©2005 Investment Company Institute. All rights reserved. Information may be abridged and therefore incomplete.
Communications from the Institute do not constitute, and should not be considered a substitute for, legal advice.
[19298]
October 26, 2005
TO: ACCOUNTING/TREASURERS COMMITTEE No. 18-05
CLOSED-END INVESTMENT COMPANY COMMITTEE No. 39-05
SEC RULES COMMITTEE No. 58-05
RE: FASB ISSUES WORKING DRAFT OF FORTHCOMING STANDARD ON FAIR VALUE
MEASUREMENTS
The Financial Accounting Standards Board recently issued a working draft of its
forthcoming accounting standard on fair value measurements.1 The forthcoming accounting
standard would amend generally accepted accounting principles and would apply to all entities
that prepare GAAP-based financial statements, including investment companies. The standard
would apply broadly to financial and non-financial assets and liabilities that are required to be
measured at fair value under existing accounting standards.
We are pleased to report that the Working Draft reflects many of the Institute’s
recommendations in its comment letter on the Board’s original proposal.2 In particular:
• The Working Draft clarifies that securities traded on multiple exchanges should be
valued by reference to the principal market (i.e., the market where the preponderance of
transactions take place).
• The Working Draft clarifies that securities traded in over-the-counter dealer markets
may be valued at the bid price or a price within the bid-ask spread that provides an
estimate of the price at which market participants would currently transact, consistently
applied.
1 Statement of Financial Accounting Standards, Fair Value Measurements, (October 21, 2005) (the “Working Draft”).
The Working Draft is posted on the FASB website http://www.fasb.org/project/fvm_working_draft_standard.pdf.
2 See Institute Memorandum to Accounting/Treasurers Members No. 32-04, Closed-end Investment Company
Members No. 60-04, SEC Rules Members No. 128-04 [No. 17960], dated September 8, 2004.
2
• The Working Draft precludes application of block discount factors to readily available
market prices for unrestricted securities. The Working Draft notes that adjusting market
prices for the size of the position introduces management intent (to trade in block size)
into the valuation process, reducing comparability.
• The Working Draft precludes adjusting the current market price for expected transaction
costs (e.g., brokerage commissions to be incurred on disposal).
Fair Value
The Working Draft defines fair value as the price that would be received for an asset or
paid to transfer a liability in a current transaction between marketplace participants in the
reference market for the asset or liability. A current transaction is not a forced or distress sale.
Rather, a current transaction is an orderly transaction that assumes adequate exposure to the
market. Marketplace participants are entities that are independent, knowledgeable, and have
legal and financial ability to transact. The reference market is the most advantageous market in
which the entity would transact.
Valuation Techniques
The Working Draft retains the original proposal’s three valuation techniques. In
particular, the “market approach” uses observable prices and other relevant information
generated by market transactions. The “income approach” converts future amounts (e.g., cash
flows or earnings) to a single discounted present value amount. The “cost approach” is based
on the amount that would be required to replace an asset in service (i.e., replacement cost).
Valuation techniques used to estimate fair value should maximize the use of market inputs and
minimize the use of entity inputs.
Fair Value Hierarchy
The fair value hierarchy distinguishes between the inputs to valuation techniques used
to estimate fair value, considering the relative reliability of the inputs. While the original
proposal contained three levels within the proposed fair value hierarchy, the Working Draft
contains five levels.
• Level 1 inputs are market inputs that reflect quoted prices for identical assets or liabilities
in active markets. The Working Draft clarifies that matrix pricing is a pricing method
within Level 1.
• Level 2 inputs are market inputs that reflect quoted prices not encompassed within Level
1, that is, (a) quoted prices for identical assets or liabilities in markets that are not active
and (b) quoted prices for similar assets or liabilities in all markets, regardless of the level
of activity.
• Level 3 inputs are market inputs other than quoted prices (e.g., interest rates, yield curves,
volatilities, default rates, etc.).
• Level 4 inputs are market inputs that are not directly observable for the asset or liability
but that are corroborated by other market data through correlation. Examples include
inputs that are derived through extrapolation.
3
• Level 5 inputs are entity inputs. Examples include inputs derived through extrapolation
but that are not corroborated by other market data.
Disclosure Requirements
Similar to the original proposal, the Working Draft requires disclosure of the amount of
assets remeasured at fair value on a recurring basis as of the reporting date, in total and as a
percentage of total assets. In addition, the Working Draft requires disclosure of where within
the fair value hierarchy the fair value estimates fall, segregating those estimates that fall within
Level 1, Levels 2-4, and Level 5. Fair value estimates for restricted securities would typically fall
within Levels 2-4.
Effective Date
The Fair Value Measurements standard will be effective for financial statements issued for
fiscal years beginning after December 15, 2006, and interim periods within those fiscal years.
However, the disclosure requirements will be effective for financial statements issued for fiscal
years ending after December 15, 2006.
Final Standard to be Issued During Fourth Quarter
The Working Draft will be available on the FASB website through November 21, 2005.
While the Board is not formally seeking comments at this time, they will consider any
comments provided by interested parties. If you have any comments on the Working Draft,
please contact the undersigned at 202/326-5851 or smith@ici.org.
Gregory M. Smith
Director - Operations/Compliance & Fund
Accounting