Readily Determinable Fair Value Updates and the Use of Net Asset Value
readily-determinable-fair-value-updates-and-the-use-of-net-asset-value

Readily Determinable Fair Value Updates and the Use of Net Asset Value

Does the technical correction to the definition of readily determinable fair value (RDFV) that was issued as part of ASU 2015-10 impact your application of net asset value (NAV) as a practical expedient? If you have investments in funds and apply the NAV as a practical expedient to fair value guidance (and perhaps glossed over the RDFV definition update), you may want to revisit whether this definition change impacts you.

Readily Determinable Fair Value Definition Update

The FASB has a perpetual project, Technical Corrections and Improvements, that was created in 2010 to address and implement incremental improvements and corrections and to provide clarification to U.S. GAAP. The issues that the FASB addresses through this project are those that are not expected to have a significant effect on current accounting practice or create significant costs to entities to implement. So, for the most part, these amendments do not get a lot of front page attention.

While that was the case when ASU 2015-10, Technical Corrections and Improvements, was issued in June 2015, some are finding that one particular amendment included in that guidance, the update to the definition of readily determinable fair value, may potentially have a more significant impact on certain entities.

ASU 2015-10 revised the definition of readily determinable fair value in the Master Glossary (the amendments are underlined below) to be:

Readily Determinable Fair Value

An equity security has a readily determinable fair value if it meets any of the following conditions:

  1. The fair value of an equity security is readily determinable if sales prices or bid-and-asked quotations are currently available on a securities exchange registered with the U.S. Securities and Exchange Commission (SEC) or in the over-the-counter market, provided that those prices or quotations for the over-the-counter market are publicly reported by the National Association of Securities Dealers Automated Quotations systems or by OTC Markets Group Inc. Restricted stock meets that definition if the restriction terminates within one year.
  2. The fair value of an equity security traded only in a foreign market is readily determinable if that foreign market is of a breadth and scope comparable to one of the U.S. markets referred to above.
  3. The fair value of an equity security that is an investment in a mutual fund or in a structure similar to a mutual fund (that is, a limited partnership or a venture capital entity) is readily determinable if the fair value per share (unit) is determined and published and is the basis for current transactions.

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What’s the Big Deal?

So, what’s the big fuss about a few additional words to part c of the definition?

Under the updated definition, there are now references to “equity security” and “structure[s] similar to a mutual fund” that must be considered when assessing whether an investment has a readily determinable fair value. More specifically, an entity needs to determine whether an investment is an equity security, whether an investment is a structure similar to a mutual fund, as well as whether the fair value per share for these instruments are published and used as the basis for current transactions.

What happens if an investment now meets the definition of having a readily determinable fair value? Well, there are two potential impacts, especially if the entity elects to use net asset value as a practical expedient to fair value.

1. Use of NAV as a Practical Expedient

If you recall, ASC Topic 820, Fair Value Measurements, permits use of the NAV as a practical expedient election if:

  1. The investment does not have a “readily determinable fair value”
  2. The investment is an investment company within the scope of ASC 946 (or real estate fund for which industry practice is to measure investment assets at fair value and issue financial statements consistent with principles in ASC 946)
  3. NAVs calculated consistent with the measurement principles of ASC 946 as of the reporting entity’s measurement date.

Thus, whether an investment has a readily determinable fair value impacts whether or not an entity can apply the NAV as a practical expedient to measure fair value. If the investment now meets the definition of having a readily determinable fair value, the entity will no longer be able to use NAV as a practical expedient to fair value. It will now have to determine the investment’s actual fair value.

Since the changes to the RDFV definition, along with all the amendments in ASU 2015-10, were effective upon issuance, and the FASB did not provide any specific transition guidance, it appears that this not only affects assessments and application of NAV as a practical expedient taking place after the issuance of ASU 2015-10 but retrospectively to previous conclusions and elections.

And the potential impacts to using NAV as a practical expedient don’t end here. There is an additional consideration – fair value hierarchy accounting implications.

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2. Fair Value Hierarchy

An important component of the FASB’s framework for fair value measurement accounting and disclosures is the fair value hierarchy as it established priorities that are required to be followed in estimating the fair value of assets and liabilities.

The hierarchy prioritizes the inputs to valuation techniques used with the highest priority given to quoted prices in active markets for identical assets or liabilities and the lowest priority given to unobservable inputs. The FASB established the fair value hierarchy with the intention to increase consistency and comparability of fair value measurements and disclosures as well as to provide financial statement users insight into the subjectivity in the determination of fair value measurements made by an entity.

While the objective of the fair value hierarchy is aimed at consistency and comparability, an area of diversity in practice surfaced regarding how investments measured at NAV under the practical expedient were being classified.

The FASB issued ASU 2015-07, Disclosures for Investments in Certain Entities that Calculate Net Asset Value per Share (or its Equivalent) to address this diversity in practice. ASU 2015-07 removed the requirements to categorize investments within the fair value hierarchy for which fair value is measured using the net asset value per share practical expedient

So, whether an investment has a readily determinable fair value also affects whether an entity includes or excludes an equity investment in the fair value hierarchy disclosures. And, if an entity is applying NAV as a practical expedient to an investment but that investment no longer meets the requirements to elect NAV due to the updated RDFV definition, it must include that investment in the fair value hierarchy disclosures.

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Comments (8)

  1. M V:
    Sep 26, 2017 at 04:59 PM

    FASB has really gone nuts, IMO.

    There is really NO need and an obligation NOT to confuse the readers of Financial Statements - and that is exactly what they did with ASC 820.

    The practitioners can't figure it out - how are the readers supposed to know what any of this means. FASB should be ashamed of this, and work to simplify and clarify the language used here.

  2. Rory D Lien:
    Nov 09, 2018 at 12:55 PM

    My wife and I had invested in a fund, which devalued by 13% in the month of April 2016, 6 months after we purchased it. The broker said new regulations were driving cost per share change due to meeting fair value criteria for the investment. He also said it would be equitably remedied in the end. We cashed out of the fund, recently, Nov 2018, finding no equitable remedy. Was the regulation meant to burden the investors, by taking the fair value difference out of their portfolio? Is my broker being accurate with me, and in that case, who ended up with the windfall $.?

  3. Mike Walworth, CPA:
    Nov 12, 2018 at 06:24 PM

    Rory, I honestly have no idea what your broker is talking about. It is doubtful the FASB wanted to burden investors with this "new regulation." Quite the contrary. If the fund follows U.S. GAAP, it is required to account for all of its investments at fair value. However, there is a caveat to that, which this post explores. That is, using the net asset value (NAV) as a practical expedient to fair value if certain criteria were met. The "new regulations" were not new, but basically a clarification of what constitute readily determinable fair value (RDFV). If an investment is deemed to have a RDFV, the "new regulations" basically require the fund to use RDFV for its investment instead of some arbitrary NAV produced by the management of the investment.

    I definitely would request more information from the broker. Did your investment "devalue" 13% or did the fees charged by your broker increase? That being said, investing in certain types of funds does carry risk. I personally stick with the low-cost, index-based funds myself (but then again I'm a wimpy accountant)!

  4. Rory D Lien:
    Nov 16, 2018 at 01:38 PM

    Thanks for the reply and insight, Mike. I went back to the broker to assure I understood what caused the 13% drop in 1 mo, 6 mo after we invested money for the fund. (We just now sold, and I was surprised that the drop was not remedied, He indicated the company would make it equitable. It did not happen, at least not through $/share or # of shares, or % return relative to our understanding when we entered this investment). He repeated that the Department of Labor made a decree, stating all non-traded funds needed to expose the costs of issuing, writing and sales cost - hence they were complying to the requirement for "fair value" as he termed it. I would have expected the initial sale to have a plan for recovery of these costs, without a government decree. Now, I am left thinking they received authorization from the government entity to recover the costs again. There was no plan for a redemption fee for exiting the investment, although initially, we understood we had to stay into the investment for 4 years. We exited, upon his advice, at 3 years. Can you reason why this might be a legitimate claim? Thanks again, Rory

  5. Mike Walworth, CPA:
    Nov 16, 2018 at 02:16 PM

    Rory,
    Here's what happened. The Department of Labor (DOL) finalized their Fiduciary Rule on April 2016 (the date the investment "lost" value), which significantly expanded who was deemed a fiduciary. The rule went into effect on June 9, 2017, but has been part of court battles ever since. In fact, as of now, the law is officially dead. See write up by Investopedia here:

    https://www.investopedia.com/updates/dol-fiduciary-rule/

    Although originally meant to protect investors, it did add additional expenses for advisors (and others) to ensure they complied with the new rules. Obviously, most just passed on these costs to the investors in the form of a reduction in NAV (net asset value) as a result of the higher expenses. That being said, 16% does seem fairly steep and, happening 6 months after your purchased the investment, seem a bit suspect. I also would be more than a tad pissed at your broker as well for not warning you that this was a possibility (since the DOL didn't just pass this rule instantaneously...i.e. it was out there for a while). I can assure that not all fund investments had a 16% fund devaluation in April 2016. Of course, the fact that the rule is now overruled, makes the loss even more sour.

    Again, sorry about your investment loss, but I am happy to report that it wasn't the "bean counters" (i.e. accountants) it was the politicians, brokers, etc.

  6. Rory D Lien:
    Nov 17, 2018 at 04:00 AM

    Mike, the information regarding the DOL Fiduciary Rule is an incredible contribution to my understanding. A good read on what happened, and why. That said, I do see some misstatements by my broker, and compliance issues pertaining to the statement about putting the client before the broker's financial interests. Sounded like good intent. I still expect remedy, and will continue in that direction. Thanks again, Rory

  7. Abdulaziz:
    Dec 23, 2018 at 12:50 PM

    Dear Mike,,
    First of all, thanks for your being supportive.

    I would like to inquire about the cost method used in Investments in Other Entities, is it correct that the standard has changed to classifying it Trading & Available for Sale, and now using Readily to Determinable or non Readily to Determinable regardless the type of securities in investment (Trading & Available for Sale)?

  8. Mike Walworth, CPA:
    Mar 15, 2019 at 02:57 PM

    Abdulaziz,

    First of all, thanks for reading and my apologies for the late reply. We had some issues with spam and, as a result, I was not receiving notifications of legitimate comments to our blog.

    You are correct. ASU 2016-01 eliminated the Trading and AFS categories for investments in equity securities (old ASC 320), recreating a whole new topic (ASC 321). It also eliminated the "cost method" previously allowed by ASC 325. We created a short video on it available on YouTube at this link:

    https://youtu.be/NGXrg2tHmOU

    If you are interested in learning more about ASC 321 and the change in the accounting for equity securities, we've created an entire online course available here:

    https://revolution.gaapdynamics.com/courses/investments-equity-securities

    Hope it helps and thanks again for reading!

    Mike


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