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by Marshall Harvey, CPA, CFE
Additional Disclosure Requirements for Fair Value Measurement
In May 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The primary purpose of this update is to clarify existing fair value measurement guidance and achieve common fair value measurement and disclosure requirements in United States Generally Accepted Accounting Principles and International Financial Reporting Standards. The most significant new guidance requires entities that measure assets and liabilities at fair value to include additional disclosures about their valuation processes and the interrelationships between significant unobservable (Level 3) inputs used in these processes.
By nature, private equity and venture capital funds invest in securities and instruments of private companies that are categorized within Level 3 of FASB’s fair value hierarchy. ASU 2011-04 clarifies that a reporting entity should disclose quantitative information about the significant unobservable inputs and assumptions used to measure fair value for Level 3 investments. This is now an explicit requirement which will be most burdensome for investment funds that hold investments whose valuations are based on models with significant unobservable inputs. Management of private equity and venture capital funds should ensure that the appropriate time and resources are given to develop these disclosures in advance of the preparation of its year-end financial statements.
Best practices will be to present the quantitative information in a tabular format by investment class. For example, if a private equity or venture capital fund holds investments in a particular industry sector, the tabular disclosure may include the valuation technique used for that class of investments (such as discounted cash flow) and a listing of each unobservable input including a weighted average range for each input used (such as the weighted cost of capital, long-term revenue growth rate, discount for lack of marketability, control premium, etc.). The disclosure requirements also include qualitative information on how the entity determines its valuation policies and procedures, and a discussion of the changes in fair value measurements from year to year. An entity is not required to create and report on quantitative information if it doesn’t develop the quantitative inputs in measuring fair value. Prices of prior transactions and the use of net asset value as a practical expedient are examples of significant unobservable inputs that are not developed by the entity. Entities that use these inputs would not be required to quantify these inputs and assumptions for these investments even though they may be Level 3 investments.
The following is an example of the recommended tabular disclosure of quantitative information for Level 3 fair value measurements:
Effective Date
ASU 2011-04 is effective for non-public entities for annual periods beginning after December 15, 2011.
Exemptions for Non-Public Entities
Some specific provisions of ASU 2011-04 are not required for recurring fair value measurements of non-public entities. These provisions include:
- Information about transfers between Level 1 and Level 2 of the fair value hierarchy
- Information about the sensitivity of Level 3 securities to changes in significant unobservable inputs
Additional ASU 2011-04 Clarifications
ASU 2011-04 also clarifies that the use of blockage factors is prohibited for all levels in the fair value hierarchy.
Blockage factors are:
- Adjustments to fair value based on the size of the entity’s position,
- Deemed to arise from entity-specific decisions, and
- Are not considered by a market participant.
Control premiums and noncontrolling interest discounts, on the other hand, can be considered for Level 2 and 3 investments when consistent with marketplace assumptions for the given unit of account.
We Can Help
These new disclosure requirements could have a significant impact on your entity’s financial statements. Decosimo’s investment fund specialists can advise you on compliance with these new requirements. Contact one of our team leaders if you have questions or would like to discuss these new requirements further.
Marshall Harvey, CPA, CFE
Assurance Principal, Chattanooga Office
Robert Belcher, CPA
Assurance Principal, Chattanooga Office
Brad East, CPA
Assurance Principal, Cincinnati Office
John Murray, CPA
Assurance Principal, Cincinnati Office
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