FASB Issues ASU No. 2022-03, Amends Fair Value Guidance in U.S. GAAP

When it comes to financial reporting, one area is often paramount for investment managers: measuring the fair value of investments held. This has a direct effect on the computation of net asset value (NAV), which in turn impacts two areas that are important to both current and prospective investors: performance and fees. 

It's important for investment managers to consider all relevant facts when measuring fair value, and it’s just as important for investment managers to have proper guidance from the accounting literature, especially for certain scenarios that are more subjective. 

Key Takeaways  

1. Clarified Fair Value: ASU 2022-03 standardizes fair value measurement for restricted equity securities under U.S. GAAP.
2. Holder vs. Security: Restrictions on the holder (person/entity) generally do not impact fair value. Restrictions on the security itself do impact fair value.
3. Disclosures to Include: Three disclosures are required for restricted equity securities, detailing fair value, restriction nature/duration, and lapse circumstances (unless pledged as collateral).
4. Investment Company Nuance: Investment companies (ASC 946) have specific prospective and grandfathering transition rules to avoid disproportionate market volatility.

Main Provisions of ASU 2022-03 

Historically, a significant challenge arose in measuring the fair value of equity securities subject to contractual sale restrictions. Diversity in practice emerged, partly due to a previous illustrative example issued by the Financial Accounting Standards Board (FASB). Some investment managers applied a discount to reflect these restrictions, while others did not, leading to inconsistencies in financial statements prepared under U.S. Generally Accepted Accounting Principles (U.S. GAAP). 

Given the importance of comparability of financial information across reporting entities, the FASB issued Accounting Standards Update (ASU) No. 2022-03 in June 2022, which amended the fair value guidance in U.S. GAAP.  

The goal of the update was to increase comparability of financial information by clarifying that a contractual sale restriction on the holder of the equity security is not considered part of the unit of account of the equity security itself and, therefore, should not be considered in measuring fair value.  

On the other hand, if a contractual restriction on sale applies to the equity security itself (as opposed to the holder of the equity security), then it is appropriate to consider that contractual restriction in measuring fair value. 

Additionally, the update introduced new disclosure requirements and amended the previous illustrative example that gave rise to the diversity in practice. 

Disclosure Requirements of ASU 2022-03 

ASU 2022-03 requires three new disclosures for equity securities subject to contractual restrictions: 

• The fair value of equity securities subject to contractual sale restrictions reflected in the balance sheet.
• The nature and remaining duration of the restriction(s).
• Any circumstances that could cause a lapse in the restriction(s).

Important Note: These disclosure requirements do not apply if the equity security is restricted solely because it has been pledged as collateral. 

When preparing these disclosures, reporting entities should carefully consider the level of detail, emphasis, aggregation, or disaggregation necessary to provide users of financial statements with sufficient information to evaluate the disclosed data effectively. 

Effective Dates and Transition Requirements 

The effective dates for ASU 2022-03 are:  

• Public Business Entities: For fiscal years beginning after December 15, 2023, including interim periods within those fiscal years 
• All Other Entities (including private entities that are not investment companies): For fiscal years beginning after December 15, 2024, including interim periods within those fiscal years. 

Specialized Transition for Investment Companies (ASC Topic 946) 

For entities that are investment companies under ASC Topic 946, amendments from this ASU should be applied as follows: 

1. For an equity security in which the contractual restriction that prohibits the sale of the equity security is executed or modified on or after the date of adoption, prospectively.
2. An equity security subject to a contractual sale restriction that was executed before the date of adoption should continue to be accounted for using the accounting policy applied before the adoption of this ASU until the contractual restrictions expires or is modified.

The reason the FASB concluded that investment companies should have specialized transition guidance was because the FASB “wanted to avoid introducing nonmarket-based volatility that would disproportionately affect transaction values on the date of adoption if investment companies applied the amendments to all equity securities on the date of adoption.” 

Maintaining Compliance with ASU 2022-23 

ASU 2022-03 marked a significant step towards greater clarity and comparability in fair value measurement for restricted equity securities. Investment managers need to understand these guidelines, particularly the distinction between holder-specific and security-specific restrictions, and make sure their valuation policies and financial reporting practices fully comply with the new disclosure requirements.  

If you have questions about ASU 2022-03 or need assistance evaluating your fair value measurement policies, contact our team today for a consultation.