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Reporting reset – Fair value disclosures · PwC's accounting podcast

• 0:00
  SPEAKER_00: Thought Leadership from PWC's National Office.
• 0:07
  SPEAKER_03: Hello, and welcome to PWC's Accounting Podcast.
• 0:10
  SPEAKER_03: I'm Heather Horn and I'll be your host today.
• 0:16
  SPEAKER_03: In today's episode, we're continuing our series on presentation and disclosure in the financial statements, focusing on fair value disclosures.
• 0:25
  SPEAKER_03: And as I'm sure many of you already know, fair value estimates are used in the financial statements in a lot of areas.
• 0:31
  SPEAKER_03: So that would range from things like derivatives and available for sales securities, which are always reported at fair value.
• 0:37
  SPEAKER_03: Then we have other instruments like loans and debt that can be reported at fair value if a company elects to apply the fair value option.
• 0:45
  SPEAKER_03: And then sometimes we also see items remeasured to fair value on a non-recurrent basis.
• 0:50
  SPEAKER_03: For example, this may happen with an impairment.
• 0:52
  SPEAKER_03: So definitely a lot of scenarios where fair value is important.
• 0:56
  SPEAKER_03: And I'm happy to say for this far-reaching and, as I said, important topic, I'm happy to be joined by Brett Julie, Deputy Chief Accountant in our national office who leads our financial instruments team.
• 1:07
  SPEAKER_03: So, Brett, welcome.
• 1:08
  SPEAKER_01: Thanks, Heather.
• 1:09
  SPEAKER_03: So obviously, Brett, there are a lot of disclosure requirements related to fair value.
• 1:14
  SPEAKER_03: And I think this would be very long and probably boring podcast if we were going to list them all out.
• 1:20
  SPEAKER_03: So I didn't have that in mind, but instead I thought that we could highlight some of the more important ones today.
• 1:27
  SPEAKER_03: Maybe, and actually as a backdrop to all of that, I think it's helpful just to start out with the objective.
• 1:32
  SPEAKER_03: Like why do we have these specific disclosures about fair value?
• 1:35
  SPEAKER_01: Yeah, I think that's a great place to start because, like you noted, you could easily turn this into just a long list of individual requirements that don't really may not seem like they hang together, but I think there is some framework to talk about.
• 1:48
  SPEAKER_01: And I think the first thing to keep in mind is we are talking about two types of fair value measures that are covered by these disclosures.
• 1:56
  SPEAKER_01: Um, the first is recurring.
• 1:58
  SPEAKER_01: Uh, these are instruments that are measured at fair value at each reporting period.
• 2:02
  SPEAKER_01: Um, going back to your introduction, think derivatives, trading securities, uh, fair value option items uh like you mentioned.
• 2:10
  SPEAKER_01: And then there's a second group of non-recurring um measures.
• 2:14
  SPEAKER_01: These are disclosure instruments that aren't marked to market, but they're required to be measured at fair value periodically, maybe because of impairment or something else.
• 2:24
  SPEAKER_01: So when I step back from for both of these, the goal of disclosures um maybe maybe threefold around the information needs for stakeholders.
• 2:33
  SPEAKER_01: One is around the valuation techniques and inputs that are actually used to measure fair value, including those judgments that are made and assumptions being made.
• 2:43
  SPEAKER_01: So a reader can get a sense of um you know how these measure, how these fair value estimates are being made.
• 2:51
  SPEAKER_01: The second we'll talk about is uh giving users a picture about the uncertainty in those fair value measures as of the reporting date.
• 3:01
  SPEAKER_01: Fair value is often an estimate, right?
• 3:04
  SPEAKER_01: And um and there's a range of the level of uncertainty that uh may exist in any estimate around fair value.
• 3:11
  SPEAKER_01: And then the third is helping users understand how changes in fair value affect performance and cash flows.
• 3:18
  SPEAKER_03: All right, very helpful.
• 3:19
  SPEAKER_03: And I think in particular, some of the disclosures that that help with uncertainty are particularly important from a user perspective.
• 3:26
  SPEAKER_03: And I think we'll touch on some of those as we get into the disclosures.
• 3:30
  SPEAKER_03: So maybe with that backdrop, why don't we run through some of the more general requirements that you are required to make for each class of assets and liabilities measured at fair value?
• 3:41
  SPEAKER_01: Sure.
• 3:41
  SPEAKER_01: Maybe we start out with some simple things like um the first thing you have to disclose is the fair value measurements at the end of the reporting period.
• 3:48
  SPEAKER_03: Okay, that's a good one.
• 3:49
  SPEAKER_01: Things are at a fair value and recurring basis, it's just the fair value of the of the balance sheet date.
• 3:54
  SPEAKER_01: Uh for non-recurring uh fair value measure measurements, it's the fair value at that relevant measurement date.
• 4:01
  SPEAKER_01: Um, the reason it was remeasured to fair value, and if it wasn't remeasured at the period end date, the date it was remeasured.
• 4:09
  SPEAKER_01: Um then there'll be a whole group of disclosures around what we call the fair value hierarchy.
• 4:16
  SPEAKER_01: For podcast listeners, this is the fair value levels one, two, and three that we often talk about.
• 4:22
  SPEAKER_01: And we'll talk about um them again in a bit.
• 4:24
  SPEAKER_01: But this applies to both recurring and non-recurring measurements.
• 4:28
  SPEAKER_01: In addition to those leveling disclosures, for some uh investments in entities like funds, for example, um, they may qualify for a practical expedient where the net asset value or nav or NAV can be used in place of fair value.
• 4:45
  SPEAKER_01: And these investments wouldn't be disclosed within that fair value hierarchy at all, but would still be shown within that disclosure because amounts need to reconcile back to the balance sheet.
• 4:55
  SPEAKER_01: So for these types of investments under the NAV practical expedient, there are some additional disclosures.
• 5:02
  SPEAKER_01: And then there are some investments that don't qualify for that NAV practical expedient, but the fair value estimate of the instrument itself is based off of a nav.
• 5:12
  SPEAKER_01: Um and those for those investments, they'd be included in the general fair value hierarchy disclosures we're going to talk about.
• 5:19
  SPEAKER_01: Within uh that hierarchy, we've talked about level three.
• 5:22
  SPEAKER_01: This is the bucket with the most um measurement uncertainty.
• 5:27
  SPEAKER_01: For those uh types of instruments, you need to show a roll forward of the balance.
• 5:31
  SPEAKER_01: Um, and there are several pieces involved in that uh role in that roll forward.
• 5:37
  SPEAKER_01: And that roll forward also provide information about unrealized gains and losses that are showing up in the PL or maybe in OCI.
• 5:45
  SPEAKER_01: We often think of fair value measures as applying to financial assets, but there's a piece in here for nonfinancial assets too.
• 5:52
  SPEAKER_01: So for recurring and non-recurring fair value measures for nonfinancial assets, um, the guidance requires us to compute fair value based on an asset's highest and best use that would maximize its fair value.
• 6:04
  SPEAKER_01: But we know that for business purposes, sometimes that that actual use of that asset is not its highest and best use from a marketplace perspective.
• 6:13
  SPEAKER_01: And so uh, if the current use is different from that highest and best use, you need to disclose that and also why.
• 6:20
  SPEAKER_01: A lot of what we talk about uh today will make a lot of sense on an individual basis.
• 6:26
  SPEAKER_01: If I just have one thing.
• 6:27
  SPEAKER_01: Yes.
• 6:27
  SPEAKER_01: Um, but often you're not valuing one thing, you're valuing things in a portfolio.
• 6:32
  SPEAKER_01: And there is uh accounting policy election to apply this a portfolio exception to value certain financial assets and liabilities on a net basis.
• 6:41
  SPEAKER_01: And if you take that election, um, that that needs to be disclosed.
• 6:45
  SPEAKER_01: And then, you know, maybe one other thing to remember, um, you know, for all disclosures and the fair value disclosures, I think really emphasize this.
• 6:53
  SPEAKER_01: It's important that the users are be able to reconcile this information in the disclosures back to what's on the balance sheet.
• 6:59
  SPEAKER_01: So you make sure you you've got completeness and they understand where that shows up in the footnotes.
• 7:04
  SPEAKER_03: All right.
• 7:04
  SPEAKER_03: So, Brett, definitely a long list there.
• 7:06
  SPEAKER_03: And I want to emphasize one point that I asked in my question, but I think it definitely could have got easily gotten lost there.
• 7:14
  SPEAKER_03: So when you're making these disclosures, this is not everything all clumped together, but it's really supposed to be for each class of assets and liabilities.
• 7:23
  SPEAKER_03: And I think you touched on that, but I also think it's easy to get lost.
• 7:27
  SPEAKER_03: And also then, how do companies think about what level, what is a class of assets and liabilities?
• 7:33
  SPEAKER_01: Yeah.
• 7:34
  SPEAKER_01: So there's some judgment involved in that when we can talk about how to how to group assets.
• 7:38
  SPEAKER_01: Um, you know, generally you're looking at the nature of the assets, the risks uh involved.
• 7:43
  SPEAKER_01: Um, this is all a lot easier to visualize if you see a table.
• 7:46
  SPEAKER_01: Yes.
• 7:46
  SPEAKER_01: But it is a table where you think of, you know, down the rows are a bunch of different classes of an at of assets.
• 7:53
  SPEAKER_01: And across, you know, the columns are like the leveling disclosures, for example, we we said.
• 7:58
  SPEAKER_01: But you're right, this isn't just you know a one-number disclosure, which is why, especially for institutions or preparers that have a lot of these, these disclosures can go on for pages and pages just to show all of the information in one spot.
• 8:12
  SPEAKER_03: It makes sense.
• 8:13
  SPEAKER_03: All right.
• 8:13
  SPEAKER_03: Well, let's move on then.
• 8:15
  SPEAKER_03: Um, and we talked a bit at the beginning about one of the reasons for these disclosures is so users can understand uncertainty in the financial statements.
• 8:23
  SPEAKER_03: And I think one of the biggest places that can really help understand that uncertainty is the fair value hierarchy disclosures.
• 8:30
  SPEAKER_03: And I always think it's funny that FASB did not get too creative with its its category names, but this is where we have the level one, two, or three.
• 8:39
  SPEAKER_03: And then there's this concept of leveling, which has to only be an accounting term used in the in this context.
• 8:45
  SPEAKER_03: But what do we think about with these three levels and what do we mean when we say leveling?
• 8:49
  SPEAKER_01: Yeah, I think it's important to understand this because I think the use of these levels is sometimes misunderstood by users.
• 8:56
  SPEAKER_01: And really the leveling is designed to be a measure of how observable the inputs are to an estimate of fair value.
• 9:04
  SPEAKER_01: So um think of level one um inputs or um level one values may be based on unadjusted quoted prices for identical assets or liabilities in active markets.
• 9:17
  SPEAKER_01: A simple example of this is an equity security traded on the New York Stock Exchange.
• 9:21
  SPEAKER_01: Um I can see it in an active it's it's an active market, I can see it quoted directly, I'm not making any adjustments to it.
• 9:28
  SPEAKER_01: Uh that may be level one.
• 9:30
  SPEAKER_01: Level two instruments are where the inputs are either directly or indirectly observable, but don't qualify as level one.
• 9:38
  SPEAKER_01: For example, you may get a dealer quote uh where the dealer stands ready and is able to transact at that price, uh, or you may have a modeled value, think of like some type of derivative instrument where all of the inputs to that model are observable.
• 9:54
  SPEAKER_01: But the instrument itself isn't traded actively on an exchange.
• 9:59
  SPEAKER_01: And so it's level two.
• 10:00
  SPEAKER_01: And so I think this distinction between level one and level two can sometimes be confusing because sometimes people think of level one as certain and level two is less certain, but it's really uh some level two inputs may have little valuation uncertainty to them.
• 10:18
  SPEAKER_03: Yeah, although then there's it's a spectrum, right?
• 10:20
  SPEAKER_03: In level two, and then we get to level three where there's a lot more uncertainty.
• 10:24
  SPEAKER_03: Trevor Burrus, Jr.
• 10:24
  SPEAKER_01: Exactly.
• 10:25
  SPEAKER_01: So level three is where there is little, if any, um, market or activity for that instrument or the input.
• 10:33
  SPEAKER_01: And you may have information that's derived from extrapolation or interpolation of level one or level two inputs.
• 10:40
  SPEAKER_01: And it's important to remember that the level of instrument is characterized in its entirety for, you know, it's one measure for that whole instrument by the lowest level for where there is a significant input.
• 10:52
  SPEAKER_03: Yeah.
• 10:53
  SPEAKER_03: And so I think then, Brett, that's such an important point.
• 10:56
  SPEAKER_03: So if I have something that I'm valuing, and there's level one inputs, level two inputs, and level three inputs, and this definitely the case, especially for some commodity derivatives, I'll say, from personal experience, then that would be a level three instrument because if if all of those inputs were significant.
• 11:14
  SPEAKER_01: That's exactly right.
• 11:15
  SPEAKER_01: And that's where it's important for users to understand this, because you could misinterpret a level three instrument as you know a shot in the dark in its entirety, where it may be that 75% of that value is actually very well estimated and very well known by level one inputs.
• 11:33
  SPEAKER_01: It's just that there's a significant input that's not.
• 11:36
  SPEAKER_03: Yeah.
• 11:36
  SPEAKER_03: So any could you get any examples that you could give on that, maybe?
• 11:40
  SPEAKER_01: I think you know, we run into it.
• 11:41
  SPEAKER_01: You've seen in the in the commodity space.
• 11:44
  SPEAKER_01: Um you see it in in in almost every type of instrument, um, uh like a derivative instrument that's based on a model.
• 11:52
  SPEAKER_01: It's pretty unusual for every input to a model to be unobservable.
• 11:56
  SPEAKER_01: Um you may have some types of credit derivatives, for example, or equity um equity derivatives that have that have some level of um and and a large degree of level one inputs, interest rate risk, um, interest rate inputs, and things like that.
• 12:13
  SPEAKER_01: But there may be one component that that's just not.
• 12:16
  SPEAKER_03: So then, Brett, as you know, as we're talking through this, and as someone who can visualize the financial statements footnotes, maybe can picture, you can wind up with a lot of numbers and a lot of different inputs and otherwise.
• 12:29
  SPEAKER_03: And so from a uh prepared's perspective, well then as well for users to understand what are some of the types of things that you are required to disclose about how you're valuing, particularly level two and level three instruments.
• 12:45
  SPEAKER_01: Maybe a couple of things to mention there.
• 12:47
  SPEAKER_01: One is um, you know, for level two and level three instruments, you need to describe those valuation techniques and the inputs that you're using in the measurement.
• 12:55
  SPEAKER_01: And if there have been changes to those, which often um there are, you need to um you need to disclose that change and the reason uh for making it.
• 13:04
  SPEAKER_01: And then for level three instruments in particular, you're required to disclose quantitative information about those significant unobservable inputs.
• 13:13
  SPEAKER_03: Yeah.
• 13:13
  SPEAKER_03: So again, I think this goes back to the point of trying to give more disclosure about things that where there's uncertainty.
• 13:20
  SPEAKER_03: And so it's kind of tying in to this point on uncertainty, then for companies that have level three uh measurements, the standard does allow you to disclose a range or it may be a weighted average for those inputs.
• 13:34
  SPEAKER_03: So what is what are those disclosures around level three that you would highlight?
• 13:38
  SPEAKER_01: Yeah, I I think your point around range and averages is important.
• 13:42
  SPEAKER_01: Some of what we're talking about here is very clear.
• 13:44
  SPEAKER_01: If I've got one level three instrument, I can easily tell you how I value that and what estimates I had to make.
• 13:52
  SPEAKER_01: It's much different to tell a coherent story when you're dealing with thousands of instruments, um, even if even if I'm aggregating those.
• 14:00
  SPEAKER_01: So and there are more disclosures related to level three instruments, um, which is not surprising based on all the judgment that's required uh in estimating the values.
• 14:10
  SPEAKER_01: Some things that we haven't mentioned that I think are important.
• 14:14
  SPEAKER_01: One is the total amount of gains and losses on level three instruments on what was included in PL versus OCI.
• 14:23
  SPEAKER_01: This is required for recurring measurements.
• 14:25
  SPEAKER_01: So you can understand how much of unrealized gains and losses there may be in the PL related to those level three instruments.
• 14:33
  SPEAKER_01: And then for recurring level three measurements, um, you should provide a narrative description about the uncertainty of the measurement that that results from the use of unobservable inputs.
• 14:43
  SPEAKER_01: For example, you might disclose how a change in one of those inputs might impact the fair value estimate and if there's interrelationships between the different inputs.
• 14:52
  SPEAKER_03: So, Brett, let's stick then with these unobservable inputs and also a little bit about valuation techniques.
• 14:58
  SPEAKER_03: So you mentioned this, the fact that you are required to disclose valuation approach and technique by again, we're back to this class of instruments, as well as if you're making any changes.
• 15:09
  SPEAKER_03: But specifically, then when we're thinking about unobservable inputs, there are some additional disclosures.
• 15:16
  SPEAKER_03: So specifically, what is required for those unobservable inputs?
• 15:20
  SPEAKER_01: Sure.
• 15:21
  SPEAKER_01: A few things.
• 15:22
  SPEAKER_01: Uh I think disclosures of unobservable inputs is presented, like you said, by class of asset and liability.
• 15:29
  SPEAKER_01: And I think there is a lot of judgment required in thinking about what's an appropriate class.
• 15:34
  SPEAKER_01: I think some considerations you may think about are the nature, the characteristics, and the risks of those assets and liabilities.
• 15:42
  SPEAKER_01: And I think it's important that it's sufficiently detailed to allow users to understand significant unobservable inputs and how they vary over time.
• 15:51
  SPEAKER_01: You know, if you approach this with too level, too high a level of aggregation, it's just not going to tell a coherent story around what's going on with values.
• 16:01
  SPEAKER_01: And um, for user, for listeners here who uh have this situation, I think chapter 20 of our financial statement presentation guide has some additional factors that an entity could consider in thinking about that level of disaggregation.
• 16:15
  SPEAKER_03: I right.
• 16:15
  SPEAKER_03: I think that's helpful.
• 16:16
  SPEAKER_03: And I also think, Brett, getting this level of disaggregation right is important because if you are aggregating things that don't really quite belong together, and then you have an anomaly in some period and you need to start splitting things out.
• 16:29
  SPEAKER_03: I think that can cause additional complexity versus if you've kind of set things right to begin with and been able to explain those to begin with, I think it helps from an ongoing consistency point of view.
• 16:40
  SPEAKER_01: I I think that's right.
• 16:41
  SPEAKER_01: And sometimes you talked about the ranges and use of weighted averages.
• 16:45
  SPEAKER_01: If you have too much aggregation, those ranges suddenly will not make any sense.
• 16:49
  SPEAKER_03: Yes, exactly.
• 16:50
  SPEAKER_03: Exactly.
• 16:51
  SPEAKER_03: All right, so definitely a lot.
• 16:52
  SPEAKER_03: And for for companies dealing with a lot of level three, obviously dig in more to the guidance.
• 16:58
  SPEAKER_03: And again, I think getting the disaggregation right and as well as making sure you get all these details right is important.
• 17:04
  SPEAKER_03: But let's move on to some of the other specific types of disclosures.
• 17:08
  SPEAKER_03: So let's focus in on credit risk disclosures.
• 17:11
  SPEAKER_03: What are some of those requirements?
• 17:13
  SPEAKER_01: Yeah, there's a few uh disclosures required about concentrations of credit risk.
• 17:17
  SPEAKER_01: And obviously, when you're going through uncertain economic times, um these disclosures become even more relevant.
• 17:25
  SPEAKER_01: But entities are required to disclose the where they have significant concentrations of credit risk arising from financial instruments.
• 17:32
  SPEAKER_01: And it's not just credit risk from an individual counterparty, although that may be one if you have a large receivable from one entity, but also from groups of counterparties that may be engaged in similar activities or have similar economic characteristics.
• 17:48
  SPEAKER_01: And where you have concentrations of credit risk, the disclosures include uh information on those exposures and how you determined those groups that you're presenting, the maximum amount of loss that could uh exist due to that credit risk, information around any collateral provisions and collateral protection that you have, and then also information around masternetting agreements that may allow you to offset and mitigate some of that risk.
• 18:13
  SPEAKER_03: All right.
• 18:13
  SPEAKER_03: And maybe I'll chime in and say that in addition to these concentrations of credit risk, companies that are not required but encouraged to disclose quantitative information about market risk of financial instruments, um, considering, you know, it's kind of thinking through how they're managed, and this would be separate from those that are required to be an MDNA.
• 18:31
  SPEAKER_03: So these would be in the financial statements.
• 18:34
  SPEAKER_03: So just one other note there.
• 18:35
  SPEAKER_03: All right.
• 18:36
  SPEAKER_03: So then let's move on then to fair value disclosures for instruments not measured at fair value, which almost sounds like it should be an oxymoron, however, it's not.
• 18:45
  SPEAKER_03: And these are specific disclosures uh required for public business entities, so not all companies, but many, related to the fair value financial instruments that are not reported at fair value.
• 18:56
  SPEAKER_03: So can you explain?
• 18:58
  SPEAKER_01: Right.
• 18:58
  SPEAKER_01: So this is outside of what we talked about recurring or non-recurring fair value measurements.
• 19:03
  SPEAKER_01: These are things that are presented on the balance sheet, financial instruments that are presented on the balance sheet uh not at fair value.
• 19:08
  SPEAKER_01: And public business entities are required to disclose the fair value of those financial instruments, whether or not they're on the balance sheet at fair value.
• 19:17
  SPEAKER_01: There are some scope-outs from that, things like employer and plan obligations for pension benefits, um, but they've applied broadly.
• 19:27
  SPEAKER_01: And there are also some addition, there are some additional disclosure requirements depending on specific instruments.
• 19:33
  SPEAKER_01: For example, equity instruments without a readily determinable fair value.
• 19:38
  SPEAKER_01: So even if you don't think you have these things, uh these instruments measure at fair value, there's still some disclosures that you should be digging into.
• 19:46
  SPEAKER_03: All right.
• 19:46
  SPEAKER_03: Definitely don't want to miss those.
• 19:48
  SPEAKER_03: So then I mentioned this at the very beginning.
• 19:50
  SPEAKER_03: There's also, in some cases, an option for companies to measure things at fair value, conveniently known as the fair value option.
• 19:58
  SPEAKER_03: And very creative again.
• 20:00
  SPEAKER_03: Exactly, exactly.
• 20:01
  SPEAKER_03: Really give them credit for that.
• 20:03
  SPEAKER_03: So so, Brett, what are some of the places uh where we see the fair value option popping up in the literature?
• 20:09
  SPEAKER_01: Yeah, sure.
• 20:10
  SPEAKER_01: There's actually two key standards that have a fair value option that are covered by what we're talking about today.
• 20:15
  SPEAKER_01: One is in the derivative and hedging guidance, that there's a there's a fair value option for some hybrid financial instruments that have embedded derivatives that would otherwise require separation and separate recognition.
• 20:27
  SPEAKER_01: Uh, but I think what generally when we talk about fair value option, people are referring to financial instrument guidance in ASC 825 that provides for an election for a wide range of financial instruments.
• 20:40
  SPEAKER_03: All right.
• 20:41
  SPEAKER_03: And that's sort of the one I think when people say fair value option that they're really thinking of.
• 20:45
  SPEAKER_03: Uh, but this one is interesting because it actually, because the way this is applied, you really can, it can result in a lack of comparability across entities, because let's say you have the same instruments I do, and one of us selects fair value and the others don't.
• 21:02
  SPEAKER_03: But what are some of the things in terms of how the fair value option is applied and then how you think about these disclosures?
• 21:09
  SPEAKER_01: Yeah, um, I think there's there's two um there's two points here that that can create some non-comparability because the fair value option is an instrument by instrument election.
• 21:20
  SPEAKER_01: It doesn't have to be applied broadly across all instruments or even broadly across all similar instruments, even within an entity.
• 21:28
  SPEAKER_03: And so that's very I think confusing.
• 21:32
  SPEAKER_03: For the users, yeah.
• 21:33
  SPEAKER_01: That's right.
• 21:33
  SPEAKER_01: But I think you know, broadly in practice, you don't see that many entities applying it truly instrument by instrument.
• 21:41
  SPEAKER_01: I'm gonna pick A, but not B.
• 21:43
  SPEAKER_01: There's usually some business reason that that you know that they make these distinctions, um, even though the the literature permits it.
• 21:51
  SPEAKER_01: Um But for instruments under fair value option, um we need to do a couple things.
• 21:57
  SPEAKER_01: You need to separately report on the balance sheet.
• 22:00
  SPEAKER_01: Either by a separate line item or parenthetically the fair value and non-fair value amounts.
• 22:06
  SPEAKER_01: So you can differentiate what's measured at what.
• 22:09
  SPEAKER_01: And then another important reminder is when you elect the fair value option on liabilities, the change in instrument-specific credit risk is reported in OCI, and other changes in fair value are reported in earnings.
• 22:23
  SPEAKER_03: All right.
• 22:23
  SPEAKER_03: So definitely a few things to keep track of there.
• 22:25
  SPEAKER_03: And then I obviously, hopefully this goes without saying, if you have instruments that are accounted for following the fair value option, you have to make all of those other disclosures we talked about before and some we didn't get into.
• 22:38
  SPEAKER_03: But then you also have incremental disclosures that are required because these instruments are following the fair value option.
• 22:45
  SPEAKER_03: So what are some of those items that you would want to cover?
• 22:48
  SPEAKER_01: Yeah, you you're right.
• 22:49
  SPEAKER_01: So once you elect fair value option, you're you've opted into all of those recurring basis disclosures that we talked about.
• 22:56
  SPEAKER_01: And then the ones that are specific to the fair value option uh instruments, there's a I guess there's a few of them.
• 23:03
  SPEAKER_01: Um one is just disclosing the reason for electing fair value option.
• 23:08
  SPEAKER_01: And like we talked about, if you elected only for some items, but not all, you're required to provide a description of those items and the reason that FEO fair value option was only elected on some of them, but not all.
• 23:21
  SPEAKER_01: Um for the balance sheet, um, you need to show for each balance sheet line item where you have items that are under an FEO election, uh, you need to disclose the amounts reported on the balance sheet and how that balance sheet line item relates to the classes and of assets and liabilities that reported in the fair value disclosures.
• 23:42
  SPEAKER_01: Again, like think about reconciling what's back in this footnote in these disclosures for what's actually on the on the face of the balance sheet.
• 23:49
  SPEAKER_01: Um for any balance sheet line item that has items that aren't eligible for the FEO, you need to disclose uh that amount.
• 23:57
  SPEAKER_01: And then disclose the amount of gains or losses from changes in fair value that are included in earnings during the period.
• 24:04
  SPEAKER_01: Remind companies should also disclose how interest and dividends are measured and where they're reported in the income statement on these items.
• 24:12
  SPEAKER_01: And then for specifically for loans and receivables that are held that are held as assets, there's a number of additional disclosures about conveying the information about the credit risk of those assets, because remember, those assets aren't under the normal CESOL model.
• 24:26
  SPEAKER_03: All right.
• 24:26
  SPEAKER_03: Oh, yes, excellent point.
• 24:28
  SPEAKER_03: So then, Brett, I have a specific question about liabilities.
• 24:32
  SPEAKER_03: But before we go on to that, just if this is possible, I'm not sure it is, but big picture, would you say that the fair value option is very common?
• 24:41
  SPEAKER_03: I know you said you don't see a lot where people are sort of picking and choosing within a class of assets, but just in general, is this something that we see a lot of companies using, or it really depends on facts and circumstances?
• 24:54
  SPEAKER_01: I think it depends, but I think um I so I wouldn't say every company has some items under fair value option, particularly among financial institutions.
• 25:03
  SPEAKER_01: The it's it's fairly common uh to be used.
• 25:06
  SPEAKER_01: There are some um types of securization structures, for example, that may be consolidated where entities want to show the fair value of the assets and the fair value of the liabilities of that consolidated entity on a comparable basis.
• 25:21
  SPEAKER_01: So they use that.
• 25:22
  SPEAKER_01: Um there are there are some types of business activities where you may have loans and receivables, for example, that are in a trading business.
• 25:31
  SPEAKER_01: They're actively traded.
• 25:32
  SPEAKER_01: They're technically not trading assets, they're not trading securities under a different standard, but a lot of financial institutions will want to elect fair value option for those.
• 25:42
  SPEAKER_01: So I'd say among banks and financial institutions, pretty pervasive.
• 25:46
  SPEAKER_01: Um, but maybe among corporates, maybe a little less so.
• 25:49
  SPEAKER_03: Yeah, I think um that definitely makes sense.
• 25:51
  SPEAKER_03: And I also think, again, not to use too broad a brush, but your point that there's a specific business purpose tends to make sense because otherwise you're creating a lot of work and disclosure for yourself if you know if there's not a purpose to it versus just following historical cost model.
• 26:08
  SPEAKER_03: So all right, that's helpful.
• 26:09
  SPEAKER_03: Now let me just loop back because you did mention that the when you have fair value option liabilities, you put the changes in fair value related to the instrument-specific credit risk in OCI.
• 26:21
  SPEAKER_03: Um and I know there's some additional specific disclosures you need to make related to those amounts.
• 26:26
  SPEAKER_01: Yeah.
• 26:27
  SPEAKER_01: This all came about, obviously, because when when people were looking at um liabilities that were measured at fair value, I think a number of constituents thought it was a little odd that when you elected FEO on a liability, if an entity's credit was deteriorating, the value of that liability would go down.
• 26:47
  SPEAKER_01: And that actually creates a gain for the institution.
• 26:51
  SPEAKER_01: And vice versa when your credit improves.
• 26:54
  SPEAKER_01: And that is a little counterintuitive.
• 26:56
  SPEAKER_01: And so rather than having those gains and losses that are in that are you know uh issuer specific apply uh impact PL, the model is changed so that those changes are reported in equity or in AOCI.
• 27:09
  SPEAKER_01: So from a disclosure standpoint, you need to disclose how gains and losses uh attributable to that instrument specific credit risk were determined, uh kind of your methodology and inputs to that, the amount of the change of the fair value of the liability due to instrument-specific credit risk, both for the period and cumulatively over time.
• 27:28
  SPEAKER_01: And then if an instrument was actually settled during that period, the amount of OCI that was recognized in net income as of the settlement.
• 27:36
  SPEAKER_03: All right, that's helpful.
• 27:37
  SPEAKER_03: And I just to confirm, Brett, these additional disclosures only apply in a case where it's a fair value option applied to liabilities.
• 27:45
  SPEAKER_03: This would not pertain to other liabilities measured at fair value.
• 27:49
  SPEAKER_01: Aaron Powell That's exactly right.
• 27:50
  SPEAKER_03: Okay, very important to note that.
• 27:52
  SPEAKER_03: Okay, so that was definitely a quick tour of all of the fair value disclosures.
• 27:57
  SPEAKER_03: I I think one of the reasons people like to tune in though is to get some additional insight or context.
• 28:03
  SPEAKER_03: And one of those places that uh we see particular interest is where we're getting SEC comments.
• 28:09
  SPEAKER_03: So which of these disclosures have we seen additional comments on or comments on?
• 28:14
  SPEAKER_03: So what are some of the SEC comments we've seen on fair value?
• 28:18
  SPEAKER_01: Yeah, I think there are a few.
• 28:20
  SPEAKER_01: Um sometimes the SEC staff will ask about or ask for more information around valuation techniques and key inputs used to determine fair value, including uh where management has disclosed that they use third party as third parties as part of the valuation process.
• 28:36
  SPEAKER_01: Remember, throughout here, um, you know, whether you use a third party to help or whether you do all of this in-house, they're still your estimates.
• 28:46
  SPEAKER_01: And so taking ownership of those estimates from a content perspective, but also from a disclosure perspective, I think is important to the to the SEC staff.
• 28:57
  SPEAKER_01: Uh sometimes they've asked for quantitative information on level three uh fair value measurements, not surprising given the amount of uncertainty and and sometimes they've asked for the sensitivity of the fair value measurements to changes in those unobservable inputs.
• 29:13
  SPEAKER_01: Um We talked briefly about the NAV practical expedient.
• 29:18
  SPEAKER_01: Uh sometimes they will ask how management determined how certain investments qualify for that practical expedient or how how the company thought about that.
• 29:27
  SPEAKER_01: Um then just kind of blocking and tackling.
• 29:31
  SPEAKER_01: Sometimes there's comments noting that certain disclosures that we talked about are just missing.
• 29:35
  SPEAKER_01: Um sometimes non-recurring fair values can be can be prone for this.
• 29:40
  SPEAKER_01: They don't happen all the time, but um you know, when there's an impairment, you know, going back and making sure those fair value measurement disclosures for that impairment are are in there, uh, sometimes the staff will ask for that.
• 29:51
  SPEAKER_03: All right.
• 29:51
  SPEAKER_03: Very helpful.
• 29:52
  SPEAKER_03: And definitely I think that attention to detail is very important across the financial statements, but particularly here.
• 29:58
  SPEAKER_03: So then uh I know Brett that we covered a lot of different topics at a high level.
• 30:04
  SPEAKER_03: If our listeners wanted more information, what's the best place to look?
• 30:07
  SPEAKER_01: Yeah.
• 30:07
  SPEAKER_01: I would I would say three three places.
• 30:10
  SPEAKER_01: One, our financial statement presentation guide, it's in chapter 20, goes through a lot of the disclosure requirements, including like some things that we didn't touch on in that list.
• 30:19
  SPEAKER_01: Um, our fair value guide goes through the actual guidance on determining fair value, um, as well as information around the fair value hierarchy of the levels that we talked about.
• 30:29
  SPEAKER_01: And then for a complete list of the disclosure requirements, we have our disclosure checklist out there that will provide a long list of things.
• 30:36
  SPEAKER_03: And then, Brett, just from a practical point of view, taking a step back, what's a recommendation you would have for companies, particularly the companies that have some fair value but they're not dealing with it as much, maybe anything particular you would say to them?
• 30:51
  SPEAKER_01: Yeah, I think it's always important to stand back from these disclosures and be able to make sure they tell the full story of what's going on for an institution that doesn't have a lot of this, but still will have it in from time to time, like thinking about the level of aggregation that's appropriate and um thinking of how this information is organized in order to be useful uh to the users, I think is an important thing to be able to step back and feel good about.
• 31:19
  SPEAKER_03: All right.
• 31:19
  SPEAKER_03: Well, Brett, it's always such a pleasure to talk to you.
• 31:22
  SPEAKER_03: Thanks so much for joining me today.
• 31:23
  SPEAKER_01: Thanks, Heather.
• 31:25
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• 31:27
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• 31:47
  SPEAKER_02: From Thought Leadership at PWC, I'm Heather Horn.
• 31:51
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