What You Need to Know About Fair Value Accounting Sunday, May 22, 2016, 2:40 PM, 1 CPE Credit

Melinda M. Gildart, CPA, MBA, Chief Financial Officer, Illinois Finance Authority

Ted Williamson, CPA, Partner, RubinBrown LLP

AGENDA  

Ø GASB  STATEMENT  NO.  72:    AN  OVERVIEW  OF  THE  REQUIREMENTS  

Ø ACTION  STEPS  FOR  GOVERNMENTS  

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GASB  Statement  No.  72:    An  Overview  of  the  Requirements  

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BACKGROUND  

Ø Effec(ve  for  periods  beginning  aJer  6/15/2015  

Ø Addresses   accoun(ng   and   financial   repor(ng   issues  related  to  fair  value  measurements  

Ø Provides   guidance   for   determining   a   fair   value  measurement  for  financial  repor(ng  

Ø Also  provides  guidance  for  applying  fair  value  to  certain  investments   and   disclosures   related   to   all   fair   value  measurements  

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STATEMENT  OBJECTIVES  Ø Primarily   clarifies/expands   on   GASB   Statement   No.   31  and  Statement  No.  53    

Ø Review/revise  the  defini(on  of  fair  value  

Ø Clarify  the  methods  used  to  measure  fair  value  

Ø Determine   the   applicability   of   fair   value   guidance   to  investments/other   items   currently   reported   at   fair  value  

Ø Determine   poten(al   disclosures   about   fair   value  measurements  

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GENERAL  PRINCIPLES  

Ø WHAT  IS  FAIR  VALUE?  

Ø ASSETS,  LIABILITIES  AND  UNITS  OF  ACCOUNT  

Ø PRINCIPAL  VS.  ADVANTAGEOUS  MARKETS  

Ø PRICE  AND  TRANSACTION  COSTS  

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FAIR  VALUE  DEFINITION  Fair  value   is   the  price   that  would  be   received  to  sell  an  asset  or  paid   to   transfer   a   liability   in   an   orderly   transac6on   between  market  par6cipants  at  the  measurement  date.    

Ø  Fair   value   is   a   market-­‐based   measurement,   not   an   en(ty-­‐specific  measurement.    

Ø  The  objec(ve  of  a  fair  value  measurement  is  to  es(mate  the  exit  price  of  assets  and  liabili(es.  

Ø  Fair   value   is   an   exit   price   at   the  measurement   date   from   the  perspec(ve  of  a  market  par[cipant  that  controls  the  asset  or  is  obligated  for  the  liability.  

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ASSETS,  LIABILITIES  AND  UNITS  OF  ACCOUNT  Ø  The  item(s)  to  be  valued  could  be  a    

Ø Single  asset  or  liability,  such  as  a  financial  instrument;  Ø A  group  of  assets  or  a  liabili(es;  or    Ø A  group  of  related  assets  and  liabili(es,  such  as  a  partnership  

Ø Unit  of  account  refers  to  the  level  at  which  an  asset  or  a  liability  is   aggregated   or   disaggregated   for  measurement,   recogni(on,  or  disclosure  purposes.    

Ø  Transac(on   costs,   such   as   commissions,   do   not   meet   the  defini(on   of   an   asset   and   should   be   recognized   as   expenses  when  incurred.  

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PRINCIPAL  &  ADVANTAGEOUS  MARKET  In   a   fair   value   measurement,   the   sale   of   an   asset   or   the  transfer   of   a   liability  would   be   expected   to   take   place   in   the  principal  market  for  the  asset  or  liability.  

Ø  The   principal   market   is   the   market   that   the   government  would  normally  enter  into  for  its  transac(ons.  

Ø  In  the  absence  of  a  principal  market,  the  government  may  use  the  most  advantageous  market.  Ø The   determina(on   takes   into   account   both   transac(on   and  transporta(on  costs.  

Ø Most  advantageous  market…  

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PRINCIPAL  &  ADVANTAGEOUS  MARKET  To  iden6fy  the  principal  market,  the  government  should  take  into  account  all  informa6on  that  is  reasonably  available.  

Ø A   government   should   have   access   to   the   principal   or  most  advantageous  market  at  the  measurement  date.  

Ø Access   to   the  market   is   needed,   but   the   government  does  not  need   to  be  able   to   sell   the  asset  or   transfer  the  liability  at  the  measurement  date.  

Ø The  assumed  transac(on  is  the  basis  for  the  fair  value  price.  

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PRICE  AND  TRANSACTION  COSTS  Ø Quoted  prices  are  the  most  preferable  source  for   fair  value  

informa(on.  

Ø Certain   market   condi(ons   may   make   quoted   prices   less  reliable  for  fair  value  measurement.  

Ø Addi(onal    analysis  of  quoted  market  prices  is    needed  in  the  presence  of  material  changes   in  the  volume,  nature  or   level  of  ac(vity  for  “normal”  market  ac(vity.    

Ø  If  support/evidence  exists  that  a  transac(on  is  not  orderly,  a  government  would  rely  less,  if  at  all,  on  the  transac(on  price.  

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VALUATIONS  AND  APPROACHES  

VALUATION  TECHNIQUES  AND  INPUTS  Ø OBSERVABLE  VS.  UNOBSERVABLE  

VALUATION  APPROACHES  Ø MARKET  APPROACH  Ø COST  APPROACH    Ø INCOME  APPROACH  

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VALUATION  TECHNIQUES  AND  INPUTS  

Valua6on  techniques  are  used  to  determine  fair  value.  

Ø Governments  should  use  valua(on  techniques  that  are  appropriate  to  the  circumstances  and  for  which  sufficient  data  is  available  to  measure  fair  value.  

Ø Must  consider  the  difference  between  observable  and  unobservable  inputs  when  determining  fair  value.  

Ø  It  is  preferable  to  use  observable  inputs  such  as  quoted  prices  in  ac(ve  markets,  rather  than  less  reliable,  non-­‐objec(ve,  internally  generated  informa(on  (unobservable).  

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VALUATION  APPROACHES  Apply  valua6on  technique(s)  that  best  represent  fair  value  in  the  circumstances  using  one  of  the  three  approaches:        

Ø Market   approach:  Uses   prices   and   other   relevant   data   derived  from   market   transac(ons   for   iden(cal     or   similar   assets,  liabili(es,  or  a  group  of  assets  and  liabili(es.  

Ø  Cost   approach:   Reflects   the   amount   that   would   be   required  currently  to  replace  the  present  service  capacity  of  an  asset.  

Ø  Income  approach:  Converts  future  amounts  to  a  single  discounted  amount.  The  fair  value  measurement  would  also  reflect  any  current  market  expecta(ons  for  future  amounts.  

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VALUATION  TECHNIQUES  AND  INPUTS  

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Apply  valua6on  technique(s)  that  best  represent  fair  value  in  the  circumstances  using  one  of  the  three  inputs:        

Level  1-­‐Most  Reliable  Quoted  prices  (unadjusted)  in  ac[ve  markets  for  iden[cal  assets  or  

liabili(es  

Level  2-­‐Reliable  Quoted  prices  for  similar  assets  or  liabili(es,  quoted  prices  for  

iden[cal  or  similar  assets  or  liabili(es  in  markets  that  are  not  ac[ve,  or  other  observables    

 

Level  3-­‐Least  Reliable  Unobservable  inputs    

INVESTMENTS  

Ø DEFINITION  

Ø INCLUSIONS  

Ø EXCEPTIONS  

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INVESTMENTS  

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An  investment  is  a  security  or  other  asset  that  is  held  primarily  for  the  purpose  of  income  or  profit.    

Ø  It   has   a   present   service   capacity   that   is   based   solely   on   its   ability   to  generate  cash  or  to  be  sold  to  generate  cash.    

Ø  Service  capacity  refers  to  a  government’s  mission  to  provide  services.    

Ø  Held   primarily   for   income   or   profit—acquired   first   and   foremost   for  future  income  and  profit.    

Ø  Assets   that   meet   the   defini(on   of   an   investment   generally   are   to   be  measured  at  fair  value.    

Ø  Excep(ons  to  fair  value  include  money  market  funds  or  2a7-­‐like  external  investment  pools.  

What  is  the  asset’s  purpose?  Ø  The  “purpose”  of   the  asset   is  determined  by   the  government  at  

the  (me  of  acquisi(on.  

Ø Once   the   government   determines   whether   the   asset   is   an  investment  or   another   type  of   asset,   the   classifica(on   should  be  retained  for  future  financial  repor(ng  purposes-­‐even  if  the  government’s  usage  of  the  asset  changes  over  (me.    

Ø  If  an  asset  is  ini(ally  reported  as  a  capital  asset  and  then  later  is  held  only   for   resale,   the  asset   should  not  be   reclassified  as  an  investment.  

INVESTMENTS  

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Ø  Example  #1-­‐Mortgage  Loans:  Are  not  investments  if  the  loans  are  the   result   of   a   government’s   program   that   provides   financing   to  first-­‐(me  homebuyers.  The  present  service  capacity  of  the  loans  is  not  based  solely  on  the  loans’  ability  to  generate  cash.  

Ø  Example   #2-­‐Capital   Assets:   Once   the   government   determines  whether   the  asset   is  an   investment  or  another   type  of  asset,   the  classifica(on   should   be   retained   for   financial   repor(ng   purposes,  even  if  the  government’s  usage  of  the  asset  changes  over  (me.    

EXAMPLES  

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LIABILITIES  

Ø BASIC  PRINCIPLES  

Ø LIABILITIES  HELD  BY  OTHER  PARTIES  AS  ASSETS  

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Ø  Basic   Principles:  Measurement   of   the   fair   value   of   a   liability   (for  example,   an   interest   rate   swap   that   is   in   a   liability   posi(on   to   a  government)   assumes   that   the   liability   is   transferred   to  a  market  par(cipant  at  the  measurement  date.  

Ø  Liabili[es  Held  By  Other  Par[es:  If  a  quoted  price  for  the  transfer  of  an   iden(cal  or  similar   liability   is  not  available  and  the   iden(cal  item   is   held   by   another   party   as   an   asset,   a   government   should  measure   the   fair   value   of   the   liability   similar   to   how   the   asset  would  be  measured.  

LIABILITIES  

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FINANCIAL  REPORTING  DISCLOSURES    

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The  following  informa6on  is  required  for  each  class  or  type  of  assets  and/or  liabili6es  measured  at  fair  value:      

Ø  FV   measurement   at   the   end   of   the   repor(ng   period   and   for  nonrecurring   FV   measurements,   the   reasons     for   the  measurement.    

Ø  Level   of   the   FV   hierarchy/Inputs   showing   how   each   of   the   FV  measurements  are  categorized  (Level  1,  2,  or  3).    

Ø Descrip(on  of  the  valua(on  technique(s)  used.  Ø  FV   measurements   categorized   within   Level   3   of   the   fair   value  

hierarchy.    Ø  The   effect   of   those   investments   on   investment   income   for   the  

repor(ng  period.    

EXAMPLE  DISCLOSURE  –  CITY  GOVERNMENT  

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EXAMPLE  DISCLOSURE  –  PENSION  PLAN  

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EXAMPLE  DISCLOSURE  –  PENSION  PLAN  CONT’D  

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NOTE:    This  represents  the  fair  value  hierarchy  table  por(on  of  the  disclosure  only,  and  excludes  the  narra(ve  por(ons  of  this  disclosure.  

EXAMPLE  DISCLOSURE  –  PENSION  PLAN  CONT’D  

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NOTE:    This  table  will  be  accompanied  by  addi(onal  narra(ve  disclosures  describing  the  fund  strategies  and  how  fair  value  has  been  calculated  for  each  investment.  

Ac[on  Steps  for  Governments  

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STEP  1:    IDENTIFY  ITEMS  AT  FAIR  VALUE  

Ø Begin  by  developing  a   lis(ng  of   the  assets  and   liabili(es  you  will  be  required  to  report  at  fair  value.  

Ø Paragraph   64   of   GASB   72   requires   investments   to   be  reported  at  fair  value.  

Ø Per  Basis  of  Conclusions  paragraph  B3,  GASB  72  does  not  require  anything  else  to  be  reported  at  fair  value  unless  another   GASB   statement   has   already   required   it   to   be  reported  at  fair  value.  

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STEP  1:    IDENTIFY  ITEMS  AT  FAIR  VALUE  

Ø Most  common  other  asset/liability  at  fair  value  is  deriva[ve  instruments  per  GASB  53:  Ø  Interest  rate  swaps  Ø Foreign  currency  exchange  contracts  Ø Fuel  purchase  contracts  Ø Others?  

 

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STEP  2:    DETERMINE  FAIR  VALUE  SOURCE  Ø Determine  what   the   source  of   the   fair   value   informa[on  

will  be  for  each  item.  Ø  Quoted  market  prices  as  determined  by  the  government  Ø  Pricing  services  or  brokers  Ø  Audited   financial   statements   or   other   statements   received   from  

alterna(ve  investment  funds  Ø  Appraisals  (how  olen  are  these  prepared?)  

Ø Don’t   simply   rely   on   the   fair   value   reported   to   you   on  monthly   bank   statements   or   brokerage   statements.    Contact   the  financial   ins[tu[on   to   understand  how   they  determine  the  fair  value.  

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STEP  3:    CONTACT  PRICING  SERVICES  Ø For   fair  value  quotes  obtained   from  pricing   services  or  

brokers,   contact   them   to   clarify   how   they   determine  the  price  quote.  Ø Actual  quoted  market  prices  (level  1)  Ø Pricing  models  or  matrices  (generally  level  2)  

Ø Keep   in  mind   that  U.S.   Treasury   and   agency   securi[es  and   corporate   bonds   are   oJen  priced  using  models   or  matrices  and  thus  would  be  level  2.  Ø Refer  to  GASB  72,  Illustra(on  2,  example  1  

 

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STEP  4:    ADDRESS  INVESTMENTS  AT  NAV  For   investments   measured   at   Net   Asset   Value   (NAV),  various  specific  steps  should  be  performed,  as  follows:    

Ø A.   Obtain   the   investment   fund   agreement   and/or  contact   the   fund   to   obtain   the   necessary   informa[on  for  the  disclosure.  Ø  Unfunded  commitments  Ø  Redemp(on  frequency  and  no(ce  period  Ø  Fund  strategy  and  method  for  determining  fair  value  

 

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STEP  4:    ADDRESS  INVESTMENTS  AT  NAV  Ø B.    Consider  the  source  and  reliability  of  fair  value  

informa[on:  Ø  Statements  provided  by  the  fund  itself:    are  these  

sufficiently  independent  to  rely  upon?  

Ø  Audited  financial  statements  for  the  fund  are  preferred.    Make  sure  these  financial  statements  are:  

Ø  Presented  in  accordance  with  U.S.  generally  accepted  accoun(ng  principles  

Ø  An  unmodified  opinion  was  rendered  by  the  auditors  Ø  Informa(on  can  be  extracted  in  order  to  value  your  

share  of  the  fund  (for  ex.,  a  net  asset  value  per  share)    

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STEP  4:    ADDRESS  INVESTMENTS  AT  NAV  Ø C.    Consider  the  [meliness  of  fair  value  informa[on:  Ø Statements   provided   by   the   fund   are   olen   on   a   one-­‐

month  or  one-­‐quarter  lag.    Make  sure  the  informa(on  you  are  using  is  actually  as  of  your  financial  statement  date.  

Ø Audited  financial  statements  involves  the  following  issues:  Ø For  some  funds,  these  are  not  available  un(l  5-­‐6  months  

aler  year  end  Ø Most   funds   have  December   31st   fiscal   year-­‐ends.     This  

could  be  problema(c  if  your  fiscal  year-­‐end  is  something  other  than  December  31.  

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STEP  4:    ADDRESS  INVESTMENTS  AT  NAV  Ø Remember   that,   per   paragraph   71   of   GASB   72,   these  

provisions   apply   to   investments   valued   at   NAV   or   its  equivalent  Ø Some  funds  calculate  a  net  asset  value  per  share  Ø Other   funds   simply   report   the   dollar   value   of   your  

capital  account.    This  is  considered  to  be  the  equivalent  of  NAV.  

 

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STEP  5:    CLASSIFY  FAIR  VALUE  BY  LEVEL  Ø Make  a  first  anempt   to   classify   fair   values   for  all   assets  

and   liabili(es   within   the   Level   1,   2,   and   3   classifica(on  scheme.  

Ø Beware   of   corporate   bonds,   U.S.   Treasuries   and   U.S.  agency    securi(es,  which  are  olen  level  2.  

Ø Beware   of   publicly   traded   alterna(ve   investment   funds  (which  must  be  classified   in   the   level  1/2/3  scheme)  vs.  alterna(ve  investment  funds  reported  at  NAV  (which  are  not  classified  in  the  level  1/2/3  scheme)  

   

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STEP  6:    ACCUMULATE  DISCLOSURE  INFO  Ø Determine  whether  all  necessary  informa[on  to  

prepare  the  narra[ve  por[on  of  the  footnotes  is  available,  as  required  by  paragraph  81  of  GASB  72:  Ø Descrip(on  of  valua(on  techniques  Ø Nature  of  any  material  changes  in  valua(on  techniques  Ø Nonrecurring  fair  value  measurements  and  the  reason  

(for  example,  capital  asset  impairments,  per  Illustra(on  5,  example  1)  

Ø Required  disclosures  for  those  investments  reported  at  NAV  

   

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STEP  6:    ACCUMULATE  DISCLOSURE  INFO  

Ø Also,  determine  at  what  level  assets  and  liabili[es  will  be  aggregated  for  footnote  disclosure  purposes.  

Ø Follow  the  guidance  in  GASB  72,  paragraph  80.  

 

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STEP  7:    PREPARE  DRAFT  DISCLOSURE  Ø Prepare  a  first  draJ  of  your  fair  value  disclosure.  

Ø Consider  sharing  this  draJ  with  your  auditors  prior  to  the  start  of  your  financial  statement  audit,  so  they  can  concur  with/challenge  your:  Ø Source  of  fair  value  informa(on  Ø Level  of  aggrega(on  Ø Classifica(on  as  level  1,  2,  or  3  Ø Thoroughness  of  disclosure  

Ø This  will  give  you  sufficient  [me  to  make  correc[ons  as  necessary.  

   

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STEP  8:    DONATED  CAPITAL  ASSETS  Ø Per  GASB  72,  paragraph  79,  these  are  now  to  be  

reported  at  acquisi[on  value    (an  entry  price).  

Ø Most  common  examples  are  donated  infrastructure  and  donated  art  and  historical  treasures.  

   

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STEP  8:    DONATED  CAPITAL  ASSETS  Ø For  donated  infrastructure:  Ø  Are  you  no(fied  of  donated  infrastructure  as  it  is  received?  Ø  Do   you   receive   construc(on   cost   informa(on   from   the  

developer?  Ø  If   not,   do   you   have   a   process   in   place   to   es(mate   the  

acquisi(on  cost:  Ø  Accumulate   the   number   of   lane   miles   or   square   feet  

obtained  Ø  Have  a  current  construc(on  cost  per  lane  mile  or  square  

foot  available  Ø  Mul(ply  these  to  calculate  an  es(mated  acquisi(on  cost  

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STEP  8:    DONATED  CAPITAL  ASSETS  Ø For  donated  art  and  historical  treasures:  Ø  Are  you  no(fied  of  donated  art  and  historical  

treasures  as  it  is  received?  Ø  Do  you  receive  cost  or  appraisal  informa(on  from  the  

donor?  Ø  If  not,  do  you  have  a  process  in  place  to  es(mate  the  

acquisi(on  cost  (e.g.  An  appraisal  process)?    

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QUESTIONS?