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March 16, 2016 Article 10 min read
Image of a stack of papers with a question mark on top 
Plante Moran recently hosted a webinar on the Governmental Accounting Standards Board’s new accounting pronouncement dealing with fair value, GASB 72.  We had significant participation in this web event, and many great questions were submitted during the webinar.  We thought that everyone might benefit from hearing the answers to the most frequently asked questions that were posed to our panel of experts.  The more common questions can be grouped into four main themes: applicability of GASB 72, new investment definition and unit of account concepts, use of acquisition value, and fair value level disclosures.

Applicability of GASB 72

Understandably, we have been receiving many questions concerning when GASB 72 applies.  First, let’s reiterate that GASB 72 would potentially apply to any organization that is reporting under the governmental accounting standards promulgated by GASB.  The extent of the impact of this standard is going to be dependent upon the magnitude and type of investments held by your organization.  Pension plans, institutions of higher education, and certain healthcare organizations that follow GASB will be impacted more than other governmental organizations with less significant and less complex types of investments.

It might also be helpful to understand the scope of statement 72.  GASB 72 provides comprehensive guidance on fair value measurement, but very narrowly scoped guidance on fair value application.  GASB 72 applicability related to the application of fair value is limited to assets and liabilities that are currently measured at fair value and certain investments that are NOT currently measured at fair value.  The standard does not extend the application of fair value measurements to assets other than investments, or to liabilities that were not previously measured at fair value.  Because the application of fair value to investments did change in GASB 72, there may be certain limited instances where an asset is now considered to be an investment for the first time that had not been previously measured at fair value and will now be recorded at fair value (or vice versa).

While a majority of GASB 72 applies to assets, the standard also applies to liabilities required to be measured at fair value, such as investment derivative instruments like interest rate swaps and foreign exchange contracts in a liability position.

Despite what some may think, not all assets meeting the definition of an investment are going to be reported at fair value.  There are some exceptions that GASB delineates within paragraph 69 of GASB 72, as follows:

Chart describing paragraph 69 exceptions of GASB 72

In order to determine whether certain types of investments are scoped out in paragraph 69, you need to understand enough about the investment to determine whether they fit into one of the categories in the above table. For example, the following investments are included in the definition of either a money market investment or an interest earning investment contract:
  • Commercial paper
  • Bankers’ acceptances
  • US Treasury obligations
  • Agency obligations
  • Time deposits with financial institutions
  • Repurchase agreements
  • Guaranteed investment contracts
  • Bank investment contracts
Based on the above, checking accounts, savings accounts, money market savings accounts, and nonnegotiable certificates of deposit are not subject to fair value and would also not be subject to the fair value level disclosures we discuss below. 
 
Specific to life insurance contracts, there is a distinction between (a) a life insurance policy that is entered into to indemnify a loss; and (b) a life settlement contract that is entered into as an investment, resulting in different measurements. A life settlement contract that is acquired when there is no insurable interest meets the definition of an investment and, therefore, should be measured at fair value. That is, the purpose of the instrument is solely to generate cash. Governments that hold life insurance policies that do not meet the definition of a life settlement contract should continue to measure such policies at cash surrender value.
 
Many have asked about applying GASB 72 to assets that aren’t reported within the organization’s financial statements, or perhaps not explicitly.  For example, many organizations with section 457 plans do not report the related assets within their financial statements, given the provisions of GASB 32.  Because GASB 72 only applies to assets recorded within your organization’s financial statements, you would not have to include any GASB 72 disclosures for those unrecorded assets related to the 457 plans.
 
Certain governments have recorded property available for sale and other inventory-like amounts within their financial statements.  GASB 72 would not apply to inventory or inventory-like amounts. That said, be certain that you revisit the new definition of an investment to ensure that the item you are considering for applicability under GASB 72 does not meet the new definition of an investment.  As mentioned above, if an asset or liability previously was not required to be recorded at fair value, other than investments, this standard will not change the measurement basis of that particular asset or liability.

New investment definition and unit of account

The statement generally requires investments to be measured at fair value. An investment is defined as “a security or other asset that a government holds (1) primarily for the purpose of income or profit and (2) its present service capacity is based solely on its ability to generate cash or to be sold to generate cash.” The asset must meet both criteria to be classified as an investment. An interesting point of consideration within GASB 72 is that a government will determine if the security or asset is an investment at acquisition, and it would remain as such for the life of the asset, even if the use changes over time. For example, if an asset is purchased and initially determined to be a capital asset, but then later the use changes such that it really does now meet the definition of an investment, it would remain as a capital asset until it is sold or disposed. It would not be reclassified to investments once its use changes.

In this standard, GASB emphasizes the importance of the concept of unit of account, or the level at which an asset or a liability is aggregated or disaggregated. A government should consider the unit of account before determining relevant measurement attributes and disclosures. Perhaps an example best illustrates this concept. For example, a local government’s city hall building that is used to house the government’s own offices as well as to generate income as retail space rented out by the government.  Let’s say the retail space represents 15 percent of the entire building. If you view the building as two units – one portion used by the government and the other used as rental space, the portion of the building used to house the government’s operations would clearly be a capital asset whereas the portion used for retail space would most likely meet the definition of an investment. This is critical because capital assets and investments are accounted for very differently.

On the other hand, if you view the entire building as one unit, you would need to decide whether the building meets the definition of an investment. In this case, the key is consideration under GASB 72 is your organization’s determination of the primary purpose of the building, because the definition of investment is an asset used “primarily for the purpose of income or profit.” Unfortunately, “primarily” is not defined by GASB, but the Merriam-Webster dictionary definition is “the main purpose of something, reason for something, etc.” If the government decides its primary use of the building is not for the purpose of income or profit, the entire building would be considered a capital asset.

Fortunately, GASB does not dictate how organizations define the unit of account – it is a matter of judgment on how you apply that concept.  But, once applied, you need to follow the related accounting standards.

Use of acquisition value

Once GASB 72 is adopted, certain capital assets that were previously reported at fair value would be measured instead on a go-forward basis at acquisition value. Donated capital assets, donated works of art and historical treasures, and capital assets received in service concession arrangements should be measured at acquisition value. Donated capital assets and donated works of art/treasures were previously reported at estimated fair value at the time of acquisition, in accordance with GASB 34. Capital assets received in a service concession arrangement were also previously valued at fair value when placed in operation in accordance with GASB 60.

Acquisition value is not the same as fair value. Fair value is an exit price notion whereas acquisition value is an entry price notion. Acquisition value is the price that would be paid to acquire an asset with equivalent service capacity in an orderly market transaction at the acquisition date. The use of acquisition value should be applied prospectively to transactions occurring after GASB 72 is effective; organizations do not have to restate these types of capital assets to acquisition value upon implementation.

Fair value disclosures

The new disclosures required by GASB 72 cover all assets and liabilities measured at fair value, and revolve around the fair value hierarchy and net asset value (NAV). 

The hierarchy of inputs used to measure fair value prioritizes the inputs into three categories — level one, level two, and level three inputs — considering the relative reliability of the inputs.

Infographic describing the different levels of GASB 72 inputs

Net asset value (NAV) per share is the amount of net assets attributable to each share of capital stock outstanding at the close of the period. Investments measured at NAV for fair value are not subject to level classification. NAV is its “own” category.

While some investment custodians and consultants might provide initial leveling classifications for a governments’ investments, it is ultimately the government’s responsibility to review and determine the appropriate classification conclusions. This might be accomplished through discussing fair value inputs with the investment custodian/consultant to determine the observability of those inputs, determination through review of internet finance sites that the identical investments are actively traded, or following up with fund managers directly.

The additional disclosures describe the fair value levels and net asset value, in addition to the assets and liabilities classified in each category. The key to the disclosures is the disaggregation of the investments themselves, which differs from current guidance that focuses on reporting entity segments, such as governmental activities, major fund types, and component units. The standard provides general guidelines rather than prescriptive requirements regarding the appropriate level of detail and will require professional judgment.

The most common disaggregation might be the investment-type disclosures because it best addresses risks, nature, and characteristics of the asset or liability. For example, disclosing a U.S. Treasury bill holding as a category communicates limited credit risk and interest rate risk, while disclosing a mortgage-backed investment holding would signal to readers a greater interest rate risk and default exposure. For equity securities, disaggregating the disclosures to address the industry or domestic versus international stock would meet the consideration of the nature of the investment in stock.

Distinguishing between level 3 and those investments valued at net asset value (NAV) can be challenging. The standard allows for investments to be measured at NAV or its equivalent, which means the NAV category will likely include hedge funds, limited partnerships, private equity and real estate funds. When there are other inputs into the valuation of any of these types of investments, a level 3 classification may be more representative. For example, if the investment is valued using discounted cash flow, a market comparable companies’ technique, or if the illiquid investment is expected to be sold at a price other than its NAV but instead determined using recent observable transaction information for similar investments and nonbinding bids received from potential buyers of the investments, the investment would be classified as level 3 and would not fall into the NAV classification.

Additionally, it will be common for governments to use an interim NAV if a year-end value is not provided in time. The standard states that the government should consider whether an adjustment to the most recent NAV is necessary. The government should adjust the valuation at the measurement date provided by the general partner by rolling it forward to the date of the pension plan’s statement of fiduciary net position. Adjustments should be made for the following events:
  1. Capital contributions made by the organization or distributions received from the general partner since the valuation date of the NAV per share (or its equivalent) reported to the organization.
  2. Changes in the composition of assets or liabilities reported by the general partner since the valuation date of the NAV per share (or its equivalent) reported to the organization.
  3. Fair value changes of assets or liabilities reported by the general partner since the valuation date of the NAV per share (or its equivalent) reported to the organization.
Even with these adjustments, the investment should be reported as measured at net asset value in the footnotes.