© 1 Fair Value Measurements S F
Dec 24, 2015
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Fair Value MeasurementsFair Value Measurements
SFAS 157
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What Does SFAS 157 Accomplish?What Does SFAS 157 Accomplish?
Defines fair value
Establishes a framework for measuring fair value in GAAP
Expands disclosures about fair value measurements
Though it does not specify when fair value must be used
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Why Was SFAS 157 Issued?Why Was SFAS 157 Issued?
Raised the bar by specifying new factors to consider when measuring already-required GAAP fair values
Deficiencies in previous GAAP that resulted in varying definitions of fair value
Limited guidance for applying those definitionsExisting guidance dispersed among many pronouncements
Resulted in inconsistency and complexity
Paved the way for SFAS 159, “Fair Value Option for Financial Assets and Financial Liabilities”
Sets the stage for new Conceptual Framework project
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How Does SFAS 157 Differ from Previous Practice?How Does SFAS 157 Differ from Previous Practice?
Definition of fair value – 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
Retains the exchange price notion provided in earlier definitions of fair value
Clarifies that the exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability
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How Does SFAS 157 Differ from Previous Practice? (cont.)How Does SFAS 157 Differ from Previous Practice? (cont.)
The transaction to sell the asset or transfer the liability is a hypothetical transaction at the market date
It is considered from the perspective of a market participant that holds the asset or owes the liability
The hypothetical transaction occurs in the principal or most advantageous market for the asset or liability
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How Does SFAS 157 Differ from Current Practice? (cont.)How Does SFAS 157 Differ from Current Practice? (cont.)
The definition focuses on the price that would be received to sell the asset or paid to transfer the liability, not the price that would be paid to acquire the asset or received to assume the liability
an exit price rather than an entry price
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Long-Standing Fair Value Controversy:Exit Price vs. Entry Price?Long-Standing Fair Value Controversy:Exit Price vs. Entry Price?
• Exit Price• Amount owner would receive upon selling an asset• Outcome could be immediate loss to buyer
• Entry Price• Amount owner would pay to buy a new asset
Differences between the two are actually the sources of most income
FASB resolved dilemma by requiring presumption of sale based on “highest and best use” by market participants
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Determining Fair ValueDetermining Fair Value
It is a market-based measurement - not an entity-specific measurementFair value measurements should be based on the assumptions that market participants would use in pricing the asset or liabilityCreates a hierarchy that distinguishes between
observable inputs and unobservable inputs
Intended to allow for situations where there is little, if any, market activity
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Determining Fair Value, cont.Determining Fair Value, cont.
Statement requires that market participants’ assessment of risk be included
ExamplesRisk inherent in valuation techniques usedRisks inherent in inputs used in valuation models
Required even if adjustment is difficult to determineFair value measurements for liabilities must include risk of nonperformanceStatement requires that restrictions on sale or use of an asset be included
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What is Market?What is Market?
Must assume that the transaction occurs in the principal market for the asset or liability
The principal market is the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability
If there is a principal market for the asset or liability, the fair value measurement shall represent the price in that market even if the price in a different market is potentially more advantageous
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The MarketThe Market
In the absence of a principal market, must assume that the transaction occurs in the most advantageous market for the asset or liability.
The most advantageous market is the market in which the reporting entity would sell the asset or transfer the liability with the price that maximizes the amount that would be received for the asset or minimizes the amount that would be paid to transfer the liability
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Who Are Market Participants?Who Are Market Participants?
The concept of “market participants” is central to SFAS 157.
Buyers and sellers in the principal (or most advantageous) market that are
Independent of the reporting entity
Have a reasonable understanding about the asset or liability and transaction
Able to transact for asset or liability
Willing to transact for asset or liability
Motivated but not forced
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Initial Fair Value RecognitionInitial Fair Value Recognition
In many cases, the transaction price represents fair value.
Possible exceptions:
The transaction is between related parties
The transaction occurs under duress (e.g.,seller is experiencing financial difficulty)
Market where transaction occurs isn’t the most advantageous market
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Inputs to Valuation TechniquesInputs to Valuation Techniques
Assumptions that market participants would use in pricing the asset or liability including assumptions about risk.
Observable inputs
reflect assumptions by market participants based on market data obtained from sources independent of the reporting entity
Use of these should be maximized
Unobservable inputs
reflect the reporting entity’s own assumptions about the assumptions that market participants would use based on the best information available in the circumstances.
Use of these should be minimized
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Fair Value HierarchyFair Value Hierarchy
Prioritizes the inputs to valuation techniques
Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities
Very few items, especially physical assets, trade in active markets
Level 2 – Inputs other than quoted prices that are observable for the asset or liability
Quoted prices for similar assets or liabilities in active marketsQuoted prices for identical or similar assets or liabilities in markets that are not active (e.g., few transactions, prices are not current, little information is available) Inputs other than quoted prices that are observable for the asset or liabilityInputs that are derived principally from or corroborated by observable market data
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Fair Value Hierarchy, cont.Fair Value Hierarchy, cont.
Level 3 – Unobservable inputsBased on entity’s own assumptions about the assumptions market participants would use
Not independent sources
To be used to the extent that observable inputs are not available
Situations where there is little, if any, market activity
Measurement objective is still the same – exit price for market participant
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Implementation ConcernsImplementation Concerns
Recent financial crisis raised the question of what constituted an inactive market, and the impact on market values
Concern raised that the required accounting may have contributed to a “downward spiral”
FASB issued FSP 157-3, which provides the following guidance:
in an inactive market, companies may determine that observable (Level 2) inputs require significant adjustment, and thus it would be more appropriate to use unobservable (Level 3) inputs in determining fair valueMeans that when a market is inactive and market inputs are distressed, reporting entities have the discretion to override observable inputs with unobservable inputs and assumptions
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Implementation Concerns, continuedImplementation Concerns, continued
FSP 157-4Issued to help accountants determine if a market is inactive, if transactions are not orderly, and how to measure fair value in those situationsProvides factors to consider, though also states that the lists are not exhaustive
Thus companies still have discretion in determining whether a market is inactive and transactions are not orderly
Still focuses on market-based measurements, not entity-specific measurements
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Disclosure RequirementsDisclosure Requirements
For assets and liabilities that are measured at fair value on a recurring basis in periods subsequent to initial recognition (example – trading securities), companies must disclose
information to help users assess inputs used to develop the measures the impact of those measurements on earnings
Specific disclosures required:The fair value measurements at the reporting dateThe level within the fair value hierarchy in which the fair value measurements fall segregated by levelFor fair value measurements using significant unobservable inputs (Level 3), a reconciliation of the beginning and ending balancesThe amount of the total gains or losses for the period included earnings or changes in net assets that are attributable to the change in unrealized gains or losses relating to those assets and liabilities still held at the reporting dateIn annual periods only, the valuation techniques used to measure fair value and a discussion of changes in valuation techniques, if any, during the period
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Disclosure Requirements, cont.Disclosure Requirements, cont.
For assets and liabilities that are measured at fair value on a nonrecurring basis in periods subsequent to initial recognition (for example, impaired assets), companies must disclose information that enables users to assess inputs used to develop those measures
Specific requirements:
The fair value measurements recorded during the period and the reasons for the measurements
The level within the fair value hierarchy in which the fair value measurements fall segregated by level
For fair value measurements using significant unobservable inputs (Level 3), a description of the inputs and the information used to develop the inputs
In annual periods only, the valuation techniques used to measure fair value and a discussion of changes in valuation techniques, if any, in prior periods