Michael G. Wolfe

Applying Financial Accounting Standards Board (FASB) Statement 157, Fair Value Measurements, (FAS 157 or Codification Topic 820), to alternative investments has presented numerous accounting and auditing challenges.  On September 30, 2009, the FASB responded to these challenges by issuing Accounting Standards Update (ASU) 2009-12, which provides additional guidance related to measurement and disclosure for investments in these types of instruments.

Summary

In ASU 2009-12, the FASB now permits, as a practical expedient, entities to use net asset value per share (NAV)—or its equivalent—of investments within its scope to measure their fair value.  The ASU also provides guidance on the classification of these investments within the fair value hierarchy and outlines additional disclosure requirements.  The guidance in the ASU is effective for interim and annual periods ending after December 15, 2009.  Earlier adoption of the practical expedient and fair value hierarchy guidance is permitted for interim and annual periods for which financial statements have not yet been issued.  Entities electing to apply this guidance early are not required to also apply the related disclosure provisions early.

Scope of the Update

The guidance in this Update applies only to investments meeting both of the following criteria at the reporting entity’s measurement date (measurement date):

1. The investment does not have a readily determinable fair value
2. The investment is in an entity that reports its investment assets at fair value and has all of the following attributes as listed in ASC 946-10-15-2:
1. Is a separate legal entity
2. Its primary business activity involves investing its assets for current income, appreciation or both
3. Ownership in the entity is represented by units of investment (e.g., shares of stock, partnership interests, membership interests, etc.) to which proportionate shares of net assets can be attributed
4. The funds of the entity’s owners are pooled to avail owners of professional investment management
5. The entity is the primary reporting entity

If one or more of these attributes is not present, but the investment is in an entity for which industry practice is to issue financial statements using guidance consistent with the measurement principles in ASC 946 (for example, a real estate fund that measures investment assets at fair value on a recurring basis), the second criterion is deemed to be satisfied.

Investments not meeting both of the above criteria are outside the scope of this Update.

Use of Practical Expedient for Fair Value

A reporting entity is permitted to use the NAV of the investment as of the measurement date as a practical expedient for the fair value of its investments within the scope of the Update.  If the NAV of the investment is as of a date other than the measurement date, the reporting entity should consider whether an adjustment to the most recent NAV is required.  In these situations, the reporting entity should generally obtain updated NAV information as of the measurement date and evaluate whether NAV changes from the valuation date to the measurement date are supportable.  The decision about whether to use the practical expedient should be made on an investment-by-investment basis and should be applied consistently.

Exception:  If it is probable at the measurement date that the reporting entity will sell the investment for an amount different from NAV, the practical expedient may not be used.  Such a sale is considered probable only if all of the following criteria are met:

• Management, having authority to approve the action, commits to a plan to sell the investment
• An active program to locate a buyer and perform any other actions necessary to complete the plan to sell the investment have been initiated
• The investment is available for immediate sale subject only to terms that are usual and customary for the sale of such investments
• Actions required to complete the plan indicate it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn

FAS 157 Hierarchy Classification

Fair value hierarchy classification for these investments is subject to judgment, considering the following:

1. If the reporting entity has the ability to redeem its investment with the investee at NAV at the measurement date, this investment would be categorized as Level 2.
2. If the reporting entity will never have the ability to redeem its investment with the investee at NAV, this investment would be categorized as Level 3.
3. If the reporting entity cannot redeem its investment with the investee at NAV at the measurement date but the investment may be redeemed with the investee at a future date (e.g., investments subject to lockup or other redemption limitations), the reporting entity should consider the length of time until the investment is redeemable to determine whether the investment is Level 2 or Level 3.  For example, if the reporting entity does not know when it will have the ability to redeem the investment or it does not have the ability to redeem the investment in the near term at NAV, the fair value measurement should be classified as Level 3. 

Disclosure Requirements

For investments within the scope of this Update, the reporting entity is required to disclose information that enables users of the financial statements to understand the nature and risks of the investments and whether it is probable the investments will be sold at amounts different from NAV.  The disclosure requirements apply regardless of whether you use the NAV practical expedient.  These disclosures should be made separately for each major category of investment:

1. The fair value of the investments in the major category and a description of the significant investment strategies of the investee(s) in each major category
2. For each major category of investments containing investments that can never be redeemed with the investee, but the reporting entity receives distributions through the liquidation of underlying assets of the investee, the reporting entity’s estimate of the period of time over which the underlying assets are expected to be liquidated by the investee(s)
3. Amount of reporting entity’s unfunded commitments related to investments in the major category
4. General description of the terms and conditions upon which the investor may redeem investments in the major category
5. The circumstances under which an otherwise redeemable investment in the major category might not be redeemable.  For otherwise redeemable investments restricted from redemption as of the measurement date, the reporting entity’s estimate of when the restriction from redemption might lapse, or if such an estimate cannot be made, a disclosure of that fact and how long the restriction has been in effect
6. Any other significant restriction on the ability to sell investments in the major category at the measurement date
7. If it is probable an investment will be sold at an amount other than NAV (as described above), the total fair value of such investments and any remaining actions required to complete the sale
8. If a group of investments would otherwise meet the criteria for probable sale at other than NAV, but the individual investments to be sold have not been identified (e.g., entity decides to sell 20% of its private equity investments but has not identified the individual investments to be sold) and, therefore, the practical expedient may still be used, reporting entity should disclose its plans to sell and any remaining actions necessary to complete the sale

Transition

The Update is effective for an entity’s first reporting period ending after December 15, 2009.  Early application is permitted for financial statements of interim and annual periods that have not yet been issued.  If an entity elects to early apply the practical expedient and fair value hierarchy classification guidance, it is not required to also early adopt the related disclosure provisions.  Any revisions resulting from a change in valuation technique should be accounted for as a change in accounting estimate.

In the period of adoption, the reporting entity should disclose the change, if any, in valuation technique and related inputs resulting from application of the Update and should quantify the total effect, if practicable.

Please contact your BKD advisor if you have any questions about the impact of ASU 2009-12 on your financial statements.