The Disclosure at Issue
In May 2011, in conjunction with the International Accounting Standards Board (IASB), FASB issued new standards for public and private companies on fair value measurement and disclosures. The standards were part of an effort to achieve common fair value measurement and disclosure requirements in U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
Among other things, the standards — found in ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs — describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements.
In particular, the guidance in the ASU amended Accounting Standards Codification (ASC) Section 825-10-50-10(d), which addresses the disclosure of the fair value of financial instruments in an entity’s balance sheet, to require the disclosure of the level of the “fair value hierarchy” within which the fair value measurements for an instrument are categorized.
The fair value hierarchy identifies three levels of assets and liabilities, with the level of required disclosures essentially increasing as the associated valuations become less reliable:
- Level 1 assets and liabilities are valued according to a quoted price in an active market, generally without any adjustments.
- Level 2 assets and liabilities are valued based on “observable inputs” other than quoted active market prices, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, and interest rates and yield curves.
- Level 3 assets and liabilities are valued based on “unobservable inputs,” such as a company’s own estimates and pricing models.
Because Level 3 assets and liabilities can’t easily be sold in active markets, they’re difficult to value. So their fair values are less reliable than the fair values of Level 1 assets and liabilities and could undermine the reliability of financial statements. These risky and illiquid assets and liabilities, therefore, are subject to the most expansive disclosure requirements.
FASB’s Intent vs. Reality
In developing the amendments in ASU 2011-04, FASB concluded that some of the disclosures shouldn’t be required of nonpublic entities because of the characteristics of the users of their financial statements. It considered, for example, the ability of those users to access information about the financial positions of nonpublic entities and the relevance to those users of the information that would be disclosed.
At a public meeting before the release of ASU 2011-04, FASB expressed its explicit intent that the guidance in the ASU exempt all nonpublic entities from the disclosure required in ASC Section 825-10-50-10(d). In December 2012, however, several stakeholders raised concerns about the amendments. They pointed out that the cross-referencing between ASC Topic 820 and ASC Topic 825 was potentially confusing because the nonpublic entity exemptions seemed to conflict with one another and with FASB’s intent.
For example, ASC Section 820-10-50-2F exempts nonpublic entities from the requirement to disclose the level of the fair value hierarchy for items not reported at fair value in the balance sheet “unless required by another Topic.” Topic 825 requires such disclosure of nonpublic entities with assets greater than $100 million or that have derivative instruments. The amendments, therefore, suggested that nonpublic entities that have total assets of $100 million or more or that have one or more derivative instruments wouldn’t qualify for the intended exemption.
The guidance found in ASU 2013-03 makes clear that the requirement to disclose the level of the fair value hierarchy within which the fair value measurements are categorized doesn’t apply to nonpublic entities for financial assets and liabilities that aren’t measured at fair value in the balance sheet but for which fair value is disclosed in the footnotes.
For example, if a private company’s own debt is measured at amortized cost in its balance sheet, the fair value of that liability must be disclosed in the footnotes to the financial statements. Under the guidance found in ASU 2013-03, the company need not disclose the level of the fair value hierarchy for that footnoted measurement.
FASB didn’t, however, take action to tackle additional concerns raised by stakeholders about the overlap and potential redundancy between Topic 820 and Topic 825, noting that it would require a comprehensive review that would need “considerably more time and effort.”
Retained Disclosure Requirements
The amendments found in ASU 2013-03 don’t change any of the other fair value disclosure requirements in Topic 820 or Topic 825, including the expanded fair value measurement disclosures required by the amendments in ASU 2011-04.
Under those amendments, for Level 3 items, a company must disclose 1) its valuation processes, and 2) the sensitivity of the measurement to changes in unobservable inputs and any interrelationships between those unobservable inputs. Nonpublic companies are exempt from the latter requirement. For all items, companies must disclose their use of a nonfinancial asset that differs from its highest and best use if the asset is measured at fair value in the company’s balance sheet or its fair value is disclosed on the basis of highest and best use.
The amendments in ASU 2011-04 took effect for nonpublic entities for annual periods beginning after Dec. 15, 2011 (calendar year 2012), meaning many nonpublic entities are in the process of adopting them. In light of that, FASB decided to make the amendments in ASU 2013-03 effective immediately. If you have questions about whether the amendments affect you or how to comply with fair value reporting requirements, we’d be pleased to help.