In December 2015, the Financial Accounting Standards Board (FASB) released a proposal intended to improve financial statement disclosures about the estimates used to determine the fair values of assets and liabilities. After an almost two-year lull, the FASB resumed its deliberations on this project and, in March 2018, voted to approve its 2015 proposal. Here’s a closer look at fair value and how the requirements for reporting fair value will change under the updated standard.
Fair value hierarchy
Accounting Standards Codification (ASC) Topic 820, Fair Value Measurements and Disclosures, defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly market transaction, as opposed to a fire sale or other unusual circumstance.” It spells out how businesses should estimate the fair value of assets and liabilities by using available, quantifiable data such as market prices and also judgments and estimates.
Fair value measurements are separated into the following three-tier hierarchy depending on the judgment used:
Typically, valuation professionals or other specialists are brought in to determine the fair value of an asset or liability. The securities industry often uses third-party pricing services for instruments that don’t have an active trading market.
Need for change
In December 2015, the FASB released Proposed Accounting Standards Update (ASU) No. 2015-350, Fair Value Measurement (Topic 820): Disclosure Framework — Changes to the Disclosure Requirements for Fair Value Measurement. The proposal aimed to improve the footnote disclosures under ASC 820 by eliminating requirements considered to be redundant and adding requirements for more details about assets that are difficult to value.
Auditors, analysts and businesses told the FASB that certain fair value disclosures were no longer useful. Examples include disclosures about the policy for timing the transfers between levels, the valuation processes for Level 3 fair value measurements, and the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy. In February, the FASB agreed to erase these disclosures.
The FASB had a harder time coming to a consensus on provisions that would add to the disclosure requirements. FASB members spent significant time discussing investor views of so-called “rollforwards” of information about fair value measurements.
ASC 820 requires a business with recurring Level 3 fair value measurements to present a reconciliation of the opening balances to the closing balances and a separate disclosure of the total gains or losses for the period recognized in earnings or comprehensive income. Purchases, sales and settlements, along with the amounts of the transfers in or out of Level 3, also have to be disclosed.
Investors told the FASB that they would like to see the information that’s provided for Level 3 instruments also made available for Level 2 and Level 1 measurements, especially for banks and other financial institutions. Businesses and auditors, on the other hand, said this would be onerous to provide, in part because companies hold significantly higher volumes of assets classified under Levels 1 and 2 of the fair value hierarchy.
In March, the FASB decided to retain the information just for Level 3 measurements. After weighing the pros and cons, a majority of the FASB opposed industry-specific fair value measurement disclosure rules for financial institutions.
FASB member Harold Schroeder plans to dissent from the final amendment. In his view the FASB missed an opportunity to require businesses — financial institutions, in particular — to provide more details about certain hard-to-value instruments. For investors, the information is crucial during a recession or market crisis.
Work in progress
The updated fair value disclosure requirements go into effect for all businesses for fiscal years and interim periods that start after December 15, 2019. However, early adoption is permitted.
This project is part of the FASB’s broader effort to reduce so-called “disclosure overload.” In addition to establishing an internal guide to help set consistent disclosure requirements, the FASB is currently examining the existing disclosure requirements for defined benefit plans, income taxes and inventory.