Fair Value Measurement (SFAS 157)

Fair Value Measurement (SFAS 157)

Kaipo DoorleyAmper Politziner and Mattia

Agenda – Topics Covered

Fair Value Issues Fair Value Framework Fair Value Disclosure Requirements Alternative Investments Audit Considerations Recent Standard Setting Activity SEC Update

FV Issues - The Fair Value “Movement”

Moving toward everything eventually being “initially” measured at fair value

Less and less use of cost-based measures for financial instruments SFAS 115, 133, 155, 156, 159 Held to maturity debt securities and APB 18 are

exceptions Nonfinancial instruments generally still use historic cost

with impairment testing

FV Issues – Problem and Possible Solution

The Problem – Reliability of measures Different parties could get inconsistent measures Possible for management to influence measures

The (Partial) Solution – SFAS 157 Detailed definition of “fair value” for use in accounting Does not expand use of fair value Provides guidance to make fair value measures more

consistent and understandable to investors Requires disclosures to help users understand reliability of

inputs Financial statement users still prefer fair value while

management and auditors do not believe the “market” is always the most accurate reflection of a transaction/account

FV Issues – The Good News

The Good News For most securities, decrease in value are being

reported as they occur Impairment of other assets are being recognized Despite difficulty, companies/auditors have been able

to come up with values FV disclosures are helpful to users (Level 3 assets, etc.) Fair Value has been around for a very long time and

now there is one definition of fair value• Valuation specialists and certain industries have dealt with

fair value for years and have expertise and insight

FV Issues – The Bad News

Impairment models are inconsistent Some tests are impossible (other-than temporary) Standard-setters being pressured to back off Many implementation issues/question on 157

FASB’s VRG and staff working Some FSPs raise more questions than answers

Tendency to apply “rules” instead of principles Looking to transactions that aren’t representative Supporting pricing service estimates

Hard to convince auditors that losses are temporary The timing of SFAS 157 and the economic crisis

Fair Value Framework - Definition

Definition of Fair Value – Exit Price not Entry Price What could you sell for in an orderly transaction Assume exit in principal or most advantages market

Marketplace participant assumptions, not entity specific Looking to the market should reduce management bias

and promote consistency (in concept) “Marketplace participants” are knowledgeable,

independent parties willing and able to transact Transaction costs are not part of fair value Always include credit risk if inherent in asset/liability

Fair Value Framework - Measurement

Step 1: Determine the unit of account (based on accounting/reporting rule driving measurement) Stand alone asset/liability or group of assets For example is the unit of account a “reporting unit”

being tested for goodwill or a single equity security recorded as available for sale


Step 2: Highest and best use (market participant view) In-use (used with a group of assets/liabilities to maximize

value) In-exchange (stand alone basis) For example a market participant is a real estate developer

and purchases a construction company for:• In-use: Integrate the company’s PP&E• In-exchange: Operate the company as a stand alone

entity Must be physically possible, legally permissible and financially

feasible to the market participant The reporting entity’s current or intended use of the

asset/liability does not matter


Step 3: Determine principal or most advantageous (based on highest and best use) Principal market has the greatest volume and activity In the absence of a principal market, the most advantageous

market in which the “reporting entity” would sell the asset/transfer the liability with the price that maximizes amounts received and minimizes amounts paid

Based on market principal/most advantageous market the reporting entity identifies (not specifically) market participants

The market and market participants should be evaluated at recognition and re-evaluated at each measurement date

Inactive market and disorderly transactions discussed later


Fair value hierarchy Prioritizes inputs to the valuation technique used to

measure fair value Level 1 – quoted prices (unadjusted) in active markets

for identical assets and liabilities Level 2 – inputs and other quoted prices included in

Level 1 that are observable either directly or indirectly Level 3 – unobservable inputs reflecting the reporting

entity’s own assumptions about market participant assumptions

Fair Value Frame Work - Measurement

Characteristics of Level 1 Inputs Transactions occur with sufficient frequency and

volume to provide pricing information on an ongoingbasis.

Reporting entity has ability to access• Alternative pricing methods (e.g. matrix pricing) may be

used as a practical expedient• Alternative pricing method results in a lower level

measurement After-hours trading or news events

• Not required, but should be considered


Characteristics of Level 2 Inputs Quoted prices for similar assets or liabilities in active

markets Quoted prices for identical or similar assets or liabilities

in markets that are not active Inputs other than quoted prices that are observable

(e.g. yield curves) Market-corroborated inputs: Derived principally from or

corroborated by observable market data by correlation or other means

• Adjustments necessary to corroborate inputs may result in Level 3 measurement


Characteristics of Level 3 Inputs Unobservable inputs used to the extent that observable

inputs are not available• Includes assumptions about risk, developed based on best

information available without undue cost andeffort

Data used to develop the inputs should be adjusted if there are contrary data indicating market participants would use different assumptions

FV may be determined based on the best available information in the circumstances


Valuation techniques consistent with market, income and/or cost approaches shall be used to measure FV

Market Approach – Uses observable prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities

Income Approach – Converts cash flow or earnings to a single present amount (discounted) . Value indicated by current market expectation about future amounts

Cost Approach – Amount that would currently be required to replace the service capacity of an asset (current replacement cost)

Use valuation techniques that are appropriate in the circumstances and for which sufficient data are available

Single or multiple techniques may be appropriate depending on the circumstances.

Fair Value Disclosure Requirements

Assets and liabilities measured at FV on a recurring basis Disclose the level of inputs used (tabular format) Level 3 inputs rolled forward Valuation techniques – annually (see FSP updates)

Assets and liabilities measured at FV on a nonrecurring basis Same as above AND The reasons for the measurement

Note FASB fair value disclosure project discussed later

Alternative Investments

What is an alternative investment? AICPA Practice Aid AICPA Draft Issue Paper Specific Issues for Alternative Investments FASB FSP 157-g Estimating the Fair Value of Investments

in Investment Companies That Have Calculated Net Asset Value per Share in Accordance with the AICPA Audit and Accounting Guide, Investment Companies – Issued Monday June 8,2009 and comment period ends July 8, 2009 Will be effectiv3e immediately upon release

Alternative Investments – Specific Issues

Defining markets/market participants Factors in deciding whether a market is active Evaluating transactions

Transparency Relevance Distressed

Determining fair value of interest in alternative investments

Unique Elements of Private Equity Consideration of use of NAV as a practical expedient

FASB issues FSP FAS 157-g

Audit Considerations

Auditing standards If market assumptions not available, an entity may use

own assumptions as long as no contrary data that market participants would consider

Auditor must understand the entity’s process for determining fair value and relevant controls to develop an audit approach

Use of specialists Auditor must find the assumptions reasonable and the

valuation methods appropriate and properly applied Consideration of variances from period to period

Audit Considerations (cont’d)

Non-Authoritative Guidance AICPA Toolkit for Auditing Fair Value Measurements and

Disclosures Auditor must understand the entity’s process for

determining fair value and relevant controls to develop an audit approach

Use of specialists Auditor must find the assumptions reasonable and the

valuation methods appropriate and properly applied Consideration of variances from period to period Practice Issues for Non-Issuers

Recent Standard Setting Activity

FSP FAS 157-4 (fair value measurement) FSP FAS 157-f (fair value of liabilities) FSP FAS 107-1 and APB 28-1 (fair value disclosures) FSP FAS 115-2 and FAS 124-2 (OTTI of debt securities) Ongoing FASB Projects

Fair Value Disclosure Project Financial Instruments Project Recoveries of Other-Than-Temporary Impairment

(Reversal) Project

Recent Standard Setting Activity – FSP 157-4

FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly Superseded FSP FAS 157-3 No longer just relates to financial assets Despite a significant decrease in market activity for an

asset, the objective of fair value measurement remain Provides factors to consider for significant decrease in

volume and level of activity When market activity significantly declines, further and

more robust analysis required


FSP FAS 157-4 (cont’d) Requires additional disclosures of fair value

measurements• For interim and annual periods the inputs and valuation

technique(s) used to measure fair value and a discussion of changes in valuation techniques and related inputs, if any, during the period

Major security types shall be based on the nature and risks of the security. Disaggregation of financial instruments are much greater and a listing is included in the FSP

Effective for periods ending after 6/15/09


FSP FAS 157-4 (cont’d) Provides circumstances that may indicate a transaction

is “NOT” orderly• If not orderly, place little if any weight• If orderly, consider transaction price and weight

depends on facts and circumstances• If not sufficient information available to determine

whether orderly or not, the transaction price may not be determinative of fair value

Use of broker quotes and pricing services not precluded, but a reporting entity must evaluate the quote

Recent Standard Setting Activity – FSP 157-f

FSP FAS 157-f, Measuring Liabilities Under SFAS 157 FASB is redeliberating a proposed FSP to provide

additional guidance on determining the fair value of liabilities

A proposed FSP was issued in May for comment Generally estimate fair value of liabilities as you would

estimate fair value of an asset However, should not make any adjustments due to

restrictions on the transfer of a liability

Recent Standard Setting Activity – FSP 157-f

FSP FAS 157-f, Measuring Liabilities Under SFAS 157 FASB is redeliberating a proposed FSP to provide

additional guidance on determining the fair value of liabilities

A proposed FSP was issued in May for comment Generally estimate fair value of liabilities as you would

estimate fair value of an asset However, should not make any adjustments due to

restrictions on the transfer of a liability


FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments Applies to all public companies Applies to fair value disclosures for any financial

instruments that are not currently reflected on the balance sheet at fair value

Requires disclosures on a quarterly basis, providing qualitative and quantitative information about fair value estimates for financial instruments not measured on the balance sheet at fair value

Effective for periods ending after 6/15/09

Recent Standard Setting Activity (cont’d)

FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments Applies debt securities scope in to SFAS 115 If FV < CV (amortized cost), instrument is impaired If an entity intends to sell or more likely than not will be

required to sell before recovery, all OTTI recognized through earnings

If entity does not intend to sell and it is not more likely than not, OTTI is separated into (a) credit loss and (b) amounts related to other factors

Credit loss through earnings and the rest through OCI Note covered in greater detail


Fair Value Disclosure Project FASB recently added a project to its agenda to improve

disclosures of fair value measurements Project will consider additional disclosures, such as:

• Sensitivities of measurement to key inputs• Transfers of items between the fair value hierarchy

levels • Levels of aggregation• Expected timing for this project is year end 2009


Financial Instruments Project Financial Instruments: Improvements to Recognition

and Measurement – Joint project of the IASB and FASB Project objectives:

• Simplify reporting to improve decision usefulness and understandability

• Determine which financial instruments should be recognized at fair value and which financial instruments would be recognized at a different measurement attribute

• Address impairment, hedging, fair value option, and financial statement presentation issues

Expected timing for this project is by year end 2009


Recoveries of Other-Than-Temporary Impairment (Reversal) Project Objective of this project is to consider allowing an entity

to recover, through earnings, a previously recognized OTTI loss when evidence exists that an impairment loss has reversed

Another objective of this project is to converge with IFRS with regard to the accounting for recoveries of OTTI

Expected timing for this project is by year end 2009

SEC Update

SEC Staff Views of Fair Value Measurements SEC Staff Letters – Financial Asset Impairments Hot Topics Related to Fair Value Measurements

Control premiums Discount rates/WACC Valuation of restricted stock Use of valuation Specialists Limited scope engagements

Questions?

“The material contained in this presentation is for

general information and should not be acted upon without prior professional

consultation.”

Documents

Fair Value Measurement (SFAS 157)