Why Fair Value Disclosures Draw So Much Attention

Fair value disclosures exist to let financial statement users assess two things: how reliable the reported fair values are, and how sensitive they might be to changes in assumptions. Because Level 3 measurements rest on unobservable inputs, ASC 820 imposes its most detailed disclosure requirements there — this final guide in the series walks through what belongs in the footnotes and why.

Disclosures Required for All Levels

For assets and liabilities measured at fair value on a recurring or nonrecurring basis, an entity generally discloses:

• The fair value measurement at the reporting date (and, for nonrecurring measurements, the reasons for the measurement)
• The level of the fair value hierarchy within which the measurement falls in its entirety
• For recurring measurements, transfers between Level 1 and Level 2, with the reason for the transfer and the entity’s policy for determining when transfers are deemed to occur
• A description of the valuation technique(s) and inputs used, and any change in technique with the reason for the change

Additional Disclosures Required for Level 3

Level 3 measurements carry a materially heavier disclosure load, reflecting the greater judgment involved:

• Reconciliation of beginning and ending balances, separately presenting total gains and losses for the period (split between amounts recognized in earnings and other comprehensive income), purchases, sales, issuances, settlements, and transfers into or out of Level 3
• Amount of unrealized gains or losses for the period included in earnings that relate to assets and liabilities still held at the reporting date, and the line item in which they are recognized
• Description of the valuation processes used, including how the entity decides on its valuation policies and procedures and how it analyzes changes in fair value measurements from period to period
• Quantitative information about significant unobservable inputs — for example, the range and weighted average of a discount rate or growth rate used across a portfolio of similar Level 3 assets
• Narrative description of the sensitivity of the fair value measurement to changes in unobservable inputs, and any interrelationships between inputs that might amplify or offset the effect of a change

Worked Example: A Level 3 Sensitivity Disclosure

Notice the structure: the disclosure names the specific inputs, gives a quantitative range, and explains directionally how a change in each input would move the fair value — this is the level of specificity auditors and the SEC staff look for, rather than boilerplate language that could apply to any Level 3 asset.

Series Wrap-Up

Across this five-part series we’ve covered the classification framework (Part 1), worked through real Level 1, 2, and 3 examples (Part 2), gone deep on building and documenting Level 3 inputs (Part 3), addressed the special highest-and-best-use test for nonfinancial assets (Part 4), and now closed with the disclosure requirements that tie the whole framework together. The common thread throughout: fair value measurement under ASC 820 is as much about the quality of the process and its documentation as it is about the number itself.