The Government Accounting Standards Board (GASB) has issued a new pronouncement number 72 that will be effective for fiscal year 2016, with earlier application encouraged.
The objective of this statement is to improve financial reporting by clarifying the definition of fair value and providing additional fair value application guidance, as well as enhancing disclosures about fair value measurements; by establishing general principles for measuring fair value and financial reporting for assets and liabilities. The most common application will be used for investments and contributed assets.
Valuation techniques are used to determine fair value that are appropriate under the circumstances and for which sufficient data is available and measureable. A government should use one of the following three techniques: market approach, cost approach, or income approach.
This statement also establishes a hierarchy of inputs to valuation techniques used to measure fair value. The hierarchy has three levels that are outlined below along with other key provisions and definitions.
New financial statement disclosures will be made in relation to the fair value measurement to include the level of fair value hierarchy and the valuation technique used.
- Fair value is the price that would be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value hierarchy inputs to valuation are determined using one of three levels:
- Level 1 – Quoted prices in active markets for identical assets or liabilities.
- Level 2 – Inputs, other than quoted prices within Level 1, that are observable for the asset or liability, either directly or indirectly
- Level 3 – Unobservable inputs, such as management’s assumption of the default rate among underlying mortgages of a mortgage-backed security
- The fair value hierarchy gives the highest priority to level one inputs and the lowest to level three inputs.
- Certain equity investments that do not have readily determined fair values can be based on their net asset value (NAV) per share.
- Although similar to the FASB version, GASB 72 does differ.
- Investments historically carried on either the cost or equity method will now be measured at fair value on a recurring basis.
- GASB 72 requires measurement at acquisition value for donated capital assets, donated works of art, historical treasures, and similar assets. These assets were previously required to be measured at fair value.
- An investment is defined as a security or other asset that a government holds primarily for the purpose of income or profit, and that has a present service capacity based solely on its ability to generate cash or to be sold to generate cash.
- Fair value is the price that would be received to sell an asset or be paid to transfer a liability in an orderly transaction between market participants at the measurement date.
- Price is the amount that would be paid to acquire an asset with equivalent service potential in an orderly market transaction at the acquisition date, or the amount at which a liability could be liquidated with the counterparty at the acquisition date is referred to as acquisition value.
- Market Approach: A valuation technique that uses prices and other relevant information generated by market transactions involving identical or comparable assets, liabilities, or group of assets and liabilities.
- Cost Approach: A valuation technique that reflects the amount that would be required currently to replace the service capacity of an asset (often referred to as replacement cost).
- Income Approach: A valuation technique that converts future amounts (for example, cash flows or income and expenses) to a single current (discounted) amount.
If you have questions please contact Jennifer Reddington, CPA, Audit Manager at firstname.lastname@example.org or 800-282-2440.
Jennifer Reddington, CPA