Apr 17, 2017
Andy Cromer CPA
Reporting entities must adhere to what is commonly referred to as fair value standards. These standards prescribe how fair value is measured and the disclosures that must be made about those fair values. The Financial Accounting Standards Board (FASB) was the first to introduce this concept and the Governmental Accounting Standards Board later followed suit by copying the FASB requirements, minus a few subtle disclosure requirements. This is one of the few areas where both state and local governments and for-profit and not-for-profit enterprises have very similar overarching requirements.
The most obvious requirement to users of financial reports was the introduction of the fair value hierarchy. The three levels of the hierarchy are below:
Level 1: Quoted prices in active markets for identical assets
Level 2: Other significant observable inputs
Level 3: Significant unobservable inputs (including management’s own assumptions used to determine the fair value)
The hierarchy serves two purposes, to maximize the use of observable inputs and to increase consistency and comparability in reporting fair values. A few misconceptions have come from the hierarchy and these stated goals. It’s important to remember, the hierarchy is not an indicator of risk or liquidity. While there may be some indirect relationships in these areas, the hierarchy does not measure these attributes. Another common problem area is the disclosure of items in the hierarchy that do not belong in the hierarchy. The fair value standards specifically exclude assets or liabilities reported at amortized cost. Common examples are certain money market funds and certificates of deposit. These items may be viewed as investments by the general public or the finance community, but have been specifically exempted and should not be included in the fair value disclosures.