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Government - January 2016

 

GASB Statement No. 72 - Fair Value Measurement and Application

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From a bird's eye view, it is clear that we are one step closer to bridging the gap between GASB's and FASB's definitions and financial reporting requirements regarding "Fair Value." This is due to the release of GASB 72.

Overview:

GASB Statement No. 72 defines fair value as "the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date." Based on this definition, fair value is viewed as an exit price for which, at that moment (measurement date), there may be observable inputs or not, hence defining the level of the investment. The measurement assumes that the transaction is occurring in the entity's principal market, or in the absence of such, the entity's most advantageous market. Note that transaction costs should be excluded from the valuation of the asset or liabilities since these costs are not truly associated with either.

In determining the fair value of an asset or liability, the objective should be to increase the number of applicable observable inputs and reduce the number of unobservable inputs utilized. Whether your entity is using the market approach, the cost approach, or the income approach (the three valuation techniques presented in GASB 72), the technique should be applied consistently from period to period.

In the first paragraph, we mentioned the level of the investment. The fair value hierarchy categorizes the inputs to valuation techniques used to measure fair value in three levels. Level 1 inputs are quoted prices (unadjusted) for identical assets or liabilities in active markets that a government can access at the measurement date. Level 2 inputs are inputs—other than quoted prices included within Level 1 - that are observable for an asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for an asset or liability. One important item to note is that when developing the fair value estimate for an asset or liability, the entity may consider multiple levels of inputs. In such cases, the lowest level of the inputs used to determine fair value is the level at which the asset or liability will be categorized.

GASB 72 defines the term investment as “a security or other asset that (a) a government holds primarily for the purpose of income or profit and (b) has a present service capacity based solely on its ability to generate cash or to be sold to generate cash.” The majority of investments should be valued at fair value; however, there are exceptions.

Investments not measured at fair value include:

  • Money market investments
  • 2a7-like external investment pools
  • Investments in life insurance contracts
  • Common stock meeting the criteria for applying the equity method
  • Unallocated insurance contracts
  • Synthetic guaranteed investment contracts

If the entity invests in certain entities that calculate the net asset value (NAV) per share, the entity may use the NAV as the fair value of that investment. In order to utilize this method, the NAV must be calculated as of the measurement date relevant to the investor entity.

The required disclosures under GASB 72 are covered in paragraphs 80 through 82 of the pronouncement and include items such as:

  • Type of investment including characteristics and risks
  • Classification of the investment in accordance with the fair value hierarchy
  • Whether the fair value measurement will be recurring or nonrecurring

For investments whose fair value is calculated using the NAV per share, there are additional disclosures covered in paragraph 82 of GASB 72, including redemption restrictions, unfunded commitments, and selling restrictions.

Benefits:

The Governmental Accounting Standards Board believes many positive outcomes will derive from the implementation of the standard. Once implemented, there will be a greater consistency in the application of fair value and more robust disclosure, which will lead to greater comparability and increased transparency.

Effective Date:

The requirements of this Statement are effective for financial statements for reporting periods beginning after June 15, 2015.

From our experience, several governments have decided to implement the standard early.

Action Steps:

The additional information required to determine fair value as well as to develop the additional disclosures may cause many entities to modify or enhance their financial close and reporting procedures associated with investments. Additionally, in the initial year of implementation, financial statements presented for prior periods should be restated for the effect of the application of GASB 72.

 
 
 
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