Fair Value Accounting
- 1. MFA – Moody, Famiglietti & Andronico, LLP Copyright 2008. Moody, Famiglietti & Andronico, LLP. All Rights Reserved. Bill Duratti, CPA, ABV, CVA Partner November 19, 2008 Fair Value Accounting
- 2. Fair Value Accounting FAS Statement No. 157: Fair Value Measurements FAS Statement No 159: Fair Value Option for Financial Assets and Financial Liabilities
- 3. FAS 157 – Fair Value Measurements Provides one-stop shopping on fair value guidance Defines fair value (FV) Establishes a method for measuring FV Eliminates current diversity and inconsistencies surrounding fair value Applies to almost eighty (80) pronouncements that reference fair value Expands disclosure requirements
- 4. FAS 159 – Fair Value Option for Financial Assets & Financial Liabilities Permits a one-time irrevocable election to report at fair value certain financial instruments on a contract-by-contract basis , with fair value included in earnings Applicable for fiscal years beginning after November 15, 2007
- 5. FAS 157 – Current News “ Congress, Regulators Spar on Fair-Value Accounting” Compliance Week – October 2008 “ The Rest of Fair Value’s Problems” Compliance Week – October 2008 “ Fair Value Under Fire, Financial Crisis Spurs Debate Over Standard” Accounting Today – November 2008
- 6. FAS 157 – Current News Congress & Regulators Fair value accounting – “political whipping boy” in the federal bailout package 65 members of Congress appealed to the SEC to suspend all fair value Bailout includes language reminding the SEC of its authority to override accounting rules
- 7. FAS 157 – Current News FASB “ Hanging tough” Wants standard to be principals based , not rules based Wants auditors to curb their own “letter-of-the-law” interpretations of the standard ( use judgment ) SEC-FASB guidance clarifies need for judgment in distressed market has bankers doing “dance of joy”
- 8. FAS 157 – When Is It Effective? Effective prospectively for financial statements issued for fiscal years beginning after: November 15, 2007 for financial assets and liabilities November 15, 2008 for non-financial assets and liabilities
- 9. FAS 157 – The Definition of Fair Value Fair Value is 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 The transaction is a hypothetical transaction at the measurement date The definition focuses on the price that would be received – an exit price
- 10. FAS 157 - How Do You Determine Fair Value? Answer these questions: What is the unit of account ? What is the measurement date ? What is an orderly transaction ? What is an exit price ? Who are the market participants ? What is the exit market ? What is the highest and best use (assets) or nonperformance risk (liabilities)? What are the valuation inputs ? What are the valuation techniques ?
- 11. How Does FAS 157 Define “Unit of Account” and “Measurement Date”? Unit of Account What is being measured Determined in accordance with the provisions of other accounting pronouncements Measurement Date is based on either: Event (transaction) Time (reporting date)
- 12. What is an “Orderly Transaction”? Assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary It is not a forced transaction (liquidation or distressed sale) Must be considered from the perspective of market participants Objective is to determine the price that would be received to sell the asset ( an exit price )
- 13. What is Meant By “Exit Price”? Fair value focuses on the price received to sell an asset or paid to transfer the liability ( exit price ) Entities do not necessarily sell assets at the prices paid to acquire them An entry price (not exit price) represents the price paid to acquire an asset In many cases, the entry price will equal the exit price and therefore, equals fair value
- 14. Who are the “Market Participants”? Market participants are buyers and sellers in the principal market for the asset or liability that are: Non-related parties Knowledgeable Able to transact Willing to transact Fair value should be determined based on assumptions that market participants would use in pricing (adjustments for risk, effects of restrictions, etc.)
- 15. What Do They Mean By “Exit Market”? Principal or most advantageous market Principal - greatest volume and activity Most advantageous - maximum price, considering transaction costs Selection of the exit market is considered from reporting entities viewpoint If there is a principal market , it must be used , even if a different market would result in a higher exit price
- 16. What is Meant By Highest & Best Use? A fair value measurement assumes the highest and best use of the asset by market participants In-use (in combination with other assets) vs. in-exchange (standalone basis) premise Maximizes the value of asset (even if the intended use by the reporting entity is different)
- 17. Fair Value of Liabilities – What Needs to be Considered? Non-performance risk should be considered and includes the entity’s own credit risk Those who might hold the obligations as assets would consider the entity’s credit standing in determining the price they would be willing to pay
- 18. What are Valuation Inputs? Valuation inputs are assumptions that market participants would use in pricing an asset or liability Observable inputs (e.g., NYSE) vs. unobservable inputs (e.g., model assumptions) Level 1 (most reliable) - Unadjusted quoted prices in active markets for identical assets or liabilities Level 2 - Other than Level 1 quoted prices that are directly/indirectly observable for asset/liability Level 3 (least reliable) - Unobservable inputs for asset/liability
- 19. What Do I Need to Know About Valuation Techniques? There are market, income and asset based approaches Valuation techniques should maximize use of observable , and minimize unobservable inputs Hierarchy does not prioritize valuation techniques
- 20. What Do I Need to Know About Valuation Techniques? Valuation techniques used to measure fair value should be consistently applied A change in a valuation technique is appropriate if the change results in a measurement that is more representative of fair value Level of asset or liability is determined based on the lowest level input that is significant to the measurement in its entirety
- 21. What Does FAS 157 Require in Terms of Disclosures? Information enabling reader to assess the inputs used to develop fair value measurements For recurring fair value measurements, the effect of the measurements on earnings For each major category of assets and liabilities: The fair value measurement at or during the reporting date and related levels within the fair value hierarchy For recurring Level 3 measurements, a reconciliation of beginning and ending balances (gains, purchases, sales, transfers, etc.) In annual periods only, the valuation techniques used to measure fair value
- 22. Planning Considerations Early on, identify assets and liabilities that require fair value measurements Understand expanded audit considerations versus current practices Understand expanded disclosures (especially for Level 3) for recurring and non-recurring fair value measurements
- 23. Planning Considerations Consider whether current information systems are adequate to provide needed information Ensure internal controls are adequate for measuring fair value Consider the use of valuation specialists
- 24. Questions?
- 25. MFA – Moody, Famiglietti & Andronico, LLP Material discussed in this presentation is meant to provide general information and should not be acted on without obtaining professional advice tailored to your firm’s individual and specific needs. This information is for general guidance only and is not a substitute for professional advice. IRC Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Editor's Notes
- #2: Good afternoon. I hope everyone enjoyed the luncheon. This afternoon I’ve been asked to speak to you some pretty heavy subject matter – Fair Value Accounting. In the short time I have this afternoon, it is certainly not my intention to turn you into fair value experts but rather to give you a brief, high-level overview of what fair value accounting is… to familiarize you with the concept, point out the inherent challenges of fair value accounting and, in the end, offer some planning considerations.