Understanding FASB ASC 820 – and Important Proposed Changes
By Sean R. Saari, Partner, Advisory Services
FASB ASC 820 (ASC 820; formerly FAS 157) is an accounting standard established by the Financial Accounting Standards Board (FASB) that defines the notion of fair value, establishes a framework for measuring it and expands disclosures about fair value measurements. It’s an important standard for accounting professionals to understand from every angle; and proposed changes can also have big impacts if or when they eventually take effect.
First, a standard definition is in order. According to ASC 820-10-20: “Fair value is 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.”
It’s important to note that ASC 820 must be followed for any entity’s financial statements prepared in compliance with generally accepted accounting principles (GAAP) for reporting periods beginning on or after November 15, 2007. The Employee Retirement Income Security Act (ERISA) requires that financial statements for employee benefit plans subject to Title I of ERISA be prepared in conformity with GAAP. ASC 820 may also affect the reporting for non-ERISA plans if those assets are reported on the financial statements of the plan sponsor.
ASC 820 fundamentally changes the definition of value by shifting the emphasis from a purchase price to a selling price—or to put it another way, from an entry concept (i.e., the value at which an asset is purchased) to an exit concept (the expected proceeds from the sale of that given asset). Prior to the effective date of ASC 820, an asset’s purchase price was used as the reporting measurement. Now, ASC 820 requires exit value.
ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Additionally, ASC 820 clarifies that the exchange price is the transaction price between market participants to sell a specific asset or transfer a specific liability in the principal or most advantageous market for the asset or liability. At the measurement date, the transaction to sell that asset or transfer that liability is purely hypothetical. Accordingly, the definition of ASC 820 focuses on the price that would be received to sell that particular asset, or the price that would be paid to transfer that liability, rather than the price that would be paid to acquire that asset, or the entry price to assume the liability.
ASC 820 requirements apply to all employee benefit plans that are audited. Those plans must generally measure and report their investments in their financial statements at fair value, so ASC 820 provides a fair value framework that can be used to value investments. Additionally, it offers valuation techniques and inputs to those techniques. And, it provides a fair value hierarchy which prioritizes the inputs and requires specific disclosures within the financial statement about plan investment valuations.
Proposed Changes for ASC 820
On May 12, 2016, the FASB issued a Proposed Accounting Standards Update relating to Topic 350—specifically, Intangibles—Goodwill and Others. To summarize, this update would eliminate Step 2 of the current goodwill impairment test, which requires a hypothetical purchase price allocation to measure impairment loss. Under the FASB’s proposal, goodwill impairment loss would instead be measured as the amount by which a reporting unit’s carrying amount exceeds its fair value. All other goodwill impairment guidance would remain unchanged. The language in the update states, “The Board recently amended the Accounting Standards Codification to allow private companies an alternative accounting treatment for subsequently measuring goodwill.”
The FASB’s proposal would apply to all entities, with the exception of private companies that have adopted the Private Company Council (PCC) goodwill accounting alternative (ASU 2014-02).
In order to determine whether a two-step goodwill impairment test is necessary, an entity may first assess qualitative factors under the current guidance. If and when the entity bypasses or fails Step 0, the two-step goodwill impairment test is performed. Step 1 compares the fair value of a reporting unit to its carrying amount to determine if an impairment actually exists. If the reporting unit’s carrying amount exceeds its fair value, then it’s necessary to complete Step 2, which involves first determining the implied fair value of goodwill, and then comparing it to the carrying amount of that goodwill to measure any impairment loss.
The FASB’s proposal would recognize an impairment loss for the amount by which the reporting unit’s carrying amount exceeds its fair value—provided that it indeed does exceed that value. Note that that impairment loss amount would not exceed the carrying amount of goodwill in that particular reporting unit.
The proposed guidance would apply prospectively to all existing goodwill. The proposal would not change the timing of goodwill impairment—and, an entity would still be able to perform a qualitative assessment before moving on to the quantitative goodwill impairment test.
Comments on the proposal are due by July 11, 2016. This proposal is the first phase of a two-phase project. For Phase Two, the FASB will work with the International Accounting Standards Board (IASB) to deliberate the merits of additional changes to the subsequent accounting for goodwill. The FASB will determine an effective date at some point in the future.
What’s the relevance?
The FASB acted out of concern from private companies and their stakeholders about the cost and complexity of the current goodwill impairment test. Accordingly, to measure goodwill impairment, the ASC 820 proposal would eliminate the need to determine the fair value of individual assets and liabilities of a reporting unit. Rather, the amount of impairment recognized under the FASB proposal could be larger or smaller, depending on the delta between the carrying value and the fair value of certain long-lived assets. This promises to simplify financial reporting, and it would also diminish differences between US GAAP and IFRS since IFRS also has a single step for goodwill impairment.
Expertise in financial reporting valuations
Whether determining the fair value of private equity portfolio companies or an ownership interest in a non-public entity held by your company, external auditors often require a third-party appraisal to support the corresponding values for such assets reported on a company’s balance sheet. Marcum professionals are able to efficiently perform these valuations to provide clients with supportable values to record on their balance sheets.
Do you have questions about ASC 820 or other valuation issues? Please contact Sean Saari at 440-459-5700 or email Sean.