What You Need to Know:
Fair Value Measurement and Application
The GASB has just approved guidance to bring more clarity to areas of uncertainty.Although fair value often is readily available from stock markets and other sources, it sometimes requires the use of estimates and professional judgment. Fortunately, the GASB has just approved guidance to bring more clarity to areas of uncertainty—including direction on how to apply fair value when market values cannot be obtained and where management judgments are necessary.
GASB Statement No. 72, Fair Value Measurement and Application, defines fair value as the price that would be received from the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This reflects the Board’s view that fair value is a market-based measurement and represents an exit price (what a government would get to sell an asset), as opposed to an entry price (what a government would pay to purchase an asset), which may be different.
The Statement extends the application of fair value reporting to most investments by defining an investment as “a security or other asset that a government holds primarily for the purpose of income or profit, and its present service capacity is based solely on its ability to generate cash or to be sold to generate cash.”
The Statement also establishes a three-level hierarchy of inputs used to measure fair value. Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Finally, Level 3 inputs are unobservable inputs, such as management’s assumption of the default rate among underlying mortgages of a mortgage-backed security.
Finally, the new standards provide guidance on applying fair value to alternative investments, such as hedge and private equity funds. It also enhances disclosure requirements around those types of investments.
Why did the GASB decide to take a fresh look at this issue? Simply put, it was time for an update.Why did the GASB decide to take a fresh look at this issue? Simply put, it was time for an update.
For many years, the GASB and the FASB—which sets accounting standards for public and private companies and not-for profits—had identical definitions of fair value. Over time, however, FASB stakeholders raised concerns about the lack of application guidance surrounding fair value—and the resulting lack of consistency in how it was being measured. To address those concerns, in 2006, the FASB issued a new standard on fair value.
In 2012, the GASB added a project to its agenda to consider modifications to its fair value standards, including aligning its definition of fair value with the FASB’s updated definition. In June 2013, the GASB approved a Preliminary Views, Fair Value Measurement and Application, laying out its initial thinking on this topic.
Stakeholder input on the ED—including the GASB’s proposal to harmonize the GASB and FASB definitions of fair value—has been incorporated into the upcoming final Statement.
In May 2014, the Board followed its Preliminary Views with an Exposure Draft that was issued for public comment. Stakeholder input on the ED—including the GASB’s proposal to harmonize the GASB and FASB definitions of fair value—has been incorporated into the upcoming final Statement, which is expected to be issued on or about February 27, 2015.