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Asset Management Update: FASB Modifies Fair Value Disclosure Requirements

ASU 2018-13 significantly reduces disclosure requirements related to level 3 investments held by private investment companies

Introduction

In August 2018, the Financial Accounting Standards Board issued Accounting Standards Update No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.i This update is part of the FASB’s larger disclosure framework project intended to improve the effectiveness of financial statement footnote disclosure.  ASU 2018-13 modifies required fair value disclosures related primarily to level 3 investments.  The ASU impacts non-publicii and public entities differently; a summary of changes to disclosure requirements categorized by nonpublic and public entities is presented below.
    
Nonpublic Entities (including private investment companies such as hedge and private equity funds):

Disclosure Removals

  • Valuation process for level 3 measurements.

    Insight: Specifically, the ASU deletesiii ASC  820-10-55-105, which required a description of the group responsible for valuation policies and procedures, its methods of calibration and back testing, its process for analyzing changes in fair value measurements, its process for analyzing third-party information used in valuation, and its methods used to develop and substantiate unobservable inputs.

  • Policy regarding the timing of transfers between levels in the fair value hierarchy.

    Insight: ASU 2018-13 eliminates the requirement to disclose this policy, however, entities will still be required to set and consistently follow a policy on transfer timing (typically (a) the date of the event or change in circumstances that caused the transfer, (b) the beginning of the reporting period or (c) the end of the reporting period).

  • Changes in unrealized gains and losses for Level 3 fair value measurements still held at the end of the period.

    Insight: Previously, this disclosure was often presented as a supplement to the “level 3 roll-forward” table.

Disclosure Modifications

  • In lieu of a reconciliation of opening and closing balances “roll-forward” of level 3 fair value measurements, disclosure is required of transfers into and out of level 3 of the fair value hierarchy and purchases and issues of Level 3 assets and liabilities.

    Insight: Each of the elements noted above, purchases, issues, transfers in, and transfers out must be disclosed separately under the ASU.  Similar to existing GAAPiv , the reasons for transfers into or out of level 3 must also be disclosed.

  • For investments valued using the practical expedient (unadjusted net asset value), the requirements to disclose (1) an estimate of the timing of liquidity events of the investee and (2) the timing on when limitations on redemptions related to the investee may lapse only apply if the investee has already disclosed this information publicly or directly to the reporting entity.

    Insight: This modification eliminates the need for entities to make its own estimate on timing of such events. Disclosure is now required only if it is known.

  • Deletion of the words “at a minimum” from the phrase “an entity shall disclose at a minimum” throughout the guidance to promote the appropriate exercise of discretion by entities when considering fair value measurement disclosures and to clarify that materiality is an appropriate consideration of entities and their auditors when evaluating disclosure requirements.

    Insight: Disclosure of weighted average and range of unobservable (level 3) inputs for nonpublic entities

    Prior to ASU 2018-13, all entities were required to provide quantitative information about significant unobservable inputs for level 3 fair value measurements.  This has not changed under the ASU.  General practice for investment companies has developed such that the range and weighted average of unobservable inputs are generally disclosed to comply with this requirement.  As discussed below, the ASU added an explicit requirement for public entities to disclose range and weighted average of unobservable inputs.  Non-public entities are exempt from this specific requirement, however, the requirement to provide quantitative information about unobservable inputs remains.  Entity management must use judgement in determining the most appropriate quantitative information about unobservable inputs to disclose going forward.

Public Entities (Including 1940 Act mutual funds, BDCs and broker-dealers)

Disclosure Additions

  • Explicit requirement to 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.  Other quantitative information (such as the median or arithmetic average) may be disclosed in lieu of the weighted average if it is determined to be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop level 3 fair value measurements.

  • Changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period

    Insight: Investment companies will not be significantly impacted by this requirement as under ASC 946, they recognize unrealized gains and losses related to investments on the income statement, not a statement of other comprehensive income.

Disclosure Removals

  • Details on transfers between Level 1 and Level 2 of the fair value hierarchy.

    Insight: Note that nonpublic entities are exempt from this requirement under current GAAP and ASU 2018-13.

  • Policy regarding the timing of transfers between levels in the fair value hierarchy.

  • Valuation process for Level 3 measurements.

Disclosure Modifications

  • For investments valued using the practical expedient (net asset value), the requirements to disclose (1) an estimate of the timing of liquidity events of the investee and (2) the timing on when limitations on redemptions related to the investee may lapse only apply if the investee has already disclosed this information publicly or directly to the reporting entity.

  • Deletion of the words “at a minimum” from the phrase “an entity shall disclose at a minimum” throughout the guidance to promote the appropriate exercise of discretion by entities when considering fair value measurement disclosures and to clarify that materiality is an appropriate consideration of entities and their auditors when evaluating disclosure requirements.

  • Clarification that the measurement uncertainty disclosure is to communicate information about the uncertainty in measurement as of the reporting date rather than sensitivity to future changes in fair value.

    Insight: Note that nonpublic entities are exempt from this requirement under current GAAP and ASU 2018-13.


Effective Date and Transition

ASU 2018-13 is effective for all entities for annual periods beginning after December 15, 2019 and interim periods within those annual periods.  Early adoption is permitted.  Entities are permitted to early adopt any removed or modified disclosures and delay adoption of additional disclosures until their effective date.

The prospective method of adoption is required for additional or modified disclosures related to (1) changes in unrealized gains or losses included in OCI, (2) range and weighted average for significant inputs to level 3 investments and (3) uncertainty in measurement as of the reporting date.  All other disclosure changes resulting from the ASU should be applied retrospectively.


i   Hereafter referred to as the “ASU” or “ASU 2018-13”
ii  A “Nonpublic entity” is an entity that does not meet any of the following conditions:

  1. 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.
  2. 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).
  3. It files with a regulatory agency in preparation for the sale of any class of debt or equity securities in a public market.
  4. It is required to file or furnish financial statements with the Securities and Exchange Commission.
  5. It is controlled by an entity covered by criteria (a) through (d)

iii  Accounting Standards Codification
iv  Generally Accepted Accounting Principles


Asset Management Intelligence – Q4 2018

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Matthew Maulbeck has accounting, financial reporting and auditing expertise with public and private companies in the financial services, real estate, retail and pharmaceutical industries, including SEC rules and regulations and reviewing SEC filings.

Melissa Miro is a Financial Services Group Senior Audit Manager focusing on hedge funds and funds of funds.