additional fair value disclosures for nonpublic companies

our roots run deepTM

MAYER HOFFMAN MCCANN P.C. – AN INDEPENDENT CPA FIRM

A publication of the Professional Standards Group

MHMMessenger

© 2 0 1 3 M AY E R H O F F M A N M C C A N N P. C . 877-887-1090 • www.mhm-pc.com • All rights reserved.

TM

Nonpublic companies that measure and record assets or liabilities at fair value need to provide additional fair value disclosures starting with annual financial statements for years beginning on or after December 15, 2011, (i.e., 2012 financial statements for calendar year-end companies). The additional required disclosures for nonpublic companies are not as extensive as the requirements for public companies; however management may wish to consider if inclusion of the incremental disclosures required of public companies would be useful to their financial statement users as well.

The experiences of SEC registrants can be helpful, since those companies with calendar year-ends were required to include the expanded disclosures starting with the interim financial statements included in the first quarter Form 10-Q as of March 31, 2012.

This Messenger highlights the additional fair value disclosure requirements, explains which ones are not required, and therefore, optional for nonpublic companies, and provides answers to questions that often arise when compiling information necessary for the disclosures.

February 2013

Additional Fair Value Disclosures for Nonpublic Companies

A product of convergence

The additional disclosures were introduced as part of convergence efforts by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) in FASB Accounting Standards Update No. 2011-04 (ASU 2011-04), “Fair Value Measurement: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04, issued in connection with IFRS 13 “Fair Value Measurement,” contains a large number of relatively minor clarifications designed to better align U.S. standards for fair value measurements and disclosures with those terms included in IFRS 13. It also clarifies certain measurement concepts and adds disclosure requirements that require an even more in-depth understanding of how an entity’s fair value measurements are determined. These disclosures can be difficult to compile.

How is your company affected?

The fair value measurement principles and concepts of ASU 2011-04 apply equally to all reporting entities, however, as noted above most of the amendments are clarifying in nature and do not result in significant changes in practice. The most impactful changes for companies relates to the additional required disclosures. Nonpublic companies may need to analyze several factors to determine which disclosures are required and which are optional (required by public companies but not for nonpublic companies). Key considerations include the following.


MHMMessenger

2

1. Does the company meet the definition of a nonpublic company? In applying the disclosure requirements of ASU 2011-04, the definition of a nonpublic company is any entity that does not meet any of the following conditions:

• A company whose debt or equity securities trade in a public market.

• A conduit bond obligor for conduit debt securities that are traded in a public market.

• An entity that files with a regulatory agency in preparation for the sale of any class of debt or equity securities in a public market.

• An entity that is required to file or furnish financial statements with the U.S. Securities and Exchange Commission.

• A company that is controlled by an entity covered by the above criteria.

2. Fair Value Measurements: The determining factor for applying the disclosure requirements for nonpublic entities generally relates to the measurement requirement for a Company’s financial and nonfinancial assets and liabilities at fair value in the financial statements as well as the measurement level within the hierarchy. Considerations for nonpublic companies include the following:

• In general all of the disclosure requirements apply to assets and liabilities measured at fair value in the statement of financial position and classified as a Level 1 or Level 2 measurement.

Such items would include financial instruments that are recorded at fair value each reporting period (recurring measurements) and nonfinancial assets which are recorded at fair value on a one time or otherwise infrequent basis due to an impairment (non-recurring measurement).

• Disclosure of the fair value measurement within the fair value hierarchy is not required for financial assets and liabilities for which fair value measurements are only required to be disclosed. ASC 825 requires disclosure of the fair value for all financial instruments held by certain entities, including certain nonpublic companies. Nonpublic companies that are required to disclose fair value measurements in accordance with ASC 825 are not required to include the level of the measurement within the fair value hierarchy.

• ASU 2011-04 included expanded disclosure requirements for Level 3 fair value measurements, including a qualitative discussion of the sensitivity of the fair value measurement to the significant unobservable inputs. Nonpublic companies are not required to include these expanded disclosure requirements relating to the sensitivity of the estimated fair value for those items classified as Level 3 measurements.

The matrix on the next page summarizes the significant differences in disclosure requirements for public and nonpublic entities. Explanations of the various types of disclosures are provided on the pages following the table.

MHMMessenger


MHMMessenger

3

Comparison of Disclosure Requirements for Public and Nonpublic Companies

Public Companies Nonpublic companies

For Items Measured at

Fair Value

For Disclosure-only Fair Value Measurements

For Items Measured at Fair

Value

For Disclosure-only Fair Value measurements

Fair value hierarchy

– Level in fair value hierarchy Required Required Required Optional*

– Transfers between levels Required Optional*

Descriptions of valuation techniques and inputs

– Valuation techniques Required Required Required Optional*

– Valuation processes Required Required

– Unobservable inputs Required Required

– Sensitivity to changes in unobservable inputs Required Optional*

Reasons for non-recurring measurements Required Required

Information about the highest and best use of a nonfinancial asset

Required Required Required Optional*

Additional information about recurring fair value measurements in Level 3

Required Required

Optional* = Not required unless required by another Topic ASC 825 requires disclosure of the valuation techniques for financial instruments held by certain nonpublic companies.


MHMMessenger

4

MHMMessengerDisclosure Requirements: The information needed to prepare the required and optional disclosures listed in the table is summarized below.

1. Fair value hierarchy. ASC 820, as amended by ASU 2011-04, requires several disclosures related to the fair value hierarchy.

• Level in fair value hierarchy. All companies must disclose the level of the fair value hierarchy within which recurring and nonrecurring fair value measurements are categorized in their entirety, which is not a change from the original disclosure requirements of ASC 820. Certain public and nonpublic entities are required to disclose the fair value of all financial instruments held in accordance with the requirements of ASC 825. ASC 820, as amended by ASU 2011-04, now requires the level of the fair value measurement within the fair value hierarchy be disclosed for these measurements as well, however, as mentioned above, these expanded disclosure requirements apply only to public entities. The FASB issued an exposure draft of a proposed ASU in January 2013 further clarifying the scope and intent of the exclusion for nonpublic entities.

• Transfers between levels. ASC 820 also requires public companies to disclose the transfers of assets and liabilities measured at fair value between Levels 1 and 2 of the fair value hierarchy, along with the reasons for the transfer and the company’s policy for determining when transfers are deemed to occur. These disclosures apply only to items that are measured at fair value in the statement of financial position.

2. Descriptions of valuation techniques and inputs. The amendments included in ASU 2011-04 significantly expand the information that

must be disclosed by both public and nonpublic companies for Level 2 and Level 3 fair value measurements. Each of the first three items listed below are required for all recurring and nonrecurring measurements recorded during the reporting period

• Valuation techniques. For items categorized in Levels 2 and 3, all entities must disclose the techniques and inputs used to determine the fair value, which typically includes a description of the models and/or methodologies, and the significant inputs used to determine the fair value measurement. Valuation processes. For measurements categorized as Level 3, all entities must include a description of the valuation processes used by the reporting entity. For example, this disclosure might include information about how a company decides its valuation policies and procedures and analyzes changes in fair value measurements from period to period.

• Unobservable inputs. For fair value measurements categorized as level 3, all companies must include quantitative information about the significant unobservable inputs used in the fair value measurement. An illustrative example is provided in the Appendix to this Messenger.

• Sensitivity to changes in unobservable inputs. For recurring fair value measurements categorized in Level 3 of the fair value hierarchy, public companies must provide a description of the sensitivity of the fair value measurement to changes in the significant unobservable inputs, and the interrelationships between those unobservable inputs. This disclosure is not required for nonpublic companies.


MHMMessenger

5

3. Reasons for non-recurring measurements. If a fair value measurement is not recurring, meaning the assets or liabilities are required or permitted to be measured at fair value in the statement of financial position only in particular circumstances, ASU 2011-04 amended ASC 820 to require disclosure of the reason for the measurement. Examples include a long-lived asset or disposal group that is classified as held for sale and must be measured at fair value less costs to sell because the asset or disposal group is impaired. Non-recurring measurements would also include impairment of long-lived assets.

4. Information about the highest and best use of a nonfinancial asset. For both recurring and nonrecurring fair value measurements, if the highest and best use of a nonfinancial asset differs from its current use, ASC 820 requires disclosure of this fact along with an explanation of why the nonfinancial asset is being used in a manner that differs from its highest and best use. All companies must make this disclosure for items measured at fair value in the statement of financial position. Public companies are also required to provide this information for fair value measurements performed only for disclosure purposes (i.e. required by ASC 825).

5. Additional information about recurring fair value measurements classified as Level 3. For recurring fair value measurements categorized within Level 3 of the fair value hierarchy, ASC 820 requires a reconciliation from the opening balances to the closing balances with certain items broken out separately (a rollforward with items presented gross). These items include gains or losses for the period and the line item(s) in which they are recognized in the statement of income or statement of other comprehensive income, as well as the amounts of any transfers into or out of Level 3. Companies are also required to disclose the reasons for the transfers and the company’s

policy for determining when transfers between levels are deemed to have occurred. Additionally, companies are required to disclose the amount of gains or losses attributable to assets and liabilities held at the end of the reporting period and the line item(s) in the statement of income (or activities) in which those unrealized gains or losses are recognized.

Questions that often arise in compiling the disclosures

1. Does management need to disclose information about all of the significant unobservable inputs for Level 3 measurements? The answer is yes, and the need to identify all of the significant unobservable inputs can require significant additional analysis. Prior to the effective date of ASU 2011-04, a company may have classified a financial instrument as Level 3 because the instrument had one significant unobservable input used in standard valuation models and practices for that instrument that clearly indicated it was a Level 3 measurement. That meant it was not necessary for the company to identify all of the unobservable inputs as only classification within the hierarchy was needed. However, in order to comply with the expanded disclosure requirements introduced in ASU 2011-04, companies must identify all significant inputs as either observable or unobservable.

2. What are the criteria for classification of inputs as observable or unobservable? The definitions provided in the ASU are as follows:

•Observable Inputs. Inputs that are developed using market data, such as publicly available information about actual events or transactions, and that reflect the assumptions that market participants would use when pricing the asset or liability.


MHMMessenger

6

The information in this MHM Messenger is a brief summary and may not include all the details relevant to your situation. PleasecontactyourMHMserviceprovidertofurtherdiscusstheimpactonyourfinancialstatements.

•Unobservable Inputs. Inputs for which market data are not available and that are developed using the best information available about the assumptions that market participants would use when pricing the asset or liability.

In practice, the application of these definitions can require significant judgment. Early consultation with your accounting professionals and thorough documentation are encouraged.

3. Why did the FASB change the concept of “highest and best use” for financial instruments? Essentially, the highest and best use concept indicates that fair value measurements should take into account a market participant’s ability to generate economic benefits by employing the asset at its highest or best use or by selling the asset to another market participant that would employ the asset at its highest and best use. The FASB decided this concept does not apply to financial assets and liabilities because they do not have an alternative use and their fair value does not depend on their use within a group of other assets or liabilities.

4. Does MHM provide other resources to help companies deal with the complexities of fair value? To help companies of all sizes and industries enhance their understanding of the complexities, Mayer Hoffman McCann’s Professional Services Group has prepared a course on financial instruments as part of the Executive Education Series. Materials can be found at http://www.mhm-pc.com/articles/vw/1/itemid/323.aspx.

For more information

If you have any specific questions about the additional disclosures required, please contact Mike Loritz or James Comito of MHM’s Professional Standards Group or your MHM service professional. You can reach Mike in our Kansas City office at [email protected] or 913-234-1226, and you can reach James in our San Diego office at [email protected] or 858-795-2029.

http://www.mhm-pc.com/articles/vw/1/itemid/323.aspx

http://www.mhm-pc.com/articles/vw/1/itemid/323.aspx

mailto:[email protected]

mailto:[email protected]

MHM Messenger 3-13 Appendix: Illustrative Disclosure of Quantitative information about

Level 3 Fair Value Measurements ($ in millions)

Fair Value at 12/31/12

Valuation Technique(s) Unobservable input Range (Weighted Average)

Residential mortgage-backed securities

$125 Discounted cash flow Constant prepayment rate Probability of default Loss severity

3.5%–5.5% (4.5%) 5%–50% (10%)

40%–100% (BO%)Commercial mortgage-backed securities

$50 Discounted cash flow Constant prepayment rate Probability of default Loss seventy

3.0%–5.0% (4.1%) 2%–25% (5%)

10%–50% (20%)Collateralized debt obligations

$35 Consensus pricing Offered quotes Comparability adjustments (%)

20–45 -10%–+15% (+5%)

Direct venture capital investments: healthcare

$53 Discounted cash flow Weighted average cost of capital Long-term revenue growth rate Long-term pretax operating margin Discount for lack of marketability (a) Control premium (a)

7%–16% (12.1%) 2%–5% (4.2%)

3%–20% (10.3%) 5%–20% (17%)

10%–30% (20%)Market comparable companies

EBITDA multiple (b) Revenue multiple (b) Discount for lack of marketability (a) Control premium (a)

10–13 (11.3) 1.5–2.0 (1.7)

5%–20% (17%) 10%–30% (20%)

Direct venture capital investments: energy

$32 Discounted cash flow Weighted average cost of capital Long-term revenue growth rate Long-term pretax operating margin Discount for lack of marketability (a) Control premium (a)

6%–12% (11.1%) 3%–5.5% (4.2%)

7.5%–13% (9.2%) 5%–20% (10%)

10%–20% (12%)Market comparable companies

EBITDA multiple (b) Revenue multiple (b) Discount for lack of marketability (a) Control premium (a)

9.5–12 (9.5) 1.0–3.0 (2.0)

5%–20% (10%) 10%–20% (12%)

Credit contracts $38 Option model Annualized volatility of credit (c) Counterparty credit risk (d) Own credit risk (d)

10%–20% 0.5%–3.5% 0.3%–2.0%

(a) Represents amounts used when the reporting entity has determined that market participants would take into account these premiums and discounts when pricing the investments.(b) Represents amounts used when the reporting entity has determined that market participants would use such multiples when pricing the investments. (c) Represents the range of the volatility curves used in the valuation analysis that the reporting entity has determined market participants would use when pricing the contracts. (d) Represents the range of the credit default swap spread curves used in the valuation analysis that the reporting entity has determined market participants would use when pricing the contracts.

(Note: For liabilities, a similar table should be presented.)

additional fair value disclosures for nonpublic companies

Economy & Finance