After more than five years of joint work, the International Accounting Standards Board and the Financial Accounting Standards Board (FASB) issued new guidance to improve and align fair value measurement and disclosure requirements. The guidance was issued as International Financial Reporting Standard (IFRS) 13, Fair Value Measurement,and FASB Accounting Standards Update (ASU) No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. These have nearly identical provisions. These standards do not specify where fair value must be used. Rather, they provide guidance on how it is defined where its use is already required or permitted. These standards also outline significant disclosures.
This has been an evolving process. The Financial Accounting Standards Board issued Statement on Financial Accounting Standards No. 157 in September 2006. That set the U.S. GAAP definition of fair value and the first set of disclosure requirements. That standard was renamed as ASC 820 when U.S. GAAP was codified in 2009. It has been modified several times since then with particular emphasis on the disclosures related to the determination of fair value.
That is why I see this topic as being of particular interest to the fiduciaries of ERISA plans. As you know, ERISA requires that investments be reported at "current value." ERISA Section 3(26) defines "current value" as follows:
The term "current value" means fair market value where available and otherwise the fair value as determined in good faith by a trustee or a named fiduciary (as defined in section 402(a)(2)) pursuant to the terms of the plan and in accordance with regulations of the Secretary, assuming an orderly liquidation at the time of such determination.
The new accounting standard defines fair value as:
...the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
In the same way that the ERISA standard distinguishes prices set by the market from the value of an asset without an active market, GAAP sets 3 levels of fair value determinants. Level 1 is quoted prices in active markets for the same instrument. Level 3 applies where the value is determined based upon inputs that are not directly observable in the marketplace. For example, the profitability of a closely-held company would be such an input. Level 2 applies where the value is largely based upon observable inputs but may be modified by items which are not observed. Investments may move between levels based upon the attributes of the marketplace, such as where an active market becomes inactive.
Why is this important? The nature of the required disclosures varies with these levels. Also, GAAP establishes certain concepts that apply to the determination of fair value which may vary from the process used by the fiduciary in determining fair value.
In subsequent postings, I am going to go through the following:
1. Where might fair value for GAAP vary from fair value as determined by the ERISA fiduciary?
2. What options might the plan sponsor consider where that difference is significant?
3. What kind of disclosures are required depending upon an investment is characterized as Level 1, 2 or 3?
4. What other disclosures requirements are presented by GAAP with respect to investments that the fiduciary must consider?
Note, this new standard is generally effective for financial period beginning after December 15, 2011, so this does not impact the financial reports for the 2010 filings that you might be reviewing right now. BUT, as I noted above, this is just an amendment of a standard that was issued in 2006. There are significant fair value disclosures required for the 2010 financial statements. So, you might want to pull those out and look them over for consistency with actual practice, before the Form 5500 is filed.
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