Proposed Amendment to FASC Topic 820 Fair Value Measurements
The FASB and the IASB both issued exposure drafts on Fair Value Measurements. If adopted this proposed ASU will more closely converge US GAAP with IFRS. No proposed effective date has been set yet, but comments are due by September 7, 2010.
The main provisions of the proposed ASU are:
- Allowing offsetting of certain financial instruments when calculating fair value.
- Requiring an uncertainty analysis around the inputs to Level 3 inputs.
- Requiring disclosure of the fair value level for financial instruments not recorded at fair value. (I.e. our debt would be added to the hierarchy tables in the footnotes.)
- Highest and best use premise only for non-financial assets.
- Fair value of instruments classified in equity should be based on market participant assumptions.
- Clarification of blockage factors and other premiums and discounts.
1. Allowing offsetting of certain financial instruments when calculating fair value.
This proposed amendment would give an exception to those entities that manage certain market risks (pricing, interest rate or credit) on a net basis. For example: whether they are in a net long position (asset) or a net short position (liability). This comes into play when the bid-ask spread is being used to determine fair value. A net long position would use the bid price, while the net short position would use the ask price. This proposed amendment would also allow an entity to take into account its entire position with a counterparty when determining a credit risk valuation adjustment.
2. Requiring an uncertainty analysis around the inputs to Level 3 inputs.
Since Level 3 inputs are inherently subjective, an analysis of the uncertainty around the inputs would be required to be disclosed. An entity would be required to discuss what different inputs could have been used, if, those inputs would have caused a significant difference in the fair value of the instrument. An entity would not have to make an exhaustive search for different inputs and would only disclose those inputs that it reasonably would have used. The disclosure is only required for recurring fair value measurements. (As opposed to non-recurring measurements such as AROs or impairment analysis.)
3. Requiring disclosure of the fair value level for financial instruments not recorded at fair value.
This amendment would update FASC Topic 825 Financial Instruments. It requires the fair value of all financial instruments to be disclosed by Hierarchy Level. This includes financial instruments recorded at amortized cost, such as debt. Previously these were excluded from the FASC Topic 820 disclosures.
4. Highest and best use premise only for non-financial assets.
This amendment clarifies the Board’s position that the highest and best use premise is for non-financial assets. Financial assets and liabilities often do not have alternative uses and are generally not valued within the context of a group. A non-financial asset can either be used by itself or in combination with other related assets and liabilities. For example a video game is more valuable when combined with the related game console. Neither the video game nor the game console can be used by itself. The two assets must be used in combination.
5. Fair value of instruments classified in equity should be based on market participant assumptions.
This amendment clarifies that financial instruments classified in equity (such as equity interest issued as consideration in a business combination) should be measured at fair value using the exit price from the perspective of a market participant who holds the equity instrument as an asset (investment). This would not include share-based compensation recorded in equity since share-based compensation is not measured at fair value and is scoped out of FASC Topic 820. (Share-based compensation recorded in equity is measured at grant-date fair value per the guidance in FASC Topic 718.)
6. Clarification of blockage factors and other premiums and discounts.
This amendment clarifies that a blockage factor (discount for a large volume of an asset being bought or sold at the same time) is excluded from fair value measurements, regardless of the classification of the fair value measurement. Previous guidance did not specify whether a blockage factor could be used for Level 2 or Level 3 inputs.
This amendment also clarifies that other premiums and discounts (control premium or non-controlling interest discount) should be taken into account when determining fair value if a market participant would use the premium or discount when calculating fair value.
For most companies, these changes will not be significant. If any of them are a big concern in your company, take the time to write a comment letter and send it to the FASB.
Linda is a CPA living in Southwestern Ohio, working as a research accountant for an investor-owned publicly traded utility company. She specializes in implementing new FASB and SEC requirements and FAS 133 derivative issues. In her role at the utility she has encountered many issues and written many memos, so send in your implementation and derivative issues and Linda will help figure out an answer.