Utilities Unbundled issue 13

Another spotlight on fair value

  • Share

New disclosure rules focus on companies’ most subjective fair value measurements.

The most prevalent fair value measurements subject to the new rules for energy companies are long-dated derivative instruments.

New rules from the Financial Accounting Standards Board (FASB) mean power and utility companies now have to cope with even more disclosures on how they develop and review their fair value measurements.

But our recent survey of public energy companies in the US market – part of a larger survey of 60 public companies across various industries13 – found divergence in how they initially addressed disclosures.

The new FASB rules focused on:

  • The unobservable inputs used by companies to estimate the fair value of their most hard-to-measure assets or liabilities (i.e., Level 3 measurements)
  • The valuation processes surrounding these measurements

Our survey examined the financial statement disclosures of public companies in the five sectors where Level 3 measurements tend to be more prevalent:

  • Banking
  • Asset management
  • Insurance
  • Energy
  • Real estate

Derivatives and fair value complexity

The most prevalent fair value measurements subject to the new rules for energy companies are long-dated derivative instruments. As a contract to sell electricity or natural gas extends further into the future, the forward price curves used to value those contracts become unobservable – and extremely difficult to estimate.

The new disclosure rules require companies to quantitatively disclose estimates of those unobservable pricing points (e.g., the range and weighted average).

Delivery points for physical derivatives may also trigger fair value complexity, particularly when the delivery is not at an active or liquid hub. In such cases, a company must estimate, and quantitatively disclose, the basis adjustment that is used in the fair value measurement. In some instances, companies disclosed the basis-only price, while others disclosed the “all-in” forward price.

Improving disclosure

Looking ahead, we believe energy companies can gain insight from the disclosures made by their peers as well as comments from the U.S. Securities and Exchange Commission (SEC) or other relevant regulators. Comments provided by SEC staff to date include, but were not limited to, the following:

  • Consider disclosing weighted averages. When a wide range of data for significant inputs is disclosed, a registrant should consider disclosing a weighted average of the inputs and discuss how that average was determined.
  • Consider multiple valuation techniques. When multiple valuation techniques are used for a class of instruments (such as an income approach and a market approach for certain debt instruments), registrants should consider disclosing the amounts determined under each valuation approach.
  • Consider the level of aggregation. The guidance does not detail what level of aggregation the disclosures should follow. The SEC staff has indicated that it wants to see more granular information in qualitative sensitivity disclosures.

For more information, contact Tyler Dorn.

  • 13 The new fair value disclosures, EY, July 2012.

<< PreviousNext >>