As the Financial Accounting Standards Board of the United States and the International Accounting Standards Board continue to work on their convergence project, Account Standards Update (ASU) 2011-04 issued in May 2011 will take effect for interim and annual periods starting after December 15, 2011. The update carries with it a handful of new fair value disclosure requirements and clarifications applicable to public and non-public investment companies.

Note: items identified below with an (*) are not required for non-public entities, such as private partnerships or non-registered funds.

More Transparency
Some of the more significant provisions of the update relate to increasing transparency of the valuation procedures and inputs used in determining fair value for Level 3 assets and liabilities. Some of these changes include:

• In general, funds should disclose quantitative information about the unobservable inputs used for Level 3 assets/liabilities. However, certain inputs are exempted from this requirement, including but not limited to instances when a fund is using the practical expedient or prior transaction costs as the input (although, quantitative adjustments to these inputs are required to be disclosed).
• Funds also should include a narrative disclosure describing the sensitivity of the fair value measurement in its entirety to changes in the unobservable inputs used and the interrelationships between those unobservable inputs, (how a change in one input might cause another input to fluctuate and the corresponding magnification or mitigation on the fair value for that security).*
• Finally, a fund should add disclosures describing the valuation process it employs throughout the year, including the role of any valuation committees, how valuation policies and procedures are determined, and how changes in fair value are analyzed.

Additional Provisions
Currently, in addition to disclosing transfers into or out of Level 3, funds are required to disclose any significant transfers between Levels 1 and 2 and the reason for the transfer. As part of ASU 2011-04, fair value disclosures are required to be expanded to include notation of all transfers between Levels 1 and 2 and the reason for those transfers.*

Furthermore, prior to the update being effective, blockage factors are not permitted to be used as an adjustment to other observable inputs for Level 1 securities. Under ASU 2011-04, this restriction is extended to all levels of securities. Funds should consider other premiums or discounts (i.e. control premiums/non-controlling discounts), so long as those premiums and discounts do not relate to the size as a characteristic of the fund’s holding.

Another new requirement included in the update is that a fund should disclose the items (by level) that are not measured at fair value on the balance sheet, but that are required to be measured at fair value (for instance, if measured at amortized cost).*

ASU 2011-04 also clarified the definition of the term "Principal Market" as being the market for a security that has the greatest volume or level of activity, not necessarily the market in which the security was established or in which the fund transacts.

The information is provided by Cohen Fund Audit Services and is intended for informational purposes only. You should consult with your legal and other advisors specific to your situation before taking any subsequent action.