1 ST Convergence with IASB. 2 SFAS No. 151 – Inventory Costs Part of the “international convergence” project. Clarifies that abnormal costs of idle facilities

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ST Convergence ST Convergence with IASBwith IASB

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SFAS No. 151 – Inventory Costs SFAS No. 151 – Inventory Costs

Part of the “international convergence” project. Clarifies that abnormal costs of idle facilities

should not be capitalized as product costs. Companies should use “normal capacity” for the

allocation of overhead. Any unallocated overhead is expensed during the

period in which they are incurred. Other abnormal handling costs or abnormal levels of

spoilage might also need to be expensed.

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Coming soonComing soon

Short-term convergence with IASB EPS (ED expected 1st half 2007) Income taxes (ED expected 1st half 2007)

Research and Development - ?

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Fair Value Fair Value MeasurementsMeasurements

SFAS No. 157

Signs of the Future!

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FAS157 Issued Sept. 2006FAS157 Issued Sept. 2006

With a few exceptions, it does not change WHAT is currently measured using fair value

Sets out a framework for measuring fair value

Requires additional disclosures about fair value measurements

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FAS157 – Definition of Fair ValueFAS157 – Definition of Fair Value

Paragraph 5 - Fair value is 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.This is an exit-price definition of fair value

(see paragraph 7)

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FAS157 – Related definitionsFAS157 – Related definitions

Market Participants (4 criteria) Independent of reporting entityHave knowledge needed for reasonable

understanding about transactionFinancial and legal ability to enter into the

transactionBe willing to enter into transaction without

compulsion

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Principal Market Has the greatest volume and level of activity.

If there is no principal market, use the most advantageous market

Most Advantageous Market Most advantageous market has price that maximizes

the net amount that would be received or minimizes the net amount paid

Transactions costs are included in determining which market to use but do NOT become part of the fair value measurement

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Example of which market…Example of which market…

Market A Market B

Selling price $50 $48

Transaction cost $5 $2

Net proceeds $45 $46

Fair value to use $48

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Assumptions about the market The asset or liability is exchanged in an orderly

transaction between market participants An orderly transaction is a transaction that assumes

exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities;

it is not a forced transaction (for example, a forced liquidation or distress sale).

The price is for a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the item

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Valuation premise – the assumption about how market participants would use an assetChoose the premise based on “highest and

best use” In-use premise

Provides maximum value through use in combination with other assets

In-exchange premise Provides maximum value principally on a stand-alone

basis

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Valuation TechniquesValuation Techniques

Market approach Uses observable prices from market transactions for

comparable assets or liabilities

Income approach Analysis of future cash flows using present values

Cost approach Estimates cost to replace an asset’s service capacity

A change in valuation technique is a change in accounting estimate, not a change in accounting principle

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The “Fair Value Hierarchy”The “Fair Value Hierarchy”

Level Inputs to achieve reliability level

1 Quoted prices in active markets for identical assets or liabilities

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Observable prices in active markets for similar assets or liabilities, or prices from markets that are not active. Market inputs for substantially full term of item (interest rates). Market inputs that are not directly observable but can be derived or corroborated by market data

3Unobservable inputs based on the reporting entity’s own assumptions about assumptions that market participants would use. Cannot be corroborated by observable market data

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Valuing LiabilitiesValuing Liabilities

The valuation technique must consider the reporting entity’s credit standingA reporting entity could record a GAIN for

derivatives at a measurement date because the fair value of the liability decreases in response to a credit downgrade if all other inputs remain unchanged

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Restrictions on AssetsRestrictions on Assets

Restrictions are evaluated to determine whether they are an attribute of the asset or an attribute of the reporting entity If sold, would the restriction transfer to another

holder? If yes, the impact of the restriction would be taken into

consideration (adjust asset fair value downward) If no, the restriction would not reduce the fair value

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Other provisions of FAS157Other provisions of FAS157

It is now possible to recognize a gain on the day recognized (previously prohibited under EITF 02-3)

Blockage adjustments are not permitted in pricing

Bid-ask spreadsUse the price within the bid-ask spread that is

most representative of fair value in the circumstances

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FAS 157 DisclosuresFAS 157 Disclosures

Will be extensive and reported in three sections (see paragraph A33-A36 for examples) Assets and liabilities measured at fair value on a

recurring basis Tabular display reconciles beginning and ending amounts

when significant Level 3 inputs are used Assets and liabilities measured at fair value on a

nonrecurring basis (impairment of assets, etc.) For all fair value measurements, a table showing the

reliance on Level 1, 2 or 3 inputs plus discussion of the valuation techniques used for the measurements

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FAS 157 – effective dateFAS 157 – effective date

Implementation is prospective Required for financial statements issued

for fiscal years beginning AFTER Nov. 15, 2007

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FAS 159 – The Fair FAS 159 – The Fair Value OptionValue Option

Optional use of fair value for certain assets and liabilities

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Essentially a one-time electionEssentially a one-time election

On a contract by contract basis, company can designate specified financial instrument to be accounted for using fair value instead of the usual measurement technique

Companies may be able to reduce volatility in reported earnings caused by measuring assets and liabilities differently

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Other “benefits”Other “benefits”

Movement toward accounting for all financial instruments at fair value

Brings US GAAP into closer agreement with IASB 39 which already contains a fair value election

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Eligible assets & liabilitiesEligible assets & liabilities

Most recognized investments including those currently accounted for using the equity method But cannot be used to recognized investments that

must be consolidated (VIEs, subsidiaries)

Many recognized liabilities Excluding leases, demand deposits of banks,

postretirement plans, etc.

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Eligible assets & liabilitiesEligible assets & liabilities

Firm purchase commitments that would otherwise not be recognized at inception (but only for ones involving financial instruments)

Rights and obligations under warranties that meet certain requirements

Certain host financial instruments that result from separation of embedded nonfinancial hybrid instruments under FAS133

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Irrevocable electionIrrevocable election

Must be applied to contracts as a whole and not to parts of contracts

Changes in fair value will be recognized in earnings during each reporting period

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Election dateElection date

Transition – any eligible item as of the date that FAS159 is initially adopted

Thereafter:The eligible item is first recognized (including

entering into an eligible firm commitment)Occurrence of a short list of other events

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DisclosuresDisclosures

If fair value option is elected, company must disclose separately assets and liabilities measured at fair value from those not measured at fair value Intended to help readers compare companies

that choose the option to those that choose not to elect fair value accounting

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Disclosures – specific (1)Disclosures – specific (1)

Why fair value option was selected for each eligible item

Difference between fair value and aggregate unpaid principal amounts

Relation to other fair value measurements under FAS157

Description of partial applications to groups of similar items and why company chose not to be consistent

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Disclosures – specific (2)Disclosures – specific (2)

Loans carried at assets at fair value that are past due by 90 days or more

APB18 disclosures about investments that would otherwise have been reported using equity method

Description of how interest and dividends are measured and reported for items with fair value election

Quantitative information (line by line) as to where gains and losses related to fair value option have been reported in the income statement

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FIN 46R and 48FIN 46R and 48

Lecture notes are in doc file (not ppt) and this was covered as part of the deferred tax lectures

Note to self – need to verify FIN46R notes were only in doc file, I think

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FSP of interestFSP of interest

Note that FSP158-1 (Feb 21, 2007) contains Update of Illustrations, Application GuidanceDon’t hit ‘print’ – 257 pages!Fixes examples in FAS87, FAS88 & FAS106

as related to issuance of FAS158. FAS132R was “fixed” in FAS158 so is not included in this FSP

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What’s Next?What’s Next?

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Forthcoming – first half 2007Forthcoming – first half 2007

Conceptual Framework – Reporting Entity – preliminary views

Business Combinations – for-profit:Applying the Acquisition Method (final)Noncontrolling Interests (final)

Derivatives disclosures (final)

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Forthcoming – first half 2007Forthcoming – first half 2007

Implementation ProjectsStatement 140—Transfers of Financial Assets

(ED) Insurance Risk Transfer (ED)Financial Guarantee Insurance (ED and

maybe final by mid year) Definition of liability vs. equity (Prelim

views expected first half of 2007)

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Forthcoming – second half 2007Forthcoming – second half 2007

Financial Statement Presentation (prelim views maybe by 3rd quarter)

Revenue recognition (PV by 3rd or 4th Quarters)

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Longer term projectsLonger term projects

Not-for-profit business combinations and intangible assets In process of reviewing comments (nothing on

calendar about when a final version is expected)

Documents

1 ST Convergence with IASB. 2 SFAS No. 151 – Inventory Costs Part of the “international convergence” project. Clarifies that abnormal costs of idle facilities