Guidelines for fair value & disclosure of shares (ASC 820)

Are you a business owner and want to integrate the benefits of offering options to your employees? If so, there are some points to consider to stay in compliance with the rules. Offering options comes with many benefits both for the company and the employees, but is also comes with a lot of responsibilities, such as paying taxes on time for option purchases (for employees, shareholders, consultants). There are also guidelines that have to be followed by the company and the optionee.

ASC 820 is a set of guidelines, which is governed by the shareholding disclosure. It is one of the many rules related to issuing and purchasing options that has to be followed strictly. The rule is for the company to report the fair value of their assets, if needed to be sold or given out, which would be sold under the fair value determined.

Not clear with the idea regarding the rule ASC 820? Well, this article would explain all about this rule in details. Read on to know more.

What is ASC 820?

ASC 820 is called the Fair Value Measurements and Shareholding Disclosure, based on the US GAAP. The ASC 820 permits or requires the shareholding disclosures or fair value measurements from a company offering shares to anyone other than the owner. The ASC 820 offers a straightforward framework used to measure the fair value and needs to follow the shareholding disclosure about fair value measurement. In short, the ASC 820 is a set of guidelines and rules for obtaining the fair market value of items in a business.

Initially known as SFAS 157, ASC 820 is applicable in the valuation of the following components in a company:

• Earnout/contingent consideration liabilities
• Investments reported at fair value
• Goodwill and intangible assets in annual impairment analyses (ASC 350)
• Share-based compensation (ASC 718)
• Intangible assets acquired in a business combination (ASC 805)

Anything that a company has as an asset of has to be reported to the government at the fair value of that period. To be clear, the ASC 820 rule defines the “fair value” as the value at which the company would sell it off. It also discusses the valuation techniques that are acceptable by law. The ASC 820 offers a framework used for getting the fair value based on a fair value hierarchy.

These three levels are defined as:

• Level 1 – The prices of identical liabilities or assets in the active market.
• Level 2 – Valuation based on market observables. An identical asset may not exist or the market may be less active or a quoted market price is unavailable.
• Level 3 – Unobservable valuation used when level 1 and level 2 inputs are not available.

The assets of the company is normally calculated as the NAV, which is the Net Asset Value per share in the financial statements between level 2 and level 3 investments. The investments given the value via the NAV can be redeemed at the Balance Sheet date and are kept at level 2. On the other hand, those investments that have been valued at NAV, but cannot be redeemed, are taken under level 3.

Nonetheless, the investments valued at NAV that cannot be redeemed on the Balance Sheet date, but can be redeemed at some later point, needs the right judgement of professionals to figure out the proper presentation.

In addition to this, the FASB launched the ASU 2015-07 entitled “Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent)” in efforts to make the financial reporting more consistent.

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How does this rule apply?

For any employee benefit plan offered in a company, the fair market value of the assets and how the measurements are done have to comply with the FASB ASC 820 accounting rules (FASB Accounting Standards Codification® (ASC 820)). This rule has been created for getting the value of an asset and then reporting that value of investments in the financial statements of the plan.

Every company has a different way of following the rule, as the complexity varies for each case based on the information available and the kinds of investments held.

On the other hand, plans which hold investments that have a little (if any) market activity during the measurement date may find it tough to comply with the FASB ASC 820 requirements. These investments include certain fixed income securities, certain investment contracts with insurance companies, real estate/real estate funds, investments in limited partnerships and hedge funds.

The FASB ASC 820 permits investments in specific entities like the bank collective investment funds, private equity funds, hedge funds, and pooled separate accounts to use the NAV per share or an equivalent as the practical expedient. As soon as the NAV is available on the measurement date of the entity, the investments are much easier to value.

Investments like insurance and fully benefit-responsive contracts in the contribution towards the health, welfare plans and the retirement plans are measured at the contract value as per the FASB ASC 962 and 965. Hence, they are not included in the FASB ASC 820 shareholding disclosure.

Mistakes to Avoid

Most companies that hire third-party companies to prepare their financial report per the ASC 820 guidelines make some mistakes, such as not sharing all the important details with the service providers. Due to the lack of details or unprofessional service providers, getting the value of certain investments may be difficult. They come across many challenges, for example the input and techniques used for the valuation are correct as per the FASB ASC 820 fair value definition.

Another challenge comes when the service providers who are preparing the financial report for the company are not sure if the values the company offered follow the year-end plan. For instance, the NAV of the investments in the limited partnership reported by the custodian or trustee can be as of the partnership’s year-end and not of the plan’s year-end.

The challenges come in due to the lack of proper information regarding the pricing and valuation of the investment plans. Because of this, the planned financial reporting done by the third-party organization can end up being incorrect and not comply with the ASC 820. There are also some specific investments for which you might need to hire extra valuation services for which year-end fair value information is not available.

There are three levels in the reporting form explained in the next parts.

Level 1

Under level 1 of the financial plan reporting as per the ASC 820, the assets like funds, bonds, listed stocks or any such assets have the standard “mark to market” mechanism for obtaining the fair market value. The assets in this section usually have prices that can be observed before the actual fair value is obtained. And due to this, the fair market value obtained is also reliable.

Publicly traded companies have to classify their assets depending on how easily they can be valued. And level 1 is the easiest. The liquidity and market depth is the biggest part of the asset valuation. For a market that is well developed, the activities that take place in the market work as a natural price discovery mechanism. This is also the main element for the market liquidity, a related device for measuring the ability of the market for purchasing or selling an asset without bringing any major alterations in the price of the asset.

For example, investors, banks, and regulators favor companies like these as they trust the supplied financial statements of the businesses, which have a market-based valuation for most of their assets. For other businesses that use complex financial instruments and derivatives to get the valuation of an asset have most of their assets under level 2 or level 3 of the ASC 820 shareholding disclosure.

Level 2

The level 2 assets are those assets that do not have any standard market pricing, but their fair market value can be found based on various other data values or prices in the market. Level 2 asset values can be found out approximately using extrapolation methods and simple methods with observed and known prices as the parameters. The companies that are publicly traded need to report the make-up of their financial assets to investors based on the faith of the fair value calculations.

An example of an asset that comes under level 2 assets is an interest rate swap, where the value is found depending on the observed values of the market-determined risk premiums and underlying interest rates. In short, level 2 assets fall in the middle of classification of the ASC 820 shareholding disclosure. It is based on how assuredly can the fair market values of the assets be calculated.

Level 3

Level 3 assets fair market value aren’t determinable using simple measure like the models and market prices, or observable inputs.

Introduced in 2009 in the ASC 820 topic, the companies don’t only need to state the value of the level 3 asset, they also have to give an outline explaining the various valuation techniques that affected the valued stated. ASC 820 needs a settlement of the beginning and ending balances for the assets of level 3.

As per the GAAP, companies have to register the assets they own at the current value and not the historical cost. For giving out equity or getting investments, the company needs the valuation done, and the ASC 820 is a standard rule on how the assets are valued.These assets value determination is difficult, and are not traded actively in the market and their values can be found utilizing multiple complex market prices, subjective assumptions and mathematical models.

Some examples of level 3 assets are distressed debt, foreign stocks, complex derivatives, private equity shares, mortgage-backed securities (MBS), etc. The value stated for a level 3 asset is subjected to interpretation for accounting purposes. Due to this, there is a margin of safety that is needed to be factored into account for any mistakes in using level 3 inputs that would help in valuing an asset. In short, the procedure for determining the level 3 asset valuation is known as mark to management.

Further, particular attention is given to alterations in the values of the existing assets along with the information on the transfers of the new assets inside and outside the level 3 status. Publicly traded companies also have to report level 3 assets, just like they have to do for level 1 and level 2 assets. And although level 3 assets are hard to value, they are kept by commercial banks and investment shops in the billions. They are the actual thing that makes the company’s valuation high.

Important things to know

Recently on 28th August of 2018, the FASB issued the ASU 2018-13 that had some alterations in the fair value measurement disclosure requirements of the ASC 820. The amendments were to improve the effectiveness of ASC 820’s disclosure requirements. Below are the details of the modifications that took place.

Key Changes Made to ASC 820

For promoting the appropriate exercise of the discretion by the entities, the ASU had modified the shareholding disclosure paragraphs to remove the clauses:

1. “At a minimum” from the phrase “an entity shall disclose at a minimum”
2. Other similar “open-ended” disclosure requirements

Basically, the aim of the disclosures requirements here is to offer the users of any financial statements with the details regarding the assets and liabilities measured at a fair value in the statement of financial position. It also offers the details of the assets measured at FMV disclosed in the notes to financial statements:

• The inputs and techniques used for valuation of a company uses to get the fair value measurement, including the assumptions that the company makes.
• As of the reporting date, the uncertainty in the fair value measurements.
• How the alterations in the measurements of the fair value affect the cash flows and performance of the entity.

New Disclosure Requirements

As shared above, there have been some alterations in the ASC 820 set of rules, which includes new shareholding disclosure requirements. Below are the new requirements that are needed, though they are not applicable to nonpublic entities:

Level 3 Changes in Unrealized Gains or Losses

As per ASU 2018-13, all public companies have to disclose the total amount of gains or losses for the period which the OCI recognizes, referable to fair value changes in the assets and liabilities held on the date on the balance sheet and have been categorized within Level 3 of the fair value hierarchy.

Level 3 Range and Weighted Average Utilized to Develop Significant Unobservable Inputs

Companies now have to offer quantitative information regarding the important unobservable inputs for Level 3 fair value measurements. The companies would have to disclose:

The weighted average and range used for developing the notable unobservable inputs; and
How the weighted average has been determined for the fair value to categorize it under level 3 of the fair value hierarchy.

Companies can also disclose other quantitative information instead of the weighted average. This is in case they find out that such details contain a more rational and reasonable method of showing the categorization of the notable unobservable inputs utilized for developing Level 3 fair value measurements. In such cases, the companies do not have to disclose the reason why they have not disclosed the weighted average.

Eliminated Disclosure Requirements

Other than the new rules of the shareholding disclosure in the ASC 820, there are some requirements that have been removed.

Below are the details for it:

Transfers Between Level 1 and Level 2 of the Fair Value Hierarchy

As per the ASU 2018-13, all companies,excluding the nonpublic companies, are not required to disclose the amounts and reason for transferring any asset and liability held at the end of the period between level 1 and level 2.

Policies Related to the Timing & Valuation Processes of Transfers Between Levels of the Fair Value Hierarchy

As per the recent updates in the US GAAP, companies are required to develop and continuously comply with a single policy to determine when the transfers between levels have taken place in the fair value hierarchy. This rule has not been changed, but companies do not have to disclose the policy in the notes to the financial statements. The ASU 2018-13 has even removed the requirements for entities to disclose their valuation processes.

Modified Disclosure Requirements

The shareholding disclosure requirements for any recurring Level 3 fair value measurements have also been modified. The following would explain more about the modifications:

Level 3 rollforward

Under the ASU 2018-13, all nonpublic entities do not have to finish the reconciliation of the opening balances to the closing balances of recurring Level 3 fair value measurements. Instead the companies just need to separately disclose the changes for the Level 3 fair value measurements in the time attributable to:

• Transfers into or out of Level 3, where each kind has to be separated and the reason for transfer disclosed; and
• Purchases and issues (each type separately).

Moreover, the ASU 2018-13 hasn’t altered the quantitative Level 3 rollforward shareholding disclosure requirements as per the US GAAP for public companies.

Conclusion

With all the details on the ASC 820, you can now easily comply with the rules and follow this as per your company’s structure. With the knowledge about the ASC 820, you can now avoid any such issues that might come up with the government or lose any investor due to a valuation done by yourself.

Furthermore, if you are an owner and already have a lot going on with the shares in your company, it is important to keep a track of it. The best way to do so is with the cap table application. Eqvista is a great cap table application to keep track of all the shares of your company. Visit now to check it out!