Amid concerns over implementation of the Fair Value Measurements standard, the FASB decided at its June 28 meeting to add a new fair value-related project to
its agenda. The new project arises from concerns about the apparent diversity in
practice under existing accounting standards for business combinations and
impairment. Specifically, the FASB is expected to address the use of
entity-specific assumptions rather than market participant assumptions to
measure the fair value of nonfinancial assets and nonfinancial liabilities under
Statements 141, Business Combinations, 142, Goodwill and Other Intangible
Assets, and 144, Accounting for the Impairment or Disposal of Long-Lived Assets.
The new project will result in the issuance of a FASB Staff Position (FSP), with
an exposure draft scheduled for the third quarter of 2006 and a final document
by year end. The Board has not confirmed a release date for the final Fair Value
Measurements standard but has said that its issuance is pending, subject to the
Board's deliberations in the related FSP.
Market Participant Assumptions
The Fair Value Measurements standard is expected to require that fair values be
based on the perspective of a "market participant." Consideration of the market
participant's viewpoint in fair value estimates is not new; the use of
market-participant assumptions is provided for in Statements 141, 142, and 144.
For example, when determining fair value in the context of an impairment, both
Statements 142 and 144 provide for the use of market participant assumptions
when that information is "available without undue cost and effort." Otherwise,
an entity's own assumptions may be used. The Board believes that diversity in
practice has arisen because some practitioners are defaulting to entity-specific
assumptions on the presumption that market participant assumptions are not
available without undue cost and effort whenever there are no quoted market
prices.
Since there has been much redeliberating by the FASB regarding the original Fair
Value Measurements exposure draft, we thought it would be helpful to review the
main principles that are expected to be contained in the final statement.
Definition Of Fair Value
The new statement will include a single definition of fair value which will
provide the basis for measuring fair value in financial reporting. Fair value is
expected to be defined as "the price that would be received to sell an asset or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date."
Fair Value Hierarchy
The Board proposed in the ED a "fair value hierarchy" to rank the reliability of
inputs used in a valuation approach to estimate fair value. The final standard
will also include a hierarchy that, while different from the initial proposal,
continues to focus on the reliability of the inputs to the valuation model. The
hierarchy takes on practical importance because it is likely that the type of
disclosures and perhaps even the accounting for assets and liabilities measured
at fair value will vary depending on which level's inputs were used.
The final standard is expected to identify three levels for the hierarchy. The
first - and highest - level will refer to quoted prices for identical assets or
liabilities in an active market. When those prices are not available, the second
- or middle - level will base fair value estimates on observable inputs that a
market participant would use. If observable inputs are not available, the third
- and lowest - level will require the use of unobservable inputs. However, the
objective of fair value remains the same and thus even unobservable inputs will
need to incorporate the assumptions a market participant would use in developing
an exit price.
Valuation Approaches
The final standard is expected to state that valuation techniques consistent
with the market approach, income approach and/or cost approach should be used to
estimate fair value. Selection of a valuation method, or multiple valuation
methods, will depend on the nature of the item being valued as well as the
availability of data. For example, the final standard is expected to indicate
that a single valuation technique may be appropriate when valuing an asset or
liability for which quoted prices in an active market for an identical item are
available. In contrast, multiple valuation techniques may be appropriate when
valuing a reporting unit.
Valuation specialists are required by professional valuation standards and
practices to consider all three approaches, but they may choose not to apply one
of the approaches, particularly if the results of the approach would not be
relevant, or if the data needed to employ the approach is not available. A
valuation expert exercises judgement in deciding which approaches to use and in
"weighing" the various value conclusions in order to select the most appropriate
value.
Implications
The Fair Value Measurements standard is expected to be effective for fiscal
years beginning after November 15, 2007. While there is no indication as to when
the proposed FSP would become effective, the changes in the proposed FSP could
be effective before that date. Importantly, the proposed FSP could affect
current accounting standards which require fair value measurements, including
the allocation of purchase price in a business combination and impairment of
goodwill and other long-lived assets. In addition, the FSP could affect
convergence with IASB standards. The FASB will consider how the FSP project
could impact these areas. For more information about fair value measurements,
contact your Valuation Research representative or Greg Barber at (415) 277-1802.
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