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April 19, 2011
Defined as anything that is not stocks, bonds or cash.
The effect on a fair value measurement of a restriction on the sale or use of an asset by a reporting entity will differ depending on whether the restriction would be considered by market participants in pricing the asset.
Inputs to the valuation methodology are unadjusted quoted prices for identical assets or liabilities in active markets that the Company has the ability to access. Level 1 is the highest and most reliable level in the fair value hierarchy.
Example: Publicly traded security
If the asset or liability has a specified (contractual) term, the level 2 input must be observable for substantially the full term of the asset or liability.
Real estate agent who pulls comparable sales to determine asking price for home.
Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Level 3 is the lowest level of reliability.
Basically, under Level 3, management is determining a value for an asset, subject to generally accepted valuation techniques.
Valuation techniques used to measure fair value shall be consistently applied. However, a change in a valuation technique or its application is appropriate if the change results in a measurement that is equally or more representative of fair value in the circumstances.
Examples of factors that might affect valuation:
a. New markets develop
b. New information becomes available
c. Information previously used is no longer available
d. Valuation techniques improve
Must disclose information that enables users of financial statements to understand the nature and risks of the investments and whether the investments are probable of being sold at amounts different from net asset value per share.
By category, management’s estimation of the period of time over which the underlying investments are to be liquidated.
Does the fund have a 5 or 7 year expectation?
By major category, details of any unfunded commitment on staged investments.
A general description of the terms and conditions upon which the investor may redeem.
Example: Quarterly redemption with 60 day notice
By major category, any restrictions on redemptions in terms of date or amount.
Management must estimate of when restrictions may lapse.
If cannot estimate, must disclose how long restrictions have been in effect.
AU 328.04 states:
Management is responsible for making the fair value measurements and disclosures included in the financial statements. As part of fulfilling its responsibility, management needs to establish an accounting and financial reporting process for determining the fair value measurements and disclosures, select appropriate valuation methods, identify and adequately support any significant assumptions used, prepare the valuation, and ensure that the presentation and disclosure of the fair value measurements are in accordance with GAAP.
The responsibility for determination of fair value cannot, under any circumstances, be outsourced or assigned to a party outside of the investor entity’s management.
Although the investor entity’s management may look to the fund manager for the mechanics of the valuation, management must have sufficient information to evaluate and independently challenge the fund’s valuation.
The underlying investments generally are measured at estimated fair value by the fund manager in accordance with its stated valuation policies for determining net asset value.
ALTERNATIVE INVESTMENTS – AUDIT CONSIDERATIONS
A Practice Aid for Auditors