Memo No.
Issue Summary No. 1
Issue Date September 4, 2014
Memo
Meeting Date(s) EITF September 18, 2014
Contact(s)
Adam M. Smith
Lead Author
(203) 956-3424
Jennifer Hillenmeyer
EITF Coordinator
(203) 956-5282
Bret Dooley
EITF Liaison
Project
EITF Issue No. 14-B, "Fair Value Hierarchy Levels for Certain Investments Measured
at Net Asset Value"
Project Stage
Initial Deliberations
Dates
previously
discussed by
EITF
None
Previously
distributed
memo
numbers
None
Objective of This Memo
1.
The purpose of this memo is to assist the Task Force in determining how certain
investments whose fair values are measured at net asset value (NAV) should be
categorized within the fair value hierarchy.
Background Information
2.
Paragraphs 820-10-35-59 through 35-62 permit reporting entities, as a practical expedient,
to estimate the fair value of an investment within the scope of paragraphs 820-10-15-4
through 15-5 using the NAV (or its equivalent) of the investment.

The alternative views presented in this Issue Summary are for purposes of discussion by the EITF. No individual
views are to be presumed to be acceptable or unacceptable applications of Generally Accepted Accounting
Principles until the Task Force makes such a determination, exposes it for public comment, and it is ratified by
the Board.
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3.
It is common for entities that make investments in investment companies to measure
those investments at NAV. For reporting entities that have investments with fair value
measured at NAV, it is common for those investments to have periodic redemption dates.
The frequency of redemption dates generally depends on the nature of the underlying
investments made by the investment companies. Investment companies that hold very
liquid investments, such as money market funds, publicly traded equity funds, or short
term fixed-income securities, are often redeemable at all times or at frequent intervals,
such as monthly. Investment companies holding less liquid assets, such as longer term
fixed income securities, are often redeemable at less frequent intervals, such as quarterly
or yearly. Funds with investments in illiquid securities, such as private equity funds,
often do not have periodic redemption features at all.
4.
The categorization within the fair value hierarchy of investments in certain entities that
calculate NAV (or its equivalent) is discussed in paragraph 820-10-35-54B. Investments
that are redeemable at the measurement date at the NAV are always categorized in Level
2 and investments that will never be redeemable at the NAV are always categorized in
Level 3. However, for investments that are not redeemable at NAV at the measurement
date but become redeemable at a future date, judgment is applied in the determination of
whether the fair value measurement is Level 2 or Level 3. When applying judgment for
investments that may be redeemable with the investee at a future date, paragraph 820-1035-54B suggests that reporting entities take into account the length of time until those
investments become redeemable. If the future redemption dates are unknown or not in
the near term, the investment should be categorized in Level 3. For convenience,
paragraph 820-10-35-54B is included in Appendix 14-BA.
5.
Near term is not defined in Topic 820. While Topic 275 on risks and uncertainties
defines near term as a period of time not to exceed one year from the date of the financial
statements, the guidance in Topic 820 does not use that definition and preparers
commonly interpret near term to mean within a few weeks or months. The staff notes
that near term is not used elsewhere in Topic 820.
6.
The AICPA Technical Questions and Answers (TIS) 2220.25 notes that near term in the
context of Topic 820 is a matter of professional judgment and depends on specific facts
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and circumstances. However, the TIS further notes that a period of 90 days or less would
typically be considered near term.
7.
The staff reviewed SEC filings from several public business entities (PBEs) and found
that some reporting entities disclosed their policies regarding what constituted near term.
That research indicated that while many entities seem to interpret near term as a period of
90 days or less, other reporting entities use longer periods, such as 180 days. While not
disclosed in the public filings reviewed by the staff, the staff is aware of other reporting
entities who consider near term to be within one year.
8.
While Topic 820 is largely converged with IFRS, IFRS 13 does not provide a
practicability exception for investments in entities that calculate NAV. As such, this
Issue is unique to U.S. GAAP.
9.
Stakeholders have raised concerns with practice related to the categorization within the
fair value hierarchy of investments measured at NAV that have periodic redemption dates
at intervals that can be interpreted as being longer than the near term. The concerns
include:
(a)
Some reporting entities re-categorize such investments between Level 2 and Level 3
at different dates during the year depending on whether they consider the next
redemption date to be in the near term or not. Paragraph 820-10-50-2(c) requires
reporting entities to disclose transfers into Level 3 separately from transfers out of
Level 3, the reasons for the transfers, and the reporting entity’s policy for
determining when transfers between levels are deemed to have occurred. Some
stakeholders believe that transfers into and out of Level 3 that are strictly based on
whether or not the next redemption date for an investment is in the near term and
the related disclosures are confusing to users.
(b)
Some reporting entities interpret near term to mean within the next year, resulting
in investments measured at NAV with at least yearly periodic redemption dates
always being categorized within Level 2 of the fair value hierarchy.
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(c)
Reporting entities that have different fiscal years may categorize identical
investments differently depending on how each reporting entity’s fiscal year aligns
with their investment’s redemption date(s).
10.
Stakeholders have requested further guidance on categorizing investments measured at
NAV that have periodic redemption dates in the fair value hierarchy.
11.
The staff discussed this Issue with a user at an organization that invests in funds of funds,
that is, investment companies that invest in other investment companies and frequently
measure the fair value of those investments at NAV. The user generally felt that recategorizing investments between Level 2 and Level 3 throughout the year is confusing
and does not provide decision-useful information. The user supported an approach that
would more consistently categorize investments whose fair value is measured at NAV in
either Level 2 or Level 3. The user indicated that he would be comfortable if investments
with redemption dates at least annually were categorized in Level 2 at all times.
12.
The Board discussed the agenda request on this Issue at its August 13, 2014 agenda
prioritization meeting and added the project to the EITF’s agenda.
Categorization within the Fair Value Hierarchy
13.
The staff has identified three alternatives that could reduce costs and complexity, that
could improve comparability, and that may be acceptable to stakeholders:
(a)
Alternative A: Define Near Term to Reduce Diversity in Practice
(b)
Alternative B: Require Level 2 Categorization for Investments with Periodic
Redemption Dates at Least Annually
(c)
Alternative C: Require Level 3 Categorization for Investments with Periodic
Redemption Dates Less Frequently than Quarterly.
Question 1 for the Task Force
How should an investment whose fair value is measured at NAV and that has
periodic redemption dates be categorized within the fair value hierarchy?
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Staff Analysis
Alternative A: Define Near Term to Reduce Diversity in Practice
14.
Proponents of this alternative believe that the purpose of the fair value hierarchy is to
provide information as of a particular balance sheet date and that it may be appropriate to
re-categorize investments measured at NAV between Level 2 and Level 3 as
circumstances change. They note that regardless of whether an investment is categorized
as Level 2 or Level 3, the reporting entity’s financial statements report the same NAV.
As such, without disclosures regarding movements between levels, users might have no
way of knowing that the reporting entity’s ability to redeem the investment at NAV
changes throughout the fiscal year.
15.
Proponents of this alternative believe that all reporting entities should be consistently
moving investments with periodic redemption dates between Level 2 and Level 3
depending on whether the next redemption date is in the near term; however, currently,
reporting entities interpret near term differently.
16.
The staff believes that the most viable definitions of near term would be a period of either
less than one quarter or less than one year.
17.
If near term is defined as a period of less than one quarter, investments measured at NAV
with periodic redemption dates occurring less frequently than quarterly (for example,
semi-annually or annually) would alternate between Level 2 and Level 3 classification in
the fair value hierarchy at different balance sheet dates. The staff believes that it would
still be fairly common for investments to alternate between Level 2 and Level 3 under this
definition, but there would be greater consistency among reporting entities.
18.
If the near term is defined as a period of less than one year, only investments measured at
NAV with periodic redemption dates occurring less frequently than annually would
alternate between Level 2 and Level 3 classification in the fair value hierarchy. The staff
believes that there would be significantly fewer investments alternating between Level 2
and Level 3 under this definition.
19.
Opponents of this alternative believe that it is confusing to reclassify investments between
Level 2 and Level 3 solely on the basis of the timing of the next periodic redemption date.
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They note that while it may be reasonable for a previously unredeemable investment to
move from Level 3 to Level 2 when it becomes redeemable, that action represents a more
fundamental change to the investment. They believe that a periodically redeemable
investment does not fundamentally change throughout the year and should be consistently
classified in the fair value hierarchy.
20.
Opponents of this view also believe that it is inappropriate for two entities to classify the
same investment differently simply because the two entities have different fiscal years
and balance sheet dates. For example, if near term is defined as a period of less than 90
days and an investment measured at NAV is redeemable only on January first of each
year, a reporting entity with a fiscal year end of December 31 would classify the
investment in Level 2, while a January 31 fiscal year-end reporting entity would classify
the same investment in Level 3.
Alternative B: Require Level 2 Categorization for Investments with Periodic Redemption Dates at
Least Annually
21.
As noted in paragraph 820-10-35-54B, knowledge of when an investment can be
redeemed is important to the decision to categorize it to Level 2 or Level 3 of the fair
value hierarchy. Proponents of this alternative believe that an investment with regular,
periodic redemption dates (at least annually) should be classified as Level 2. These
proponents believe that the certainty of the redemption rights justifies a Level 2
categorization, even if the redemption occurs at intervals beyond what some reporting
entities currently consider near term for purposes of applying this guidance.
22.
This alternative also would include further clarification that if the periodic redemption
dates do not occur at least annually, the investment should be categorized in Level 3 of
the fair value hierarchy at all times, even if the next periodic redemption date is within a
few days or months.
23.
Some opponents of this alternative do not believe that a redemption date that could be up
to 12 months away should be described as near term because there are many factors that
could affect a fair value measurement over a 12-month period. They note that just
applying a present value adjustment could have a significant effect over a 12-month
period.
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24.
Some opponents to this alternative believe that it would be inappropriate to categorize an
investment with periodic redemption dates that don’t occur at least annually at Level 3 at
every measurement date even though it may be redeemable at or near particular
measurement dates. These opponents point out that the alternative could contradict the
guidance in paragraph 820-10-35-54B that states that if an investment is redeemable at
the measurement date, it should be classified in Level 2. However, the staff believes that
it is rare for investments measured at NAV to have periodic redemption dates that occur
less frequently than annually.
Alternative C: Require Level 3 Categorization for Investments with Periodic Redemption Dates
Less Frequently Than Quarterly
25.
Proponents of this alternative believe that for an investment to be classified as Level 2, it
should be redeemable at its NAV at all times or at intervals that are much shorter than one
year, such as within one quarter. They believe that if an investment is not always
redeemable within one quarter, it should be consistently categorized in Level 3 of the fair
value hierarchy even if the next redemption date happens to be within 90 days.
26.
Opponents of this alternative believe that it would be inappropriate to categorize an
investment at Level 3 at every measurement date even though it may be redeemable at or
near particular balance sheet dates. These opponents point out that the alternative could
contradict the guidance in paragraph 820-10-35-54B that states that if an investment is
redeemable at the measurement date, it should be classified in Level 2; however, that
guidance could be amended to clarify that it does not apply to investments with periodic
redemption dates.
27.
However, proponents believe that there is little reason to categorize investments with
longer periods between redemption dates in Level 2 just because a balance sheet date
happens to coincide with a redemption date. They believe that by the time the financial
statements are issued, the redemption date has often passed and the knowledge that the
investment could have been redeemed in the past has little relevance to users.
28.
Opponents of this alternative also believe that an investment measured at NAV that has
regular and predictable redemption rights should not be subject to the additional
disclosures required for Level 3 measurements, such as describing the valuation processes
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and policies, and the sensitivity of the fair value measurements to changes in
unobservable inputs. These opponents believe that such disclosures are not meaningful or
useful for investments measured at NAV that have periodic redemption dates.
Staff Recommendation
29.
The staff does not recommend Alternative A. The staff believes that re-categorizing an
investment whose fair value is measured at NAV within the fair value hierarchy solely based
on the timing of periodic and predictable redemption dates does not provide significant useful
information to financial statement users.
30.
The staff recognizes the merits of both Alternative B and Alternative C, and believes that
either alternative would be a significant improvement to GAAP. The staff acknowledges that
many preparers may prefer Alternative B because Level 2 fair value measurements require
fewer disclosures. However, some stakeholders believe that investments measured at NAV
with periodic redemption dates are more similar to items typically categorized in Level 3 of
the fair value hierarchy.
31.
The staff believes that the primary goal of the accounting change should be to achieve
consistency in reporting and avoid reclassifications between levels for these investments.
Therefore, the staff recommends either Alternative B or Alternative C.
32.
The staff has prepared suggested amendments to paragraph 820-10-35-54B for Alternative
B and Alternative C. The suggested changes are included as Appendix 14-BB.
Disclosures
33.
If the Task Force decides that investments measured at NAV that have periodic
redemption dates should be consistently categorized within either Level 2 or Level 3,
additional disclosures may be warranted.
34.
For example, if all such investments are categorized in Level 2, additional disclosures
could be required to clarify that certain investments included in Level 2 are only
redeemable at certain times, rather than as of each reporting date. If all such investments
are categorized in Level 3, it may be useful to disclose that some of the investments
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included in Level 3 do have periodic redemption dates, unlike other Level 3 investments
that could potentially never be redeemable at NAV.
Question 2 for the Task Force
Does the Task Force want to require entities to provide additional disclosures
related to investments measured at NAV that have periodic redemption dates?
Staff Analysis
35.
The staff acknowledges that disclosing that certain investments categorized within Level
2 or Level 3 are redeemable on a periodic basis (rather than redeemable at the
measurement date for other Level 2 measurements or not redeemable at all for other Level
3 measurements) may provide useful information to some users. However, any
amendment to the guidance in paragraph 820-10-35-54B would already make it clear in
which category of the fair value hierarchy investments measured at NAV with periodic
redemption periods are included. Given that there are already significant disclosures
surrounding fair value measurements, the staff believes that the benefits associated with
additional disclosures may not be significant enough to warrant the costs associated with
those disclosures.
Transition
36.
The Task Force could require retrospective transition, could require prospective
transition, or could allow reporting entities to choose retrospective or prospective
transition.
Question 3 for the Task Force
Does the Task Force want to require retrospective transition, require prospective
transition, or allow reporting entities to choose retrospective or prospective
transition?
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Staff Analysis
37.
The staff does not believe that there would be significant benefit to applying any of the
potential alternatives retrospectively.
38.
If retrospective application is applied, reporting entities would need to change the
historical categorization within the fair value hierarchy of investments measured at NAV.
Depending on which alternative is selected, those changes could require additional
disclosures. However, the historical re-categorization within the fair value hierarchy and
any associated additional disclosures would not provide decision-useful information to
users because the historically reported fair values and related categories are unlikely to
still be relevant to users. Further, a re-categorization in prior periods may be confusing to
users when the NAV has not changed.
39.
While there may be some benefit to making it easier for investors to track fluctuations in
the fair value of investments by categorizing investments more consistently in certain
levels of the fair value hierarchy, Topic 820 already requires disclosures related to
movements between levels, which allows investors to perform such an analysis.
Therefore, the staff believes that the potential benefits do not warrant the costs associated
with retrospective application.
Transition Disclosures
40.
Subtopic 250-10, Accounting Changes and Error Corrections – Overall, requires the
following disclosures in the period in which a change in accounting principle is made:
250-10-50-1 An entity shall disclose all of the following in the fiscal period in
which a change in accounting principle is made:
a. The nature of and reason for the change in accounting principle, including an
explanation of why the newly adopted accounting principle is preferable.
b. The method of applying the change, including all of the following:
1. A description of the prior-period information that has been retrospectively
adjusted, if any.
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2. The effect of the change on income from continuing operations, net income
(or other appropriate captions of changes in the applicable net assets or
performance indicator), any other affected financial statement line item, and
any affected per-share amounts for the current period and any prior periods
retrospectively adjusted. Presentation of the effect on financial statement
subtotals and totals other than income from continuing operations and net
income (or other appropriate captions of changes in the applicable net assets
or performance indicator) is not required.
3. The cumulative effect of the change on retained earnings or other
components of equity or net assets in the statement of financial position as
of the beginning of the earliest period presented.
4. If retrospective application to all prior periods is impracticable, disclosure
of the reasons therefore, and a description of the alternative method used to
report the change (see paragraphs 250-10-45-5 through 45-7).
c. If indirect effects of a change in accounting principle are recognized both of
the following shall be disclosed:
1. A description of the indirect effects of a change in accounting principle,
including the amounts that have been recognized in the current period, and
the related per-share amounts, if applicable
2. Unless impracticable, the amount of the total recognized indirect effects of
the accounting change and the related per-share amounts, if applicable, that
are attributable to each prior period presented. Compliance with this
disclosure requirement is practicable unless an entity cannot comply with it
after making every reasonable effort to do so.
Financial statements of subsequent periods need not repeat the disclosures required
by this paragraph. If a change in accounting principle has no material effect in the
period of change but is reasonably certain to have a material effect in later periods,
the disclosures required by (a) shall be provided whenever the financial statements
of the period of change are presented.
250-10-50-2 An entity that issues interim financial statements shall provide the
required disclosures in the financial statements of both the interim period of the
change and the annual period of the change.
250-10-50-3 In the fiscal year in which a new accounting principle is adopted,
financial information reported for interim periods after the date of adoption shall
disclose the effect of the change on income from continuing operations, net income
(or other appropriate captions of changes in the applicable net assets or performance
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indicator), and related per-share amounts, if applicable, for those post-change
interim periods.
Questions 4a and 4b for the Task Force
Does the Task Force believe that the proposed amendments should refer reporting
entities to the transition disclosures in paragraphs 250-10-50-1 through 3?
Are there any additional transition disclosures the Task Force believes are
necessary?
Staff Analysis
41.
The required disclosures in paragraphs 250-10-50-1(b) through (c) and paragraph 250-1050-3 are not relevant to this Issue. As this Issue relates only to categorization within the
fair value hierarchy, there would be no effect of this change in accounting principle on
income, per share amounts, or retained earnings.
42.
The staff recommends that reporting entities disclose only the nature of and reason for the
change in accounting principle (that is, the requirements from paragraph 250-10-50-1(a))
in the first interim and annual period of adoption. The staff does not believe that any
additional transition disclosures are necessary.
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Appendix 14-BA – Existing Guidance
> > Categorizing Investments in Certain Entities That Calculate Net Asset Value per
Share (or its Equivalent) within the Fair Value Hierarchy
820-10-35-54B Categorization within the fair value hierarchy of a fair value measurement
of an investment within the scope of paragraphs 820-10-15-4 through 15-5 that is
measured at net asset value per share (or its equivalent, for example member units or an
ownership interest in partners’ capital to which a proportionate share of net assets is
attributed) requires judgment, considering the following:
(a)
If a reporting entity has the ability to redeem its investment with the investee at
net asset value per share (or its equivalent) at the measurement date, the fair
value measurement of the investment shall be categorized within Level 2 of the
fair value hierarchy.
(b)
If a reporting entity will never have the ability to redeem its investment with the
investee at net asset value per share (or its equivalent), the fair value
measurement of the investment shall be categorized within Level 3 of the fair
value hierarchy.
(c)
If a reporting entity cannot redeem its investment with the investee at net asset
value per share (or its equivalent) at the measurement date but the investment
may be redeemable with the investee at a future date (for example, investments
subject to a lockup or gate or investments whose redemption period does not
coincide with the measurement date), the reporting entity shall take into account
the length of time until the investment will become redeemable in determining
whether the fair value measurement of the investment shall be categorized within
Level 2 or Level 3 of the fair value hierarchy. For example, if the reporting
entity does not know when it will have the ability to redeem the investment or it
does not have the ability to redeem the investment in the near term at net asset
value per share (or its equivalent), the fair value measurement of the investment
shall be categorized within Level 3 of the fair value hierarchy.
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Appendix 14-BB – Suggested Language for Alternative B and Alternative C
> > Categorizing Investments in Certain Entities That Calculate Net Asset Value per
Share (or its Equivalent) within the Fair Value Hierarchy
820-10-35-54B Categorization within the fair value hierarchy of a fair value measurement
of an investment within the scope of paragraphs 820-10-15-4 through 15-5 that is
measured at net asset value per share (or its equivalent, for example member units or an
ownership interest in partners’ capital to which a proportionate share of net assets is
attributed) requires judgment, considering the following:
(a)
Except for investments that are redeemable with the investee at regular periodic
intervals, if If a reporting entity has the ability to redeem its investment with the
investee at net asset value per share (or its equivalent) at the measurement date,
the fair value measurement of the investment shall be categorized within Level 2
of the fair value hierarchy.
(b)
If a reporting entity has the ability to redeem its investment with the investee at
net asset value per share (or its equivalent) at regular periodic intervals occurring
at least annually [quarterly], the fair value measurement of the investment shall
be categorized within Level 2 of the fair value hierarchy at all times. If the
regular periodic intervals do not occur at least annually [quarterly], the fair value
measurement of the investment shall be categorized within Level 3 of the fair
value hierarchy at all times.
(c)
(b) If a reporting entity will never have the ability to redeem its investment with
the investee at net asset value per share (or its equivalent), the fair value
measurement of the investment shall be categorized within Level 3 of the fair
value hierarchy.
(d)
(c) If a reporting entity cannot redeem its investment with the investee at net
asset value per share (or its equivalent) at the measurement date or does not have
the ability to redeem the investment at regular periodic intervals but the
investment may be redeemable with the investee at a future date (for example,
investments subject to a lockup or gate or investments whose redemption period
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does not coincide with the measurement date), the reporting entity shall take into
account the length of time until the investment will become redeemable in
determining whether the fair value measurement of the investment shall be
categorized within Level 2 or Level 3 of the fair value hierarchy. For example, if
the reporting entity does not know when it will have the ability to redeem the
investment or it does not have the ability to redeem the investment in the near
term at net asset value per share (or its equivalent), the fair value measurement of
the investment shall be categorized within Level 3 of the fair value hierarchy.
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