Investment Companies Advisor: ASU 2015-07 Will Simplify Process for Tracking Categorization of Investments in the Fair Value Hierarchy

Earlier this year, the Financial Accounting Standards Board (FASB) addressed a costly and time-consuming disclosure requirement for investment companies by issuing the Accounting Standards Update No. 2015-07. The new pronouncement will become effective for all public entities with fiscal years beginning after December 15, 2015. The effective date for all other entities is for fiscal years beginning after December 15, 2016. Early adoption is also permitted on a prospective basis, which means all periods presented in a company’s financial statements will reflect the changes stipulated by the update. ASU 2015-07 is being hailed as a change that simplifies the processes involved in categorizing investments measured at net asset value per share using the practical expedient in the fair value hierarchy.

Prior to establishing the guidance under ASU 2015-07, hedge funds and funds of hedge funds that measured investments at net asset value using the practical expedient based the determination between Level 2 and Level 3 in the fair value hierarchy on when the investments could be liquidated. If liquidation was allowed in the near term, the investment would be a classified within Level 2 in the fair value hierarchy. If there was a stipulated lock-up period or a type of gate on the investment where the investment could not be liquidated until some future period or unknown date, it would have been classified within Level 3 in the fair value hierarchy. Near term was not specifically defined in prior accounting guidance, creating the use of judgement and different interpretations among investment companies.

The old guidance created the necessity to categorize investments within the specified levels while also tracking the liquidity status of the investments. If the liquidity of an investment changed, it would have to be transferred into a new level and each change in level status required additional disclosures in the financial statements. It should be noted that those investments categorized within Level 3 were also required to be disclosed in a roll-forward table of investment activity from the beginning of year to the end of year.

Through the implementation of ASU 2015-07, entities that measure net asset value of investments using the practical expedient will no longer have to categorize these investments in the fair value hierarchy. Along with eliminating the level-tracking requirements, entities no longer have to provide a roll-forward disclosure of investment activity in the notes within the financial statements for these investments.

Taking the Steps to Implement ASU 2015-07

One of the first steps in implementing this update should be to identify investments where fair value is measured at net asset value per share using the practical expedient. Once those investments are identified, they can be removed from the fair value hierarchy. It is important to note that while there are other types of investments that would fall within Level 2 or Level 3, ASU 2015-07 only applies to investments that are measured at net asset value per share using the practical expedient. The qualifier for applying ASU 2015-07 is the use of the practical expedient.

Consider the following example: A hedge fund (Hedge Fund A) invests in another hedge fund (Hedge Fund B). Hedge Fund A’s investment in Hedge Fund B is valued at Hedge Fund A’s percentage ownership of the total net asset value of Hedge Fund B. If Hedge Fund A’s investment is valued in this manner, which must be consistent with the measurement principles for investment companies as determined by authoritative accounting standards, then Hedge Fund A could utilize the practical expedient. The valuation of these investments remains the same as it did prior to ASU 2015-07. The changes resulting from the update affect only the financial statement disclosures, as shown in the following example:

Format before ASU 2015-07:

Table1_FormatBeforeASU2015-07

The following tables present a reconciliation of activity for the Level 3 financial instruments:

Table2_ReconciliationLevel3FinancialInstruments


Format after ASU 2015-07:

Table3_FormatAfterASU2015-07

(1) Certain investments measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been categorized in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the statement of financial condition.

As noted by the examples, the table is essentially the same. The main difference between the new pronouncement and the previous guidance is the placement of the values in the table and the removal of the roll forward of investment activity for investments measured at net asset value using the practical expedient that were previously classified as level 3 in the fair value hierarchy There is also a disclosure paragraph that has been added to note the changes regarding the categorization. It is important to note that the guidance does not explicitly state how this information should be presented.

We Can Help!

ASU 2015-07 will be the standard going forward. The effective date for all public entities is fiscal years beginning after December 15, 2015. The effective date for all other entities is for fiscal years beginning after December 15, 2016. Early adoption is permitted for all entities. The Elliott Davis Decosimo Investment Companies Team is well versed in the changes and opportunities ASU 2015-07 will present for investment companies. If you have any questions regarding ASU 2015-07, please check with your Elliott Davis Decosimo advisor or contact our Investment Companies Practice Leader Renee Ford.

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