Financial Reporting Valuations: ASC 820

Overview of ASC 820

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:

  • Intangible assets acquired in a business combination
  • Share-based compensation
  • Goodwill and intangible assets in annual impairment analyses
  • Investments reported at fair value
  • Earnout/contingent consideration liabilities
  • Other valuation-related components of financial statements.

“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.

Scope of ASC 820

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:

  • Business combinations (intangible assets, contingent consideration, deferred revenue)
  • Share-based payments
  • Goodwill and intangible asset impairment testing
  • Investments in debt and equity securities (including private equity investments)
  • Loans
  • Insurance contracts
  • Servicing assets and liabilities
  • Derivative assets and liabilities
  • Disclosure requirements (Level 1 / Level 2 / Level 3)

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:

  • Level 1 – Value is based on observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
  • Level 2 – Value is based on inputs other than quoted market prices included in Level 1 that are observable for the asset or liability either directly or indirectly. Level 2 inputs are those in markets for which there are few transactions, the prices are not current, little public information exists, or in instances where prices vary substantially over time or among brokered market makers. Levels 2 asset or liability values may also be based on model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
  • Level 3 – Value is based on unobservable inputs (e.g. a reporting entity’s own financial information). Level 3 values are driven by models with one or more significant inputs or significant value drivers that are unobservable. Unobservable inputs are those that reflect a company’s own assumptions that market participants would use to price the asset or liability based on the best available information.

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.

Sean Saari HS 2019
Sean Saari
CPA/ABV, CVA, MBA
Partner

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Skoda Minotti’s Valuation and Litigation Advisory Services Group offers the expertise to assist executive management and boards of directors of both private and public companies in satisfying their external audit requirements related to fair value financial reporting.

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