United States

Audit and Enterprise Risk Services

Financial Reporting Considerations Related to Implementation of Fair Value Measurement Disclosures Required by ASU 2010-06

Financial Reporting Alert 10-5

April 9, 2010

Background

In January 2010, in response to requests from financial statement users for additional information about fair value measurements, the FASB issued ASU 2010-06,¹ which amends ASC 820² (formerly Statement 157³). Certain provisions of ASU 2010-06, including those addressed in this alert, are effective for interim and annual periods beginning after December 15, 2009; thus, for calendar-year-end entities subject to quarterly reporting requirements, the provisions are effective for the interim period ending March 31, 2010.

We have recently received several implementation questions about ASU 2010-06. The purpose of this alert is to address some high-level considerations in response to these questions and to highlight some of the key changes resulting from ASU 2010-06. This alert discusses the following:⁴

·       Transfers between Levels 1, 2, and 3 of the fair value hierarchy. 

·       Level of disaggregation of derivative contracts for fair value measurement disclosures. 

·       Disclosures about fair value measurement inputs and valuation techniques.

Each of these issues is discussed in more detail below. Engagement teams with specific questions about the alert or other implementation questions regarding ASU 2010-06 are encouraged to consult with specialists, including Financial Instruments & Valuation Subject Matter Resources, professionals in the accounting advisory group within Financial Accounting & Reporting Services (FA&RS), or professionals in National Office — Accounting Consultation. Clients are encouraged to consult with their Deloitte engagement partner.

Transfers Between Levels — New Requirements for Timing of Transfer Recognition

Before the effective date of ASU 2010-06, ASC 820 only required disclosures about transfers into and out of Level 3 for recurring fair value measurements as part of the Level 3 reconciliation of beginning and ending balances. The ASU 2010-06 amendments expand these disclosure requirements to include all three levels of the fair value hierarchy. Specifically, a reporting entity is now required to disclose separately the amounts of, and reasons for, significant transfers (1) between Level 1 and Level 2 of the fair value hierarchy and (2) into and out of Level 3 of the fair value hierarchy for the reconciliation of Level 3 measurements.

In addition, under the amendments made by ASU 2010-06, a reporting entity is no longer permitted to adopt a policy of recognizing transfers into Level 3 as of the beginning of the reporting period and transfers out of Level 3 as of the end of the reporting period. Rather, an entity must disclose and follow a consistent policy for determining when transfers between levels are recognized. ASC 820-10-50-2(bb)⁵ states, in part:

A reporting entity shall disclose and consistently follow its policy for determining when transfers between levels are recognized. The policy about the timing of recognizing transfers shall be the same for transfers into the levels as that for transfers out of the levels. Examples of policies for when to recognize the transfers are as follows:

1.   The actual date of the event or change in circumstances that caused the transfer

2.   The beginning of the reporting period

3.   The end of the reporting period. [Emphasis added]

Further, a reporting entity that changes its policy for the timing of transfers into and out of Level 3 as a result of ASU 2010-06 should follow the ASU’s transition provision that requires prospective application in the period of initial adoption. That is, previous approaches for determining the timing of transfer recognition do not need to be recast for comparative reporting purposes. However, a reporting entity’s policy description should highlight the change in policy so that financial statement users understand that transfers into and out of Level 3 may not be comparable with prior periods. In periods after initial adoption, comparative disclosures are required.

Level of Disaggregation of Derivative Contracts for Fair Value Measurement Disclosures — ASC 815  Contract Type May Differ From Class

Questions have recently arisen regarding the level of disaggregation for derivative contracts — more specifically, whether the level of disaggregation for disclosures under ASC 820 (as amended by ASU 2010-06) is the same as that for disclosures under ASC 815 (formerly Statement 133⁶).⁷

ASC 820-10-50-2⁸ states, in part:

[T]he reporting entity shall disclose all of the [fair value disclosure information] in (a) through (e) for each interim and annual period separately for each class of assets and liabilities. The reporting entity shall determine appropriate classes of assets and liabilities on the basis of guidance in the following paragraph. It shall provide sufficient information to permit reconciliation of the fair value measurement disclosures for the various classes of assets and liabilities to the line items in the statement of financial position.

Moreover, ASC 820-10-50-2A provides guidance on determining classes of assets and liabilities, stating, in part:

For all other assets and liabilities, judgment is needed to determine the appropriate classes of assets and liabilities for which disclosures about fair value measurements should be provided. Fair value measurement disclosures for each class of assets and liabilities often will require greater disaggregation than the reporting entity’s line items in the statement of financial position. A reporting entity shall determine the appropriate classes for those disclosures on the basis of the nature and risks of the assets and liabilities and their classification in the fair value hierarchy (that is, Levels 1, 2, and 3). In determining the appropriate classes for fair value measurement disclosures, the reporting entity shall consider the level of disaggregated information required for specific assets and liabilities under other Topics. For example, under Topic 815, disclosures about derivative instruments are presented separately by type of contract such as interest rate contracts, foreign exchange contracts, equity contracts, commodity contracts, and credit contracts. The classification of the asset or liability in the fair value hierarchy also shall affect the level of disaggregation because of the different degrees of uncertainty and subjectivity involved in Level 1, Level 2, and Level 3 measurements. For example, the number of classes may need to be greater for fair value measurements using significant unobservable inputs (that is, Level 3 measurements) to achieve the disclosure objectives because Level 3 measurements have a greater degree of uncertainty and subjectivity. [Emphasis added]

Consequently, questions have arisen about how the term “class,” as discussed in ASC 820, compares with the term “type of contract” used for the ASC 815 tabular disclosures. In supporting its judgments about the determination of class for its derivative contracts, a reporting entity should consider the type of derivative contracts it holds (i.e., the level of disaggregation required for the ASC 815 tabular disclosures). However, as described in ASC 820-10-50-2A, class is based on the nature and risks of the derivatives and their classification in the hierarchy and is often at a greater level of disaggregation than the reporting entity’s line items in the statement of financial position. Therefore, in determining the nature and risks of its derivative contracts, a reporting entity should consider the following factors (in addition to type of contracts): the valuation techniques and inputs used to determine fair value, the classification in the fair value hierarchy, and the level of disaggregation in the statement of financial position. A reporting 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.

For equity and debt securities, ASC 320-10-50-1B provides guidance on class determination and provides useful general considerations for assessing nature and risks. On the basis of those requirements, we believe concentrations are likely to be key considerations in the class determination for all assets and liabilities within the scope of the ASU. For example, a reporting entity that engages in material commodity transacting may consider concentrations in areas such as commodity type, or a reporting entity with a material foreign exchange portfolio may consider concentrations by discrete currencies.

In summary, the classes of derivative contracts under the ASC 820 disclosures may differ from the “type of contracts” used for the ASC 815 tabular disclosures. Depending on the facts and circumstances, class may be more disaggregated than “type of contract” but generally should not be more condensed.

Disclosures About Fair Value Measurement Inputs and Valuation Techniques — Quantitative Information About Inputs

Various constituents have asked whether ASC 820 now requires entities to disclose quantitative information about inputs.

ASC 820, as amended by ASU 2010-06, requires a reporting entity to provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements in Level 2 or Level 3 of the fair value hierarchy and for each class of assets and liabilities.

In addition, ASC 820-10-50-2(e)⁹ states that entities must disclose:

For fair value measurements using significant other observable inputs (Level 2) and significant unobservable inputs (Level 3), a description of the valuation technique (or multiple valuation techniques) used, such as the market approach, income approach, or the cost approach, and the inputs used in determining the fair values of each class of assets or liabilities. If there has been a change in the valuation technique(s) (for example, changing from a market approach to an income approach or the use of an additional valuation technique), the reporting entity shall disclose that change and the reason for making it. For examples of disclosures that a reporting entity may present to comply with the requirement to disclose the inputs used in measuring fair value in this paragraph, see paragraphs 820-10-55-22A through 55-22B.

ASC 820-10-55-22A states, in part:

Examples of disclosures that the reporting entity may present to comply with the input disclosure requirement of paragraph 820-10-50-2(e) include the following:

a.     Quantitative information about the inputs, for example, for certain debt securities or derivatives, information such as, but not limited to, prepayment rates, rates of estimated credit losses, interest rates (for example, LIBOR swap rate) or discount rates, and volatilities.

From the above ASC 820 guidance, as amended by ASU 2010-06, and informal feedback received from the FASB staff, one can conclude that a reporting entity is not required to disclose quantitative information about inputs. However, in many instances, a reporting entity may conclude that such information is appropriate. This determination will be based on the reporting entity’s evaluation of what types of input disclosures enable financial statement users to assess the entity’s valuation techniques and inputs.¹⁰ In preparing its disclosures about inputs, a reporting entity should follow the above-cited guidance from ASC 820-10-50-2(e). In other words, the discussion of inputs is expected to vary by class of assets or liabilities, level in the fair value hierarchy, and the valuation technique(s) used. Likewise, we also believe that there should be some degree of consistency between the items discussed in the narrative about inputs and valuation techniques and the class determination discussed earlier in this alert.  For example, disclosure about inputs specific to a certain commodity type (e.g., average tenor and geographic concentration for natural gas positions) may suggest that the commodity type should represent a class of its own.

__________________

1   FASB Accounting Standards Update No. 2010-06, Improving Disclosures About Fair Value Measurements.

2   For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”

3   FASB Statement No. 157, Fair Value Measurements.

4   This alert does not address all amendments required by ASU 2010-06. For a complete discussion of the amendments, readers are encouraged to refer to the ASU itself as well as to Deloitte’s January 22, 2010, Heads Up.

5   ASC 820-10-50-2(bb) specifically relates to transfers between Level 1 and Level 2 of the fair value hierarchy. However, note that the guidance in ASC 820-10-50-2(bb) is consistent with the guidance in ASC 820-10-50-2(c)(3) on transfers into and out of Level 3.

6   FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.

7   A detailed discussion of the disclosure requirements of ASC 815 (as amended by FASB Statement No. 161, Disclosures About Derivative Instruments and Hedging Activities) is beyond the scope of this alert. Subscribers to Technical Library: The Deloitte Accounting Research Tool are encouraged to refer to Deloitte’s interpretive guidance on derivative disclosures.

8   ASC 820-10-50-2 specifically relates to assets and liabilities measured at fair value on a recurring basis. However, note that the guidance on the determination of class and the disclosures about inputs and valuation techniques is consistent for recurring and nonrecurring fair value measurements.

9   See footnote 8.

10 This disclosure objective is referred to in ASC 820-10-50-1 (for recurring fair value measurements) and ASC 820-10-50-5 (for nonrecurring fair value measurements).