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Private Investment Forum - Fall 2018

 

A Break on FASB Disclosure Requirements

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The objective of financial reporting is to provide information on an entity’s financial position, performance and cash flows to current and potential investors, creditors, and other stakeholders, so that informed investment decisions can be made. Over the past 12 years, since the implementation of FAS 157 (now ASC 820), fair value measurement reporting requirements have multiplied and enhanced financial statement disclosures to allow for more transparency and notification of related risks. Many have wondered, however, if these increased disclosures are obscuring the important and significant data by adding volumes of irrelevant, confusing, or immaterial information. In fact, there’s been a push by the Securities & Exchange Commission (SEC) over the past few years to simplify disclosures, and in August 2018, the SEC adopted final rules to amend certain public company disclosure requirements that were deemed redundant, duplicative, overlapping, outdated, or superseded.

Accounting Standards Update (ASU) 2018-13, Fair Value Measurement (Topic 820) Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, issued on August 28, 2018, follows this new trend for financial reporting for both public and non-public entities, in that it eliminates and modifies certain existing reporting requirements related to fair value measurements. These changes will simplify disclosures and should make it easier to report the relevant information on a timely basis.

Background

The amendments in this ASU are the result of a four-year-long broader disclosure project called FASB Concepts Statement, Conceptual Framework for Financial Reporting - Chapter 8: Notes to Financial Statements, which was finalized in August 2018. The objective of the Concepts Statement project was to improve the effectiveness of disclosures by developing a consistent framework that considers whether the expected benefits of a given disclosure requirement justify the expected costs of obtaining that information. The Board’s aim is to communicate the information required by GAAP while also enabling reporting entities to exercise the appropriate level of discretion. The intention is for the Board to use the Concept Statement when evaluating existing disclosure requirements and establishing future accounting standards.

Removed Disclosure Requirements

ASU 2018-13 removes the following disclosure requirements from ASC 820, Fair Value Measurement:

  1. The amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy (non-public entities were not originally subject to this).
  2. The policy for recognizing transfers between levels. While an entity still needs to follow a consistent policy for the timing of transfers (i.e., whether at the beginning, ending, or on the actual date of the event that causes the transfer from, say, Level 3 to Level 2), it does not need to be disclosed in the footnotes.
  3. The valuation processes for Level 3 fair value measurements. While a robust valuation process that includes designation of individuals who are responsible to conduct periodic reviews and evaluate the consistent application of the valuation policy for Level 3 investments, it need not be disclosed in the financial statements.
  4. For non-public entities, the changes in unrealized gains and losses for the period included in earnings for recurring Level 3 fair value measurements held at the end of the reporting period. This is a welcomed change, as this computation is often complicated for investments that were partially sold during the year, and inconsistency in its calculation has been observed.

Modified Disclosure Requirements

ASU 2018-13 modifies the following disclosure requirements in ASC 820:

  1. In lieu of a roll-forward for Level 3 fair value measurements, a non-public entity can disclose changes during the period due to transfers into and out of Level 3 of the fair value hierarchy, and purchases and issues of Level 3 assets and liabilities. This is big news for financial statement preparers with Level 3 investments, who no longer will have to disclose a reconciliation of beginning and ending balances for these investments by their individual components, including realized and unrealized gains and losses, sales, and dispositions of investments. The reason for transfers between levels, however, will still need to be disclosed. This is important as it provides insight to users on changes in the observability of market data during the year which would likely trigger a transfer between Levels 2 and 3. Roll-forwards of Level 3 investments are still required for public entities.
  2. For investments in certain entities that calculate net asset value, the entity is required to disclose the timing of liquidation of an investee's assets and the date when restrictions from redemption might lapse only if the investee has communicated the timing to the entity or announced the timing publicly. If unknown, the entity is required to disclose that fact.
  3. The ASU clarifies that the measurement uncertainty disclosure is to communicate information about the uncertainty as of the reporting date, as opposed to a future period, as with a sensitivity analysis, for example, which could convey the effect of expected future changes to unobservable inputs. A narrative, and not a quantitative disclosure, is required. The Board expects that if an entity is currently disclosing uncertainty at the reporting date and not sensitivity to expected future changes, its disclosure should be unaffected by the amendment in this ASU. However, if an entity had misinterpreted the disclosure because of the term sensitivity and was disclosing sensitivity to expected future changes, the Board expects that an entity no longer would disclose that forward-looking information in complying with the requirement. (It should be noted that non- public entities were not originally subject to this rule).

Added Disclosure Requirements

The amendments in ASU 2018-13 add the following disclosure requirements to ASC 820 for public entities only:

  1. The changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period.
  2. The range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and how the weighted average was calculated. However, the Board recognized that for certain investments, this information may not be meaningful to properly reflect the distribution of unobservable inputs. Derivatives, for instance, pose a problem if you weight by notional value because notional values may not be directly linked to fair values. Weighting by fair value, however, causes too much variability. Accordingly, the Board determined that for certain unobservable inputs an entity may disclose other quantitative information (such as the median or arithmetic average) in lieu of the weighted average.

In addition, the amendments eliminate at a minimum from the phrase an entity shall disclose at a minimum, to promote the appropriate exercise of discretion by entities when considering fair value measurement disclosures and to clarify that materiality is an appropriate consideration of entities and their auditors when evaluating disclosure requirements.

Effective Date

ASU 2018-13 is effective for all entities for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019 (calendar 2020). The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted upon issuance of ASU 2018-13. An entity is permitted to early adopt any removed or modified disclosures upon issuance of ASU 2018-13 and delay adoption of the additional disclosures until their effective date. It is recommended to early adopt these provisions, as it should save time in gathering data for and preparing year-end financial statements.

For questions about how this affects your fund’s financial statements and disclosures, consult your Marcum professional.

 
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Marni Pankin, Partner, Assurance

Partner
Alternative Investments
Assurance
New York, NY
 
 
 
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