GASB Update: Statement No. 72, Fair Value Measurement and Application
An incredible amount of the focus on these changes over the last few years has been on the recent pension pronouncements, but with those largely implemented at this point, it’s time to turn our attention towards some of the other new standards that will be becoming effective over the next few years. One of the larger standards of most immediate concern is GASB Statement No. 72, Fair Value Measurement and Application.
GASB No. 72 is effective for reporting periods beginning after June 15, 2015. Practically speaking, this means that school districts will be implementing these changes for the year ending June 30, 2016, followed by municipalities implementing these changes for the year ending December 31, 2016.
So what does this new pronouncement do? GASB No. 72 clarifies the definition of fair value, establishes general principles for measuring fair value, and enhances disclosures about fair value measurements. Generally, under this statement, fair value is described 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. The statement also outlines three approaches to measuring fair value: the market approach, the cost approach, and the income approach.
The market approach uses prices and other relevant information generated by market transactions involving identical or similar assets or liabilities. The most common methods of measurement would be using quoted market price, although there are alternative methodologies outlined by the statement. The cost approach measures fair value based on the amount that would be needed to currently replace the asset. For a seller, the price is based on the cost to a marketplace buyer to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence. The final approach to measuring fair value, the income approach, converts future amounts, such as cash flows, or revenues and expenses, to a single current amount. This fair value reflects current market expectations about those future amounts.
The new fair value measurement and application guidelines also establish a new fair value hierarchy, with three levels, as follows:
- Level 1 – inputs are quoted prices for identical assets/liabilities in active markets that a government can access at the measurement date. Examples of markets in which inputs may be observable include exchange markets, dealer markets, and brokered markets.
- Level 2 – inputs, other than quoted prices included in level 1, that are directly or indirectly observable for an asset or liability. Level 2 inputs include quoted prices for similar assets.
- Level 3 – inputs are unobservable. In these instances a government should develop inputs using the best information available under the circumstances.
Beyond these conceptual differences in fair market value measurement, there are also significant changes to be made to the financial statement footnote disclosures. The new footnote disclosures should include a description of the fair value hierarchy, as outlined above, and then for each type of asset or liability that is recorded, the footnotes to the financial statement should disclose the following:
- The fair value measurement at the end of the reporting period,
- The level of the fair value hierarchy within which the fair value measurements are categorized, and
- The valuation techniques used
For example, if the government has on the balance sheet investments of $1,000, disclosure meeting the requirements above may read something like this:
U.S Treasury securities of $250 are valued using quoted market prices (Level 1 inputs)
Corporate bonds of $750 are valued using a matrix pricing model (Level 2 inputs)
It’s important to point out though that this is a fairly simple, straightforward example. Based on the number of investments or other assets or liabilities requiring fair value measurements, these disclosures could be considerably more complex and require a great deal of attention.
As with many of the new and upcoming GASB Statements, significant planning and effort is required to ensure compliance with the new requirements. For more information on GASB Statement No. 72, Fair Value Measurement and Application, you can find the complete pronouncement, which is a public document, on www.gasb.org, or feel free to contact us for more information.