September 22, 2022
The Financial Accounting Standards Board (FASB) recently issued an Accounting Standards Update (Update) to (1) clarify guidance in Topic 820, Fair Value Measurement, on measuring the fair value of an equity security that is subject to a contractual restriction and (2) require specific disclosures about those securities. Note that when the SEC adopted new Rule 2a-5 under the Investment Company Act of 1940 (Rule), which updated the regulatory framework for fund valuation practices and had a compliance date of September 8, 2022, the SEC also rescinded Accounting Series Release 113 (ASR 113) and Accounting Series Release 118 (ASR 118). ASR 113 and ASR 118 provided guidance on how to determine fair value for restricted securities.
Under current guidance, industry practices have varied with respect to whether contractual sale restrictions should be considered when measuring the fair value of equity securities that are subject to such restrictions. The amendments in the Update clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value (i.e., no discount should apply to the security because of the contractual sale restriction). According to the Update, a contractual sale restriction on the reporting entity that prevents the sale of an equity security in the market does not prevent the entity from measuring the fair value of the equity security on the basis of the price in that principal market.
The effect on a fair value measurement arising from a restriction on the sale or use of an asset by a reporting entity will differ depending on whether the restriction would be taken into account by market participants when pricing the asset. Example 6, Case A in the Update indicates that when measuring fair value, an entity should:
Here, the reporting entity should measure the fair value of the equity security on the basis of the market price of the similar unrestricted equity security adjusted to reflect the effect of the restriction. The adjustment will vary depending on the following:
a. The nature and remaining duration of the restriction;
b. The extent to which buyers are limited by the restriction (for example, there might be a large number of qualifying investors); and
c. Qualitative and quantitative factors specific to both the instrument and the issuer.
Here, the fair value of the equity security subject to the contractual sale restriction should be measured on the basis of the market price of the same equity security without the contractual sale restriction and should not be adjusted to reflect the reporting entity’s inability to sell the equity security on the measurement date.
The amendments in the Update require the following disclosures for equity securities that are subject to contractual sale restrictions:
Investment companies should apply the amendments in the Update to investments in equity securities subject to contractual sale restrictions executed or modified on or after December 15, 2023. An investment company with an equity security subject to a contractual sale restriction that was executed before December 15, 2023, should continue to use the accounting policy applied before December 15, 2023 (i.e., if an investment company was incorporating the effects of the restriction in the measurement of fair value, it would continue to do so).
See Accounting Standards Update 2022-03 – Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions here.
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The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm or its clients, or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.
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