Fair Value Measurements: What is the Latest? Mark L. Zyla CPA/ABV, CFA, ASA Acuitas, Inc. Accountants One Seminar March 10, 2010

Fair Value Measurements: What Fair Value Measurements: What is the Latest?is the Latest?

Mark L. Zyla CPA/ABV, CFA, ASAMark L. Zyla CPA/ABV, CFA, ASA

Acuitas, Inc.Acuitas, Inc.

Accountants One SeminarAccountants One Seminar

March 10, 2010March 10, 2010

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Objectives of the PresentationObjectives of the Presentation

• Trends Toward Fair Value Measurement in Financial Reporting• Overview of Fair Value Accounting – SFAS 157, Fair Value

Measurement (ASC 820)• Update on the latest GAAP and GAAS pronouncements, including

Implementation Issues related to SFAS 157, Fair Value Measurement – Fair Value Measurement and the Current Credit Crisis– Implementation Issues for SFAS 141(R) Business Combinations (ASC

805)• Fair Value Measurements and IFRS including SME’s• Fair Value and Alternative Investments• Fair Value and Not for Profits• Status of the Valuation Profession’s “Best Practices”

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The Trends Toward Fair Value The Trends Toward Fair Value AccountingAccounting

• The changing economic environment facing business today– The Information Revolution– Global competition– Wall Street “expectations”– Complexity of financial transactions

• Trend towards increasing regulation– Passage of Sarbanes Oxley Act in 2002– The establishment of the PCAOB– The focus of the SEC on transparency

• The FASB and IASB Convergence Project• The implementation of Fair Value Accounting in US GAAP

– Principles Based Accounting versus Rules Based Accounting

For additional information see Fair Value Measurements: Practical Guidance and Implementation, John Wiley & Sons

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Rule Making Bodies that Influence Accounting Standards Such as GAAP

• Financial Accounting Standards Board ( FASB)• International Accounting Standards Board

( IASB)• Security and Exchange Commission (SEC)• Public Company Accounting Oversight Board

( PCAOB)• American Institute of Certified Public

Accountants (AICPA)

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The Global Public Policy The Global Public Policy SymposiumSymposium

• Sponsored by the six largest international accounting firms including the Big Four plus BDO and Grant Thornton

• Goal: To provide an international forum for collaboration to maintain healthy capital markets and to improve the quality, reliability and accessibility of financial and other information that stakeholders need.

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Global Capital Markets and the Global Global Capital Markets and the Global Economy: A Vision from the CEOs of the Economy: A Vision from the CEOs of the

International Audit NetworksInternational Audit Networks

• White Paper written November 2006 by the Global Public Policy Symposium• Six Elements relating to audits that the accounting profession should be

addressing:– Investor needs for information– Roles of various stakeholders– The auditing profession– A new business reporting model– Large, collusive frauds are rare– Information is reported and audited pursuant to globally consistent

standards

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SEC Recent ReleasesSEC Recent Releases• Release No. 33-8818, Acceptance from Foreign Private Issuers of Financial

Statements Prepared in Accordance with International Financial Reporting Standards Without Reconciliation to U.S. GAAP ( Issued July 2, 2007)– November 15, 2007 SEC voted unanimously to eliminate reconciliation

requirement for foreign issuers.– November 29, 2007 EU Commissioner called on the body to eliminate

reconciliation requirement for U.S. GAAP issuers– Dual reporting system

• Release No. 33-8831, Concept Release on Allowing U.S. Issuers to Prepare Financial Statements in Accordance with International Financial Reporting Standards ( Issued August 7, 2007)– Comment Period recently ended– AICPA comment letter recommended SEC allow U.S. firms

report using IFRS– Never finalized

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Roadmap for the Potential Use of Financial Roadmap for the Potential Use of Financial Statements Prepared in Accordance with Statements Prepared in Accordance with

International Financial Reporting Standards International Financial Reporting Standards by U.S. Issuersby U.S. Issuers

• SEC Release No. 33-8982, issued November 28, 2008• SEC demonstrates its support for the FASB and IASB

Convergence Project through this release• Would require U.S. issuers to use IFRS by 2014, if

milestones are achieved• Comment period was recently extended• SEC has recently expressed a possibility of extending

implementation to 2015.

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ASC 820 ASC 820 Fair Value Measurements and Fair Value Measurements and DisclosuresDisclosures (SFAS 157) - (SFAS 157) - Effective DatesEffective Dates

• Note: Revised by the FASB on November 14th 2007• Effective for Fiscal Years beginning After November 15,

2007– Financial assets and liabilities– Other assets and liabilities carried at fair value on a recurring

basis– Examples include derivatives, loan-servicing assets and

liabilities, and some loans and debt linked to business combinations.

• One year deferral (November 15, 2008) – Nonfinancial assets and liabilities– Examples include nonfinancial assets and liabilities related to

business combinations such as goodwill and intangible assets, and discontinued operations

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SFAS 157 SFAS 157 Fair Value Fair Value Measurements Measurements (ASC 820)(ASC 820)

• Statement provides a framework for Fair Value Measurements

• Changes the Definition of Fair Value• Further elaborated on the concept of Market

Participants• Introduced Principal Market and Most

Advantageous Market• Introduced the concept of Fair Value Hierarchy• Introduced the concept of defensive value.

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Definition of Fair ValueDefinition of Fair Value

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.

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Fair Value HierarchyFair Value Hierarchy

• Level 1 – Quoted prices in active markets for identical assets or liabilities

• Level 2 – Inputs other than quoted prices that are observable, either directly or indirectly

• Level 3 – Unobservable inputs based on best information available in the circumstances

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SFAS 159,SFAS 159,The Fair Value Option The Fair Value Option (ASC 825)(ASC 825)

• Relates only to certain financial instruments• All entities can choose to measure eligible

items at fair value.• Resulting unrealized gains and losses will

be reflected in earnings• May be applied instrument by instrument• Is irrevocable

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Fair Value Measurement and the Fair Value Measurement and the Credit CrisisCredit Crisis

“Accounting rules require banks to value many assets at something close to a very low fire-sale price rather than the hold-to– maturity price.”

Federal Reserve Chairman Ben S. Bernanke testimony to the Senate Banking Committee on September 23, 2008

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Responses to the Credit CrisisResponses to the Credit Crisis• SEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value AccountingSEC Office of the Chief Accountant and FASB Staff Clarifications on Fair Value Accounting

FOR IMMEDIATE RELEASE 2008-234FOR IMMEDIATE RELEASE 2008-234September 30, 2008September 30, 2008

• Joint Statement The Center for Audit Quality, Joint Statement The Center for Audit Quality, The Council of Institutional Investors and The Council of Institutional Investors and The CFA InstituteThe CFA InstituteOpposing Suspension of Mark-to-Market Accounting (October 1, 2008)Opposing Suspension of Mark-to-Market Accounting (October 1, 2008)

• CFA Institute Official Position onCFA Institute Official Position onFair Value ReportingFair Value Reporting

• FSP FAS 157-3 (ASC 820-10-35),FSP FAS 157-3 (ASC 820-10-35),Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not ActiveActive(Issued October 10, 2008)(Issued October 10, 2008)

• SEC’s “Mark to Market” SEC’s “Mark to Market” Accounting StudyAccounting Study(Issued December 30, 2008)(Issued December 30, 2008)

• FSP FAS 157-4, FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity Determining Fair Value When the Volume and Level of Activity for the Liability Have Significantly Decreased and Identifying Transactions That for the Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly Are Not Orderly (ASC 820-10-55-4) March 2009(ASC 820-10-55-4) March 2009

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SEC’s “Mark to Market” SEC’s “Mark to Market” Accounting StudyAccounting Study

(Issued December 30, 2008)(Issued December 30, 2008)

• The SEC study outlines eight recommendations:

– FASB Statement No. 157 should be improved, but not suspended – Existing fair value and mark-to market requirements should not be

suspended – While the Staff does not recommend a suspension of existing fair value

standards, additional measures should be taken to improve the application and practice related to existing fair value requirements (particularly as they relate to both Level 2 and Level 3 estimates)

– The accounting for financial asset impairments should be readdressed – Implement further guidance to foster the use of sound judgment – Accounting standards should continue to be established to meet the needs

of investors – Additional formal measures to address the operation of existing accounting

standards in practice should be established – Address the need to simplify the accounting for

investments in financial assets

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FSP FAS 157-3 (ASC 820-10-35),FSP FAS 157-3 (ASC 820-10-35),Determining the Fair Value of a Financial Asset Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not ActiveWhen the Market for That Asset Is Not Active

(Issued October 10, 2008)(Issued October 10, 2008)• Fair value measurement represents the price at which a transaction would

occur between market participants at the measurement date. ( An exit price). Determining fair value in a dislocated market depends on the facts and circumstances and may require the use of significant judgment about whether individual transactions are forced liquidations or distressed sales.

• …the use of the reporting entity’s own assumptions about future cash lows and appropriately risk-adjusted discount rates is acceptable when relevant observable inputs are not available.

• Broker ( or pricing service) quotes may be an appropriate input when measuring fair value, but are not necessarily determinative is an active market does not exist for the financial assets.

• Amends Statement 157 for paragraphs A32A-A32F for an example that illustrates these concepts

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FASB Credit Crisis Projects

• FASB added projects in response to SEC recommendations from the Mark to Market Accounting Study

• Five completed projects to date– 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 (codified as 820-10-65)

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FASB Credit Crisis Projects

• Completed Projects– FSP FAS 115-2 and FAS 124-2, Recognition and

Presentation of Other-Than-Temporary Impairments (ASC 350-50-1 & 2)

– FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments (ASC 825-10-65)

– Accounting Standards Update (ASU) 2009-05 (ASC 820), Measuring Liabilities at Fair Value, originally proposed as FSP FAS 157-c, then as 157-f

– ASU 2009-12 (ASC 820), Investment in Certain Entities that Calculate Net Asset Value per Share (or Its Equivalent), originally FSP FAS 157-g

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FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Liability Have Significantly Decreased and Identifying Transactions That Are Not

Orderly (ASC 820-10-55-4)

• Step One – Determine whether there has been a significant decrease in the volume and level of activity. If so, quoted prices may not be determinative of fair value

• Step Two – Determine whether the transaction is orderly, or not

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FSP 157-4: The Transaction Price

• When the transaction is not orderly, place little or no weight on the transaction price

• When the transaction is orderly, – Consider the transaction price– Adjustments to transaction price may be appropriate– Weight given to transaction price vs. other indications of fair value

depends on• Facts and circumstances• Relative volume• Proximity of transaction date to measurement date

– FV should reflect appropriate risk premium for uncertainty in cash flows• If insufficient evidence to conclude whether orderly or not

– Transaction price shall be considered– Transaction price may not be the sole or primary basis for fair value

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FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of

Financial Instruments (ASC 825-10-65)• Requires disclosure about the fair value of

financial instruments in interim and annual financial statements– When any summarized financial information is

presented– Can report fair value in the body of financial

statements or in footnotes– Fair value must be presented with carrying value– Methods and assumptions must be disclosed– Purpose is to improve transparency & quality– Financial instruments reported using different

measurement attributes in GAAP

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Accounting Standards Update (ASU) No. 2009-05, Measuring Liabilities at

Fair Value (Topic 820)

• Quoted market price of an identical liability is the best evidence of fair value (Level 1)

• If not available, maximize the use of relevant observable inputs and minimize unobservabel inputs– Quoted price of an identical liability traded as an asset– Quoted prices for similar liabilities or similar liabilities

traded as assets– Another valuation technique – income or market

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Fair Value

– FV of a liability measured using the price of the liability when traded as an asset also Level 1

– Quoted prices for liabilities traded as assets may require adjustments for

• Condition or location of the asset• Degree of comparability• Level and volume of activity• Adjustments will cause fair value to be lower than

Level 1

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Fair Value

– Contractual restriction on the transfer of a liability is already included in the transaction price

– No adjustment to inputs based on a contractual restriction on the transfer of a liability is warranted

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Accounting Standards Update (ASU) No. 2009-12, Investment in Certain

Entities that Calculate Net Asset Value per Share (or Its Equivalent) Topic 820

– Applies to investments measured or disclosed at fair value that do not have readily determinable fair values, such as investments in:

• hedge funds, private equity funds, real estate funds, venture capital funds and fund of funds

– Permits the entity to measure fair value of an investment on the basis of net asset value as a practical expedient

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Accounting Standards Update (ASU) No. 2009-12, Investment in Certain

Entities that Calculate Net Asset Value per Share (or Its Equivalent)

– To qualify, the investment must:• Have investment activity• Have unit ownership• Have pooling of funds• Be the primary reporting entity

– Required disclosures, by major category of investment

• Nature of any restriction on redemption• Any unfunded commitments• The investment strategy

SFAS 141(R) SFAS 141(R) Business Combinations Business Combinations

(ASC 805)(ASC 805)

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The Acquisition MethodThe Acquisition Method

Under Statement 141(R) (ASC 805), all business combinations will be accounted for by applying the “acquisition method.”

Applying this method requires:• Identifying the acquirer;• Determining the acquisition date and purchase price;• Recognizing at their acquisition-date fair values the

identifiable assets acquired, liabilities assumed, and any noncontrolling interests in the acquiree; and

• Recognizing goodwill or, in the case of a bargain purchase, a gain.

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Key Provisions Under Key Provisions Under The Acquisition MethodThe Acquisition Method

The acquirer is the entity that obtains control of the acquiree. The acquiree is a business or businesses that the acquirer obtains control of in a business combination.

The acquisition date is the date on which the acquirer obtains control of the acquiree.

The fair value of the business combination will be measured at the fair value of the business acquired.

Transaction related costs will be expensed rather than capitalized.

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The fair value of the business combination will be measured at the fair value of the business acquired.

Contingent consideration usually is an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met.

Contingent consideration is recognized at its fair value as of the acquisition date.

Transaction related costs will be expensed rather than capitalized.

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Acquisition-related and restructuring costs are to be accounted for separately from the business combination and generally recognized as expenses when incurred.

Acquired in-process research and development (IPR&D) will be capitalized

Certain contingent assets and liabilities will be recognized at fair value.

Goodwill is an asset representing the future economic benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.

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Indentified Assets in a Business Indentified Assets in a Business CombinationsCombinations

• Under Topic ASC 805 Business Combinations ( formerly SFAS 141(R)), and asset is considered “identifiable” in a business combinations if it meets one of two criteria:– If it is separable, either by itself of part of an

asset group and can be monetized in some manner or

– If it is part of a contractual agreement.

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FASB FSP 141(R) – 1 FASB FSP 141(R) – 1 Accounting for Assets and Liabilities Assumed in a Accounting for Assets and Liabilities Assumed in a

Business Combination that Arise from Business Combination that Arise from Contingencies (ASC 805-20)Contingencies (ASC 805-20)

• If the acquisition date fair value can be determined before the end of the measurement period, the acquisition date asset or liability shall be recognized

• If the acquisition date fair value can not be determined before the end of the measurement period, the asset or liability shall be recognized if both criteria are met:1. Information available before the end of the measurement period

indicates that it is probable that an asset existed or a liability had been incurred at the acquisition date, and

2. The amount of the asset or liability can be reasonably estimated.• If both conditions are not met, do not recognize the

asset or liability.

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Fair Value and Not for Profits

• Statement 164, Not-for-Profit Entities:

Mergers and Acquisitions– How it compares to Statement 141(R)

• Similarities (The Acquisition Method)• Differences (Recognition of Goodwill)

– Two types of not-for-profit entities• Those that are solely or predominately supported by

contributions and returns on investments• Those the receive support from fees for services (more

“businesslike”)

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Business Combinations for Not Business Combinations for Not for Profit Entitiesfor Profit Entities

FASB recently issues Statement No. 164 in an effort to clarify M&A transactions among non-profits. According to the FASB, the statement aims to: “improve the relevance, representational faithfulness and comparability of the information that a not-for-profit entity provides in its financial reports about a combination with other not-for-profit entities, businesses or non-profit activities by establishing principles and requirements.”

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• The Statement provides guidance on “how a not-for-profit entity: • Determining when a combination is a merger or an acquisition • Applying the carryover method in accounting for a merger • Applying the acquisition method in accounting for an acquisition,

including identifying the acquirer between or among the combining entities

• Determining the information to disclose to allow users of financial statements to evaluate the nature and financial effects of a combination”

• Statement 164 takes effect for mergers whose initial reporting period is on or after Dec 15, 2009 and for acquisitions whose 1st annual reporting period begins on or after December 15, 2009 and early applications are not permitted. The only way to make clear accounting disclosures is to ensure that your financial statements conform to these new standards

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SFAS 164 distinguishes between a Merger and an Acquisition

Mergers accounted for on ‘carryover basis’ - similar to pooling accounting under APB 16

Acquisitions accounted for on ‘acquisition basis’ - similar to SFAS 141(R)

Determining factor of a merger: ceding of control by the governing bodies of two (or more) organizations to a new organization; the governing board of the new entity must be newly formed, but establishing a new legal entity is not a requirement

Other factors such as relative size, relative dominance of the process and of the combined entity, and relative financial health, can be considered in judging whether control has been ceded, but are not themselves determinants of a merger vs. an acquisition

All other combinations are acquisitions

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Identifiable assets and liabilities (and any noncontrolling interest) of the acquired entity are brought in at their fair values at date of acquisition

If the value of the acquired assets exceeds the sum of the acquired liabilities plus any consideration, the difference is recorded as an inherent contribution and reported as a separate credit in the statement of activities

If the sum of the liabilities plus consideration exceeds the assets, the difference is recorded as goodwill, except:

if the entity is predominantly supported by contributions and/or investment return, the goodwill is

written off immediately as a separate charge in the statement of activities (‘predominantly supported

by’ means that contributions and investment return are expected to be significantly more than the

total of all other revenues)

Fee for service entities are treated in a manner similar to SFAS 141 (R) Topic ASC 350 ( SFAS 142) Goodwill Impairment has been emended to include Not for

Profit Entities

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Common Fair Value Implementation Issues

• Large differences between income and market approaches in impairment testing.

• Identification of market participants• Developing discount rates on a market participant basis• Comparison of the fair value indications from the cost

approach and the income approaches• Consideration of EITF 02-13 factors in impairment

testing• Unit of account in impairment testing of long lived assets

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Valuation Profession Best Practices Update

• AICPA– Impairment Task Force– Equity as Compensation Task Force– IPR& D Task Force

• Appraisal Foundation– Contributory Asset Charges– Customer List– Control Premium

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Valuation Profession Best Practices Update

• Valuation Resource Group of the FASB• Appraisal Issues Task Force• Training and Education

– AICPA’s Fair Value Measurement Conference Chicago June, 2010

– AICPA’s Fair Value Measurements Workshop Dallas, February 2010

– ASA’s Valuation of Intangible Assets for Financial Reporting Purposes (BV301)

– AICPA courses Fair Value Accounting and Accounting for Goodwill and Other Intangible Assets

Questions?Questions?

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Mark L. Zyla, CPA/ABV, CFA, ASA

Mark L. Zyla is a Managing Director of Acuitas, Inc. an Atlanta Georgia based valuation and litigation consultancy firm. Mark has provided valuation consulting for various types of entities for a wide variety of purposes.

Mark received a BBA degree in Finance from the University of Texas at Austin and an MBA degree with a concentration in Finance from Georgia State University. Mark also completed the Mergers and Acquisitions Program at the Aresty Institute of The Wharton School of the University of Pennsylvania and the Valuation Program at the Graduate School of Business at Harvard University. He is a Certified Public Accountant, Accredited in Business Valuation (“CPA/ABV”), Certified in Financial Forensics (“CFF”) by the AICPA, a Chartered Financial Analyst (“CFA”), and an Accredited Senior Appraiser with the American Society of Appraisers certified in Business Valuation (“ASA”).

Mark is a member of the American Society of Appraisers (“ASA”), the American Institute of Certified Public Accountants (“AICPA”), and the CFA Institute. He was named as Vice Chairman of The Appraisal Foundation’s Business Valuation Best Practices Working Group on Contributory Asset Charges and to the AICPA’s Fair Value Resource Panel. He is currently working on the AICPA’s Impairment Practice Aid. He is also the Chairman of the AICPA’s Fair Value Measurement Conference Committee. Mark is a former member of the Business Valuations Committee of the AICPA, and a former Chairman of the ABV Examination Committee of the AICPA. He is also a former member of the Business Valuation Standards Subcommittee of the ASA.

Mark is a frequent presenter and author on valuation issues. Mark is the co-author of the courses, “Fair Value Accounting: A Critical New Skill for All CPAs” and “Accounting for Goodwill and Intangible Assets” published by the AICPA. He is the author of Fair Value Measurements: Practical Guidance and Implementation which has just been published by John Wiley & Sons.

Mark L. Zyla CPA/ABV, CFA, ASAMark L. Zyla CPA/ABV, CFA, ASAManaging DirectorManaging Director

Acuitas, Inc.Acuitas, Inc.One Midtown Plaza, Suite 950One Midtown Plaza, Suite 950

Atlanta, Georgia 30309Atlanta, Georgia 30309(404) 898-1137(404) 898-1137

[email protected]@acuitasinc.com

Documents

Fair Value Measurements: What is the Latest? Mark L. Zyla CPA/ABV, CFA, ASA Acuitas, Inc. Accountants One Seminar March 10, 2010