Dataline A look at current financial reporting issues

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1 Dataline A look at current financial reporting issues No April 26, 2013 What s inside: Overview... 1 At a glance... 1 The main details... 1 Key provisions... 2 Overview of classification & measurement model... 2 Overview of impairment model for debt instruments...4 Implications for various assets and liabilities... 5 Trade receivables... 5 Debt securities...6 Equity instruments...6 Loans receivable... 8 Bonds and notes payable...9 Derivatives...9 Contribution-related assets and liabilities...9 Next steps Questions Appendices: Appendix A: The not-forprofit reporting model and "other comprehensive income" Appendix B: Implications for equity securities a closer look How FASB's financial instruments proposals would affect not-for-profit organizations Overview At a glance Not-for-profit organizations (or NPOs ) are included within the scope of the FASB's recent proposals to change the classification, measurement, and impairment models for financial instruments. Financial assets would be measured and reported depending on how the NPO would realize value from them as part of its activities. Generally, they will be carried at fair value or amortized cost. Most financial liabilities would be carried at amortized cost. For impaired debt instruments, an allowance for credit losses would be based on a current estimate of contractual cash flows not expected to be collected over the life of the instrument. The proposed guidance emphasizes financial reporting terminology for example, "net income" and "other comprehensive income" that is not used in the not-forprofit financial reporting model. This may create challenges for not-for-profit organizations in evaluating the proposals. This Dataline discusses how the proposed classification, measurement, and impairment models would be applied by not-for-profit organizations. The main details.1 In February 2013, the FASB issued a revised exposure draft of a proposed standard for the classification and measurement of financial instruments (the "C&M proposal"). A proposed impairment model for debt instruments was described in a separate exposure draft issued in December 2012 (the "impairment proposal"). This Dataline discusses how the classification, measurement, and impairment approaches described in those proposals might be applied by most not-for-profit organizations..2 The proposals reflect a complete reconsideration of the guidance the FASB originally proposed in May Together, they would replace most of the FASB's existing National Professional Services Group CFOdirect Network Dataline 1

2 financial instruments guidance, except the guidance on derivatives (which will be addressed in a separate project). For an in-depth look at the general requirements of the proposals, see Dataline , Financial instruments classification and measurement FASB issues its exposure draft, and Dataline , Credit losses on financial assets An overview of the FASB's current expected credit loss model. Key provisions Overview of the classification & measurement model.3 In general, all financial assets and financial liabilities would be measured using one of two different measurement attributes, either fair value or amortized cost. 1 The C&M proposal outlines a different model for financial assets as compared to financial liabilities. The measurement of financial liabilities would be consistent with how the entity expects to settle those liabilities. This means that generally financial liabilities would be carried at amortized cost, with limited exceptions..4 Financial assets would be measured and reported based on how a reporting entity would realize value from them as part of its activities. This would focus on both the cash flow characteristics of the asset and the entity s business model for managing the asset, rather than on the asset's legal form (that is, whether a "debt asset" is a loan receivable or a debt security) as is done today. Based on this assessment, financial assets would be classified into one of three categories for measurement purposes. Because the proposal describes the categories in terms that are not commonly used within the not-for-profit reporting model, this Dataline refers to them as Category 1, Category 2, and Category 3. A table on page 3 maps those categories to the terminology used in the proposal. Category 1 financial assets whose cash flows are limited to payments of principal and interest and are held for the collection of the contractual cash flows. Category 2 financial assets whose cash flows are limited to payments of principal and interest and are held for both the collection of contractual cash flows and for sale. Category 3 financial assets that do not fall within Category 1 or 2. Classification of financial assets a closer look.5 As stated previously, the classification and measurement of a financial asset would depend upon the cash flow characteristics of the asset and the entity s business model for managing the asset..6 The cash flow characteristics criterion asks, "Are the cash flows associated with the asset limited to payments of principal and interest on specified dates?" 2 It highlights an important difference between plain-vanilla debt instruments and, for example, instruments that contain embedded derivatives or are equity instruments. The business model criterion asks, "Why does the entity hold the instrument?" In other words, is a student loan entered into to help a student finance his or her education (in which case, the school would likely hold the loan and collect the payments, and reflect the loan at amortized cost)? Or, is the loan simply an instrument held for investment purposes to sell when the market is right (which would be reflected at fair value)? 1 Amortized cost is a cost-based measure of a financial asset or financial liability that adjusts the initial cash inflow or outflow (or the noncash equivalent) for factors such as amortization or other allocations. The proposal provides a formal definition of the term. 2 The contractual cash flow characteristics criterion is satisfied "if the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding." The features of each instrument (for example, any prepayment options or rate resets) would need to be carefully evaluated to determine whether this criterion is met. National Professional Services Group CFOdirect Network Dataline 2

3 Classification of financial assets: crosswalk table for NPOs Instrument characteristics Classification What it means for NPOs Debt instruments that pay principal and interest and are being held to collect the contractual cash flows Debt instruments that pay principal and interest; entity does not know at inception whether it will hold or sell the instrument All other debt instruments Equity instruments "Category 1" (Amortized cost) "Category 2" (Fair value through other comprehensive income) "Category 3" (Fair value through net income) Initially measure at transaction price*; thereafter, measure at amortized cost, subject to impairment testing Initially measure at transaction price*; thereafter, measure at fair value, with fair value changes reported in appropriate class of net assets** NPO health care entities would report unrestricted fair value changes below the performance indicator Measure at fair value both initially and subsequently, with fair value changes reported in appropriate class of net assets NPO health care entities would report unrestricted fair value changes above the performance indicator (except for changes associated with hedging derivatives) * "Transaction price" is the price paid to acquire an instrument; it is an entry-price notion. Fair value, on the other hand, is an exit-price notion reflecting what the instrument could be sold for. The primary difference involves the treatment of transaction costs that sometimes accompany the acquisition of an instrument. However, transaction costs are likely to be more of an issue for financial institutions than they are for not-for-profit entities. ** The appropriate classes of net assets would be permanently restricted, temporarily restricted, and unrestricted net assets..7 The assessment of the cash flow characteristics and business model would be made when a financial asset initially is acquired (or in the case of a loan receivable, when it is originated), and the results of the assessment would determine how the asset would be classified and measured, both initially and going forward. National Professional Services Group CFOdirect Network Dataline 3

4 Financial assets that pay principal and interest.8 Financial assets that pay principal and interest (for example, loans receivable or debt securities) would be subject to measurement and classification as follows. Category 1 instruments (that is, those that the entity intends to hold in order to collect the principal and interest payments) would be initially measured at transaction price and thereafter reported at amortized cost. Under amortized cost measurement, changes in value are recognized in the financial statements at the time they are realized by the reporting entity (for example, when they are sold or if impairment occurs). Category 2 instruments (that is, those that the entity does not know at acquisition whether it plans to hold to collect contractual cash flows, sell in short order, or hold for awhile and then sell) are initially measured at transaction price and subsequently measured at fair value. For not-for-profit health care organizations, qualifying changes in fair value would be reported outside the performance indicator (analogous to recognizing such items in other comprehensive income (OCI)). Category 3 instruments (that is, all other instruments that pay principal and interest that are not in Categories 1 or 2) would be measured at fair value initially and subsequently. Not-for-profit health care organizations would report the fair value changes within the performance indicator. All other financial assets.9 Receivables, loans, and debt securities are financial instruments for which an entity would need to consider the cash flow characteristics criterion, whereas an entity would not consider that criterion for equity instruments, which are addressed separately in the model. Equity instruments would be classified in Category 3 and, except as discussed below, would be measured at fair value initially and on a recurring basis..10 With the exception of investments that result in consolidation or that qualify for the equity method of accounting, equity investments generally would be measured at fair value. This includes equity investments that do not have readily determinable fair values (that is, fair values are not indicated by quoted market prices or similar evidence 3 ). The net asset value (NAV) "practical expedient" currently used to estimate fair value for certain of those investments would be retained. 4 In addition, an exception to fair value measurement (the "practicability exception") is provided for investments that do not qualify for the practical expedient. An entity that elects the practicability exception would be permitted to measure equity investments at their cost, adjusted for both impairment and changes that result from observable price changes ( if information about a price change is "observable" based on known transactions). Overview of the impairment model for debt instruments.11 Financial assets that are debt instruments within Categories 1 or 2 would need to be assessed for impairment. For most not-for-profit organizations, these would likely include trade receivables, loans receivable, loan commitments, lease receivables, and debt securities that are not classified in Category 3. The proposed impairment model is set out in a separate exposure draft issued in December That exposure draft proposes a "current expected credit loss" (CECL) model, which calls for an entity to recognize an allowance for credit losses based on its current estimate of contractual cash flows not expected to be collected. 3 For the authoritative definition of "readily-determinable fair value," see the FASB ASC's glossary 4 See FASB ASC National Professional Services Group CFOdirect Network Dataline 4

5 .12 The CECL model would replace the multiple impairment models that currently exist for debt instruments (used in the allowance for doubtful accounts, allowance for loan losses, and other-than-temporary impairment analyses) with a single impairment measurement approach. Each Category 1 or Category 2 debt instrument would have an allowance for expected credit losses. The allowance amount would represent management's current estimate of the contractual cash flows the entity does not expect to collect over the life of the instrument. What's more, that estimate would be made and booked on "Day 1." From that point forward, at each balance sheet date, management would reflect its current estimate of expected credit losses. The statement of activities for the period would show how much the credit risk of the financial instrument may have deteriorated or improved. PwC observation: The CECL model would allow entities to consider more forward-looking information than is permitted under current GAAP. When credit losses are measured today, an organization primarily considers past events and current conditions. The CECL model would allow entities to consider reasonable and supportable forecasts about the future..13 A key principle underlying the CECL model is that the estimate of expected credit losses must reflect both the possibility that a credit loss will occur and the possibility that no credit loss will occur. In other words, the estimated credit loss cannot be based solely on the most likely outcome. Bottom line, the CECL model generally means that some amount of credit loss will need to be reflected for these debt instruments on "Day 1," with one possible exception that is described in paragraph 18. Implications for various assets and liabilities.14 Below, we provide a brief summary of the implications of these proposed standards for various types of financial assets and financial liabilities commonly held by not-forprofit organizations. Trade receivables.15 Short-term receivables arising in the normal course of business would continue to be reported at net realizable value that is, at amortized cost less a valuation allowance for credit losses (often referred to as an allowance for doubtful accounts). However, the allowance for doubtful accounts would be determined using the CECL model, under which the full amount of expected credit losses would be recognized at the time the receivable is initially recorded..16 A commonly used technique for establishing the allowance for doubtful accounts involves an aging of accounts receivable in a matrix format. The proposal acknowledges that estimates based on a "provision matrix" (such as an aging technique) rely on an extensive population of actual loss data and, thus, implicitly incorporate multiple outcomes without the need for probability weighting of scenarios. An example of an impairment calculation using a doubtful accounts provision matrix is included in the proposal. National Professional Services Group CFOdirect Network Dataline 5

6 Debt securities.17 As a general rule, investments in debt securities would be carried at fair value or amortized cost based on the entity's business strategy for managing the asset (see chart on page 3). Debt securities for which the entity does not know at acquisition what its plans are that is, whether it will hold or sell the securities, or hold the securities for awhile and then sell them would initially be measured at the transaction price and thereafter measured at fair value (Category 2). Changes in fair value would be reported as changes in the appropriate net asset classes. For health care organizations, changes in fair value that are not related to credit losses would initially be reported below the performance indicator and then "recycled" into earnings when they are subsequently realized, similar to the treatment of debt securities classified as "available for sale" today. Impairments related to credit losses would be reported in the performance indicator. PwC observation: Most debt securities held in longer-term investment portfolios generally would fall into Category 2. However, an election is available to classify these securities in Category 3, where they would be marked-to-market at inception and on a recurring basis thereafter, as if they were held for trading. This election might be appealing to not-for-profit organizations that wish to avoid having to assess the security for impairment. If a not-for-profit organization acquires a debt security that meets the cash flow characteristics criterion and anticipates holding it to maturity, that security would be initially measured at the transaction price and thereafter reported at amortized cost (Category 1). Debt securities that do not fall within either of the above categories (that is, they are Category 3 securities) would be reported at fair value, both initially and subsequently. For health care organizations, the changes in fair value would be included in the performance indicator..18 Debt securities classified in Categories 1 or 2 would be subject to an impairment assessment using the CECL model. The other-than-temporary impairment assessment required today for not-for-profit organizations that report an earnings measure (such as health care entities) would be eliminated. Instead, when a debt security classified in one of these categories is acquired, the entity would be required to reflect a "Day 1" allowance for credit losses on that security. From that day forward, any improvement or deterioration in credit risk (or change in the timing of the cash flows) that was not considered in determining the initial estimate would be reflected in the statement of activities. However, for Category 2 debt securities, entities would be permitted to use the following practical expedient: an initial credit loss would not be required if fair value is at or above amortized cost and the expected losses are insignificant (such as would often be the case for Treasury securities). Not-for-profit health care entities would continue to report impairments related to credit losses within the performance indicator. Equity instruments (e.g., equity securities, partnerships, limited partnerships, LLCs).19 Under the proposal, equity investments would generally be measured at fair value unless they qualify for the equity method of accounting or result in consolidation. All changes in fair value would be reported as a change in the appropriate net asset class (and for health care entities, fair value changes reported within the unrestricted net asset class would be included in the performance indicator). For health care organizations, use National Professional Services Group CFOdirect Network Dataline 6

7 of an "available-for-sale" or "other than trading" classification, which allowed unrealized gains and losses to be reported below the performance indicator, would no longer be permitted..20 Special considerations would apply when equity instruments (for example, alternative investments such as limited partnership investments) do not have a readily determinable fair value. When such investments are measured at fair value today, current GAAP provides an option to estimate the fair value using reported net asset values (NAVs), assuming certain conditions are met. 5 This practical expedient, which greatly simplifies the process of estimating fair value and significantly reduces the time and effort involved, would be retained under the proposal..21 Some equity investments that do not have readily determinable fair values would not qualify for the practical expedient because, for example, no NAV is available; NAV is not calculated consistent with the guidance for investment companies; or it is probable that the investment would be sold for an amount other than NAV. In those situations, the proposal would permit the investor to opt out of fair value measurement. Under this instrument-by-instrument election referred to as the "practicability exception" the investments would be measured at cost, adjusted for impairment and for changes that result from upward or downward changes in "observable prices" 6 for the same or similar investment, if available. Organizations would not be expected to perform an exhaustive search to identify observable prices under this exception. They would use information that they would reasonably be expected to know or that would be readily obtainable (for example, through information provided in a call for a subsequent round of financing). PwC observation: The "practical expedient," which involves a simplified process for estimating the fair value of a nonmarketable equity investment based on its NAV, and the "practicability exception," which allows an entity to opt-out of fair value measurement altogether and apply a special adjusted cost method, are two ways in which the FASB has tried to be sensitive to the potential implementation challenges of its proposal..22 Because use of the practicability exception would result in a cost-based measure, instruments to which it is applied would require an ongoing assessment for potential impairment. This would involve assessing indicators of impairment to determine whether it is more likely than not that the fair value of the investment is less than its carrying amount. If so, an impairment charge would be required, which for health care organizations would be included in the performance indicator. Use of the equity method.23 Today the equity method of accounting is applied when an investor has the ability to exercise significant influence over the operating and financial policies of the investee. Not-for-profit organizations (except health care entities) can elect to measure nonmarketable equity investments at fair value in situations where the equity method would otherwise be required..24 Under the C&M proposal, the equity method of accounting would generally continue to apply, with one important change. When an equity investment first qualifies for equity method accounting (because it meets the "significant influence" test) a held for sale evaluation would also need to be performed. If the investment is "held for sale," the equity method cannot be used, and measurement would follow the general guidance 5 See ASC Observable price changes are prices in orderly transactions for the identical investment or a similar investment of the same issuer. National Professional Services Group CFOdirect Network Dataline 7

8 described in paragraph.19 above for equity investments. An equity method investment would be deemed held for sale if the holder has specifically identified potential exit strategies (even though it may not yet have selected the one that will be used) or has defined when it expects to exit the investment. This could be an expected date (or range of dates); a time defined by specific facts and circumstances (such as achieving an identified milestone); or based on the entity s investment objectives..25 The proposed guidance also would eliminate the other-than-temporary impairment model used for equity method investments today, and replace it with a one-step impairment model that assesses qualitative factors to determine when it is "more likely than not" that the fair value of the equity investment is below its carrying amount. This is the same impairment model that would be used for alternative investments measured using the "practicability exception." The "portfolio-wide" fair value measurement option.26 Historically, not-for-profit organizations (except health care entities) have been afforded a special "portfolio-wide" election to measure alternative investments at fair value in situations where the equity method would otherwise have been required. The proposed guidance would retain the portfolio-wide election for those entities, thus avoiding the need to apply the equity method to investments (for example, investments in limited partnerships and partnership-like limited liability companies) where the equity method is applied at a relatively low ownership threshold..27 The portfolio-wide election would be revised, however, to be slightly narrower in scope than the existing guidance, differing in two ways. First, the election would only be available as an alternative to the equity method. This would eliminate an exception in existing GAAP under which a not-for-profit organization that is a general partner in a limited partnership is permitted to carry that investment at fair value instead of consolidating it, as would normally be required. PwC observation: Many nonmarketable investment vehicles are structured as limited partnerships (or as limited-liability companies that function like limited partnerships). A limited partnership consists of a general partner (who has unlimited liability) plus one or more limited partners. Not-for-profit organizations that apply the "portfolio-wide election should review their investments in those entities to identify any holdings where they are acting in the role of a general partner. If those situations exist, the not-for-profit organization may wish to begin now to evaluate the financial reporting implications of potentially consolidating those investment entities..28 Second, investments that are not financial instruments (for example, real estate holdings or oil and gas interests) would no longer be within the scope of the portfoliowide election. However, the proposed guidance would establish a separate provision in GAAP that permits non-healthcare not-for-profit organizations to carry such investments at either cost or fair value. Not-for-profit health care organizations would continue to carry such investments at amortized cost, as they do today. Loans receivable.29 Under the exposure draft, loans receivable would be carried at amortized cost or fair value, depending on the not-for-profit organization s business strategy for making the loan. Loans that the organization intends to hold and collect (for example, student loans and loans to faculty or physicians) would be measured at amortized cost, as compared with loans that might be sold or traded by financial institutions (which typically would be measured at fair value). National Professional Services Group CFOdirect Network Dataline 8

9 .30 Loans carried at amortized cost would be subject to the requirements of the CECL model for debt instruments. If a university originates a student loan with payments due over 7 years, under today's model its allowance for loan losses would be established based on prior collection experience and current economic factors that could influence the ability of the loan recipient to repay the loan. Under the impairment proposal, the allowance for loan losses would reflect management s current estimate of the contractual cash flows that it does not expect to collect, taking into consideration all losses that it expects to occur during the entire 7-year term of the loan. What's more, that estimate would be made and booked on "Day 1" (that is, when the loan is made). From that point forward, the statement of activities would reflect only the impact of deterioration or improvement in the estimate originally made. Bonds and notes payable.31 Under the proposal, an entity's own debt generally would be measured at amortized cost. Issuance costs would continue to be deferred and amortized in the same manner as under current GAAP. PwC observation: In its May 2010 exposure draft, the FASB proposed measuring most financial liabilities at fair value. The comment letters the FASB received indicated overwhelming disagreement with this. Respondents did not believe it appropriate to measure financial liabilities at any amount other than the amount at which the liability most likely will be settled. Derivatives.32 Derivatives are scoped out of the C&M proposal, as the board intends to consider hedge accounting in a separate phase of the project. All derivatives, whether in an asset or liability position, will continue to be measured at fair value, with changes in fair value reported in the appropriate class of net assets. Health care organizations will continue to report such changes in the performance indicator, unless the derivative is designated as the hedging instrument in a cash flow hedge or hedge of a net investment in foreign operations. Contribution-related assets and liabilities.33 "Contribution-related assets and liabilities" include contributions receivable and payable (that is, pledges), split-interest agreements, and beneficial interests in trusts..34 All pledges receivable or payable by a not-for-profit organization are scoped out of the proposed standard. The FASB decided that it would be more efficient to address the measurement attributes for pledges after having an opportunity to review broader recommendations related to not-for-profit accounting, including whether there would be specific attributes or implementation issues related to the receivables and payables. The scope exception for pledges receivable applies only to the not-for-profit organization s receivable or payable; it would not apply to the counterparty s payable or receivable unless that counterparty is also a not-for-profit organization. PwC observation: Although pledges receivable are outside the scope of the proposed guidance, not-forprofit organizations that have elected the fair value option (informally referred to as the "FAS 159" fair value option) for measuring their pledges would no longer be able to utilize that option, as it would be eliminated by the proposal. National Professional Services Group CFOdirect Network Dataline 9

10 .35 Split-interest agreements, regardless of their structure, are not likely to be significantly impacted. If a third party institution, such as a bank, serves as the trustee for the arrangement, a not-for-profit beneficiary s beneficial interest in the trust is already required to be measured at fair value on a recurring basis, and no changes would be required. If the not-for-profit beneficiary also serves as the trustee for the arrangement, existing GAAP requires the not-for-profit organization to recognize the assets contributed to the trust at fair value, recognize a liability to the beneficiaries of the lead or remainder interests (as appropriate) using a present value measurement, and recognize the difference as contribution revenue. The liability to the beneficiaries under this type of structure represents a financial liability, which would be considered an entity's "own debt" that would continue to be measured at amortized cost. Next steps.36 Comments on the C&M proposal are due by May 15, 2013, and comments on the impairment proposal are due by May 31, An effective date will be decided during final deliberations, after the FASB has received feedback through comment letters and outreach. Given the timing of the proposals, we are unlikely to see a final standard before 2014, which makes an effective date earlier than 2015 unlikely. Questions.37 PwC clients who have questions about this Dataline should contact their engagement partner. Engagement teams that have questions should contact a member of the Not-for- Profit or Financial Instruments teams in the National Professional Services Group ( ). National Professional Services Group CFOdirect Network Dataline 10

11 Appendix A: The not-for-profit financial reporting model and "other comprehensive income" A significant difference between the financial reporting model used by business enterprises and the financial reporting model used by not-for-profit organizations is that the not-for-profit financial reporting model does not employ a concept of "other comprehensive income." A not-for-profit organization reports the total change in net assets during a period (which is analogous to total comprehensive income for a business enterprise), but (with the exception of health care organizations) is not required to report an intermediate subtotal that represents earnings for the period. Not-for-profit health care organizations use a variation of the not-for-profit reporting model, which is widely regarded as being the not-for-profit "analog" to reporting by commercial enterprises. Among other things, not-for-profit health care organizations are required to report a "performance indicator" that is the functional equivalent of income from continuing operations reported by a for-profit enterprise. (The term performance indicator is used to denote the earnings measure because the FASB deemed the term net income inappropriate for describing that measure in the not-for-profit environment.) Because they report earnings, not-for-profit health care organizations (and other not-for-profit organizations that voluntarily report an earnings subtotal analogous to the performance indicator) are able to utilize "other comprehensive income" concepts within their financial statements. National Professional Services Group CFOdirect Network Dataline 11

12 Appendix B: Implications for equity securities a closer look Not-for-profit health care organizations Today, investments in equity securities that have readily determinable fair values (often informally referred to as "FAS 124" equity securities) are measured at fair value, but the treatment of the changes in fair value differs based on an entity's accounting designations. Some health care organizations report the fair value changes in the performance indicator, either because they carry the securities in a trading portfolio or because they have elected the "FAS 159" fair value option. The proposed guidance will have little impact on those organizations. However, investments that are classified within an "available for sale" (other-than-trading) portfolio today would be affected, as fair value changes would no longer be permitted to be excluded from the performance indicator. The accounting for investments in equity securities that do not have readilydeterminable fair values could be significantly impacted, depending on how broadly the FASB intends the "held for sale" criterion to be interpreted. Many alternative investment vehicles are structured as limited partnerships or limited liability companies. Because "significant influence" is deemed to exist at very low ownership levels within those types of structures, most health care entities today report non-marketable equity investments using the equity method. If the "held for sale" criterion is narrowly interpreted (for example, if an exit strategy must exist for each investment individually), then these investments would likely continue to be reported under the equity method. If the "held for sale" criterion is applied broadly (for example, if all investments carried within an externally-managed portfolio are deemed to be implicitly "held for sale," or if the fact that many of these structures involve "limited life" entities means that they inherently have specified an exit date), the equity method could no longer be used. Instead, those investments would be required to be measured at fair value. In that situation, the measurement change likely would not have a significant impact on amounts reported in either the balance sheet or the statement of operations. This is because the equity method measurements often approximate fair value (particularly for investments for which a NAV is reported), and the "equity pickup" amount already is included in the performance indicator. The biggest changes would involve disclosure, as there are significant disclosure requirements associated with fair value measurement, particularly for level 3 measures. In addition, modifications to the entity's system of internal control over financial reporting for investments likely would be required to accommodate the shift from equity method valuation to fair value measurement. (When fair value is the measurement attribute, the entity's control system becomes a critical aspect of its ability to appropriately estimate and monitor the valuations used.) For investments that do not qualify for the NAV "practical expedient" for simplified fair value measurement, a health care organization could elect the "practicability exception" and use the special adjusted cost basis. In those situations, the measurement amounts would likely differ, but the fair value disclosure requirements would not apply. In addition, the impairment assessment would be simpler than it is today for either equity method investments or cost-method investments. For any alternative investments carried at cost today, the changes associated with marking-to-market and reporting fair value changes in the performance indicator could be more extensive than they would be for investments measured using the equity method. If the NAV "practical expedient" is not available for those investments, electing the "practicability exception" would help to mitigate volatility and eliminate the need for fair value disclosures. National Professional Services Group CFOdirect Network Dataline 12

13 Other not-for-profit organizations Organizations that are within the scope of the AICPA audit and accounting guide Notfor-Profit Entities would not experience any changes associated with their "FAS 124" equity securities, as those investments would continue to be reported at fair value, with fair value changes reported within the appropriate class of net assets. For equity securities that do not have readily-determinable fair values, the existing guidance described in ASC related to reporting alternative investments based on the type of not-for-profit organization (higher education, voluntary health and welfare, health care, or other not-for-profit) would be eliminated. Entities that currently utilize the "portfolio-wide" fair value option for alternative investments could continue to do so, even if they exceed the threshold where use of the equity method would normally be required. The one area of potential change would involve investments in limited partnerships where the not-for-profit organization serves as the general partner. In those situations, the not-for-profit organization would be required to consolidate the investee, instead of carrying it at fair value (as is permitted today). For organizations within the scope of the Not-for-Profit Entities guide that do not currently elect the portfolio-wide fair value option, the expected changes would affect equity method investments that are deemed to be "held for sale," and any cost method investments. For those entities, the implications would be similar to those described for not-for-profit health care organizations. National Professional Services Group CFOdirect Network Dataline 13

14 Authored by: Martha Garner Managing Director Phone: Victoria Brennan Senior Manager Phone: Karen Pfeil Senior Manager Phone: Elaine O'Keeffe Senior Manager Phone: Christopher Rickli Senior Manager Phone: Datalines address current financial-reporting issues and are prepared by the National Professional Services Group of PwC. They are for general information purposes only, and should not be used as a substitute for consultation with professional advisors. To access additional content on financial reporting issues, register for CFOdirect Network ( PwC s online resource for financial executives PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see for further details.