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Classification & Disclosure of Fair Value Hierarchy No Longer Required for Qualifying Investments

July 1, 2015

Many investments are reported using the net asset value (NAV) as a practical expedient to estimating the fair value. Generally accepted accounting principles currently require investments reported using the NAV practical expedient to be classified within the fair value hierarchy, which is determined based on the ability to redeem the investment with the investee. Redemption restrictions (such as lock up, gate or similar provisions) do not affect the NAV reported by an entity when the practical expedient is applied. However, they do affect disclosures regarding which level of the fair value hierarchy applies to the measurement. Depending on the length of the redemption restriction, the investment is classified as either a level 2 or level 3 fair value measurement. These terms and conditions can be complex, and the application to the hierarchy can be unclear. This has led to diversity in practice among entities reporting fair value disclosures for investments in which the reporting entity does not have the ability to redeem the investment as of the reporting date, but may have the ability at a future date.

A recent accounting standards update (ASU) issued by the Financial Accounting Standards Board (FASB) is designed to eliminate this diversity in practice and simplify reporting for qualifying investments reported using the NAV as a practical expedient. ASU 2015-07, Fair Value Measurement (Topic 820), Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) eliminates the disclosure requirement that investments that qualify for, and are reported using, the net asset value (NAV) practical expedient be categorized within the fair value hierarchy. Disclosure of the measurement within the fair value hierarchy remains applicable to investments that are not reported using the NAV as a practical expedient. However, the update does eliminate certain disclosures previously applicable to all investments that were eligible for the NAV practical expedient, regardless of whether the practical expedient was applied, thereby reducing certain disclosure requirements for investments that calculate the NAV per share, but for which the practical expedient is not applied.

Background

Accounting Standards Codification (ASC) Topic 820 requires entities to consider market-observable information, where available, when making their fair value determination. For investments not listed on national exchanges or over-the-counter markets, market observable information is generally not available. Alternative investments such as common/collective funds and pooled separate accounts, private equity funds, real estate funds and venture capital funds may calculate the NAV as a measure of the value of investor's equity, and often represents the redemption value.

ASC 820 required entities that use the NAV practical expedient to categorize the measurement within the fair value hierarchy based on whether the investment can be redeemed at the NAV on the measurement date or, if not, if it may be redeemed at the NAV on a future date. If redeemable only at a future date, the analysis is generally based on redemption restrictions, including gate restrictions, lock up provisions, and similar terms. If expected to be redeemed at a future date due to restrictions, entities must consider when in the future the investment can be redeemed in order to classify it within the hierarchy as a level 2 or level 3 measurement. Further complicating the process, the guidance for how to evaluate the classification within the fair value hierarchy investments that use the NAV practical expedient differs from the guidance used for assets that do not qualify for the use of the expedient.

The FASB issued ASU 2015-07 in part to simplify reporting requirements and in part to keep the inputs and measurements affecting the fair value hierarchy classification consistent for all reported measurements. Upon implementation, investments that are reported using the NAV practical expedient are not required to be classified within the fair value hierarchy disclosures. Additional disclosures applicable to investments reported using the NAV practical expedient are not affected by the ASU and remain applicable. These disclosures are designed to provide insight into the nature and risks of each investment and how probable it is that the asset would be sold for an amount that differs from its NAV.

Effective Date

The accounting standards update takes effect for public companies in fiscal years and interim periods beginning after December 15, 2015. All other entities will apply the change to fiscal years and interim periods beginning after December 15, 2016, however, early adoption is permitted. Entities will need to apply the change retrospectively to all periods presented within their financial statement when adopting the new standard.

For More Information

If you have specific comments, questions or concerns about the change to ASC Topic 820, please contact Mike Loritz of MHM's Professional Standards Group or your MHM service professional. You can reach Mike at mloritz@cbiz.com or 816.945.5611.

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