Non-Profit Organizations: Fair Value Assessment Guidelines

The Financial Accounting Standards Board (FASB) requires that when organizations prepare their financial statements, they generally disclose the fair value of their investments. In addition to the process of determining the fair value of your investments, the FASB has in recent years stipulated that organizations furthermore disclose how they reach their valuations. The FASB has therefore established different investment categories to assess the reliability and verifiability of an organization’s valuation.2479_wpm_hires

Some investments such as money market accounts generally have a constant fair value of $1 per share, and thus, their fair values are reported as equal to cost basis. The FASB has created a leveling system to disclose the reliability of the fair value when properly reporting an organization’s marketable securities and more lucrative investments.

Calculating Fair Value for Publicly Traded Investments

The fair value of investments like stocks in publicly traded companies is clearly measurable; although the value of investments like these innately fluctuates, their value is quoted, publicly available, and traceable over time. Any investment whose value is quoted–such as shares of a company traded on a public stock exchange like NASDAQ–uses Level 1 inputs in determining the value of the investment.  Accordingly, the fair value is deemed to be the most reliable.

Calculating Fair Value for Fixed-Income Investments

Some investments, like fixed-income securities, accrue consistent interest, and therefore, their fair value can be clearly measured by known data even if their sale price does not reflect their value to their owner. Investments valued using observable data or verifiable data use Level 2 inputs.  When calculating their fair value an organization must consider their interest rate, bond term, and the credit rating of the securities issuer in order to properly value the investment. Furthermore, the organization must disclose the method and valuation technique used to value the investments that use Level 2 inputs.

Calculating Fair Value for Alternative Investments

Level 3 inputs are unobservable inputs that cannot be corroborated using outside data.  Investments valued using Level 3 inputs include many alternative investments, such as limited partnerships, private equity funds, real estate, and other nuanced holdings. These are usually not frequently traded and whose fair value is not calculable with publicly available information alone—they usually require estimates. The organization is required to disclose purchases, sales, gains/losses on investments, and transfers into/out of Level 3 (i.e., when an investment starts using Level 3 inputs and when an investment no longer uses Level 3 inputs).  Furthermore, the organization must disclose the method and valuation technique used to value the investments that use Level 3 inputs

Furthermore the FASB requires that investments using net asset value as a practical expedient for fair value disclose these holdings’ investment objectives and the restrictions on withdrawals that investors experience on these holdings. These investments generally use Level 2 or 3 inputs.

When reporting information about the investments that your organization holds, it is important to remember that you accord with FASB requirements for fair value calculation and information disclosure. Investments are classified using the lowest level of significant input in determining the fair value with Level 3 being the lowest and Level 1 being the highest.  Below is a table explaining the different FASB requirements for classifying investments as Level 1, 2, and 3.

Investment level Examples (with some exceptions) How is fair value calculated? What should I disclose about this investment?
Level 1 Investments publicly traded over stock exchanges. Observable, quoted, market price for an identical asset. No extra disclosures required
Level 2 Fixed-income securities, privately traded funds comprising of publicly traded securities, interest rate swaps, certain hedge funds Other observable inputs or inputs that can be corroborated. Description of the valuation technique and methodology used.
Level 3 Private equity funds, real estate, limited partnerships, beneficial interest in charitable trusts Unobservable inputs that cannot be corroborated and the fair value generally uses estimates as inputs. Changes in value since beginning of fiscal year based on purchases, sales, gains/losses, and transfers when investment valuations start or stop using Level 3 inputs.Description of the valuation technique and methodology used.