Entities reporting their investments at fair value should follow the guidance in FASB ASC 820, Fair Value Measurement, when determining fair value of those investments.
Estimating fair value requires significant judgment in normal circumstances. However, in the current environment characterized by market volatility and uncertain outlook, applying judgement in determining fair value will be even more challenging.
During April 8, 2020 FASB Board Meeting, the FASB staff provided an update on certain technical inquiries related to the effects of COVID-19, including fair value measurements. According to FASB’s summary of tentative Board decisions:
The staff recently received a request to suspend mark-to-market accounting. In that request, the authors of the letter specifically referenced guidance developed during the 2008-2009 financial crisis. The staff provided a reminder of the orderly transaction guidance in Topic 820, Fair Value Measurement, specifically paragraphs 820-10-35-54C through 54J, which provide guidance for measuring fair value when the volume or level of activity for an asset or a liability has significantly decreased and identifying transactions that are not orderly. The staff stands ready to address any interpretive questions with respect to that guidance.
This information will also be memorialized in FASB’s meeting minutes to be posted to the FASB website.
This article discusses the guidance referenced above and is intended to assist readers with applying FASB ASC 820 guidance during COVID-19 crisis.
FASB ASC 820 establishes a framework for measuring fair value when US GAAP requires or permits a fair value measurement. Fair value is defined in FASB ASC 820 as "[t]he 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." FASB ASC 820-10-35-41 indicates that "[a] quoted price in an active market provides the most reliable evidence of fair value and shall be used without adjustment to measure fair value whenever available, except as specified in paragraph 820-10-35-41C." In other words, if a security trades in an active market at the measurement date, its fair value will equal the quoted price.
FASB ASC 820 defines active market as “[a] market in which transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis” and does not provide bright lines or rules of thumb for what constitutes an active market. For markets that are not active, FASB ASC 820 does not specify that the value must be measured at P*Q, but FASB ASC 820-10-35-36 states that "[v]aluation techniques used to measure fair value shall maximize the use of relevant observable inputs and minimize the use of unobservable inputs."
FASB ASC 820 defines orderly transaction as “[a] transaction that assumes exposure to the market for a period before the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (for example, a forced liquidation or distress sale).” However, FASB ASC 820 does not include the concept of “orderly” or “not orderly” as it relates to markets. Instead, FASB ASC 820 differentiates between “active” and “not active” market.
To assist entities with determining fair value in periods of market disruption, paragraphs 54C-54H of FASB ASC 820-10-35 provide guidance on measuring fair value when the volume or level of activity for an asset or a liability has significantly decreased, while paragraphs 54I-54J of FASB ASC 820-10-35 provide guidance about identifying transactions that are not orderly and how to consider such transactions. If the entity is unable to conclude whether a transaction is orderly, FASB ASC 820-10-35-54J(c) requires that the transaction price be given some weight. If the evidence indicates the transaction is not orderly, FASB ASC 820-10-35-54J(a) provides that a reporting entity should place little, if any, weight (compared with other indications of fair value) on that transaction price.
In situations when there has been a significant decrease in the volume or level of activity, it may be appropriate to consider other valuation techniques in estimating the fair value. However, as indicated in FASB ASC 820-10-35-54H, “[a] reporting entity’s intention to hold the asset or to settle or otherwise fulfill the liability is not relevant when measuring fair value because fair value is a market-based measurement, not an entity-specific measurement.” Furthermore, FASB ASC 820-10-35-54G provides that “[e]ven when there has been a significant decrease in the volume or level of activity for the asset or liability, the objective of a fair value measurement remains the same. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction (that is, not a forced liquidation or distress sale) between market participants at the measurement date under current market conditions.”
When determining fair value of investments, entities should use FASB ASC 820 as a primary resource as well as consider other relevant resources. For example, when valuing portfolio company investments, investment companies and similar entities (such as corporate venture capital groups or pension funds) that invest in portfolio companies, may find it helpful to refer to the recently published AICPA Accounting and Valuation Guide, Valuation of Portfolio Company Investments of Venture Capital and Private Equity Funds and Other Investment Companies. This guide provides guidance and illustrations regarding the accounting for and valuation of portfolio company investments of venture capital funds, private equity funds and other investment companies. During current turbulent times, the following sections may be of particular relevance:
- Chapter 2, Fair Value and Related Concepts (especially paragraphs 2.08–.30)
- Chapter 6, Valuation of Debt Instruments
- Chapter 10, Calibration
- “Significant Decrease in Volume or Activity or Distressed Transactions” section in chapter 13 (paragraphs 13.20–.24)
- Many Q&As in chapters 14 (especially 14.75–.77 which address questions related to measuring fair value when the volume or level of activity for an asset or a liability with observable prices or quotes has significantly decreased)
Yelena Mishkevich, CPA, CGMA
Senior Manager, Accounting Standards - AICPA