FASB Issues ASU No. 2022-03, Amends Fair Value Guidance in U.S. GAAP
August 18, 2022
By John Regan
For investment managers, when it comes time for financial reporting, there is often one area that is paramount -- measuring the fair value of investments held. This area is generally the most meaningful as it has a direct effect on the computation of net asset value and therefore impacts two areas that are important to both current and prospective investors: performance and fees.
It is important for investment managers to consider all relevant facts when measuring fair value, and it is just as important for investment managers to have proper guidance from the accounting literature, especially for certain scenarios that are more subjective.
One such area was, until recently, measuring the fair value of an equity security that was subject to contractual restrictions preventing the holder from selling those securities. There had been diversity in practice in how an entity measured the fair value of an equity security when the security is subject to a contractual restriction prohibiting the sale for a period of time. One of the primary reasons for the diversity in practice was a result of a previous illustrative example that the Financial Accounting Standards Board (“FASB”) issued. This example led some investment managers to apply a discount to the price of an equity security that was subject to contractual restrictions, whereas other investment managers did not consider a discount to be appropriate under the fair value principles in U.S. generally accepted accounting principles (“U.S. GAAP”).
Given the importance of comparability of financial information across reporting entities, the FASB in June 2022 issued Accounting Standards Update (“ASU”) No. 2022-03, which amends the fair value guidance in U.S. GAAP. The goal of the update is to increase comparability of financial information by clarifying that a contractual sale restriction on the holder of the equity security is not considered part of the unit of account of the equity security itself and, therefore, should not be considered in measuring fair value. On the other hand, if a contractual restriction on sale applies to the equity security itself (as opposed to the holder of the equity security), then it is appropriate to consider that contractual restriction in measuring fair value.
Additionally, the update introduces new disclosure requirements and amends the previous illustrative example that gave rise to the diversity in practice.
ASU 2022-03 requires three new disclosures for equity securities subject to contractual restrictions:
- The fair value of equity securities subject to contractual sale restrictions reflected in the balance sheet.
- The nature and remaining duration of the restriction(s).
- Any circumstances that could cause a lapse in the restriction(s).
If the equity security is restricted for sale because it has been pledged as collateral, the disclosures above do not apply.
When complying with the above disclosure requirements, a reporting entity should consider 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, and whether users of financial statements need additional information to evaluate the information disclosed.
Effective Dates and Transition Requirements
For entities that are investment companies under ASC Topic 946, amendments from this ASU should be applied as follows:
- For 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 of adoption, prospectively.
- An equity security subject to a contractual sale restriction that was executed before the date of adoption should continue to be accounted for using the accounting policy applied before the adoption of this ASU until the contractual restrictions expires or is modified.
The reason the FASB concluded that investment companies should have specialized transition guidance was because the FASB “wanted to avoid introducing nonmarket-based volatility that would disproportionately affect transaction values on the date of adoption if investment companies applied the amendments to all equity securities on the date of adoption.”
For private entities that do not meet the definition of an investment company under ASC Topic 946, the amendments in this ASU should be made prospectively and any adjustments from the amendments should be recognized in earnings and disclosed on the date it was adopted.
For public entities, the effective date is for fiscal years beginning after December 15, 2023, and all interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2024, and all interim periods within those fiscal years. Early adoption is permitted for all financial statements (interim and annual) that have not yet been issued.
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