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Full disclosure: Fair value · PwC's accounting podcast

• 0:00
  SPEAKER_01: Thought Leadership from PWC.
• 0:08
  SPEAKER_03: Welcome to PWC's Accounting Podcast.
• 0:11
  SPEAKER_03: I'm Heather Horn.
• 0:13
  SPEAKER_03: Thanks for tuning in to the next episode in our full disclosure summer series, the show all about presentation and disclosure, from the top of the financial statements down to the last footnote.
• 0:23
  SPEAKER_03: While it may sound like accounting 101, I guarantee you'll learn something new each episode.
• 0:29
  SPEAKER_03: Today's focus fair value disclosure requirements.
• 0:33
  SPEAKER_02: You really have to balance giving users information that's helpful, but not overwhelming them with information that they can't really take and put into context.
• 0:44
  SPEAKER_03: That's my guest, Chip Curry, PwC National Office Partner.
• 0:48
  SPEAKER_03: Because of the use of fair value throughout the financial statements, there are a lot of disclosures.
• 0:53
  SPEAKER_03: So today, Chip's taking us back to the basics on fair value hierarchy leveling and other required fair value disclosures.
• 1:00
  SPEAKER_03: Chip and I have a lot to talk about, so let's get started.
• 1:08
  SPEAKER_03: So, Chip, thanks so much for joining me today.
• 1:11
  SPEAKER_03: And this is on a topic that I know you've spent a lot of time on.
• 1:15
  SPEAKER_03: And actually, way back in the day, I actually was involved in writing our first fair value guide.
• 1:20
  SPEAKER_03: So something at one time at least I knew something about.
• 1:23
  SPEAKER_03: But in any event, I know fair value is used in the financials, other cases used for disclosure.
• 1:29
  SPEAKER_03: So definitely a lot for us to talk about.
• 1:31
  SPEAKER_03: But maybe starting with the really big picture, can we just jump in to some of the biggest disclosure requirements related to fair value?
• 1:42
  SPEAKER_02: Yeah, absolutely.
• 1:43
  SPEAKER_02: And Heather, I think, like you said, the reason that there are so many disclosures around fair value is the use of fair value is very prevalent throughout the financial statement.
• 1:55
  SPEAKER_02: Sometimes we're measuring things on a recurring basis.
• 1:57
  SPEAKER_02: Sometimes every once in a while we will measure something to fair value if there's a specific event or something that would drive that.
• 2:04
  SPEAKER_02: And you'll see some of that stuff kind of filtering through the disclosures.
• 2:09
  SPEAKER_02: So so not surprisingly, right?
• 2:11
  SPEAKER_02: The first thing that you that they ask for in the disclosures is what are the fair value measurements at the end of the reporting period?
• 2:19
  SPEAKER_02: And break that into two pieces.
• 2:21
  SPEAKER_02: For for things that we're constantly remeasuring at fair value, like derivatives or available for sales security, we disclose the fair value at the balance sheet date.
• 2:30
  SPEAKER_02: For things that we're not remeasuring on a non-recurring basis.
• 2:34
  SPEAKER_02: So think things like if you impair goodwill, what we do is we disclose the fair value at whatever its last relevant measurement date was.
• 2:44
  SPEAKER_02: And then we need to tell people, hey, this was a non-recurring fair value, and this was the last time it was measured.
• 2:50
  SPEAKER_02: One of the big ones that we'll talk about in this podcast a couple of times that you'll hear a lot about is the fair value levels.
• 2:56
  SPEAKER_02: They call it the fair value hierarchy disclosures, the levels, right?
• 3:00
  SPEAKER_02: You and I spent a lot of time on that guide, Heather, of writing guidance on levels.
• 3:04
  SPEAKER_02: Um, and so you'll hear a lot about this, and that applies to both recurring and non-recurring measures.
• 3:08
  SPEAKER_02: You'll hear a lot of additional disclosures for level three fair value measures.
• 3:14
  SPEAKER_02: These are the ones that are the most difficult to value.
• 3:16
  SPEAKER_02: So you hear us talk about a lot of things like roll forwards and information about unrealized gains and losses in PL and OCI relating to these level three measures.
• 3:26
  SPEAKER_02: And again, they're just trying to focus on disclosing information about the things that are more difficult to come up with estimates of fair value.
• 3:34
  SPEAKER_02: So stepping outside the financial services space, which is always dangerous for me, Heather.
• 3:38
  SPEAKER_02: I'll keep you on.
• 3:39
  SPEAKER_02: Yeah, make sure I stay in the fair way here.
• 3:41
  SPEAKER_02: But, you know, occasionally we'll re-measure non-financial assets to fair value.
• 3:46
  SPEAKER_02: And the accounting literature requires that when we do that, we're supposed to fair value a non-financial asset considering it's like highest and best use, not necessarily what we're using it for, but what would be its highest and best use to maximize value if we were to sell it.
• 4:01
  SPEAKER_02: And so one of the disclosures is well, if you're not using the asset in the same way as its highest and best use on which we've assumed fair value, we should tell people about that.
• 4:11
  SPEAKER_02: So you'll see some disclosures of that nature.
• 4:13
  SPEAKER_02: There's a couple of other disclosures that are out there.
• 4:16
  SPEAKER_02: Like if you're electing to apply, there's a portfolio exception that applies to certain offsetting financial assets and liabilities, disclosures about inseparable third-party credit enhancement.
• 4:27
  SPEAKER_02: But I guess the most important thing on the kickoff part I'd leave you with, it's it's really important, and you'll see this emphasized throughout the literature, and we'll talk about it a couple of times, that these detailed disclosures and roll forwards and hierarchy stuff, it's important that users should be able to track and tie that information from the footnotes to the balance sheet.
• 4:47
  SPEAKER_02: I know that sounds obvious, we should be able to try to tie the footnotes to the balance sheet, and maybe saying it out loud is even more obvious.
• 4:53
  SPEAKER_02: But I think what people find is sometimes it's easy to get lost in the granularity of the required disclosures, and you still got to kind of reconcile it back to people to get to what's in the balance sheet.
• 5:03
  SPEAKER_03: All right, so Chip, before we get into more detail, and this could be showing my bias as a former double accounting and history major, I love talking about the history of all of this stuff.
• 5:14
  SPEAKER_03: And specific to fair value, I know there's been various points of time where it's almost been use the word controversial in terms of people either didn't like the fair value standards, they didn't like the disclosures, et cetera, et cetera.
• 5:27
  SPEAKER_03: So if we rewind from your perspective, maybe what's the genesis of some of this fair value disclosure?
• 5:34
  SPEAKER_03: So like when did we really start focusing on that from an accounting perspective?
• 5:39
  SPEAKER_03: And then it feels to me like most of that controversy is pretty much gone.
• 5:44
  SPEAKER_03: Like I don't really hear people sort of arguing about fair value or not, but just curious your perspective on that.
• 5:50
  SPEAKER_02: Yeah, I think it's a great question.
• 5:51
  SPEAKER_02: And I and I like the history too, not because I was a history major, but I've I've been I've been around for a long time now.
• 5:56
  SPEAKER_02: So I, you know.
• 6:00
  SPEAKER_02: It's it is interesting.
• 6:01
  SPEAKER_02: I think you're right.
• 6:02
  SPEAKER_02: I mean, I think in the financial asset space, right, the kind of debates around what should be fair valued and what shouldn't be fair valued, I think those have faded a little bit.
• 6:12
  SPEAKER_02: You know, I still think in the non-financial asset space, there's still a lot of discussion around is fair value a better measure in certain circumstances?
• 6:20
  SPEAKER_02: And and some of that stuff is on, I guess, the FASB's like invitation to comment, right?
• 6:24
  SPEAKER_02: Like non-financial assets, digital assets, you know, things that people hold for investment purposes.
• 6:30
  SPEAKER_02: And I think similarly, these disclosures that we're talking about, they've been around for a while now.
• 6:34
  SPEAKER_02: So people have kind of broadly speaking gotten used to them.
• 6:38
  SPEAKER_02: Um, so I would agree in that front, too, some of that kind of debate has faded.
• 6:42
  SPEAKER_03: And then Chip, FAST 107 was disclosure-only standard, right?
• 6:47
  SPEAKER_03: That's obviously again going way back.
• 6:49
  SPEAKER_03: I was trying to think, and maybe it's just be my question to stump you, is it the first disclosure-only standard?
• 6:55
  SPEAKER_03: Or there must have been others prior to that?
• 6:58
  SPEAKER_02: Yeah, I think there were some um disclosure-only, well, certainly projects and things like that, like in like enhancing uh disclosure about debt agreements and equity arrangements and things like that.
• 7:08
  SPEAKER_02: But you're right, I mean, FAS 107 was very much focused on disclosures of fair value, including disclosures of fair value of instruments that are not actually measured at fair value.
• 7:20
  SPEAKER_02: You know, a lot of what FAS 107, I think, was about was if you're already fair value measuring it, the information's in the financial statements.
• 7:27
  SPEAKER_02: But if you're not, if you're doing like amortized cost basis, it's it's not.
• 7:30
  SPEAKER_02: And in some cases, users wanted that information.
• 7:34
  SPEAKER_02: And so when they redid fair value and looked at it as a measurement, they also looked at disclosure.
• 7:40
  SPEAKER_02: And I think you're right, a lot of these disclosures that we'll talk about today, they may sound familiar to some of us, some of our fellow historians of GAP, that they were really carried forward from FAS 107.
• 7:50
  SPEAKER_03: All right, so this is my last question, then we'll get back to disclosures.
• 7:53
  SPEAKER_03: So if we think about 107 was disclosure-only standard, and then you go all the way to FAS from 57 to you know fair value itself.
• 8:02
  SPEAKER_03: So 50 standards it took between disclosure and then recognition.
• 8:07
  SPEAKER_03: So, any perspective from your background working with all this of why it took that length of time?
• 8:14
  SPEAKER_03: Is it just because there's so much to think about, including some of these disclosures we're going to talk about today?
• 8:19
  SPEAKER_02: I mean, it's a great question.
• 8:20
  SPEAKER_02: I mean, I think between FAS 107 and FAS 157, a lot of things happened from a standard setting perspective.
• 8:27
  SPEAKER_02: There were a lot more things that were required to be measured at fair value.
• 8:30
  SPEAKER_02: So, like FAS 115, which was the dead and equity security model, that was after 107.
• 8:35
  SPEAKER_02: FAS 133, the derivative standard, uh was after 107 as well.
• 8:40
  SPEAKER_03: And so FAS 141 and FAS 141 are this is another one.
• 8:44
  SPEAKER_03: I guess on some level, FAS 123 for stock options.
• 8:48
  SPEAKER_03: So there's a lot of different things in there.
• 8:50
  SPEAKER_02: Exactly.
• 8:51
  SPEAKER_02: And I think also that's just we're just talking about things that are measured at fair value.
• 8:54
  SPEAKER_02: You know, then you've got like the you know impairment models and things like that.
• 8:58
  SPEAKER_03: Oh, that was in between too.
• 9:00
  SPEAKER_03: So yeah.
• 9:01
  SPEAKER_02: And so I think there was a lot that happened from a measurement perspective.
• 9:04
  SPEAKER_02: And then honestly, I think people realize that in in some cases, estimating fair value can be challenging and require a use of a lot of management judgment.
• 9:15
  SPEAKER_02: And, you know, some of these disclosures are designed to highlight where those some of those judgmental efforts are and provide more information about the judgments that management was making.
• 9:24
  SPEAKER_02: And so I think as fair value increased use in the financial statements, some of the user requests also increased as well for more information.
• 9:31
  SPEAKER_03: All right.
• 9:31
  SPEAKER_03: Well, that is a perfect lead-in, almost as though we planned it, even though we didn't, to my next question back to the disclosures, which is on, as you mentioned, levels one, two, and three.
• 9:41
  SPEAKER_03: And again, I think for people who deal with this a lot, that seems old hat.
• 9:45
  SPEAKER_03: I think it's kind of confusing if you don't.
• 9:47
  SPEAKER_03: So can you explain to us what those are and how you think about them?
• 9:50
  SPEAKER_02: So again, I think the leveling is really about how difficult it is to value something.
• 9:56
  SPEAKER_02: And the way that the FASB approached leveling was principally through the inputs.
• 10:00
  SPEAKER_02: So if you think about valuation, you have inputs, you put it in a model, you get an output.
• 10:05
  SPEAKER_02: And so they were very much focused on how observable are the inputs, and that would drive the leveling.
• 10:11
  SPEAKER_02: So level one, these are um unadjusted quoted prices, identical assets, and liabilities.
• 10:19
  SPEAKER_02: So I'm trying to evaluate a security, it trades on the New York Stock Exchange.
• 10:24
  SPEAKER_02: Wang, there's a quoted price and an active market.
• 10:27
  SPEAKER_02: Uh, I can look to that would be a level one sort of input and estimate, if you will.
• 10:31
  SPEAKER_02: Level two are inputs that are sort of directly or indirectly observable, but they're not quite level one.
• 10:38
  SPEAKER_02: So think of like a quote of a similar security.
• 10:41
  SPEAKER_02: You see a traded price.
• 10:43
  SPEAKER_02: Think uh you know, interest rate curves that are that are published.
• 10:47
  SPEAKER_02: A dealer quote where a dealer provides a quote where they stand ready to actually execute on that quote as opposed to an indicative quote, those might be level two inputs.
• 10:56
  SPEAKER_02: And then level three is where there's inputs where there's little, if any, market activity.
• 11:01
  SPEAKER_02: And that could include just there's no market activity in the item as well, but it could also include where there is market activity, but so for example, there's market activity on bonds trading up to 10 years of this type, but there's not for 20 years.
• 11:17
  SPEAKER_02: And so we're it includes where we take data that is observable and we sort of extrapolate or interpolate off of that.
• 11:24
  SPEAKER_02: I had to get those words extrapolate and interpolate in some way.
• 11:27
  SPEAKER_02: Good job.
• 11:27
  SPEAKER_02: Yeah, thanks you.
• 11:28
  SPEAKER_02: Uh I know you told me I wasn't supposed to, but I had I I couldn't resist.
• 11:31
  SPEAKER_03: I almost want you to define them, but I'll I'll save you from that.
• 11:35
  SPEAKER_02: Or our listeners from from that as it may be.
• 11:38
  SPEAKER_02: But now the key is what you're gonna find too is a lot of valuations, they will be a mixture like of level one, level two, and level three inputs.
• 11:47
  SPEAKER_02: And so the way that you you you deal with that is we look at the lowest level of where there's a significant input, and that drives the level of the instrument.
• 11:57
  SPEAKER_03: All right, so I have a follow-up question on that, but and I'm sorry, this is more sort of perspective.
• 12:02
  SPEAKER_03: It's a question for you.
• 12:04
  SPEAKER_03: First of all, it seems like one and two are relatively narrow, and then three is like everything else.
• 12:10
  SPEAKER_03: Is that a fair characterization, or is that probably because I'm dealing with less financial assets and more other stuff?
• 12:17
  SPEAKER_02: You know, I I think that I think you're dead on.
• 12:19
  SPEAKER_02: I think it varies very much depending on what asset type you're talking about, right?
• 12:24
  SPEAKER_02: So let's take equity securities.
• 12:27
  SPEAKER_02: We have lots of level one equity securities because they trade on one of the exchanges.
• 12:31
  SPEAKER_02: We have lots of level three things for private equity valuations.
• 12:35
  SPEAKER_02: Um, when you step into the non-financial asset space, you know, things like commodities, right?
• 12:40
  SPEAKER_02: Like oil, gold, electricity, of certain types, though, of certain grades and credit quality and quality, if you will, they they trade on exchanges and you might be able to see, you know, very transparent pricing.
• 12:53
  SPEAKER_02: But then you have other non-financial assets where there's not an active market and active trading, and they might be level two or level three.
• 13:00
  SPEAKER_03: And then Chip, I know these tables are difficult to put together, and we're gonna get into the detail.
• 13:06
  SPEAKER_03: But if I actually again take a step back and think about the information they're sharing, these are actually very helpful from an investor perspective to just, okay, there's a fair value in there, and either I know it's based on a quote versus I, you know, it's level three, it might be based on a model or something else.
• 13:22
  SPEAKER_03: There's a big difference, and it really does feel like valuable information from a user perspective.
• 13:28
  SPEAKER_02: Yeah, I would agree.
• 13:29
  SPEAKER_02: I mean, I think the the users have repeatedly said that they like that information, that it's helpful to them, as well as some of the other disclosures, particularly around the level three assets that they've found helpful.
• 13:42
  SPEAKER_03: All right, so then let me go back to what you said.
• 13:44
  SPEAKER_03: And I just want to maybe you can walk through a little bit of an example or help our listeners.
• 13:49
  SPEAKER_03: So you said, okay, you have something that's you have these three levels, and you have something that includes, let's say, measurements from level two and level three, but then in your tables, you would actually just put the whole amount as level three.
• 14:02
  SPEAKER_02: That's right.
• 14:03
  SPEAKER_02: If you had level two and level three, and they were both significant inputs from a valuation perspective, your classification would be based upon the lowest input levels.
• 14:13
  SPEAKER_02: In your fact pattern, the entire instrument would be reported as level three.
• 14:17
  SPEAKER_02: It'd be difficult, if not impossible, to bifurcate a single instrument across multiple lines, particularly when valuation puts inputs frequently interact with each other.
• 14:27
  SPEAKER_02: And so it's not really clear how you build them up, you know, individually and discreetly.
• 14:32
  SPEAKER_02: That's why it's based upon the lowest, uh, the lowest input.
• 14:36
  SPEAKER_03: Okay.
• 14:36
  SPEAKER_03: So then, Chip, for companies that if you have a lot of these level threes, then I know you can make some supplemental disclosures in terms of like the range and maybe the weighted average of your unobservable inputs.
• 14:48
  SPEAKER_03: Do you anything else you can share on that?
• 14:50
  SPEAKER_02: Yeah, a great point.
• 14:51
  SPEAKER_02: I mean, just to set the picture a little bit, as much as one can set the picture for a disclosure here, usually what you're going to see is like a table, right?
• 15:00
  SPEAKER_02: What are the types of things that you would see?
• 15:02
  SPEAKER_02: You might see a row titled like equity securities in the real estate investment space.
• 15:08
  SPEAKER_02: And you might see in you know, in column one, for level one, an amount there, and in level three, and another amount there, and like the third column.
• 15:16
  SPEAKER_02: So you'll see rows, asset type columns leveling so people can see um, you know, sort of where your fair value estimates fall.
• 15:25
  SPEAKER_02: Um and then for level three investments, there's a lot more disclosures.
• 15:28
  SPEAKER_02: And and I think you're right, the one that you're you're focused on is is the well, what is like the range of what is the what are the level three inputs that you use from from evaluation?
• 15:39
  SPEAKER_02: And typically what you'll see is companies that have level three assets or liabilities, they they they don't have one, they have they have a number of them.
• 15:46
  SPEAKER_02: And so um what you'll see is uh frequently people disclose the ranges of those inputs.
• 15:52
  SPEAKER_02: A good example would be mortgage-backed securities and prepayment speeds is a level three estimate.
• 15:58
  SPEAKER_02: And so you might see in a disclosure sort of the range of prepayment speeds that were used in the valuation.
• 16:04
  SPEAKER_02: Because you really you really have to balance giving users information that's helpful, but not overwhelming them with information that they can't really take and put into context.
• 16:15
  SPEAKER_03: And then um you also usually include a narrative, right, in this area in terms of the valuation.
• 16:21
  SPEAKER_02: Absolutely, where you talk about your valuation techniques.
• 16:25
  SPEAKER_02: So that's more of the model, like what do you do with those inputs?
• 16:29
  SPEAKER_02: You talk a lot about if there's any changes to the way that you're doing your modeling and valuation, that type of stuff as well is important.
• 16:37
  SPEAKER_03: And so then, Chip, if we're thinking about disclosure, and so we just said you're gonna disclose valuation approach and technique by your class of instrument, and then changes for any changes and techniques for level two or level three.
• 16:51
  SPEAKER_03: But then you also need to disclose, um, make quantitative disclosure of significant unobservable inputs.
• 16:59
  SPEAKER_03: So, what does that look like typically?
• 17:01
  SPEAKER_02: Yeah, and and I'd say it varies a little bit depending upon the asset types you have, the number of unobservable inputs that go into those valuations.
• 17:09
  SPEAKER_02: Um the the first thing I think that that people spend a lot of time thinking about is at what class, at what level do I make these disclosures, particularly to your point, the unobservable inputs.
• 17:20
  SPEAKER_02: You know, and and you know, we actually have within our um financial statement presentation guide and within chapter 20, which is our sort of fair value chapter, some factors that you would consider with respect to disaggregation.
• 17:32
  SPEAKER_02: But that's where I think you get to the level of, you know, there's sort of like an axis, if you will, the level of disaggregation, and then coupled with, okay, well, that's where you would see the range of information being disclosed at that level of granularity.
• 17:45
  SPEAKER_03: So then, Chip, I know that there's also uh requirements to provide narrative disclosures about the uncertainties with recurring level three fair value measurements reflecting certain changes and significant unobservable inputs.
• 17:58
  SPEAKER_03: So again, I know that the disclosure requirements here are for level three because there's so much inherent judgment and uncertainty.
• 18:06
  SPEAKER_02: Absolutely.
• 18:06
  SPEAKER_02: And you and you'll see that as a recurring theme throughout the disclosures about level three things.
• 18:13
  SPEAKER_02: And maybe what we do, Heather, we could pivot a bit off of the leveling table because I mean you know me, I can talk all day about fair value levels, and but that won't be fun for anybody but me.
• 18:24
  SPEAKER_03: Although I do have more questions about like the background of how they came up with the levels, but I guess you and I can talk about it.
• 18:29
  SPEAKER_02: We can talk offline, but I and I'm ready for that.
• 18:31
  SPEAKER_02: Um, but you mentioned early on, like 107 and some previous disclosures too, like 105 and things like that, too, where um, and one of the things that's required in these disclosures is about concentrations of credit risk, right?
• 18:44
  SPEAKER_02: And so that's where that disclosure that used to be in the FASB statement found its way into the codifications, actually part of the fair value disclosures.
• 18:52
  SPEAKER_02: And so what you have to disclose here is significant concentration of credit risk from financial instruments, and it's not just an instrument by instrument level, but it would also require you to group counterparties and credit risk together where where you have activities that are exposures that are with clients that are engaged in uh similar activities or have similar economic characteristics.
• 19:16
  SPEAKER_02: And and so you have to disclose information about the credit exposure and how you grouped it, how groups were formed.
• 19:22
  SPEAKER_02: You have to disclose the maximum possible amount of loss due to credit risk reside, you know, resulting from those disclosures.
• 19:31
  SPEAKER_02: Um and then it requires you to disclose additional information that might mitigate some of that credit risk.
• 19:37
  SPEAKER_02: So, for example, if there are collateral requirements um that might mitigate the credit exposure, or you usually see this in like the the repo or the derivative space, if there's master netting arrangement that would allow you to offset assets and liabilities against each other.
• 19:53
  SPEAKER_03: And I think Chip, hopefully Cecil has convinced people otherwise.
• 19:57
  SPEAKER_03: But I think sometimes they hear you hear credit risk and you assume it's financial institutions only.
• 20:03
  SPEAKER_03: Uh, but these disclosures are for all companies and probably a place where I would say, particularly if there's new activities, it's something you don't want to save till the end because it's not that sometimes that straightforward to figure out how you're gonna make the groups and how you're gonna do this disclosure.
• 20:20
  SPEAKER_02: Absolutely.
• 20:20
  SPEAKER_02: And in some cases, how you calculate the maximum possible exposure to loss.
• 20:25
  SPEAKER_03: Right.
• 20:26
  SPEAKER_03: And then I guess just in addition to the concentration of credit risk, then another disclosure, just to remind people, is quantitative information about market risk of financial instruments and in particular considering how you're managing those risks.
• 20:40
  SPEAKER_03: I think that's another one that people sometimes skip over.
• 20:43
  SPEAKER_03: But this is also separate.
• 20:46
  SPEAKER_03: Those these disclosures are separate from the ones that are required in MDNA.
• 20:49
  SPEAKER_03: And again, I feel like this is an area where companies may think because they've made it in one place, they don't have to do it here, or they think it's the exact same, but it's this is an area to focus on.
• 21:00
  SPEAKER_03: So, Jeff, you mentioned this before, but I wanted to come back to it.
• 21:04
  SPEAKER_03: So we often will see, you know, where you a company will have um investments in mutual funds and where those are measured at net asset value.
• 21:13
  SPEAKER_03: And so I know there's special rules of how you think about that for your disclosures and where they fit in the hierarchy table.
• 21:20
  SPEAKER_03: So, what can you share on that?
• 21:21
  SPEAKER_02: Yeah, actually, I'm glad you brought that up because um investing in equity securities as a result of you know uh ASC321, we're measuring more equity securities at fair value than we were before.
• 21:34
  SPEAKER_02: Now, a lot of companies have, and a lot of non-financial services companies, they have equity investments in mutual funds as part of their investment strategy.
• 21:41
  SPEAKER_02: And one of the things that you can do as a practical expedient if you meet certain criteria is you can assume that the fair value of a mutual fund is actually just its net asset value, is its NAV.
• 21:54
  SPEAKER_02: Other times, nav is the fair value of that security because that's where you see.
• 22:00
  SPEAKER_02: Being traded at.
• 22:02
  SPEAKER_02: And so a lot of questions came up like if I'm using nav as a practical expedient, I'm not really doing the fair value calculation.
• 22:09
  SPEAKER_02: So how am I supposed to disclose it in the hierarchy table if I'm not actually doing the calculation with inputs?
• 22:14
  SPEAKER_02: And so the answer came back, and there was some standard setting that was done around this that said, all right, well, the first thing you need to do is you need to figure out are you doing nav as a practical expedient, or do you actually computing fair value and it just happens to be nav?
• 22:30
  SPEAKER_02: Because if the answer is you're just using nav as a practical expedient, then what the guidance would tell you is that doesn't go into the hierarchy table because you know we're not using inputs, we're not going through the valuation process, we're just using nav as a as a practical expedient.
• 22:43
  SPEAKER_02: You know, on the other hand, if you're doing real fair value and you've just concluded that you know full ASC 820 fair value is the same as nav, then it would go into the hierarchy table.
• 22:53
  SPEAKER_02: So it really depends upon are you using it as a practical expedient or are you doing it because you really think nav is fair value?
• 23:00
  SPEAKER_03: And then Chip, from a practical point of view, do you normally see then like those items will be a separate line in the fair value table or are they below, or how do companies deal with that?
• 23:11
  SPEAKER_02: No, you're it's a it's a great point.
• 23:12
  SPEAKER_02: So if if it's not being included in the table, right, because you're using nav as a practical expedient, you're bringing us back to the importance of being able to reconcile to the financial statements, right?
• 23:24
  SPEAKER_02: And so you're absolutely right.
• 23:25
  SPEAKER_02: What you'll typically see is that as a separate line, you know, so that you can kind of get, you know, it won't be leveled, so it won't be in the leveling table to be kind of separate from that, but it'll help users be able to then add and get back to the financial statements.
• 23:38
  SPEAKER_02: You know, so for example, if you had a line in your financial statements that was investment in equity securities, some of the story is gonna get told at the for value table where you have that as level one, two, or three, but some of it might be in this, you know, nav as a practical expedient line.
• 23:52
  SPEAKER_03: Yeah, I think this is another one where it's easy to kind of get lost in the disclosure.
• 23:57
  SPEAKER_03: So important reminder.
• 23:59
  SPEAKER_03: And then, Chip, let's talk specifically for public business entities because I know they have some of their kind of uh extra, I'll call them requirements, but this would be disclosing the fair value of financial instruments that aren't reported at fair value.
• 24:14
  SPEAKER_03: So it's a little bit of a tongue twister, but what can you share with about that?
• 24:17
  SPEAKER_02: Uh well, go back to what you said earlier.
• 24:19
  SPEAKER_02: This came from FAS 107, so it wasn't new, you know, with with ASC A20.
• 24:24
  SPEAKER_02: But what they did have done recently is they've said, like, look, if you have things like loans or liabilities that you're not measuring at fair value, and we'll get into fair value option, you know, next year.
• 24:34
  SPEAKER_02: But you what 107 said was disclose what is carried at and what it's fair value, even though it's not being measured at fair value.
• 24:43
  SPEAKER_02: And then I think the board got a lot of feedback that that's more not as useful for non-public entities where people might have more access to management and to data.
• 24:52
  SPEAKER_02: And so now those disclosures are only required for public business entities.
• 24:57
  SPEAKER_02: Now, there are certain things that get scoped out of that disclosure, like uh employers and plan obligations for pensions.
• 25:05
  SPEAKER_02: Um, and depending on the type of instrument that you have, there might be additional disclosures that are required.
• 25:12
  SPEAKER_02: But you're right, generally the whole fair value disclosure for things that are not measured at fair value is a public business entity disclosure.
• 25:19
  SPEAKER_03: All right.
• 25:20
  SPEAKER_03: So then, Chip, let's move on.
• 25:21
  SPEAKER_03: You mentioned this, uh fair value option.
• 25:24
  SPEAKER_03: And this is definitely one that, again, coming from a non-financial service background, I always thought was kind of a cool standard that you could just choose that you're going to suddenly start applying fair value in cases where it wouldn't otherwise apply.
• 25:36
  SPEAKER_03: Um, but I also know that if you do make the fair value, um, take the fair value option.
• 25:42
  SPEAKER_03: Obviously, there's rules about applying it, but then there's definitely rules that we could cover about what you need to disclose.
• 25:48
  SPEAKER_02: Yeah, and I don't know if I would characterize this as accounting theory or accounting history, but when people say the fair value option, there's actually, and I'm gonna learn from my last podcast, several as opposed to a couple of standards that provide for a fair value option.
• 26:05
  SPEAKER_02: So, for example, uh within the derivative and hedging guidance, there's a fair value option that if you for certain financial instruments, if you don't want to bifurcate embedded derivatives and just fair value the whole thing, the derivative standard will have it.
• 26:19
  SPEAKER_02: When you're dealing with like mortgage servicing rights and things like that in ASC 860, there's another fair value option that's in there that if you want to just fair value the mortgage service right to have its accounting kind of line up with how some of your hedging activity might be accounted for, you can do that.
• 26:35
  SPEAKER_02: But I think if you're not a fair value historian, that what most people are referring to when they say fair value options sits within topic 825, which is a more general fair value option for mostly financial assets and certain financial instruments.
• 26:51
  SPEAKER_03: All right.
• 26:52
  SPEAKER_03: Well, definitely I have to admit I was thinking of the one that's in 825 that was from 159.
• 26:57
  SPEAKER_03: So thank you for clarifying that.
• 26:59
  SPEAKER_03: If so, I guess no matter which of these that you have, they have different disclosure requirements as well, right?
• 27:05
  SPEAKER_03: Depending which option you're taking.
• 27:07
  SPEAKER_02: Yeah, and you're right.
• 27:09
  SPEAKER_02: I mean, you know, what when the board gave people the ability to account for something at fair value or a fair value option, they recognize that that could have an impact on comparability because what you elect to do, Heather, might be different than what I elect to do.
• 27:21
  SPEAKER_02: I love fair value, so you know, I might elect to do it on more things than others.
• 27:26
  SPEAKER_02: And so, so just as a reminder, and we covered this on our investments podcast, you do have to tell people, you know, sort of on the face or parenthetically, what assets are being measured at fair value and which ones are not.
• 27:38
  SPEAKER_02: Like you have to separately show people that.
• 27:40
  SPEAKER_02: So if you have loans and some of them you've elected fair value option on, um, you need to disclose what's being fair valued and what's not.
• 27:48
  SPEAKER_02: And you know, these are even more important disclosures because that general fair value option is at an instrument by instrument levels.
• 27:55
  SPEAKER_02: Like I said, you might be not doing it for all loans, you might only have to be doing it some.
• 27:59
  SPEAKER_02: One other important, I know this is a disclosure podcast, but accounting reminder is when you elect the fair value option on liabilities, the change in fair value due to instrument-specific credit risk is not going through PL, it's going through OCI.
• 28:16
  SPEAKER_02: So as we talk a little bit more about some of these fair value option disclosures, it's important to keep that reminder as liabilities because that will obviously drive some additional disclosure requirements.
• 28:26
  SPEAKER_03: Yeah, and I guess you know, for these other podcasts in the series, we've spent a lot more time talking about presentations.
• 28:31
  SPEAKER_03: So it's good we have at least one presentation thing to talk about here.
• 28:35
  SPEAKER_03: So then, Chip, uh, I know there's a lot to say, and you don't have to cover every single one, but what are some of the specific disclosures people should be making when they elect the fair value option?
• 28:49
  SPEAKER_02: Um, yeah, and I and I I think some of it highlights some of the things we just talked about.
• 28:52
  SPEAKER_02: So if you elected fair value option on some but not all, but not all assets, you need to tell people that.
• 28:58
  SPEAKER_02: And you need to describe what drove you to elect fair value in some circumstances, but not others.
• 29:04
  SPEAKER_02: That gets your comparability point.
• 29:06
  SPEAKER_02: You know, we talked a little bit about like, you know, having to separately disclose on the balance sheet what's being fair valued and what's not being fair valued, but you also have to tell people within a financial statement line item like loans, what's being fair valued and what's not.
• 29:19
  SPEAKER_02: So people can kind of understand that and and pull that apart.
• 29:22
  SPEAKER_02: You have to tell people what went through earnings, you know, what would what change in fair value went through earnings or what went through OCI for the instrument-specific credit risk.
• 29:31
  SPEAKER_02: Because again, you know, we're very much focused on what's the unrealized gain or loss that we have from fair valuing things.
• 29:38
  SPEAKER_02: There's not a lot of gap on things like how to calculate interest income and dividends on instruments that are being measured at fair value.
• 29:45
  SPEAKER_02: So one of the required disclosures is for these financial instruments is how did you recognize interest and dividends?
• 29:51
  SPEAKER_02: And then lastly, I'd say there's some additional disclosures dependent upon the type of the assets.
• 29:56
  SPEAKER_02: So, for example, loans and receivables, even if you elect fair value option, there's a couple of extra disclosures in there just to give people, you know, highlight things about like credit risk.
• 30:04
  SPEAKER_03: Okay, so then Chip, let me go back to the presentation item we talked about, which is that if you elect the fair value option on liabilities, then you show the changes in fair value for those instruments.
• 30:16
  SPEAKER_03: This instrument-specific credit risk goes through OCI.
• 30:20
  SPEAKER_03: I'm thinking most of our listeners aren't going to have this circumstance, but if they do, what are the disclosures they should be thinking about?
• 30:27
  SPEAKER_02: Yeah, and instrument-specific credit ROF goes through OCI just rolls off the tongue, right?
• 30:31
  SPEAKER_02: I mean, exactly.
• 30:32
  SPEAKER_02: We should come up with some kind of acronym for that.
• 30:34
  SPEAKER_03: It's like an acronym for the something like that.
• 30:36
  SPEAKER_02: But maybe again, uh just a moment on the theory behind that.
• 30:40
  SPEAKER_02: Um, so when when people elected fair value option and they started fair value option like liabilities like debt, one of the things that people observed is as your credit worsens, the fair value of the liability declines, and so we book a gain.
• 30:56
  SPEAKER_02: And as your credit improves, the fair value of your liability goes up and we book a loss.
• 31:01
  SPEAKER_02: And and some commented that that's a bit counterintuitive that when things are going good for you, you're booking losses and they're going bad, you're booking gains.
• 31:11
  SPEAKER_02: And that kind of flowing through PL confused people, and that's why they said, all right, for the instrument-specific credit risk, we'll pull that out of PL and put that in OCI.
• 31:20
  SPEAKER_02: Um, so so not surprisingly, you know, the disclosures have followed.
• 31:24
  SPEAKER_02: So, how did you calculate instrument-specific credit risk?
• 31:28
  SPEAKER_02: That's a required disclosure.
• 31:30
  SPEAKER_02: How much of uh the change in fair value, both for the period and cumulative, was related to instrument-specific credit risk, and therefore it's reported in OCI as opposed to PL.
• 31:41
  SPEAKER_02: And then lastly, if you settle a liability during the period, you know, you pay it off, how much that was originally in OCI then gets flushed out of OCI into PL upon settlement, that's another required disclosure.
• 31:54
  SPEAKER_02: So, not not not terribly surprising that those would be the disclosures that would be required when we're carving a piece of the change in fair value off and reporting it somewhere else.
• 32:03
  SPEAKER_03: All right.
• 32:03
  SPEAKER_03: And Chip, I do want to point out that even us non-financial services people know what settling a liability is, but thank you for clarifying that point, Fred.
• 32:11
  SPEAKER_03: Um, so Chip, we covered a lot of different stuff.
• 32:14
  SPEAKER_03: And actually, um, we're getting to our wrap-up, and this is a perfect point for me to ask.
• 32:19
  SPEAKER_03: I have two questions to stump you this time.
• 32:21
  SPEAKER_03: I almost feel bad asking the first one, but let me go for it.
• 32:25
  SPEAKER_03: So, how many fair value disclosures are there?
• 32:29
  SPEAKER_02: Oh, you know what?
• 32:31
  SPEAKER_02: I'm gonna go with I'm gonna go with my favorite answer.
• 32:33
  SPEAKER_02: It depends.
• 32:34
  SPEAKER_03: It depends on whether you're Oh my gosh, that's like not fair.
• 32:39
  SPEAKER_03: Oh, come on now.
• 32:41
  SPEAKER_03: It was a tough question.
• 32:42
  SPEAKER_03: Okay, it's a good answer.
• 32:43
  SPEAKER_03: It's a good answer.
• 32:44
  SPEAKER_02: It depends if it's a recurring fair value measure, a non-recurring firm value measure, if you're doing it because of fair value option.
• 32:50
  SPEAKER_02: So I'm gonna go with a firm.
• 32:52
  SPEAKER_02: It depends.
• 32:52
  SPEAKER_03: All right, well that probably wasn't what you were looking for, but it wasn't because what I was hoping you say is I have no idea.
• 32:58
  SPEAKER_03: And then we could say, right, and even listening to this podcast, our listeners would not get all of them.
• 33:05
  SPEAKER_03: So where should they go look to find all of them was where we were supposed to go.
• 33:08
  SPEAKER_03: I got this.
• 33:09
  SPEAKER_03: Although I do like your it depends answer.
• 33:11
  SPEAKER_02: So all right, well, well, let's let me say this.
• 33:13
  SPEAKER_02: I answered it depends because I actually don't know.
• 33:16
  SPEAKER_02: And if you had asked me any of those one buckets individually, I don't know.
• 33:20
  SPEAKER_02: But you're right, there, you know, where would I go to find out?
• 33:24
  SPEAKER_02: I would say there's a couple of places I would look.
• 33:28
  SPEAKER_02: One is our financial statement presentation guide.
• 33:30
  SPEAKER_02: I mentioned that earlier.
• 33:31
  SPEAKER_02: We have chapter 20 that goes through a lot of the disclosure requirements, and then our disclosure checklist, uh, which is which is a great tool, uh, that is a very complete list of the disclosures.
• 33:41
  SPEAKER_02: But the the other place that I would look that that might give some of the disclosures, but more importantly, give some additional context around them is actually our fair value guide.
• 33:50
  SPEAKER_02: So our fair value guide goes through the actual kind of rules around measuring fair value.
• 33:56
  SPEAKER_02: And so some of the disclosure information information in there might be helpful in the context of framing the disclosures.
• 34:02
  SPEAKER_03: Well, and I think Chip, I'm not one to really be like, yes, go read this chapter of the guide just for fun.
• 34:08
  SPEAKER_03: But I do think this is one case where if you're dealing with these disclosures, reading that back, getting a little more of that understanding actually can be very helpful.
• 34:17
  SPEAKER_03: So I would highly recommend just reading some of that to get more detail on those, the hierarchy.
• 34:23
  SPEAKER_02: And Heather, I'm just gonna say, assume that recommendation has nothing to do with the fact that many years ago you and I probably wrote the first version of that.
• 34:30
  SPEAKER_02: And there's some of the okay, some of the things that nothing to do with it.
• 34:34
  SPEAKER_03: Nothing.
• 34:35
  SPEAKER_03: Well, I'll end I was thinking that you probably have written every word that's in there.
• 34:40
  SPEAKER_03: Uh it is not, but I do know it is a good read.
• 34:42
  SPEAKER_03: So I I would recommend it.
• 34:47
  SPEAKER_03: Fact check.
• 34:48
  SPEAKER_03: It looks like Chip is right.
• 34:50
  SPEAKER_03: It does depend.
• 34:51
  SPEAKER_03: There are at least 41 required disclosures in AST 820, depending on how you count them.
• 34:56
  SPEAKER_03: And there'd be even more from other guidance discussing fair value options.
• 35:05
  SPEAKER_03: Now, Chip, so just to wrap things up, I do have one final question that's slightly easier, but I think still might be difficult.
• 35:13
  SPEAKER_03: And, you know, we mentioned throughout this uh podcast, like many of in this series, all these old standards.
• 35:20
  SPEAKER_03: And for our many of our listeners, they're thinking, like, you know, come on, this is all about the codification.
• 35:26
  SPEAKER_03: So from a codification point of view, it's this is mostly an ASC 820.
• 35:31
  SPEAKER_03: And then you mentioned fair value option and ASC 825.
• 35:35
  SPEAKER_03: How many different standards went into creating 820?
• 35:41
  SPEAKER_02: Uh, that's a great question.
• 35:42
  SPEAKER_02: I mean, it's gotta be, it's I I if I were to guess, and I guess I will guess, um, I would have guessed like between five to seven standards, right?
• 35:51
  SPEAKER_02: Because certainly, like you mentioned, like some of the disclosure requirements, like 107 um and and concentrations of credit risk was a separate standard.
• 36:00
  SPEAKER_02: So there's two.
• 36:00
  SPEAKER_02: Fair value option was in FAS 159.
• 36:04
  SPEAKER_02: Um, you know, that's kind of an 825, but some of it's an 820.
• 36:07
  SPEAKER_02: And then I think through there were probably elements picked up of a lot more standards too that actually required measurements of fair value.
• 36:15
  SPEAKER_02: Um, you know, where there was guidance on how to calculate the fair value that got pulled in.
• 36:19
  SPEAKER_02: But I don't know.
• 36:21
  SPEAKER_02: There, there I'm gonna definitely say there's probably north of five to seven standards that have guidance that found, you know, that found its way into 820.
• 36:29
  SPEAKER_03: I actually think that's a very good guess.
• 36:31
  SPEAKER_03: And I also think this might be a question to definitive hard question to definitively answer, but we'll see what we can find.
• 36:41
  SPEAKER_03: Fact check.
• 36:42
  SPEAKER_03: It's hard to definitively say how many standards went into ASC 820.
• 36:47
  SPEAKER_03: However, if we look to ASC 820's primary precursor, FAS 157, it deleted or amended at least 23 standards before being codified.
• 36:58
  SPEAKER_03: So perhaps that's the question I should have asked Joe.
• 37:05
  SPEAKER_03: As always, enjoyed chatting with you.
• 37:07
  SPEAKER_03: Thanks for going through this uh very long list of fair value disclosures, and as always, appreciate your insight.
• 37:14
  SPEAKER_03: Thanks a lot.
• 37:16
  SPEAKER_03: That does it for today.
• 37:17
  SPEAKER_03: Thanks for tuning in.
• 37:19
  SPEAKER_03: Join me back here every Tuesday and Thursday for new podcast episodes.
• 37:23
  SPEAKER_03: Don't forget to tune in to our new Facts on SPAC series on Thursdays.
• 37:28
  SPEAKER_03: And if you didn't get enough of Chip today, he's my guest this Thursday on our SPAC Financial Instruments episode.
• 37:35
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• 37:40
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• 37:46
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• 37:51
  SPEAKER_03: From the thought leadership of PWC, I'm Heather Horn.
• 37:55
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