When a company has any items in its financial statements with a valuation-related component, the valuation analysis is governed by ASC 820 – Fair Value Measurements and Disclosures (formerly SFAS 157). ASC 820 is applicable in the valuation of:
“Fair value” is defined in ASC 820 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.”
When a company has unconsolidated investments in other entities, those investments may need to be reported at fair value every reporting period. This covers everything from investments in marketable securities (which have readily determinable market prices) to investments by private equity firms in privately-held portfolio companies (which need to be valued using asset, income and market-based approaches because these assets are not publicly-traded investments with readily available market prices). As expected, the documentation requirements to support the values of investments in privately-held entities are much greater than when an investment is made in publicly-traded securities where a market price is readily available.
Given the complexity associated with appropriately valuing non-publicly-traded assets and liabilities under ASC 820, it is a best practice for companies to get out in front of any valuation issues before their year-end audit begins. Companies should discuss their planned approach to addressing valuation-related issues with their auditors and determine whether the use of a third-party valuation expert will be necessary. Proactively addressing these issues can lead to a much smoother audit process and avoid potential delays that may be encountered otherwise.
ASC 820 provides guidance on a number of topics encountered in determining the fair value of assets and liabilities reported in a company’s financial statements. Some of the more common accounting considerations addressed by ASC 820 are summarized below:
Fair Value Hierarchy Under ASC 820
The fair value standards under ASC 820 establish a three-level hierarchy to prioritize the inputs used for valuing assets and liabilities, each of which is discussed in more detail below:
As one works their way down the hierarchy, the reliability of the reported values declines and the risk associated with the values reported in the financial statements increases. It is when quoted market prices are not available and an asset or liability is classified in Level 3 of the fair value hierarchy that a third-party valuation analysis may be necessary to support the value to be utilized in preparing a company’s financial statements. Companies should discuss their planned approach to addressing valuation-related issues with their auditors to determine the level of documentation that will be necessary.