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Rules Require Valuation of Assets to be Abandoned |
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In response to the need for consistent fair value measurement guidance, the FASB
has issued its long-awaited Statement of Financial Accounting Standards (SFAS),
No. 157, Fair Value Measurements. The Standard, which applies to nonfinancial
assets and liabilities, is effective for fiscal years beginning after November
15, 2007.
SFAS 157 has major implications with respect to accounting for assets, such as
trademarks, patents, or software, which an acquirer plans to abandon after an
acquisition. Under the new rules, if a company has an asset that is not going to
be actively used in the reporting entity's business, but is being retained for
defensive purposes, it will still have to assign a value to the asset. In a
situation where a market participant would find value in using this type of
asset standalone in the market place, the asset would need to be valued based on
what a market participant would pay for it.
In addition, the asset would have to be tested annually for impairment. In
future reporting periods, this analysis could result in an impairment charge
relating to the asset and would add to the reporting entity's requirements to
properly address this type of asset for financial reporting purposes.
The following is a review of the main points contained in SFAS 157.
Market Participant Assumptions
SFAS 157 requires 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 mandated 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.
Definition Of Fair Value
Fair value is defined in SFAS 157 as "the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants in the market which would be the most advantageous for the
asset or liability." Notably, this definition focuses on exit values, e.g. the
value when an asset is sold, rather than entrance values.
Fair Value Hierarchy
SFAS 157 identifies a fair value hierarchy to rank the reliability of inputs
used in a valuation approach. The first – and highest – level refers 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. The reporting
entity's own data may be used to develop unobservable inputs, provided that
information which shows that market participants would use different assumptions
is not readily available with undue cost and effort.
Valuation Premise
The valuation premise used to measure the fair value of an asset depends on
the highest and best use of the asset by market participants. Highest and best
use refers to how an asset or group of assets would be used by a marketplace
participant so as to maximize the value of the asset or the group of assets in
which the asset would be used. It's important to note that highest and best use
is based on the market participant's use of the asset, regardless of the
intended use of the asset by the reporting entity. Market participants,
generally classified as strategic buyers and financial buyers, would likely
assign different values to an asset depending on how each group intends to use
the asset.
Valuation Approaches
SFAS 157 states 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 judgment in deciding which approaches to use and in
"weighing" the various value conclusions in order to select the most appropriate
value.
FSP to be Issued
Along with the release of SFAS 157, the FASB has decided to issue a FASB staff
position (FSP), which will address the use of entity-specific assumptions rather
than market-participant assumptions to measure fair value of nonfinancial assets
and liabilities under Statements 141, Business Combinations, 142, Goodwill and
Other Intangible Assets, and 144, Accounting for the Impairment or Disposal of
Long-Lived Assets. For more information, contact your Valuation Research
representative or Jeff Trader at (414) 221-6250.
VR
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