Local Governments Have New Fair Value Disclosures Under GASB 72
Measuring assets and liabilities at fair value may not be a concept that local governments have given much thought to while preparing financial statements in recent years. Investment advisors provide us the year-end value of investments, which become the amounts reported on the statement of net position. Disclosure requirements have remained consistent over the last several years, and we’ve all had a good understanding of them. But now there are some changes we need to be aware of.
In February 2015, the Governmental Accounting Standards Board (GASB) issued Statement Number 72, Fair Value Measurement and Application. This statement changes the definition of fair value and adds new disclosure requirements. GASB 72 is effective for periods beginning after June 15, 2015 (i.e., financial statements for June 30, 2016, and beyond).
Definition of fair value
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction. In determining this amount, three valuation techniques are available:
- Market approach — This uses prices generated for identical or similar assets or liabilities. The most common example is an investment in a public security traded in an active exchange such as the NYSE.
- Cost approach — This technique determines the amount required to replace the current asset. This approach may be ideal for valuing donations of capital assets or historical treasures.
- Income approach — This approach converts future amounts (such as cash flows) into a current discounted amount.
Each of these valuation techniques requires inputs to calculate a fair value. Observable inputs should be maximized in fair value measures, and unobservable inputs should be minimized.
Hierarchy of inputs
GASB 72 establishes a hierarchy of inputs to the valuation techniques above. This hierarchy has three levels:
- Level 1 — Inputs are quoted prices in active markets for identical assets or liabilities.
- Level 2 — These are quoted market prices for similar assets or liabilities, quoted prices for identical or similar assets or liabilities in markets that are not active, or other than quoted prices that are not observable
- Level 3 — These are unobservable inputs, such as a property valuation or an appraisal.
When measuring an asset or liability at fair value, a government should maximize use of relevant observable inputs and minimize use of unobservable inputs. An example of a level 1 input would be ownership in shares of a company that is publicly traded on the NASDAQ or NYSE exchanges; a level 2 example would be ownership of a corporate bond that trades on an exchange that is not active; and a level three example would be ownership in a private hedge fund that does not trade on a public exchange.
Additional assets and liabilities not required to be measured at fair value
Good news: GASB 72 does not require any additional assets or liabilities to be measured at fair value. Assets and liabilities currently recorded at fair value on the balance sheet or statement of net position, such as investments and interest rate swap liabilities, will continue to be required to be measured, recognized, and disclosed in accordance with GASB 72. Existing exceptions to fair value, for example investments in 2a-7-like pools, will remain.
New disclosure requirements
Depending on the amount and complexity of the assets and liabilities measured at fair value at your local government, additional required disclosures can be significant. For each class or type (e.g. fixed income governmental, corporate, U.S. etc.) of assets and liabilities measured at fair value must disclose:
- Fair value measurement at the end of the reporting period (for recurring fair value measures)
- Level of the fair value hierarchy within which the fair value measurements are categorized (level 1, 2, or 3)
Descriptions of the valuation techniques are also required.
These disclosures are required to be organized by type of asset or liability. Presenting the required disclosures on one line item in the notes to the financial statements labeled “investments” would not be enough information, whereas making the required disclosures for each and every individual security within your investment portfolio could be too much. In assessing the proper level of disaggregation, GASB 72 states the following items should be considered:
- The nature, characteristics, and risks of the assets and liabilities. Assets and liabilities that share these attributes can be aggregated.
- The level of the fair value hierarchy within which the fair value measurement is categorized. Fair value measurements categorized within level 3 of the fair value hierarchy may need greater disaggregation.
- Whether Statement No. 72 or another statement specifies a type for an asset or a liability. Disclosures should be disaggregated by type as specified by relevant accounting standards.
- The objective or the mission of the government. The level of aggregation or disaggregation may differ based upon the objective or mission of the government.
- The characteristics of the government. Additional disclosures may be appropriate if the risk exposure of a particular fund is significantly greater than the deposit and investment risks of the primary government.
- Relative significance of assets and liabilities.
- Whether separately issued financial statements are available. A local government may further aggregate disclosures if a component unit issues its own separate financial statements containing disaggregated information.
- Line items presented in the balance sheet or statement of net position. A type of asset or liability will often require greater disaggregation than the line items presented in the statement of net position.
Additional disclosure requirements include if there has been a change in valuation technique that is significant, that change and the reasons for making it. For nonrecurring fair value measures, the reason(s) for the measurement must be disclosed.
For certain types of investments, most notably alternative investments, Net Asset Value (NAV) equivalent is used to estimate fair value. An example of such an investment would be a private hedge fund. These investments are not required to be categorized as level 1, 2 or 3. However, there are additional disclosures required such as:
- A description of the investment’s strategies
- Government’s unfunded commitments, if any
- Redemption provisions
- Redemption restrictions and period of lapse
- Restriction on the ability to sell
- Pending sale information
- Examples of all these disclosures are included in Statement 72 – Illustration 5.
The requirements of Statement No. 72 are similar to those that private companies have followed for several years. You can look to their practices for examples of different assets and liabilities measured at fair value.
How we can help
We understand the requirements and intricacies of Statement No. 72, how it will impact the measurement and recognition of assets and liabilities measured at fair value, and the significant disclosures which are now required. Our state and local government industry professionals can guide you through the multifaceted changes, provide informative training on key issues, help implement internal compliance protocols, and assist in identifying effective solutions for your specific needs.