PICPA  >  CPA Now
CPA Now
Oct 18, 2021

Fair Value Measurements and Financial Instruments: Disclosure Requirement Basics

Sheila BorderBy Sheila A. Border, CPA


There have been numerous Financial Accounting Standards Board (FASB) updates over the years to Topic 820, Fair Value Measurement, and Topic 825, Financial Instruments. When reading through these topics or consulting a financial statement disclosures checklist, it is not always easy to see which rules apply for a given period.

To help simplify matters, let’s look at the Topic 820 and Topic 825 disclosures in effect for private entities (nonpublic business entities) for calendar year 2021.

Some ground rules first: for this blog, I will only consider private entities (nonpublic). I will not be addressing the Fair Value Option; not including disclosures required for assets valued using net asset value as a practical expedient; and not taking into account ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which is effective for private entities in calendar 2023. Don’t worry. There is still plenty to cover.

What Is Covered by Each?

Reviewing Disclosure Requirements in Financial ReportingFair Value Measurement (Topic 820) – This topic defines fair value, provides a framework for measuring fair value, and includes required disclosures. In and of itself, it does not require fair value measurement; fair value measurement is required by other topics. When other topics require an asset or liability to be measured at fair value, then Topic 820 is used and the disclosure requirements must be followed.

The basics of Topic 820 define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants, prescribe valuation techniques for determining fair value, and categorize assets and liabilities measured at fair value into three levels of a hierarchy based on the valuation inputs used:

  • Level 1 – Quoted prices in active markets (highest level)
  • Level 2 – Observable inputs other than Level 1
  • Level 3 – Unobservable inputs

Financial Instruments (Topic 825) – This topic has undergone a lot of changes. Private entities have seen the disclosure requirements expand and contract. Currently, prior to adoption of ASU 2016-13, this topic only requires minimal disclosures for private entities.

Financial instruments are defined as follows:

  • Cash
  • Evidence of ownership in an entity
  • Contracts that …
    – Impose on one entity an obligation to deliver cash or a financial instrument to another entity or exchange financial instruments on potentially unfavorable terms with another entity, and
    – Convey to the other entity the right to receive cash or another financial instrument from the first entity or exchange other financial instruments on potentially favorable terms with the first entity.

Perhaps it’s a cumbersome definition, but think of a trade receivable or payable: they exactly follow the contract definition. Typical financial instruments for private entities include cash, trade receivables, notes receivable, marketable securities, trade payables, and notes payable.

What Are the Disclosure Requirements?

Fair Value Measurement (Topic 820) – When reviewing the requirements, it’s important to note if the asset or liability is being measured at FAIR VALUE on a recurring basis or nonrecurring basis.

  • Recurring – Is fair value the typical basis for the item, such as marketable securities, which are always measured at fair value?
  • Nonrecurring – Is the typical basis other than fair value, such as intangible assets measured at historical cost or amortized cost but required to be measured at fair value when an impairment in value has occurred.

It is required to disclose the following in table form (recurring and nonrecurring are similar, except where noted):

  • The dollar amount of the fair value measurement at the applicable date
  • Level within the fair value hierarchy

If the item is categorized as Level 1, you are essentially finished. Remember to make sure the information in the table can be tied back to the line amounts in the balance sheet.

If Level 2 or 3, add a description of the valuation techniques and inputs used and disclose any changes in the valuation approach or techniques that have been made and why.

If Level 3, continue by adding quantitative information about significant unobservable inputs. If the entity has not developed the inputs and has instead, for instance, used a pricing service, disclose that fact. With nonrecurring, if the item being valued is goodwill or an indefinite-lived intangible asset after initial recognition, this information is not required.

If at Level 3 and measured on a recurring basis, additional information is needed regarding the activity during the period. While a full roll-forward is no longer required, disclosure should include purchases and issues (presented separately), the amounts of any transfers into or out of Level 3 (presented separately), and the reasons for the transfers. The disclosures in this paragraph are not required for items measured on a nonrecurring basis.

Finally, for levels 1, 2, or 3, if the item is a nonfinancial asset and it is not currently being used at its highest and best use, describe why the item is being used differently.

That’s it. You’re done with Topic 820.

Financial Instruments (Topic 825) – As noted earlier, Topic 825 is scaled down for private entities. For these entities, there are two types of disclosures required for financial instruments.

The first is that all financial instruments of an entity be grouped by form of instrument and with instruments measured on the same basis. So, you don’t want to group accounts payable together with a note payable: keep instruments of different forms separate. And you don’t want to group marketable debt securities (measured at amortized cost) with marketable equity securities (measured at fair value) - keep items measured by different bases separate. These disclosure requirements can be accomplished by separately grouping items on the balance sheet, or by disclosure in the notes to the financial statements.

The second type of disclosure for financial instruments is concentrations of credit risk. Significant concentrations of credit risk arising from all financial instruments shall be disclosed. The following items should be disclosed for each concentration:

  • Information about the activity, region, or economic characteristic that identifies the concentration
  • The maximum amount of loss due to credit risk that, based on the gross fair value of the financial instrument, the entity would incur if parties that make up the concentration failed completely to perform according to the terms of the contracts and any collateral or other security, proved to be of no value to the entity
  • If collateral is involved (see FASB ASC 825-10-50-21c)
  • If master netting arrangements exist (see FASB ASC 825-10-50-21d)

For private entities, these disclosures most commonly include concentration of cash above insured levels and concentrations of trade receivables in a specific geographic area or within a certain industry. Remember, though, this disclosure is applicable to all financial instruments, so consider if any additional concentrations exist and should be disclosed.

A welcome relief is that private entities are no longer required to disclose the fair value of financial instruments that are not recognized in the balance sheet (off-balance sheet assets or liabilities) or the fair value of financial instruments that are not recorded at fair value on the balance sheet. The requirements for these disclosures caused a lot of confusion in the past and have now been eliminated.

You have made it through Topic 825!

Conclusion

The disclosures discussed in this blog are only the incremental disclosures required for fair value measurement and financial instruments. They will supplement the disclosure requirements for each respective topic of an item. For example, marketable securities have disclosure requirements contained in the applicable investment topic; the requirements discussed here are in addition to those account-specific requirements and solely pertain to fair value measurement and financial instruments disclosures.

While still containing significant disclosure requirements, Topics 820 and 825 have been made more manageable for private entities. Grasp these basics and then stay alert for future changes and additions. Surely these topics will keep evolving.


Sheila A. Border, CPA, is a senior manager at Wipfli LLP in Radnor and a member of the Pennsylvania CPA Journal Editorial Board. She can be reached at sborder@wipfli.com.


Sign up for weekly professional and technical updates from PICPA's blogs, podcasts, and discussion board topics by completing this form.

Leave a comment

Follow @PaCPAs on Twitter
Disclaimer
Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of PICPA officers or members. The information contained in herein does not constitute accounting, legal, or professional advice. For professional advice, please engage or consult a qualified professional.