
Sublease
A transaction in which an underlying asset is re-leased by
the lessee (or intermediate lessor) to a third party (the
sublessee) and the original (or head) lease between the
lessor and the lessee remains in effect.
Subsidiary
An entity, including an unincorporated entity such as a
partnership or trust, in which another entity, known as its
parent, holds a controlling financial interest. (Also, a
variable interest entity that is consolidated by a primary
beneficiary.)
Substantive Plan
The terms of the postretirement benefit plan as understood by
an employer that provides postretirement benefits and the
employees who render services in exchange for those
benefits. The substantive plan is the basis for the
accounting for that exchange transaction. In some situations
an employer’s cost-sharing policy, as evidenced by past
practice or by communication of intended changes to a plan’s
cost-sharing provisions, or a past practice of regular
increases in certain monetary benefits, may indicate that
the substantive plan differs from the extant written
plan.
Systematic Risk
The common risk shared by an asset or a liability with the
other items in a diversified portfolio. Portfolio theory
holds that in a market in equilibrium, market participants
will be compensated only for bearing the systematic risk
inherent in the cash flows. (In markets that are inefficient
or out of equilibrium, other forms of return or compensation
might be available.) Also referred to as nondiversifiable
risk.
Trading
An activity involving securities sold in the near term and
held for only a short period of time. The term trading
contemplates a holding period generally measured in hours
and days rather than months or years. See paragraph
948-310-40-1 for clarification of the term trading for a
mortgage banking entity.
Trading Purposes
The determination of what constitutes trading purposes is
based on the intent of the issuer or holder and shall be
consistent with the definition of trading in paragraph
320-10-25-1(a).
Trading Securities
Securities that are bought and held principally for the
purpose of selling them in the near term and therefore held
for only a short period of time. Trading generally reflects
active and frequent buying and selling, and trading
securities are generally used with the objective of
generating profits on short-term differences in price.
Transaction Costs
The costs to sell an asset or transfer a liability in the
principal (or most advantageous) market for the asset or
liability that are directly attributable to the disposal of
the asset or the transfer of the liability and meet both of
the following criteria:
- They result directly from and are essential to that transaction
- They would not have been incurred by the entity had the decision to sell the asset or transfer the liability not been made (similar to costs to sell, as defined in paragraph 360-10-35-38).
Transaction Price
The amount of consideration to which an entity expects to be
entitled in exchange for transferring promised goods or
services to a customer, excluding amounts collected on
behalf of third parties.
Transfer
Definition 1
The term transfer is used in a broad sense consistent with
its use in FASB Concepts Statement No. 6, Elements of
Financial Statements (such as in paragraph 137), rather than
in the narrow sense in which it is used in Subtopic
860-10.
Definition 2
The conveyance of a noncash financial asset by and to someone
other than the issuer of that financial asset.
A transfer includes the following:
- Selling a receivable
- Putting a receivable into a securitization trust
- Posting a receivable as collateral.
A transfer excludes the following:
- The origination of a receivable
- Settlement of a receivable
- The restructuring of a receivable into a security in a troubled debt restructuring.
Transferee
An entity that receives a financial asset, an interest in a
financial asset, or a group of financial assets from a
transferor.
Transferor
An entity that transfers a financial asset, an interest in a
financial asset, or a group of financial assets that it
controls to another entity.
Transferred Financial Assets
Transfers of any of the following:
- An entire financial asset
- A group of entire financial assets
- A participating interest in an entire financial asset.
Transportation Costs
The costs that would be incurred to transport an asset from
its current location to its principal (or most advantageous)
market.
Troubled Debt Restructuring
A restructuring of a debt constitutes a troubled debt
restructuring if the creditor for economic or legal reasons
related to the debtor’s financial difficulties grants a
concession to the debtor that it would not otherwise
consider.
Trustee
Definition 1
A person appointed by the Bankruptcy Court in certain
situations based on the facts of the case, not related to
the size of the entity or the amount of unsecured debt
outstanding, at the request of a party in interest after a
notice and hearing.
Definition 2
An entity that has a duty to hold and manage assets for the
benefit of a specified beneficiary in accordance with a
charitable trust agreement. In some states, not-for-profit
entities (NFPs) are organized under trust law rather than as
corporations. Those NFPs are not trustees as defined
because, under those statutes, they hold assets in trust for
the community or some other broadly described group, rather
than for a specific beneficiary.
Unallocated Contract
A contract with an insurance entity under which payments to
the insurance entity are accumulated in an unallocated fund
(not allocated to specific plan participants) to be used
either directly or through the purchase of annuities, to
meet benefit payments when employees retire. Funds held by
the insurance entity under an unallocated contract may be
withdrawn and otherwise invested.
Uncommitted Loans
A mortgage loan that does not meet the specific terms of a
commitment or for which a reasonable doubt exists about the
acceptance of the loan under a commitment.
Unconditional Promise to Give
A promise to give that depends only on passage of time or
demand by the promisee for performance.
Underlying
A specified interest rate, security price, commodity price,
foreign exchange rate, index of prices or rates, or other
variable (including the occurrence or nonoccurrence of a
specified event such as a scheduled payment under a
contract). An underlying may be a price or rate of an asset
or liability but is not the asset or liability itself. An
underlying is a variable that, along with either a notional
amount or a payment provision, determines the settlement of
a derivative instrument.
Underlying Asset
An asset that is the subject of a lease for which a right to
use that asset has been conveyed to a lessee. The underlying
asset could be a physically distinct portion of a single
asset.
Unit of Account
The level at which an asset or a liability is aggregated or
disaggregated in a Topic for recognition purposes.
Unobservable Inputs
Inputs for which market data are not available and that are
developed using the best information available about the
assumptions that market participants would use when pricing
the asset or liability.
Unsystematic Risk
The risk specific to a particular asset or liability. Also
referred to as diversifiable risk.
Value Beyond Proven and Probable Reserves
Value beyond proven and probable reserves is the economic
value that exists in a mining asset beyond the value
attributable to proven and probable reserves. The
distinction between the categories of reserves relates to
the level of geological evidence and, therefore, confidence
in the reserve estimates.
Variable Interest Entity
A legal entity subject to consolidation according to the
provisions of the Variable Interest Entities Subsections of
Subtopic 810-10.
Voluntary Health and Welfare Entity
A not-for-profit entity (NFP) that is formed for the purpose
of performing voluntary services for various segments of
society and that is tax exempt (organized for the benefit of
the public), supported by the public, and operated on a
not-for-profit basis. Most voluntary health and welfare
entities concentrate their efforts and expend their
resources in an attempt to solve health and welfare problems
of our society and, in many cases, those of specific
individuals. As a group, voluntary health and welfare
entities include those NFPs that derive their revenue
primarily from voluntary contributions from the general
public to be used for general or specific purposes connected
with health, welfare, or community services. For purposes of
this definition, the general public excludes governmental
entities when determining whether an NFP is a voluntary
health and welfare entity.
Warranty
A guarantee for which the underlying is related to the
performance (regarding function, not price) of nonfinancial
assets that are owned by the guaranteed party. The
obligation may be incurred in connection with the sale of
goods or services; if so, it may require further performance
by the seller after the sale has taken place.
Appendix D — Titles of Standards and Other Literature
Appendix D — Titles of Standards and Other Literature
AICPA Literature
Accounting and Valuation Guides
Assets Acquired in a
Business Combination to Be Used in Research and Development
Activities
Testing Goodwill for
Impairment
Valuation of
Privately-Held-Company Equity Securities Issued as Compensation
Audit and Accounting Guide
Investment
Companies
Industry Audit Guide
Audits of Voluntary
Health and Welfare Organizations
Technical Questions and Answers
Section 6910.34,
“Application of the Notion of Value Maximization for Measuring Fair Value of
Debt and Controlling Equity Positions”
Section 6910.35, “Assessing
Control When Measuring Fair Value”
FASB Literature
ASC Topics
ASC 205, Presentation of
Financial Statements
ASC 210, Balance
Sheet
ASC 220, Income Statement
— Reporting Comprehensive Income
ASC 230, Statement of
Cash Flows
ASC 235, Notes to
Financial Statements
ASC 250, Accounting
Changes and Error Corrections
ASC 260, Earnings per
Share
ASC 270, Interim
Reporting
ASC 280, Segment
Reporting
ASC 310,
Receivables
ASC 320, Investments —
Debt Securities
ASC 321, Investments —
Equity Securities
ASC 323, Investments —
Equity Method and Joint Ventures
ASC 325, Investments —
Other
ASC 326, Financial
Instruments — Credit Losses
ASC 330,
Inventory
ASC 350, Intangibles —
Goodwill and Other
ASC 360, Property, Plant,
and Equipment
ASC 405,
Liabilities
ASC 410, Asset Retirement
and Environmental Obligations
ASC 420, Exit or Disposal
Cost Obligations
ASC 440,
Commitments
ASC 450,
Contingencies
ASC 460,
Guarantees
ASC 470, Debt
ASC 480, Distinguishing
Liabilities From Equity
ASC 505, Equity
ASC 605, Revenue
Recognition
ASC 606, Revenue From
Contracts With Customers
ASC 610, Other
Income
ASC 710, Compensation —
General
ASC 712, Compensation —
Nonretirement Postemployment Benefits
ASC 715, Compensation —
Retirement Benefits
ASC 718, Compensation —
Stock Compensation
ASC 720, Other
Expenses
ASC 730, Research and
Development
ASC 740, Income
Taxes
ASC 805, Business
Combinations
ASC 810,
Consolidation
ASC 815, Derivatives and
Hedging
ASC 820, Fair Value
Measurement
ASC 825, Financial
Instruments
ASC 830, Foreign Currency
Matters
ASC 835, Interest
ASC 840, Leases
ASC 842, Leases
ASC 845, Nonmonetary
Transactions
ASC 850, Related Party
Disclosures
ASC 852,
Reorganizations
ASC 855, Subsequent
Events
ASC 860, Transfers and
Servicing
ASC 920, Entertainment —
Broadcasters
ASC 926, Entertainment —
Films
ASC 930, Extractive
Activities — Mining
ASC 932, Extractive
Activities — Oil and Gas
ASC 940, Financial
Services — Brokers and Dealers
ASC 942, Financial
Services — Depository and Lending
ASC 944, Financial
Services — Insurance
ASC 946, Financial
Services — Investment Companies
ASC 948, Financial
Services — Mortgage Banking
ASC 950, Financial
Services — Title Plant
ASC 954, Health Care
Entities
ASC 958, Not-for-Profit
Entities
ASC 960, Plan Accounting
— Defined Benefit Pension Plans
ASC 962, Plan Accounting
— Defined Contribution Pension Plans
ASC 965, Plan Accounting
— Health and Welfare Benefit Plans
ASC 970, Real Estate —
General
ASC 972, Real Estate —
Common Interest Realty Associations
ASC 974, Real Estate —
Real Estate Investment Trusts
ASC 985, Software
ASUs
ASU 2009-05, Fair Value
Measurements and Disclosures (Topic 820): Measuring Liabilities at Fair
Value
ASU 2009-12, Fair Value
Measurements and Disclosures (Topic 820): Investments in Certain
Entities That Calculate Net Asset Value per Share (or Its
Equivalent)
ASU 2009-16, Fair Value
Measurements and Disclosures (Topic 820): Accounting for Transfers of
Financial Assets
ASU 2010-06, Fair Value
Measurements and Disclosures (Topic 820): Improving Disclosures About
Fair Value Measurements
ASU 2010-28, Intangibles
— Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill
Impairment Test for Reporting Units With Zero or Negative Carrying
Amounts
ASU 2011-04, Fair Value
Measurement (Topic 820): Amendments to Achieve Common Fair Value
Measurement and Disclosure Requirements in U.S. GAAP and IFRSs
ASU 2012-04, Technical
Corrections and Improvements
ASU 2012-07,
Entertainment — Films (Topic 926): Accounting for Fair Value
Information That Arises After the Measurement Date and Its Inclusion in
the Impairment Analysis of Unamortized Film Costs
ASU 2013-03, Financial
Instruments (Topic 825): Clarifying the Scope and Applicability of a
Particular Disclosure to Nonpublic Entities
ASU 2013-09, Fair Value
Measurement (Topic 820): Deferral of the Effective Date of Certain
Disclosures for Nonpublic Employee Benefit Plans in Update No.
2011-04
ASU 2014-13,
Consolidation (Topic 810): Measuring the Financial Assets and the
Financial Liabilities of a Consolidated Collateralized Financing
Entity — a consensus of the FASB Emerging Issues Task Force
ASU 2015-07, Fair Value
Measurement (Topic 820): Disclosures for Investments in Certain Entities
That Calculate Net Asset Value per Share (or Its Equivalent) — a
consensus of the FASB Emerging Issues Task Force
ASU 2015-10, Technical
Corrections and Improvements
ASU 2016-01, Financial
Instruments — Overall (Subtopic 825-10): Recognition and Measurement of
Financial Assets and Financial Liabilities
ASU 2016-02, Leases
(Topic 842)
ASU 2016-13, Financial
Instruments — Credit Losses (Topic 326): Measurement of Credit Losses on
Financial Instruments
ASU 2016-19, Technical
Corrections and Improvements
ASU 2017-04, Intangibles
— Goodwill and Other (Topic 350): Simplifying the Test for Goodwill
Impairment
ASU 2018-03, Technical
Corrections and Improvements to Financial Instruments — Overall
(Subtopic 825-10): Recognition and Measurement of Financial Assets and
Financial Liabilities
ASU 2018-09, Codification
Improvements
ASU 2018-13, Fair Value
Measurement (Topic 820): Disclosure Framework — Changes to the
Disclosure Requirements for Fair Value Measurement
ASU 2019-01, Leases
(Topic 842): Codification Improvements
ASU 2019-04, Codification
Improvements to Topic 326, Financial Instruments — Credit Losses,
Topic 815, Derivatives and Hedging, and Topic 825, Financial
Instruments
ASU 2019-05, Financial
Instruments — Credit Losses (Topic 326): Targeted Transition
Relief
ASU 2019-06, Intangibles
— Goodwill and Other (Topic 350), Business Combinations (Topic 805), and
Not-for-Profit Entities (Topic 958): Extending the Private Company
Accounting Alternatives on Goodwill and Certain Identifiable Intangible
Assets to Not-for-Profit Entities
ASU 2020-06, Debt — Debt
With Conversion and Other Options (Subtopic
470-20) and Derivatives and Hedging — Contracts in
Entity’s Own Equity (Subtopic 815-40): Accounting
for Convertible Instruments and Contracts in an
Entity’s Own Equity
ASU
2020-07, Not-for-Profit Entities (Topic 958) —
Presentation and Disclosures by Not-for-Profit
Entities for Contributed Nonfinancial
Assets
ASU 2022-02, Financial
Instruments — Credit Losses (Topic 326): Troubled
Debt Restructurings and Vintage
Disclosures
ASU 2022-03, Fair
Value Measurement (Topic 820): Fair Value
Measurement of Equity Securities Subject to
Contractual Sale Restrictions
ASU 2023-05, Business
Combinations — Joint Venture Formations (Subtopic
805-60): Recognition and Initial
Measurement
ASU 2023-08,
Intangibles — Goodwill and Other — Crypto
Assets (Subtopic 350-60): Accounting for and
Disclosure of Crypto Assets
FASB Concepts Statements
No. 7, Using Cash Flow
Information and Present Value in Accounting Measurements
No. 8,
Chapter 4, Elements of Financial
Statements
IFRS Literature
IFRS 9, Financial
Instruments
IFRS 13, Fair Value
Measurement
PCAOB Literature
Auditing
Standard 11, Consideration of Materiality in Planning and
Performing an Audit
SEC Literature
Accounting Series Release (ASR)
No. 118 (FRR Section 404),
Registered Investment Companies
FRM
Topic No. 2, “Other
Financial Statements Required”
Topic No. 9, “Management’s
Discussion and Analysis of Financial Position and Results of Operations
(MD&A)”
Regulation S-K
Item 303, “Management’s
Discussion and Analysis of Financial Condition and Results of
Operations”
Regulation S-X
Rule 3-09, “Separate
Financial Statements of Subsidiaries Not Consolidated and 50 Percent or Less
Owned Persons”
Rule 4-08(g), “General Notes
to Financial Statements; Summarized Financial Information of Subsidiaries
Not Consolidated and 50 Percent or Less Owned Persons”
Article 9, “Bank Holding
Companies”
SAB Topics
No. 1.M, “Financial
Statements; Materiality”
No. 5.S, “Miscellaneous
Accounting; Quasi-Reorganization”
Superseded Literature
EITF Abstracts
Issue
No. 97-14, “Accounting for Deferred Compensation
Arrangements Where Amounts Earned Are Held in a
Rabbi Trust and Invested”
Issue
No. 98-1, “Valuation of Debt Assumed in a Purchase
Business Combination”
Issue
No. 08-5, “Issuer’s Accounting for Liabilities
Measured at Fair Value With a Third-Party Credit
Enhancement”
FASB Concepts Statement
No. 6,
Elements of Financial Statements — a
replacement of FASB Concepts Statement No. 3
(incorporating an amendment of FASB Concepts
Statement No. 2)
FASB Staff Positions (FSPs)
No. FAS 132(R)-1,
Employers’ Disclosures About Postretirement
Benefit Plan Assets
No. FAS 157-1,
Application of FASB Statement No. 157 to FASB
Statement No. 13 and Other Accounting
Pronouncements That Address Fair Value
Measurements for Purposes of Lease Classification
or Measurement Under Statement 13
No. FAS 157-2, Effective
Date of FASB Statement No. 157
No. FAS 157-3,
Determining the Fair Value of a Financial Asset
When the Market for That Asset Is Not
Active
No. FAS 157-4,
Determining Fair Value When the Volume and Level
of Activity for the Asset or Liability Have
Significantly Decreased and Identifying
Transactions That Are Not Orderly
FASB Statements
No. 107, Disclosures
About Fair Value of Financial Instruments
No. 155, Accounting for
Certain Hybrid Financial Instruments — an amendment of FASB
Statements No. 133 and 140
No. 157, Fair Value
Measurements
No. 159, The Fair Value
Option for Financial Assets and Financial Liabilities
Appendix E — Abbreviations
Appendix E — Abbreviations
|
Abbreviation
|
Description
|
|---|---|
|
AICPA
|
American Institute of Certified Public Accountants
|
|
AOCI
|
accumulated other comprehensive income
|
|
APIC
|
additional paid-in capital
|
|
ARO
|
asset retirement obligation
|
|
ASC
|
Accounting Standards Codification
|
|
ASR
|
SEC Accounting Series Release
|
|
ASU
|
Accounting Standards Update
|
|
CD
|
certificate of deposit
|
|
CFE
|
collateralized financing entity
|
|
CSV
|
cash surrender value
|
|
CUSIP
|
Committee on Uniform Securities
Identification Procedures
|
|
CVA
|
credit valuation adjustment
|
|
EBITDA
|
earnings before income taxes, depreciation, and
amortization
|
|
EITF
|
FASB Emerging Issues Task Force
|
|
EPD
|
early payment default
|
|
EPS
|
earnings per share
|
|
ESOP
|
employee stock ownership plan
|
|
FASB
|
Financial Accounting Standards Board
|
|
FBRIC
|
fully benefit-responsive investment contract
|
|
FDIC
|
Federal Deposit Insurance Corporation
|
|
FRM
|
SEC Division of Corporation Finance’s Financial Reporting
Manual
|
|
FVO
|
fair value option
|
|
GAAP
|
generally accepted accounting principles
|
|
GP
|
general partner
|
|
HFS
|
held for sale
|
|
HKEx
|
Hong Kong Exchange
|
|
IASB
|
International Accounting Standards Board
|
|
IFRS
|
International Financial Reporting Standard
|
|
IPO
|
initial public offering
|
|
LIBOR
|
London Interbank Offered Rate
|
|
LP
|
limited partner
|
|
M&A
|
mergers and acquisitions
|
|
MD&A
|
Management’s Discussion and Analysis
|
|
MMBtu
|
million Btu
|
|
MW
|
megawatts
|
|
Nasdaq
|
National Association of Securities Dealers Automated
Quotations
|
|
NAV
|
net asset value
|
|
NFP
|
not for profit
|
|
NYSE
|
New York Stock Exchange
|
|
OCI
|
other comprehensive income
|
|
OTC
|
over the counter
|
|
PCAOB
|
Public Company Accounting Oversight Board
|
|
PP&E
|
property, plant, and equipment
|
|
RMBS
|
residential mortgage-backed security
|
|
SEC
|
U.S. Securities and Exchange Commission
|
|
TAB
|
tax amortization benefit
|
|
VIE
|
variable interest entity
|
Appendix F — Roadmap Updates for 2024
Appendix F — Roadmap Updates for 2024
The table below summarizes the
substantive changes made in the 2024 edition of this Roadmap.
|
Section
|
Title
|
Description
|
|---|---|---|
|
General — Measurement
|
Added Changing
Lanes to acknowledge the issuance of ASU
2023-05 and ASU 2023-08.
| |
|
Changes in the Principal or Most
Advantageous Market
|
Addressed comments made by SEC staff at the
2023 AICPA Conference on Current SEC and PCAOB
Developments.
| |
|
Creditor’s Evaluation
|
Removed superseded guidance and references
to troubled debt restructurings for creditors.
|