Defining Issues. FASB Issues Guidance to Exclude Certain Investments from Fair Value Hierarchy. May 2015, No Key Facts.

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1 Defining Issues May 2015, No FASB Issues Guidance to Exclude Certain Investments from Fair Value Hierarchy The FASB recently issued an Accounting Standards Update (ASU) that will eliminate the requirement to categorize investments in the fair value hierarchy if their fair value is measured at net asset value (NAV) per share (or its equivalent) using the practical expedient in the FASB s fair value measurement guidance. 1 This ASU is a Consensus of the FASB s Emerging Issues Task Force (EITF). 2 Key Facts Reporting entities must provide sufficient information to enable users to reconcile total investments in the fair value hierarchy and total investments measured at fair value in the statement of financial position. Contents Background... 2 Key Provisions... 4 Transition and Effective Date... 7 The scope of current disclosure requirements for investments eligible to be measured at NAV is limited to investments for which the practical expedient is applied. Key Impacts The amendments in this ASU will eliminate diversity in practice surrounding how investments measured at NAV under the practical expedient with future redemption dates have been categorized in the fair value hierarchy. This ASU will affect all entities that measure an investment at NAV under the practical expedient in the fair value measurement guidance. 1 FASB Accounting Standards Update No , Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), and FASB ASC Topic 820, Fair Value Measurement, both available at 2 EITF Issue No. 14-B, Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent), available at network of independent member firms affiliated with KPMG International Cooperative, All

2 Background Reporting entities are generally permitted to use NAV as a practical expedient to measure the fair value of an investment when: The investment does not have a readily determinable fair value; and The investment is in an investment company within the scope of the FASB s guidance about accounting for investment companies. 3 Under current U.S. GAAP (before the new ASU), categorization within the fair value hierarchy of an investment to which the practical expedient is applied depends on its redemption attributes. This is because redemption dates often depend on the nature of the underlying investments in the investment companies. For example, investment companies that hold very liquid investments (e.g., money market funds and publicly traded equity funds) often can be redeemed frequently. Investments in investment companies holding less liquid or illiquid investments (e.g., private equity and real estate funds) are generally redeemable less frequently, such as quarterly, annually, or only upon liquidation of the entity. Investments measured using the practical expedient that are redeemable at NAV on the measurement date are currently categorized as Level 2. Investments that will be redeemable only upon liquidation of the entity, or with unknown future redemption dates, are categorized as Level 3. For investments measured using the practical expedient that are redeemable at a future date, reporting entities need to determine if the investment is redeemable in the near term, in which case it is categorized as Level 2. However, near term is not defined in the FASB s guidance about the fair value hierarchy, and preparers have interpreted it differently (e.g., as the ability to redeem quarterly or semi-annually). This has resulted in diversity in practice. In addition to diversity in categorizing investments based on redemption terms, some reporting entities recategorize investments between Level 2 and Level 3 at different measurement dates when the investments are redeemable in the near term on some measurement dates but not others. As a result of differing interpretations, reporting entities with similar or identical investments may categorize those investments differently. This diversity is illustrated in Example 1. 3 FASB ASC Topic 946, Financial Services Investment Companies, available at 2 network of independent member firms affiliated with KPMG International Cooperative, All

3 Fair Value Categorization for Investments Measured at Net Asset Value Current U.S. GAAP Is the investment redeemable at the measurement date? No Is the investment redeemable only upon liquidation of the entity, or are redemption dates unknown? No The investment is redeemable at a future date Yes Level 2 Yes Level 3 Is the investment redeemable in the near term? Level 2 Yes No Level 3 Example 1: Fair Value Hierarchy for Investments Measured at NAV (Current Practice) Scenario A Facts. 123 Company (the Company), a public company, holds an investment in XYZ Fund. The investment has an annual redemption date of January 1. The Company has a calendar year-end and defines near term to mean within 90 days of the measurement date. Fair Value Hierarchy Categorization. On December 31, the Company categorizes its investment in XYZ Fund as Level 2 because, on its measurement date, the investment is redeemable in the near term (e.g., within 90 days of the measurement date). However, on March 31, June 30, and September 30, the investment is categorized as Level 3 because it is no longer redeemable in the near term. Issue. The Company categorizes the same investment at different fair value hierarchy levels at different dates during its reporting year. Scenario B Facts. ABC Fund (the Fund), a fund of funds, also holds an investment in XYZ Fund. The investment has an annual redemption date of January 1. The Fund has a fiscal year-end of January 31 and defines near term to mean within 90 days of the measurement date. Fair Value Hierarchy Categorization. On January 31, the Fund categorizes its investment in XYZ Fund as Level 3 because, on its measurement date, the investment is not redeemable in the near term. 3 network of independent member firms affiliated with KPMG International Cooperative, All

4 Example 1: Fair Value Hierarchy for Investments Measured at NAV (Current Practice) Issue. The Company and the Fund categorize a similar (or identical) investment at different levels in the fair value hierarchy because the entities have different measurement dates. Scenario C Facts. Assume the same facts as Scenario A, but the Company defines near term to mean within 120 days of the measurement date. Fair Value Hierarchy Categorization. On December 31, the Company categorizes its investment in XYZ Fund as Level 2, because on this measurement date the investment is redeemable in the near term (i.e., within 120 days of the measurement date). However, on March 31 and June 30, the investment is categorized as Level 3 because the investment is no longer redeemable in the near term. The Company will again categorize its investment as Level 2 at September 30. Issue. Diversity in practice may result from different interpretations of near term. Key Provisions The amendments in the ASU remove the requirement to categorize within the fair value hierarchy investments whose fair values are measured at NAV (or its equivalent) under the practical expedient in the FASB s fair value measurement guidance. Investments eligible for the practical expedient, but for which it has not been applied, will continue to be included in the fair value hierarchy. Reporting entities also must disclose the amount of investments measured at NAV (or its equivalent) under the practical expedient to allow users to reconcile total investments in the fair value hierarchy to total investments measured at fair value in the statement of financial position. However, the ASU does not explicitly state how this reconciliation should be presented. Example 2 illustrates one way a reporting entity might disclose investments measured at NAV under the practical expedient. The new guidance also limits the disclosure requirements that currently apply to all investments eligible to be measured at NAV under the practical expedient to only those in which the practical expedient is applied. 4 network of independent member firms affiliated with KPMG International Cooperative, All

5 Example 2: Illustrative Disclosure Amounts Measured at Net Asset Value 4 Fair Value Measurements at the End of the Reporting Period Using Description Recurring fair value measurements Available-for-sale equity securities Corporate bonds High-yield debt securities 12/31/20X6 Quoted Prices in Active Markets for Identical Assets (Level 1) Significant Other Observable Inputs (Level 2) Significant Unobservable Inputs (Level 3) Residential mortgage-backed securities Investments measured at net asset value 1 45 Total recurring fair value measurements Certain investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the statement of financial position. Scope. This ASU affects all companies that measure an investment at NAV using the practical expedient for measuring the fair value of investments in certain investment funds. This may include investments held by: Investment companies (e.g., hedge funds, fund of funds, and real estate investment funds); Not-for-profit entities; and Financial institutions (e.g., insurance companies and banks). 4 This example is adapted from Example 9 in FASB ASC Topic 820, Fair Value Measurements, available at The purpose of this table is to illustrate one way preparers can provide sufficient information to enable users to reconcile the fair value hierarchy to the statement of financial position. This example is not a complete summary of the fair value disclosure requirements in Topic network of independent member firms affiliated with KPMG International Cooperative, All

6 Conforming Amendments. The ASU makes conforming amendments to two other standards. Statement of Cash Flows Exemption for Certain Investment Companies. Investment companies are exempt from the requirement to prepare a statement of cash flows if certain criteria are met. 5 One criterion is that substantially all of the entity s investments are measured at fair value and categorized as Level 1 or Level 2 in the fair value hierarchy at the measurement date. The ASU makes a conforming amendment to continue exempting certain investment companies from the requirement to prepare a statement of cash flows. An investment company will be eligible for this exemption if substantially all of its investments are measured at fair value and categorized as Level 1 or Level 2 measurements or measured using the NAV practical expedient and are redeemable in the near term at all times. KPMG Observations The EITF s intent when drafting the consequential amendment for the statement of cash flows was to minimize changes for investment companies that are currently exempt from providing a statement of cash flows. However, the EITF raised concerns about the phrase in the near term, as it is the same phrase that initially created the issue. The EITF included at all times (i.e., at each measurement date) in its amendment to avoid situations where an investment company would be exempt from preparing a statement of cash flows in some reporting periods but not others. Thus, some investment companies will no longer meet the exemption requirements from preparing a statement of cash flows if they determine that their investments measured at NAV are not redeemable in the near term at all times. Disclosures for Pension Plan Investments. The FASB s guidance about an employer s accounting for retirement benefits does not discuss the use of NAV as a practical expedient to measure fair value or require specific disclosures for investments measured at NAV. 6 However, many reporting entities use the practical expedient when measuring the fair value of applicable pension plan assets. This ASU makes conforming amendments to clarify that pension plan assets can be valued using the NAV practical expedient. 5 FASB ASC Topic 230, Statement of Cash Flows, available at 6 FASB ASC Topic 715, Compensation Retirement Benefits, available at 6 network of independent member firms affiliated with KPMG International Cooperative, All

7 KPMG Observations The EITF decided not to make any decisions about fair value disclosure requirements for pension plan investments measured using the NAV practical expedient, and agreed that this would be better addressed by the FASB s disclosure framework team. The FASB s disclosure framework project is ongoing. Transition and Effective Date Reporting entities are required to adopt the ASU retrospectively. The effective date for public business entities is fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The effective date for all other entities is fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. Early adoption is permitted for all entities. KPMG Observations The ASU s amendments will likely simplify the disclosure requirements for investments measured at NAV. Therefore, the cost and effort to implement the new standard is not expected to be significant. All entities are encouraged to review the amendments in the ASU. Many may conclude that it will be relatively simple and cost effective to implement the ASU before the effective date. Contact us: This is a publication of KPMG s Department of Professional Practice Contributing authors: Mark M. Bielstein and Robin E. Van Voorhies Earlier editions are available at: Legal The descriptive and summary statements in this newsletter are not intended to be a substitute for the potential requirements of the standard or any other potential or applicable requirements of the accounting literature or SEC regulations. Companies applying U.S. GAAP or filing with the SEC should apply the texts of the relevant laws, regulations, and accounting requirements, consider their particular circumstances, and consult their accounting and legal advisors. Defining Issues is a registered trademark of KPMG LLP. 7 network of independent member firms affiliated with KPMG International Cooperative, All