When equity investments are valued at fair value, fair value needs to be measured based upon the requirements in Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurement.
The Financial Accounting Standards Board (“FASB”) noticed diversity in practice related to applying a discount to the price of an equity security that is subject to a contractual sale restriction. Some entities were applying a discount while others where were not applying a discount. As a result, the FASB issued Accounting Standards Update (“ASU”) 2022-03 Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions, which makes updates to Topic 820 to provide guidance related to measuring fair value for securities subject to contractual sale restrictions and adds new required disclosures to Topic 820. These updates do not change the principles of fair value measurement, but rather provide some clarity on how to follow Topic 820 for equity investments subject to contractual sale restrictions.
ASU 2022-03 has amended paragraph 820-10-35-6B to make it clear that an equity security that an entity cannot sell on the measurement date because of a contractual sale restriction shall be measured at fair value on the basis of the price in the principal (or most advantageous) market. A contractual sale restriction does not change the market in which that equity security would be sold. The ASU also amended paragraph 820-210-35-36B to make it clear that a discount applied to the price of an equity security because of a contractual sale restriction is inconsistent with the unit of account being the equity security. A contractual sale restriction is a characteristic of the reporting entity holding the equity security rather than a characteristic of the asset and, therefore, is not considered in measuring the fair value of an equity security. A contractual sale restriction prohibiting the sale of an equity security is a characteristic of the reporting entity holding the equity security and shall not be separately recognized as its own unit of account. In all cases, if there is a quoted price in an active market (that is, a Level 1 input) for an asset or a liability, a reporting entity shall use that quoted price without adjustment when measuring fair value, except as specified in paragraph 820-10-35-41C.
Disclosure Requirements
The disclosure requirements for equity securities subject to contractual sales restrictions are as follows:
a. The fair value of equity securities subject to contractual sale restrictions.
b. The nature and remaining duration of the restriction(s).
c. Circumstances that could cause a lapse in the restriction(s).
If an entity has multiple investments in equity securities subject to contractual sale restrictions, the entity shall consider the guidance in paragraph 820-10-50-1D (see below) when disclosing the information required in (a) through (c) above.
Equity securities restricted from sale because they are pledged as collateral and included in other disclosures required by other Topics shall not be included in the information required in (a) through (c) above.
Paragraph 820-10-50-1D requires an entry to consider the following items when preparing its fair value measurements disclosure:
- The level of detail necessary to satisfy the disclosure requirements.
- How much emphasis to place on each of the various requirements.
- How much aggregation or disaggregation to undertake.
- Whether users of financial statements need additional information to evaluate the quantitative information disclosed.
This ASU is effective for public business entities for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. For all other entities, this ASU is effective for fiscal years beginning after December 15, 2024, and interim periods within those fiscal years. Early adoption is permitted. This ASU is to be applied prospectively for all entities, except for investment companies defined under ASC Topic 946, Financial Services – Investment Companies. For investment companies under ASC Topic 946, this ASU should only be applied to an equity security subject to a contractual sale restriction that is executed or modified on or after the date of adoption of this ASU.
If you have equity investments subject to contractual sales restrictions and have been applying a discount to the fair value for the contractual sales restriction, you need to stop applying the discount. Once you adopt ASU 2022-03, make sure your investment note disclosure includes the new required disclosures.
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