What other provisions are contained in the new draft?
As part of the new provisions, the exposure draft indicates that you should not consider blockage factors for level 2 or 3 fair value measurements. That essentially means that you should not take further discounts to fair value just because you own a large chunk of shares, such as with large investors like Warren Buffet’s Berkshire Hathaway or hedge funds. If you have a large position and you need to liquidate, that sale will affect the price of the stock (typically downward). But you could very easily sell smaller chunks of stock over longer periods of time. Blockage discounts are viewed as transaction costs, and the effects should be recognized when the decision to sell a block is carried out, rather than as period to period fair values.
In addition, the new draft contains certain disclosure requirements when an asset is used in a way that differs from its highest and best use. Also, the highest and best use premise should only be applied to nonfinancial assets, and not financial assets or liabilities. An example of a nonfinancial asset might be in-kind donations such as clothing, food and furniture to a nonprofit charity. The proposal has some additional provisions relating to measuring fair values for items classified as shareholders’ equity, financial instruments managed within a portfolio and other disclosure requirements for financial instruments, which have not been covered in much depth in this article.
How will the changes impact businesses?
Financial statement preparers have already commented that it will entail significant effort and money to obtain this additional information. It is not information that is readily available, and it is very judgmental. It will require significant time to be incurred, especially for companies that have a significant number of level 3 assets and liabilities. For example, a financial institution enters into thousands of these types of transactions each year.
What types of companies will the changes affect?
Unfortunately, as it stands, they will affect a broad spectrum of entities, such as for-profits, nonprofits, pension plans and investment companies. No specific industry is scoped out of the exposure draft at the moment, although representatives from various industries are lobbying to have these standards not apply to them. Most of this is targeted toward public companies that file with the SEC. Unfortunately, everyone else gets pulled into it because there’s no scope of size or type of entity currently in the draft.
What can companies do now to prepare for the proposed changes?
Because this is still in exposure draft form and is not effective yet, companies have until September 7 to provide comment letters to the FASB. If it does become effective, it will take a good amount of time and effort to get the systems in place to capture data for these disclosure requirements. People who prepare financial statements should start the process of planning for the change well ahead of time, because it will become effective fairly quickly.
Do not take the fair value standards lightly. They are here to stay. Try to get up to speed as quickly as possible. Consult with your advisers and your auditors early. It is much easier to collaborate with consultants and auditors up front than to run into surprises when you have to issue your final report.
Daniel Figueredo is a manager at Burr Pilger Mayer. Reach him at (415) 288-6284 or [email protected].
