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Proposal Seeks to Update Disclosure Rules for Fair Value Measurements

The FASB has released a proposal aimed at improving the information businesses disclose about the estimates and assumptions used to determine the fair values of assets and liabilities. The proposal eliminates some existing requirements, changes others, and adds three new requirements.

The FASB on December 3, 2015, 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, to change the information businesses provide in financial statement footnotes about how they measure certain types of assets and liabilities.

Comments are due by February 29, 2016.

The proposal aims to improve the footnote disclosure requirements in Topic 820, Fair Value Measurement, by eliminating requirements considered to be redundant and adding more details for the information about assets that are difficult to value.

Topic 820, 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 special circumstance. It lays 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. The standard separates the measurements into a three-tier fair value “hierarchy” depending on the judgment used in the measurement.

The proposal takes aim at disclosures about measurements in all three tiers. The FASB assessed the usefulness of U.S. GAAP’s current fair value measurement disclosures by looking at the 2014 Proposed Statement of Financial Accounting Concepts (CON) No. 2014-200, Conceptual Framework for Financial Reporting—Chapter 8: Notes to Financial Statements, which was issued to help the FASB set more consistent, less redundant disclosure requirements. The FASB calls this its overall “disclosure framework” project but has not finalized the amendments.

“The objective and primary focus of the disclosure framework project are to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by GAAP that is most important to users of each entity’s financial statements,” the FASB wrote in the Basis for Conclusions section of Proposed ASU No. 2015-350.

In U.S. GAAP, instruments valued according to what Topic 820 defines as the Level 1 method are considered the easiest to value because they stem from price quotes in active markets, such as trades on the New York Stock Exchange. 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 methods used to price options and other derivatives contracts. The Level 3 method relies on information that is not publicly available or may be based on management’s estimates. Sometimes a business has to hire specialists such as actuaries or appraisers to determine a value. In the securities industry, there are many third-party pricing services for instruments that do not have an active trading market.

The values derived from Level 2 and Level 3 typically are subject to the most scrutiny by the PCAOB, auditors say. The values also are of interest to analysts and investors, who want to know as much as possible about the judgments used to estimate fair value.

The FASB’s proposal eliminates several disclosures that auditors, analysts, and businesses told the FASB were no longer useful. They include: 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. The plan also scraps a requirement for private companies to disclose the change in unrealized gains and losses for the period included in earnings related to recurring Level 3 fair value measurements held at the end of the reporting period.

Under the plan, private companies would be required to disclose transfers into and out of Level 3 of the fair value hierarchy and purchases of Level 3 assets and liabilities. All companies would have to disclose the timing of liquidation of the assets in an investment and the date when restrictions from redemption will lapse for investments in entities that calculate net asset value. All businesses also would have to clarify the disclosure for their uncertainty about a measurement to better communicate information about the uncertainty of the information as of the reporting date rather than information about sensitivity to changes in the future.

In addition, the FASB proposal adds three new disclosures: the changes in 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; the range and weighted average of significant unobservable inputs for recurring Level 3 fair value measurements; and the historical time period, if any, used to develop these inputs.

Private companies would be exempt from the three proposed new disclosures.

All seven FASB members voted in favor of the proposal’s release.

The fair value disclosures proposal is part of the FASB’s broader effort to change how it should approach setting requirements for financial statement disclosures. It is in part a response to years of criticism that company quarterly and annual reports are becoming increasingly lengthy because of repetitive footnotes that sometimes bury important information.

In addition to establishing an internal guide to help set consistent disclosure requirements, the FASB also is examining existing disclosure requirements in three other areas apart from fair value measurement. The review includes Topic 715-20-50, Defined Benefit Plans , Topic 740-10-50, Income Taxes , and Topic 330-10-50,Inventory .

The board also is considering a way to make it easier for businesses to decide what information should go in their financial statement footnotes and what should be scrapped. The FASB in September released Proposed CON No. 2015-300, Conceptual Framework for Financial Reporting Chapter 3: Qualitative Characteristics of Useful Financial Information, and Proposed ASU No. 2015-310 , Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material, to help the board decide how to write disclosure rules and companies determine the information their financial statement footnotes need.

The proposals call for the legal concept of materiality to be the basis by which businesses and not-for-profit organizations decide when to include information in their footnotes. The FASB’s goal was to stop businesses and not-for-profit organizations from bogging down their footnotes with extraneous information.

Reaction to the proposals has been unusually harsh from investors and analysts, who have criticized the FASB for proposing standards and guidelines that would give businesses free rein to reduce the information they make public.

FASB and SEC officials say the proposals’ critics are misinterpreting the changes, which they say are simply an effort to clarify long-standing rules and make them easier to apply.

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