Auditing Investments Measured at NAV: The ASC 820 Practical Expedient and Audit Procedures

Private equity, hedge fund and similar interests rarely have a quoted price. ASC 820 allows an investor to measure certain of them at the investee's net asset value (NAV) per share, or its equivalent, as a practical expedient. The expedient shifts the audit away from the investor's own valuation model and toward the quality of the fund's reported NAV. This post covers what the expedient permits, the disclosure it carries, and the procedures for testing a NAV-based balance. For the fund's own audit, see investment fund audit guide: ASC 946 and NAV.

What does the practical expedient allow?

Paragraph 820-10-35-59 lets a reporting entity measure fair value of investments within the scope of 820-10-15-4 and 15-5 using the investee's net asset value per share (or its equivalent, such as member units or an ownership interest in partners' capital to which a proportionate share of net assets is attributed). Paragraphs 35-59 through 35-62 govern the measurement; paragraph 35-62 contains the sale criteria discussed below.

It applies to investments in entities that calculate NAV. It is not a measurement the investor builds from the investee's underlying assets, which is why the auditor's attention turns to the reliability of the NAV and the investee's own accounting.

When does the expedient stop applying?

ASU 2018-13 describes a situation in which the investments "would otherwise meet the criteria in paragraph 820-10-35-62" but individual investments to be sold have not been identified, so they continue to qualify for the expedient and the entity discloses its plans to sell and the remaining actions (820-10-50-6A(h)). The reverse is the audit point. The sale criteria in 35-62 are the limit: an investor with a plan or a probable sale at an amount different from NAV has to assess whether the expedient still applies.

What does the investor disclose?

Paragraph 820-10-50-6A requires disclosures by class that help users understand the nature and risks of the investments and whether, if sold, they are probable of being sold at amounts different from NAV. At a minimum, for each class:

• the fair value measurement and a description of the significant investment strategies of the investees;
• for classes with investments that can never be redeemed but pay distributions on liquidation of underlying assets, the estimated period over which assets are expected to be liquidated, only if the investee has communicated or publicly announced the timing (ASU 2018-13 modified this requirement); if the timing is unknown, say so;
• the amount of unfunded commitments;
• the terms and conditions upon which the investor may redeem, and circumstances in which an otherwise redeemable investment might not be redeemable; and
• any other significant restriction on the ability to sell at the measurement date (50-6A(f)).

Audit procedures

AU-C 501.05 covers securities valued based on an investee's financial results, excluding equity-method investments. PCAOB AS 1105 Appendix B (.B1 to .B7) addresses the same subject. The steps below follow AU-C 501.05 and .06.

1. Confirm the holding and the NAV. Send a confirmation to the fund or its administrator for units held, NAV per unit, valuation date, capital account balance and unfunded commitment. Confirm directly with the administrator under AU-C 505, not through the investor's investment officer.
2. Read the investee's financial statements and audit report (AU-C 501.05a). Check the audit opinion type and date, the auditor's reputation, the basis of valuation, and the fund's own fair value hierarchy disclosure. Audited statements by an auditor whose report is satisfactory may constitute sufficient evidence. See ASC 946 investment companies for what to expect in the fund's statements.
3. If the statements are unaudited or the report is not satisfactory, apply or arrange for other auditing procedures to the investee's statements (.05b), considering the materiality of the investment.
4. Consider factors outside the investee's statements. If the carrying amount reflects factors not recognized in the investee's statements, or asset fair values materially different from the investee's carrying amounts, obtain evidence about those amounts (.05c).
5. Check the date of the NAV. If the NAV is as of a date before the investor's measurement date, determine whether management adjusted for activity in the gap and whether the adjustment is supported (.05d and .A10).
6. Read subsequent information. Obtain the fund's interim statements and make inquiries of management to find events after the investee's statement date that are material to the investor (.06).
7. Test the investor's own activity between the NAV date and year-end: capital calls, distributions and redemptions agreed to fund notices and bank statements.
8. Back-test prior NAV estimates. Compare estimates the investor used last year, if any, to the audited NAV that arrived later. A large pattern of true-ups signals the fund's interim reporting, not the fund's audit, is the weak link. See retrospective review of prior-year estimates.
9. Test disclosures as listed above, and tie the class totals to the balance sheet.
10. Evaluate valuation reasonableness where the fund holds illiquid assets: read the fund's valuation policy and its investments schedule, and consider how the fund values Level 3 holdings (see ASC 820 Level 3 valuation audit procedures).

Worked example: rolling forward a September NAV

An investor holds 5,000 units of a private fund. The fund reports NAV to the investor quarterly, with a 60-day lag. The investor's year-end is December 31. The latest statement received before the investor's close is September 30, NAV per unit $1,240.50, and the audited December 31 NAV arrives in late February.

The roll-forward holds the fund return for the fourth quarter at zero unless management has a supportable estimate. When the audited December 31 NAV of $6,310,000 arrives, the difference is $47,500, or 0.76% of the rolled-forward amount. If the final NAV arrives before the report date, it is evidence about the December 31 amount and the auditor evaluates whether the difference is a misstatement. A one-way pattern of understated carrying amounts year after year points to the investor's method of estimating the final quarter.

Frequently asked questions

Is a capital account statement enough?

No. A statement from the fund is a starting point. Confirm independently, read the audited statements and test the roll-forward.

Does the practical expedient remove the need to assess the fund's valuation?

No. The investor's reported amount equals the fund's NAV, so a misstatement in the fund's valuations passes straight through to the investor's balance.

What if the fund's auditor has a modified opinion?

Treat it as a reliability problem. The investor's auditor performs additional procedures on the investee's financial results (.05b) or considers the effect on its own opinion (.05).

Sources

• FASB, Accounting Standards Update 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework, paragraphs 820-10-50-6A and 820-10-35-62 as referenced there: https://storage.fasb.org/ASU%202018-13.pdf
• FASB, Accounting Standards Update 2015-07, Fair Value Measurement (Topic 820), paragraph 820-10-35-59 and scope in 820-10-15-4 through 15-5: https://storage.fasb.org/ASU%202015-07_2.pdf
• AICPA, AU-C Section 501, Audit Evidence, Specific Considerations for Selected Items, paragraphs .05 and .06: https://www.aicpa-cima.com/resources/landing/aicpa-professional-standards
• PCAOB, AS 1105, Audit Evidence, Appendix B: https://pcaobus.org/oversight/standards/auditing-standards/details/AS1105

CORAA prepares ready-to-review audit files for US CPA firms from client books; you review and sign. See /us.

AU-C references are to AICPA Professional Standards, paraphrased here; read the standard itself before relying on a requirement. This page is guidance, not professional advice. Report an error