The Financial Accounting Standards Board issued an Accounting Standards Update on Wednesday that aims to improve how investment companies, such as mutual funds, measure the fair value of an equity security subject to a contractual sale restriction. The new standard, effective for annual reporting periods beginning after Dec. 15, 2027, addresses a long-standing gap in U.S. GAAP where such restrictions were often ignored in valuation.
Under current rules, a contractual restriction on the sale of an equity security isn’t considered when measuring its fair value. This means an entity holding a restricted security and one holding an unrestricted security from the same investee generally use the market price of the unrestricted security. Stakeholders argued this approach can overstate net asset value and distort performance reporting.
Correcting Valuation Distortions
The amendments provide an exception to Topic 820, Fair Value Measurement, specifically for investment companies within the scope of Topic 946. These firms are now required to consider contractual sale restrictions when measuring fair value. They must also disclose the amount of the discount attributable to the restriction. This change ensures that reported amounts better align with the actual economics of restricted shares.
Market participants often price restricted securities lower than their unrestricted counterparts due to the inability to sell immediately.
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By ignoring this factor, previous standards created a disconnect between book value and market reality. The new guidance forces a more accurate reflection of these constraints in financial statements.
Implementation and Early Adoption
FASB Chair Richard Jones stated in a Sept. 9 statement that the new standard addresses stakeholder concerns about current guidance. “The new standard addresses stakeholder concerns that current guidance can produce fair value measurements that do not reflect how market participants would value equity securities with contractual sale restrictions,” Jones said. He added that the ASU better aligns reported amounts with the economics of the restricted shares.
Companies can adopt the amendments early on any date after the issuance of the ASU. The FASB noted that early adoption is permitted for any investment company within the scope of Topic 946. This flexibility allows funds to align their reporting cycles with their specific fiscal calendars rather than waiting for the mandatory 2027 start date.
Stakeholders previously told the board that applying current guidance could create different outcomes for purchasing, redeeming, and remaining shareholders. By standardizing the treatment of sale restrictions, the board aims to reduce these disparities. The update is part of a broader effort to tighten fair value reporting across the financial services sector. It requires detailed disclosure of the discount attributable to the restriction, providing greater transparency to fund investors.
