What Is ASC 820, Why Is It Important For Positive Investor Relations?

Forbes

3 days ago

Tomas Milar is the Founder and CEO of Eqvista, an equity management platform.
Financial and operational strategy optimization often overshadows the importance of maintaining positive investor relations in tiding over market turbulence. For example, the U.S. technology sector took a hit this spring against the backdrop of the trade wars triggered by announced tariff hikes. This was reflected in the Nasdaq-100 Technology Sector index, whose six-month returns were -11.84% as of April 23. In contrast, Zscaler, the company that was presented the 2024 IR Magazine Best overall investor relations (large cap) award, saw a 10.82% rise in the same period.
A key obstacle in maintaining positive investor relations is strengthening investor confidence in reported asset valuations, especially when your company has a large amount of intangible assets.
Complete and structured transparency, like that obtained by complying with ASC 820, is often the best solution to alleviate such concerns. This article will explore the significance of ASC 820 and how you can comply with this accounting standard.
ASC 820's Significance
ASC 820, also known as the Fair Value Measurement standard, is an accounting standard that guides companies in measuring and reporting their investments in a GAAP-compliant manner.
For instance, in an acquisition, ASC 805 requires the acquirer to recognize the acquired party's assets, liabilities and non-controlling interests at fair value. Under other ASC accounting standards, fair value assessments are required for intangible assets and financial assets in periodic financial reporting and reports made by investment companies to their investors. This enhances consistency and comparability in financial reporting as a result and enables investors to understand the value of assets owned by their companies.
Since ASC 820 also includes disclosure requirements, it not only requires fair value reporting but also explanations regarding valuation processes and assumptions. Such reporting enables investors to perform informed analyses and better anticipate events that could impact the value of company assets.
How To Comply With ASC 820
To comply with ASC 820, you must calculate an asset's fair value as the price at which two knowledgeable principal market participants would willingly exchange it on the measurement date. If a principal market does not exist, the market that would provide the best selling price should be considered.
Another condition for ASC 820 compliance is explaining your valuation methodology to help the intended reader interpret the fair values reported.
While this accounting standard requires you to consider prices in principal markets, not all assets have active markets. Therefore, we must categorize assets as level 1, level 2 and level 3 depending on the difficulty in ascertaining fair values and then choose appropriate valuation methodologies.
Level 1 assets have active markets and hence have quoted prices. Publicly traded stocks, commodity derivatives, government securities and exchange-traded funds (ETFs) are some examples of level 1 assets.
Assets that lack active markets and quoted prices but whose value can be calculated using observable inputs are called level 2 assets. For instance, a derivative of a level 1 asset would qualify as a level 2 asset. Such a derivative does not have an active market, but its value can be calculated based on the level 1 asset's value.
Trademarks and other intellectual properties, private equity and various other assets whose value must be determined using unobservable inputs are called level 3 assets.
These levels are informally referred to as liquidity hierarchy levels since the asset liquidity reduces with increasing levels. However, fair value hierarchy is the official term for this classification method.
The fair value of level 1 assets must be the quoted prices on the measurement date. For level 2 assets, the fair value must be calculated based on the input values reported on the measurement date. Finally, level 3 asset fair values must be calculated based on estimations and assumptions based on the latest available data on the measurement date.
Under ASC 820, the following valuation approaches are prescribed for level 2 and level 3 asset fair value reporting.
Certain assets that can generate positive cash flows can be valued using the income-based valuation approach. This involves estimating all future cash flows expected from an asset and then discounting them to arrive at their present value.
Businesses that are nearing liquidation are often valued using the asset-based valuation approach, wherein we simply calculate the business' net worth as total assets minus total liabilities.
In this valuation approach, we arrive at the value of an asset by referencing the published fair value assessments and selling prices of similar assets. One of the methodologies that comes under this approach involves establishing a market valuation multiple by dividing the total value of similar assets by an observable and relevant metric. As this method relies directly on market data, it aligns most closely with the requirements of ASC 820.
ASC 820 Disclosure Requirements
To allow investors to validate fair values and anticipate any fluctuations, ASC 820 requires you to disclose the following details.
Knowing the liquidity hierarchy level helps investors judge whether the correct valuation methodology has been used.
You must explain the valuation methodology used and the reasoning behind your choices. This is especially important in the case of level 3 assets, where you would often customize asset valuation methodologies to make accurate fair value assessments.
Any observable inputs and assumptions used in the fair value assessment must be provided to investors so they can independently validate the fair values.
Since unobservable inputs must be assumed or estimated in level 3 asset fair value assessments, you must provide a sensitivity analysis to illustrate how variations or inaccuracies in these assumptions could impact the resulting fair values.
Compliance Simplified
One can interpret the intention behind ASC 820 as aiding prudent investment decision making by increasing consistency, transparency and comparability in financial reporting. If your business can abide by the spirit of the standard, it can maintain accounting compliance and positive investor relations.
The information provided here is not investment, legal, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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