Thomson Reuters Tax & Accounting News

Featuring content from Checkpoint

Back to Thomson Reuters Tax & Accounting News

Subscribe below to the Checkpoint Daily Newsstand Email Newsletter

Fair Value Disclosure Rules May Drop Some Information on Hard-to-Price Assets

The FASB agreed to propose getting rid of some disclosure rules for fair value measurements that board members felt relied on too much subjective information and could be misinterpreted. The board also wants to strengthen some remaining disclosures so investors have a clearer picture of the estimates and assumptions used to determine the values.

The FASB wants companies to make clearer footnote descriptions about the estimates and assumptions they use when they calculate the fair value of hard-to-value financial assets and liabilities.

The discussion started on March 4, 2015, when the board went through a bevy of existing disclosure requirements in Topic 820, Fair Value Measurement, formerly SFAS No. 157, and moved to erase some of them and alter others. The board also moved to do further research on existing requirements to disclose “sensitivity information” or measurement uncertainty estimates about assets and liabilities for which there’s no observable market.

The work is part of the FASB’s effort to write an internal guide, or framework, on how it should approach setting requirements for financial statement disclosures. The accounting board undertook the effort in response to criticism that company quarterly and annual reports are becoming increasingly lengthy because of repetitive footnotes that sometimes bury important information.

Part of the FASB’s disclosure project review focuses on Topic 820. The standard lays out how companies should estimate the fair value of assets and liabilities by using both available, quantifiable data such as market prices and also judgments and estimates. The standard separates the measurements into a three-tier fair value “hierarchy” depending on how much judgment is used.

Instruments valued according to what Topic 820, defines as the Level 1 method are considered the easiest to value because they’re from price quotes from active markets. The Level 2 method uses a broader range of information than publicly quoted prices, and depending upon the asset or liability being measured, can rely on price quotes from inactive markets, interest rates, and a variety of methods used to price options and other derivatives contracts. The Level 3 method relies on information that isn’t publicly available, and the values derived from it are typically considered the least reliable.

Investors and analysts want to know as much as possible about the judgments used to estimate fair values, particularly those in Level 2 or Level 3 of the fair value hierarchy. But some of the current disclosures offer boilerplate or nonessential information, FASB staff accountants told the board.

The board voted to scrap disclosures for the policy for timing of transfers between levels; the internal valuation processes for Level 3 fair value measurements; and the amount of and the reasons for transfers between Level 1 and Level 2. The board voted to get rid of these requirements because some board members said they were largely qualitative descriptions.

The FASB staff said the disclosures about assets moving from Level 1 to Level 2 could be misleading because while analysts and investors perceive that transfers between levels indicates a deterioration in the markets and a decline in a company’s access to funding, it’s not always the case. Transfers can occur “frequently, with no correlation to the economic fundamentals of the instruments,” a FASB staff accountant said. Transfers can occur, for example, just because an asset didn’t trade at the end of a period.

FASB member Harold Schroeder voted against removing this information. If an investor has a relatively small number of investments in instruments that shift in levels, the investor would likely not be concerned about losing the information. But for bigger positions, the investor would want it, he said.

“It seems like we’re doing a blunt instrument,” Schroeder said.

The board stopped short of deleting information related to “sensitivity analysis” or what one FASB member called an analysis about “measurement uncertainty” in the fair value figures. Instead, the board voted to keep current GAAP for now but do more research about whether it needed to make changes.

“Everyone knows when there’s significant unobservable inputs, there’s some measurement uncertainty about that,” FASB member Thomas Linsmeier said. “The reporting entity and the auditor have decided what the best number was, but there was some range they considered in the process.”

The board also voted to retain a disclosure requirement for the reconciliation of opening balances to the closing balances for instruments with recurring Level 3 fair value measurements. FASB members spent a significant portion of the meeting debating whether to scale this back or require the same information for Level 2 measurements.

FASB member Daryl Buck said he was in favor of scaling back the requirement.

“Preparers are concerned that users think items in Level 3 are riskier; user outreach indicated that observation is correct,” Buck said. “The levels don’t indicate risk. They indicate uncertainty of measurement. You may be providing information that’s completely misunderstood by people.”

FASB member Marc Siegel, a former investor, said such a move should be considered a non-starter.

“I don’t see how we could be pulling information away from investors from what we all say is the most important thing about fair value measurement,” Siegel said.

A majority of the board voted to not require the reconciliation for private companies. Instead, they would have to disclose transfers in and out of Level 3 of the fair value hierarchy and purchases of Level 3 assets. FASB member Lawrence Smith expressed disappointment with this move.

“If we think this is useful to investors to public companies, please elaborate why it’s not useful for private companies,” Smith said.

The FASB also voted to add one extra disclosure to the fair value measurement standard. The board wants extra information on unrealized gains and losses for the period included in other comprehensive income and earnings for recurring Level 1, Level 2, and Level 3 fair value measurements.

In addition to reviewing disclosures in Topic 820, the FASB also plans to review the existing footnote requirements for Topic 330, Inventory, Topic 715, Defined Benefit Plans, and Topic 740, Income Taxes.

Tagged with →