October 1, 2009
Volume 16, Issue 35
Heads Up
In This Issue:
• Introduction
• Application Guidance
• Fair Value Hierarchy
Classification
• Disclosures
• Effective Date
FASB Issues Guidance on
Measuring Fair Value of Certain
Alternative Investments
.
by Shahid Shah and Beth Ann Reese, Deloitte & Touche LLP
Introduction
On September 30, the FASB issued Accounting Standards Update (ASU) 2009-121
(previously exposed for comments as proposed FSP FAS 157-g2) to provide guidance
on measuring the fair value of certain alternative investments. The ASU amends FASB
Accounting Standards Codification Topic (ASC) 8203 (formerly Statement 1574) to offer
investors a practical expedient for measuring the fair value of investments in certain
entities that calculate net asset value per share (NAV). The ASU is effective for the first
reporting period (including interim periods) ending after December 15, 2009; however,
early adoption is permitted (see Effective Date section below).
The ASU is effective
for the first
reporting period
(including interim
periods) ending after
December 15, 2009;
however, early
adoption is
permitted.
Before the issuance of the ASU, there was diversity in practice in how investors estimated
the fair value of investments in entities that calculate NAV, such as investments in hedge
funds, private equity funds, venture capital funds, offshore fund vehicles, funds of funds,
and real estate funds. Some believed that NAV is determinative of fair value, without
further adjustment as of the reporting date, while others believed that NAV should be
adjusted to account for the impact of the attributes of the investment, such as restrictions
on redemption (e.g., lockups and gates), unfunded commitments, and intangible benefits
of the investment. The ASU addresses constituents’ questions regarding how to measure
the fair value of such investments.
Application Guidance
Scope
The ASU’s measurement and disclosure guidance (discussed below) applies to
investments in entities that meet both of the following criteria as of the reporting entity's
measurement date:
• The fair value of the investment is not readily determinable.
• The investment is in an entity that has all attributes of an investment company
that are specified in ASC 946-10-15-2 or, for an entity that lacks one or more of
the attributes specified in ASC 946-10-15-2, it is industry practice to issue financial
statements in accordance with the measurement principles for investment companies
in ASC 9465 (e.g., “certain investments in real estate funds that measure investment
assets at fair value on a recurring basis”).
FASB Accounting Standards Update No. 2009-12, Investments in Certain Entities That Calculate Net Asset Value per Share (or
Its Equivalent).
2
Proposed FASB Staff Position No. FAS 157-g, “Estimating the Fair Value of Investment Companies That Have Calculated Net
Asset Value per Share in Accordance With the AICPA Audit and Accounting Guide, Investment Companies.”
3
FASB Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures.
4
FASB Statement No. 157, Fair Value Measurements.
5
FASB Accounting Standards Codification Topic 946, Financial Services — Investment Companies.
1
Furthermore, the measurement principles of the ASU do not apply to investments whose
fair value is readily determinable. The ASC master glossary defines “readily determinable
fair value” as follows:
An equity security has a readily determinable fair value if it meets any of the following
conditions:
a. The fair value of an equity security is readily determinable if sales prices or bid-andasked quotations are currently available on a securities exchange registered with the
U.S. Securities and Exchange Commission (SEC) or in the over-the-counter market,
provided that those prices or quotations for the over-the-counter market are publicly
reported by the National Association of Securities Dealers Automated Quotations
systems or by Pink Sheets LLC. Restricted stock meets that definition if the restriction
terminates within one year.
b. The fair value of an equity security traded only in a foreign market is readily
determinable if that foreign market is of a breadth and scope comparable to one of the
U.S. markets referred to above.
If an investment is
within the scope of
the ASU, a reporting
entity, as a practical
expedient, is
permitted (but not
required) to use the
investment’s NAV to
estimate its fair
value, provided that
the NAV is
calculated as of the
reporting entity’s
measurement date.
c. The fair value of an investment in a mutual fund is readily determinable if the fair value
per share (unit) is determined and published and is the basis for current transactions.
Editor’s Note: In excluding investments with readily determinable fair values from
the scope of the measurement guidance, the Board noted that such investments are
designed to be exited via secondary market transactions rather than by redemption
directly with the investee. Therefore, ASC 820 already addresses how to determine the
fair value of these investments.
Measurement
If an investment is within the scope of the ASU, a reporting entity, as a practical
expedient, is permitted (but not required) to use the investment’s NAV to estimate its fair
value, provided that the NAV is calculated as of the reporting entity’s measurement date.
The FASB concluded that measurement using NAV is reasonable for investments within
the scope of the ASU because the reporting entity typically will exit such investments
through transactions with the investee at NAV or through distributions from the investee
once the underlying assets of the investee are sold. In addition, the FASB noted in the
Basis for Conclusions of the ASU that for investments within the ASU’s scope, NAV “is
the most relevant estimate of fair value available that would not require undue cost and
effort.”
If a reporting entity determines that the NAV is not calculated as of its measurement date,
the reporting entity must adjust the NAV for significant market events that may have
occurred since the investee calculated the NAV. The objective of adjusting the NAV (as of
the reporting entity’s measurement date) is to estimate fair value in a manner consistent
with the principles of ASC 946.
The ASU prohibits a reporting entity from using NAV as a practical expedient in estimating
fair value when it is probable that an entity will sell the investment (or a portion thereof)
at a price other than NAV. The ASU states that a sale must meet the following four
criteria to be considered “probable”:
a. Management, having the authority to approve the action, commits to a plan to sell the
investment.
b. An active program to locate a buyer and other actions required to complete the plan to
sell the investment have been initiated.
c. The investment is available for immediate sale subject only to terms that are usual and
customary for sales of such investments (for example, a requirement to obtain approval
of the sale from the investee or a buyer’s due diligence procedures).
d. Actions required to complete the plan indicate that it is unlikely that significant changes
to the plan will be made or that the plan will be withdrawn.
2
Applying these criteria may require significant judgment. Even if the above criteria are met,
a reporting entity may still apply the practical expedient if it determines that it will receive
NAV for the investment. The reporting entity is only prohibited from applying the practical
expedient when the entity determines that it is probable that it will sell the investment at
an amount other than NAV.
Editor’s Note: Do these criteria sound familiar? These criteria are similar to four of
the six criteria in ASC 360-10-45-9 (formerly paragraph 30 of Statement 1446) for
determining when a long-lived asset to be sold must be classified as held for sale.
The ability to apply the practical expedient is available on an investment-by-investment
basis. However, the ASU indicates that it must be applied consistently to an entity’s "entire
position in a particular investment, unless it is probable at the measurement date that a
reporting entity will sell a portion of an investment at an amount different from [NAV].”
Fair Value Hierarchy Classification
The ASU requires
enhanced disclosures
about the nature and
risks of investments
within its scope that
are measured at fair
value on a recurring
or nonrecurring
basis.
The ASU also provides guidance on how investments within its scope would be classified
in the fair value hierarchy. The ASU clarifies that if an entity is able to redeem the
investment with the investee at NAV as of the measurement date, such an investment
must be classified as a Level 2 measurement. However, if an entity will never have the
ability to redeem the investment with the investee at NAV, the investment must be
classified as a Level 3 fair value measurement.
For investments that cannot be redeemed with the investee as of the measurement date,
but that the reporting entity may be able to redeem at a later date, the ASU requires
that the reporting entity evaluate “the length of time until the investment will become
redeemable.” For example, if the reporting entity cannot determine when it will be able
to redeem the investment, the fair value of the investment must be classified as a Level 3
measurement.
Editor’s Note: In the Basis for Conclusions, the Board acknowledged that “while
an entity is permitted to use [NAV] (or its equivalent) without further adjustment for
attributes such as restrictions to estimate fair value [i.e., as a practical expedient], the
entity must still consider restrictions when determining classification within the fair value
hierarchy.”
Disclosures
The ASU also requires enhanced disclosures about the nature and risks of investments
within its scope that are measured at fair value on a recurring or nonrecurring basis. The
reporting entity must disclose, for both interim and annual periods, the following items by
major category of investments:
• The fair value of investments and a “description of the significant investment strategies
of the investee(s).”
• Estimate of the period over which the investee may liquidate the underlying
investments (this disclosure applies only to investments that cannot be redeemed and
when the entity receives distributions via liquidation of the underlying investments by
the investee).
• The “amount of the reporting entity’s unfunded commitments related to investments
in the major category.”
• A general description of the terms and conditions upon which the investor may
redeem the investments (e.g., quarterly redemption with 60 days’ notice).
• The “circumstances in which an otherwise redeemable investment . . . might not
be redeemable” (e.g., because of lockups or gates). Further, for investments that
6
FASB Statement 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
3
are redeemable but “that are restricted from redemption as of the reporting entity’s
measurement date,” the entity’s best estimate of when the restriction from redemption
might lapse or the fact that an estimate cannot be made.
• Other significant restrictions on the entity’s ability to sell the investment as of the
measurement date.
In addition, the ASU requires that the reporting entity disclose the total fair value, and the
remaining actions required to finalize the sale, of investments for which it is probable that
the entity will sell the investment for an amount other than NAV. However, if an entity has
not identified the individual investments that it is probable will be sold, the entity must still
disclose its plan to sell and the remaining actions required to complete the sale.
Editor’s Note: The disclosure requirements apply to all investments within the scope
of the ASU, regardless of whether the entity elects to measure the investment by using
NAV as a practical expedient.
Entities should also note that the FASB took this opportunity to clarify how the term
“major category” is defined in the disclosure requirements for fair value measurements
in the FASB Codification. In practice, it was unclear whether the definition of major
category applied only to financial institutions (see ASC 942-320-50-2) or to nonfinancial
institutions as well. The FASB clarified in the ASU that for nonfinancial institutions, major
category is defined as major security type, as described in ASC 320-10-50-1B.
The FASB clarified
in the ASU that for
nonfinancial
institutions, major
category is defined
as major security
type, as described in
ASC 320-10-50-1B.
Effective Date
The guidance in ASU 2009-12 is effective for the first reporting period (including interim
periods) ending after December 15, 2009. Therefore, for a calendar-year-end entity that
issues quarterly interim reports, the ASU becomes effective on October 1, 2009. Entities
may also elect to early adopt the ASU’s measurement guidance if financial statements
have not been issued. For example, a calendar-year-end entity may elect to early adopt the
practical expedient for third-quarter 2009 reporting; however, it is not required to adopt
the disclosure requirements until its 2009 annual financial statements. In the period of
adoption, an entity must disclose any change in valuation technique and related inputs
and quantify the total effect, if practicable.
4
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