Mercer Capital | An Overview of ASC 820: Fair Value Measurement


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Topics include: "Fair Value Defined," "The Market Participant Perspective," "The Fair Value Hierarchy," "Markets That Are Not Active & Transactions That Are Not Orderly," "Practical Expedient for Investments in Funds That Report NAV," and "Disclosure Requirements"

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Mercer Capital | An Overview of ASC 820: Fair Value Measurement

  1. 1. 1ASC 820Fair ValueMeasurementAn Overview offor Firms Subject to the Investment Company Act of 1940
  2. 2. 2PresentationOutline01. Fair Value Defined02. The Market Participant Perspective03. The Fair Value Hierarchy04. Markets That Are Not Active & TransactionsThat Are Not Orderly05. Practical Expedient for Investments in FundsThat Report NAV06. Disclosure Requirements
  3. 3. 301.Fair Value Defined
  4. 4. 4The FASB believes that, in order to beuseful, accounting information should beboth relevant and reliableTheFair ValueObjectiveReliabilityHistorical CostRelevanceFair Value
  5. 5. 5TheFair ValueDefinitionFair value is the price that would bereceived to sell an asset or paid totransfer a liability in an orderlytransaction between marketparticipants at the measurementdate.
  6. 6. 6TheHypotheticalFair ValueTransactionMeasurement Attribute• Considers price received to exit anexisting position (sell asset or transferliability)Motivation• Not a forced transactionPerspective• That of the “market participant” thatholds the asset
  7. 7. 702.The Market ParticipantPerspective
  8. 8. 8MarketParticipantsMarket Participants are buyers or sellersin the principal or most advantageousmarket who are:• Independent of the reporting entity• Knowledgeable about the asset andthe transaction• Able to transact• Willing to transactFair value of an asset shall be determinedbased on the assumptions that marketparticipants would use in pricing the asset
  9. 9. 903.The Fair Value Hierarchy
  10. 10. 10TheFair ValueHierarchyObservable InputsBased on market data obtained fromsources independent of the reporting entityUnobservable InputsReflect reporting entity’s own assumptionsabout the assumptions market participantswould use
  11. 11. 11Fair ValueHierarchy:Input QualityLevel 1• Direct (unadjusted) quoted price from anactive market for identical assetsLevel 2• Quoted prices for similar assets• Other observable inputs (interest rates,yield curves, etc.)Level 3• Unobservable inputs not derived from themarket
  12. 12. 12CommonLevel 3Inputs• Cash flow forecasts for private companies• Default probabilities and loss severities forprivate placement debt or asset-backedsecurities• Growth expectations (revenue, earnings,etc.)• Required returns on illiquid investments• Anticipated holding periods for illiquidinvestments
  13. 13. 1304.Markets That Are Not Active& Transactions That Are NotOrderly
  14. 14. 14Measuring FairValue WhenMarket ActivityHas SignificantlyDecreasedRegardless of volume, objective is still todetermine FV at the measurement date undercurrent market conditions• FV is a market-based measurement, not an entity-specific measurement• If volume has decreased significantly, judgment isrequired when adjusting observed transaction prices• Although potentially difficult to estimate, applicablerisk premiums to reflect uncertainty must beconsidered• The degree of difficulty in estimating a risk premiumis not a sufficient basis for not applying a riskpremium
  15. 15. 15Factors SuggestingMarket Activity HasSignificantlyDecreased• Few recent transactions• Price quotes not developed using currentinformation• Price quotes vary substantially• Reduction of historical correlations• Significant increase in implied liquiditypremiums, etc. compared to reporting entity’sestimate of expected cash flows• Widening bid-ask spreads• Curtailment of primary market for similarinstruments• Little information publicly available
  16. 16. 16MeasuringFair Value WhenMarket ActivityHas SignificantlyDecreased:ExampleIllustrative FV yield determination (Example 8from ASC 820)• Build-up (discount rate adjustment) techniqueindicates yield of 12%• FV measurement also considered indicative(nonbinding) quotes implying yields of 15% to 17%• Concluded FV yield was 13%Discount Rate AdjustmentBenchmark Risk-Free RateAt the measurement date3.00%Original Credit SpreadBased on pricing at issuance2.50%Est. Spread on Widening Since OriginationBased on performance of relevant index7.00%Basis Adjustment for IndexObserved in most recent transaction-3.50%Liquidity Risk PremiumMeasured Relative to Index Liquidity3.00%Indicated Yield 12.00%
  17. 17. 17TransactionsThat AreNot OrderlyIndicators that a transaction was not orderly:• Not adequate exposure to the market forusual and customary marketing activities• Seller marketed the asset or liabilityto a single market participant• Seller in or near bankruptcy, or under otherregulatory or legal requirementsto sell• Transaction price an outlier compared to otherrecent transactions for the same or similarasset or liability
  18. 18. 18Weighing Reported TransactionsDoes the reporting entity havesufficient information toconclude whether observedtransaction is orderly?Consider the transaction,but give less weight thanotherwiseWas the transactionorderly?Place little, if any, weighton the transactionGive weight to transaction,considering volume,comparability, and timingYesNoNoYes
  19. 19. 1905.Practical Expedient forInvestments in Funds ThatReport NAV
  20. 20. 20Funds WithinScope ofProvisionInvestment Company attributes (946-10-15-2):• Primary business is investing in assets forcurrent income, appreciation, or both• Ownership represented by units of investmentto which proportionate share of net assets canbe attributed• Funds of owners are pooled to facilitate accessto professional investment management• Is the primary reporting entity“Venture capital investment companies, including smallbusiness investment companies and businessdevelopment companies” fall within the ambit of theinvestment company definition
  21. 21. 21Availability ofPracticalExpedientPractical expedient for fair valuemeasurement of ownership interests inan investment vehicle if:• The ownership interests do not havereadily determinable fair value• The vehicle possesses all of the attributesof an investment company, or the industrypractice relevant to the vehicle isconsistent with the reporting practicesrequired of investment companies
  22. 22. 22PracticalExpedient:Using ReportedNAVAs a practical expedient, the fair value of aninterest in an investment vehicle may beestimated using net asset value per sharereported by the company, provided:• Calculation of the reported net asset value isconsistent with fair value measurementprinciples (pursuant to ASC 946 FinancialServices – Investment Companies)• Net asset value per share was obtained at themeasurement dateAdjustments to reported net asset value may beappropriate if the preceding conditions are notmet
  23. 23. 23Exception toPracticalExpedientThe practical expedient is not available ifit is probable that an interest in theinvestment company will be sold for aprice that is different from reported netasset valueA sale is probable if:• Management decides on a plan to sell theinterest• Process of searching for buyers has begun• The interest is available for immediate sale• Significant changes to the plan are unlikely andthe plan will not be withdrawn
  24. 24. 2406.Disclosure Requirements
  25. 25. 25DisclosureRequirements:RecurringMeasurementsFor all recurring fair value measurements:• The valuation techniques and inputs used• If the use of unobservable inputs is significant to thevaluation, the effect of the measurement on earningsand comprehensive income for the periodDue consideration to be given to:• Level of detail necessary to satisfy disclosurerequirements• How much emphasis to place on each requirement• How much aggregation or disaggregation to undertake• Whether users of financial statements need additionalinformation to evaluate quantitative disclosures
  26. 26. 26DisclosureRequirements:RecurringMeasurementsFor all recurring fair value measurements:• The fair value measurement at the end ofthe period• The level of the fair value hierarchy withinwhich the fair value measurements arecategorized in their entirety• Amount of transfers between Levels 1 and2, reason for the transfers, and the policyfor determining when transfers aredeemed to have occurred
  27. 27. 27DisclosureRequirements:RecurringMeasurements(Levels 2 & 3)For changes in valuation technique:• Reasons for the change in technique• For Level 3 measurements, quantitativeinformation about the significantunobservable inputs used in the fair valuemeasurementIf the highest at best use of a nonfinancialasset differs from current use:• Disclose the fact, and;• Explain why the asset is being used in amanner other than its highest and bestuse
  28. 28. 28DisclosureRequirements:RecurringMeasurements(Level 3)For measurements using significant Level 3inputs:• Beginning balance• Total gains or losses (both realized andunrealized)• Purchase and sales of assets• Transfers in and/or out of Level 3• Amount of total gains or losses included inearnings attributable to unrealized gains orlosses• A description of the valuation processes used• A narrative description of the sensitivity tochanges in unobservable inputs, includinginterrelationships, if any, among inputs
  29. 29. 29DisclosureRequirements:Investments inEntities thatCalculate NAVRequired disclosures for interests ininvestment companies:• Fair value of interests by major category,including description of correspondinginvestment strategies• For interests that cannot be redeemed,expected liquidation period of underlying assets• Unfunded commitments related to interests• Redemption terms and conditions• Circumstances that may constrain redemptionfeatures (e.g. gates)• Other restrictions on sale of interests• Fair value of interests whose sale is deemedprobable• Intent to sell interests, if any
  30. 30. 30ContactInformationTravis W. Harms, CFA, CPA/ABV901-322-9760harmst@mercercapital.comJeff K. Davis, CFA615-345-0350jeffdavis@mercercapital.comMERCER CAPITALClark Tower5100 Poplar Avenue, Suite 2600Memphis, Tennessee
  31. 31. 31Portfolio ValuationServicesMercer Capital’s
  32. 32. 32Fair ValueScrutiny“The SEC warned it would be looking more closely atfund directors—and just sued eight former MorganKeegan fund directors for (alleged) inadequateoversight of how fund holdings were priced. Thisproblem is only getting bigger.”Barrons January 5, 2013“Valuation is one of the most significant areas ofpotential risks for funds, particularly those that holdcomplex or thinly traded securities that must be “fairvalued”. As directors consider their risk oversightresponsibilities they should pay careful attention to theadequacy of a fund’s valuation policies andprocedures.”Mutual Fund Directors Forum – Practical Guidance forFund Directors on Valuation Oversight June 2012
  33. 33. 33AboutMercer Capital• Business valuation and financial advisory firmfounded in 1982• Core competency is the valuation of private equityand debt securities• Valuation and positive assurance opinions• Fairness and solvency opinions• Transaction advisory• Litigation support• 400 assignments annually, primarily for domesticentities• 40 employees (employee-owned)• Valuation and industry thought leaders
  34. 34. 34Overviewof ServicesValuation• Tax compliance• Corporate valuation services• Employee Stock Ownership Plan valuationTransaction Advisory Services• Fairness and solvency opinions• M&A and investment banking services• Buy-sell agreements and private company transactionsFinancial Reporting• Private equity, mutual fund, BDC, and other investmentcompany portfolio valuation services• Purchase price allocation• Impairment testing servicesLitigation Support• Expert testimony• Business damages• Shareholder disputes / divorce
  35. 35. 35FinancialReportingValuationServicesMercer Capital provides a comprehensive suite of valuation services toassist boards of directors, portfolio managers, financial managers andothers with financial reporting requirements.In an environment of increasingly complex fair value reporting standardsand burgeoning regulatory scrutiny, Mercer Capital helps clients resolvefair value reporting issues successfully.Mercer Capital fair value opinions are consistently accepted by the BigFour audit firms and other reviewing entities.Our professionals hold the Accredited in Business Valuation (ABV)designation from the AICPA, the Accredited Senior Appraiser (ASA)designation from the American Society of Appraisers and the CharterFinancial Analyst (CFA) designation from the CFA Institute.Valuation Services for Investment Funds• Portfolio Investment Valuation• Fairness and Solvency Opinions• Litigation SupportValuation Services for Portfolio Companies• Purchase Price Allocation• Goodwill Impairment Testing• 409A / Equity Compensation Valuation
  36. 36. 36Key IndustryVerticalsFinancials• Depositories• Asset managers• BDCs• Insurance• Brokers and investment banksManufacturing• Durable and non-durable goods• Consumer and industrialHealthcare• Facilities companies• Medical devices• Staffing companiesDistribution and Transportation• Wholesale distribution• Asset-based transportation companies (all modes)• Third-party logistics providers
  37. 37. 37SeniorProfessionalsJeff K. Davis, CFA• Managing Director• 10 years with Mercer Capital• Spent 13 years as a sell-side analyst covering small-and mid-cap banks and specialty finance• Weekly editorial contributor to SNL FinancialTravis Harms, CFA, CPA/ABV• Senior Vice President• 15 years with Mercer Capital• Extensive financial valuation reporting experience,including on behalf of private equity, BDCs and broker-dealers
  38. 38. 38SeniorProfessionalsZ. Christopher Mercer, ASA, CFA, ABAR• CEO / Founder (1982)• Prolific author and thought leader on private securityvaluation• Has prepared and overseen over a thousandvaluations for M&A, tax, litigation and other mattersMatt Crow, ASA, CFA• President• 19 years with Mercer Capital• Senior member of Mercer’s financial reportingvaluation group
  39. 39. 39SeniorProfessionalsTimothy R. Lee, ASA• Managing Director• 19 years with Mercer Capital• Heads corporate valuation group with industry focus inbeverage, distribution, construction, retail andtransportationAndy Gibbs, CFA, CPA/ABV• Senior Vice President• 14 years with Mercer Capital• Has completed hundreds of bank and loan portfoliovaluations as head of the depository group for M&A,ESOP, and other purposes